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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
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For the quarter ended March 31, 2003 Commission file number 1-10360
CRIIMI MAE INC.
(Exact name of registrant as specified in its charter)
Maryland 52-1622022
(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification No.)
11200 Rockville Pike
Rockville, Maryland 20852
(301) 816-2300
(Address, including zip code, and telephone number,
including area code, of registrant's principal executive offices)
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Securities Registered Pursuant to Section 12(b) of the Act:
Name of each exchange on
Title of each class which registered
- ------------------- -----------------------------
Common Stock New York Stock Exchange, Inc.
Series B Cumulative Convertible New York Stock Exchange, Inc.
Preferred Stock
Series F Redeemable Cumulative Dividend New York Stock Exchange, Inc.
Preferred Stock
Series G Redeemable Cumulative Dividend New York Stock Exchange, Inc.
Preferred Stock
Securities Registered Pursuant to Section 12(g) of the Act:
None
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13 or 15 (d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes [X] No[ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Class Outstanding as of May 8, 2002
----- -------------------------------
Common Stock, $0.01 par value 15,166,685
2
CRIIMI MAE INC.
Quarterly Report on Form 10-Q
Page
PART I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets as of March 31, 2003
(unaudited) and December 31, 2002............................... 3
Consolidated Statements of Income for the three months
ended March 31, 2003 and 2002 (unaudited)....................... 4
Consolidated Statements of Changes in Shareholders' Equity
for the three months ended March 31, 2003 (unaudited)........... 5
Consolidated Statements of Cash Flows for the three
months ended March 31, 2003 and 2002 (unaudited)................ 6
Notes to Consolidated Financial Statements (unaudited)........... 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations............................. 33
Item 3. Quantitative and Qualitative Disclosures about Market Risk....... 56
Item 4. Controls and Procedures.......................................... 57
PART II. Other Information
Item 2. Changes in Securities and Use of Proceeds........................ 58
Item 6. Exhibits and Reports on Form 8-K................................. 58
Signature ................................................................ 60
Certifications ........................................................... 61
3
PART I
ITEM 1. FINANCIAL STATEMENTS
CRIIMI MAE INC.
CONSOLIDATED BALANCE SHEETS
March 31, December 31,
2003 2002
---------------------- ----------------------
(Unaudited)
Assets:
Mortgage assets:
Subordinated CMBS and Other MBS, at fair value $ 539,715,818 $ 540,755,663
CMBS pledged to secure Securitized Mortgage
Obligation - CMBS, at fair value 327,731,737 326,472,580
Insured mortgage securities, at fair value 227,711,402 275,340,234
Equity investments 5,978,155 6,247,868
Other assets 28,230,732 24,987,348
Receivables 16,930,736 16,293,489
Servicing other assets 9,594,320 13,775,138
Servicing cash and cash equivalents 2,620,270 12,582,053
Other cash and cash equivalents 8,902,760 16,669,295
Restricted cash and cash equivalents - 7,961,575
------------------ ------------------
Total assets $ 1,167,415,930 $ 1,241,085,243
================== ==================
Liabilities:
Bear Stearns variable rate secured debt $ 300,000,000 $ -
BREF senior subordinated secured note 30,000,000 -
Securitized mortgage obligations:
Collateralized bond obligations-CMBS 286,637,506 285,844,933
Collateralized mortgage obligations-
insured mortgage securities 211,943,244 252,980,104
Mortgage payable 7,242,449 7,214,189
Payables and accrued expenses 17,627,148 26,675,724
Servicing liabilities 621,720 756,865
Exit variable-rate secured borrowing - 214,672,536
Series A senior secured notes - 92,788,479
Series B senior secured notes - 68,491,323
------------------ ------------------
Total liabilities 854,072,067 949,424,153
------------------ ------------------
Shareholders' equity:
Preferred stock, $0.01 par; 75,000,000 shares
authorized; 3,424,992 shares issued and outstanding 34,250 34,250
Common stock, $0.01 par; 300,000,000 shares
authorized; 15,162,685 and 13,945,068 shares
issued and outstanding, respectively 151,627 139,451
Accumulated other comprehensive income 105,497,116 102,122,057
Deferred compensation (2,789) (19,521)
Warrants outstanding 2,564,729 -
Additional paid-in capital 630,649,247 619,197,711
Accumulated deficit (425,550,317) (429,812,858)
------------------ ------------------
Total shareholders' equity 313,343,863 291,661,090
------------------ ------------------
Total liabilities and shareholders' equity $ 1,167,415,930 $ 1,241,085,243
================== ==================
The accompanying notes are an integral part of these consolidated financial
statements.
4
CRIIMI MAE INC.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
For the three months ended March 31,
2003 2002
-------------------- -------------------
Interest income:
CMBS $ 22,071,977 $ 25,536,385
Insured mortgage securities 4,651,893 6,495,494
----------------- ----------------
Total interest income 26,723,870 32,031,879
----------------- ----------------
Interest and related expenses:
Bear Stearns variable rate secured debt 2,827,635 -
BREF senior subordinated secured note 1,051,099 -
Exit variable-rate secured borrowing 859,106 3,871,647
Series A senior secured notes 2,130,722 2,964,409
Series B senior secured notes 2,697,006 3,365,132
Fixed-rate collateralized bond obligations-CMBS 6,540,378 6,365,905
Fixed-rate collateralized mortgage obligations - insured securities 5,560,140 6,494,540
Other interest expense 236,423 244,582
----------------- ----------------
Total interest expense 21,902,509 23,306,215
----------------- ----------------
Net interest margin 4,821,361 8,725,664
----------------- ----------------
General and administrative expenses (2,948,642) (3,202,614)
Depreciation and amortization (173,290) (239,976)
Servicing revenue 2,124,561 2,763,536
Servicing general and administrative expenses (2,230,971) (2,491,094)
Servicing amortization, depreciation, and impairment expenses (333,262) (507,879)
Income tax benefit 172,376 66,444
Equity in earnings from investments 128,268 114,304
Other income, net 343,176 844,903
Net gains (losses) on mortgage security dispositions 188,210 (109,819)
Hedging expense (352,322) (89,758)
BREF Maintenance fee (371,311) -
Executive severance at recapitalization (2,616,978) -
Gain on extinguishment of debt 7,337,424 -
----------------- ----------------
1,267,239 (2,851,953)
----------------- ----------------
Net income before cumulative effect of change in accounting principle 6,088,600 5,873,711
Cumulative effect of adoption of SFAS 142 - (9,766,502)
----------------- ----------------
Net income (loss) before dividends accrued or paid on preferred shares 6,088,600 (3,892,791)
Dividends accrued or paid on preferred shares (1,826,059) (2,935,190)
----------------- ----------------
Net income (loss) to common shareholders $ 4,262,541 $ (6,827,981)
================= ================
Net income (loss) to common shareholders per common share:
Basic - before cumulative effect of change in accounting principle $ 0.28 $ 0.23
================= ================
Basic - after cumulative effect of change in accounting principle $ 0.28 $ (0.52)
================= ================
Diluted - before cumulative effect of change in accounting principle $ 0.28 $ 0.22
================= ================
Diluted - after cumulative effect of change in accounting principle $ 0.28 $ (0.52)
================= ================
Shares used in computing basic income (loss) per share 14,958,833 13,055,303
================= ================
The accompanying notes are an integral part of these consolidated financial
statements.
5
CRIIMI MAE INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
For the three months ended March 31, 2003
(Unaudited)
Preferred Common Accumulated
Stock Stock Additional Other Unearned Total
Par Par Paid-in Accumulated Comprehensive Warrants Stock Shareholders'
Value Value Capital Deficit Income Outstanding Compensation Equity
-------- ----- ---------- ------------ ------------- ----------- -------- -------------
Balance at December 31, 2002 $ 34,250 $ 139,451 $ 619,197,711 $ (429,812,858) $102,122,057 $ - $ (19,521) $291,661,090
Net income before dividends accrued or
paid on preferred shares - - - 6,088,600 - - - 6,088,600
Adjustment to unrealized gains and
losses on mortgage assets - - - - 3,026,973 - - 3,026,973
Adjustment to unrealized losses
on interest rate caps - - - - 348,086 - - 348,086
Dividends accrued or paid on
preferred shares - - - (1,826,059) - - - (1,826,059)
Common stock issued - 12,176 13,468,665 - - - 13,480,841
Amortization of deferred compensation - - - - - - 16,732 16,732
Accelerated vesting of stock options - - 547,600 - - - - 547,600
Warrants issued - - (2,564,729) - - 2,564,729 - -
-------- --------- -------------- -------------- ------------ ---------- -------- ------------
Balance at March 31, 2003 $ 34,250 $ 151,627 $ 630,649,247 $(425,550,317) $105,497,116 $2,564,729 $(2,789) $313,343,863
======== ========= ============= ============== ============ ========== ======== ============
The accompanying notes are an integral part of these consolidated financial
statements.
6
CRIIMI MAE INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
For the three months ended March 31,
2003 2002
----------------- ----------------
Cash flows from operating activities:
Net income (loss) before dividends accrued or paid on preferred shares $ 6,088,600 $ (3,892,791)
Adjustments to reconcile net income (loss) before dividends accrued or paid on
preferred shares to net cash provided by operating activities:
Gain on extinguishment of debt (non-cash portion) (7,787,370) -
Amortization of discount and deferred financing costs on debt 2,591,408 1,414,996
Accrual of extension fees related to Exit Debt 336,921 1,075,455
Depreciation and other amortization 173,290 239,976
Discount amortization on mortgage assets, net (2,627,940) (2,699,837)
Net (gains) losses on mortgage security dispositions (188,210) 109,819
Equity in earnings from investments (128,268) (114,304)
Servicing amortization, depreciation and impairment 333,262 507,879
Hedging expense 352,322 89,758
Accelerated vesting of stock options at recapitalization 547,600 -
Amortization of deferred compensation 16,732 59,957
Cumulative effect of adoption of SFAS 142 - 9,766,502
Changes in assets and liabilities:
Decrease in restricted cash and cash equivalents 7,961,575 30,208,370
Decrease (increase) in receivables and other assets 318,508 (755,376)
Decrease in payables and accrued expenses (1,598,125) (3,576,460)
Decrease (increase) in servicing other assets 521,399 (1,002,625)
Decrease (increase) in servicing liabilities (135,145) 1,568,454
Sales of other MBS, net 1,768,874 18,247
--------------- ----------------
Net cash provided by operating activities 8,545,433 33,018,020
--------------- ----------------
Cash flows from investing activities:
Proceeds from mortgage security prepayments and dispositions 47,942,601 17,802,007
Distributions received from AIM Limited Partnerships 831,905 1,052,526
Receipt of principal payments from insured mortgage securities 817,880 1,010,716
Cash received in excess of income recognized on subordinated CMBS 3,025,442 644,609
Proceeds from sale of servicing rights by CMSLP - 8,230,561
Sales of investment-grade CMBS by CMSLP 3,316,508 -
--------------- ----------------
Net cash provided by investing activities 55,934,336 28,740,419
--------------- ----------------
Cash flows from financing activities:
Principal payments on securitized mortgage debt obligations (41,971,272) (18,248,457)
Principal payments on Exit Debt (375,952,338) (9,558,143)
Principal payments on secured borrowings and other debt obligations (28,473) (26,619)
Proceeds from issuance of debt 330,000,000 -
Payment of debt issuance costs (5,910,786) -
Payment of dividends on preferred shares (1,826,059) -
Proceeds from the issuance of common stock, net 13,480,841 -
Redemption of Series E Preferred Stock, including accrued dividends - (18,733,912)
--------------- ----------------
Net cash used in financing activities (82,208,087) (46,567,131)
--------------- ----------------
Net (decrease) increase in other cash and cash equivalents (17,728,318) 15,191,308
Cash and cash equivalents, beginning of period (1) 29,251,348 17,298,873
--------------- ----------------
Cash and cash equivalents, end of period (1) $ 11,523,030 $ 32,490,181
=============== ================
(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.
7
CRIIMI MAE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
1. ORGANIZATION
General
CRIIMI MAE Inc. (together with its consolidated subsidiaries, unless the
context otherwise indicates, 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 CMBS and residential
mortgage-backed securities.
January 2003 Recapitalization
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 in proceeds from
debt and equity financings and a portion of our available cash and liquid
assets. The recapitalization included:
o BREF Equity and Secured Debt. - We issued approximately $14 million in
common equity and $30 million in 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. We refer to the secured subordinated debt as the BREF Debt.
o Bear Stearns Secured Financing. - We received $300 million in secured
financing in the form of a repurchase transaction from a unit of Bear,
Stearns & Co., Inc. (Bear Stearns). We refer to the secured financing
as the Bear Stearns Debt.
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. Mr. Blattman is also the managing
member of Brascan Real Estate Financial Partners LLC, which owns 100%
of the general partner of BREF.
See Notes 6 and 9 for a further discussion of the debt and equity
financings.
Other
We were incorporated in Delaware in 1989 under the name CRI Insured
Mortgage Association, Inc. In July 1993, we changed our name to CRIIMI MAE Inc.
and reincorporated in Maryland. In June 1995, certain mortgage businesses
affiliated with C.R.I., Inc. (CRI) were merged into CRIIMI MAE 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.
8
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. These two subsidiaries hold all of the partnership interests of
CMSLP.
Net Operating Loss for Tax Purposes/Trader Election. For tax purposes we
have elected to be classified as a trader in securities. We trade in both short
and longer duration fixed income securities, including CMBS and 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.
As a result of our election in 2000 to be taxed as a trader, 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 being
recognized evenly for tax purposes over four years beginning with the year 2000
and ending in 2003. We expect such loss to be ordinary, which allows us to
offset our ordinary income.
We generated a net operating loss (or NOL) for tax purposes of
approximately $83.6 million during the year ended December 31, 2002. As such,
our taxable income was reduced to zero and, accordingly, our REIT distribution
requirement was eliminated for 2002. 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.
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 carryforwards 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
9
"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. 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 $337.9
million as of March 31, 2003 will be limited.
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 or potential acquisition of
shares of our capital stock that has created or will create an "ownership
change" under Section 382. 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.
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 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 March 31, 2003, 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.
10
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
Our consolidated financial statements are prepared on the accrual basis of
accounting in accordance with accounting principles generally accepted in the
United States (or GAAP). 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 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.
In our opinion, the accompanying unaudited consolidated financial
statements contain all adjustments (consisting of only normal recurring
adjustments and consolidating adjustments) necessary to present fairly the
consolidated balance sheets as of March 31, 2003 and December 31, 2002
(audited), the consolidated results of operations for the three months ended
March 31, 2003 and 2002, and the consolidated cash flows for the three months
ended March 31, 2003 and 2002. The accompanying consolidated financial
statements include the financial results of CRIIMI MAE and all of our
majority-owned and controlled subsidiaries. All significant intercompany
accounts and transactions have been eliminated in consolidation.
These consolidated financial statements have been prepared pursuant to the
rules and regulations of the SEC. Certain information and note disclosures
normally included in annual financial statements prepared in accordance with
GAAP have been condensed or omitted. While management believes that the
disclosures presented are adequate to make the information not misleading, these
consolidated financial statements should be read in conjunction with the
consolidated financial statements and the notes included in our Annual Report on
Form 10-K for the year ended December 31, 2002.
Reclassifications
Certain 2002 amounts have been reclassified to conform to the 2003
presentation.
Income Recognition and Carrying Basis
Subordinated CMBS and Other Mortgage-Backed Securities
We recognize income on our subordinated CMBS in accordance with 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". 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 (or Other MBS) consists
of amortization of the discount or premium on primarily investment-grade
securities, plus the stated investment interest payments received or accrued on
Other MBS. 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 MBS 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.
11
Insured Mortgage Securities
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.
Insured mortgage securities income consists of amortization of the discount
or premium 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 security.
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.
Impairment
Subordinated CMBS and Other MBS
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. We did not recognize any impairment losses on our
subordinated CMBS during the three months ended March 31, 2003 and 2002.
We assess each Other 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 the three months ended March 31, 2003 and 2002.
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 during the three months ended March 31, 2003 and
2002.
12
Consolidated Statements of Cash Flows
The following is the supplemental cash flow information:
Three months ended March 31,
2003 2002
------------- ------------
Cash paid for interest $21,182,743 $16,734,694
Non-cash investing and financing activities:
Restricted stock issued -- 129,675
Comprehensive Income
The following table presents comprehensive income for the three months
ended March 31, 2003 and 2002:
Three months ended March 31,
2003 2002
-------------- ---------------
Net income (loss) before dividends
accrued or paid on preferred shares $ 6,088,600 $ (3,892,791)
Adjustment to unrealized
gains/losses on mortgage assets 3,026,973 1,119,093
Adjustment to unrealized losses on
interest rate caps 348,086 70,581
-------------- ---------------
Comprehensive income (loss) $ 9,463,659 $ (2,703,117)
============== ===============
The following table summarizes our accumulated other comprehensive income:
March 31, December 31,
2003 2002
-------------- ---------------
Unrealized gains on mortgage assets $ 106,136,795 $ 103,109,822
Unrealized losses on interest rate caps (639,679) (987,765)
-------------- ---------------
Accumulated other comprehensive income $ 105,497,116 $ 102,122,057
============== ===============
Stock-Based Compensation
We account for our stock-based compensation arrangements in accordance with
the intrinsic value method as defined by Accounting Principles Board Opinion
(APB) No. 25, "Accounting for Stock Issued to Employees". Statement of Financial
Accounting Standards (SFAS) No. 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure", which was effective January 1, 2003 for us, requires
certain disclosures related to our stock-based compensation arrangements. The
following table presents the effect on net income and earnings per share if we
had applied the fair value recognition provisions of SFAS No. 123, "Accounting
for Stock-Based Compensation", to our stock-based compensation:
Three months ended March 31,
2003 2002
------------- --------------
Net income (loss) to common shareholders $4,262,541 (1) $ (6,827,981) (1)
Less: Stock-based compensation expense
determined under the fair value based
method for all awards (232,201) (144,553)
------------ -------------
Pro forma net income (loss) to common
shareholders $ 4,030,340 $ (6,972,534)
============ =============
Earnings per share:
Basic - as reported $0.28 $(0.52)
============ =============
Basic - pro forma $0.27 $(0.53)
============ =============
Diluted - as reported $0.28 $(0.52)
============ =============
Diluted - pro forma $0.26 $(0.53)
============ =============
(1) Includes approximately $564,000 and $60,000 of stock-based compensation
expense during the three months ended March 31, 2003 and 2002,
respectively.
13
Recent Accounting Pronouncements
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. As discussed in Note 13, we expect to
recognize approximately $180,000 of restructuring expenses in the second quarter
of 2003 as a result of CMSLP's restructuring of its property servicing group.
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.
3. 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 March 31, 2003 As of December 31, 2002
Amortized Cost Fair Value Amortized Cost Fair Value
--------------- ------------- --------------- ------------
ASSETS:
Subordinated CMBS and Other MBS (1) $ 475,919,237 $ 539,715,818 $ 478,879,460 $540,755,663
CMBS pledged to secure Securitized Mortgage
Obligation - CMBS 287,849,020 327,731,737 287,039,586 326,472,580
Insured mortgage securities 225,360,000 227,711,402 273,655,357 275,340,234
Interest rate protection agreements 639,722 41 992,043 4,277
Servicing other assets See footnote (2) See footnote (2) See footnote (2) See footnote (2)
Servicing cash and cash equivalents 2,620,270 2,620,270 12,582,053 12,582,053
Other cash and cash equivalents 8,902,760 8,902,760 16,669,295 16,669,295
Restricted cash and cash equivalents -- -- 7,961,575 7,961,575
LIABILITIES:
BREF senior subordinated secured note 30,000,000 30,000,000 - -
Bear Stearns variable rate secured debt 300,000,000 300,000,000 - -
Exit variable-rate secured borrowing -- -- 214,672,536 214,672,536
Series A senior secured notes -- -- 92,788,479 92,788,479 (3)
Series B senior secured notes -- -- 68,491,323 68,491,323 (3)
Securitized mortgage obligations:
Collateralized bond obligations-CMBS 286,637,506 327,731,737 285,844,933 326,472,580
Collateralized mortgage obligations-insured
mortgage securities 211,943,244 222,355,967 252,980,104 266,366,729
Mortgage Payable 7,242,449 7,368,224 7,214,189 7,341,397
(1) Includes approximately $3.5 million of amortized cost and fair value
related to Other MBS as of March 31, 2003 and approximately $5.3 million of
amortized cost and $5.2 million of fair value as of December 31, 2002.
(2) CMSLP owned subordinated CMBS and interest-only strips with an aggregate
amortized cost basis of approximately $1.8 million and $1.9 million and a
fair value of approximately $1.9 million and $2.1 million as of March 31,
2003 and December 31, 2002, respectively. Additionally, CMSLP owned
investment-grade CMBS with an aggregate cost basis and fair value of
approximately $3.3 million as of December 31, 2002. The investment-grade
CMBS were sold in January 2003.
14
(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:
CMBS and Other MBS
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 underlying commercial mortgage
loans. We make further fair value adjustments to such pricing information based
on our specific knowledge of our CMBS and the impact of relevant events (such as
our recent recapitalization and the value of competing offers), 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 rated 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 March
31, 2003. Since we calculated the estimated fair value of our CMBS portfolio as
of March 31, 2003 and December 31, 2002, we have disclosed the range of discount
rates by rating category used in determining the fair values as of March 31,
2003 in Note 4.
The liquidity of the subordinated CMBS market has historically been
limited. Additionally, during adverse market conditions, the liquidity of such
market has been severely limited. For this reason, among others, management's
estimate of the value of 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.
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 March 31, 2003 and December 31, 2002, 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
the 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.
15
Obligations Under Financing Facilities
The fair values of the securitized mortgage obligations as of March 31,
2003 and December 31, 2002 were calculated using a discounted cash flow
methodology similar to that discussed for CMBS and Other MBS above. The carrying
amount of the Bear Stearns Debt (and at December 31, 2002, 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
BREF Debt is the same as the face value since the debt was recently issued in
January 2003 and we have determined that there has not been a material change in
related credit spreads. The fair value of the mortgage payable is estimated
based on current market interest rates of commercial mortgage debt. As of
December 31, 2002, the fair values of the Series A and Series B Senior Secured
Notes are the same as the face values since the notes were redeemed in January
2003.
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 March 31, 2003 and December 31, 2002, taking into account current
interest rates and the current creditworthiness of the counterparties. The
amounts were determined based on quotes received from the counterparties to the
agreements.
4. CMBS
As of March 31, 2003, 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 $864 million (representing approximately 74% of our total
consolidated assets) and an aggregate amortized cost of approximately $760
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 March 31, 2003 (in
millions):
Rating Fair Value % of CMBS
------ ---------- ---------
A+, BBB+ or BBB (a) $327.7 38%
BB+, BB or BB- $340.8 39%
B+, B, B- or CCC $176.2 21%
Unrated $19.3 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 March 31, 2003, 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 8.4 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 10.0 years, respectively. The aggregate investment by
the rating of the CMBS is as follows:
16
Discount Rate
or Range of
Weighted Loss Discount Rates
Face Amount Average Adjusted Fair Value Used to Amortized Cost Amortized Cost
as of Pass-Through Weighted as of Calculate as of 3/31/03 as of 12/31/02
Security Rating 3/31/03 (in Rate as of Average 3/31/03 (in Fair Value (in millions) (in millions)
millions) 3/31/03 Life (1) millions) as of 3/31/03 (5)
- ------------------------------------------------------------------------------------------------------------------------------
Investment Grade Portfolio
- --------------------------
A+ (4) $ 62.6 7.0% 3 years $ 66.0 5.1% $ 59.6 $ 59.4
BBB+ (4) 150.6 7.0% 9 years 151.2 7.0% 132.6 132.3
BBB (4) 115.2 7.0% 10 years 110.5 7.7% 95.6 95.3
Retained Portfolio
- ------------------
BB+ 319.0 7.0% 11 years 260.9 9.8%-10.2% 224.0 223.0
BB 70.9 7.0% 13 years 54.5 10.8% 47.0 46.8
BB- 35.5 7.0% 14 years 25.4 11.6% 20.9 20.8
B+ 88.6 7.0% 14 years 50.8 14.9% 46.3 46.0
B 177.2 7.0% 17 years 94.9 15.5%-15.7% 85.4 85.1
B- (2) 118.3 7.1% 22 years 27.3 16.0%-20.0% (8) 27.1 28.1
CCC (2) 70.9 2.4% 2 years 3.2 (9) 3.0 3.8
Unrated/Issuer's
Equity (2) (3) 324.4 1.8% 0.4 years 19.3 (9) 18.7 20.0
---------- -------- -------- --------
Total (7) $ 1,533.2 5.7% 10 years $ 864.0 (7) $ 760.2 (6) $ 760.6
========== ======== ======== ========
(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 March 31, 2003, 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) The CBO-1, CBO-2 and Nomura 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 our 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, the CBO-2 subordinated CMBS 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 March 31, 2003.
(3) The unrated subordinated CMBS from CBO-2 currently does not have a stated
coupon rate since this security is 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 (currently rated 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, from which we currently receive no cash flows, and reflected them
in our subordinated CMBS on the balance sheet.
(5) Amortized cost reflects approximately $248.4 million of cumulative
impairment charges related to certain CMBS (all bonds except those rated
A+ and BBB+), which were recognized through December 31, 2002.
17
(6) See Notes 1 and 8 to Notes to Consolidated Financial Statements for
information regarding the subordinated CMBS for tax purposes.
(7) As of March 31, 2003, the aggregate fair values of the CBO-1, CBO-2 and
Nomura bonds were approximately $18.7 million, $839.8 million and
$5.5 million, respectively.
(8) The discount rate is applied to gross scheduled cash flows as opposed to
loss adjusted cash flows for purposes of calculating fair values.
(9) As a result of the estimated loss of principal on these CMBS, we have used
a significantly higher discount rate to determine a reasonable fair value
of these CMBS. The weighted average loss adjusted yield-to-maturity of the
CCC and unrated/issuer's equity is 5.8% and 8.6%, respectively.
Mortgage Loan Pool
Through CMSLP, our servicing subsidiary, we perform servicing functions on
commercial mortgage loans totaling $16.9 billion and $17.4 billion as of March
31, 2003 and December 31, 2002, respectively. The mortgage loans underlying our
subordinated CMBS portfolio are secured by properties of the types and in the
geographic locations identified below:
03/31/03 12/31/02 03/31/03 12/31/02
Property Type Percentage(i) Percentage(i) Geographic Location(ii) Percentage(i) Percentage(i)
- ------------- ------------- ------------- ----------------------- ------------- -------------
Retail......... 31% 31% California............... 16% 17%
Multifamily.... 28% 28% Texas.................... 12% 12%
Hotel.......... 16% 15% Florida.................. 8% 8%
Office......... 14% 13% Pennsylvania............. 5% 5%
Other (iv)..... 11% 13% Georgia.................. 4% 4%
---- --------- Other(iii)............... 55% 54%
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 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 Subordinated
Healthcare/Senior-Housing CMBS. We currently estimate that the
interest shortfalls and/or realized losses on such healthcare and
senior housing mortgage loans will exceed the Subordinated
Healthcare/Senior Housing CMBS.
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 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 virtually all of the CMBS transactions related to our subordinated CMBS,
CMSLP has an incentive to efficiently and effectively resolve any loan workouts.
As of March 31, 2003 and December 31, 2002, specially serviced mortgage loans
included in the commercial mortgage loans described above were as follows:
18
03/31/03 12/31/02
-------- -----------
Specially serviced loans due to monetary default (a) $ 941.3 million $ 736.1 million
Specially serviced loans due to covenant default/other 212.7 million 74.7 million
---------------- ----------------
Total specially serviced loans (b) $1,154.0 million $ 810.8 million
================ ================
Percentage of total mortgage loans (b) 6.8% 4.7%
================ ================
(a) Includes $156.3 million and $130.5 million, respectively, of real estate
owned by the underlying securitization trusts. See also the table below
regarding property type concentrations for further information on real
estate owned by underlying trusts.
(b) As of April 30, 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 March 31, 2003 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.......... $ 767.5 (1) 66% Florida............. $ 154.6 13%
Retail......... 230.9 (2) 20% Texas............... 115.2 10%
Office......... 53.6 5% Oregon............... 96.0 8%
Multifamily.... 46.3 4% California........... 82.1 7%
Healthcare..... 31.6 3% Georgia ............. 57.9 5%
Industrial..... 14.5 1% Massachusetts........ 54.5 5%
Other.......... 9.6 1% Other................ 593.7 52%
---------- -------- ---------- -----------
Total...... $1,154.0 100% Total............. $1,154.0 100%
========== ======== ========== ===========
(1) Approximately $106.3 million of these loans in special servicing are
real estate owned by the underlying securitization trusts.
(2) Approximately $32.6 million of these loans in special servicing are
real estate owned by the underlying securitization trusts.
As reflected above, as of March 31, 2003, approximately $767.5 million, or
66%, of the specially serviced mortgage loans were 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 March 31, 2003:
Total Outstanding Percentage of Amount in
Principal Balance Total Hotel Loans Special Servicing
------------------ ----------------- -----------------
Full service hotels (1) $ 1.4 billion 54% $ 279.8 million
Limited service hotels (2) 1.2 billion 46% 487.7 million
----------------- ----------------- -----------------
Totals $ 2.6 billion 100% $ 767.5 million
================= ================= =================
(1) Full service hotels are generally mid-price, upscale or luxury hotels
with restaurant and lounge facilities and other amenities.
(2) Limited service hotels are generally hotels with room-only
operations or hotels that offer a bedroom and bathroom, but
limited other amenities, and are often in the budget or economy group.
Of the $767.5 million of hotel loans in special servicing as of March 31,
2003, approximately $528.9 million, or 69%, relate to seven borrowing
relationships more fully described as follows:
o Sixteen loans and eight real estate owned properties with scheduled
principal balances totaling approximately $91.2 million spread across
four CMBS transactions secured by hotel properties throughout the U.S.
As of March 31, 2003, our total exposure, including advances, on these
loans was approximately $95.3 million. In one of these CMBS
transactions, which contains 10 loans with scheduled principal balances
totaling $38.2 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. The 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
19
properties with scheduled principal balances totaling $26.2 million
have become real estate owned by the underlying securitization trusts
and sixteen loans with scheduled principal balances totaling $65.0
million were granted maturity date extensions, were returned to
performing status, and were transferred out of special servicing in
April 2003.
o Twenty-seven loans with scheduled principal balances as of March 31,
2003 totaling approximately $136.9 million spread across three CMBS
transactions secured by hotel properties in the west and Pacific
northwest states. As of March 31, 2003, our total exposure, including
advances, on these loans was approximately $166.6 million. The
borrower filed for bankruptcy protection in October 2001. The borrower
indicated that the properties had experienced reduced operating
performance due to new competition, the economic recession, and reduced
travel resulting from the September 11, 2001 terrorist attacks. We
entered into a consensual settlement agreement dated February 25, 2003
pursuant to which the loan terms will be amended and modified, which
was subsequently approved and confirmed by the bankruptcy court on
March 28, 2003. In addition, subsequent to March 31, 2003, the
borrower sold one of the properties that secured these loans.
Application of the net sales proceeds for that property has reduced the
total exposure by approximately $800,000. In addition, the borrower
has remitted approximately $1.5 million in funds from debtor in
possession accounts, which has been applied to arrearages. The parties
are currently proceeding toward closing a comprehensive loan
modification that should return the loans to performing status in the
near future.
o Five loans with scheduled principal balances totaling approximately
$45.5 million secured by hotel properties in Florida and Texas. As of
March 31, 2003, our total exposure, including advances, on these loans
was approximately $49.6 million. The loans are past due for the July
2002 and all subsequent payments. We have reached a preliminary
agreement with the borrower on a consensual modification of the loan
terms, and are working toward a formal modification agreement that is
expected to return the loans to performing status in 2003.
o Nine loans with scheduled principal balances totaling approximately
$19.0 million secured by limited service hotels in midwestern states.
As of March 31, 2003, our total exposure, including advances, on these
loans was approximately $21.4 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. We were attempting to
negotiate a workout with the borrower when the borrower filed for
bankruptcy protection in February 2003.
o One loan with a scheduled principal balance as of March 31, 2003
totaling approximately $80.7 million secured by 13 extended stay hotels
located throughout the U.S. 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. We 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 as of March 31, 2003
totaling approximately $129.8 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 with this borrower
in an attempt to reach a consensual resolution of this matter.
o One loan with a scheduled principal balance of approximately $25.8
million, secured by a hotel in Boston, MA. As of March 31, 2003, our
total exposure, including advances, on this loan was approximately
$26.0 million. This loan was transferred into special servicing in
March 2003. The borrower has stated an inability to make payments, and
has requested a loan restructure due to reduced operating performance
at the property.
20
For each of the borrowing relationships described in the paragraphs above,
we believe that we have made an appropriate estimate of losses that we may incur
in the future, which are used in determining our CMBS yields and fair values.
There can be no assurance that the losses incurred in the future will not exceed
our current estimates.
The following table provides a summary of the change in the balance of
specially serviced loans from December 31, 2002 to March 31, 2003:
(in millions)
-------------
Specially Serviced Loans, December 31, 2002 $ 810.8
Transfers in due to monetary default 239.7
Transfers in due to covenant default and other 158.6
Transfers out of special servicing (48.5)
Loan amortization (1) (6.6)
-------------
Specially Serviced Loans, March 31, 2003 $1,154.0
=============
(1) Represents the reduction of the scheduled principal balances due to
advances made by the master servicers.
For loans in special servicing, we are pursuing remedies available to us 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
resulting from appraisal reductions. An appraisal reduction event generally
results in reduced master servicer principal and interest advances based on the
amount by which the sum of the unpaid principal balance of the loan, accumulated
principal and interest advances and other expenses exceeds 90% (in most cases)
of the newly appraised value of the property underlying the mortgage loan. As
the holder of the lowest rated and first loss bonds, our bonds are the first to
experience interest shortfalls as a result of the reduced advancing requirement.
In general, the master servicer can advance up to a maximum of the difference
between 90% of the property's appraised value and the sum of accumulated
principal and interest advances and expenses. As an example, assuming a weighted
average coupon of 6% on a first loss subordinated CMBS, a $1 million appraisal
reduction would reduce our net cash flows by $60,000 on an annual basis. The
ultimate disposition or work-out of the mortgage loan may result in a higher or
lower realized loss on our subordinated CMBS than the calculated appraisal
reduction amount. 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
January 1, 2003 through March 31, 2003 3,190 29,224 3,845 36,259
------- -------- ------- ----------
Cumulative Appraisal Reductions through March 31, 2003 $29,749 $129,010 $18,249 $ 177,008
======= ======== ======= ==========
* 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 securities 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 March 31, 2003 (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:
21
(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
Actual realized losses, January 1 through March 31, 2003 465 6,693 662 7,820
-------- -------- ------- --------
Cumulative actual realized losses through March 31, 2003 $ 16,503 $ 41,290 $ 1,463 $ 59,256
======== ======== ======= ========
Cumulative expected realized loss estimates (including
cumulative actual realized losses) through the year 2003 $ 70,448 $171,368 $ 7,239 $249,055
Expected loss estimates for the year 2004 17,771 89,783 20,016 127,570
Expected loss estimates for the year 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
======== ======== ======= =========
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 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,
continued hostilities in the Middle East or elsewhere, terrorism, unexpected
delays 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.
Yield to Maturity
The following table summarizes yield-to-maturity information relating to
our CMBS on an aggregate pool basis:
Current
Anticipated Anticipated
Yield-to- Yield-to-
Maturity Maturity
Pool as of 1/1/02 (1) as of 1/1/03 (1)
---- ---------------- ----------------
CBO-2 CMBS 12.1% 11.6%
CBO-1 CMBS 14.3% 11.6%
Nomura CMBS 28.7% 8.0%
------ ------
Weighted Average (2) 12.4% 11.6%
(1) Represents the anticipated weighted average yield over the expected average
life of the CMBS as of January 1, 2002 and January 1, 2003 based on our
estimate of the timing and amount of future credit losses.
(2) GAAP requires that the income on 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. During the three months
ended March 31, 2003, we received cash of approximately $3.0 million
in excess of income recognized on subordinated CMBS, partially offset by
approximately $2.6 million of discount amortization due to the effective
interest method. During the three months ended March 31, 2002, we
recognized approximately $2.7 million of discount amortization, partially
offset by approximately $645,000 of cash received in excess of income
recognized on subordinated CMBS due to the effective interest method.
22
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 $49.4 million (or 5.7%) and $94.8 million (or
11.0%), respectively, and our subordinated CMBS by approximately $31.6 million
(or 5.9%) and $60.6 million (or 11.3%), 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.
5. INSURED MORTGAGE SECURITIES
We own the following insured mortgage securities directly or indirectly
through wholly owned subsidiaries:
As of March 31, 2003
Number of
Mortgage Weighted Average Weighted Average
Securities Fair Value Amortized Cost Effective Interest Rate Remaining Term
----------- -------------- ----------------- ------------------------- -----------------
CRIIMI MAE Financial Corporation 19 $ 69,609,769 $ 68,733,111 8.44% 25 years
CRIIMI MAE Financial Corporation II 24 120,912,450 119,855,916 7.21% 23 years
CRIIMI MAE Financial Corporation III (3) 14 37,189,183 36,770,973 7.99% 26 years
-- ------------- ------------ ------ ---------
57 (1) $227,711,402 $225,360,000 7.71% (2) 24 years (2)
== ============= ============ ====== =========
As of December 31, 2002
Number of
Mortgage Weighted Average Weighted Average
Securities Fair Value Amortized Cost Effective Interest Rate Remaining Term
----------- -------------- ----------------- -------------------------- ----------------
CRIIMI MAE 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 16 46,579,332 46,266,537 7.92% 27 years
-- ------------ ------------ ------ ---------
67 $275,340,234 $273,655,357 7.67% (2) 25 years (2)
== ============ ============ ====== =========
(1) During the three months ended March 31, 2003, nine mortgage loans
underlying our mortgage securities were prepaid. These prepayments
generated net proceeds of approximately $42.0 million and resulted in a
financial statement net loss of approximately $(169,000), which is included
in net gains (losses) on mortgage security dispositions in the accompanying
consolidated statement of income for the three months ended March 31, 2003.
In addition, we sold the insured mortgage security that was owned by CRIIMI
MAE for approximately $5.7 million, which resulted in a gain of
approximately $357,000 during the three months ended March 31, 2003.
Approximately 16.6% (based on amortized cost) of the insured mortgage loans
either prepaid or were sold during the three months ended March 31, 2003.
(2) 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.
(3) As of February 2003, we have the option of prepaying the CRIIMI MAE
Financial Corporation III debt since the current face value of the debt is
less than 20% of the
23
original face value.
6. OBLIGATIONS UNDER FINANCING FACILITIES
The following table summarizes our debt outstanding as of March 31, 2003
and December 31, 2002 and for the three months ended March 31, 2003.
As of and for the three months ended March 31, 2003
----------------------------------------------------------------
Average
Effective Rate Effective December 31, 2002
Ending Balance at Quarter End Average Balance Rate Ending Balance
-------------- -------------- --------------- --------- -----------------
Recourse to CRIIMI MAE:
- ----------------------
Bear Stearns debt (1) $ 300,000,000 4.9% $ 256,666,667 4.5% $ --
BREF debt (2) 30,000,000 16.2% 25,333,333 16.6% --
Exit variable-rate secured borrowing (3) -- -- 52,255,135 6.7% 214,672,536
Series A senior secured notes (4) -- -- 71,888,103 11.9% 92,788,479
Series B senior secured notes (5) -- -- 53,271,029 20.3% 68,491,323
Non-Recourse to CRIIMI MAE:
- --------------------------
Securitized mortgage obligations:
CMBS (6) 286,637,506 9.1% 286,241,220 9.1% 285,844,933
Freddie Mac funding note (7) 114,652,691 7.6% 127,101,546 9.8% 139,550,402
Fannie Mae funding note (8) 35,529,572 7.4% 40,215,992 10.5% 44,902,412
CMO (9) 61,760,981 7.5% 65,144,136 8.5% 68,527,290
Mortgage payable (10) 7,242,449 12.0% 7,225,311 12.0% 7,214,189
------------- -------------- -------------
Total debt $ 835,823,199 7.5% $ 985,342,472 8.9% $ 921,991,564
============= ============= =============
(1) The effective interest rate reflects the amortization of deferred financing
fees. During the three months ended March 31, 2003, we recognized $308,376
of interest expense related to the amortization of the deferred financing
fees.
(2) The effective interest rate reflects the amortization of deferred financing
fees. During the three months ended March 31, 2003, we recognized $76,099
of interest expense related to the amortization of the deferred financing
fees.
(3) The effective interest rate during the three months ended March 31, 2003
reflects the accrual of estimated extension fees through January 23, 2003.
During the three months ended March 31, 2003 and 2002, we recognized
interest expense of $251,391 and $842,632 related to these estimated
extension fees. This debt was repaid in full on January 23, 2003, and the
cumulative accrued extension fees (from April 17, 2001 through January 23,
2003) were reversed into income in gain on extinguishment of debt.
(4) The effective interest rate during the three months ended March 31, 2003
reflects the accrual of estimated extension fees through January 23, 2003.
During the three months ended March 31, 2003 and 2002, we recognized
interest expense of $33,664 and $64,560 related to these estimated
extension fees. This debt was repaid in full on March 10, 2003, and the
cumulative accrued extension fees (from April 17, 2001 through January 23,
2003) were reversed into income in gain on extinguishment of debt.
(5) The effective interest rate during the three months ended March 31, 2003
reflects the accrual of estimated extension fees through January 23, 2003.
During the three months ended March 31, 2003 and 2002, we recognized
interest expense of $51,866 and $168,263 related to these estimated
extension fees. This debt was repaid in full on March 10, 2003, and the
cumulative accrued extension fees (from April 17, 2001 through January 23,
2003) were reversed into income in gain on extinguishment of debt.
(6) As of March 31, 2003 and December 31, 2002, the face amount of the debt was
$328,446,000 with unamortized discount of $41,808,494 and $42,601,067,
respectively. During the three months ended March 31, 2003 and 2002,
discount amortization of $792,573 and $618,100, respectively, was recorded
as interest expense.
(7) As of March 31, 2003 and December 31, 2002, the face amount of the note was
$117,580,033 and $143,066,791, respectively, with unamortized discount of
$2,927,342 and $3,516,389, respectively. During the three months ended
March 31, 2003 and 2002, discount amortization of $589,047 and $448,508,
respectively, was recorded as interest expense. The average effective
interest rate reflects approximately $557,000 of additional interest
expense during the three months ended March 31, 2003 due to the mortgages
underlying the insured mortgage securities prepaying at a faster rate than
anticipated. Under the effective interest method of recognizing interest
expense, the prepayments of the debt required an adjustment to cumulative
interest expense related to the amortization of discount and deferred fees.
24
(8) As of March 31, 2003 and December 31, 2002, the face amount of the note was
$36,200,707 and $45,749,641, respectively, with unamortized discount of
$671,135 and $847,229, respectively. During the three months ended March
31, 2003 and 2002, discount amortization of $176,094 and $20,649,
respectively, was recorded as interest expense. The average effective
interest rate reflects approximately $247,000 of additional interest
expense during the three months ended March 31, 2003 due to the mortgages
underlying the insured mortgage securities prepaying at a faster rate than
anticipated. Under the effective interest method of recognizing interest
expense, the prepayments of the debt required an adjustment to cumulative
interest expense related to the amortization of discount and deferred fees.
(9) As of March 31, 2003 and December 31, 2002, the face amount of the note was
$63,046,537 and $69,982,117, respectively, with unamortized discount of
$1,285,556 and $1,454,827, respectively. During the three months ended
March 31, 2003 and 2002, discount amortization of $169,271 and $75,186,
respectively, was recorded as interest expense. The average effective
interest rate reflects approximately $166,000 of additional interest
expense during the three months ended March 31, 2003 due to the mortgages
underlying the insured mortgage securities prepaying at a faster rate than
anticipated. Under the effective interest method of recognizing interest
expense, the prepayments of the debt required an adjustment to cumulative
interest expense related to the amortization of discount and deferred fees.
(10) As of March 31, 2003 and December 31, 2002, the unpaid principal balance of
this mortgage payable was $8,695,423 and $8,723,895, respectively, and the
unamortized discount was $1,452,974 and $1,509,707, 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 three months ended March 31, 2003 and 2002, discount
amortization of $56,733 and $51,707, respectively, was recorded as interest
expense.
Debt Incurred in Connection with January 2003 Recapitalization
Bear Stearns Debt
Bear Stearns provided $300 million in secured financing in the form of a
repurchase transaction under the January 2003 recapitalization. The Bear Stearns
Debt matures in 2006, bears interest at a rate equal to one-month LIBOR plus 3%,
payable monthly, 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 enter into such transaction. Although CRIIMI MAE Inc.
(unconsolidated) 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. We also paid $250,000 of Bear Stearns'
legal expenses.
On the effective date of our 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. The indirect first liens are first liens on
the equity interests of three of our subsidiaries that hold certain subordinated
CMBS. 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.
BREF Debt
In connection with the January 2003 recapitalization, BREF purchased $30
million of our newly issued subordinated 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%. The interest on the BREF Debt is payable semi-annually and
there are no principal payments until maturity. If we decide
25
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. We paid an origination fee
of 0.67% to BREF related to the BREF Debt and an aggregate of $1 million for
expenses in connection with the transactions. Pursuant to the Investment
Agreement with BREF, we are also obligated to pay BREF a quarterly maintenance
fee of $434,000 through January 2006.
Exit Debt
The Exit Debt consisted of the Exit Variable-Rate Secured Borrowing, the
Series A Senior Secured Notes and the Series B Senior Secured Notes. The annual
interest rate on the Exit Variable-Rate Secured Borrowing, Series A Senior
Secured Notes and Series B Senior Secured Notes was LIBOR plus 3.25%, 11.75% and
20%, respectively. The Exit Debt was repaid in full during the three months
ended March 31, 2003.
Gain on Extinguishment of Exit Debt
During the three months ended March 31, 2003, we reversed approximately
$7.8 million of accrued extension fees related to the Exit Debt since the debt
was repaid and the extension fees were no longer payable. This reversal is
reflected as a gain on extinguishment of debt in our consolidated statement of
income. This reversal was partially offset by approximately $403,000 of breakage
fee paid to the lender of the Exit Variable-Rate Secured Borrowing and legal
fees of approximately $47,000, resulting in a gain on extinguishment of debt of
$7.4 million.
Other Debt Related Information
Fluctuations in interest rates will continue to impact the value of our
mortgage assets and could result in margin calls and impact the net interest
margin through increased cost of funds on our variable rate debt. We have an
interest rate cap to partially limit the adverse effects of rising interest
rates on our variable rate debt. When the cap expires, we will have interest
rate risk to the extent interest rates increase on our variable rate debt unless
the cap is replaced with another hedge 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 rate. See Note 7
for further discussion of the interest rate cap. As of March 31, 2003, our
debt-to-equity ratio was approximately 2.7 to 1 and our non-match-funded
debt-to-equity ratio was approximately 1.1 to 1.
The following table lists the fair market value of the collateral related
to our securitized mortgage obligations (in millions):
Collateral Fair Value as of
Securitized Mortgage Obligations March 31, 2003 December 31, 2002
- -------------------------------- -------------- -----------------
CMBS $ 328 $ 326
Freddie Mac Funding Note 121 146
Fannie Mae Funding Note 37 47
CMO 70 77
26
7. INTEREST RATE PROTECTION AGREEMENTS
As of March 31, 2003, 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. One of our caps, with a notional
amount of $165.5 million and a LIBOR cap of 5.25%, matured on April 2, 2003. At
March 31, 2003, the remaining interest rate cap had the following terms:
Notional Amount Effective Date Maturity Date Cap Index
- --------------- -------------- -------------- ---- -----
$ 175,000,000 (1) May 1, 2002 November 3, 2003 3.25% (3) 1 month LIBOR
(1) Our designated (as defined in SFAS No. 133) interest rate cap hedges
approximately 58% of our variable-rate secured debt as of March 31, 2003.
(2) One-month LIBOR was 1.30% at March 31, 2003.
8. DIFFERENCES BETWEEN FINANCIAL STATEMENT NET INCOME (LOSS) AND TAXABLE LOSS
The differences between financial statement (GAAP) net income (loss) and
taxable income (loss) are generally attributable to differing treatment of
unrealized/realized gains and losses associated with certain assets; the bases,
income, impairment, and/or credit loss recognition related to certain assets;
and amortization of various costs. The distinction between GAAP net income
(loss) and taxable income (loss) is important to 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 through 2003 for tax purposes
(i.e., approximately $120 million per year) beginning with the year 2000.
A summary of our year-to-date net operating loss as of March 31, 2003 is as
follows:
(in millions)
-----------------
January 2000 Loss $ 478.2
LESS: Amounts recognized in 2002, 2001 and 2000 (358.6)
LESS: Amounts recognized during the three months ended March 31, 2003 (29.9)
--------
Balance remaining of January 2000 Loss to be recognized during the remainder of 2003 $ 89.7
========
Taxable income for the three months ended March 31, 2003 before recognition
of January 2000 Loss $ 5.5
LESS: January 2000 Loss recognized during the three months ended March 31, 2003 (29.9)
--------
Net Operating Loss for the three months ended March 31, 2003 $ (24.4)
========
Accumulated Net Operating Loss through December 31, 2002 $(223.8)
Net Operating Loss created during the three months ended March 31, 2003 (24.4)
Net Operating Loss utilization -
--------
Net Operating Loss carried forward for use in future periods $(248.2)
========
Accumulated and unused net operating loss and remaining January 2000 Loss $ 337.9
========
27
9. COMMON STOCK
We had 300,000,000 authorized shares and 15,162,685 and 13,945,068 issued
and outstanding shares of $0.01 par value common stock as of March 31, 2003 and
December 31, 2002, respectively. In connection with the 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.
The following table summarizes the common stock activity through March 31,
2003:
Common Shares Balance of Common
Date Description Issued Shares Outstanding
- ------------------------ ----------------------------------------- ----------------- -------------------
12/31/02 Beginning balance 13,945,068
Shares issued to BREF 1,212,617
Stock options exercised 5,000
- ------------------------------------------------------------------------------------------------------------
03/31/03 Balance 15,162,685
- ------------------------------------------------------------------------------------------------------------
In connection with the January 2003 recapitalization, 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 using the Black-Scholes option pricing model. The
assumptions we used to value the warrants are consistent with the assumptions
used to value our stock options. The warrants are a component of equity.
10. PREFERRED STOCK
As of March 31, 2003 and December 31, 2002, 75,000,000 shares of preferred
stock were authorized. As of March 31, 2003 and December 31, 2002, 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, 3,760,000 shares were designated as Series G Redeemable
Cumulative Dividend Preferred Stock and 45,000 shares were designated as Series
H Junior Preferred Stock.
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.
Series B Cumulative Convertible Preferred Stock
As of March 31, 2003 and December 31, 2002, there were 1,593,982 shares of
Series B Preferred Stock issued and outstanding. The following table summarizes
the 2003 dividend payment activity for the Series B Preferred Stock:
Time Period for
Dividends per Amount of which dividends
Declaration Date Payment Date Series B Share Dividends (a) were accrued
- ----------------------------------------------------------------------------------------
March 4, 2003 March 31, 2003 $ 0.68 $ 1,083,908 04/1/02-6/30/02
(a) Although the payments of dividends for the third quarter of 2002 through
the first quarter of 2003 were deferred, as of March 31, 2003, we have
accrued $3,251,723 for the Series B Preferred Stock third quarter 2002
through first quarter 2003 dividends at a dividend rate of $0.68 per share
per quarter.
As of March 31, 2003, each share of Series B Preferred Stock was
convertible into 0.4797 shares of common stock.
28
Series E Cumulative Convertible Preferred 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 three months
ended March 31, 2002.
Series F Redeemable Cumulative Dividend Preferred Stock
As of March 31, 2003 and December 31, 2002, there were 586,354 shares of
Series F Preferred Stock issued and outstanding. The following table summarizes
the 2003 dividend payment activity for the Series F Preferred Stock:
Time period for
Dividends per Amount of which dividends
Declaration Date Payment Date Series F Share Dividends (a) were accrued
- --------------------------------------------------------------------------------------------
March 4, 2003 March 31, 2003 $ 0.30 $ 175,906 04/1/02-06/30/02
(a) Although the payments of dividends for the third quarter of 2002 through
the first quarter of 2003 were deferred, as of March 31, 2003, we have
accrued $527,719 for the Series F Preferred Stock third quarter 2002
through first quarter 2003 dividends at a dividend rate of $0.30 per share
per quarter.
Series G Redeemable Cumulative Dividend Preferred Stock
As of March 31, 2003 and December 31, 2002, there were 1,244,656 shares of
Series G Preferred Stock issued and outstanding. The following table summarizes
the 2003 dividend payment activity for the Series G Preferred Stock:
Time period for
Dividends per Amount of which dividends
Declaration Date Payment Date Series G Share Dividends (a) were accrued
- ------------------------------------------------------------------------------------
March 4, 2003 March 31, 2003 $ 0.375 $ 466,746 04/1/02-06/30/02
(a) Although the payments of dividends for the third quarter of 2002 through
the first quarter of 2003 were deferred, as of March 31, 2003, we have
accrued $1,400,238 for the Series G Preferred Stock third quarter 2002
through first quarter 2003 dividends at a dividend rate of $0.375 per share
per quarter.
Series H Junior Preferred Stock
As of March 31, 2003 and December 31, 2002, there were no issued or
outstanding shares of Series H Preferred Stock.
29
11. EARNINGS PER SHARE
The following tables reconcile basic and diluted earnings per share for the
three months ended March 31, 2003 and 2002.
For the three months ended March 31, 2003 For the three months ended March 31, 2002
Per Share Per Share
Income Shares Amount Income Shares (2) Amount
--------------- --------------- -------------- --------------- --------------- -------------
Net income before cumulative effect
of change in accounting principle $ 4,262,541 14,958,833 $ 0.28 $ 2,938,521 13,055,303 $ 0.23
Cumulative effect of change in
accounting principle related to
SFAS 142 -- -- -- (9,766,502) 13,055,303 (0.75)
-------------- -------------- ----------- --------------- ------------ -----------
Basic income (loss) per share:
- -----------------------------
Income (loss) to common
shareholders 4,262,541 14,958,833 0.28 (6,827,981) 13,055,303 (0.52)
Dilutive effect of securities (1):
Stock options -- 341,853 -- -- -- --
Warrants outstanding -- -- -- -- -- --
Convertible preferred stock -- -- -- -- -- --
-------------- -------------- ----------- --------------- ------------ -----------
Diluted income (loss) per share:
- -------------------------------
Income (loss) to common
shareholders and assumed
conversions $ 4,262,541 15,300,686 $ 0.28 $ (6,827,981) 13,055,303 $ (0.52)
============== =============== =========== =============== ============ ===========
(1) The common stock equivalents for the Preferred Stock that are convertible
as of March 31 of the applicable year and the warrants outstanding are not
included in the calculation of diluted EPS if the effect would be
anti-dilutive.
(2) Includes the weighted average number of common shares payable or paid to
preferred stockholders related to dividends as of the respective dividend
declaration dates.
12. TRANSACTIONS WITH RELATED PARTIES
Below is a summary of the related party transactions which occurred during
the three months ended March 31, 2003 and 2002.
Three months ended March 31,
2003 2002
---- ----
Amounts received or accrued from the AIM
Limited Partnerships
Income(1) $ 115,980 $ 146,449
Return of capital(2) 233,542 845,102
--------- ---------
Total $ 349,522 $ 991,551
========= =========
Amounts received or accrued from AIM
Acquisition Limited Partnership (1) $ 48,458 $ 60,976
========= =========
Expense reimbursements from AIM Limited
Partnerships (3) $ 41,484 $ 51,497
========= =========
Expense reimbursements to affliates of BREF
and employees of those affiliates (3) $ 7,452 $ -
========= =========
Expense reimbursement (to) from CRI:
Expense reimbursement to CRI (3) (4) $ (49,773) $ (43,458)
Expense reimbursement from CRI (3) (4) 53,435 22,899
--------- ---------
Net expense reimbursement from (to) CRI $ 3,662 $ (20,559)
========= =========
(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.
30
(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, 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. Our former Chairman, who is currently a director, is a
director, executive officer and principal shareholder of CRI.
As previously discussed, Barry Blattman, our Chairman, CEO and President,
is affiliated with BREF. The Board's Compensation and Stock Option Committee is
considering various alternatives with respect to the employment arrangement for
Mr. Blattman, including, but not limited to, entering into a management
agreement with Brascan Real Estate Financial Partners LLC. As of March 31, 2003,
we have accrued the estimated compensation expected to be payable upon the
completion of Mr. Blattman's employment arrangement.
As discussed in Note 6, we paid BREF an origination fee of 0.67% related to
the BREF Debt and an aggregate of $1 million for expenses in connection with the
January 2003 recapitalization transactions. Pursuant to the Investment Agreement
with BREF, we are obligated to pay BREF a quarterly maintenance fee of $434,000.
As discussed in Note 9, in connection with the January 2003 recapitalization, we
issued seven-year warrants to BREF to purchase up to 336,835 shares of our
common stock at $11.50 per share. There are also other existing and potential
relationships, transactions and agreements with BREF and/or certain of its
affiliates relating to the composition of our Board of Directors, additional
subordinated debt financing, non-competition and other matters.
In connection with the January 2003 recapitalization, we amended the
employment contracts of our former Chairman, William B. Dockser, and former
President, H. William Willoughby, to provide for their termination on January
23, 2003. During the three months ended March 31, 2003, we recognized
approximately $2.6 million of expenses related to severance and related benefit
payments, and accelerated vesting of certain outstanding stock options held by
Messrs. Dockser and Willoughby. These expenses are reflected as executive
severance at recapitalization in our consolidated statement of income.
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 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 March 31, 2003) plus 2% per annum. For the three months ended
March 31, 2003 and 2002, aggregate payments of approximately $147,000 and
$159,000, respectively, were made on the Note Receivable/deferred compensation.
These aggregate payments were split approximately equally among Messrs. Dockser
and Willoughby. The unpaid aggregate principal balance on the note
receivable/deferred compensation was approximately $1,250,533 at March 31, 2003.
The financial statement impact of these transactions is immaterial.
13. 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 mortgage securities and entities that
own government insured mortgage securities and mezzanine loans and (iv)
securities trading activities. Our income from this segment is primarily
generated from these assets.
31
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. 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.
In April 2003, CMSLP restructured its property servicing group. In
connection with the restructuring, 15 employee positions are being eliminated
during the second quarter of 2003. We expect to recognize approximately $180,000
of severance expenses during the second quarter of 2003. In conjunction with
this restructuring, we are exploring various alternatives related to the
servicing functions performed by the property servicing group, including, but
not limited to, outsourcing the responsibilities. There can be no assurance that
we will be able to achieve such alternatives.
The following tables detail our financial performance by these two primary
lines of business for the three months ended March 31, 2003 and 2002. The basis
of accounting used in the tables is GAAP.
As of and for the three months ended March 31, 2003
------------------------------------------------------------------------------------
Elimination of
Portfolio Mortgage Intercompany
Investment Servicing Transactions Consolidated
------------------- ---------------- ------------------- ------------------
Interest income $ 26,723,870 $ - $ - $ 26,723,870
Interest expense (21,905,211) - 2,702 (21,902,509)
------------------- ---------------- ------------------- ------------------
Net interest margin 4,818,659 - 2,702 4,821,361
------------------- ---------------- ------------------- ------------------
General and administrative expenses (2,809,682) - (138,960) (2,948,642)
Depreciation and amortization (173,290) - - (173,290)
Servicing income - 2,127,263 (2,702) 2,124,561
Servicing general and administrative expenses - (2,369,931) 138,960 (2,230,971)
Servicing amortization, depreciation
and impairment - (333,262) - (333,262)
Income tax benefit - 172,376 - 172,376
Equity in earnings from investments 128,268 - - 128,268
Other, net 179,064 - - 179,064
BREF Maintenance fee (371,311) (371,311)
Executive severance at recapitalization (2,616,978) (2,616,978)
Gain on extinguishment debt 7,337,424 - - 7,337,424
------------------- ---------------- ------------------- ------------------
1,673,495 (403,554) (2,702) 1,267,239
------------------- ---------------- ------------------- ------------------
Net income (loss) before changes in
accounting principles $ 6,492,154 $ (403,554) $ - $ 6,088,600
=================== ================ =================== ==================
Total assets $ 1,155,378,500 $ 12,037,430 $ - $ 1,167,415,930
=================== ================ =================== ==================
32
As of and for the three months ended March 31, 2002
------------------------------------------------------------------------------------
Elimination of
Portfolio Mortgage Intercompany
Investment Servicing Transactions Consolidated
------------------- ---------------- ------------------- ------------------
Interest income $ 32,031,879 $ - $ - $ 32,031,879
Interest expense (23,306,215) - - (23,306,215)
------------------- ---------------- ------------------- ------------------
Net interest margin 8,725,664 - - 8,725,664
------------------- ---------------- ------------------- ------------------
General and administrative expenses (3,269,940) - 67,326 (3,202,614)
Depreciation and amortization (239,976) - - (239,976)
Servicing income - 2,962,118 (198,582) 2,763,536
Servicing general and administrative
expenses - (2,622,350) 131,256 (2,491,094)
Servicing amortization, depreciation
and impairment - (507,879) - (507,879)
Income tax benefit - 66,444 - 66,444
Equity in earnings from investments 114,304 - - 114,304
Other, net 645,326 - - 645,326
------------------- ---------------- ------------------- ------------------
(2,750,286) (101,667) - (2,851,953)
------------------- ---------------- ------------------- ------------------
Net income (loss) before changes in
accounting principles $ 5,975,378 $ (101,667) $ - $ 5,873,711
=================== ================ =================== ==================
Total assets $ 1,239,647,801 $ 26,427,633 $ - $ 1,266,075,434
=================== ================ =================== ==================
33
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS. When used in this Quarterly Report on Form 10-Q, 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 Quarterly
Report on Form 10-Q pursuant to the "safe harbor" provision of the Private
Securities Litigation Reform Act of 1995. Such statements are subject to certain
risks and uncertainties, which could cause actual results to differ materially,
including, but not limited to, the risk factors contained or referenced herein
and in our reports filed with the SEC pursuant to the Securities Exchange Act of
1934, as amended, including our Annual Report on Form 10-K for the year ended
December 31, 2002. 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
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 CMBS and residential
mortgage-backed securities.
January 2003 Recapitalization
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 in proceeds from
debt and equity financings and a portion of our available cash and liquid
assets.
The recapitalization included:
o BREF Equity and Secured Debt. - We issued approximately $14 million in
common equity and $30 million in 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. We refer to the secured subordinated debt as the BREF Debt.
o Bear Stearns Secured Financing. - We received $300 million in secured
financing in the form of a repurchase transaction from a unit of Bear,
Stearns & Co., Inc. (Bear Stearns). We refer to the secured financing
as the Bear Stearns Debt.
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. Mr. Blattman is also the managing
member of Brascan Real Estate Financial Partners LLC, which owns 100%
of the general partner of BREF.
34
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. See "Financial Condition, Liquidity and Capital
Resources" for a more complete description of the recapitalization.
Goals and Strategy
Our goal is to 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 experience 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 experience 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 cash flows.
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) risks
associated with our ability to implement business strategies and achieve
business goals; (9) failure to manage the mismatch between long-term assets and
short-term funding; (10) risk of loss of REIT status and other tax matters; (11)
the effect of interest rate compression on the market price of our stock; (12)
the effect of the yield curve on borrowing costs; (13) results of operations
adversely affected by factors beyond our control; (14) competition; (15) risk of
becoming subject to the requirements of the Investment Company Act of 1940; (16)
the effect of phantom (non-cash) income on total income; and (17) taxable
mortgage pool risk.
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.
35
2003 compared to 2002
Results of Operations
Financial statement net income available to common shareholders for the
three months ended March 31, 2003 was approximately $4.3 million, or $0.28 per
diluted share. This compares to a net loss to common shareholders of
approximately $(6.8) million, or $(0.52) per diluted share, for the three months
ended March 31, 2002.
Results for the three months ended March 31, 2003, which are discussed in
further detail below, include certain items related to the January 2003
recapitalization:
o approximately $7.3 million of gain on extinguishment of debt;
o approximately $2.6 million of executive severance costs; and
o approximately $3.1 million of additional interest expense during the
45 day redemption notice period for the Series A and Series B Senior
Secured Notes.
In addition, our interest expense was approximately $1.0 million higher
during the first 23 days of 2003 under the Exit Debt as compared to the
remainder of the quarter with respect to the Bear Stearns and BREF Debt.
Results for the three months ended March 31, 2002, which are discussed in
further detail below, include:
o an approximate $9.8 million charge to write-off goodwill upon the
adoption of Statement of Financial Accounting Standards (or SFAS)
No. 142; 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).
Interest Income - CMBS
Interest income from CMBS decreased by approximately $3.5 million, or 14%,
to $22.1 million during the three months ended March 31, 2003 as compared to
$25.5 million during the three months ended March 31, 2002. This decrease in
interest income was primarily due to changes in our loss estimates related to
CMBS and the resulting reduction in the weighted average yield-to-maturity on
our CMBS. The changes resulted in the aggregate $70.2 million of non-cash
impairment charges that were recognized during the second through fourth
quarters of 2002.
Accounting principles generally accepted in the United States, or GAAP,
require that interest income earned on CMBS be recorded based on the effective
interest method using the anticipated yield over the expected life of the CMBS.
Based upon assumptions as to the timing and amount of future credit losses and
certain other items estimated by management, the weighted average anticipated
unleveraged yield for our CMBS for financial statement purposes was
approximately 11.6% as of January 1, 2003 and approximately 12.4% as of January
1, 2002. These yields were determined based on the anticipated yield over the
expected life of our CMBS, which considers, among other things, anticipated
losses and any other than temporary impairment. The effective interest method of
recognizing interest income on CMBS results in income recognition that differs
from cash received. During the three months ended March 31, 2003, we received
cash of approximately $3.0 million in excess of income recognized on
subordinated CMBS, partially offset by approximately $2.6 million of discount
amortization due to the effective interest method. During the three months ended
March 31, 2002, we recognized approximately $2.7 million of discount
amortization, partially offset by approximately $645,000 of cash received in
excess of income recognized on subordinated CMBS due to the effective interest
method.
Interest Income - Insured Mortgage Securities
Interest income from insured mortgage securities decreased by approximately
$1.8 million, or 28%, to $4.7 million for the three months ended March 31, 2003
from $6.5 million for the three months ended March 31, 2002. This decrease was
principally due to the prepayment of 29 mortgages underlying the insured
mortgage securities,
36
representing approximately 30% of the total insured mortgage portfolio,
from March 31, 2002 through March 31, 2003.
During the three months ended March 31, 2003, nine mortgages prepaid
resulting in net proceeds of $42.0 million. The prepayment activity corresponds
with the low mortgage interest rate environment and the expiration of prepayment
lock-out periods on many of the underlying 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. In addition, in January 2003 we sold a GNMA security for
approximately $5.7 million. Approximately 16.6% (based on amortized cost) of the
insured mortgage loans either prepaid or were sold during the three months ended
March 31, 2003.
Interest Expense
Interest expense of approximately $21.9 million for the three months ended
March 31, 2003 was approximately $1.4 million lower than interest expense of
approximately $23.3 million for the same period in 2002. The net decrease is
primarily attributable to a lower average debt balance during the first quarter
of 2003 ($985 million) compared to 2002 ($1.0 billion) and a lower average
effective interest rate on the total debt outstanding during the first quarter
of 2003 (8.9%), including approximately $3.1 million of additional interest as
discussed below, compared to 2002 (9.2%).
On January 23, 2003, 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
approximately $3.1 million of 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. In
addition, our interest expense was approximately $1.0 million higher during the
first 23 days of 2003 under the Exit Debt as compared to the remainder of the
quarter with respect to the Bear Stearns and BREF Debt.
The overall weighted average effective interest rate on the Bear Stearns
and BREF Debt was 5.6% for the three months ended March 31, 2003 and the
weighted average coupon (pay) rate on the Bear Stearns and BREF Debt was 4.1%
during the three months ended March 31, 2003. The difference in the weighted
average effective interest rate and the weighted average coupon (pay) rate
primarily relates to the deferral of two-thirds of the interest on the BREF
Debt. The weighted average effective interest rate on the Exit Debt was 10.2%
for the three months ended March 31, 2002. The weighted average coupon (pay)
rate on the Exit Debt was 8.0% for the three months ended March 31, 2002.
Interest expense on the collateralized mortgage obligations-insured
mortgage securities decreased following significant prepayments of mortgages
underlying the insured mortgage securities, as discussed previously. The
decrease in interest expense on the collateralized mortgage obligations-insured
mortgage securities was partially offset by approximately $971,000 of additional
discount and deferred fees amortization expenses in the first quarter of 2003,
which are reflected as interest expense, compared to approximately $363,000 of
additional amortization expenses in the first quarter of 2002. These additional
expenses are the result of the mortgages prepaying faster than anticipated
which, under the effective interest method of recognizing interest expense,
required an adjustment to cumulative interest expense.
General and Administrative Expenses
General and administrative expenses decreased by approximately $254,000 to
$2.9 million during the three months ended March 31, 2003 as compared to $3.2
million during the three months ended March 31, 2002 primarily due to a decrease
in legal fees in 2003.
Depreciation and Amortization
Depreciation and amortization was approximately $173,000 and $240,000
during the three months ended March 31, 2003 and 2002, respectively.
37
Mortgage Servicing
The following is a summary of the consolidated results of operations of our
servicing subsidiary, CMSLP:
Three months ended March 31,
Description 2003 2002
----------- ---- ----
Servicing revenue $ 2,124,561 $ 2,763,536
Servicing general and administrative expenses (2,230,971) (2,491,094)
Servicing amortization, depreciation and
impairment (333,262) (507,879)
------------ ------------
GAAP net loss from CMSLP $ (439,672) $ (235,437)
============ ============
The net loss from CMSLP of approximately $(440,000) for the three months
ended March 31, 2003 compares to a net loss of approximately $(235,000) for the
three months ended March 31, 2002. CMSLP's total revenue decreased by
approximately $639,000 to approximately $2.1 million during the three months
ended March 31, 2003 compared to $2.8 million during the three months ended
March 31, 2002. This decrease is primarily the result of a decrease in income
from loan assumptions and CMSLP's sale of its master and direct servicing
contracts in February 2002 which reduced mortgage servicing income and interest
income earned on the escrow balances, partially offset by higher revenue from
special servicing. General and administrative expenses were $2.2 million and
$2.5 million during the three months ended March 31, 2003 and 2002,
respectively. The $260,000 net decrease in general and administrative expenses
was primarily attributable to the staff reductions that occurred in the first
quarter of 2002 following the sale of the servicing contracts. During the three
months ended March 31, 2003, amortization, depreciation and impairment was
approximately $333,000 as compared to $508,000 in 2002. This decrease was
primarily the result of the sale of servicing rights in February 2002, which
reduced amortization expense.
In April 2003, CMSLP restructured its property servicing group. In
connection with the restructuring, 15 employee positions are being eliminated
during the second quarter of 2003. We expect to recognize approximately $180,000
of severance expenses during the second quarter of 2003. In conjunction with
this restructuring, we are exploring various alternatives related to the
servicing functions performed by the property servicing group, including, but
not limited to, outsourcing the responsibilities. There can be no assurance that
we will be able to achieve such alternatives.
Equity in Earnings from Investments
Total equity in earnings from investments of approximately $128,000 and
$114,000 for the three months ended March 31, 2003 and 2002, respectively,
includes our net equity from the AIM Limited Partnerships (which are four
publicly traded limited partnerships that 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.
Income Tax Benefit
During the three months ended March 31, 2003 and 2002, we recorded an
income tax benefit of approximately $172,000 and $66,000, respectively. The
income tax benefit was recognized by our taxable REIT subsidiaries (TRSs) that
own all of the partnership interests in CMSLP. These TRSs are separately taxable
entities. The income tax benefit that was recognized by our TRSs was the result
of the net loss incurred by CMSLP.
Other Income
Other income decreased by approximately $502,000 to approximately $343,000
during the three months ended March 31, 2003 from approximately $844,000 during
the three months ended March 31, 2002. This decrease was primarily attributable
to lower interest income earned on reduced cash balances during 2003 as compared
to 2002 and a decrease 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 $10,000 and $25,000 in
realized losses related to our trading of other mortgage backed securities (or
Other MBS) during the three months ended March 31, 2003 and 2002, respectively.
38
We own a shopping center in Orlando, Florida, which we account for as real
estate owned. During the three months ended March 31, 2003 and 2002, we
recognized a net loss of approximately $265,000 and $204,000, respectively, from
the operations of the shopping center, which included approximately $217,000 and
$213,000 of interest expense, respectively, and approximately $37,000 and
$44,000 of depreciation expense, respectively. The remaining net (loss) income
of approximately $(11,000) and $53,000 is included in other income in the
consolidated statements of income. 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 Gains (Losses) on Mortgage Security Dispositions
Net gains on mortgage security dispositions were approximately $188,000
during the three months ended March 31, 2003 compared to net losses of
approximately $(110,000) during the three months ended March 31, 2002. During
the first quarter of 2003, there were nine prepayments of mortgage securities
and the sale of one mortgage security, or approximately 16.6% of the related
portfolio (based on the December 31, 2002 amortized cost of the portfolio).
During the first quarter of 2002, there were six prepayments, or approximately
5.1% of the related portfolio (based on the December 31, 2001 amortized cost of
the portfolio). The net gain in 2003 was primarily attributable to the sale of
the GNMA security that was owned by CRIIMI MAE Inc. and the receipt of
prepayment penalties, partially offset by losses due to the write-off of
unamortized costs associated with disposed mortgages at the disposition dates.
The net losses in 2002 were primarily due to the write-off of unamortized costs
associated with the disposed mortgages at the disposition dates, partially
offset by prepayment penalties, if applicable. For any period, gains or losses
on mortgage dispositions are based on the number, carrying amounts and proceeds
of mortgages disposed of during the period.
Hedging Expense
During the three months ended March 31, 2003 and 2002, we recognized
hedging expense of approximately $352,000 and $90,000 on our interest rate caps,
respectively. The increase is primarily attributable to the amortization of the
cost of the interest rate cap that was purchased in April 2002. The fair value
of our interest rate cap that matures on November 3, 2003 has decreased
significantly due to a decline in interest rates since the cap was purchased in
April 2002 for $1.6 million. This cap is set at a one-month LIBOR rate of 3.25%.
As of March 31, 2003, the one-month LIBOR rate was 1.30%. As of March 31, 2003,
the fair value of this interest rate cap was $41.
BREF Maintenance Fee
Pursuant to the Investment Agreement with BREF, we are obligated to pay
BREF a quarterly maintenance fee of $434,000 through January 2006. The expense
of approximately $371,000 during the three months ended March 31, 2003
represents the accrual of the maintenance fee for the period January 14 through
March 31, 2003.
Gain on Extinguishment of Debt
During the three months ended March 31, 2003, we reversed approximately
$7.8 million of accrued extension fees related to the Exit Debt since the debt
was repaid and the extension fees were no longer payable. This reversal is
reflected as a gain on extinguishment of debt in our consolidated statement of
income. This reversal was partially offset by approximately $403,000 of breakage
fee paid to the lender of the Exit Variable-Rate Secured Borrowing and legal
fees of approximately $47,000, resulting in a net gain on extinguishment of debt
of $7.3 million.
Executive Severance at Recapitalization
In connection with the January 2003 recapitalization, we amended the
employment contracts of our former Chairman, William B. Dockser, and former
President, H. William Willoughby, to provide for their termination on January
23, 2003. During the three months ended March 31, 2003, we recognized
approximately $2.6 million of expenses related to severance and related benefit
payments, and accelerated vesting of certain outstanding stock options held by
Messrs. Dockser and Willoughby.
39
Cumulative effect of adoption of SFAS 142
In June of 2001, the Financial Accounting Standards Board issued SFAS No.
142, "Goodwill and Other Intangible Assets". 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 13 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 through June 2005.
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. For tax purposes we
have elected to be classified as a trader in securities. We trade in both short
and longer duration fixed income securities, including CMBS and 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.
As a result of our election in 2000 to be taxed as a trader, 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 being
recognized evenly for tax purposes over four years beginning with the year 2000
and ending in 2003. We expect such loss to be ordinary, which allows us to
offset our ordinary income.
We generated a net operating loss for tax purposes of approximately $83.6
million during the year ended December 31, 2002. As such, our taxable income was
reduced to zero and, accordingly, our REIT distribution requirement was
eliminated for 2002. 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.
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.
40
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 carryforwards 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. 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 $337.9
million as of March 31, 2003 will be limited.
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 or potential acquisition of
shares of our capital stock that has created or will create an "ownership
change" under Section 382. 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.
Net Operating Loss for Tax Purposes-Three months ended March 31, 2003. We
generated a net operating loss for tax purposes of approximately $24.4 million
during the three months ended March 31, 2003. A summary of our year-to-date net
operating loss as of March 31, 2003 is as follows:
(in millions)
-----------------
January 2000 Loss $ 478.2
LESS: Amounts recognized in 2002, 2001 and 2000 (358.6)
LESS: Amounts recognized during the three months ended March 31, 2003 (29.9)
--------
Balance remaining of January 2000 Loss to be recognized during the remainder of 2003 $ 89.7
========
Taxable income for the three months ended March 31, 2003 before recognition
of January 2000 Loss $ 5.5
LESS: January 2000 Loss recognized during the three months ended March 31, 2003 (29.9)
--------
Net Operating Loss for the three months ended March 31, 2003 $ (24.4)
========
Accumulated Net Operating Loss through December 31, 2002 $(223.8)
Net Operating Loss created during the three months ended March 31, 2003 (24.4)
Net Operating Loss utilization -
--------
Net Operating Loss carried forward for use in future periods $(248.2)
========
Accumulated and unused net operating loss and remaining January 2000 Loss $ 337.9
========
Cash Flow
2003 compared to 2002
Net cash provided by operating activities decreased by approximately $24.5
million to $8.5 million during the three months ended March 31, 2003 from $33.0
million during the three months ended March 31, 2002. The decrease was primarily
attributable to a smaller decrease in restricted cash and cash equivalents
during 2003 compared to 2002. The 2003 results reflect a decrease in restricted
cash following the repayment of the Exit Variable-Rate Secured Borrowing and the
release of the cash in the related account. The 2002 results reflect a decrease
in restricted cash following the settlement of the First Union litigation in
March 2002.
41
Net cash provided by investing activities increased by approximately $27.2
million to $55.9 million during the three months ended March 31, 2003 from $28.7
million during the three months ended March 31, 2002. The increase was primarily
attributable to
o a $30.1 million increase in proceeds from mortgage security prepayments and a
sale of a GNMA security;
o $3.3 million of proceeds from the sale of investment-grade CMBS by CMSLP
during 2003; and
o a $2.4 million increase in cash received in excess of income recognized on
subordinated CMBS; partially offset by
o $8.2 million of proceeds from the sale of servicing rights during 2002.
Net cash used in financing activities increased by approximately $35.6
million to $82.2 million during the three months ended March 31, 2003 from $46.6
million during the three months ended March 31, 2002. The increase is primarily
attributable to the January 2003 recapitalization. We repaid approximately
$373.6 million of Exit Debt through the incurrence of an aggregate $330.0
million of Bear Stearns and BREF Debt, the net proceeds of $13.5 million from
the issuance of common stock to BREF, and use of $30.1 million of our available
cash and liquid assets. In addition, we paid approximately $5.9 million in debt
issuance costs during the three months ended March 31, 2003. The total
transaction costs of approximately $10.1 million includes $5.9 million of debt
issuance costs, $478,000 of equity issuance costs, $2.6 million of executive
severance costs and $1.0 million of costs expensed during the year ended
December 31, 2002. The increase in cash used in financing activities was also
affected by the payment of approximately $1.8 million in preferred stock
dividends during the three months ended March 31, 2003 and a $23.7 million
increase in principal payments on the securitized mortgage debt obligations (due
to higher insured mortgage security prepayments as discussed previously). During
2002, we paid $18.7 million to redeem the Series E Preferred Stock. 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 $1.0 million difference between the aggregate
liquidation value and the redemption price is reflected as a dividend on
preferred stock in the first quarter of 2002.
The table below, which is not presented in accordance with GAAP, is
intended to provide a summary of cash available for debt service on recourse and
other debt, dividends, acquisitions and general working capital purposes. We
believe that this information better facilitates an evaluation of our cash
available for debt service on recourse debt, dividends, acquisitions and general
working capital purposes. We also believe the table is helpful in evaluating our
operating performance and our ability to fund liquidity internally. The table
below eliminates certain items which have the effect of reducing or increasing
net income (loss) before changes in accounting principles and dividends, but
have no impact on cash available to us. These items are attributable in large
part to non-cash income statement items, which are included in our Consolidated
Statement of Cash Flows, as well as GAAP net interest income or expense from our
non-recourse match funded debt associated with the investment grade CMBS and our
insured mortgage securities. In addition, we adjusted income provided by
operating activities for cash distributions (which are a return of investment)
received from the AIM Limited Partnerships, our insured mortgage securities and
CMBS. The cash available for debt service on recourse debt, dividends,
acquisitions and general working capital purposes presented below must first be
used to service our recourse debt. Due to our NOL carryforward, we are able to
retain our net cash, after debt service, for payments of dividends, acquisitions
and general working capital purposes. The presentation of the financial measure
addressed by the table below is consistent with that included in our Annual
Report on Form 10-K for the year ended December 31, 2002.
42
Quarter Ended Quarter Ended
March 31, December 31,
($ in millions) 2003 2002
- --------------- -------------- ---------------
GAAP net income (loss) before changes in accounting
principle and preferred stock dividends $ 6.1 $ (32.9)
Adjustments:
Interest expense on recourse and other debt (1) 9.8 (2) 10.2
Net interest (income) expense from match-funded
assets and liabilities 0.9 1.6
Depreciation and amortization 0.2 0.2
Impairment on CMBS -- 35.2
Equity in (income) losses from investments (0.1) 0.4
Hedging expense 0.4 0.4
Net (gains) losses on mortgage security dispositions (0.2) 0.4
Adjustment of subordinated CMBS GAAP interest
income to cash received (3) 1.2 (0.2)
Servicing operations, net (including servicing
restructuring expenses) (4) 0.4 0.1
Accelerated vesting of stock options 0.5 --
Gain on extinguishment of debt (non-cash portion) (7.8) --
Gain on sales of servicing rights and investment-grade
CMBS (4) -- (0.3)
-------------- ---------------
Income provided by operating activities 11.4 (5) 15.1
Cash distributions received from AIM Limited Partnerships 0.8 0.8
Net cash received from insured mortgage securities 0.6 0.8
-------------- ---------------
Cash available for debt service on recourse debt,
dividends, acquisitions and general working
capital purposes $ 12.8 $ 16.7
============== ===============
Uses of cash:
Principal payments on recourse and other debt $ (2.4) $ (8.6)
Interest payments on recourse and other debt (9.8) (2) (9.9) (6)
Dividend payments on preferred shares (1.8) -
-------------- ---------------
$ (14.0) $ (18.5)
============== ===============
(1) This amount includes the accreting interest on the Series B Senior Secured
Notes and the interest expense related to accrued extension fees (through
January 23, 2003 as the Exit Debt was paid off in the quarter ended March
31, 2003).
(2) This amount includes approximately $3.1 million of additional interest paid
during the 45 day redemption notice period on the Series A Senior Secured
Notes and the Series B Senior Secured Notes.
(3) We received approximately $16.7 million and $17.0 million of cash from our
subordinated CMBS during the quarter ended March 31, 2003 and December 31,
2002, respectively.
(4) The results of CMSLP are excluded since CMSLP's cash was not used to
service our recourse debt or pay dividends. Except for the cash that CMSLP
provided in connection with the January 2003 recapitalization, CMSLP
retained its cash flows to fund its operations.
(5) The results for the quarter ended March 31, 2003 include approximately $2.1
million of executive severance. In addition, we paid approximately $450,000
in a breakage fee and legal fees in connection with the repayment of the
Exit Debt, which is reflected as a reduction to the gain on extinguishment
of debt in our Consolidated Statement of Income.
(6) This amount includes the semi-annual interest payment on the Series B
Senior Secured Notes.
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.
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
43
$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%. The interest on the BREF Debt is
payable semi-annually and there are no principal payments until maturity. 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 and an aggregate of $1 million for expenses in
connection with the transactions. Pursuant to the Investment Agreement with
BREF, we are also obligated to pay BREF a quarterly maintenance fee of $434,000.
Please refer to our definitive proxy statement relating to our 2003 annual
shareholders meeting for a discussion of existing and potential relationships,
transactions and agreements (including a non-competition agreement) with BREF
and/or certain of its affiliates. As previously stated, BREF is a principal
stockholder and a creditor of ours, and Barry Blattman, our Chairman, CEO and
President, is an affiliate of BREF. All transactions between us and BREF or any
of its affiliates will be approved by disinterested directors and will be on
terms no less favorable than those which could have been obtained from unrelated
third parties.
Bear Stearns provided $300 million in secured financing in the form of a
repurchase transaction under the 2003 recapitalization. The Bear Stearns Debt
matures in 2006, bears interest at a rate equal to one-month LIBOR plus 3%,
payable monthly, 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 enter into such transaction. Although CRIIMI MAE Inc.
(unconsolidated) 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. We also paid $250,000 of Bear Stearns'
legal expenses.
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. The indirect first liens are first liens on
the equity interests of three of our subsidiaries that hold certain subordinated
CMBS. 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.
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
44
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 our 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 our 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 mortgage related investments and acquisitions or obtain
additional capital, or that the terms of any such capital will be favorable to
us.
Summary of Cash Position and Shareholders' Equity
As of March 31, 2003, our cash and cash equivalents aggregated
approximately $11.5 million, including cash and cash equivalents of
approximately $2.6 million held by CMSLP. In addition to our cash, we had
additional liquidity at March 31, 2003 comprised of $3.5 million in Other MBS,
which is included elsewhere in our balance sheet.
As of March 31, 2003 and December 31, 2002, shareholders' equity was
approximately $313.3 million or $16.50 per diluted share and approximately
$291.7 million or $16.32 per diluted share, respectively. 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). These CMBS are reflected at fair value and the
related match-funded debt at amortized cost, in each case in accordance with
GAAP.
Summary of CMBS
As of March 31, 2003, 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 $864 million (representing approximately 74% of our total
consolidated assets) and an aggregate amortized cost of approximately $760
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
March 31, 2003 (in millions):
Rating Fair Value % of CMBS
------ ---------- ---------
A+, BBB+ or BBB (a) $327.7 38%
BB+, BB or BB- $340.8 39%
B+, B, B- or CCC $176.2 21%
Unrated $19.3 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
45
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 March 31, 2003, 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 8.4 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 10.0 years, respectively. The aggregate investment by
the rating of the CMBS is as follows:
Discount Rate
or Range of
Weighted Loss Discount Rates
Face Amount Average Adjusted Fair Value Used to Amortized Cost Amortized Cost
as of Pass-Through Weighted as of Calculate as of 3/31/03 as of 12/31/02
Security Rating 3/31/03 (in Rate as of Average 3/31/03 (in Fair Value (in millions) (in millions)
millions) 3/31/03 Life (1) millions) as of 3/31/03 (5)
- ------------------------------------------------------------------------------------------------------------------------------
Investment Grade Portfolio
- --------------------------
A+ (4) $ 62.6 7.0% 3 years $ 66.0 5.1% $ 59.6 $ 59.4
BBB+ (4) 150.6 7.0% 9 years 151.2 7.0% 132.6 132.3
BBB (4) 115.2 7.0% 10 years 110.5 7.7% 95.6 95.3
Retained Portfolio
- ------------------
BB+ 319.0 7.0% 11 years 260.9 9.8%-10.2% 224.0 223.0
BB 70.9 7.0% 13 years 54.5 10.8% 47.0 46.8
BB- 35.5 7.0% 14 years 25.4 11.6% 20.9 20.8
B+ 88.6 7.0% 14 years 50.8 14.9% 46.3 46.0
B 177.2 7.0% 17 years 94.9 15.5%-15.7% 85.4 85.1
B- (2) 118.3 7.1% 22 years 27.3 16.0%-20.0% (8) 27.1 28.1
CCC (2) 70.9 2.4% 2 years 3.2 (9) 3.0 3.8
Unrated/Issuer's
Equity (2) (3) 324.4 1.8% 0.4 years 19.3 (9) 18.7 20.0
---------- -------- -------- --------
Total (7) $ 1,533.2 5.7% 10 years $ 864.0 (7) $ 760.2 (6) $ 760.6
========== ======== ======== ========
(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 March 31, 2003, 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) The CBO-1, CBO-2 and Nomura 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 our 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, the CBO-2 subordinated CMBS 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 March 31, 2003.
(3) The unrated subordinated CMBS from CBO-2 currently does not have a stated
coupon rate since this security is 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+
46
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 (currently rated
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, from which we currently receive no cash flows, and
reflected them in our subordinated CMBS on the balance sheet.
(5) Amortized cost reflects approximately $248.4 million of cumulative
impairment charges related to certain CMBS (all bonds except those rated
A+ and BBB+), which were recognized through December 31, 2002.
(6) See "REIT Status and Other Tax Matters" for information regarding the
subordinated CMBS for tax purposes.
(7) As of March 31, 2003, the aggregate fair values of the CBO-1, CBO-2 and
Nomura bonds were approximately $18.7 million, $839.8 million and
$5.5 million, respectively.
(8) The discount rate is applied to gross scheduled cash flows as opposed to
loss adjusted cash flows for purposes of calculating fair values.
(9) As a result of the estimated loss of principal on these CMBS, we have used
a significantly higher discount rate to determine a reasonable fair value
of these CMBS. The weighted average loss adjusted 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 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 underlying commercial mortgage
loans. We make further fair value adjustments to such pricing information based
on our specific knowledge of our CMBS and the impact of relevant events (such as
our recent recapitalization and the value of competing offers), 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 rated 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 March
31, 2003. Since we calculated the estimated fair value of our CMBS portfolio as
of March 31, 2003 and December 31, 2002, we have disclosed the range of discount
rates by rating category used in determining the fair values as of March 31,
2003 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.
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
47
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 $49.4
million (or 5.7%) and $94.8 million (or 11.0%), respectively, and our
subordinated CMBS by approximately $31.6 million (or 5.9%) and $60.6 million (or
11.3%), 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.
Mortgage Loan Pool
Through CMSLP, our servicing subsidiary, we perform servicing functions on
commercial mortgage loans underlying our CMBS totaling $16.9 billion and $17.4
billion as of March 31, 2003 and December 31, 2002, respectively. The mortgage
loans underlying our subordinated CMBS are secured by properties of the types
and in the geographic locations identified below:
03/31/03 12/31/02 03/31/03 12/31/02
Property Type Percentage(i) Percentage(i) Geographic Location(ii) Percentage(i) Percentage(i)
- ------------- ------------- ------------- ----------------------- ------------- -------------
Retail......... 31% 31% California............... 16% 17%
Multifamily.... 28% 28% Texas.................... 12% 12%
Hotel.......... 16% 15% Florida.................. 8% 8%
Office......... 14% 13% Pennsylvania............. 5% 5%
Other (iv)..... 11% 13% Georgia.................. 4% 4%
---- --------- Other(iii)............... 55% 54%
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 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 Subordinated
Healthcare/Senior-Housing CMBS. We currently estimate that the
interest shortfalls and/or realized losses on such healthcare and
senior housing mortgage loans will exceed the Subordinated
Healthcare/Senior Housing CMBS.
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 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 virtually all of the CMBS transactions related to our subordinated CMBS,
CMSLP has an incentive to efficiently and effectively resolve any loan workouts.
As of March 31, 2003 and December 31, 2002, specially serviced mortgage loans
included in the commercial mortgage loans described above were as follows:
48
03/31/03 12/31/02
-------- -----------
Specially serviced loans due to monetary default (a) $ 941.3 million $ 736.1 million
Specially serviced loans due to covenant default/other 212.7 million 74.7 million
---------------- ----------------
Total specially serviced loans (b) $1,154.0 million $ 810.8 million
================ ================
Percentage of total mortgage loans (b) 6.8% 4.7%
================ ================
(a) Includes $156.3 million and $130.5 million, respectively, of real estate
owned by the underlying securitization trusts. See also the table below
regarding property type concentrations for further information on real
estate owned by underlying trusts.
(b) As of April 30, 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 March 31, 2003 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.......... $ 767.5 (1) 66% Florida............. $ 154.6 13%
Retail......... 230.9 (2) 20% Texas............... 115.2 10%
Office......... 53.6 5% Oregon............... 96.0 8%
Multifamily.... 46.3 4% California........... 82.1 7%
Healthcare..... 31.6 3% Georgia ............. 57.9 5%
Industrial..... 14.5 1% Massachusetts........ 54.5 5%
Other.......... 9.6 1% Other................ 593.7 52%
---------- -------- ---------- -----------
Total...... $1,154.0 100% Total............. $1,154.0 100%
========== ======== ========== ===========
(1) Approximately $106.3 million of these loans in special servicing are
real estate owned by the underlying securitization trusts.
(2) Approximately $32.6 million of these loans in special servicing are
real estate owned by the underlying securitization trusts.
As reflected above, as of March 31, 2003, approximately $767.5 million, or
66%, of the specially serviced mortgage loans were 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 March 31, 2003:
Total Outstanding Percentage of Amount in
Principal Balance Total Hotel Loans Special Servicing
------------------ ----------------- -----------------
Full service hotels (1) $ 1.4 billion 54% $ 279.8 million
Limited service hotels (2) 1.2 billion 46% 487.7 million
----------------- ----------------- -----------------
Totals $ 2.6 billion 100% $ 767.5 million
================= ================= =================
(1) Full service hotels are generally mid-price, upscale or luxury hotels
with restaurant and lounge facilities and other amenities.
(2) Limited service hotels are generally hotels with room-only
operations or hotels that offer a bedroom and bathroom, but
limited other amenities, and are often in the budget or economy group.
Of the $767.5 million of hotel loans in special servicing as of March 31,
2003, approximately $528.9 million, or 69%, relate to seven borrowing
relationships more fully described as follows:
o Sixteen loans and eight real estate owned properties with scheduled
principal balances totaling approximately $91.2 million spread across
four CMBS transactions secured by hotel properties throughout the U.S.
As of March 31, 2003, our total exposure, including advances, on these
loans was approximately $95.3 million. In one of these CMBS
transactions, which contains 10 loans with scheduled principal balances
totaling $38.2 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. The 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 $26.2 million have become
real estate owned by the
49
underlying securitization trusts and sixteen loans with scheduled
principal balances totaling $65.0 million were granted maturity date
extensions, were returned to performing status, and were transferred
out of special servicing in April 2003.
o Twenty-seven loans with scheduled principal balances as of March 31,
2003 totaling approximately $136.9 million spread across three CMBS
transactions secured by hotel properties in the west and Pacific
northwest states. As of March 31, 2003, our total exposure, including
advances, on these loans was approximately $166.6 million. The
borrower filed for bankruptcy protection in October 2001. The borrower
indicated that the properties had experienced reduced operating
performance due to new competition, the economic recession, and reduced
travel resulting from the September 11, 2001 terrorist attacks. We
entered into a consensual settlement agreement dated February 25, 2003
pursuant to which the loan terms will be amended and modified, which
was subsequently approved and confirmed by the bankruptcy court on
March 28, 2003. In addition, subsequent to March 31, 2003, the
borrower sold one of the properties that secured these loans.
Application of the net sales proceeds for that property has reduced the
total exposure by approximately $800,000. In addition, the borrower
has remitted approximately $1.5 million in funds from debtor in
possession accounts, which has been applied to arrearages. The parties
are currently proceeding toward closing a comprehensive loan
modification that should return the loans to performing status in the
near future.
o Five loans with scheduled principal balances totaling approximately
$45.5 million secured by hotel properties in Florida and Texas. As of
March 31, 2003, our total exposure, including advances, on these loans
was approximately $49.6 million. The loans are past due for the July
2002 and all subsequent payments. We have reached a preliminary
agreement with the borrower on a consensual modification of the loan
terms, and are working toward a formal modification agreement that is
expected to return the loans to performing status in 2003.
o Nine loans with scheduled principal balances totaling approximately
$19.0 million secured by limited service hotels in midwestern states.
As of March 31, 2003, our total exposure, including advances, on these
loans was approximately $21.4 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. We were attempting to
negotiate a workout with the borrower when the borrower filed for
bankruptcy protection in February 2003.
o One loan with a scheduled principal balance as of March 31, 2003
totaling approximately $80.7 million secured by 13 extended stay hotels
located throughout the U.S. 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. We 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 as of March 31, 2003
totaling approximately $129.8 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 with this borrower
in an attempt to reach a consensual resolution of this matter.
o One loan with a scheduled principal balance of approximately $25.8
million, secured by a hotel in Boston, MA. As of March 31, 2003, our
total exposure, including advances, on this loan was approximately
$26.0 million. This loan was transferred into special servicing in
March 2003. The borrower has stated an inability to make payments, and
has requested a loan restructure due to reduced operating performance
at the property.
50
For each of the borrowing relationships described in the paragraphs above,
we believe that we have made an appropriate estimate of losses that we may incur
in the future, which are used in determining our CMBS yields and fair values.
There can be no assurance that the losses incurred in the future will not exceed
our current estimates.
The following table provides a summary of the change in the balance of
specially serviced loans from December 31, 2002 to March 31, 2003:
(in millions)
-------------
Specially Serviced Loans, December 31, 2002 $ 810.8
Transfers in due to monetary default 239.7
Transfers in due to covenant default and other 158.6
Transfers out of special servicing (48.5)
Loan amortization (1) (6.6)
-------------
Specially Serviced Loans, March 31, 2003 $1,154.0
=============
(1) Represents the reduction of the scheduled principal balances due to
advances made by the master servicers.
For loans in special servicing, we are pursuing remedies available to us 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
resulting from appraisal reductions. An appraisal reduction event generally
results in reduced master servicer principal and interest advances based on the
amount by which the sum of the unpaid principal balance of the loan, accumulated
principal and interest advances and other expenses exceeds 90% (in most cases)
of the newly appraised value of the property underlying the mortgage loan. As
the holder of the lowest rated and first loss bonds, our bonds are the first to
experience interest shortfalls as a result of the reduced advancing requirement.
In general, the master servicer can advance up to a maximum of the difference
between 90% of the property's appraised value and the sum of accumulated
principal and interest advances and expenses. As an example, assuming a weighted
average coupon of 6% on a first loss subordinated CMBS, a $1 million appraisal
reduction would reduce our net cash flows by $60,000 on an annual basis. The
ultimate disposition or work-out of the mortgage loan may result in a higher or
lower realized loss on our subordinated CMBS than the calculated appraisal
reduction amount. 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
January 1, 2003 through March 31, 2003 3,190 29,224 3,845 36,259
------- -------- ------- ----------
Cumulative Appraisal Reductions through March 31, 2003 $29,749 $129,010 $18,249 $ 177,008
======= ======== ======= ==========
* 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 securities 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 March 31, 2003 (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:
51
(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
Actual realized losses, January 1 through March 31, 2003 465 6,693 662 7,820
-------- -------- ------- --------
Cumulative actual realized losses through March 31, 2003 $ 16,503 $ 41,290 $ 1,463 $ 59,256
======== ======== ======= ========
Cumulative expected realized loss estimates (including
cumulative actual realized losses) through the year 2003 $ 70,448 $171,368 $ 7,239 $249,055
Expected loss estimates for the year 2004 17,771 89,783 20,016 127,570
Expected loss estimates for the year 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
======== ======== ======= =========
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 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,
continued hostilities in the Middle East or elsewhere, terrorism, unexpected
delays 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.
Yield to Maturity
The following table summarizes yield-to-maturity information relating to
our CMBS on an aggregate pool basis:
Current
Anticipated Anticipated
Yield-to- Yield-to-
Maturity Maturity
Pool as of 1/1/02 (1) as of 1/1/03 (1)
---- ---------------- ----------------
CBO-2 CMBS 12.1% 11.6%
CBO-1 CMBS 14.3% 11.6%
Nomura CMBS 28.7% 8.0%
------ ------
Weighted Average (2) 12.4% 11.6%
(1) Represents the anticipated weighted average yield over the expected average
life of the CMBS as of January 1, 2002 and January 1, 2003 based on our
estimate of the timing and amount of future credit losses.
(2) GAAP requires that the income on 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. During the three months
ended March 31, 2003, we received cash of approximately $3.0 million in
excess of income recognized on subordinated CMBS, partially offset by
approximately $2.6 million of discount amortization due to the effective
interest method. During the three months ended March 31, 2002, we
recognized approximately $2.7 million of discount amortization, partially
offset by approximately $645,000 of cash received in excess of income
recognized on subordinated CMBS due to the effective interest method.
52
Summary of Other Assets
Portfolio Investment
As of March 31, 2003 and December 31, 2002, our other assets consisted
primarily of insured mortgage securities, equity investments, Other MBS, cash
and cash equivalents (as previously discussed), principal and interest
receivables and real estate owned.
We had $227.7 million and $275.3 million (in each case, at fair value)
invested in insured mortgage securities as of March 31, 2003 and December 31,
2002, respectively. The reduction in fair value is primarily attributable to the
prepayment of insured mortgages which had fair values of $48.3 million at
December 31, 2002. As of March 31, 2003, 87% of our investment in insured
mortgage securities were GNMA mortgage-backed securities and approximately 13%
were FHA-insured certificates.
As of March 31, 2003 and December 31, 2002, we had approximately $6.0
million and $6.2 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 due to
loan pay-offs and normal cash flow distributions. 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.
Our Other MBS include primarily investment grade CMBS and investment grade
residential mortgage-backed securities. As of March 31, 2003 and December 31,
2002, the fair values of our Other MBS were approximately $3.5 million and $5.2
million, respectively.
As previously discussed, we own a shopping center in Orlando, Florida,
which we account for as real estate owned. As of March 31, 2003 and December 31,
2002, we had approximately $8.7 million and $8.8 million, respectively, in real
estate owned assets included in other assets ($8.5 million and $8.4 million,
respectively, relating to the actual building and land). In addition, we had
$7.2 million of mortgage payable (net of discount) related to the real estate as
of March 31, 2003 and December 31, 2002. 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.
Mortgage Servicing
As of March 31, 2003 and December 31, 2002, CMSLP's other assets consisted
primarily of investments in CMBS, advances receivable, fixed assets, investments
in interest-only strips and investments in subadvisory contracts. The servicing
other assets have decreased by approximately $4.2 million from $13.8 million at
December 31, 2002 to $9.6 million at March 31, 2003. The decrease is primarily
the result of the sale of investment grade CMBS in January 2003 in connection
with our recapitalization, which had a fair value of approximately $3.3 million
as of December 31, 2002.
Summary of Liabilities
Portfolio Investment
As of March 31, 2003 and December 31, 2002, our liabilities consisted
primarily of debt, accrued interest and accrued payables. Total recourse debt
decreased by approximately $46.0 million to $330.0 million as of March 31, 2003
from $376.0 million as of December 31, 2002 due to the repayment of the Exit
Debt during the first quarter of 2003 principally through the incurrence of the
Bear Stearns and BREF Debt. Total non-recourse debt decreased by approximately
$40.2 million to $505.8 million at March 31, 2003 from $546.0 million at
December 31, 2002. This decrease is primarily attributable to significant
prepayments of mortgages underlying the insured mortgage securities during the
first quarter of 2003, which resulted in a corresponding reduction in the
principal balances of the securitized mortgage obligations. Our payables and
accrued liabilities decreased by approximately $9.1 million to $17.6 million as
of March 31, 2003 from $26.7 million as of December 31, 2002 primarily due to
the January
53
2003 recapitalization. During the three months ended March 31, 2003, we
reversed approximately $7.5 million of extension fees that were accrued at
December 31, 2002 on the Exit Debt since they were no longer payable. In
addition, we paid $2.9 million of interest that was accrued, as of December 31,
2002, on the Series B Senior Secured Notes.
Mortgage Servicing
As of March 31, 2003 and December 31, 2002, CMSLP's liabilities consisted
primarily of operating accounts payable and accrued expenses. The servicing
liabilities decreased by approximately $135,000 to $622,000 as of March 31, 2003
from $757,000 as of December 31, 2002.
Dividends/Other
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. No cash
dividends were paid to common shareholders during the three months ended March
31, 2003. Unlike the Exit Debt, which significantly restricted the amount of
cash dividends that could be paid, we may pay cash dividends if we have made the
required principal and interest payments on the Bear Stearns Debt. However, we
cannot pay cash dividends to our common shareholders until the preferred stock
dividends in arrears are paid.
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 realized 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.
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 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 March 31, 2003, 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
54
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.
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 2 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 4 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 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
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 4 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.
55
Recent Accounting Pronouncements
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. As discussed previously, we expect to
recognize approximately $180,000 of restructuring expenses in the second quarter
of 2003 as a result of CMSLP's restructuring of its property servicing group.
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) No. 25, "Accounting for Stock Issued
to Employees," and have made the applicable disclosures in Note 2 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.
56
ITEM 3. 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 March 31, 2003, there was no significant change in the average U.S.
Treasury rate used to price our CMBS, excluding the CCC and unrated/issuer's
equity CMBS, or credit spreads compared to December 31, 2002. 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
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS-Financial Condition, Liquidity and Capital Resources" for a
discussion of our collateral coverage requirements under the Bear Stearns Debt.
Insured Mortgage Securities
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
$228,000 (or 0.1%) and approximately $446,000 (or 0.2%), respectively, as of
March 31, 2003.
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, 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 $49.4 million (or 5.7%) and approximately $94.8 million (or
11.0%), respectively, as of March 31, 2003. 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 $31.6 million (or 5.9%) and $60.6 (or 11.3%), respectively, as of
March 31, 2003.
Variable Rate Debt
We have an interest rate cap to mitigate the adverse effects of rising
interest rates on the amount of interest expense payable under our variable rate
debt. 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. This cap provides 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 cap. The terms of the cap as
well as the stated interest rate of the cap, which is currently above the
current rate of the index, will limit the amount of protection that the cap
offers. The average one-month LIBOR index was 1.34% during the three months
ended March 31, 2003, which was a 4 basis point decrease from December 31, 2002.
A 100 basis point change in the one-month LIBOR index would have changed
our interest expense on our Bear Stearns Debt by approximately $642,000 during
the three months ended March 31, 2003.
57
ITEM 4. 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
continue to implement certain actions in the current 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 evaluation of our internal controls in connection with
our recent Annual Report on Form 10-K and written observations, recommendations
and a report received from our independent auditors, we commenced implementing
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. We and our independent auditors determined that
significant improvement was needed in this process, particularly in connection
with mortgage loan valuation and credit loss estimation. To address these
matters, we have made significant progress in the initial re-underwriting of the
mortgage loans underlying our CMBS and have commenced 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 complete the initial re-underwriting
process and the implementation of most of the additional actions during 2003.
Our independent auditors were not specifically engaged to evaluate or assess the
internal controls over our overall loss estimate.
58
PART II
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
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.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
Exhibit No. Description
10.1 Deposit Trust Agreement dated as of
December 20, 1996 between CRIIMI MAE QRS1,
Inc. and Wilmington Trust Company, as Owner
Trustee (filed herewith).
10.2 Deposit Trust Agreement dated as of May 8,
1998 between CRIIMI MAE CMBS Corp. and
Wilmington Trust Company, as Owner Trustee
(filed herewith).
99.1 Special Serviced Loan Report relating to
specially serviced loans underlying the
Company's CMBS as of March 31, 2003 (filed
herewith).
99.2 Certification of Chief Executive Officer
pursuant to Section 906 of the
Sarbanes-Oxley Act (filed herewith).
99.3 Certification of Chief Financial Officer
pursuant to Section 906 of the
Sarbanes-Oxley Act (filed herewith).
(b) REPORTS ON FORM 8-K
Date Purpose
January 6, 2003 To report: (1) a press release dated
January 3, 2003 announcing a review by the
Special Committee of the Board of Directors
of a revised non-binding proposal received
from ORIX Capital Markets, L.L.C. (ORIX) to
purchase our issued and outstanding shares
of common and preferred stock, and (2) a
press release dated January 6, 2003
announcing that the Special Committee will
continue to negotiate with ORIX regarding
59
ORIX's proposal to purchase our outstanding
shares of common and preferred stock.
January 17, 2003 To report a press release dated January 15,
2003, announcing that, on January 14, 2003,
we closed in escrow a recapitalization.
January 30, 2003 To report a press release dated January 23,
2003 announcing the completion of our
recapitalization.
March 6, 2003 To report a press release dated March 5,
2003 announcing (1) the payment of a cash
dividend previously deferred for the second
quarter of 2002 on our Series B, Series F
and Series G Preferred Stock and (2) an
increase in our estimated losses over the
life of our CMBS portfolio.
March 28, 2003 To report a press release dated March 26,
2003 announcing our earnings for the fourth
quarter and year ended December 31, 2002.
60
Signature
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Registrant has duly caused this Quarterly
Report on Form 10-Q to be signed on its behalf by the undersigned, thereunto
duly authorized.
CRIIMI MAE INC.
May 13, 2003 /s/Cynthia O. Azzara
- --------------------------- ----------------------------------------
DATE Cynthia O. Azzara
Senior Vice President,
Chief Financial Officer and
Treasurer (Principal Accounting Officer)
61
CERTIFICATION
I, Barry S. Blattman, certify that:
1. I have reviewed this quarterly report on Form 10-Q of CRIIMI
MAE Inc.;
2. Based on my knowledge, this quarterly report does not contain
any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made,
not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report,
fairly present in all material respects the financial
condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries,
is made known to us by others within those entities,
particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date
within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions
about the effectiveness of the disclosure controls
and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of registrant's
board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or
operation of internal controls which could adversely
affect the registrant's ability to record, process,
summarize and report financial data and have
identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have
indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and
material weaknesses.
Date: May 13, 2003 /s/Barry S. Blattman
------------------------ ------------------------------------
Barry S. Blattman
Chairman of the Board, Chief Executive
Officer and President
62
CERTIFICATION
I, Cynthia O. Azzara, certify that:
1. I have reviewed this quarterly report on Form 10-Q of CRIIMI
MAE Inc.;
2. Based on my knowledge, this quarterly report does not contain
any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made,
not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report,
fairly present in all material respects the financial
condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries,
is made known to us by others within those entities,
particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date
within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions
about the effectiveness of the disclosure controls
and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of registrant's
board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or
operation of internal controls which could adversely
affect the registrant's ability to record, process,
summarize and report financial data and have
identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have
indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and
material weaknesses.
Date: May 13, 2003 /s/Cynthia O. Azzara
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Cynthia O. Azzara
Senior Vice President, Chief Financial
Officer and Treasurer