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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
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For the fiscal year ended December 31, 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
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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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10K or any amendment to this
Form 10K. [ ]
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities and
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [X] No [ ]
The aggregate market value (based upon the last reported sale price on the
New York Stock Exchange on June 28, 2002) of the shares of CRIIMI MAE Inc.
common stock held by non-affiliates was approximately $97,381,769. (For purposes
of calculating the previous amount only, all directors and executive officers of
the registrant are assumed to be affiliates.)
As of March 25, 2003, 15,162,685 shares of CRIIMI MAE Inc. common stock
with a par value of $0.01 were outstanding.
Documents Incorporated By Reference
The information required by Part III (Items 10, 11, 12 and 13) is incorporated
by reference to the Registrant's definitive proxy statement to be filed pursuant
to Regulation 14A relating to the Registrant's 2003 annual meeting of
shareholders.
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CRIIMI MAE INC.
2002 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
Page
PART I
Item 1. Business ................................................... 1
Item 2. Properties....................................................19
Item 3. Legal Proceedings.............................................19
Item 4. Submission of Matters to a Vote of Security Holders...........19
PART II
Item 5. Market for the Registrant's Common Stock and
Related Shareholder Matters..................................20
Item 6. Selected Financial Data.......................................22
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations....................................24
Item 7A. Quantitative and Qualitative Disclosures About Market Risk....57
Item 8. Financial Statements and Supplementary Data...................58
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.....................................58
PART III
Item 10. Directors and Executive Officers of the Registrant............60
Item 11. Executive Compensation........................................60
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Shareholders Matters..................60
Item 13. Certain Relationships and Related Transactions................60
Item 14. Controls and Procedures.......................................60
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on
Form 8-K.....................................................61
Signatures .............................................................74
Certifications.............................................................76
1
PART I
ITEM 1. BUSINESS
FORWARD-LOOKING STATEMENTS. When used in this Annual Report on Form 10-K, in
future filings with the Securities and Exchange Commission (the SEC or the
Commission), in our press releases or in our other public or shareholder
communications, the words "believe," "anticipate," "expect," "contemplate,"
"may," "will" and similar expressions are intended to identify forward-looking
statements. Statements looking forward in time are included in this Annual
Report on Form 10-K pursuant to the "safe harbor" provision of the Private
Securities Litigation Reform Act of 1995. Such statements are subject to certain
risks and uncertainties, which could cause actual results to differ materially,
including, but not limited to the risk factors contained or referenced under the
headings "Business," "Risk Factors" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" set forth below. Readers are
cautioned not to place undue reliance on these forward-looking statements, which
speak only as of the date hereof. We undertake 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 anticipated or
unanticipated events.
Business and Experience
CRIIMI MAE Inc. (together with its consolidated subsidiaries, unless the
context otherwise indicates, We or CRIIMI MAE) is a commercial mortgage company
structured as a self-administered real estate investment trust (or REIT).
We currently own, and manage, primarily through our servicing subsidiary,
CRIIMI MAE Services Limited Partnership (CMSLP or CRIIMI MAE Services), a
significant portfolio of commercial mortgage-related assets.
We have focused primarily on non-investment grade (rated below BBB- or
unrated) commercial mortgage-backed securities (subordinated CMBS). As the
holder of the most subordinate tranches, we are exposed to a higher risk of
losses, but we also have the potential for enhanced returns.
Our core holdings are subordinated CMBS backed by pools of commercial
mortgage loans on hotel, multifamily, retail and other commercial real estate.
We also own directly and indirectly government-insured mortgage backed
securities and a limited number of high-yield mezzanine commercial real estate
mortgage loans (mezzanine loans). We also are a trader in investment grade CMBS
and residential mortgage-backed securities.
Based on our prior and current activities, we have significant experience
in the following areas:
o Subordinated CMBS Acquisitions. We were a leading purchaser of
subordinated CMBS from 1996 to 1998, acquiring an aggregate face amount
during that time of approximately $2.4 billion. In connection with our
CMBS acquisitions, we engaged in extensive underwriting procedures
designed to assess the adequacy of the real property collateral for the
underlying mortgage loans and the creditworthiness of the related
borrowers.
o Resecuritizations. We completed two of the commercial real estate
industry's first resecuritizations of subordinated CMBS in 1996 and
1998. These transactions had a combined face value of $449 million and
$1.8 billion, respectively.
o Loan Originations and Securitizations. Prior to 1999, we had originated
more than $900 million in aggregate principal amount of commercial real
estate mortgage loans. In 1998, we securitized approximately $496
million of commercial mortgage loans originated or acquired by us.
o Mortgage Servicing. Through our servicing subsidiary, CRIIMI MAE
Services, we are responsible for certain commercial mortgage servicing
functions for a $19.8 billion commercial mortgage loan portfolio and
for special servicing functions for $17.4 billion of the commercial
mortgage loans underlying our subordinated CMBS.
2
Recapitalization Overview
On January 23, 2003, we completed a recapitalization of the secured debt
incurred upon our emergence from Chapter 11 in April 2001 (the Exit Debt). This
recapitalization was funded with approximately $344 million of newly issued
common equity and secured debt and a portion of our available cash and liquid
assets.
The recapitalization includes:
o BREF Equity & Secured Debt. - CRIIMI MAE issued approximately $44
million in common equity and secured subordinated debt to Brascan Real
Estate Finance Fund I L.P. (BREF), a private asset management fund
established by Brascan Corporation and a New York-based management
team.
o Bear Stearns Secured Financing. - CRIIMI MAE received $300 million in
secured financing in the form of a repurchase transaction from a unit
of Bear, Stearns & Co., Inc. (Bear Stearns).
o New Leadership. - Additions to management, including Barry S. Blattman
as Chairman of the Board, Chief Executive Officer and President.
Mr. Blattman has more than 15 years of experience in commercial real
estate finance, which included overseeing the real estate debt group at
Merrill Lynch from 1996 to 2001.
The recapitalization increases our financial flexibility primarily through
the elimination of the requirement to use virtually all of our net cash flow to
pay down principal on the Exit Debt. This, along with the elimination of REIT
distribution requirements due to our net operating losses (NOLs), provides us
with additional liquidity for mortgage-related investments and acquisitions and
other corporate purposes. We presently intend to use substantially all of our
net cash flow for acquisitions and investments, hedging activities and general
working capital purposes.
Goals and Strategy
Our goal is to re-establish CRIIMI MAE as a leader in the commercial
mortgage industry. Our strategy is to capitalize on our core strengths in real
estate and mortgage finance and our underwriting and special servicing expertise
to structure and make mortgage-related investments and acquisitions designed to
maximize the value of our current and future assets, support liquidity and earn
attractive returns. Part of this strategy is to continue to capitalize on our
special servicing expertise in connection with workouts and dispositions of
mortgage loans underlying our existing subordinated CMBS in order to minimize
losses with respect to our current subordinated CMBS.
Our four strategic priorities are:
o Maximize Existing Asset Values. - We plan to maximize the value of our
existing subordinated CMBS portfolio by accelerating workouts or
dispositions of commercial mortgage loans in special servicing.
o Pursue Acquisitions and Investments. - We plan to develop and execute
mortgage-related acquisition and investment strategies relating
primarily to CMBS and commercial mortgage loans that capitalize on our
real estate and mortgage finance, underwriting, loan management and
special servicing experience, and our access to performance information
on mortgages and real estate markets throughout the country derived
from our special servicing responsibilities.
o Refine and Develop Our Team. - We will ensure that CRIIMI MAE has
personnel with the requisite expertise to maximize asset values and
develop and execute acquisition and investment strategies.
o Earn Attractive Returns. - We seek to earn attractive returns through
the prudent investment of our capital and net cashflows.
3
January 2003 Recapitalization
Under the 2003 recapitalization, BREF acquired 1,212,617 shares of our
newly issued common stock, or approximately 8% of our outstanding common stock
after giving effect to the share acquisition, at $11.50 per share, or
approximately $13.9 million. BREF also received seven-year warrants to purchase
up to 336,835 additional shares of common stock at $11.50 per share. In
addition, BREF purchased $30 million of our newly issued subordinated debt (the
BREF Debt) and, at our option, BREF will purchase up to an additional $10
million of subordinated debt prior to January 23, 2004. The BREF Debt matures on
January 23, 2006 and bears interest at an annual rate of 15%. If we decide to
sell the additional $10 million of subordinated debt to BREF, it will bear
interest at an annual rate of 20% and mature on January 23, 2006. We have a
right to defer two-thirds of the interest on the BREF Debt (and half on the
additional $10 million, if sold to BREF) during its term. The BREF Debt is
secured by first liens on the equity interests of two of our subsidiaries.
Although this effectively provides BREF with an indirect lien on all of our
subordinated CMBS that are held by three of our other lower-tier subsidiaries,
Bear Stearns has first liens on the equity interests of these three lower tier
subsidiaries and on certain of the subordinated CMBS held by one of these lower
tier subsidiaries. Pursuant to an intercreditor agreement between BREF and Bear
Stearns, our obligations under the BREF Debt are contractually subordinate to
the prior payment in full of our obligations under the $300 million in secured
financing provided by Bear Stearns. Such intercreditor agreement also provides
for contractual restrictions on BREF's ability to realize upon its indirect
interest in the Bear Stearns first lien collateral.
Bear Stearns provided $300 million in secured financing in the form of a
repurchase transaction (the Bear Stearns Debt) under the 2003 recapitalization.
The Bear Stearns Debt matures in 2006, bears interest at a rate equal to
one-month LIBOR plus 3% and requires quarterly principal payments of $1.25
million. The principal payments will increase to $1.875 million per quarter if a
collateralized debt obligation transaction (or CDO) is not completed by January
23, 2004. The interest rate will increase by 1%, to one-month LIBOR plus 4%, if
Bear Stearns structures a CDO that meets certain rating requirements and we
decline to close. The Bear Stearns Debt is secured by first direct and/or
indirect liens on all of our subordinated CMBS. The indirect first liens are
first liens on the equity interests of three of our subsidiaries that hold
certain subordinated CMBS. A reduction in the value of this collateral could
require us to provide additional collateral or fund margin calls. Although
CRIIMI MAE Inc. is not a primary obligor of the Bear Stearns Debt, it has
guaranteed all obligations under the debt. See also "BUSINESS - Certain Risks -
Borrowing and Refinancing Risks" for a discussion of risks related to the Bear
Stearns Debt.
The Reorganization Plan
On October 5, 1998, CRIIMI MAE Inc. (unconsolidated) and two operating
subsidiaries, CRIIMI MAE Management, Inc. and CRIIMI MAE Holdings II, L.P.,
filed for relief under Chapter 11 of the U.S. Bankruptcy Code in the United
States Bankruptcy Court for the District of Maryland, Southern Division, in
Greenbelt, Maryland. On November 22, 2000, the United States Bankruptcy Court
for the District of Maryland entered an order confirming our reorganization
plan, and we emerged from Chapter 11 on April 17, 2001.
Our reorganization plan provided for the payment in full of all of our
allowed claims primarily through the Chapter 11 reorganization (including
proceeds from certain asset sales) totaling $847 million. Included in the
Chapter 11 reorganization was approximately $262.4 million in Exit Debt provided
by affiliates of Merrill Lynch Mortgage Capital, Inc. (or Merrill Lynch) and
German American Capital Corporation (or GACC) through a variable-rate secured
financing facility (the Exit Variable-Rate Secured Borrowing), in the form of a
repurchase transaction, and approximately $166.8 million in Exit Debt provided
through two series of senior secured notes issued to some of our unsecured
creditors. All rights and obligations of Merrill Lynch and GACC under the Exit
Variable-Rate Secured Borrowing operative agreements were subsequently assigned
to ORIX Capital Markets, LLC. The Exit Debt was directly or indirectly secured
by substantially all of our assets, and virtually all of our cash flows relating
to existing assets were used to satisfy principal, interest and fee obligations
under the Exit Debt and to pay our general and administrative and other
operating expenses. The terms of the Exit Debt significantly restricted the
amount of cash dividends that could be paid to shareholders. Under our
reorganization plan, the holders of our equity retained their shares of stock.
See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS" and Note 7 to Notes to Consolidated Financial Statements for a
further discussion of the Exit Debt. All Exit Debt was paid off in
4
connection with the January 2003 recapitalization.
Other
We were incorporated in Delaware in 1989 under the name CRI Insured
Mortgage Association, Inc. In July 1993, CRI Insured Mortgage Association
changed its name to CRIIMI MAE Inc. and reincorporated in Maryland. In June
1995, certain mortgage businesses affiliated with C.R.I., Inc. were merged into
CRIIMI MAE Inc. (the Merger). We are not a government sponsored entity or in
any way affiliated with the United States government or any United States
government agency.
The CMBS Market
Historically, traditional lenders, including commercial banks, insurance
companies and savings and loans have been the primary holders of commercial
mortgages. The real estate market of the late 1980s and early 1990s created
business and regulatory pressure to reduce the real estate assets held on the
books of these institutions. As a result, there has been significant movement of
commercial real estate debt from private institutional holders to the public
markets. According to Commercial Mortgage Alert, CMBS issuances in the U.S.
totaled approximately $66.4 billion in 2002, $74.3 billion in 2001, and $48.9
billion in 2000.
CMBS are generally created by pooling commercial mortgage loans and
directing the cash flow from such mortgage loans to various tranches of
securities. The tranches consist of investment grade (AAA to BBB-),
non-investment grade (BB+ to CCC) and unrated securities. The first step in the
process of creating CMBS is loan origination. Loan origination occurs when a
financial institution lends money to a borrower to refinance or to purchase a
commercial real estate property, and secures the loan with a mortgage on the
property that the borrower owns or purchases. Commercial mortgage loans are
typically non-recourse to the borrower. A pool of these commercial
mortgage-backed loans is then accumulated, often by a large commercial bank or
other financial institution. One or more rating agencies then analyze the loans
and the underlying real estate to determine their credit quality. The mortgage
loans are then deposited into an entity that is not subject to taxation, often a
real estate mortgage investment conduit (or REMIC). The investment vehicle then
issues securities backed by the commercial mortgage loans, or CMBS.
The CMBS are divided into tranches, which are afforded certain priority
rights to the cash flow from the underlying mortgage loans. Interest payments
typically flow first to the most senior tranche until it receives all of its
accrued interest and then to the junior tranches in order of seniority.
Principal payments typically flow to the most senior tranche until it is
retired. Tranches are then retired in order of seniority, based on available
principal. Losses, if any, are generally first applied against the principal
balance of the lowest rated or unrated tranche. Losses are then applied in
reverse order of seniority. Each tranche is assigned a credit rating by one or
more rating agencies based on the agencies' assessment of the likelihood of the
tranche receiving its stated payment of principal. The CMBS are then sold to
investors through either a public offering or a private placement. CRIIMI MAE
has primarily focused on acquiring or retaining non-investment grade and unrated
tranches, issued by mortgage conduits, where we believed our market knowledge
and real estate expertise allowed us to earn attractive risk-adjusted returns.
At the time of a securitization, one or more entities are appointed as
"servicers" for the pool of mortgage loans, and are responsible for performing
servicing duties which include collecting payments (master or direct servicing),
monitoring performance (loan management) and working out or foreclosing on
defaulted loans (special servicing). Each servicer typically receives a fee and
other financial incentives based on the type and extent of servicing duties.
Business Segments
Management assesses our performance and allocates resources principally on
the basis of two lines of business: portfolio investment and mortgage servicing.
These two lines of business, or operating segments, are managed separately as
they provide different sources and types of revenues.
5
Portfolio Investment
Portfolio investment primarily includes (i) acquiring subordinated CMBS,
(ii) securitizing pools of mortgage loans and pools of CMBS, (iii) direct
investments in government insured securities and entities that own government
insured securities and mezzanine loans and (iv) securities trading activities.
Our income from this segment is primarily generated from these assets.
CMBS Acquisitions
As of December 31, 2002, our $1.2 billion portfolio of assets included $862
million of CMBS (representing approximately 69% of our total consolidated
assets). As of December 31, 2002, our CMBS had the following ratings (based on
fair value) reflected as a percentage of total CMBS:
Rating % of CMBS
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A+, BBB+ or BBB 38% (a)
BB+, BB or BB- 39%
B+, B, B- or CCC 21%
Unrated 2%
(a) Represents investment grade securities reflected on our balance sheet
as a result of CBO-2, our second resecuritization transaction.
See "BUSINESS-Portfolio Investment-Resecuritizations" and "BUSINESS-
Portfolio Investment's Assets-CMBS and Other MBS" for further discussion of our
CMBS. We did not acquire any subordinated CMBS in 2002, 2001 or 2000. Prior to
the fall of 1998, we generally acquired subordinated CMBS in privately
negotiated transactions, which allowed us to perform due diligence on a
substantial portion of the mortgage loans underlying the subordinated CMBS as
well as the underlying real estate prior to consummating the purchase. In
connection with our subordinated CMBS acquisitions, we targeted diversified
mortgage loan pools with a mix of property types, geographic locations and
borrowers. We financed a substantial portion of our subordinated CMBS
acquisitions with short-term, variable-rate debt secured by the acquired
subordinated CMBS. As discussed below in "Resecuritizations," our business
strategy was to periodically refinance a substantial portion of our short term,
variable-rate debt through a resecuritization of our subordinated CMBS primarily
to attain a better matching of the maturities of our assets and liabilities
through the refinancing of such short-term, variable-rate, recourse debt with
long-term, fixed-rate, non-recourse debt.
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 our 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.
Resecuritizations
We initially funded a substantial portion of our subordinated CMBS
acquisitions with short-term, variable-rate secured debt. To further mitigate
our exposure to interest rate risk, our business strategy was to periodically
refinance a significant portion of this short-term, variable-rate recourse debt
with fixed-rate, non-recourse debt having maturities that matched those of our
mortgage assets securing such debt, also known as match-funded debt. We effected
such refinancing by pooling subordinated CMBS, once a sufficient pool of
subordinated CMBS had been accumulated, and issuing newly created CMBS backed by
the pooled subordinated CMBS. The CMBS issued in such resecuritizations were
fixed-rate obligations with maturities that matched the maturities of the
subordinated CMBS backing the new CMBS. These resecuritizations also increased
the amount of borrowings available to us due to the increased collateral value
of the new CMBS relative to the pooled subordinated CMBS. The increase in
collateral value was principally attributable to the seasoning of the underlying
mortgage loans and the diversification that occurred when such subordinated CMBS
were pooled. We generally used the cash proceeds from the investment grade CMBS
that were sold in the resecuritization to reduce the amount of our short-term,
variable-rate debt. We then used the net excess borrowing capacity created by
the resecuritization to obtain new short-term, variable-rate secured borrowings
which were used with additional new short-term, variable-rate secured borrowings
typically provided by the subordinated CMBS seller and, to a lesser extent,
cash, to purchase additional subordinated
6
CMBS. Although our resecuritizations mitigated our exposure to interest
rate risk through match-funding, our short-term, variable-rate secured
borrowings increased from December 31, 1996 to December 31, 1998 as a result of
our continued acquisitions of subordinated CMBS during that period.
In December 1996, we completed our first resecuritization of subordinated
CMBS, CRIIMI MAE Trust I Series 1996-C1 (CBO-1), with a combined face value of
approximately $449 million involving 35 individual securities collateralized by
12 mortgage securitization pools. In CBO-1 we sold, in a private placement,
securities with a face amount of $142 million and retained securities with a
face amount of approximately $307 million. As a result of CBO-1, we refinanced
approximately $142 million of short-term, variable-rate, secured recourse debt
with fixed-rate, non-recourse, match-funded debt. CBO-1 generated excess
borrowing capacity of approximately $22 million primarily as a result of a
higher overall weighted average credit rating for the new CMBS, as compared to
the weighted average credit rating on the related CMBS collateral.
In May 1998, we completed our second resecuritization of subordinated CMBS,
CRIIMI MAE Commercial Mortgage Trust Series 1998-C1 (CBO-2), with a combined
face value of approximately $1.8 billion involving 75 individual securities
collateralized by 19 mortgage securitization pools and three of the retained
securities from CBO-1. In CBO-2, we eventually sold, in private transactions,
securities with an aggregate face amount of $673 million and retained securities
with a face amount of approximately $1.1 billion. CBO-2 generated net excess
borrowing capacity of approximately $160 million primarily as a result of a
higher overall weighted average credit rating for the new CMBS, as compared to
the weighted average credit rating on the related CMBS collateral.
As of December 31, 2002, our total debt was approximately $922.0 million,
of which approximately 59% was fixed-rate, match-funded, non-recourse debt and
approximately 41% was variable-rate or fixed-rate debt that was not
match-funded. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS" and Notes 5, 7 and 19 to the Notes to Consolidated
Financial Statements for further information regarding our resecuritizations and
variable-rate secured borrowings.
Loan Originations and Securitizations
Previously, we originated mortgage loans principally through mortgage loan
conduit programs with major financial institutions for the primary purpose of
pooling such loans for securitization. We viewed a securitization as a means of
extracting the maximum value from the mortgage loans originated. A portion of
the mortgage loans originated was financed through the sale of investment grade
CMBS to third parties in connection with the securitization. We received net
cash flow on the retained CMBS not sold to third parties after payment of
amounts due to secured creditors who had provided acquisition financing.
Additionally, we received origination and servicing fees related to the mortgage
loan conduit programs.
In June 1998, we securitized approximately $496 million of the commercial
mortgage loans originated or acquired by us through a mortgage loan conduit
program with Citicorp Real Estate, Inc. and, through CRIIMI MAE CMBS Corp.,
issued Commercial Mortgage Loan Trust Certificates, Series 1998-1 (CMO-IV). In
CMO-IV, we sold $397 million face amount of fixed-rate, investment grade CMBS.
We originally intended to sell all of the investment grade tranches of CMO-IV;
however, two investment grade tranches were not sold until 1999. We had call
rights, or the right to repurchase the sold CMBS once their outstanding
aggregate principal balances were reduced to certain specified levels, on each
of the issued CMBS and therefore did not surrender control of the CMBS, thus
requiring the transaction to be accounted for as a financing of the mortgage
loans collateralizing the investment grade CMBS sold in the securitization. We
sold our remaining interest in CMO-IV in November 2000. See "MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS-Financial Condition, Liquidity and Capital Resources" and Note 5 to
the Notes to Consolidated Financial Statements for additional information
regarding this securitization, the sale of our interest in CMO-IV and certain
financial and accounting effects of such sale.
Underwriting Procedures
Since we generally acquired CMBS through privately negotiated transactions
and originated commercial mortgage loans, we were able to perform extensive due
diligence on a majority of the mortgage loans as well as the underlying real
estate prior to consummating any purchase or origination. We underwrote every
loan we originated
7
and re-underwrote a substantial portion of the loans underlying the
subordinated CMBS we acquired. Furthermore, our credit committee, composed of
members of senior management, reviewed originated loans and subordinated CMBS
acquisitions.
Our underwriting guidelines were designed to assess the adequacy of the
real property as collateral for the loan and the borrower's creditworthiness.
The underwriting process entailed a full independent review of the operating
records, appraisals, environmental studies, market studies and architectural and
engineering reports, as well as site visits to properties representing a
majority of the CMBS portfolio. We then tested the historical and projected
financial performance of the properties to determine their resiliency to a
market downturn and applied varying capitalization rates to assess collateral
value. To assess the borrower's creditworthiness, we reviewed the borrower's
financial statements, credit history, bank references and managerial experience.
We purchased subordinated CMBS when satisfactory arrangements existed that
enabled us to closely monitor the underlying mortgage loans and provided us with
appropriate workout and foreclosure rights.
Portfolio Investment's Assets
CMBS and Other MBS
As of December 31, 2002, we owned, for purposes of generally accepted
accounting principles (GAAP), CMBS rated from A+ to CCC and unrated with a total
fair value amount of approximately $862 million (representing approximately 69%
of our total consolidated assets), an aggregate amortized cost of approximately
$761 million, and an aggregate face amount of approximately $1.5 billion. The
CMBS represent investments in CBO-1, CBO-2 and Nomura Asset Securities
Corporation Series 1998-D6 (Nomura). See "MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" for a discussion of our CMBS.
In addition to the CMBS discussed above, as of December 31, 2002 we owned
$5.2 million of other mortgage backed securities (or Other MBS), which are held
for trading purposes. See also "Risk of Loss of REIT Status and Other Tax
Matters".
Insured Mortgage Securities
As of December 31, 2002, we had $275.3 million at fair value (representing
approximately 22% of our total consolidated assets) and $273.7 million at
amortized cost invested in insured mortgage securities, consisting of GNMA
mortgage-backed securities and FHA-insured certificates, as well as Freddie Mac
participation certificates that are collateralized by GNMA mortgage-backed
securities. As of December 31, 2002, 88% of our investment in insured mortgage
securities were GNMA mortgage-backed securities (including certificates that
collateralize Freddie Mac participation certificates) and approximately 12% of
our investment in insured mortgage securities were FHA-insured certificates. See
Note 6 to the Notes to Consolidated Financial Statements for further discussion.
Equity Investments
As of December 31, 2002, we had approximately $6.2 million in investments
accounted for under the equity method of accounting. Included in our equity
investments as of December 31, 2002 are (a) the general partnership interests
(2.9% to 4.9% ownership interests) in American Insured Mortgage Investors,
American Insured Mortgage Investors-Series 85, L.P., American Insured Mortgage
Investors L.P.-Series 86 and American Insured Mortgage Investors L.P.-Series 88
(collectively, the AIM Limited Partnerships), owned by CRIIMI, Inc., a wholly
owned subsidiary of CRIIMI MAE, and (b) a 20% limited partnership interest in
the advisor to the AIM Limited Partnerships. The AIM Limited Partnerships are
four publicly traded limited partnerships that hold insured mortgage loans and
insured mortgage securities.
Real Estate Owned
As of December 31, 2002, we had approximately $8.8 million of real estate
being held for investment. This real estate consists of a shopping center in
Orlando, Florida. See "Other Income" and "Summary of Other
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Assets" in "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS" for a further discussion of this real estate.
Mortgage Servicing
We conduct our mortgage loan servicing operations through CMSLP. In July
2001, we began accounting for CMSLP on a consolidated basis due to a
reorganization which resulted in the partnership interests of CMSLP being held
by two of our wholly owned taxable REIT subsidiaries (or TRSs). Prior to July
2001, we accounted for CMSLP under the equity method as we 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 our
consolidated financial statements.
In February 2002, CMSLP sold all of its rights and obligations under its
CMBS master and primary servicing contracts primarily because the contracts were
not profitable, given the relatively small volume of master and primary CMBS
servicing that CMSLP was performing. In connection with this restructuring, 34
employee positions were eliminated. Restructuring charges of approximately
$189,000 and $438,000 were recorded during the years ended December 31, 2002 and
2001, respectively, to account for employee severance costs, noncancellable
lease costs, and other costs related to the restructuring. CMSLP received
approximately $12.4 million in cash, which included reimbursement of advances.
This sale resulted in a gain of approximately $4.9 million during the year ended
December 31, 2002. See Note 9 to Notes to the Consolidated Financial Statements
for a further discussion of this sale of servicing rights.
As of December 31, 2002 and 2001, CMSLP was performing certain servicing
functions on commercial mortgage loans with aggregate principal balances of
$19.8 billion and $20.8 billion, respectively, which included commercial
mortgage loans underlying CRIIMI MAE's CMBS with aggregate principal balances of
$17.4 billion and $20.4 billion, respectively. CMSLP's principal servicing
activities are described below. For a summary and discussion of the financial
results of CMSLP, see "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS".
Special Servicing
A special servicer typically provides asset management and resolution
services with respect to nonperforming or underperforming loans within a pool of
mortgage loans. When acquiring subordinated CMBS, we typically required that we
retain the right to appoint the special servicer for the related mortgage pools.
When serving as special servicer of mortgage loans in a CMBS pool, CMSLP has the
authority 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. We believe that because we own the
first loss unrated or lowest rated bond of all but two CMBS transactions, CMSLP
has an incentive to quickly resolve any loan workouts. As of December 31, 2002,
CMSLP was designated as the special servicer for approximately 3,600 commercial
mortgage loans, representing an aggregate principal amount of approximately
$19.2 billion, which included approximately $17 billion of commercial mortgage
loans underlying CRIIMI MAE's CMBS. See "CMBS and Other MBS" above and Note 5 to
the Notes to Consolidated Financial Statements regarding mortgage loans included
in the special servicing portfolio.
As of December 31, 2002, CMSLP had a special servicer rating of "average"
from S&P and "CSS2+" from Fitch.
Loan Management
In certain cases, CMSLP acts as loan manager and monitors the ongoing
performance of properties securing the mortgage loans underlying our
subordinated CMBS portfolio by continuously reviewing the property level
operating data and through regular site inspections. For approximately half of
these loans, CMSLP performs these duties on a contractual basis; for the
remaining loans, as part of its routine asset monitoring process, it reviews the
analyses performed by other servicers. This allows CMSLP to identify and resolve
potential issues that could result in losses. As of December 31, 2002, CMSLP
served as contractual loan manager for approximately 1,500
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commercial mortgage loans representing an aggregate principal amount of
approximately $7.1 billion. As of December 31, 2002, CMSLP reviewed analyses
performed by other servicers for 2,200 commercial mortgage loans, representing
an aggregate principal amount of $12.7 billion.
Master Servicing
A master servicer typically provides administrative and reporting services
to the trustee with respect to a particular issuance of CMBS or other
securitized pools of mortgages. Mortgage loans underlying securitized pools
generally are serviced by a number of primary servicers. Under most master
servicing arrangements, the primary servicers retain primary responsibility for
administering the mortgage loans and the master servicer acts as an intermediary
in overseeing the work of the primary servicers, monitoring their compliance
with the standards of the issuer of the related CMBS and consolidating the
servicers' respective periodic accounting reports for transmission to the
trustee. As master servicer, CMSLP was usually paid a fee and earned float
income on the deposits held. As discussed above, in February 2002, CMSLP sold
all rights and obligations under its CMBS master and primary servicing
contracts. CMSLP remains a master servicer on 63 non-CMBS mortgage loans,
including mortgage loans underlying our insured mortgage securities and mortgage
loans owned by the American Insured Mortgage Investors limited partnerships,
with an aggregate principal amount of $134.3 million.
Direct (or Primary) Servicing
Direct (or primary) servicers typically perform certain functions for the
master servicer. CMSLP collected loan payments directly from the borrower
(including tax and insurance escrows and replacement reserves) for those loans
which it direct serviced. The loan payments are remitted to the master servicer
for the loan (which may be the same entity as the direct servicer), usually on a
fixed date each month. The direct servicer is usually paid a fee to perform
these services, and is eligible to earn float income on the deposits held. As
discussed above, in February 2002, CMSLP sold all rights and obligations under
its CMBS master and direct servicing contracts. CMSLP remains a direct servicer
on 23 non-CMBS mortgage loans with an aggregate principal amount of $76.9
million, some of which are included in the master servicing amounts above.
Certain Risk Factors
In addition to the risk factors set forth below, please see those set forth
in "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS."
Substantial Indebtedness; Leverage
We are highly leveraged. As of December 31, 2002, our total consolidated
indebtedness was $922 million (of which $376 million was recourse debt), and our
shareholders' equity was approximately $292 million. As of January 31, 2003,
after giving effect to our recently completed recapitalization, our total
consolidated indebtedness was approximately $876 million (of which approximately
$330 million was recourse debt). The January 31, 2003 indebtedness amount
excludes amounts deposited with the indenture trustee on January 23, 2003 to pay
all principal and interest on our outstanding Series A and Series B Senior
Secured Notes on the March 10, 2003 redemption date. This redemption required 45
days prior notice. For GAAP purposes, these notes were not considered repaid
until the March 10, 2003 redemption date. See "MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" and Note 7 to Notes
to the Consolidated Financial Statements. From the time we emerged from Chapter
11 in April 2001 through January 2003, virtually all cash flows relating to
existing assets were used to satisfy principal, interest and fee obligations
under the Exit Debt and to pay our general and administrative and other
operating expenses. Our payment obligations under the Bear Stearns and BREF
Debt, although substantial in amount, are significantly less than those under
the Exit Debt.
Our ability to meet our debt service obligations 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 underlying mortgage loans and
changes in interest rates and spreads) and to generate capital internally from
operating and investing activities and expected reductions in REIT distribution
requirements to shareholders due to net operating losses for tax purposes, in
each case consistent with the terms and conditions of the operative documents
evidencing the Bear Stearns and BREF Debt. There can be no assurance that
targeted levels of cash flow
10
will actually be achieved, that reductions in REIT distribution
requirements will be realized, or that, if required, new capital will be
available to us. Our ability to maintain or increase cash flow and access new
capital will depend upon, among other things, interest rates (including hedging
costs and margin calls), prevailing economic conditions, restrictions under the
operative documents evidencing the Bear Stearns and BREF Debt, and other
factors, many of which are beyond our control. Our cash flow will also be
negatively affected by realized losses, interest payment shortfalls and
appraisal reduction amounts on properties related to mortgages underlying our
subordinated CMBS. We expect losses on our CMBS to increase in 2003, resulting
in decreased CMBS cash flows as compared to 2002. Our cash flows are also likely
to decrease as a result of any prepayments of mortgage loans underlying our
insured mortgage securities and any prepayments of mortgages held by the AIM
Limited Partnerships. Prepayments of these mortgage loans will result in
reductions in the respective mortgage bases. As a result, the net cash flows to
us are likely to decrease over time. Our net cash flows will also decrease due
to the failure to close the CDO transaction prior to January 23, 2004 or if we
refinance the Bear Stearns Debt with debt which has a higher interest rate
and/or greater amortization requirements. Cash flows are also likely to be
affected if we incur further debt to acquire additional CMBS or for other
corporate purposes.
Our high level of debt limits our ability to obtain additional capital,
reduces income available for other activities, restricts our ability to react
quickly to changes in our business, limits our ability to hedge our assets and
liabilities, and makes us more vulnerable to economic downturns. The terms and
conditions of the operative documents evidencing the Bear Stearns and BREF Debt
impose operating and financial restrictions on us.
Our ability to resume the acquisition of subordinated CMBS, as well as our
securitization programs (if we determine to do so) depends, among other things,
on our ability to engage in such activities under the terms and conditions of
the operative debt documents, our internally generated cash flows, and our
ability to access additional capital. Factors which could affect our 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 our business, restrictions under the operative debt documents,
results of our operations, and our financial leverage, financial condition, and
business prospects. There can be no assurance that we will be able to resume any
of our prior activities or obtain additional capital, or that the terms of any
such capital will be favorable to us.
Borrowing and Refinancing Risks
The Bear Stearns and BREF Debt mature in January 2006. As a result, we must
either refinance or retire the remaining principal balances of each of the Bear
Stearns and BREF Debt at their maturity in 2006. There can be no assurance that
we will be able to refinance each of the Bear Stearns and BREF Debt at all, or
upon terms that are comparable to the terms under these deals. In particular, we
may not be able to refinance each of the Bear Stearns and BREF Debt at the same
interest rates and maturity, with the same collateral and margin requirements
and limitations upon our business. If we cannot refinance or extend the Bear
Stearns and BREF Debt upon their expected maturities, we may be required to sell
our CMBS that serve as collateral for the Bear Stearns and BREF debt. There can
be no assurance that we will be able to sell our CMBS at all, or at prices that
are advantageous to us.
Substantially all of our borrowings, including the Bear Stearns and BREF
Debt, are, and are expected to continue to be, in the form of collateralized
borrowings. The Bear Stearns Debt is collateralized by first direct and/or
indirect (in connection with an affiliate reorganization discussed in "RISK
FACTORS--Taxable Mortgage Pool Risks" and Note 7 to Notes to Consolidated
Financial Statements) liens on all of our subordinated CMBS, and is subject to a
number of terms, conditions and restrictions including, without limitation,
scheduled principal and interest payments, and restrictions and requirements
with respect to the collection and application of funds. If the outstanding loan
amount under the Bear Stearns Debt exceeds 85% of the aggregate market value of
the collateral securing the Bear Stearns Debt, as determined by Bear Stearns in
its sole good faith discretion, then Bear Stearns can require us to transfer
cash, cash equivalents or securities so that the outstanding loan amount will be
less than or equal to 80% of the aggregate market value of the collateral
(including any additional collateral provided). Failure to meet any margin call
could result in an event of default which would enable Bear Stearns to exercise
various rights and remedies including acceleration of the maturity date of the
Bear Stearns Debt and the sale of the collateral. In order to meet a margin
call, we may be required to sell assets at prices lower than their carrying
value
11
which could result in losses. See "BUSINESS--January 2003 Recapitalization"
and "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS."
A substantial portion of our borrowings in the future, if CMBS acquisitions
are resumed, may be, in the form of collateralized, short-term floating-rate
secured borrowings. The amount borrowed under such agreements is typically based
on the market value of the CMBS pledged to secure specific borrowings. Under
adverse market conditions, the value of pledged CMBS would decline, and lenders
could initiate margin calls (in which case we could be required to post
additional collateral or to reduce the amount borrowed to restore the ratio of
the amount of the borrowing to the value of the collateral). We may be required
to sell assets to reduce the amount borrowed. If these sales were made at prices
lower than the carrying value of the assets, we would experience losses.
A default under our collateralized borrowings could result in a liquidation
of the collateral. If we are forced to liquidate CMBS that qualify as qualified
real estate assets (under the REIT Provisions of the Internal Revenue Code) to
repay borrowings, there can be no assurance that we will be able to maintain
compliance with the REIT Provisions of the Internal Revenue Code regarding asset
and source of income requirements. The liquidation of CMBS could also result in
the loss of our Investment Company Act exclusion. See "Investment Company Act."
In connection with the Bear Stearns Debt, we engaged Bear Stearns with
respect to the proposed structuring of a CDO transaction in which we would
contribute substantially all of our subordinated CMBS to a special purpose
entity that would issue debt securities, the interest and principal payments on
which would be payable from the interest and principal payments received on the
subordinated CMBS collateral. Under the terms of the Bear Stearns Debt, if Bear
Stearns is able to structure the CDO transaction to meet certain rating
requirements but we decline to close the CDO transaction, then the interest rate
on the Bear Stearns Debt would increase by 100 basis points, or 1%, from
one-month LIBOR plus 3.00% to one-month LIBOR plus 4.00%, and we would have to
pay Bear Stearns $2 million. In addition, the quarterly principal amortization
will increase from $1.25 million to $1.875 million. There can be no assurance
that a CDO transaction will be entered into and, if entered into, that it will
be advantageous to us. A CDO transaction may increase the cost of our
borrowings, require increased amortization payments and cash sweeps and fail to
provide us with sufficient funds to retire the entire amount outstanding of the
Bear Stearns and BREF Debt, all of which may significantly reduce our cash flow,
increase the risk of defaults on the underlying CMBS and further limit our
financial flexibility.
Limited Protection from Hedging Transactions
To minimize the risk of rising interest rates on our variable-rate debt
(and to comply with the terms of the Bear Stearns Debt), we hedge a portion of
our variable-rate debt. As of December 31, 2002, approximately 82% of our
variable rate debt was hedged with interest rate caps (or caps) that partially
limit the adverse effects of potential rising interest rates. Caps provide
protection to us to the extent interest rates, based on a readily determinable
interest rate index, increase above the stated interest rate cap, in which case
we will receive payments based on the difference between the index and the
stated interest rate cap. When these interest rate caps expire, we will have
increased interest rate risk unless we are able to enter into replacement
hedges. As of December 31, 2002, we had the following interest rate caps:
Notional Amount Effective Date Maturity Date Cap Index
- --------------- -------------- -------------- ---- -----
$ 175,000,000 May 1, 2002 November 3, 2003 3.25% 1 month LIBOR
$ 170,000,000 April 2, 2001 April 2, 2003 5.25% 1 month LIBOR
Upon expiration of the current caps, there can be no assurance that we will
be able to obtain replacement hedges on satisfactory terms or to adequately
protect against rising interest rates on our variable rate debt.
We are exposed to credit loss in the event of non-performance by the
counterparties to the interest rate caps should interest rates exceed the stated
interest rate cap. However, we do not anticipate non-performance by the
counterparties. The counterparties have long-term debt ratings of A+ or above by
S&P and A1 or above by Moody's. Although our caps are not exchange-traded, there
are a number of financial institutions which enter into these types of
transactions as part of their day-to-day activities.
12
During 2002, 2001 and 2000, we did not hedge against interest rate risks,
including increases in interest rate spreads and increases in U.S. Treasury
rates, which adversely affect the value of our CMBS. Moreover, hedging involves
risk and typically involves transaction and other costs. Such costs increase
dramatically as the period covered by the hedge increases and during periods of
rising and volatile interest rates. In 2003, it is likely we will hedge against
interest rate risks which adversely affect the value of our CMBS.
Risks of Owning Subordinated CMBS
As an owner of the most subordinate tranches of CMBS, we will be the first
to bear any loss and will absorb 100% of the losses on the underlying mortgage
loan collateral until cumulative losses exceed the principal amount of our
subordinated CMBS. We will also be the last to receive cash flow from the
underlying mortgage loans. Interest payments typically flow first to the most
senior tranche until it receives all of its accrued interest and then to the
junior tranches in order of seniority. Principal payments typically flow to the
most senior tranche until it is retired. Tranches are then retired in order of
seniority based on available principal. When delinquencies and defaults occur,
cash flows otherwise due to us may not be advanced to the extent required to
meet scheduled principal and interest payments, resulting in interest shortfalls
to our subordinated CMBS.
The value of our subordinated CMBS can change due to a number of economic
factors. These factors include changes in the value of the underlying real
estate, fluctuations in U.S. Treasury rates, and changes in the spread between
our subordinated CMBS and the U.S. Treasury securities with comparable
maturities. For instance, changes in the credit quality of the properties
securing the underlying mortgage loans can result in interest payment shortfalls
to the extent there are mortgage payment delinquencies, and principal losses to
the extent that there are payment defaults and the amounts of such principal and
interest shortfalls are not fully recovered. These losses may result in a
permanent decline in the value of our CMBS and may change our anticipated yield
to maturity if the losses are in excess of those previously estimated. CMBS are
priced at a spread above the current U.S. Treasury security (such as the 10 year
U.S. Treasury Note) with a maturity that most closely matches the CMBS's
weighted average life. The value of CMBS can be affected by changes in U.S.
Treasury rates, as well as changes in the spread between such CMBS and the U.S.
Treasury security with a comparable maturity. Generally, increases and decreases
in both U.S. Treasury rates or spreads will result in temporary changes in the
value of our subordinated CMBS assuming that we have the ability and intent to
hold our CMBS investments until maturity. However, such temporary changes in the
value of our subordinated CMBS become permanent changes realized through our
income statement when we no longer intend or fail to have the ability to hold
such subordinated CMBS to maturity or the expected credit losses related to
those CMBS are greater or occur sooner than originally anticipated. Our revised
overall cumulative actual and expected loss estimate of $503 million through the
life of our CMBS represents our estimate of total principal writedowns to our
CMBS due to realized losses related to underlying mortgage loans and is included
in the calculation of our current weighted average anticipated
yield-to-maturity. If defaults and loss severities on the mortgage loans
underlying our CMBS continue to increase and/or the timing of losses occur
sooner than anticipated, our revised overall expected loss estimate of $503
million may be exceeded. There can be no assurance that our revised estimate of
expected losses will not be exceeded as a result of additional or continuing
adverse events or circumstances, such as a continuing economic slowdown or
recession. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - Results of Operations for 2002 compared to 2001
(Impairment on CMBS); Results of Operations for 2001 compared to 2000
(Impairment on CMBS), and Financial Condition, Liquidity and Capital Resources
(Summary of CMBS)" and Note 5 to Notes to Consolidated Financial Statements.
We have historically been unable to obtain financing at the time of
acquisition of our subordinated CMBS that matches the maturity of the related
investments, resulting in a need to obtain short-term variable rate debt secured
by the acquired CMBS. If we resume the acquisition of subordinated CMBS and use
short-term variable rate debt to finance the acquisition, the inability to
refinance this short-term variable rate debt with long-term fixed-rate debt or a
decline in the value of the CMBS collateral securing such short-term variable
rate debt could result in a situation in which we are required to sell assets or
provide additional collateral, which could have, and has had, an adverse effect
on us and our financial position and results of operations. Our ability to
borrow amounts in the future may be impacted by, among other things, the credit
performance of the commercial mortgage loans underlying our subordinated CMBS
and other factors affecting our subordinated CMBS, and restrictions under the
operative documents evidencing the Bear Stearns and BREF Debt.
13
Failure to Manage Mismatch Between Long-Term Assets and Short-Term Funding
Our operating results will depend in large part on differences between the
income from our CMBS and our borrowing costs. If we resume the acquisition of
subordinated CMBS, we may finance a significant portion of these CMBS
acquisitions with borrowings having adjustable interest rates (or borrowing
rates) that reset while the rates on fixed rate CMBS stay constant. If interest
rates rise, borrowing rates (and borrowing costs) are expected to rise more
quickly than coupon rates (and investment income) on our CMBS. This would
decrease both our net income, potentially resulting in a net loss, and the
mark-to-market value of our net assets, and would be expected to decrease the
market price of our common stock and to slow future acquisitions of assets.
Although we intend to invest primarily in fixed-rate CMBS, we also may own
adjustable rate CMBS. The coupon rates of adjustable rate CMBS normally
fluctuate with reference to specific rate indices. We may fund these adjustable
rate CMBS with borrowings having borrowing rates which reset monthly or
quarterly. To the extent that there is a difference between (i) the interest
rate index used to determine the coupon rate of the adjustable rate CMBS (asset
index) and (ii) the interest rate index used to determine the borrowing rate for
the related financing (borrowing index), we will be exposed to the "basis" rate.
Typically, if the borrowing index rises more than the asset index, our net
income would decrease, all other things being constant. Additionally, our
adjustable rate CMBS may be subject to periodic rate adjustment limitations and
periodic and lifetime rate caps which limit the amount that the coupon rate can
change during any given period. No assurance can be given as to the amount or
timing of changes in interest rates or their effect on our CMBS, their valuation
or income derived therefrom. During periods of changing interest rates, coupon
rate and borrowing rate mismatches could negatively impact our net income,
distributions and the market price of our common stock.
Limited Liquidity of Subordinated CMBS Market
There is no active secondary trading market for subordinated CMBS. This
limited liquidity results in uncertainty in the valuation of our portfolio of
subordinated CMBS. The liquidity of such market has historically been limited,
and during adverse market conditions has been severely limited. Future adverse
market conditions would likely adversely impact the value of our subordinated
CMBS and amounts we could realize if we were required to sell all or a portion
of our subordinated CMBS.
Possible Effects of Terrorist Attacks, Economic Slowdown and/or Recession
on Losses and Defaults
The economic slowdown, recession, terrorist attacks and threats of further
terrorist attacks have contributed to loan defaults, and may contribute to
further defaults on mortgage loans underlying our subordinated CMBS. Mortgage
loan defaults have resulted in increased losses, and may result in further
losses on our subordinated CMBS. These factors may continue to negatively
impact the values of the commercial real estate securing the mortgage loans,
weakening collateral coverage and increasing the possibility of defaults and
losses, and the demand for the commercial real estate securing the underlying
mortgage loans. See Note 5 to the Notes to Consolidated Financial Statements and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" for information regarding the performance of the underlying mortgage
loans.
Risks of Loss of REIT Status and Other Tax Matters
REIT Status. We have elected to qualify as a REIT for tax purposes under
sections 856-860 of the Internal Revenue Code. We are required to meet income,
asset, ownership and distribution tests to maintain our REIT status for federal
and state tax purposes. We believe that we have satisfied the REIT requirements
for all years through, and including 2002, although there can be no assurance.
There can also be no assurance that we will maintain our REIT status for 2003 or
subsequent years. If we fail to maintain our REIT status for any taxable year,
we 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, we may
have insufficient funds to pay any such tax and also may be unable to comply
with our obligations under the operative documents evidencing the Bear Stearns
and BREF Debt.
Net Operating Loss for Tax Purposes/Trader Election. Beginning in 2000, we
began trading in both short and longer duration fixed income securities,
including non-investment grade and investment grade CMBS and
14
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 us or any qualified REIT subsidiary, meaning
generally any wholly owned subsidiary that is not a taxable REIT subsidiary).
Such Trading Assets are classified as Subordinated CMBS and Other MBS on our
balance sheet. We seek maximum total return through short-term trading,
consistent with prudent investment management. Returns from such activities
include interest and capital appreciation/depreciation resulting from changes in
interest rates and spreads, if any, and other arbitrage opportunities.
As a result of our election in 2000 to be taxed as a trader for federal
income tax purposes, we recognized a mark-to-market tax loss on our 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). We
expect such loss to be ordinary, which would allow us to offset our ordinary
income. Additionally, as a result of our trader election, we are required to
mark-to-market our 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 a REIT subsidiary, CBO REIT, as part of our
Chapter 11 reorganization (and subsequently transferred by CBO REIT to CBO REIT
II as part of our recent recapitalization) are no longer required to be
marked-to-market on a tax basis since CBO REIT was not, and CBO REIT II 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 ordinary, any gains will generally increase taxable income and any losses
will generally decrease taxable income. Since the REIT rules require us to
distribute 90% of our taxable income to our 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 the mark-to-market adjustments, but the cash flow
from our Trading Assets will not fluctuate as a result of the mark-to-market
adjustments.
We generated a net operating loss for tax purposes of approximately $83.6
million and $90.6 million during the years ended December 31, 2002 and 2001,
respectively. As such, our taxable income was reduced to zero and, accordingly,
our REIT distribution requirement was eliminated for 2002 and 2001. As of
December 31, 2002, our accumulated and unused net operating loss (or NOL) was
$223.8 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 we are 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.
There can be no assurance that our position with respect to our election as
a trader in securities will not be challenged by the Internal Revenue Service
(or IRS) and, if challenged, will be defended successfully by us. 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, however, interest may also be due to
the IRS on the amount of this under-distribution.
If we are required to make taxable income distributions to our shareholders
to satisfy required REIT distributions, all or a substantial portion of these
distributions, if any, may 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
15
such, we could lose our REIT status or may not be able to satisfy our
obligations under the operative documents evidencing the Bear Stearns and BREF
Debt.
Our 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 Internal
Revenue Code. As a result of these limitations imposed by Section 382 of the
Internal Revenue Code, in the event of an ownership change, our ability to use
our 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 carry forwards would expire unutilized.
Accordingly, after any ownership change, our ability to use our 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.
We do not believe the BREF investment in our common stock and warrant to
purchase common stock has created an "ownership change" under Section 382. In
addition, we are not aware of any other acquisition of shares of our capital
stock that has created an "ownership change" under Section 382. Currently, we do
not know of any potential acquisition of shares of our capital stock that will
create an "ownership change" under Section 382 of the Internal Revenue Code. We
have adopted a shareholder rights plan and amended our charter to minimize the
chance of an ownership change within the meaning of Section 382 of the Internal
Revenue Code; however there can be no assurance that an ownership change will
not occur.
If an "ownership change" occurs under Section 382 of the Internal Revenue
Code, our prospective use of our accumulated and unused NOL and the remaining
January 2000 Loss of a combined total amount of approximately $343.4 million as
of December 31, 2002 will be limited. If we had lost our ability to use our
accumulated NOL as of January 1, 2002, our taxable income would have been
approximately $36.0 million for the year ended December 31, 2002. This increase
in taxable income would have created a requirement to distribute 90% of this
income to our shareholders in order to maintain REIT status, and would be
subject to corporate income tax to the extent we do not distribute 100% of our
taxable income to shareholders. If we were unable to distribute at least 90% of
our taxable income to shareholders, we would have been subject to corporate
Federal and state income taxes of up to approximately $14.7 million for the year
ended December 31, 2002.
Changes in Tax Laws. Our activities, structure and operations may be
adversely affected by changes in the tax laws applicable to REITs and "traders
in securities" for tax purposes.
Effect of Rate Compression on Market Price of Stock
Our actual earnings performance as well as the market's perception of our
ability to achieve earnings growth may affect the market price of our common
stock. In our case, the level of earnings (or losses) depends to a significant
extent upon the width and direction of the spread between the net yield received
on our income-earning assets (principally, the long term, fixed-rate assets
comprising our CMBS portfolio) and our variable-rate cost of borrowing. In
periods of narrowing or compressing spreads, the resulting pressure on our
earnings may adversely affect the market value of our common stock. Spread
compression can occur in high or low interest rate environments and typically
results when the net yield on long term assets adjusts less frequently than the
current rate on debt used to finance their purchase. For example, if we rely on
short term, variable-rate debt to finance the purchase of long term fixed-rate
CMBS, we may experience rate compression and a resulting diminution of earnings
if the interest rate on the debt increases while the coupon and yield measure
for the financed CMBS remain constant. In such an event, the market price of our
common stock may decline to reflect the actual or perceived decrease in our
value resulting from the spread compression.
Shape of the Yield Curve Adversely Affects Income
The relationship between short-term and long-term interest rates is often
referred to as the "yield curve." Ordinarily, short-term interest rates are
lower than long-term interest rates. If short-term interest rates rise
disproportionately relative to long-term interest rates (a flattening of the
yield curve), our borrowing costs, to the extent they are based on short-term
interest rates, may increase more rapidly than the interest income earned on our
16
assets. Because borrowings will likely bear interest at short-term rates (such
as LIBOR) and CMBS will likely bear interest at medium-term to long-term rates
(such as those calculated based on the ten-year U.S. Treasury rate), a
flattening of the yield curve will tend to decrease our net income, assuming our
short-term borrowing rates bear a strong relationship to short-term U.S.
Treasury rates. Additionally, to the extent cash flows from long-term assets are
reinvested in other long-term assets, the spread between the coupon rates of
long-term assets and short-term borrowing rates may decline and also may tend to
decrease the net income and mark-to-market value of our net assets. It is also
possible that short-term interest rates may adjust relative to long-term
interest rates such that the level of short-term rates exceeds the level of
long-term rates (a yield curve inversion). In this case, as well as in a flat or
slightly positively sloped yield curve environment, borrowing costs could exceed
the interest income and operating losses would be incurred.
Results of Operations Adversely Affected by Factors Beyond Our Control
Our results of operations can be adversely affected by various factors,
many of which are beyond our control, and will depend on, among other things,
the level of net interest income generated by, and the market value of, our CMBS
portfolio. Our net interest income and results of operations will vary primarily
as a result of fluctuations in interest rates, CMBS pricing, and borrowing
costs. Our results of operations also will depend upon our ability to protect
against the adverse effects of such fluctuations as well as credit risks.
Interest rates, credit risks, borrowing costs and credit losses depend upon the
nature and terms of the CMBS and the performance of the underlying collateral,
conditions in financial markets, the fiscal and monetary policies of the U.S.
government, effects of terrorism, international economic and financial
conditions and competition, none of which can be predicted with any certainty.
Because changes in interest rates may significantly affect our CMBS and other
assets, our operating results will depend, in large part, upon our ability to
manage our interest rate and credit risks effectively while maintaining our
status as a REIT. See "BUSINESS-Risk Factors-Limited Protection from Hedging
Transactions" for further discussion.
There can be no assurance that we will resume subordinated CMBS
acquisitions and/or securitizations. Our ability to resume any one or more of
such activities will be based, in large part, upon our ability to access
capital, prevailing industry conditions and the general business climate, and
our ability to do so in light of restrictions under the operative documents
evidencing the Bear Stearns and BREF Debt. Although the Bear Stearns and BREF
Debt documents permit the foregoing activities, these activities must be
effected within certain specified limitations and restrictions. All decisions
concerning resumption of business activities will be made by our Board of
Directors, as determined to be in our best interests and subject to the
constraints referenced in the preceding sentence. Although there can be no
assurance that the resumption of any one or more of these activities will
improve our results of operations, failure to resume subordinated CMBS
acquisitions and/or securitizations could adversely impact our results of
operations.
Competition
If we resume the acquisition of subordinated CMBS, we would compete with
mortgage REITs, specialty finance companies, banks, hedge funds, investment
banking firms, other lenders, and other entities purchasing subordinated CMBS.
Many of these competitors may have greater access to capital and other resources
(or the ability to obtain capital at a lower cost) and may have other advantages
over us. Although subject to a three year non-competition agreement with us,
BREF and its controlled affiliates are permitted to sponsor collateral bond or
loan obligations (CBOs) and to acquire subordinated CMBS for inclusion in such
CBOs. As a result, BREF could compete with us.
There can be no assurance that we would be able to obtain financing at
borrowing rates below the asset yields of our subordinated CMBS. In such event,
we could incur losses or could be forced to further reduce the size of our
subordinated CMBS portfolio. We would face competition for financing sources,
which could limit the availability of, and affect the cost of, funds to us.
Investment Company Act
Under the Investment Company Act of 1940, as amended, an investment company
is required to register with the Securities and Exchange Commission (SEC) and is
subject to extensive restrictive and potentially adverse
17
regulation relating to, among other things, operating methods, management,
capital structure, dividends and transactions with affiliates. However, as
described below, companies 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, we, among other
things, must maintain at least 55% of our assets in Qualifying Interests (the
55% Requirement) and are 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, we believe that all of our government-insured mortgage
securities constitute Qualifying Interests. In accordance with current SEC staff
interpretations, we believe that all of our subordinated CMBS constitute Other
Real Estate Interests and that certain of our subordinated CMBS also constitute
Qualifying Interests. On certain of our subordinated CMBS, we, along with other
rights, have the unilateral right to direct foreclosure with respect to the
underlying mortgage loans. Based on such rights and our economic interest in the
underlying mortgage loans, we believe that the related subordinated CMBS
constitute Qualifying Interests. As of December 31, 2002, we believe that we
were 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, we could, among
other things, be required either (i) to change the manner in which we conduct
our 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 us. If we were required to change the manner in which we
conduct our business, we would likely have to dispose of a significant portion
of our subordinated CMBS or acquire significant additional assets that are
Qualifying Interests. Alternatively, if we were required to register as an
investment company, we expect that our operating expenses would significantly
increase and that we would have to significantly reduce our indebtedness, which
could also require us to sell a significant portion of our 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 Bear
Stearns and BREF Debt which could limit possible actions we may take in response
to any need to modify our 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 this Debt. Any
such results could have a material adverse effect on us.
Further, if we were deemed an unregistered investment company, we could be
subject to monetary penalties and injunctive relief. We would be unable to
enforce contracts with third parties and third parties could seek to obtain
rescission of transactions undertaken during the period we were deemed an
unregistered investment company, unless the 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.
Phantom Income May Result in Tax Liability
Our investment in subordinated CMBS and certain other types of mortgage
related assets may cause us, under certain circumstances, to recognize taxable
income in excess of our economic income (phantom income) and to experience an
offsetting excess of economic income over our taxable income in later years. As
a result, our shareholders, from time to time, may be required to treat
distributions that economically represent a return of capital as taxable
dividends for federal income tax purposes. Such distributions would be offset in
later years by distributions representing economic income that would be treated
as returns of capital for federal income tax purposes. Accordingly, if we
recognize phantom income, our shareholders may be required to pay federal income
tax with respect to such income on an accelerated basis (i.e., before such
income is realized by shareholders in an economic sense). Taking into account
the time value of money, such an acceleration of federal income tax liabilities
would cause shareholders to receive an after-tax rate of return on an investment
in our stock that would be less than the after-tax rate of return on an
investment with an identical before-tax rate of return that did not generate
phantom income. As the ratio of our phantom income to our total income
increases, the after-tax rate of return received by a shareholder paying taxes
on such distributions will decrease.
18
Taxable Mortgage Pool Risks
An entity that constitutes a "taxable mortgage pool" as defined in the
Internal Revenue Code (TMP) is treated as a separate corporate level taxpayer
for federal income tax purposes. In general, for an entity to be treated as a
TMP (i) substantially all of the assets must consist of debt obligations and a
majority of those debt obligations must consist of mortgages, (ii) the entity
must have more than one class of debt securities outstanding with separate
maturities, and (iii) the payments on the debt securities must bear a
relationship to the payments received from the mortgages. As of December 31,
2002, we owned all of the equity interests in two trusts that constitute TMPs
(individually a Trust and together the Trusts). The Trusts were formed in
connection with our CBO-1 and CBO-2 resecuritization transactions. See
"BUSINESS-Resecuritizations" and Note 5 to the Notes to Consolidated Financial
Statements for descriptions of CBO-1 and CBO-2. The statutory provisions and
regulations governing the tax treatment of TMPs (the TMP Rules) provide an
exemption for TMPs that constitute "qualified REIT subsidiaries" (that is,
entities whose equity interests are wholly owned by a REIT or a qualified REIT
subsidiary). As a result of this exemption and the fact that as of December 31,
2002 we owned all of the equity interests in each of the Trusts, as of December
31, 2002 the Trusts were not required to pay a separate corporate level tax on
income they derive from their underlying mortgage assets.
As of December 31, 2002, we also owned certain securities structured as
bonds issued by the Trusts (the Bonds). As of December 31, 2002, certain of the
Bonds owned by us served as collateral (the Pledged Bonds) for certain secured
debt. If a creditor were to seize or sell the Pledged Bonds (unless seized by or
sold to a REIT or a qualified REIT subsidiary) and the Pledged Bonds were deemed
to constitute equity interests (rather than debt) in the Trusts, then the Trusts
would no longer qualify for the exemption under the TMP Rules provided for
qualified REIT subsidiaries. The Trusts would then be required to pay a
corporate level federal income tax. As a result, available funds from the
underlying mortgage assets that would ordinarily be used by the Trusts to make
payments on certain securities issued by the Trusts (including the equity
interests and the Pledged Bonds) would instead be applied to tax payments. Since
the equity interests and Bonds owned by us are the most subordinated securities
and, therefore, would absorb payment shortfalls first, the loss of the exemption
under the TMP Rules could have a material adverse effect on their value, the
payments received thereon and the value of our stock.
In addition to causing the loss of the exemption under the TMP Rules, a
seizure or sale of the Pledged Bonds and a characterization of them as equity
for tax purposes could also jeopardize our REIT status if the value of the
remaining ownership interests in any Trust held by us (i) exceeded 5% of the
total value of our assets or (ii) constituted more than 10% of the Trust's
voting interests. Although it is possible that the election by the TMPs to be
treated as taxable REIT subsidiaries could prevent the loss of our REIT status,
there can be no assurance that a valid election could be made given the timing
of a seizure or sale of the Pledged Bonds.
On the effective date of our recent January 2003 recapitalization, we
effected an affiliate reorganization principally to indirectly secure the Bear
Stearns Debt with the equity interests in the Trusts. As a result of the
affiliate reorganization, our REIT subsidiary (CBO REIT II), owns the Pledged
Bonds and indirectly owns all of the equity interests in the Trusts (through its
ownership of two qualified REIT subsidiaries which hold the equity interests in
the Trusts). We believe that the TMP risks set forth above remain applicable, as
of the effective date of our recent January 2003 recapitalization, with respect
to CBO REIT II; provided, however, that the risks referenced in the two
immediately preceding paragraphs should only apply if a creditor were to seize
or sell collateral which constituted or represented only a portion of the equity
interests in a Trust.
Employees
As of March 1, 2003, we had 107 employees, 72 of which are employed by
CMSLP and 35 of which are employed by CRIIMI MAE Management, Inc., one of our
wholly owned subsidiaries.
Executive Officers
The following table sets forth information concerning our executive
officers as of March 1, 2003:
19
Name Age Position
- ---- --- --------
Barry S. Blattman 40 Chairman of the Board, Chief Executive
Officer and President
David B. Iannarone 42 Executive Vice President and Chief Operating
Officer
Cynthia O. Azzara 43 Senior Vice President,
Chief Financial Officer and
Treasurer
Craig Lieberman 41 Senior Vice President and Chief Portfolio Risk
Officer
Brian L. Hanson 41 Senior Vice President
Barry S. Blattman has served as Chairman of the Board, Chief Executive
Officer and President since January 23, 2003.
David B. Iannarone has served as Chief Operating Officer since January 23,
2003, as Executive Vice President since December 2000, as Senior Vice President
and General Counsel from March 1998 to December 2000 and as Vice President and
General Counsel from July 1996 to March 1998.
Cynthia O. Azzara has served as Chief Financial Officer since 1994, Senior
Vice President since 1995 and Treasurer since 1997.
Craig Lieberman has served as Senior Vice President and Chief Portfolio
Risk Officer since February 4, 2003.
Brian L. Hanson has served as Senior Vice President since March 1998 and as
Group Vice President from March 1996 to March 1998.
Internet Website
Our internet website can be found at www.criimimaeinc.com. We make
available, free of charge on or through our website, access to our annual
reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form
8-K and amendments to those reports filed pursuant to Section 13(a) or 15(d) of
the Securities Exchange Act of 1934 as soon as reasonably practicable after such
material is filed with, or furnished to, the SEC.
ITEM 2. PROPERTIES
We lease our corporate offices at 11200 Rockville Pike, Rockville,
Maryland. As of December 31, 2002, these offices occupy approximately 67,600
square feet. As of March 1, 2003, approximately 1,100 square feet of this office
space was sublet to third parties and an additional 29,600 square feet of this
office space was available to sublet to third parties.
ITEM 3. LEGAL PROCEEDINGS
In the course of our normal business activities, various lawsuits, claims
and proceedings have been or may be instituted or asserted against us. Although
there can be no assurance, based on currently available facts, we believe that
the disposition of matters pending or asserted will not have a material adverse
effect on our consolidated financial position, results of operations or
liquidity. See Note 16 of Notes to Consolidated Financial Statements.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We did not submit any matters to a vote of security holders during the
fourth quarter of 2002.
20
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER
MATTERS
Market Data
Our common stock is listed on the New York Stock Exchange (symbol: CMM). On
October 17, 2001, we implemented a one-for-ten reverse stock split designed, in
part, to satisfy the New York Stock Exchange market price listing requirement.
All share and per share information in this Annual Report on Form 10-K has 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.
As of March 1, 2003, we had approximately 3,100 holders of record of our
common stock. The following table sets forth the high and low closing sales
prices for our common stock during the periods indicated.
2002 2001
-------------------------------- -------------------------------
Sales Price Sales Price
-------------------------------- -------------------------------
Quarter Ended High Low High Low
- ---------------------- ------------- -------------- -------------- -------------
March 31 $4.19 $3.49 $9.00 $6.90
June 30 7.39 3.45 7.90 5.70
September 30 8.87 6.15 7.00 3.90
December 31 10.43 7.69 4.25 2.53
Dividends
No cash dividends were paid to common shareholders during 2002 or 2001. See
"BUSINESS - Certain Risk Factors - Risk of Loss of REIT Status and Other Tax
Matters" for a brief discussion of the elimination of our REIT distribution
requirements for 2002 and 2001 due to our net operating loss.
Under the operative documents evidencing the BREF Debt and Bear Stearns
Debt, we are permitted to pay cash dividends to shareholders after the payment
of required principal and interest on that debt.
Dividends for the four quarters of 2001 and the first quarter of 2002 were
paid to preferred shareholders in the form of shares of common stock, except for
a cash dividend paid to the holder of our Series E Cumulative Convertible
Preferred Stock as discussed below. See Notes 11 and 12 to Notes to Consolidated
Financial Statements.
On March 21, 2002, we redeemed in cash all 173,000 outstanding shares of
our Series E Cumulative Convertible 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 ($396,000 of which represented accrued and unpaid dividends).
On May 16, 2002, September 10, 2002 and December 30, 2002, the Board of
Directors decided to defer the payment of dividends on our Series B Cumulative
Convertible Preferred Stock, Series F Redeemable Cumulative Dividend Preferred
Stock and Series G Redeemable Cumulative Dividend Preferred Stock for the
second, third and fourth quarters of 2002, respectively. On March 4, 2003, the
Board of Directors declared a cash dividend for the second quarter of 2002 on
our Series B, Series F and Series G Preferred Stock payable on March 31, 2003 to
shareholders of record on March 17, 2003.
21
Recent Sale of Unregistered Securities
Under the recently completed January 2003 recapitalization, BREF acquired
1,212,617 shares of our newly issued common stock, or approximately 8% of our
outstanding common stock after giving effect to the share acquisition, at $11.50
per share, or approximately $13.9 million. BREF also received seven-year
warrants to purchase up to 336,835 additional shares of common stock at a
purchase price of $11.50 per share. In connection with the sale, BREF
represented that it was an "accredited investor" within the meaning of Rule 501
under the Securities Act and that it had no intent to distribute the purchased
securities. Exemption from registration under the Securities Act was claimed
under Rule 506 of Regulation D.
The information required by Part II, Item 5 relating to Equity Compensation
Plans is incorporated herein by reference to our definitive proxy statement to
be filed pursuant to Regulation 14A relating to our 2003 annual meeting of
stockholders.
Other Shareholder Matters
For adjustments to the conversion price for the Series B Preferred Stock,
see Note 12 to Notes to Consolidated Financial Statements.
22
ITEM 6. SELECTED FINANCIAL DATA
Selected Consolidated Financial Data
Accounting Under Accounting Principles Generally Accepted in the United States
For the years ended December 31,
2002 2001 2000 1999 1998
---------- ----------- ----------- ----------- ------------
(in thousands, except per share amounts)
Consolidated Income Statement Data:
Interest income $124,460 $134,376 $195,252 $222,323 $ 207,307
Interest and related expense 92,642 97,788 139,366 151,337 136,268
---------- ----------- ----------- ----------- ------------
Net interest margin 31,818 36,588 55,885 70,986 71,039
---------- ----------- ----------- ----------- ------------
Servicing operations, net (42) (585) - - -
Impairment on CMBS (70,226) (34,655) (143,478) - -
Reorganization items - (1,813) (68,572) (178,900) (9,857)
Net (loss) income before cumulative
effect of accounting changes (46,359) (17,937) (148,584) (126,529) 42,369
Dividends accrued or paid on
preferred shares (8,123) (8,146) (6,912) (5,840) (6,998)
Net (loss) income to common
shareholders (64,248) (24,223) (155,495) (132,369) 35,371
Net (loss) income per diluted share
after cumulative effect of
accounting changes $ (4.69) $(2.18) $(25.02) $(24.51) $ 7.48
Financial Data:
Cash flows provided by (used in):
Operating activities $56,512 $ 53,476 $(6,818) $ 26,064 $ 48,861
Investing activities 87,198 52,737 113,351 130,693 (894,647)
Financing activities (131,758) (195,484) (53,474) (125,073) 865,504
As of December 31,
2002 2001 2000 1999 1998
---------- ----------- ----------- ----------- ------------
(in thousands)
Consolidated Balance Sheet Data:
Mortgage Assets:
CMBS and Other MBS $867,228 $832,682 $856,846 $1,179,363 $1,274,186
Insured mortgage securities 275,340 343,091 385,751 394,857 488,095
Investment in originated loans - - - 470,205 499,076
Servicing assets 26,357 24,766 - - -
Total assets 1,241,085 1,315,004 1,557,840 2,293,661 2,437,918
Debt:
Total recourse debt 375,952 407,637 558,585 925,704 1,125,036
Total nonrecourse debt 546,039 616,715 645,170 1,056,646 960,686
Total liabilities 949,424 1,053,959 1,289,582 2,074,313 2,130,041
Shareholders' equity 291,661 261,045 268,258 219,349 307,877
There were no cash dividends declared per common share for any of the
periods presented. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS" for a discussion of the accounting for
CMSLP and a discussion of our Chapter 11 reorganization, both of which affect
the comparability of the periods presented above.
23
The selected consolidated statement of income data presented above for the
years ended December 31, 2002, 2001 and 2000, and the selected consolidated
balance sheet data as of December 31, 2002 and 2001, were derived from, and are
qualified by, reference to our consolidated financial statements, which are
included elsewhere in this Annual Report on Form 10-K. The selected consolidated
statement of income data for the years ended December 31, 1999 and 1998, and the
selected consolidated balance sheet data as of December 31, 2000, 1999 and 1998,
were derived from audited financial statements not included as part of this
Annual Report on Form 10-K. This data should be read in conjunction with the
consolidated financial statements and the related notes.
Tax Basis Accounting
For the year ended December 31,
2002 2001 2000 1999 1998
------------- ------------- ----------- ----------- -----------
(in thousands)
Interest income $ 181,462 $ 187,079 $246,576 $278,450 $248,598
Interest and related expense 120,789 129,186 171,282 186,766 161,860
------------- ------------- ----------- ----------- -----------
Net interest margin 60,673 57,893 75,294 91,684 86,738
Other, net (9,701) (5,099) (6,253) (7,516) (2,176)
Net capital (losses) gains (460) 224 572 3,276 1,746
Credit losses (14,480) (4,370) (1,287) (621) -
January 2000 Loss recognized (119,542) (119,542) (119,600) - -
Mark-to-market loss on trading assets as of 04/17/01 - (8,573) - - -
Mark-to-market (loss) gain on trading assets (60) (135) 49,933 - -
Dividends accrued or paid on preferred shares (8,123) (8,145) (6,912) (5,840) (6,998)
Dividends not deductible due to net operating loss 8,123 8,145 6,912 - -
Reorganization items - (10,159) (35,604) (12,950) (4,819)
Emergence loan origination fee - (937) - - -
Loss on warehouse obligation - - - (36,328) -
Realized loss on reverse repurchase obligation - - - - (4,503)
Write-off of capitalized origination costs - - - - (3,284)
Loss on sale of trading assets - - (12,607) - -
------------- ------------- ----------- ----------- -----------
(Net operating loss)/taxable income (83,570) (90,698) (49,552) 31,705 66,704
Accumulated net operating loss, January 1 (140,250) (49,552) - - -
Remaining January 2000 Loss (119,485) (239,027) (358,569) - -
------------- ------------- ----------- ----------- -----------
Accumulated and unused net operating loss and
remaining January 2000 Loss $(343,305) $(379,277) $(409,121) $ - $ -
============= ============= =========== =========== ===========
24
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Introduction
The following discussion and analysis contains statements that may be
considered forward-looking. These statements contain a number of risks and
uncertainties as discussed here and in Item 1 of this Form 10-K that could cause
actual results to differ materially.
All information set forth in this Annual Report on Form 10-K has been
retroactively adjusted to reflect a one-for-ten reverse stock split implemented
on October 17, 2001.
Results of Operations
2002 compared to 2001
Financial statement net loss to common shareholders for the years ended
December 31, 2002 and 2001 was $(64.2) million and $(24.2) million,
respectively. The significant change in the 2002 results from 2001 was primarily
the result of $70.2 million of impairment charges related to certain
subordinated CMBS that were recognized during 2002 compared to impairment
charges of $34.7 million that were recognized during 2001.
2002 results include:
o approximately $70.2 of impairment charges related to certain
subordinated CMBS;
o an approximate $9.8 million non-cash charge to write-off goodwill upon
the adoption of Statement of Financial Accounting Standards (or SFAS)
No. 142;
o approximately $4.9 million from the gain on the sale by CMSLP of master
and direct servicing rights; and
o approximately $1.0 million reflected as an additional dividend on
preferred stock in connection with the redemption of the Series E
Preferred Stock (representing the difference between the aggregate
liquidation value and the redemption price).
2001 results include:
o approximately $34.7 million of impairment charges related to certain
subordinated CMBS;
o approximately $1.9 million of net revenue due to the effect of changes
in accounting principles, primarily a change in accounting for
servicing revenue;
o an aggregate of approximately $5.7 million of expenses relating to the
Chapter 11 reorganization; and
o approximately $2.8 million of amortization that was recorded during
the year ended December 31, 2001 on the goodwill written-off on
January 1, 2002.
The following table provides a summary of the components of pro forma net
loss to common shareholders and a reconciliation of pro forma net loss to common
shareholders to GAAP net loss to common shareholders for the years ended
December 31, 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.
25
Years ended December 31,
2002 2001
---- ----
Net interest margin $31,818,273 $36,587,984
General and administrative expenses (10,728,457) (10,951,420)
Depreciation and amortization (1,095,861) (929,013)
Servicing operations, net (excluding one-time items discussed above) (41,936) (2,864,600) (a)
Impairment on CMBS (70,225,506) (34,654,930)
Recapitalization expenses (1,048,559) --
Hedging expense (1,101,746) (1,073,392)
Income tax (expense) benefit (460,288) 336,439
Other, net 1,608,739 4,588,526
Dividends accrued or paid on preferred shares (7,084,791) (8,145,481)
--------------- ---------------
Pro forma net loss to common shareholders (58,360,132) (17,105,887)
Adjustments to GAAP net loss:
Servicing gain on sale of servicing rights 4,864,274 --
Servicing gain on sales of investment-grade CMBS 241,160 --
Servicing restructuring expenses (188,614) (437,723)
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 -- (2,789,472)
Reorganization items -- (1,813,220)
Emergence financing origination fee -- (3,936,616)
---------------- ------------
GAAP net loss to common shareholders $ (64,247,814) $ (24,222,798)
================ ==============
(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 $4.9
million, or 4.7%, to $100.6 million during 2002 as compared to $105.5 million
during 2001. This overall decrease in interest income was principally the result
of a reduction in the amortized cost of the subordinated CMBS during 2002
primarily as a result of the aggregate $65.8 million of impairment charges that
were recognized during the fourth quarter of 2001 through the third quarter of
2002 due to changes in the loss estimates related to the subordinated CMBS.
These impairment charges represent 7.7% of the amortized cost of the
subordinated CMBS as of December 31, 2001 before the fourth quarter impairment
charge was recorded. The reduction in the interest income generally corresponded
with the reduction in the amortized cost of the subordinated CMBS and the
changes in the average yield-to-maturity, as discussed below.
Accounting principles generally accepted in the United States, or GAAP,
require 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 assumptions as to the timing and amount of
future credit losses and other certain items estimated by management, as
discussed below, the weighted average anticipated unleveraged yield for our
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, approximately
12.0% as of October 1, 2002 and approximately 11.6% as of January 1, 2003. These
yields were determined based on the anticipated yield over the expected life of
our 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 years ended December 31, 2002 and 2001,
the amount of income recognized in excess of cash received due to the effective
interest rate method was approximately $11.4 million and $10.2 million,
respectively.
Interest Income - Insured Mortgage Securities
Interest income from insured mortgage securities decreased by approximately
$5.0 million, or 17%, to $23.8 million during 2002 from $28.9 million during
2001. This decrease was principally due to the prepayment of 25 mortgages
underlying the insured mortgage securities, representing approximately 21% of
the total insured
26
mortgage portfolio from December 31, 2001 through December 31, 2002. The
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 $92.6 million for 2002 was approximately
$5.1 million lower than the interest expense of approximately $97.8 million for
2001. The decrease is attributable to a lower average debt balance during 2002
($975 million) compared to 2001 ($1.1 billion), partially offset by a higher
average effective interest rate on total debt outstanding during 2002 (9.5%)
compared to 2001 (8.9%). Interest expense on the collateralized mortgage
obligations-insured mortgage securities decreased following significant
prepayments of mortgages underlying the insured mortgage securities. The
decrease in interest expense on the collateralized mortgage obligations-insured
mortgage securities was partially offset by approximately $2.8 million of
additional discount amortization expenses during 2002, which are included in
interest expense. These additional amortization expenses are the result of the
mortgages prepaying faster than previously anticipated which, under the
effective interest method of recognizing interest expense, required an
adjustment to cumulative interest expense. In addition, we adjusted our assumed
prepayment speed for the amortization of the deferred financing costs and
discount.
The overall weighted average effective interest rate on the Exit Debt was
10.4% during the year ended December 31, 2002. The weighted average coupon (pay)
rate on the Exit Debt was 8.0% during 2002. The overall weighted average
effective interest rate on the Exit Debt was 11.1% for the period April 17, 2001
to December 31, 2001. The weighted average coupon rate on the Exit Debt was 8.9%
for the period April 17 to December 31, 2001. The difference in the Exit Debt's
weighted average effective interest rate and the weighted average coupon (pay)
rate primarily related to the accrual of estimated 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.
General and Administrative Expenses
General and administrative expenses decreased by approximately $223,000 to
$10.7 million during 2002 as compared to $11.0 million during 2001 primarily due
to a decrease in legal fees in 2002, partially offset by an increase in
employment costs and higher directors and officers liability insurance premiums
in 2002.
Depreciation and Amortization
Depreciation and amortization decreased by approximately $2.6 million to
$1.1 million during 2002 as compared to $3.7 million during 2001. The decrease
is primarily attributable to the adoption of SFAS No. 142, "Goodwill and Other
Intangible Assets," on January 1, 2002. The adoption of SFAS No. 142 reduced our
annual amortization expense by approximately $2.8 million. See further
discussion of SFAS No. 142 in "Cumulative Effect of Adoption of SFAS 142" below.
Mortgage Servicing/Equity in Earnings (Losses) from Investments
In July 2001, we began accounting for CMSLP on a consolidated basis due to
a reorganization which resulted in the partnership interests of CMSLP being held
by two of our wholly owned taxable REIT subsidiaries (or TRSs). Prior to July
2001, we accounted for CMSLP under the equity method as we 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 our
consolidated financial statements.
The following is a summary of the consolidated results of operations of
CMSLP:
27
Year ended December 31,
Description 2002 2001
----------- -------------------- -------------------
CMSLP's results of operations (reflected in
consolidated income statements
effective July 1, 2001):
Servicing revenue $ 10,985,770 $ 6,683,886
Servicing general and administrative expenses (8,854,569) (5,570,162)
Servicing amortization, depreciation and impairment (2,173,137) (1,699,186)
Servicing restructuring expenses (188,614) (437,723)
Servicing gain on sale of servicing rights 4,864,274 (1) -
Servicing gain on sale of investment-grade CMBS 241,160 -
-------------------- -------------------
GAAP net income (loss) from CMSLP $ 4,874,884 $ (1,023,185)
==================== ===================
(1) See also the discussion in "Income Tax (Expense) Benefit" below.
The net income from CMSLP of $4.9 million for the year ended December 31,
2002 compares to the aggregate of the net equity in losses from CMSLP/CRIIMI MAE
Services, Inc. (or CMSI) of $(2.3) million for the year ended December 30, 2001
(as summarized below) and the net loss from CMSLP of $(1.0) million for the six
months ended December 31, 2001. CMSLP's net income of $4.9 million during 2002
includes a $4.9 million gain from the sale of servicing rights and $189,000 of
restructuring expenses. CMSLP's total revenue decreased by approximately $1.5
million to approximately $11.0 million during 2002 compared to $12.5 million
during 2001 (includes full year 2001 results). 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 $8.9
million and $11.9 million (includes full year 2001 results) during the years
ended December 31, 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 2002, amortization, depreciation and impairment was approximately
$2.2 million as compared to $3.4 million (includes full year 2001 results)
during 2001. This $1.2 million 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. The decrease
was partially offset by impairment that was recorded on CMSLP's investment in
AIM Limited Partnerships' subadvisory contracts. During 2002, the AIM Limited
Partnerships experienced a significant amount of prepayments of their insured
mortgages. These prepayments reduced CMSLP's cash flows from its subadvisory
contracts with the AIM Limited Partnerships. As a result, in accordance with
SFAS No. 142, "Goodwill and Other Intangible Assets," and SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets," we evaluated
CMSLP's investment in the subadvisory contracts for impairment. Our estimated
future undiscounted cash flows from this investment were projected to be less
than the book value of the investment as of December 31, 2002. As a result, we
believed that CMSLP's investment in the subadvisory contracts was impaired at
December 31, 2002. We estimated the fair value of the investment using a
discounted cash flow methodology. We wrote down the value of CMSLP's investment
in the subadvisory contracts with the AIM Limited Partnerships and recorded an
impairment charge of approximately $340,000 as of December 31, 2002.
In February 2002, CMSLP sold all of its rights and obligations under its
CMBS master and direct servicing contracts primarily 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, non-cancellable lease costs, and other costs related to the
restructuring. During 2002, additional net restructuring expenses of
approximately $189,000 were recorded primarily to account for vacant office
space that is taking longer to sublease than originally anticipated. CMSLP
received approximately $12.4 million in cash, which included reimbursement of
servicing advances, in connection with this sale.
Total equity in (losses) earnings from investments for the years ended
December 31, 2002 and 2001 includes our net equity from the AIM Limited
Partnerships (which are four publicly traded limited partnerships that
28
hold insured mortgages and whose general partner is one of our
subsidiaries) and the net equity from our 20% limited partnership interest in
the adviser to the AIM Limited Partnerships during these periods, and includes
net equity from CMSLP/CMSI for the six months ended June 30, 2001 (since CMSLP's
operations are consolidated effective July 1, 2001). In addition, as discussed
below, the 2002 results include an impairment charge on our equity investment in
the advisor to the AIM Limited Partnerships. On a comparative basis, the net
equity from the AIM Limited Partnerships decreased primarily due to a reduction
in the AIM Limited Partnerships' mortgage assets.
As previously discussed, during 2002, the AIM Limited Partnerships
experienced a significant amount of prepayments of their insured mortgages.
These prepayments reduced cash flows on our 20% investment in the advisor to the
AIM Limited Partnerships. As a result, in accordance with SFAS No. 142 and SFAS
No. 144, the advisor to the AIM Limited Partnerships evaluated its investment in
the advisory contracts for impairment. The estimated future undiscounted cash
flows from this investment were projected to be less than the book value of the
investment as of December 31, 2002. As a result, the advisor believed that its
investment in the advisory contracts was impaired at December 31, 2002. The
advisor estimated the fair value of its investment using a discounted cash flow
methodology. The advisor wrote down the value of its investment in the advisory
contracts to the AIM Limited Partnerships and recorded an impairment charge. We
recorded our portion of the impairment charge, totaling approximately $460,000,
as of December 31, 2002. This impairment charge is included in Equity in
(losses) earnings from investments in our Consolidated Statement of Income. This
investment is included in our Portfolio Investment segment.
The following is a summary of our equity in (losses) earnings from
investments:
Year ended December 31,
Description 2002 2001
----------- ---------------- ------------------
Equity in (Losses) Earnings from Investments (as presented
on income statements):
AIM Limited Partnerships - net equity in earnings $ 418,531 $ 647,096
Impairment on investment in AIM Limited Partnerships' advisor (460,413) --
CMSLP/CMSI - net equity in (losses) earnings -- (2,279,138)
---------------- ---------------
Total Equity in (Losses) Earnings from Investments $ (41,882) $(1,632,042)
================== ==============
Income Tax (Expense) Benefit
During 2002, we recorded a net income tax expense of approximately
$460,000. During 2001, we recorded an income tax benefit of approximately
$336,000. During 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 CMBS 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 2002. The income tax expense
was incurred by our TRSs that own the partnership interests in CMSLP. These TRSs
are separately taxable entities that cannot use our net operating loss
carryforward to reduce their taxable income. The income tax benefit that was
recognized by our TRSs during 2001 was the result of the net loss incurred by
CMSLP during the period July through December, 2001.
Other Income
Other income decreased by approximately $1.4 million to $2.6 million during
2002 from $4.0 million during 2001. This decrease was primarily attributable to
lower interest income earned on reduced cash balances during 2002 as compared to
2001, partially offset by an increase in net income (before interest expense and
depreciation expense) from a shopping center that we account for as real estate
owned, as discussed below. In addition, we recognized approximately $71,000 and
$44,000 in realized gains related to our trading of Other MBS during 2002 and
2001, respectively.
In October 2001, one of our wholly owned subsidiaries acquired certain
partnership interests in a partnership that was the obligor on a mezzanine loan
payable to us in exchange for curing a default on the first mortgage loan
through a cash payment of approximately $276,000. This partnership and another
of our wholly owned subsidiaries own 100% of the partnership interests in the
partnership which is the obligor on the first
29
mortgage loan. The first mortgage loan is secured by a shopping center in
Orlando, Florida. As a result of this acquisition, we own 100% of the
partnership interests and are consolidating the partnership's financial results
as of October 1, 2001. We account for these assets as real estate owned, and the
real estate is being held for investment. During the years ended December 31,
2002 and 2001, we recognized a net loss of approximately $773,000 and $266,000,
respectively, from the operations of the shopping center, which includes
approximately $858,000 and $213,000 of interest expense, respectively, and
approximately $149,000 and $26,000 of depreciation expense, respectively. The
remaining net income (expense) of approximately $234,000 and $(27,000) is
included in other income in the consolidated statements of income during the
years ended December 31, 2002 and 2001, respectively. We hope to reposition and
stabilize this asset to increase its value, although there can be no assurance
we will be able to do so.
Net Losses on Mortgage Security Dispositions
Net losses on mortgage security dispositions were approximately $995,000
during 2002 compared to approximately $42,000 during 2001. During 2002 and 2001,
there were 25 and nine loan prepayments, respectively. In addition, losses of
approximately $163,000 were recognized during 2002 following the final financial
settlement on the two mortgages that were assigned to the U.S. Department of
Housing and Urban Development (or HUD) in 2001. The original losses on these two
mortgages that were assigned to HUD were recognized during 2001. The net losses
in 2002 and 2001 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
Impairment on CMBS increased by approximately $35.5 million to $70.2
million during 2002 compared to $34.7 million during 2001. The paragraphs that
follow discuss the impairment charges that were recorded during 2002 and 2001.
The following table provides a summary of the changes in the overall expected
loss estimates on subordinated CMBS from January 1, 2001 through December 31,
2002:
Overall Impairment
Expected Recorded During
($ in millions) Loss Estimate Quarter Ended Impaired CMBS
- --------------- ------------- ------------- -------------
January 1, 2001 $298 $ -
September 30, 2001 307 3.9 Both bonds in CBO-1, and Nomura unrated bond
December 31, 2001 335 30.8 Both bonds in CBO-1, and BB- through unrated/issuer's equity
bonds in CBO-2
June 30, 2002 351 5.2 Nomura and CBO-2 unrated/issuer's equity bonds
September 30, 2002 448 29.9 All unrated/issuer's equity bonds, and the CCC bond and the B-
bond in CBO-2
December 31, 2002 503 35.1 All unrated/issuer's equity bonds, and the CCC bond and the B-
bond in CBO-2
Although the total amount of loans in special servicing only increased
slightly from $792 million as of December 31, 2001 to $811 million as of
December 31, 2002, the amount of estimated total mortgage loan defaults has
increased, the projected loss severities of the underlying mortgage loans
currently or anticipated to be in special servicing have increased and the
timing of certain projected losses is anticipated to occur sooner than
previously estimated, all of which has resulted in an increase in our overall
expected loss estimate related to our subordinated CMBS portfolio to $503
million as of December 31, 2002 as detailed in the table above. The 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 and increased expectation of defaults,
has resulted in higher projected loss severities on mortgage 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 mortgage 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. In addition, two significant hotel portfolios transferred
into special servicing in early January 2003. The unpaid principal balances of
these two hotel portfolios aggregate approximately $212.2 million. For a further
discussion of our significant hotel borrowing relationships, see "Summary of
CMBS." Since we
30
determined that there had been an adverse change in expected future cash
flows, we believed some of our subordinated CMBS had been impaired under EITF
99-20 and SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," as of December 31, 2002. As the fair values of the impaired
subordinated CMBS aggregated approximately $5.2 million, $29.9 million and $35.1
million below the amortized cost basis as of June 30, 2002, September 30, 2002
and December 31, 2002, respectively, we recorded other than temporary impairment
charges through the income statement of these same amounts during the second,
third and fourth quarters of 2002.
During 2001, we revised our overall expected loss estimate related to our
subordinated CMBS portfolio as detailed in the table above. The revisions to the
overall expected loss estimate during 2001 were primarily the result of the
continued slowing U.S. economy and recession exacerbated by the terrorist
attacks on September 11, 2001 and subsequent threats of terrorism, which were
principal causes of greater than previously anticipated monetary defaults on the
underlying mortgage loans and lower than previously anticipated appraisal
amounts on properties underlying certain defaulted loans. These factors
increased the estimated principal loss on the mortgage loans. As we determined
that there had been an adverse change in expected future cash flows, we believed
some of our subordinated CMBS had been impaired under EITF 99-20 and SFAS No.
115 as of September 30, 2001 and December 31, 2001. As the fair value of the
impaired subordinated CMBS was approximately $3.9 million and $30.8 million
below the amortized cost as of September 30, 2001 and December 31, 2001,
respectively, we recorded other than temporary impairment charges through the
income statement of these same amounts during the third and fourth quarters of
2001.
There can be no assurance that our revised overall expected loss estimate
of $503 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 weak economy or recession, an act of war, a delay in the
disposition of specially serviced mortgage loans, additional defaults, losses
occurring sooner than anticipated or an unforeseen reduction in expected
recoveries, any of which could result in additional future credit losses and/or
further impairment to our subordinated CMBS, the effect of which could be
materially adverse to us.
Hedging Loss and Cumulative Effect of Adoption of FAS 133
During 2002 and 2001, we recognized hedging expense through earnings of
approximately $1.1 million on our interest rate caps. In addition, we recognized
a $135,000 loss through earnings during 2001 due to the adoption of SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities".
In April 2002, we purchased an interest rate cap for approximately $1.6
million. This interest rate cap, which was effective on May 1, 2002, is for a
notional amount of $175.0 million, caps the one-month London Interbank Offered
Rate, or LIBOR, at 3.25% and matures on November 3, 2003. The fair value of this
cap has decreased by approximately $910,000 to approximately $4,000 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. As of December 31, 2002, the one-month LIBOR
rate was 1.38%.
The fair value of the interest rate cap that was effective in April 2001
and matures in April 2003 has become worthless due to a decline in interest
rates since the cap was purchased for $1.5 million. This cap is set at a
one-month LIBOR rate of 5.25%. As of December 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 December 31, 2002, the fair value of this interest rate cap was $0.
Recapitalization Expenses
In connection with our January 2003 recapitalization, we incurred
approximately $9.9 million of transaction costs (including amounts incurred in
2003). Included in this total is approximately $6.2 million of commitment fees,
and investment banking, legal and tax professional fees directly associated with
the Bear Stearns and BREF transaction. These costs will be allocated between
debt and equity. Included in the total recapitalization expenses is
approximately $1.0 million of investment banking, legal and tax professional
fees were incurred prior to our signing a letter of intent with BREF in 2002
during our evaluation of strategic alternatives. These amounts were expensed in
2002. Included in the total costs of $9.8 million are $2.6 million of expenses
which will be recognized in 2003 related to severance and
31
related payments, and accelerated vesting of stock options for our former
Chairman, William B. Dockser, and former President, H. William Willoughby, whose
employment contracts were terminated on January 23, 2003. As of December 31,
2002, we have approximately $1.4 million of the aforementioned transaction costs
included in Other Assets on our Consolidated Balance Sheet. See "Subsequent
Events" for a discussion of the total estimated cost of the transactions.
Reorganization Items
During 2001, we recorded reorganization items due to the Chapter 11 filings
of CRIIMI MAE Inc., CRIIMI MAE Management, Inc., and CRIIMI MAE Holdings II,
L.P. as follows:
Reorganization Items
--------------------
Short-term interest income $ 2,491,311
Professional fees (3,870,185)
Other (800,875)
Net recovery (loss) on real estate owned (1) 366,529
-------------
Total reorganization expense, net $ (1,813,220)
=============
(1) We recognized impairment on our investment in real estate
owned in 2000. This asset was sold in July 2000.
We did not recognize any reorganization expense in 2002.
Emergence Financing Origination Fee
In connection with the emergence from Chapter 11 in April 2001, we paid a
one-time, emergence financing origination fee of approximately $3.9 million
related to the Exit Variable-Rate Secured Borrowing. This fee was required to be
expensed immediately under GAAP.
Cumulative Effect of Adoption of SFAS 142
In June of 2001, the Financial Accounting Standards Board issued SFAS No.
142. SFAS No. 142, which 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 No. 142, the method
for testing goodwill for impairment occurs at the reporting unit level (as
defined in SFAS No. 142) and is performed using a fair value based approach.
SFAS No. 142 was effective for us on January 1, 2002. Effective upon adoption on
January 1, 2002, we 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 18 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 price
of our common stock price since the Merger in 1995. This change in accounting
principle reduced our annual amortization expense by approximately $2.8 million.
The pro forma net income and pro forma earnings per share disclosures in Note 3
of the Notes to Consolidated Financial Statements present our net income and
earnings per share as if this accounting principle had been applied to those
periods presented.
Cumulative Effect of Change in Accounting Principle Related to Servicing
Revenue
As discussed below, the cumulative effect of the change in accounting
principle of $2.0 million related to servicing revenue is reflected as of
January 1, 2001 as an adjustment to net income and therefore is reflected in the
year ended December 31, 2001 net income.
As of July 1, 2001, CMSLP changed its accounting policy related to the
recognition of special servicing fee revenue. Special servicing fees are paid to
CMSLP when mortgage loans collateralizing our CMBS are in default. Typically,
CMSLP is paid 25 basis points of the unpaid principal balance of the defaulted
mortgage loans for as long as the loans are in default. The fees are paid to
compensate the special servicer for managing and resolving the defaulted loan.
Historically, CMSLP had deferred special servicing fee revenue and recorded that
revenue into
32
earnings using the method consistent with our policy of recognizing
interest income over the life of our CMBS on the level yield basis. CMSLP is now
recording these special servicing fees in earnings on a current basis. This
change was made to better match revenues and expenses related to the actual
special servicing of the defaulted loans. The special servicing fees are paid on
a current basis by the trusts holding the mortgage loans and those payments
directly reduce the cash flow paid on our CMBS. Therefore, the special servicing
fees paid are built into the GAAP yields we use to record interest income on our
CMBS. CMSLP changed its accounting policy to recognize the special servicing
fees in earnings on a current basis as we believe this policy better matches the
special servicing fees CMSLP earns with the direct costs expended for performing
its special servicing obligations. The CMBS and special servicing contracts are
separate legal instruments or contracts.
We were required to reflect this change in accounting principle as a
cumulative catch-up as of January 1, 2001. As of January 1, 2001, CMSLP had
approximately $2.0 million in deferred revenue related to the special servicing
fee revenue. As a result, this amount was recorded in income and reflected as a
cumulative change in accounting principle for the year ended December 31, 2001.
The results of operations for the year ended December 31, 2001 reflect the
recognition of special servicing fee revenue on a current basis. As previously
discussed, prior to July 1, 2001, CMSLP was accounted for using the equity
method and, as a result, the impact of the new accounting principle (except for
the cumulative catch-up) is reflected in equity in earnings (losses) from
investments for the six months ended June 30, 2001 and on a consolidated basis
for the six months ended December 31, 2001. The pro forma net income and pro
forma earnings per share disclosures in Note 13 of the Notes to Consolidated
Financial Statements present our net income and earnings per share as if this
accounting principle had been applied to those periods presented. Net income
would have been $2.8 million less for the year ended December 31, 2001 had this
new accounting principle not been adopted.
REIT Status/Net Operating Loss for Tax Purposes
See "BUSINESS - Certain Risk Factors - Risk of Loss of REIT Status and
Other Tax Matters" for a discussion of REIT status, net operating loss and other
tax matters.
Net Operating Loss for Tax Purposes. We generated a net operating loss for
tax purposes of approximately $83.6 million for the year ended December 31, 2002
compared to a net operating loss of approximately $90.6 million in 2001.
As previously discussed, as a result of our trader election in early 2000,
we 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 $120 million per year) beginning with the year 2000.
A summary of our 2002 and 2001 net operating losses for tax purposes is as
follows:
($ in millions) 2002 2001
--------------- ---- ----
January 1, 2000 Loss $478.2 $478.2
LESS: Amounts recognized in 2000 (119.6) (119.6)
LESS: Amounts recognized in 2001 (119.5) (119.5)
LESS: Amounts recognized in 2002 (119.5) --
------- -------
Balance Remaining of January 1, 2000 Loss to be recognized in future periods $119.6 $239.1
======= =======
Taxable Income for the year before recognition of January 1, 2000 Loss $ 36.0 $ 29.0 (1)(2)
LESS: January 1, 2000 Loss recognized (119.5) (119.5)
PLUS: Mark-to-market unrealized loss on trading securities (0.1) (0.1)
------- --------
Net operating loss for the year ended December 31 $ (83.6) $ (90.6)
========= ========
Accumulated net operating loss through January 1 $(140.2) $ (49.6)
Net operating loss created during the year ended December 31 (83.6) (90.6)
Net operating loss utilization -- --
-------- --------
Net operating loss carried forward for use in future periods $(223.8) $(140.2)
======== ========
33
(1) Taxable income for the year ended December 31, 2001 includes an
approximate $8.6 million loss on certain trading securities in
connection with the transfer of certain trading securities on April 17,
2001 to CBO REIT following the reorganization effected to facilitate
the collateral structure for the Exit Debt. Assets transferred to CBO
REIT (and subsequently transferred to CBO REIT II in January 2003) are
no longer required to be marked-to-market on a tax basis.
(2) The taxable income for the year ended December 31, 2001 has been
increased by $6.3 million to reflect the actual taxable income included
on our 2001 income tax return, which was completed during 2002.
Results of Operations
2001 compared to 2000
Financial statement net loss to common shareholders for the years ended
December 31, 2001 and 2000 was $(24.2) million and $(155.5) million,
respectively. The significant change in the 2001 results from 2000 was primarily
the result of $34.7 million of accounting impairment charges related to certain
subordinated CMBS that were recognized during 2001 compared to impairment
charges of $143.5 million that were recognized during 2000. Additionally, net
loss to common shareholders for the year ended December 31, 2001 includes
approximately $1.9 million of net revenue due to the effect of changes in
accounting principles and an aggregate of approximately $5.8 million of expenses
relating to the Chapter 11 reorganization. The 2000 results include
approximately $66.1 million of expenses relating to the Chapter 11
reorganization.
The following table provides a summary of the components of pro forma net
loss to common shareholders and a reconciliation of pro forma net loss to common
shareholders to GAAP net loss to common shareholders for the years ended
December 31, 2001 and 2000. 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.
Year ended December 31,
2001 2000
---- ----
Net interest margin $ 36,587,984 $ 55,885,272
General and administrative expenses (10,951,420) (9,651,468)
Depreciation and amortization (3,718,485) (3,771,064)
Servicing operations, net (excluding one-time items discussed above) (2,864,600) (a) 810,602 (a)
Impairment on CMBS (34,654,930) (143,478,085)
Hedging expense (1,073,392) --
Income tax (expense) benefit 336,439 --
Other, net 4,588,526 5,384,689
Dividends accrued or paid on preferred shares (8,145,481) (6,911,652)
--------------- ---------------
Pro forma net loss to common shareholders (19,895,359) (101,731,706)
Adjustments to GAAP net loss:
Servicing restructuring expenses (437,723) --
Cumulative effect of accounting changes 1,860,120 --
Gain on extinguishment of debt -- 14,808,737
Litigation expense -- (2,500,000)
Reorganization items (1,813,220) (66,072,460)
Emergence financing origination fee (3,936,616) --
--------------- ----------------
GAAP net loss to common shareholders $ (24,222,798) $ (155,495,429)
============== ================
(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 $31.5
million, or 23%, to $105.5 million during 2001 as compared to $137.1 million
during 2000. This overall decrease in interest income was primarily the result
of the sale of certain CMBS during 2000 as part of our Chapter 11 reorganization
plan, partially offset by a higher weighted average yield-to-maturity on the
CMBS. The weighted average anticipated unleveraged yield for our subordinated
CMBS for financial statement purposes as of January 1, 2001 was approximately
12.4%, as compared to the anticipated weighted average yield used to recognize
income from April 1, 2000 to December
34
31, 2000 of 11.1% and 10.1% from January 1, 2000 through March 31, 2000.
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 years ended December 31, 2001 and 2000,
the amount of income recognized in excess of cash received due to the effective
interest rate method was approximately $10.2 million and $15.2 million,
respectively.
Interest Income - Insured Mortgage Securities
Interest income from insured mortgage securities decreased by approximately
$1.8 million or 6% to $28.9 million for 2001 from $30.7 million for 2000. This
decrease was principally due to the prepayment of nine mortgage securities and
the assignment to HUD of two mortgage securities during 2001. These prepayments
represented approximately 9% of the total insured mortgage portfolio.
Interest Income - Originated Loans
Interest income from originated loans decreased to $0 for 2001 as compared
to $27.5 million for 2000. Interest income from originated loans was derived
from originated loans included in the CMO-IV securitization, a securitization of
$496 million face value of conduit loans in June 1998. The decrease was due to
the sale of our interest in CMO-IV in November 2000.
Interest Expense
Total interest expense decreased by approximately $41.6 million or 30% to
approximately $97.8 million for 2001 from approximately $139.4 million for 2000.
This decrease was primarily attributable to the sale of our interest in CMO-IV
and certain CMBS during 2000 and the reduction of the related debt. These
decreases were partially offset by higher rates of interest incurred subsequent
to April 17, 2001 on our Exit Debt and the amortization of the related extension
fees on the Exit Debt under the effective interest method beginning in April
2001, as compared to the interest rates incurred during 2000 on the recourse
debt existing prior to emergence from Chapter 11.
The overall weighted average effective interest rate on the Exit Debt was
11.1% for the period April 17, 2001 to December 31, 2001. The weighted average
coupon rate on the Exit Debt was 8.9% for the period April 17 to December 31,
2001. The difference in the Exit Debt's weighted average effective interest rate
and weighted average coupon (pay) rate primarily relates to the amortization of
estimated extension fees and the accrued interest related to the 7% per annum,
accreting interest on the series B secured notes, both of which are included in
the weighted average effective interest rate, but not included in the weighted
average coupon (pay) rate.
The weighted average effective and coupon interest rates on the recourse
debt were 7.8% for the year ended December 31, 2000.
General and Administrative Expenses
General and administrative expenses increased by approximately $1.3 million
to $10.9 million in 2001 as compared to $9.7 million in 2000 primarily due to an
increase in professional fees, partially offset by lower employment costs due to
fewer employees and no CMO-IV mortgage servicing fees in 2001.
Depreciation and Amortization
Depreciation and amortization decreased by approximately $53,000 to $3.7
million in 2001 as compared to $3.8 million in 2000.
Mortgage Servicing/Equity in Income (Losses) from Investments
Beginning July 1, 2001, we began accounting for CMSLP on a consolidated
basis due to a reorganization which resulted in the partnership interests of
CMSLP being held by two of our wholly owned taxable
35
REIT subsidiaries (or TRSs). Prior to July 2001, we accounted for CMSLP
under the equity method as we 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 our consolidated financial statements.
The following is a summary of the consolidated results of operations of
CMSLP:
Year ended December 31,
Description 2001 2000
----------- -------------------- -------------------
CMSLP's results of operations (reflected in
consolidated inc income statements
effective July 1, 2001):
Servicing revenue $ 6,683,886 N/A
Servicing general and administrative expenses (5,570,162) N/A
Servicing amortization, depreciation and impairment (1,699,186) N/A
Servicing restructuring expenses (437,723) N/A
-------------------- -------------------
GAAP net loss from CMSLP $ (1,023,185) $ --
==================== ===================
The aggregate of the net equity in losses from CMSLP/CMSI of $(2.3) million
for the year ended December 30, 2001 (as summarized below) and the net loss from
CMSLP of $(1.0) million for the six months ended December 31, 2001 compares to
the net equity in earnings from CMSLP/CMSI of $811,000. CMSLP's total revenues
decreased by approximately $2.2 million to $12.5 million in 2001 compared to
$14.7 million in 2000, primarily due to lower interest income and assumption
fees resulting from low current interest rates and the decrease in mortgage
loans serviced. General and administrative expenses were $11.9 million and $11.3
million in 2001 and 2000, respectively. The increase was due primarily to an
increase in information technology expenses. CMSLP's amortization, depreciation
and impairment increased by approximately $0.5 million to $3.4 million in 2001
as compared to $2.9 million in 2000. In addition, the 2001 results include
restructuring expenses of $438,000 million related to CMSLP's sale of its rights
and obligations under its master and primary servicing contracts.
Total equity in earnings (losses) from investments for the years ended
December 31, 2001 and 2000 includes our net equity from the AIM Limited
Partnerships and the net equity from our 20% limited partnership interest in the
adviser to the AIM Limited Partnerships during these periods, and include net
equity from CMSLP/CMSI for the year ended December 31, 2000 and the six months
ended June 30, 2001 (since CMSLP's operations were consolidated effective July
1, 2001). On a comparative basis, the net equity from the AIM Limited
Partnerships decreased primarily due to a reduction in the AIM Limited
Partnerships mortgage assets. The following is a summary of our equity in
earnings (losses) from investments:
Year ended December 31,
Description 2001 2000
----------- ---------------- -----------------
Equity in (Losses) Earnings from Investments (as
presented on income statements):
AIM Limited Partnerships - net equity in earnings $ 647,096 $ 701,403
CMSLP/CMSI - net equity in (losses) earnings (2,279,138) 810,602
---------------- -----------------
Total Equity in (Losses) Earnings from Investments $(1,632,042) 1,512,005
================ =================
Other Income
Other income decreased by approximately $175,000 to $4.0 million during
2001 as compared to $4.2 million during 2000. This decrease was primarily
attributable to lower interest rates earned on fewer temporary investments. Also
included in other income is approximately $44,000 and $10,000 in realized gains
related to our trading of other MBS in 2001 and 2000, respectively.
In October 2001, one of our wholly owned subsidiaries acquired certain
partnership interests in a partnership that was the obligor on a mezzanine loan
payable to us in exchange for curing a default on the first mortgage loan
through a cash payment of approximately $276,000. This partnership and another
of our wholly-owned subsidiaries own 100% of the partnership interests in the
partnership which is the obligor on the first
36
mortgage loan. The first mortgage loan is secured by a shopping center in
Orlando, Florida. As a result of this acquisition, we own 100% of the
partnership interests and are consolidating the partnership's financial results
as of October 1, 2001. We account for these assets as real estate owned, and the
real estate is being held for investment. During the year ended December 31,
2001, we recognized a net loss of approximately $266,000 from the operations of
the shopping center, which includes approximately $213,000 of interest expense
and approximately $26,000 of depreciation expense. The remaining net expense of
approximately $27,000 is included in other income in the consolidated statements
of income during the year ended December 31, 2001.
Net (Losses) Gains on Mortgage Security and Originated Loan Dispositions
During 2001, net losses on mortgage security dispositions were
approximately $(42,000) as a result of nine prepayments and two assignments to
HUD of mortgage securities. There were no gains or losses on originated loan
dispositions in 2001 since our originated loans were sold in 2000. During 2000,
net gains on mortgage security and originated loan dispositions were
approximately $524,000, which was comprised of net gains on mortgage security
dispositions of approximately $280,000 and net gains on originated loan
dispositions of $244,000. During 2000, there were six prepayments of mortgage
securities and two prepayments of originated loans. 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
Impairment of CMBS decreased by approximately $108.8 million to $34.7
million during 2001 compared to $143.5 million during 2000.
As of September 30, 2001, we revised our overall expected loss estimate
related to our subordinated CMBS from $298 million to $307 million. As of
December 31, 2001, we again revised our overall expected loss estimate related
to our subordinated CMBS from $307 million to $335 million over the life of the
CMBS. These revisions to loss estimates were primarily the result of the
continued slowing U.S. economy and recession, exacerbated by the terrorist
attacks on September 11, 2001 and threats of subsequent terrorism. Principally
as a result of these adverse factors, the underlying mortgage loans had a
greater than previously anticipated number of monetary defaults during 2001.
Additionally, appraisal amounts on properties underlying certain defaulted loans
were significantly lower than previously anticipated, thereby increasing the
estimated principal loss on the commercial loans. As we determined that there
had been an adverse change in expected future cash flows, we believed some of
our subordinated CMBS had been impaired under EITF 99-20 and SFAS No. 115 as of
September 30, 2001 and December 31, 2001. As the fair value of the impaired CMBS
was approximately $3.9 million and $30.8 million below the amortized cost as of
September 30, 2001 and December 31, 2001, respectively, we recorded other than
temporary impairment charges through the income statement of these same amounts
during the third and fourth quarters of 2001.
As of December 31, 2000, we revised our overall expected loss estimate
related to our subordinated CMBS portfolio from $225 million to $298 million. In
addition, we expected such revised losses to occur sooner than originally
expected because of the slowing U.S. economy. This revised loss estimate was a
result of an increase in the number of loans that were placed in special
servicing due primarily to loan defaults. As we had determined that the current
estimate of expected credit losses exceeded credit losses as previously
projected, we believed our subordinated CMBS had been impaired under SFAS No.
115. As the fair value of the impaired CMBS was $143.5 million below the
amortized cost basis as of December 31, 2000, we recorded an other than
temporary impairment charge through the income statement of $143.5 million
during the fourth quarter of 2000.
Hedging Loss and Cumulative Effect of Adoption of FAS 133
During 2001, we recognized hedging expense through earnings of
approximately $1.1 million on our interest rate cap and a $135,000 loss through
earnings due to the adoption of SFAS No. 133.
37
Litigation Expense
During 2000, we recognized a $2.5 million expense based on the settlement
of the Capital Company of America, LLC Chapter 11 claim related to a letter of
intent in 1998 for the purchase of subordinated CMBS. No such expense was
recorded during 2001.
Reorganization Items
During 2001 and 2000, we recorded reorganization items due to the Chapter
11 filings of CRIIMI MAE, CRIIMI MAE Management, Inc. and CRIIMI MAE Holdings
II, L.P. as follows:
Reorganization Items 2001 2000
- -------------------- ----------------- ------------------
Short-term interest income $ 2,491,311 $ 6,850,362
Professional fees (3,870,185) (9,317,772)
Employee Retention Program -- (851,948)
Other (800,875) (1,136,319)
Excise tax accrued -- (495,000)
--------------- ---------------
Subtotal (2,179,749) (4,950,677)
Impairment on CMBS regarding Reorganization (2) -- (15,832,817)
Net recovery (loss) on real estate owned (1) 366,529 (924,283)
Net gain on sale of CMBS -- 1,481,029
Loss on originated loans -- (45,845,712)
---------------- ----------------
Total reorganization expense, net $ (1,813,220) $ (66,072,460)
================ ================
(1) We recognized impairment on an investment in real estate owned in 2000.
This asset was sold in July 2000.
(2) We recognized impairment on the CMBS subject to the sales of select
CMBS in 2000. The final bonds subject to the sales were sold in
November 2000.
Emergence Financing Origination Fee
In connection with our emergence from Chapter 11 in April 2001, we paid a
one-time, emergence financing origination fee of approximately $3.9 million
related to our Exit Variable-Rate Secured Borrowing. This fee was required to be
expensed immediately under GAAP.
Cumulative Effect of Change in Accounting Principle Related to Servicing
Revenue
The cumulative effect of the change in accounting principle of $2.0 million
related to servicing revenue is reflected as of January 1, 2001 as an adjustment
to net income and therefore is reflected in the year ended December 31, 2001 net
income. See discussion of this change in accounting principle in "2002 compared
to 2001".
REIT Status/Net Operating Loss for Tax Purposes
See "BUSINESS - Certain Risk Factors - Risk of Loss of REIT Status and
Other Tax Matters" for a discussion of our REIT status, net operating loss and
other tax matters.
Net Operating Loss for Tax Purposes. We generated a net operating loss for
tax purposes of approximately $(90.6) million for the year ended December 31,
2001 compared to a net operating loss of approximately $(49.6) million in 2000.
As previously discussed, as a result of our trader election in early 2000,
we 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 $120 million per year) beginning with the year 2000.
A summary of our 2001 and 2000 net operating losses for tax purposes is as
follows:
38
($ in millions) 2001 2000
- --------------- ---- ----
January 1, 2000 Loss $ 478.2 $ 478.2
LESS: Amounts recognized in 2000 (119.6) (119.6)
LESS: Amounts recognized in 2001 (119.5) --
--------- --------
Balance Remaining of January 1, 2000 Loss to be recognized in future
periods $ 239.1 $ 358.6
========= ========
Taxable Income for the year before recognition of January 1, 2000 Loss $ 29.0 (1)(2) $ 20.1
LESS: January 1, 2000 Loss recognized (119.5) (119.6)
PLUS: Mark-to-market unrealized (loss) gain on trading securities (0.1) 49.9
---------- ---------
Net operating loss for the year ended December 31 $ (90.6) $ (49.6)
========== =========
Accumulated net operating loss through January 1 $ (49.6) $ --
Net operating loss created during the year ended December 31 (90.6) (49.6)
Net operating loss utilization -- --
----------- ---------
Net operating loss carried forward for use in future periods $ (140.2) $ (49.6)
=========== =========
(1) Taxable income for the year ended December 31, 2001 includes an
approximate $8.6 million loss on certain trading securities in
connection with the transfer of certain trading securities on April 17,
2001 to CBO REIT following the reorganization effected to facilitate
the collateral structure for the Exit Debt. Assets transferred to CBO
REIT (and subsequently transferred to CBO REIT II in January 2003) are
no longer required to be marked-to-market on a tax basis.
(2) The taxable income for the year ended December 31, 2001 has been
increased by $6.3 million to reflect the actual taxable income included
on our 2001 income tax return, which was completed during 2002.
Cash Flow
2002 compared to 2001
Net cash provided by operating activities increased by approximately $3.0
million during 2002 as compared to 2001. The increase was primarily attributable
to net sales of other MBS during 2002 compared to net purchases during 2001. The
2002 results also 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 our 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 April 17, 2001 Chapter 11
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 Exit Debt and
$7.4 million to pay accrued payables related to the Chapter 11 filing.
Net cash provided by investing activities increased by approximately
$34.5 million to $87.2 million during 2002 compared to $52.7 million during
2001. The increase was primarily attributable to:
o a $37.8 million increase in proceeds from mortgage security prepayments
during 2002;
o $8.8 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
o net cash of $4.4 million that CMSLP invested in investment-grade CMBS
during 2002; and
o $6.8 million of cash reflected in 2001 as a result of the consolidation
of CMSLP beginning in July 2001.
Net cash used in financing activities decreased by approximately $63.7
million to $131.8 million during 2002 compared to $195.5 million during 2001.
The decrease in cash used is primarily attributable to:
o a $119.8 million decrease in principal payments on our recourse and
other non match funded debt,
including the Exit Debt, during 2002; partially offset by
o $18.7 million paid to redeem the Series E Preferred Stock; and
o a $37.3 million increase in principal payments on the securitized
mortgage debt obligations due primarily to higher mortgage security
dispositions in 2002.
The 2001 principal payments on recourse debt include approximately $127.2
million paid on the April 17,
39
2001 Chapter 11 effective date, which was used to pay off a portion of the
aggregate principal relating to debt incurred prior to the Chapter 11 filing.
In March 2002, we redeemed all 173,000 outstanding shares of the 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 table below, which is not presented in accordance with GAAP, is
intended to provide a summary of cash available for debt service on recourse
debt, dividends, acquisitions and general working capital purposes. We believe
that this information better facilitates an evaluation of our cash flows
available for debt service on recourse debt, dividends, acquisitions and general
working capital purposes. We also believe the table is helpful in evaluating our
recurring operating performance and our ability to fund liquidity internally.
The table below eliminates certain items which have the effect of reducing or
increasing net loss before changes in accounting principles and dividends, but
have no impact on cash available to us. These items are attributable in large
part to non-cash income statement items, which are included in our Consolidated
Statement of Cash Flows, as well as GAAP net interest income or expense from our
non-recourse match funded debt associated with the investment grade CMBS and our
insured mortgage securities. In addition, we adjusted income provided by
operating activities for cash distributions (which are a return of investment)
received from the AIM Limited Partnerships, our insured mortgage securities and
CMBS. The cash flows available for debt service on recourse debt, dividends,
acquisitions and general working capital purposes presented below must first be
used to service our recourse debt. Due to our NOL carryforward, we are able to
retain our net cash flows, after debt service, for payments of dividends,
acquisitions and general working capital purposes. The presentation of the
financial measure addressed by the table below is different than the
presentation included in previous periods. We have changed our presentation to
depict the reconciliation of this non-GAAP financial measure to the GAAP net
loss before accounting changes and preferred stock dividends. Although presented
differently, we believe that this reconciliation provides similar information to
that provided in previous periods.
40
Quarter Ended Year Ended
December 31, December 31,
($ in millions) 2002 2002
- --------------- -------------- -------------
GAAP net loss before changes in accounting principles
and preferred stock dividends $ (32.9) $ (46.4)
Adjustments:
Interest expense on recourse debt (1) 10.2 41.3
Net interest (income) expense from match-funded
assets and liabilities 1.6 1.3
Depreciation and amortization 0.2 1.1
Impairment on CMBS 35.2 70.2
Equity in (income) losses from investments 0.4 0.1
Hedging expense 0.4 1.1
Net losses (gains) on mortgage security dispositions 0.4 1.0
Amortization of deferred compensation - 0.1
Adjustment of subordinated CMBS GAAP interest
income to cash received (0.2) (4.0)
Servicing operations, net (including servicing
restructuring expenses) (2) 0.1 0.2
Gain on sales of servicing rights and
investment-grade CMBS (2) (0.3) (5.1)
-------------- --------------
Income provided by operating activities 15.1 60.9
Cash distributions received from AIM Limited 0.8 3.0
Partnerships
Net cash received from insured mortgage securities 0.8 3.4
-------------- --------------
Cash flows available for debt service on recourse
debt, dividends, acquisitions and general working
capital purposes $ 16.7 $ 67.3
============== ==============
Uses of cash:
Principal payments on recourse and other debt $ (8.6) $ (36.3)
Interest payments on recourse and other debt (9.9) (3) (32.2)
Dividend payments - (0.4) (4)
-------------- --------------
$ (18.5) $ (68.9)
============== ==============
(1) This amount includes the accreting interest on the Series B Senior
Secured Notes and the interest expense related to accrued extension fees.
(2) The results of CMSLP are excluded since CMSLP's cash was not used to
service our recourse debt or pay dividends. CMSLP retained its cash flows
to fund its operations.
(3) This amount includes the semi-annual interest payment on the Series B
Senior Secured Notes.
(4) This amount includes the cash dividends paid to the holder of the Series E
Preferred Stock at the time of redemption of such shares. It does not
include the $1.0 million difference between the aggregate liquidation value
and the redemption price of the Series E Preferred Stock, which is
reflected as a dividend on preferred stock in the Consolidated Statement of
Income.
2001 compared to 2000
Net cash provided by operating activities increased by approximately $60.3
million to $53.5 million during 2001 compared to $(6.8) million during 2000. The
increase was primarily due to a decrease in restricted cash and cash equivalents
and a decrease in receivables and other assets, partially offset by a decrease
in payables and accrued expenses. Receivables decreased primarily as a result of
the receipt in January 2001 of funds withheld related to our interest in CMO-IV.
The decrease in restricted cash and cash equivalents and the decrease in
payables and accrued expenses were primarily caused by cash outflows on the
April 17, 2001 Chapter 11 effective date, including approximately $44.7 million
to payoff 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 Exit Debt and $7.4 million to pay accrued payables related to the Chapter 11
filing.
Net cash provided by investing activities decreased by approximately $60.6
million to $52.7 million during 2001 compared to $113.4 million during 2000. The
decrease was primarily attributable to:
o net proceeds of $72.6 million received from the sale of CMBS during 2000 as
part of our reorganization plan;
41
o a $6.0 million decrease in proceeds from originated loan disposition as all
of our originated loans were sold in 2000;
o net proceeds of $3.5 million received from the sale of CMO IV in 2000 as
part of our reorganization plan; partially offset by
o a $22.7 million increase in the proceeds from insured mortgage securities
prepayments during 2001; and
o a $7.2 million decrease in principal payments from originated loans and
insured mortgage securities following the sale of the originated loans
during 2000 and prepayments of insured mortgage securities during 2001.
Net cash used in financing activities increased by approximately $142.0
million to $195.5 million during 2001 compared to $53.5 million during 2000. The
increase in cash used in 2001 was primarily attributable to:
o an outflow of cash of approximately $127.2 million on the April 17,
2001 Chapter 11 effective date, which was used to payoff a portion of
the aggregate principal relating to debt incurred prior to the Chapter
11 filing; and
o a $9.3 million increase in principal payments on the securitized
mortgage debt obligations due primarily to higher mortgage security
dispositions in 2001.
Financial Condition, Liquidity and Capital Resources
Limited Summary of January 2003 Recapitalization
On January 23, 2003, we completed a recapitalization of all of the Exit
Debt, which was funded with approximately $44 million from common equity and
secured subordinated debt issuances to BREF, $300 million in secured financing
in the form of a repurchase transaction from Bear Stearns and a portion of our
available cash and liquid assets. This recapitalization increases our financial
flexibility and provides new additions to management including Barry S.
Blattman, as Chairman of the Board and Chief Executive Officer, and Craig
Lieberman, as Senior Vice President and Chief Portfolio Risk Officer.
Under this recently completed recapitalization, BREF acquired 1,212,617
shares of our newly issued common stock, or approximately 8% of our outstanding
common stock after giving effect to the share acquisition, at $11.50 per share,
or approximately $13.9 million. BREF also received seven year warrants to
purchase up to 336,835 additional shares of common stock at $11.50 per share.
BREF also purchased $30 million of the BREF Debt and, at our option, BREF will
purchase up to an additional $10 million of subordinated debt prior to January
23, 2004. The BREF Debt matures on January 23, 2006 and bears interest at an
annual rate of 15%. If we decide to sell the additional $10 million of
subordinated debt to BREF, it will bear interest at an annual rate of 20% and
also matures on January 23, 2006. We have a right to defer two-thirds of the
interest on the BREF Debt (and half on the additional $10 million if sold to
BREF) during its term. The BREF Debt is secured by first liens on the equity
interests of two of our subsidiaries. Although this effectively provides BREF
with an indirect lien on all of our subordinated CMBS that are held by three of
our other lower tier subsidiaries, Bear Stearns has a first lien on the equity
interests of these three lower tier subsidiaries and on certain of the
subordinated CMBS held by one of these lower tier subsidiaries. Our obligations
under the BREF Debt are contractually subordinate to the prior payment in full
of our obligations under the $300 million in secured financing provided by Bear
Stearns. There are contractual restrictions on BREF's ability to realize upon
its indirect interest in the Bear Stearns first lien collateral. We paid an
origination fee of 0.67% to BREF related to the BREF Debt. We are also obligated
to pay BREF a quarterly maintenance fee of $434,000 in connection with arranging
the Bear Stearns Debt.
Under this recently completed recapitalization, Bear Stearns provided $300
million in secured financing in the form of a repurchase transaction (the Bear
Stearns Debt). The Bear Stearns Debt matures in 2006, bears interest at a rate
equal to one month LIBOR plus 3% and requires quarterly principal payments of
$1.25 million. The interest rate will increase to one month LIBOR plus 4% if a
CDO is not completed within one year from the closing of the Bear Stearns Debt.
In addition, the quarterly principal amortization will increase to $1.875
million if a CDO is not completed by January 23, 2004. The Bear Stearns Debt is
secured by first direct and/or indirect liens on all of our subordinated CMBS.
The indirect first liens are first liens on the equity interests of three of our
subsidiaries that
42
hold certain subordinated CMBS. A reduction in the value of this collateral
could require us to provide additional collateral or fund margin calls. If the
outstanding loan amount under the Bear Stearns Debt exceeds 85% of the aggregate
market value of the collateral securing the Bear Stearns Debt, as determined by
Bear Stearns in its sole good faith discretion, then Bear Stearns can require us
to transfer cash, cash equivalents or securities so that the outstanding loan
amount will be less than or equal to 80% of the aggregate market value of the
collateral (including any additional collateral provided). Failure to meet any
margin call could result in an event of default which would enable Bear Stearns
to exercise various rights and remedies including acceleration of the maturity
date of the Bear Stearns Debt and the sale of the collateral. In order to meet a
margin call, we may be required to sell assets at prices lower than their
carrying value which could result in losses. Although CRIIMI MAE Inc. is not a
primary obligor of the Bear Stearns Debt, it has guaranteed the debt. We paid a
commitment fee of 0.5% to Bear Stearns. See also "BUSINESS - Certain Risks -
Borrowing and Refinancing Risks" for a discussion of a possible CDO transaction
and certain collateral requirements related to the Bear Stearns Debt.
Our ability to meet our debt service obligations 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 changes in interest rates and spreads) and to generate capital internally
from operating and investing activities and expected reductions in REIT
distribution requirements to shareholders due to net operating losses for tax
purposes, in each case consistent with the terms and conditions of the operative
documents evidencing the Bear Stearns and BREF 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 us. Our ability to maintain or increase cash flow
and access new capital will depend upon, among other things, interest rates
(including hedging costs and margin calls), prevailing economic conditions,
restrictions under the operative documents evidencing the Bear Stearns and BREF
Debt, and other factors, many of which are beyond our control. Our cash flow
will also be negatively affected by realized losses, interest payment shortfalls
and appraisal reduction amounts on properties related to mortgages underlying
our subordinated CMBS. We expect losses on our CMBS to increase in 2003,
resulting in decreased CMBS cash flows as compared to 2002. Our cash flows are
also likely to decrease as a result of any prepayments of mortgage loans
underlying our insured mortgage securities and any prepayments of mortgages held
by the AIM Limited Partnerships. Prepayments of these mortgage loans will result
in reductions in the respective mortgage bases. As a result, the net cash flows
to us are likely to decrease over time. Our net cash flows will also decrease
due to the failure to close the CDO transaction prior to January 23, 2004 or if
we refinance the Bear Stearns Debt with debt which has a higher interest rate
and/or greater amortization requirements. Cash flows are also likely to be
affected if we incur further debt to acquire additional CMBS or for other
corporate purposes. See "QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK." Our high level of debt limits our ability to obtain additional capital,
significantly reduces income available for other activities, restricts our
ability to react quickly to changes in our business, limits our ability to hedge
our assets and liabilities, and makes us more vulnerable to economic downturns.
Our ability to make mortgage related investments and acquisitions depends,
among other things, on our ability to engage in such activities under the terms
and conditions of the operative debt documents, our internally generated cash
flows, and our ability to access additional capital. Factors which could affect
our ability to access additional capital include, among other things, the cost
and availability of such capital, the availability of investment product at
attractive rates of return, 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 our business, restrictions under the operative debt
documents, results of our operations, and our financial leverage, financial
condition, and business prospects. There can be no assurance that we will be
able to resume any of our prior activities or obtain additional capital, or that
the terms of any such capital will be favorable to us.
Limited Summary of Chapter 11 Reorganization Plan Including Exit Debt
Our Chapter 11 reorganization plan (effective April 2001) provided for the
payment in full of all of our allowed claims primarily through Chapter 11
recapitalization financing (including proceeds from certain asset sales)
totaling $847 million. The sales of select CMBS and the sale of our interest in
CMO-IV, a securitization transaction, generated proceeds of approximately $418.3
million toward the recapitalization financing, of which approximately $342.3
million was used to pay related borrowings and approximately $76.0 million was
used to help fund our reorganization plan. Included in the balance of the
recapitalization financing was approximately $262.4 million in Exit Debt
provided by affiliates of Merrill Lynch and GACC through the Exit Variable-Rate
Secured Borrowing, in the form of a repurchase transaction, and approximately
$166.8 million in Exit Debt provided through two new series of senior secured
notes issued to some of our unsecured creditors. As of June 5, 2001, all rights
and obligations of Merrill Lynch and GACC under the Exit Variable-Rate Secured
Borrowing operative agreements were assigned to ORIX Capital Markets, LLC. All
Exit Debt, described in further detail below, was paid off in connection with
the January 23, 2003 recapitalization.
43
The approximate $262.4 million (original principal amount) Exit
Variable-Rate Secured Borrowing provided for (i) interest at a rate of one-month
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 would not have constituted an event of default but would have
resulted 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 Chapter 11
effective date and (iv) maturity on April 16, 2005 assuming we exercised our
options to extend the maturity date of the debt. The approximate $166.8 million
fixed-rate secured financing was effected through the issuance of two series of
secured notes under two separate indentures. The Series A Senior Secured Notes,
representing an aggregate original principal amount of $105 million, provided
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 would not have constituted an event of default but would have resulted
in a 200 basis point increase in the interest rate on the unpaid principal
amount if certain miscellaneous collateral was 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 Chapter 11 effective date and (iv)
maturity on April 15, 2006. The Series B Senior Secured Notes, representing an
aggregate original principal amount of approximately $61.8 million, provided 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 Chapter 11 effective date (with the payment 60 months
after the Bankruptcy effective date also including an amount based on the unpaid
principal balance 66 months after the Bankruptcy effective date) and (iii)
maturity on April 15, 2007. The Exit Debt described above was secured directly
or indirectly by substantially all of our assets. There were 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 Exit Debt. See Note 7 to Notes
to Consolidated Financial Statements for additional information regarding the
Exit Debt.
The terms of the Exit Debt significantly restricted the amount of cash
dividends that could be paid to shareholders. One restriction provided that if
total realized losses and appraisal reduction amounts on properties related to
mortgage loans underlying our subordinated CMBS, as determined under the Exit
Debt operative documents, exceeded certain loss thresholds, then we were
prohibited from paying cash dividends or making other cash distributions or
payments to shareholders, except as required to maintain REIT status. As of
December 31, 2001 and December 31, 2002, total realized losses and appraisal
reduction amounts had exceeded the loss threshold amounts under the applicable
Exit Debt operative documents. Exceeding such loss threshold amounts resulted in
restrictions on the acquisition of CMBS rated "B" or lower or unrated.
Additional restrictions included restrictions on the use of proceeds from our
equity investments and specified cash flows from certain assets acquired after
the Chapter 11 effective date.
Summary of Cash Position and Shareholders' Equity
As of December 31, 2002, our restricted and unrestricted cash and cash
equivalents aggregated approximately $37.2 million, including cash and cash
equivalents of approximately $12.6 million held by CMSLP. In addition to our
cash, we had additional liquidity at December 31, 2002 comprised of a $5.7
million GNMA mortgage-backed security, $5.2 million in Other MBS and $3.3
million of investment grade CMBS owned by CMSLP, all of which are included
elsewhere in our balance sheet. After giving effect to the January 2003
recapitalization, the related retirement of the Exit Debt, and operations thru
mid March 2003, our total liquidity was approximately $17.8 million at March 21,
2003.
As of December 31, 2002 and 2001, shareholders' equity was approximately
$291.7 million or $16.32 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, our pro forma book value per diluted share would have been $14.18 as
of December 31, 2001. These diluted book value per share amounts are based on
shareholders' equity presented in accordance with GAAP. These amounts include,
among other things, the net assets related to our CMBS rated A+ through BBB,
which we do not actually own, but they are required by GAAP to be included on
our balance sheet (see "Summary of CMBS" below for a further discussion).
44
These CMBS are reflected at fair value and the related match-funded debt at
amortized cost, in each case in accordance with GAAP. The increase in the
diluted book value per share is primarily attributable to an overall increase in
the total fair value of our CMBS and insured mortgage securities primarily due
to a decrease in long-term interest rates and tighter spreads on certain CMBS as
of December 31, 2002 compared to December 31, 2001, partially offset by the net
loss to common shareholders of approximately $64.2 million for the year ended
December 31, 2002.
Summary of CMBS
As of December 31, 2002, we owned, in accordance with GAAP, CMBS (excludes
Other MBS) with an aggregate face amount of approximately $1.5 billion rated
from A+ to CCC and unrated. Such CMBS had an aggregate fair value of
approximately $862 million (representing approximately 69% of our total
consolidated assets) and an aggregate amortized cost of approximately $761
million. Such CMBS represent investments in securities issued in connection with
CRIIMI MAE Trust I Series 1996-C1 (or CBO-1), CRIIMI MAE Commercial Mortgage
Trust Series 1998-C1 (or CBO-2) and Nomura Asset Securities Corporation Series
1998-D6 (or Nomura). The following is a summary of the ratings of our CMBS as of
December 31, 2002:
Rating Fair Value % of CMBS
------ ---------- ---------
A+, BBB+ or BBB (a) $326.5 38%
BB+, BB or BB- $338.9 39%
B+, B, B- or CCC $176.6 21%
Unrated $20.0 2%
(a) Represents investment grade CMBS that we reflect as assets on our
balance sheet as a result of CBO-2. As indicated in footnote 4 to
the table below, GAAP requires both these assets (reflected as
"CMBS pledged to Secure Securitized Mortgage Obligation-CMBS") and
their related liabilities (reflected as "Collateralized bond
obligations - CMBS") to be reflected on our balance sheet. All
cash flows related to the investment grade CMBS are used to
service the corresponding debt. As a result, we currently receive
no cash flows from the investment grade CMBS.
As of December 31, 2002, the weighted average interest rate and the loss
adjusted weighted average life (based on face amount) of the investment grade
securities was 7.0% and 8.6 years, respectively. The weighted average interest
rate and the loss adjusted weighted average life (based on face amount) of
the BB+ through unrated CMBS securities, sometimes referred to as the retained
portfolio, were 5.3% and 10.5 years, respectively. The aggregate investment by
the rating of the CMBS is as follows:
45
Discount Rate
or Range of
Weighted Discount Rates
Average Loss Fair Value Used to
Face Amount Pass-Through Adjusted as of Calculate Fair Amortized Cost Amortized Cost
as of Rate as Weighted 12/31/02 Value as of 12/31/02 as of 12/31/01
12/31/02 (in of Average Life (in as of 12/31/02 (in millions) (in millions)
Security Rating millions) 12/31/02 (1) millions) (9) (10) (5) (6)
- ----------------------------------------------------------------------------------------------------------------------
Investment Grade Portfolio
A+ (4) $ 62.6 7.0% 4 years $ 66.0 5.1% $ 59.4 $ 58.7
BBB+ (4) 150.6 7.0% 10 years 150.6 7.0% 132.3 131.1
BBB (4) 115.2 7.0% 10 years 109.9 7.7% 95.3 94.2
Retained Portfolio
BB+ 319.0 7.0% 11 years 259.4 9.8%-10.2% 223.0 219.0
BB 70.9 7.0% 13 years 54.2 10.8% 46.8 46.0
BB- 35.5 7.0% 14 years 25.3 11.6% 20.8 20.5
B+ 88.6 7.0% 14 years 50.4 14.9% 46.0 45.2
B 177.2 7.0% 17 years 94.3 15.4%-15.7% 85.1 83.7
B- (2) 118.3 7.1% 24 years 28.1 16.0%- 28.1 48.1
20.0% (9)
CCC (2) 70.9 0.1% 2 years 3.8 (10) 3.8 13.1
Unrated/Issuer's
Equity (2) (3) 326.1 2.1% 1 year 20.0 (10) 20.0 62.8
---------- --------- ---------- ----------
Total (8) $1,534.9 5.7% 10 years $ 862.0 (8) $ 760.6 (7) $ 822.4
========== ========= ========== ==========
(1) The loss adjusted weighted average life represents the weighted average
expected life of the CMBS based on our current estimate of future losses.
As of December 31, 2002, the fair values of the B-, CCC and the
unrated/issuer's equity in Nomura, CBO-1, and CBO-2 were derived solely
from interest cash flow anticipated to be received since our 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 December 31, 2002, the subordinated CMBS from CBO-1 and CBO-2 (with
the exception of the CBO-2 issuer's equity which has no stated coupon
rate) 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 8.3% and 6.7%, respectively (prior to the consideration
of losses, prepayments and extensions on the underlying mortgage loans).
The subordinated CMBS 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 subordinated CMBS. Such interest
shortfalls will continue to accumulate until they (i) are repaid 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 our
overall expected loss estimate as of December 31, 2002, the CBO-2
subordinated CMBS currently rated B- and CCC and the Nomura unrated CMBS
are expected to incur approximately $55.4 million, $4.6 million, and $1.9
million, respectively, of 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 December 31, 2002.
(3) The unrated subordinated CMBS from CBO-2 currently does not have a stated
coupon rate since these 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-2.
(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 CMBS 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, we
initially retained $90.6 million (originally BBB rated, currently BBB+
rated) and $115.2 million (originally BBB- rated, currently BBB rated)
face amount of CMBS, both with call options, with the intention to sell
these CMBS at a later date. Such sale occurred March 5, 1999. Since we
retained call options on certain sold CMBS (the A+, BBB+ and BBB bonds),
we did not surrender control of these CMBS pursuant to the requirements of
SFAS No. 125 and thus these CMBS are accounted for as a financing and not
a sale. Since the transaction is recorded as a partial financing and a
partial sale, we have retained these CMBS with call options and reflected
them in our subordinated CMBS on the balance sheet to which we currently
receive no economic benefit.
46
(5) Amortized cost reflects impairment charges of approximately $70.2 million
related to the unrated/issuer's equity bonds, the CCC bond and the B- bond
in CBO-2, which were recognized during the year ended December 31, 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 CMBS except those rated A+
and BBB+), which were recognized through December 31, 2001.
(7) See "BUSINESS - Certain Risk Factors - Risk of Loss of REIT Status and
Other Tax Matters" for information regarding the subordinated CMBS for
tax purposes.
(8) As of December 31, 2002, the aggregate fair values of the CBO-1, CBO-2 and
Nomura bonds were approximately $19.3 million, $837.2 million and
$5.5 million, respectively.
(9) The discount rate is applied to gross scheduled cash flows as opposed to
loss adjusted cash flows for purposes of calculating fair values.
(10) As a result of the significant loss of principal on these CMBS, we have
used a significantly high discount rate to determine a reasonable fair
value of these CMBS. The weighted average yield-to-maturity of the CCC and
unrated/issuer's equity is 5.8% and 8.6%, respectively.
Determination of Fair Value of CMBS
Our determination of fair values for our 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 our view, is commensurate with the market's perception of value
and risk of comparable assets. We use a variety of sources to compile such
pricing information including: (i) recent offerings and/or secondary trades of
comparable CMBS (i.e., securities comparable to our CMBS or to the CMBS (or
collateral) underlying our CMBS issued in connection with CBO-1 and CBO-2), (ii)
communications with dealers and active CMBS investors regarding the pricing and
valuation of comparable securities, (iii) institutionally available research
reports, (iv) analyses prepared by the nationally recognized rating
organizations responsible for the initial rating assessment and on-going
surveillance of such CMBS, and (v) other qualitative and quantitative factors
that may impact the value of the CMBS such as the market's perception of the
issuers of the CMBS and the credit fundamentals of the commercial properties
securing each pool of commercial mortgage loans. We make further fair value
adjustments to such pricing information, which is then used to determine the
fair value of our CMBS using a discounted cash flow approach. Expected future
gross cash flows are discounted at market yields for our rated CMBS, depending
on the rating, and at a fixed discount rate for our unrated/issuer's equity.
Furthermore, the fair value for those CMBS incurring principal losses and
interest shortfalls (i.e., CBO-2 B-and CCC bonds, and our unrated/issuer's
equity) based on our overall expected loss estimate are valued at a
loss-adjusted yield to maturity that, in our view, is commensurate with the
market's perception of value and risk of comparable securities, 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 December
31, 2002. In addition, we considered the impact of our recent recapitalization
and the value of competing offers in determining our year end fair values. Since
we calculated the estimated fair value of our CMBS as of December 31, 2002 and
2001, we have disclosed the range of discount rates by rating category used in
determining the fair values as of December 31, 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 our 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
Through CMSLP, we perform servicing functions on commercial mortgage loans
underlying our CMBS totaling $17.4 billion and $19.3 billion as of December 31,
2002 and 2001, respectively. The mortgage loans underlying our subordinated CMBS
are secured by properties of the types and in the geographic locations
identified below:
47
12/31/02 12/31/01 12/31/02 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) Our ownership interest in one of the 20 CMBS transactions
underlying CBO-2 includes subordinated CMBS in which our 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"). These other
subordinated CMBS are not owned by us and are subordinate to our CMBS
in this transaction. As a result, our 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 other subordinated CMBS not owned by us.
Specially Serviced Mortgage Loans
CMSLP performs special servicing on the loans underlying our subordinated
CMBS. 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. We believe
that because we own over a majority of (and in almost all cases 100% of) the
first loss unrated or lowest rated bond of all but two of the CMBS transactions
underlying our subordinated CMBS, CMSLP has an incentive to efficiently and
effectively resolve any loan workouts. As of December 31, 2002 and 2001,
specially serviced mortgage loans included in the commercial mortgage loans
described above are as follows:
12/31/02 12/31/01
-------- --------
Specially serviced loans due to monetary default (a) $736.1 million $701.7 million
Specially serviced loans due to covenant default/other 74.7 million 90.0 million
-------------- ----------------
Total specially serviced loans (b) $810.8 million $791.7 million
============== ================
Percentage of total mortgage loans (b) 4.7% 4.1%
============== ================
(a) Includes $130.5 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 February 28, 2003, total specially serviced loans were
approximately $1.1 billion, or 6.3% of the total mortgage loans.
See discussion below for additional information regarding
specially serviced loans.
The specially serviced mortgage loans as of December 31, 2002 were secured
by properties of the types and located in the states identified below:
48
Property Type $ (in millions) Percentage Geographic Location $ (in millions) Percentage
- ------------- --------------- ---------- ------------------- --------------- ----------
Hotel............ $ 494.7 (1) 61% Florida............... $ 134.3 17%
Retail........... 200.8 (2) 25% Oregon................ 91.8 11%
Multifamily...... 42.6 5% Texas................. 86.6 11%
Healthcare....... 26.7 3% California............ 46.1 6%
Office........... 22.6 3% Georgia .............. 42.1 5%
Industrial....... 13.7 2% North Carolina........ 28.9 3%
Other............ 9.7 1% Other................. 381.0 47%
------------ ---------- -------- ---------
Total.......... $ 810.8 100% Total............... $ 810.8 100%
============ ========== ======== =========
(1) Approximately $80.4 million of these loans in special servicing are real
estate owned by underlying trusts.
(2) Approximately $32.7 million of these loans in special servicing are real
estate owned by underlying trusts.
As reflected above, as of December 31, 2002, approximately $494.7 million,
or 61%, of the specially serviced mortgage loans are secured by mortgages on
hotel properties. The hotel properties that secure the mortgage loans underlying
our subordinated CMBS are geographically diverse, with a mix of hotel property
types and franchise affiliations. The following table summarizes the hotel
mortgage loans underlying our subordinated CMBS as of December 31, 2002:
Total Outstanding Percentage of Amount in
Principal Balance Total Hotel Loans Special Servicing
----------------- ----------------- -----------------
Full service hotels (2) $ 1.4 billion 54% $ 206.6 million
Limited service hotels (1) 1.2 billion 46% 288.1 million
-------------- ---- ----------------
Totals $ 2.6 billion 100% $ 494.7 million
============= ==== ================
(1) 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.
(2) Full service hotels are generally mid-price, upscale or luxury hotels with
restaurant and lounge facilities and other amenities.
Of the $494.7 million of hotel loans in special servicing as of December
31, 2002, approximately $295.2 million, or 60%, relate to four borrowing
relationships more fully described as follows:
o Sixteen loans and eight real estate owned properties with scheduled
principal balances totaling approximately $92.2 million spread across four
CMBS transactions secured by hotel properties throughout the U.S. As of
December 31, 2002, our total exposure, including advances, on these loans
is approximately $96.4 million. In one of these CMBS transactions, which
contains 10 loans with scheduled principal balances totaling $39.0 million,
we hold only a 25% ownership interest in the non-rated class. In the other
three CMBS transactions, we hold a 100% ownership interest in the non-rated
class. Twenty-five loans were transferred into special servicing in
December 2001 due to the bankruptcy filing of each special purpose
borrowing entity and their parent company. Since the bankruptcy filing, as
part of a consensual plan, eight properties with scheduled principal
balances totaling $26.3 million have become real estate owned by underlying
trusts, one loan with a scheduled principal balance totaling $5.3 million
has been paid in full and the remaining sixteen loans with scheduled
principal balances totaling $65.9 million were granted maturity date
extensions and have been returned to performing status, and are in the
process of being transferred out of special servicing.
o Twenty-seven loans with scheduled principal balances totaling approximately
$138.1 million spread across three CMBS transactions secured by hotel
properties in the west and Pacific northwest states. As of December 31,
2002, our total exposure, including advances, on these loans is
approximately $160.4 million. The borrower had filed for bankruptcy
protection in October 2001. 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. We have entered into a consensual settlement
agreement dated February 25, 2003 pursuant to which the loan terms will be
amended and modified. The parties are currently proceeding toward closing
a comprehensive loan modification that should return the loans to
performing status.
49
o Five loans with scheduled principal balances totaling approximately $45.7
million secured by hotel properties in Florida and Texas. As of December
31, 2002, our total exposure, including advances, on these loans is
approximately $50.7 million. The loans are past due for the July 2002 and
all subsequent payments. The balance and paid-through date do not reflect
the recent application in 2003 of approximately $3.5 million of insurance
proceeds and of sporadic payments received from the borrower throughout the
year. The borrower and lender have entered into negotiations concerning a
consensual modification of the loan terms.
o Nine loans with scheduled principal balances totaling approximately
$19.2 million secured by limited service hotels in midwestern states.
As of December 31, 2002, our total exposure, including advances, on
these loans is approximately $20.9 million. 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 was attempting
to negotiate a workout with the borrower, but the borrower filed for
bankruptcy protection in February 2003.
In addition to the borrowing relationships described above, subsequent to
December 31, 2002 there were the following two additional transfers to special
servicing of large hotel loans, one for an imminent payment default and the
other for a non-monetary default. These defaults were considered in our December
31, 2002 loss assessment.
o One loan with a scheduled principal balance totaling approximately
$81.1 million secured by 13 extended stay hotels located throughout the
country. This loan was transferred to special servicing in January
2003 due to the borrower's request for forbearance and the resulting
possibility of an imminent payment default. In its request, the
borrower cited continuing reduced operating performance at its hotel
properties, which it did not expect to improve in the foreseeable
future. CMSLP entered into a short-term forbearance agreement with the
borrower, and a consensual term sheet to restructure and modify the
loan terms. We recently closed a loan modification agreement with the
borrower that is expected to return the loan to performing status in
the future.
o One loan with a scheduled principal balance totaling
approximately $131.1 million, secured by 93 limited service hotels
located in 29 states. The loan was transferred to special servicing
in January 2003. The loan is current for payments, but was
transferred to special servicing due to the unauthorized leasing of
some of the collateral properties by the borrower, and unapproved
franchise changes by the borrower, among other reasons. We have entered
into a Confidentiality and Pre-Negotiation Agreement in an attempt to
reach a consensual resolution of this matter.
For each of the borrowing relationships described in the paragraphs above,
we believe that we have adequate reserves for losses that we may incur in the
future. There can be no assurance that the losses incurred in the future will
not exceed our current reserves (see discussion below regarding increase in loss
estimates).
The following table provides a summary of the change in the balance of
specially serviced loans from December 31, 2001 to December 31, 2002:
(in
millions)
-------------
Specially Serviced Loans, December 31, 2001 $ 791.7
Transfers in due to monetary default 372.8
Transfers in due to covenant default and other 23.6
Transfers out of special servicing (353.9)
Loan amortization (1) (23.4)
-------------
Specially Serviced Loans, December 31, 2002 $ 810.8 (2)
=============
(1) Represents the reduction of the scheduled principal balances due to advances
made by the master servicers.
(2) Specially serviced loans total approximately $1.1 billion as of
February 28, 2003.
50
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(o)
to this Annual Report on Form 10-K for a detailed listing of all specially
serviced loans underlying our subordinated CMBS as of December 31, 2002.
Advance Limitations, Appraisal Reductions and Losses on CMBS
We experience shortfalls in expected cash flow on our CMBS prior to the
recognition of a realized loss primarily due to servicing advance limitations to
the most subordinate securities (only in certain underlying CMBS transactions)
or 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.
Thereafter, no future monthly principal and interest advances will be made by
the master servicer until the amount of the most subordinate CMBS current coupon
is eliminated. 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 sum of unpaid principal balance of the loan,
advances and other expenses exceeds 90% (in most cases) of the appraisal amount,
thus reducing our cash flows 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 our net cash flows 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 we retain 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
Year 2002 9,088 48,953 13,530 71,571
-------- -------- -------- ---------
Cumulative Appraisal Reductions through December 31, 2002 $26,559 $99,786 $14,404 $ 140,749
======== ======== ======== ==========
* 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, certain bonds 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 our
CMBS through December 31, 2002 (including realized mortgage loan losses expected
to pass through to our CMBS during the next month) 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
Year 2002 actual realized losses 11,554 25,113 563 37,230
------- -------- -------- --------
Cumulative actual realized losses through December 31, 2002 $ 16,038 $34,597 $ 801 $51,436
======== ======== ======== ========
Cumulative actual realized losses through December 31, 2002 $ 16,038 $34,597 $ 801 $51,436
Expected loss estimates for the year 2003 54,410 136,771 6,438 197,619
Expected loss estimates for the years 2004 17,771 89,783 20,016 127,570
Expected loss estimates for the years 2005 11,887 37,545 4,452 53,884
Expected loss estimates for the years 2006-2008 5,268 32,684 10,257 48,209
Expected loss estimates for the years 2009-2011 3,543 5,904 3,206 12,653
Expected loss estimates for the remaining life of CMBS 2,865 7,557 1,364 11,786
-------- -------- --------- ----------
Cumulative expected loss estimates (including cumulative
actual realized losses) through life of CMBS $111,782 $344,841 $46,534 $ 503,157
======== ======== ========= ==========
We revised our overall expected loss estimate related to our subordinated
CMBS from $335 million as of December 31, 2001 to $351 million as of June 30,
2002 to $448 million as of September 30, 2002 to $503 million as of December 31,
2002, with such total losses occurring or expected to occur through the life of
the subordinated CMBS. These revisions to the overall expected loss estimate
were primarily the result of increased mortgage loan defaults and increased
projected losses (and assuming the related timing of losses will occur sooner
than previously estimated) due to lower than anticipated appraisals and lower
internal estimates of values on real estate owned by
51
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 mortgage 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. In
addition, as previously discussed, two significant hotel loan portfolios
transferred into special servicing in January 2003. The unpaid principal
balances of these two hotel loan portfolios aggregate approximately $212.2
million. Our overall expected loss estimate of $503 million through the life of
our subordinated CMBS includes our estimate of total principal write-downs to
our 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 our revised overall expected loss estimate of $503 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 weak economy or
recession, an act of war, a delay in the 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
further impairment to our subordinated CMBS, the effect of which could be
materially adverse to us.
At September 30, 2001, we revised our overall expected loss estimate
related to our subordinated CMBS from $298 million to $307 million and, as of
December 31, 2001, we further revised our overall expected loss estimate from
$307 million to $335 million, with such total losses occurring or expected to
occur over the life of the subordinated CMBS. The revisions to loss estimates
during 2001 were primarily the result of the continued slowing U.S. economy and
recession, exacerbated by the terrorist attacks on September 11, 2001 and
threats of subsequent terrorism. As previously discussed, principally as a
result of these adverse factors, the underlying mortgage loans had a greater
than previously anticipated number of monetary defaults during 2001.
Additionally, appraisal amounts on properties underlying certain defaulted loans
were significantly lower than previously anticipated, thereby increasing the
estimated principal loss on the commercial loans.
See "Impairment on CMBS" for a discussion of the impairment charges
recognized during 2002, 2001 and 2000.
Yield to Maturity
The following table summarizes yield-to-maturity information relating to
our CMBS on an aggregate pool basis:
Current
Anticipated Anticipated Anticipated
Yield-to- Yield-to- Yield-to-
Maturity Maturity Maturity
Pool as of 1/1/01 (1) as of 1/1/02 (1) as of 1/1/03 (1)
---- ---------------- ---------------- ----------------
CBO-2 CMBS 11.8% (2) 12.1% (2) 11.6% (2)
CBO-1 CMBS 21.0% (2) 14.3% (2) 11.6% (2)
Nomura CMBS 25.3% (2) 28.7% (2) 8.0% (2)
---------- ------------ --------------
Weighted Average (3) 12.4% (2) 12.4% (2) 11.6% (2)
(1) Represents the anticipated weighted average yield over the expected average
life of the CMBS as of January 1, 2001, January 1, 2002, and January 1,
2003 based on our estimate of the timing and amount of future credit
losses.
(2) As previously discussed, as of December 31, 2000, September 31, 2001,
December 31, 2001, June 30, 2002, September 30, 2002 and December 31, 2002,
we revised our overall expected loss estimate related to our subordinated
CMBS to $298 million, $307 million, $335 million, $351 million, $448
million and $503 million, respectively, which resulted in impairment
recognition to certain subordinated CMBS. As a result of recognizing
impairment, we revised the anticipated yields as of January 1, 2001,
October 1, 2001, January 1, 2002, July 1, 2002, October 1, 2002 and
January 1, 2003, which were or are, in the case of revised anticipated
yields as of January 1, 2003, used to recognize
52
interest income beginning on each of those dates. These anticipated revised
yields took into account the lower cost basis due to the impairment
recognized on the 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. The
weighted average yield-to-maturity was 12.5% and 12.0% as of July 1, 2002
and October 1, 2002, respectively.
(3) 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 accounting income
recognition which is greater than or less than cash received. For the years
ended December 31, 2002, 2001 and 2000, the amount of income recognized in
excess of cash received on all of the subordinated CMBS due to the
effective interest rate method was approximately $11.4 million, $10.2
million and $15.2 million, respectively.
Sensitivity of Fair Value to Changes in the Discount Rate
The required rate of return used to determine the fair value of our
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
properties underlying each pool of commercial mortgage loans. If we assumed that
the discount rate used to determine the fair value of our 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 our CMBS (A+
through unrated bonds) by approximately $50.0 million (or 5.8%) as of December
31, 2002. The 100 basis point increase in the discount rate would have resulted
in a corresponding decrease in the value of our subordinated CMBS (BB+ through
unrated bonds) by approximately $31.8 million (or 6.0%) as of December 31, 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 subordinated CMBS 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
Portfolio Investment
As of December 31, 2002 and 2001, our 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 and real estate owned.
We had $275.3 million and $343.1 million (at fair value) invested in
insured mortgage securities as of December 31, 2002 and 2001, respectively. The
reduction in fair value is primarily attributable to the prepayment of insured
mortgages which had fair values of $71.9 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 December 31, 2002, 88% of our investment in insured
mortgage securities were GNMA mortgage-backed securities and approximately 12%
were FHA-insured certificates.
As of December 31, 2002 and 2001, we had approximately $6.2 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 Limited Partnerships,
and (b) a 20% limited partnership interest in the advisor to the AIM Limited
Partnerships. The decrease in these investments is primarily the result of
partner distributions declared by the AIM Limited Partnerships during 2002 due
to loan pay-offs and normal cash flow distributions and impairment of
approximately $460,000 that we recognized on our investment in the advisor to
the AIM Limited Partnerships during 2002 (see discussion in "Mortgage
Servicing/Equity in (Losses) Income from Investments"). The carrying values of
our equity investments are expected to continue to decline over time as the AIM
Limited Partnerships' asset bases decrease and proceeds are distributed to
partners.
53
Our Other MBS include primarily investment grade CMBS and investment grade
residential mortgage-backed securities. As of December 31, 2002 and 2001, the
fair values of our other MBS were approximately $5.2 million and $8.5 million,
respectively.
In October 2001, one of our wholly owned subsidiaries acquired certain
partnership interests in a partnership that was the obligor on a mezzanine loan
payable to us in exchange for curing a default on the first mortgage loan
through a cash payment of approximately $276,000. This partnership and another
of our wholly owned subsidiaries 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, we own 100% of the partnership interests and are consolidating the
partnership's financial results as of October 1, 2001. We account for these
assets as real estate owned, and the real estate is being held for investment.
The mezzanine loan payable is eliminated in consolidation. As of December 31,
2002 and 2001, we had $8.8 million and $8.6 million, respectively, in real
estate owned assets included in other assets ($8.4 million and $8.3 million,
respectively, relating to the actual building and land). In addition, we had
$7.2 million and $7.1 million of mortgage payable (net of discount) related to
the real estate as of December 31, 2002 and 2001, respectively. We hope to
reposition and stabilize this asset to increase its value, although there can be
no assurance we will be able to do so.
As discussed previously, $9.8 million of our goodwill and intangible assets
related to the 1995 Merger were written-off on January 1, 2002 upon the adoption
of SFAS No. 142.
Mortgage Servicing
As of December 31, 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 decreased by approximately $4.5 million from $18.3 million at
December 31, 2001 to $13.8 million at December 31, 2002. The decrease is
primarily the result of:
o a $4.1 million decrease in investments in mortgage servicing rights
and a $1.9 million decrease in advances receivable following the sale
of the CMBS servicing rights; and
o a $872,000 decrease in AIM Limited Partnerships' subadvisory contracts
due to the decreasing mortgage base being serviced for the AIM Limited
Partnerships by CMSLP and the impairment that was recognized on
CMSLP's investment in the subadvisory contracts (see discussion in
"Mortgage Servicing/Equity in (Losses) Income from Investments");
partially offset by
o the purchase of liquid, investment grade CMBS during 2002, which have a
fair value of approximately $3.3 million as of December 31, 2002.
Summary of Liabilities
Portfolio Investment
As of December 31, 2002 and 2001, our liabilities consisted primarily of
debt, accrued interest and accrued payables. Total recourse debt decreased by
approximately $31.5 million to $376.0 million as of December 31, 2002 from
$407.6 million as of December 31, 2001 due to principal repayments of $36.2
million during 2002, partially offset by interest accretion of $4.6 million on
the Series B Senior Secured Notes. Total non-recourse debt decreased by
approximately $70.7 million to $546.0 million as of December 31, 2002 from
$616.7 million as of December 31, 2001. This decrease is primarily attributable
to significant prepayments of mortgages underlying the insured mortgage
securities during 2002, which resulted in a corresponding reduction in the
principal balances of the securitized mortgage obligations. Our payables and
accrued liabilities increased by approximately $729,000 to $26.7 million as of
December 31, 2002 from $25.9 million as of December 31, 2001 primarily as a
result of a $4.3 million increase in accrued interest and extension fees on the
Exit Debt and a $3.2 million increase in dividends payable due to the deferral
of the second, third and fourth 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.
54
Mortgage Servicing
As of December 31, 2002 and 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 $2.9 million to $757,000 as of December 31, 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.
Subsequent Events
As previously discussed in "Limited Summary of January 2003
Recapitalization," BREF acquired 1,212,617 shares of our newly issued common
stock, or approximately 8% of our outstanding common stock after giving effect
to the share acquisition, at $11.50 per share, or approximately $13.9 million.
BREF also received seven year warrants to purchase up to 336,835 additional
shares of common stock at $11.50 per share. The fair value of the warrants was
calculated as approximately $2.6 million. The assumptions we used to value the
warrants are consistent with the assumptions used to value our stock options.
The warrants will be accounted for as a component of equity. BREF also purchased
$30 million of the BREF Debt and, at our option, BREF will purchase up to an
additional $10 million of subordinated debt prior to January 23, 2004. Bear
Stearns provided $300 million in secured financing in the form of a repurchase
transaction.
On the date of our recent January 2003 recapitalization, we effected an
affiliate reorganization principally to indirectly secure the Bear Stearns Debt
with the equity interests in CBO-1 and CBO-2. As a result of the affiliate
reorganization, our REIT subsidiary (CBO REIT II), owns all securities
previously pledged to secure the Exit Debt and indirectly owns all of the equity
interests in CBO-1 and CBO-2 (through its ownership of the two qualified REIT
subsidiaries which hold the equity interests in CBO-1 and CBO-2).
In connection with the recapitalization, we expect to recognize certain
amounts in our Consolidated Statement of Income during the first quarter of
2003. These amounts include the following:
o On January 23, 2003 and in connection with the closing of the
recapitalization, amounts were deposited with the indenture trustee to
pay all principal and interest on our outstanding Series A and Series
B Senior Secured Notes on the March 10, 2003 redemption date. This
redemption required 45 days prior notice. These notes were not
considered repaid for GAAP purposes until the March 10, 2003
redemption date. The 45 day notice period resulted in additional
interest expense during the period January 23, 2003 through March 10,
2003 since the Bear Stearns and BREF Debt were outstanding and the
senior secured notes were also outstanding. This additional interest
expense related to the 45 day notice period, which will be recognized
during the first quarter of 2003, totaled approximately $3.1 million.
o Approximately $7.4 million will be recognized as a gain on
extinguishment of debt, primarily due to the reversal of accrued
extension fees on the Exit Debt.
o Approximately $2.6 million of expenses will be recognized related to
severance and related payments, and accelerated vesting of stock
options for our former Chairman, William B. Dockser, and former President,
H. William Willoughby, whose employment contracts were terminated on
January 23, 2003.
In addition to the income statement items described above, transaction
costs currently estimated to be approximately $6.2 million related to the
recapitalization will be included on the Consolidated Balance Sheet as of March
31, 2003. Such costs will be allocated between debt and equity. The costs
allocated to debt will be amortized using the effective interest method over the
lives of the related debt. The costs allocated to equity will be reflected in
equity net of the proceeds from the issuance of the common stock.
55
Dividends/Other
No cash dividends were paid to common shareholders in 2002 or 2001. Unlike
the Exit Debt, which significantly restricted the amount of cash dividends that
could be paid, the BREF and Bear Stearns Debt permit the payment of cash
dividends after the payment of required principal and interest on that debt.
Other factors which could impact dividends, if any, include (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 our LIBOR-based debt is priced, as well as the rate we pay on our other
borrowings and fluctuations in long-term interest rates, (iv) changes in
operating expenses, including hedging costs, (v) margin calls, (vi) the level of
income earned on our insured mortgage securities depending primarily on
prepayments and defaults, (vii) the rate at which cash flows from mortgage
assets, mortgage dispositions, and, to the extent applicable, distributions from
our subsidiaries can be reinvested, (viii) cash dividends paid on preferred
shares, (ix) to the extent applicable, whether our taxable mortgage pools
continue to be exempt from corporate level taxes, (x) realized losses on certain
transactions, and (xi) the timing and amounts of cash flows attributable to our
other lines of business - mortgage servicing and other fee income.
Taxable Mortgage Pool Risks
See "Business - Risk Factors - Taxable Mortgage Pool Risks" for a
discussion of taxable mortgage pool risks.
Investment Company Act
For a discussion of the Investment Company Act and the risk to the Company
if it were required to register as an Investment Company, see "BUSINESS-Risk
Factors-Investment Company Act".
Critical Accounting Policies
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities, the disclosure of contingent assets and liabilities at
the date of the financial statements, and the reported amounts of revenues and
expenses during the reporting periods. We continually evaluate the estimates we
use to prepare the consolidated financial statements, and update those estimates
as necessary. In general, management's estimates are based on historical
experience, on information from third party professionals, and other various
assumptions that are believed to be reasonable under the facts and
circumstances. Actual results could differ materially from those estimates.
Our significant accounting policies are described in Note 3 to Notes to
Consolidated Financial Statements. We believe our most critical accounting
estimates (a critical accounting policy being one that is both very important to
the portrayal of our financial condition and results of operations and requires
management's most difficult, subjective or complex judgments) include the
determination of fair value of our subordinated CMBS and interest income
recognition related to our subordinated CMBS.
o Fair Value of subordinated CMBS - Due to the limited liquidity of
the subordinated CMBS market and the resulting lack of a secondary
market, we estimate the values of our subordinated CMBS internally.
These estimates require significant judgment regarding assumptions
for defaults on the underlying commercial mortgage loan collateral,
timing of loss realization and resultant loss severity and discount
rates. Note 5 to Notes to Consolidated Financial Statements
contains a detailed discussion of the methodology used to determine
the fair value of our subordinated CMBS as well as a sensitivity
analysis related to the fair value of these subordinated CMBS due
to changes in assumptions related to losses on the underlying
commercial mortgage loan collateral and discount rates.
o Interest Income recognition related to subordinated CMBS - Interest
income recognition under EITF No. 99-20 requires us to make estimates
regarding expected prepayment speeds as well as expected
56
losses on the underlying commercial mortgage loan collateral (which
directly impact the cash flows on our subordinated CMBS in the form of
interest shortfalls and loss of principal) and the impact these factors
would have on future cash flow. Note 5 to Notes to Consolidated Financial
Statements details the expected realized losses by year that we expect
to incur related to our subordinated CMBS. The cash flows we project to
arrive at the effective interest rate to recognize interest income are
adjusted for these expected losses. The judgment regarding future
expected credit losses is subjective as credit performance is particular
to an individual deal's specific underlying commercial mortgage loan
collateral. In general, if we increase our expected losses or determine
such losses will occur sooner than previously projected and the CMBS's
fair value is below cost, then the CMBS will be considered impaired and
adjusted to fair value with the impairment charge recorded through
earnings.
Recent Accounting Pronouncements
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 supersedes SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of," and the accounting and reporting provisions of
Accounting Principles Board Opinion No. 30, "Reporting Results of
Operations-Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequent Occurring Events and Transactions" for the
disposal of segments of a business. SFAS No. 144 established accounting and
reporting standards for the impairment or disposal of long-lived assets by
requiring those long-lived assets be measured at the lower of carrying costs or
fair value less selling costs, whether reported on continuing operations or in
discontinued operations. The provisions of SFAS No. 144 are effective for
financial statements issued for fiscal years beginning after December 15, 2001.
We adopted SFAS No. 144 on January 1, 2002. As discussed previously, we
recognized approximately $801,000 of impairment in our Consolidated Statement of
Income during 2002 related to our Portfolio Investment segment's investment in
the advisor to the AIM Limited Partnerships and our Mortgage Servicing segment's
investment in the AIM Limited Partnerships subadvisory contracts.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections," that, among other things, rescinded SFAS No. 4, "Reporting Gains
and Losses from Extinguishment of Debt." With the rescission of SFAS No. 4, the
early extinguishment of debt generally will no longer be classified as an
extraordinary item for financial statement presentation purposes. The provision
is effective for fiscal years beginning after May 15, 2002, with earlier
application related to the rescission of SFAS No. 4 encouraged. We adopted the
provisions related to the rescission of SFAS No. 4 on April 1, 2002. As a
result, we have reclassified a $14.8 million gain on debt extinguishment in 2000
from an extraordinary item to an operating item. In addition, in 2003, we expect
to recognize a gain on extinguishment of debt as a result of the retirement of
the Exit Debt following the recapitalization in January 2003. The gain will be
classified as an operating item.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities," which replaces Emerging Issues
Task Force Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." The new standard requires companies to
recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit or disposal plan.
The statement is to be applied prospectively to exit or disposal activities
initiated after December 31, 2002. We do not expect the adoption of SFAS No. 145
to have a material effect on our financial position or results of operations.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure," which amended SFAS No. 123
"Accounting for Stock-Based Compensation." The new standard provides alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. Additionally, the statement
amends the disclosure requirements of SFAS No. 123 to require prominent
disclosures in the annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results. This statement is effective for financial statements
for fiscal years ending after December 15, 2002. In accordance with SFAS No.
148, we have elected to continue to follow the intrinsic value method in
accounting for our stock-based employee compensation arrangements as defined by
Accounting Principles Board Opinion (APB)
57
No. 25, "Accounting for Stock Issued to Employees," and have made the
applicable disclosures in Note 14 to the consolidated financial statements.
In January 2003, the FASB issued FASB Interpretation (or FIN) No. 46,
"Consolidation of Variable Interest Entities", an interpretation of Accounting
Research Bulletin No. 51, "Consolidated Financial Statements." FIN No. 46
explains how to identify variable interest entities and how an enterprise
assesses its interests in a variable interest entity to decide whether to
consolidate that entity. This Interpretation requires existing unconsolidated
variable interest entities to be consolidated by their primary beneficiaries if
the entities do not effectively disperse risks among parties involved. FIN No.
46 is effective immediately for variable interest entities created after January
31, 2003, and to variable interest entities in which an enterprise obtains an
interest after that date. The Interpretation applies in the first fiscal year or
interim period beginning after June 15, 2003, to variable interest entities in
which an enterprise holds a variable interest that it acquired before February
1, 2003. We do not expect the adoption of FIN No. 46 to have a material effect
on our financial position or results of operations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our principal market risk is exposure to changes in interest rates related
to the U.S. Treasury market as well as the LIBOR market. We will have
fluctuations in the amount of interest expense paid on our variable rate debt
primarily due to changes in one-month LIBOR. We will also experience
fluctuations in the market value of our mortgage assets related to changes in
the yields of U.S. Treasury securities as well as changes in the spread between
U.S. Treasury securities and the mortgage assets. The combination of the risk
free rate (U.S. Treasury yields) and the related spread is the discount rate
used to determine the fair value of our mortgage assets. The U.S. Treasury yield
used to determine the fair value of our mortgage assets is the current yield on
a U.S. Treasury which has the same weighted average life of the related mortgage
asset. As of December 31, 2002, the average U.S. Treasury rate used to price our
CMBS, excluding the CCC and unrated/issuer's equity CMBS, had decreased by
approximately 124 basis points and credit spreads had tightened on certain CMBS
compared to December 31, 2001. The fair values of our B- and CCC CMBS in CBO-2
and our unrated/issuer's equity are determined using a loss adjusted yield to
maturity, which is commensurate with the market's perception of value and risk
of comparable assets. As described, interest rates impact the fair values of our
CMBS, which affects our collateral coverage. See "Item 1 - BUSINESS - Borrowing
and Refinancing Risks" for a discussion of our collateral coverage requirements
under the Bear Stearns Debt.
We have changed our method of presenting market risk disclosures from those
disclosures presented in the December 31, 2001 Annual Report on Form 10-K. We
believe that the market risk disclosures presented below provide more meaningful
information to our shareholders in assessing the affect of changes in interest
rates on the values of our assets and the interest expense on our variable rate
debt.
Insured Mortgage Securities
As of December 31, 2002, the weighted average life of the U.S. Treasury
securities that were used to value the insured mortgage securities were
significantly shorter than those used at December 31, 2001 due to lower market
interest rates and other loan attributes of the underlying insured mortgage
securities, which made the likelihood of the mortgage securities prepaying
greater than the previous year. If we assumed that the discount rate used to
determine the fair values of our insured mortgage securities increased by 100
basis points and 200 basis points, the increase in the discount rate would have
resulted in a corresponding decrease in the fair values of our insured mortgage
securities by approximately $161,000 (or 0.1%) and approximately $319,000 (or
0.1%), respectively, as of December 31, 2002. A 100 basis point and 200 basis
point increase in the discount rate would have resulted in a corresponding
decrease in the fair values of our insured mortgage securities by approximately
$15.3 million (or 4.5%) and approximately $29.4 million (or 8.6%), respectively,
as of December 31, 2001.
CMBS
The required rate of return used to determine the fair values of our 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 CMBS's assumed stream of future cash flows,
results in the fair value of such cash flows. The determination of such rate is
dependent on many quantitative and qualitative factors, such as,
58
but not limited to, the market's perception of the issuers of the CMBS and
the credit fundamentals of the commercial properties underlying each underlying
pool of commercial mortgage loans.
If we assumed that the discount rate used to determine the fair values of
our CMBS (A+ through unrated bonds) increased by 100 basis points and 200 basis
points, the increase in the discount rate would have resulted in a corresponding
decrease in the fair values of our CMBS (A+ through unrated bonds) by
approximately $50.0 million (or 5.8%) and approximately $95.9 million (or
11.1%), respectively, as of December 31, 2002. A 100 basis point and 200 basis
point increase in the discount rate would have resulted in a corresponding
decrease in the fair values of our CMBS (A+ through unrated bonds) by
approximately $46.2 million (or 5.6%) and $88.5 million (or 10.7%),
respectively, as of December 31, 2001. A 100 basis point and 200 basis point
increase in the discount rate would have resulted in a corresponding decrease in
the value of our subordinated CMBS (BB+ through unrated bonds) by approximately
$31.8 million (or 6.0%) and $60.9 (or 11.5%), respectively, as of December 31,
2002. A 100 basis point and 200 basis point increase in the discount rate would
have resulted in a corresponding decrease in the value of our subordinated CMBS
(BB+ through unrated bonds) by approximately $28.9 million (or 5.5%) and $55.3
million (or 10.5%), respectively, as of December 31, 2001.
See also Note 5 of Notes to Consolidated Financial Statements for a
discussion of other factors that could affect the fair values of our CMBS,
including changes in the timing and/or amount of credit losses on underlying
mortgage loans, the receipt of mortgage payments earlier than projected due to
prepayments, and delays in the receipt of monthly cash flow distributions on
CMBS due to mortgage loan defaults and/or extensions in loan maturities.
Variable Rate Debt
We have interest rate caps to mitigate the adverse effects of rising
interest rates on the amount of interest expense payable under our variable rate
debt. In April 2002, we purchased an interest rate cap. This interest rate 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. Our caps provide protection 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, we 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 1.77%
during the year ended December 31, 2002, which was a 10 basis point decrease
from December 31, 2001.
A 100 basis point change in the one-month LIBOR index would have changed
our interest expense on our Exit Variable-Rate Secured Borrowing by
approximately $2.3 million and $1.8 million during the years ended December 31,
2002 and 2001, respectively. As of March 1, 2003, a 100 basis point change would
change our annual interest expense on the Bear Stearns Debt by approximately
$3.0 million.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary data are set forth in this
Annual Report on Form 10-K commencing on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On June 5, 2002, the Board of Directors, upon recommendation of the Audit
Committee, selected Ernst & Young LLP as our independent accountants for our
consolidated financial statements for the year ending on December 31, 2002. The
Board, upon the recommendation of the Audit Committee, dismissed Arthur Andersen
LLP on May 8, 2002, effective as of May 14, 2002, when Arthur Andersen completed
its audit of the December 31, 2001 financial statements of the CRIIMI MAE
Management Inc. Retirement Plan.
59
Except as noted below, Arthur Andersen's reports on our consolidated
financial statements for the years ended December 31, 2001 and 2000 did not
contain an adverse opinion or disclaimer of opinion, nor were such reports
qualified or modified as to uncertainty, audit scope or accounting principles.
Arthur Andersen's report on our consolidated financial statements for the year
ended December 31, 2000 contained a qualified opinion about our ability to
continue as a going concern because of our voluntary filing for relief under
Chapter 11 of the Bankruptcy Code on October 5, 1998. We emerged from Chapter 11
on April 17, 2001 and Arthur Andersen's subsequent report on our consolidated
financial statements for the year ended December 31, 2001 did not contain such
qualifying opinion. Arthur Andersen's report on our consolidated financial
statements for the year ended December 31, 2001 referenced a change in (1) our
method of accounting for derivatives and (2) the method of accounting related to
the recognition of special servicing fee revenue of CMSLP.
During the years ended December 31, 2001 and 2000 and through the date of
dismissal, there were: (i) no disagreements with Arthur Andersen on any matter
of accounting principle or practice, financial statements disclosure, or
auditing scope or procedure which, if not resolved to Arthur Andersen's
satisfaction, would have caused them to make reference to the subject matter in
connection with their report on our consolidated financial statements for such
years; and (ii) there were no reportable events as defined in Item 304(a)(1)(v)
of Regulation S-K.
We provided Arthur Andersen with a copy of the foregoing disclosures and
Arthur Andersen submitted a letter, dated May 10, 2002, stating its agreement
with such statements. These disclosures and Arthur Andersen's letter were filed
with the SEC under Form 8-K on May 10, 2002.
During the years ended December 31, 2001 and 2000 and the subsequent
interim period through June 5, 2002, neither we nor anyone on our behalf
consulted Ernst & Young LLP with respect to the application of accounting
principles to a specified transaction, either completed or proposed; or the type
of audit opinion that might be rendered on our consolidated financial
statements, or any other matters or reportable events listed in Items
304(a)(2)(i) and (ii) of Regulation S-K.
60
PART III
The information required by Part III (Item 10-Directors and Executive
Officers, Item 11-Executive Compensation, Item 12-Security Ownership of Certain
Beneficial Owners and Management and Item 13-Certain Relationships and Related
Transactions) is incorporated herein by reference to our definitive proxy
statement to be filed pursuant to Regulation 14A relating to our 2003 annual
meeting of shareholders.
ITEM 14. CONTROLS AND PROCEDURES
Within the 90 days prior to the filing date of this report, we carried out
an evaluation, under the supervision and with the participation of our
management, including our Chief Executive Officer and Chief Financial Officer,
of the effectiveness of the design and operation of our disclosure controls and
procedures pursuant to Securities Exchange Act Rule 15d-15. Our management,
including the Chief Executive Officer and Chief Financial Officer, does not
expect that our disclosure controls and procedures will prevent all error and
all fraud. A control system, no matter how well conceived and operated, can
provide only reasonable assurance that the objectives of the control system are
met. Further, the design of a control system must reflect the fact that there
are resource constraints, and the benefits of controls must be considered
relative to their costs. Because of the inherent limitations in all control
systems, no evaluation of controls can provide absolute assurance that all
control issues within the company have been detected. These inherent limitations
include the realities that judgments in decision-making can be faulty, and that
breakdowns can occur because of simple error or mistake. The design of any
system of controls also is based in part upon certain assumptions about the
likelihood of future events, and there can be no assurance that any design will
succeed in achieving its stated goals under all potential future conditions.
Over time, control may become inadequate because of changes in conditions, or
the degree of compliance with the policies or procedures may deteriorate.
Because of the inherent limitations in a cost-effective control system,
misstatements due to error or fraud may occur and not be detected. Our Chief
Executive Officer and Chief Financial Officer have concluded, based on our
evaluation of our disclosure controls and procedures, that our disclosure
controls and procedures under Rule 13a-14(c) and Rule 15d-14(c) of the
Securities Exchange Act of 1934 are effective. Subsequent to our evaluation,
there were no significant changes in internal controls or other factors that
could significantly affect these internal controls; however, we intend to
implement certain actions within the next quarter designed to improve our credit
loss estimation process, as discussed below.
Although we believe our overall credit loss estimate is reasonable and
correct, based upon our recent evaluation of our internal controls and written
observations and recommendations received from our independent auditors, we have
determined to take specific actions to improve our credit loss estimation
process. This process is important to our CMBS income recognition, CMBS fair
value determination and CMBS impairment assessment. Although we have made
progress in improving our credit loss estimation process, we and our independent
auditors believe that improvement is still needed in this process, particularly
in connection with mortgage loan valuation and credit loss projection. In order
to address these matters, we have already commenced re-underwriting all mortgage
loans underlying our CMBS and have determined to take a number of additional
actions designed to improve our credit loss estimation process including
(a) creating a new underwriting internal valuation group, (b) developing
additional policies and procedures to better standardize our process, and
(c) employing, as appropriate, additional resources and expertise to the
management of the loan loss estimation process. We intend to implement most of
these actions prior to the end of the second quarter of 2003. It is noted that
our independent auditors were not specifically engaged to evaluate or assess the
internal controls over our overall loss estimate.
61
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) List of documents filed as part of this report:
1 and 2. Financial Statements and Financial Statement Schedules
Description Page
- ----------- ----
Report of Independent Public Accountants...................................F-1
Consolidated Balance Sheets as of December 31, 2002 and 2001...............F-2
Consolidated Statements of Income for the years ended
December 31, 2002, 2001 and 2000.........................................F-3
Consolidated Statements of Changes in Shareholders' Equity and Comprehensive
Income for the years ended December 31, 2002, 2001 and 2000................F-4
Consolidated Statements of Cash Flows
for the years ended December 31, 2002, 2001 and 2000.....................F-5
Notes to Consolidated Financial Statements ................................F-6
All other financial statements and financial statement schedules have been
omitted since the required information is included in the financial statements
or the notes thereto, or is not applicable or required.
(a) 3. Exhibits (listed according to the number assigned in the table in
Item 601 of Regulation S-K)
Exhibit No. 2 - Plan of Acquisition, Reorganization,
Arrangement, Liquidation, or Succession.
a. Articles of Dissolution of CBO REIT,
Inc., filed with the Maryland State
Department of Assessments and Taxation
on January 23, 2003 (incorporated by
reference to Exhibit 2.1 to Form 8-K
filed with the Securities and Exchange
Commission (or SEC) on January 30,
2003).
b. Third Amended Joint Plan of
Reorganization as confirmed by the
United States Bankruptcy Court for the
District of Maryland, Greenbelt Division
on November 22, 2000 (incorporated by
reference to Exhibit 2.1 to Form 8-K
filed with the SEC on December 28,
2000).
Exhibit No. 3 - Articles of Incorporation and bylaws.
a. Articles of Incorporation of CRIIMI
Newco Member, Inc., filed with the
Maryland State Department of Assessments
and Taxation on January 10, 2003
(incorporated by reference to Exhibit
3.1 to Form 8-K filed with the SEC on
January 30, 2003).
b. Bylaws of CRIIMI Newco Member, Inc.,
effective as of January 10, 2003
(incorporated by reference to Exhibit
3.2 to Form 8-K filed with the SEC on
January 30, 2003).
c. Certificate of Formation of CRIIMI
Newco, LLC, filed with the Delaware
Secretary of State on January 10, 2003
(incorporated by reference to Exhibit
3.3 to Form 8-K filed with the SEC on
January 30, 2003).
62
d. Limited Liability Company Agreement of
CRIIMI Newco, LLC, dated as of January
13, 2003 (incorporated by reference to
Exhibit 10.6 to Form 8-K filed with the
SEC on January 30, 2003).
e. Management Agreement for CRIIMI Newco,
LLC, dated as of January 13, 2003
(incorporated by reference to Exhibit
10.7 to Form 8-K filed with the SEC on
January 30, 2003).
f. Articles of Incorporation of CBO REIT
II, Inc., filed with the Maryland State
Department of Assessments and Taxation
on January 13, 2003 (incorporated by
reference to Exhibit 3.4 to Form 8-K
filed with the SEC on January 30, 2003).
g. Bylaws of CBO REIT II, Inc., effective
as of January 13, 2003 (incorporated by
reference to Exhibit 3.5 to Form 8-K
filed with the SEC on January 30, 2003).
h. Certificate of Amendment of Certificate
of Incorporation of CRIIMI MAE CMBS
Corp., filed with the Maryland State
Department of Assessments and Taxation
on January 23, 2003 (incorporated by
reference to Exhibit 3.6 to Form 8-K
filed with the SEC on January 30, 2003).
i. Certificate of Amendment of Certificate
of Incorporation of CRIIMI MAE QRS 1,
Inc., filed the Maryland State
Department of Assessments and Taxation
on January 23, 2003 (incorporated by
reference to Exhibit 3.7 to Form 8-K
filed with the SEC on January 30, 2003).
j. Registrant's Articles of Amendment,
filed with the Maryland State Department
of Assessments and Taxation on October
12, 2001 (incorporated by reference to
Exhibit 3.1 to the Company's Form S-8
filed with the SEC on June 13, 2002).
k. Registrant's Articles Supplementary for
its Series H Junior Preferred Stock,
filed with the Maryland State Department
of Assessments and Taxation on January
30, 2002 (incorporated by reference to
Exhibit 3.2 to the Company's Form S-8
filed with the SEC on June 13, 2002).
l. Registrant's Articles of Amendment,
filed with the Maryland State Department
of Assessments and Taxation on May 15,
2002 (incorporated by reference to
Exhibit 3 to the Registrant's Current
Report on Form 8-K filed with the SEC on
May 16, 2002).
m. Articles of Amendment and Restatement
of CRIIMI MAE Inc., including Exhibit A,
Exhibit B, Exhibit C and Exhibit D
thereto pertaining to the preferences,
conversion and other rights, voting
powers, restrictions and limitations as
to dividends, qualifications and terms
and conditions of redemption of the
Series B Cumulative Convertible
Preferred Stock, Series E Cumulative
Convertible Preferred Stock, the Series
F Redeemable Cumulative Dividend
Preferred Stock and the Series G
Redeemable Cumulative Dividend Preferred
Stock, respectively, filed with the
Maryland State Department of Assessments
and Taxation on April 17, 2001
(incorporated by reference to Exhibit
3.1 to Current Report on Form 8-K filed
with the SEC on June 1, 2001).
63
n. Articles of Amendment to Exhibit B of
the Articles of Amendment and
Restatement of CRIIMI MAE Inc. which
pertains to the preferences, conversion
and other rights, voting powers,
restrictions and limitations as to
dividends, qualifications and terms and
conditions of redemption of the Series E
Cumulative Convertible Preferred Stock
(incorporated by reference to Exhibit 3
to the Quarterly Report on Form 10-Q for
the quarter ended September 30, 2001).
o. Second Amended and Restated Bylaws of
CRIIMI MAE Inc. (incorporated by
reference to Exhibit 3.2 to Current
Report on Form 8-K filed with the SEC on
June 1, 2001).
p. Articles of Incorporation of CBO REIT,
Inc. filed with the Maryland State
Department of Assessments and Taxation
on April 11, 2001 (incorporated by
reference to Exhibit 3.3 to Current
Report on Form 8-K filed with the SEC on
June 1, 2001).
q. Bylaws of CBO REIT, Inc., effective as
of April 17, 2001 (incorporated by
reference to Exhibit 3.4 to Current
Report on Form 8-K filed with the SEC
on June 1, 2001).
r. Certificate of Incorporation of CRIIMI
MAE QRS 1, Inc. (incorporated by
reference to Exhibit 3(p) to Annual
Report on Form 10-K for 1996.)
s. Bylaws of CRIIMI MAE QRS 1, Inc.
(incorporated by reference to Exhibit
3(q) to Annual Report on Form 10-K for
1996).
t. Certificate of Incorporation of CRIIMI
MAE CMBS Corp (incorporated by reference
to Exhibit 3(h) to Annual Report on Form
10-K for 2001).
u. Bylaws of CRIIMI MAE CMBS Corp
(incorporated by reference to Exhibit
3(i) to Annual Report on Form 10-K for
2001).
v. Articles of Incorporation of CRIIMI MAE
Financial Corporation (incorporated by
reference to Exhibit 3.1 to Form S-3
Registration Statement filed with the
Securities and Exchange Commission on
September 12, 1995).
w. By-laws of CRIIMI MAE Financial
Corporation (incorporated by reference
to Exhibit 3.2 to Form S-3 Registration
Statement filed with the Securities and
Exchange Commission on September 12,
1995).
x. Articles of Incorporation of CRIIMI MAE
Financial Corporation II (incorporated
by reference to Exhibit 3(q) to Annual
Report on Form 10-K for 1995).
y. Bylaws of CRIIMI MAE Financial
Corporation II (incorporated by
reference to Exhibit 3(r) to Annual
Report on Form 10-K for 1995).
z. Articles of Incorporation of CRIIMI MAE
Financial Corporation III (incorporated
by reference to Exhibit 3(s) to Annual
Report on Form 10-K for 1995).
aa. Bylaws of CRIIMI MAE Financial
Corporation III (incorporated by
reference to Exhibit 3(t) to Annual
Report on Form 10-K for 1995).
64
bb. Limited Partnership Agreement of CRIIMI
MAE Services Limited Partnership
effective as of June 1, 1995 between
CRIIMI MAE Management, Inc. and CRIIMI
MAE Services, Inc. (incorporated by
reference to Exhibit 3(n) to Annual
Report on Form 10-K for 1995).
cc. First Amendment to the Limited
Partnership Agreement of CRIIMI MAE
Services Limited Partnership effective
as of December 31, 1995 between CRIIMI
MAE Management Inc. and CRIIMI MAE
Services, Inc. (incorporated by
reference to Exhibit 3(g) to Annual
Report on Form 10-K for 1998).
dd. Second Amendment to the Limited
Partnership Agreement of CRIIMI MAE
Services Limited Partnership effective
as of January 2, 1997 between CRIIMI MAE
Management Inc. and CRIIMI MAE Services,
Inc. (incorporated by reference to
Exhibit 3(h) to Annual Report on Form
10-K for 1998).
ee. Third Amendment to the Limited
Partnership Agreement of CRIIMI MAE
Services Limited Partnership effective
as of December 31, 1997 between CRIIMI
MAE Management Inc. and CRIIMI MAE
Services, Inc. (incorporated by
reference to Exhibit 3(i) to Annual
Report on Form 10-K for 1998).
ff. Fourth Amendment to Limited Partnership
Agreement of CRIIMI MAE Services Limited
Partnership effective as of March 9,
2001 between CRIIMI MAE Services, Inc.,
CRIIMI MAE Management, Inc. and CMSLP
Holding Company, Inc. (incorporated by
reference to Exhibit 3(t) to Annual
Report on Form 10-K for 2001).
gg. Articles of Merger merging CRI
Acquisition, Inc., CRICO Mortgage
Company, Inc. and CRI/AIM Management,
Inc. into CRIIMI MAE Management, Inc.
(incorporated by reference to Exhibit
10(i) to Annual Report on Form 10-K for
1995).
hh. Agreement and Articles of Merger between
CRIIMI MAE Inc. and CRI Insured Mortgage
Association, Inc. as filed with the
Office of the Secretary of the State of
Delaware (incorporated by reference to
Exhibit 3(f) to Quarterly Report on Form
10-Q for the quarter ended June 30,
1993).
ii. Agreement and Articles of Merger between
CRIIMI MAE Inc. and CRI Insured Mortgage
Association, Inc. as filed with the
State Department of Assessment and
Taxation for the State of Maryland
(incorporated by reference to Exhibit
3(g) to Quarterly Report on Form 10-Q
for the quarter ended June 30, 1993).
Exhibit No. 4 - Instruments defining the rights of security
holders, including indentures.
a. Senior Subordinated Secured Note
Agreement, dated as of January 14, 2003,
and all exhibits and schedules thereto,
by and between CRIIMI MAE Inc. and
Brascan Real Estate Finance Fund I, L.P.
(incorporated by reference to Exhibit
4.1 to Form 8-K filed with the SEC on
January 30, 2003).
65
b. Intercreditor and Subordination
Agreement, dated as of January 14, 2003,
by and among Bear, Stearns International
Limited and Brascan Real Estate
Financial Investments LLC (incorporated
by reference to Exhibit 4.2 to Form 8-K
filed with the SEC on January 30, 2003).
c. Warrant to Purchase Common Stock of
CRIIMI MAE Inc., dated as of January
23, 2003 (incorporated by reference to
Exhibit 4.3 to Form 8-K filed with the
SEC on January 30, 2003).
d. Registration Rights Agreement, dated as
of January 14, 2003, between CRIIMI MAE
Inc. and Brascan Real Estate Finance
Fund, L.P. (filed herewith).
e. Rights Agreement, dated as of January
23, 2002 between CRIIMI MAE Inc. and
Registrar and Transfer Company, as
Rights Agent (the "Rights Agreement").
The Rights Agreement includes, as
Exhibit A, the form of Articles
Supplementary to the Articles of
Incorporation of the Company setting
forth the terms of the Series H
Preferred Stock, as Exhibit B, the form
of Rights Certificate and, as Exhibit C,
the form of Summary of Rights to
Purchase Preferred Shares (incorporated
by reference to Exhibit 4 to Current
Report on Form 8-K filed on January 25,
2002).
f. Amended and Restated First Amendment to
Rights Agreement, dated as of June 10,
2002 between CRIIMI MAE Inc. and
Registrar and Transfer Company, as
Rights Agent (incorporated by reference
to Exhibit 4.1 to the Company's Form
8-A/A filed with the SEC on June 13,
2002).
g. Second Amendment to Rights Agreement,
dated as of November 14, 2002 between
CRIIMI MAE Inc. and Registrar and
Transfer Company, as Rights Agent
(incorporated by reference to Exhibit
4.2 to Form 8-A/A filed on November 15,
2002).
h. Third Amendment to Rights Agreement,
dated as of January 3, 2003 between
CRIIMI MAE Inc. and Registrar and
Transfer Company, as Rights Agent
(incorporated by reference to the
Company's Form 8-A/A filed with the SEC
on January 3, 2003).
i. Indenture, dated as of April 17, 2001
and all exhibits and schedules thereto,
by and between CRIIMI MAE Inc. and Wells
Fargo Bank Minnesota, National
Association, as trustee relating to the
Series A Notes (incorporated by
reference to Exhibit T3C to Amendment
No. 2 to Form T-3 relating to Series A
Notes Indenture filed with the SEC on
April 13, 2001).
j. Indenture, dated as of April 17, 2001,
and all exhibits and schedules thereto,
by and between CRIIMI MAE Inc. and Wells
Fargo Bank Minnesota, National
Association, as trustees relating to the
Series B Notes (incorporated by
reference to Exhibit T3C to Amendment
No. 2 to Form T-3 relating to Series B
Notes Indenture filed with the SEC on
April 13, 2001).
k. Registrant's 2001 Stock Incentive Plan
(incorporated by reference to Annex B to
Definitive Proxy Statement filed with
the SEC on August 16, 2001).
l. Registrant's Second Amended and Restated
Stock Option Plan for Key Employees
(incorporated by reference herein to
Exhibit G to Exhibit 99.6 to the
Registrant's Current Report on Form 8-K
filed with the SEC on September 22,
2000).
66
m. Dividend Reinvestment and Stock Purchase
Plan between CRIIMI MAE Inc. and
shareholders (incorporated by reference
from the registration statement on Form
S-3A filed December 9, 1997).
n. Prospectus dated July 8, 1998 whereby
CRIIMI MAE Inc. offers participation in
its Dividend Reinvestment and Stock
Purchase Plan (incorporated by reference
from Form S-3 filed on July 9, 1998).
Exhibit No. 10 - Material contracts.
a. Repurchase Agreement, dated as of
January 14, 2003, and all exhibits and
schedules, among Bear, Stearns
International Limited, as Buyer, CRIIMI
Newco, LLC, as a Seller, and CBO REIT
II, Inc., as a Seller (incorporated by
reference to Exhibit 10.1 to Form 8-K
filed with the SEC on January 30, 2003).
b. Company Pledge Agreement, dated as of
January 14, 2003, by and between CRIIMI
MAE Inc. and Brascan Real Estate Finance
Fund I, L.P. (incorporated by reference
to Exhibit 10.3 to Form 8-K filed with
the SEC on January 30, 2003).
c. Newco Member Pledge Agreement, dated as
of January 14, 2003, by and between
CRIIMI Newco Member, Inc. and Brascan
Real Estate Finance Fund I, L.P.
(incorporated by reference to Exhibit
10.4 to Form 8-K filed with the SEC on
January 30, 2003).
d. Guarantee, dated as of January 14, 2003,
by CRIIMI MAE Inc. in favor of Bear,
Stearns International Limited
(incorporated by reference to Exhibit
10.5 to Form 8-K filed with the SEC on
January 30, 2003).
e. Engagement Letter, dated as of January
14, 2003, by and between CRIIMI MAE Inc.
and Bear, Stearns & Co. Inc.
(incorporated by reference to Exhibit
10.8 to Form 8-K filed with the SEC on
January 30, 2003).
f. Amendment to Employment Agreement of
William B. Dockser, dated as of January
14, 2003 (incorporated by reference to
Exhibit 10.9 to Form 8-K filed with the
SEC on January 30, 2003).
g. Amendment to Employment Agreement of H.
William Willoughby, dated as of January
14, 2003 (incorporated by reference to
Exhibit 10.10 to Form 8-K filed with the
SEC on January 30, 2003).
h. Investment Agreement dated as of
November 14, 2002 between CRIIMI MAE
Inc. and Brascan Real Estate Financial
Investments LLC (incorporated by
reference to Exhibit 10.2 to Form 8-K
filed with the SEC on December 4, 2002).
i. Amendment No. 1 to Investment Agreement
dated as of December 2, 2002 to the
Investment Agreement between CRIIMI MAE
Inc. and Brascan Real Estate Financial
Investments LLC (incorporated by
reference to Exhibit 10.1 to Form 8-K
filed with the SEC on December 4, 2002).
j. Amendment No. 2 to Investment Agreement,
dated as of January 13, 2003, by and
between CRIIMI MAE Inc. and Brascan Real
Estate Financial Investments LLC
(incorporated by reference to Exhibit
10.2 to Form 8-K filed with the SEC on
January 30, 2003).
67
k. 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 (incorporated
by reference to Exhibit 10.5 to
Quarterly Report on Form 10-Q for the
quarter ended September 30, 2002).
l. Agreement dated May 20, 2002 between
CRIIMI MAE Inc. and Friedman, Billings,
Ramsey & Co., Inc. (or FBR) to retain
FBR as our financial advisor
(incorporated by reference to Exhibit 10
to Quarterly Report on Form 10-Q for the
quarter ended June 30, 2002).
m. Master Repurchase Agreement and Annex I
to the Master Repurchase Agreement,
including Schedule 1-A (CBO-2
Securities), Schedule 1-B (CBO-1/Nomura
Securities), Schedule 1-D (Loss
Threshold Amount) and Disclosure
Schedule thereto (incorporated by
reference to Exhibit 10.1 to Current
Report on Form 8-K filed on June 1,
2001).
n. Security and Pledge Agreement, dated as
of April 17, 2001, made by CRIIMI MAE
Inc. in favor of Merrill Lynch, Pierce,
Fenner & Smith Incorporated, as
collateral agent (incorporated by
reference to Exhibit 10.3 to Current
Report on Form 8-K filed on June 1,
2001).
o. Addendum to Security and Pledge
Agreement, dated as of April 17, 2001,
executed by CBO REIT, Inc. and accepted
and agreed to by Merrill Lynch, Pierce,
Fenner & Smith, Incorporated, as
collateral agent (incorporated by
reference to Exhibit 10.5 to Current
Report on Form 8-K filed on August 14,
2001).
p. Security, Pledge and Collateral
Assignment Agreement, dated as of April
17, 2001, among the Company, CRIIMI MAE
Management, Inc. and CM Mallers
Building, Inc. in favor of Wells Fargo
Bank Minnesota, National Association, as
collateral agent (incorporated by
reference to Exhibit 10.4 to Current
Report on Form 8-K filed on August 14,
2001).
q. Foreclosure/Transfer Agreement, dated as
of April 17, 2001, among CRIIMI MAE
Inc., Merrill Lynch International,
acting through its agent, Merrill Lynch,
Pierce, Fenner & Smith Incorporated and
Wells Fargo Bank Minnesota, National
Association, acting as trustee under two
Indentures relating to Series A Notes
and Series B Notes (incorporated by
reference to Exhibit 10.2 to Current
Report on Form 8-K filed on June 1,
2001).
r. Intercreditor Agreement, dated as of
April 17, 2001, among Merrill Lynch
International, acting through its agent,
Merrill Lynch, Pierce, Fenner & Smith
Incorporated and Wells Fargo Bank
Minnesota, National Association, acting
as trustee under two indentures relating
to the Series A Notes and Series B Notes
(incorporated by reference to Exhibit
4.1 to Current Report on Form 8-K filed
with the SEC on June 1, 2001).
s. Employment Agreement dated and effective
as of June 29, 2001 between the Company
and William B. Dockser (incorporated by
reference to Exhibit 10.1 to Current
Report on Form 8-K filed on July 10,
2001).
68
t. Employment Agreement dated and effective
as of June 29, 2001 between the Company
and H. William Willoughby (incorporated
by reference to Exhibit 10.2 to Current
Report on Form 8-K filed on July 10,
2001).
u. Employment Agreement, dated and
effective as of July 25, 2001, between
the Company and David B. Iannarone
(incorporated by reference to Exhibit
10.1 to Current Report on Form 8-K filed
on August 14, 2001).
v. Employment Agreement, dated and
effective as of July 25, 2001, between
the Company and Cynthia O. Azzara
(incorporated by reference to Exhibit
10.2 to Current Report on Form 8-K filed
on August 14, 2001).
w. Employment Agreement, dated and
effective as of July 25, 2001, between
the Company and Brian L. Hanson
(incorporated by reference to Exhibit
10.3 to Current Report on Form 8-K filed
on August 14, 2001).
x. CRIIMI MAE Management, Inc. Retirement
Plan's Non-Standardized Adoption
Agreement dated January 1, 2002 (filed
herewith).
y. Accudraft, Inc. Prototype Defined
Contribution Retirement Plan (Basic Plan
#01) for CRIIMI MAE Management, Inc.
(filed herewith).
z. Preferred Stock Exchange Agreement
entered into July 26, 2000 by CRIIMI MAE
Inc. and the holder of its Series D
Cumulative Convertible Preferred Stock
(incorporated by reference to Exhibit
99.8 to Current Report on Form 8-K filed
with the SEC on September 22, 2000).
aa. Preferred Stock Exchange Agreement
between CRIIMI MAE Inc. and MeesPierson
Investments Inc. dated February 22, 2000
(incorporated by reference to Exhibit
99.1 to Current Report on Form 8-K filed
with the SEC on April 10, 2000).
bb. Terms Indenture Agreement dated May 8,
1998 between CRIIMI MAE Commercial
Mortgage Trust and the trustee
(incorporated by reference to Exhibit
10(s) to Annual Report on Form 10-K for
2001).
cc. Standard Indenture Provisions dated as
of May 8, 1998 related to Terms
Indenture Agreement dated May 8, 1998
between CRIIMI MAE Commercial Mortgage
Trust and the trustee (incorporated by
reference to Exhibit 10(t) to Annual
Report on Form 10-K for 2001).
dd. Indenture Agreement dated December 20,
1996 between CRIIMI MAE QRS 1, Inc. and
the trustee (incorporated by reference
from Exhibit 4(sss) to Annual Report on
Form 10-K for 1996).
ee. Form of Bond to CRIIMI MAE Trust 1
Commercial Mortgage Bonds, Class A-1
(incorporated by reference to Exhibit
4(ttt) to Annual Report on Form 10-K for
1996).
ff. Form of Bond to CRIIMI MAE Trust 1
Commercial Mortgage Bonds, Class A-2
(incorporated by reference to Exhibit
4(uuu) to Annual Report on Form 10-K for
1996).
69
gg. Form of Bond to CRIIMI MAE Trust 1
Commercial Mortgage Bonds, Class B
(incorporated by reference to Exhibit
4(vvv) to Annual Report on Form 10-K for
1996).
hh. Form of Bond to CRIIMI MAE Trust 1
Commercial Mortgage Bonds, Class C
(incorporated by reference to Exhibit
4(www) to Annual Report on Form 10-K for
1996).
ii. Form of Bond to CRIIMI MAE Trust 1
Commercial Mortgage Bonds, Class D
(incorporated by reference to Exhibit
4(xxx) to Annual Report on Form 10-K for
1996).
jj. Form of Bond to CRIIMI MAE Trust 1
Commercial Mortgage Bonds, Class E
(incorporated by reference to Exhibit
4(yyy) to Annual Report on Form 10-K for
1996).
kk. Form of Bond to CRIIMI MAE Trust 1
Commercial Mortgage Bonds, Class F
(incorporated by reference to Exhibit
4(zzz) to Annual Report on Form 10-K for
1996).
ll. Form of Indenture between CRIIMI MAE
Financial Corporation and the trustee
(incorporated by reference to Exhibit
4.1 to S-3 Registration Statement filed
with the Securities and Exchange
Commission on September 12, 1995).
mm. Form of Bond (incorporated by reference
to Exhibit 4.2 to S-3 Registration
Statement filed with the Securities and
Exchange Commission on September 12,
1995).
nn. Seven Percent Funding Note due September
17, 2031 dated September 22, 1995
between CRIIMI MAE Financial Corporation
II and the Federal Home Loan Mortgage
Corporation (incorporated by reference
to Exhibit 4(bbb) to Annual Report on
Form 10-K for 1995).
oo. Funding Note Purchase and Security
Agreement dated as of September 22, 1995
among the Federal Home Loan Mortgage
Corporation, CRIIMI MAE Inc. and CRIIMI
MAE Financial Corporation II
(incorporated by reference to Exhibit
4(ccc) to Annual Report on Form 10-K for
1995).
pp. Assignment and Agreement dated as of
September 22, 1995 between CRIIMI MAE
Inc. and CRIIMI MAE Financial
Corporation II (incorporated by
reference to Exhibit 4(ddd) to Annual
Report on Form 10-K for 1995).
qq. Funding Note dated December 15, 1995
between CRIIMI MAE Financial Corporation
III and the Federal National Mortgage
Association (incorporated by reference
to Exhibit 4(lll) to Annual Report on
Form 10-K for 1995).
rr. Assignment and Agreement dated as of the
15th day of December, 1995, by and
between CRIIMI MAE Inc. and CRIIMI MAE
Financial Corporation III (incorporated
by reference from Exhibit 4(mmm) to
Annual Report on Form 10-K for 1995).
ss. Funding Note Issuance and Security
Agreement dated as of December 15, 1995
among Federal National Mortgage
Association, CRIIMI MAE Inc.
70
and CRIIMI MAE Financial Corporation III
(incorporated by reference to Exhibit
4(nnn) to Annual Report on Form 10-K for
1995).
tt. Administrative Services Agreement dated
June 30, 1995 between CRIIMI MAE Inc.
and C.R.I., Inc. (incorporated by
reference to Exhibit 10(d) to Annual
Report on Form 10-K for 1995).
uu. Asset Purchase Agreement dated as of
June 30, 1995 among CRICO Mortgage
Company, Inc., CRIIMI MAE Services,
Inc., William B. Dockser and H. William
Willoughby (incorporated by reference to
Exhibit 10(e) to Annual Report on Form
10-K for 1995).
vv. Asset Purchase Agreement dated as of
June 30, 1995 among CRI/AIM Management,
Inc., CRIIMI MAE Services, Inc., William
B. Dockser and H. William Willoughby
(incorporated by reference to Exhibit
10(f) to Annual Report on Form 10-K for
1995).
ww. Sublease dated June 30, 1995 between
C.R.I., Inc. and CRIIMI MAE Inc.
(incorporated by reference to Exhibit
10(h) to Annual Report on Form 10-K for
1995).
xx. Reimbursement Agreement dated as of June
30, 1995 between CRIIMI MAE Management,
Inc. and C.R.I., Inc. (incorporated by
reference to Exhibit 10(j) to Annual
Report on Form 10-K for 1995).
yy. Certificate of Merger dated June 30,
1995 merging CRICO Mortgage Company,
Inc., CRI/AIM Management, Inc. and CRI
Acquisition, Inc. into CRIIMI MAE
Management, Inc. (incorporated by
reference to Exhibit 10(k) to Annual
Report on Form 10-K for 1995).
zz. Asset Purchase Agreement dated as of
June 30, 1995 among C.R.I., Inc., CRI
Acquisition, Inc. and William B. Dockser
and H. William Willoughby (incorporated
by reference from Exhibit 10(l) to the
Annual Report on Form 10-K for 1995).
aaa. Allonge to Amended and Restated
Promissory Note dated as of June 23,
1995 between C.R.I., Inc. and CRI/AIM
Management, Inc. (incorporated by
reference to Exhibit 10(c) to Annual
Report on Form 10-K for 1995).
Exhibit No. 16 - Letter re: change in certifying accountant
a. Letter from Arthur Andersen LLP to the
SEC dated May 10, 2002 (incorporated by
reference to Exhibit 16 to Current
Report on Form 8-K filed with the SEC on
May 10, 2002).
Exhibit No. 18 - Letter re: change in accounting principles
a. Letter from the Company's former
independent public accountants, Arthur
Andersen LLP, regarding the change in
accounting policy related to the
recognition of special servicing fee
revenue by CRIIMI MAE Services Limited
Partnership, a wholly owned subsidiary
of the Company (incorporated by
reference to Exhibit 18 to Quarterly
Report on Form 10-Q for the quarter
ended September 30, 2001).
71
Exhibit No. 21 - Subsidiaries of the Registrant.
a. CRIIMI, Inc., incorporated in Maryland.
b. CRIIMI MAE Financial Corporation,
incorporated in Maryland.
c. CRIIMI MAE Financial Corporation II,
incorporated in Maryland.
d. CRIIMI MAE Financial Corporation III,
incorporated in Maryland.
e. CRIIMI MAE Management, Inc.,
incorporated in Maryland.
f. CRIIMI MAE QRS 1, Inc., incorporated in
Delaware.
g. CRIIMI MAE Services Limited Partnership,
formed in Maryland.
h. CRIIMI MAE CMBS Corp., incorporated in
Delaware.
i. CBO REIT, Inc., incorporated in Maryland
(dissolved January 23, 2003).
j. CMSLP Management Company, Inc.,
incorporated in Maryland.
k. CMSLP Holding Company, Inc.,
incorporated in Maryland.
l. CBO REIT II, Inc., incorporated in
Maryland.
m. CRIIMI Newco Member, Inc., incorporated
in Maryland.
n. CRIIMI Newco, LLC, formed in Delaware.
Exhibit No. 22 - Consents of Experts and Counsel
a. Consent of Ernst & Young LLP
Exhibit No. 99 - Additional Exhibits
a. Stipulation and Consent Order selling
certain commercial mortgage-backed
securities to Lehman Ali Inc. free and
clear of liens, claims and encumbrances
entered April 19, 2000 (incorporated by
reference from Exhibit 99(a) to the
Quarterly Report on Form 10-Q for
quarter ended March 31, 2000).
b. Motion for Entry of an Order Amending
Stipulation and Agreed Order Selling
certain Commercial Mortgage-Backed
Securities to German American Capital
Corporation Free and Clear of Liens,
Claims and Encumbrances entered August
3, 2000 (incorporated by reference from
Exhibit 99(d) to the Quarterly Report on
Form 10-Q for quarter ended June 30,
2000).
c. Notice of Motion to Approve Stipulation
and Consent Order Selling Certain
Commercial Mortgage-Backed Securities to
Lehman Ali, Inc. Free and Clear of
Liens, Claims and Encumbrances entered
March 21, 2000 (incorporated by
reference from Exhibit 99(a) to the
Quarterly Report on Form 10-Q for
quarter ended September 30, 2000).
72
d. Notice of Motion to Approve Stipulation
and Consent Order Selling Certain
Commercial Mortgage-Backed Securities to
ORIX Real Estate Capital Markets, LLC
Free and Clear of Liens, Claims and
Encumbrances and Compromising and
Settling Claims entered on September 21,
2000 (incorporated by reference from
Exhibit 99(b) to the Quarterly Report on
Form 10-Q for the quarter ended
September 30, 2000).
e. Stipulation and Consent Order selling
certain Commercial Mortgage-Backed
Securities to ORIX Real Estate Capital
Markets, LLC Free and Clear of Liens,
Claims and Encumbrances and Compromising
and Settling claims entered by the
Bankruptcy Court on October 12, 2000
(incorporated by reference from Exhibit
99(g) to the Quarterly Report on Form
10-Q for the quarter ended September 30,
2000).
f. Amendment to Agreed Proceeds in
Connection with Stipulation and Consent
Order selling certain Commercial
Mortgage-Backed Securities to ORIX Real
Estate Capital Markets, LLC Free and
Clear of Liens, Claims and Encumbrances
and Compromising and Settling Claims
entered by the Bankruptcy Court on
October 30, 2000 (incorporated by
reference from Exhibit 99(h) to the
Quarterly Report on Form 10-Q for the
quarter ended September 30, 2000).
g. Order confirming Third Amended Joint
Plan of Reorganization entered by the
United States Bankruptcy Court for the
District of Maryland, Greenbelt on
November 22, 2000 (the "Confirmation
Order") (incorporated by reference from
Exhibit 99.1 to Form 8-K filed with the
Securities and Exchange Commission on
December 28, 2000).
h. Exhibit 11 in support of the
Confirmation Order - CMBS Sale Portfolio
Schedule filed with the Bankruptcy Court
on November 15, 2000 (incorporated by
reference to Exhibit 99.1 to Form 8-K
filed with the Securities and Exchange
Commission on January 22, 2001).
i. Exhibit 13 in support of the
Confirmation Order - Definition of
Distribution Record filed with the
Bankruptcy Court on November 15, 2000
(incorporated by reference to Exhibit
99.2 to Form 8-K filed with the
Securities and Exchange Commission on
January 22, 2001).
j. Exhibit 14 in support of the
Confirmation Order - Unaudited Pro Forma
Consolidated Financial Statements and
Projected Financial Information filed
with the Bankruptcy Court on November
15, 2000 (incorporated by reference to
Exhibit 99.3 to Form 8-K filed with the
Securities and Exchange Commission on
January 22, 2001).
k. Exhibit 17 in support of the
Confirmation Order - Liquidation
Analysis filed with the Bankruptcy Court
on November 15, 2000 (incorporated by
reference to Exhibit 99.4 to Form 8-K
filed with the Securities and Exchange
Commission on January 22, 2001).
l. Letter to Securities and Exchange
Commission from the Company dated March
27, 2002 regarding the representations
received from Arthur Andersen LLP in
connection with its audit of the
Company's December 31, 2001 consolidated
financial statements (incorporated by
reference to Exhibit 99(p) to Annual
Report on Form 10-K for 2001).
73
m. Settlement Agreement, dated as of
February 6, 2002, between CRIIMI MAE
Inc. and First Union National Bank
(incorporated by reference to Exhibit
99.1 to Current Report on Form 8-K filed
with the SEC on February 13, 2002.)
n. Order Approving Settlement and
Compromise with First Union National
Bank dated March 5, 2002 (incorporated
by reference to Exhibit 99.1 to Current
Report on Form 8-K filed with the SEC on
March 22, 2002).
o. Special Serviced Loan Report relating to
specially serviced loans underlying the
Company's CMBS as of December 31, 2002
(filed herewith).
p. Certification of Chief Executive Officer
pursuant to Section 906 of the
Sarbanes-Oxley Act (filed herewith).
q. Certification of Chief Financial Officer
pursuant to Section 906 of the
Sarbanes-Oxley Act (filed herewith).
(b) Reports on Form 8-K
Date Purpose
December 4, 2002 To report: (1) Amendment No. 1
to the Investment Agreement,
executed by CRIIMI MAE Inc. and
Brascan Real Estate Financial
Investments LLC on December 2,
2002, and (2) a corrected
version of the previously filed
Investment Agreement, dated as
of November 14, 2002, by and
between CRIIMI MAE Inc. and
Brascan Real Estate Financial
Investments LLC.
December 16, 2002 To report a press release dated
December 12, 2002 announcing (1)
the completion of due diligence
by an affiliate of Brascan Real
Estate Financial Partners LLC
for the previously announced
transactions to recapitalize and
refinance CRIIMI MAE Inc. and
(2) the signing of a commitment
letter by Bear, Stearns & Co.,
Inc. to provide CRIIMI MAE Inc.
with a secured financing of up
to $300 million in the form of a
repurchase transaction.
December 19, 2002 To report a press release dated
December 18, 2002 announcing the
receipt of a proposal from ORIX
Capital Markets, LLC on December
11, 2002, to purchase up to 100%
of the subordinated commercial
mortgage-backed securities owned
by CRIIMI MAE Inc. or 100% of
CRIIMI MAE Inc.'s outstanding
common stock.
(c) Exhibits
The list of Exhibits required by Item 601 of Regulation S-K is included in
Item (a)(3) above.
74
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
CRIIMI MAE INC.
March 28, 2003 /s/Barry S. Blattman
- ------------------ --------------------------------------
DATE Barry S. Blattman
Chairman of the Board, Chief Executive
Officer and President
75
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Barry S. Blattman, his attorney-in-fact,
each with the power of substitution for him in any and all capacities, to sign
any amendments to this Annual Report on Form 10-K and to file the same with
exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, hereby ratifying and confirming all that
each said attorney-in-fact, or his substitute or substitutes, may do or cause to
be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated:
March 28, 2003 /s/Barry S. Blattman
- ----------------------- --------------------------------------
DATE Barry S. Blattman
Chairman of the Board, Chief Executive
Officer and President (Principal
Executive Officer)
March 28, 2003 /s/Cynthia O. Azzara
- ---------------------- --------------------------------------
DATE Cynthia O. Azzara
Senior Vice President, Chief
Financial Officer and Treasurer
(Principal Accounting Officer)
March 26, 2003 /s/John R. Cooper
- ---------------------- --------------------------------------
DATE John R. Cooper
Director
March 26, 2003 /s/William B. Dockser
- ---------------------- --------------------------------------
DATE William B. Dockser
Director
- ---------------------- --------------------------------------
DATE Joshua B. Gillon
Director
- ---------------------- --------------------------------------
DATE Mark R. Jarrell
Director
March 26, 2003 /s/Donald J. MacKinnon
- ---------------------- --------------------------------------
DATE Donald J. MacKinnon
Director
March 26, 2003 /s/Robert J. Merrick
- ---------------------- --------------------------------------
DATE Robert J. Merrick
Director
March 26, 2003 Robert E. Woods
- ---------------------- --------------------------------------
DATE Robert E. Woods
Director
76
CERTIFICATIONS
I, Barry S. Blattman, certify that:
1. I have reviewed this annual report on Form 10-K of CRIIMI MAE Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-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 annual
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
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about
the effectiveness of the disclosure controls and
procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent functions):
a) all significant deficiencies in the design or
operation of internal controls which could adversely
affect the registrant's ability to record, process,
summarize and report financial data and have
identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: March 28, 2003 /s/Barry S. Blattman
----------------- --------------------------------------
Barry S. Blattman
Chairman of the Board, Chief Executive
Officer and President
77
CERTIFICATIONS
I, Cynthia O. Azzara, certify that:
1. I have reviewed this annual report on Form 10-K of CRIIMI MAE Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-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 annual
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
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about
the effectiveness of the disclosure controls and
procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent functions):
a) all significant deficiencies in the design or
operation of internal controls which could adversely
affect the registrant's ability to record, process,
summarize and report financial data and have
identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: March 28, 2003 /s/Cynthia O. Azzara
------------------ --------------------------------
Cynthia O. Azzara
Senior Vice President,
Chief Financial Officer
and Treasurer
F-1
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Shareholders
CRIIMI MAE Inc.
We have audited the accompanying consolidated balance sheet of CRIIMI MAE Inc.
and subsidiaries (CRIIMI MAE) as of December 31, 2002, and the related
consolidated statements of income, changes in stockholders' equity and
comprehensive income, and cash flows for the year then ended. These financial
statements are the responsibility of CRIIMI MAE's management. Our responsibility
is to express an opinion on these financial statements based on our audit. The
financial statements of CRIIMI MAE as of December 31, 2001, and for the years
ended December 31, 2001 and 2000, were audited by other auditors who have ceased
operations and whose report dated March 21, 2002, expressed an unqualified
opinion on those statements and included an explanatory paragraph that disclosed
the change in CRIIMI MAE's method of accounting for derivatives and CRIIMI MAE
Services Limited Partnership's, a wholly-owned subsidiary of CRIIM MAE, method
of accounting for special servicing fee revenue both of which are discussed in
Note 3 to these consolidated financial statements.
We conducted our audit in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the 2002 consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
CRIIMI MAE at December 31, 2002, and the consolidated results of its operations
and its cash flows for the year then ended in conformity with accounting
principles generally accepted in the United States.
As discussed in Note 3 to the consolidated financial statements, on January 1,
2002, CRIIMI MAE changed its method of accounting for goodwill and other
intangible assets.
Ernst & Young LLP
McLean, Virginia
March 26, 2003
F-2
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders of
CRIIMI MAE Inc.:
We have audited the accompanying consolidated balance sheets of CRIIMI MAE
Inc. and its subsidiaries (CRIIMI MAE) as of December 31, 2001 and 2000, and the
related consolidated statements of income, changes in shareholders' equity and
comprehensive income and cash flows for the years ended December 31, 2001, 2000
and 1999. These financial statements are the responsibility of CRIIMI MAE's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of CRIIMI MAE as
of December 31, 2001 and 2000, and the consolidated results of their operations
and their cash flows for the years ended December 31, 2001, 2000 and 1999, in
conformity with accounting principles generally accepted in the United States.
As discussed in Note 3 to the consolidated financial statements, effective
January 1, 2001, CRIIMI MAE changed its method of accounting for derivatives. In
addition, as discussed in Note 3 to the consolidated financial statements,
effective January 1, 2001, CRIIMI MAE Services Limited Partnership, a
wholly-owned subsidiary of CRIIMI MAE, changed its method of accounting related
to the recognition of special servicing fee revenue.
Arthur Andersen, LLP
Vienna, Virginia
March 21, 2002
This is a copy of the audit report previously issued by Arthur Andersen LLP in
connection with our filing of our Annual Report on Form 10-K for the year ended
December 31, 2001. This audit report has not been reissued by Arthur Andersen
LLP in connection with this Annual Report on Form 10-K. See Exhibit 16(a) for
further discussion.
F-3
CRIIMI MAE INC.
CONSOLIDATED BALANCE SHEETS
December 31, December 31,
2002 2001
------------------- -------------------
Assets:
Mortgage assets:
Subordinated CMBS and Other MBS, at fair value $ 540,755,663 $ 536,204,992
CMBS pledged to secure Securitized Mortgage
Obligation - CMBS, at fair value 326,472,580 296,477,050
Insured mortgage securities, at fair value 275,340,234 343,091,303
Equity investments 6,247,868 9,312,156
Other assets 24,987,348 37,180,968
Receivables 16,293,489 18,973,680
Servicing other assets 13,775,138 18,250,824
Servicing cash and cash equivalents 12,582,053 6,515,424
Restricted cash and cash equivalents 7,961,575 38,214,277
Other cash and cash equivalents 16,669,295 10,783,449
------------------- -------------------
Total assets $ 1,241,085,243 $ 1,315,004,123
=================== ===================
Liabilities:
Variable-rate secured borrowing $ 214,672,536 $ 244,194,590
Series A senior secured notes 92,788,479 99,505,457
Series B senior secured notes 68,491,323 63,937,383
Payables and accrued expenses 26,675,724 25,946,959
Mortgage payable 7,214,189 7,109,252
Servicing liabilities 756,865 3,660,173
Securitized mortgage obligations:
Collateralized bond obligations-CMBS 285,844,933 283,047,470
Collateralized mortgage obligations-
insured mortgage securities 252,980,104 326,558,161
------------------- -------------------
Total liabilities 949,424,153 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 103,109,822 (6,060,398)
Unrealized losses on interest rate caps (987,765) (383,200)
Deferred compensation (19,521) -
Additional paid-in capital 619,197,711 632,887,967
Accumulated deficit (429,812,858) (365,565,044)
------------------- -------------------
Total shareholders' equity 291,661,090 261,044,678
------------------- -------------------
Total liabilities and shareholders' equity $ 1,241,085,243 $ 1,315,004,123
=================== ===================
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
CRIIMI MAE INC.
CONSOLIDATED STATEMENTS OF INCOME
For the years ended December 31,
2002 2001 2000
------------------ ---------------- -----------------
Interest income:
Subordinated CMBS $ 100,614,091 $ 105,522,833 $ 137,072,372
Insured mortgage securities 23,845,841 28,852,719 30,668,228
Originated loans - - 27,511,041
------------------ ---------------- -----------------
Total interest income 124,459,932 134,375,552 195,251,641
------------------ ---------------- -----------------
Interest and related expenses:
Variable-rate secured borrowing 14,928,105 14,648,215 -
Series A senior secured notes 11,638,828 8,780,576 -
Series B senior secured notes 13,904,086 9,224,817 -
Fixed-rate collateralized bond obligations-CMBS 25,788,683 25,518,425 25,345,519
Fixed-rate collateralized mortgage obligations - insured securities 25,394,390 27,097,730 30,211,712
Fixed-rate collateralized mortgage obligations- originated loans - - 22,716,109
Variable-rate secured borrowings-CMBS - 7,325,059 43,785,955
Fixed-rate senior unsecured notes - 2,712,142 9,125,004
Other interest expense 987,567 2,480,604 8,182,070
------------------ ---------------- -----------------
Total interest expense 92,641,659 97,787,568 139,366,369
------------------ ---------------- -----------------
Net interest margin 31,818,273 36,587,984 55,885,272
------------------ ---------------- -----------------
General and administrative expenses (10,728,457) (10,951,420) (9,651,468)
Depreciation and amortization (1,095,861) (3,718,485) (3,771,064)
Servicing revenue 10,985,770 6,683,886 -
Servicing general and administrative expenses (8,854,569) (5,570,162) -
Servicing amortization, depreciation, and impairment expenses (2,173,137) (1,699,186) -
Servicing restructuring expenses (188,614) (437,723) -
Servicing gain on sale of servicing rights 4,864,274 - -
Servicing gain on sale of investment-grade CMBS 241,160 - -
Income tax (expense) benefit (460,288) 336,439 -
Equity in (losses) earnings from investments (41,882) (1,632,042) 1,512,005
Other income, net 2,646,033 3,983,412 4,158,891
Net (losses) gains on mortgage security and originated
loan dispositions (995,412) (41,982) 524,395
Impairment on CMBS (70,225,506) (34,654,930) (143,478,085)
Hedging expense (1,101,746) (1,073,392) -
Recapitalization expenses (1,048,559) - -
Litigation expense - - (2,500,000)
Reorganization items - (1,813,220) (66,072,460)
Emergence financing origination fee - (3,936,616) -
Gain on debt extinguishment - - 14,808,737
------------------ ---------------- -----------------
(78,176,794) (54,525,421) (204,469,049)
------------------ ---------------- -----------------
Net loss before cumulative effect of changes in accounting principles (46,358,521) (17,937,437) (148,583,777)
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 before dividends accrued or paid on preferred shares (56,125,023) (16,077,317) (148,583,777)
Dividends accrued or paid on preferred shares (8,122,791) (8,145,481) (6,911,652)
------------------ ---------------- -----------------
Net loss to common shareholders $ (64,247,814) $ (24,222,798) $ (155,495,429)
================== ================ =================
Net loss to common shareholders per common share:
Basic - before cumulative effect of changes in
accounting principles $ (3.97) $ (2.35) $ (25.02)
================== ================ =================
Basic - after cumulative effect of changes in
accounting principles $ (4.69) $ (2.18) $ (25.02)
================== ================ =================
Diluted - before cumulative effect of changes in
accounting principles $ (3.97) $ (2.35) $ (25.02)
================== ================ =================
Diluted - after cumulative effect of changes in
accounting principles $ (4.69) $ (2.18) $ (25.02)
================== ================ =================
Shares used in computing basic loss per share 13,710,914 11,087,790 6,214,479
================== ================ =================
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
CRIIMI MAE INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY AND
COMPREHENSIVE INCOME
For the years ended December 31, 2002, 2001 and 2000
Accumulated
Preferred Common Additional Other Unearned Total
Stock Par Stock Par Paid-in Accumulated Comprehensive Stock Shareholders' Comprehensive
Value Value Capital Deficit Income (Loss) Comp. Equity Income (Loss)
---------- ---------- ----------- ------------ ------------- ----- ----------- -------------
Balance at January 1, 2000 $ 26,471 $ 59,955 $575,118,863 $(148,434,915) $(207,421,788) $ - $219,348,586
Net loss - - - (148,583,777) - (148,583,777) $(148,583,777)
Other comprehensive income:
Adjustment to unrealized
losses on mortgage assets - - - - 204,402,109 - 204,402,109 204,402,109
-------------
Comprehensive income $ 55,818,332
=============
Dividends accrued or paid on
preferred shares - - - (6,911,652) - - (6,911,652)
Conversion of preferred
shares into common shares (2,638) 2,396 242 - - - -
Common shares issued - 2 2,748 - - - 2,750
Preferred shares issued 37,412 - 37,374,490 (37,411,902) - - -
--------- -------- ------------- -------------- ----------- ------ -----------
Balance at December 31, 2000 61,245 62,353 612,496,343 (341,342,246) (3,019,679) - 268,258,016
Net loss - - - (16,077,317) - - (16,077,317) $ (16,077,317)
Other comprehensive income:
Adjustment to unrealized
losses on mortgage assets - - - - (3,040,719) - (3,040,719) (3,040,719)
Adjustment to unrealized loss
on interest rate cap - - - - (383,200) - (383,200) (383,200)
-------------
Comprehensive loss $ (19,501,236)
==============
Dividends accrued or paid on
preferred shares - - - (8,145,481) - - (8,145,481)
Common shares issued related
to preferred stock dividends - 30,334 20,405,150 - - - 20,435,484
Conversion of preferred
shares into common shares (25,265) 36,695 (11,430) - - - -
Common shares issued - 2 1,458 - - - 1,460
Common shares redeemed in
reverse stock split in lieu
of fractional shares - (11) (3,554) - - - (3,565)
--------- -------- -------------- ------------ ------------ ------ -----------
Balance at December 31, 2001 35,980 129,373 632,887,967 (365,565,044) (6,443,598) - 261,044,678
Net loss - - - (56,125,023) - - (56,125,023) $ (56,125,023)
Other comprehensive income:
Adjustment to unrealized
gains and losses on
mortgage assets - - - - 109,170,220 - 109,170,220 109,170,220
Adjustment to unrealized
losses on interest rate caps - - - - (604,565) - (604,565) (604,565)
-------------
Comprehensive income $ 52,440,632
=============
Dividends accrued or paid on
preferred shares - - - (8,122,791) - - (8,122,791)
Common shares issued related
to preferred stock dividends - 9,664 3,435,128 - - - 3,444,792
Common shares issued - 89 43,341 - - - 43,430
Restricted stock issued - 325 129,350 - - (129,675) -
Amortization of deferred
compensation - - - - - 110,154 110,154
Redemption of Series E
Preferred Stock (1,730) - (17,298,075) - - - (17,299,805)
-------- -------- ------------- ------------- ------------ -------- ------------
Balance at December 31, 2002 $ 34,250 $139,451 $ 619,197,711 $(429,812,858) $102,122,057 $(19,521) $291,661,090
======== ======== ============= ============= ============ ======== ============
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
CRIIMI MAE INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31,
2002 2001 2000
---------------- --------------- -----------------
Cash flows from operating activities:
Net loss before dividends accrued or paid on preferred shares $ (56,125,023) $ (16,077,317) $ (148,583,777)
Adjustments to reconcile net loss before dividends accrued or
paid on preferred shares to net cash provided by (used in)
operating activities:
Gain on sales of servicing rights and investment-grade CMBS (5,105,434) - -
Amortization of discount and deferred financing costs on debt 7,581,595 4,650,912 8,535,024
Accrual of extension fees related to Exit Debt 4,308,290 3,142,159 -
Depreciation and other amortization 1,095,861 3,718,485 3,771,064
Discount amortization on mortgage assets, net (11,310,220) (10,121,136) (14,179,631)
Net losses (gains) on mortgage security and originated
loan dispositions 995,412 41,982 (524,395)
Equity in losses (income) from investments 41,882 1,632,042 (1,512,005)
Servicing amortization, depreciation and impairment 2,173,137 1,699,186 -
Hedging expense 1,101,746 1,208,534 -
Amortization of deferred compensation 110,154 - -
Impairment on CMBS 70,225,506 34,654,930 143,478,085
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 (increase) in restricted cash and cash equivalents 30,252,702 57,631,724 (57,809,377)
Decrease (increase) in receivables and other assets 247,903 25,044,068 (3,033,944)
(Decrease) increase in payables and accrued expenses (2,269,482) (44,468,312) 21,408,572
Decrease (increase) in servicing other assets 3,036,686 (1,369,229) -
(Decrease) increase in servicing liabilities (2,903,308) 449,580 -
Sales (purchases) of other MBS, net 3,288,094 (4,244,330) (4,208,635)
Change in reorganization items accrual - (1,755,193) (471,568)
Non-cash reorganization items - (366,529) 46,313,051
---------------- --------------- -----------------
Net cash provided by (used in) operating activities 56,512,003 53,476,294 (6,817,536)
---------------- --------------- -----------------
Cash flows from investing activities:
Proceeds from mortgage security prepayments 73,070,231 35,235,975 12,572,549
Distributions received from AIM Limited Partnerships 3,022,406 2,759,382 2,661,871
Receipt of principal payments from insured mortgage securities
and originated loans 3,823,603 4,308,118 11,498,572
Cash received in excess of income recognized on Subordinated CMBS 2,919,904 3,591,841 4,536,108
Proceeds from sale of servicing rights by CMSLP 8,810,923 - -
Purchases of investment-grade CMBS by CMSLP (10,108,652) - -
Sales of investment-grade CMBS by CMSLP 5,659,875 - -
Cash reflected upon consolidation of CMSLP - 6,841,907 -
Proceeds from originated loan dispositions - - 5,970,384
Proceeds from sale of CMBS, net - - 72,591,594
Proceeds from sale of CMO IV, net - - 3,519,468
---------------- --------------- -----------------
Net cash provided by investing activities 87,198,290 52,737,223 113,350,546
---------------- --------------- -----------------
Cash flows from financing activities:
Principal payments on securitized mortgage debt obligations (76,727,913) (39,386,850) (30,136,067)
Principal payments on Exit Debt (36,239,032) (23,740,992) -
Principal payments on secured borrowings and other debt obligations (100,392) (132,353,015) (23,337,476)
Proceeds from the issuance of common stock 43,431 - -
Redemption of Series E Preferred Stock, including accrued dividends (18,733,912) - -
Common stock redeemed - (3,565) -
---------------- --------------- -----------------
Net cash used in financing activities (131,757,818) (195,484,422) (53,473,543)
---------------- --------------- -----------------
Net increase (decrease) in other cash and cash equivalents 11,952,475 (89,270,905) 53,059,467
Cash and cash equivalents, beginning of period (1) 17,298,873 106,569,778 53,510,311
---------------- --------------- -----------------
Cash and cash equivalents, end of period (1) $ 29,251,348 $ 17,298,873 $ 106,569,778
================ =============== =================
(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.
F-7
CRIIMI MAE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION
General
CRIIMI MAE Inc. (together with its consolidated subsidiaries, unless the
context otherwise indicates, We or CRIIMI MAE) is a commercial mortgage company
structured as a self-administered real estate investment trust (or REIT). We
currently own, and manage, primarily through our servicing subsidiary, CRIIMI
MAE Services Limited Partnership (CMSLP or CRIIMI MAE Services), a significant
portfolio of commercial mortgage-related assets. We have focused primarily on
non-investment grade (rated below BBB- or unrated) commercial mortgage-backed
securities (subordinated CMBS). As the holder of the most subordinate tranches,
we are exposed to a higher risk of losses, but we also have the potential for
enhanced returns.
Our core holdings are subordinated CMBS backed by pools of commercial
mortgage loans on hotel, multifamily, retail and other commercial real estate.
We also own directly and indirectly government-insured mortgage backed
securities and a limited number of high-yield mezzanine commercial real estate
mortgage loans (mezzanine loans). We also are a trader in investment grade CMBS
and residential mortgage-backed securities.
January 2003 Recapitalization
On January 23, 2003, we completed a recapitalization of all of the secured
debt incurred upon our emergence from Chapter 11 reorganization in April 2001
(the Exit Debt). This recapitalization was funded with approximately $44 million
from common equity and secured subordinated debt issuances to Brascan Real
Estate Finance Fund I L.P. (BREF), a private asset management fund established
by Brascan Corporation and a management team led by Barry S. Blattman, $300
million in secured financing in the form of a repurchase transaction from a unit
of Bear, Stearns & Co., Inc. (Bear Stearns) and a portion of our available cash
and liquid assets. This recapitalization increases our financial flexibility and
provides new additions to management including Barry S. Blattman, as Chairman of
the Board, Chief Executive Officer and President.
Under the 2003 recapitalization, BREF acquired 1,212,617 shares of our
newly issued common stock, or approximately 8% of our outstanding common stock
after giving effect to the share acquisition, at $11.50 per share, or
approximately $13.9 million. BREF also received seven-year warrants to purchase
up to 336,835 additional shares of common stock at $11.50 per share. In
addition, BREF purchased $30 million of our newly issued subordinated debt (the
BREF Debt) and, at our option, BREF will purchase up to an additional $10
million of subordinated debt prior to January 23, 2004. The BREF Debt matures on
January 23, 2006 and bears interest at an annual rate of 15%. If we decide to
sell the additional $10 million of subordinated debt to BREF, it will bear
interest at an annual rate of 20% and mature on January 23, 2006. We have a
right to defer two-thirds of the interest on the BREF Debt (and half on the
additional $10 million, if sold to BREF) during its term. The BREF Debt is
secured by first liens on the equity interests of two of our subsidiaries.
Although this effectively provides BREF with an indirect lien on all of our
subordinated CMBS that are held by three of our other lower-tier subsidiaries,
Bear Stearns has first liens on the equity interests of these three lower tier
subsidiaries and on certain of the subordinated CMBS held by one of these lower
tier subsidiaries. Pursuant to an intercreditor agreement between BREF and Bear
Stearns, our obligations under the BREF Debt are contractually subordinate to
the prior payment in full of our obligations under the $300 million in secured
financing provided by Bear Stearns. Such intercreditor agreement also provides
for contractual restrictions on BREF's ability to realize upon its indirect
interest in the Bear Stearns first lien collateral.
Bear Stearns provided $300 million in secured financing in the form of a
repurchase transaction (the Bear Stearns Debt) under the 2003 recapitalization.
The Bear Stearns Debt matures in 2006, bears interest at a rate equal to
one-month LIBOR plus 3% and requires quarterly principal payments of $1.25
million. The principal payments will increase to $1.875 million per quarter if a
collateralized debt obligation transaction (or CDO) is not completed
F-8
by January 23, 2004. The interest rate will increase by 1%, to one-month
LIBOR plus 4%, if Bear Stearns structures a CDO that meets certain rating
requirements and we decline to close. The Bear Stearns Debt is secured by first
direct and/or indirect liens on all of our subordinated CMBS. The indirect first
liens are first liens on the equity interests of three of our subsidiaries that
hold certain subordinated CMBS. A reduction in the value of this collateral
could require us to provide additional collateral or fund margin calls. Although
CRIIMI MAE Inc. is not a primary obligor of the Bear Stearns Debt, it has
guaranteed all obligations under the debt.
Risks
Our 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 and refinancing risks; (3) risks associated with
potential margin calls under the Bear Stearns Debt; (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) continuing
adverse effects of terrorist attacks, threats of further terrorist attacks, acts
of war, the economic slowdown and/or recession and other matters on defaults and
losses related to the mortgages underlying our CMBS portfolio; (8) failure to
manage the mismatch between long-term assets and short-term funding; (9) risk of
loss of REIT status and other tax matters; (10) the effect of interest rate
compression on the market price of our stock; (11) the effect of the yield curve
on borrowing costs; (12) results of operations adversely affected by factors
beyond our control; (13) competition; (14) risk of becoming subject to the
requirements of the Investment Company Act of 1940; (15) the effect of phantom
(non-cash) income on total income; and (16) taxable mortgage pool risk.
The Reorganization Plan
On October 5, 1998, CRIIMI MAE Inc. (unconsolidated) and two operating
subsidiaries, CRIIMI MAE Management, Inc. and CRIIMI MAE Holdings II, L.P.,
filed for relief under Chapter 11 of the U.S. Bankruptcy Code in the United
States Bankruptcy Court for the District of Maryland, Southern Division, in
Greenbelt, Maryland. On November 22, 2000, the United States Bankruptcy Court
for the District of Maryland, entered an order confirming our reorganization
plan, and we emerged from Chapter 11 on April 17, 2001.
Our reorganization plan provided for the payment in full of all of our
allowed claims primarily through the Chapter 11 reorganization (including
proceeds from certain asset sales) totaling $847 million. Included in the
Chapter 11 reorganization was approximately $262.4 million in Exit Debt provided
by affiliates of Merrill Lynch Mortgage Capital, Inc. (or Merrill Lynch) and
German American Capital Corporation (or GACC) through a variable-rate secured
financing facility (the Exit Variable-Rate Secured Borrowing), in the form of a
repurchase transaction, and approximately $166.8 million in Exit Debt provided
through two series of senior secured notes issued to some of our unsecured
creditors. All rights and obligations of Merrill Lynch and GACC under the Exit
Variable-Rate Secured Borrowing operative agreements were subsequently assigned
to ORIX Capital Markets, LLC. The Exit Debt was directly or indirectly secured
by substantially all of our assets, and virtually all of our cash flows relating
to existing assets were used to satisfy principal, interest and fee obligations
under the Exit Debt and to pay our general and administrative and other
operating expenses. The terms of the Exit Debt significantly restricted the
amount of cash dividends that could be paid to shareholders. See Note 7 for a
further discussion of the Exit Debt. All Exit Debt was paid off in connection
with the January 2003 recapitalization. Under our reorganization plan, the
holders of our equity retained their shares of stock.
Other
Prior to the Chapter 11 filing, our primary activities included (a)
acquiring 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 our subordinated CMBS.
We were incorporated in Delaware in 1989 under the name CRI Insured
Mortgage Association, Inc. In July 1993, CRI Insured Mortgage Association
changed its name to CRIIMI MAE Inc. and reincorporated in Maryland. In June
1995, certain mortgage businesses affiliated with C.R.I., Inc. were merged into
CRIIMI MAE Inc. (the Merger). We are not a government sponsored entity or in
any way affiliated with the United States government or any United States
government agency.
F-9
REIT Status/Net Operating Loss for Tax Purposes
REIT Status. We have elected to qualify as a REIT for tax purposes under
sections 856-860 of the Internal Revenue Code. We are required to meet income,
asset, ownership and distribution tests to maintain our REIT status. Although
there can be no assurance, we believe that we have satisfied the REIT
requirements for all years through, and including 2002. There can also be no
assurance that we will maintain our REIT status for 2003 or subsequent years. If
we fail to maintain our REIT status for any taxable year, we 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, we may have insufficient funds
to pay any such tax and also may be unable to comply with our obligations under
the operative documents evidencing the Bear Stearns and BREF Debt.
We and two of our subsidiaries incorporated in 2001 jointly elected to
treat such two subsidiaries as taxable REIT subsidiaries (TRS) effective January
1, 2001. The TRSs allow us to earn non-qualifying REIT income while maintaining
our REIT status. For tax and other reasons, a reorganization of CMSLP was
effected such that the partnership interests of CMSLP are held by these two
subsidiaries.
Our 2002 and 2001 Net Operating Loss for Tax Purposes/Trader Election
In 2000, we 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 us or any qualified REIT subsidiary, meaning generally
any wholly owned subsidiary that is not a taxable REIT subsidiary). Such Trading
Assets are classified as Subordinated CMBS and Other MBS on our balance sheet.
We seek maximum total return through short-term trading, consistent with prudent
investment management. Returns from such activities include interest and capital
appreciation/depreciation resulting from changes in interest rates and spreads,
if any, and other arbitrage opportunities.
Internal Revenue Service Procedure 99-17 provides securities and
commodities traders with the ability to elect mark-to-market treatment for the
2000 tax year and all future tax years, unless the election is revoked with the
consent of the Internal Revenue Service. On March 15, 2000, we elected for tax
purposes to be classified as a trader in securities effective January 1, 2000.
As a result of our election in 2000 to be taxed as a trader for federal
income tax purposes, we recognized a mark-to-market tax loss on our 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). We
expect such loss to be ordinary, which would allow us to offset our ordinary
income. Additionally, as a result of our trader election, we are required to
mark-to-market our 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 a REIT subsidiary, CBO REIT, as part of our
Chapter 11 reorganization (and subsequently transferred by CBO REIT to CBO REIT
II as part of our recent recapitalization) are no longer required to be
marked-to-market on a tax basis since CBO REIT was not, and CBO REIT II 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 ordinary, any gains will generally increase taxable income and any losses
will generally decrease taxable income. Since the REIT rules require us to
distribute 90% of our taxable income to our 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).
F-10
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 the mark-to-market adjustments, but the cash flow
from our Trading Assets will not fluctuate as a result of the mark-to-market
adjustments.
We generated a net operating loss for tax purposes of approximately $83.6
million and $90.6 million during the years ended December 31, 2002 and 2001,
respectively. As such, our taxable income was reduced to zero and, accordingly,
our REIT distribution requirement was eliminated for 2002 and 2001. As of
December 31, 2002, our accumulated and unused net operating loss (or NOL) was
$223.8 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 we are 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.
There can be no assurance that our position with respect to our election as
a trader in securities will not be challenged by the Internal Revenue Service
(or IRS) and, if challenged, will be defended successfully by us. 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, however, interest may also be due to
the IRS on the amount of this under-distribution.
If we are required to make taxable income distributions to our shareholders
to satisfy required REIT distributions, all or a substantial portion of these
distributions, if any, may 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, we could lose our REIT status or may not be able to
satisfy our obligations under the operative documents evidencing the Bear
Stearns and BREF Debt.
Our 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 Internal
Revenue Code. As a result of these limitations imposed by Section 382 of the
Internal Revenue Code, in the event of an ownership change, our ability to use
our 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 carry forwards would expire unutilized.
Accordingly, after any ownership change, our ability to use our 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.
We do not believe the BREF investment in our common stock and warrant to
purchase common stock has created an "ownership change" under Section 382. In
addition, we are not aware of any other acquisition of shares of our capital
stock that has created an "ownership change" under Section 382. Currently, we do
not know of any potential acquisition of shares of our capital stock that will
create an "ownership change" under Section 382 of the Internal Revenue Code. We
have adopted a shareholder rights plan and amended our charter to minimize the
chance of an ownership change within the meaning of Section 382 of the Internal
Revenue Code; however there can be no assurance that an ownership change will
not occur.
If an "ownership change" occurs under Section 382 of the Internal Revenue
Code, our prospective use of our accumulated and unused NOL and the remaining
January 2000 Loss of a combined total amount of approximately $343.4 million as
of December 31, 2002 will be limited. If we had lost our ability to use our
accumulated NOL as of January 1, 2002, our taxable income would have been
approximately $36.0 million for the year ended December 31, 2002. This increase
in taxable income would have created a requirement to distribute 90% of this
income to our shareholders in order to maintain REIT status, and would be
subject to corporate income tax to the extent we do not distribute 100% of our
taxable income to shareholders. If we were unable to distribute at
F-11
least 90% of our taxable income to shareholders, we would have been subject
to corporate Federal and state income taxes of up to approximately $14.7 million
for the year ended December 31, 2002.
2. INVESTMENT COMPANY ACT OF 1940
Under the Investment Company Act of 1940, as amended, 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
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, we, among other
things, must maintain at least 55% of our assets in Qualifying Interests (the
55% Requirement) and are 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, we believe that all of our government-insured mortgage
securities constitute Qualifying Interests. In accordance with current SEC staff
interpretations, we believe that all of our subordinated CMBS constitute Other
Real Estate Interests and that certain of our subordinated CMBS also constitute
Qualifying Interests. On certain of our subordinated CMBS, we, along with other
rights, have the unilateral right to direct foreclosure with respect to the
underlying mortgage loans. Based on such rights and our economic interest in the
underlying mortgage loans, we believe that the related subordinated CMBS
constitute Qualifying Interests. As of December 31, 2002, we believe that we
were 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, we could, among
other things, be required either (i) to change the manner in which we conduct
our 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 us. If we were required to change the manner in which we
conduct our business, we would likely have to dispose of a significant portion
of our subordinated CMBS or acquire significant additional assets that are
Qualifying Interests. Alternatively, if we were required to register as an
investment company, we expect that our operating expenses would significantly
increase and that we would have to significantly reduce our indebtedness, which
could also require us to sell a significant portion of our 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 Bear
Stearns and BREF Debt which could limit possible actions we may take in response
to any need to modify our 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 this Debt. Any
such results could have a material adverse effect on us.
Further, if we were deemed an unregistered investment company, we could be
subject to monetary penalties and injunctive relief. We would be unable to
enforce contracts with third parties and third parties could seek to obtain
rescission of transactions undertaken during the period we were deemed an
unregistered investment company, unless the 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.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Consolidation and Minority Interests
The consolidated financial statements reflect the financial position,
results of operations and cash flows of CRIIMI MAE and all of our majority-owned
and controlled subsidiaries for all periods presented. All significant
intercompany accounts and transactions have been eliminated in consolidation.
F-12
Effective July 2001, we acquired voting control of CMSLP and began
accounting for this subsidiary on a consolidated basis. We had previously
accounted for CMSLP under the equity method. CMSLP's assets, liabilities,
revenues and expenses are labeled as "servicing" on the Company's consolidated
financial statements.
Method of Accounting
Our consolidated financial statements are prepared on the accrual basis of
accounting in accordance with accounting principles generally accepted in the
United States. The preparation of financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from those estimates.
Reclassifications
We have reclassified certain 2001 and 2000 amounts to conform to the 2002
presentation.
Other Cash and Cash Equivalents and Servicing Cash and Cash Equivalents
Cash and cash equivalents consist of U.S. Government and agency securities,
certificates of deposit, time deposits and commercial paper with original
maturities of three months or less.
Restricted Cash and Cash Equivalents
Restricted cash and cash equivalents consist of cash, certificates of
deposit and interest bearing securities maturing within three months from the
date of purchase that are legally restricted pursuant to covenants under the
post-emergence debt or, pursuant to various stipulation and consent orders which
provide for adequate protection with certain of our creditors which litigation
was not resolved prior to our emergence from Chapter 11.
Transfer of Financial Assets
We have transferred assets (mortgages and mortgage securities) in
securitization transactions where the transferred assets become the sole source
of repayment for newly issued debt. These transfers of financial assets were
accounted for in accordance with SFAS No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishment of Liabilities," as amended by
SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities - a Replacement of FASB Statement No. 125." The
transfer is treated as a sale when both legal and control rights to a financial
asset are transferred. Transfers are assessed on an individual component basis.
In a securitization, the cost basis of the original assets transferred is
allocated to each of the new financial components based upon the relative fair
value of the new financial components. For components where sale treatment is
achieved, a gain or loss is recognized for the difference between that
component's allocated cost basis and fair value. For components where sale
treatment is not achieved, an asset is recorded representing the allocated cost
basis of the new financial components retained and the related incurrence of
debt is also recorded. In transactions where none of the components are sold, we
recognize the incurrence of debt and the character of the collateralizing assets
remains unchanged.
Income Recognition and Carrying Basis
Subordinated CMBS and Other Mortgage-Backed Securities
Prior to April 1, 2001, we recognized income from subordinated CMBS using
the effective interest method, using the anticipated yield over the projected
life of the investment. Changes in anticipated yields were generally calculated
due to revisions in estimates of future credit losses, actual losses incurred,
revisions in estimates of future prepayments and actual prepayments received.
Changes in anticipated yields resulting from prepayments were recognized through
a cumulative catch-up adjustment at the date of the change which reflected the
change in income of the security from the date of purchase through the date of
change in anticipated yield. The new yield was then used for income recognition
for the remaining life of the investment. Changes in anticipated yields
resulting from
F-13
reduced estimates of losses were recognized on a prospective basis. When
other than temporary impairment was recognized, a new yield was calculated on
the CMBS based on its new cost basis (fair value at date of impairment) and
expected future cash flows. This revised yield was employed prospectively.
Effective April 1, 2001, we 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
our subordinated CMBS. Under EITF 99-20, we calculate a revised yield based on
the current amortized cost of the investment and the revised future cash flows
when there has been a change in estimated future cash flows from the cash flows
previously projected (due to credit losses and/or prepayment speeds). This
revised yield is applied prospectively to recognize interest income. We classify
our subordinated CMBS as available for sale and carry them at fair market value
where temporary changes in fair value are recorded as a component of
shareholders' equity.
Interest income on other mortgage-backed securities 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.
Our other mortgage-backed securities are classified as "available for
sale." As a result, we carry 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.
Insured Mortgage Securities
Insured mortgage securities income consists of amortization of the discount
or premiums plus the stated mortgage interest payments received or accrued. 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 mortgage using the effective interest method. The
effective interest method provides a constant yield of income over the term of
the mortgage.
Our insured mortgage securities are classified as "available for sale." As
a result, we carry our insured mortgage securities at fair value where changes
in fair value are recorded as a component of shareholders' equity.
Our consolidated investment in insured mortgage securities consists of
participation certificates evidencing a 100% undivided beneficial interest in
government-insured multifamily mortgages issued or sold pursuant to programs of
the Federal Housing Administration, or FHA, and mortgage-backed securities
guaranteed by the Government National Mortgage Association, or GNMA. Payment of
principal and interest on FHA-insured certificates is insured by the U.S.
Department of Housing and Urban Development, or HUD, pursuant to Title 2 of the
National Housing Act. Payment of principal and interest on GNMA mortgage-backed
securities is guaranteed by GNMA pursuant to Title 3 of the National Housing
Act.
Equity Investments
CRIIMI, Inc., a wholly owned subsidiary, owns all of the general
partnership interests in American Insured Mortgage Investors, American Insured
Mortgage Investors - Series 85, L.P., American Insured Mortgage Investors L.P. -
Series 86 and American Insured Mortgage Investors L.P. - Series 88
(collectively, referred to as the AIM Limited Partnerships). The AIM Limited
Partnerships own mortgage assets which are substantially similar to our insured
mortgage securities. CRIIMI, Inc. receives the general partner's share of
income, loss and distributions (which ranges from 2.9% to 4.9%) from each of the
AIM Limited Partnerships. In addition, CRIIMI MAE and CRIIMI MAE Management each
own 50% of the limited partnership that owns a 20% limited partnership interest
in the adviser to the AIM Limited Partnerships. We are utilizing the equity
method of accounting (because we do not control these investees) for our
investment in the AIM Limited Partnerships and advisory partnership, which
provides for recording our share of net earnings or losses in the AIM Limited
Partnerships and advisory partnership reduced by distributions from the limited
partnerships and adjusted for purchase accounting amortization.
F-14
On July 1, 2001, we began accounting for our servicing subsidiary, CMSLP,
on a consolidated basis as opposed to accounting for CMSLP under the equity
method. This change in accounting method was a result of a reorganization in
which the partnership interests in CMSLP are now held by two of our wholly-owned
and controlled taxable REIT subsidiaries. Prior to July 1, 2001, we accounted
for CMSLP under the equity method since we 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 consolidated financial statements.
Impairment
Subordinated CMBS and Other Mortgage-Backed Securities
We assess 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) our revised projected cash flows
related to the subordinated CMBS and the subordinated CMBS's current cost basis
result in a decrease in the yield compared to what was previously used to
recognize income, or (2) fair value has been below amortized cost for a
significant period of time and we conclude that we no longer have 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 we expect the value to recover
to amortized cost. This decrease in yield would be primarily a result of the
credit quality of the security declining and a determination 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. We assess current economic events
and conditions that impact the value of our subordinated CMBS and the underlying
real estate in making judgments as to whether or not other than temporary
impairment has occurred. Impairment charges on subordinated CMBS aggregating
approximately $70.2 million, $34.7 million and $143.5 million were recognized
during the years ended December 31, 2002, 2001 and 2000, respectively. See Note
5 for further discussion of the impairment charges.
We assess each other mortgage-backed security, or MBS, for other than
temporary impairment when the fair market value of the security declines below
the respective amortized cost and we conclude that we no longer have 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. We did
not recognize any impairment losses on our other MBS during 2002, 2001 and 2000.
Insured Mortgage Securities
We assess each insured mortgage security for other than temporary
impairment when the fair market value of the asset declines below amortized cost
for a significant period of time and we conclude that we no longer have the
ability to hold the security through the market downturn. The amount of
impairment loss is measured by comparing the fair value of an insured mortgage
security to its current amortized cost basis, with the difference recognized as
a loss in the income statement. We did not recognize any impairment on our
insured mortgage securities in 2002, 2001 and 2000.
Equity Investments
We recognize impairment on our investments accounted for under the equity
method if a decline in the market value of the investment below its carrying
basis is judged to be "other than temporary". During 2002, the AIM Limited
Partnerships experienced a significant amount of prepayments of their insured
mortgages. These prepayments reduced cash flows on our 20% investment in the
advisor to the AIM Limited Partnerships. As a result, in accordance with SFAS
No. 142, "Goodwill and Other Intangible Assets," and SFAS No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets," the advisor to the AIM
Limited Partnerships evaluated its investment in the advisory contracts for
impairment. The estimated future undiscounted cash flows from this investment
were projected to be less than the book value of the investment as of December
31, 2002. As a result, the advisor believed that its investment in the advisory
contracts was impaired at December 31, 2002. The advisor estimated the fair
value of its investment using a discounted cash flow methodology. The advisor
wrote down the value of its investment in the advisory contracts to the AIM
Limited Partnerships and recorded an impairment
F-15
charge. We recorded our portion of the impairment charge, totaling
approximately $460,000, as of December 31, 2002. This impairment charge is
included in Equity in (losses) earnings from investments in our Consolidated
Statement of Income. This investment is included in our Portfolio Investment
segment. We did not recognize any impairment losses on our equity investments in
2001 and 2000.
Receivables
Receivables primarily consist of interest and principal receivables. In
addition, prepayments in the insured mortgage securities portfolio, if any, that
have not yet been received are included in receivables.
Other Assets
Other assets primarily include deferred financing costs, deferred costs,
investment in mezzanine loans and real estate owned.
The assets acquired and costs incurred in connection with the Merger were
recorded using the purchase method of accounting. The amounts allocated to the
assets acquired were based on management's estimate of their fair values, with
the excess of purchase price over fair value allocated to goodwill. The goodwill
and intangible assets acquired were amortized using the straight-line method
over 10 years. As discussed later in this footnote, we wrote-off $9.8 million of
goodwill and intangible assets related to these merger assets on January 1, 2002
upon the adoption of SFAS No. 142, "Goodwill and Other Intangible Assets."
Deferred financing costs are costs incurred in connection with the
establishment of our financing facilities and are amortized using the effective
interest method over the terms of the borrowings. Also included in deferred
costs are mortgage selection fees, which were paid in connection with the
insured mortgage securities. These deferred costs are being amortized using the
effective interest method on a specific mortgage basis from the date of the
acquisition of the related mortgage over the term of the mortgage. Upon
disposition of a mortgage, the related unamortized fee is treated as part of the
mortgage asset carrying value in order to measure the gain or loss on the
disposition.
Property held for investment is carried at cost and depreciated over its
estimated useful life and will be evaluated for impairment when events or
changes in circumstances indicate that the carrying amount of the asset may not
be recoverable. At such time, if the expected future undiscounted cash flows
from the property are less than the cost basis, the assets will be marked down
to fair value. Costs relating to development and improvement of property are
capitalized, provided that the resulting carrying value does not exceed fair
value. Costs relating to holding the assets are expensed.
Servicing Other Assets and Servicing Liabilities
As previously discussed, in July 2001, we began accounting for our
servicing subsidiary, 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 of our wholly-owned and controlled taxable REIT subsidiaries. Prior to July
1, 2001, we accounted for CMSLP under the equity method since we 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
consolidated financial statements.
Components of Servicing Other Assets and Servicing Liabilities
At December 31, 2002 and 2001, the following comprised servicing other
assets and servicing liabilities:
F-16
2002 2001
---- ----
Receivables and other assets $ 5,717,299 $ 7,612,446
Investment in interest-only certificates and CMBS 5,374,209 2,395,576
AIM Limited Partnerships' subadvisory contracts (1) 1,034,373 1,906,542
Fixed assets, net 1,617,569 2,239,927
Acquired mortgage servicing rights 31,688 4,096,333
------------ -----------
Total servicing other assets $13,775,138 $18,250,824
============ ===========
Accounts and notes payable $ 756,865 $ 3,660,173
============ ===========
(1) During 2002, the AIM Limited Partnerships experienced a
significant amount of prepayments of their insured mortgages.
These prepayments reduced CMSLP's cash flows from our subadvisory
contracts with the AIM Limited Partnerships. As a result, in
accordance with SFAS No. 142 and SFAS No. 144, we evaluated
CMSLP's investment in the subadvisory contracts for impairment.
Our estimated future undiscounted cash flows from this investment
were projected to be less than the book value of the investment as
of December 31, 2002. As a result, we believed that CMSLP's
investment in the subadvisory contracts was impaired at December
31, 2002. We estimated the fair value of the investment using a
discounted cash flow methodology. We wrote down the value of
CMSLP's investment in the subadvisory contracts with the AIM
Limited Partnerships and recorded an impairment charge of
approximately $340,000 as of December 31, 2002. This impairment
charge is included in Servicing amortization, depreciation and
impairment in our Consolidated Statement of Income.
Servicing Revenue, Servicing General and Administrative Expenses, and
Servicing Amortization, Depreciation and Impairment
Servicing revenue represents revenue earned by CMSLP, which primarily
consists of mortgage servicing fees, assumption fees, other ancillary servicing
fees, interest income, and AIM Limited Partnerships' subadvisory fees. Servicing
general and administrative expenses represent CMSLP's general and administrative
expenses. Servicing amortization, depreciation and impairment expenses represent
CMSLP's amortization of mortgage servicing rights, impairment on mortgage
servicing rights, impairment on subadvisory contracts (as discussed above) and
depreciation and amortization of fixed and other assets.
Components of Servicing Revenue, Servicing General and Administrative
Expenses, and Servicing Amortization, Depreciation and Impairment
For the years ended December 31, 2002 and 2001, the following comprised
servicing revenue and servicing expenses:
2002 2001 (1)
---- ----
Mortgage servicing fees $ 5,462,814 $ 3,570,603
Assumption fees and other servicing income 4,312,000 2,178,077
Interest income 694,445 834,664
AIM Limited Partnerships' subadvisory fees 516,511 302,713
------------ -------------
Total servicing revenue (2) $ 10,985,770 $ 6,886,057
============ ============
Servicing general and administrative expenses $ 8,854,569 $ 5,882,889
============ ============
Amortization of mortgage servicing rights $ 690,091 $ 734,258
Depreciation and amortization of fixed and other assets 1,073,207 466,403
Impairment on AIM Limited Partnerhips' subadvisory contracts 340,356 -
Impairment on mortgage servicing rights and CMBS 69,483 498,525
------------ -------------
Total servicing amortization, depreciation and impairment $ 2,173,137 $ 1,699,186
============ ============
(1) The 2001 amounts reflect CMSLP's results during the period July 1, 2001
through December 31, 2001, since CMSLP was not accounted for on a
consolidated basis until July 2001.
(2) Excludes gain on sales of servicing rights and investment-grade CMBS,
which were recognized in 2002.
F-17
Discounts and Deferred Financing Costs on Debt
Discounts and deferred financing costs incurred in connection with the
issuance of debt are amortized using the effective interest method over the
projected term of the related debt, which is based on management's estimate of
prepayments on the underlying collateral and are included as a component of
interest expense. In addition, as discussed in Note 7, there were extension fees
payable under the terms of the Exit Debt. We had estimated the amounts of these
extension fees and were amortizing the fees using the effective interest method
over the term of the related debt. However, these accrued extension fees were
reversed into income in January 2003 (as they were no longer payable) due to the
repayment of the Exit Debt (see Note 19).
Interest Rate Protection Agreements
We have used interest rate caps to hedge the variability in interest
payments associated with our variable rate debt. During 1998, the Financial
Accounting Standards Board, or FASB, issued SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities." In June 1999, the FASB issued
SFAS No. 137, "Accounting for Derivative Instruments and Hedging
Activities-Deferral of the Effective Date of FASB Statement No. 133." In June
2000, the FASB issued SFAS No. 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities, an amendment of FASB Statement No.
133." We determined that our interest rate caps are effective cash flow hedges
under SFAS No. 133. From January 1, 2001 through June 30, 2001, in accordance
with SFAS No. 133, all changes in the fair value of the interest rate caps
related to intrinsic value were recorded in other comprehensive income and all
changes in fair value related to time value were recorded through earnings as
those changes in fair value were considered ineffective. Beginning July 1, 2001,
we recorded all changes in fair value (both intrinsic and time value) through
other comprehensive income in accordance with a FASB Derivatives Implementation
Group interpretation. Amounts recorded in other comprehensive income will be
reclassified into earnings in the period in which earnings are affected by the
hedged cash flows, which is monthly as the variable rate debt's interest rate
resets monthly to one month LIBOR as does the interest rate cap. Upon the
termination of a hedging relationship, the amount in accumulated other
comprehensive income will be amortized over the remaining life of the previously
hedged cash flows. We adopted SFAS No. 133 on January 1, 2001. In accordance
with the transition provisions of SFAS No. 133, we recorded a cumulative effect
type adjustment of $(135,142) in earnings to recognize, at fair value, the
interest rate caps designated as cash flow hedges as of January 1, 2001. The
interest rate caps are carried at an aggregate book value of $4,000 at December
31, 2002 and are included in Other Assets on the Consolidated Balance Sheet.
Shareholders' Equity
On October 17, 2001, we effected a one-for-ten reverse stock split. All
share and per share information in these Notes to Consolidated Financial
Statements and the accompanying Consolidated Financial Statements has 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. See Notes 11
and 12 for further discussion.
Per Share Amounts
Basic earnings per share amounts represent net income, or loss, available
to common shareholders divided by the weighted average common shares outstanding
during the year. The weighted average common shares outstanding amounts include
the weighted average amount of common shares payable or paid to preferred
shareholders related to dividends as of the respective dividend declaration
dates. Diluted earnings per share amounts represent basic EPS adjusted for
dilutive common stock equivalents, which could include stock options and certain
series of convertible preferred stock. See Note 13 for a reconciliation of basic
earnings per share to diluted earnings per share.
F-18
Income Taxes
We have elected to qualify as a REIT for tax purposes under Sections
856-860 of the Internal Revenue Code for the 2002 and 2001 tax years. We are
required to meet income, asset, ownership and distribution tests to maintain our
REIT status for federal and state tax purposes. We will monitor and minimize the
levels of non-qualifying income in order to meet REIT qualification criteria.
See Note 1 for additional discussion.
During the years ended December 31, 2002 and 2001, no excess inclusion was
distributed. During the year ended December 31, 2000, excess inclusion income of
$0.1474 per common share was distributed with the Series G Preferred Stock
dividend. Excess inclusion income results from our prior resecuritization of
mortgage securities in our portfolio. A shareholder's allocable share of excess
inclusion represents the minimum taxable income reportable by the shareholder
for that year; it may not be offset by a net operating loss and may represent
unrelated business taxable income for some shareholders. The excess inclusion
distributed in 2000 was generated in 1999.
We account for income taxes under SFAS No. 109, "Accounting for Income
Taxes." SFAS No. 109 requires the reporting of deferred tax assets and
liabilities using rates expected to be in effect in future tax years when the
book-to-tax differences reverse. Additionally, SFAS No. 109 requires that a
valuation allowance be established for deferred tax assets if it is determined
that the realization of the asset is not "more likely than not."
We and two of our subsidiaries incorporated in 2001 jointly elected to
treat such two subsidiaries as TRS effective January 1, 2001. These subsidiaries
allow us to earn non-qualifying REIT income while maintaining our REIT status.
The partnership interests of CMSLP are held by these subsidiaries. These
subsidiaries are separately taxable entities that cannot use our net operating
loss carry forward to reduce their taxable income. Thus, we will recognize
income tax expense to the extent these subsidiaries are subject to income taxes.
Consolidated Statements of Cash Flows
Since the consolidated statements of cash flows are intended to reflect
only cash receipt and cash payment activity, the consolidated statements of cash
flows do not reflect investing and financing activities that affect recognized
assets and liabilities while not resulting in cash receipts or cash payments. On
April 17, 2001, cash of approximately $127.2 million was used to payoff a
portion of the aggregate principal relating to debt incurred prior to the
Chapter 11 filing. The aggregate Exit Debt principal of approximately $429.2
million was incurred on April 17, 2001 to satisfy the remaining principal owed
on the debt incurred prior to the Chapter 11 filing. The cash outflow of $127.2
million is included in principal payments on secured borrowings and other debt
obligations in the financing activities section of the consolidated statements
of cash flows. The aggregate Exit Debt principal of $429.2 million resulted in
no cash inflow and, accordingly, is not reflected in the consolidated statements
of cash flows. Also on April 17, 2001, cash of approximately $44.7 million was
used to payoff accrued interest on debt incurred prior to the Chapter 11 filing,
cash of approximately $3.9 million was used to pay an emergence financing
origination fee related to a portion of the Exit Debt, and cash of approximately
$7.4 million was used to pay accrued payables related to the Chapter 11 filing.
This cash activity is reflected in the operating activities section of the
consolidated statements of cash flows within the net income line or the change
in payables and accrued expenses line.
In 2000, based upon stipulation agreements with certain of our lenders, we
reflected the receipt of interest on certain of our CMBS of $82.0 million, along
with the corresponding pay down of interest payable of $50.2 million. Net cash
flow of $32 million was used to pay down approximately $19 million debt related
to the respective variable rate financing facilities of those lenders.
Additionally, CMBS asset sales generated approximately $418 million in proceeds,
approximately $342 million of which was used to pay down debt. Only the net
proceeds were remitted to us, and as such, only the net proceeds are reflected
in the consolidated statements of cash flows.
The following is the supplemental cash flow information:
F-19
2002 2001 2000
---- ---- ----
Cash paid for interest $ 72,488,764 $ 124,468,367 $ 137,110,022
Cash paid for income taxes 947,300 42,000 1,642,000
Non-cash investing and financing activities:
Restricted stock issued 129,675 -- --
Preferred stock dividends paid in shares of common stock 3,444,792 20,443,229 --
Fair value of real estate assets acquired -- 8,784,105 --
Fair value of real estate liabilities acquired -- (569,991) --
Fair value of mortgage assumed -- (7,130,638) --
Comprehensive Income
Comprehensive income includes net earnings as currently reported (before
dividends accrued or paid on preferred shares) adjusted for other comprehensive
income. Other comprehensive income consists of (a) changes in unrealized gains
and losses related to our CMBS and other MBS and insured mortgage securities
which were disposed of or impaired during the period with the resulting gain or
loss reflected in net earnings (reclassification adjustments), (b) the change in
the unrealized gain or loss related to those investments that were not disposed
of or impaired during the period, and (c) certain changes in the fair value of
the interest rate caps accounted for under SFAS No. 133. The table below details
other comprehensive income for the periods presented:
2002 2001 2000
---- ---- ----
Reclassification adjustment for losses from dispositions
included in net income $1,829,607 $ 350,066 $ 282,723
Reclassification adjustment for impairment losses recognized on
CMBS included in net income (406,724) -- 180,177,910
Unrealized holding gains (losses) on mortgage securities
arising during the period 107,747,337 (3,390,785) 23,941,476
Unrealized losses on interest rate caps (604,565) (383,200) --
------------- ------------ -------------
Net adjustment to other comprehensive income $108,565,655 $(3,423,919) $204,402,109
============= ============ =============
Change in Accounting Principle related to Special Servicing Fee Revenue
Recognition
As of July 1, 2001, CMSLP changed its accounting policy related to the
recognition of special servicing fee revenue. Special servicing fees are paid to
CMSLP when mortgage loans collateralizing CMBS owned by CRIIMI MAE are in
default. Typically, CMSLP is paid 25 basis points of the unpaid principal
balance of the defaulted mortgage loans for as long as the loans are in default.
The fees are paid to compensate the special servicer for managing and resolving
the defaulted loan. Historically, CMSLP had deferred special servicing fee
revenue and recorded that revenue into earnings using the method consistent with
our policy of recognizing interest income over the life of our CMBS on the level
yield basis. CMSLP is now recording these special servicing fees in earnings on
a current basis. This change in accounting policy was made to better match
revenues and expenses related to the actual special servicing of the defaulted
loans. The special servicing fees are paid on a current basis by the trusts
holding the mortgage loans and those payments directly reduce the cash flow paid
on our CMBS. Therefore, the special servicing fees paid are built into the GAAP
yields we use to record interest income on our CMBS. CMSLP has changed its
accounting policy to recognize the special servicing fees in earnings on a
current basis as it believes this policy better matches the special servicing
fees it earns with the direct costs expended for special servicing the loans.
The CMBS and special servicing contracts are separate legal instruments or
contracts.
We were required to reflect this change in accounting principle as a
cumulative catch-up as of January 1, 2001. As of January 1, 2001 CMSLP had
approximately $2.0 million in deferred revenue related to the special servicing
fee revenue. As a result, this amount was recorded into income and was reflected
as a cumulative change in accounting principle for the year ended December 31,
2001. The results of operations for the year ended December 31, 2001 reflect the
recognition of special servicing fee revenue on a current basis. As previously
discussed, prior to July 1, 2001, CMSLP was accounted for using the equity
method and, as a result, the impact of the new accounting principle (except for
the cumulative catch-up) is reflected in equity in income from investments for
the six months ended June 30, 2001 and on a consolidated basis for the six
months ended December 31, 2001.
F-20
The following table presents pro forma disclosures assuming that the change
in accounting for servicing fee revenue was adopted at the beginning of 2000:
For the years ended December 31,
2001 2000
---------------- ----------------
Reported net loss to common shareholders $(24,222,798) $(155,495,429)
Add: Net revenue deferred -- 379,138
Less: Cumulative effect of change in accounting for servicing revenue (1,995,262) --
---------------- ----------------
Adjusted net loss to common shareholders $(26,218,060) $(155,116,291)
================ ================
Basic and diluted earnings per share:
Reported basic and diluted earnings per share after cumulative effect of
changes in accounting principles $(2.18) $(25.02)
Net revenue deferred -- 0.06
Cumulative effect of change in accounting for servicing revenue (0.18) --
---------------- ----------------
Adjusted basic and diluted earnings per share after cumulative effect of
changes in accounting principles $(2.36) $(24.96)
================ ================
Change in Accounting Principle due to Adoption of SFAS No. 142
In June of 2001, the Financial Accounting Standards Board (or FASB) issued
Statement of Financial Accounting Standards (or SFAS) No. 142, "Goodwill and
Other Intangible Assets." SFAS No. 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 No.
142, the method for testing goodwill for impairment occurs at the reporting unit
level (as defined in SFAS No. 142) and is performed using a fair value based
approach. SFAS No. 142 was effective on January 1, 2002. The transition
provisions of SFAS No. 142 required us to reclassify $8.4 million of intangible
assets related to the Merger to goodwill. When combined with the current
goodwill of $1.4 million, this resulted in $9.8 million of goodwill on our
books. Effective upon adoption on January 1, 2002, we 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 segment (as defined in Note 18). The fair value of the
segment was determined using a market capitalization approach and the impairment
was primarily a result of the significant decrease in our common stock price
since the merger in 1995. This change in accounting principle reduces our annual
amortization expense by approximately $2.8 million through June 2005.
The following table presents pro forma disclosures assuming that SFAS No.
142 was adopted at the beginning of 2000:
For the years ended December 31,
2002 2001 2000
--------------- --------------- ----------------
Reported net loss to common shareholders $(64,247,814) $(24,222,798) $(155,495,429)
Add: Goodwill amortization -- 399,468 399,468
Add: Intangible assets amortization -- 2,390,004 2,390,004
Add: Cumulative effect of adoption of SFAS No. 142 9,766,502 -- --
--------------- --------------- ----------------
Adjusted net loss to common shareholders $(54,481,312) $(21,433,326) $(152,705,957)
=============== =============== ================
Basic and diluted earnings per share:
Reported basic and diluted earnings per share after
cumulative effect of changes in accounting principles $(4.69) $(2.18) $(25.02)
Goodwill amortization -- 0.04 0.06
Intangible assets amortization -- 0.21 0.39
Cumulative effect of adoption of SFAS No. 142 0.72 -- --
--------------- --------------- ----------------
Adjusted basic and diluted earnings per share after
cumulative effect of changes in accounting principles $(3.97) $(1.93) $(24.57)
=============== =============== ================
F-21
Accounting during Chapter 11 Proceedings
Liabilities Subject to Chapter 11 Proceedings
Liabilities which were subject to Chapter 11 proceedings, including claims
that became known after the Chapter 11 petition date, were reported at their
expected allowed claim amount in accordance with SFAS No. 5, "Accounting for
Contingencies." To the extent that the amounts of claims changed as a result of
actions in the Chapter 11 or other factors, the recorded amount of liabilities
subject to the Chapter 11 proceeding was adjusted. The gain or loss resulting
from the entries to record the adjustment was recorded as a reorganization item.
Reorganization Items
Reorganization items were items of income and expense that were realized or
incurred because of the Chapter 11 reorganization. These included, but were not
limited, to the following:
o short-term interest income that would not have been earned but for the Chapter
11 proceedings;
o professional fees and similar types of expenditures directly relating to the
Chapter 11 proceedings;
o employee retention program costs and severance payments; and
o loss accruals or realized gains or losses resulting from activities of the
reorganization process such as the sale of certain assets, rejection of
certain executory contracts and the write-off of debt issuance costs and debt
discounts.
During the years ended December 31, 2001 and 2000, we recorded
reorganization items due to the Chapter 11 filings of CRIIMI MAE, CRIIMI MAE
Management and CRIIMI MAE Holdings II as follows:
Reorganization Items 2001 2000
-------------------- ---------------- ------------------
Short-term interest income $ 2,491,311 $ 6,850,362
Professional fees (3,870,185) (9,317,772)
Employee Retention Program -- (851,948)
Other (800,875) (1,136,319)
Excise tax accrued -- (495,000)
-------------- ---------------
Subtotal (2,179,749) (4,950,677)
Impairment on CMBS regarding reorganization (2) -- (15,832,817)
Net recovery (loss) on real estate owned (1) 366,529 (924,283)
Net gain on sale of CMBS -- 1,481,029
Loss on originated loans -- (45,845,712)
-------------- ---------------
Total reorganization expense, net $ (1,813,220) $ (66,072,460)
============== ==============
(1) We recognized impairment on our investment in real estate owned in 2000.
This asset was sold in July 2000.
(2) We recognized impairment on the CMBS subject to the sales of select CMBS in
1999 and additional impairment on the remaining CMBS subject to the sales of
select CMBS in 2000. The final bonds subject to the sales were sold in
November 2000.
Recent Accounting Pronouncements
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 supersedes SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of," and the accounting and reporting provisions of
Accounting Principles Board Opinion No. 30, "Reporting Results of
Operations-Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequent Occurring Events and Transactions" for the
disposal of segments of a business. SFAS No. 144 established accounting and
reporting standards for the impairment or disposal of long-lived assets by
requiring those long-lived assets be measured at the lower of carrying costs or
fair value less selling costs, whether reported on continuing operations or in
discontinued operations. The provisions of SFAS No. 144 are effective for
financial statements issued for fiscal years beginning after December 15, 2001.
We adopted SFAS No. 144 on January 1, 2002. As discussed previously, we
recognized approximately $801,000 of impairment in our Consolidated Statement of
Income during 2002 related to our Portfolio Investment segment's (as
F-22
defined in Note 18) investment in the advisor to the AIM Limited
Partnerships and our Mortgage Servicing segment's (as defined in Note 18)
investment in AIM Limited Partnerships subadvisory contracts.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections," that, among other things, rescinded SFAS No. 4, "Reporting Gains
and Losses from Extinguishment of Debt." With the rescission of SFAS No. 4, the
early extinguishment of debt generally will no longer be classified as an
extraordinary item for financial statement presentation purposes. The provision
is effective for fiscal years beginning after May 15, 2002, with earlier
application related to the rescission of SFAS No. 4 encouraged. We adopted the
provisions related to the rescission of SFAS No. 4 on April 1, 2002. As a
result, we have reclassified a $14.8 million gain on debt extinguishment in 2000
from an extraordinary item to an operating item. In addition, in 2003, we expect
to recognize a gain on extinguishment of debt as a result of the retirement of
the Exit Debt following the recapitization in January 2003. The gain will be
classified as an operating item.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities," which replaces Emerging Issues
Task Force Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." The new standard requires companies to
recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit or disposal plan.
The statement is to be applied prospectively to exit or disposal activities
initiated after December 31, 2002. We do not expect the adoption of SFAS No. 146
to have a material effect on our financial position or results of operations.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure," which amended SFAS No. 123
"Accounting for Stock-Based Compensation." The new standard provides alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. Additionally, the statement
amends the disclosure requirements of SFAS No. 123 to require prominent
disclosures in the annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results. This statement is effective for financial statements
for fiscal years ending after December 15, 2002. In accordance with SFAS No.
148, we have elected to continue to follow the intrinsic value method in
accounting for its stock-based employee compensation arrangement as defined by
Accounting Principles Board Opinion (APB) No. 25, "Accounting for Stock Issued
to Employees," and have made the applicable disclosures in Note 14 to the
consolidated financial statements.
In January 2003, the FASB issued FASB Interpretation (or FIN) No. 46,
"Consolidation of Variable Interest Entities", an interpretation of Accounting
Research Bulletin No. 51, "Consolidated Financial Statements." FIN No. 46
explains how to identify variable interest entities and how an enterprise
assesses its interests in a variable interest entity to decide whether to
consolidate that entity. This Interpretation requires existing unconsolidated
variable interest entities to be consolidated by their primary beneficiaries if
the entities do not effectively disperse risks among parties involved. FIN No.
46 is effective immediately for variable interest entities created after January
31, 2003, and to variable interest entities in which an enterprise obtains an
interest after that date. The Interpretation applies in the first fiscal year or
interim period beginning after June 15, 2003, to variable interest entities in
which an enterprise holds a variable interest that it acquired before February
1, 2003. We do not expect the adoption of FIN No. 46 to have a material effect
on our financial position or results of operations.
F-23
4. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following estimated fair values of our 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 our liquidation value or the value of the
securities under a portfolio liquidation.
As of December 31, 2002 As of December 31, 2001
Amortized Cost Fair Value Amortized Cost Fair Value
-------------- ---------- -------------- ----------
ASSETS:
Subordinated CMBS and Other MBS (1) $ 478,879,460 $540,755,663 $ 546,981,955 $ 536,204,992
Subordinated CMBS pledged to secure
Securitized Mortgage Obligation - CMBS 287,039,586 326,472,580 283,993,690 296,477,050
Insured mortgage securities 273,655,357 275,340,234 350,982,991 343,091,303
Interest rate protection agreements 992,043 4,277 448,789 65,589
Servicing other assets See footnote (2) See footnote (2) See footnote (2) See footnote (2)
Servicing cash and cash equivalents 12,582,053 12,582,053 6,515,424 6,515,424
Restricted cash and cash equivalents 7,961,575 7,961,575 38,214,277 38,214,277
Other cash and cash equivalents 16,669,295 16,669,295 10,783,449 10,783,449
LIABILITIES:
Variable-rate secured borrowing 214,672,536 214,672,536 244,194,590 244,194,590
Series A senior secured notes 92,788,479 92,788,479 (3) 99,505,457 95,276,475
Series B senior secured notes 68,491,323 68,491,323 (3) 63,937,383 54,826,306
Securitized mortgage obligations:
Collateralized bond obligations-CMBS 285,844,933 326,472,580 283,047,470 296,477,050
Collateralized mortgage obligations-insured
mortgage securities 252,980,104 266,366,729 326,558,161 351,983,544
Mortgage payable 7,214,189 7,341,397 7,109,252 7,109,252
(1) Includes approximately $5.3 million of amortized cost and $5.2 million of
fair value related to other MBS as of December 31, 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 $1.9 million and $2.3 million and a
fair value of approximately $2.1 million and $2.4 million as of December
31, 2002 and 2001, respectively. Additionally, CMSLP owns investment-grade
CMBS with an aggregate cost basis and fair value of approximately $3.3
million as of December 31, 2002.
(3) Since these notes were redeemed in January 2003 at face value, we have
disclosed the face value as the fair value as of December 31, 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
Our determination of fair values for our 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 our view, is commensurate with the market's perception of value
and risk of comparable assets. We use a variety of sources to compile such
pricing information including: (i) recent offerings and/or secondary trades of
comparable CMBS (i.e., securities comparable to our CMBS or to the CMBS (or
collateral) underlying our CMBS issued in connection with CRIIMI MAE Trust I
Series 1996-C1 (or CBO-1) and CRIIMI MAE Commercial Mortgage Trust Series
1998-C1 (or CBO-2)), (ii) communications with dealers and active CMBS investors
regarding the pricing and valuation of comparable securities, (iii)
institutionally available research reports, (iv) analyses prepared by the
nationally recognized rating organizations responsible for the initial rating
assessment and on-going surveillance of such CMBS, and (v) other qualitative and
quantitative factors that may impact the value of the CMBS such as the market's
perception of the issuers of the CMBS and the credit fundamentals of the
commercial properties securing each pool of commercial mortgage loans. We make
further fair value adjustments to such pricing information based on our specific
knowledge of our CMBS, which is then used to determine the fair value of our
CMBS using a discounted cash flow approach. Expected future gross cash flows are
discounted at market yields for our rated CMBS, depending on the rating, and at
a fixed discount rate for our unrated/issuer's equity. Furthermore, the fair
value for those CMBS incurring principal losses and interest shortfalls (i.e.,
CBO-2 B-
F-24
and CCC bonds, and our unrated/issuer's equity) based on our overall
expected loss estimate are valued at a loss adjusted yield to maturity that, in
our view, is commensurate with the market's perception of value and risk of
comparable securities, using the same discounted cash flow approach. Such
anticipated principal losses and interest shortfalls have been taken into
consideration in the calculation of fair values and yields to maturity used to
recognize interest income as of December 31, 2002. In addition, we considered
the impact of our recent recapitalization and the value of competing offers in
determining our year end fair values. Since we calculated the estimated fair
value of our CMBS portfolio as of December 31, 2002 and 2001, we have disclosed
the range of discount rates by rating category used in determining the fair
values as of December 31, 2002 in Note 5.
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, our estimate of
the value of the subordinated CMBS could vary significantly from the value that
could be realized in a current transaction between a willing buyer and a willing
seller.
The fair value of the other MBS is an estimate based on the indicative
market price from publicly available pricing services. We normally apply a
slight discount to such prices as we believe it better reflects fair value
between willing buyers and sellers due to the relatively smaller sizes of this
component of the trading securities.
Insured Mortgage Securities
We calculated the estimated fair market value of the insured mortgage
securities portfolio as of December 31, 2002 and 2001, using a discounted cash
flow methodology. The cash flows were discounted using a discount rate and other
assumptions that, in our view, was commensurate with the market's perception of
risk and value. We 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 December 31,
2002 and 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 the same as the face values as the notes
were redeemed in January 2003. The carrying amount of the Exit 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 Caps
The fair values of our interest rate caps, which are used to hedge our
variable rate debt, are the estimated amounts that we would receive to terminate
the caps as of December 31, 2002 and 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.
5. CMBS
As of December 31, 2002, we owned, in accordance with GAAP, CMBS (excluding
Other MBS) with an aggregate face amount of approximately $1.5 billion rated
from A+ to CCC and unrated. Such CMBS had an aggregate fair value of
approximately $862 million (representing approximately 69% of our total
consolidated assets) and an aggregate amortized cost of approximately $761
million. Such CMBS represent investments in securities issued in connection with
CBO-1, CBO-2 and Nomura Asset Securities Corporation Series 1998-D6 (or Nomura).
The following is a summary of the ratings of our CMBS as of December 31, 2002:
F-25
Rating Fair Value % of CMBS
------ ---------- ---------
A+, BBB+ or BBB (a) $326.5 38%
BB+, BB or BB- $338.9 39%
B+, B, B- or CCC $176.6 21%
Unrated $20.0 2%
(a) Represents investment grade securities that we reflect as assets
on our balance sheet as a result of CBO-2. As indicated in
footnote 4 to the table below, GAAP requires both these assets
(reflected as "CMBS pledged to Secure Securitized Mortgage
Obligation-CMBS") and their related liabilities (reflected as
"Collateralized bond obligations - CMBS") to be reflected on our
balance sheet. All cash flows related to the investment grade CMBS
are used to service the corresponding debt. As a result, we
currently receive no cash flows from the investment grade CMBS.
As of December 31, 2002, the weighted average interest rate and the loss
adjusted weighted average life (based on face amount) of the investment grade
securities was 7.0% and 8.6 years, respectively. The weighted average interest
rate and the loss adjusted weighted average life (based on face amount) of
the BB+ through unrated CMBS securities, sometimes referred to as the retained
portfolio, were 5.3% and 10.5 years, respectively. The aggregate investment by
the rating of the CMBS is as follows:
Discount Rate
or Range of
Weighted Discount Rates
Average Loss Fair Value Used to
Face Amount Pass-Through Adjusted as of Calculate Fair Amortized Cost Amortized Cost
as of Rate as Weighted 12/31/02 Value as of 12/31/02 as of 12/31/01
12/31/02 (in of Average Life (in as of 12/31/02 (in millions) (in millions)
Security Rating millions) 12/31/02 (1) millions) (9) (10) (5) (6)
- ----------------------------------------------------------------------------------------------------------------------
Investment Grade Portfolio
A+ (4) $ 62.6 7.0% 4 years $ 66.0 5.1% $ 59.4 $ 58.7
BBB+ (4) 150.6 7.0% 10 years 150.6 7.0% 132.3 131.1
BBB (4) 115.2 7.0% 10 years 109.9 7.7% 95.3 94.2
Retained Portfolio
BB+ 319.0 7.0% 11 years 259.4 9.8%-10.2% 223.0 219.0
BB 70.9 7.0% 13 years 54.2 10.8% 46.8 46.0
BB- 35.5 7.0% 14 years 25.3 11.6% 20.8 20.5
B+ 88.6 7.0% 14 years 50.4 14.9% 46.0 45.2
B 177.2 7.0% 17 years 94.3 15.4%-15.7% 85.1 83.7
B- (2) 118.3 7.1% 24 years 28.1 16.0%- 28.1 48.1
20.0% (9)
CCC (2) 70.9 0.1% 2 years 3.8 (10) 3.8 13.1
Unrated/Issuer's
Equity (2) (3) 326.1 2.1% 1 year 20.0 (10) 20.0 62.8
---------- --------- ---------- ----------
Total (8) $1,534.9 5.7% 10 years $ 862.0 (8) $ 760.6 (7) $ 822.4
========== ========= ========== ==========
(1) The loss adjusted weighted average life represents the weighted average
expected life of the CMBS based on our current estimate of future losses.
As of December 31, 2002, the fair values of the B-, CCC and the
unrated/issuer's equity in Nomura, CBO-1, and CBO-2 were derived solely
from interest cash flow anticipated to be received since our 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 December 31, 2002, the subordinated CMBS from CBO-1 and CBO-2 (with
the exception of the CBO-2 issuer's equity which has no stated coupon
rate) 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 8.3% and 6.7%, respectively (prior to the consideration
of losses, prepayments and extensions on the underlying mortgage loans).
The subordinated CMBS 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 subordinated CMBS. Such interest
shortfalls will continue to accumulate until they (i) are repaid 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 our
overall expected loss estimate as of December 31, 2002, the CBO-
F-26
2 subordinated CMBS currently rated B- and CCC and the Nomura unrated CMBS
are expected to incur approximately $55.4 million, $4.6 million, and $1.9
million, respectively, of 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 December 31, 2002.
(3) The unrated subordinated CMBS from CBO-2 currently does not have a stated
coupon rate since these 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-2.
(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 CMBS 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, we
initially retained $90.6 million (originally BBB rated, currently BBB+
rated) and $115.2 million (originally BBB- rated, currently BBB rated)
face amount of CMBS, both with call options, with the intention to sell
these CMBS at a later date. Such sale occurred March 5, 1999. Since we
retained call options on certain sold CMBS (the A+, BBB+ and BBB bonds),
we did not surrender control of these CMBS pursuant to the requirements of
SFAS No. 125 and thus these CMBS are accounted for as a financing and not
a sale. Since the transaction is recorded as a partial financing and a
partial sale, we have retained these CMBS with call options and reflected
them in our subordinated CMBS on the balance sheet to which we currently
receive no economic benefit.
(5) Amortized cost reflects impairment charges of approximately $70.2 million
related to the unrated/issuer's equity bonds, the CCC bond and the B- bond
in CBO-2, which were recognized during the year ended December 31, 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 5.
(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 10 to Notes to Consolidated Financial Statements for
information regarding the Subordinated CMBS for tax purposes.
(8) As of December 31, 2002, the aggregate fair values of the CBO-1, CBO-2
and Nomura bonds were approximately $19.3 million, $837.2 million and
$5.5 million, respectively.
(9) The discount rate is applied to gross scheduled cash flows as opposed to
loss adjusted cash flows for purposes of calculating fair values.
(10) As a result of the significant loss of principal on these CMBS, we have
used a significantly high discount rate to determine a reasonable fair
value of these CMBS. The weighted average yield-to-maturity of the CCC and
unrated/issuer's equity is 5.8% and 8.6%, respectively.
Mortgage Loan Pool
Through CMSLP, we perform servicing functions on commercial mortgage loans
totaling $17.4 billion and $19.3 billion as of December 31, 2002 and 2001,
respectively. The mortgage loans underlying our subordinated CMBS portfolio are
secured by properties of the types and in the geographic locations identified
below:
12/31/02 12/31/01 12/31/02 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) Our ownership interest in one of the 20 CMBS transactions underlying
CBO-2 includes subordinated CMBS in which our 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"). These other CMBS are
not owned by and are subordinate to our CMBS in this transaction. As a
result, our 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 other CMBS not
owned by us.
Specially Serviced Mortgage Loans
CMSLP performs special servicing on the loans underlying our subordinated
CMBS portfolio. A special servicer typically provides asset management and
resolution services with respect to nonperforming or
F-27
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. We believe that because we own the first loss
unrated or lowest rated bond of all but one of the CMBS transactions related to
our subordinated CMBS, CMSLP has an incentive to efficiently and effectively
resolve any loan workouts. As of December 31, 2002 and 2001, specially serviced
mortgage loans included in the commercial mortgage loans described above are as
follows:
12/31/02 12/31/01
-------- --------
Specially serviced loans due to monetary default (a) $736.1 million $701.7 million
Specially serviced loans due to covenant default/other 74.7 million 90.0 million
-------------- ----------------
Total specially serviced loans (b) $810.8 million $791.7 million
============== ================
Percentage of total mortgage loans (b) 4.7% 4.1%
============== ================
(a) Includes $130.5 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 February 28, 2003, total specially serviced loans were
approximately $1.1 billion, or 6.3% of the total mortgage loans.
See discussion below for additional information regarding
specially serviced loans.
The specially serviced mortgage loans as of December 31, 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............ $ 494.7 (1) 61% Florida............... $ 134.3 17%
Retail........... 200.8 (2) 25% Oregon................ 91.8 11%
Multifamily...... 42.6 5% Texas................. 86.6 11%
Healthcare....... 26.7 3% California............ 46.1 6%
Office........... 22.6 3% Georgia .............. 42.1 5%
Industrial....... 13.7 2% North Carolina........ 28.9 3%
Other............ 9.7 1% Other................. 381.0 47%
------------ ---------- -------- ---------
Total.......... $ 810.8 100% Total............... $ 810.8 100%
============ ========== ======== =========
(1) Approximately $80.4 million of these loans in special servicing are real
estate owned by underlying trusts.
(2) Approximately $32.7 million of these loans in special servicing are real
estate owned by underlying trusts.
As reflected above, as of December 31, 2002, approximately $494.7 million,
or 61%, of the specially serviced mortgage loans are secured by mortgages on
hotel properties. The hotel properties that secure the mortgage loans underlying
our subordinated CMBS are geographically diverse, with a mix of hotel property
types and franchise affiliations. The following table summarizes the hotel
mortgage loans underlying our subordinated CMBS as of December 31, 2002:
Total Outstanding Percentage of Amount in
Principal Balance Total Hotel Loans Special Servicing
----------------- ----------------- -----------------
Full service hotels (2) $ 1.4 billion 54% $ 206.6 million
Limited service hotels (1) 1.2 billion 46% 288.1 million
-------------- ---- ----------------
Totals $ 2.6 billion 100% $ 494.7 million
============= ==== ================
(1) 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.
(2) Full service hotels are generally mid-price, upscale or luxury hotels with
restaurant and lounge facilities and other amenities.
Of the $494.7 million of hotel loans in special servicing as of December
31, 2002, approximately $295.2 million, or 60%, relate to four borrowing
relationships more fully described as follows:
F-28
o Sixteen loans and eight real estate owned properties with scheduled
principal balances totaling approximately $92.2 million spread across four
CMBS transactions secured by hotel properties throughout the U.S. As of
December 31, 2002, our total exposure, including advances, on these loans
is approximately $96.4 million. In one of these CMBS transactions, which
contains 10 loans with scheduled principal balances totaling $39.0 million,
we hold only a 25% ownership interest in the non-rated class. In the other
three CMBS transactions, we hold a 100% ownership interest in the non-rated
class. Twenty-five loans were transferred into special servicing in
December 2001 due to the bankruptcy filing of each special purpose
borrowing entity and their parent company. Since the bankruptcy filing, as
part of a consensual plan, eight properties with scheduled principal
balances totaling $26.3 million have become real estate owned by underlying
trusts, one loan with a scheduled principal balance totaling $5.3 million
has been paid in full and the remaining sixteen loans with scheduled
principal balances totaling $65.9 million were granted maturity date
extensions and have been returned to performing status, and are in the
process of being transferred out of special servicing.
o Twenty-seven loans with scheduled principal balances totaling approximately
$138.1 million spread across three CMBS transactions secured by hotel
properties in the west and Pacific northwest states. As of December 31,
2002, our total exposure, including advances, on these loans is
approximately $160.4 million. The borrower had filed for bankruptcy
protection in October 2001. 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. We have entered into a consensual settlement
agreement dated February 25, 2003 pursuant to which the loan terms will be
amended and modified. The parties are currently proceeding toward closing
a comprehensive loan modification that should return the loans to
performing status.
o Five loans with scheduled principal balances totaling approximately $45.7
million secured by hotel properties in Florida and Texas. As of December
31, 2002, our total exposure, including advances, on these loans is
approximately $50.7 million. The loans are past due for the July 2002 and
all subsequent payments. The balance and paid-through date do not reflect
the recent application in 2003 of approximately $3.5 million of insurance
proceeds and of sporadic payments received from the borrower throughout the
year. The borrower and lender have entered into negotiations concerning a
consensual modification of the loan terms.
o Nine loans with scheduled principal balances totaling approximately
$19.2 million secured by limited service hotels in midwestern states.
As of December 31, 2002, our total exposure, including advances, on
these loans is approximately $20.9 million. 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 was attempting
to negotiate a workout with the borrower, but the borrower filed for
bankruptcy protection in February 2003.
In addition to the borrowing relationships described above, subsequent to
December 31, 2002 there were the following two additional transfers to special
servicing of large hotel loans, one for an imminent payment default and the
other for a non-monetary default. These defaults were considered in our December
31, 2002 loss assessment.
o One loan with a scheduled principal balance totaling approximately
$81.1 million secured by 13 extended stay hotels located throughout the
country. This loan was transferred to special servicing in January
2003 due to the borrower's request for forbearance and the resulting
possibility of an imminent payment default. In its request, the
borrower cited continuing reduced operating performance at its hotel
properties, which it did not expect to improve in the foreseeable
future. CMSLP entered into a short-term forbearance agreement with the
borrower, and a consensual term sheet to restructure and modify the
loan terms. We recently closed a loan modification agreement with the
borrower that is expected to return the loan to performing status in the
future.
o One loan with a scheduled principal balance totaling
approximately $131.1 million, secured by 93 limited service hotels
located in 29 states. The loan was transferred to special servicing
in January 2003.
F-29
The loan is current for payments, but was transferred to special
servicing due to the unauthorized leasing of some of the collateral
properties by the borrower, and unapproved franchise changes by the
borrower, among other reasons. We have entered into a Confidentiality and
Pre-Negotiation Agreement in an attempt to reach a consensual resolution of
this matter.
For each of the borrowing relationships described in the paragraphs above,
we believe that we have adequate reserves for losses that we may incur in the
future. There can be no assurance that the losses incurred in the future will
not exceed our current reserves (see discussion below regarding increase in loss
estimates).
The following table provides a summary of the change in the balance of
specially serviced loans from December 31, 2001 to December 31, 2002:
(in
millions)
-------------
Specially Serviced Loans, December 31, 2001 $ 791.7
Transfers in due to monetary default 372.8
Transfers in due to covenant default and other 23.6
Transfers out of special servicing (353.9)
Loan amortization (1) (23.4)
-------------
Specially Serviced Loans, December 31, 2002 $ 810.8 (2)
=============
(1) Represents the reduction of the scheduled principal balances due to advances
made by the master servicers.
(2) Specially serviced loans total approximately $1.1 billion as of
February 28, 2003.
For all loans in special servicing, CMSLP is pursuing remedies available to
it in order to maximize the recovery of the outstanding debt.
Advance Limitations, Appraisal Reductions and Losses on CMBS
We experience shortfalls in expected cash flow on our CMBS prior to the
recognition of a realized loss primarily due to servicing advance limitations to
the most subordinate securities (only in certain underlying CMBS transactions)
or 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.
Thereafter, no future monthly principal and interest advances will be made by
the master servicer until the amount of the most subordinate CMBS current coupon
is eliminated. 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 sum of unpaid principal balance of the loan,
advances and other expenses exceeds 90% (in most cases) of the appraisal amount,
thus reducing our cash flows 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 our net cash flows 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 we retain 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
Year 2002 9,088 48,953 13,530 71,571
-------- -------- -------- ---------
Cumulative Appraisal Reductions through December 31, 2002 $26,559 $99,786 $14,404 $ 140,749
======== ======== ======== ==========
* 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, certain bonds 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 our
CMBS through December 31, 2002 (including realized mortgage loan losses expected
to pass through to our CMBS during the next month) and the expected future
losses through the life of the CMBS:
F-30
(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
Year 2002 actual realized losses 11,554 25,113 563 37,230
------- -------- -------- --------
Cumulative actual realized losses through December 31, 2002 $ 16,038 $34,597 $ 801 $51,436
======== ======== ======== ========
Cumulative actual realized losses through December 31, 2002 $ 16,038 $34,597 $ 801 $51,436
Expected loss estimates for the year 2003 54,410 136,771 6,438 197,619
Expected loss estimates for the years 2004 17,771 89,783 20,016 127,570
Expected loss estimates for the years 2005 11,887 37,545 4,452 53,884
Expected loss estimates for the years 2006-2008 5,268 32,684 10,257 48,209
Expected loss estimates for the years 2009-2011 3,543 5,904 3,206 12,653
Expected loss estimates for the remaining life of CMBS 2,865 7,557 1,364 11,786
-------- -------- --------- ----------
Cumulative expected loss estimates (including cumulative
actual realized losses) through life of CMBS $111,782 $344,841 $46,534 $ 503,157
======== ======== ========= ==========
The following table provides a summary of the changes in the overall
expected loss estimates on subordinated CMBS from January 1, 2001 through
December 31, 2002:
Overall Impairment
Expected Recorded During
($ in millions) Loss Estimate Quarter Ended Impaired CMBS
- --------------- ------------- ------------- -------------
January 1, 2001 $298 $ -
September 30, 2001 307 3.9 Both bonds in CBO-1, and Nomura unrated bond
December 31, 2001 335 30.8 Both bonds in CBO-1, and BB- through unrated/issuer's equity
bonds in CBO-2
June 30, 2002 351 5.2 Nomura and CBO-2 unrated/issuer's equity bonds
September 30, 2002 448 29.9 All unrated/issuer's equity bonds, and the CCC bond and the B-
bond in CBO-2
December 31, 2002 503 35.1 All unrated/issuer's equity bonds, and the CCC bond and the B-
bond in CBO-2
We revised our overall expected loss estimate related to our subordinated
CMBS portfolio during 2002 as summarized in the table above with an overall
expected loss estimate of approximately $503 million as of December 31, 2002,
with such total losses occurring or expected to occur through the life of the
subordinated CMBS portfolio. These revisions to the overall expected loss
estimate were primarily the result of increased mortgage loan defaults and
increased projected losses (and assuming the related timing of losses will 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
mortgage 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. In addition, as
previously discussed, two significant hotel loan portfolios transferred into
special servicing in January 2003. The unpaid principal balances of these two
hotel loan portfolios aggregate approximately $212.2 million. Our overall
expected loss estimate of $503 million through the life of our subordinated CMBS
includes our estimate of total principal write-downs to our 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 our revised overall expected
loss estimate of $503 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 weak economy or recession, an act of war, a delay in the
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 further impairment to our subordinated
CMBS, the effect of which could be materially adverse to us.
During 2002, we had also determined that there had been an adverse change
in expected future cash flows
F-31
for certain of the CMBS as of June 30, 2002, September 30, 2002 and
December 31, 2002 (as summarized in the table above) due to the factors
mentioned in the preceding paragraph. As a result, we believed these bonds had
been impaired under EITF 99-20 and SFAS No. 115, "Accounting for Certain
Investments in Debt and Equity Securities," as of each of those dates. As the
fair values of these impaired bonds were approximately $5.2 million, $29.9
million and $35.1 million below the amortized cost basis as of June 30, 2002,
September 30, 2002 and December 31, 2002, respectively, we recorded other than
temporary impairment charges through the income statement during the second,
third and fourth quarters of 2002.
During 2001, we revised our overall expected loss estimate related to our
subordinated CMBS portfolio as detailed in the table above. The revisions to
loss estimates during 2001 were primarily the result of the continued slowing
U.S. economy and recession, which were exacerbated by the terrorist attacks on
September 11, 2001 and subsequent terrorist actions and threats. As previously
discussed, principally as a result of the slowing economy and terrorist actions
and threats, the underlying mortgage loans had a greater than previously
anticipated number of monetary defaults during 2001. Additionally, appraisal
amounts on properties underlying certain defaulted loans were significantly
lower than previously anticipated, thereby increasing the estimated principal
loss on the commercial loans. As we had determined that there had been an
adverse change in expected future cash flows and that the current estimate of
expected credit losses exceeded credit losses as previously projected, we
believed certain of the CMBS had been impaired under EITF 99-20 and SFAS No. 115
as of September 30, 2001 and again as of December 31, 2001. As the fair value of
the impaired bonds was approximately $3.9 million and $30.8 million below the
amortized cost basis as of September 30, 2001 and December 31, 2001,
respectively, we recorded other than temporary non-cash impairment charges
through the income statement of those same amounts during the third and fourth
quarters of 2001.
Yield to Maturity
The following table summarizes yield-to-maturity information relating to
our CMBS on an aggregate pool basis:
Current
Anticipated Anticipated Anticipated
Yield-to- Yield-to- Yield-to-
Maturity Maturity Maturity
Pool as of 1/1/01 (1) as of 1/1/02 (1) as of 1/1/03 (1)
---- ---------------- ---------------- ----------------
CBO-2 CMBS 11.8% (2) 12.1% (2) 11.6% (2)
CBO-1 CMBS 21.0% (2) 14.3% (2) 11.6% (2)
Nomura CMBS 25.3% (2) 28.7% (2) 8.0% (2)
---------- ------------ --------------
Weighted Average (3) 12.4% (2) 12.4% (2) 11.6% (2)
(1) Represents the anticipated weighted average yield over the expected average
life of the CMBS as of January 1, 2001, January 1, 2002, and January 1,
2003 based on our estimate of the timing and amount of future credit
losses.
(2) As previously discussed, as of December 31, 2000, September 30, 2001,
December 31, 2001, June 30, 2002, September 30, 2002 and December 31, 2002,
we revised our overall expected loss estimate related to our subordinated
CMBS to $298 million, $307 million, $335 million, $351 million, $448
million and $503 million, respectively, which resulted in impairment
recognition to certain subordinated CMBS. As a result of recognizing
impairment, we revised the anticipated yields as of January 1, 2001,
October 1, 2001, January 1, 2002, July 1, 2002, October 1, 2002 and
January 1, 2003, which were or are, in the case of revised anticipated
yields as of January 1, 2003, used to recognize interest income beginning
on each of those dates. These anticipated revised yields took into account
the lower cost basis due to the impairment recognized on the 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. The weighted average yield-to-maturity was
12.5% and 12.0% as of July 1, 2002 and October 1, 2002, respectively.
(3) 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 accounting income
recognition which is greater than or less than cash received. For the years
ended December 31, 2002, 2001 and 2000, the amount of income recognized in
excess of cash received on all of the subordinated CMBS due to the
effective interest rate method was approximately $11.4 million, $10.2
million and $15.2 million, respectively.
F-32
Determining Fair Value of CMBS
We use a discounted cash flow methodology for determining the fair value of
our subordinated CMBS. See Note 4 for a discussion of our fair value
methodology.
Key Assumptions in Determining Fair Value
The gross mortgage loan cash flows from each commercial mortgage loan pool
and their corresponding distribution on the CMBS may be affected by numerous
assumptions and variables including:
(i) changes in the timing and/or amount of credit losses on the commercial
mortgage loans (credit risk), which are a function of:
o the percentage of mortgage loans that experience a default either
during the mortgage term or at maturity (referred to in the industry
as a default percentage);
o the recovery period represented by the time that elapses between
the default of a commercial mortgage loan and the subsequent
foreclosure and liquidation of the corresponding real estate (a
period of time referred to in the industry as a lag); and,
o the percentage of mortgage loan principal lost as a result of the
deficiency in the liquidation proceeds resulting from the
foreclosure and sale of the commercial real estate (referred to in
the industry as a loss severity);
(ii) the discount rate used to derive fair value which is comprised of the
following:
o a benchmark risk-free rate, calculated by using the current,
"on-the-run" U.S. Treasury curve and interpolating a comparable
risk-free rate based on the weighted-average life of each CMBS; plus,
o a credit risk premium; plus,
o a liquidity premium;
(iii) delays in the receipt of monthly cash flow distributions to CMBS as a
result of mortgage loan defaults and/or extensions in the loan's term
to maturity (see Extension Risk below); and
(iv) the receipt of mortgage payments earlier than projected (prepayment).
Sensitivities of Key Assumptions
Since we use a discounted cash flow methodology to derive the fair value of
our CMBS, changes in the timing and/or the amount of cash flows received from
the underlying commercial mortgage loans, and their allocation to the CMBS, will
directly impact the value of such securities. Accordingly, delays in the receipt
of cash flows and/or decreases in future cash flows resulting from higher than
anticipated credit losses will result in an overall decrease in the fair value
of our CMBS. Furthermore, any increase/(decrease) in the required rate of return
for CMBS will result in a corresponding (decrease)/increase in the value of such
securities. We have included the following narrative and numerical disclosures
to demonstrate the sensitivity of such changes to the fair value of our CMBS.
Key Assumptions Resulting in an Adverse Impact to Fair Value
Factors which could adversely affect the valuation of our CMBS include: (i)
the receipt of future cash flows less than anticipated due to higher credit
losses (i.e., higher credit losses resulting from a larger percentage of loan
defaults, and/or losses occurring sooner than projected, and/or longer periods
of recovery between the date of default and liquidation, and/or higher loss of
principal, see "Sensitivity of Fair Value to Changes in Credit Losses" below),
(ii) an increase in the required rate of return (see "Sensitivity of Fair Value
to Changes in the Discount Rate" below) for CMBS, and/or (iii) the receipt of
cash flows later than anticipated (see "Sensitivity of Fair Value to Extension
Risk" below).
Sensitivity of Fair Value to Changes in Credit Losses
For purposes of this disclosure, we used a market convention for simulating
the impact of increased credit losses on CMBS. Generally, the industry uses a
combination of an assumed percentage of loan defaults (referred to in the
industry as a Constant Default Rate or "CDR"), a lag period, and an assumed
loss severity.
F-33
For purposes of this disclosure, we assumed the following loss scenarios,
each of which was assumed to begin 12 months from December 31, 2002: (i) 2.0%
per annum of the commercial mortgage loans were assumed to default, a 12 month
period of time was assumed to elapse between the date of default and the date of
liquidation (it was further assumed that the master servicer only continued to
advance 75% of the scheduled principal and interest payments on behalf of the
borrower during this time), and 35% of the then outstanding principal amount of
the defaulted commercial mortgage loans were assumed to be lost (referred to in
the industry as a 2.0% CDR, 12 month lag, and 35% loss severity, and referred to
herein as the "2.0% CDR Loss Scenario"), and (ii) 3.0% per annum of each
commercial mortgage was assumed to default, a 12 month period of time was
assumed to elapse between the date of default and the date of liquidation (it
was assumed that the master servicer continued to advance 75% of the scheduled
principal and interest payments on behalf of the borrower during this time), and
35% of the then outstanding principal amount of each commercial mortgage loan
was assumed to be lost (referred to in the industry as a 3.0% CDR, 12 month lag,
and 35% loss severity, and referred to herein as the "3.0% CDR Loss Scenario").
The delay in receipt and the reduction in amount of cash flows resulting from
the 2.0% CDR Loss Scenario and the 3.0% CDR Loss Scenario, would result in a
corresponding decline in the fair value of our aggregate CMBS by approximately
$53.0 million (or 6.1%) and $132.3 million (or 15.4%), respectively. The delay
in receipt and the reduction in amount of cash flows resulting from the 2.0% CDR
Loss Scenario and the 3.0% CDR Loss Scenario would result in a corresponding
decline in the fair value of our subordinated CMBS (BB+ through unrated/issuer's
equity) by approximately $50.5 million (or 9.4%) and $128.8 million (or 24.2%),
respectively.
The aggregate amount of credit losses assumed under the 2.0% CDR Loss
Scenario and the 3.0% CDR Loss Scenario totaled approximately $696 million and
$994 million, respectively. These amounts are in comparison to the aggregate
amount of anticipated credit losses assumed by us as of December 31, 2002 of
approximately $503 million used to calculate GAAP income yields. It should be
noted that the amount and timing of the anticipated credit losses assumed by us
related to the GAAP income yields are not directly comparable to those assumed
under the 2.0% CDR Loss Scenario and the 3.0% CDR Loss Scenario.
Sensitivity of Fair Value to Changes in the Discount Rate
The required rate of return used to determine the fair value of our 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 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 and the credit fundamentals
of the commercial real estate underlying each pool of commercial mortgage loans.
For purposes of this disclosure, we assumed that the discount rate used to
determine the fair value of our CMBS increased by 100 basis points and 200 basis
points. The increase in the discount rate by 100 and 200 basis points,
respectively, would result in a corresponding decline in the value of our
aggregate CMBS by approximately $50.0 million (or 5.8%) and $95.9 million (or
11.1%), respectively, and our subordinated CMBS by approximately $31.8 million
(or 6.0%) and $60.9 million (or 11.5%), respectively.
The sensitivities above are hypothetical and should be used with caution.
As the figures indicate, 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.
Sensitivity of Fair Value to Extension Risk
For purposes of this disclosure, we assumed that the maturity date of each
commercial mortgage loan underlying the CMBS was extended for a period of 12
months and 24 months beyond the contractual maturity date specified in each
mortgage loan. The delay in the timing and receipt of such cash flows for an
extended period of time consisting of 12 months and 24 months, respectively,
would result in a corresponding decline in the value of our aggregate CMBS by
approximately $6.3 million (or 0.7%) and $12.5 million (or 1.5%), respectively,
and our subordinated CMBS by approximately $4.1 million (or 0.8%) and $8.3
million (or 1.6%), respectively.
F-34
Impact of Prepayment Risk on Fair Value
Our investments in subordinated CMBS are purchased at a discount to their
face amount due to their subordinated claim to principal and interest cash flows
and priority of allocation of realized losses. As a result of the discounted
purchase price, the return of principal sooner than anticipated from
prepayments, and/or in amounts greater than initially assumed when determining
the discounted purchase price, would result in an increase in the value of our
subordinated CMBS. Such appreciation in value would result from the higher
subordination level of the CMBS transaction relative to comparable CMBS and the
potential for an upgrade in the ratings category of the security. Since the
effects of prepayments would enhance the value of our subordinated CMBS, the
effects of increased prepayments were excluded from the sensitivity analysis
below. (It should be noted that the effects of a decline in prepayments is
reflected in the Sensitivity of Fair Value to Extension Risk above).
6. INSURED MORTGAGE SECURITIES
Our consolidated portfolio of mortgage securities is comprised of GNMA
mortgage-backed securities and FHA-insured certificates. Additionally, mortgage
securities include Federal Home Loan Mortgage Corporation, or Freddie Mac,
participation certificates which are collateralized by GNMA mortgage-backed
securities, as discussed below. As of December 31, 2002, 88% of our investment
in mortgage securities were GNMA mortgage-backed securities (including
securities which collateralized Freddie Mac participation certificates) and
approximately 12% were FHA-insured certificates.
CRIIMI MAE owns the following insured mortgage securities directly or
indirectly through its wholly-owned subsidiaries referenced below:
As of December 31, 2002
-----------------------
Number of Weighted
Mortgage Average Effective Weighted Average
Securities Fair Value Amortized Cost Interest Rate Remaining Term
----------- -------------- ----------------- ---------------------- -------------------
CRIIMI MAE (4) 1 $ 5,730,315 $ 5,339,840 8.00% 32 years
CRIIMI MAE Financial Corporation 22 77,454,269 76,653,272 8.40% 25 years
CRIIMI MAE Financial Corporation II 28 145,576,318 145,395,708 7.19% 23 years
CRIIMI MAE Financial Corporation III (5) 16 46,579,332 46,266,537 7.92% 27 years
-- ------------- -------------- ----- --------
67 (1) $275,340,234 $273,655,357 7.67% (3) 25 years (3)
== ============ ============ ===== ========
As of December 31, 2001
-----------------------
Number of Weighted
Mortgage Average Effective Weighted Average
Securities Fair Value Amortized Cost 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 (2) $343,091,303 $350,982,991 7.70% (3) 26 years (3)
== ============ ============ ===== ========
(1) During the year ended December 31, 2002, 25 mortgage loans underlying our
mortgage securities were prepaid. These prepayments generated net proceeds
of approximately $72.6 million and resulted in a financial statement net
loss of approximately $832,000, which is included in net losses on mortgage
security dispositions in the accompanying consolidated statement of income
for the year ended December 31, 2002. In addition to these losses, we
recognized additional losses of $163,000 during the year ended December 31,
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) During the year ended December 31, 2001, there were 9 prepayments of
mortgage loans underlying our mortgage securities. These prepayments
generated net proceeds of approximately $29.9 million and resulted in net
financial statement gains of approximately $53,000, which are included in
net (losses) gains on mortgage security and originated loan dispositions in
the accompanying consolidated statement of income for the year ended
December 31, 2001. During the year ended December 31, 2001, one of our
subsidiaries referenced above
F-35
received payments from the U.S. Department of Housing and Urban
Development relating to the assignment of two mortgage loans with a
combined amortized cost of approximately $5.5 million. These
assignments resulted in a net financial statement loss of approximately
($95,000), which is included in net (losses) gains on mortgage security and
originated loan dispositions in the accompanying consolidated statement of
income for the year ended December 31, 2001.
(3) Weighted averages were computed using total face value of the mortgage
securities. It is possible that some of the underlying mortgage loans may
prepay due to the low current mortgage interest rates.
(4) Sold in January 2003 in connection with our recapitalization.
(5) As of February 2003, we have the option of selling the insured mortgage
securities held by CRIIMI MAE Financial Corporation III and prepaying the
related match funded debt, with a face amount of approximately $45.7
million at December 31, 2002, with the proceeds from the sale since the
face value of the debt is less than 20% of the original face value. If we
decide to exercise this option, we will retain any proceeds in excess of
the unpaid principal balance of the debt.
As shown in the table referenced above, the total mortgage securities of
$275.3 million includes an unencumbered insured mortgage security with a fair
value of $5.7 million (which was sold in January 2003). The remaining $269.6
million of mortgage securities are pledged to secure certain collateralized
mortgage obligations or securities issued in connection with three
securitization transactions. As discussed in Note 7, the secured obligations
cost basis was approximately $253.0 million as of December 31, 2002. We receive
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, which represent the total
cash flows that we receive from these mortgage securities. These net cash flows
after debt service were applied as principal amortization payments (in
connection with cash flow from other miscellaneous assets) on the Series A
Senior Secured Notes, prior to the redemption of these notes in 2003.
Descriptions of the mortgage securities that we own, directly or
indirectly, which exceed 3% of the total carrying value of the consolidated
mortgage securities as of December 31, 2002, summarized information regarding
other mortgage securities and mortgage securities income earned in 2002, 2001
and 2000, including interest earned on the disposed mortgage securities, are as
follows:
F-36
Mortgage Securities as of December 31, 2002 Mortgage Income Earned
---------------------------------------------------------------- ---------------------------------
Final
Effective Maturity
Face Value Fair Value Amortized Interest Date
(1) (2)(4) Cost (1)(3) Rate Range 2002 2001 2000
------------- ------------- -------------- -------- --------- ---------- ----------- ----------
CRIIMI MAE
GNMA Mortgage-Backed
Securities
Other (1 mortgage
security) (5) $ 5,339,840 $ 5,730,315 $ 5,339,840 8.00% 02/2035 $428,612 $431,096 $433,385
----------- ------------ ------------- --------- ---------- ---------
CRIIMI MAE Financial Corporation
FHA-Insured Certificates
Stoddard Baptist Nursing
Home 8,764,672 9,098,957 8,838,749 7.90% 3/2027 703,355 712,238 720,448
Other (10 mortgage 7.35%- 02/2019-
securities) 23,530,761 23,755,346 23,492,626 11.00% 04/2034 2,232,353 2,251,003 2,268,007
GNMA Mortgage-Backed
Securities
Bellhaven Nursing Center 13,749,383 13,747,871 13,749,383 8.63% 12/2031 1,156,241 1,164,470 1,172,021
Capital Crossing Apts. 9,548,378 9,643,862 9,582,619 7.93% 5/2021 745,343 761,795 776,996
Other (9 mortgage 8.03%- 10/2015-
securities) 21,037,544 21,208,233 20,989,895 8.78% 04/2035 1,696,798 1,715,945 1,733,586
------------ ------------- ------------- ---------- --------- ----------
76,630,738 77,454,269 76,653,272 6,534,090 6,605,451 6,671,058
------------ ------------- ------------- ---------- --------- -----------
CRIIMI MAE Financial Corporation II
GNMA Mortgage-Backed
Securities
Oakwood Garden Apartments 12,243,915 12,366,355 12,470,483 7.51% 10/2023 885,020 901,325 916,455
San Jose South 26,617,202 26,883,374 26,810,167 7.66% 10/2023 1,939,599 1,974,586 2,007,005
Somerset Park Apartments 27,844,895 28,123,344 28,302,174 7.41% 07/2028 2,040,984 2,065,888 2,089,020
Yorkshire Apartments 14,228,138 14,370,419 14,289,751 7.21% 07/2031 999,535 1,009,096 1,017,995
Other (24 mortgage 7.14%- 06/2018-
securities) 63,200,818 63,832,826 63,523,133 7.84% 05/2029 4,646,785 4,712,121 4,772,742
------------ ------------ ------------ ----------- ---------- -----------
144,134,968 145,576,318 145,395,708 10,511,923 10,663,016 10,803,217
------------ -------------- -------------- ---------- ----------- -----------
CRIIMI MAE Financial Corporation III
GNMA Mortgage-Backed
Securities
Other (16 mortgage 7.45%- 08/2014-
securities) 46,205,072 46,579,332 46,266,537 10.39% 02/2035 3,684,054 3,721,516 3,756,041
------------ ----------- ------------ ---------- ----------- -----------
Total Insured Mortgage
Securities $272,310,618 $275,340,234 $273,655,357 21,158,679 21,421,079 21,663,701
============ ============ ============
Insured Mortgage Security Dispositions 2,687,162 7,431,640 9,004,527
----------- ----------- -----------
Insured Mortgage Securities Interest $23,845,841 $28,852,719 $30,668,228
=========== =========== ===========
(1) Principal and interest on mortgage securities is payable at level amounts
over the life of the mortgage asset. Total annual debt service payable to
CRIIMI MAE and the referenced financing subsidiaries for the mortgage
securities held as of December 31, 2002 is approximately $24.8 million.
(2) Reconciliations of the carrying amount of our insured mortgage securities
for the years ended December 31, 2002 and 2001 follow:
For the year ended December 31,
2002 2001
---------------- ----------------
Balance at beginning of year $ 343,091,303 $ 385,751,407
Amortization of discount 13,552 15,688
Adjustment to net unrealized gains and losses on mortgage
securities 9,576,565 (2,802,216)
Principal payments (3,823,603) (4,308,118)
Mortgage prepayments (73,437,354) (35,469,292)
Amortization of premium (80,229) (96,166)
---------------- ----------------
Balance at end of year $ 275,340,234 $ 343,091,303
================ ================
(3) All mortgages are collateralized by first or second liens on residential
apartment, retirement home, nursing home or townhouse complexes which have
diverse geographic locations and are FHA-insured certificates or GNMA
mortgage-backed securities. Payment of the principal
F-37
and interest on FHA-insured certificates is insured by the U.S. Department
of Housing and Urban Development pursuant to Title 2 of the National
Housing Act. Payment of the principal and interest on GNMA mortgage-backed
securities is guaranteed by GNMA pursuant to Title 3 of the National
Housing Act.
(4) None of these mortgage securities are delinquent as of December 31, 2002.
(5) Sold in January 2003 in connection with our recapitalization.
7. OBLIGATIONS UNDER FINANCING FACILITIES
The following table summarizes our debt outstanding as of December 31, 2002
and 2001:
As of and for the year ended December 31, 2002
-------------------------------------------------------------------
Average
Effective Rate Effective
Ending Balance at Year End Average Balance Rate
-------------- ------------- --------------- ---------
Recourse to CRIIMI MAE:
Exit variable-rate secured borrowing (1) $214,672,536 6.2% $228,731,683 6.5%
Series A senior secured notes (2) 92,788,479 12.2% 96,077,252 12.1%
Series B senior secured notes (3) 68,491,323 21.1% 66,005,024 21.1%
Non-Recourse to CRIIMI MAE:
Securitized mortgage obligations:
CMBS (4) 285,844,933 9.1% 284,436,363 9.1%
Freddie Mac funding note (5) 139,550,402 7.6% 157,145,288 8.8%
Fannie Mae funding note (6) 44,902,412 7.4% 46,662,564 8.2%
CMO (7) 68,527,290 7.5% 88,584,927 8.8%
Mortgage payable (8) 7,214,189 12.0% 7,157,361 12.0%
--------------- -------------
Total Debt $921,991,564 9.2% $974,800,462 9.5%
=============== =============
As of and for the year ended December 31, 2001
-------------------------------------------------------------------
Average
Effective Rate Effective
Ending Balance at Year End Average Balance Rate
-------------- ------------- --------------- ----------
Recourse to CRIIMI MAE:
Exit variable-rate secured borrowing (1) $244,194,590 6.5% $179,214,481 8.2%
Series A senior secured notes (2) 99,505,457 12.2% 71,723,157 12.2%
Series B senior secured notes (3) 63,937,383 21.1% 43,876,198 21.0%
Non-Recourse to CRIIMI MAE:
Securitized mortgage obligations:
CMBS (4) 283,047,470 9.1% 282,017,637 9.1%
Freddie Mac funding note (5) 180,291,091 7.5% 187,895,844 7.5%
Fannie Mae funding note (6) 48,062,403 7.4% 53,304,433 7.4%
CMO (7) 98,204,667 7.5% 107,514,532 7.5%
Mortgage payable (8) 7,109,252 12.0% 1,777,203 12.0%
Variable-rate secured borrowings-CMBS (9) -- -- 108,784,948 6.7%
Senior unsecured notes (9) -- -- 29,722,222 9.1%
Bank term loan (9) -- -- 386,389 7.0%
Working capital line of credit (9) -- -- 11,888,889 7.5%
Bridge loan (9) -- -- 14,786,663 8.0%
--------------- ---------------
Total Debt $1,024,352,313 9.1% $1,092,892,596 8.9%
=============== ===============
(1) The effective interest rate at December 31, 2002 and 2001 and during the
years ended December 31, 2002 and 2001 reflects the accrual of estimated
extension fees that were payable in the future. During the years ended
December 31, 2002 and 2001, we recognized interest expense of $3,255,621
and $2,372,379 related to these estimated extension fees. As of December
31, 2002, we had $5,628,000 of accrued extension fees included in payables
and accrued expenses in the accompanying consolidated balance sheet. This
debt was repaid in full on January 23, 2003, and the accrued extension fees
will be reversed into income in the first quarter of 2003.
F-38
(2) The effective interest rate at December 31, 2002 and 2001 and during the
years ended December 31, 2002 and 2001 reflects the accrual of estimated
extension fees that were payable in the future. During the years ended
December 31, 2002 and 2001, we recognized interest expense of $350,812 and
$337,390 related to these estimated extension fees. As of December 31,
2002, we had $688,202 of accrued extension fees included in payables and
accrued expenses in the accompanying consolidated balance sheet. This debt
was repaid in full on March 10, 2003, and the accrued extension fees will
be reversed into income in the first quarter of 2003.
(3) The effective interest rate at December 31, 2002 and 2001 and during the
years ended December 31, 2002 and 2001 reflects the accrual of estimated
extension fees that were payable in the future. During the years ended
December 31, 2002 and 2001, we recognized interest expense of $701,857 and
$432,390 related to these estimated extension fees. As of December 31,
2002, we had $1,134,247 of accrued extension fees included in payables and
accrued expenses in the accompanying consolidated balance sheet. This debt
was repaid in full on March 10, 2003, and the accrued extension fees will
be reversed into income in the first quarter of 2003.
(4) As of December 31, 2002 and 2001, the face amount of the debt was
$328,446,000 with unamortized discount of $42,601,067 and $45,398,530,
respectively. During the years ended December 31, 2002 and 2001, discount
amortization of $2,797,463 and $2,527,205, respectively, was recorded as
interest expense.
(5) As of December 31, 2002 and 2001, the face amount of the note was
$143,066,791 and $185,616,298, respectively, with unamortized discount of
$3,516,389 and $5,325,207, respectively. During the years ended December
31, 2002 and 2001, discount amortization of $1,808,818 and $576,636,
respectively, was recorded as interest expense.
(6) As of December 31, 2002 and 2001, the face amount of the note was
$45,749,641 and $49,182,632, respectively, with unamortized discount of
$847,229 and $1,120,229, respectively. During the years ended December 31,
2002 and 2001, discount amortization of $273,000 and $227,510,
respectively, was recorded as interest expense.
(7) As of December 31, 2002 and 2001, the face amount of the note was
$69,982,117 and $100,727,532, respectively, with unamortized discount of
$1,454,827 and $2,522,865, respectively. During the years ended December
31, 2002 and 2001, discount amortization of $1,068,038 and $490,940,
respectively, was recorded as interest expense.
(8) As of December 31, 2002 and 2001, the unpaid principal balance of this
mortgage payable was $8,723,895 and $8,824,288, respectively, and the
unamortized discount was $1,509,707 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 years ended December 31, 2002 and 2001, discount
amortization of $205,329 and $46,929, respectively, was recorded as
interest expense.
(9) All outstanding unpaid amounts under these facilities, to the extent they
constituted allowed claims, were paid in full in connection with the
reorganization plan, except for the allowed claim related to First Union,
as discussed in Note 16, through either cash payment or issuance of Exit
Debt or a combination of both.
(10) Stated maturities per respective loan agreements as of December 31, 2002.
Our debt maturities were as follows (assuming the Exit Debt remained
in place):
2003 $ 30,285,349
2004 42,341,338
2005 206,707,677
2006 108,362,761
2007 73,833,807
Thereafter 510,389,850
-----------------
$ 971,920,782 (a)(b)(c)(d)
=================
(a) The projected principal payments on the Exit Variable-Rate Secured
Borrowing are based on the applicable amortization schedule
provided in the operative documents. These principal payments are
based on our estimate of future cash flows, which are subject to
continuous change due to, without limitation, changes in interest
rates, realized losses, appraisal reductions, interest shortfalls,
credit performance of underlying loans, unanticipated expenses on
foreclosed and non-performing loans, accumulated advances, prepayments,
our general and administrative and other operating expenses,
and cash dividends, if any, paid to shareholders. There can be no
assurance that projected cash flows will approximate the actual cash
flows. The stated annual interest rate on the Exit Variable-Rate
Secured Borrowing was LIBOR plus 3.25%. The average stated interest
rate assumes that LIBOR is unchanged from the December 31, 2002 LIBOR
rate of 1.38% over the remaining term of the debt. Any changes in the
LIBOR rate would have affected the actual principal payments on
our Exit Variable-Rate Secured Borrowing in the future. This debt was
repaid in full as part of our recapitalization in January 2003.
(b) The projected principal payments on the Series A Senior Secured Notes
are based, in part, on our estimate of the cash flows from the
collateral securing the Series A Senior Secured Notes. In addition,
there were principal payment obligations of $5 million, $15 million,
and $15 million due on April 15, 2003, 2004 and 2005, respectively.
These projected cash flows were subject to continuous change due to,
without limitation, changes in interest rates, realized losses,
appraisal reductions, interest shortfalls, credit performance of
underlying loans, unanticipated expenses on foreclosed and
non-performing loans, accumulated advances, prepayments, our general
and administrative and other operating expenses, and cash dividends,
if any, paid to shareholders. There can be no assurance that the
projected cash flows will approximate the actual cash flows. This debt
was repaid in full as part of our recapitalization in January 2003.
F-39
(c) The Series B Senior Secured Notes had no contractual principal
payment requirements until maturity on April 15, 2007. The Series
B Senior Secured Notes accreted interest at an annual rate of 7%.
This accreted interest was added to the principal balance
semi-annually on the interest payment dates. For purposes of this
disclosure, we have not included any future accreted interest in
the contractual principal payment amount at maturity. This debt
was repaid in full as part of our recapitalization in January 2003.
(d) Payments of principal on the securitized mortgage obligations are
required to the extent mortgage principal is received on the
related collateral. The projected principal payments on the
securitized mortgage obligations are based on the stated terms of
the underlying mortgages.
Exit Debt Effective as of Emergence from Chapter 11
The Exit Debt, which closed on April 17, 2001, consisted of three
components, as summarized below. Substantially all cash flows relating to
existing assets were used to satisfy principal, interest and fee obligations
under the Exit Debt. The Exit Debt was secured by substantially all of our
assets. There were 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 Exit
Debt. The terms of the Exit Debt significantly restricted the amount of cash
dividends that could be paid to shareholders.
Exit Variable-Rate Secured Borrowing
The Exit Variable-Rate Secured Borrowing, in an original principal amount
of $262.4 million, provided for (i) interest at a rate of one month 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, (iii) extension fees of 1.5% of the
unpaid principal balance payable at the end of each of 24, 30, 36 and 42 months
after April 17, 2001, and (iv) maturity on April 16, 2005 assuming we exercised
our options to extend the maturity date of the debt. The Exit Variable-Rate
Secured Borrowing had an outstanding principal balance of $214.7 million as of
December 31, 2002. In connection with this debt, the outstanding stock of CBO
REIT held by CRIIMI MAE was transferred to the lenders pursuant to a repurchase
agreement. The obligations under the Exit Variable-Rate Secured Borrowing were
secured by a first or third priority lien on certain CMBS, the stock in certain
subsidiaries, and certain deposit accounts. The foregoing transferred stock and
assets securing the Exit Variable-Rate Secured Borrowing also secured the Series
A and Series B Senior Secured Notes, which constituted the balance of the Exit
Debt. The Exit Variable-Rate Secured Borrowing was repaid in full on January 23,
2003 in connection with our recapitalization.
Series A Senior Secured Notes
The Series A Senior Secured Notes, representing an aggregate original
principal amount of $105 million, provided 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 would not have constituted an
event of default but would have resulted in a 200 basis point increase in the
interest rate on the unpaid principal amount if certain miscellaneous collateral
was not sold or otherwise disposed of), (iii) extension fees of 1.5% of the
unpaid principal balance payable at the end of each of 48, 54, and 60 months
after April 17, 2001, and (iv) maturity on April 15, 2006. The cash flow from
the miscellaneous assets referenced below, which secured both the Series A
Senior Secured Notes and the Series B Senior Secured Notes, was applied, on a
monthly basis, as principal amortization payments on the Series A Senior Secured
Notes. The Series A Senior Secured Notes had an aggregate outstanding principal
balance of $92.8 million as of December 31, 2002, and were secured by a first
priority lien on the stock transferred in connection with the Exit Variable-Rate
Secured Borrowing, by a first or second priority lien on certain CMBS, the stock
in certain subsidiaries, and certain deposit accounts (these assets also secured
the Exit Variable-Rate Secured Borrowing), and by a first priority lien on
certain miscellaneous assets. The Series A Senior Secured Notes were redeemed on
March 10, 2003 in connection with our recapitalization.
Series B Senior Secured Notes
The Series B Senior Secured Notes, representing an aggregate original
principal amount of approximately $61.8 million, provided for (i) interest at a
rate of 13% per annum, payable semi-annually, with additional interest at
F-40
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 each of 48, 54 and
60 months after April 17, 2001 (with the payment 60 months after the April 17,
2001 also including an amount based on the unpaid principal balance 66 months
after April 17, 2001), and (iii) maturity on April 15, 2007. The Series B Senior
Secured Notes had an aggregate outstanding principal balance of $68.5 million as
of December 31, 2002, and were secured by a second priority lien on the stock
transferred in connection with the Exit Variable-Rate Secured Borrowing (this
asset also secured the Series A Senior Secured Notes), by a second or third
priority lien on certain CMBS, the stock in certain subsidiaries, and certain
deposit accounts (those assets also secured the Exit Variable-Rate Secured
Borrowing and the Series A Senior Secured Notes), and by a second priority lien
on certain miscellaneous assets (these assets also secured the Series A Senior
Secured Notes). The Series B Senior Secured Notes were redeemed on March 10,
2003 in connection with our recapitalization.
Bear Stearns and BREF Debt
See Note 19 for a discussion of the Bear Stearns and BREF Debt that was
incurred in January 2003 in connection with our recapitalization, and certain
related effects on our first quarter 2003 results of operations.
Affiliate Reorganization
On the April 17, 2001 effective date of the reorganization plan, we
effected an affiliate reorganization in order to indirectly secure the Exit Debt
with the equity interests in CBO-1 and CBO-2. Pursuant to the affiliate
reorganization, we formed a new REIT subsidiary (CBO REIT, Inc.), all shares of
which were initially issued to us, pledged the previously pledged bonds (Pledged
Bonds) and all outstanding shares of two qualified REIT subsidiaries (which own
the equity interests in CBO-1 and CBO-2) (the QRS Shares) to secure the Exit
Debt, pledged the shares held by us in CBO REIT (the REIT Shares) to secure the
Exit Debt represented by the Series A and Series B Senior Secured Notes,
contributed the Pledged Bonds and the QRS Shares to CBO REIT, and transferred
the REIT Shares, in a repurchase transaction, to the lenders which provided the
Exit Variable-Rate Secured Borrowing. CBO REIT was dissolved in January 2003 in
connection with our recapitalization. See Note 19.
Information Regarding Certain Exit Debt Collateral
Set forth below is certain information relating to the carrying value of
certain assets which secured all three components of the Exit Debt (until it was
paid off in early 2003).
Carrying Value at December 31, 2002
Collateral ($ in millions)
---------- ----------------------------------
Certain CMBS $511.7 (1)
CBO REIT Stock (2)
CMBS Corp Stock (3)
QRS 1, Inc. Stock (4)
(1) Represents certain bonds pledged by us (i.e., the CBO-2 B-, B, B+, BB-,
BB, BB+ rated bonds and the Nomura unrated bond) to secure the Exit
Debt. Prior to the recent recapitalization, such bonds were owned by
CBO REIT, a then subsidiary of CRIIMI MAE. As part of our
recapitalization in January 2003, these assets were transferred to CBO
REIT II.
(2) Represents all outstanding shares of CBO REIT held by CRIIMI MAE Inc.
first pledged by CRIIMI MAE Inc. to secure the Series A Senior Secured
Notes and Series B Senior Secured Notes and then transferred in a
repurchase transaction in connection with the Exit Variable-Rate
Secured Borrowing. Prior to the recent recapitalization, CBO REIT owned
the pledged bonds identified in footnote (1) above.
(3) Represents all outstanding shares of CRIIMI MAE CMBS Corp pledged by us
to secure the Exit Debt. Prior to the recent recapitalization, such
shares were owned by CBO REIT. Such shares are currently owned by CBO
REIT II. CRIIMI MAE CMBS Corp owns the CCC rated and unrated bonds from
CBO-2 (representing the equity interests in CBO-2). The carrying value
of these CBO-2 bonds was approximately $4.4 million at December 31,
2002.
(4) Represents all outstanding shares of CRIIMI MAE QRS 1, Inc. pledged by
CRIIMI MAE Inc. to secure the Exit Debt. Prior to the recent
recapitalization, such shares were owned by CBO REIT. Such shares are
currently owned by CBO
F-41
REIT II. CRIIMI MAE QRS 1, Inc. owns the B- rated and unrated bonds
from CBO-1 (representing the equity interests in CBO-1). The carrying
value of these CBO-1 bonds was approximately $19.3 million at
December 31, 2002.
Other Debt Related Information
Fluctuations in interest rates will continue to impact the value of our
mortgage assets and could cause margin calls and impact the net interest margin
through increased cost of funds on our variable rate debt. We have interest rate
caps to partially limit the adverse effects of rising interest rates on our
variable rate debt. When the caps expire, we will have interest rate risk to the
extent interest rates increase on our variable rate debt unless the caps are
replaced with other hedges or other steps are taken to mitigate this risk.
Furthermore, we have interest rate risk to the extent that the LIBOR interest
rate increases between the current rate and the cap rates. See Note 8 for
further discussion of interest rate caps. As of December 31, 2002, our
debt-to-equity ratio was approximately 3.2 to 1 and our non-match-funded
debt-to-equity ratio was approximately 1.3 to 1.
The following table lists the fair value of the collateral related to our
securitized mortgage obligations as of December 31, 2002 and 2001 (in millions):
Securitized Mortgage Obligations December 31, 2002 December 31, 2001
- -------------------------------- ----------------- -----------------
CMBS $ 326 $ 296
Freddie Mac Funding Note 146 183
Fannie Mae Funding Note 47 49
CMO 77 106
Changes in interest rates will have no impact on the cost of funds or the
collateral requirements on these securitized mortgage obligations.
Debt Prior to Emergence from Chapter 11
Variable-Rate Secured Borrowings-CMBS
When we purchased subordinated CMBS, we initially financed (generally
through short-term, variable-rate secured borrowings) a portion of the purchase
price of the subordinated CMBS. These secured borrowings were either provided by
the issuer of the CMBS pool or through other lenders under master secured
borrowing agreements. The allowed claims related to the foregoing variable-rate
secured borrowings were paid in full on April 17, 2001 in cash or through a
combination of cash and the Exit Debt.
Senior Unsecured Notes
In November 1997, we issued senior unsecured notes due on December 1, 2002
in an aggregate principal amount of $100 million. Such unsecured notes were
effectively subordinated to the claims of any secured lender to the extent of
the value of the collateral securing such indebtedness. The allowed claims
related to such unsecured notes were paid in full on April 17, 2001 through a
combination of cash, Series A Senior Secured Notes and Series B Senior Secured
Notes.
Bank Term Loan
In connection with the merger in 1995, CRIIMI MAE Management assumed
certain debt of certain mortgage businesses affiliated with CRI, Inc. in the
principal amount of $9.1 million. The bank term loan was secured by certain cash
flows generated by our direct and indirect interests in the AIM Funds and was
guaranteed by CRIIMI MAE. The allowed claim related to the bank term loan was
paid in full, in cash, on April 17, 2001.
F-42
Working Capital Line of Credit
In 1996, we entered into an unsecured working capital line of credit
provided by two lenders which provided for up to $40 million in borrowings. The
credit facility matured on December 31, 1998. Our litigation with First Union
(one of the two lenders) was not settled or resolved prior to April 17, 2001,
and therefore, the classification of First Union's claim under the
reorganization plan was not determined at the April 17, 2001 effective date. See
Note 16 for further information regarding the settlement of the First Union
litigation. The allowed claim related to the other lender was paid in full on
April 17, 2001 through a combination of cash, Series A Senior Secured Notes and
Series B Senior Secured Notes.
Bridge Loan
In August 1998, we entered into a bridge loan for $50 million. The total
unpaid principal balance and accrued interest was due in February 1999. The
allowed claim related to the bridge loan was paid in full on April 17, 2001
through a combination of cash, Series A Senior Secured Notes and Series B Senior
Secured Notes.
8. INTEREST RATE PROTECTION AGREEMENTS
As of December 31, 2002, we have interest rate caps indexed to one-month
LIBOR to partially limit the adverse effects of potential rising interest rates
on our variable-rate debt. Interest rate caps provide protection to the extent
interest rates, based on a readily determinable interest rate index, increase
above the stated interest rate cap, in which case, we will receive payments
based on the difference between the index and the cap. At December 31, 2002, we
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
$ 170,000,000 (2) April 2, 2001 April 2, 2003 5.25% (3) 1 month LIBOR
(1) Our designated (as defined in SFAS No. 133) interest rate cap hedges
approximately 82% of our variable-rate secured borrowings as of December
31, 2002. This interest rate cap was purchased in April 2002 for
approximately $1.6 million.
(2) This interest rate cap is undesignated (as defined in SFAS No. 133). Due to
the nominal fair value of this cap at the date we purchased the second cap
in May 2002, we retained this cap as a non-hedge derivative.
(3) One-month LIBOR was 1.38% at December 31, 2002.
We are exposed to credit loss in the event of non-performance by the
counterparties to the interest rate caps should interest rates exceed the caps.
However, we do not anticipate non-performance by the counterparties. The
counterparties have long-term debt ratings of A+ or above by S&P and A1 or above
by Moody's. Although our caps are not exchange-traded, there are a number of
financial institutions which enter into these types of transactions as part of
their day-to-day activities.
9. 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 primarily 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 $12.4 million
in cash, which included reimbursement of servicing advances. This sale resulted
in a gain of approximately $4.9 million during the year ended December 31, 2002.
During the year ended December 31, 2002, approximately $1.0 million of income
tax expense was recognized primarily 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 our wholly-owned taxable REIT subsidiaries that own
partnership interests in CMSLP. These subsidiaries are separately taxable
entities that cannot use our net operating loss carry forward 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 year ended December 31, 2002, CMSLP recorded additional restructuring
expenses of approximately $208,000 primarily related to rent on vacant office
space that is taking
F-43
longer to sublease than originally anticipated, net of accrual reversals of
approximately $19,000. The following is a reconciliation of the restructuring
accrual:
Severance and
other employee Non-cancelable
benefits Lease Costs Other Total
------------------ --------------- ------------ ------------
Amounts accrued in 2001 $240,903 $133,834 $62,986 $437,723
Amounts paid in 2001 (55,936) (33,462) (52,986) (142,384)
---------------- ----------- ---------- ----------
Balance, December 31, 2001 184,967 100,372 10,000 295,339
Amounts paid in 2002 (174,745) (239,048) (13,686) (427,479)
Additional accrual in 2002 - 195,150 12,786 207,936
Accrual reversed in 2002 (10,222) (9,100) (19,322)
---------------- ----------- ---------- ----------
Balance, December 31, 2002 $ - $ 56,474 $ -- $ 56,474
================ =========== ========== ==========
10. DIFFERENCES BETWEEN FINANCIAL STATEMENT NET 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 our shareholders because
dividends or distributions, if any, are declared and paid on the basis of
taxable income or taxable loss. We do not pay Federal income taxes as long as we
satisfy the requirements for exemption from taxation pursuant to the REIT
requirements of the Internal Revenue Code. We calculate our taxable income or
taxable loss, as if we were a regular domestic corporation. This taxable income
or taxable loss level determines the amount of dividends, if any, we are
required to distribute over time in order to eliminate our tax liability.
As a result of our trader election in early 2000, we recognized a
mark-to-market tax loss of approximately $478 million on certain trading
securities on January 1, 2000. The January 1, 2000 mark-to-market loss is
expected to be recognized evenly over four years (2000, 2001, 2002, and 2003)
for tax purposes (i.e., approximately $120 million per year) beginning with the
year 2000.
A summary of our 2002 and 2001 net operating losses for tax purposes is as
follows:
($ in millions) 2002 2001
--------------- ---- ----
January 1, 2000 Loss $478.2 $478.2
LESS: Amounts recognized in 2000 (119.6) (119.6)
LESS: Amounts recognized in 2001 (119.5) (119.5)
LESS: Amounts recognized in 2002 (119.5) --
------- -------
Balance Remaining of January 1, 2000 Loss to be recognized in future periods $119.6 $239.1
======= =======
Taxable Income for the year before recognition of January 1, 2000 Loss $ 36.0 $ 29.0 (1)(2)
LESS: January 1, 2000 Loss recognized (119.5) (119.5)
PLUS: Mark-to-market unrealized loss on trading securities (0.1) (0.1)
------- --------
Net operating loss for the year ended December 31 $ (83.6) $ (90.6)
========= ========
Accumulated net operating loss through January 1 $(140.2) $ (49.6)
Net operating loss created during the year ended December 31 (83.6) (90.6)
Net operating loss utilization -- --
-------- --------
Net operating loss carried forward for use in future periods $(223.8) $(140.2)
======== ========
(1) Taxable income for the year ended December 31, 2001 includes an
approximate $8.6 million loss on certain trading securities in
connection with the transfer of certain trading securities on April 17,
2001 to CBO REIT following the reorganization effected to facilitate
the collateral structure for the Exit Debt. Assets transferred to CBO
REIT (and subsequently transferred to CBO REIT II in January 2003) are
no longer required to be marked-to-market on a tax basis.
(2) The taxable income for the year ended December 31, 2001 has been
increased by $6.3 million to reflect the actual taxable income included
on our 2001 income tax return, which was completed during 2002.
During the year ended December 31, 2002 and 2001, no excess inclusion
income was distributed. A shareholder's allocable share of excess inclusion
represents the minimum taxable income reportable by the
F-44
shareholder for that year; it may not be offset by an net operating loss
and may represent unrelated business taxable income for some shareholders.
11. COMMON STOCK
On October 17, 2001, we implemented a one-for-ten reverse stock split
designed, in part, to satisfy the New York Stock Exchange market price listing
requirement. All share and per share information in these notes to consolidated
financial statements and the accompanying consolidated financial statements has
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.
We 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 December 31, 2002 and
2001, respectively.
As discussed in Note 1 under "The Reorganization Plan", the terms of the
Exit Debt significantly restricted the amount of cash dividends that could be
paid to shareholders. Under the operative documents evidencing the BREF Debt and
Bear Stearns Debt, we are permitted to pay cash dividends to shareholders after
the payment of required principal and interest on that debt. Preferred stock
dividends for the four quarters of 2001 and the first quarter of 2002 were paid
in shares of common stock except for dividends on our 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 2002 and 2001 common stock
activity:
Common Shares Common Shares
Date Description Issued Outstanding
- ------------------------ ----------------------------------------- ----------------- -------------------
12/31/00 Balance 6,235,317
Director Stock Plan 200
Conversions of Series E Preferred Stock 414,764
Conversions of Series G Preferred Stock 3,254,704
Dividends to Preferred Stock 3,033,393
Cash paid in lieu of fractional shares
in connection with the one-for-ten
reverse split (1,037)
- ------------------------------------------------------------------------------------------------------------
12/31/01 Balance 12,937,341
- ------------------------------------------------------------------------------------------------------------
Restricted stock issued 32,500
Dividends to Preferred Stock 966,327
Stock options exercised 8,900
- ------------------------------------------------------------------------------------------------------------
12/31/02 Balance 13,945,068 (1)
- ------------------------------------------------------------------------------------------------------------
(1) In January 2003, we issued 1,212,617 shares of our common stock in
connection with the recapitalization.
Shareholder Rights Plan
In January, 2002, our Board of Directors adopted a Shareholder Rights Plan
to preserve our net operating losses for tax purposes. As discussed in Note 1,
the future use of our net operating loss carryforward could be substantially
limited in the event of an "ownership change" within the meaning of Section 382
of the Internal Revenue Code. The Shareholder Rights Plan is designed to deter
an "ownership change" within the meaning of Section 382 of the Internal Revenue
Code by discouraging any person or group from acquiring five percent or more of
our outstanding common shares.
Under the Shareholder Rights Plan, one right was distributed for each share
of our common stock to shareholders of record as of February 4, 2002. The rights
trade with the underlying shares of our common stock. The rights will become
exercisable if a person or group (or Acquiring Person) acquires beneficial
ownership of 5% of our outstanding common stock or announces a tender offer for
5% or more of the common stock. An Acquiring Person also includes a person or
group that held 5% or more of the common stock as of January 23, 2002, and that
acquires additional common shares. An exception could be made if the transaction
is approved by our board of directors.
F-45
If the rights become exercisable, each right will entitle its holder to
purchase one one-thousandth of a share of a new series of preferred stock (the
Series H Junior Preferred Stock) at an exercise price of $23 per share. If a
person or group becomes an Acquiring Person in a transaction that has not been
approved by the board of directors, then each right, other than those owned by
the Acquiring Person, would entitle the holder to purchase $46.00 worth of our
common stock for the $23.00 exercise price.
We generally will be entitled to redeem the rights at $0.001 per right. The
rights will expire 10 years after the date of issuance. However, the Board of
Directors may amend the Shareholder Rights Plan to provide that the rights will
expire at an earlier date. The Shareholder Rights Plan was filed with the
Securities and Exchange Commission as an exhibit to a Current Report on Form 8-K
on January 25, 2002.
In connection with BREF's recent equity investment, the definition of an
Acquiring Person in the Shareholder Rights Plan was amended to exclude BREF with
respect to the equity purchased in the transaction.
12. PREFERRED STOCK
As of December 31, 2002 and 2001, 75,000,000 shares of preferred stock were
authorized. As of December 31, 2002 and 2001, 3,000,000 shares were designated
as Series B Cumulative Convertible Preferred Stock, 1,610,000 shares were
designated as Series F Redeemable Cumulative Dividend Preferred Stock, and
3,760,000 shares were designated as Series G Redeemable Cumulative Dividend
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 December 31, 2002.
On December 3, 2001, our Board of Directors decided to defer the payment of
dividends on the 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. Such preferred stock
dividends, payable in shares of common stock, were paid on April 15, 2002 to
holders of record on April 1, 2002.
On May 16, 2002, September 10, 2002 and December 30, 2002, the Board of
Directors decided to defer the payment of dividends on the Series B Preferred
Stock, Series F Preferred Stock and Series G Preferred Stock for the second,
third, and fourth quarters of 2002, respectively. On March 4, 2003, the Board of
Directors declared a cash dividend for the second quarter of 2002 on our Series
B, Series F and Series G Preferred Stock payable on March 31, 2003 to
shareholders of record on March 17, 2003.
The following is a brief summary of certain terms of each series of
preferred stock and is qualified by and subject to the descriptions contained in
our Articles of Amendment and Restatement, as amended, and reference is made to
such Articles of Amendment and Restatement for a complete description of the
relative rights and preferences of each series of preferred stock.
Series B Cumulative Convertible Preferred Stock
The Series B Preferred Stock pays a dividend in an amount equal to the sum
of (i) $0.68 per share per quarter plus (ii) the product of the excess over
$0.30, if any, of the quarterly cash dividend declared and paid with respect to
each share of common stock times a conversion ratio of 0.4668 times one plus a
conversion premium of 3%, subject to adjustment upon the occurrence of certain
events. Since the Series B Preferred Stock voted to accept the Chapter 11
reorganization plan, the relative rights and preferences of the Series B
Preferred Stock were amended to permit the payment of dividends in cash or
common stock (or a combination thereof) at our election. The Series B Preferred
Stock is (i) convertible at the option of the holders and (ii) subject to
redemption at our sole discretion after the tenth anniversary of issuance in
August 2006. Each share of Series B Preferred Stock was originally convertible
into 0.22844 shares of common stock, subject to adjustment upon the occurrence
of certain events. Due to certain adjustment provisions in Exhibit A of our
Articles of Amendment and Restatement related to the Series B Preferred Stock,
the payment of dividends to holders of common stock in the form of preferred
stock in 1999 and 2000, the payment of dividends on other series of preferred
stock in shares of common stock during 2001 and 2002,
F-46
and the reverse stock split effected in 2001 resulted in adjustments to the
Series B conversion price such that one share of Series B Preferred Stock was
convertible into 0.4797 shares of common stock as of December 31, 2002. The
liquidation preference and the redemption price on the Series B Preferred Stock
is $25 per share, together with accrued and unpaid dividends.
As of December 31, 2002 and 2001, there were 1,593,982 shares of Series B
Preferred Stock issued and outstanding. The following table summarizes the
dividend payment activity for 2002 and 2001 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 (c) Dividends (c) are accrued Issued
-------------------------------------------------------------------------------------------------------
May 10, 2001 June 1, 2001 $ 6.80 $ 10,839,078 9/1/98-3/31/01 1,454,508 (a)
September 4, 2001 October 10, 2001 $ 1.36 $ 2,167,816 4/1/01-9/30/01 413,145 (b)
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. We
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) Represents the number of shares of common stock issued in connection with
the payment of dividends to holders of Series B Preferred Stock. We
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 (interrupted
by the closing of equity markets due to the terrorist attacks) beginning
one trading day after the dividend declaration date. As a result of the
temporary closing of the U.S. equity markets from September 11 through
September 14, the original payment date of September 28, 2001 was extended
to October 10, 2001.
(c) Although the payments of dividends for the second, third and fourth
quarters of 2002 were deferred as of December 31, 2002, we have accrued
$3,251,723 for the Series B Preferred Stock second, third and fourth
quarter dividends at a dividend rate of $0.68 per share per quarter. On
March 4, 2003, the Board of Directors declared a cash dividend for the
second quarter of 2002 payable on March 31, 2003 to shareholders of record
on March 17, 2003.
Since the holders of the Series B Preferred Stock accepted the Chapter 11
reorganization plan, the relative rights and preferences of the Series B
Preferred Stock were amended to permit the payment of dividends, including
accrued and unpaid dividends, in common stock or cash, or a combination of both,
at our election.
Series C and Series D Cumulative Convertible Preferred Stock
As of February 22, 2000, all of the outstanding shares of Series C
Cumulative Convertible Preferred Stock were exchanged for Series E Preferred
Stock. On April 17, 2001, the date of emergence from Chapter 11, we paid, as an
allowed claim, dividends and interest of $1,161,137 (through the issuance of
common stock aggregating 167,794 shares) on the former Series C Preferred Stock
which represented dividends accrued and unpaid through February 22, 2000 (the
date the Series C Preferred Stock shares were exchanged for Series E Cumulative
Convertible Preferred Stock shares) plus interest on accrued and unpaid
dividends from February 23, 2000 through April 17, 2001.
As of July 26, 2000, all of the outstanding shares of Series D Cumulative
Convertible Preferred Stock were exchanged for Series E Preferred Stock. On
April 17, 2001, the date of emergence from Chapter 11, we paid, as an allowed
claim, dividends and interest of $1,310,122 (through the issuance of common
stock aggregating 189,324 shares) on the former Series D Preferred Stock which
represented dividends accrued and unpaid through July 26, 2000 (the date the
Series D Preferred Stock shares were exchanged for Series E Preferred Stock
shares) plus interest on accrued and unpaid dividends from July 27, 2000 through
April 17, 2001.
F-47
Series E Cumulative Convertible Preferred Stock
On February 22, 2000, CRIIMI MAE and the holder of our Series C Preferred
Stock entered into a Preferred Stock Exchange Agreement pursuant to which
103,000 shares of Series C Preferred Stock were exchanged for 103,000 shares of
a new series of preferred stock designated as Series E Cumulative Convertible
Preferred Stock. On July 26, 2000, CRIIMI MAE and the holder of our Series D
Preferred Stock entered into a Preferred Stock Exchange agreement pursuant to
which 100,000 shares of Series D Preferred Stock were exchanged for 100,000
shares of Series E Preferred Stock. The principal purpose of the exchanges was
to effect an extension of the mandatory conversion dates, upon which the Series
C Preferred Stock and Series D Preferred Stock would have converted into common
stock.
On March 21, 2002, we redeemed all 173,000 outstanding shares of the 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 $18,734,000 ($396,000 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 year ended
December 31, 2002. The Series E Preferred Stock was held by a former principal
creditor.
As of December 31, 2002 and 2001, there were 0 and 173,000 shares,
respectively, of Series E Preferred Stock issued and outstanding. The following
table summarizes the dividend payment activity for 2001 for the Series E
Preferred Stock:
Time period for Number of Shares of
Amount of which dividends Common Stock Issued
Declaration Date Payment Date Dividends are accrued (a)
- --------------------------------------------------------------------------------------------------------------
March 26, 2001 April 17, 2001 $ 1,426,538 2/22/00-4/17/01 206,147
June 4, 2001 June 29, 2001 $ 262,308 4/18/01-6/30/01 40,605
September 4, 2001 September 28, 2001 $ 278,088 7/01/01-9/30/01 64,373
(a) Represents the number of shares of common stock issued in connection with
the payment of dividends to holders of Series E Preferred Stock. We
determined the number of shares of common stock to issue by dividing the
dollar amount of the dividend payable by the average of the closing sale
prices of the common stock for the 5-trading days prior to the dividend
payment date.
Series F Redeemable Cumulative Dividend Preferred Stock
On September 14, 1999, we declared a dividend on its common stock for the
purpose of distributing approximately $15.7 million in undistributed 1998
taxable income. The dividend was paid to common shareholders of record on
October 20, 1999, provided that the shareholders maintained ownership of their
common stock through the payment date. The dividend was paid on November 5, 1999
in 1,606,595 shares of Series F Preferred Stock.
Holders of record of our common stock who maintained ownership of their
common stock through November 5, 1999, received, for each share held, 3/100ths
of a share of Series F Preferred Stock (i.e., three shares of Series F Preferred
Stock for every 100 shares of common stock held). The Series F Preferred Stock
was convertible into shares of common stock during two 10-business day
conversion periods. The first conversion period was from November 15, 1999
through November 30, 1999 and the second conversion period was from January 21,
2000 through February 3, 2000. Conversions were based on the volume-weighted
average of the sale prices of the common stock for the 10-trading days prior to
the date converted, subject to a floor of 50% of the volume-weighted average of
the sale prices of the common stock on November 5, 1999. During the first
conversion period, 756,453 shares of Series F Preferred Stock were converted,
resulting in the issuance of 640,144 shares of common stock. During the second
and final conversion period (January 21 through February 3, 2000) for the Series
F Preferred Stock, 263,788 additional shares were converted, resulting in the
issuance of 239,657 shares of common stock. Accrued and unpaid dividends were
not paid on shares of Series F Preferred Stock converted into common stock
during the conversion periods. After February 3, 2000, the Series F Preferred
Stock is not convertible into common stock.
F-48
Since the holders of Series F Preferred Stock voted to accept the Chapter
11 reorganization plan, the relative rights and preferences of the Series F
Preferred Stock were amended to permit the payment of dividends in cash or
common stock (or a combination thereof) at our election. The Series F Preferred
Stock is redeemable at our option in cash or shares of parity stock, at our
election, at a price of $10.00 per share together with an amount (in cash and/or
common stock, as applicable) equal to any accrued and unpaid dividends through
the dividend declaration date next preceding the redemption date. The Series F
Preferred Stock provides for dividends at a fixed annual rate of 12%. The
liquidation value of the Series F Preferred Stock is $10.00 per share plus
accrued and unpaid dividends.
As of December 31, 2002 and 2001, there were 586,354 shares of Series F
Preferred Stock issued and outstanding. The following table summarizes the
dividend payment activity for 2002 and 2001 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 (c) are accrued Stock Issued
- ---------------------------------------------------------------------------------------------------------------
June 4, 2001 July 2, 2001 $ 1.99 $ 1,166,844 11/5/99-6/30/01 185,996 (a)
September 4, 2001 October 10, 2001 $ 0.30 $ 175,906 7/1/01-9/30/01 33,334 (b)
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. We
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) Represents the number of shares of common stock issued in connection with
the payment of dividends to holders of Series F Preferred Stock. We
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 (interrupted
by the closing of equity markets due to the terrorist attacks) beginning
one trading day after the dividend declaration date. As a result of the
temporary closing of the U.S. equity markets from September 11 through
September 14, the original payment date of September 28, 2001 was extended
to October 10, 2001.
(c) Although the payments of dividends for the second, third and fourth
quarters of 2002 were deferred as of December 31, 2002, we have accrued
$527,719 for the Series F Preferred Stock second, third and fourth quarter
dividends at a dividend rate of $0.30 per share per quarter. On March 4,
2003, the Board of Directors declared a cash dividend for the second
quarter of 2002 payable on March 31, 2003 to shareholders of record on
March 17, 2003.
Series G Redeemable Cumulative Dividend Preferred Stock
On September 11, 2000, we declared a dividend on our common stock for the
purpose of distributing approximately $37.5 million in undistributed 1999
taxable income. The dividend was paid to common shareholders of record on
October 27, 2000, provided that the shareholders maintained ownership of their
common stock through the payment date. The dividend was paid on November 13,
2000 in 3,741,191 shares of Series G Preferred Stock.
Holders of record of our common stock who maintained ownership of their
common stock through November 13, 2000, received, for each share held, 6/100ths
of a share of Series G Preferred Stock (i.e., six shares of Series G Preferred
Stock for every 100 shares of common stock held). The Series G Preferred Stock
was convertible into shares of common stock during a period of 10 consecutive
trading days commencing on February 21, 2001 and ended on March 6, 2001.
Conversions were based on the volume-weighted average of the sale prices of the
common stock for the 10-trading days prior to the date converted, subject to a
floor of 50% of the volume-weighted average of the sale prices of the common
stock on November 13, 2000. During the conversion period, 2,496,535 shares of
Series G Preferred Stock were converted, resulting in the issuance of 3,254,704
shares of common stock. Accrued and unpaid dividends were not paid on shares of
Series G Preferred Stock converted into common stock during the conversion
period. After March 6, 2001, the Series G Preferred Stock is not convertible
into common stock.
F-49
Holders of Series G Preferred Stock will be entitled to receive, when
declared by the Board of Directors, cumulative dividends, payable in cash or
common stock (or a combination thereof) at our option, at an annual rate of 15%.
Since the holders of the Series G Preferred Stock voted to accept the Chapter 11
reorganization plan, the relative rights and preferences of the Series G
Preferred Stock were amended to permit the payments of dividends in cash or
common stock (or a combination thereof) at our election. The Series G Preferred
Stock is redeemable, at our option, in whole or in part, at any time after
issuance in cash or shares of parity capital stock, at our election, at a price
of $10.00 per share together with an amount (in cash and/or common stock, as
applicable) equal to any accrued and unpaid dividends through the dividend
declaration date next preceding the redemption date. The liquidation value of
the Series G Preferred Stock is $10 per share plus accrued and unpaid dividends.
As of December 31, 2002 and 2001, there were 1,244,656 shares of Series G
Preferred Stock issued and outstanding. The following table summarizes the
dividend payment activity for 2002 and 2001 for the Series G Preferred Stock:
Time period for Number of Shares
Dividends per Amount of which dividends of Common Stock
Declaration Date Payment Date Series G Share Dividends (c) are accrued Issued
------------------------------------------------------------------------------------------------------------
June 4, 2001 July 2, 2001 $ 0.955 $1,188,646 11/13/00-6/30/01 189,450 (a)
September 4, 2001 October 10, 2001 $ 0.375 $ 466.746 7/01/01-9/30/01 88,717 (b)
March 21, 2002 April 15, 2002 $ 0.750 $ 933,492 10/01/01-3/31/02 260,565 (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. We
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) Represents the number of shares of common stock issued in connection with
the payment of dividends to holders of Series G Preferred Stock. We
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 (interrupted
by the closing of equity markets due to the terrorist attacks) beginning
one trading day after the dividend declaration date. As a result of the
temporary closing of the U.S. equity markets from September 11 through
September 14, the original payment date of September 28, 2001 was extended
to October 10, 2001.
(c) Although the payments of dividends for the second, third and fourth
quarters of 2002 were deferred as of December 31, 2002, we have accrued
$1,400,238 for the Series G Preferred Stock second, third and fourth
quarter dividends at a dividend rate of $0.375 per share per quarter. On
March 4, 2003, the Board of Directors declared a cash dividend for the
second quarter of 2002 payable on March 31, 2003 to shareholders of record
on March 17, 2003.
Series H Junior Preferred Stock
On January 23, 2002, in connection with the adoption of our Shareholder
Rights Plan, our Board of Directors declared a dividend of one preferred share
purchase right (a "Right") for each outstanding share of common stock. See Note
11 for a further discussion of the adoption of and reasons for adopting the
Shareholder Rights Plan. Unless otherwise determined by the Board consistent
with the terms of the Rights Plan, each Right, when it becomes exercisable, will
entitle the registered holder (other than Rights beneficially owned by the
Acquiring Person (defined below)) to purchase from us one one-thousandth of a
share of Series H Junior Preferred Stock at a price of $ 23.00 per one
one-thousandth of a share of a Series H Junior Preferred Stock, subject to
adjustment. The Rights will become exercisable if a person or group ("Acquiring
Person") acquires beneficial ownership of 5% or more of our outstanding common
stock or announces a tender offer for 5% or more of the common stock. An
Acquiring Person also includes a person or group that held 5% or more of our
common stock as of January 23, 2002, and that acquires additional common shares.
See Note 11 regarding exclusion of BREF from definition of Acquiring Person.
Shares of Series H Junior Preferred Stock purchasable upon exercise of the
Rights will not be redeemable. Each share of Series H Junior Preferred Stock
will be entitled to a minimum preferential quarterly dividend payment of $10.00
per share but will be entitled to an aggregate dividend of 1,000 times the
dividend declared per share of common stock. In the event of liquidation, the
holders of the Series H Junior Preferred Stock will be entitled to a
F-50
minimum preferential liquidation payment of $1,000 per share but will be
entitled to an aggregate payment of 1,000 times the payment made per share of
common stock. Each share of Series H Preferred Stock will have 1,000 votes,
voting together with the shares of common stock. Finally, in the event of any
merger, consolidation or other transaction in which shares of common stock are
exchanged, each share of Series H Junior Preferred Stock will be entitled to
receive 1,000 times the amount received per share of common stock. These rights
are protected by customary antidilution provisions.
As of December 31, 2002 there were no shares of Series H Preferred Stock
issued and outstanding.
13. EARNINGS PER SHARE
The following table reconciles basic and diluted earnings per share for the
years ended December 31, 2002, 2001, and 2000. Per share amounts have been
adjusted to reflect the one-for-ten reverse stock split effected on October 17,
2001.
Per Share
(Loss)/income Shares Amount
---------------- -------------- ----------
Year ended December 31, 2002
- ------------------------------------
Net loss before cumulative effect of
changes in accounting principles $(54,481,312) 13,710,914 $(3.97)
Cumulative effect of change in accounting
principle related to SFAS 142 (9,766,502) 13,710,914 (0.72)
---------------- -------------- ----------
Basic and diluted earnings per share (1):
Loss to common shareholders and
assumed conversions $(64,247,814) 13,710,914 $(4.69)
================ ============== ==========
Year ended December 31, 2001
- ------------------------------------
Net loss before cumulative effect of
changes in accounting principles $(26,082,918) 11,087,790 $(2.35)
Cumulative effect of change in accounting
principle related to SFAS 133 (135,142) 11,087,790 (0.01)
Cumulative effect of change in accounting
principle related to servicing fee revenue 1,995,262 11,087,790 0.18
---------------- -------------- ----------
Basic and diluted earnings per share (1):
Loss to common shareholders and
assumed conversions $(24,222,798) 11,087,790 $(2.18)
================ ============== ==========
Year ended December 31, 2000
- ------------------------------------
Basic and diluted earnings per share (1):
Loss to common shareholders and
assumed conversions $ (155,495,429) 6,214,479 $(25.02)
================ ============== ==========
(1) The common stock equivalents for the preferred stock and stock options are
not included in the calculation of diluted earnings per share for 2002,
2001 or 2000 because the effect would be anti-dilutive.
F-51
14. STOCK BASED COMPENSATION PLANS
We have three stock option and/or award plans: the 2001 Stock Incentive
Plan, the Second Amended and Restated Stock Option Plan for Key Employees and
the 1996 Non-Employee Director Stock Plan.
2001 Stock Incentive Plan
Under the 2001 Stock Incentive Plan, a maximum of 1,235,000 shares are
available for grant pursuant to stock awards and stock options. As of December
31, 2002, options granted to employees and directors to purchase 594,000 shares
were outstanding, and restricted stock awards of 32,500 shares had been granted
to employees. Under the 2001 Stock Incentive Plan, options granted must have an
option price of not less than fair market value of a share of common stock on
the date of grant. The following is a summary of the grants during 2002 and
2001:
Date of Grant Recipients # of Options Granted Exercise Price
- -------------------------- ------------------- ----------------------- ---------------------
November 16, 2001 Employees 285,000 $2.78 (1)
January 2, 2002 Directors 24,000 3.99 (2)
June 5, 2002 Employees 293,000 7.00 (1)
------- ----
602,000 $4.88
======= =====
(1) These options vest ratably with 33% vesting on the date of grant and
33% vesting on each of the first and second anniversaries of the date
of grant and expire in 10 years.
(2) These options vest ratably with 50% vesting on the date of grant and
25% vesting on each of the first and second anniversaries of the date
of grant and expire in 10 years.
In addition to the stock option grants included in the table above, 32,500
shares of restricted stock were awarded to certain employees on January 2, 2002.
The restricted stock vests 33% on the date of grant, 33% on August 15, 2002 and
33% on April 15, 2003. The price of our common stock on the award date was $3.99
per share. The fair value of the restricted stock is being expensed over the
vesting period through our Consolidated Statement of Income.
No option or award of stock may be granted under the 2001 Stock Incentive
Plan after July 1, 2011.
Second Amended and Restated Stock Option Plan for Key Employees
Under the Key Employee Plan, a maximum of 450,000 shares were available for
grant pursuant to stock options. Options may no longer be granted under the Key
Employee Plan. As of December 31, 2002, options to purchase 434,272 shares had
been granted to employees. Under the Key Employee Plan, options granted prior to
July 28, 1995 have an option price of $97.70, and options granted after July 28,
1995 have an option price of not less than fair market value of a share of
common stock on the date of grant and expire after eight years. On June 18,
2001, we granted options to purchase an aggregate 137,500 shares under the Key
Employee Plan. These options vested on the date of grant, expire in 8 years, and
have an exercise price of $5.70 per share, which was the closing price of the
common stock on the date of grant.
1996 Non-Employee Director Stock Plan
Under the Director Plan, a maximum of 87,313 shares are available for grant
pursuant to stock awards and stock options. As of December 31, 2002, options to
purchase 2,040 shares had been granted to directors. These options have an
exercise price equal to the market price of a share of common stock on the date
of grant, vested on the date of grant, and expire after ten years. The options
to directors are currently being issued under the 2001 Stock Incentive Plan.
A summary of these stock plans as of December 31, 2002, 2001 and 2000, and
changes during the years then ended is presented in the table below:
F-52
2001 Stock Plan Key Employee Plan Directors' Plan
------------------------ ------------------------------ --------------------------
Weighted Weighted Weighted
Average Average Average
Shares Price Shares Price Shares Price
----------------------------------------------------------------------------------------
Balance, January 1, 2000 - $ - 185,051 $ 104.13 800 $ 105.63
Adjustment of 2/00 (1) - - 30,386 104.13 131 105.63
Granted - - 12,135 10.63 200 13.75
Exercised - - - - - -
Forfeited - - (19,747) 68.46 - -
---------- --------- ---------- ---------- ---------- -----------
Balance, December 31, 2000 - 207,825 102.08 1,131 87.25
Adjustment of 3/01 (2) - - 103,844 102.08 609 87.25
Granted 285,000 2.78 137,500 5.70 300 7.30
Exercised - - - - - -
Forfeited - - (14,302) 75.61 - -
---------- --------- ---------- ---------- ---------- -----------
Balance, December 31, 2001 285,000 $ 2.78 434,867 $ 72.94 2,040 $75.49
Granted 317,000 6.77 - - - -
Exercised (2,500) 2.78 (6,400) 5.70 - -
Forfeited (8,000) 2.78 (16,889) 45.65 - -
---------- --------- ---------- ---------- ---------- -----------
Balance, December 31, 2002 591,500 $ 4.92 411,578 $ 74.61 2,040 $75.49
========== ========= ========= ========== ========== ===========
Exercisable, December 31, 2000 -- -- 116,180 $ 124.60 1,131 $ 87.25
========== ========= ========= ========== ========== ===========
Exercisable, December 31, 2001 94,998 $ 2.78 389,435 $ 78.53 2,040 $ 75.49
========== ========= ========= ========= ========== ==========
Exercisable, December 31, 2002 295,493 $ 4.23 407,413 $ 75.27 2,040 $ 75.49
========== ========= ========= ========= ========== ==========
(1) Adjustment as a result of anti-dilution provision associated with
Series F Preferred Stock dividend paid to holders of common stock.
(2) Adjustment as a result of anti-dilution provision associated with
Series G Preferred Stock dividend paid to holders of common stock.
In addition to the stock option grants included in the table above, 32,500
shares of restricted stock were awarded to certain employees under the 2001
Stock Incentive Plan. The weighted average price of our common stock was $3.99
at the award date, and 10,834 of the restricted shares are unvested as of
December 31, 2002. The fair value of approximately $130,000 was recognized as
deferred compensation and is being recognized into earnings over 15 months.
In addition to the option information included in the table above, with
respect to options granted to the principals at the time of the 1995 merger,
options to acquire 316,593 shares were outstanding as of December 31, 2000.
These options expired during 2001. There were no exercises during the years
ended December 31, 2001 and 2000.
The following table summarizes information about stock options
outstanding at December 31, 2002:
Options Outstanding Options Exercisable
------------------------------------------------------ ------------------------------
Weighted Weighted Weighted
Average Average Average
Range of Number Remaining Exercise Number Exercise
Exercise prices outstanding Contractual Life Price exercisable Price
-------------------- ------------ -- ------------------ ---------------- -- ------------ --------------
$2.78 - $15.93 760,810 8.4 $ 5.29 460,638 $ 5.17
$15.94 - $31.87 61,687 4.2 31.25 61,687 31.25
$31.88 - $47.81 348 6.0 35.63 348 35.63
$47.82 - $111.56 17,165 0.9 101.69 17,165 101.69
$111.57 - $143.44 3,840 2.2 127.50 3,840 127.50
$143.45 - $159.38 161,268 2.9 158.21 161,268 158.21
------------ ------------------ ---------------- ------------ --------------
$2.78 - $159.38 1,005,118 7.1 $ 33.24 704,946 $ 45.49
============ ================== ================ ============ ==============
F-53
We have adopted the disclosure-only provisions of SFAS No. 123, "Accounting
for Stock-Based Compensation." As a result, we account for these plans under
Accounting Principles Board Opinion No. 25, under which no compensation cost has
been recognized. SFAS No. 123 requires pro forma disclosure of the impact on net
income and earnings per share as if the options were recorded at their estimated
fair value at the issuance date and amortized over the options' vesting period.
If compensation cost for these plans had been determined consistent with SFAS
No. 123, our net income and earnings per share would have been recorded at the
following pro forma amounts:
Years ended December 31,
2002 2001 2000
----------------- ----------------- -----------------
Pro forma net loss to common shareholders $ (65,287,114) $ (25,493,873) $ (156,370,899)
================= ================= =================
Pro forma basic loss per share $ (4.76) $ (2.30) $ ( 25.16)
================= ================= =================
Pro forma diluted loss per share $ (4.76) $ (2.30) $ (25.16)
================= ================= =================
The weighted average fair value of the options granted was $4.74, $2.66,
and $8.30 during 2002, 2001 and 2000, respectively. The fair value of the 2002,
2001 and 2000 option grants was estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted average
assumptions:
2002 2001 2000
--------------- --------------- ---------------
Risk-free interest rate 4.23% 4.29% 6.44%
Expected life 4.73 years 4.78 years 5.29 years
Expected volatility 89.2% 91.4% 96.2%
Dividend yield --% --% --%
F-54
15. TRANSACTIONS WITH RELATED PARTIES
Below is a summary of the related party transactions that occurred during
the years ended December 31, 2002, 2001 and 2000. These items are described
further in the text which follows:
For the years ended December 31,
2002 2001 2000
---- ---- ----
Amounts received or accrued from the AIM Limited
Partnerships
Income(1) $ 544,226 $ 751,021 $ 746,570
Return of capital(2) 2,245,304 1,723,949 1,573,335
---------- ---------- ----------
Total $2,789,530 $2,474,970 $2,319,905
========== ========== ==========
Amounts received or accrued for AIM Acquisition
Limited Partnership (1) $ 232,873 $ 284,411 $ 341,965
========= ========= =========
Expense reimbursements from:
AIM Limited Partnerships (3) $ 203,668 $183,898 $168,978
CMSLP (3)(5) - 248,428 39,602
---------- --------- ---------
Total $ 203,668 $432,326 $208,580
========== ========= ========
Expense reimbursement (to) from CRI:
Expense reimbursement to CRI (3) (4) (6) $ (340,847) $(321,505) $(151,171)
Expense reimbursement from CRI (3) 190,095 87,381 30,096
----------- ---------- ----------
Net expense reimbursement $ (150,752) $(234,124) $(121,075)
=========== ========== ==========
(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 administrative services agreement between us and CRI, Inc.,
CRI provided us with certain administrative and office facility services and
other services, at cost, with respect to certain aspects of our business. We
used the services provided under the administrative services agreement to the
extent such services were not performed by CRIIMI MAE Management or provided by
another service provider. The administrative services agreement was terminable
on 30 days notice at any time. The majority of such services under this
agreement were terminated in March 2003.
(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 $103,000 of expenses during the
period January 1, 2001 through June 30, 2001 and approximately $202,000 of
expenses during the year ended December 31, 2000. These reimbursements are
not included in the reimbursements for the years ended December 31, 2001
and 2000 since the financial results of CMSLP were not consolidated until
July 1, 2001. The CMSLP reimbursements to CRI for the six months ended
December 31, 2001 and for the year ended December 31, 2002 are included in
this table.
In addition to the transactions listed above, in connection with the Merger
in 1995, we entered into a deferred compensation arrangement with William
Dockser, Chairman until January 23, 2003 (a Director after January 23, 2003),
and H. William Willoughby, President and a Director until January 23, 2003, in
an original aggregate amount of $5,002,183 pursuant to which we agreed to pay
Messrs. Dockser and Willoughby for services performed in connection with the
structuring of the merger. Our 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, Inc. 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 (4.25% as of December 31, 2002) plus 2% per annum. From October 5, 1998
through April 17, 2001, no deferred compensation payments were made as a result
of our Chapter 11 proceeding. For the years ended December 31, 2002, 2001 and
2000, aggregate payments of $616,091, $2,571,455 (including $945,740 in accrued
interest) and $0, 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
F-55
was approximately $1,375,588 at December 31, 2002. The financial statement
impact of these transactions is immaterial.
16. LITIGATION
Bankruptcy Proceedings and Other Litigation
On the October 5, 1998 petition date, CRIIMI MAE Inc., CRIIMI MAE
Management, Inc. and CRIIMI MAE Holdings II, L.P. filed voluntary petitions for
relief under Chapter 11 of the Bankruptcy Code in the Bankruptcy Court. On
November 22, 2000, the Bankruptcy Court entered an order confirming the
reorganization plan before it. We emerged from Chapter 11 on April 17, 2001, at
which date all material litigation matters existing subsequent to the petition
date had been settled or resolved except for the First Union litigation, which
was settled in February 2002 as discussed below.
First Union
We entered into a settlement agreement with First Union National Bank dated
as of February 6, 2002. On March 5, 2002, the Bankruptcy Court entered an order
approving the settlement agreement. The settlement agreement became effective on
March 20, 2002. The dispute concerned whether First Union was a secured or
unsecured creditor in connection with certain credit and custodian agreements
between CRIIMI MAE and First Union. First Union's claim amount was approximately
$18.6 million. Reference is made to the settlement agreement, previously filed
with the Bankruptcy Court (and with the Securities and Exchange Commission as an
exhibit to a Current Report on Form 8-K filed on February 13, 2002), for a more
detailed description of the terms and conditions of the settlement agreement.
On March 20, 2002, a previously issued Series A Senior Secured Note having
a December 31, 2001 face amount of $7,484,650 and previously issued Series B
Senior Secured Notes having a December 31, 2001 aggregate face amount of
$4,809,273 were released from escrow to First Union. On March 20, 2002, First
Union sold the notes. The proceeds from the sale of the notes, combined with the
escrowed cash, resulted in total proceeds of approximately $18.8 million. We
retained the approximate $238,000 of cash in excess of the First Union claim
amount of $18.6 million. In addition, approximately $22,938,260 of our
restricted cash became unrestricted.
Other
In the course of our normal business activities, various lawsuits, claims
and proceedings have been or may be instituted or asserted against us. Based on
currently available facts, we believe that the disposition of matters pending or
asserted will not have a material adverse effect on our consolidated financial
position, results of operations or liquidity.
F-56
17. SUMMARY OF QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a summary of unaudited quarterly results of operations for
the years ended December 31, 2002, 2001 and 2000:
2002
-------------------------------------------------------------------------
First Quarter Second Quarter Third Quarter Fourth Quarter
---------------- ---------------- ---------------- ----------------
Interest Income $ 32,031,879 $ 31,743,348 $ 31,508,173 $ 29,176,532
Net income (loss) (6,827,981) 2,295,745 (25,101,506) (34,614,072)
Basic net earnings (loss) per share (0.52) 0.16 (1.80) (2.48)
Diluted net earnings (loss) per share (0.52) 0.16 (1.80) (2.48)
2001
-------------------------------------------------------------------------
First Quarter Second Quarter Third Quarter Fourth Quarter
---------------- ---------------- ---------------- ----------------
Interest Income $ 33,811,044 $ 33,718,486 $ 33,588,020 $ 33,258,002
Net income (loss) 6,030,160 (1) (2,375,818) (1) (723,708) (27,153,432)
Basic net earnings (loss) per share 0.80 (1) (0.21) (1) (0.06) (2.10)
Diluted net earnings (loss) per share 0.64 (1) (0.21) (1) (0.06) (2.10)
2000
-------------------------------------------------------------------------
First Quarter Second Quarter Third Quarter Fourth Quarter
---------------- ---------------- ---------------- ----------------
Interest Income $ 55,454,598 $ 51,274,382 $ 49,066,581 $ 39,456,080
Net income (loss) 4,035,611 3,742,484 (44,463,063) (118,810,461)
Basic net earnings (loss) per share 0.66 0.60 (7.13) (19.05)
Diluted net earnings (loss) per share 0.56 0.54 (7.13) (19.05)
(1) The net income has been adjusted to reflect the change in accounting
principle related to servicing revenue.
18. SEGMENT REPORTING
Management assesses our 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.
Portfolio investment primarily includes (i) acquiring subordinated CMBS,
(ii) securitizing pools of mortgage loans and pools of CMBS, (iii) direct and
indirect investments in government insured securities and entities that own
government insured securities and mezzanine loans and (iv) securities trading
activities. Our income from this segment 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 our 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 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
other income which includes, among other things, assumption fees and
modification fees. Through June 30, 2001, CMSLP was an unconsolidated affiliate.
Therefore, up through June 30, 2001, the results of its operations were reported
in our income statement in equity in (losses) earnings from investments.
Beginning in the third quarter of 2001, CMSLP's results were consolidated into
our consolidated financial statements as a result of a change in the ownership
of CMSLP. See Note 3 for further discussion. Revenues, expenses and assets are
accounted for in accordance with the accounting policies set forth in
F-57
Note 3. 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. As discussed in Note
9, CMSLP sold all of its rights and obligations under its CMBS master and
primary servicing contracts in February 2002.
The following tables detail the financial performance by these two primary
lines of business for the years ended December 31, 2002, 2001 and 2000. The
basis of accounting used in the tables is GAAP.
As of and for the year ended December 31, 2002
-------------------------------------------------------------------------------
Elimination of
Portfolio Mortgage Intercompany
Investment Servicing Transactions Consolidated
----------------- --------------- ------------------ -----------------
Interest income $ 124,459,932 $ - $ - $ 124,459,932
Interest expense (92,663,283) - 21,624 (92,641,659)
---------------- ------------- ----------------- ---------------
Net interest margin 31,796,649 - 21,624 31,818,273
---------------- -------------- ----------------- ---------------
General and administrative expenses (10,825,129) - 96,672 (10,728,457)
Depreciation and amortization (1,095,861) - - (1,095,861)
Equity in earnings (losses) from
investments (41,882) - - (41,882)
Other, net 548,875 - - 548,875
Impairment on CMBS (70,225,506) - - (70,225,506)
Recapitalization expenses (1,048,559) - - (1,048,559)
Servicing income - 11,570,862 (585,092) 10,985,770
Servicing general and administrative
expenses - (9,321,365) 466,796 (8,854,569)
Servicing amortization, depreciation
and impairment - (2,173,137) - (2,173,137)
Servicing restructuring expenses - (188,614) - (188,614)
Servicing gain on sale of servicing
rights - 4,864,274 - 4,864,274
Servicing gain on sale of
investment-grade CMBS - 241,160 - 241,160
Income tax benefit (expense) 326,998 (787,286) - (460,288)
---------------- -------------- ------------------ -----------------
(82,361,064) 4,205,894 (21,624) (78,176,794)
---------------- -------------- ------------------ -----------------
Net income (loss) before changes in
accounting principles $ (50,564,415) $ 4,205,894 $ - $ (46,358,521)
=============== ============== ================== =================
Total assets $1,214,741,938 $ 26,812,985 $ (469,680) $1,241,085,243
=============== ============== ================== =================
F-58
As of and for the year ended December 31, 2001
------------------------------------------------------------------------------
Elimination of
Portfolio Mortgage Intercompany
Investment Servicing Transactions (1) Consolidated
----------------- --------------- ------------------ -----------------
Interest income $ 134,375,552 $ - $ - $ 134,375,552
Interest expense (97,787,568) - - (97,787,568)
----------------- --------------- ------------------ ------------------
Net interest margin 36,587,984 - - 36,587,984
----------------- --------------- ------------------ ------------------
General and administrative
expenses (10,840,864) - (110,556) (10,951,420)
Depreciation and amortization (3,718,485) - - (3,718,485)
Equity in earnings (losses) from
investments 646,692 - (2,278,734) (1,632,042)
Other, net 2,868,038 - - 2,868,038
Impairment on CMBS (34,654,930) - - (34,654,930)
Reorganization items (1,813,220) - - (1,813,220)
Emergence loan origination fee (3,936,616) - - (3,936,616)
Servicing income - 12,705,666 (6,021,780) 6,683,886
Servicing general and
administrative expenses - (12,165,374) 6,595,212 (5,570,162)
Servicing amortization,
depreciation and impairment - (3,378,076) 1,678,890 (1,699,186)
Servicing restructuring expenses - (437,723) - (437,723)
Income tax benefit (expense) - 336,439 - 336,439
----------------- --------------- ------------------ ------------------
(51,449,385) (2,939,068) (136,968) (54,525,421)
----------------- --------------- ------------------ ------------------
Net income (loss) before changes
in accounting principles $ (14,861,401) $ (2,939,068) $ (136,968) $ (17,937,437)
================= =============== ================== ==================
Total assets $ 1,289,827,494 $ 25,176,629 $ - $ 1,315,004,123
================= =============== ================== ==================
(1) We perform the mortgage servicing functions 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 our consolidated financial statements. Beginning in the third quarter of
2001, CMSLP's results were consolidated into our consolidated financial
statements.
F-59
As of and for the year ended December 31, 2000
-------------------------------------------------------------------------------
Elimination of
Portfolio Mortgage Intercompany
Investment Servicing Transactions (1) Consolidated
----------------- --------------- ------------------ ------------------
Interest income $ 195,251,641 $ - $ - $ 195,251,641
Interest expense (139,366,369) - - (139,366,369)
----------------- --------------- ------------------ ------------------
Net interest margin 55,885,272 - - 55,885,272
----------------- --------------- ------------------ ------------------
General and administrative
expenses (9,651,468) - - (9,651,468)
Depreciation and amortization (3,771,064) - - (3,771,064)
Equity in earnings (losses) from
investments 701,403 - 810,602 1,512,005
Other, net 2,183,286 - - 2,183,286
Impairment on CMBS (143,478,085) - - (143,478,085)
Reorganization items (66,072,460) - - (66,072,460)
Servicing income - 14,684,667 (14,684,667) -
Servicing general and
administrative expenses - (11,986,788) 11,986,788 -
Servicing amortization,
depreciation and impairment - (2,178,652) 2,178,652 -
Income tax benefit (expense) - - - -
Gain on debt extinguishment 14,808,737 - - 14,808,737
----------------- --------------- ------------------ ------------------
(205,279,651) 519,227 291,375 (204,469,049)
----------------- --------------- ------------------ ------------------
Net income (loss) before changes
in accounting principles $ (149,394,379) $ 519,227 $ 291,375 $ (148,583,777)
================= =============== ================== ==================
Total assets $ 1,535,468,572 $ 25,930,760 $ (3,559,687) $ 1,557,839,645
================= =============== ================== ==================
(1) We perform the mortgage servicing functions through CMSLP which, during the
period covered, was accounted for under the equity method. The elimination
column reclassifies CMSLP under the equity method as it is accounted for in
our consolidated financial statements.
19. Subsequent Events
On January 23, 2003, we completed a recapitalization of all of the Exit
Debt funded with approximately $44 million from common equity and secured
subordinated debt issuances to BREF, a private asset management fund established
by Brascan Corporation and a management team led by Barry S. Blattman, $300
million in secured financing, in the form of a repurchase transaction, from a
unit of Bear Stearns and a portion of our available cash and liquid assets. This
recapitalization increases our financial flexibility and provides new additions
to management including Barry S. Blattman, as Chairman of the Board, Chief
Executive Officer and President.
Under the 2003 recapitalization, BREF acquired 1,212,617 shares of our
newly issued common stock, or approximately 8% of our outstanding common stock
after giving effect to the share acquisition, at $11.50 per share, or
approximately $13.9 million. BREF also received seven year warrants to purchase
up to 336,835 additional shares of common stock at $11.50 per share. The fair
value of the warrants was calculated as approximately $2.6 million. The
assumptions we used to value the warrants are consistent with the assumptions
used to value our stock options. The warrants will be accounted for as a
component of equity. BREF also purchased $30 million of the BREF Debt and, at
our option, BREF will purchase up to an additional $10 million of subordinated
debt prior to January 23, 2004. The BREF Debt matures on January 23, 2006 and
bears interest at an annual rate of 15%. If we decide to sell the additional $10
million of subordinated debt to BREF, it will bear interest at an annual rate of
20% and also matures on January 23, 2006. We have a right to defer a portion of
the interest on the BREF Debt (and on the additional $10 million, if sold to
BREF) during its term. The BREF Debt is secured by first liens on the equity
interests of two of our subsidiaries. Although this effectively provides BREF
with an indirect lien on all of our subordinated CMBS that are held by three of
our other lower-tier subsidiaries, Bear Stearns has first liens on the equity
interests of these three lower tier subsidiaries and on certain of the
F-60
subordinated CMBS held by one of these lower tier subsidiaries. Pursuant to an
intercreditor agreement between BREF and Bear Stearns, our obligations under the
BREF Debt are contractually subordinate to the prior payment in full of our
obligations under the $300 million in secured financing provided by Bear
Stearns. Such intercreditor agreement also provides for contractual restrictions
on BREF's ability to realize upon its indirect interest in the Bear Stearns
first lien collateral. We paid an origination fee of 0.67% to BREF related to
the BREF Debt. We are also obligated to pay BREF a quarterly maintenance fee of
$434,000 in connection with arranging the Bear Stearns Debt.
Under the recently completed recapitalization, Bear Stearns provided the
Bear Stearns Debt. The Bear Stearns Debt matures in 2006, bears interest at a
rate equal to one-month LIBOR plus 3% and requires quarterly principal payments
of $1.25 million. The principal payments will increase to $1.875 million per
quarter if a collateralized debt obligation transaction (or CDO) is not
completed by January 23, 2004. The interest rate will increase by 1%, to
one-month LIBOR plus 4%, if Bear Stearns structures a CDO that meets certain
rating requirements and we decline to close. The Bear Stearns Debt is secured by
first direct and/or indirect liens on all of our subordinated CMBS. The indirect
first liens are first liens on the equity interests of three of our subsidiaries
that hold certain subordinated CMBS. A reduction in the value of this collateral
could require us to provide additional collateral or fund margin calls. Although
CRIIMI MAE Inc. is not a primary obligor of the Bear Stearns Debt, it has
guaranteed all obligations under the debt. We paid a commitment fee of 0.5% of
the Bear Stearns Debt to Bear Stearns.
On the effective date of our recent January 2003 recapitalization, we
effected an affiliate reorganization principally to indirectly secure the Bear
Stearns Debt with the equity interests in CBO-1 and CBO-2. As a result of the
affiliate reorganization, our REIT subsidiary (CBO REIT II), owns all bonds
previously pledged to secure the Exit Debt and indirectly owns all of the equity
interests in CBO-1 and CBO-2 (through its ownership of the two qualified REIT
subsidiaries which hold the equity interests in CBO-1 and CBO-2).
The Bear Stearns Debt is collateralized by first direct and/or indirect
liens on all of our subordinated CMBS, and is subject to a number of terms,
conditions and restrictions including, without limitation, scheduled principal
and interest payments, and restrictions and requirements with respect to the
collection and application of funds. If the outstanding loan amount under the
Bear Stearns Debt exceeds 85% of the aggregate market value of the collateral
securing the Bear Stearns Debt, as determined by Bear Stearns in its sole good
faith discretion, then Bear Stearns can require us to transfer cash, cash
equivalents or securities so that the outstanding loan amount will be less than
or equal to 80% of the aggregate market value of the collateral (including any
additional collateral provided). Failure to meet any margin call could result in
an event of default which would enable Bear Stearns to exercise various rights
and remedies including acceleration of the maturity date of the Bear Stearns
Debt and the sale of the collateral. In order to meet a margin call, we may be
required to sell assets at prices lower than their carrying value which could
result in losses.
In connection with the 2003 recapitalization, we expect to recognize
certain amounts in our Consolidated Statement of Income during the first quarter
of 2003. These amounts include the following:
o On January 23, 2003 and in connection with the closing of the
recapitalization, amounts were deposited with the indenture trustee to
pay all principal and interest on our outstanding Series A and Series
B Senior Secured Notes on the March 10, 2003 redemption date. This
redemption required 45 days prior notice. These notes were not
considered repaid for GAAP purposes until the March 10, 2003
redemption date. The 45 day notice period resulted in additional
interest expense during the period January 23, 2003 through March 10,
2003 since the Bear Stearns and BREF Debt were outstanding and the
senior secured notes were also outstanding. This additional interest
expense related to the 45 day notice period, which will be recognized
during the first quarter of 2003, totaled approximately $3.1 million.
o Approximately $7.4 million will be recognized as a gain on
extinguishment of debt, primarily due to the reversal of accrued
extension fees on the Exit Debt.
o Approximately $2.6 million of expenses will be recognized related to
severance and related payments, and accelerated vesting of stock
options for our former Chairman, William B. Dockser, and former
President, H. William Willoughby, whose employment contracts were
terminated on January 23, 2003.
In addition to the income statement items described above, transaction
costs currently estimated to be approximately $6.2 million related to the
recapitalization will be included on the Consolidated Balance Sheet as of
F-61
March 31, 2003. Such costs will be allocated between the debt and equity
issued. The costs allocated to debt will be amortized using the effective
interest method over the lives of the related debt. The costs allocated to
equity will be reflected in equity net of the proceeds from the issuance of the
common stock.