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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
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For the quarter ended September 30, 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 November 11, 2003
----- -----------------------------------
Common Stock, $0.01 par value 15,307,932
2
CRIIMI MAE INC.
Quarterly Report on Form 10-Q
Page
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PART I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets as of September 30, 2003
(unaudited) and December 31, 2002............................... 3
Consolidated Statements of Income for the three and nine months
ended September 30, 2003 and 2002 (unaudited).................... 4
Consolidated Statements of Changes in Shareholders' Equity
for the nine months ended September 30, 2003 (unaudited)........ 5
Consolidated Statements of Cash Flows for the nine
months ended September 30, 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............................. 40
Item 3. Quantitative and Qualitative Disclosures about Market Risk....... 67
Item 4. Controls and Procedures.......................................... 69
PART II. Other Information
Item 6. Exhibits and Reports on Form 8-K................................. 70
Signature ................................................................ 72
3
PART I
ITEM 1. FINANCIAL STATEMENTS
CRIIMI MAE INC.
CONSOLIDATED BALANCE SHEETS
September 30, December 31,
2003 2002
---------------------- ----------------------
(Unaudited)
Assets:
Mortgage assets:
Subordinated CMBS pledged to secure recourse debt, at fair value $ 528,257,275 $ 535,507,892
CMBS pledged to secure Securitized Mortgage
Obligations - CMBS, at fair value 332,062,684 326,472,580
Other MBS, at fair value 3,904,944 5,247,771
Insured mortgage securities, at fair value 168,293,213 275,340,234
Equity investments 3,955,591 6,247,868
Other assets 26,643,950 24,987,348
Receivables 17,649,861 16,293,489
Servicing other assets 9,540,349 13,775,138
Servicing cash and cash equivalents 2,489,700 12,582,053
Other cash and cash equivalents 14,461,302 16,669,295
Restricted cash and cash equivalents - 7,961,575
---------------------- ----------------------
Total assets $ 1,107,258,869 $ 1,241,085,243
====================== ======================
Liabilities:
Bear Stearns variable rate secured debt $ 297,500,000 $ -
BREF senior subordinated secured note 31,266,667 -
Securitized mortgage obligations:
Collateralized bond obligations-CMBS 288,377,418 285,844,933
Collateralized mortgage obligations-
insured mortgage securities 157,217,861 252,980,104
Mortgage payable 7,303,276 7,214,189
Payables and accrued expenses 11,472,312 26,675,724
Servicing liabilities 2,268,213 756,865
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 795,405,747 949,424,153
---------------------- ----------------------
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; 15,263,006 and 13,945,068 shares
issued and outstanding, respectively 152,630 139,451
Accumulated other comprehensive income 114,803,213 102,122,057
Deferred compensation (642,857) (19,521)
Warrants outstanding 2,564,729 -
Additional paid-in capital 632,661,204 620,411,938
Accumulated deficit (437,720,047) (431,027,085)
---------------------- ----------------------
Total shareholders' equity 311,853,122 291,661,090
---------------------- ----------------------
Total liabilities and shareholders' equity $ 1,107,258,869 $ 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 For the nine months
ended September 30, ended September 30,
2003 2002 2003 2002
--------------- -------------- --------------- --------------
(as adjusted-
Note 2)
Interest income:
CMBS $ 22,121,471 $ 25,678,715 $ 66,307,216 $ 76,815,219
Insured mortgage securities 3,486,162 5,829,458 12,413,163 18,468,181
--------------- -------------- --------------- --------------
Total interest income 25,607,633 31,508,173 78,720,379 95,283,400
--------------- -------------- --------------- --------------
Interest and related expenses:
Bear Stearns variable rate secured debt 3,550,104 - 10,047,040 -
BREF senior subordinated secured note 1,261,084 - 3,519,973 -
Exit variable-rate secured borrowing - 3,700,424 859,106 11,397,375
Series A senior secured notes - 2,889,054 2,130,722 8,781,875
Series B senior secured notes - 3,480,499 2,697,006 10,289,704
Fixed-rate collateralized bond obligations-CMBS 7,032,898 6,397,966 19,775,900 19,337,866
Fixed-rate collateralized mortgage obligations - insured
securities 5,353,098 5,642,316 15,028,861 18,297,034
Hedging expense 274,167 353,085 900,655 749,412
Other interest expense 240,179 245,984 711,556 743,966
--------------- -------------- --------------- --------------
Total interest expense 17,711,530 22,709,328 55,670,819 69,597,232
--------------- -------------- --------------- --------------
Net interest margin 7,896,103 8,798,845 23,049,560 25,686,168
--------------- -------------- --------------- --------------
General and administrative expenses (3,027,061) (2,782,419) (8,815,893) (8,588,203)
Deferred compensation expense (23,810) (16,732) (43,331) (93,422)
Depreciation and amortization (131,472) (312,388) (450,296) (920,928)
Servicing revenue 2,425,138 2,976,371 7,314,725 8,233,944
Servicing general and administrative expenses (2,500,850) (2,222,008) (6,824,975) (6,847,992)
Servicing amortization, depreciation, and impairment expenses (293,090) (508,000) (1,180,842) (1,418,810)
Servicing restructuring expenses (6,301) - (150,672) (141,240)
Servicing gain on sale of servicing rights - 34,309 - 4,851,907
Income tax benefit (expense) 323,704 481,256 509,934 (427,520)
Equity in earnings from investments 91,006 98,005 212,341 330,747
Other income, net 292,549 711,923 988,208 2,142,354
Net losses on mortgage security dispositions (749,305) (310,722) (522,805) (567,014)
Impairment on CMBS (4,704,878) (29,884,497) (13,652,756) (35,035,588)
BREF maintenance fee (434,000) - (1,229,667) -
Executive contract termination costs (2,875,699) - (2,875,699) -
Hedging ineffectiveness (1,930,198) - (1,930,198) -
Recapitalization expenses - (438,889) (3,148,841) (683,333)
Gain on extinguishment of debt - - 7,337,424 -
--------------- -------------- --------------- --------------
(13,544,267) (32,173,791) (24,463,343) (39,165,098)
--------------- -------------- --------------- --------------
Net loss before cumulative effect of change in accounting
principle (5,648,164) (23,374,946) (1,413,783) (13,478,930)
Cumulative effect of adoption of SFAS 142 - - - (9,766,502)
--------------- -------------- --------------- --------------
Net loss before dividends paid or accrued on preferred shares (5,648,164) (23,374,946) (1,413,783) (23,245,432)
Dividends paid or accrued on preferred shares (1,726,560) (1,726,560) (5,279,179) (7,602,537)
--------------- -------------- --------------- --------------
Net loss to common shareholders $ (7,374,724) $ (25,101,506) $ (6,692,962) $ (30,847,969)
=============== ============== =============== ==============
Earnings per common share:
Basic - before cumulative effect of change in accounting
principle $ (0.49) $ (1.80) $ (0.44) $ (1.55)
=============== ============== =============== ==============
Basic - after cumulative effect of change in accounting
principle $ (0.49) $ (1.80) $ (0.44) $ (2.26)
=============== ============== =============== ==============
Diluted - before cumulative effect of change in accounting
principle $ (0.49) $ (1.80) $ (0.44) $ (1.55)
=============== ============== =============== ==============
Diluted - after cumulative effect of change in accounting
principle $ (0.49) $ (1.80) $ (0.44) $ (2.26)
=============== ============== =============== ==============
Shares used in computing basic earnings per share 15,204,913 13,926,600 15,114,173 13,635,656
=============== ============== =============== ==============
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 nine months ended September 30, 2003
(Unaudited)
Preferred Common Accumulated
Stock Stock Additional Other Total
Par Par Paid-in Accumulated Comprehensive Warrants Deferred Shareholders'
Value Value Capital Deficit Income Outstanding Comp. Equity
-------- ----- ---------- ------------ ------------- ----------- -------- -------------
Balance at December 31, 2002
as previously reported $34,250 $ 139,451 $619,197,711 $(429,812,858) $102,122,057 $ - $(19,521)$291,661,090
Adjustment for preferred
stock issuance costs (Note 2) - - 1,214,227 (1,214,227) - - - -
-------- -------- -------------- -------------- ------------- ---------- ------ ------------
Adjusted balance at December 31, 2002 34,250 139,451 620,411,938 (431,027,085) 102,122,057 - (19,521) 291,661,090
Net income before dividends paid or
accrued on preferred shares - - - (1,413,783) - - - (1,413,783)
Adjustment to unrealized gains and
losses on mortgage assets - - - - 8,327,381 - - 8,327,381
Adjustment to unrealized gains and losses
on derivative financial instruments - - - - 4,353,775 - - 4,353,775
Dividends paid on preferred share - - - (5,279,179) - - - (5,279,179)
Common stock issued - 12,599 13,600,308 - - - - 13,612,907
Restricted stock issued - 580 666,087 - - - (666,667) -
Amortization of deferred compensation - - - - - - 43,331 43,331
Accelerated vesting of stock options - - 547,600 - - - - 547,600
Warrants issued - - (2,564,729) - - 2,564,729 - -
-------- --------- ------------- -------------- ------------ ---------- -------- ------------
Balance at September 30, 2003 $ 34,250 $ 152,630 $632,661,204 $(437,720,047) $114,803,213 $2,564,729$(642,857)$311,853,122
======== ========= ============= ============== ============ ========== ======== ============
The accompanying notes are an integral part of
these consolidated financial statements.
6
CRIIMI MAE INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
For the nine months ended September 30,
2003 2002
--------------------- -------------------
Cash flows from operating activities:
Net loss before dividends paid or accrued on preferred shares $ (1,413,783) $ (23,245,432)
Adjustments to reconcile net loss before dividends paid or accrued 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 8,181,400 4,351,381
Discount amortization on mortgage assets, net (7,925,150) (8,784,389)
Accrual of extension fees related to Exit Debt 336,921 3,189,836
Depreciation and other amortization 450,296 920,928
Net losses on mortgage security dispositions 522,803 567,014
Equity in earnings from investments (212,341) (330,747)
Servicing amortization, depreciation and impairment 1,180,842 1,418,810
Hedging expense 900,655 749,412
Recapitalization expenses (non-cash portion) 1,079,463 -
Amortization of deferred compensation 43,331 93,422
Impairment on CMBS 13,652,756 35,035,588
Interest accreted to debt 1,266,667 2,237,808
Hedging ineffectiveness expense 1,930,198 -
Gain on sale of servicing rights - (4,851,907)
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 30,338,328
Increase in receivables and other assets (137,456) (2,439,587)
Decrease in payables and accrued expenses (3,105,145) (3,569,388)
(Increase) decrease in servicing other assets (182,260) 3,623,587
Increase (decrease) in servicing liabilities 1,511,348 (2,565,072)
Sales (purchases) of other MBS, net 1,358,699 (348,882)
--------------------- -------------------
Net cash provided by operating activities 19,613,449 46,157,212
--------------------- -------------------
Cash flows from investing activities:
Proceeds from mortgage security prepayments and dispositions 104,793,816 51,467,197
Proceeds from prepayment of mezzanine loan 1,696,749 -
Distributions received from AIM Limited Partnerships 2,101,912 2,190,497
Receipt of principal payments from insured mortgage securities 2,231,261 2,783,761
Cash received in excess of income recognized on subordinated CMBS 4,270,088 2,448,171
Proceeds from sale of servicing rights by CMSLP - 8,180,561
Purchases of investment-grade CMBS by CMSLP - (9,905,520)
Sales of investment-grade CMBS by CMSLP 3,316,508 -
--------------------- -------------------
Net cash provided by investing activities 118,410,334 57,164,667
--------------------- -------------------
Cash flows from financing activities:
Principal payments on securitized mortgage debt obligations (98,651,367) (51,803,306)
Principal payments on recourse debt (378,452,338) (27,668,184)
Principal payments on secured borrowings and other debt obligations (79,910) (74,160)
Proceeds from issuance of debt 330,000,000 -
Payment of debt issuance costs (6,294,562) -
Payment of dividends on preferred shares (10,458,859) -
Proceeds from the issuance of common stock, net 13,612,907 43,431
Redemption of Series E Preferred Stock, including accrued dividends - (18,733,912)
--------------------- -------------------
Net cash used in financing activities (150,324,129) (98,236,131)
--------------------- -------------------
Net (decrease) increase in other cash and cash equivalents (12,300,346) 5,085,748
Cash and cash equivalents, beginning of period (1) 29,251,348 17,298,873
--------------------- -------------------
Cash and cash equivalents, end of period (1) $ 16,951,002 $ 22,384,621
===================== ===================
(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.
Our core holdings are subordinated CMBS ultimately backed by pools of
commercial mortgage loans on retail, multifamily, hotel, and other commercial
real estate. We also own directly and indirectly government-insured mortgage
backed securities and a limited number of other assets. We also are a trader in
CMBS, residential mortgage-backed securities, agency debt securities and other
fixed income 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., 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 and
Brascan Real Estate Finance Fund I L.P. as BREF Fund.
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. We refer to the secured financing as the Bear
Stearns Debt and the unit of Bear Stearns & Co., Inc. as Bear Stearns.
o New Leadership. - Barry S. Blattman joined CRIIMI MAE 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 Fund. In addition, on September 15, 2003, Mark R.
Jarrell, a director, assumed the position of President and Chief
Operating Officer. Upon appointment as President, Mr. Jarrell resigned
as director. Mr. Blattman continues as our Chairman of the Board and
Chief Executive Officer.
See Notes 6 and 12 for a further discussion of these 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 some or all of our
obligations, including 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, residential
mortgage-backed securities and agency debt 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 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 some or all of our obligations, including 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
9
of our accumulated and unused NOL and the remaining January 2000 Loss of a
combined total amount of approximately $317.0 million as of September 30, 2003
will be limited.
We do not believe BREF Fund's investment in our common stock and warrant to
purchase common stock has created an "ownership change" under Section 382. In
addition, we are not aware of any other acquisition of shares of our capital
stock that has created an "ownership change" under Section 382. 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 Other Real Estate Interests and that certain of our
government insured mortgage securities also 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
September 30, 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 our
obligations, 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 these obligations. 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 September 30, 2003 and December 31, 2002
(audited), the consolidated results of operations for the three and nine months
ended September 30, 2003 and 2002, and the consolidated cash flows for the nine
months ended September 30, 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
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 (generally 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 and temporary changes in fair value are recorded as a component of
shareholders' equity.
Insured Mortgage Securities
Our consolidated investment in insured mortgage securities consists of
participation certificates generally 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. Our insured mortgage securities are classified as
"available for sale." As a result, we carry our insured mortgage securities at
fair value and changes in fair value are recorded as a component of
shareholders' equity.
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
11
mortgage using the effective interest method. The effective interest method
provides a constant yield of income over the term of the mortgage security.
Other Mortgage-Backed Securities
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 and changes in fair
value are recorded as a component of shareholders' equity. Upon the sale of such
securities, any gain or loss is recognized in the income statement.
Impairment
Subordinated CMBS
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. During the three months ended September 30, 2003 and
2002, we recognized impairment charges of $4.7 million and $29.9 million on our
subordinated CMBS, respectively. During the nine months ended September 30, 2003
and 2002, we recognized approximately $13.7 million and $35.0 million of
impairment charges on our subordinated CMBS, respectively. See Note 4 for
further discussion of the impairment charges.
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 and nine months ended September 30,
2003 and 2002.
Equity Investments
We recognize impairment on our investments accounted for under the equity
method if a decline in the market value of the investment below its carrying
basis is judged to be "other than temporary". During 2003, American Insured
Mortgage Investors, American Insured Mortgage Investors - Series 85, L.P.,
American Insured Mortgage Investors L.P. - Series 86 and American Insured
Mortgage Investors L.P. - Series 88 (collectively referred to as the AIM Limited
Partnerships for which we serve through a subsidiary as the general partner, own
a partnership interest from 2.9% to 4.9% in each of the partnerships, and own a
20% interest in the advisor to each partnership) experienced a significant
amount of prepayments of their insured mortgages. These prepayments reduced cash
flows on our 20% investment in the advisor to the AIM Limited Partnerships. As a
result, in accordance with SFAS No. 142, "Goodwill and Other Intangible Assets,"
and SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets," the advisor to the AIM Limited Partnerships evaluated its investment in
the advisory contracts for impairment. The estimated future undiscounted cash
flows from this investment were projected to be less than the book value of the
investment as of June 30, 2003. As a result, the
12
advisor believed that its investment in the advisory contracts was impaired
at June 30, 2003. The advisor estimated the fair value of its investment using a
discounted cash flow methodology. The advisor wrote down the value of its
investment in the advisory contracts to the AIM Limited Partnerships and
recorded an impairment charge. We recorded our portion of the impairment charge,
totaling approximately $109,000, during the second quarter of 2003. This
impairment charge is included in Equity in earnings from investments in our
Consolidated Statement of Income. This investment is included in our Portfolio
Investment segment. We did not recognize any impairment charges on our equity
investments during the three months ended September 30, 2003 or the three and
nine months ended September 30, 2002.
As a result of the significant prepayments experienced by the AIM Limited
Partnerships, CMSLP's cash flows from its subadvisory contracts with the AIM
Limited Partnerships have been reduced. As a result, in accordance with SFAS No.
142 and SFAS No. 144, we evaluated CMSLP's investment in the subadvisory
contracts for impairment. Our estimated future undiscounted cash flows from this
investment were projected to be less than the book value on the investment at
June 30, 2003. As a result, we believed that CMSLP's investment in the
subadvisory contracts was impaired at June 30, 2003. We estimated the fair value
of the investment using a discounted cash flow methodology. We wrote down the
value of CMSLP's investment in the subadvisory contracts with the AIM Limited
Partnerships and recorded an impairment charge of approximately $198,000 during
the second quarter of 2003, which is included in Servicing amortization,
depreciation and impairment expenses in our Consolidated Statement of Income. We
made no adjustments for the three months ended September 30, 2003.
Consolidated Statements of Cash Flows
The following is the supplemental cash flow information:
Three months ended September 30, Nine months ended September 30,
2003 2002 2003 2002
------------- -------------- ------------ -------------
Cash paid for interest $12,425,296 $15,854,513 $47,247,682 $53,009,882
Cash paid for income taxes (26,144) 190,500 254,856 924,800
Non-cash investing and financing activities:
Restricted stock issued 666,667 -- 666,667 129,675
Preferred stock dividends paid in shares
of common stock -- -- -- 3,444,792
Comprehensive Income
The following table presents comprehensive income for the three and nine
months ended September 30, 2003 and 2002:
Three months ended September 30, Nine months ended September 30,
2003 2002 2003 2002
------------- ----------------- -------------- ---------------
Net loss before dividends paid
or accrued on preferred shares $ (5,648,164) $(23,374,946) $(1,413,783) $(23,245,432)
Adjustment to unrealized gains and
losses on mortgage assets (10,436,860) 52,816,904 8,327,381 89,484,932
Adjustment to unrealized gains and
losses on derivative financial
instruments 3,794,618 (164,679) 4,353,775 (906,153)
------------- ----------------- --------------- ---------------
Comprehensive (loss) income $(12,290,406) $ 29,277,279 $11,267,373 $ 65,333,347
============= ================= =============== ===============
The following table summarizes our accumulated other comprehensive income:
September 30, December 31,
2003 2002
--------------- --------------
Unrealized gains on mortgage assets $ 111,437,203 $ 103,109,822
Unrealized gains (losses) on
derivative financial instruments 3,366,010 (987,765)
--------------- --------------
Accumulated other comprehensive income $ 114,803,213 $ 102,122,057
=============== ==============
13
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". 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 (in thousands, except per share
amounts):
Three months ended September 30, Nine months ended September 30,
2003 2002 2003 2002
---------- ------------ ------------ -----------
Net loss to common shareholders (1) $ (7,375) $ (25,101) $ (6,693) $ (30,848)
Less: Stock-based compensation expense
determined under the fair value based
method for all awards (114) (170) (327) (845)
---------- ----------- ----------- ------------
Pro forma net loss to common
shareholders $ (7,489) $ (25,271) $ (7,020) $ (31,693)
========== =========== =========== ============
Earnings (loss) per share:
Basic and diluted - as reported $ (0.49) $ (1.80) $ (0.44) $ (2.26)
========== ============ =========== ============
Basic and diluted - pro forma $ (0.49) $ (1.81) $ (0.46) $ (2.32)
========== ============ =========== ============
(1) Includes approximately $24 and $17 of stock-based compensation
expense during the three months ended September 30, 2003 and 2002,
respectively, and approximately $591 and $93 during the nine
months ended September 30, 2003 and 2002, respectively.
Adjustment for Initial Preferred Stock Issuance Costs
At the July 31, 2003 Emerging Issues Task Force meeting, the SEC Observer
clarified the application of Topic D-42 related to preferred stock issuance
costs. According to the clarification, all preferred stock issuance costs,
regardless of where in the stockholders' equity section the costs were initially
recorded, should be charged to income available to common shareholders for the
purpose of calculating earnings per share at the time the preferred stock is
redeemed. The SEC Observer indicated that preferred stock issuance costs not
previously charged to income available to common shareholders should be
reflected retroactively in financial statements for reporting periods ending
after September 15, 2003 by restating the financial statements of prior periods
on an as filed basis.
As the result of this guidance, we have charged to income available to
common shareholders approximately $1.2 million in preferred stock offering costs
related to our Series E preferred stock redeemed in March 2002. The following is
a summary of the effect of this change in accounting principle on our
Consolidated Statement of Income during the nine months ended September 30,
2002:
As reported Adjustment Adjusted
--------------- --------------- --------------
Dividends paid or accrued on preferred shares $ (6,388,310) $ (1,214,227) $ (7,602,537)
Net loss to common shareholders (29,633,742) (1,214,227) (30,847,969)
Earnings (loss) per common share:
Basic and diluted - before cumulative effect of
change in accounting principle (1.46) (0.09) (1.55)
Basic and diluted - after cumulative effect of
change in accounting principle (2.17) (0.09) (2.26)
All applicable 2002 disclosures have been adjusted to reflect this change
in accounting principle. The effect on shareholders' equity is reflected on our
Consolidated Statement of Changes in Stockholders' Equity.
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
14
applied prospectively to exit or disposal activities initiated after
December 31, 2002. See Notes 9 and 11 for a discussion of the effect of this
pronouncement on our 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. According to FASB Staff Position No. 46-6 issued on
October 9, 2003, the Interpretation applies at the end of the first fiscal year
or interim period ending after December 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 September 30, 2003 As of December 31, 2002
(in thousands) Amortized Cost Fair Value Amortized Cost Fair Value
- -------------- -------------- ---------- -------------- ----------
ASSETS:
Subordinated CMBS pledged to secure
recourse debt (1) $ 461,147 $ 528,257 $ 473,571 $ 535,508
CMBS pledged to secure Securitized Mortgage
Obligations - CMBS (1) 289,504 332,063 287,040 326,473
Other MBS (1) 3,949 3,905 5,308 5,248
Insured mortgage securities (1) 166,676 168,293 273,655 275,340
Derivative financial instruments (1) 91 1,527 992 4
Servicing other assets See footnote (2) See footnote (2) See footnote (2) See footnote (2)
Servicing cash and cash equivalents 2,490 2,490 12,582 12,582
Other cash and cash equivalents 14,461 14,461 16,669 16,669
Restricted cash and cash equivalents -- -- 7,962 7,962
LIABILITIES:
BREF senior subordinated secured note 31,267 34,638 -- --
Bear Stearns variable rate secured debt 297,500 297,500 -- --
Exit variable-rate secured borrowing -- -- 214,673 214,673
Series A senior secured notes -- -- 92,788 92,788 (3)
Series B senior secured notes -- -- 68,491 68,491 (3)
Securitized mortgage obligations:
Collateralized bond obligations-CMBS 288,377 332,063 285,845 326,473
Collateralized mortgage obligations-insured
mortgage securities 157,218 162,891 252,980 266,367
Mortgage payable 7,303 7,391 7,214 7,341
(1) Recorded at fair value in the accompanying Consolidated Balance Sheet.
(2) CMSLP owned subordinated CMBS and interest-only strips with an aggregate
amortized cost basis of approximately $1.6 million and $1.9 million and a
fair value of approximately $1.8 million and $2.1 million as of September
30, 2003 and December 31, 2002, respectively. Additionally, as of December
31, 2002, CMSLP owned investment-grade CMBS with an aggregate cost basis
and fair value of approximately $3.3 million. The investment-grade CMBS
were sold in January 2003 in connection with our recapitalization.
(3) Since these notes were redeemed in January 2003 at face value, we disclosed
the face value as the fair value as of December 31, 2002.
15
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments:
CMBS
Our determination of fair values for our CMBS portfolio is a subjective
process. The process begins with the compilation and evaluation of pricing
information (such as nominal spreads to U.S. Treasury securities or nominal
yields) that, in our view, is commensurate with the market's perception of value
and risk of comparable assets. We use a variety of sources to compile such
pricing information including: (i) recent offerings and/or secondary trades of
comparable CMBS (i.e., securities comparable to our CMBS or to the CMBS (or
collateral) underlying our CMBS issued in connection with CBO-1 and CBO-2), (ii)
communications with dealers and active CMBS investors regarding the pricing and
valuation of comparable securities, (iii) institutionally available research
reports, (iv) analyses prepared by the nationally recognized rating
organizations responsible for the initial rating assessment and on-going
surveillance of such CMBS, and (v) other qualitative and quantitative factors
that may impact the value of the CMBS such as the market's perception of the
issuers of the CMBS and the credit fundamentals of the commercial properties
securing each pool of 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, 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 assumed market yields for our CMBS rated A+
through B+, depending on the rating. The fair value for those CMBS incurring
principal losses and interest shortfalls (i.e., B rated bonds through 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 the value and risk of comparable securities, using a
discounted cash flow approach. Such anticipated principal losses and interest
shortfalls, as well as the timing and amount of potential recoveries of such
shortfalls, are critical estimates and have been taken into consideration in the
calculation of fair values and yields to maturity used to recognize interest
income as of September 30, 2003. We have disclosed the range of discount rates
by rating category used in determining the fair values as of September 30, 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.
Other MBS
The fair value of the Other MBS is an estimate based on the indicative
market price from publicly available pricing services, as well as management
estimates.
Insured Mortgage Securities
We calculated the estimated fair value of the insured mortgage securities
portfolio as of September 30, 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.
Obligations Under Financing Facilities
The fair values of the securitized mortgage obligations as of September 30,
2003 and December 31, 2002 were calculated using a discounted cash flow
methodology similar to that discussed for CMBS 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 was estimated by
applying a discount rate to the debt's future cash flows. The discount rate was
16
determined by considering the BREF Debt's relative position in our capital
structure in relation to our other capital. 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.
Derivative Financial Instruments
The fair values of our interest rate swaps and interest rate cap are the
estimated amounts that we would realize to terminate the agreements as of
September 30, 2003 and December 31, 2002, taking into account current interest
rates and the current creditworthiness of the counterparties. The amounts were
determined based on valuations received from the counterparties to the
agreements.
4. CMBS
As of September 30, 2003, our assets, in accordance with GAAP, include CMBS
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 $860 million
(representing approximately 78% of our total consolidated assets) and an
aggregate amortized cost of approximately $751 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). See Note 3 for a
discussion of the determination of CMBS fair values. The following is a summary
of the ratings of our CMBS as of September 30, 2003 (in millions):
Rating (1) Fair Value % of CMBS
---------- ---------- ---------
A+, BBB+ or BBB (2) $332.1 39%
BB+, BB or BB- $337.2 39%
B+, B, B- or CCC $166.1 19%
Unrated/Issuer's Equity $ 24.9 3%
(1) Ratings are provided by Standard & Poor's.
(2) 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
Obligations-CMBS") and their related liabilities (reflected as
"Collateralized Bond Obligations - CMBS") to be reflected on our
balance sheet. As of September 30, 2003, the fair value of these
assets, as reflected in our balance sheet, was approximately
$332.1 million and the amortized cost of the debt, as reflected in
our balance sheet, was approximately $288.4 million. All cash
flows related to the investment grade CMBS are used to service the
corresponding securitized mortgage obligations. As a result, we
currently receive no cash flows from the investment grade CMBS.
17
As of September 30, 2003, the weighted average pay rate and the loss
adjusted weighted average life (based on face amount) of the investment grade
securities was 7.0% and 8.0 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, was 5.4% and 11.5 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 Pay Weighted as of Calculate Fair as of 09/30/03 as of 12/31/02
Security Rating 09/30/03 (in Rate as of Average 09/30/03 (in Value as of (in millions) (in millions)
millions) 9/30/03 Life (1) millions) 09/30/03 (5) (6)
- ------------------------------------------------------------------------------------------------------------------------------
Investment Grade Portfolio
- --------------------------
A+ (4) $ 62.6 7.0% 3 years $ 66.0 4.3% $ 60.0 $ 59.4
BBB+ (4) 150.6 7.0% 9 years 154.0 6.6% 133.3 132.3
BBB (4) 115.2 7.0% 10 years 112.1 7.4% 96.2 95.3
Retained Portfolio
- ------------------
BB+ 319.0 7.0% 11 years 259.8 9.9%-10.3% 226.1 223.0
BB 70.9 7.0% 13 years 53.8 11.0% 47.3 46.8
BB- 35.5 7.0% 14 years 23.6 12.8% 21.1 20.8
B+ 88.6 7.0% 14 years 50.1 15.1% 46.7 46.0
B 177.2 7.0% 20 years 98.0 12.7%(9) 85.9 85.1
B- (2)(10)(11) 118.3 7.9% 24 years 18.0 15.0%(9) 16.8 28.1
CCC (2) 70.9 0.0% 1 year - 15.0%(9) - 3.8
Unrated/Issuer's
Equity (2)(3) 270.9 1.5% 1 year 24.9 15.0%(9) 17.2 20.0
--------- -------- --------- ---------
Total $ 1,479.7 5.7% 11 years $ 860.3(8) $ 750.6(7) $ 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 September 30, 2003, the fair values of the B, B-, CCC and the
unrated/issuer's equity in Nomura, CBO-1, and CBO-2 were derived primarily
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 are repaid
through either excess interest and/or recoveries on the underlying CMBS or
a recharacterization of principal cash flows, in which case they may be
realized as a loss of principal on the subordinated CMBS. Such
anticipated losses, including shortfalls, have been taken into
consideration in the calculations of fair market values and yields to
maturity used to recognize interest income as of September 30, 2003.
(3) The unrated/issuer's equity subordinated CMBS from CBO-1 and CBO-2
currently do not have a stated coupon rate since these securities are only
entitled to the residual cash flow payments, if any, remaining after
paying the securities with a higher payment priority. As a result,
effective coupon rates on these securities are highly sensitive to the
effective coupon rates and monthly cash flow payments received from the
underlying CMBS that represent the collateral for CBO-1 and 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 CBO-2 transaction is recorded as a
partial financing and a partial sale, we are deemed to have retained these
CMBS with call options issued in connection with CBO-2, from which we
currently receive no cash flows, and are required to reflect them in our
CMBS on the balance sheet.
(5) Amortized cost reflects approximately $13.7 million of impairment charges
related to the unrated/issuer's equity bonds, the CCC bond and the B- bond
in CBO-2, which were recognized during the nine months ended September 30,
2003. These impairment charges are in
18
addition to the cumulative impairment charges of approximately $248.4
million that were recognized through December 31, 2002. The impairment
charges are discussed later in this Note 4 of Notes to
Consolidated Financial Statements.
(6) 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.
(7) See Notes 1 and 8 to Notes to Consolidated Financial Statements for
information regarding the subordinated CMBS for tax purposes.
(8) As of September 30, 2003, the aggregate fair values of the CBO-1, CBO-2
and Nomura bonds were approximately $24.1 million, $828.7 million and $7.5
million, respectively.
(9) As a result of the estimated loss of principal on these CMBS, the fair
values and discount rates of these CMBS are based on a loss adjusted yield
to maturity.
(10) Although the principal balance of the B- bond in CBO-2 is expected to
be outstanding for approximately 25 years, the bond is not expected to
receive any cash flows beyond the next 18 months.
(11) In November 2003, the B- bond in CBO-2, with fair value of approximately
$11.4 million, was downgraded to D by Standard & Poor's.
Mortgage Loan Pool
We have approximately $15.8 billion and $17.4 billion of seasoned
commercial mortgage loans underlying our subordinated CMBS portfolio as of
September 30, 2003 and December 31, 2002, respectively, secured by properties of
the types and in the geographic locations identified below:
09/30/03 12/31/02 Geographic 09/30/03 12/31/02
Property Type Percentage(i) Percentage(i) Location(ii) Percentage(i) Percentage(i)
- ------------- ------------- ------------- ----------- ------------- -------------
Retail....... 31% 31% California........ 16% 17%
Multifamily.. 27% 28% Texas............. 12% 12%
Hotel........ 15% 15% Florida........... 8% 8%
Office....... 14% 13% Pennsylvania...... 6% 5%
Other (iv)... 13% 13% New York.......... 4% 4%
---- ---- Other(iii)........ 54% 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. The principal balance of the Subordinated Healthcare/Senior
Housing CMBS as of September 30, 2003 is approximately $3.4 million.
As of October 2003, the aggregate principal balance of healthcare and
senior housing mortgage loans, underlying the Subordinated
Healthcare/Senior Housing CMBS, that are specially serviced by another
special servicer, and therefore not in our special servicing loan
balance, is approximately $83 million.
19
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 September 30, 2003 and December 31, 2002, specially serviced mortgage
loans included in the commercial mortgage loans described above were as follows:
09/30/03 12/31/02
--------------- ---------------
Specially serviced loans due to monetary default (a) $ 935.7 million $736.1 million
Specially serviced loans due to covenant default/other 44.8 million 74.7 million
--------------- ----------------
Total specially serviced loans (b) $ 980.5 million $810.8 million
=============== ================
Percentage of total mortgage loans (b) 6.2% 4.7%
=============== ================
(a) Includes $111.3 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 October 31, 2003, total specially serviced loans were approximately
$969.6 million, or 6.2% of the total mortgage loans.
The specially serviced mortgage loans as of September 30, 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........ $ 486.9 (1) 50% Florida............ $ 151.2 15%
Retail....... 255.7 (2) 26% Texas.............. 114.6 12%
Healthcare... 81.5 8% Oregon............. 93.3 9%
Multifamily.. 81.1 8% California......... 46.9 5%
Office....... 45.3 5% Massachusetts...... 45.5 5%
Industrial... 20.7 2% Other.............. 529.0 54%
Other........ 9.3 1% ---------- ----
-------- ---- Total............ $ 980.5 100%
Total.... $ 980.5 100% ========== ====
======== ====
(1) Approximately $78.1 million of these loans in special servicing are
real estate owned by the underlying securitization trusts.
(2) Approximately $21.8 million of these loans in special servicing are
real estate owned by the underlying securitization trusts.
The following table provides a summary of the change in the balance of
specially serviced loans from July 1, 2003 to September 30, 2003 and from April
1, 2003 to June 30, 2003 (in millions):
July - September April - June
2003 2003
--------------- -------------
Specially Serviced Loans, beginning of period $1,168.8 $1,154.0
Transfers in due to monetary default 131.5 166.3
Transfers in due to covenant default and other 1.4 7.4
Transfers out of special servicing (314.9) (153.2)
Loan amortization (1) (6.3) (5.7)
------------- -----------
Specially Serviced Loans, end of period $ 980.5 $1,168.8
============= ===========
(1) Represents the reduction of the scheduled principal balances due to
borrower payments or, in the case of loans in monetary default,
advances made by master servicers.
As reflected above, as of September 30, 2003, approximately $486.9 million,
or 50%, of the specially serviced mortgage loans were secured by mortgages on
hotel properties. The hotel properties that secure the mortgage loans underlying
our CMBS are geographically diverse, with a mix of hotel property types and
franchise
20
affiliations. The following table summarizes the hotel mortgage loans
underlying our CMBS as of September 30, 2003:
Total Outstanding Percentage of Amount in
Principal Balance Total Hotel Loans Special Servicing
----------------- ----------------- -----------------
Full service hotels (1) $ 1.3 billion 58% $ 192.9 million
Limited service hotels (2) 1.0 billion 42% 294.0 million
------------- --- ---------------
Totals $ 2.3 billion 100% $ 486.9 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 $486.9 million of hotel loans in special servicing as of September
30, 2003, approximately $272.1 million, or 56%, relate to six borrowing
relationships more fully described as follows:
o Twenty-seven loans with scheduled principal balances as of
September 30, 2003 totaling approximately $135 million spread across
three CMBS transactions secured by hotel properties in the western and
Pacific northwestern states. As of September 30, 2003, our total
exposure, including advances of approximately $30 million, on these
loans was approximately $165 million. The total exposure is prior
to the application of payments made to date by the borrower under the
terms of our consensual settlement agreement; however, the total
exposure is expected to be reduced by the application of such payments
at closing. The borrower initially filed for bankruptcy protection in
February 2002 and 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 subsequently entered into a consensual settlement
agreement dated February 25, 2003 pursuant to which the loan terms were
amended and modified. This agreement was subsequently approved and
confirmed by the bankruptcy court on March 28, 2003. The parties are
currently proceeding toward closing a comprehensive loan modification,
which is expected to occur in the fourth quarter of 2003 and is
expected to return the loans to performing status. The borrower
continues to make payments under the modified terms. As of September
30, 2003, the borrower has made principal and interest payments
totaling approximately $6.9 million, the majority of which represents
interest paid (as compared to principal amortization) on the modified
loan balances. During the nine months ended September 30, 2003, the
borrower also sold one of the properties that secured these loans. In
addition, as of September 30, 2003, the borrower has remitted
approximately $1.5 million in funds from debtor-in-possession accounts,
which is expected to be applied to arrearages at closing. If we are
not successful in resolving this loan favorably, our annual cash
received from CMBS could be significantly reduced.
o Five loans with scheduled principal balances as of September 30, 2003
totaling approximately $45.1 million secured by hotel properties in
Florida and Texas. As of September 30, 2003, our total exposure,
including advances, on these loans was approximately $50.2 million.
Four of the five loans are past due for the November 2002 and all
subsequent payments. One of the loans is past due for the October 2002
and all subsequent payments. The borrower has not been able to perform
under a preliminary modification agreement due to decreased demand in
the Orlando hospitality market. We expect the properties to become real
estate owned by the underlying securitization trusts.
o Six real estate owned properties with scheduled principal balances as
of September 30, 2003 totaling approximately $20.0 million secured by
hotel properties. As of September 30, 2003, our total exposure,
including advances, on these loans was approximately $25.3 million. 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. As part of a consensual plan, eight properties
were foreclosed and became real estate owned by underlying
securitization trusts. During the three months ended September 30,
2003, two of these eight properties with an aggregate unpaid balance of
$5.9 million were sold.
o One loan with a scheduled principal balance as of September 30, 2003
totaling approximately $27.6 million, secured by nine limited service
hotels located in eight states. As of September 30, 2003 the loan was
current. The loan is currently in special servicing due to an
unauthorized transfer of the properties to an entity which assumed the
controlling interest in the borrowing entity. Subsequent to the
transfer, the new controlling party in interest has made an application
for the assumption of the debt, which is anticipated to close in the
fourth quarter of 2003.
21
o One loan with a scheduled principal balance as of September 30, 2003 of
approximately $25.5 million, secured by a full service hotel in Boston,
Massachusetts. As of September 30, 2003, our total exposure, including
advances, on this loan was approximately $27.0 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
restructuring due to reduced operating performance at the property.
o Nine loans with scheduled principal balances as of September 30, 2003
totaling approximately $18.6 million secured by limited service hotels
in midwestern states. As of September 30, 2003, our total exposure,
including advances, on these loans was approximately $22.3 million. The
loans are past due for the April 2002 and all subsequent payments. The
borrower cites reduced occupancy related to the 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.
The exposure amounts included above are as of September 30, 2003. The
amounts are not necessarily indicative of the exposures as of the projected
resolution dates.
During the three months ended September 30, 2003, two significant hotel
loans in special servicing, included in our June 30, 2003 disclosure of
significant borrowing relationships, were transferred out of special servicing
as follows:
o One hotel loan, with a scheduled principal balance of approximately
$128.4 million as of June 30, 2003, and secured by 93 limited service
hotels located in 29 states, was paid off.
o One hotel loan, with a scheduled principal balance of approximately
$80.7 million as of June 30, 2003, and secured by 13 extended stay
hotels located throughout the U.S., was sold to a third party.
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 any of the loans described above will return to
performing status or otherwise be satisfactorily resolved. Circumstances which
could prevent them from returning to performing status or otherwise being
satisfactorily resolved include, but are not limited to, changes in workout
negotiations, a more pronounced downturn in the economy or in the real estate
market, a change in local market conditions, a drop in performance of the
property, an increase in interest rates, and terrorist attacks. There can be no
assurance that the losses incurred in the future will not exceed our current
estimates (also see discussion below regarding the increase in loss estimates).
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 can result 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 up to $60,000 on an annual basis,
assuming that the total exposure was equal to or greater than 90% of the
appraised value immediately prior to receipt of the new appraisal (appraisal
reduction). 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):
22
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 September 30, 2003 30,146 40,640 9,455 80,241
------- -------- ------- ---------
Cumulative Appraisal Reductions through September 30, 2003 $56,705 $140,426 $23,859 $ 220,990
======= ======== ======= =========
* 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 September 30, 2003 (including realized mortgage loan losses
expected to pass through to our CMBS during the next month) and the expected
future real estate losses underlying our CMBS (in thousands):
CBO-1 CBO-2 Nomura Total
----- ------ ------- ------
Year 1999 actual realized losses $ 738 $ -- $ -- $ 738
Year 2000 actual realized losses 3,201 1,087 -- 4,288
Year 2001 actual realized losses 545 8,397 238 9,180
Year 2002 actual realized losses 11,554 25,113 563 37,230
Actual realized losses, January 1 through September 30, 2003 10,041 46,880 662 57,583
-------- -------- ------- ---------
Cumulative actual realized losses through September 30, 2003 $ 26,079 $ 81,477 $ 1,463 $ 109,019
======== ======== ======= =========
Cumulative expected realized loss estimates (including cumulative
actual realized losses) through the year 2003 $ 26,079 $ 91,243 $ 1,463 $ 118,785
Expected loss estimates for the year 2004 51,503 147,007 13,425 211,935
Expected loss estimates for the year 2005 30,019 89,882 10,514 130,415
Expected loss estimates for the year 2006 3,523 18,188 3,372 25,083
Expected loss estimates for the year 2007 1,908 14,643 3,292 19,843
Expected loss estimates for the year 2008 1,784 10,623 2,608 15,015
Expected loss estimates for the remaining life of CMBS 7,972 31,998 6,647 46,617
-------- -------- ------- ---------
Cumulative expected loss estimates (including cumulative
actual realized losses) through life of CMBS $122,788 $403,584 $41,321 $ 567,693
======== ======== ======= =========
We revised our overall expected loss estimate related to our subordinated
CMBS from $503 million at December 31, 2002 to $559 million at June 30, 2003 to
$568 million at September 30, 2003, with such total losses occurring or expected
to occur through the life of the subordinated CMBS portfolio. These revisions to
the overall expected loss estimate are primarily the result of increased
projected losses due to lower internal estimates of values on properties
underlying certain mortgage loans and real estate owned by underlying trusts,
and changes in the timing of resolution and disposition of certain specially
serviced assets, which when combined, has resulted in higher projected loss
severities on loans and real estate owned by underlying trusts currently or
anticipated to be in special servicing. The primary reasons for lower estimates
of value include the poor performance of certain properties and related markets
and changes to workout negotiations due, in large part, to the softness in the
economy, the continued slowdown in travel and, in some cases, over-supply of
hotel properties, and a shift in retail activity in some markets.
There can be no assurance that our revised overall expected loss estimate
of $568 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 or internal values at
lower than anticipated amounts, legal proceedings (including bankruptcy filings)
involving borrowers, unforeseen reductions in cash received from our
subordinated CMBS, a deterioration in the economy or recession generally, or in
certain industries or sectors specifically, continued hostilities in the Middle
East or elsewhere, terrorism, unexpected delays in the disposition or other
resolution of specially serviced mortgage loans, additional defaults, or an
unforeseen reduction in expected recoveries, any of which could result in
additional future credit losses, impact our cash received from subordinated CMBS
and/or result in further impairment to our subordinated CMBS, the effect of
which could be materially adverse to us.
As of September 30, 2003, we determined that there had been an adverse
change in expected future cash flows for the B- and CCC bonds in CBO-2 due to
the factors mentioned in the paragraph above. As a result, we believed these
bonds had been impaired under EITF 99-20 and SFAS No. 115, "Accounting for
Certain Investments in Debt and Equity Securities," as of September 30, 2003. As
the fair values of these impaired bonds aggregated approximately $4.7 million
below the amortized cost basis as of September 30, 2003, we recorded other than
temporary impairment charges through the income statement of that same amount
during the three months ended September 30, 2003.
23
As of June 30, 2003, we determined that there had been an adverse change in
expected future cash flows for the unrated/issuer's equity bonds, the CCC bond
and the B- bond in CBO-2 due to the factors mentioned in the paragraphs above.
As a result, we believed these bonds had been impaired as of June 30, 2003. As
the fair values of these impaired bonds aggregated approximately $8.9 million
below the amortized cost basis as of June 30, 2003, we recorded other than
temporary impairment charges through the income statement of that same amount
during the three months ended June 30, 2003.
Yield to Maturity
The following table summarizes yield-to-maturity information relating to
our CMBS on an aggregate pool basis:
Current
Anticipated Anticipated Anticipated Anticipated
Yield-to- Yield-to- Yield-to- Yield-to-
Maturity Maturity Maturity Maturity
Pool as of 1/1/02 (1) as of 1/1/03 (1) as of 7/1/03 (1) as of 10/1/03 (1)
---- ---------------- ---------------- ---------------- ------------------
CBO-2 CMBS 12.1% 11.6% 11.5% 11.3%
CBO-1 CMBS 14.3% 11.6% 21.6% 36.8%
Nomura CMBS 28.7% 8.0% 16.9% 27.9%
------ ----- ----- -----
Weighted Average (2) 12.4% 11.6% 11.7% 12.0%
(1) Represents the anticipated weighted average yield over the expected average
life of the CMBS based on our estimate of the timing and amount of future
credit losses and other significant items that are anticipated to affect
future cash flows.
(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 nine months
ended September 30, 2003, we recognized approximately $8.0 million of
discount amortization, partially offset by approximately $4.3 million of
cash received in excess of income recognized on subordinated CMBS due to
the effective interest method. During the nine months ended September 30,
2002, we recognized approximately $8.8 million of discount amortization,
partially offset by approximately $2.4 million of cash received in excess
of income recognized on subordinated CMBS due to the effective interest
method.
Determining Fair Value of CMBS
We use a discounted cash flow methodology for determining the fair value of
our subordinated CMBS. See Note 3 for a discussion of our fair value
methodology.
Key Assumptions in Determining Fair Value
The gross mortgage loan cash flows from each commercial mortgage loan pool
and their corresponding distribution on the CMBS may be affected by numerous
assumptions and variables including:
(i) changes in the timing and/or amount of credit losses on the commercial
mortgage loans (credit risk), which are a function of:
o the percentage of mortgage loans that experience a default either
during the mortgage term or at maturity (referred to in the
industry as a default percentage);
o the recovery period represented by the time that elapses between
the default of a commercial mortgage loan and the subsequent
foreclosure and liquidation of the corresponding real estate (a
period of time referred to in the industry as a lag); and,
o the percentage of mortgage loan principal lost as a result of the
deficiency in the liquidation proceeds resulting from the
foreclosure and sale of the commercial real estate (referred to in
the industry as a loss severity);
(ii) the discount rate used to derive fair value, which is comprised of the
following:
o a benchmark risk-free rate, calculated by using the current,
"on-the-run" U.S. Treasury curve and interpolating a comparable
risk-free rate based on the weighted-average life of each CMBS;
plus,
o a credit risk premium; plus,
o a liquidity premium;
(iii) changes in cash flows related to principal losses and interest
shortfalls, as well as the timing and amount of potential recoveries of
such shortfalls, based on our overall expected loss estimate for our
CMBS, the fair value of which is determined using a loss adjusted yield
to maturity;
24
(iv) delays and changes in monthly cash flow distributions relating to
mortgage loan defaults and/or extensions in the loan's term to maturity
(see Extension Risk below); and
(v) the receipt of mortgage payments earlier than projected (prepayment).
Sensitivities of Key Assumptions
Since we use a discounted cash flow methodology to derive the fair value of
our CMBS, changes in the timing and/or the amount of cash flows received from
the underlying commercial mortgage loans, and their allocation to the CMBS, will
directly impact the value of such securities. Accordingly, delays in the receipt
of cash flows and/or decreases in future cash flows resulting from higher than
anticipated credit losses will result in an overall decrease in the fair value
of our CMBS. Furthermore, any increase/(decrease) in the required rate of return
for CMBS will result in a corresponding (decrease)/increase in the value of such
securities. We have included the following narrative and numerical disclosures
to demonstrate the sensitivity of such changes to the fair value of our CMBS.
Key Assumptions Resulting in an Adverse Impact to Fair Value
Factors which could adversely affect the valuation of our CMBS include: (i)
the receipt of future cash flows less than anticipated due to higher credit
losses (i.e., higher credit losses resulting from a larger percentage of loan
defaults, and/or losses occurring greater or sooner than projected, and/or
longer periods of recovery between the date of default and liquidation, (see
also "Key Assumptions in Determining Fair Values" and "Sensitivity of Fair Value
to Changes in Credit Losses" below), (ii) an increase in the required rate of
return (see "Sensitivity of Fair Value to Changes in the Discount Rate" below)
for CMBS, and/or (iii) the receipt of cash flows later than anticipated (see
"Sensitivity of Fair Value to Extension Risk" below).
Sensitivity of Fair Value to Changes in Credit Losses
For purposes of this disclosure, we used a market convention for simulating
the impact of increased credit losses on CMBS. Generally, the industry uses a
combination of an assumed percentage of loan defaults (referred to in the
industry as a Constant Default Rate or "CDR"), a lag period and an assumed loss
severity. For purposes of this disclosure, we assumed the following loss
scenarios, each of which was assumed to begin immediately following September
30, 2003: (i) 3.0% per annum of the commercial mortgage loans were assumed to
default and 30% of the then outstanding principal amount of the defaulted
commercial mortgage loans were assumed to be lost (referred to in the industry
as a 3.0% CDR and 30% loss severity, and referred to herein as the "3%/30% CDR
Loss Scenario"), and (ii) 3.0% per annum of each commercial mortgage was assumed
to default and 40% of the then outstanding principal amount of each commercial
mortgage loan was assumed to be lost (referred to in the industry as a 3.0% CDR
and 40% loss severity, and referred to herein as the "3%/40% CDR Loss
Scenario"). The reduction in amount of cash flows resulting from the 3%/30% CDR
Loss Scenario and the 3%/40% CDR Loss Scenario would result in a corresponding
decline in the fair value of our aggregate CMBS by approximately $76.7 million
(or 8.9%) and $179.6 million (or 20.9%), respectively. The reduction in amount
of cash flows resulting from the 3%/30% CDR Loss Scenario and the 3%/40% CDR
Loss Scenario would result in a corresponding decline in the fair value of our
subordinated CMBS (BB+ through unrated/issuer's equity) by approximately $73.9
million (or 14.0%) and $174.1 million (or 33.0%), respectively.
The aggregate amount of credit losses assumed under the 3%/30% CDR Loss
Scenario and the 3%/40% CDR Loss Scenario totaled approximately $815 million and
$1.1 billion, respectively. These amounts are in comparison to the aggregate
amount of anticipated credit losses estimated by us as of September 30, 2003 of
approximately $568 million used to calculate GAAP income yields. It should be
noted that the amount and timing of the anticipated credit losses assumed by us
related to the GAAP income yields are not directly comparable to those assumed
under the 3%/30% CDR Loss Scenario and the 3%/40% CDR Loss Scenario.
Sensitivity of Fair Value to Changes in the Discount Rate
The required rate of return used to determine the fair value of our CMBS is
comprised of many variables, such as a risk-free rate, a liquidity premium and a
credit risk premium. These variables are combined to determine a total rate
that, when used to discount the CMBS's assumed stream of future cash flows,
results in a net present value of such cash flows. The determination of such
rate is dependent on many quantitative and qualitative factors, such as, but not
limited to, the market's perception of the issuers and the credit fundamentals
of the commercial real
25
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 $49.1 million (or 5.7%) and $94.2 million (or 11.0%),
respectively, and our subordinated CMBS by approximately $32.3 million (or 6.1%)
and $61.7 million (or 11.7%), respectively.
The sensitivities above are hypothetical and should be used with caution.
As the figures indicate, changes in fair value based on variations in
assumptions generally cannot be extrapolated because the relationship of the
change in assumption to the change in fair value may not be linear. Also, the
effect of a variation in a particular assumption on the fair value of the
retained interest is calculated without changing any other assumption; in
reality, changes in one factor may result in changes in another (for example,
increases in market interest rates may result in lower prepayments and increased
credit losses), which might magnify or counteract the sensitivities.
Sensitivity of Fair Value to Extension Risk
For purposes of this disclosure, we assumed that the maturity date of each
commercial mortgage loan underlying the CMBS was extended for a period of 12
months and 24 months beyond the contractual maturity date specified in each
mortgage loan. The delay in the timing and receipt of such cash flows for an
extended period of time consisting of 12 months and 24 months, respectively,
would result in a corresponding decline in the value of our aggregate CMBS by
approximately $8.2 million (or 0.8%) and $16.0 million (or 1.5%), respectively,
and our subordinated CMBS by approximately $6.8 million (or 1.0%) and $12.6
million (or 1.8%), respectively.
Impact of Prepayment Risk on Fair Value
Our investments in subordinated CMBS are purchased at a discount to their
face amount due to their subordinated claim to principal and interest cash flows
and priority of allocation of realized losses. As a result of the discounted
purchase price, the return of principal sooner than anticipated from
prepayments, and/or in amounts greater than initially assumed when determining
the discounted purchase price, would result in an increase in the value of our
subordinated CMBS. Such appreciation in value would result from the higher
subordination level of the CMBS transaction relative to comparable CMBS and the
potential for an upgrade in the ratings category of the security. Since the
effects of prepayments would enhance the value of our subordinated CMBS, other
than if high-coupon mortgage loans underlying our subordinated CMBS are prepaid
thus reducing the excess interest available to our subordinated CMBS, the
effects of increased prepayments were excluded from the sensitivity analysis
above. It should be noted that the effects of a decline in prepayments is
reflected in the Sensitivity of Fair Value to Extension Risk above.
26
5. INSURED MORTGAGE SECURITIES
We own the following insured mortgage securities directly or indirectly
through wholly owned subsidiaries (in thousands):
As of September 30, 2003
------------------------
Number of Weighted
Mortgage Average Effective Weighted Average
Securities Fair Value Amortized Cost Interest Rate Remaining Term (4)
---------- ----------- --------------- ----------------- ------------------
CRIIMI MAE Financial Corporation 16 $ 63,274 $62,619 8.41% 25 years
CRIIMI MAE Financial Corporation II 17 74,186 73,604 7.21% 21 years
CRIIMI MAE Financial Corporation III (3) 12 30,833 30,453 8.02% 25 years
-- --------- -------- ----- --------
45 (1) $ 168,293 $166,676 7.81% (2) 23 years (2)
== ========= ======== ===== ========
As of December 31, 2002
-----------------------
Number of Weighted
Mortgage Average Effective Weighted Average
Securities Fair Value Amortized Cost Interest Rate Remaining Term (4)
---------- ----------- --------------- ----------------- ------------------
CRIIMI MAE 1 $ 5,730 $ 5,340 8.00% 32 years
CRIIMI MAE Financial Corporation 22 77,454 76,653 8.40% 25 years
CRIIMI MAE Financial Corporation II 28 145,576 145,396 7.19% 23 years
CRIIMI MAE Financial Corporation III 16 46,580 46,266 7.92% 27 years
-- -------- -------- ------ --------
67 $275,340 $273,655 7.67% (2) 25 years (2)
== ======== ======== ===== ========
(1) During the nine months ended September 30, 2003, twenty-one mortgage loans
underlying our mortgage securities were prepaid. These prepayments
generated net proceeds of approximately $98.5 million and resulted in a
financial statement net loss of approximately $(880,000), primarily due to
the write-off of unamortized costs, which is included in net losses on
mortgage security dispositions in the accompanying consolidated statement
of income for the nine months ended September 30, 2003. In addition, we
sold one insured mortgage security that was owned by CRIIMI MAE Inc. for
approximately $5.7 million, which resulted in a gain of approximately
$357,000 during the nine months ended September 30, 2003. Approximately 38%
(based on amortized cost) of our insured mortgage loans prepaid or were
sold during the nine months ended September 30, 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) We currently 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 original face value.
(4) The weighted average lives are one year or less based on our prepayment
assumptions.
27
6. OBLIGATIONS UNDER FINANCING FACILITIES
The following table summarizes our debt outstanding as of September 30,
2003 and December 31, 2002 and for the nine months ended September 30, 2003 (in
thousands):
As of and for the nine months ended September 30, 2003
----------------------------------------------------------
Effective Average
Rate at Average Effective December 31, 2002
Ending Balance Quarter End Balance Rate Ending Balance
-------------- ----------- ------- ---- --------------
Recourse to CRIIMI MAE:
- -----------------------
Bear Stearns debt (1) $ 297,500 4.7% $ 284,510 4.7% $ --
BREF debt (2) 31,267 16.2% 28,937 16.2% --
Exit variable-rate secured borrowing (3) -- -- 17,227 6.7% 214,673
Series A senior secured notes (3) -- -- 23,963 11.9% 92,789
Series B senior secured notes (3) -- -- 17,757 20.3% 68,491
Non-Recourse to CRIIMI MAE:
- ---------------------------
Securitized mortgage obligations:
CMBS (4) 288,377 9.1% 286,947 9.2% 285,845
Freddie Mac funding note (5) 70,334 7.7% 110,314 10.2% 139,550
Fannie Mae funding note (6) 29,491 7.4% 35,447 9.9% 44,902
CMO (7) 57,393 7.6% 61,357 8.7% 68,527
Mortgage payable (8) 7,303 12.0% 7,253 12.0% 7,214
--------- --------- ---------
Total debt $ 781,665 7.4% $ 873,712 8.4% $ 921,991
========= ========= =========
(1) The effective interest rate includes the amortization of deferred financing
fees. During the nine months ended September 30, 2003, we recognized $1.1
million of interest expense related to the amortization of the deferred
financing fees.
(2) The effective interest rate includes the amortization of deferred financing
fees. During the nine months ended September 30, 2003, we recognized
$252,000 of interest expense related to the amortization of the deferred
financing fees.
(3) The effective interest rate during the nine months ended September 30, 2003
includes the accrual of estimated extension fees through January 23, 2003.
During the nine months ended September 30, 2003 and 2002, we recognized
aggregate interest expense of $337,000 and $3.2 million related to
estimated extension fees on these facilities, respectively. The exit
variable-rate secured borrowing was repaid in full on January 23, 2003 and
the Series A and B senior secured notes were repaid in full on March 10,
2003. The cumulative accrued extension fees (from April 17, 2001 through
January 23, 2003) were reversed into income in gain on extinguishment of
debt in 2003.
(4) As of September 30, 2003 and December 31, 2002, the face amount of the debt
was $328.4 million with unamortized discount of $40.1 million and $42.6
million, respectively. During the nine months ended September 30, 2003 and
2002, discount amortization of $2.5 million and $2.1 million, respectively,
was recorded as interest expense.
(5) As of September 30, 2003 and December 31, 2002, the face amount of the note
was $71.8 million and $143.1 million, respectively, with unamortized
discount of $1.5 million and $3.5 million, respectively. During the nine
months ended September 30, 2003 and 2002, discount amortization of $2.0
million and $974,000, respectively, was recorded as interest expense. The
average effective interest rate includes approximately $1.7 million and
$661,000 of additional interest expense during the nine months ended
September 30, 2003 and 2002, respectively, due to the mortgages underlying
the insured mortgage securities prepaying at a faster rate than anticipated
and an adjustment in 2003 to the assumed prepayment speeds. 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.
(6) As of September 30, 2003 and December 31, 2002, the face amount of the note
was $30.0 million and $45.8 million, respectively, with unamortized
discount of $462,000 and $847,000, respectively. During the nine months
ended September 30, 2003 and 2002, discount amortization of $386,000 and
$98,000, respectively, was recorded as interest expense. The average
effective interest rate includes approximately $501,000 and $20,000 of
additional interest expense during the nine months ended September 30, 2003
and 2002, respectively, due to the mortgages underlying the insured
mortgage securities prepaying at a faster rate than anticipated and an
adjustment in 2003 to the assumed prepayment speeds. 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. We currently 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 original face value.
(7) As of September 30, 2003 and December 31, 2002, the face amount of the note
was $58.4 million and $70.0 million, respectively, with unamortized
discount of $963,000 and $1.5 million, respectively. During the nine months
ended September 30, 2003 and 2002, discount amortization of $492,000 and
$403,000, respectively, was recorded as interest expense. The average
effective interest rate includes approximately $466,000 and $284,000 of
additional interest expense during the nine months ended September 30, 2003
and 2002,
28
respectively, due to the mortgages underlying the insured
mortgage securities prepaying at a faster rate than anticipated and an
adjustment in 2003 to the assumed prepayment speeds. 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.
(8) As of September 30, 2003 and December 31, 2002, the unpaid principal
balance of this mortgage payable was $8.6 million and $8.7 million,
respectively, and the unamortized discount was $1.3 million and $1.5
million, respectively. The coupon rate on the mortgage payable is 7.34%.
The effective interest rate on the mortgage payable is 12.00% as a result
of the discount amortization. The discount is being amortized to interest
expense through maturity in 2008. During the nine months ended September
30, 2003 and 2002, discount amortization of $169,000 and $153,000,
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 to two of our
subsidiaries, in the form of a repurchase transaction under the January 2003
recapitalization. The Bear Stearns Debt matures in 2006, bears interest at a per
annum rate equal to one-month LIBOR plus 3%, payable monthly, and currently
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% and we will have to pay Bear
Stearns an additional $2 million in cash, 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,
if, and as, permitted after the application of the terms of a netting agreement
entered into in connection with an interest rate swap (as described below), 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. Under the
Bear Stearns Debt, we are required to obtain interest rate protection in the
form of a cap, swap or other derivative.
BREF Debt
In connection with the January 2003 recapitalization, BREF Fund purchased
$30 million of our newly issued subordinated debt and, at our option, BREF Fund
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 Fund, 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, which we are currently
deferring, (and half on the additional $10 million, if sold to BREF Fund) during
its term. The BREF Debt is secured by first liens on the equity interests of two
of our subsidiaries. Although these liens effectively provide BREF Fund 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 direct 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 Brascan Real Estate Financial Investments LLC,
which we refer to as BREF Investments, and Bear Stearns, BREF Investments has
agreed generally that the BREF Debt is subordinate
29
and junior to the prior payment of the Bear Stearns Debt and has further
agreed to contractual restrictions on its ability to realize upon its liens. We
paid BREF Investments an origination fee of $200,000, equal to 0.5% of the $30
million in subordinated debt it had acquired plus the additional $10 million in
subordinated debt that, at our option, it may acquire. We also paid BREF
Investments an aggregate of $1 million for expenses in connection with the
transactions. Pursuant to the Investment Agreement with BREF Investments, we are
also obligated to pay BREF Investments a quarterly maintenance fee of $434,000
through January 2006.
Interest Rate Swap Agreement and Netting Agreement
During the second quarter of 2003, two of our subsidiaries (the primary
obligors of the Bear Stearns Debt) entered into an interest rate swap agreement
for the purpose of hedging the variability of expected future interest payments
on our anticipated CDO, as more fully described under Note 7. In the second and
third quarters of 2003, we entered into a total of three interest rate swap
transactions under this agreement in which we have agreed to pay Bear Stearns a
weighted average fixed interest rate of 4.15% per annum in exchange for floating
payments based on one-month LIBOR on the total notional amount of $100 million.
These swaps are effective on October 15, 2003, terminate on October 15, 2013 and
provide for monthly interest payments commencing November 15, 2003. On November
15, 2003 we will begin making monthly payments to Bear Stearns equal to the
difference between the weighted average swap rate of 4.15% and the then current
one-month LIBOR rate, which was 1.12% on October 15, 2003, on the notional
amount of $100 million. See further discussion in Note 7. We anticipate that the
interest rate swaps will be terminated or otherwise disposed of, in each case
subject to the consent of Bear Stearns, upon issuance of the CDO.
Under the interest rate swap documents, our two subsidiaries have granted
to Bear Stearns a security interest in all of their rights, title and interest
in certain assets, including property now or hereafter held by Bear Stearns in
connection with the Bear Stearns Debt or the interest rate swap documents and
certain contract rights under the Bear Stearns Debt and interest rate swap
documents (including the subsidiaries' rights to any "margin excess" related to
the collateral securing the Bear Stearns Debt, with margin excess as defined in
the Bear Stearns Debt documents), to secure their obligations under the interest
rate swap documents and the Bear Stearns Debt. This security interest
constitutes additional collateral for the Bear Stearns Debt. Also under the
interest rate swap documents, on any day on which there exists any obligation
for us to deliver cash or additional eligible collateral under either the
interest rate swap or the Bear Stearns Debt, such obligation will be deemed
satisfied to the extent there exists a margin excess under the Bear Stearns Debt
or an obligation for Bear Stearns to deliver cash or eligible collateral under
the interest rate swap. CRIIMI MAE Inc. has guaranteed all of its subsidiaries'
obligations under the interest rate swap documents, as well as the Bear Stearns
Debt.
Bear Stearns $200 Million Secured Borrowing Facility
On August 28, 2003, one of our subsidiaries finalized and executed
(effective as of June 26, 2003) a $200 million secured borrowing facility, in
the form of a repurchase transaction, with Bear Stearns. This facility may be
used for the acquisition of subordinated CMBS and for financing certain other
transactions involving securities. The securities to be transferred to Bear
Stearns in each transaction under this facility will be subject to the approval
of Bear Stearns in its sole discretion. The debt will be secured by the
securities transferred to Bear Stearns, and if the market value of the
collateral declines we may be required to pay down the debt or post additional
collateral. This facility may be used for one or more transactions. The
financing available for a subordinated CMBS purchased under this facility ranges
from 80% to 15% of the market value of the CMBS. The applicable percentage
depends primarily upon the ratings category of the CMBS and, to a lesser extent,
upon the number of issuer trusts from which we have purchased CMBS. The maturity
date of each transaction will be determined at the time the transaction is
closed and, in each case, will be on or before August 14, 2005. As to each
transaction, accrued and unpaid interest will be payable monthly at an annual
rate ranging from one-month LIBOR plus 0.8% to one-month LIBOR plus 2% and all
unpaid principal and accrued and unpaid interest will be payable at maturity.
Commencing on the date of the closing of the first transaction under this
facility, we will be required to maintain liquidity of at least $10 million in
cash and investment grade securities. Since the CDO was not closed by October
14, 2003, this liquidity requirement will increase by $2.5 million per calendar
quarter subsequent to October 14, 2003. The liquidity requirement will terminate
upon the closing of the CDO or repayment in full of the Bear Stearns Debt.
CRIIMI MAE Inc. has guaranteed the obligations of its subsidiary under this
facility. If we do a CDO transaction with securities purchased under the Bear
Stearns secured borrowing facility and Bear Stearns is not a lead manager, then
we may be required to pay Bear Stearns an exit and/or disappointment fee. There
were no borrowings outstanding under this facility at September 30, 2003.
30
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 net gain on extinguishment of debt
of approximately $7.3 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 and anticipated
CDO. We have an interest rate cap and swaps to partially limit the adverse
effects of rising interest rates on our variable rate debt and the anticipated
CDO. 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, including the anticipated CDO, are taken to
mitigate this risk. Furthermore, with respect to the cap, we currently 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 our
derivative financial instruments. As of September 30, 2003, our debt-to-equity
ratio was approximately 2.5 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 September 30, 2003 December 31, 2002
- -------------------------------- ------------------ -----------------
CMBS $ 332 $ 326
Freddie Mac Funding Note 74 146
Fannie Mae Funding Note 31 47
CMO 63 77
7. DERIVATIVE FINANCIAL INSTRUMENTS
In the second and third quarters of 2003, we entered into a total of three
interest rate swaps to hedge the variability of the future interest payments on
the anticipated CDO attributable to changes in interest rates. Our obligations
to Bear Stearns under the interest rate swap documents are collateralized by
certain assets as described in Note 6. These swaps are treated as cash flow
hedges for GAAP. Under these swaps, we agreed to pay Bear Stearns a weighted
average fixed interest rate of 4.15% per annum in exchange for floating payments
based on one-month LIBOR on the total notional amount of $100 million. These
swaps are effective on October 15, 2003, terminate on October 15, 2013 and
provide for monthly interest payments commencing November 15, 2003. On November
15, 2003 we will begin making monthly payments to Bear Stearns equal to the
difference between the weighted average swap rate of 4.15% per annum and the
then current one-month LIBOR rate, which was 1.12% per annum on October 15,
2003, on the notional amount of $100 million. The interest rate swaps were
designated to hedge future interest payments on the proposed CDO. As the
expected date of the CDO has been changed, we recognized approximately $1.9
million of hedging ineffectiveness during the three months ended September 30,
2003, in accordance with SFAS No. 133. The $1.9 million expense represents the
present value of the expected payments during the period of delay. We have an
asset of approximately $1.5 million in Other Assets as of September 30, 2003,
representing the aggregate fair value of the interest rate swaps. We intend to
terminate the swaps simultaneously with the issuance of the CDO.
31
We maintain an interest rate cap indexed to one-month LIBOR to partially
limit the adverse effects of potential rising interest rates on our
variable-rate debt. The interest rate cap provides 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 would receive payments
based on the difference between the index and the cap. At September 30, 2003,
our interest rate cap had a notional amount of $175 million, capped one-month
LIBOR at 3.25% and had a fair value of $0. This cap matured on November 3, 2003.
On October 31, 2003, we purchased an interest rate cap for $45,000 with a
notional amount of $50 million, an effective date of November 4, 2003, maturity
on November 4, 2004, and capping one-month LIBOR at 2.25%. We designated both of
these interest rate caps, in accordance with SFAS No. 133, to hedge the Bear
Stearns Debt.
We are exposed to credit loss in the event of non-performance by the
counterparties to the interest rate cap and interest rate swaps should interest
rates exceed the cap rate, or if the floating rate exceeds the fixed swap rates
respectively, however, we do not anticipate non-performance by the
counterparties. The counterparties (or the parent to the counterparty in the
case of the interest rate swaps) have long-term debt ratings of A or above by
Standard and Poor's and A2 or above by Moody's. Although neither the cap nor
swaps are exchange-traded, there are a number of financial institutions which
enter into these types of transactions as part of their day-to-day activities.
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 September 30, 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 nine months ended September 30, 2003 89.7
---------
Balance remaining of January 2000 Loss to be recognized during the remainder of 2003 $ (29.9)
=========
Taxable income for the nine months ended September 30, 2003 before recognition $ 26.4
of January 2000 Loss
LESS: January 2000 Loss recognized during the nine months ended September 30, 2003 (89.7)
---------
Net Operating Loss for the nine months ended September 30, 2003 $ (63.3)
=========
Accumulated Net Operating Loss through December 31, 2002 $ (223.8)
Net Operating Loss for the nine months ended September 30, 2003 (63.3)
Net Operating Loss utilization -
---------
Net Operating Loss carried forward for use in future periods $ (287.1)
=========
Accumulated and unused net operating loss and remaining January 2000 Loss $ (317.0)
=========
32
9. SERVICING RESTRUCTURING AND SALE OF CMBS MASTER AND DIRECT SERVICING
RIGHTS
In April 2003, CMSLP restructured its property servicing group. In
connection with the restructuring, 15 employee positions were eliminated in the
second and third quarters of 2003. The elimination of these positions resulted
in the termination of 11 employees. We recognized approximately $151,000 of
servicing restructuring expenses, representing employee severance and related
benefits, during the nine months ended September 30, 2003. In conjunction with
this restructuring, we have outsourced substantially all of our property
servicing duties on a considerable portion of the properties underlying our
mortgage assets to another servicer, effective October 2003. We expect to
outsource the balance of our property servicing duties, excluding consents and
assumptions, by the end of the fourth quarter of 2003. This outsourcing will not
relieve us of any of our obligations or reduce any of our rights as property
servicer since CMSLP remains the property servicer of record. The table below
provides a summary of the change in the liability balance associated with the
restructuring of our property servicing group. All amounts in the accrual are
severance and other employee benefits.
Balance, April 1, 2003 $ --
Amounts accrued 150,672
Amounts paid (148,878)
--------
Balance, September 30, 2003 $ 1,794
========
In February 2002, CMSLP sold all of its rights and obligations under its
CMBS master and direct servicing contracts because the contracts were not
profitable, given the relatively small volume of master and direct CMBS
servicing that CMSLP was performing. In connection with this restructuring, 34
employee positions were eliminated. During the nine months ended September 30,
2002, approximately $1.0 million of income tax expense was recognized as a
result of the income taxes on the gain on the sale by CMSLP of its master and
direct servicing rights. The income tax expense was incurred by us through our
wholly-owned taxable REIT subsidiaries ("TRSs") that own partnership interests
in CMSLP. These TRSs are separately taxable entities that cannot use our NOL to
reduce their taxable income. As a result of this sale and related restructuring,
CMSLP recorded restructuring expenses in the fourth quarter of 2001. During the
nine months ended September 30, 2002, CMSLP recorded additional restructuring
expenses of $141,000 primarily related to rent on vacant office space that was
taking longer to sublease than originally anticipated.
10. EXECUTIVE CONTRACT TERMINATION COSTS
In August 2003, the employment contracts for David Iannarone, Cynthia
Azzara and Brian Hanson expired and were not renewed. These contracts were put
into place in 2001 to ensure management continuity following our emergence from
Chapter 11 proceedings and through our January 2003 recapitalization. In
connection with the contract terminations, we recognized approximately $1.0
million of expenses for each of Mr. Iannarone and Ms. Azzara and approximately
$847,000 of expense related to severance and related benefit payments for Mr.
Hanson. Mr. Iannarone and Ms. Azzara were each paid their contract termination
payments during the three months ended September 30, 2003. Approximately
$306,000 of Mr. Hanson's payments were made during the three months ended
September 30, 2003. The remaining $542,000 related to Mr. Hanson will be paid
over 17 months in accordance with the terms of his terminated employment
agreement.
Ms. Azzara has agreed to continue with us as an "at will" employee and has
been promoted to Executive Vice President, Chief Financial Officer and
Treasurer. Mr. Hanson is no longer employed by us, but has agreed to a
short-term consulting arrangement. Mr. Iannarone subsequently resigned his
position as Executive Vice President, Legal and Deal Management effective
October 24, 2003. Mr. Iannarone was granted 13,055 shares of restricted common
stock on October 3, 2003, valued at approximately $140,000 based on the closing
price of our common stock on October 3, 2003, under our 2001 Stock Incentive
Plan. Mr. Iannarone's restricted common stock was forfeited effective upon his
resignation.
11. RECAPITALIZATION EXPENSES
We consolidated our office space in connection with our January 2003
recapitalization and, as a result, we recorded approximately $532,000 of expense
for vacant office space during the second quarter of 2003. We reduced our
accrual by approximately $9,000 during the three months ended September 30,
2003, which represents the expense amortization for the period.
33
The accrual for the vacant space represents the fair value of lease
payments through 2007, a tenant improvement allowance and a broker commission,
all net of estimated sublease revenue in accordance with SFAS No. 146. In
addition, as discussed in Note 15, we recognized approximately $2.6 million of
expenses related to the termination of our former Chairman and former President
during the three months ended March 31, 2003.
12. COMMON STOCK
We had 300,000,000 authorized shares and 15,263,006 and 13,945,068 issued
and outstanding shares of $0.01 par value common stock as of September 30, 2003
and December 31, 2002, respectively. In connection with the January 2003
recapitalization, BREF Fund 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 September
30, 2003:
Common Shares Balance of Common
Date Description Issued Shares Outstanding
- ------------------------- ----------------------------------------- ----------------- -------------------
December 31, 2002 Beginning balance 13,945,068
Shares issued to BREF Fund 1,212,617
Stock options exercised 5,000
- -------------------------------------------------------------------------------------------------------------
March 31, 2003 Balance 15,162,685
- -------------------------------------------------------------------------------------------------------------
Stock options exercised 39,000
- -------------------------------------------------------------------------------------------------------------
June 30, 2003 Balance 15,201,685
- -------------------------------------------------------------------------------------------------------------
Stock options exercised 3,300
Restricted stock granted 58,021
- -------------------------------------------------------------------------------------------------------------
September 30, 2003 Balance 15,263,006
- -------------------------------------------------------------------------------------------------------------
In connection with the January 2003 recapitalization, BREF Fund 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.
13. PREFERRED STOCK
As of September 30, 2003 and December 31, 2002, 75,000,000 shares of
preferred stock were authorized. As of September 30, 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.
As of September 30, 2003, there were no accrued and unpaid dividends for
any series of our preferred stock. On November 11, 2003, the Board of Directors
declared cash dividends of $0.68, $0.30 and $0.375 per share of Series B, Series
F and Series G Preferred Stock, respectively, payable on December 31, 2003 to
shareholders of record on December 16, 2003.
Series B Cumulative Convertible Preferred Stock
As of September 30, 2003 and December 31, 2002, there were 1,593,982 shares
of Series B Preferred Stock issued and outstanding. The Series B Preferred Stock
provides for a dividend in an amount equal to the sum of (i) $0.68 per share per
quarter plus (ii) the product of the excess over $3.00, if any, of the quarterly
cash dividend declared and paid with respect to each share of common stock times
a conversion ratio of 0.4797 times one plus a conversion premium of 3%, subject
to further adjustment upon the occurrence of certain events. The following table
summarizes the 2003 dividend payment activity for the Series B Preferred Stock:
34
Time Period for
Dividends per Amount of Dividends which dividends
Declaration Date Payment Date Series B Share were accrued
-------------------------------------------------------------------------------------------------
March 5, 2003 March 31, 2003 $ 0.68 $ 1,083,908 4/01/02-6/30/02
May 15, 2003 June 30, 2003 $ 0.68 $ 1,083,908 7/01/02-9/30/02
June 3, 2003 June 30, 2003 $ 2.04 $ 3,251,723 10/01/02-6/30/03
August 14, 2003 September 30, 2003 $ 0.68 $ 1,083,908 7/01/03-9/30/03
As of September 30, 2003, each share of Series B Preferred Stock was
convertible into 0.4797 shares of common stock.
Series E Cumulative Convertible Preferred Stock
In March 2002, we redeemed all 173,000 outstanding shares of the Series E
Preferred Stock at the stated redemption price of $106 per share 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
$2,252,000 difference between the aggregate liquidation value, including the
initial preferred stock issuance costs, and the redemption price is reflected as
a dividend on preferred stock during the nine months ended September 30, 2002.
Series F Redeemable Cumulative Dividend Preferred Stock
As of September 30, 2003 and December 31, 2002, there were 586,354 shares
of Series F Preferred Stock issued and outstanding. The Series F Preferred Stock
provides for dividends at a fixed annual rate of 12%. The following table
summarizes the 2003 dividend payment activity for the Series F Preferred Stock:
Time Period for
Dividends per Amount of Dividends which dividends
Declaration Date Payment Date Series F Share were accrued
-------------------------------------------------------------------------------------------------
March 5, 2003 March 31, 2003 $ 0.30 $ 175,906 4/01/02-6/30/02
May 15, 2003 June 30, 2003 $ 0.30 $ 175,906 7/01/02-9/30/02
June 3, 2003 June 30, 2003 $ 0.90 $ 527,719 10/01/02-6/30/03
August 14, 2003 September 30, 2003 $ 0.30 $ 175,906 7/01/03-9/30/03
Series G Redeemable Cumulative Dividend Preferred Stock
As of September 30, 2003 and December 31, 2002, there were 1,244,656 shares
of Series G Preferred Stock issued and outstanding. The Series G Preferred Stock
provides for dividends at a fixed annual rate of 15%. The following table
summarizes the 2003 dividend payment activity for the Series G Preferred Stock:
Time Period for
Dividends per Amount of Dividends which dividends
Declaration Date Payment Date Series G Share were accrued
-------------------------------------------------------------------------------------------------
March 5, 2003 March 31, 2003 $ 0.375 $ 466,746 4/01/02-6/30/02
May 15, 2003 June 30, 2003 $ 0.375 $ 466,746 7/01/02-9/30/02
June 3, 2003 June 30, 2003 $ 1.125 $ 1,400,238 10/01/02-6/30/03
August 14, 2003 September 30, 2003 $ 0.375 $ 466,746 7/01/03-9/30/03
Series H Junior Preferred Stock
As of September 30, 2003 and December 31, 2002, there were no issued and
outstanding shares of Series H Preferred Stock.
35
14. EARNINGS PER SHARE
The following tables reconcile basic and diluted earnings per share for the
three and nine months ended September 30, 2003 and 2002.
For the three months ended September 30, 2003 For the three months ended September 30, 2002
Per Share Per Share
Income Shares Amount Income Shares (2) Amount
-------------- --------------- ------------- ------------- ------------ -----------
Basic and diluted earnings per share (1):
- ----------------------------------------
Net loss to common shareholders $ (7,374,724) 15,204,913 $ (0.49) $(25,101,506) 13,926,600 $(1.80)
============== =============== ============= ============= ============ ===========
For the nine months ended September 30, 2003 For the nine months ended September 30, 2002
Per Share Per Share
Income Shares Amount Income Shares (2) Amount
-------------- --------------- ------------ ------------- ------------ ------------
Net loss to common shareholders
before cumulative effect of
change in accounting principle $ (6,692,962) 15,114,173 $ (0.44) $(21,081,467) 13,635,656 $(1.55)
Cumulative effect of change in
accounting principle related to
SFAS 142 -- -- -- (9,766,502) 13,635,656 (0.71)
-------------- --------------- ------------- ------------- ------------ -----------
Basic and diluted earnings per share (1):
- ----------------------------------------
Net loss to common shareholders $ (6,692,962) 15,114,173 $ (0.44) $(30,847,969) 13,635,656 $(2.26)
============== ============== ============= ============= ============ ===========
(1) The common stock equivalents for stock options, the preferred stock that is
convertible and the warrants outstanding are not included in the
calculation of diluted EPS because the effect would be anti-dilutive.
(2) Includes the weighted average number of common shares payable or paid to
preferred stockholders related to dividends as of the respective dividend
declaration dates.
15. TRANSACTIONS WITH RELATED PARTIES
The following is a summary of the related party transactions which occurred
during the three and nine months ended September 30, 2003 and 2002:
Three months ended September 30, Nine months ended September 30,
2003 2002 2003 2002
---- ---- ---- ----
Amounts received or accrued from the AIM Limited
Partnerships
- ------------------------------------------------
Income(1) $ 83,436 $ 129,249 $ 306,126 $ 419,880
Return of capital(2) 1,116,759 538,778 2,071,161 1,590,826
----------- --------- ----------- -----------
Total $ 1,200,195 $ 668,027 $ 2,377,287 $ 2,010,706
=========== ========= =========== ===========
Amounts received or accrued from AIM Acquisition
Limited Partnership (1) $ 36,456 $ 58,397 $ 127,337 $ 179,791
=========== ========= =========== ===========
Expense reimbursements from AIM Limited
Partnerships (3) (5) $ 49,992 $ 47,851 $ 161,099 $ 143,078
=========== ========= =========== ===========
Expense reimbursements to affiliates of BREF
Fund and employees of those affiliates (3) $ 12,365 $ - $ 30,477 $ -
=========== ========= =========== ===========
Expense reimbursement (to) from CRI:
- -----------------------------------
Expense reimbursement to CRI (3) (4) $ (7,316) $(156,100) $ (83,307) $ (245,862)
Expense reimbursement from CRI (3) (4) 8,388 69,415 80,867 145,853
=========== ========== =========== ===========
Net expense reimbursement from (to) CRI $ 1,072 $ (86,685) $ (2,440) $ (100,009)
=========== ========== =========== ===========
(1) Included as equity in earnings from investments on the accompanying
consolidated statements of income.
(2) Included as a reduction of equity investments on the accompanying
consolidated balance sheets.
(3) Included in general and administrative expenses on the accompanying
consolidated statements of income.
(4) Pursuant to an administrative services agreement between us and CRI,
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
36
another service provider. The majority of such services under this
agreement were terminated in March 2003. Our former Chairman, who is
currently one of our directors, is a director, executive officer and
principal shareholder of CRI.
(5) During the three months ended September 30, 2003, CMSLP accrued
approximately $150,000 as a payable to AIM 84 and AIM 85 due to an
obligation incurred related to servicing a loan.
As previously discussed, Barry Blattman, our Chairman and CEO, is
affiliated with BREF Fund and BREF Investments. The Board's Compensation and
Stock Option Committee is considering various alternatives with respect to the
employment arrangement for Mr. Blattman. We have accrued approximately $550,000
in estimated compensation, subject to the approval of the Compensation and Stock
Option Committee, as of September 30, 2003 which is expected to be payable in
connection with Mr. Blattman's employment. Additional compensation may be
payable in connection with such employment arrangement in the form of restricted
stock or other equity-like compensation.
As discussed in Note 6, we paid BREF Investments an origination fee of
$200,000 related to the BREF Debt and an aggregate of $1.0 million for expenses
in connection with the January 2003 recapitalization transactions. Pursuant to
the Investment Agreement with BREF Investments, we are obligated to pay BREF
Investments a quarterly maintenance fee of $434,000. As discussed in Note 12, in
connection with the January 2003 recapitalization, we issued seven-year warrants
to BREF Fund 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 Fund and/or certain of its affiliates (including BREF
Investments) relating to the composition of our Board of Directors, additional
subordinated debt financing, non-competition and other matters.
In conjunction with the hiring of Mark Jarrell on September 15, 2003 as our
President and Chief Operating Officer, Mr. Jarrell was granted 58,021 shares of
restricted common stock on September 15, 2003, valued at $666,667 based on the
closing price of our common stock on August 12, 2003, under our 2001 Stock
Incentive Plan. This initial grant will vest 25% on December 31, 2003 and 75% on
December 31, 2004. In addition, Mr. Jarrell will be granted shares of common
stock equivalent to $500,000 on each of December 31, 2005 and 2006, provided he
is employed by us on those dates and subject to certain terms of his Employment
Offer Letter Agreement dated August 11, 2003. We expect to recognize
approximately $143,000 of deferred compensation expense related to the
restricted common stock award during the remainder of 2003 and approximately
$500,000 of deferred compensation expense during 2004.
On October 3, 2003, Cynthia Azzara, our Executive Vice President, Chief
Financial Officer and Treasurer, was granted 13,055 shares of restricted common
stock, valued at approximately $140,000 based on the closing price of our common
stock on October 3, 2003, under our 2001 Stock Incentive Plan. This grant will
vest 33% on each of December 31, 2004, 2005 and 2006.
On October 29, 2003, Stephen Abelman was hired as Executive Vice President
of Asset Management. In connection with his employment, Mr. Abelman was granted
12,500 shares of restricted stock on 2003, valued at approximately $142,000
based on the closing price of our common stock on November 6, 2003 under our
2001 Stock Incentive Plan. This grant will vest 33% on each of December 31,
2004, 2005 and 2006.
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 recapitalization
expenses 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
37
Receivable/deferred compensation are payable quarterly and terminate in
June 2005. The Note Receivable/deferred compensation bears interest at the prime
rate (4.00% as of September 30, 2003) plus 2% per annum. During the nine months
ended September 30, 2003 and 2002, aggregate payments of approximately $434,000
and $466,000, 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 $1,000,423 at September 30, 2003. The
financial statement impact of these transactions is immaterial.
16. 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.
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.
The following tables detail the financial performance of these operating
segments for the three and nine months ended September 30, 2003 and 2002. The
basis of accounting used in the tables is GAAP.
38
As of and for the three months ended September 30, 2003
------------------------------------------------------------------------------------
Elimination of
Portfolio Mortgage Intercompany
Investment Servicing Transactions Consolidated
------------------- ---------------- ------------------- ------------------
Interest income $ 25,607,633 $ - $ - $ 25,607,633
Interest expense (17,711,530) - - (17,711,530)
------------------- ---------------- ------------------- ------------------
Net interest margin 7,896,103 - - 7,896,103
------------------- ---------------- ------------------- ------------------
General and administrative expenses (2,629,658) - (397,403) (3,027,061)
Deferred compensation expense (23,810) - - (23,810)
Depreciation and amortization (131,472) - - (131,472)
Impairment on CMBS (4,704,878) - - (4,704,878)
Servicing revenue - 2,425,138 - 2,425,138
Servicing general and administrative expenses - (2,898,253) 397,403 (2,500,850)
Servicing amortization, depreciation
and impairment - (293,090) - (293,090)
Servicing restructuring expenses - (6,301) - (6,301)
Income tax benefit (expense) - 323,704 - 323,704
Equity in earnings from investments 91,006 - - 91,006
Other, net (456,756) - - (456,756)
BREF maintenance fee (434,000) - - (434,000)
Executive contract termination costs (2,028,343) (847,356) - (2,875,699)
Recapitalization expenses - - - -
Gain on extinguishment debt - - - -
Hedging ineffectiveness (1,930,198) - - (1,930,198)
------------------- ---------------- ------------------- ------------------
(12,248,109) (1,296,158) - (13,544,267)
------------------- ---------------- ------------------- ------------------
Net income (loss) before changes in
accounting principles $ (4,352,006) $ (1,296,158) $ - $ (5,648,164)
=================== ================ =================== ==================
Total assets $ 1,095,408,313 $ 11,850,556 $ - $ 1,107,258,869
=================== ================ =================== ==================
As of and for the three months ended September 30, 2002
------------------------------------------------------------------------------------
Elimination of
Portfolio Mortgage Intercompany
Investment Servicing Transactions Consolidated
------------------- ---------------- ------------------- ------------------
Interest income $ 31,508,173 $ - $ - $ 31,508,173
Interest expense (22,719,404) - 10,076 (22,709,328)
------------------- ---------------- ------------------- ------------------
Net interest margin 8,788,769 - 10,076 8,798,845
------------------- ---------------- ------------------- ------------------
General and administrative expenses (2,766,584) - (15,835) (2,782,419)
Deferred compensation expense (16,732) - - (16,732)
Depreciation and amortization (312,388) - - (312,388)
Impairment on CMBS (29,884,497) - - (29,884,497)
Servicing revenue - 3,110,378 (134,007) 2,976,371
Servicing general and administrative expenses - (2,361,774) 139,766 (2,222,008)
Servicing amortization, depreciation
and impairment - (508,000) - (508,000)
Servicing restructuring expenses - - - -
Servicing gain on sale of servicing
rights - 34,309 - 34,309
Income tax benefit (expense) 326,998 154,258 - 481,256
Equity in earnings from investments 98,005 - - 98,005
Other, net 401,201 - - 401,201
Recapitalization expenses (438,889) - - (438,889)
------------------- ---------------- ------------------- ------------------
(32,592,886) 429,171 (10,076) (32,173,791)
------------------- ---------------- ------------------- ------------------
Net income (loss) before changes in
accounting principles $ (23,804,117) $ 429,171 $ - $ (23,374,946)
=================== ================ =================== ==================
Total assets $ 1,258,335,741 $ 27,333,329 $ (458,133) $ 1,285,210,937
=================== ================ =================== ==================
39
As of and for the nine months ended September 30, 2003
------------------------------------------------------------------------------------
Elimination of
Portfolio Mortgage Intercompany
Investment Servicing Transactions Consolidated
------------------- ---------------- ------------------- ------------------
Interest income $ 78,720,379 $ - $ - $ 78,720,379
Interest expense (55,673,521) - 2,702 (55,670,819)
------------------- ---------------- ------------------- ------------------
Net interest margin 23,046,858 - 2,702 23,049,560
------------------- ---------------- ------------------- ------------------
General and administrative expenses (8,003,063) - (812,830) (8,815,893)
Deferred compensation expense (43,331) - - (43,331)
Depreciation and amortization (450,296) - - (450,296)
Impairment on CMBS (13,652,756) - - (13,652,756)
Servicing revenue - 7,317,427 (2,702) 7,314,725
Servicing general and administrative expenses - (7,637,805) 812,830 (6,824,975)
Servicing amortization, depreciation
and impairment - (1,180,842) - (1,180,842)
Servicing restructuring expenses - (150,672) - (150,672)
Income tax benefit (expense) - 509,934 - 509,934
Equity in earnings from investments 212,341 - - 212,341
Other, net 465,403 - - 465,403
BREF maintenance fee (1,229,667) - - (1,229,667)
Executive contract termination costs (2,028,343) (847,356) - (2,875,699)
Recapitalization expenses (3,148,841) - - (3,148,841)
Gain on extinguishment debt 7,337,424 - - 7,337,424
Hedging ineffectiveness (1,930,198) - - (1,930,198)
------------------- ---------------- ------------------- ------------------
(22,471,327) (1,989,314) (2,702) (24,463,343)
------------------- ---------------- ------------------- ------------------
Net income (loss) before changes in
accounting principles $ 575,531 $ (1,989,314) $ - $ (1,413,783)
=================== ================ =================== ==================
Total assets $ 1,095,408,313 $ 11,850,556 $ - $ 1,107,258,869
=================== ================ =================== ==================
As of and for the nine months ended September 30, 2002
------------------------------------------------------------------------------------
Elimination of
Portfolio Mortgage Intercompany
Investment Servicing Transactions Consolidated
------------------- ---------------- ------------------- ------------------
Interest income $ 95,283,400 $ - $ - $ 95,283,400
Interest expense (69,607,308) - 10,076 (69,597,232)
------------------- ---------------- ------------------- ------------------
Net interest margin 25,676,092 - 10,076 25,686,168
------------------- ---------------- ------------------- ------------------
General and administrative expenses (8,697,969) - 109,766 (8,588,203)
Deferred compensation expense (93,422) - - (93,422)
Depreciation and amortization (920,928) - - (920,928)
Impairment on CMBS (35,035,588) - - (35,035,588)
Servicing revenue - 8,692,686 (458,742) 8,233,944
Servicing general and administrative expenses - (7,186,892) 338,900 (6,847,992)
Servicing amortization, depreciation
and impairment - (1,418,810) - (1,418,810)
Servicing restructuring expenses (141,240) (141,240)
Servicing gain on sale of servicing rights 4,851,907 4,851,907
Income tax benefit (expense) 326,998 (754,518) - (427,520)
Equity in earnings from investments 330,747 - - 330,747
Other, net 1,575,340 - - 1,575,340
Recapitalization expenses (683,333) - - (683,333)
------------------- ---------------- ------------------- ------------------
(43,198,155) 4,043,133 (10,076) (39,165,098)
------------------- ---------------- ------------------- ------------------
Net income (loss) before changes in
accounting principles $ (17,522,063) $ 4,043,133 $ - $ (13,478,930)
=================== ================ =================== ==================
Total assets $ 1,258,335,741 $ 27,333,329 $ (458,133) $ 1,285,210,937
=================== ================ =================== ==================
40
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.
Our core holdings are subordinated CMBS ultimately backed by pools of
commercial mortgage loans on retail, multifamily, hotel, and other commercial
real estate. We also own directly and indirectly government-insured mortgage
backed securities and a limited number of other assets. We also are a trader in
CMBS, residential mortgage-backed securities, agency debt securities and other
fixed income 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., 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 and
Brascan Real Estate Finance Fund I L.P. as BREF Fund.
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. We refer to the secured financing as the Bear
Stearns Debt and the unit of Bear Stearns & Co., Inc. as Bear Stearns.
o New Leadership. - Barry S. Blattman joined CRIIMI MAE 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 Fund. In addition on September 15, 2003, Mark R.
Jarrell, a director, assumed the position of President and Chief
Operating Officer. Upon appointment as President, Mr. Jarrell resigned
as director. Mr. Blattman continues as our Chairman of the Board and
Chief Executive Officer.
41
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.
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 or collateral calls under the Bear Stearns financings and
interest rate swap documents; (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, economic
slowdown and/or recession and other matters on defaults, servicer advances and
losses and the related cash flow impact 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.
2003 compared to 2002
Results of Operations
Financial statement net loss to common shareholders for the three months
ended September 30, 2003 and 2002 was approximately $(7.4) million, $(0.49) per
diluted share, and approximately $(25.1) million, or $(1.80) per diluted share,
respectively. Results for the three months ended September 30, 2003, which are
discussed in further detail below, includes approximately $4.7 million of
impairment charges related to certain subordinated CMBS, approximately $2.9
million of executive contract termination expenses, approximately $1.9 million
of hedging ineffectiveness expense and approximately $1.6 million of additional
non-cash amortization expense on collateralized mortgage obligations. Results
for the three months ended September 30, 2002, which are discussed in further
detail below, include, approximately $29.9 million of impairment charges related
to certain subordinated CMBS.
Financial statement net loss to common shareholders for the nine months
ended September 30, 2003 and 2002 was approximately $(6.7) million, or $(0.44)
per diluted share, and approximately $(30.8) million, or $(2.26) per diluted
share, respectively.
Results for the nine months ended September 30, 2003, which are discussed
in further detail below, include:
o approximately $13.7 million of impairment charges related to certain
subordinated CMBS;
o approximately $7.3 million of gain on extinguishment of debt;
o approximately $3.1 million of recapitalization expenses;
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;
o approximately $2.9 million in executive contract termination expenses;
o approximately $2.6 million of additional non-cash amortization expense on
collateralized mortgage obligations; and
o approximately $1.9 million in hedging ineffectiveness expense.
42
Results for the nine months ended September 30, 2002, which are discussed
in further detail below, include:
o approximately $35.0 million of impairment charges related to certain
subordinated CMBS;
o an approximate $9.8 million charge to write-off goodwill upon the adoption of
Statement of Financial Accounting Standards (or SFAS) No. 142;
o approximately $4.9 million from the gain on the sale of master and direct
servicing rights by CMSLP; and
o approximately $2.2 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,
including the initial preferred stock issuance costs, and the redemption
price).
Interest Income - CMBS
Interest income from CMBS decreased by approximately $3.6 million, or 14%,
to $22.1 million during the three months ended September 30, 2003 as compared to
$25.7 million during the three months ended September 30, 2002. Interest income
from CMBS decreased by approximately $10.5 million, or 14%, to $66.3 million
during the nine months ended September 30, 2003 as compared to $76.8 million
during the nine months ended September 30, 2002. These decreases in interest
income were primarily due to changes in our loss estimates related to CMBS
during 2002 and 2003 and the resulting reduction in interest income on CMBS.
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 12.4% as of January 1, 2002, approximately 12.5% as of July, 2002,
approximately 11.6% as of January 1, 2003, approximately 11.7% as of July 1,
2003 and approximately 12.0% as of October 1, 2003. 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 nine
months ended September 30, 2003, we recognized approximately $8.0 million of
discount amortization, partially offset by approximately $4.3 million of cash
received in excess of income recognized on subordinated CMBS due to the
effective interest method. During the nine months ended September 30, 2002, we
recognized approximately $8.8 million of discount amortization, partially offset
by approximately $2.4 million 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
$2.3 million, or 40%, to $3.5 million for the three months ended September 30,
2003 from $5.8 million for the three months ended September 30, 2002. This
decrease was due to the prepayment or sale of 28 mortgages underlying the
insured mortgage securities, representing approximately 43% of the total insured
mortgage portfolio, from September 30, 2002 through September 30, 2003.
Interest income from insured mortgage securities decreased by approximately
$6.1 million, or 33%, to $12.4 million for the nine months ended September 30,
2003 from $18.5 million for the nine months ended September 30, 2002. As
discussed above, this decrease was primarily due to the prepayment of mortgages
underlying the insured mortgage securities.
During the nine months ended September 30, 2003, 21 mortgages prepaid
resulting in net proceeds of $98.5 million. The prepayment activity corresponds
with the relatively low mortgage interest rate environment during this period
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 an unencumbered GNMA security for
approximately $5.7 million.
43
Interest Expense
Interest expense of approximately $17.7 million for the three months ended
September 30, 2003 was approximately $5.0 million lower than interest expense of
approximately $22.7 million for the same period in 2002. The net decrease is
primarily attributable to a lower average debt balance during the third quarter
of 2003 ($805 million) compared to 2002 ($964 million) and a lower average
effective interest rate on the total debt outstanding during the third quarter
of 2003 (8.6%) compared to 2002 (9.3%). These decreases were partially offset by
additional amortization on the collateralized mortgage obligations as discussed
below.
Interest expense of approximately $55.7 million for the nine months ended
September 30, 2003 was approximately $13.9 million lower than interest expense
of approximately $69.6 million for the same period in 2002. The net decrease is
primarily attributable to a lower average debt balance during the nine months
ended September 30, 2003 ($874 million) compared to 2002 ($987 million) and a
lower average effective interest rate on the total debt outstanding during 2003
(8.4%), including approximately $3.1 million of additional interest as discussed
below, compared to 2002 (9.3%). These decreases were partially offset by
additional amortization on the collateralized mortgage obligations as discussed
below.
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 $1.6 million and $2.6
million of additional discount and deferred fees amortization expenses during
the three and nine months ended September 30, 2003, respectively, which are
reflected as interest expense, compared to approximately $205,000 and $964,000
of additional amortization expenses during the three and nine months ended
September 30, 2002, respectively. The increase in amortization is 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. In addition, we adjusted our assumed prepayment
speed for the amortization of the discount and deferred financing fees during
the three months ended September 30, 2003.
The overall weighted average effective interest rate on the Bear Stearns
and BREF Debt was 5.8% for the three and nine months ended September 30, 2003,
and the weighted average coupon (pay) rate on the Bear Stearns and BREF Debt was
4.2% during the same periods. 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 10.4% and 10.3% for the
three and nine months ended September 30, 2002, respectively. The weighted
average coupon (pay) rate on the Exit Debt was 8.1% and 8.0% during the same
periods.
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 Debt, BREF Debt,
and the senior secured notes were outstanding at the same time.
During the three months ended September 30, 2003 and 2002, we recognized
hedging expense of approximately $274,000 and $353,000 on our interest rate
caps, respectively. During the nine months ended September 30, 2003 and 2002, we
recognized hedging expense of approximately $901,000 and $749,000 on our
interest rate caps, respectively. Our interest rate cap which matured on
November 3, 2003 (which we purchased in April 2002) set one-month LIBOR at a
rate of 3.25%. The fair value of this interest rate cap was $0 as of September
30, 2003. On October 31, 2003, we purchased an interest rate cap for $45,000
with a notional amount of $50 million, an effective date of November 4, 2003,
maturity on November 4, 2004, and capping one-month LIBOR at 2.25%. As of
September 30, 2003, the one-month LIBOR rate was 1.12%.
General and Administrative Expenses
General and administrative expenses increased by approximately $245,000 to
$3.0 million during the three months ended September 30, 2003 as compared to
$2.8 million during the three months ended September 30, 2002 primarily due to
an increase in legal fees incurred in connection with the interest rate swap and
netting agreement.
44
General and administrative expenses increased by approximately $228,000 to
$8.8 million during the nine months ended September 30, 2003 as compared to $8.6
million during the nine months ended September 30, 2002 primarily due to vacant
office space during 2003.
Depreciation and Amortization
Depreciation and amortization was approximately $131,000 and $312,000
during the three months ended September 30, 2003 and 2002, respectively, and
approximately $450,000 and $921,000 during the nine months ended September 30,
2003 and 2002, respectively. The decreases in depreciation and amortization are
primarily attributable to a lower balance of depreciable assets in 2003 as
compared to 2002.
Mortgage Servicing
The following is a summary of the consolidated results of operations of
CMSLP (in thousands):
Three months ended September 30, Nine months ended September 30,
Description 2003 2002 2003 2002
----------- ---- ---- ---- ----
Servicing revenue $ 2,425 $ 2,976 $ 7,315 $ 8,234
Servicing general and administrative expenses (2,501) (2,222) (6,825) (6,848)
Servicing amortization, depreciation and
impairment (293) (508) (1,181) (1,419)
Servicing restructuring expenses (6) -- (151) (141)
Servicing gain on sale of servicing rights -- 34 -- 4,852
-------- -------- --------- --------
GAAP net (loss) income from CMSLP $ (375) $ 280 $ (842) $ 4,678
======== ======== ========= ========
The net loss from CMSLP of approximately $(375,000) for the three months
ended September 30, 2003 compares to net income of approximately $280,000 for
the three months ended September 30, 2002. CMSLP's total revenue decreased by
approximately $551,000 to approximately $2.4 million during the three months
ended September 30, 2003 compared to $3.0 million during the three months ended
September 30, 2002. This decrease is primarily the result of several large
principal recovery fees that were collected in 2002. General and administrative
expenses were $2.5 million during the three months ended September 30, 2003
compared to $2.2 million during the three months ended September 30, 2002 due to
increased expenses related to additional resources dedicated to special
servicing resolutions. During the three months ended September 30, 2003,
amortization, depreciation and impairment expenses were approximately $293,000
as compared to $508,000 in 2002. This decrease was primarily the result of a
lower balance of depreciable assets in 2003 as compared to 2002.
The net loss from CMSLP of approximately $(842,000) for the nine months
ended September 30, 2003 compares to net income of approximately $4.7 million
for the nine months ended September 30, 2002. CMSLP's 2002 results include a
$4.9 million gain from the sale of certain servicing rights. CMSLP's total
revenue decreased by approximately $919,000 to approximately $7.3 million during
the nine months ended September 30, 2003 compared to $8.2 million during the
nine months ended September 30, 2002. This decrease is primarily the result of
several large principal recovery fees that were collected in 2002 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 a recovery of $285,000 of legal fees during 2003 that were
paid in a previous year. General and administrative expenses were $6.8 million
during the nine months ended September 30, 2003 and 2002, respectively. During
the nine months ended September 30, 2003, amortization, depreciation and
impairment expenses aggregated approximately $1.2 million as compared to $1.4
million in 2002. This decrease was primarily the result of the sale of servicing
rights in February 2002 and a lower balance of depreciable assets in 2003,
partially offset by an impairment charge of approximately $198,000 during 2003
related to the subadvisory contracts with the AIM Limited Partnerships, as
discussed below.
During 2003, the AIM Limited Partnerships have experienced a significant
amount of prepayments of their insured mortgages (which corresponded with the
low interest rate environment). These prepayments reduced CMSLP's cash flow from
its subadvisory contracts with the AIM Limited Partnerships. As a result, in
accordance with SFAS No. 142, "Goodwill and Other Intangible Assets," and SFAS
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," we
evaluated CMSLP's investment in the subadvisory contracts for impairment. Our
estimated future undiscounted cash flows from this investment were projected to
be less than the book value on the investment as of June 30, 2003. As a result,
we believed that CMSLP's investment in the subadvisory contracts was impaired at
June 30, 2003. We estimated the fair value of the investment using a discounted
cash flow
45
methodology. We wrote down the value of CMSLP's investment in the
subadvisory contracts with the AIM Limited Partnerships and recorded an
impairment charge of approximately $198,000 as of June 30, 2003.
In April 2003, CMSLP restructured its property servicing group. In
connection with the restructuring, 15 employee positions were eliminated in the
second and third quarters of 2003. The elimination of these positions resulted
in the termination of 11 employees. We recognized approximately $151,000 of
servicing restructuring expenses, representing employee severance and related
benefits, during the nine months ended September 30, 2003. In conjunction with
this restructuring, we have outsourced substantially all of our property
servicing duties on a considerable portion of the properties underlying our
mortgage assets to another servicer, effective October 2003. We expect to
outsource the balance of our property servicing duties, excluding consents and
assumptions, by the end of the fourth quarter of 2003. This outsourcing will not
relieve us of any of our obligations or reduce any of our rights as property
servicer since CMSLP remains the property servicer of record.
Equity in Earnings from Investments
Total equity in earnings from investments of approximately $91,000 and
$98,000 for the three months ended September 30, 2003 and 2002, respectively,
and approximately $212,000 and $331,000 for the nine months ended September 30,
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 advisor to the AIM
Limited Partnerships. The results for the nine months ended September 30, 2003
also include an impairment charge on our equity investment in the advisor to the
AIM Limited Partnerships.
During 2003, the AIM Limited Partnerships have experienced a significant
amount of prepayments of their insured mortgages. These prepayments reduced cash
flows on our 20% investment in the advisor to the AIM Limited Partnerships. As a
result, in accordance with SFAS No. 142, "Goodwill and Other Intangible Assets,"
and SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets," the advisor to the AIM Limited Partnerships evaluated its investment in
the advisory contracts for impairment. The estimated future undiscounted cash
flows from this investment were projected to be less than the book value of the
investment as of June 30, 2003. As a result, the advisor believed that its
investment in the advisory contracts was impaired at June 30, 2003. The advisor
estimated the fair value of its investment using a discounted cash flow
methodology. The advisor wrote down the value of its investment in the advisory
contracts to the AIM Limited Partnerships and recorded an impairment charge. We
recorded our portion of the impairment charge, totaling approximately $109,000,
during the second quarter of 2003. This impairment charge is included in Equity
in earnings from investments in our Consolidated Statement of Income. This
investment is included in our Portfolio Investment segment. We did not recognize
any impairment changes on our equity investments during the three months ended
September 30, 2003 or during the three and nine months ended September 30, 2002.
Income Tax Benefit (Expense)
During the three and nine months ended September 30, 2003, we recorded an
income tax benefit of approximately $324,000 and $510,000, respectively. During
the three months ended September 30, 2002, we recorded income tax benefit of
approximately $481,000. During the nine months ended September 30, 2002, we
recorded income tax expense of approximately $428,000. The income tax benefit
(expense) 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 (expense) that was recognized by our TRSs was the result
of CMSLP's financial results. The expense during the nine months ended September
30, 2002 was primarily the result of the gain on the sale of servcing rights by
CMSLP.
Other Income
Other income decreased by approximately $419,000 to approximately $293,000
during the three months ended September 30, 2003 from approximately $712,000
during the three months ended September 30, 2002. Other income decreased by
approximately $1.2 million to approximately $988,000 during the nine months
ended September 30, 2003 from approximately $2.1 million during the nine months
ended September 30, 2002. These decreases were primarily attributable to lower
interest income earned on reduced cash balances during 2003 as compared to 2002,
a decrease in income from trading activities 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.
46
We own a shopping center in Orlando, Florida, which we account for as real
estate owned. The following is a summary of the financial results of the
shopping center (in thousands):
Three months ended September 30, Nine months ended September 30,
2003 2002 2003 2002
------------ --------------- -------------- ----------------
Interest expense $ (218) $ (215) $ (652) $ (642)
Depreciation expense (41) (35) (116) (114)
Other, net 25 93 79 247
------------ --------------- -------------- ----------------
Net loss $ (234) $ (157) $ (689) $ (509)
============ =============== ============== ================
The other, net amount is included in other income. Interest expense and
depreciation expense are included in their respective captions in our
Consolidated Statements of Income. We hope to reposition and stabilize this
asset to increase its value, although there can be no assurance.
Impairment on CMBS
The following table provides a summary of the changes in the overall
expected loss estimates on subordinated CMBS from January 1, 2002 through
September 30, 2003:
Overall Impairment
Expected Recorded During
($ in millions) Loss Estimate Quarter Ended Impaired CMBS
- --------------- ------------- ------------- -------------
June 30, 2002 $ 351 $5.2 Nomura and CBO-2 unrated/issuer's equity bonds
September 30, 2002 448 29.9 All unrated/issuer's equity bonds, and the CCC
bond and the B- bond in CBO-2
December 31, 2002 503 35.1 All unrated/issuer's equity bonds, and the CCC
bond and the B- bond in CBO-2
June 30, 2003 559 8.9 Unrated/issuer's equity bonds, CCC bond and the
B- bond in CBO-2
September 30, 2003 568 4.7 B- bond and CCC bond in CBO-2
The projected loss severities of the underlying mortgage loans have
increased (including a change in the estimated resolution and disposition dates
of certain specially serviced loans) which has resulted in an increase in our
overall expected loss estimate related to our subordinated CMBS from $503
million as of December 31, 2002 to $559 million as of June 30, 2003 to $568
million as of September 30, 2003. These revisions to the overall expected loss
estimate are primarily the result of increased projected losses due to lower
internal estimates of values on properties underlying certain mortgage loans and
real estate owned by underlying trusts, and changes in the timing of resolution
and disposition of certain specially serviced assets, which when combined, has
resulted in higher projected loss severities on loans and real estate owned by
underlying trusts currently or anticipated to be in special servicing. The
primary reasons for lower estimates of value include the poor performance of
certain properties and related markets and changes to workout negotiations due,
in large part, to the softness in the economy, the continued slowdown in travel
and, in some cases, over-supply of hotel properties, and a shift in retail
activity in some markets.
There can be no assurance that our revised overall expected loss estimate
of $568 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 or internal values at
lower than anticipated amounts, legal proceedings (including bankruptcy filings)
involving borrowers, unforeseen reductions in cash received from our
subordinated CMBS, a deterioration in the economy or recession generally or in
certain industries or sectors specifically, continued hostilities in the Middle
East or elsewhere, terrorism, unexpected delays in the disposition or other
resolution of specially serviced mortgage loans, additional defaults, or an
unforeseen reduction in expected recoveries, any of which could result in
additional future credit losses, impact our cash received from subordinated CMBS
and/or result in further impairment to our subordinated CMBS, the effect of
which could be materially adverse to us.
During 2002, we revised our overall expected loss estimate related to our
subordinated CMBS portfolio as detailed in the table above. The revisions to the
overall expected loss estimate during 2002 were primarily the result of the same
factors as those listed in the paragraph above. As we determined that there had
been an adverse change
47
in expected future cash flows, we believed some of our CMBS had been
impaired under EITF 99-20 and SFAS No. 115 as of June 30, 2002 and September 30,
2002. As the fair value of the impaired subordinated CMBS was approximately $5.2
million and $29.9 million below the amortized cost as of June 30, 2002 and
September 30, 2002, respectively, we recorded other than temporary impairment
charge through the income statement of this same amount during the second and
third quarters of 2002.
Net Losses on Mortgage Security Dispositions
The following is a summary of mortgage security dispositions:
Three months ended September 30, Nine months ended September 30,
2003 2002 2003 2002
---------------- --------------- -------------- ----------------
Net loss recognized $ (749,305) $ (310,722) $ (522,805) $ (567,014)
Number of dispositions 8 6 22 19
Percentage of amortized cost (1) 18.7% 4.1% 38.3% 14.7%
(1) Based on amortized cost as of December 31 of the previous year.
The net losses 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.
BREF Maintenance Fee
Pursuant to the Investment Agreement with BREF Investments, we are
obligated to pay BREF Investments a quarterly maintenance fee of $434,000
through January 2006. The expense of approximately $434,000 and $1.2 million
during the three and nine months ended September 30, 2003, respectively,
represents the maintenance fee for the period January 14 through September 30,
2003.
Executive Contracts
In August 2003, the employment contracts for David Iannarone, Cynthia
Azzara and Brian Hanson expired and were not renewed. These contracts were put
into place in 2001 to ensure management continuity following our emergence from
Chapter 11 proceedings and through our January 2003 recapitalization. In
connection with the contract terminations, we recognized approximately $1.0
million of executive contract termination expenses for each of Mr. Iannarone and
Ms. Azzara and approximately $847,000 of executive contract termination expense
related to severance and related benefit payments for Mr. Hanson during the
three months ended September 30, 2003. Mr. Iannarone and Ms. Azzara were each
paid their contract termination payments during the three months ended September
30, 2003. Approximately $306,000 of Mr. Hanson's payments were made during the
three months ended September 30, 2003. The remaining $542,000 related to Mr.
Hanson will be paid over 17 months in accordance with the terms of his
terminated employment agreement.
Ms. Azzara has agreed to continue with us as an "at will" employee and has
been promoted to Executive Vice President, Chief Financial Officer and
Treasurer. Mr. Hanson is no longer employed by us, but has agreed to a
short-term consulting arrangement. Mr. Iannarone subsequently resigned his
position as Executive Vice President, Legal and Deal Management effective
October 24, 2003. Ms. Azzara and Mr. Iannarone were each granted 13,055 shares
of restricted common stock on October 3, 2003, valued at approximately $140,000
based on the closing price of our common stock on October 3, 2003, under our
2001 Stock Incentive Plan. Mr. Iannarone's restricted common stock was forfeited
effective upon his resignation. Ms. Azzara's grant will vest 33% on each of
December 31, 2004, 2005 and 2006.
In conjunction with the hiring of Mark Jarrell on September 15, 2003 as our
President and Chief Operating Officer, Mr. Jarrell was granted 58,021 shares of
restricted common stock on September 15, 2003, valued at $666,667 based on the
closing price of our common stock on August 12, 2003, under our 2001 Stock
Incentive Plan. This initial grant will vest 25% on December 31, 2003 and 75% on
December 31, 2004. In addition, Mr. Jarrell will be granted shares of common
stock equivalent to $500,000 on each of December 31, 2005 and 2006, provided he
is employed by us on those dates and subject to certain terms of his Employment
Offer Letter Agreement dated August 11, 2003. We expect to recognize
approximately $143,000 of deferred compensation
48
expense related to the restricted common stock award during the remainder of
2003 and approximately $500,000 of deferred compensation expense during 2004.
On October 29, 2003, Stephen Abelman was hired as Executive Vice President
of Asset Management. Mr. Abelman will be responsible for all asset management
functions, including special servicing, surveillance and loan management. In
connection with his employment, Mr. Abelman was granted 12,500 shares of
restricted stock on 2003, valued at approximately $142,000 based on the closing
price of our common stock on November 6, 2003, under our 2001 stock incentive
plan. This grant will vest 33% on each of December 31, 2004, 2005 and 2006.
Effective November 13, 2003, Craig Lieberman, our Senior Vice President -
Strategic Asset Resolutions, was no longer employed by us.
Hedging Ineffectiveness Expense
In the second and third quarters of 2003, we entered into a total of three
interest rate swaps to hedge the variability of the future interest payments on
the anticipated CDO attributable to changes in interest rates. Our obligations
to Bear Stearns under the interest rate swap documents are collateralized by
certain assets as described in "Financial Condition, Liquidity and Capital
Resources - Interest Rate Swap Agreement and Netting Agreement." These swaps are
treated as cash flow hedges for GAAP. Under these swaps, we agreed to pay Bear
Stearns a weighted average fixed interest rate of 4.15% per annum in exchange
for floating rate payments based on one-month LIBOR on the total notional amount
of $100 million. These swaps are effective on October 15, 2003, terminate on
October 15, 2013 and provide for monthly interest payments commencing November
15, 2003. On November 15, 2003 we will begin making monthly payments to Bear
Stearns equal to the difference between the weighted average swap rate of 4.15%
per annum and the then current one-month LIBOR rate, which was 1.12% per annum
on October 15, 2003, on the notional amount of $100 million. The interest rate
swaps were designated to hedge future interest payments on the proposed CDO. As
the expected date of the CDO has been changed, we recognized approximately $1.9
million of hedging ineffectiveness during the three months ended September 30,
2003, in accordance with SFAS No. 133. The $1.9 million expense represents the
present value of the expected payments during the period of delay. If we had
completed the CDO by the original anticipated date of October 15, 2003, we would
have terminated the swap and recognized the $1.5 million fair value as of
September 30, 2003 as a reduction to interest expense over the term of the CDO.
We have an asset of approximately $1.5 million in Other Assets as of September
30, 2003, representing the aggregate fair value of the interest rate swaps.
Recapitalization Expenses
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.
We consolidated our office space in connection with our January 2003
recapitalization and, as a result, we recorded approximately $532,000 of expense
for vacant office space during the three months ended June 30, 2003. We reduced
our accrual by approximately $9,000 during the three months ended September 30,
2003, which represents the expense amortization for the period. The accrual for
the vacant space represents the fair value of lease payments through 2007, a
tenant improvement allowance and a broker commission, all net of estimated
sublease revenue in accordance with SFAS No. 146.
During the three and nine months ended September 30, 2002, we recognized
approximately $439,000 and $683,000, respectively, of recapitalization expenses
related to the services performed by our investment banking firm during the
initial stages of our exploration of strategic alternatives.
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.
49
Dividends Paid or Accrued on Preferred Shares
At the July 31, 2003 Emerging Issues Task Force meeting, the SEC Observer
clarified the application of Topic D-42 related to preferred stock issuance
costs. According to the clarification, all preferred stock issuance costs,
regardless of where in the stockholders' equity section the costs were initially
recorded, should be charged to income available to common shareholders for the
purpose of calculating earnings per share at the time the preferred stock is
redeemed. The SEC Observer indicated that preferred stock issuance costs not
previously charged to income available to common shareholders should be
reflected retroactively in financial statements for reporting periods ending
after September 15, 2003 by restating the financial statements of prior periods
on an as filed basis.
As the result of this guidance, we have charged to income available to
common shareholders approximately $1.2 million in preferred stock offering costs
related to our Series E preferred stock redeemed in March 2002. The following is
a summary of the effect of this change in accounting principle on our
Consolidated Statement of Income during the nine months ended September 30,
2002:
As reported Adjustment Adjusted
----------- ---------- --------
Dividends paid or accrued on preferred shares $ (6,388,310) $ (1,214,227) $ (7,602,537)
Net loss to common shareholders (29,633,742) (1,214,227) (30,847,969)
Earnings (loss) per common share:
Basic and diluted - before cumulative effect
of change in accounting principle (1.46) (0.09) (1.55)
Basic and diluted - after cumulative effect
of change in accounting principle (2.17) (0.09) (2.26)
All applicable 2002 disclosures have been adjusted to reflect this change
in accounting principle. The effect on shareholders' equity is reflected on our
Consolidated Statement of Changes is Stockholders' Equity.
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, 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 our 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 16 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 some or all of our obligations, including 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, residential
mortgage-backed securities and agency debt securities (such securities traded
and all other
50
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 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. 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 some or all of our obligations, including 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 $317.0
million as of September 30, 2003 will be limited.
We do not believe BREF Fund's investment in our common stock and warrant to
purchase common stock has created an "ownership change" under Section 382. In
addition, we are not aware of any other acquisition of shares of our capital
stock that has created an "ownership change" under Section 382. 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.
51
Net Operating Loss for Tax Purposes-Nine months ended September 30, 2003.
We generated a net operating loss for tax purposes of approximately $63.3
million during the nine months ended September 30, 2003. A summary of our
year-to-date net operating loss as of September 30, 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 nine months ended September 30, 2003 89.7
---------
Balance remaining of January 2000 Loss to be recognized during the remainder of 2003 $ (29.9)
=========
Taxable income for the nine months ended September 30, 2003 before recognition $ 26.4
of January 2000 Loss
LESS: January 2000 Loss recognized during the nine months ended September 30, 2003 (89.7)
---------
Net Operating Loss for the nine months ended September 30, 2003 $ (63.3)
=========
Accumulated Net Operating Loss through December 31, 2002 $ (223.8)
Net Operating Loss for the nine months ended September 30, 2003 (63.3)
Net Operating Loss utilization -
---------
Net Operating Loss carried forward for use in future periods $ (287.1)
=========
Accumulated and unused net operating loss and remaining January 2000 Loss $ (317.0)
=========
Cash Flow
2003 compared to 2002
Net cash provided by operating activities decreased by approximately $26.5
million to $19.6 million during the nine months ended September 30, 2003 from
$46.2 million during the nine months ended September 30, 2002. The decrease was
primarily attributable to a decrease in cash received from our subordinated
CMBS, a decrease in interest income from insured mortgages, $2.3 million paid to
certain executives for contract terminations, and $2.1 million of severance paid
to our former Chairman and former President.
Net cash provided by investing activities increased by approximately $61.2
million to $118.4 million during the nine months ended September 30, 2003 from
$57.2 million during the nine months ended September 30, 2002. The increase was
primarily attributable to:
o a $53.3 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;
o a $1.8 million increase in cash received in excess of income recognized on
subordinated CMBS;
o $1.7 million of proceeds from the prepayment of a mezzanine loan; and
o $9.9 million of purchases of investment-grade CMBS by CMSLP during 2002;
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 $52.1
million to $150.3 million during the nine months ended September 30, 2003 from
$98.2 million during the nine months ended September 30, 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 Fund, and used $30.1 million of our
available cash and liquid assets. 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
$10.5 million in preferred stock dividends during the nine months ended
September 30, 2003 and a $46.8 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
(approximately $396,000 of which represented accrued and unpaid dividends) 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 approximate $2.2 million difference between the aggregate liquidation value,
including preferred stock issuance costs, and the redemption price is reflected
as a dividend on preferred stock in 2002.
52
The cash flows described above include the following cash generated by our
assets:
o Approximately $14.6 million and $17.5 million of cash that we
received from our CMBS rated BB+ through unrated during the three
months ended September 30, 2003 and 2002, respectively, and
approximately $45.7 million and $53.6 million during the nine
months ended September 30, 2003 and 2002, respectively;
o Cash distributions (which are primarily a return of investment)
from the AIM Limited Partnerships of approximately $872,000 and
$351,000 during the three months ended September 30, 2003 and
2002, respectively, and approximately $2.1 million and $1.9
million during the nine months ended September 30, 2003 and 2002,
respectively;
o Cash received from the insured mortgage securities after the
related debt was serviced of approximately $576,000 and $842,000
during the three months ended September 30, 2003 and 2002,
respectively, and approximately $1.7 million and $2.6 million
during the nine months ended September 30, 2003 and 2002,
respectively; and
o Approximately $1.9 million and $261,000 of cash received from our
investment in mezzanine loans during the three months ended
September 30, 2003 and 2002, respectively, and approximately $2.5
million and $780,000 during the nine months ended September 30,
2003 and 2002, respectively. The 2003 amounts include
approximately $1.7 million from the payoff of one of the mezzanine
loans in August 2003.
Our cash flows described above also reflect the following cash used to
service our recourse debt:
o Principal payments (excluding the retirement of recourse debt) on
our recourse debt of approximately $1.3 million and $8.8 million
during the three months ended September 30, 2003 and 2002,
respectively, and approximately $4.9 and $27.7 million during the
nine months ended September 30, 2003 and 2002, respectively; and
o Interest payments on our recourse debt of approximately $3.2
million and $7.9 million during the three months ended September
30, 2003 and 2002, respectively, and approximately $16.7 million
and $24.0 million during the nine months ended September 30, 2003
and 2002, respectively.
We also made preferred dividend payments of approximately $1.7 million and
$0 during the three months ended September 30, 2003 and 2002, respectively, and
approximately $10.5 million and $396,000 during the nine months ended September
30, 2003 and 2002, respectively, which are included in our Consolidated
Statement of Cash Flows. Our Consolidated Statement of Income includes
approximately $3.0 million and $2.8 million of corporate general and
administrative expenses during the three months ended September 30, 2003 and
2002, respectively, and approximately $8.8 and $8.6 million during the nine
months ended September 30, 2003 and 2002, respectively. In addition, our
Consolidated Statement of Income includes approximately $434,000 and $1.2
million of expense related to the BREF maintenance fee during the three and nine
months ended September 30, 2003, respectively.
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 Fund, $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 Fund 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
Fund received seven year warrants to purchase up to 336,835 additional shares of
common stock at $11.50 per share. BREF Fund also purchased $30 million of the
BREF Debt and, at our option, BREF Fund 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 Fund, 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, which we are currently deferring, (and half on the
53
additional $10 million if sold to BREF Fund) during its term. The operative
documents evidencing the BREF Debt restrict our ability to take certain actions
such as prepay the BREF Debt, prepay any indebtedness that is expressly
subordinated to the BREF Debt, incur indebtedness, sell assets and engage in
business other than that expressly permitted. We are required to make an offer
to repurchase all of the BREF Debt in the event of a change of control. The BREF
Debt is secured by first liens on the equity interests of two of our
subsidiaries. Although these liens effectively provide BREF Fund 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 direct 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 Investments and Bear Stearns, BREF
Investments has agreed generally that the BREF Debt is subordinate and junior to
the prior payment of the Bear Stearns Debt and has further agreed to contractual
restrictions on its ability to realize upon its liens. We paid BREF Investments
an origination fee of $200,000, equal to 0.5% of the $30 million in subordinated
debt it had acquired plus the additional $10 million in subordinated debt that,
at our option, it may acquire. We also paid BREF Investments an aggregate of $1
million for expenses in connection with the transactions. Pursuant to the
Investment Agreement with BREF Investments, we are also obligated to pay BREF
Investments a quarterly maintenance fee of $434,000 through January 2006. 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 Fund and/or
certain of its affiliates (including BREF Investments). As previously stated,
BREF Fund is a principal stockholder and a creditor of ours, and Barry Blattman,
our Chairman and CEO, is an affiliate of BREF Fund and BREF Investments. All
transactions between us and BREF Fund and BREF Investments 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 to two of our
subsidiaries, in the form of a repurchase transaction under the January 2003
recapitalization. The Bear Stearns Debt matures in 2006, bears interest at a per
annum rate equal to one-month LIBOR plus 3%, payable monthly, and currently
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% and we will have to pay Bear
Stearns an additional $2 million in cash, 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,
if, and as permitted after the application of the terms of a netting agreement
entered into in connection with an interest rate swap (as described below), 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. Under the
Bear Stearns Debt, we are required to obtain interest rate protection in the
form of a cap, swap or other derivative.
Interest Rate Swap Agreement and Netting Agreement
In the second and third quarters of 2003, we entered into a total of three
interest rate swaps to hedge the variability of the future interest payments on
the anticipated CDO attributable to changes in interest rates as discussed in
"Hedging Ineffectiveness Expense."
Under the interest rate swap documents, our two subsidiaries have granted
to Bear Stearns a security interest in all of their rights, title and interest
in certain assets, including property now or hereafter held by Bear Stearns in
connection with the Bear Stearns Debt or the interest rate swap documents and
certain contract rights under the Bear Stearns Debt and interest rate swap
documents (including the subsidiaries' rights to any "margin
54
excess" related to the collateral securing the Bear Stearns Debt, with
margin excess as defined in the Bear Stearns Debt documents), to secure their
obligations under the interest rate swap documents and the Bear Stearns Debt.
This security interest constitutes additional collateral for the Bear Stearns
Debt. Also under the interest rate swap documents, on any day on which there
exists any obligation for us to deliver cash or additional eligible collateral
under either the interest rate swap or the Bear Stearns Debt, such obligation
will be deemed satisfied to the extent there exists a margin excess under the
Bear Stearns Debt or an obligation for Bear Stearns to deliver cash or eligible
collateral under the interest rate swap. CRIIMI MAE Inc. has guaranteed all of
its subsidiaries' obligations under the interest rate swap documents, as well as
the Bear Stearns Debt.
Bear Stearns $200 Million Secured Borrowing Facility
On August 28, 2003, one of our subsidiaries finalized and executed
(effective as of June 26, 2003) a $200 million secured borrowing facility, in
the form of a repurchase transaction, with Bear Stearns. This facility may be
used for the acquisition of subordinated CMBS and for financing certain other
transactions involving securities. The securities to be transferred to Bear
Stearns in each transaction under this facility will be subject to the approval
of Bear Stearns in its sole discretion. The debt will be secured by the
securities transferred to Bear Stearns, and if the market value of the
collateral declines we may be required to pay down the debt or post additional
collateral. This facility may be used for one or more transactions. The
financing available for a subordinated CMBS purchased under this facility ranges
from 80% to 15% of the market value of the CMBS. The applicable percentage
depends primarily upon the ratings category of the CMBS and, to a lesser extent,
upon the number of issuer trusts from which we have purchased CMBS. The maturity
date of each transaction will be determined at the time the transaction is
closed and, in each case, will be on or before August 14, 2005. As to each
transaction, accrued and unpaid interest will be payable monthly at an annual
rate ranging from one-month LIBOR plus 0.8% to one-month LIBOR plus 2% and all
unpaid principal and accrued and unpaid interest will be payable at maturity.
Commencing on the date of the closing of the first transaction under this
facility, we will be required to maintain liquidity of least $10 million in cash
and investment grade securities. Since the CDO was not closed by October 14,
2003, this liquidity requirement will increase by $2.5 million per calendar
quarter subsequent to October 14, 2003. The liquidity requirement will terminate
upon the closing of the CDO or repayment in full of the Bear Stearns Debt.
CRIIMI MAE Inc. has guaranteed the obligations of its subsidiary under this
facility. If we do a CDO transaction with securities purchased under the Bear
Stearns secured borrowing facility and Bear Stearns is not a lead manager, then
we may be required to pay Bear Stearns an exit and/or disappointment fee. There
were no borrowings outstanding under this facility at September 30, 2003.
Other
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 mortgage loans underlying
our subordinated CMBS 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 our obligations. 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, the credit performance of the mortgage loans underlying our
subordinated CMBS, restrictions under the operative documents evidencing our
obligations, and other factors, many of which are beyond our control. Our cash
flow will also be negatively affected by realized losses, interest payment
shortfalls, master servicer advances and appraisal reduction amounts on
properties securing the mortgage loans underlying our subordinated CMBS. We
expect realized losses on our CMBS to continue to increase in 2003, resulting,
generally, in decreased CMBS cash flows as compared to 2002. In addition, if we
are not successful in resolving one of the significant hotel loans in special
servicing (see "Summary of CMBS"), our annual cash flow could be significantly
reduced. 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 mortgage loans held by the AIM Limited Partnerships. Prepayments
of these mortgage loans will result in reductions in the respective mortgage
bases and corresponding reductions in amounts paid to us from our interests in
the advisor and subadvisor to the AIM Limited Partnerships. 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 anticipated 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. In addition, our
net cash flows may be adversely affected by the anticipated CDO transaction, if
and when closed and depending on the terms of such transaction, and our swap
transactions including required payments under such transactions. Cash flows are
also likely to be affected if we
55
incur further debt, under our new secured borrowing facility or otherwise,
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 general adverse economic and industry conditions.
Our ability to make mortgage related investments and acquisitions depends
on, among other things, our ability to engage in such activities under the terms
and conditions of the operative documents evidencing our obligations, our
internally generated cash flows, available liquidity, and our ability to access
additional capital. Factors which could affect our ability to access additional
capital include, among other things, the cost and availability of such capital,
the availability of investment product at attractive rates of return, changes in
interest rates and interest rate spreads, changes in the commercial mortgage
industry and the commercial real estate market, the effects of terrorism,
general economic conditions, perceptions in the capital markets of our business,
restrictions under the operative documents evidencing our obligations, 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 September 30, 2003, our cash and cash equivalents aggregated
approximately $17.0 million, including cash and cash equivalents of
approximately $2.5 million held by CMSLP. In addition to our cash, we had
additional liquidity at September 30, 2003 comprised of $3.9 million in Other
MBS, which is included elsewhere in our balance sheet. As of November 7, 2003,
our liquidity included approximately $25.0 million of cash and cash equivalents
and approximately $4.3 million of Other MBS.
As of September 30, 2003 and December 31, 2002, shareholders' equity was
approximately $311.9 million or $16.26 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, approximately
$43.7 million of 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 investment
grade CMBS, which aggregate approximately $332.1 million at September 30, 2003,
are reflected at fair value and the related match-funded debt, which aggregates
approximately $288.4 million at September 30, 2003, is reflected at amortized
cost, in each case in accordance with GAAP. The increase in total shareholders'
equity is primarily the result of the issuance of common stock to BREF Fund as
previously discussed. Although total shareholder's equity increased, book value
per share decreased due to an increase in the number of shares outstanding as a
result of the January 2003 recapitalization.
Summary of CMBS
As of September 30, 2003, our assets, in accordance with GAAP, include CMBS
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 $860 million
(representing approximately 78% of our total consolidated assets) and an
aggregate amortized cost of approximately $751 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 September 30, 2003 (in millions):
Rating (1) Fair Value % of CMBS
---------- ---------- ---------
A+, BBB+ or BBB (2) $332.1 39%
BB+, BB or BB- $337.2 39%
B+, B, B- or CCC $166.1 19%
Unrated/Issuer's Equity $ 24.9 3%
(1) Ratings are provided by Standard & Poor's.
(2) 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
Obligations-CMBS") and their related liabilities (reflected as
"Collateralized bond obligations - CMBS") to be reflected on our
balance sheet. As of September 30, 2003, the fair value of these
assets as reflected in our balance sheet was approximately $332.1
million and the amortized cost of the debt as reflected in our
balance sheet was approximately $288.4 million. All cash
56
flows related to the investment grade CMBS are used to service the
corresponding securitized mortgage obligations. As a result, we currently
receive no cash flows from the investment grade CMBS.
As of September 30, 2003, the weighted average pay rate and the loss
adjusted weighted average life (based on face amount) of the investment grade
securities was 7.0% and 8.0 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 5.4% and 11.5 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 Pay Weighted as of Calculate Fair as of 09/30/03 as of 12/31/02
Security Rating 09/30/03 (in Rate as of Average 09/30/03 (in Value as of (in millions) (in millions)
millions) 9/30/03 Life (1) millions) 09/30/03 (5) (6)
- ------------------------------------------------------------------------------------------------------------------------------
Investment Grade Portfolio
- --------------------------
A+ (4) $ 62.6 7.0% 3 years $ 66.0 4.3% $ 60.0 $ 59.4
BBB+ (4) 150.6 7.0% 9 years 154.0 6.6% 133.3 132.3
BBB (4) 115.2 7.0% 10 years 112.1 7.4% 96.2 95.3
Retained Portfolio
- ------------------
BB+ 319.0 7.0% 11 years 259.8 9.9%-10.3% 226.1 223.0
BB 70.9 7.0% 13 years 53.8 11.0% 47.3 46.8
BB- 35.5 7.0% 14 years 23.6 12.8% 21.1 20.8
B+ 88.6 7.0% 14 years 50.1 15.1% 46.7 46.0
B 177.2 7.0% 20 years 98.0 12.7%(9) 85.9 85.1
B- (2)(10)(11) 118.3 7.9% 24 years 18.0 15.0%(9) 16.8 28.1
CCC (2) 70.9 0.0% 1 year - 15.0%(9) - 3.8
Unrated/Issuer's
Equity (2)(3) 270.9 1.5% 1 year 24.9 15.0%(9) 17.2 20.0
--------- -------- --------- ---------
Total $ 1,479.7 5.7% 11 years $ 860.3(8) $ 750.6(7) $ 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 September 30, 2003, the fair values of the B, B-, CCC and the
unrated/issuer's equity in Nomura, CBO-1, and CBO-2 were derived primarily
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 are repaid
through either excess interest and/or recoveries on the underlying CMBS or
a recharacterization of principal cash flows, in which case they may be
realized as a loss of principal on the subordinated CMBS. Such anticipated
losses, including shortfalls, have been taken into consideration in the
calculations of fair market values and yields to maturity used to
recognize interest income as of September 30, 2003.
(3) The unrated/issuer's equity subordinated CMBS from CBO-1 and CBO-2
currently do not have a stated coupon rate since these securities are only
entitled to the residual cash flow payments, if any, remaining after
paying the securities with a higher payment priority. As a result,
effective coupon rates on these securities are highly sensitive to the
effective coupon rates and monthly cash flow payments received from the
underlying CMBS that represent the collateral for CBO-1 and 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 CBO-2 transaction is recorded as a
partial financing and a partial sale, we are deemed to have retained these
CMBS with call options issued in connection with CBO-2, from which we
currently receive no cash flows, and are required to reflect them in our
CMBS on the balance sheet.
57
(5) Amortized cost reflects approximately $13.7 million of impairment charges
related to the unrated/issuer's equity bonds, the CCC bond and the B- bond
in CBO-2, which were recognized during the nine months ended September 30,
2003. These impairment charges are in addition to the cumulative
impairment charges of approximately $248.4 million that were recognized
through December 31, 2002. See discussion of the impairment charges in
"Impairment on CMBS".
(6) 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.
(7) See Notes 1 and 8 to Notes to Consolidated Financial Statements for
information regarding the subordinated CMBS for tax purposes.
(8) As of September 30, 2003, the aggregate fair values of the CBO-1, CBO-2
and Nomura bonds were approximately $24.1 million, $828.7 million and $7.5
million, respectively.
(9) As a result of the estimated loss of principal on these CMBS, the fair
values and discount rates of these CMBS are based on a loss adjusted yield
to maturity.
(10) Although the principal balance of the B- bond in CBO-2 is expected to be
outstanding for approximately 25 years, the bond is not expected to
receive any cash flows beyond the next 18 months.
(11) In November 2003, the B- bond in CBO-2, with fair value of approximately
$11.4 million, was downgraded to D by Standard & Poor's.
Determination of Fair Value of CMBS
Our determination of fair values for our CMBS portfolio is a subjective
process. The process begins with the compilation and evaluation of pricing
information (such as nominal spreads to U.S. Treasury securities or nominal
yields) that, in our view, is commensurate with the market's perception of value
and risk of comparable assets. We use a variety of sources to compile such
pricing information including: (i) recent offerings and/or secondary trades of
comparable CMBS (i.e., securities comparable to our CMBS or to the CMBS (or
collateral) underlying our CMBS issued in connection with CBO-1 and CBO-2), (ii)
communications with dealers and active CMBS investors regarding the pricing and
valuation of comparable securities, (iii) institutionally available research
reports, (iv) analyses prepared by the nationally recognized rating
organizations responsible for the initial rating assessment and on-going
surveillance of such CMBS, and (v) other qualitative and quantitative factors
that may impact the value of the CMBS such as the market's perception of the
issuers of the CMBS and the credit fundamentals of the commercial properties
securing each pool of 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, 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 assumed market yields for our CMBS rated A+
through B+, depending on the rating. The fair value for those CMBS incurring
principal losses and interest shortfalls (i.e., B rated bonds through 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 the value and risk of comparable securities, using a
discounted cash flow approach. Such anticipated principal losses and interest
shortfalls, as well as the timing and amount of potential recoveries of such
shortfalls, are critical estimates and have been taken into consideration in the
calculation of fair values and yields to maturity used to recognize interest
income as of September 30, 2003. We have disclosed the range of discount rates
by rating category used in determining the fair values as of September 30, 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.
58
Mortgage Loan Pool
We have $15.8 billion and $17.4 billion of seasoned commercial mortgage
loans underlying our subordinated CMBS portfolio as of September 30, 2003 and
December 31, 2002, respectively, secured by properties of the types and in the
geographic locations identified below:
09/30/03 12/31/02 Geographic 09/30/03 12/31/02
Property Type Percentage(i) Percentage(i) Location(ii) Percentage(i) Percentage(i)
- ------------- ------------- ------------- ----------- ------------- -------------
Retail....... 31% 31% California........ 16% 17%
Multifamily.. 27% 28% Texas............. 12% 12%
Hotel........ 15% 15% Florida........... 8% 8%
Office....... 14% 13% Pennsylvania...... 6% 5%
Other (iv)... 13% 13% New York.......... 4% 4%
---- ---- Other(iii)........ 54% 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. The principal balance of the Subordinated Healthcare/Senior
Housing CMBS as of September 30, 2003 is approximately $3.4 million.
As of October 2003, the aggregate principal balance of healthcare and
senior housing mortgage loans, underlying the Subordinated
Healthcare/Senior Housing CMBS, that are specially serviced by another
special servicer, and therefore not in our special servicing loan
balance, is approximately $83 million.
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 September 30, 2003 and December 31, 2002, specially serviced mortgage
loans included in the commercial mortgage loans described above were as follows:
09/30/03 12/31/02
--------------- ---------------
Specially serviced loans due to monetary default (a) $ 935.7 million $736.1 million
Specially serviced loans due to covenant default/other 44.8 million 74.7 million
--------------- --------------
Total specially serviced loans (b) $ 980.5 million $810.8 million
=============== ==============
Percentage of total mortgage loans (b) 6.2% 4.7%
=============== ==============
(a) Includes $111.3 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 October 31, 2003, total specially serviced loans were approximately
$969.6 million, or 6.2% of the total mortgage loans.
59
The specially serviced mortgage loans as of September 30, 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........ $ 486.9 (1) 50% Florida............ $ 151.2 15%
Retail....... 255.7 (2) 26% Texas.............. 114.6 12%
Healthcare... 81.5 8% Oregon............. 93.3 9%
Multifamily.. 81.1 8% California......... 46.9 5%
Office....... 45.3 5% Massachusetts...... 45.5 5%
Industrial... 20.7 2% Other.............. 529.0 54%
Other........ 9.3 1% ---------- ----
-------- ---- Total............ $ 980.5 100%
Total.... $ 980.5 100% ========== ====
======== ====
(1) Approximately $78.1 million of these loans in special servicing are
real estate owned by the underlying securitization trusts.
(2) Approximately $21.8 million of these loans in special servicing are
real estate owned by the underlying securitization trusts.
The following table provides a summary of the change in the balance of
specially serviced loans from July 1, 2003 to September 30, 2003 and from April
1, 2003 to June 30, 2003 (in millions):
July - September April - June
2003 2003
--------------- -------------
Specially Serviced Loans, beginning of period $1,168.8 $1,154.0
Transfers in due to monetary default 131.5 166.3
Transfers in due to covenant default and other 1.4 7.4
Transfers out of special servicing (314.9) (153.2)
Loan amortization (1) (6.3) (5.7)
------------- -----------
Specially Serviced Loans, end of period $ 980.5 $1,168.8
============= ===========
(1) Represents the reduction of the scheduled principal balances due to
borrower payments or, in the case of loans in monetary default,
advances made by master servicers.
As reflected above, as of September 30, 2003, approximately $486.9 million,
or 50%, of the specially serviced mortgage loans were secured by mortgages on
hotel properties. The hotel properties that secure the mortgage loans underlying
our CMBS are geographically diverse, with a mix of hotel property types and
franchise affiliations. The following table summarizes the hotel mortgage loans
underlying our CMBS as of September 30, 2003:
Total Outstanding Percentage of Amount in
Principal Balance Total Hotel Loans Special Servicing
----------------- ----------------- -----------------
Full service hotels (1) $ 1.3 billion 58% $ 192.9 million
Limited service hotels (2) 1.0 billion 42% 294.0 million
------------- --- ---------------
Totals $ 2.3 billion 100% $ 486.9 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 $486.9 million of hotel loans in special servicing as of September
30, 2003, approximately $272.1 million, or 56%, relate to six borrowing
relationships more fully described as follows:
o Twenty-seven loans with scheduled principal balances as of
September 30, 2003 totaling approximately $135 million spread across
three CMBS transactions secured by hotel properties in the western and
Pacific northwestern states. As of September 30, 2003, our total
exposure, including advances of approximately $30 million, on these
loans was approximately $165 million. The total exposure is prior
to the application of payments made to date by the borrower under the
terms of our consensual settlement agreement; however, the total
exposure is expected to be reduced by the application of such payments
at closing. The borrower initially filed for bankruptcy protection in
February 2002 and 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 subsequently entered into a consensual settlement
agreement dated February 25, 2003 pursuant to which the loan terms were
amended
60
and modified. This agreement was subsequently approved and
confirmed by the bankruptcy court on March 28, 2003. The parties are
currently proceeding toward closing a comprehensive loan modification,
which is expected to occur in the fourth quarter of 2003 and is
expected to return the loans to performing status. The borrower
continues to make payments under the modified terms. As of September
30, 2003, the borrower has made principal and interest payments
totaling approximately $6.9 million, the majority of which represents
interest paid (as compared to principal amortization) on the modified
loan balances. During the nine months ended September 30, 2003, the
borrower also sold one of the properties that secured these loans. In
addition, as of September 30, 2003, the borrower has remitted
approximately $1.5 million in funds from debtor-in-possession accounts,
which is expected to be applied to arrearages at closing. If we are
not successful in resolving this loan favorably, our annual cash
received from CMBS could be significantly reduced.
o Five loans with scheduled principal balances as of September 30, 2003
totaling approximately $45.1 million secured by hotel properties in
Florida and Texas. As of September 30, 2003, our total exposure,
including advances, on these loans was approximately $50.2 million.
Four of the five loans are past due for the November 2002 and all
subsequent payments. One of the loans is past due for the October 2002
and all subsequent payments. The borrower has not been able to perform
under a preliminary modification agreement due to decreased demand in
the Orlando hospitality market. We expect the properties to become real
estate owned by the underlying securitization trusts.
o Six real estate owned properties with scheduled principal balances as
of September 30, 2003 totaling approximately $20.0 million secured by
hotel properties. As of September 30, 2003, our total exposure,
including advances, on these loans was approximately $25.3 million. 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. As part of a consensual plan, eight properties
were foreclosed and became real estate owned by underlying
securitization trusts. During the three months ended September 30,
2003, two of these eight properties with an aggregate unpaid balance of
$5.9 million were sold.
o One loan with a scheduled principal balance as of September 30, 2003
totaling approximately $27.6 million, secured by nine limited service
hotels located in eight states. As of September 30, 2003 the loan was
current. The loan is currently in special servicing due to an
unauthorized transfer of the properties to an entity which assumed the
controlling interest in the borrowing entity. Subsequent to the
transfer, the new controlling party in interest has made an application
for the assumption of the debt, which is anticipated to close in the
fourth quarter of 2003.
o One loan with a scheduled principal balance as of September 30, 2003 of
approximately $25.5 million, secured by a full service hotel in Boston,
Massachusetts. As of September 30, 2003, our total exposure, including
advances, on this loan was approximately $27.0 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
restructuring due to reduced operating performance at the property.
o Nine loans with scheduled principal balances as of September 30, 2003
totaling approximately $18.6 million secured by limited service hotels
in midwestern states. As of September 30, 2003, our total exposure,
including advances, on these loans was approximately $22.3 million. The
loans are past due for the April 2002 and all subsequent payments. The
borrower cites reduced occupancy related to the 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.
The exposure amounts included above are as of September 30, 2003. The
amounts are not necessarily indicative of the exposures as of the projected
resolution dates.
During the three months ended September 30, 2003, two significant hotel
loans in special servicing, included in our June 30, 2003 disclosure of
significant borrowing relationships, were transferred out of special servicing
as follows:
o One hotel loan, with a scheduled principal balance of approximately
$128.4 million as of June 30, 2003, and secured by 93 limited service
hotels located in 29 states, was paid off.
o One hotel loan, with a scheduled principal balance of approximately
$80.7 million as of June 30, 2003, and secured by 13 extended stay
hotels located throughout the U.S., was sold to a third party.
61
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 any of the loans described above will return to
performing status or otherwise be satisfactorily resolved. Circumstances which
could prevent them from returning to performing status or otherwise being
satisfactority resolved include, but are not limited to, changes in workout
negotiations, a more pronounced downturn in the economy or in the real estate
market, a change in local market conditions, a drop in performance of the
property, an increase in interest rates, and terrorist attacks. There can be no
assurance that the losses incurred in the future will not exceed our current
estimates (also see discussion below regarding the increase in loss estimates).
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 can result 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 up to $60,000 on an annual basis,
assuming that the total exposure was equal to or greater than 90% of the
appraised value immediately prior to receipt of the new appraisal (appraisal
reduction). 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 September 30, 2003 30,146 40,640 9,455 80,241
------- -------- ------- ---------
Cumulative Appraisal Reductions through September 30, 2003 $56,705 $140,426 $23,859 $ 220,990
======= ======== ======= =========
* 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 September 30, 2003 (including realized mortgage loan losses
expected to pass through to our CMBS during the next month) and the expected
future real estate losses underlying our CMBS (in thousands):
CBO-1 CBO-2 Nomura Total
----- ------ ------- ------
Year 1999 actual realized losses $ 738 $ -- $ -- $ 738
Year 2000 actual realized losses 3,201 1,087 -- 4,288
Year 2001 actual realized losses 545 8,397 238 9,180
Year 2002 actual realized losses 11,554 25,113 563 37,230
Actual realized losses, January 1 through September 30, 2003 10,041 46,880 662 57,583
-------- -------- ------- ---------
Cumulative actual realized losses through September 30, 2003 $ 26,079 $ 81,477 $ 1,463 $ 109,019
======== ======== ======= =========
Cumulative expected realized loss estimates (including cumulative
actual realized losses) through the year 2003 $ 26,079 $ 91,243 $ 1,463 $ 118,785
Expected loss estimates for the year 2004 51,503 147,007 13,425 211,935
Expected loss estimates for the year 2005 30,019 89,882 10,514 130,415
Expected loss estimates for the year 2006 3,523 18,188 3,372 25,083
Expected loss estimates for the year 2007 1,908 14,643 3,292 19,843
Expected loss estimates for the year 2008 1,784 10,623 2,608 15,015
Expected loss estimates for the remaining life of CMBS 7,972 31,998 6,647 46,617
-------- -------- ------- ---------
Cumulative expected loss estimates (including cumulative
actual realized losses) through life of CMBS $122,788 $403,584 $41,321 $ 567,693
======== ======== ======= =========
62
We revised our overall expected loss estimate related to our subordinated
CMBS from $503 million at December 31, 2002 to $559 million at June 30, 2003 to
$568 million at September 30, 2003, with such total losses occurring or expected
to occur through the life of the subordinated CMBS portfolio. These revisions to
the overall expected loss estimate are primarily the result of increased
projected losses due to lower internal estimates of values on properties
underlying certain mortgage loans and real estate owned by underlying trusts,
and changes in the timing of resolution and disposition of certain specially
serviced assets, which when combined, has resulted in higher projected loss
severities on loans and real estate owned by underlying trusts currently or
anticipated to be in special servicing. The primary reasons for lower estimates
of value include the poor performance of certain properties and related markets
and changes to workout negotiations due, in large part, to the softness in the
economy, the continued slowdown in travel and, in some cases, over-supply of
hotel properties, and a shift in retail activity in some markets.
There can be no assurance that our revised overall expected loss estimate
of $568 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 or internal values at
lower than anticipated amounts, legal proceedings (including bankruptcy filings)
involving borrowers, unforeseen reductions in cash received from our
subordinated CMBS, a deterioration in the economy or recession generally or in
certain industries or sectors specifically, continued hostilities in the Middle
East or elsewhere, terrorism, unexpected delays in the disposition or other
resolution of specially serviced mortgage loans, additional defaults, or an
unforeseen reduction in expected recoveries, any of which could result in
additional future credit losses, impact our cash received from subordinated CMBS
and/or result in further impairment to our subordinated CMBS, the effect of
which could be materially adverse to us.
As of September 30, 2003, we determined that there had been an adverse
change in expected future cash flows for the B- and CCC bonds in CBO-2 due to
the factors mentioned in the paragraph above. As a result, we believed these
bonds had been impaired under EITF 99-20 and SFAS No. 115, "Accounting for
Certain Investments in Debt and Equity Securities," as of September 30, 2003. As
the fair values of these impaired bonds aggregated approximately $4.7 million
below the amortized cost basis as of September 30, 2003, we recorded other than
temporary impairment charges through the income statement of that same amount
during the three months ended September 30, 2003.
As of June 30, 2003, we determined that there had been an adverse change in
expected future cash flows for the unrated/issuer's equity bonds, the CCC bond
and the B- bond in CBO-2 due to the factors mentioned in the paragraphs above.
As a result, we believed these bonds had been impaired as of June 30, 2003. As
the fair values of these impaired bonds aggregated approximately $8.9 million
below the amortized cost basis as of June 30, 2003, we recorded other than
temporary impairment charges through the income statement of that same amount
during the three months ended June 30, 2003.
Yield to Maturity
The following table summarizes yield-to-maturity information relating to
our CMBS on an aggregate pool basis:
Current
Anticipated Anticipated Anticipated Anticipated
Yield-to- Yield-to- Yield-to- Yield-to-
Maturity Maturity Maturity Maturity
Pool as of 1/1/02 (1) as of 1/1/03 (1) as of 7/1/03 (1) as of 10/1/03 (1)
---- ---------------- ---------------- --------------- -----------------
CBO-2 CMBS 12.1% 11.6% 11.5% 11.3%
CBO-1 CMBS 14.3% 11.6% 21.6% 36.8%
Nomura CMBS 28.7% 8.0% 16.9% 27.9%
------ ----- ----- ------
Weighted Average (2) 12.4% 11.6% 11.7% 12.0%
(1) Represents the anticipated weighted average yield over the expected average
life of the CMBS based on our estimate of the timing and amount of future
credit losses and other significant items that are anticipated to affect
future cash flows.
(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 nine months
ended September 30, 2003, we recognized approximately $8.0 million of
discount amortization, partially offset by approximately $4.3 million of
cash received in excess of income recognized on subordinated CMBS due to
the effective interest method. During the nine months ended September 30,
2002, we recognized approximately $8.8 million of discount amortization,
partially offset by approximately $2.4 million of cash received in excess
of income recognized on subordinated CMBS due to the effective interest
method.
63
Summary of Other Assets
Portfolio Investment
As of September 30, 2003 and December 31, 2002, our other assets consisted
primarily of insured mortgage securities, equity investments, mezzanine loans,
Other MBS, cash and cash equivalents (as previously discussed), principal and
interest receivables and real estate owned.
We had $168.3 million and $275.3 million (in each case, at fair value)
invested in insured mortgage securities as of September 30, 2003 and December
31, 2002, respectively. The reduction in total fair value is primarily
attributable to the prepayment or sale of approximately 38% (based on amortized
cost) of the insured mortgages during the nine months ended September 30, 2003.
As of September 30, 2003, 84% of our investments in insured mortgage securities
were GNMA mortgage-backed securities and approximately 16% were FHA-insured
certificates.
As of September 30, 2003 and December 31, 2002, we had approximately $4.0
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, and impairment of
approximately $109,000 that we recognized on our investments in the adviser to
the AIM Limited Partnerships during the second quarter of 2003 (see discussion
in "Equity in Income from Investments"). The carrying values of our equity
investments are expected to continue to decline over time as the AIM Limited
Partnerships' asset bases decrease and proceeds are distributed to partners.
During the three months ending September 30, 2003, we had one mezzanine
loan prepay. This prepayment resulted in a decrease in Other Assets of
approximately $1.7 million. As of September 30, 2003 we have approximately $4.2
million in mezzanine loans.
Our Other MBS primarily include investment grade CMBS, investment grade
residential mortgage-backed securities, agency debt securities and other fixed
income securities. As of September 30, 2003 and December 31, 2002, the fair
values of our Other MBS were approximately $3.9 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 September 30, 2003 and December
31, 2002, we had approximately $8.8 million, respectively, in real estate owned
assets included in other assets ($8.4 million relating to the actual building
and land). In addition, we had $7.3 million and $7.2 million of mortgage payable
(net of discount) related to the real estate as of September 30, 2003 and
December 31, 2002, respectively. We hope to reposition and stabilize this asset
to increase its value, although there can be no assurance we will be able to do
so.
Mortgage Servicing
As of September 30, 2003 and December 31, 2002, CMSLP's other assets
consisted primarily of advances receivable, investments in CMBS, 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 $9.5 million at September 30, 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, and a $512,000 decrease in
fixed assets due to depreciation. In October 2003, we received approximately
$2.5 million in advances receivable reimbursement related to one loan, which
resulted in a corresponding decrease in advances receivable.
Summary of Liabilities
Portfolio Investment
As of September 30, 2003 and December 31, 2002, our liabilities consisted
primarily of debt, accrued interest and accrued payables. Total recourse debt
decreased by approximately $47.2 million to $328.8 million as of September 30,
2003 from $376.0 million as of December 31, 2002 primarily due to the repayment
of the Exit Debt
64
during the first quarter of 2003 principally through the incurrence of the
Bear Stearns and BREF Debt. Total non-recourse debt decreased by approximately
$93.1 million to $452.9 million at September 30, 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
nine months ended September 30, 2003, which resulted in a corresponding
reduction in the principal balances of the securitized mortgage obligations. Our
payables and accrued liabilities decreased by approximately $15.2 million to
$11.5 million as of September 30, 2003 from $26.7 million as of December 31,
2002 primarily due to the January 2003 recapitalization and the payment of
preferred stock dividends that were previously deferred. 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. As of December
31, 2002, we had accrued approximately $5.2 million of preferred stock
dividends. As of September 30, 2003, there were no accrued and unpaid dividends
on our preferred stock.
Mortgage Servicing
As of September 30, 2003 and December 31, 2002, CMSLP's liabilities
consisted primarily of operating accounts payable and accrued expenses. The
servicing liabilities increased by approximately $1.5 million to $2.3 million as
of September 30, 2003 from $757,000 as of December 31, 2002 primarily due to the
accrual of executive contract termination costs and other normal operating
expenses.
Dividends/Other
On August 14, 2003, the Board of Directors declared a cash dividend for the
third quarter of 2003 on our Series B, Series F and Series G Preferred stock
payable on September 30, 2003 to shareholders of record on September 17, 2003.
No cash dividends were paid to common shareholders during the nine months ended
September 30, 2003. Based on current taxable income estimates, it is expected
that preferred or common dividends paid in 2004 and thereafter will be taxable
to the shareholders. Dividends paid in 2001, 2002, and 2003 were, or are
expected to be, considered "return of capital" for tax purposes.
On November 11, 2003, the Board of Directors declared cash dividends of
$0.68, $0.30 and $0.375 per share of Series B, Series F and Series G Preferred
Stock, respectively, payable on December 31, 2003 to shareholders of record on
December 16, 2003.
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. Cash dividends
on our common stock are subject to the prior payment of all accrued and unpaid
dividends on our preferred stock, and cash dividends on our junior classes of
preferred stock are subject to the prior payment of all accrued and unpaid
dividends on our senior preferred stock.
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.
65
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 Other Real Estate Interests and that certain of our
government insured mortgage securities also 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
September 30, 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 our
obligations, 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 these obligations. 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 Estimates
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.
Management considers an accounting estimate to be critical if:
o it requires assumptions to be made that were uncertain at the time the
estimate was made; and
o changes in the estimate or different estimates that could have been selected
could have a material impact on our consolidated results of operations or
financial condition.
We believe our critical accounting estimates include the determination of
fair value of our subordinated CMBS and interest income recognition related to
our CMBS.
o Fair value of CMBS - Due to the limited liquidity of the subordinated CMBS
market and the resulting lack of a secondary market, the values of our
subordinated CMBS are based on available market information and management's
estimates. These estimates require significant judgment regarding assumptions
for defaults on the underlying commercial mortgage loan collateral, timing of
loss realization and resultant loss severity, timing and amount of principal
losses and interest shortfalls,
66
timing and amount of potential recoveries of such shortfalls and discount
rates. Notes 3 and 4 to Notes to Consolidated Financial Statements contain
a detailed discussion of the methodology used to determine the fair value of
our subordinated CMBS as well as a sensitivity analysis related to the fair
value of these subordinated CMBS due to changes in assumptions related to
losses on the underlying commercial mortgage loan collateral and discount
rates.
o Interest income recognition related to subordinated CMBS - Interest income
recognition under EITF No. 99-20 requires us to make estimates regarding
expected prepayment speeds as well as expected 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.
Recent Accounting Pronouncements
We adjusted certain 2002 amounts due to recent SEC guidance as discussed in
"Dividends Paid or Accrued on Preferred Shares". See "Recent Accounting
Pronouncements" in Note 2 to Notes to Consolidated Financial Statements for
further discussion of recent accounting pronouncements.
67
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 and overall required returns.
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, that are not expected to experience losses, is the current yield on a
U.S. Treasury which has the same weighted average life of the related mortgage
asset. As of September 30, 2003, the average U.S. Treasury rate used to price
our CMBS, excluding the B through unrated/issuer's equity CMBS, had increased by
12 basis points, compared to December 31, 2002. As of September 30, 2003, credit
spreads used to price our investment grade CMBS tightened and there was no
significant change in credit spreads used to price our subordinated CMBS not
expected to experience losses, excluding BB-, 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.
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 $49.1 million (or 5.7%) and approximately $94.2 million (or
11.0%), respectively, as of September 30, 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 $32.3 million (or 6.1%) and $61.7 million (or 11.7%),
respectively, as of September 30, 2003.
See also Note 4 of Notes to Consolidated Financial Statements for a
discussion of other factors that could affect the fair values of our CMBS,
including changes in the timing and/or amount of credit losses on underlying
mortgage loans, the receipt of mortgage payments earlier than projected due to
prepayments, and delays in the receipt of monthly cash flow distributions on
CMBS due to mortgage loan defaults and/or extensions in loan maturities.
Interest Rate Swap
In the second and third quarters of 2003, we entered into three interest
rate swaps to hedge the variability of the future interest payments on the
anticipated CDO attributable to changes in interest rates. Our obligations to
Bear Stearns under the interest rate swap documents are collateralized by
certain assets as described in Note 6 to Notes to Consolidated Financial
Statements. These swaps are treated as cash flow hedges for GAAP. Under these
swaps, we have agreed to pay Bear Stearns a weighted average interest fixed rate
of 4.15% per annum in exchange for floating payments based on one-month LIBOR on
the total notional amount of $100 million. These swaps were effective on October
15, 2003.
The swaps are intended to protect our cost of financing in connection with
our anticipated CDO transaction. We intend to terminate the swaps simultaneously
with the issuance of the CDO. As of September 30, 2003, the aggregate fair value
of the interest rate swaps was an asset of approximately $1.5 million. A 100
basis point decrease in the 10 year swap rates would result in an approximate $8
million decrease in the fair value of our interest rate swaps, with an aggregate
notional amount of $100 million.
68
Variable Rate Debt
We maintain 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. Our interest rate cap, which was effective on May 1, 2002, was for a
notional amount of $175.0 million, capped LIBOR at 3.25%, and matured on
November 3, 2003. As of September 30, 2003, this interest rate cap had a fair
value of $0. On October 31, 2003, we purchased an interest rate cap for $45,000
with a notional amount of $50 million, an effective date of November 4, 2003,
maturity on November 4, 2004, and capping one-month LIBOR at 2.25%. Our 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 would receive payments based on the
difference between the index and the cap. The term of the cap as well as the
stated interest rate of the cap, which is currently above the current rate of
the index, would limit the amount of protection that the cap offers. The average
one-month LIBOR index was 1.24% during the nine months ended September 30, 2003,
which was a 14 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 $760,000 and $2.2
million during the three and nine months ended September 30, 2003, respectively.
Insured Mortgage Securities
There would not be a material change in the fair values of our insured
mortgage securities if we assumed that the discount rate used to determine the
fair values increased by 100 basis points and 200 basis points as of September
30, 2003.
69
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 completed the initial re-underwriting of the mortgage loans
underlying our CMBS and are continuing with the implementation of additional
actions designed to improve our credit loss estimation process including (a)
employing an underwriting internal valuation group, (b) developing additional
policies and procedures to better standardize our process, and (c) employing, as
appropriate, additional resources and expertise related to our credit loss and
valuation processes. Our independent auditors were not specifically engaged to
evaluate or assess the internal controls over our overall loss estimate.
70
PART II
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
Exhibit No. Description
----------- -----------
10.1 Termination of Employment Agreement,
dated as of August 26, 2003, by and
between David B. Iannarone and CRIIMI
MAE Inc. (incorporated by reference to
Exhibit 10.1 to Form 8-K filed with
the SEC on September 5, 2003).
10.2 Employment Offer Letter, dated as of
August 26, 2003, by and among David B.
Iannarone, CRIIMI MAE Inc. and CRIIMI
MAE Management, Inc. (incorporated by
reference to Exhibit 10.2 to Form 8-K
filed with the SEC on September 5,
2003).
10.3 Termination of Employment Agreement,
dated as of August 26, 2003, by and
between Cynthia O. Azzara and CRIIMI
MAE Inc. (incorporated by reference to
Exhibit 10.3 to Form 8-K filed with
the SEC on September 5, 2003).
10.4 Employment Offer Letter, dated as of
August 26, 2003, by and among Cynthia
O. Azzara, CRIIMI MAE Inc. and CRIIMI
MAE Management, Inc. (incorporated by
reference to Exhibit 10.4 to Form 8-K
filed with the SEC on September 5,
2003).
10.5 Master Repurchase Agreement, executed
on August 28, 2003 to be effective as
of June 26, 2003, by and between Bear,
Stearns & Co. Inc., as Agent for Bear,
Stearns International Limited, and
CRIIMI MAE Asset Acquisition Corp.
(incorporated by reference to
Exhibit 10.5 to Form 8-K filed with
the SEC on September 5, 2003).
10.6 Annex I to Master Repurchase
Agreement, executed on August 28, 2003
to be effective as of June 26, 2003,
by and between Bear, Stearns & Co.
Inc., as Agent for Bear, Stearns
International Limited and CRIIMI MAE
Asset Acquisition Corp. (incorporated
by reference to Exhibit 10.6 to
Form 8-K filed with the SEC on
September 5, 2003).
10.7 Side Letter Agreement , executed on
August 28, 2003 to be effective as
of June 26, 2003, by and between Bear,
Stearns & Co. Inc., CRIIMI MAE
Asset Acquisition Corp. and CRIIMI MAE
Inc. (incorporated by reference to
Exhibit 10.7 to Form 8-K filed with
the SEC on September 5, 2003).
10.8 Restricted Stock Award Agreement,
dated as of September 15, 2003, by
and between CRIIMI MAE Inc. and Mark
Jarrell (filed herewith).
10.9 Restricted Stock Award Agreement,
dated as of October 3, 2003, by and
between CRIIMI MAE Inc. and Cynthia O.
Azzara (filed herewith).
10.10 Consulting Agreement and Release,
dated as of August 25, 2003, by and
between CRIIMI MAE Inc. and Brian L.
Hanson (filed herewith).
10.11 Employment Offer Letter, dated as of
October 29, 2003, by and among
Stephen M. Abelman, CRIIMI MAE Inc.
and CRIIMI MAE Services Limited
Partnership (filed herewith).
71
10.12 Restricted Stock Award Agreement,
dated as of November 6, 2003, by and
between CRIIMI MAE Inc. and Stephen M.
Abelman (filed herewith).
31.1 Certification of Chief Executive
Officer pursuant to Exchange Act
Rule 13a-14(a) (filed herewith).
31.2 Certification of Chief Financial
Officer pursuant to Exchange Act
Rule 13a-14(a) (filed herewith).
32.1 Certification of Chief Executive
Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 (filed
herewith).
32.2 Certification of Chief Financial
Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 (filed
herewith).
99.1 Special Serviced Loan Report relating
to specially serviced loans underlying
the Company's CMBS as of September 30,
2003 (filed herewith).
(b) REPORTS ON FORM 8-K
Date Purpose
---- -------
August 14, 2003 To report: (1) a press release dated
August 14, 2003 announcing the
election of Mark R. Jarrell as our
President and Chief Operating
Officer effective September 15, 2003,
(2) a press release dated August 14,
2003 announcing the declaration of
cash dividends for the third quarter
of 2003 on our Series B, Series F, and
Series G Preferred Stock, and (3) a
press release dated August 13, 2003
announcing our financial results for
the three and six months ended
June 30, 2003.
September 5, 2003 To report: (1) a press release dated
September 3, 2003 announcing a charge
in the third quarter of 2003 as a
result of payments in connection with
the termination of employment
contracts of three of our senior
executive officers, and (2) the
execution of a $200 million secured
financing facility in the form of a
repurchase agreement.
72
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.
November 14, 2003 /s/Cynthia O. Azzara
- --------------------------- ----------------------------------------
DATE Cynthia O. Azzara
Executive Vice President,
Chief Financial Officer and
Treasurer (Principal Accounting Officer)