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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
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For the quarter ended September 30, 2002 Commission file number 1-10360
CRIIMI MAE INC.
(Exact name of registrant as specified in its charter)
Maryland 52-1622022
(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification No.)
11200 Rockville Pike
Rockville, Maryland 20852
(301) 816-2300
(Address, including zip code, and
telephone number, including area code, of
registrant's principal executive offices)
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Securities Registered Pursuant to Section 12(b) of the Act:
Name of each exchange on
Title of each class which registered
- ------------------- ---------------------------------
Common Stock New York Stock Exchange, Inc.
Series B Cumulative Convertible New York Stock Exchange, Inc.
Preferred Stock
Series F Redeemable Cumulative Dividend New York Stock Exchange, Inc.
Preferred Stock
Series G Redeemable Cumulative Dividend New York Stock Exchange, Inc.
Preferred Stock
Securities Registered Pursuant to Section 12(g) of the Act:
None
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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 whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13 or 15 (d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes [X] No[ ]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Class Outstanding as of November 11, 2002
----- ------------------------------------
Common Stock, $0.01 par value 13,945,068
CRIIMI MAE INC.
Quarterly Report on Form 10-Q
Page
PART I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets as of September 30, 2002
(unaudited) and December 31, 2001................................. 3
Consolidated Statements of Income for the three and nine
months ended September 30, 2002 and 2001 (unaudited)............. 4
Consolidated Statements of Changes in Shareholders' Equity
for the nine months ended September 30, 2002 (unaudited)......... 5
Consolidated Statements of Cash Flows for the nine
months ended September 30, 2002 and 2001 (unaudited)............. 6
Notes to Consolidated Financial Statements (unaudited)........... 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.............................. 38
Item 3. Quantitative and Qualitative Disclosures about Market Risk....... 65
Item 4. Controls and Procedures.......................................... 65
PART II. Other Information
Item 5. Other Information................................................ 66
Item 6. Exhibits and Reports on Form 8-K................................. 66
Signature ................................................................ 67
Certifications ........................................................... 68
PART I
ITEM 1. FINANCIAL STATEMENTS
CRIIMI MAE INC.
CONSOLIDATED BALANCE SHEETS
September 30, December 31,
2002 2001
------------------- -------------------
(unaudited)
Assets:
Mortgage assets:
Subordinated CMBS and Other MBS, at fair value $ 553,615,003 $ 536,204,992
Subordinated CMBS pledged to secure Securitized Mortgage
Obligation - CMBS, at fair value 329,470,137 296,477,050
Insured mortgage securities, at fair value 298,968,613 343,091,303
Equity investments 7,452,402 9,312,156
Other assets 25,094,967 37,180,968
Receivables 20,195,388 18,973,680
Servicing other assets 20,153,857 18,250,824
Servicing cash and cash equivalents 6,690,078 6,515,424
Restricted cash and cash equivalents 7,875,949 38,214,277
Other cash and cash equivalents 15,694,543 10,783,449
------------------- -------------------
Total assets $ 1,285,210,937 $ 1,315,004,123
=================== ===================
Liabilities:
Variable-rate secured borrowing $ 221,561,399 $ 244,194,590
Series A senior secured notes 94,470,465 99,505,457
Series B senior secured notes 66,175,191 63,937,383
Payables and accrued expenses 27,076,818 25,946,959
Mortgage payable 7,188,552 7,109,252
Servicing liabilities 1,095,101 3,660,173
Securitized mortgage obligations:
Collateralized bond obligations-CMBS 285,141,921 283,047,470
Collateralized mortgage obligations-
insured mortgage securities 276,229,935 326,558,161
------------------- -------------------
Total liabilities 978,939,382 1,053,959,445
------------------- -------------------
Shareholders' equity:
Preferred stock, $0.01 par; 75,000,000
shares authorized; 3,424,992 and 3,597,992 shares
issued and outstanding, respectively 34,250 35,980
Common stock, $0.01 par; 300,000,000 shares
authorized; 13,945,068 and 12,937,341 shares
issued and outstanding, respectively 139,451 129,373
Accumulated other comprehensive income (loss):
Unrealized gains (losses) on mortgage assets 83,424,534 (6,060,398)
Unrealized losses on interest rate caps (1,289,353) (383,200)
Deferred compensation (36,253) -
Additional paid-in capital 619,197,712 632,887,967
Accumulated deficit (395,198,786) (365,565,044)
------------------- -------------------
Total shareholders' equity 306,271,555 261,044,678
------------------- -------------------
Total liabilities and shareholders' equity $ 1,285,210,937 $ 1,315,004,123
=================== ===================
The accompanying notes are an integral part of these consolidated financial
statements.
CRIIMI MAE INC.
CONSOLIDATED STATEMENTS OF INCOME
For the three For the nine
months ended September 30, months ended September 30,
2002 2001 2002 2001
------------ ------------ ------------ ------------
Interest income:
Subordinated CMBS $ 25,678,715 $ 26,443,069 $ 76,815,219 $ 79,114,530
Insured mortgage securities 5,829,458 7,144,951 18,468,181 22,003,020
------------- ------------ ------------- ------------
Total interest income 31,508,173 33,588,020 95,283,400 101,117,550
------------- ------------ ------------- ------------
Interest and related expenses:
Variable-rate secured borrowing 3,700,424 5,464,043 11,397,375 10,228,293
Series A senior secured notes 2,889,054 3,085,107 8,781,875 5,700,429
Series B senior secured notes 3,480,499 3,284,027 10,289,704 5,910,212
Fixed-rate collateralized bond obligations-CMBS 6,397,966 6,370,858 19,337,866 19,157,020
Fixed-rate collateralized mortgage obligations - insured securities 5,642,316 6,516,462 18,297,034 20,353,650
Other interest expense 245,984 56,846 743,966 2,152,538
Variable-rate secured borrowings-CMBS - - - 7,325,059
Fixed-rate senior unsecured notes - - - 2,712,142
------------- ------------ ------------- ------------
Total interest expense 22,356,243 24,777,343 68,847,820 73,539,343
------------- ------------ ------------- ------------
Net interest margin 9,151,930 8,810,677 26,435,580 27,578,207
------------- ------------ ------------- ------------
General and administrative expenses (2,799,151) (3,175,927) (8,681,625) (8,158,978)
Depreciation and amortization (312,388) (947,002) (920,928) (2,787,685)
Servicing revenue 2,976,371 3,353,195 8,233,944 3,353,195
Servicing general and administrative expenses (2,222,008) (2,823,706) (6,847,992) (2,823,706)
Servicing amortization, depreciation, and impairment expenses (508,000) (669,560) (1,418,810) (669,560)
Servicing restructuring expenses - - (141,240) -
Servicing gain on sale of servicing rights 34,309 - 4,851,907 -
Income tax benefit (expense) 481,256 - (427,520) -
Equity in earnings (losses) from investments 98,005 163,250 330,747 (1,791,291)
Other income, net 711,923 939,612 2,142,354 3,292,461
Net (losses) gains on mortgage security dispositions (310,722) 56,109 (567,014) 307
Impairment on CMBS (29,884,497) (3,886,347) (35,035,588) (3,886,347)
Hedging expense (353,085) (75,210) (749,412) (996,249)
Investment banking fees (438,889) - (683,333) -
Reorganization items - (464,152) - (1,909,780)
Emergence financing origination fee - - - (3,936,616)
------------- ------------ ------------- ------------
(32,526,876) (7,529,738) (39,914,510) (20,314,249)
------------- ------------ ------------- ------------
Net (loss) income before cumulative effect of changes in accounting
principles (23,374,946) 1,280,939 (13,478,930) 7,263,958
Cumulative effect of adoption of SFAS 142 - - (9,766,502) -
Cumulative effect of change in accounting principle related to
servicing revenue - - - 1,995,262
Cumulative effect of adoption of SFAS 133 - - - (135,142)
------------- ------------ ------------- ------------
Net (loss) income before dividends accrued or paid on preferred shares (23,374,946) 1,280,939 (23,245,432) 9,124,078
Dividends accrued or paid on preferred shares (1,726,560) (2,004,647) (6,388,310) (6,193,444)
------------- ------------ ------------- ------------
Net (loss) income available to common shareholders $ (25,101,506) $ (723,708) $ (29,633,742) $ 2,930,634
============= ============ ============= ============
Net (loss) income available to common shareholders per common share:
Basic - before cumulative effect of changes in accounting
principles $ (1.80) $ (0.06) $ (1.46) $ 0.10
============= ============ ============= ============
Basic - after cumulative effect of changes in accounting
principles $ (1.80) $ (0.06) $ (2.17) $ 0.28
============= ============ ============= ============
Diluted - before cumulative effect of changes in accounting
principles $ (1.80) $ (0.06) $ (1.46) $ 0.10
============= ============ ============= ============
Diluted - after cumulative effect of changes in accounting
principles $ (1.80) $ (0.06) $ (2.17) $ 0.28
============= ============ ============= ============
Shares used in computing basic (loss) earnings per share 13,926,600 12,508,253 13,635,656 10,464,433
============= ============ ============= ============
The accompanying notes are an integral part of these consolidated financial
statements.
CRIIMI MAE INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
For the nine months ended September 30, 2002
(Unaudited)
Accumulated
Preferred Common Additional Other Total
Stock Par Stock Par Paid-in Accumulated Comprehensive Deferred Shareholders'
Value Value Capital Deficit Income (Loss) Compensation Equity
--------- ----------- ----------- ------------ -------------- ------------- -------------
Balance at December 31, 2001 $ 35,980 $ 129,373 $ 632,887,967 $ (365,565,044) $ (6,443,598) $ - $261,044,678
Net loss before dividends
accrued or paid on
preferred shares - - - (23,245,432) - - (23,245,432)
Adjustment to unrealized
gains/losses on mortgage
assets - - - - 89,484,932 - 89,484,932
Adjustment to unrealized
losses on interest rate caps - - - - (906,153) - (906,153)
Dividends accrued or paid on
preferred shares - - - (6,388,310) - - (6,388,310)
Common shares issued related
to preferred stock dividends - 9,664 3,435,128 - - - 3,444,792
Common shares issued - 89 43,342 - - - 43,431
Restricted stock issued - 325 129,350 - - (129,675) -
Amortization of deferred
compensation - - - - - 93,422 93,422
Redemption of Series E
Preferred Stock (1,730) - (17,298,075) - - - (17,299,805)
---------- --------- -------------- -------------- -------------- ---------- ---------------
Balance at September 30, 2002 $ 34,250 $ 139,451 619,197,712 $ (395,198,786) $ 82,135,181 $ (36,253) $306,271,555
========== ========== =============== ============== ============= ========== ==============
The accompanying notes are an integral part of these consolidated financial
statements.
CRIIMI MAE INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the nine months ended September 30,
2002 2001
------------------------ --------------------
Cash flows from operating activities:
Net (loss) income before dividends accrued or paid on preferred shares $ (23,245,432) $ 9,124,078
Adjustments to reconcile net (loss) income before dividends accrued or paid on
preferred shares to net cash provided by operating activities:
Gain on sale of servicing rights (4,851,907) -
Amortization of discount and deferred financing costs on debt 4,351,381 3,099,806
Accrual of extension fees related to New Debt 3,189,836 2,012,791
Depreciation and amortization 920,928 2,782,102
Discount amortization on mortgage assets, net (8,784,389) (7,833,722)
Net losses (gains) on mortgage security dispositions 567,014 (307)
Equity in (earnings) losses from investments (330,747) 1,791,291
Servicing amortization, depreciation and impairment 1,418,810 669,560
Hedging expense 749,412 1,131,391
Amortization of deferred compensation 93,422 -
Impairment on CMBS 35,035,588 3,886,347
Cumulative effect of adoption of SFAS 142 9,766,502 -
Cumulative effect of change in accounting principle related to
servicing revenue - (1,995,262)
Changes in assets and liabilities:
Decrease in restricted cash and cash equivalents 30,338,328 58,724,363
(Increase) decrease in receivables and other assets (2,439,587) 24,486,205
Decrease in payables and accrued expenses (1,331,580) (38,467,311)
Decrease in servicing other assets 3,623,587 1,441,535
Decrease in servicing liabilities (2,565,072) (599,328)
Purchases of other MBS, net (348,882) (3,906,347)
Change in reorganization items accrual - (1,506,712)
Non-cash reorganization items - (366,529)
------------------------ --------------------
Net cash provided by operating activities 46,157,212 54,473,951
------------------------ --------------------
Cash flows from investing activities:
Proceeds from mortgage security prepayments 51,467,197 29,138,799
Distributions received from AIM Investments 2,190,497 2,274,681
Receipt of principal payments from insured mortgage securities 2,783,761 3,183,829
Cash received in excess of income recognized on unrated Subordinated CMBS 2,448,171 3,253,090
Proceeds from sale of servicing rights by CMSLP 8,180,561 -
Purchases of investment-grade CMBS by CMSLP (9,905,520) -
------------------------ --------------------
Net cash provided by investing activities 57,164,667 37,850,399
------------------------ --------------------
Cash flows from financing activities:
Principal payments on securitized mortgage obligations (51,803,306) (32,051,429)
Principal payments on New Debt (27,668,184) (15,120,446)
Principal payments on secured borrowings and other debt obligations (74,160) (132,284,698)
Proceeds from the issuance of common stock 43,431 -
Redemption of Series E Preferred Stock, including accrued dividends (18,733,912) -
------------------------ --------------------
Net cash used in financing activities (98,236,131) (179,456,573)
------------------------ --------------------
Net increase (decrease) in cash and cash equivalents 5,085,748 (87,132,223)
Cash and cash equivalents, beginning of period (1) 17,298,873 113,411,685
------------------------ --------------------
Cash and cash equivalents, end of period (1) $ 22,384,621 $ 26,279,462
======================== ====================
(1) Comprised of Servicing cash and cash equivalents and Other cash and cash equivalents.
The accompanying notes are an integral part of these consolidated financial
statements.
CRIIMI MAE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
1. ORGANIZATION
General
CRIIMI MAE Inc. (together with its consolidated subsidiaries, unless the
context otherwise indicates, "CRIIMI MAE" or the "Company") is a commercial
mortgage company structured as a self-administered real estate investment trust
("REIT"). On April 17, 2001, the Company and certain of its subsidiaries emerged
from reorganization under Chapter 11 of the U.S. Bankruptcy Code (the "Effective
Date").
The Company's current primary activities include the ownership and
management, in large part through the Company's servicing subsidiary, CRIIMI MAE
Services Limited Partnership ("CMSLP"), of a significant portfolio of
mortgage-related assets. Prior to the Chapter 11 filing, CRIIMI MAE's primary
activities included (a) acquiring non-investment grade securities (rated below
BBB- or unrated) backed by pools of commercial mortgage loans on multifamily,
retail and other commercial real estate ("Subordinated CMBS"), (b) originating
and underwriting commercial mortgage loans, (c) securitizing pools of commercial
mortgage loans and resecuritizing pools of Subordinated CMBS, and (d) primarily
through CMSLP, performing servicing functions principally with respect to the
mortgage loans underlying the Company's Subordinated CMBS.
Virtually all of the Company's cash flows relating to existing assets are,
and are currently expected to be (assuming the Company remains obligated under
the New Debt (defined below)), used to satisfy principal, interest and fee
obligations under the Company's variable-rate secured financing facility (the
"Variable-Rate Secured Borrowing"), Series A Senior Secured Notes, and Series B
Senior Secured Notes (collectively, the "New Debt") and to pay general and
administrative and other operating expenses of the Company. Therefore, although
the Company continues to pay down its debt obligations, the utilization of cash
flows for debt service and operating expenses results in virtually no remaining
net cash flow available for other activities, to the extent permitted under the
operative documents evidencing the New Debt.
During the third quarter of 2002, the Company received a number of
expressions of interest in connection with the Company's evaluation of strategic
alternatives designed to maximize shareholder value. A special committee of the
Company's Board of Directors, consisting of independent directors, after
considerable review, analysis and negotiation with the assistance of Friedman,
Billings, Ramsey & Co., Inc. ("FBR"), the Company's investment banking firm, has
recommended that the Company proceed with a transaction with an affiliate of
Brascan Real Estate Financial Partners LLC. The proposed transaction
contemplates an investment in subordinated debt and common stock and a secured
financing in the form of a repurchase transaction, the aggregate proceeds of
which will be used to retire the New Debt. There can be no assurance that this
transaction will be completed. See Note 15 for a further discussion of this
proposed transaction.
The Company's business is subject to a number of risks and uncertainties
including, but not limited to: (1) risks associated with substantial
indebtedness or leverage; (2) borrowing risks; (3) restrictions on dividends;
(4) the limited protection provided by hedging transactions; (5) inherent risks
in owning Subordinated CMBS; (6) the limited liquidity of the Subordinated CMBS
market; (7) possible effects of terrorist attacks, an economic slowdown and/or
recession on losses and defaults related to the mortgages underlying the
Company's CMBS portfolio; (8) risks related to the New Debt including the
ability to meet payment and other obligations thereunder; (9) risks associated
with the trader election and limitation or loss of net operating losses for tax
purposes; (10) results of operations adversely affected by factors beyond the
Company's control; (11) the effect of the yield curve on borrowing costs; (12)
the effect of phantom (non-cash) income on total income; (13) the effect of
interest rate compression on the market price of the Company's stock; (14) risk
of loss of REIT status and other tax matters; (15) failure to manage the
mismatch between long-term assets and short-term funding; (16) competition; (17)
taxable mortgage pool risk; (18) risk of becoming subject to the requirements of
the Investment Company Act of 1940; (19) risk that future issuances of shares of
common stock issued in payment of dividends on preferred shares could adversely
affect the common stock price and impair the Company's ability to raise capital;
(20) risk of failure to
achieve strategic alternatives; and (21) risk that charter ownership
limitations and anti-takeover measures could prevent or delay a change in
control.
The Company was incorporated in Delaware in 1989 under the name CRI Insured
Mortgage Association, Inc. ("CRI Insured"). In July 1993, CRI Insured changed
its name to CRIIMI MAE Inc. and reincorporated in Maryland. In June 1995,
certain mortgage businesses affiliated with C.R.I., Inc. ("CRI") were merged
into CRIIMI MAE (the "Merger"). The Company is not a government sponsored entity
or in any way affiliated with the United States government or any United States
government agency.
REIT Status and Other Tax Matters
REIT Status. CRIIMI MAE is required to meet income, asset, ownership and
distribution tests to maintain its REIT status. Although there can be no
assurance, the Company believes that it has satisfied the REIT requirements for
all years through, and including 2001. There can also be no assurance that
CRIIMI MAE will maintain its REIT status for 2002 or subsequent years. If the
Company fails to maintain its REIT status for any taxable year, it will be taxed
as a regular domestic corporation subject to federal and state income tax in the
year of disqualification and for at least the four subsequent years. Depending
on the amount of any such federal and state income tax, the Company may have
insufficient funds to pay any such tax and also may be unable to comply with its
obligations under the New Debt.
The Company's Net Operating Loss for Tax Purposes/Shareholder Rights Plan
In 2000, the Company began trading in both short and longer duration fixed
income securities, including non-investment grade and investment grade CMBS and
investment grade residential mortgage-backed securities (such securities traded
and all other securities of the type described constituting the "Trading Assets"
to the extent owned by CRIIMI MAE Inc. or any qualified REIT subsidiary, meaning
generally any wholly owned subsidiary that is not a taxable REIT subsidiary
("Other MBS")), which, for financial reporting purposes, are classified as
Subordinated CMBS and Other MBS on the balance sheet. The Company seeks maximum
total return through short term trading, consistent with prudent investment
management. Returns from such activities include capital
appreciation/depreciation resulting from changes in interest rates and spreads,
if any, and other arbitrage opportunities.
As a result of its trader election in 2000, CRIIMI MAE recognized a
mark-to-market tax loss in its income tax return on its Trading Assets on
January 1, 2000 of approximately $478 million (the "January 2000 Loss"). Such
loss is expected to be recognized evenly for tax purposes over four years
beginning with the year 2000 (i.e., approximately $120 million per year). The
Company expects such loss to be an ordinary loss for tax purposes. Additionally,
as a result of its trader election, the Company is required to mark-to-market
its Trading Assets on a tax basis at the end of each tax year. Any increase or
decrease in the value of the Trading Assets as a result of the year-end
mark-to-market requirement will generally result in either a tax gain (if an
increase in value) or a tax loss (if a decrease in value). Such tax gains or
losses, as well as any realized gains or losses from the disposition of Trading
Assets during each year, are also expected to be ordinary gains or losses.
Assets transferred to CBO REIT, a subsidiary of the Company, as part of the
Company's Chapter 11 reorganization plan (the "Reorganization Plan") are no
longer required to be marked-to-market on a tax basis since CBO REIT is not a
trader in securities for tax purposes. As a result, the mark-to-market of such
assets ceased as of April 17, 2001.
Since gains and losses associated with trading activities are expected to
be treated as ordinary, any gains will generally increase taxable income and any
losses will generally decrease taxable income. Because the REIT rules generally
require the Company to distribute 90% of its taxable income to shareholders, any
increases in taxable income from trading activities will generally result in an
increase in REIT distribution requirements and any decreases in taxable income
from trading activities will generally result in a decrease in REIT distribution
requirements (or, if taxable income is reduced to zero because of a net
operating loss or loss carry forward, eliminate REIT distribution requirements).
Gains and losses from the mark-to-market requirement (including the January
2000 Loss) are unrealized. This creates a mismatch between REIT distribution
requirements and cash flow since the REIT distribution
requirements will generally fluctuate due to mark-to-market adjustments,
but the cash flow from the Company's Trading Assets will not fluctuate as a
result of mark-to-market adjustments.
The Company generated a net operating loss for tax purposes of
approximately $90.7 million for the year ended December 31, 2001. As such, the
Company's taxable income was reduced to zero and, accordingly, the Company's
REIT distribution requirement was eliminated for 2001. As of December 31, 2001,
the Company's accumulated and unused net operating loss ("NOL") was $140.2
million. Any accumulated and unused net operating losses, subject to certain
limitations, generally may be carried forward for up to 20 years to offset
taxable income until fully utilized. Accumulated and unused net operating losses
cannot be carried back because CRIIMI MAE is a REIT. If a Trading Asset is
marked down because of an increase in interest rates, rather than from credit
losses, such mark-to-market losses may be recovered over time through taxable
income. Any recovered mark-to-market losses will generally be recognized as
taxable income, although there is expected to be no corresponding increase in
cash flow. See also the discussion in Note 9 with respect to the remaining
January 2000 Loss.
There can be no assurance that the Company's position with respect to its
election as a trader in securities will not be challenged by the Internal
Revenue Service ("IRS"), and, if challenged, will be defended successfully by
the Company. As such, there is a risk that the January 2000 Loss will be limited
or disallowed, resulting in higher tax basis income and a corresponding increase
in REIT distribution requirements. It is possible that the amount of any
under-distribution for a taxable year could be corrected with a "deficiency
dividend" as defined in Section 860 of the Internal Revenue Code of 1986, as
amended (the "Tax Code"), however, interest may also be due to the IRS on the
amount of this under-distribution.
If CRIIMI MAE is required to make taxable income distributions to its
shareholders to satisfy required REIT distributions, all or a substantial
portion of these distributions, if any, are currently expected to be in the form
of non-cash dividends. There can be no assurance that such non-cash dividends
would satisfy the REIT distribution requirements and, as such, the Company could
lose its REIT status or may not be able to satisfy its obligations under the
operative documents evidencing the New Debt.
The Company's future use of NOLs for tax purposes could be substantially
limited in the event of an "ownership change" as defined under Section 382 of
the Tax Code. As a result of these limitations imposed by Section 382 of the Tax
Code, in the event of an ownership change, the Company's ability to use its NOL
carryforwards in future years may be limited and, to the extent the NOL
carryforwards cannot be fully utilized under these limitations within the
carryforward periods, the NOL carryforwards would expire unutilized.
Accordingly, after any ownership change, the Company's ability to use its NOLs
to reduce or offset taxable income would be substantially limited or not
available under Section 382. In general, a company reaches the "ownership
change" threshold if the "5% shareholders" increase their aggregate ownership
interest in the company over a three-year testing period by more than 50
percentage points. The ownership interest is measured in terms of total market
value of the Company's capital stock.
The Company is not aware of any acquisition of shares of its capital stock
that has created an "ownership change" under Section 382 of the Tax Code.
Currently, the Company does not know of any potential acquisition of shares of
its capital stock that will create an "ownership change" under Section 382 of
the Tax Code. The Company adopted a shareholder rights plan in January 2002 and
amended its corporate charter in May 2002 to allow it to minimize the chance of
an ownership change within the meaning of Section 382 of the Tax Code. There can
be no assurance that an ownership change will not occur.
If an "ownership change" occurs under Section 382 of the Tax Code, the
Company's prospective use of its accumulated and unused NOL and the remaining
January 2000 Loss, representing a combined total amount of approximately $350.7
million (as of September 30, 2002), will be limited. If the Company had lost its
ability to use its accumulated NOL as of January 1, 2001, the Company's taxable
income would have been $28.8 million for the year ended December 31, 2001. This
increase in taxable income would have created a requirement to distribute 100
percent of this income to the Company's shareholders in order to avoid any
REIT-level income taxes. If the Company was unable to distribute the taxable
income to its shareholders, it would have been subject to corporate Federal and
state income taxes of up to approximately $11.8 million for the year ended
December 31, 2001.
Investment Company Act
Under the Investment Company Act of 1940, as amended (the "Investment
Company Act"), an investment company is required to register with the Securities
and Exchange Commission ("SEC") and is subject to extensive restrictive and
potentially adverse regulation relating to, among other things, operating
methods, management, capital structure, dividends and transactions with
affiliates. However, as described below, companies that are primarily engaged in
the business of acquiring mortgages and other liens on and interests in real
estate ("Qualifying Interests") are excluded from the requirements of the
Investment Company Act.
To qualify for the Investment Company Act exclusion, CRIIMI MAE, among
other things, must maintain at least 55% of its assets in Qualifying Interests
(the "55% Requirement") and is also required to maintain an additional 25% in
Qualifying Interests or other real estate-related assets ("Other Real Estate
Interests" and such requirement, the "25% Requirement"). According to current
SEC staff interpretations, CRIIMI MAE believes that all of its
government-insured mortgage securities constitute Qualifying Interests with the
exception of one such security which constitutes an Other Real Estate Interest.
In accordance with current SEC staff interpretations, the Company believes that
all of its Subordinated CMBS constitute Other Real Estate Interests and that
certain of its Subordinated CMBS also constitute Qualifying Interests. On
certain of the Company's Subordinated CMBS, the Company, along with other
rights, has the unilateral right to direct foreclosure with respect to the
underlying mortgage loans. Based on such rights and its economic interest in the
underlying mortgage loans, the Company believes that the related Subordinated
CMBS constitute Qualifying Interests. As of September 30, 2002, the Company
believes that it was in compliance with both the 55% Requirement and the 25%
Requirement.
If the SEC or its staff were to take a different position with respect to
whether such Subordinated CMBS constitute Qualifying Interests, the Company
could, among other things, be required either (i) to change the manner in which
it conducts its operations to avoid being required to register as an investment
company or (ii) to register as an investment company, either of which could have
a material adverse effect on the Company. If the Company were required to change
the manner in which it conducts its business, it would likely have to dispose of
a significant portion of its Subordinated CMBS or acquire significant additional
assets that are Qualifying Interests. Alternatively, if the Company were
required to register as an investment company, it expects that its operating
expenses would significantly increase and that the Company would have to
significantly reduce its indebtedness, which could also require it to sell a
significant portion of its assets. No assurances can be given that any such
dispositions or acquisitions of assets, or deleveraging, could be accomplished
on favorable terms, or at all. There are restrictions under certain of the
operative documents evidencing the New Debt which could limit possible actions
the Company may take in response to any need to modify its business plan in
order to register as an investment company or avoid the need to register.
Certain dispositions or acquisitions of assets could require approval or consent
of certain holders of the New Debt. Any such results could have a material
adverse effect on the Company.
Further, if the Company were deemed an unregistered investment company, the
Company could be subject to monetary penalties and injunctive relief. The
Company would be unable to enforce contracts with third parties and third
parties could seek to obtain rescission of transactions undertaken during the
period the Company was deemed an unregistered investment company, unless a court
found that under the circumstances, enforcement (or denial of rescission) would
produce a more equitable result than nonenforcement (or grant of rescission) and
would not be inconsistent with the Investment Company Act.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
In management's opinion, the accompanying unaudited consolidated financial
statements contain all adjustments (consisting of only normal recurring
adjustments and consolidating adjustments) necessary to present fairly the
consolidated balance sheets as of September 30, 2002 and December 31, 2001
(audited), the consolidated results of operations for the three and nine months
ended September 30, 2002 and 2001, and the consolidated cash flows for the nine
months ended September 30, 2002 and 2001. The accompanying consolidated
financial statements include the financial results of CRIIMI MAE and all of its
majority-owned and controlled subsidiaries.
Effective July 2001, CRIIMI MAE, which had previously accounted for CMSLP
under the equity method, acquired voting control of CMSLP and began accounting
for this subsidiary on a consolidated basis. CMSLP's assets, liabilities,
revenues and expenses are labeled as "servicing" on the Company's consolidated
financial statements.
These consolidated financial statements have been prepared pursuant to the
rules and regulations of the SEC. Certain information and note disclosures
normally included in annual financial statements prepared in accordance with
generally accepted accounting principles ("GAAP") have been condensed or
omitted. While management believes that the disclosures presented are adequate
to make the information not misleading, these consolidated financial statements
should be read in conjunction with the consolidated financial statements and the
notes included in CRIIMI MAE's Annual Report on Form 10-K for the year ended
December 31, 2001.
Reclassifications
Certain 2001 amounts have been reclassified to conform to the 2002
presentation.
Income Recognition and Carrying Basis
Subordinated CMBS and Other Mortgage-Backed Securities
Effective April 1, 2001, CRIIMI MAE adopted Emerging Issues Task Force
("EITF") Issue No. 99-20, "Recognition of Interest Income and Impairment on
Purchased and Retained Beneficial Interests in Securitized Financial Assets," to
recognize income on its Subordinated CMBS. Under EITF 99-20, when there has been
a change in estimated future cash flows from the cash flows previously projected
(due to prepayment speeds and/or credit losses), the Company calculates a
revised yield based on the current amortized cost of the investment and the
revised future cash flows. This revised yield is applied prospectively to
recognize interest income. CRIIMI MAE classifies its Subordinated CMBS as
Available for Sale and carries them at fair market value where temporary changes
in fair value are recorded as a component of shareholders' equity. Upon the sale
of such securities, any gain or loss is recognized in the income statement.
Interest income on Other MBS consists of amortization of the discount or
premium on primarily investment-grade securities, plus the stated investment
interest payments received or accrued on other mortgage-backed securities. The
difference between the cost and the unpaid principal balance at the time of
purchase is carried as a discount or premium and amortized over the remaining
contractual life of the investment using the effective interest method. The
effective interest method provides a constant yield of income over the term of
the investment. The Company's Other MBS are classified as Available for Sale. As
a result, the Company carries these securities at fair value where changes in
fair value are recorded as a component of shareholders' equity. Upon the sale of
such securities, any gain or loss is recognized in the income statement
Impairment
Subordinated CMBS and Other Mortgage-Backed Securities
CRIIMI MAE assesses each Subordinated CMBS for other than temporary
impairment when the fair market value of the asset declines below amortized cost
and when one of the following conditions also exists: (1) fair value has been
below amortized cost for a significant period of time and the Company concludes
that it no longer has the ability or intent to hold the security for the period
that fair value is expected to be below amortized cost through the period of
time the Company expects the value to recover to amortized cost, or (2) the
Company's revised projected cash flows related to the Subordinated CMBS and the
Subordinated CMBS's current cost basis result in a decrease in the yield that
was previously used to recognize income. This decrease in yield would be
primarily a result of the credit quality of the security declining and the
Company determining that the current estimate of expected future credit losses
exceeds credit losses as originally projected or that expected credit losses
will occur sooner than originally projected. The amount of impairment loss is
measured by comparing the fair value, based on available market information and
management's estimates, of the Subordinated CMBS to its current amortized cost
basis; the difference is recognized as a loss in the income statement. The
Company assesses current
economic events and conditions that impact the value of its Subordinated
CMBS and the underlying real estate in making judgments as to whether or not
other than temporary impairment has occurred. Impairment charges aggregating
approximately $29.9 million and $35.0 million were recognized during the three
and nine months ended September 30, 2002, respectively. See Note 4 for further
discussion of the impairment charges.
CRIIMI MAE assesses each Other MBS for other than temporary impairment when
the fair market value of the security declines below the respective amortized
cost and CRIIMI MAE concludes that it no longer has the ability to hold the
security through the market downturn. The amount of impairment loss is measured
by comparing the fair value of the security to its current cost basis; the
difference is recognized as a loss in the income statement. No impairment loss
was recognized during the three and nine months ended September 30, 2002.
Consolidated Statements of Cash Flows
The following is the supplemental cash flow information:
Three months ended September 30, Nine months ended September 30,
2002 2001 2002 2001
------------- ----------------- ------------- -----------------
Cash paid for interest $15,910,286 $20,239,492 $53,065,657 $102,987,193
Cash paid for income taxes 190,500 10,500 924,800 31,500
Non-cash investing and financing
activities:
Restricted stock issued -- -- 129,675 --
Preferred stock dividends paid in
shares of common stock -- 278,088 3,444,792 15,277,271
Comprehensive Income
The following table presents comprehensive income for the three and nine
months ended September 30, 2002 and 2001:
Three months ended September 30, Nine months ended September 30,
2002 2001 2002 2001
-------------- --------------- --------------- -----------------
Net (loss) income before dividends
accrued or paid on preferred shares $(23,374,946) $ 1,280,939 $(23,245,432) $ 9,124,078
Adjustment to unrealized
gains/losses on mortgage assets 52,816,904 11,760,310 89,484,932 7,377,224
Adjustment to unrealized losses on
interest rate caps (164,679) (448,810) (906,153) (448,810)
-------------- -------------- -------------- ----------------
Comprehensive income $ 29,277,279 $ 12,592,439 $ 65,333,347 $ 16,052,492
============== ============== ============== ================
Change in Accounting Principle due to Adoption of SFAS No. 142
In June of 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 142 "Goodwill and Other
Intangible Assets" ("FAS 142"). FAS 142, among other things, prohibits the
amortization of existing goodwill and certain types of other intangible assets
and establishes a new method of testing goodwill for impairment. Under FAS 142,
the method for testing goodwill for impairment occurs at the reporting unit
level (as defined in FAS 142) and is performed using a fair value based
approach. FAS 142 was effective for the Company on January 1, 2002. The
transition provisions of FAS 142 required the Company to reclassify $8.4 million
of intangible assets related to the Merger in 1995 to goodwill. When combined
with the current goodwill of $1.4 million, this resulted in $9.8 million of
goodwill on the Company's books. Effective upon adoption on January 1, 2002, the
Company wrote off this goodwill and recorded a resulting non-cash impairment
charge of approximately $9.8 million for this change in accounting principle.
The goodwill relates to the Portfolio Investment reporting unit (as defined in
Note 14). The fair value of the reporting unit was determined using a market
capitalization approach and the impairment was primarily a result of the
significant decrease in the Company's common stock price since the Merger in
1995. This change in accounting principle reduces the Company's annual
amortization expense by approximately $2.8 million.
The following table presents pro forma disclosures assuming that FAS 142
was adopted at the beginning of 2001:
Three months Nine months
ended ended
September 30, September 30,
2001 2001
---------------- ----------------
Reported net (loss) income available to common shareholders for the 2001 periods $(723,708) $ 2,930,634
Add: Goodwill amortization 99,867 299,601
Add: Intangible assets amortization 597,501 1,792,503
---------------- ----------------
Adjusted net (loss) income available to common shareholders $(26,340) $ 5,022,738
================ ================
Basic earnings per share ("EPS"):
Reported basic EPS after cumulative effect of changes in accounting principles $(0.06) $0.28
Goodwill amortization 0.01 0.03
Intangible assets amortization 0.05 0.17
---------------- ----------------
Adjusted basic EPS after cumulative effect of changes in accounting principles $ -- $0.48
================ ================
Diluted EPS:
Reported diluted EPS after cumulative effect of changes in accounting principles $(0.06) $0.28
Dilutive effect of convertible preferred stock (a) -- (0.02)
Goodwill amortization 0.01 0.03
Intangible assets amortization 0.05 0.17
---------------- ----------------
Adjusted diluted EPS after cumulative effect of changes in accounting principles $ -- $0.46
================ ================
(a) The addition of the goodwill and intangible assets amortization to reported
net income caused the Series E Preferred Stock (as defined in Note 11) to
be dilutive for the nine months ended September 30, 2001.
3. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following estimated fair values of CRIIMI MAE's consolidated financial
instruments are presented in accordance with GAAP, which define fair value as
the amount at which a financial instrument could be exchanged in a current
transaction between willing parties, in other than a forced sale or liquidation.
These values do not represent the liquidation value of the Company or the value
of the securities under a portfolio liquidation.
As of September 30, 2002 As of December 31, 2001
Amortized Cost Fair Value Amortized Cost Fair Value
-------------- ---------- -------------- ----------
ASSETS:
Subordinated CMBS and Other MBS (1) $ 516,425,613 $ 553,615,003 $ 546,981,955 $ 536,204,992
Subordinated CMBS pledged to secure
Securitized Mortgage Obligation - CMBS 286,251,545 329,470,137 283,993,690 296,477,050
Insured mortgage securities 296,445,522 298,968,613 350,982,991 343,091,303
Interest rate protection agreements 1,344,364 55,024 448,789 65,589
Servicing other assets See footnote (2) See footnote (2) See footnote (2) See footnote (2)
Servicing cash and cash equivalents 6,690,078 6,690,078 6,515,424 6,515,424
Restricted cash and cash equivalents 7,875,949 7,875,949 38,214,277 38,214,277
Other cash and cash equivalents 15,694,543 15,694,543 10,783,449 10,783,449
LIABILITIES:
Variable-rate secured borrowing 221,561,399 221,561,399 244,194,590 244,194,590
Series A senior secured notes 94,470,465 89,274,589 99,505,457 95,276,475
Series B senior secured notes 66,175,191 56,910,664 63,937,383 54,826,306
Securitized mortgage obligations:
Collateralized bond obligations-CMBS 285,141,921 329,470,137 283,047,470 296,477,050
Collateralized mortgage obligations-
insured mortgage securities 276,229,935 320,491,023 326,558,161 351,983,544
Mortgage Payable 7,188,552 7,364,558 7,109,252 7,109,252
(1) Includes approximately $8.9 million of amortized cost and $9.0 million of
fair value related to Other MBS as of September 30, 2002 and approximately
$8.6 million of amortized cost and $8.5 million of fair value as of
December 31, 2001.
(2) CMSLP owns Subordinated CMBS and interest-only strips with an aggregate
amortized cost basis of approximately $1.8 million and $2.3 million and a
fair value of approximately $1.9 million and $2.4 million as of September
30, 2002 and December 31, 2001, respectively. Additionally, in June 2002,
CMSLP purchased investment-grade CMBS for approximately $9.9 million. These
investment-grade CMBS have an aggregate cost basis of approximately $9.3
million and a fair value of approximately $9.7 million as of September 30,
2002.
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments:
Subordinated CMBS and Other Mortgage-Backed Securities
The Company's determination of fair market value for its Subordinated CMBS
portfolio is a subjective process. The process begins with the compilation and
evaluation of pricing information (such as nominal spreads to U.S. Treasury
securities or nominal yields) that, in the Company's view, is commensurate with
the market's perception of value and risk of comparable assets. The Company uses
a variety of sources to compile such pricing information including: (i) recent
offerings and/or secondary trades of comparable CMBS securities (i.e.,
securities comparable to the CMBS held in the Company's portfolio or that
represent collateral underlying the Company's CBO-1 and CBO-2 securities), (ii)
communications with dealers and active Subordinated CMBS investors regarding the
pricing and valuation of comparable securities, (iii) institutionally available
research reports, (iv) analyses prepared by the nationally recognized
statistical rating organizations responsible for the initial rating assessment
and on-going surveillance of such securities, and (v) other qualitative and
quantitative factors that may impact the value of the securities such as the
market's perception of the issuers of the Subordinated CMBS and the credit
fundamentals of the commercial real estate underlying each pool of commercial
loans. The Company makes further fair market value adjustments to such pricing
information, which is then used to determine the fair market value of the
Company's Subordinated CMBS using a discounted cash flow approach. Furthermore,
the fair market value for those Subordinated CMBS incurring principal losses and
interest shortfalls (i.e., CBO-2 B-, CCC, and unrated/issuer's equity bonds)
based on the Company's overall expected loss estimate
are valued at a loss-adjusted yield to maturity that, in the Company's
view, is commensurate with the market's perception of value and risk of
comparable assets, using the same discounted cash flow approach. Such
anticipated principal losses and interest shortfalls have been taken into
consideration in the calculation of fair market values and yields to maturity
used to recognize interest income as of September 30, 2002. Since the Company
calculated the estimated fair market value of its Subordinated CMBS portfolio as
of September 30, 2002 and December 31, 2001, it has disclosed the range of
discount rates by rating category used in determining the fair market values as
of September 30, 2002 in Note 4.
The liquidity of the Subordinated CMBS market has historically been
limited. Additionally, during adverse market conditions, the liquidity of such
market has been severely limited. For this reason, among others, management's
estimate of the value of the Company's Subordinated CMBS could vary
significantly from the value that could be realized in a current transaction
between a willing buyer and a willing seller in other than a forced sale or
liquidation.
The fair value of the Other MBS is an estimate based on the indicative
market price from publicly available pricing services. The Company normally
applies a slight discount to such prices as the Company believes it better
reflects fair value between willing buyers and sellers due to the relatively
smaller sizes of this component of the Trading Assets.
Insured Mortgage Securities
The Company calculated the estimated fair market value of its insured
mortgage securities portfolio as of September 30, 2002 and December 31, 2001,
using a discounted cash flow methodology. The cash flows were discounted using a
discount rate and other assumptions that, in the Company's view, was
commensurate with the market's perception of risk and value. The Company used a
variety of sources to determine its discount rate including (i) institutionally
available research reports and (ii) communications with dealers and active
insured mortgage security investors regarding the valuation of comparable
securities.
Servicing, Restricted and Other Cash and Cash Equivalents
The carrying amount approximates fair value because of the short maturity
of these instruments.
Obligations Under Financing Facilities
The fair values of the securitized mortgage obligations as of September 30,
2002 and December 31, 2001 were calculated using a discounted cash flow
methodology similar to that discussed in Subordinated CMBS above. The fair
values of the Series A and Series B Senior Secured Notes are based on quoted
market prices from an investment banking institution. The carrying amount of the
Variable-Rate Secured Borrowing approximates fair value because the current rate
on the debt resets monthly based on market rates. The fair value of the mortgage
payable is estimated based on current market interest rates of mortgage debt.
Interest Rate Protection Agreements
The fair values of the interest rate protection agreements used to hedge
CRIIMI MAE's Variable-Rate Secured Borrowing are the estimated amounts that
CRIIMI MAE would receive to terminate the agreements as of September 30, 2002
and December 31, 2001, taking into account current interest rates and the
current creditworthiness of the counterparties. The amounts were determined
based on quotes received from the counterparties to the agreements.
4. SUBORDINATED CMBS
As of September 30, 2002, the Company owned CMBS rated from A+ to CCC and
unrated with an aggregate fair value amount for purposes of GAAP of
approximately $874 million (representing approximately 68% of the Company's
total consolidated assets), an aggregate amortized cost of approximately $794
million, and an aggregate
face amount of approximately $1.5 billion. Such CMBS represent investments
in securities issued in connection with CRIIMI MAE Trust I Series 1996-C1
("CBO-1"), CRIIMI MAE Commercial Mortgage Trust Series 1998-C1 ("CBO-2") and
Nomura Asset Securities Corporation Series 1998-D6 ("Nomura"). The September 30,
2002 aggregate fair value includes approximately 37% (with a fair value of
approximately $321.2 million) of the Company's CMBS which are rated BB+, BB, or
BB-, 22% (with a fair value of approximately $191.8 million) which are rated B+,
B, B- or CCC and 4% (with a fair value of approximately $31.6 million) which are
unrated (collectively referred to as the "Retained Portfolio"). The remaining
CMBS totaling approximately 37% (with a fair value of approximately $329.5
million) represent investment grade securities that the Company reflects on its
balance sheet as a result of CBO-2 (referred to as the "Investment Grade
Portfolio").
As indicated in footnote 4 to the table below, GAAP requires the Investment
Grade Portfolio to be included as assets on the Company's balance sheet
(reflected as "Subordinated CMBS pledged to Secure Securitized Mortgage
Obligation-CMBS") and the related liability to be included on the balance sheet
(reflected as "collateralized bond obligations - CMBS"). All cash flows related
to the Investment Grade Portfolio are used to service the corresponding debt. As
a result, the Company currently receives no economic benefit from the Investment
Grade Portfolio. As of September 30, 2002, the weighted average interest rates
and the weighted average lives of the securities in the Investment Grade
Portfolio and the Retained Portfolio were 7.0% and 5.5%, respectively, and 8.2
years and 13.6 years, respectively.
The aggregate investment by the rating of the Subordinated CMBS is as
follows:
Discount Rate
or Range of
Weighted Discount Rates
Face Amount Average Fair Value Used to Amortized Cost Amortized Cost
as of Pass-Through Weighted as of Calculate as of 9/30/02 as of 12/31/01
Security Rating 9/30/02 (in Rate Average 9/30/02 (in Fair Value (in millions) (in millions)
millions) 9/30/02 Life (1) millions) as of 9/30/02 (5) (6)
- --------------------------------------------------------------------------------------------------------------------
Investment Grade Portfolio
- --------------------------
A+ (4) $ 62.6 7.0% 4 years $ 66.2 5.2% $ 59.2 $ 58.7
BBB+ (4) 150.6 7.0% 9 years 152.2 6.9% 132.0 131.1
BBB (4) 115.2 7.0% 10 years 111.1 7.5% 95.0 94.2
Retained Portfolio
- ------------------
BB+ 319.0 7.0% 11 years 246.0 10.6%-10.9% 222.0 219.0
BB 70.9 7.0% 11 years 51.7 11.4% 46.6 46.0
BB- 35.5 7.0% 12 years 23.5 12.7% 20.7 20.5
B+ 88.6 7.0% 12 years 48.5 15.5% 45.9 45.2
B 177.2 7.0% 13 years 87.3 16.5%-17.0% 84.8 83.7
B- (2) 118.3 7.1% 14 years 47.7 19.8%-20.1% 47.6 48.1
CCC (3) 70.9 7.0% 15 years 8.3 63.9% 8.3 13.1
Unrated/Issuer's
Equity (1)(3) 340.8 1.7% 18 years 31.6 50.2%-217.2% 31.6 62.8
-------- ------- ------- -------
Total (8) $1,549.6 5.9% 13 years $874.1 (8) $793.7 (7) $ 822.4
======== ======= ======= =======
(1) Weighted average life represents the weighted average expected life of the
Subordinated CMBS prior to the consideration of losses, extensions, or
prepayments. The weighted average life of the Subordinated CMBS may be
significantly shorter, particularly with respect to the unrated/issuer's
equity in Nomura (face amount of $45.7 million), CBO-1 (face amount of
$85.2 million) and CBO-2 (face amount of $209.9 million), based on the
Company's current loss expectations which are greater than the outstanding
face amount of such securities. As of September 30, 2002, the fair value
of the unrated/issuer's equity in Nomura, CBO-1, and CBO-2 were derived
solely from interest cash flow anticipated to be received since the
Company's current loss expectation assumes that the full principal amount
of these securities will not be recovered. See also "Advance Limitations,
Appraisal Reductions and Losses on CMBS" below.
(2) As of September 30, 2002, the Company's Subordinated CMBS from CBO-1 and
CBO-2 currently rated B- have stated coupon rates of
8.0% and 7.0%, respectively, while the weighted average net coupon
rates of the CMBS underlying CBO-1 and CBO-2 are approximately 9.05% and
8.37%, respectively (prior to the consideration of losses, prepayments and
extensions on the underlying mortage loans). The Company's Subordinated
CMBS may experience interest shortfalls when the weighted average net
coupon rate on the underlying CMBS is less than the weighted average
stated coupon payments on the Company's Subordinated CMBS. Such interest
shortfalls will continue to accumulate until they (i) are paid through
excess interest and/or recoveries on the underlying CMBS or (ii) are
realized as a loss of principal on the Subordinated CMBS. Based on the
Company's overall expected loss estimate as of September 30, 2002, the
CBO-2 Subordinated CMBS currently rated B- are expected to incur
approximately $18 million of principal losses directly attributable to
accumulated and unpaid interest shortfalls over their expected lives.
Such anticipated losses and shortfalls have been taken into consideration
in the calculations of fair market values and yields to maturity used to
recognize interest income as of September 30, 2002.
(3) The Subordinated CMBS from CBO-1 and CBO-2 currently rated CCC and unrated
do not have stated coupon rates since the securities are only entitled to
the residual cash flow payments, if any, remaining after paying the
securities with a higher payment priority. As a result, effective coupon
rates on these securities are highly sensitive to the effective coupon
rates and monthly cash flow payments received from the underlying CMBS
that represent the collateral for CBO-1 and CBO-2. Also, based on the
Company's overall expected loss estimate and related principal write-downs
on the Subordinated CMBS as of September 30, 2002, the weighted average
lives of the CBO-2 unrated/issuer's equity and Subordinated CMBS currently
rated CCC are substantially less than the Subordinated CMBS currently
rated B-. The shorter average lives have been taken into consideration in
determining the fair market values and yields to maturity used to
recognize interest income related to these Subordinated CMBS.
(4) In connection with CBO-2, $62.6 million (originally A rated, currently A+
rated) and $60.0 million (originally BBB rated, currently BBB+ rated) face
amount of investment grade securities were sold with call options and $345
million (originally A rated, currently A+ rated) face amount were sold
without call options. Also in connection with CBO-2, in May 1998, the
Company initially retained $90.6 million (originally BBB rated, currently
BBB+ rated) and $115.2 million (originally BBB- rated, currently BBB
rated) face amount of securities, both with call options, with the
intention to sell the securities at a later date. Such sale occurred March
5, 1999. Since the Company retained call options on certain sold bonds
(the A+, BBB+ and BBB bonds), the Company did not surrender control of
these securities pursuant to the requirements of SFAS No. 125 and thus
these securities are accounted for as a financing and not a sale. Since
the transaction is recorded as a partial financing and a partial sale,
CRIIMI MAE has retained the securities with call options in its
Subordinated CMBS portfolio reflected on its balance sheet (previously
referred to as the Investment Grade Portfolio).
(5) Amortized cost reflects impairment charges of approximately $35.0 million
related to the unrated/issuer's equity bonds, the CCC bond and the B- bond
in CBO-2, which were recognized during the nine months ended September 30,
2002. These impairment charges are in addition to the cumulative
impairment charges of approximately $178.1 million that were recognized
through December 31, 2001. The impairment charges are discussed later in
this Note 4.
(6) Amortized cost reflects approximately $178.1 million of cumulative
impairment charges related to certain CMBS (all bonds except those rated
A+ and BBB+), which were recognized through December 31, 2001.
(7) See Notes 1 and 9 to Notes to Consolidated Financial Statements for
information regarding the Subordinated CMBS for tax purposes.
(8) As of September 30, 2002, the aggregate fair values of the CBO-1, CBO-2
and Nomura bonds were approximately $25.0 million, $843.1 million and
$6.0 million, respectively.
Mortgage Loan Pool
CRIIMI MAE, through CMSLP, performs servicing functions on commercial
mortgage loans totaling $17.9 billion and $19.3 billion as of September 30, 2002
and December 31, 2001, respectively. The mortgage loans underlying CRIIMI MAE's
Subordinated CMBS portfolio are secured by properties of the types and in the
geographic locations identified below:
9/30/02 12/31/01 9/30/02 12/31/01
Property Type Percentage(i) Percentage(i) Geographic Location(ii) Percentage(i) Percentage(i)
- ------------- ------------- ------------- ------------------- ----------- -------------
Retail............ 31% 30% California.............. 17% 16%
Multifamily....... 28% 29% Texas................... 12% 13%
Hotel............. 15% 14% Florida................. 8% 8%
Office............ 13% 13% Pennsylvania............ 5% 5%
Other (iv)........ 13% 14% Georgia................. 4% 5%
--- --------- Other(iii).............. 54% 53%
Total......... 100% 100% ---- -----------
==== ========= Total............... 100% 100%
==== ===========
(i) Based on a percentage of the total unpaid principal balance of the
underlying loans.
(ii) No significant concentration by region.
(iii) No other individual state makes up more than 5% of the total.
(iv) The Company's ownership interest in one of the 20 CMBS transactions
underlying CBO-2 includes subordinated CMBS in which the Company's
exposure to losses arising from certain healthcare and senior housing
mortgage loans is limited by other subordinated CMBS (referred to herein
as the "Subordinated Healthcare/Senior-Housing CMBS"). The Subordinated
Healthcare/Senior-Housing CMBS are not owned by and are subordinate to
the CMBS owned by CRIIMI MAE in this transaction. As a result, CRIIMI
MAE's investment in such underlying CMBS will only be affected if
interest shortfalls and/or realized losses on such healthcare and senior
housing mortgage loans are in excess of the Subordinated
Healthcare/Senior-Housing CMBS. As of September 30, 2002, the Company
reviewed the loans currently under surveillance by the healthcare and
senior housing mortgage loans servicer. Based on its review as of
September 30, 2002, the Company does not believe that the aggregate
remaining shortfalls and/or realized losses on such healthcare and
senior housing mortgage loans currently in monetary default is greater
than the current outstanding Subordinated Healthcare/Senior-Housing
CMBS. As a result, the Company's current estimate of future credit
losses as of September 30, 2002 does not include any specific provision
for shortfalls and/or realized losses arising from the healthcare and
senior housing mortgage loans currently in monetary default in this CMBS
transaction. It should be noted that changes in the future performance
of the healthcare and senior housing mortgage loans that result in
greater shortfalls and/or losses may result in future specific losses
and/or possible impairment to certain of CRIIMI MAE's Subordinated CMBS.
Specially Serviced Mortgage Loans
CMSLP performs special servicing on the loans underlying CRIIMI MAE's
Subordinated CMBS portfolio. A special servicer typically provides asset
management and resolution services with respect to nonperforming or
underperforming loans within a pool of mortgage loans. When serving as special
servicer of a mortgage loan pool, CMSLP has the authority, subject to certain
restrictions in the applicable CMBS pooling and servicing documents, to deal
directly with any borrower that fails to perform under certain terms of its
mortgage loan, including the failure to make payments, and to manage any loan
workouts and foreclosures. As special servicer, CMSLP earns fee income on
services provided in connection with any loan servicing function transferred to
it from the master servicer. CRIIMI MAE believes that because it owns the first
loss unrated or lowest rated bond of all but one of the CMBS transactions
related to its Subordinated CMBS, CMSLP has an incentive to efficiently and
effectively resolve any loan workouts. As of September 30, 2002 and December 31,
2001, specially serviced mortgage loans included in the commercial mortgage
loans described above are as follows:
9/30/02 12/31/01
------- --------
Specially serviced loans due to monetary default (a) $728.2 million $701.7 million
Specially serviced loans due to covenant default/other 85.4 million 90.0 million
-------------- ----------------
Total specially serviced loans (b) $813.6 million $791.7 million
============== ================
Percentage of total mortgage loans (b) 4.6% 4.1%
============== ================
(a) Includes $121.5 million and $94.5 million, respectively, of real estate
owned by underlying trusts. See also the table below regarding property
type concentrations for further information on real estate owned by
underlying trusts.
(b) As of October 31, 2002, total specially serviced loans were approximately
$806 million, or 4.6% of the total mortgage loans. See discussion below for
additional information regarding specially serviced loans.
The specially serviced mortgage loans as of September 30, 2002 were secured
by properties of the types and located in the states identified below:
Property Type $ (in millions) Percentage Geographic Location $ (in millions) Percentage
- ------------- --------------- ---------- ------------------- --------------- ----------
Hotel........... $ 464.3 (1) 57% Florida............... $ 140.4 17%
Retail.......... 226.7 (2) 28% Oregon................ 92.6 11%
Multifamily..... 47.6 6% Texas................. 67.4 8%
Healthcare...... 25.1 3% New York.............. 43.2 5%
Office.......... 22.8 3% California............ 37.0 5%
Industrial...... 17.4 2% Georgia............... 32.7 4%
Other........... 9.7 1% Other................. 400.3 50%
--------- ---------- -------- --------
Total......... $ 813.6 100% Total............... $ 813.6 100%
========= ========== ======== ========
(1) Approximately $70.9 million of these loans in special servicing are real
estate owned by underlying trusts.
(2) Approximately $29.4 million of these loans in special servicing are real
estate owned by underlying trusts.
As reflected above, as of September 30, 2002, approximately $464.3 million,
or 57%, of the specially serviced mortgage loans are secured by mortgages on
hotel properties. The hotel properties that secure the mortgage loans underlying
the Company's Subordinated CMBS portfolio are geographically diverse, with a mix
of hotel property types and franchise affiliations. Of the mortgage loans
underlying the Company's Subordinated CMBS, loans representing a total
outstanding principal amount of $1.2 billion, or 46% of the hotel loans, are
secured by limited service hotels, of which $280.2 million are in special
servicing as of September 30, 2002. Limited service hotels are generally hotels
with room-only operations or hotels that offer a bedroom and bathroom, but
limited other amenities, and are often in the budget or economy group. Of the
mortgage loans underlying the Company's Subordinated CMBS, loans representing a
total outstanding principal amount of $1.5 billion, or 54% of the hotel loans,
are secured by full service hotels, of which $184.1 million are in special
servicing as of September 30, 2002. Full service hotels are generally mid-price,
upscale or luxury hotels with restaurant and lounge facilities and other
amenities. Of the $464.3 million of hotel loans in special servicing as of
September 30, 2002, approximately $302.4 million, or 65%, relate to four
borrowing relationships more fully described as follows:
o 25 loans totaling $97.8 million spread across four CMBS transactions
secured by hotel properties throughout the U.S. In one of these CMBS
transactions, which contains 10 loans totaling $39.0 million, the
Company holds only a 25% ownership interest in the non-rated class. In
the other three CMBS transactions, the Company holds a 100% ownership
interest in the non-rated class. The 25 loans were transferred into
special servicing in December 2001 due to the bankruptcy filing of each
special purpose borrowing entity and their parent company. The parent
company was able to obtain debtor-in-possession financing. The
borrowers are currently paying post-petition interest on $71 million of
these loans. The properties relating to the remaining $27 million of
loans were deemed by the borrowers to be highly leveraged, and
therefore, not able to support additional debt. Interest is not being
paid current on these loans, and consensual resolution and emergence
strategies are being negotiated. Based on current negotiations and
estimates of property values and potential recoveries related to these
loans at the completion of the expected workout period, the Company's
revised estimate of future credit losses includes $9.9 million arising
from these mortgage loans currently in special servicing. This loss
estimate represents an increase of $6.8 million over the previous loss
estimate of $3.1 million primarily due to a change in the borrowers'
bankruptcy plan providing for the transfer by the borrowers to the
lender of title to the properties underlying the highly leveraged
loans. The increased estimated loss is intended to allow for a longer
period of holding the properties and the related costs of operating the
properties and maintaining appropriate franchise affiliations during a
marketing and sale period. Under the initial proposed plan, a portion
of these costs were to be borne by the borrowers.
o 27 loans totaling $139.3 million spread across three CMBS transactions
secured by hotel properties in the west and Pacific northwest states.
The borrower has filed for bankruptcy protection. The borrower has
indicated that the properties have experienced reduced operating
performance due to new competition, the economic recession, and reduced
travel resulting from the September 11, 2001 terrorist attacks. Based
upon the current estimate of potential recoveries on these loans, which
in turn is based on the Company's estimates of property values and
pending additional developments in the bankruptcy proceedings, the
Company's current estimate of future credit losses includes
approximately $5.5 million arising from these mortgage loans currently
in special servicing. This loss estimate is unchanged from the
previous loss
estimate. In calculating estimated recoveries, management considered
potential additional recoveries available because of the cross
collateralization of certain of these loans as well as other factors
specific to the bankruptcy filing. The Company expects to reevaluate
recoveries on these loans within approximately 60 days, after the
acceptance of final appraisals, which have been delayed since their
initial projected date of receipt.
o Five loans totaling $45.9 million secured by hotel properties in
Florida and Texas. The loans are past due for the February 2002 and all
subsequent payments. Currently, there is approximately $3.5 million of
insurance proceeds in escrow that can be used to pay amounts
outstanding, including, but not limited to, expenses and principal and
interest payments. Based upon current negotiations and appraised
values of these properties, the Company's current estimate of future
credit losses includes $7.3 million arising from these mortgage loans
currently in special servicing. This loss estimate is unchanged from
the previous loss estimate.
o Nine loans totaling $19.4 million secured by limited service hotels in
midwestern states. The loans are past due for the April 2002 and all
subsequent payments. The borrower cites reduced occupancy related to
the recent downturn in travel as the cause for a drop in operating
performance at the properties. CMSLP is attempting to negotiate a
workout with the borrower. Based on current negotiations and appraised
values of these properties, the Company's current estimate of future
credit losses does not include any provision for losses arising from
these mortgage loans currently in special servicing.
In addition to the specially serviced loans described above, the Company's
overall estimate of losses related to its Subordinated CMBS portfolio has
increased from $351 million as of June 30, 2002 to $448 million as of September
30, 2002 due primarily to an increase in the projected loss severity of the
underlying mortgage loans and a change in the timing of the projected losses on
loans in default, which is more fully described below. There can be no assurance
that the Company's estimate of future credit losses related to any one or more
of the foregoing mortgage loans or other mortgage loans underlying the Company's
Subordinated CMBS will not be exceeded as a result of additional or existing
adverse events or circumstances. Such events or circumstances include, but are
not limited to, the receipt of new or updated appraisals at lower than
anticipated amounts, legal proceedings (including bankruptcy filings) involving
borrowers, a continued weakening of the economy, an economic downturn or
recession, a delay in disposition of specially serviced mortgage loans,
additional defaults, or an unforeseen reduction in expected recoveries, any of
which could result in additional future credit losses and/or possible impairment
to CRIIMI MAE's Subordinated CMBS, the effect of which could be potentially
adverse to CRIIMI MAE.
The following table provides a summary of the change in the balance of
specially serviced loans from June 30, 2002 to September 30, 2002 and from March
31, 2002 to June 30, 2002:
6/30/02 3/31/02
to to
9/30/02 6/30/02
--------- ------------
(in millions)
Specially Serviced Loans, beginning of period $ 892.7 $ 898.9
Transfers in due to monetary default 53.7 48.4
Transfers in due to covenant default and other 0.8 4.2
Transfers out of special servicing (129.4) (2) (54.2)
Loan amortization (1) (4.2) (4.6)
--------- ------------
Specially Serviced Loans, end of period $ 813.6 $ 892.7
========= ============
(1) Represents the reduction of the scheduled principal balances due to
advances made by the master servicers.
(2) During the three months ended September 30, 2002, loans totaling
approximately $52 million of the $129.4 million related to a portfolio
of retail property loans transferred out of special servicing.
For all loans in special servicing, CMSLP is pursuing remedies available to
it in order to maximize the recovery of the outstanding debt. See Exhibit 99.1
to this Quarterly Report on Form 10-Q for a detailed listing of all specially
serviced loans underlying the Company's Subordinated CMBS.
Advance Limitations, Appraisal Reductions and Losses on CMBS
The Company experiences shortfalls in expected cash flow on its securities
prior to the recognition of a realized loss primarily due to: (i) servicing
advance limitations to the most subordinate securities (only in certain
underlying CMBS transactions), or (ii) appraisal reductions. The servicing
advance limitations permit the master servicer (in those certain underlying CMBS
transactions) to make only one principal and interest advance with regard to a
delinquent mortgage loan. All future advances are reduced up to the aggregate
amount of the most subordinate securities' current coupon payment. This
restriction is enforced until an appraisal reduction has been determined or the
loan payments are brought current. The appraisal reduction generally requires
the master servicer to stop advancing interest payments on the amount by which
the aggregate of debt, advances and other expenses exceeds 90% (in most cases)
of the appraisal amount, thus reducing the cash flows to CRIIMI MAE as the
holder of the first loss unrated or lowest rated bonds, as if such appraisal
reduction was a realized loss. For example, assuming a weighted average coupon
of 6%, a $1 million appraisal reduction would reduce net cash flows to the
Company by $60,000 on an annual basis. An appraisal reduction may result in a
higher or lower realized loss based on the ultimate disposition or work-out of
the mortgage loan. Appraisal reductions for the CMBS transactions in which the
Company retains an ownership interest as reported by the underlying trustees or
as calculated by CMSLP* were as follows:
(in thousands) CBO-1 CBO-2 Nomura Total
- -------------- ----- ----- ------ -----
Year 2000 $ 1,872 $18,871 $ -- $ 20,743
Year 2001 15,599 31,962 874 48,435
January 1, 2002 through September 30, 2002 6,363 42,969 9,222 58,554
-------- -------- ------- ---------
Cumulative Appraisal Reductions through September 30, 2002 $23,834 $93,802 $10,096 $ 127,732
======== ======== ======= =========
* Not all underlying CMBS transactions require the calculation of an
appraisal reduction; however, when CMSLP obtains a third-party appraisal, it
calculates one.
As previously discussed, the Company's unrated bonds/issuer's equity from
the CBO-1, CBO-2 and Nomura transactions are expected to experience principal
write-downs over their expected lives. The following tables summarize the actual
realized losses on CMBS through September 30, 2002 (including realized mortgage
loan losses expected to pass through to the CMBS during the next two months) and
the expected future losses through the life of the CMBS:
(in thousands) CBO 1 CBO 2 Nomura Total
- -------------- ----- ----- ------ -----
Year 1999 actual realized losses $ 738 $ -- $ -- $ 738
Year 2000 actual realized losses 3,201 1,087 -- 4,288
Year 2001 actual realized losses 545 8,397 238 9,180
-------- ------- ------- ---------
Cumulative actual realized losses through the year 2001 4,484 9,484 238 14,206
Actual realized losses, January 1 through September 30, 2002 10,386 17,117 563 28,066
-------- -------- -------- ---------
Cumulative actual realized losses through September 30, 2002 $ 14,870 $ 26,601 $ 801 $42,272
======== ======== ======= =========
Cumulative expected loss estimates (including cumulative
actual realized losses) through the year 2002 $ 17,541 $41,014 $ 2,812 $61,367
Expected loss estimates for the year 2003 42,488 110,820 6,063 159,371
Expected loss estimates for the years 2004-2006 38,254 109,771 26,183 174,208
Expected loss estimates for the years 2007-2009 4,306 16,437 7,725 28,468
Expected loss estimates for the remaining life of CMBS
(for the years 2010-2027) 4,783 16,008 3,749 24,540
-------- --------- -------- ---------
Cumulative expected loss estimates (including cumulative
actual realized losses) through life of CMBS $107,372 $294,050 $46,532 $ 447,954
======== ========= ======== =========
As previously noted, as of September 30, 2002, the Company further revised
its overall expected loss estimate related to its Subordinated CMBS portfolio
from $351 million to $448 million, with such total losses occurring or expected
to occur through the life of its Subordinated CMBS portfolio. This revision to
the overall expected loss estimate is primarily the result of increased
projected loan losses (and the related timing of losses is anticipated to occur
sooner than previously estimated) due to lower than anticipated appraisals and
lower internal estimates of values on real estate owned by underlying trusts and
properties underlying certain defaulted mortgage loans, which, when combined
with the updated loss severity experience, has resulted in higher projected loss
severities on loans and real estate owned by underlying trusts currently or
anticipated to be in special servicing. Primary reasons for lower appraisals and
lower estimates of value resulting in higher projected loss severities on loans
include the poor performance of certain properties and related markets, failed
workout negotiations, and extended time needed to liquidate assets due, in large
part, to the continued softness in the economy, the continued downturn in travel
and, in some cases, over-supply of hotel properties, and a shift in retail
activity in some markets, including the closing of stores by certain national
and regional retailers. The Company's overall expected loss estimate of $448
million through the life of its Subordinated CMBS portfolio includes the
Company's estimate of total principal write-downs to its Subordinated
CMBS due to realized losses related to underlying mortgage loans, and is
included in the calculation of the current weighted average anticipated yield to
maturity, as discussed below. There can be no assurance that this revised
overall expected loss estimate will not be exceeded as a result of additional or
existing adverse events or circumstances.
The Company has also determined that there has been an adverse change in
expected future cash flows for the unrated/issuer's equity bonds, the CCC bond
and the B- bond in CBO-2 as of September 30, 2002 due to the factors mentioned
in the preceding paragraph. As a result, the Company believes these bonds have
been impaired under EITF 99-20 and Statement of Financial Accounting Standard
("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," ("SFAS 115") as of September 30, 2002. As the fair values of these
impaired bonds aggregated approximately $29.9 million below the amortized cost
basis as of September 30, 2002, the Company recorded other than temporary
impairment charges through the income statement of that same amount during the
three months ended September 30, 2002.
The Company had previously revised its overall expected loss estimate
related to its Subordinated CMBS portfolio from $335 million to $351 million as
of June 30, 2002, with such total losses occurring or expected to occur through
the life of its Subordinated CMBS portfolio. Such revision to the overall
expected loss estimate was primarily the result of increased projected loan
losses due to lower than anticipated appraisals and revised internal estimates
on properties underlying certain defaulted mortgage loans. The Company also had
previously determined that there had been an adverse change in expected future
cash flows for the Nomura and CBO-2 unrated bonds as of June 30, 2002. As a
result, the Company believed the Nomura and CBO-2 unrated bonds had been
impaired under EITF 99-20 and SFAS 115 as of June 30, 2002. As the fair values
of the impaired Nomura and CBO-2 unrated bonds aggregated approximately $5.2
million below the amortized cost basis as of June 30, 2002, the Company recorded
other than temporary impairment charges through the income statement of that
same amount during the three months ended June 30, 2002.
Yield to Maturity
The following table summarizes yield-to-maturity information relating to
the Company's Subordinated CMBS on an aggregate pool basis:
Current
Anticipated Anticipated Anticipated Anticipated
Yield-to- Yield-to- Yield-to- Yield-to-
Maturity Maturity Maturity Maturity
Pool as of 1/1/01 (1) as of 1/1/02 (1) as of 7/1/02 (1) as of 10/1/02 (1)
---- ---------------- ---------------- ---------------- -----------------
Retained securities from CBO-2 11.8% (2) 12.1% (2) 12.1% (2) 11.8% (2)
Retained securities from CBO-1 21.0% (2) 14.3% (2) 18.8% (2) 16.5% (2)
Retained securities from Nomura 25.3% (2) 28.7% (2) 19.7% (2) 16.0% (2)
--------- --------- --------- ---------
Weighted Average (3) 12.4% (2) 12.4% (2) 12.5% (2) 12.0% (2)
(1) Represents the anticipated weighted average yield over the expected average
life of the Company's Subordinated CMBS portfolio as of January 1, 2001,
January 1, 2002, July 1, 2002 and October 1, 2002 based on management's
estimate of the timing and amount of future credit losses.
(2) As previously discussed, as of December 31, 2000, December 31, 2001, June
30, 2002 and September 30, 2002, the Company revised its overall expected
loss estimate related to its Subordinated CMBS portfolio to $298 million,
$335 million, $351 million and $448 million, respectively, which resulted
in non-cash impairment recognition to certain Subordinated CMBS. As a
result of recognizing impairment, the Company revised its anticipated
yields as of January 1, 2001, January 1, 2002, July 1, 2002 and October 1,
2002, which were or is, in the case of revised anticipated yields as of
October 1, 2002, used to recognize interest income beginning on each of
those dates. These anticipated revised yields took into account the lower
cost basis on the impaired Subordinated CMBS as of dates the losses were
revised, and contemplated larger than previously anticipated losses that
were generally expected to occur sooner than previously anticipated.
(3) The accounting treatment under GAAP requires that the income on
Subordinated CMBS be recorded based on the effective interest method using
the anticipated yield over the expected life of these mortgage assets. This
method can result in GAAP income recognition which is greater than or less
than cash received. For the nine months ended September 30, 2002 and 2001,
the amount of income recognized in
excess of cash received on all of the Subordinated CMBS owned by the
Company due to the effective interest rate method was approximately
$8.8 million and $7.7 million, respectively.
Sensitivity of Fair Value to Changes in the Discount Rate
The required rate of return used to determine the fair value of the
Company's Subordinated CMBS is comprised of many variables, such as a risk-free
rate, a liquidity premium and a credit risk premium. These variables are
combined to determine a total rate that, when used to discount the Subordinated
CMBS's assumed stream of future cash flows, results in a net present value of
such cash flows. The determination of such rate is dependent on many
quantitative and qualitative factors, such as, but not limited to, the market's
perception of the issuers of the Subordinated CMBS and the credit fundamentals
of the commercial real estate underlying each pool of commercial mortgage loans.
If the Company assumed that the discount rate used to determine the fair value
of its Subordinated CMBS (A+ through unrated bonds) increased by 100 basis
points, the increase in the discount rate would have resulted in a corresponding
decrease in the value of the Company's Subordinated CMBS (A+ through unrated
bonds) by approximately $50.4 million (or 5.8 percent) as of September 30, 2002.
The 100 basis point increase in the discount rate would have resulted in a
corresponding decrease in the value of the Company's Retained Portfolio by
approximately $31.7 million (or 5.8 percent) as of September 30, 2002.
This sensitivity is hypothetical and should be used with caution. Changes
in fair value based on variations in assumptions generally cannot be
extrapolated because the relationship of the change in assumption to the change
in fair value may not be linear. Also, the effect of a variation in a particular
assumption on the fair value of the retained interest is calculated without
changing any other assumption; in reality, changes in one factor may result in
changes in another (for example, increases in market interest rates may result
in lower prepayments and increased credit losses), which might magnify or
counteract the sensitivities.
5. INSURED MORTGAGE SECURITIES
CRIIMI MAE owns the following insured mortgage securities directly or indirectly
through wholly owned subsidiaries:
As of September 30, 2002
------------------------
Number of
Mortgage Weighted Average Weighted Average
Securities Fair Value Amortized Cost Effective Interest Rate Remaining Term
----------- -------------- ---------------- ----------------------- -------------------
CRIIMI MAE 1 $ 5,415,705 $ 5,348,207 8.00% 32 years
CRIIMI MAE Financial Corporation 24 92,126,210 90,918,010 8.32% 26 years
CRIIMI MAE Financial Corporation II 31 154,105,818 153,349,549 7.20% 24 years
CRIIMI MAE Financial Corporation III 17 47,320,880 46,829,756 7.94% 27 years
-- ----------- ----------- ----- --------
73 (1) $298,968,613 $296,445,522 7.67% (2) 25 years (2)
== ============ ============ ===== ========
As of December 31, 2001
-----------------------
Number of
Mortgage Weighted Average Weighted Average
Securities Fair Value Amortized Cost Effective Interest Rate Remaining Term
----------- -------------- ---------------- ----------------------- -------------------
CRIIMI MAE 1 $ 5,254,885 $ 5,372,303 8.00% 33 years
CRIIMI MAE Financial Corporation 30 106,445,595 107,546,937 8.44% 27 years
CRIIMI MAE Financial Corporation II 42 182,696,905 188,339,465 7.19% 25 years
CRIIMI MAE Financial Corporation III 19 48,693,918 49,724,286 7.97% 28 years
-- ------------ ------------ ----- --------
92 $343,091,303 $350,982,991 7.70% (2) 26 years (2)
== ============ ============ ===== ========
(1) During the nine months ended September 30, 2002, 19 mortgage loans
underlying mortgage securities held by CRIIMI MAE and its subsidiaries were
prepaid. These prepayments generated net proceeds of approximately $51.1
million and resulted in a financial statement net loss of approximately
$415,000, which is included in net losses on mortgage security dispositions
in the accompanying consolidated statement of income for the nine months
ended September 30, 2002. In addition to these losses, the Company
recognized additional losses of $152,000 during the nine months ended
September 30, 2002 resulting from the final financial settlement on the two
mortgages that were assigned to the U.S. Department of Housing and Urban
Development in 2001 due to payment defaults.
(2) Weighted averages were computed using total face value of the mortgage
securities.
6. OBLIGATIONS UNDER FINANCING FACILITIES
The following table summarizes CRIIMI MAE's debt outstanding as of
September 30, 2002 and December 31, 2001 and for the nine months ended September
30, 2002.
As of and for the nine months ended September 30, 2002
-------------------------------------------------------------------
Average
Effective Rate Effective December 31, 2001
Ending Balance at Quarter End Average Balance Rate Ending Balance
--------------- -------------- --------------- --------- -----------------
Variable-rate secured borrowing (1) $221,561,399 6.5% $ 232,345,827 6.6% $ 244,194,590
Series A senior secured notes (2) 94,470,465 12.2% 96,908,385 12.1% 99,505,457
Series B senior secured notes (3) 66,175,191 21.0% 65,304,932 21.0% 63,937,383
Securitized mortgage obligations:
CMBS (4) 285,141,921 9.1% 284,084,009 9.1% 283,047,470
Freddie Mac funding note (5) 146,658,949 7.6% 161,825,492 8.3% 180,291,091
Fannie Mae funding note (6) 45,289,376 7.4% 47,184,788 7.7% 48,062,403
CMO (7) 84,281,610 7.5% 92,645,086 7.9% 98,204,667
Mortgage payable (8) 7,188,552 12.0% 7,144,135 12.0% 7,109,252
--------------- ------------- --------------
Total Debt $ 950,767,463 9.2% $ 987,442,654 9.3% $1,024,352,313
=============== ============= ==============
(1) The effective interest rate at September 30, 2002 and during the nine
months ended September 30, 2002 reflects the accrual of estimated extension
fees that are payable in the future, assuming that the Company remains
obligated under this debt obligation. During the nine months ended
September 30, 2002 and 2001, the Company recognized interest expense of
$2,421,146 and $1,477,124 related to these potential extension fees. As of
September 30, 2002, the Company has $4,793,525 of accrued extension fees
included in payables and accrued expenses in the accompanying consolidated
balance sheet.
(2) The effective interest rate at September 30, 2002 and during the nine
months ended September 30, 2002 reflects the accrual of estimated extension
fees that are payable in the future, assuming that the Company remains
obligated under these debt obligations. During the nine months ended
September 30, 2002 and 2001, the Company recognized interest expense of
$257,538 and $221,650 related to these potential extension fees. As of
September 30, 2002, the Company has $594,928 of accrued extension fees
included in payables and accrued expenses in the accompanying consolidated
balance sheet.
(3) The effective interest rate at September 30, 2002 and during the nine
months ended September 30, 2002 reflects the accrual of estimated extension
fees that are payable in the future, assuming that the Company remains
obligated under these debt obligations. During the nine months ended
September 30, 2002 and 2001, the Company recognized interest expense of
$511,152 and $314,017 related to these potential extension fees. As of
September 30, 2002, the Company has $943,542 of accrued extension fees
included in payables and accrued expenses in the accompanying consolidated
balance sheet.
(4) As of September 30, 2002 and December 31, 2001, the face amount of the debt
was $328,446,000 with unamortized discount of $43,304,079 and $45,398,530,
respectively. During the nine months ended September 30, 2002 and 2001,
discount amortization of $2,094,451 and $1,913,604, respectively, was
recorded as interest expense.
(5) As of September 30, 2002 and December 31, 2001, the face amount of the note
was $151,010,600 and $185,616,298, respectively, with unamortized discount
of $4,351,651 and $5,325,207, respectively. During the nine months ended
September 30, 2002 and 2001, discount amortization of $973,556 and
$403,527, respectively, was recorded as interest expense.
(6) As of September 30, 2002 and December 31, 2001, the face amount of the note
was $46,311,408 and $49,182,632, respectively, with unamortized discount of
$1,022,032 and $1,120,229, respectively. During the nine months ended
September 30, 2002 and 2001, discount amortization of $98,197 and $100,627,
respectively, was recorded as interest expense.
(7) As of September 30, 2002 and December 31, 2001, the face amount of the note
was $86,401,147 and $100,727,532, respectively, with unamortized discount
of $2,119,537 and $2,522,865, respectively. During the nine months ended
September 30, 2002 and 2001, discount amortization of $403,328 and
$294,833, respectively, was recorded as interest expense.
(8) As of September 30, 2002 and December 31, 2001, the unpaid principal
balance of this mortgage payable was $8,750,128 and $8,824,288,
respectively, and the unamortized discount was $1,561,576 and $1,715,036,
respectively. The coupon rate on the mortgage payable is 7.34%. The
effective interest rate on the mortgage payable is 12.00% as a result of
the discount amortization. The discount is being amortized to interest
expense through maturity in 2008. During the nine months ended September
30, 2002 and 2001, discount amortization of $153,460 and $-0-,
respectively, was recorded as interest expense.
Information Regarding Certain Terms and Restrictions Pertaining to New Debt
Substantially all cash flows relating to the Company's existing assets are,
and are currently expected to be (assuming the Company remains obligated under
the New Debt), used to satisfy principal, interest and fee obligations under the
New Debt. The New Debt is secured by substantially all of the Company's assets.
The operative documents governing the New Debt contain restrictive covenants,
including financial covenants and certain restrictions and requirements with
respect to cash accounts and the collection, management, use and application of
funds in connection with the New Debt. The terms of the New Debt significantly
restrict the amount of cash dividends that can be paid by the Company to
shareholders. One such restriction provides that any cash dividends required to
maintain REIT status (assuming the Company has the cash to make such
distributions and that it is permitted to make such distributions under the
terms of the New Debt) would be paid first to holders of certain of the New Debt
who convert their secured notes into one or two new series of preferred stock,
which new series of preferred stock would be senior to all other series of
preferred stock of the Company, in the form of redemption payments. Another such
restriction provides that if total realized losses and appraisal reduction
amounts with respect to mortgage loans underlying the Company's Subordinated
CMBS (as determined under the New Debt documents) exceed certain loss threshold
amounts, then the Company is prohibited from paying cash dividends to its
shareholders, except as required to maintain REIT status, with any such cash
dividends to be paid in accordance with the terms set forth in the preceding
sentence. As of September 30, 2002, the Company had exceeded the loss threshold
amounts under the applicable operative documents evidencing the New Debt.
Reference is made to the New Debt operative documents filed as exhibits to a
Current Report on Form 8-K in June 2001 for a more detailed description of the
New Debt including the payment terms, restrictions, covenants, events of
default, and collateral.
Although there can be no assurance, the Company believes that it will have
sufficient cash resources to pay interest, scheduled principal and any other
required payments on the New Debt through 2003. The Company's ability to meet
its debt service obligations under the New Debt through 2003 will depend on a
number of factors, including management's ability to maintain cash flow (which
is impacted by, among other things, the credit performance of the underlying
mortgage loans) and to generate capital internally from operating and investing
activities and expected reductions in REIT distribution requirements to
shareholders due to expected net operating losses for tax purposes, in each case
consistent with the terms of the operative documents governing the New Debt.
There can be no assurance that targeted levels of cash flow will actually be
achieved, that reductions in REIT distribution requirements will be realized, or
that, if required, new capital will be available to the Company. The Company's
ability to maintain or increase cash flow and access new capital will depend
upon, among other things, interest rates, prevailing economic conditions,
covenants and restrictions under the operative documents evidencing the New
Debt, and other factors, many of which are beyond the control of the Company.
The Company's cash flow will also be negatively affected by appraisal reductions
on properties underlying the Subordinated CMBS and realized losses on
Subordinated CMBS. The Company expects losses on CMBS to increase in 2003;
accordingly CMBS cash flows are expected to decrease in 2003 as compared to
2002. In addition, the Company's cash flows will be affected by prepayments of
mortgages underlying the Company's insured mortgage securities and prepayments
of mortgages held by the AIM Funds. Prepayments of mortgages underlying the
insured mortgage securities and the AIM Funds will result in reductions in the
respective mortgage bases. Accordingly, the net cash flows to CRIIMI MAE, after
any required debt pay down, are likely to decrease over time. See also the
effect on interest expense paid on the Variable-Rate Secured Borrowing
attributable to changes in one-month LIBOR discussed in "Quantitative and
Qualitative Disclosures About Market Risk". The Company's high level of debt
limits its ability to obtain additional capital, significantly reduces income
available for other activities, restricts the Company's ability to react quickly
to changes in its business, limits its ability to hedge its assets and
liabilities, and makes the Company more vulnerable to economic downturns.
Additionally, there can be no assurance that the Company will be able to
refinance all or any portion of the New Debt at or prior to maturity on terms
favorable to it, or on any terms at all. As discussed in Note 15, the Company is
proceeding with a proposed transaction which contemplates, among other matters,
the refinancing of the New Debt. There can be no assurance that this transaction
will be completed.
Other Debt Related Information
Fluctuations in interest rates will continue to impact the value of CRIIMI
MAE's mortgage assets and could impact the net interest margin through increased
cost of funds on the Variable-Rate Secured Borrowing. CRIIMI MAE has purchased
interest rate cap agreements in order to partially limit the adverse effects of
rising interest rates
on the Company's Variable-Rate Secured Borrowing. When the interest rate
cap agreements expire, CRIIMI MAE will have interest rate risk to the extent
interest rates increase on any variable-rate borrowings unless the interest rate
caps are replaced at equivalent rates or other steps are taken to mitigate this
risk. Furthermore, CRIIMI MAE has interest rate risk to the extent that the
LIBOR interest rate increases between the current rate and the cap rate. See
Note 7 for further discussion of interest rate caps.
For the nine months ended September 30, 2002, CRIIMI MAE's weighted average
cost of borrowing, including amortization of discounts, deferred financing fees
and extension fees of approximately $7.5 million, was approximately 9.3%. As of
September 30, 2002, CRIIMI MAE's debt-to-equity ratio was approximately 3.1 to 1
and CRIIMI MAE's non-match-funded debt-to-equity ratio was approximately 1.3 to
1.
The following table lists the fair market value of the collateral related
to the Company's Securitized Mortgage Obligations:
Collateral Fair Value as of
Securitized Mortgage Obligations September 30, 2002 December 31, 2001
- -------------------------------- ------------------ -----------------
(in millions)
CMBS $ 329 $ 296
Freddie Mac Funding Note 154 183
Fannie Mae Funding Note 47 49
CMO 92 106
7. INTEREST RATE PROTECTION AGREEMENTS
As of September 30, 2002, CRIIMI MAE has interest rate protection
agreements ("interest rate caps") to partially limit the adverse effects of
potential rising interest rates on its Variable-Rate Secured Borrowing. Interest
rate caps provide protection to CRIIMI MAE to the extent interest rates, based
on a readily determinable interest rate index, increase above the stated
interest rate cap, in which case, CRIIMI MAE will receive payments based on the
difference between the index and the cap. At September 30, 2002, CRIIMI MAE held
the following interest rate caps:
Notional Amount Effective Date Maturity Date Cap Index
- --------------- -------------- -------------- ---- -----
$ 175,000,000 (1) May 1, 2002 November 3, 2003 3.25% (3) 1 month LIBOR
$ 174,500,000 (2) April 2, 2001 April 2, 2003 5.25% (3) 1 month LIBOR
(1) CRIIMI MAE's designated (as defined in SFAS No. 133) interest rate
protection agreement, which hedges CRIIMI MAE's variable-rate borrowing
costs, hedges approximately 79% of the Company's Variable-Rate Secured
Borrowing. This interest rate cap was purchased in April 2002 for
approximately $1.6 million.
(2) This interest rate protection agreement is undesignated (as defined in SFAS
No. 133). (3) One-month LIBOR was 1.81% at September 30, 2002.
8. SALE OF CMBS MASTER AND DIRECT SERVICING RIGHTS
In February 2002, CMSLP sold all of its rights and obligations under its
CMBS master and direct servicing contracts because the contracts were not
profitable, given the relatively small volume of master and direct CMBS
servicing that CMSLP was performing. In connection with this restructuring, 34
employee positions were eliminated. CMSLP received approximately $11.8 million
in cash in the first quarter of 2002, which included reimbursement of servicing
advances. CMSLP expects to receive additional cash of approximately $649,000
from the sale within the next few months, which assumes that the purchaser will
retain approximately $316,000 of the sales price upon final settlement of the
post-closing contingencies. Any difference in the actual amount retained by the
purchaser and CMSLP's estimate of the amount to be retained as of September 30,
2002 will be reflected as an adjustment to the gain on the sale of servicing
rights in the fourth quarter of 2002. During the nine months ended September 30,
2002, approximately $1.0 million of income tax expense was recognized as a
result of the income taxes on the gain on the sale by CMSLP of its master and
direct servicing rights. The income tax expense was incurred by the Company
through its wholly-owned taxable REIT subsidiaries ("TRSs") that own
partnership interests in CMSLP. These TRSs are separately taxable entities
that cannot use the Company's NOL to reduce their taxable income
As a result of this sale and related restructuring, CMSLP recorded
restructuring expenses of approximately $438,000 in the fourth quarter of 2001.
During the nine months ended September 30, 2002, CMSLP recorded additional
restructuring expenses of approximately $151,000 primarily related to rent on
vacant office space that is taking longer to sublease than originally
anticipated. The following is a reconciliation of the restructuring accrual:
Severance and
other employee Non-cancelable
benefits Lease Costs Other Total
------------------ --------------- ------------ ------------
Balance, December 31, 2001 $ 184,967 $ 100,372 $ 10,000 $ 295,339
Amounts paid (174,745) (155,843) (13,686) (344,274)
Additional accrual - 138,676 12,786 151,462
Accrual reversed (10,222) - - (10,222)
------------ ----------- ---------- -----------
Balance, September 30, 2002 $ - $ 83,205 $ 9,100 $ 92,305
============ =========== ========== ===========
9. DIFFERENCES BETWEEN FINANCIAL STATEMENT NET INCOME (LOSS) AND TAXABLE
LOSS
The differences between financial statement (GAAP) net income (loss) and
taxable income (loss) are generally attributable to differing treatment of
unrealized/realized gains and losses associated with certain assets; the bases,
income, impairment, and/or credit loss recognition related to certain assets;
and amortization of various costs. The distinction between GAAP net income
(loss) and taxable income (loss) is important to the Company's shareholders
because dividends or distributions are declared and paid on the basis of taxable
income or taxable loss. The Company does not pay Federal income taxes as long as
it satisfies the requirements for exemption from taxation pursuant to the REIT
requirements of the Tax Code. The Company calculates its taxable income or
taxable loss, as if the Company were a regular domestic corporation. This
taxable income or taxable loss level determines the amount of dividends, if any,
the Company is required to distribute over time in order to eliminate its tax
liability.
As a result of its trader election in early 2000, CRIIMI MAE recognized a
mark-to-market tax loss of approximately $478 million on certain Trading Assets
on January 1, 2000 (the "January 2000 Loss"). The January 2000 Loss is expected
to be recognized evenly over four years (2000, 2001, 2002, and 2003) for tax
purposes (i.e., approximately $120 million per year) beginning with the year
2000.
A summary of the Company's year-to-date net operating loss as of September
30, 2002 is as follows:
(in millions)
-------------
January 2000 Loss $ (478.2)
LESS: Amounts recognized in 2001 and 2000 239.1
LESS: Amounts recognized during the nine months ended September 30, 2002 89.7
----------
Balance remaining of January 2000 Loss to be recognized in future periods $ (149.4)
==========
Taxable income for the nine months ended September 30, 2002 before recognition $ 28.6
of January 2000 Loss
LESS: January 2000 Loss recognized during the nine months ended September 30, 2002 (89.7)
----------
Net Operating Loss for the nine months ended September 30, 2002 $ (61.1)
==========
Accumulated Net Operating Loss through December 31, 2001 $ (140.2) (1)
Net Operating Loss created during the nine months ended September 30, 2002 (61.1)
Net Operating Loss utilization -
----------
Net Operating Loss carried forward for use in future periods $ (201.3)
==========
(1) The accumulated NOL as of December 31, 2001 has been reduced by $6.3
million to reflect the actual NOL included on the Company's 2001 income
tax return, which was completed during the third quarter of 2002.
10. COMMON STOCK
On October 17, 2001, the Company implemented a one-for-ten reverse stock
split designed, in part, to satisfy the New York Stock Exchange ("NYSE") market
price listing requirement. There can be no assurance that such market price
listing requirement or that all other NYSE requirements will continue to be met.
All share and per share information in these notes to consolidated financial
statements and the accompanying consolidated financial statements have been
retroactively adjusted to reflect the reverse stock split. Share information
adjustments include, without limitation, adjustments to the number of common
shares issued and outstanding, issued as dividends on and upon conversion of
shares of preferred stock and issuable under outstanding options. CRIIMI MAE had
300,000,000 authorized shares and 13,945,068 and 12,937,341 issued and
outstanding shares of $0.01 par value common stock as of September 30, 2002 and
December 31, 2001, respectively.
As discussed in Note 6, the terms of the New Debt significantly restrict
the amount of cash dividends that can be paid by the Company to shareholders.
Presently, cash distributions may only be paid if required to maintain REIT
status, with such payments being made first, and possibly solely, to holders of
certain of the New Debt who convert their secured notes into one or two new
series of preferred stock. Preferred stock dividends for the fourth quarter of
2001 and the first quarter of 2002 were paid in shares of common stock in April
2002 except for dividends on the Company's Series E Cumulative Convertible
Preferred Stock ("Series E Preferred Stock"), which were paid in cash in
conjunction with the redemption of the Series E Preferred Stock. The following
table summarizes the common stock activity through September 30, 2002:
Common Shares Balance of Common
Date Description Issued Shares Outstanding
- ------------------------ ----------------------------------------- ----------------- -------------------
12/31/01 Beginning balance 12,937,341
01/02/02 Restricted stock issued 32,500
- ------------------------------------------------------------------------------------------------------------
03/31/02 Balance 12,969,841
- ------------------------------------------------------------------------------------------------------------
04/15/02 Dividends to Series B Preferred Stock 607,938
04/15/02 Dividends to Series F Preferred Stock 97,824
04/15/02 Dividends to Series G Preferred Stock 260,565
06/10-18/02 Stock options exercised 5,500
- ------------------------------------------------------------------------------------------------------------
06/30/02 Balance 13,941,668
- ------------------------------------------------------------------------------------------------------------
08/29/02 Stock options exercised 3,400
- ------------------------------------------------------------------------------------------------------------
09/30/02 Balance 13,945,068
- ------------------------------------------------------------------------------------------------------------
11. PREFERRED STOCK
As of September 30, 2002 and December 31, 2001, 75,000,000 shares of
preferred stock were authorized. As of September 30, 2002 and December 31, 2001,
3,000,000 shares were designated as Series B Cumulative Convertible Preferred
Stock ("Series B Preferred Stock"), 1,610,000 shares were designated as Series F
Redeemable Cumulative Dividend Preferred Stock ("Series F Preferred Stock"), and
3,760,000 shares were designated as Series G Redeemable Cumulative Dividend
Preferred Stock ("Series G Preferred Stock"). In addition, 203,000 shares were
designated as Series E Preferred Stock as of December 31, 2001 and 45,000 shares
were designated as Series H Junior Preferred Stock as of September 30, 2002.
On December 3, 2001, the Company's Board of Directors decided to defer the
payment of dividends on CRIIMI MAE's Series B Preferred Stock, Series E
Preferred Stock, Series F Preferred Stock, and Series G Preferred Stock for the
fourth quarter of 2001. In connection with the redemption of the Series E
Preferred Stock on March 21, 2002, the Board contemporaneously declared
dividends on shares of Series B Preferred Stock, Series F Preferred Stock and
Series G Preferred Stock for the fourth quarter of 2001 and the first quarter of
2002, which dividends were payable in shares of common stock. Such preferred
stock dividends, payable in shares of the Company's common stock, were paid on
April 15, 2002 to holders of record on April 1, 2002.
On May 16, 2002 and September 10, 2002, the Company's Board of Directors
decided to defer the payment of dividends on the Company's Series B Preferred
Stock, Series F Preferred Stock and Series G Preferred Stock for the second and
third quarters of 2002, respectively.
Series B Cumulative Convertible Preferred Stock
As of September 30, 2002 and December 31, 2001, there were 1,593,982 shares
of Series B Preferred Stock issued and outstanding. The following table
summarizes the 2002 dividend payment activity for the Series B Preferred Stock:
Number of
Time Period for Shares of
Dividends per Amount of which dividends Common Stock
Declaration Date Payment Date Series B Share Dividends (b) are accrued Issued
- -------------------------------------------------------------------------------------------------------
March 21, 2002 April 15, 2002 $ 1.36 $ 2,167,816 10/1/01-3/31/02 607,938 (a)
(a) Represents the number of shares of common stock issued in connection with
the payment of dividends to holders of Series B Preferred Stock. The
Company determined the number of shares of common stock to issue by
dividing the dollar amount of the dividend payable by the volume-weighted
average of the sale prices of the common stock for the 10-trading day
period commencing after the declaration date.
(b) Although the payments of dividends for the second and third quarters of
2002 were deferred, as of September 30, 2002, the Company has accrued
$2,167,816 for the Series B Preferred Stock second and third quarter
dividends at a dividend rate of $0.68 per share per quarter.
As of September 30, 2002, each share of Series B Preferred Stock was
convertible into 0.4797 shares of common stock.
Series E Cumulative Convertible Preferred Stock
On March 21, 2002, the Company redeemed all 173,000 outstanding shares of
its Series E Preferred Stock at the stated redemption price of $106 per share in
cash plus accrued and unpaid dividends through and including the date of
redemption. The total redemption price was $18,734,107 ($396,107 of which
represented accrued and unpaid dividends for the period October 1, 2001 through
March 21, 2002). The $1,038,000 difference between the aggregate liquidation
value and the redemption price is reflected as a dividend on preferred stock
during the nine months ended September 30, 2002. The Series E Preferred Stock
was held by the Company's principal creditor. As of September 30, 2002 and
December 31, 2001, there were 0 and 173,000 shares, respectively, of Series E
Preferred Stock issued and outstanding.
Series F Redeemable Cumulative Dividend Preferred Stock
As of September 30, 2002 and December 31, 2001, there were 586,354 shares
of Series F Preferred Stock issued and outstanding. The following table
summarizes the 2002 dividend payment activity for the Series F Preferred Stock:
Time period for Number of
Dividends per Amount of which dividends Shares of Common
Declaration Date Payment Date Series F Share Dividends (b) are accrued Stock Issued
- ---------------------------------------------------------------------------------------------------------------
March 21, 2002 April 15, 2002 $ 0.60 $ 351,812 10/1/01-3/31/02 97,824 (a)
(a) Represents the number of shares of common stock issued in connection with
the payment of dividends to holders of Series F Preferred Stock. The
Company determined the number of shares of common stock to issue by
dividing the dollar amount of the dividend payable by the volume-weighted
average of the sale prices of the common stock for the 10-trading day
period commencing after the declaration date.
(b) Although the payments of dividends for the second and third quarters of
2002 were deferred, as of September 30, 2002, the Company has accrued
$351,812 for the Series F Preferred Stock second and third quarter
dividends at a dividend rate of $0.30 per share per quarter.
Series G Redeemable Cumulative Dividend Preferred Stock
As of September 30, 2002 and December 31, 2001, there were 1,244,656 shares
of Series G Preferred Stock issued and outstanding. The following table
summarizes the 2002 dividend payment activity for the Series G Preferred Stock:
Time period for Number of
Dividends per Amount of which dividends Shares of Common
Declaration Date Payment Date Series G Share Dividends (b) are accrued Stock Issued
- ------------------------------------------------------------------------------------------------------------
March 21, 2002 April 15, 2002 $ 0.75 $ 933,492 10/1/01-3/31/02 260,565 (a)
(a) Represents the number of shares of common stock issued in connection with
the payment of dividends to holders of Series G Preferred Stock. The
Company determined the number of shares of common stock to issue by
dividing the dollar amount of the dividend payable by the volume-weighted
average of the sale prices of the common stock for the 10-trading day
period commencing after the declaration date.
(b) Although the payments of dividends for the second and third quarters of
2002 were deferred, as of September 30, 2002, the Company has accrued
$933,492 for the Series G Preferred Stock second and third quarter
dividends at a dividend rate of $0.375 per share per quarter.
12. EARNINGS PER SHARE
The following tables reconcile basic and diluted EPS for the three and nine
months ended September 30, 2002 and 2001. The 2001 per share amounts have been
adjusted to reflect the one-for-ten reverse stock split effected on October 17,
2001.
For the three months ended September 30, 2002 For the three months ended September 30, 2001
Per Share Per Share
Income Shares Amount Income Shares (2) Amount
--------------- --------------- -------------- --------------- --------------- ------------
Basic loss per share:
Net loss to common shareholders $(25,101,506) 13,926,600 $(1.80) $(723,708) 12,508,253 $(0.06)
Dilutive effect of securities:
Stock options -- -- -- -- -- --
Convertible preferred stock (1) -- -- -- -- -- --
-------------- -------------- ------------- ------------ ----------- ------------
Diluted loss per share:
Loss to common shareholders
and assumed conversions $(25,101,506) 13,926,600 $(1.80) $(723,708) 12,508,253 $(0.06)
============== ============== ============= ============ =========== ============
For the nine months ended September 30, 2002 For the nine months ended September 30, 2001
Per Share Per Share
Income Shares (2) Amount Income Shares (2) Amount
--------------- --------------- -------------- --------------- --------------- ------------
Net (loss) income before cumulative
effect of changes in accounting
principles $ (19,867,240) 13,635,656 $(1.46) $1,070,514 10,464,433 $ 0.10
Cumulative effect of change in
accounting principle related
to SFAS 142 (9,766,502) 13,635,656 (0.71) -- -- --
Cumulative effect of change in
accounting principle related
to servicing fee revenue -- -- -- 1,995,262 10,464,433 0.19
Cumulative effect of change in
accounting principle related
to SFAS 133 -- -- -- (135,142) 10,464,433 (0.01)
--------------- ------------ ------------ ------------- ------------ ------------
Basic (loss) income per share:
- ------------------------------
(Loss) income to common
shareholders (29,633,742) 13,635,656 (2.17) 2,930,634 10,464,433 0.28
Dilutive effect of securities:
Stock options -- -- -- -- 9,408 --
Convertible preferred stock (1) -- -- -- -- -- --
--------------- ------------ ------------ ------------- ------------ ------------
Diluted (loss) income per share:
(Loss) income to common shareholders
and assumed conversions $ (29,633,742) 13,635,656 $(2.17) $2,930,634 10,473,841 $0.28
=============== ============ ============ ============= ============ ============
(1) The common stock equivalents for the Preferred Stock that are convertible
as of September 30 of the applicable year are not included in the
calculation of diluted EPS because the effect would be anti-dilutive.
(2) Includes the weighted average number of common shares payable or paid to
preferred stockholders related to dividends as of the respective dividend
declaration dates.
13. TRANSACTIONS WITH RELATED PARTIES
Below is a summary of the related party transactions which occurred during
the three and nine months ended September 30, 2002 and 2001.
Three months ended September 30, Nine months ended September 30,
2002 2001 2002 2001
---- ---- ---- ----
Amounts received or accrued from related parties:
AIM Funds
Income(1) $ 129,249 $ 203,164 $ 419,880 $ 563,505
Return of capital(2) 538,778 370,996 1,590,826 1,507,474
--------- --------- ---------- -----------
Total $ 668,027 $ 574,160 $2,010,706 $ 2,070,979
========= ========= ========== ===========
AIM Acquisition Limited Partnership (1) $ 58,397 $ 69,061 $ 179,791 $ 219,556
========= ========= ========== ===========
Expense reimbursements from:
AIM Funds (3) $ 47,851 $ 42,197 $ 143,078 $ 141,152
CMSLP (3)(5) - - - 248,428
--------- --------- ---------- -----------
Total $ 47,851 $ 42,197 $ 143,078 $ 389,580
========= ========= ========== ===========
Expense reimbursement (to) from CRI:
Expense reimbursement to CRI (3) (4) (6) $ (78,211) $ (81,183) $ (245,862) $ (206,920)
Expense reimbursement from CRI (3) 69,415 44,475 145,853 55,366
--------- ---------- ----------- -----------
Net expense reimbursement $ (8,796) $ (36,708) $ (100,009) $ (151,554)
========= ========== =========== ===========
(1) Included as equity in earnings from investments on the accompanying
consolidated statements of income.
(2) Included as a reduction of equity investments on the accompanying
consolidated balance sheets.
(3) Included in general and administrative expenses on the accompanying
consolidated statements of income.
(4) Pursuant to an agreement between CRIIMI MAE and CRI (the "CRI
Administrative Services Agreement"), CRI provides CRIIMI MAE with certain
administrative and office facility services and other services, at cost,
with respect to certain aspects of CRIIMI MAE's business. CRIIMI MAE uses
the services provided under the CRI Administrative Services Agreement to
the extent such services are not performed by CRIIMI MAE Management or
provided by another service provider. The CRI Administrative Services
Agreement is terminable on 30 days notice at any time by CRIIMI MAE.
(5) Includes payroll reimbursement for services provided by CRIIMI MAE
Management employees to CMSLP through June 30, 2001. Since CMSLP has been
accounted for on a consolidated basis since July 1, 2001, there are no
related party transactions with CMSLP after that date.
(6) CMSLP reimbursed CRI for approximately $78,000 of expenses during the
period January 1, 2001 through June 30, 2001. These reimbursements are not
included in the reimbursements for the nine months ended September 30, 2001
since the financial results of CMSLP were not consolidated until July 1,
2001. The CMSLP reimbursements to CRI for the three months ended September
30, 2001 and for all of 2002 are included in this table.
In addition to the transactions listed above, in connection with the Merger
in 1995, the Company entered into a deferred compensation arrangement with
William Dockser, Chairman and CEO, and H. William Willoughby, President, in an
original aggregate amount of $5,002,183 pursuant to which the Company agreed to
pay Messrs. Dockser and Willoughby for services performed in connection with the
structuring of the Merger. The Company's obligation to pay the deferred
compensation is limited, with certain exceptions, to the creation of an
irrevocable grantor trust for the benefit of Messrs. Dockser and Willoughby and
the transfer to such trust of the right to receive such deferred compensation
(the "Note Receivable") in the original aggregate principal amount of
$5,002,183. The deferred compensation is fully vested and payable only to the
extent that payments are made by CRI on the Note Receivable. Payments of
principal and interest on the Note Receivable/deferred compensation are payable
quarterly and terminate in June 2005. The Note Receivable/deferred compensation
bears interest at the prime rate (4.75% as of September 30, 2002) plus 2% per
annum. From October 5, 1998 through April 17, 2001, no deferred compensation
payments were made as a result of the Company's Chapter 11 proceeding. For the
three and nine months ended September 30, 2001, aggregate payments of $2,571,455
(including $945,740 in accrued interest) were made on the Note
Receivable/deferred compensation. For the three and nine months ended September
30, 2002, aggregate payments of $152,413 and $465,504, respectively, were made
on the Note Receivable/deferred compensation. These aggregate payments were
split approximately equally among Messrs. Dockser and Willoughby. The unpaid
aggregate principal balance on the Note Receivable/deferred compensation was
approximately $1,500,643 at September 30, 2002.
14. SEGMENT REPORTING
Management assesses Company performance and allocates capital principally
on the basis of two lines of business: portfolio investment and mortgage
servicing. These two lines of business are managed separately as they provide
different sources and types of revenues for the Company.
Portfolio investment primarily includes (i) managing the Company's
Subordinated CMBS, (ii) managing its investments in government-insured mortgage
securities and entities that own government-insured mortgage securities and
(iii) securities trading activities. The Company's income is primarily generated
from these assets.
Mortgage servicing, which consists of all the operations of CMSLP,
primarily includes performing servicing functions with respect to the mortgage
loans underlying the Company's Subordinated CMBS. CMSLP performs a variety of
servicing including special servicing and loan management. For these services,
CMSLP earns a servicing fee which is calculated as a percentage of the principal
amount of the servicing portfolio and is typically paid when the related service
is rendered. These services may include either routine monthly services,
non-monthly periodic services or event-triggered services. In acting as a
servicer, CMSLP also earns interest income on the investment of escrows held on
behalf of borrowers and other income which includes, among other things,
assumption fees and modification fees. Through June 30, 2001, CMSLP was an
unconsolidated affiliate of CRIIMI MAE. Therefore, up through June 30, 2001, the
results of its operations were reported in the Company's income statement in
equity in earnings (losses) from investments. Beginning in the third quarter of
2001, CMSLP's results were consolidated into CRIIMI MAE's consolidated financial
statements as a result of a change in the ownership of CMSLP. Overhead expenses,
such as administrative expenses, are allocated either directly to each business
line or through estimates based on factors such as number of personnel or square
footage of office space.
The following tables detail the Company's financial performance by these
two primary lines of business for the three and nine months ended September 30,
2002 and 2001. The basis of accounting used in the tables is GAAP.
As of and for the three months ended September 30, 2002
------------------------------------------------------------------------------------
Elimination of
Portfolio Mortgage Intercompany
Investment Servicing Transactions Consolidated
------------------- ---------------- ------------------- ------------------
Interest income $ 31,508,173 $ - $ - $ 31,508,173
Interest expense (22,366,319) - 10,076 (22,356,243)
------------------- ---------------- ------------------- ------------------
Net interest margin 9,141,854 - 10,076 9,151,930
------------------- ---------------- ------------------- ------------------
General and administrative expenses (2,783,316) - (15,835) (2,799,151)
Depreciation and amortization (312,388) - - (312,388)
Equity in earnings (losses) from investments 98,005 - - 98,005
Other, net 48,116 - - 48,116
Impairment on CMBS (29,884,497) - - (29,884,497)
Investment banking expense (438,889) - - (438,889)
Servicing income - 3,110,378 (134,007) 2,976,371
Servicing general and administrative
expenses - (2,361,774) 139,766 (2,222,008)
Servicing amortization, depreciation
and impairment - (508,000) - (508,000)
Servicing restructuring expenses - - - -
Servicing gain on sale of servicing rights - 34,309 - 34,309
Income tax benefit (expense) 326,998 154,258 - 481,256
------------------- ---------------- ------------------- ------------------
(32,945,971) 429,171 (10,076) (32,526,876)
------------------- ---------------- ------------------- ------------------
Net income (loss) before changes in
accounting principles $ (23,804,117) $ 429,171 $ - $ (23,374,946)
=================== ================ =================== ==================
Total assets $ 1,258,335,741 $ 27,333,329 $ (458,133) $ 1,285,210,937
=================== ================ =================== ==================
As of and for the three months ended September 30, 2001
------------------------------------------------------------------------------------
Elimination of
Portfolio Mortgage Intercompany
Investment Servicing Transactions Consolidated
------------------- ---------------- ------------------- ------------------
Interest income $ 33,588,020 - - 33,588,020
Interest expense (24,777,343) - - (24,777,343)
------------------- ---------------- ------------------- ------------------
Net interest margin 8,810,677 - - 8,810,677
------------------- ---------------- ------------------- ------------------
General and administrative expenses (3,036,349) - (139,578) (3,175,927)
Depreciation and amortization (947,002) - - (947,002)
Equity in earnings (losses) from investments 163,250 - - 163,250
Other, net 920,511 - - 920,511
Impairment on CMBS (3,886,347) - - (3,886,347)
Reorganization items (464,152) - - (464,152)
Emergence loan origination fee - - - -
Servicing income - 3,353,195 - 3,353,195
Servicing general and administrative
expenses - (2,963,284) 139,578 (2,823,706)
Servicing amortization, depreciation
and impairment - (669,560) - (669,560)
------------------- ---------------- ------------------- ------------------
(7,250,089) (279,649) - (7,529,738)
------------------- ---------------- ------------------- ------------------
Net income (loss) before changes in
accounting principles $ 1,560,588 $ (279,649) $ - $ 1,280,939
=================== ================ =================== ==================
Total assets $ 1,337,779,421 $ 24,954,923 $ (934,698) $ 1,361,799,646
=================== ================ =================== ==================
As of and for the nine months ended September 30, 2002
------------------------------------------------------------------------------------
Elimination of
Portfolio Mortgage Intercompany
Investment Servicing Transactions Consolidated
------------------- ---------------- ------------------- ------------------
Interest income $ 95,283,400 $ - $ - $ 95,283,400
Interest expense (68,857,896) - 10,076 (68,847,820)
------------------- ---------------- ------------------- ------------------
Net interest margin 26,425,504 - 10,076 26,435,580
------------------- ---------------- ------------------- ------------------
General and administrative expenses (8,791,391) - 109,766 (8,681,625)
Depreciation and amortization (920,928) - - (920,928)
Equity in earnings (losses) from investments 330,747 - - 330,747
Other, net 825,928 - - 825,928
Impairment on CMBS (35,035,588) - - (35,035,588)
Investment banking expense (683,333) - - (683,333)
Servicing income - 8,692,686 (458,742) 8,233,944
Servicing general and administrative
expenses - (7,186,892) 338,900 (6,847,992)
Servicing amortization, depreciation
and impairment - (1,418,810) - (1,418,810)
Servicing restructuring expenses - (141,240) - (141,240)
Servicing gain on sale of servicing
rights - 4,851,907 - 4,851,907
Income tax benefit (expense) 326,998 (754,518) - (427,520)
------------------- ---------------- ------------------- ------------------
(43,947,567) 4,043,133 (10,076) (39,914,510)
------------------- ---------------- ------------------- ------------------
Net income (loss) before changes in
accounting principles $ (17,522,063) $ 4,043,133 $ - $ (13,478,930)
=================== ================ =================== ==================
Total assets $ 1,258,335,741 $ 27,333,329 $ (458,133) $ 1,285,210,937
=================== ================ =================== ==================
As of and for the nine months ended September 30, 2001
------------------------------------------------------------------------------------
Portfolio Mortgage
Investment Servicing Elimination (1) Consolidated
------------------- ---------------- ------------------- ------------------
Interest income $ 101,117,550 $ - $ - $ 101,117,550
Interest expense (73,539,343) - - (73,539,343)
------------------- ---------------- ------------------- ------------------
Net interest margin 27,578,207 - - 27,578,207
------------------- ---------------- ------------------- ------------------
General and administrative expenses (8,019,400) - (139,578) (8,158,978)
Depreciation and amortization (2,787,685) - - (2,787,685)
Equity in earnings (losses) from investments 487,443 - (2,278,734) (1,791,291)
Other, net 2,296,519 - - 2,296,519
Impairment on CMBS (3,886,347) - - (3,886,347)
Reorganization items (1,909,780) - - (1,909,780)
Emergence loan origination fee (3,936,616) - - (3,936,616)
Servicing income - 9,172,804 (5,819,609) 3,353,195
Servicing general and administrative
expenses - (9,215,769) 6,392,063 (2,823,706)
Servicing amortization, depreciation
and impairment - (2,378,451) 1,708,891 (669,560)
------------------- ---------------- ------------------- ------------------
(17,755,866) (2,421,416) (136,967) (20,314,249)
------------------- ---------------- ------------------- ------------------
Net income (loss) before changes in
accounting principles $ 9,822,341 $ (2,421,416) $ (136,967) $ 7,263,958
=================== ================ =================== ==================
Total assets $ 1,337,779,421 $ 24,954,923 $ (934,698) $ 1,361,799,646
=================== ================ =================== ==================
(1) The Company performs the mortgage servicing function through CMSLP which,
through June 30, 2001, was accounted for under the equity method. The
elimination column reclassifies CMSLP under the equity method as it was
accounted for in the Company's consolidated financial statements. Beginning in
the third quarter of 2001, CMSLP's results were consolidated into CRIIMI MAE
Inc.'s consolidated financial statements.
15. SUBSEQUENT EVENTS
On November 14, 2002, the Company entered into an Investment Agreement with
an affiliate of Brascan Real Estate Financial Partners LLC ("BREF"), which
contemplates an equity and subordinated debt investment by BREF and a secured
financing (in the form of a repurchase transaction) to be arranged by BREF with
Bear, Stearns & Co. Inc. ("Bear Stearns"). The proceeds from the BREF
investments and the secured financing of up to approximately $353 million
together with a substantial portion of the Company's liquid assets would be used
to retire the New Debt.
As contemplated by the Investment Agreement, BREF would purchase, in a
private transaction, (a) such number of shares of the Company's common stock as
would result in BREF owning, after giving effect to such purchase, 10% of the
outstanding shares of common stock at the lower of $8.22 per share and the
average of the respective closing prices per share on the ten most recent
trading days prior to the transaction closing date, and (b) up to $40 million of
subordinated debt to be issued by the Company. The first $30 million of
subordinated debt would bear interest at the rate of 15% per annum and the
remaining $10 million, issuable at the Company's option, would bear interest at
the rate of 20% per annum. All subordinated debt would mature three years after
the closing of the first $30 million and be secured by a second lien on
substantially all of the Company's Subordinated CMBS (the "Subordinated CMBS
Collateral"). The Company would pay BREF various fees, including a quarterly
maintenance fee of $375,000 in connection with arranging the repurchase
transaction with Bear Stearns.
Based on discussions with BREF and Bear Stearns and a preliminary
indication of terms with respect to the proposed secured financing to be
provided by Bear Stearns, the Company would receive a commitment for a secured
financing in the principal amount of $300 million which would mature in three
years, bear interest at a rate equal to one-month LIBOR plus 3.5% (increasing to
one-month LIBOR plus 4.5% if a collateralized debt obligation transaction
("CDO") is not successfully completed within a specified period of time),
require quarterly principal payments based on a 30-year amortization schedule
(changing to a 20-year amortization schedule if the CDO is not successfully
completed) and be secured by a first lien on the Subordinated CMBS Collateral.
The Investment Agreement also contemplates that Barry Blattman, the
president of BREF will be named Chairman of the Board and Chief Executive
Officer of the Company, that BREF will name two additional directors to the
Company's Board and that BREF and the Company would agree on two additional
individuals to be nominated for election as directors in 2003. The Board of
Directors would consist of nine directors. Upon closing of the contemplated
transactions, William B. Dockser would resign as Chairman of the Board, but
remain as a director. H. William Willoughby would resign as President and as a
director. Pursuant to amendments to their respective employment agreements, each
of Mr. Dockser and Willoughby would receive their contractual 18-month severance
payments in a lump-sum payment and certain other benefits, including an
acceleration of the vesting of outstanding options.
If the Investment Agreement is terminated under certain limited
circumstances, including termination by the Company in connection with its
acceptance, approval or authorization of a superior proposal, the Company shall
pay BREF a termination fee as set forth in the Investment Agreement.
The Company has agreed not to solicit any competing proposal or enter into
any agreement with respect to a competing proposal during the term of the
Investment Agreement.
The completion of the transactions contemplated by the Investment Agreement
is conditioned upon, among other matters, BREF's satisfaction with its due
diligence review, the absence of any material adverse change, and the receipt of
the secured financing proceeds. No commitment for the secured financing has been
received.
The BREF investment is not expected to cause an ownership change within the
meaning of Section 382 of the Tax Code. In connection with the contemplated
transactions, the Company expects to use approximately $40 million of its liquid
assets in connection with the retirement of its New Debt and to pay fees and
estimated expenses related to the contemplated transactions. Immediately after
closing of the contemplated transactions and assuming the Company issues $30
million of the $40 million available under the subordinated debt, the Company
expects to have approximately $8-$10 million of cash and liquid assets depending
upon the timing of the closing of the comtemplated transactions. These amounts
are only estimates and are subject to change. There can be no assurance that the
actual amount of liquid assets used or cash and liquid assets remaining will
approximate the amounts set forth above.
There can be no assurance that the transactions, including the secured
financing, contemplated by the Investment Agreement will be completed.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS. When used in this Quarterly Report on Form 10-Q, the
words "believes," "anticipates," "expects" and similar expressions are intended
to identify forward-looking statements. Statements looking forward in time are
included in this Quarterly Report on Form 10-Q pursuant to the "safe harbor"
provision of the Private Securities Litigation Reform Act of 1995. Such
statements are subject to certain risks and uncertainties, which could cause
actual results to differ materially, including, but not limited to, the risk
factors contained below and in the Company's reports filed with the Securities
and Exchange Commission pursuant to the Securities Exchange Act of 1934, as
amended, including its Annual Report on Form 10-K for the year ended December
31, 2001. Readers are cautioned not to place undue reliance on these
forward-looking statements, which speak only as of the date hereof. The Company
undertakes no obligation to publicly revise these forward-looking statements to
reflect events or circumstances occurring after the date hereof or to reflect
the occurrence of unanticipated events.
All information set forth in this Quarterly Report on Form 10-Q has been
retroactively adjusted to reflect a one-for-ten reverse stock split effected on
October 17, 2001.
General
CRIIMI MAE Inc. (together with its consolidated subsidiaries, unless the
context otherwise indicates, "CRIIMI MAE" or the "Company") is a commercial
mortgage company structured as a self-administered real estate investment trust
("REIT"). On April 17, 2001, the Company and certain of its subsidiaries emerged
from reorganization under Chapter 11 of the U.S. Bankruptcy Code (the "Effective
Date").
The Company's current primary activities include the ownership and
management, in large part through the Company's servicing subsidiary, CRIIMI MAE
Services Limited Partnership ("CMSLP"), of a significant portfolio of
mortgage-related assets. Prior to the Chapter 11 filing, CRIIMI MAE's primary
activities included (a) acquiring non-investment grade securities (rated below
BBB- or unrated) backed by pools of commercial mortgage loans on multifamily,
retail and other commercial real estate ("Subordinated CMBS"), (b) originating
and underwriting commercial mortgage loans, (c) securitizing pools of commercial
mortgage loans and resecuritizing pools of Subordinated CMBS, and (d) primarily
through CMSLP, performing servicing functions principally with respect to the
mortgage loans underlying the Company's Subordinated CMBS.
Virtually all of the Company's cash flows relating to existing assets are,
and are currently expected to be (assuming the Company remains obligated under
the New Debt (as defined below)), used to satisfy principal, interest and fee
obligations under the Company's variable-rate secured financing facility (the
"Variable-Rate Secured Borrowing"), Series A Senior Secured Notes, and Series B
Senior Secured Notes (collectively, the "New Debt") and to pay general and
administrative and other operating expenses of the Company. Therefore, although
the Company continues to pay down its debt obligations, the utilization of cash
flows for debt service and operating expenses results in virtually no remaining
net cash flow available for other activities, to the extent permitted under the
operative documents evidencing the New Debt.
During the third quarter of 2002, the Company received a number of
expressions of interest in connection with the Company's evaluation of strategic
alternatives designed to maximize shareholder value. A special committee of the
Company's Board of Directors, consisting of independent directors, after
considerable review, analysis and negotiation with the assistance of Friedman,
Billings, Ramsey & Co., Inc. ("FBR"), the Company's investment banking firm, has
recommended that the Company proceed with a transaction with an affiliate of
Brascan Real Estate Financial Partners LLC. The proposed transaction
contemplates an investment in subordinated debt and common stock and a secured
financing in the form of a repurchase transaction, the aggregate proceeds of
which will be used to retire the New Debt. There can be no assurance that this
transaction will be completed. See "Recent Developments" for a further
discussion of this proposed transaction.
The Company's business is subject to a number of risks and uncertainties
including, but not limited to: (1) risks associated with substantial
indebtedness or leverage; (2) borrowing risks; (3) restrictions on dividends;
(4) the limited protection provided by hedging transactions; (5) inherent risks
in owning Subordinated CMBS; (6) the
limited liquidity of the Subordinated CMBS market; (7) possible effects of
terrorist attacks, an economic slowdown and/or recession on losses and defaults
related to the mortgages underlying the Company's CMBS portfolio; (8) risks
related to the New Debt including the ability to meet payment and other
obligations thereunder; (9) risks associated with the trader election and
limitation or loss of net operating losses for tax purposes; (10) results of
operations adversely affected by factors beyond the Company's control; (11) the
effect of the yield curve on borrowing costs; (12) the effect of phantom
(non-cash) income on total income; (13) the effect of interest rate compression
on the market price of the Company's stock; (14) risk of loss of REIT status and
other tax matters; (15) failure to manage the mismatch between long-term assets
and short-term funding; (16) competition; (17) taxable mortgage pool risk; (18)
risk of becoming subject to the requirements of the Investment Company Act of
1940; (19) risk that future issuances of shares of common stock issued in
payment of dividends on preferred shares could adversely affect the common stock
price and impair the Company's ability to raise capital; (20) risk of failure to
achieve strategic alternatives; and (21) risk that charter ownership limitations
and anti-takeover measures could prevent or delay a change in control.
2002 compared to 2001
Results of Operations
Financial Statement Net Income
Financial statement net loss to common shareholders for the three months
ended September 30, 2002 was approximately $(25.1) million compared to
approximately $(724,000) for the three months ended September 30, 2001. The
significant change in the third quarter 2002 results from 2001 was primarily the
result of $29.9 million accounting impairment charges related to certain
Subordinated CMBS that were recognized during the third quarter of 2002 compared
to impairment charges of $3.9 million that were recognized during the third
quarter of 2001. Additionally, the third quarter 2002 results include an
adjustment to the one-time gain from the sale by CMSLP of its master and direct
servicing rights of approximately $34,000 and approximately $481,000 of net
income tax benefit related to tax refunds which were not previously accrued. The
2001 results include approximately $464,000 of net expenses relating to the
Company's bankruptcy reorganization and approximately $697,000 of amortization
that was recorded during the three months ended September 30, 2001 on the
goodwill written-off on January 1, 2002.
The following table provides a summary of the components of pro forma net
(loss) income to common shareholders and a reconciliation of the pro forma net
(loss) income to common shareholders to net loss to common shareholders reported
in accordance with generally accepted accounting principles ("GAAP") for the
three months ended September 30, 2002 and 2001. The intent of this table is to
provide a summary of the recurring results from operations and to isolate the
non-recurring items due to the number of non-recurring items included in the
consolidated statements of income in accordance with GAAP.
Three months ended September 30,
2002 2001
---- ----
Net interest margin $ 9,151,930 $ 8,810,677
General and administrative expenses (2,799,151) (3,175,927)
Depreciation and amortization (312,388) (249,634)
Servicing operations, net (excluding one-time items discussed above) 246,363 (140,071)
Impairment on CMBS (29,884,497) (3,886,347)
Investment banking fees (438,889) --
Hedging expense (353,085) (75,210)
Other, net 499,206 1,158,971
Dividends accrued or paid on preferred shares (1,726,560) (2,004,647)
------------ ------------
Pro forma net (loss) income to common shareholders (25,617,071) 437,812
Adjustments to GAAP net loss:
- -----------------------------
Servicing gain on sale of servicing rights 34,309 --
Income tax benefit (expense) 481,256 --
Amortization of goodwill and intangible assets written-off -- (697,368)
Reorganization items -- (464,152)
------------- ------------
GAAP net loss to common shareholders $(25,101,506) $ (723,708)
============= ============
Financial statement net loss to common shareholders for the nine months
ended September 30, 2002 was $(29.6) million compared to net income of
approximately $2.9 million for the nine months ended September 30, 2001. The
significant change in the 2002 results from 2001 was primarily the result of
$35.0 million of impairment charges related to certain Subordinated CMBS that
were recognized during the nine months ended September 30, 2002 compared to
impairment charges of $3.9 million that were recognized during the same period
in 2001. Additionally, net loss to common shareholders for the nine months ended
September 30, 2002 includes an approximate $9.8 million non-cash charge related
to the adoption of Statement of Financial Accounting Standards ("SFAS") No. 142,
approximately $1.0 million reflected as an additional dividend on preferred
stock in connection with the redemption of Series E Preferred Stock
(representing the difference between the aggregate liquidation value and the
redemption price), approximately $4.9 million from the gain on the sale by CMSLP
of its master and direct servicing rights, approximately $428,000 of net income
tax expense related to the sale of the servicing rights and tax refunds, and
approximately $141,000 of additional servicing restructuring expenses. The 2001
results include approximately $1.9 million of net revenue due to the effect of
changes in accounting principles, an aggregate of approximately $5.8 million of
expenses relating to the Company's bankruptcy reorganization, and approximately
$2.1 million of amortization that was recorded during the nine months ended
September 30, 2001 on the goodwill written-off on January 1, 2002.
The following table provides a summary of the components of pro forma net
(loss) income to common shareholders and a reconciliation of pro forma net
(loss) income to common shareholders to GAAP net (loss) income to common
shareholders for the nine months ended September 30, 2002 and 2001. The intent
of this table is to provide a summary of the recurring results from operations
and to isolate the non-recurring items due to the large number of non-recurring
items included in the consolidated statements of income in accordance with GAAP.
Nine months ended September 30,
2002 2001
---- ----
Net interest margin $ 26,435,580 $ 27,578,207
General and administrative expenses (8,681,625) (8,158,978)
Depreciation and amortization (920,928) (695,581)
Servicing operations, net (excluding one-time items discussed above) (32,858) (2,419,209) (a)
Impairment on CMBS (35,035,588) (3,886,347)
Investment banking fees (683,333) --
Hedging expense (749,412) (996,249)
Other, net 1,906,087 3,780,615
Dividends accrued or paid on preferred shares (5,350,310) (6,193,444)
--------------- --------------
Pro forma net (loss) income to common shareholders (23,112,387) 9,009,014
Adjustments to GAAP net (loss) income:
Servicing gain on sale of servicing rights 4,851,907 --
Income tax benefit (expense) (427,520) --
Servicing restructuring expenses (141,240) --
Cumulative effect of accounting changes (9,766,502) 1,860,120
Additional Series E Preferred Stock dividends (1,038,000) --
Amortization of goodwill and intangible assets written-off -- (2,092,104)
Reorganization items -- (1,909,780)
Emergence financing origination fee -- (3,936,616)
--------------- --------------
GAAP net (loss) income to common shareholders $ (29,633,742) $ 2,930,634
=============== ==============
(a) Included in equity in earnings (losses) from investments through June 30,
2001.
Interest Income - Subordinated CMBS
Interest income from Subordinated CMBS decreased by approximately $0.8
million, or 3%, to $25.7 million during the three months ended September 30,
2002 as compared to $26.4 million during the three months ended September 30,
2001. This overall decrease in interest income was primarily the result of a
3.5% reduction in the amortized cost of the Subordinated CMBS from September 30,
2001 to June 30, 2002 primarily as a result of the aggregate $35.9 million of
non-cash impairment charges that were recognized during the fourth quarter of
2001 and
the second quarter of 2002 due to changes in the Company's loss estimates
related to the Subordinated CMBS. The weighted average yield-to-maturity was
12.5% and 12.4% during the three months ended September 30, 2002 and 2001,
respectively. The reduction in the interest income generally corresponded with
the reduction in the amortized cost of the Subordinated CMBS, partially offset
by the increased average yield-to-maturity.
Interest income from Subordinated CMBS decreased by approximately $2.3
million, or 3%, to $76.8 million during the nine months ended September 30, 2002
as compared to $79.1 million during the nine months ended September 30, 2001.
This decrease corresponded with the 3% reduction in the amortized cost of the
Subordinated CMBS from December 31, 2000 to December 31, 2001.
GAAP requires that interest income earned on Subordinated CMBS be recorded
based on the effective interest method using the anticipated yield over the
expected life of the Subordinated CMBS. Based upon the timing and amount of
future credit losses and certain other assumptions estimated by management, as
discussed below, the weighted average anticipated unleveraged yield for CRIIMI
MAE's Subordinated CMBS for financial statement purposes was approximately 12.4%
as of January 1, 2002 and 2001, approximately 12.5% as of July 1, 2002, and
approximately 12.0% as of October 1, 2002. These yields were determined based on
the anticipated yield over the expected life of the Subordinated CMBS, which
considers, among other things, anticipated losses and any other than temporary
impairment. The effective interest method of recognizing interest income on
Subordinated CMBS results in income recognition that differs from cash received.
For the three months ended September 30, 2002 and 2001, the amount of income
recognized in excess of cash received due to the effective interest rate method
was approximately $3.1 million and $3.0 million, respectively. For the nine
months ended September 30, 2002 and 2001, the amount of income recognized in
excess of cash received was approximately $8.8 million and $7.7 million,
respectively.
Interest Income - Insured Mortgage Securities
Interest income from insured mortgage securities decreased by approximately
$1.3 million, or 18%, to $5.8 million for the three months ended September 30,
2002 from $7.1 million for the three months ended September 30, 2001. This
decrease was principally due to the prepayment of 23 mortgages underlying the
insured mortgage securities, representing approximately 16% of the total insured
mortgage portfolio, from September 30, 2001 through September 30, 2002.
Interest income from insured mortgage securities decreased by approximately
$3.5 million, or 16%, to $18.5 million during the nine months ended September
30, 2002 from $22.0 million during the nine months ended September 30, 2001.
This decrease was primarily due to the prepayments and assignments of the
mortgages underlying the insured mortgage securities from September 30, 2001 to
September 30, 2002.
During the nine months ended September 30, 2002, 19 mortgages prepaid
resulting in net proceeds of $51.1 million to the Company. This increase in
prepayment activity corresponds with the low mortgage interest rate environment
and the expiration of prepayment lock-out periods on many of the insured
mortgages. These prepayments result in corresponding reductions in the
outstanding principal balances of the collateralized mortgage
obligations-insured mortgage securities and the related interest expense.
Interest Expense
Interest expense of approximately $22.4 million for the three months ended
September 30, 2002 was approximately $2.4 million lower than interest expense of
approximately $24.8 million for the same period in 2001. The decrease is
primarily attributable to the Company's lower average debt balance during the
third quarter of 2002 ($964 million) compared to 2001 ($1.0 billion) and a lower
average effective interest rate on the total debt outstanding during the third
quarter of 2002 (9.3%) compared to 2001 (9.4%). In addition, interest expense on
the collateralized mortgage obligations-insured mortgage securities decreased
following significant prepayments of mortgages underlying the insured mortgage
securities, as discussed previously. The decrease in interest expense on the
collateralized mortgage obligations-insured mortgage securities was partially
offset by $205,000 of additional deferred financing costs and discount
amortization expenses, which are reflected as interest expense. These additional
expenses are the result of the mortgages prepaying faster than anticipated
which, under the effective interest method of recognizing interest expense,
required an adjustment to cumulative interest expense.
Interest expense of approximately $68.8 million for the nine months ended
September 30, 2002 was approximately $4.7 million lower than the interest
expense of approximately $73.5 million for the same period in 2001. The decrease
is attributable to the Company's lower average debt balance during the nine
months ended September 30, 2002 ($987 million) compared to 2001 ($1.1 billion),
partially offset by a higher average effective interest rate on the total debt
outstanding during 2002 (9.3%) compared to 2001 (8.8%) (the New Debt was not
effective until April 17, 2001). In addition, interest expense on the
collateralized mortgage obligations-insured mortgage securities decreased
following significant prepayments of mortgages underlying the insured mortgage
securities discussed previously. The decrease in interest expense on the
collateralized mortgage obligations-insured mortgage securities was partially
offset by approximately $964,000 of additional deferred financing costs and
discount amortization expenses, which are reflected as interest expense. These
additional expenses are the result of the mortgages prepaying faster than
anticipated which, under the effective interest method of recognizing interest
expense, required an adjustment to cumulative interest expense.
The overall weighted average effective interest rate on the New Debt was
10.4% and 10.3% for the three and nine months ended September 30, 2002,
respectively, and the weighted average coupon (pay) rate on the New Debt was
8.1% and 8.0% during the three and nine months ended September 30, 2002,
respectively. The difference in the New Debt's weighted average effective
interest rate and the weighted average coupon (pay) rate primarily relates to
the accrual of estimated potential extension fees and the accrued interest
related to the 7% per annum, accreting interest on the Series B Senior Secured
Notes, both of which are included in the weighted average effective interest
rate, but not included in the weighted average pay rate. The weighted average
effective interest rate on the recourse debt was 11.3% and 9.5% for the three
and nine months ended September 30, 2001, respectively. The weighted average
coupon (pay) rate on the recourse debt was 9.0% and 8.3% for the three and nine
months ended September 30, 2001, respectively.
General and Administrative Expenses
General and administrative expenses decreased by approximately $0.4 million
to $2.8 million during the three months ended September 30, 2002 as compared to
$3.2 million during the three months ended September 30, 2001 primarily due to a
decrease in legal fees in 2002, partially offset by higher directors and
officers liability insurance premiums in 2002.
General and administrative expenses increased by approximately $0.5 million
to $8.7 million during the nine months ended September 30, 2002 as compared to
$8.2 million during the nine months ended September 30, 2001 primarily due to an
increase in employment costs in 2002 compared to 2001 and higher directors and
officers liability insurance premiums in 2002, partially offset by a decrease in
legal fees.
Depreciation and Amortization
Depreciation and amortization was approximately $312,000 and $947,000
during the three months ended September 30, 2002 and 2001, respectively, and
approximately $920,000 and $2.8 million during the nine months ended September
30, 2002 and 2001, respectively. The decreases are primarily attributable to the
Company's adoption of SFAS No. 142, "Goodwill and Other Intangible Assets,"
("SFAS 142") on January 1, 2002. The adoption of SFAS 142 reduced the Company's
amortization expense by approximately $0.7 million and $2.1 million during the
three and nine months ended September 30, 2002, respectively, as compared to
2001. See further discussion of SFAS 142 in "Cumulative Effect of Adoption of
SFAS 142" below.
Equity in Earnings (Losses) from Investments/Servicing Operations
Beginning July 1, 2001, CRIIMI MAE began accounting for CMSLP on a
consolidated basis as opposed to accounting for CMSLP using the equity method.
This change in accounting method was a result of a reorganization in which the
partnership interests of CMSLP are now held by two wholly owned and controlled
taxable REIT subsidiaries ("TRSs") of CRIIMI MAE. Prior to July 1, 2001, CRIIMI
MAE accounted for CMSLP under the equity method as the Company did not control
the voting common stock of the general partner of CMSLP. CMSLP's assets,
liabilities, revenues and expenses are labeled as "servicing" on the Company's
consolidated
financial statements.
The following is a summary of the consolidated results of operations of
CMSLP:
Three months ended September 30, Nine months ended September 30,
Description 2002 2001 2002 2001
----------- ---- ---- ---- ----
CMSLP's results of operations (reflected in
consolidated income statements effective
July 1, 2001):
Servicing revenue $2,976,371 $ 3,353,195 $ 8,233,944 $ 3,353,195
Servicing general and administrative expenses (2,222,008) (2,823,706) (6,847,992) (2,823,706)
Servicing amortization, depreciation and
impairment (508,000) (669,560) (1,418,810) (669,560)
Servicing restructuring expenses -- -- (141,240) --
Servicing gain on sale of servicing rights 34,309 (1) -- 4,851,907 (1) --
----------- ------------- -------------- -------------
GAAP net income (loss) from CMSLP $ 280,672 $ (140,071) $ 4,677,809 $ (140,071)
=========== ============= ============== =============
(1) See also the discussion in "Income Tax Benefit (Expense)," which follows.
The net income from CMSLP of approximately $281,000 for the three months
ended September 30, 2002 compares to a net loss of approximately $(140,000) for
the three months ended September 30, 2001. CMSLP's total revenue decreased by
approximately $0.4 million to approximately $3.0 million during the three months
ended September 30, 2002 compared to $3.4 million during the three months ended
September 30, 2001. This decrease is primarily the result of the sale of
servicing rights which reduced mortgage servicing income and interest income
earned on the escrow balances, partially offset by higher revenue from special
servicing. General and administrative expenses were $2.2 million and $2.8
million during the three months ended September 30, 2002 and 2001, respectively.
The decrease in general and administrative expenses was primarily attributable
to the staff reductions that occurred in the fourth quarter of 2001 and the
first quarter of 2002 following CMSLP's sale of its CMBS master and direct
servicing contracts, as discussed below. During the three months ended September
30, 2002, amortization, depreciation and impairment was approximately $508,000
as compared to $670,000 in 2001. This decrease was primarily the result of the
sale of servicing rights in February 2002, which reduced amortization expense,
and lower impairment on CMBS held by CMSLP during 2002 as compared to 2001,
partially offset by $127,000 of losses from the disposal of fixed assets.
The net income from CMSLP of $4.7 million for the nine months ended
September 30, 2002 compares to the aggregate of the net equity in losses from
CMSLP/CMSI of $(2.3) million for the nine months ended September 30, 2001 (as
summarized below) and the net loss from CMSLP of $(140,000) for the three months
ended September 30, 2001. CMSLP's net income of $4.7 million during the nine
months ended September 30, 2002 includes a $4.9 million gain from the sale of
servicing rights and $141,000 of restructuring expenses. CMSLP's total revenue
decreased by approximately $1.0 million to approximately $8.2 million during the
nine months ended September 30, 2002 compared to $9.2 million during the nine
months ended September 30, 2001. This decrease is primarily the result of the
sale of servicing rights which reduced mortgage servicing income and interest
income earned on the escrow balances, partially offset by higher revenue from
special servicing. General and administrative expenses were $6.8 million and
$9.3 million during the nine months ended September 30, 2002 and 2001,
respectively. The decrease in general and administrative expenses was primarily
attributable to the staff reductions that occurred in the fourth quarter of 2001
and the first quarter of 2002 following CMSLP's sale of its CMBS master and
direct servicing contracts, as discussed below. During the nine months ended
September 30, 2002, amortization, depreciation and impairment was approximately
$1.4 million as compared to $2.4 million during the nine months ended September
30, 2001. This decrease was primarily the result of the sale of servicing rights
in February 2002, which reduced amortization expense, and lower impairment on
CMBS held by CMSLP during 2002 as compared to 2001, partially offset by $127,000
of losses from the disposal of fixed assets.
In February 2002, CMSLP sold all of its rights and obligations under its
CMBS master and direct servicing contracts because the contracts were not
profitable, given the relatively small volume of master and direct CMBS
servicing that CMSLP was performing. In connection with this restructuring, 34
employee positions were eliminated. A restructuring charge of approximately
$438,000 was recorded during the fourth quarter of 2001 to account for employee
severance costs, noncancellable lease costs, and other costs related to the
restructuring. During the three months ended June 30, 2002, additional
restructuring expenses of approximately $141,000 were
recorded primarily to account for vacant office space that is taking longer
to sublease than originally anticipated. CMSLP received approximately $11.8
million in cash in the first quarter of 2002, which included reimbursement of
servicing advances in connection with this sale. CMSLP expects to receive
additional cash of approximately $649,000 from the sale within the next few
months, which assumes that the purchaser will retain approximately $316,000 of
the sales price upon final settlement of the post-closing contingencies. Any
difference in the actual amount retained by the purchaser and CMSLP's estimate
of the amount to be retained as of September 30, 2002 will be reflected as an
adjustment to the gain on the sale of servicing rights in the fourth quarter of
2002.
Total equity in earnings (losses) from investments for the three and nine
months ended September 30, 2002 and 2001 includes CRIIMI MAE's net equity from
the AIM Funds (four limited partnerships that hold investments in insured
mortgages whose general partnership interests are owned by a subsidiary of the
Company) during these periods, and include net equity from CMSLP/CMSI for the
six months ended June 30, 2001 (since CMSLP's operations are consolidated into
CRIIMI MAE effective July 1, 2001). On a comparative basis, the net equity from
the AIM Funds decreased primarily due to a reduction in the AIM Funds' mortgage
assets. The following is a summary of the Company's equity in earnings (losses)
from investments:
Three months ended September 30, Nine months ended September 30,
Description 2002 2001 2002 2001
----------- ---- ---- ---- ----
Equity in Earnings (Losses) from Investments (as
presented on income statements):
The AIM Funds - net equity in income $ 98,005 $ 163,250 $ 330,747 $ 487,847
CMSLP/CMSI - net equity in losses -- -- -- (2,279,138)
---------- --------- --------- ------------
Total Equity in Earnings (Losses) from Investments $ 98,005 $ 163,250 $ 330,747 $(1,791,291)
========== ========= ========= ============
Income Tax Benefit (Expense)
For the three months ended September 30, 2002 and 2001, the Company
recorded an income tax benefit of approximately $481,000 and $0, respectively.
For the nine months ended September 30, 2002 and 2001, the Company incurred net
income tax expense of approximately $428,000 and $0, respectively. During the
nine months ended September 30, 2002, approximately $1.0 million of income tax
expense was recognized as a result of the income taxes on the gain on the sale
by CMSLP of its master and direct servicing rights. This tax expense of $1.0
million was partially offset by tax refunds that were not previously accrued of
approximately $552,000 that were recognized during the three and nine months
ended September 30, 2002. The income tax expense was incurred by the Company
through its TRSs that own partnership interests in CMSLP. These TRSs are
separately taxable entities that cannot use the Company's NOL to reduce their
taxable income.
Other Income
Other income decreased by approximately $228,000 to $712,000 during the
three months ended September 30, 2002 from $940,000 during the same period in
2001. During the nine months ended September 30, 2002, other income decreased by
approximately $1.2 million to $2.1 million from $3.3 million during the same
period in 2001. These decreases were primarily attributable to lower interest
income due to lower cash balances during 2002 as compared to the same periods in
2001.
In October 2001, a wholly owned subsidiary of CRIIMI MAE acquired certain
partnership interests in a partnership that was the obligor on a mezzanine loan
payable to CRIIMI MAE in exchange for curing a default on the first mortgage
loan through a cash payment of approximately $276,000. This partnership and
another wholly-owned subsidiary of CRIIMI MAE own 100% of the partnership
interests in the partnership which is the obligor on the first mortgage loan.
The first mortgage loan is secured by a shopping center in Orlando, Florida
("REO"). As a result of this acquisition, the Company, through certain of its
wholly owned subsidiaries, owns 100% of the partnership interests and is
consolidating its financial results as of October 1, 2001. The Company accounts
for these assets as REO, and the REO is being held for investment. During the
three and nine months ended September 30, 2002, the Company recognized a net
loss of approximately $137,000 and $489,000 from the operations of the REO,
respectively, which includes approximately $215,000 and $642,000 of interest
expense, respectively, and approximately $35,000 and $114,000 of depreciation
expense, respectively. The remaining income of
approximately $113,000 and $267,000 is included in other income in the
consolidated statements of income during the three and nine months ended
September 30, 2002, respectively. The Company hopes to reposition and stabilize
this asset to increase its value, although there can be no assurance the Company
will be able to do so. Currently, the Company expects that it will hold the REO
for more than one year.
Net (Losses) Gains on Mortgage Security Dispositions
Net losses on mortgage security dispositions were approximately $(311,000)
during the three months ended September 30, 2002 compared to approximately
$56,000 of gains during the three months ended September 30, 2001. During the
third quarter of 2002, there were six prepayments of mortgage securities, or
approximately 4.1% of the related portfolio (based on the December 31, 2001 face
amounts of the portfolio). During the third quarter of 2001, there were three
prepayments. In addition, during the three months ended September 30, 2002,
losses of approximately $152,000 were recognized following the final financial
settlement on the two mortgages that were assigned to the U.S. Department of
Housing and Urban Development ("HUD") in 2001. During the nine months ended
September 30, 2002, net losses on mortgage security dispositions were
approximately $(567,000) compared to net gains of approximately $300 during the
nine months ended September 30, 2001. During the nine months ended September 30,
2002 and 2001, there were 19 and five prepayments, respectively. In addition, as
discussed above, the losses on the mortgages assigned to HUD were adjusted
during 2002. The original losses on these two mortgages that were assigned to
HUD were recognized during the nine months ended September 30, 2001. The net
losses in 2002 were primarily due to the write-off of unamortized costs
associated with the disposed mortgages at the disposition dates, partially
offset by prepayment penalties, if applicable. For any period, gains or losses
on mortgage dispositions are based on the number, carrying amounts and proceeds
of mortgages disposed of during the period.
Impairment on CMBS
Although the amount of loans in special servicing declined from $893
million as of June 30, 2002 to $814 million as of September 30, 2002, the
projected loss severities of the underlying mortgage loans currently or
anticipated to be in special servicing have increased and the timing of the
projected losses is anticipated to occur sooner than previously estimated, which
has resulted in an increase in the Company's overall expected loss estimate
related to its Subordinated CMBS portfolio from $351 million to $448 million.
This revision to the overall expected loss estimate is primarily the result of
increased projected loan losses due to lower than anticipated appraisals and
lower internal estimates of values on real estate owned by underlying trusts and
properties underlying certain defaulted mortgage loans, which, when combined
with the updated loss severity experience, has resulted in higher projected loss
severities on loans and real estate owned by underlying trusts currently or
anticipated to be in special servicing. Primary reasons for lower appraisals and
lower estimates of value resulting in higher projected loss severities on loans
include the poor performance of certain properties and related markets, failed
workout negotiations, and extended time needed to liquidate assets due, in large
part, to the continued softness in the economy, the continued downturn in travel
and, in some cases, over-supply of hotel properties, and a shift in retail
activity in some markets, including the closing of stores by certain national
and regional retailers. This increase in expected loss estimates has resulted in
an adverse change in the expected future cash flows for the Company's
unrated/issuer's equity bonds, the CCC bond and the B- bond in CBO-2 as of
September 30, 2002. As a result, the Company believes these bonds have been
impaired under EITF 99-20 and Statement of Financial Accounting Standard
("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," ("SFAS 115") as of September 30, 2002. As the fair values of the
impaired bonds aggregated approximately $29.9 million below the amortized cost
basis as of September 30, 2002, the Company recorded other than temporary
impairment charges through the income statement of that same amount during the
three months ended September 30, 2002.
In addition, the Company also had previously determined that there had been
an adverse change in expected future cash flows for the Nomura and CBO-2 unrated
bonds as of June 30, 2002 due primarily to increased projected loan losses
resulting from lower than anticipated appraisals and revised internal estimates
on properties underlying certain mortgage loans. As a result, the Company
believed the Nomura and CBO-2 unrated bonds had been impaired under EITF 99-20
and SFAS 115 as of June 30, 2002. As the fair values of the impaired Nomura and
CBO-2 unrated bonds aggregated approximately $5.2 million below the amortized
cost basis as of June 30, 2002, the Company recorded other than temporary
non-cash impairment charges through the income statement of that same amount
during the three months ended June 30, 2002.
There can be no assurance that the Company's revised overall expected loss
estimate of $448 million will not be exceeded as a result of additional or
existing adverse events or circumstances. Such events or circumstances include,
but are not limited to, the receipt of new or updated appraisals at lower than
anticipated amounts, legal proceedings (including bankruptcy filings) involving
borrowers, a continued weakening of the economy, an economic downturn or
recession, a delay in the disposition of specially serviced mortgage loans, or
an unforeseen reduction in expected recoveries, any of which could result in
additional future credit losses and/or possible impairment to CRIIMI MAE's
Subordinated CMBS, the effect of which could be potentially adverse to CRIIMI
MAE.
Hedging Expense and Cumulative Effect of Adoption of SFAS 133
In April 2002, CRIIMI MAE entered into a second interest rate protection
agreement. This interest rate protection agreement, or cap, which was effective
on May 1, 2002, is for a notional amount of $175.0 million, caps LIBOR at 3.25%,
and matures on November 3, 2003. The cap was purchased for approximately $1.6
million and has been designated to hedge the Variable-Rate Secured Borrowing.
The fair value of this cap has decreased by approximately $1.1 million to
approximately $55,000 since the purchase date. This decrease is reflected in
other comprehensive income and is attributable to a change in the expectation of
future interest rates since the cap was purchased in April 2002.
During the three months ended September 30, 2002 and 2001, the Company
recognized hedging expense through earnings of approximately $353,000 and
$75,000 on its interest rate caps, respectively. During the nine months ended
September 30, 2002 and 2001, the Company recognized hedging expense through
earnings of approximately $749,000 and $1.0 million, respectively, on its
interest rate caps and a $135,000 loss through earnings due to the adoption of
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities"
("SFAS 133") during the nine months ended September 30, 2001.
The fair value of the first interest rate cap has decreased significantly
due to a decline in interest rates since the cap was purchased in April 2001 for
$1.5 million. This cap is set at a one-month LIBOR rate of 5.25%. As of
September 30, 2002, the one-month London Interbank Offered Rate ("LIBOR") rate
was 1.81%. As of September 30, 2002, this interest rate cap was undesignated. As
a result, all future changes in the fair value will be recognized through
current earnings in the consolidated statements of income. As of September 30,
2002, the fair value of this interest rate cap was $13.
Investment Banking Fees
The Company hired FBR in May 2002 to assist the Company with an evaluation
of strategic alternatives to maximize shareholder value. The investment banking
fees of approximately $439,000 and $683,000 for the three and nine months ended
September 30, 2002, respectively, represent the fees attributable to the
services performed by FBR through September 30, 2002. Additional compensation to
FBR of at least $167,000 is expected to be recognized in the fourth quarter of
2002 in accordance with the terms set forth in the engagement letter.
Reorganization Items
During the three and nine months ended September 30, 2001, the Company
expensed approximately $464,000 and $1.9 million, respectively, of
reorganization items due to the Chapter 11 bankruptcy proceedings. During 2002,
there were no expenses related to the Chapter 11 bankruptcy proceedings.
Emergence Financing Origination Fee
In connection with the emergence from Chapter 11 bankruptcy reorganization,
in April 2001, the Company paid a one-time emergence financing origination fee
of approximately $3.9 million related to its Variable-Rate Secured Borrowing.
GAAP required such fee to be expensed immediately.
Cumulative effect of adoption of SFAS 142
In June of 2001, the FASB issued SFAS 142. SFAS 142, among other things,
prohibits the amortization of existing goodwill and certain types of other
intangible assets and establishes a new method of testing goodwill for
impairment. Under SFAS 142, the method for testing goodwill for impairment
occurs at the reporting unit level (as defined in SFAS 142) and is performed
using a fair value based approach. SFAS 142 was effective for the Company on
January 1, 2002. Effective upon adoption on January 1, 2002, the Company wrote
off this goodwill and recorded a resulting impairment charge of approximately
$9.8 million for this change in accounting principle. The goodwill relates to
the Portfolio Investment reporting unit (as defined in Note 14 of the Notes to
Consolidated Financial Statements). The fair value of the reporting unit was
determined using a market capitalization approach and the impairment was
primarily a result of the significant decrease in the Company's common stock
price since the Company's merger of certain mortgage businesses affiliated with
C.R.I., Inc. (the "Merger") in 1995. This change in accounting principle will
reduce the Company's annual amortization expense by approximately $2.8 million.
REIT Status and Other Tax Matters
REIT Status. CRIIMI MAE is required to meet income, asset, ownership and
distribution tests to maintain its REIT status. Although there can be no
assurance, the Company believes that it has satisfied the REIT requirements for
all years through, and including 2001. There can also be no assurance that
CRIIMI MAE will maintain its REIT status for 2002 or subsequent years. If the
Company fails to maintain its REIT status for any taxable year, it will be taxed
as a regular domestic corporation subject to federal and state income tax in the
year of disqualification and for at least the four subsequent years. Depending
on the amount of any such federal and state income tax, the Company may have
insufficient funds to pay any such tax and also may be unable to comply with its
obligations under the New Debt.
The Company's Net Operating Loss for Tax Purposes/Shareholder Rights Plan
In 2000, the Company began trading in both short and longer duration fixed
income securities, including non-investment grade and investment grade CMBS and
investment grade residential mortgage-backed securities (such securities traded
and all other securities of the type described constituting the "Trading Assets"
to the extent owned by CRIIMI MAE Inc. or any qualified REIT subsidiary, meaning
generally any wholly owned subsidiary that is not a taxable REIT subsidiary
("Other MBS")), which, for financial reporting purposes, are classified as
Subordinated CMBS and Other MBS on the balance sheet. The Company seeks maximum
total return through short term trading, consistent with prudent investment
management. Returns from such activities include capital
appreciation/depreciation resulting from changes in interest rates and spreads,
if any, and other arbitrage opportunities.
As a result of its trader election in 2000, CRIIMI MAE recognized a
mark-to-market tax loss in its income tax return on its Trading Assets on
January 1, 2000 of approximately $478 million (the "January 2000 Loss"). Such
loss is expected to be recognized evenly for tax purposes over four years
beginning with the year 2000 (i.e., approximately $120 million per year). The
Company expects such loss to be an ordinary loss for tax purposes. Additionally,
as a result of its trader election, the Company is required to mark-to-market
its Trading Assets on a tax basis at the end of each tax year. Any increase or
decrease in the value of the Trading Assets as a result of the year-end
mark-to-market requirement will generally result in either a tax gain (if an
increase in value) or a tax loss (if a decrease in value). Such tax gains or
losses, as well as any realized gains or losses from the disposition of Trading
Assets during each year, are also expected to be ordinary gains or losses.
Assets transferred to CBO REIT, a subsidiary of the Company, as part of the
Company's Chapter 11 reorganization plan (the "Reorganization Plan") are no
longer required to be marked-to-market on a tax basis since CBO REIT is not a
trader in securities for tax purposes. As a result, the mark-to-market of such
assets ceased as of April 17, 2001.
Since gains and losses associated with trading activities are expected to
be treated as ordinary, any gains will generally increase taxable income and any
losses will generally decrease taxable income. Because the REIT rules generally
require the Company to distribute 90% of its taxable income to shareholders, any
increases in taxable income from trading activities will generally result in an
increase in REIT distribution requirements and any
decreases in taxable income from trading activities will generally result
in a decrease in REIT distribution requirements (or, if taxable income is
reduced to zero because of a net operating loss or loss carry forward, eliminate
REIT distribution requirements).
Gains and losses from the mark-to-market requirement (including the January
2000 Loss) are unrealized. This creates a mismatch between REIT distribution
requirements and cash flow since the REIT distribution requirements will
generally fluctuate due to mark-to-market adjustments, but the cash flow from
the Company's Trading Assets will not fluctuate as a result of mark-to-market
adjustments.
The Company generated a net operating loss for tax purposes of
approximately $90.7 million for the year ended December 31, 2001. As such, the
Company's taxable income was reduced to zero and, accordingly, the Company's
REIT distribution requirement was eliminated for 2001. As of December 31, 2001,
the Company's accumulated and unused net operating loss ("NOL") was $140.2
million. Any accumulated and unused net operating losses, subject to certain
limitations, generally may be carried forward for up to 20 years to offset
taxable income until fully utilized. Accumulated and unused net operating losses
cannot be carried back because CRIIMI MAE is a REIT. If a Trading Asset is
marked down because of an increase in interest rates, rather than from credit
losses, such mark-to-market losses may be recovered over time through taxable
income. Any recovered mark-to-market losses will generally be recognized as
taxable income, although there is expected to be no corresponding increase in
cash flow. See also the discussion that follows with respect to the remaining
January 2000 Loss.
There can be no assurance that the Company's position with respect to its
election as a trader in securities will not be challenged by the Internal
Revenue Service ("IRS"), and, if challenged, will be defended successfully by
the Company. As such, there is a risk that the January 2000 Loss will be limited
or disallowed, resulting in higher tax basis income and a corresponding increase
in REIT distribution requirements. It is possible that the amount of any
under-distribution for a taxable year could be corrected with a "deficiency
dividend" as defined in Section 860 of the Internal Revenue Code of 1986, as
amended (the "Tax Code"), however, interest may also be due to the IRS on the
amount of this under-distribution.
If CRIIMI MAE is required to make taxable income distributions to its
shareholders to satisfy required REIT distributions, all or a substantial
portion of these distributions, if any, are currently expected to be in the form
of non-cash dividends. There can be no assurance that such non-cash dividends
would satisfy the REIT distribution requirements and, as such, the Company could
lose its REIT status or may not be able to satisfy its obligations under the
operative documents evidencing the New Debt.
The Company's future use of NOLs for tax purposes could be substantially
limited in the event of an "ownership change" as defined under Section 382 of
the Tax Code. As a result of these limitations imposed by Section 382 of the Tax
Code, in the event of an ownership change, the Company's ability to use its NOL
carryforwards in future years may be limited and, to the extent the NOL
carryforwards cannot be fully utilized under these limitations within the
carryforward periods, the NOL carryforwards would expire unutilized.
Accordingly, after any ownership change, the Company's ability to use its NOLs
to reduce or offset taxable income would be substantially limited or not
available under Section 382. In general, a company reaches the "ownership
change" threshold if the "5% shareholders" increase their aggregate ownership
interest in the company over a three-year testing period by more than 50
percentage points. The ownership interest is measured in terms of total market
value of the Company's capital stock.
The Company is not aware of any acquisition of shares of its capital stock
that has created an "ownership change" under Section 382 of the Tax Code.
Currently, the Company does not know of any potential acquisition of shares of
its capital stock that will create an "ownership change" under Section 382 of
the Tax Code. The Company adopted a shareholder rights plan in January 2002 and
amended its corporate charter in May 2002 to allow it to minimize the chance of
an ownership change within the meaning of Section 382 of the Tax Code. There can
be no assurance that an ownership change will not occur.
If an "ownership change" occurs under Section 382 of the Tax Code, the
Company's prospective use of its accumulated and unused NOL and the remaining
January 2000 Loss, representing a combined total amount of approximately $350.7
million (as of September 30, 2002), will be limited. If the Company had lost its
ability to use its accumulated NOL as of January 1, 2001, the Company's taxable
income would have been $28.8 million for the
year ended December 31, 2001. This increase in taxable income would have
created a requirement to distribute 100 percent of this income to the Company's
shareholders in order to avoid any REIT-level income taxes. If the Company was
unable to distribute the taxable income to its shareholders, it would have been
subject to corporate Federal and state income taxes of up to approximately $11.8
million for the year ended December 31, 2001.
Net Operating Loss for Tax Purposes-Nine months ended September 30, 2002.
CRIIMI MAE generated a net operating loss for tax purposes of approximately
$61.1 million during the nine months ended September 30, 2002.
As previously discussed, as a result of its trader election in early 2000,
CRIIMI MAE recognized a mark-to-market tax loss of approximately $478 million on
certain Trading Assets on January 1, 2000. The January 2000 Loss is expected to
be recognized evenly over four years (2000, 2001, 2002, and 2003) for tax
purposes (i.e., approximately $120 million per year) beginning with the year
2000.
A summary of the Company's year-to-date net operating loss as of
September 30, 2002 is as follows:
(in millions)
-------------
January 2000 Loss $ (478.2)
LESS: Amounts recognized in 2001 and 2000 239.1
LESS: Amounts recognized during the nine months ended September 30, 2002 89.7
----------
Balance remaining of January 2000 Loss to be recognized in future periods $ (149.4)
==========
Taxable income for the nine months ended September 30, 2002 before recognition $ 28.6
of January 2000 Loss
LESS: January 2000 Loss recognized during the nine months ended September 30, 2002 (89.7)
----------
Net Operating Loss for the nine months ended September 30, 2002 $ (61.1)
==========
Accumulated Net Operating Loss through December 31, 2001 $ (140.2) (1)
Net Operating Loss created during the nine months ended September 30, 2002 (61.1)
Net Operating Loss utilization -
----------
Net Operating Loss carried forward for use in future periods $ (201.3)
==========
(1) The accumulated NOL as of December 31, 2001 has been reduced by $6.3
million to reflect the actual NOL included on the Company's 2001 income
tax return, which was completed during the third quarter of 2002.
Cash Flow
2002 compared to 2001
Net cash provided by operating activities decreased by approximately $8.3
million to $46.2 million during the nine months ended September 30, 2002 from
$54.5 million during the nine months ended September 30, 2001. The decrease was
primarily attributable to a smaller decrease in restricted cash and cash
equivalents and an increase in receivables and other assets during 2002 compared
to a decrease in 2001, partially offset by a smaller decrease in accounts
payable and accrued expenses and lower net purchases of Other MBS during 2002.
The 2002 results reflect a decrease in restricted cash and accounts payable and
accrued expenses following the settlement of the First Union litigation in March
2002. The 2001 decrease in receivables and other assets reflects the January
2001 receipt of funds withheld related to the Company's interest in CMO-IV. The
2001 results also reflect a decrease in restricted cash and accounts payable and
accrued expenses caused by cash outflows on the Effective Date, including
approximately $44.7 million to pay off accrued interest on debt incurred prior
to the Chapter 11 filing, $3.9 million to pay an emergence financing origination
fee related to a portion of the New Debt, and $7.4 million to pay accrued
payables related to the Chapter 11 filing.
Net cash provided by investing activities increased by approximately $19.3
million to $57.2 million during the nine months ended September 30, 2002 from
$37.9 million during the nine months ended September 30, 2001. The increase was
primarily attributable to a $22.3 million increase in proceeds from mortgage
security prepayments and $8.2 million of proceeds from the sale by CMSLP of its
servicing rights (excludes reimbursement of advances,
which are included in operating cash flows) during 2002, partially offset
by $9.9 million of cash that CMSLP invested in investment-grade CMBS.
Net cash used in financing activities decreased by approximately $81.2
million to $98.2 million during the nine months ended September 30, 2002 from
$179.5 million during the nine months ended September 30, 2001. The decrease in
cash used is primarily attributable to an outflow of cash of approximately
$127.2 million on the Effective Date in April 2001, which was used to pay off a
portion of the aggregate principal relating to debt incurred prior to the
Chapter 11 filing. During 2002 there was $18.7 million paid to redeem the Series
E Preferred Stock, a $12.5 million increase in principal payments on the New
Debt, and a $19.8 million increase in principal payments on the securitized
mortgage debt obligations due primarily to higher mortgage security dispositions
in 2002. On March 21, 2002, the Company redeemed all 173,000 outstanding shares
of its Series E Preferred Stock at the stated redemption price of $106 per share
plus accrued and unpaid dividends through and including the date of redemption.
The total redemption price was approximately $18.7 million (approximately
$396,000 of which represented accrued and unpaid dividends). The approximate
$1.0 million difference between the aggregate liquidation value and the
redemption price is reflected as a dividend on preferred stock in the first
quarter of 2002.
The following table, which is intended to provide a clearer understanding
of net cash flows, but which is not presented in accordance with GAAP, provides
a summary of CRIIMI MAE's net operating cash flows for the three months ended
September 30, 2002 and June 30, 2002 (in millions):
Three months Three months
ended 09/30/02 ended 06/30/02
-------------- --------------
Net cash flows (1)(4):
CMBS cash inflows (BB+ through unrated) (2) $ 17.5 $18.1
Other cash, net 1.7 2.5
Interest expense paid on Variable-Rate
Secured Borrowing (2.9) (3.1)
Interest expense paid on Series A Senior Secured Notes (2.8) (2.9)
Interest expense accrued for Series B Senior Secured
Notes' semi-annual payment (2.2) (2.1)
General and administrative expenses (2.8) (3.0)
------- -----
Net cash flows during the quarter $ 8.5 $ 9.5
======= =====
Principal payments on New Debt:
Variable-Rate Secured Borrowing $ 7.4 (3) $ 7.2 (3)
Series A Senior Secured Notes 1.4 2.2
------- -----
Total principal payments on New Debt during the
quarter $ 8.8 $ 9.4
======= =====
(1) Virtually all cash flows relating to existing assets are, and are
currently expected to be (assuming the Company remains obligated under
the New Debt), used to satisfy principal, interest and fee obligations
under the New Debt, and to pay general and administrative and other
operating expenses of the Company. Therefore, although the Company
continues to pay down its New Debt obligations, the utilization of cash
flows for debt service and operating expenses currently results in
virtually no remaining net cash flow available for other activities.
(2) The Company believes total CMBS cash inflows will decline in 2003 as
compared to 2002 due primarily to an anticipated increase in losses on
Subordinated CMBS.
(3) For the three months ended September 30, 2002, the Company paid $7.4
million in principal payments on the Variable-Rate Secured Borrowing,
which is $4.6 million in excess of the minimum principal payment
requirement of $2.8 million based upon a 15-year amortization schedule
for the same three month period.
(4) The Company expects to pay a total of approximately $1.0 million in
2002 to service the mortgage debt on its REO and to fund capital
improvements, because the REO is not projected to generate sufficient
operating income in 2002 to service its mortgage debt or fund its
capital improvements.
Financial Condition, Liquidity and Capital Resources
Limited Summary of New Debt
The following limited summary of the New Debt is qualified by reference to
the operative documents evidencing the New Debt. The Variable-Rate Secured
Borrowing provides for (i) interest at a rate of one month London Interbank
Offered Rate ("LIBOR") plus 3.25% payable monthly, (ii) principal
repayment/amortization obligations, including, without limitation, a requirement
to pay down an aggregate $50 million in principal by April 16, 2003 (the failure
to pay down this amount will not constitute an event of default but will result
in the continuation or reinstatement of certain restrictions and additional
restrictions), (iii) extension fees of 1.5% of the unpaid principal balance
payable at the end of 24, 30, 36 and 42 months after the Effective Date and (iv)
maturity on April 16, 2005 assuming the Company exercises its options to extend
the maturity date of the debt. The Series A Senior Secured Notes provides for
(i) interest at a rate of 11.75% per annum payable monthly, (ii) principal
repayment/amortization obligations, including, without limitation, a principal
payment obligation of $5 million due April 15, 2003 (the failure to make this
payment will not constitute an event of default but will result in a 200 basis
point increase in the interest rate on the unpaid principal amount if certain
miscellaneous collateral is not sold or otherwise disposed of), (iii) extension
fees of 1.5% of the unpaid principal balance payable at the end of 48, 54 and 60
months after the Effective Date and (iv) maturity on April 15, 2006. The Series
B Senior Secured Notes provides for (i) interest at a rate of 13% per annum
payable semi-annually with additional interest at the rate of 7% per annum
accreting over the debt term, (ii) extension fees of 1.5% of the unpaid
principal balance payable at the end of 48, 54 and 60 months after the Effective
Date (with the payment 60 months after the Effective Date also including an
amount based on the unpaid principal balance 66 months after the Effective Date)
and (iii) maturity on April 15, 2007. The New Debt described above is secured
directly or indirectly by substantially all of the Company's assets. There are
restrictive covenants, including financial covenants and certain restrictions
and requirements with respect to cash accounts and the collection, management,
use and application of funds in connection with the New Debt.
The terms of the New Debt significantly restrict the amount of cash
dividends that can be paid to shareholders. One such restriction provides that
any cash dividends required to maintain REIT status (assuming the Company has
the cash to make such distributions and that it is permitted to make such
distributions under the terms of the New Debt) would be paid first to holders of
certain of the New Debt who convert their secured notes into one or two new
series of preferred stock, which new series of preferred stock would be senior
to all other series of preferred stock of the Company, in the form of redemption
payments. Another such restriction provides that if total realized losses and
appraisal reduction amounts with respect to mortgage loans underlying the
Company's Subordinated CMBS (as determined under the New Debt operative
documents) exceed certain loss threshold amounts, then the Company is prohibited
from paying cash dividends or making other cash distributions or payments to its
shareholders, except as required to maintain REIT status, with any such cash
distributions to be paid in accordance with the terms set forth in the preceding
sentence. As of September 30, 2002, the Company had exceeded the loss threshold
amounts under the applicable operative documents evidencing the New Debt.
Exceeding such loss threshold amounts has also resulted in restrictions on the
acquisition of CMBS rated "B" or lower or unrated. Additional restrictions
include restrictions on the use of proceeds from equity investments in the
Company and specified cash flows from certain assets acquired after the
Effective Date. The restrictions implemented as a result of exceeding the loss
threshold amounts cease to apply after total realized losses and appraisal
reduction amounts no longer exceed the loss threshold amounts under the
applicable operative documents evidencing the New Debt.
Although there can be no assurance, the Company believes that it will have
sufficient cash resources to pay interest, scheduled principal and any other
required payments on the New Debt through 2003. The Company's ability to meet
its debt service obligations under the New Debt through 2003 will depend on a
number of factors, including management's ability to maintain cash flow (which
is impacted by, among other things, the credit performance of the underlying
mortgage loans) and to generate capital internally from operating and investing
activities and expected reductions in REIT distribution requirements to
shareholders due to expected net operating losses for tax purposes, in each case
consistent with the terms of the operative documents governing the New Debt.
There can be no assurance that targeted levels of cash flow will actually be
achieved, that reductions in REIT distribution requirements will be realized, or
that, if required, new capital will be available to the Company. The Company's
ability to maintain or increase cash flow and access new capital will depend
upon, among other things,
interest rates, prevailing economic conditions, covenants and restrictions
under the operative documents evidencing the New Debt, and other factors, many
of which are beyond the control of the Company. The Company's cash flow will
also be negatively affected by appraisal reductions on properties underlying the
Subordinated CMBS and realized losses on Subordinated CMBS. The Company expects
losses on CMBS to increase in 2003; accordingly CMBS cash flows are expected to
decrease in 2003 as compared to 2002. In addition, the Company's cash flows will
be affected by prepayments of mortgages underlying the Company's insured
mortgage securities and prepayments of mortgages held by the AIM Funds.
Prepayments of mortgages underlying the insured mortgage securities and the AIM
Funds will result in reductions in the respective mortgage bases. Accordingly,
the net cash flows to CRIIMI MAE, after any required debt paydown, are likely to
decrease over time. See also the effect on interest expense paid on the
Variable-Rate Secured Borrowing attributable to changes in one-month LIBOR
discussed in "Quantitative and Qualitative Disclosures About Market Risk". The
Company's high level of debt limits its ability to obtain additional capital,
significantly reduces income available for other activities, restricts the
Company's ability to react quickly to changes in its business, limits its
ability to hedge its assets and liabilities, and makes the Company more
vulnerable to economic downturns. Additionally, there can be no assurance that
the Company will be able to refinance all or any portion of the New Debt at or
prior to maturity on terms favorable to it, or on any terms at all. As discussed
below under "Recent Developments," the Company is proceeding with a proposed
transaction which contemplates, among other matters, the refinancing of the New
Debt. There can be no assurance that this transaction will be completed.
The Company's ability to resume the acquisition of Subordinated CMBS, as
well as its securitization programs (if it determines to do so) depends, among
other things, on its ability to engage in such activities under the terms and
conditions of the operative documents evidencing the New Debt (and/or any debt
incurred to refinance all or any portion of the New Debt) and its ability to
access additional capital (including for the purpose of refinancing all or any
portion of the New Debt). Factors which could affect the Company's ability to
access additional capital include, among other things, the cost and availability
of such capital, changes in interest rates and interest rate spreads, changes in
the commercial mortgage industry and the commercial real estate market, the
effects of terrorism, general economic conditions, perceptions in the capital
markets of the Company's business, covenants and restrictions under the
operative documents evidencing the New Debt (or any debt incurred to refinance
all or any portion of such New Debt), results of the Company's operations, and
the Company's financial leverage, financial condition, and business prospects.
The Company can give no assurance as to whether it will be able to resume its
prior activities or obtain additional capital or the terms of any such capital.
As discussed above, CRIIMI MAE is currently prohibited from acquiring CMBS rated
"B" or lower or unrated under certain documents evidencing the New Debt.
Summary of Cash Position and Shareholders' Equity
As of September 30, 2002, CRIIMI MAE's restricted and unrestricted cash and
cash equivalents aggregated approximately $23.6 million, which includes $3.6
million of accrued interest on the Series B Senior Secured Notes held in reserve
and payable on October 15, 2002. Additionally, CMSLP had cash and cash
equivalents of approximately $6.7 million and liquid, investment-grade CMBS of
approximately $9.7 million, at fair value ($9.3 million at amortized cost), as
of September 30, 2002.
As of September 30, 2002 and December 31, 2001, shareholders' equity was
approximately $306.3 million or $17.47 per diluted share and approximately
$261.0 million or $11.54 per diluted share, respectively. After giving effect to
the redemption of the Series E Preferred Stock and the First Union settlement
which occurred in March 2002, the Company's pro forma book value per diluted
share would have been $14.18 as of December 31, 2001. These diluted book value
per share amounts, which are based on shareholders' equity presented in
accordance with GAAP, include, among other things, the net assets related to the
Company's Subordinated CMBS rated A+ through BBB which, although not actually
owned by the Company, are required by GAAP to be included on the Company's
balance sheet (see "Summary of Subordinated CMBS" below for a further
discussion). These assets are reflected at fair values and the related
match-funded debt at amortized cost in accordance with GAAP. The increase in the
diluted book value per share is primarily attributable to an overall increase in
fair value of the Company's Subordinated CMBS and insured mortgage securities
primarily due to a decrease in long-term interest rates as of September 30, 2002
compared to December 31, 2001, partially offset by the net loss to common
shareholders of approximately $29.6 million for the nine months ended September
30, 2002.
Summary of Subordinated CMBS
As of September 30, 2002, the Company owned CMBS rated from A+ to CCC and
unrated with an aggregate fair value amount for purposes of GAAP of
approximately $874 million (representing approximately 68% of the Company's
total consolidated assets), an aggregate amortized cost of approximately $794
million, and an aggregate face amount of approximately $1.5 billion. Such CMBS
represent investments in securities issued in connection with CRIIMI MAE Trust I
Series 1996-C1 ("CBO-1"), CRIIMI MAE Commercial Mortgage Trust Series 1998-C1
("CBO-2") and Nomura Asset Securities Corporation Series 1998-D6 ("Nomura"). The
September 30, 2002 aggregate fair value includes approximately 37% (with a fair
value of approximately $321.2 million) of the Company's CMBS which are rated
BB+, BB, or BB-, 22% (with a fair value of approximately $191.8 million) which
are rated B+, B, B- or CCC and 4% (with a fair value of approximately $31.6
million) which are unrated (collectively referred to as the "Retained
Portfolio"). The remaining CMBS totaling approximately 37% (with a fair value of
approximately $329.5 million) represent investment grade securities that the
Company reflects on its balance sheet as a result of CBO-2 (referred to as the
"Investment Grade Portfolio").
As indicated in footnote 4 to the table below, GAAP requires the Investment
Grade Portfolio to be included as assets on the Company's balance sheet
(reflected as "Subordinated CMBS pledged to Secure Securitized Mortgage
Obligation-CMBS") and the related liability to be included on the balance sheet
(reflected as "collateralized bond obligations - CMBS"). All cash flows related
to the Investment Grade Portfolio are used to service the corresponding debt. As
a result, the Company currently receives no economic benefit from the Investment
Grade Portfolio. As of September 30, 2002, the weighted average interest rate
and the weighted average lives of the securities in the Investment Grade
Portfolio and the Retained Portfolio were 7.0% and 5.5%, respectively, and 8.2
years and 13.6 years, respectively.
The aggregate investment by the rating of the Subordinated CMBS is as
follows:
Discount Rate
or Range of
Weighted Discount Rates
Face Amount Average Fair Value Used to Amortized Cost Amortized Cost
as of Pass-Through Weighted as of Calculate as of 9/30/02 as of 12/31/01
Security Rating 9/30/02 (in Rate Average 9/30/02 (in Fair Value (in millions) (in millions)
millions) 9/30/02 Life (1) millions) as of 9/30/02 (5) (6)
- --------------------------------------------------------------------------------------------------------------------
Investment Grade Portfolio
- --------------------------
A+ (4) $ 62.6 7.0% 4 years $ 66.2 5.2% $ 59.2 $ 58.7
BBB+ (4) 150.6 7.0% 9 years 152.2 6.9% 132.0 131.1
BBB (4) 115.2 7.0% 10 years 111.1 7.5% 95.0 94.2
Retained Portfolio
- ------------------
BB+ 319.0 7.0% 11 years 246.0 10.6%-10.9% 222.0 219.0
BB 70.9 7.0% 11 years 51.7 11.4% 46.6 46.0
BB- 35.5 7.0% 12 years 23.5 12.7% 20.7 20.5
B+ 88.6 7.0% 12 years 48.5 15.5% 45.9 45.2
B 177.2 7.0% 13 years 87.3 16.5%-17.0% 84.8 83.7
B- (2) 118.3 7.1% 14 years 47.7 19.8%-20.1% 47.6 48.1
CCC (3) 70.9 7.0% 15 years 8.3 63.9% 8.3 13.1
Unrated/Issuer's
Equity (1)(3) 340.8 1.7% 18 years 31.6 50.2%-217.2% 31.6 62.8
-------- ------- ------- -------
Total (8) $1,549.6 5.9% 13 years $874.1 (8) $793.7 (7) $ 822.4
======== ======= ======= =======
(1) Weighted average life represents the weighted average expected life of the
Subordinated CMBS prior to the consideration of losses,
extensions, or prepayments. The weighted average life of the Subordinated
CMBS may be significantly shorter, particularly with respect to the
unrated/issuer's equity in Nomura (face amount of $45.7 million), CBO-1
(face amount of $85.2 million) and CBO-2 (face amount of $209.9 million),
based on the Company's current loss expectations which are greater than
the outstanding face amount of such securities. As of September 30, 2002,
the fair value of the unrated/issuer's equity in Nomura, CBO-1, and CBO-2
were derived solely from interest cash flow anticipated to be received
since the Company's current loss expectation assumes that the full
principal amount of these securities will not be recovered. See also
"Advance Limitations, Appraisal Reductions and Losses on CMBS" below.
(2) As of September 30, 2002, the Company's Subordinated CMBS from CBO-1 and
CBO-2 currently rated B- have stated coupon rates of 8.0% and 7.0%,
respectively, while the weighted average net coupon rates of the CMBS
underlying CBO-1 and CBO-2 are approximately 9.05% and 8.37%, respectively
(prior to the consideration of losses, prepayments and extensions on the
underlying mortage loans). The Company's Subordinated CMBS may experience
interest shortfalls when the weighted average net coupon rate on the
underlying CMBS is less than the weighted average stated coupon payments
on the Company's Subordinated CMBS. Such interest shortfalls will
continue to accumulate until they (i) are paid through excess interest
and/or recoveries on the underlying CMBS or (ii) are realized as a loss of
principal on the Subordinated CMBS. Based on the Company's overall
expected loss estimate as of September 30, 2002, the CBO-2 Subordinated
CMBS currently rated B- are expected to incur approximately $18 million of
principal losses directly attributable to accumulated and unpaid interest
shortfalls over their expected lives. Such anticipated losses and
shortfalls have been taken into consideration in the calculations of fair
market values and yields to maturity used to recognize interest income as
of September 30, 2002.
(3) The Subordinated CMBS from CBO-1 and CBO-2 currently rated CCC and unrated
do not have stated coupon rates since the securities are only entitled to
the residual cash flow payments, if any, remaining after paying the
securities with a higher payment priority. As a result, effective coupon
rates on these securities are highly sensitive to the effective coupon
rates and monthly cash flow payments received from the underlying CMBS
that represent the collateral for CBO-1 and CBO-2. Also, based on the
Company's overall expected loss estimate and related principal write-downs
on the Subordinated CMBS as of September 30, 2002, the weighted average
lives of the CBO-2 unrated/issuer's equity and Subordinated CMBS currently
rated CCC are substantially less than the Subordinated CMBS currently
rated B-. The shorter average lives have been taken into consideration in
determining the fair market values and yields to maturity used to
recognize interest income related to these Subordinated CMBS.
(4) In connection with CBO-2, $62.6 million (originally A rated, currently A+
rated) and $60.0 million (originally BBB rated, currently BBB+ rated) face
amount of investment grade securities were sold with call options and $345
million (originally A rated, currently A+ rated) face amount were sold
without call options. Also in connection with CBO-2, in May 1998, the
Company initially retained $90.6 million (originally BBB rated, currently
BBB+ rated) and $115.2 million (originally BBB- rated, currently BBB
rated) face amount of securities, both with call options, with the
intention to sell the securities at a later date. Such sale occurred March
5, 1999. Since the Company retained call options on certain sold bonds
(the A+, BBB+ and BBB bonds), the Company did not surrender control of
these securities pursuant to the requirements of SFAS No. 125 and thus
these securities are accounted for as a financing and not a sale. Since
the transaction is recorded as a partial financing and a partial sale,
CRIIMI MAE has retained the securities with call options in its
Subordinated CMBS portfolio reflected on its balance sheet (previously
referred to as the Investment Grade Portfolio).
(5) Amortized cost reflects impairment charges of approximately $35.0 million
related to the unrated/issuer's equity bonds, the CCC bond and the B- bond
in CBO-2, which were recognized during the nine months ended September 30,
2002. These impairment charges are in addition to the cumulative impairment
charges of approximately $178.1 million that were recognized through
December 31, 2001. The impairment charges are discussed in "Results of
Operations."
(6) Amortized cost reflects approximately $178.1 million of cumulative
impairment charges related to certain CMBS (all bonds except those rated A+
and BBB+), which were recognized through December 31, 2001.
(7) See "REIT Status and Other Tax Matters" for information regarding the
Subordinated CMBS for tax purposes.
(8) As of September 30, 2002, the aggregate fair values of the CBO-1, CBO-2 and
Nomura bonds were approximately $25.0 million, $843.1 million and $6.0
million, respectively.
Determination of Fair Market Value of Subordinated CMBS
The Company's determination of fair market value for its Subordinated CMBS
portfolio is a subjective process. The process begins with the compilation and
evaluation of pricing information (such as nominal spreads to U.S. Treasury
securities or nominal yields) that, in the Company's view, is commensurate with
the market's perception of value and risk of comparable assets. The Company uses
a variety of sources to compile such pricing information including: (i) recent
offerings and/or secondary trades of comparable CMBS securities (i.e.,
securities comparable to the CMBS held in the Company's portfolio or that
represent collateral underlying the Company's CBO-1 and CBO-2 securities), (ii)
communications with dealers and active Subordinated CMBS investors regarding the
pricing and valuation of comparable securities, (iii) institutionally available
research reports, (iv) analyses prepared by the nationally recognized
statistical rating organizations responsible for the initial rating assessment
and on-going surveillance of such securities, and (v) other qualitative and
quantitative factors that may impact the value of the securities such as the
market's perception of the issuers of the Subordinated CMBS and the credit
fundamentals of the commercial real estate underlying each pool of commercial
loans. The Company makes further fair market value adjustments to such pricing
information, which is then used to determine the fair market value of the
Company's Subordinated CMBS using a discounted cash flow
approach. Furthermore, the fair market value for those Subordinated CMBS
incurring principal losses and interest shortfalls (i.e., CBO-2 B-, CCC, and
unrated/issuer's equity bonds) based on the Company's overall expected loss
estimate on the underlying mortgage loans and corresponding interest shortfall
from the Subordinated CMBS are valued at a loss-adjusted yield to maturity
that, in the Company's view, is commensurate with the market's perception of
value and risk of comparable assets, using the same discounted cash flow
approach. Such anticipated principal losses and interest shortfalls have been
taken into consideration in the calculation of fair market values and yields to
maturity used to recognize interest income as of September 30, 2002. Since the
Company calculated the estimated fair market value of its Subordinated CMBS
portfolio as of September 30, 2002 and December 31, 2001, it has disclosed the
range of discount rates by rating category used in determining the fair market
values as of September 30, 2002 in the table above.
The liquidity of the Subordinated CMBS market has historically been
limited. Additionally, during adverse market conditions, the liquidity of such
market has been severely limited. For this reason, among others, management's
estimate of the value of the Company's Subordinated CMBS could vary
significantly from the value that could be realized in a current transaction
between a willing buyer and a willing seller in other than a forced sale or
liquidation.
Mortgage Loan Pool
CRIIMI MAE, through CMSLP, performs servicing functions on commercial
mortgage loans totaling $17.9 billion and $19.3 billion as of September 30, 2002
and December 31, 2001, respectively. The mortgage loans underlying CRIIMI MAE's
Subordinated CMBS portfolio are secured by properties of the types and in the
geographic locations identified below:
9/30/02 12/31/01 9/30/02 12/31/01
Property Type Percentage(i) Percentage(i) Geographic Location(ii) Percentage(i) Percentage(i)
- ------------- ------------- ------------- ------------------- ----------- -------------
Retail............ 31% 30% California.............. 17% 16%
Multifamily....... 28% 29% Texas................... 12% 13%
Hotel............. 15% 14% Florida................. 8% 8%
Office............ 13% 13% Pennsylvania............ 5% 5%
Other (iv)........ 13% 14% Georgia................. 4% 5%
--- --------- Other(iii).............. 54% 53%
Total......... 100% 100% ---- -----------
==== ========= Total............... 100% 100%
==== ===========
(i) Based on a percentage of the total unpaid principal balance of the
underlying loans.
(ii) No significant concentration by region.
(iii) No other individual state makes up more than 5% of the total.
(iv) The Company's ownership interest in one of the 20 CMBS transactions
underlying CBO-2 includes subordinated CMBS in which the Company's
exposure to losses arising from certain healthcare and senior housing
mortgage loans is limited by other subordinated CMBS (referred to herein
as the "Subordinated Healthcare/Senior-Housing CMBS"). The Subordinated
Healthcare/Senior-Housing CMBS are not owned by and are subordinate to
the CMBS owned by CRIIMI MAE in this transaction. As a result, CRIIMI
MAE's investment in such underlying CMBS will only be affected if
interest shortfalls and/or realized losses on such healthcare and senior
housing mortgage loans are in excess of the Subordinated
Healthcare/Senior-Housing CMBS. As of September 30, 2002, the Company
reviewed the loans currently under surveillance by the healthcare and
senior housing mortgage loans servicer. Based on its review as of
September 30, 2002, the Company does not believe that the aggregate
remaining shortfalls and/or realized losses on such healthcare and
senior housing mortgage loans currently in monetary default is greater
than the current outstanding Subordinated Healthcare/Senior-Housing
CMBS. As a result, the Company's current estimate of future credit
losses as of September 30, 2002 does not include any specific provision
for shortfalls and/or realized losses arising from the healthcare and
senior housing mortgage loans currently in monetary default in this CMBS
transaction. It should be noted that changes in the future performance
of the healthcare and senior housing mortgage loans that result in
greater shortfalls and/or losses may result in future specific losses
and/or possible impairment to certain of CRIIMI MAE's Subordinated CMBS.
Specially Serviced Mortgage Loans
CMSLP performs special servicing on the loans underlying CRIIMI MAE's
Subordinated CMBS portfolio. A special servicer typically provides asset
management and resolution services with respect to nonperforming or
underperforming loans within a pool of mortgage loans. When serving as special
servicer of a mortgage loan pool, CMSLP has the authority, subject to certain
restrictions in the applicable CMBS pooling and servicing documents, to deal
directly with any borrower that fails to perform under certain terms of its
mortgage loan, including the failure to make payments, and to manage any loan
workouts and foreclosures. As special servicer, CMSLP earns fee
income on services provided in connection with any loan servicing function
transferred to it from the master servicer. CRIIMI MAE believes that because it
owns the first loss unrated or lowest rated bond of all but one of the CMBS
transactions related to its Subordinated CMBS, CMSLP has an incentive to
efficiently and effectively resolve any loan workouts. As of September 30, 2002
and December 31, 2001, specially serviced mortgage loans included in the
commercial mortgage loans described above are as follows:
9/30/02 12/31/01
------- --------
Specially serviced loans due to monetary default (a) $728.2 million $701.7 million
Specially serviced loans due to covenant default/other 85.4 million 90.0 million
-------------- ----------------
Total specially serviced loans (b) $813.6 million $791.7 million
============== ================
Percentage of total mortgage loans (b) 4.6% 4.1%
============== ================
(a) Includes $121.5 million and $94.5 million, respectively, of real estate
owned by underlying trusts. See also the table below regarding property
type concentrations for further information on real estate owned by
underlying trusts.
(b) As of October 31, 2002, total specially serviced loans were approximately
$806 million, or 4.6% of the total mortgage loans. See discussion below for
additional information regarding specially serviced loans.
The specially serviced mortgage loans as of September 30, 2002 were secured
by properties of the types and located in the states identified below:
Property Type $ (in millions) Percentage Geographic Location $ (in millions) Percentage
- ------------- --------------- ---------- ------------------- --------------- ----------
Hotel........... $ 464.3 (1) 57% Florida............... $ 140.4 17%
Retail.......... 226.7 (2) 28% Oregon................ 92.6 11%
Multifamily..... 47.6 6% Texas................. 67.4 8%
Healthcare...... 25.1 3% New York.............. 43.2 5%
Office.......... 22.8 3% California............ 37.0 5%
Industrial...... 17.4 2% Georgia............... 32.7 4%
Other........... 9.7 1% Other................. 400.3 50%
--------- ---------- -------- --------
Total......... $ 813.6 100% Total............... $ 813.6 100%
========= ========== ======== ========
(1) Approximately $70.9 million of these loans in special servicing are real
estate owned by underlying trusts.
(2) Approximately $29.4 million of these loans in special servicing are real
estate owned by underlying trusts.
As reflected above, as of September 30, 2002, approximately $464.3 million,
or 57%, of the specially serviced mortgage loans are secured by mortgages on
hotel properties. The hotel properties that secure the mortgage loans underlying
the Company's Subordinated CMBS portfolio are geographically diverse, with a mix
of hotel property types and franchise affiliations. Of the mortgage loans
underlying the Company's Subordinated CMBS, loans representing a total
outstanding principal amount of $1.2 billion, or 46% of the hotel loans, are
secured by limited service hotels, of which $280.2 million are in special
servicing as of September 30, 2002. Limited service hotels are generally hotels
with room-only operations or hotels that offer a bedroom and bathroom, but
limited other amenities, and are often in the budget or economy group. Of the
mortgage loans underlying the Company's Subordinated CMBS, loans representing a
total outstanding principal amount of $1.5 billion, or 54% of the hotel loans,
are secured by full service hotels, of which $184.1 million are in special
servicing as of September 30, 2002. Full service hotels are generally mid-price,
upscale or luxury hotels with restaurant and lounge facilities and other
amenities. Of the $464.3 million of hotel loans in special servicing as of
September 30, 2002, approximately $302.4 million, or 65%, relate to four
borrowing relationships more fully described as follows:
o 25 loans totaling $97.8 million spread across four CMBS transactions
secured by hotel properties throughout the U.S. In one of these CMBS
transactions, which contains 10 loans totaling $39.0 million, the
Company holds only a 25% ownership interest in the non-rated class. In
the other three CMBS transactions, the Company holds a 100% ownership
interest in the non-rated class. The 25 loans were transferred into
special servicing in December 2001 due to the bankruptcy filing of each
special purpose borrowing entity and their parent company. The parent
company was able to obtain debtor-in-possession financing. The
borrowers are currently paying post-petition interest on $71 million of
these loans. The properties relating to the remaining $27 million of
loans were deemed by the borrowers to be highly
leveraged, and therefore, not able to support additional debt.
Interest is not being paid current on these loans, and consensual
resolution and emergence strategies are being negotiated. Based on
current negotiations and estimates of property values and potential
recoveries related to these loans at the completion of the expected
workout period, the Company's revised estimate of future credit losses
includes $9.9 million arising from these mortgage loans currently in
special servicing. This loss estimate represents an increase of
$6.8 million over the previous loss estimate of $3.1 million primarily
due to a change in the borrowers' bankruptcy plan providing for the
transfer by the borrowers to the lender of title to the properties
underlying the highly leveraged loans. The increased estimated loss is
intended to allow for a longer period of holding the properties and the
related costs of operating the properties and maintaining appropriate
franchise affiliations during a marketing and sale period. Under the
initial proposed plan, a portion of these costs were to be borne by the
borrowers.
o 27 loans totaling $139.3 million spread across three CMBS transactions
secured by hotel properties in the west and Pacific northwest states.
The borrower has filed for bankruptcy protection. The borrower has
indicated that the properties have experienced reduced operating
performance due to new competition, the economic recession, and reduced
travel resulting from the September 11, 2001 terrorist attacks. Based
upon the current estimate of potential recoveries on these loans, which
in turn is based on the Company's estimates of property values and
pending additional developments in the bankruptcy proceedings, the
Company's current estimate of future credit losses includes
approximately $5.5 million arising from these mortgage loans currently
in special servicing. This loss estimate is unchanged from the
previous loss estimate. In calculating estimated recoveries,
management considered potential additional recoveries available because
of the cross collateralization of certain of these loans as well as
other factors specific to the bankruptcy filing. The Company expects
to reevaluate recoveries on these loans within approximately 60 days,
after the acceptance of final appraisals, which have been delayed since
their initial projected date of receipt.
o Five loans totaling $45.9 million secured by hotel properties in
Florida and Texas. The loans are past due for the February 2002 and all
subsequent payments. Currently, there is approximately $3.5 million of
insurance proceeds in escrow that can be used to pay amounts
outstanding, including, but not limited to, expenses and principal and
interest payments. Based upon current negotiations and appraised values
of these properties, the Company's current estimate of future credit
losses includes $7.3 million arising from these mortgage loans
currently in special servicing. This loss estimate is unchanged from
the previous loss estimate.
o Nine loans totaling $19.4 million secured by limited service hotels in
midwestern states. The loans are past due for the April 2002 and all
subsequent payments. The borrower cites reduced occupancy related to
the recent downturn in travel as the cause for a drop in operating
performance at the properties. CMSLP is attempting to negotiate a
workout with the borrower. Based on current negotiations and appraised
values of these properties, the Company's current estimate of future
credit losses does not include any provision for losses arising from
these mortgage loans currently in special servicing.
There can be no assurance that the Company's estimate of future credit
losses related to any one or more of the foregoing mortgage loans or other
mortgage loans underlying the Company's Subordinated CMBS will not be exceeded
as a result of additional or existing adverse events or circumstances. Such
events or circumstances include, but are not limited to, the receipt of new or
updated appraisals at lower than anticipated amounts, legal proceedings
(including bankruptcy filings) involving borrowers, a continued weakening of the
economy, an economic downturn or recession, a delay in disposition of specially
serviced mortgage loans, additional defaults, or an unforeseen reduction in
expected recoveries, any of which could result in additional future credit
losses and/or possible impairment to CRIIMI MAE's Subordinated CMBS, the effect
of which could be potentially adverse to CRIIMI MAE.
The following table provides a summary of the change in the balance of
specially serviced loans from June 30, 2002 to September 30, 2002 and from March
31, 2002 to June 30, 2002:
6/30/02 3/31/02
to to
9/30/02 6/30/02
--------- ------------
(in millions)
Specially Serviced Loans, beginning of period $ 892.7 $ 898.9
Transfers in due to monetary default 53.7 48.4
Transfers in due to covenant default and other 0.8 4.2
Transfers out of special servicing (129.4) (2) (54.2)
Loan amortization (1) (4.2) (4.6)
--------- ------------
Specially Serviced Loans, end of period $ 813.6 $ 892.7
========= ============
(1) Represents the reduction of the scheduled principal balances due to
advances made by the master servicers.
(2) During the three months ended September 30, 2002, loans totaling
approximately $52 million of the $129.4 million related to a portfolio of
retail property loans transferred out of special servicing.
For all loans in special servicing, CMSLP is pursuing remedies available to
it in order to maximize the recovery of the outstanding debt. See Exhibit 99.1
to this Quarterly Report on Form 10-Q for a detailed listing of all specially
serviced loans underlying the Company's Subordinated CMBS.
Advance Limitations, Appraisal Reductions and Losses on CMBS
The Company experiences shortfalls in expected cash flow on its securities
prior to the recognition of a realized loss primarily due to: (i) servicing
advance limitations to the most subordinate securities (only in certain
underlying CMBS transactions), or (ii) appraisal reductions. The servicing
advance limitations permit the master servicer (in those certain underlying CMBS
transactions) to make only one principal and interest advance with regard to a
delinquent mortgage loan. All future advances are reduced up to the aggregate
amount of the most subordinate securities' current coupon payment. This
restriction is enforced until an appraisal reduction has been determined or the
loan payments are brought current. The appraisal reduction generally requires
the master servicer to stop advancing interest payments on the amount by which
the aggregate of debt, advances and other expenses exceeds 90% (in most cases)
of the appraisal amount, thus reducing the cash flows to CRIIMI MAE as the
holder of the first loss unrated or lowest rated bonds, as if such appraisal
reduction was a realized loss. For example, assuming a weighted average coupon
of 6%, a $1 million appraisal reduction would reduce net cash flows to the
Company by $60,000 on an annual basis. An appraisal reduction may result in a
higher or lower realized loss based on the ultimate disposition or work-out of
the mortgage loan. Appraisal reductions for the CMBS transactions in which the
Company retains an ownership interest as reported by the underlying trustees or
as calculated by CMSLP* were as follows:
(in thousands) CBO-1 CBO-2 Nomura Total
- -------------- ----- ----- ------ -----
Year 2000 $ 1,872 $18,871 $ -- $ 20,743
Year 2001 15,599 31,962 874 48,435
January 1, 2002 through September 30, 2002 6,363 42,969 9,222 58,554
-------- -------- ------- ---------
Cumulative Appraisal Reductions through September 30, 2002 $23,834 $93,802 $10,096 $ 127,732
======== ======== ======= =========
* Not all underlying CMBS transactions require the calculation of an
appraisal reduction; however, when CMSLP obtains a third-party appraisal, it
calculates one.
As previously discussed, the Company's unrated bonds/issuer's equity from
the CBO-1, CBO-2 and Nomura transactions are expected to experience principal
write-downs over their expected lives. The following tables summarize the actual
realized losses on CMBS through September 30, 2002 (including realized mortgage
loan losses expected to pass through to the CMBS during the next two months)
and the expected future losses through the life of the CMBS:
(in thousands) CBO 1 CBO 2 Nomura Total
- -------------- ----- ----- ------ -----
Year 1999 actual realized losses $ 738 $ -- $ -- $ 738
Year 2000 actual realized losses 3,201 1,087 -- 4,288
Year 2001 actual realized losses 545 8,397 238 9,180
-------- ------- ------- ---------
Cumulative actual realized losses through the year 2001 4,484 9,484 238 14,206
Actual realized losses, January 1 through September 30, 2002 10,386 17,117 563 28,066
-------- -------- -------- ---------
Cumulative actual realized losses through September 30, 2002 $ 14,870 $ 26,601 $ 801 $42,272
======== ======== ======= =========
Cumulative expected loss estimates (including cumulative
actual realized losses) through the year 2002 $ 17,541 $41,014 $ 2,812 $61,367
Expected loss estimates for the year 2003 42,488 110,820 6,063 159,371
Expected loss estimates for the years 2004-2006 38,254 109,771 26,183 174,208
Expected loss estimates for the years 2007-2009 4,306 16,437 7,725 28,468
Expected loss estimates for the remaining life of CMBS
(for the years 2010-2027) 4,783 16,008 3,749 24,540
-------- --------- -------- ---------
Cumulative expected loss estimates (including cumulative
actual realized losses) through life of CMBS $107,372 $294,050 $46,532 $ 447,954
======== ========= ======== =========
As previously noted, as of September 30, 2002, the Company further revised
its overall expected loss estimate related to its Subordinated CMBS portfolio
from $351 million to $448 million, with such total losses occurring or expected
to occur through the life of its Subordinated CMBS portfolio. This revision to
the overall expected loss estimate is primarily the result of increased
projected loan losses, and the related timing of losses, due to lower than
anticipated appraisals and lower internal estimates of values on real estate
owned by underlying trusts and properties underlying certain defaulted mortgage
loans, which, when combined with the updated loss severity experience, has
resulted in higher projected loss severities on loans and real estate owned by
underlying trusts currently or anticipated to be in special servicing. Primary
reasons for lower appraisals and lower estimates of value resulting in higher
projected loss severities on loans include the poor performance of certain
properties and related markets, failed workout negotiations, and extended time
needed to liquidate assets due, in large part, to the continued softness in the
economy, the continued downturn in travel and, in some cases, over-supply of
hotel properties, and a shift in retail activity in some markets, including the
closing of stores by certain national and regional retailers. The Company's
overall expected loss estimate of $448 million through the life of its
Subordinated CMBS portfolio includes the Company's estimate of total principal
write-downs to its Subordinated CMBS due to realized losses related to
underlying mortgage loans, and is included in the calculation of the current
weighted average anticipated yield to maturity, as discussed below. There can be
no assurance that this revised overall expected loss estimate will not be
exceeded as a result of additional or existing adverse events or circumstances.
The Company had previously revised its overall expected loss estimate
related to its Subordinated CMBS portfolio from $335 million to $351 million as
of June 30, 2002, with such total losses occurring or expected to occur through
the life of its Subordinated CMBS portfolio. This revision to the overall
expected loss estimate was primarily the result of increased projected loan
losses due to lower than anticipated appraisals and revised internal estimates
on properties underlying certain defaulted mortgage loans.
See "Impairment on CMBS" for a discussion of the impairment charges
recognized during 2002.
Yield to Maturity
The following table summarizes yield-to-maturity information relating to
the Company's Subordinated CMBS on an aggregate pool basis:
Current
Anticipated Anticipated Anticipated Anticipated
Yield-to- Yield-to- Yield-to- Yield-to-
Maturity Maturity Maturity Maturity
Pool as of 1/1/01 (1) as of 1/1/02 (1) as of 7/1/02 (1) as of 10/1/02 (1)
---- ---------------- ---------------- ---------------- -----------------
Retained securities from CBO-2 11.8% (2) 12.1% (2) 12.1% (2) 11.8% (2)
Retained securities from CBO-1 21.0% (2) 14.3% (2) 18.8% (2) 16.5% (2)
Retained securities from Nomura 25.3% (2) 28.7% (2) 19.7% (2) 16.0% (2)
--------- --------- --------- ---------
Weighted Average (3) 12.4% (2) 12.4% (2) 12.5% (2) 12.0% (2)
(1) Represents the anticipated weighted average yield over the expected average
life of the Company's Subordinated CMBS portfolio as of January 1, 2001,
January 1, 2002, July 1, 2002 and October 1, 2002 based on management's
estimate of the timing and amount of future credit losses.
(2) As previously discussed, as of December 31, 2000, December 31, 2001, June
30, 2002 and September 30, 2002, the Company revised its overall expected
loss estimate related to its Subordinated CMBS portfolio to $298 million,
$335 million, $351 million and $448 million, respectively, which resulted
in non-cash impairment recognition to certain Subordinated CMBS. As a
result of recognizing impairment, the Company revised its anticipated
yields as of January 1, 2001, January 1, 2002, July 1, 2002 and October 1,
2002, which were or is, in the case of revised anticipated yields as of
October 1, 2002, used to recognize interest income beginning on each of
those dates. These anticipated revised yields took into account the lower
cost basis on the impaired Subordinated CMBS as of dates the losses were
revised, and contemplated larger than previously anticipated losses that
were generally expected to occur sooner than previously anticipated.
(3) The accounting treatment under GAAP requires that the income on
Subordinated CMBS be recorded based on the effective interest method using
the anticipated yield over the expected life of these mortgage assets. This
method can result in GAAP income recognition which is greater than or less
than cash received. For the nine months ended September 30, 2002 and 2001,
the amount of income recognized in excess of cash received on all of the
Subordinated CMBS owned by the Company due to the effective interest rate
method was approximately $8.8 million and $7.7 million, respectively.
Sensitivity of Fair Value to Changes in the Discount Rate
The required rate of return used to determine the fair value of the
Company's Subordinated CMBS is comprised of many variables, such as a risk-free
rate, a liquidity premium and a credit risk premium. These variables are
combined to determine a total rate that, when used to discount the Subordinated
CMBS's assumed stream of future cash flows, results in a net present value of
such cash flows. The determination of such rate is dependent on many
quantitative and qualitative factors, such as, but not limited to, the market's
perception of the issuers of the Subordinated CMBS and the credit fundamentals
of the commercial real estate underlying each pool of commercial mortgage loans.
If the Company assumed that the discount rate used to determine the fair value
of its Subordinated CMBS (A+ through unrated bonds) increased by 100 basis
points, the increase in the discount rate would have resulted in a corresponding
decrease in the value of the Company's Subordinated CMBS (A+ through unrated
bonds) by approximately $50.4 million (or 5.8 percent) as of September 30, 2002.
The 100 basis point increase in the discount rate would have resulted in a
corresponding decrease in the value of the Company's Retained Portfolio by
approximately $31.7 million (or 5.8 percent) as of September 30, 2002.
This sensitivity is hypothetical and should be used with caution. Changes
in fair value based on variations in assumptions generally cannot be
extrapolated because the relationship of the change in assumption to the change
in fair value may not be linear. Also, the effect of a variation in a particular
assumption on the fair value of the retained interest is calculated without
changing any other assumption; in reality, changes in one factor may result in
changes in another (for example, increases in market interest rates may result
in lower prepayments and increased credit losses), which might magnify or
counteract the sensitivities.
Summary of Other Assets
CRIIMI MAE's Other Assets
As of September 30, 2002 and December 31, 2001, the CRIIMI MAE's other
assets consisted primarily of insured mortgage securities, equity investments,
other mortgage-backed securities, cash and cash equivalents (as previously
discussed), principal and interest receivables on its various assets, and REO.
The Company had $299.0 million and $343.1 million (at fair value) invested
in insured mortgage securities as of September 30, 2002 and December 31, 2001,
respectively. The change in fair value is primarily attributable to the
prepayment of insured mortgages which had fair values of $50.6 million at
December 31, 2001, partially offset by the effect of lower interest rates on the
market value of the insured mortgage securities. As of September 30, 2002, 89%
were GNMA Mortgage-Backed Securities and approximately 11% of CRIIMI MAE's
investment in insured mortgage securities were FHA-Insured Certificates. The
total mortgage securities of $299.0 million include an unencumbered insured
mortgage security with a fair value of $5.4 million. The remaining $293.6
million of mortgage securities are pledged to secure certain collateralized
mortgage obligations or securities issued in connection with three
securitization transactions aggregating $276.2 million as of September 30, 2002.
CRIIMI MAE receives the net cash flows after debt service, generally excess
interest and prepayment penalties, from the three wholly owned subsidiaries that
pledged these insured mortgage securities to secure the related obligations,
along with the cash flow from the one unencumbered mortgage security, which
represent the total cash flows that the Company receives from these mortgage
securities. The net cash flows after debt service are applied as principal
amortization payments (in connection with cash flow from other miscellaneous
assets) on Series A Senior Secured Notes.
As of September 30, 2002 and December 31, 2001, the Company had
approximately $7.5 million and $9.3 million, respectively, in investments
accounted for under the equity method of accounting. Included in equity
investments are (a) the general partnership interests (2.9% to 4.9% ownership
interests) in the AIM Funds, and (b) a 20% limited partnership interest in the
adviser to the AIM Funds. The decrease in these investments is primarily the
result of partner distributions declared by the AIM Funds during the first three
quarters of 2002 due to loan pay-offs and normal cash flow distributions. The
carrying values of these equity investments are expected to continue to decline
over time as the AIM Funds decrease their asset bases and distribute proceeds to
their partners.
The Company's Other Mortgage-Backed Securities includes primarily
investment grade CMBS and investment grade residential mortgage-backed
securities. As of September 30, 2002 and December 31, 2001, the fair values of
the Company's Other Mortgage-Backed Securities were approximately $9.0 million
and $8.5 million, respectively.
In October 2001, a wholly owned subsidiary of CRIIMI MAE acquired certain
partnership interests in a partnership that was the obligor on a mezzanine loan
payable to CRIIMI MAE in exchange for curing a default on the first mortgage
loan through a cash payment of approximately $276,000. This partnership and
another wholly-owned subsidiary of CRIIMI MAE own 100% of the partnership
interests in the partnership which is the obligor on the first mortgage loan.
The first mortgage loan is secured by a shopping center in Orlando, Florida. As
a result of this acquisition, the Company, through certain of its wholly owned
subsidiaries, owns 100% of the partnership interests and is consolidating its
financial results as of October 1, 2001. The Company accounts for these assets
as REO, and the REO is being held for investment. The mezzanine loan payable is
eliminated in consolidation. As of September 30, 2002 and December 31, 2001, the
Company had $8.7 million and $8.6 million, respectively, in REO assets included
in other assets ($8.3 million relating to the actual building and land). In
addition, the Company had $7.2 million and $7.1 million of mortgage payable (net
of discount) related to the REO as of September 30, 2002 and December 31, 2001,
respectively. The Company hopes to reposition and stabilize this asset to
increase its value, although there can be no assurance the Company will be able
to do so. Currently, the Company expects that it will hold the REO for more than
one year.
As discussed previously, $9.8 million of the Company's goodwill and
intangible assets related to the 1995 Merger (previously included in the
Company's other assets) were written-off on January 1, 2002 upon the adoption of
SFAS 142.
Servicing's Other Assets
As of September 30, 2002, CMSLP's other assets consisted primarily of
investments in liquid, investment-grade CMBS, advances receivable, fixed assets,
investments in interest-only strips and investments in subadvisory contracts. As
of December 31, 2001, CMSLP's other assets consisted primarily of advances
receivable, investments in mortgage servicing rights, fixed assets, investments
in interest-only strips and investments in subadvisory contracts. The servicing
other assets have increased by approximately $1.9 million from $18.3 million at
December 31, 2001 to $20.2 million at September 30, 2002. The increase is
primarily the result of CMSLP's purchase of liquid, investment-grade CMBS in
June 2002, which have a fair value of approximately $9.7 million as of September
30, 2002. This increase was partially offset by a $4.1 million decrease in
investments in mortgage servicing rights and a $2.2 million decrease in advances
receivable following the sale of the servicing rights.
Liabilities
CRIIMI MAE's Liabilities
As of September 30, 2002 and December 31, 2001, CRIIMI MAE's liabilities
consisted primarily of debt, accrued interest, and accounts payable. Total
recourse debt decreased by approximately $25.3 million to $389.4 million as of
September 30, 2002 from $414.7 million as of December 31, 2001 due to principal
repayments of $27.7 million during the nine months ended September 30, 2002,
partially offset by interest accretion of $2.2 million on the Series B Senior
Secured Notes. An additional $2.3 million of accrued interest on the Series B
Senior Secured Notes accreted to principal on October 15, 2002. Total
non-recourse debt decreased by approximately $48.2 million to $561.4 million as
of September 30, 2002 from $609.6 million as of December 31, 2001. This decrease
is primarily attributable to the significant prepayments of the mortgages
underlying the insured mortgage securities that occurred during the nine months
ended September 30, 2002, which resulted in a corresponding reduction in the
principal balances of the securitized mortgage obligations. CRIIMI MAE's
payables and accrued liabilities increased by approximately $1.1 million to
$27.1 million as of September 30, 2002 from $25.9 million as of December 31,
2001 primarily as a result of a $6.1 million increase in accrued interest and
extension fees on the New Debt and a $1.5 million increase in dividends payable
due to the deferral of the second quarter 2002 preferred stock dividends,
partially offset by a $6.8 million decrease in payables following the settlement
of the litigation with First Union National Bank in March 2002.
Servicing's Liabilities
As of September 30, 2002 and December 31, 2001, CMSLP's liabilities
consisted primarily of accounts payable and accrued expenses. The liabilities as
of December 31, 2001 also included a payable for a line of credit that was used
by CMSLP to fund property protection advances as a master servicer. The
servicing liabilities decreased by approximately $2.6 million to $1.1 million as
of September 30, 2002 from $3.7 million as of December 31, 2001. The decrease is
primarily the result of the repayment of the $1.7 million line of credit for
property protection advances following the sale of servicing rights in February
2002. The remaining decrease is the result of reduced normal operations
following the sale of the servicing rights and the resulting reduction in staff.
Dividends/Other
The terms of the New Debt significantly restrict the amount of cash
dividends that can be paid. Among the other factors which impact CRIIMI MAE's
dividends, if any, are (i) the level of income earned on uninsured mortgage
assets, such as Subordinated CMBS (including, but not limited to, the amount of
original issue discount income, interest shortfalls and losses on Subordinated
CMBS), (ii) net operating losses, (iii) the fluctuating yields on short-term,
variable-rate debt and the rate at which CRIIMI MAE's LIBOR-based debt is
priced, as well as the rate CRIIMI MAE pays on its other borrowings, (iv)
changes in operating expenses, (v) the level of income earned on CRIIMI MAE's
insured mortgage securities depending primarily on prepayments and defaults,
(vi) the rate at which cash flows from mortgage assets, mortgage dispositions,
and, to the extent applicable, distributions from its subsidiaries can be
reinvested, (vii) to the extent applicable, cash dividends paid on preferred
shares, (viii) to the extent applicable, whether the Company's taxable mortgage
pools continue to be exempt from corporate level taxes,
(ix) realized losses on certain transactions, and (x) the timing and
amounts of cash flows attributable to its other lines of business - mortgage
servicing and other fee income. See "Financial Condition, Liquidity and Capital
Resources" for a discussion of restrictions on paying cash dividends.
Investment Company Act
Under the Investment Company Act of 1940, as amended (the "Investment
Company Act"), an investment company is required to register with the Securities
and Exchange Commission ("SEC") and is subject to extensive restrictive and
potentially adverse regulation relating to, among other things, operating
methods, management, capital structure, dividends and transactions with
affiliates. However, as described below, companies that are primarily engaged in
the business of acquiring mortgages and other liens on and interests in real
estate ("Qualifying Interests") are excluded from the requirements of the
Investment Company Act.
To qualify for the Investment Company Act exclusion, CRIIMI MAE, among
other things, must maintain at least 55% of its assets in Qualifying Interests
(the "55% Requirement") and is also required to maintain an additional 25% in
Qualifying Interests or other real estate-related assets ("Other Real Estate
Interests" and such requirement, the "25% Requirement"). According to current
SEC staff interpretations, CRIIMI MAE believes that all of its
government-insured mortgage securities constitute Qualifying Interests with the
exception of one such security, which constitutes an Other Real Estate Interest.
In accordance with current SEC staff interpretations, the Company believes that
all of its Subordinated CMBS constitute Other Real Estate Interests and that
certain of its Subordinated CMBS also constitute Qualifying Interests. On
certain of the Company's Subordinated CMBS, the Company, along with other
rights, has the unilateral right to direct foreclosure with respect to the
underlying mortgage loans. Based on such rights and its economic interest in the
underlying mortgage loans, the Company believes that the related Subordinated
CMBS constitute Qualifying Interests. As of September 30, 2002, the Company
believes that it was in compliance with both the 55% Requirement and the 25%
Requirement.
If the SEC or its staff were to take a different position with respect to
whether such Subordinated CMBS constitute Qualifying Interests, the Company
could, among other things, be required either (i) to change the manner in which
it conducts its operations to avoid being required to register as an investment
company or (ii) to register as an investment company, either of which could have
a material adverse effect on the Company. If the Company were required to change
the manner in which it conducts its business, it would likely have to dispose of
a significant portion of its Subordinated CMBS or acquire significant additional
assets that are Qualifying Interests. Alternatively, if the Company were
required to register as an investment company, it expects that its operating
expenses would significantly increase and that the Company would have to
significantly reduce its indebtedness, which could also require it to sell a
significant portion of its assets. No assurances can be given that any such
dispositions or acquisitions of assets, or deleveraging, could be accomplished
on favorable terms, or at all. There are restrictions under certain of the
operative documents evidencing the New Debt which could limit possible actions
the Company may take in response to any need to modify its business plan in
order to register as an investment company or avoid the need to register.
Certain dispositions or acquisitions of assets could require approval or consent
of certain holders of the New Debt. Any such results could have a material
adverse effect on the Company.
Further, if the Company were deemed an unregistered investment company, the
Company could be subject to monetary penalties and injunctive relief. The
Company would be unable to enforce contracts with third parties and third
parties could seek to obtain rescission of transactions undertaken during the
period the Company was deemed an unregistered investment company, unless a court
found that under the circumstances, enforcement (or denial of rescission) would
produce a more equitable result than nonenforcement (or grant of rescission) and
would not be inconsistent with the Investment Company Act.
Recent Developments
On November 14, 2002, the Company entered into an Investment Agreement with
an affiliate of Brascan Real Estate Financial Partners LLC ("BREF"), which
contemplates an equity and subordinated debt investment by BREF and a secured
financing (in the form of a repurchase transaction) to be arranged by BREF with
Bear, Stearns & Co. Inc. ("Bear Stearns"). The proceeds from the BREF
investments and the secured financing of up to approximately $353 million
together with a substantial portion of the Company's liquid assets would be used
to retire the New Debt.
As contemplated by the Investment Agreement, BREF would purchase, in a
private transaction, (a) such number of shares of the Company's common stock as
would result in BREF owning, after giving effect to such purchase, 10% of the
outstanding shares of common stock at the lower of $8.22 per share and the
average of the respective closing prices per share on the ten most recent
trading days prior to the transaction closing date, and (b) up to $40 million of
subordinated debt to be issued by the Company. The first $30 million of
subordinated debt would bear interest at the rate of 15% per annum and the
remaining $10 million, issuable at the Company's option, would bear interest at
the rate of 20% per annum. All subordinated debt would mature three years after
the closing of the first $30 million and be secured by a second lien on
substantially all of the Company's Subordinated CMBS (the "Subordinated CMBS
Collateral"). The Company would pay BREF various fees, including a quarterly
maintenance fee of $375,000 in connection with arranging the repurchase
transaction with Bear Stearns.
Based on discussions with BREF and Bear Stearns and a preliminary
indication of terms with respect to the proposed secured financing to be
provided by Bear Stearns, the Company would receive a commitment for a secured
financing in the principal amount of $300 million which would mature in three
years, bear interest at a rate equal to one-month LIBOR plus 3.5% (increasing to
one-month LIBOR plus 4.5% if a collateralized debt obligation transaction
("CDO") is not successfully completed within a specified period of time),
require quarterly principal payments based on a 30-year amortization schedule
(changing to a 20-year amortization schedule if the CDO is not successfully
completed) and be secured by a first lien on the Subordinated CMBS Collateral.
The Investment Agreement also contemplates that Barry Blattman, the
president of BREF will be named Chairman of the Board and Chief Executive
Officer of the Company, that BREF will name two additional directors to the
Company's Board and that BREF and the Company would agree on two additional
individuals to be nominated for election as directors in 2003. The Board of
Directors would consist of nine directors. Upon closing of the contemplated
transactions, William B. Dockser would resign as Chairman of the Board, but
remain as a director. H. William Willoughby would resign as President and as a
director. Pursuant to amendments to their respective employment agreements, each
of Mr. Dockser and Willoughby would receive their contractual 18-month severance
payments in a lump-sum payment and certain other benefits, including an
acceleration of the vesting of outstanding options.
If the Investment Agreement is terminated under certain limited
circumstances, including termination by the Company in connection with its
acceptance, approval or authorization of a superior proposal, the Company shall
pay BREF a termination fee as set forth in the Investment Agreement.
The Company has agreed not to solicit any competing proposal or enter into
any agreement with respect to a competing proposal during the term of the
Investment Agreement.
The completion of the transactions contemplated by the Investment Agreement
is conditioned upon, among other matters, BREF's satisfaction with its due
diligence review, the absence of any material adverse change, and the receipt of
the secured financing proceeds. No commitment for the secured financing has been
received.
The BREF investment is not expected to cause an ownership change within the
meaning of Section 382 of the Tax Code. In connection with the contemplated
transactions, the Company expects to use approximately $40 million of its liquid
assets in connection with the retirement of its New Debt and to pay fees and
estimated expenses related to the contemplated transactions. Immediately after
closing of the contemplated transactions and assuming the Company issues $30
million of the $40 million available under the subordinated debt, the Company
expects to have approximately $8-$10 million of cash and liquid assets depending
upon the timing of the closing of the comtemplated transactions. These amounts
are only estimates and are subject to change. There can be no assurance that the
actual amount of liquid assets used or cash and liquid assets remaining will
approximate the amounts set forth above.
There can be no assurance that the transactions, including the secured
financing, contemplated by the Investment Agreement will be completed.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's principal market risk is exposure to changes in interest
rates related to the U.S. Treasury market as well as the LIBOR market. The
Company will have fluctuations in the amount of interest expense paid on its
Variable-Rate Secured Borrowing primarily due to changes in one-month LIBOR. The
Company will also experience fluctuations in the market value of its mortgage
assets related to changes in the interest rates of U.S. Treasury securities as
well as changes in the spread between U.S. Treasury securities and the mortgage
assets. As of September 30, 2002, the average U.S. Treasury rate used to price
the Company's CMBS had decreased by approximately 145 basis points and credit
spreads had widened by approximately 79 basis points compared to December 31,
2001. In addition to the factors described above, the fair values of the insured
mortgage securities are also affected by changes in the weighted average lives
of the insured mortgage securities, which results in adjustments to the terms of
the U.S. Treasury securities that are used in the determination of the fair
values. As of September 30, 2002, the terms of the U.S. Treasury securities that
were used to value the insured mortgage securities were shorter than those used
at December 31, 2001 due to lower market interest rates and other loan
attributes of the underlying insured mortgage securities.
The required rate of return used to determine the fair value of the
Company's Subordinated CMBS is comprised of many variables, such as a risk-free
rate, a liquidity premium and a credit risk premium. These variables are
combined to determine a total rate that, when used to discount the Subordinated
CMBS's assumed stream of future cash flows, results in a net present value of
such cash flows. The determination of such rate is dependent on many
quantitative and qualitative factors, such as, but not limited to, the market's
perception of the issuers of the Subordinated CMBS and the credit fundamentals
of the commercial real estate underlying each pool of commercial mortgage loans.
If the Company assumed that the discount rate used to determine the fair value
of its Subordinated CMBS (A+ through unrated bonds) increased by 100 basis
points, the increase in the discount rate would have resulted in a corresponding
decrease in the value of the Company's Subordinated CMBS (A+ through unrated
bonds) by approximately $50.4 million (or 5.8 percent) as of September 30, 2002.
The 100 basis point increase in the discount rate would have resulted in a
corresponding decrease in the value of the Company's economic Subordinated CMBS
(BB+ through unrated bonds) by approximately $31.7 million (or 5.8 percent) as
of September 30, 2002.
CRIIMI MAE has interest rate caps to mitigate the adverse effects of rising
interest rates on the amount of interest expense payable under its Variable-Rate
Secured Borrowing. In April 2002, CRIIMI MAE entered into a second interest rate
protection agreement. This interest rate protection agreement, or cap, which was
effective on May 1, 2002, is for a notional amount of $175.0 million, caps LIBOR
at 3.25%, and matures on November 3, 2003. The cap was purchased for
approximately $1.6 million. The caps provide protection to CRIIMI MAE to the
extent interest rates, based on a readily determinable interest rate index
(typically one-month LIBOR), increase above the stated interest rate cap, in
which case, CRIIMI MAE will receive payments based on the difference between the
index and the caps. The terms of the caps as well as the stated interest rates
of the caps, which in all cases are currently above the current rate of the
index, will limit the amount of protection that the caps offer. The average
one-month LIBOR index was 1.84% during the nine months ended September 30, 2002,
which was a 3 basis point decrease from December 31, 2001.
A 100 basis point change in the one-month LIBOR index would have changed
the Company's interest expense on its Variable-Rate Secured Borrowing by
approximately $584,000 and $1.8 million during the three and nine months ended
September 30, 2002, respectively.
ITEM 4. CONTROLS AND PROCEDURES
Within 90 days prior to the date of filing this Quarterly Report on Form
10-Q, the Company carried out an evaluation, under the supervision and with the
participation of the Company's management, including the Chairman of the Board
(CEO) and the Chief Financial Officer (CFO), of the effectiveness of the design
and operation of the Company's disclosure controls and procedures pursuant to
Securities Exchange Act Rule 13a-14 under the Securities Exchange Act of 1934,
as amended (the "Exchange Act"). Based on that evaluation, the Company's CEO and
CFO concluded that the Company's disclosure controls and procedures are
effective and timely in alerting them to material information relating to the
Company, including its consolidated subsidiaries, required to be included in the
Company's periodic SEC filings. There were no significant changes in the
Company's internal controls or in other factors that could significantly affect
these internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies and
material weaknesses.
PART II
ITEM 5. OTHER INFORMATION
Section 10(A)(i)(2) of the Securities Exchange Act of 1934 requires the
Company to disclose any non-audit services approved by the Audit Committee to be
performed by Ernst & Young LLP, the Company's independent auditors. On August
14, 2002, the Audit Committee, subject to any rules that may be adopted by the
Public Company Accounting Oversight Board, approved the engagement of Ernst &
Young LLP to provide tax services to the Company and its subsidiaries, including
REIT tax compliance and planning advice that is requested by the Company's Board
of Directors, Audit Committee or officers from time to time during the fiscal
year ending December 31, 2002.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
Exhibit No. Description
10.1 Investment Agreement dated as of November 14, 2002
between CRIIMI MAE Inc. and Brascan Real Estate
Financial Investments LLC (filed herewith).
10.2 Exhibit A (Terms of Repurchase Agreement) to the
Investment Agreement dated as of November 14, 2002
between CRIIMI MAE Inc. and Brascan Real Estate
Financial Investments LLC (filed herewith).
10.3 Exhibit B (Summary of Terms of the Senior
Subordinated Secured Notes) to the Investment
Agreement dated as of November 14, 2002
between CRIIMI MAE Inc. and Brascan Real Estate
Financial Investments LLC (filed herewith).
10.4 Exhibit C (Form of Registration Rights Agreement) to
the Investment Agreement dated as of
November 14, 2002 between CRIIMI MAE Inc. and
Brascan Real Estate Financial Investments LLC
(filed herewith).
10.5 Exhibit D (Form of Non-Competition Agreement) to
the Investment Agreement dated as of
November 14, 2002 between CRIIMI MAE Inc. and
Brascan Real Estate Financial Investments LLC
(filed herewith).
10.6 Exhibit E (Form of Opinion of Venable, Baetjer,
Howard & Civiletti, LLP) to the Investment
Agreement dated as of November 14, 2002 between
CRIIMI MAE Inc. and Brascan Real Estate Financial
Investments LLC (filed herewith).
10.7 Exhibit F (Form of Opinion of the Company's General
Counsel) to the Investment Agreement dated as of
November 14, 2002 between CRIIMI MAE Inc. and
Brascan Real Estate Financial Investments LLC
(filed herewith).
99.1 Special Serviced Loan Report relating to specially
serviced loans underlying the Company's CMBS as of
September 30, 2002 (filed herewith).
99.2 Certification of Chief Executive Officer pursuant to
Section 906 of the Sarbanes-Oxley Act (filed
herewith).
99.3 Certification of Chief Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act (filed
herewith).
(b) REPORTS ON FORM 8-K
None
Signature
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Registrant has duly caused this Report on
Form 10-Q to be signed on its behalf by the undersigned, thereunto duly
authorized.
CRIIMI MAE INC.
November 14, 2002 /s/Cynthia O. Azzara
- ----------------- -------------------------------
DATE Cynthia O. Azzara
Senior Vice President,
Principal Accounting Officer
and Chief Financial Officer
CERTIFICATION
I, William B. Dockser, certify that:
1. I have reviewed this quarterly report on Form 10-Q of CRIIMI
MAE Inc.;
2. Based on my knowledge, this quarterly report does not contain
any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made,
not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report,
fairly present in all material respects the financial
condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries,
is made known to us by others within those entities,
particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date
within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions
about the effectiveness of the disclosure controls
and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of registrant's
board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or
operation of internal controls which could adversely
affect the registrant's ability to record, process,
summarize and report financial data and have
identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have
indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and
material weaknesses.
Date: November 14, 2002 /s/William B. Dockser
-------------------------- -------------------------------
William B. Dockser
Chairman of the Board and
Chief Executive Officer
CERTIFICATION
I, Cynthia O. Azzara, certify that:
1. I have reviewed this quarterly report on Form 10-Q of CRIIMI
MAE Inc.;
2. Based on my knowledge, this quarterly report does not contain
any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made,
not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report,
fairly present in all material respects the financial
condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries,
is made known to us by others within those entities,
particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date
within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions
about the effectiveness of the disclosure controls
and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of registrant's
board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or
operation of internal controls which could adversely
affect the registrant's ability to record, process,
summarize and report financial data and have
identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have
indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and
material weaknesses.
Date: November 14, 2002 /s/Cynthia O. Azzara
--------------------------- ---------------------------------
Cynthia O. Azzara
Senior Vice President, Principal
Accounting Officer and Chief
Financial Officer