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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------------------------
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _______TO_________
Commission file number 001-11981
MUNICIPAL MORTGAGE & EQUITY, LLC
(Exact name of Registrant as Specified in Its Charter)
Delaware 52-1449733
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
218 North Charles Street, Suite 500
Baltimore, Maryland 21201
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (443) 263-2900
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of Each Exchange on Which Registered
------------------- -----------------------------------------
Common Shares New York Stock Exchange, Inc.
Securities registered pursuant to
Section 12(g) of the Act: Preferred Shares
Preferred Capital Distribution Shares
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [x] NO [ ].
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the Company's Common Shares held by
non-affiliates of the registrant as of March 22, 2002 (computed by reference to
the closing price of such shares on the New York Stock Exchange) was
$605,000,208. The Company had 25,208,342 Common Shares outstanding as of March
22, 2002.
Portions of the Company's Proxy Statement with respect to the 2002 Annual
Meeting of Shareholders to be filed subsequent to the date hereof are
incorporated by reference Items 10, 11, 12 and 13 of Part III.
Forward Looking Information
Assumptions relating to various portions of the Company's Annual Report on Form
10_K involve judgments with respect to, among other things, future economic
market conditions and future business decisions, all of which are difficult or
impossible to predict accurately and many of which are beyond the control of the
Company. Although the Company believes that the assumptions underlying the
forward-looking information included herein are reasonable, any of the
assumptions could be inaccurate and, therefore there can be no assurance that
such forward-looking information will prove to be accurate. In light of the
significant uncertainties inherent in forward-looking information, the inclusion
of such information should not be regarded as a representation by the Company or
any other person that the objectives and plans of the Company will be achieved.
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MUNICIPAL MORTGAGE & EQUITY, LLC
INDEX TO FORM 10-K
Part I
Item 1. Description of Business ........................................ Page 4
Item 2. Properties ..................................................... Page 16
Item 3. Legal Proceedings .............................................. Page 17
Item 4. Submission of Matters to a Vote of Security Holders ............ Page 17
Part II
Item 5. Market for Registrant's Equity Securities and
Related Stockholder Matters .......................................... Page 18
Item 6. Selected Financial Data ........................................ Page 21
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations ........................ Page 23
Item 7A. Quantitative and Qualitative Disclosures
about Market Risk .................................................... Page 43
Item 8. Financial Statements and Supplementary Data .................... Page 47
Item 9. Changes in and Disagreements on Accounting and
Financial Disclosure ................................................. Page 47
Part III
Item 10. Directors and Executive Officers of the Registrant ............ Page 48
Item 11. Executive Compensation ........................................ Page 48
Item 12. Security Ownership of Certain Beneficial
Owners and Management ................................................ Page 48
Item 13. Certain Relationships and Related Transactions ................ Page 48
Part IV
Item 14. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K .................................................. Page 49
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Part I
Item 1. Description of Business.
General Development of Business.
Municipal Mortgage & Equity, LLC ("MuniMae") and its subsidiaries (together
with MuniMae, the "Company") are principally engaged in originating, investing
in and servicing investments related to multifamily housing and other real
estate financings. A significant portion of the Company's investments are
tax-exempt bonds, or interests in bonds, issued by state and local governments
or their agencies or authorities to finance multifamily housing developments.
Interest income from the majority of these investments is exempt for federal
income tax purposes. Multifamily housing developments, as well as the rents paid
by the tenants, secure these investments. Midland Financial Holdings, Inc.
("Midland"), a corporate subsidiary, is a fully integrated real estate
investment firm that specializes in originating, investing in and servicing
investments in the affordable multifamily housing industry. These investments
generate taxable, not tax-exempt, income.
MuniMae is a Delaware limited liability company and is the successor to the
business of SCA Tax Exempt Fund Limited Partnership (the "Partnership"), a
closed-end limited partnership that was merged into MuniMae on August 1, 1996.
As a limited liability company, the Company combines the limited liability,
governance and management characteristics of a corporation with the pass-through
income features of a partnership. Since MuniMae is classified as a partnership
for federal income tax purposes, no recognition of income taxes is made at the
corporate level (except for income earned through subsidiaries of the Company
organized as corporations). Instead, the distributive share of MuniMae's income,
deductions and credits is included in each shareholder's income tax return.
The Predecessor
The Partnership commenced operations in 1986 when it sold two series of
Beneficial Assignee Certificates ("BACs"), representing the assignment of its
limited partnership interests. The Partnership invested the $296 million of
proceeds from the sale in 22 tax-exempt bonds (the "original bonds") and related
working capital loans held in two separate pools, "Series I" and "Series II,"
corresponding with the related series of BACs. In a February 1995 financing (the
"1995 Financing"), the Partnership raised $67.7 million through the sale of
multifamily revenue bond receipts (the "Receipts") secured by newly refunded
bonds (the "Refunding") issued in exchange for 11 of the original bonds and the
cash stream from one additional bond. Effective December 31, 1997, the
additional bond was released as additional collateral. Of the $67.7 million of
proceeds, $5.0 million was invested in demand notes and the remainder, after
expenses and working capital reserves, of $56.8 million has been principally
invested in additional tax-exempt bonds and other bond related investments.
The Merger
In connection with the August 1, 1996 merger of the Partnership into
MuniMae (the "Merger"), the Partnership's BAC holders were given the opportunity
to elect among three different securities of the Company for which to exchange
their BACs: Preferred Shares, Preferred Capital Distribution Shares
(collectively the "Preferred Shares") or Common Shares. The Preferred Shares
were structured to give BAC holders a security substantially the same as their
BACs as if the 1995 Financing had not occurred. Thus, the Preferred Shares
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participate in their pro rata share of income from the 22 original bonds as they
existed immediately after the Refunding and before the 1995 Financing. The
Preferred Capital Distribution Shares (the "Preferred CD Shares") were
structured to give their holders the income they would have received from their
original BACs, but provided for a distribution of their pro rata share of the
proceeds of the 1995 Financing. Thus, the Preferred CD Shares participate in
their pro rata share of income from the 22 original bonds as they existed
immediately after the Refunding and the 1995 Financing. The Common Shares,
unlike either the Preferred Shares or Preferred CD Shares, were structured to
enable their holders to participate in all of the income from investment of the
proceeds of the 1995 Financing, as well as future financings, in addition to
their pro rata share of the income from the original bonds as they existed
immediately after the 1995 Financing. As a result of the election process, the
holders of 8.09% of the outstanding BACs received Preferred Shares, the holders
of 4.29% of the outstanding BACs received Preferred CD Shares and the holders of
86.62% of the outstanding BACs received Common Shares of the Company.
The Company is required to distribute to the holders of Preferred Shares
and Preferred CD Shares cash flow attributable to such shares (as defined in the
Company's Amended and Restated Certificate of Formation and Operating Agreement,
the "Operating Agreement"). The Company is required to distribute 2.0% of the
net cash flow to the holders of Term Growth Shares. Term Growth Shares were
issued to the former general partners of the Partnership in exchange for their
general partnership interests and to a Merrill Lynch Pierce Fenner & Smith
Incorporated ("Merrill Lynch") affiliate in exchange for their subordinated
BACs. The balance of the Company's cash flow is available for distribution to
Common Shares and the Company's current policy is to distribute to Common
Shareholders at least 80% of the cash flow associated with this income.
Preferred Share Redemptions
In accordance with the Company's Operating Agreement, the Preferred Shares
and the Preferred CD Shares must be partially redeemed when any bond
attributable to the shares is sold or, beginning in the year 2000, when any bond
attributable to the shares reaches par value (which includes accrued but unpaid
base interest under the original bond terms and accrued but unpaid interest
under the then current bond terms) based on receipt of an appraisal securing the
bond. The Company must redeem the Preferred Shares and Preferred CD Shares
within six months of the occurrence of a redemption event. Four bonds
attributable to Series I Preferred Shares and Preferred CD Shares and four bonds
attributable to Series II Preferred Shares and Preferred CD Shares reached par
value in December 2000. As a result, in June of 2001, the Company redeemed
approximately 26% and 56% of the Series I and Series II Preferred Shares and
Preferred CD Shares, respectively.
In addition to the bonds that reached par value in December 2000, the
remaining bonds attributable to the shares were either paid off, sold and/or
reached par value during the last four months of 2001 and in January 2002. As a
result, in March 2002, the Company redeemed the remaining Series I and Series II
Preferred Shares and Preferred CD Shares at an aggregate cost of approximately
$19.3 million. The Operating Agreement also requires that the Term Growth shares
be redeemed after the last Preferred Share is redeemed. As a result, the Term
Growth shares which had no residual value, were also redeemed in 2002.
5
Subsidiaries
MuniMae TE Bond Subsidiary, LLC
In 1999, the Company placed a substantial portion of its tax-exempt bonds
and bond related investments in MuniMae TE Bond Subsidiary, LLC ("TE Bond Sub"),
an indirect subsidiary of the Company. In May1999, TE Bond Sub sold to
institutional investors $84 million of Series A Cumulative Preferred Shares
("Series A Preferred Shares"). In June 2000, TE Bond Sub sold to institutional
investors $60 million of Series B Cumulative Preferred Shares ("Series B
Preferred Shares"). In October 2001, TE Bond Sub sold to institutional investors
$16 million of Series A-1 Cumulative Preferred Shares ("Series A-1 Preferred
Shares") and $8 million of Series B-1 Subordinate Cumulative Preferred Shares
("Series B-1 Preferred Shares"; all four Series, collectively, the "TE Bond
Preferred Shares").
The Series A and A-1 Preferred Shares bear interest at 6.875% and 6.30% per
annum, respectively, or, if lower, the aggregate net income of the issuing
company, TE Bond Sub. The Series A and A-1 Preferred Shares have a senior claim
to the income derived from the investments owned by TE Bond Sub. The Series A-1
Preferred Shares are equal in priority of payment to the Series A Preferred
Shares. The Series B and B-1 Preferred Shares bear interest at 7.75% and 6.80%
per annum, respectively, or, if lower, the aggregate net income of the issuing
company, TE Bond Sub, after payment of distributions to the Series A and Series
A-1 Preferred Shares. The TE Bond Preferred Shares have a senior claim to the
income derived from the investments owned by TE Bond Sub. Any income from TE
Bond Sub available after payment of the cumulative distributions of the TE Bond
Preferred Shares is allocated to the Company. The assets of TE Bond Sub and its
subsidiaries, while indirectly controlled by MuniMae and thus included in the
consolidated financial statements of MuniMae, are legally owned by TE Bond Sub
and are not available to the creditors of MuniMae.
Midland
In October 1999 the Company acquired Midland for approximately $45 million.
Of this amount, the Company paid approximately $23 million in cash and
approximately $12 million in Common Shares at the closing of the transaction. In
addition, $3.3 million in MuniMae Common Shares was payable annually over a
three year period if Midland met certain performance targets, including an
annual contribution to cash available for distribution ("CAD"). In December
2000, MuniMae paid approximately $3.3 million in Common Shares in consideration
for Midland meeting its first year performance targets. In 2001, in order to
increase MuniMae's flexibility in operating Midland, MuniMae agreed with the
former owners of Midland that the payment of the 2001 and 2002 installments
would no longer be conditioned on Midland meeting certain performance targets.
In December 2001, MuniMae paid approximately $3.3 million in Common Shares and,
subject to certain conditions, MuniMae expects to make the final payment of
Common Shares having a value of approximately $3.3 million in December 2002.
Midland is a fully integrated real estate investment firm specializing in
providing financing to the affordable multifamily housing industry. Midland
provides construction and permanent debt financing, mortgage servicing and asset
management services to the multifamily housing industry. Midland is a Federal
National Mortgage Association ("Fannie Mae") Delegated Underwriter and Servicer
("DUS") and a Federal Housing Administration approved mortgagee. Midland
syndicates equity for investment in low income housing tax credits. Midland also
syndicates equity and originates debt for investment in student/conventional
housing, a unique and growing segment of the multifamily housing industry. A
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subsidiary of Midland is a registered investment advisor with the Securities and
Exchange Commission and a wholly owned special purpose subsidiary of Midland
provides advisory services to pension funds. Midland currently manages
approximately $350 million of pension fund money.
Business Segments
In October 1999, as a result of the Midland acquisition, the Company
restructured its operations into two business segments: (1) an investing segment
consisting of subsidiaries holding investments producing primarily tax-exempt
interest income; and (2) an operating segment that primarily generates taxable
interest income and, through corporate subsidiaries, fee income by providing
servicing, loan origination and tax credit equity syndication services. The
revenues associated with the investing segment consist of interest earned on
tax-exempt bonds, other bond related investments and certain short-term taxable
loans and investments. The revenues associated with the operating segment
consist of loan servicing and loan origination fees for the Company's own
portfolio and for portfolios of third parties, syndication and brokerage fees
associated with the origination of tax credit syndications, taxable interest and
fees earned on construction lending activities and other fee income. Segment
results include all direct revenues and expenses of each segment and allocations
of indirect expenses based on specific methodologies. The Company's reportable
segments are strategic business units that primarily generate different income
streams and are managed separately. The majority of the income generated by the
operating segment was acquired as a unit and the management of such unit was
retained.
For the years ended December 31, 2001 and 2000, the Company's revenues, net
income and identifiable assets have been distributed among the following
segments (in thousands):
2001 2000
---- ----
Investing Operating Adjustments(1) Total Investing Operating Adjustments(1) Total
--------- --------- -------------- ----- --------- --------- -------------- -----
Revenues $ 57,914 $ 68,669 ($820) $ 125,763 $ 46,064 $ 56,333 ($1,545) $100,852
Net Income
Identifiable 19,312 7,390 ($820) 25,882 29,136 3,984 ($1,545) 31,575
Assets 791,199 498,077 -- 1,289,276 616,376 371,506 -- 987,882
(1) Represents origination fees on purchased investments that are deferred and
amortized into income over the life of the investment.
Prior to October 1999, all of the Company's operations were attributable to
the investing segment.
Raising Capital
Capital is the raw material that enables the Company to fund its
investments. In order to facilitate growth, the Company will require additional
capital to pursue acquisition opportunities. The Company has primarily used two
sources of capital: securitizations and equity offerings from MuniMae and
certain subsidiaries. The most economically efficient way to fund future
acquisitions is through securitizations, which the Company uses to leverage its
investments; however, our securitizations can limit our flexibility in managing
our assets and additional leverage increases the risk in our investment
portfolio. As a result, the Company has decided that a conservative capital
structure that avoids over-leveraging is the most prudent course to take.
Therefore, the Company, through equity offerings, periodically decreases its
outstanding off-balance-sheet debt to reduce leverage. Also, as a result of the
Midland acquisition, the
7
Company has expanded its access to capital. Midland's syndication and pension
fund investors are essentially alternative financing sources to securitizations,
as are Fannie Mae and the Federal Home Mortgage Corporation ("Freddie Mac")
through their multifamily securitization programs.
Securitizations
Through securitizations, the Company seeks to enhance its overall return on
its investments and to generate proceeds that, along with equity offering
proceeds, facilitate the acquisition of additional investments. The Company uses
various programs to facilitate the securitization and credit enhancement of its
bond investments. At December 31, 2001, the Company had on-balance sheet
obligations of $213.4 million and off-balance sheet obligations of $334.2
million related to securitization transactions.
In order to facilitate the securitization of certain assets at higher
leverage ratios than otherwise would be available to the Company without the
posting of additional collateral, the Company has pledged additional bonds and
taxable loans to a pool that acts as collateral for senior interests in certain
securitization trusts and credit enhancement facilities. At December 31, 2001,
the total carrying amount of the bonds and taxable loans pledged as collateral
was $361.8 million.
The following is a description of the Company's various credit enhancement
and securitization investment vehicles and a discussion of the activity in these
programs during 2001.
The Company securitizes mortgage bonds in its portfolio through the
Residual Interest Tax-Exempt Securities Receipts ("RITESSM")/Puttable Floating
Option Tax-Exempt Receipts ("P-FLOATsSM") program offered by Merrill Lynch
Pierce Fenner & Smith Incorporated ("Merrill Lynch"). Through this program, the
Company sells bonds to Merrill Lynch or structures a transaction whereby Merrill
Lynch buys bonds from third parties. Merrill Lynch deposits the bonds into
trusts, which are created to hold these assets. Subsequently, these bonds are
credit enhanced by Merrill Lynch. Two types of securities, P-FLOATsSM and
RITESSM, are created for each asset deposited into the trusts. The P-FLOATsSM
are short-term floating rate interests in the trusts that have priority on the
cash flows of the deposited bonds and bear interest at rates that are reset
weekly by the remarketing agent, Merrill Lynch. The P-FLOATsSM are sold to
qualified third party investors. When Merrill Lynch buys the bond directly, the
Company purchases the RITESSM. The RITESSM are the subordinate security and
receive the residual interest on the bond after the payment of all fees and the
P-FLOATsSM interest. To the extent these transactions create interest rate
risks, the Company enters into interest rate swap contracts designed to reduce,
but not eliminate such risks.
During 2001 and 2000, the Company raised $180 million and $155 million,
respectively, through securitizations of 12 and 11 tax-exempt bonds,
respectively. The Company's effective annual costs of its P-FLOATsSM
securitization was approximately 4.4% and 5.6%, at December 31, 2001 and 2000,
respectively.
In March 1999, the Company consummated a transaction with an affiliate of
Merrill Lynch that converted a $67.8 million portion of the Company's investment
in the securitization trusts discussed above into a longer-term securitization
facility. This transaction enabled the Company to (a) reduce its exposure to
credit and annual renewal risks associated with the liquidity and credit
enhancement features of the securitization ?trusts and the swap agreements, (b)
reduce the annual financing costs and (c) eliminate the risk of receiving
taxable net swap payments which serve to hedge tax-exempt investments (see
discussion in Note 5 to the consolidated financial statements included herein).
In July 2001, TE Bond Sub refinanced this longer-term securitization facility.
8
The result of the refinancing was a reduction of the outstanding debt by $22.0
million while all other terms of the debt remained the same (see further
discussion in Note 5 to the consolidated financial statements). As a result of
certain call provisions available to the subordinate certificate holders, the
Company has accounted for this transaction as a borrowing. Accordingly, the
senior certificates were recorded as long-term debt and the bonds associated
with this transaction are included in investments in tax-exempt bonds. Prior to
this transaction, these assets and liabilities had received sale treatment and
therefore were off-balance sheet financing.
In December 2000 the Company closed a $100 million credit enhancement
facility through Fannie Mae. The facility refinanced the short-term credit
enhancement on approximately $70 million of the Company's existing
securitization portfolio with long-term credit enhancement through Fannie Mae.
The facility also provided credit enhancement to two of our previously
unenhanced tax-exempt bonds having an aggregate fair market value of
approximately $10 million at December 31, 2000. The new facility also replaced
the credit enhancement on approximately $20 million of tax-exempt bonds that
were previously credit enhanced by a credit facility provided through MMA Cap,
LLC prior to December 2000.
The $100 million credit enhancement facility, which was completed through
MMA Cap, LLC, a wholly owned subsidiary of the Company, is an open ended
facility and will facilitate the placement of long term securitization capital,
thereby enabling the Company to securitize its mortgage bonds at a fixed rate
and for a term that more closely matches the term of the underlying bond. The
MMA Cap credit enhancement facility was arranged through Midland and enables the
Company to diversify its securitization capabilities. In order to provide credit
enhancement to the bonds secured by this facility, the Company pledged
additional investments to this facility.
In December 2001, the Company developed a tender option bond program with
Freddie Mac. Through this program, the Company securitized 12 bonds with an
aggregate unpaid principal balance of approximately $91.0 million and deposited
the bonds into 12 trusts. Prior to this transaction, approximately $34.3 million
of these bonds had been securitized through the P-FLOATsSM program. The trusts
issued approximately $69.0 million of fixed-rate senior certificates and
approximately $22.0 million of fixed-rate subordinate certificates. The Company
purchased the subordinate certificates and the senior certificates were sold to
third party investors. The net proceeds to the Company upon completion of this
transaction were approximately $34.7 million. Which represents $69.0 million in
proceeds from the sale of the fixed-rate senior certificates less $34.3 million
for the purchase of the bonds in the P-FLOATsSM program. To increase the
attractiveness of the senior certificates to outside investors, Freddie Mac
provided credit enhancement through a standby guaranty of payment and agreed to
provide liquidity by lending the Company the money to repurchase the senior
certificates at the remarketing date (if they are not successfully remarketed),
which is five years from issuance. The Company agreed to pay Freddie Mac for the
first $22.0 million of losses if any of the bonds fail to generate sufficient
income to pay the senior certificate holders, and the Company pledged our
subordinate certificates to Freddie Mac to secure this obligation. Freddie Mac's
recourse to the Company for losses on the credit enhancement is limited to its
right to liquidate the subordinate certificates.
Recent Public Offerings
On February 8, 2002, the Company sold to the public 3.0 million Common
Shares at a price of $24.70 per share and granted the underwriters an option to
purchase up to an aggregate of 450,000 Common Shares to cover over-allotments at
the same price. Net proceeds on the 3.0 million shares approximated $70.5
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million. On February 15, 2002, the underwriters exercised their option to
purchase 300,000 Common Shares generating net proceeds of approximately $7.1
million. The net proceeds from this offering will be used for general corporate
purposes, including new investments and working capital.
On February 6, 2001, the Company sold to the public 3.8 million Common
Shares at a price of $23.07 per share. The net proceeds from this offering have
been used for general corporate purposes, including new investments and working
capital.
The Tax-Exempt Bonds
The proceeds of the tax-exempt bonds held by the Company are used to make
mortgage loans for the construction, acquisition or refinancing of multifamily
housing developments and other real estate financings through out the United
States. The underlying developments are "qualified residential rental
properties" under section 142(d) of the Internal Revenue Code of 1986, as
amended (the "Code"), which requires that a specified percentage of their rental
units be rented to persons whose incomes do not exceed specified percentages of
local median income levels. Certain of the mortgage bonds qualify as 501(c)(3)
bonds under Section 145 of the Code, which requires that the owner of the
underlying property be a 501(c)(3) organization or a governmental unit that
meets certain additional requirements. Accordingly, the bonds are "qualified
bonds" within the meaning of section 141(e) of the Code, and the interest paid
on the bonds is exempt from federal income taxes.
Each tax-exempt bond is secured by an assignment to the Company of the
related mortgage loan, which in turn is secured by a mortgage on the underlying
property and assignment of rents. Although the bonds are issued by state or
local governments or their agencies or authorities, the bonds are not general
obligations of any state or local government, no government is liable under the
bonds, nor is the taxing power of any government pledged to the payment of
principal or interest under the bonds. In addition, the underlying mortgage
loans are nonrecourse, which means that the owners of the underlying properties,
who are also the borrowers under the mortgage loans, are not liable for the
payment of principal and interest under the loans. Accordingly, the sole source
of funds for payment of principal and interest under the bonds is the revenue
derived from operation of the mortgaged properties and amounts derived from the
sale, typically refinancing or other disposition of such properties.
As of December 31, 2001, the Company held $616.5 million of bonds or
certificates of participation ("COPs") of which $83.6 million were
participating, $460.0 million were non-participating, $55.7 million were
participating subordinate and $17.2 million were non-participating subordinate.
(See Note 4 to the Company's consolidated financial statements included herein
for a complete discussion.)
Other Bond Related Investments
The Company holds investments in RITESSM (as discussed above under the
caption "Securitizations"), a security offered by Merrill Lynch through its
P-FLOATsSM Program. In conjunction with the purchase of the RITESSM with respect
to fixed rate bonds, the Company enters into interest rate swap contracts to
hedge against interest rate exposure on the Company's investment in the RITESSM.
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Loans Receivable
The Company's investment in construction loans primarily consists of
short-term taxable loans originated by Midland. The proceeds of these loans are
used to build low-to-moderate income apartment communities. These construction
loans are typically underwritten so as to facilitate a permanent takeout through
Fannie Mae's DUS program. The Company, through Midland, is able to provide
funding for the construction of these properties by utilizing capital it manages
for various pension funds. The Company also provides taxable second loans and
parity working capital loans to certain properties in conjunction with the
purchase of tax-exempt bonds.
Acquisitions
Investment Acquisition Program
Through the investing segment, the Company seeks to acquire investments
that primarily generate tax-exempt interest income and that are available on
attractive terms. The Company believes that currently there are a substantial
number of tax-exempt bonds and similar investments available at attractive
prices including:
o Tax-exempt bonds that are used to finance development or rehabilitation of
multifamily properties, in conjunction with the affordable housing tax
credit.
o Existing bonds as the underlying mortgages are refinanced. There are a
significant number of mortgage bonds backed by multifamily properties that
were originated in the late 1980s. The Company believes, in light of the
current interest rate environment, that many of the obligors on these
mortgage bonds may consider refinancing them.
o Bonds issued for the benefit of charitable organization obligors (otherwise
referred to as 501(c)(3) developers) that own and manage multifamily
housing. These properties generally serve moderate-income families with
incomes between 50% and 80% of a region's median income.
o Revenue bonds issued to finance development of large scale real estate
developments, including single-family housing developments. These bonds are
generally not secured by a mortgage on real property, but by assessment
payments imposed by residents of the development or other specific payments
pledged by the local government or special assessment district issuing the
bonds.
o Other portfolios of bonds and related investments backed by multifamily
housing properties that meet the Company's underwriting criteria and target
risk-adjusted returns.
The Company will focus its efforts on supplying tax-exempt financing to
quality, multifamily housing owned or developed by tax credit and 501(c)(3)
developers as well as refinancings of existing mortgage bonds.
Competition
The need for capital for multifamily housing developments continues to
grow, especially in the affordable housing sector. Mature properties need to be
recapitalized and new properties are being built to meet increasing demands in
various markets. State and federal government programs, which provide
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incentives and/or subsidies to build and reinvest in multifamily housing,
motivate continuous activity in multifamily development. Increasingly, these
needs are being financed with tax-exempt bonds and affordable housing tax
credits.
The Company actively seeks investment opportunities throughout the United
States and is encouraged by the business opportunities that exist. Although the
Company operates in a competitive environment, there are only a handful of
competitors that are primarily focused on providing tax-exempt financing for
multifamily housing consistent with the Company's acquisition programs. As a
result, the Company is able to offer financing programs that are custom-tailored
to meet the customer's needs. The 1999 acquisition of Midland extended the
Company's lending reach and product offerings by providing access to new forms
of debt and equity capital. When MuniMae's tax-exempt lending is coupled with
Midland's debt and equity capital, the Company has the ability to provide one
stop shopping to borrowers seeking debt and equity financing for affordable
multifamily housing communities.
The primarily competitive factors in originating new investments are
pricing, service, ease of execution and certainty of execution. The Company's
ability to follow through on these factors is the key to continued growth.
Property Performance
The Company structured $468.4 million in tax-exempt investment transactions
during 2001, of which $99.6 million were retained by the Company as bonds or
other bond related investments. The properties collateralizing the mortgage
loans underlying the investments are geographically dispersed and include new
construction projects and acquisition or refinancing of existing properties.
Aggregate occupancy for all of the properties collateralizing the Company's
bonds and other bond related investments was 92.2% at December 31, 2001, as
compared with 93.1% at December 31, 2000.
The 22 original bonds held by the Partnership at the time of the 1995
Financing had been acquired by the Partnership in 1986 and 1987. Due to an
imbalance in the real estate markets in the late 1980's and early 1990's, many
of the mortgage properties collateralized by the original bonds were unable to
achieve the rent increases originally anticipated and, consequently, the net
cash flow from most of the properties was insufficient to pay the base interest
due. Consequently, the former managing general partners were forced to draw
funds from project level sources such as reserves and guarantees or declare
monetary defaults and initiate loan workout discussions in instances where no
project level sources existed.
Construction starts for new apartment units declined significantly
throughout the United States during the mid-1980s and fell to a record low in
1993. This decline in construction starts coupled with a general economic
recovery brought about tightening markets, stabilized and higher occupancies,
and an ability to realize greater rent increases. Apartment starts bottomed in
1993 and grew dramatically before leveling off in the late 1990's, with relative
balance between new supply and marginal demand for existing housing in most
markets.
As of December 31, 2001, the Company held $616.5 million of bonds or COPs,
of which $83.6 million were participating, $460.0 million were
non-participating, $55.7 million were participating subordinate and $17.2
million were non-participating subordinate. Participating bonds have additional
interest features that allow the Company to participate in the growth of the
underlying property. These participating bonds provide for payment of additional
interest from available cash flow of the property in addition to the base
12
interest. The terms of the additional interest to be received on a bond are
specific to that bond and are set forth in the bond documents. Other bonds
provide for payment of a fixed rate of interest but are not non-participating
and do not contain additional interest features. Certain participating and
non-participating bonds are considered "subordinate" bonds as the payment of
interest and principal on the bonds occurs only after payment of principal and
interest on a bond that has priority to the cash flow of the underlying
collateral.
The following table provides certain information for the months ended
December 31, 2001, September 30, 2001 and December 31, 2000 with respect to the
properties collateralizing the mortgage loans underlying the bond and other bond
related investments held by the Company at December 31, 2001.
13
Occupancy
-------------------------------------------
Month Ended Month Ended Month Ended
Month/Year Apartment December 31, September 30, December 31,
Apartment Community Acquired Units 2001 2001 2000
------------------- -------- ----- -------------------------------------------
Participating Mortgage Bonds:
Alban Place Sep-86 194 90.7% 92.3% 86.1%
Cobblestone Aug-99 184 94.0% 98.9% 95.7%
Creekside Village Nov-87 296 99.7% 99.7% 98.6%
Crossings Jan-97 200 95.5% 95.5% 92.5%
Jefferson Commons Dec-00 173 94.8% 96.4% N/A
Lakeview Sep-87 180 97.2% 97.8% 97.2%
North Pointe Sep-86 540 96.9% 94.3% 95.6%
Timber Ridge Dec-00 168 96.4% 97.6% 96.4%
Villas at LaRiviera Jun-99 199 96.5% 96.0% 95.5%
-----------
Subtotal Participating Mortgage Bonds 2,134
-----------
Mortgage Bonds
Applewood (a.k.a. Paola) Jul-99 48 91.7% 87.5% 95.8%
Buchanan Bay Mar-01 228 71.5% 86.4% N/A
Cielo Vista Aug-99 378 89.7% 91.5% 90.7%
Charter House (2) Dec-96 -- N/A N/A N/A
Country Club Jul-99 101 87.1% 89.1% 92.0%
Delta Village Jun-99 80 93.8% 95.0% 93.8%
Elmbrooke Aug-00 54 100.0% 100.0% 77.8%
Florida A&M Feb-00 96 69.8% 69.8% 96.0%
Gannon (Broward) Feb-98 315 97.5% 97.8% 91.1%
Gannon (Dade) (3) Feb-98 1,252 95.1% 95.0% 97.5%
Gannon (St. Louis) Feb-98 336 91.1% 94.0% 93.8%
Gannon A Bond Feb-98 -- N/A N/A N/A
Hidden Valley Dec-96 82 87.8% 91.5% 92.4%
Honey Creek Mar-99 656 91.6% 93.3% 93.8%
Hunter's Glen Mar-01 383 91.1% 92.3% N/A
Lake Piedmont Apr-98 648 85.0% 82.2% 79.3%
Monroe (Oakmont, Towne Oak) Dec-98 364 98.4% 99.4% 92.2%
Mountain View (Willowgreen) Nov-86 241 92.5% 97.5% 96.9%
Northridge Park II Aug-87 128 97.7% 96.9% 96.3%
Oakbrook Dec-96 170 95.9% 99.4% 94.7%
Orangevale Apr-98 64 100.0% 96.9% 100.0%
Parkwood Jun-99 180 97.2% 98.9% 93.8%
Riverset II (1) Jan-96 -- N/A N/A N/A
Sahuarita Jun-99 52 75.0% 92.3% 95.0%
Santa Fe Springs Jun-00 310 88.4% 89.4% 95.0%
Shadowbrook Jun-99 193 96.4% 97.9% 98.0%
Torries Chase Dec-96 99 99.0% 99.0% 96.0%
Villa Hialeah Nov-87 245 97.1% 94.3% 95.6%
Village at Stone Mountain Oct-97 722 93.1% 93.5% 95.8%
Village Green Feb-00 200 90.5% 94.0% 89.0%
Western Hills Dec-98 80 100.0% 97.5% 91.7%
Willow Key Mar-99 384 99.0% 99.2% 97.0%
Woodmark Jun-99 173 97.7% 96.0% 90.2%
-----------
Subtotal Mortgage Bonds 8,262
-----------
Participating Subordinate Mortgage Bonds:
Barkley Place May-87 156 92.9% 95.5% 96.5%
Gilman Meadows Mar-87 125 94.4% 90.4% 95.8%
Hamilton Chase Feb-87 300 94.0% 92.7% 96.5%
Mallard Cove I & II Feb-87 198 87.4% 91.9% 94.3%
Meadows Jan-88 200 98.5% 94.0% 93.7%
Montclair Oct-86 159 90.6% 95.6% 96.6%
Newport Village Dec-86 220 95.9% 97.7% 99.8%
Nicollet Ridge Dec-87 339 90.0% 97.6% 96.2%
Riverset II Jan-96 148 88.2% 89.0% 94.6%
Steeplechase Oct-88 450 96.2% 96.2% 93.0%
Whispering Lake Oct-87 384 88.3% 92.4% 88.6%
-----------
Subtotal Participating Subordinate Mortgage Bonds 2,679
-----------
Avg. Monthly Rent
Per Apartment Unit
----------------------------------------------
Month Month Month
Ended Ended Ended
December 31, September 30, December 31,
Apartment Community 2001 2001 2000
------------------- ----------------------------------------------
Participating Mortgage Bonds:
Alban Place $895 $886 $854
Cobblestone 568 570 548
Creekside Village 513 501 497
Crossings 742 739 735
Jefferson Commons 1,331 1,322 N/A
Lakeview 684 669 660
North Pointe 664 657 632
Timber Ridge 491 493 N/A
Villas at LaRiviera 653 644 593
Subtotal Participating Mortgage Bonds
Mortgage Bonds
Applewood (a.k.a. Paola) $557 $553 $494
Buchanan Bay 678 677 N/A
Cielo Vista 424 423 426
Charter House (2) N/A N/A N/A
Country Club 443 442 432
Delta Village 562 544 511
Elmbrooke 716 705 591
Florida A&M 1,384 1,384 1,352
Gannon (Broward) 651 649 629
Gannon (Dade) (3) 731 728 705
Gannon (St. Louis) 557 554 543
Gannon A Bond N/A N/A N/A
Hidden Valley 538 538 519
Honey Creek 563 555 529
Hunter's Glen 568 564 N/A
Lake Piedmont 472 472 461
Monroe (Oakmont, Towne Oak) 478 477 452
Mountain View (Willowgreen) 618 610 583
Northridge Park II 1,022 1,023 971
Oakbrook 446 446 446
Orangevale 957 915 896
Parkwood 455 449 442
Riverset II (1) N/A N/A N/A
Sahuarita 546 546 540
Santa Fe Springs 593 592 581
Shadowbrook 476 475 460
Torries Chase 488 488 472
Villa Hialeah 671 666 651
Village at Stone Mountain 722 716 698
Village Green 635 634 628
Western Hills 506 497 517
Willow Key 639 633 616
Woodmark 696 684 671
Subtotal Mortgage Bonds
Participating Subordinate Mortgage Bonds:
Barkley Place $2,097 $2,110 $2,021
Gilman Meadows 1,032 1,022 976
Hamilton Chase 607 605 590
Mallard Cove I & II 762 744 713
Meadows 606 602 596
Montclair 1,841 1,841 1,786
Newport Village 824 817 772
Nicollet Ridge 939 923 892
Riverset II 705 705 702
Steeplechase 587 565 578
Whispering Lake 648 648 644
Subtotal Participating Subordinate Mortgage Bonds
14
Occupancy
-------------------------------------------
Month Ended Month Ended Month Ended
Month/Year Apartment December 31, September 30, December 31,
Apartment Community Acquired Units 2001 2001 2000
------------------- -------- ----- -------------------------------------------
Subordinate Mortgage Bonds:
CAPREIT Sep-99 -- N/A N/A N/A
Cinnamon Ridge Jan-99 -- N/A N/A N/A
Farmington Meadows Aug-99 69 100.0% 100.0% 100.0%
Independence Ridge Aug-96 336 83.9% 77.4% 85.5%
Locarno Aug-96 110 92.7% 98.2% 89.2%
Olde English Manor Nov-99 -- N/A N/A N/A
Peaks of Conyer Sep-01 260 N/A N/A N/A
Rillito Village Jul-00 -- N/A N/A N/A
Winter Oaks Nov-99 460 86.1% 88.5% 92.5%
-----------
Subtotal Subordinate Mortgage Bonds 1,235
-----------
Other Bond Related Investments:
Briarwood Dec-98 600 97.3% 95.5% 93.3%
Cinnamon Ridge Dec-97 264 95.8% 90.5% 94.2%
Golfside Villas (f.k.a. Club West) Mar-99 194 99.0% 99.0% 99.0%
Park Center Oct-01 325 92.9% 97.5% N/A
Park at Landmark Sep-00 396 94.7% 97.0% 100.0%
Poplar Glen Jun-97 191 98.4% 94.8% 98.2%
RITES - Charter House Dec-96 280 89.3% 96.4% 93.2%
RITES - Indian Lakes Jul-97 296 91.9% 100.0% 93.6%
RITES - LaPaloma Apr-99 120 100.0% 96.7% 95.4%
RITES - LeMirador (Coleman Senior) Apr-98 141 96.5% 97.9% 99.1%
RITES - Museum Towers Apr-01 286 89.5% 96.9% N/A
RITES - Oklahoma City (4) Aug-98 772 88.1% 89.0% 92.0%
RITES - Olde English Manor Jun-98 264 91.3% 93.6% 90.5%
RITES - Palisades Park Feb-98 304 99.3% 99.3% 95.5%
RITES - Pavillion Apr-99 132 99.2% 99.2% 98.5%
RITES - Queen Anne IV Jul-98 110 99.1% 97.3% 92.7%
RITES - Rancho/Villas May-00 417 85.8% 86.6% 89.7%
RITES - Rillito Village Aug-98 272 86.8% 86.4% 90.3%
RITES - Riverset (1) Aug-88 352 88.2% 89.0% 95.3%
RITES - Riverset II (1) Jan-96 -- N/A N/A N/A
RITES - Sienna (a.k.a. Italian Gardens) Apr-98 140 95.0% 97.1% 100.0%
RITES - Sonterra May-98 156 76.3% 84.6% 90.7%
RITES - Southgate Crossings Jun-97 215 100.0% 97.2% 96.7%
RITES - Southwood Nov-97 1,286 82.0% 85.4% 83.4%
-----------
Subtotal Other Bond Related Investments 7,513
-----------
Total Units/Weighted Average Investments 21,823 91.9% 93.1% 93.1%
===========
Total/Same Stores (6) 20,168 92.2% 93.1% 93.1%
Construction/Substantial Rehab Properties
and Other Investments
Arlington Dec-00 176 N/A N/A N/A
Barrington at Beach Street Oct-00 398 N/A N/A N/A
Bedford Park Oct-00 312 41.0% 37.8% 63.1%
CAPREIT (5) Mar-01 2,942 93.7% 94.3% N/A
Chancellor Nov-01 101 N/A N/A N/A
Cool Springs Aug-00 124 17.7% 9.7% N/A
Fort Branch Dec-00 250 N/A N/A N/A
Hidden Brooks Sep-01 201 87.1% N/A N/A
Lincoln Corner Dec-01 134 N/A N/A N/A
Meridian at Bridgewater Nov-99 90 52.2% 30.0% N/A
North White Road Nov-01 157 N/A N/A N/A
Oak Grove Commons Dec-01 168 N/A N/A N/A
Penn Valley Dec-01 42 N/A N/A N/A
Riverview Jun-00 224 17.0% N/A N/A
Silver Springs Dec-99 250 86.4% 81.6% 2.0%
Southwind Aug-00 88 96.6% 95.5% 65.9%
Village Apartments May-00 210 84.8% 74.3% N/A
Village at Sun Valley May-00 276 32.6% 9.8% N/A
Weatherstone Sep-00 100 40.0% 14.0% N/A
Woodglen Dec-99 250 92.4% 77.2% N/A
-----------
Subtotal Construction/Rehab Properties 6,493
-----------
Total Units 28,316
===========
Avg. Monthly Rent
Per Apartment Unit
----------------------------------------------
Month Month Month
Ended Ended Ended
December 31, September 30, December 31,
Apartment Community 2001 2001 2000
------------------- ----------------------------------------------
Subordinate Mortgage Bonds:
CAPREIT N/A N/A N/A
Cinnamon Ridge N/A N/A N/A
Farmington Meadows $814 $814 $814
Independence Ridge 550 545 532
Locarno 866 861 836
Olde English Manor N/A N/A N/A
Peaks of Conyer N/A N/A N/A
Rillito Village N/A N/A N/A
Winter Oaks 547 541 520
Subtotal Subordinate Mortgage Bonds
Other Bond Related Investments:
Briarwood $589 $586 $570
Cinnamon Ridge 916 933 885
Golfside Villas (f.k.a. Club West) 587 581 546
Park Center 1,429 1,389 N/A
Park at Landmark 1,046 1,015 954
Poplar Glen 919 915 875
RITES - Charter House 611 613 609
RITES - Indian Lakes 774 766 738
RITES - LaPaloma 620 583 589
RITES - LeMirador (Coleman Senior) 814 799 832
RITES - Museum Towers 1,355 1,355 N/A
RITES - Oklahoma City (4) 472 470 462
RITES - Olde English Manor 473 472 474
RITES - Palisades Park 525 525 505
RITES - Pavillion 655 659 619
RITES - Queen Anne IV 1,085 1,073 957
RITES - Rancho/Villas 792 792 474
RITES - Rillito Village 447 450 450
RITES - Riverset (1) 699 701 702
RITES - Riverset II (1) N/A N/A N/A
RITES - Sienna (a.k.a. Italian Gardens) 807 787 832
RITES - Sonterra 844 845 864
RITES - Southgate Crossings 943 925 892
RITES - Southwood 489 489 480
Subtotal Other Bond Related Investments
Total Units/Weighted Average Investments $678 $670 $611
Total/Same Stores (6) $637 $629 $611
Construction/Substantial Rehab Properties and Other Investments
Arlington N/A N/A N/A
Barrington at Beach Street N/A N/A N/A
Bedford Park $526 $519 $459
CAPREIT (5) 638 629 N/A
Chancellor N/A N/A N/A
Cool Springs 1,958 1,953 N/A
Fort Branch N/A N/A N/A
Hidden Brooks 1,050 N/A N/A
Lincoln Corner N/A N/A N/A
Meridian at Bridgewater 3,100 3,150 N/A
North White Road N/A N/A N/A
Oak Grove Commons N/A N/A N/A
Penn Valley N/A N/A N/A
Riverview 676 N/A N/A
Silver Springs 783 780 N/A
Southwind 680 666 N/A
Village Apartments 474 479 N/A
Village at Sun Valley 643 643 N/A
Weatherstone 800 810 N/A
Woodglen 631 647 N/A
Subtotal Construction/Rehab Properties
Total Units
(1) The Company owns a participating bond, a participating subordinate bond and
a RITES interest collateralized by the Riverset property.
(2) The Company owns a non-participating bond and a RITES interest
collateralized by the Charter House property.
(3) The Dade Gannon Portfolio represents eight properties.
(4) The Oklahoma City Portfolio represents three properties.
(5) The CAPREIT Portfolio represents eleven properties.
(6) Same Stores includes properties reporting for each of the past three
quarters.
15
Portfolio Management
The Company is responsible for a full range of loan servicing and asset
management functions for its own investments and for others. Through Midland,
the Company is a Fannie Mae approved DUS lender authorized to process loans and
collect origination and servicing fees. The Company, through Midland, also
manages equity syndication financings.
The Company monitors the timely receipt of all debt service payments and
promptly notifies a borrower of any delinquency, deficiency or default.
Reporting systems are in place that allow the Company to review and analyze the
revenue, expenses and leasing activity of each property on a periodic basis. In
addition, the Company inspects each property and market area on a regular basis.
The loan servicing and asset management oversight is designed to enable the
Company to track the performance of each property and to alert management to
potential problems. While actions will vary depending upon the nature of an
individual problem, the Company generally notifies borrowers of any problems or
concerns and recommends corrective action.
The Company responds to defaults on tax-exempt bonds and construction loans
on a case-by-case basis. After sending requisite default notices, the Company
typically holds discussions with the property owner/developer. In the event the
Company determines that the owner/developer remains committed to the project and
capable of successful operations, a workout or other forbearance arrangement may
be negotiated. Whenever the Company determines that successful operation by the
current owner/developer is not feasible, negotiations for the transfer of a
deed, in lieu of foreclosure, to an affiliated entity may be undertaken. In the
absence of reserves or operating deficit guarantees, the Company may face
additional risk from operations with respect to properties so transferred, which
may require subsidies from Company reserves to cover potential operating
deficits before debt service. The Company does not currently anticipate that any
such operating deficits before debt service will occur in 2002.
Employees
As of December 31, 2001, the Company had 218 employees. The Company is not
a party to any collective bargaining agreement.
Item 2. Properties.
The Company leases office space as follows:
Baltimore, Maryland. In November 1998, the Company assumed the office lease
agreement from an affiliate for office space. The office space contains 11,124
square feet and the lease expires in March 2003. In June 2001, the Company
entered into a lease agreement for additional space in the same office building.
The new office space contains 2,939 square feet and the lease expires in March
2003.
Clearwater, Florida. In June 1996, Midland entered into a seven-year lease for a
14,876 square feet office facility. In September 1998, Midland negotiated a new
lease for an additional 6,180 square feet of space in the same location with an
expiration coinciding with the original lease. In December 2000, Midland
negotiated a new lease that brings the space rented to a total of 36,004 square
feet. The lease expires in December 2005.
16
The Company, through Midland, also leases office space for its regional
offices in Dallas, Texas, San Francisco, California, Los Angeles, California,
Chicago, Illinois, and Detroit, Michigan. The Company believes its facilities
are suitable for its requirements and are adequate for its current and
contemplated future operations.
Item 3. Legal Proceedings.
None.
Item 4. Submission of Matters to a Vote of Security Holders.
No matter was submitted to a vote of the Company's? shareholders during the
three months ended December 31, 2001.
17
Part II
Item 5. Market for Registrant's Equity Securities and Related Stockholder
Matters
The following table sets forth the high and low sale prices per share of
the Common Shares as reported by the NYSE for each calendar quarter in 2001 and
2000 and the distributions declared with respect to such shares allocable to
such period.
Distributions
High Low Declared
------------- ------------- -------------
2001:
First Quarter $ 24.33 $ 21.75 $0.4250
Second Quarter 23.50 22.00 0.4275
Third Quarter 25.25 25.80 0.4300
Fourth Quarter 25.80 23.11 0.4325
2000:
First Quarter 20.00 18.19 $0.4125
Second Quarter 20.63 18.88 0.4175
Third Quarter 21.88 20.13 0.4200
Fourth Quarter 23.50 20.25 0.4225
As of March 18, 2002, there were approximately 17,511 holders of record of
Common Shares.
The Company's current policy is to distribute to holders of Common Shares
at least 80% of cash available for distribution to Common Shares. The Company
pays distributions to its holders of Common Shares quarterly in February, May,
August and November.
The Preferred Shares and the Preferred CD Shares which were redeemed in
March 2002 are not listed for trading on any national securities exchange and
there is no established public trading market for those shares.
Description of Shares
As of December 31, 2001 there were 16,737 Preferred Shares (10,995 Series I
and 5,742 Series II), 4,567 Preferred CD Shares (3,176 Series I and 1,391 Series
II), 2,000 Term Growth Shares and 21,857,312 Common Shares outstanding.
Shareholder approval may not be required for the Company to issue additional
shares in the future. Although the Company will not issue additional Preferred
Shares or Preferred CD Shares, it may from time to time issue additional Common
Shares depending upon market conditions. In addition, the Company is authorized
to issue new classes of shares, which may be senior to the Common Shares but
cannot be senior to the Preferred Shares or Preferred CD Shares. No shareholders
have pre-emptive rights.
The rights of the holders of each class of shares of the Company, including
the distributions to which each class is entitled, are set forth in full in the
Company's Operating Agreement, a copy of which is filed as an exhibit to this
report. The following is a summary of the rights, privileges and preferences of
the holders of each class of shares outstanding at December 31, 2001.
18
Preferred Shares. The performance of, and distributions with respect to,
each series of Preferred Shares (which were redeemed in March 2002) is based
solely upon the performance of that portion of the original bonds attributable
to such series as they existed immediately following the Refunding and prior to
the 1995 Financing. Accordingly, the holders of the Preferred Shares are
entitled to their proportionate share of distributions with respect to the 11
original bonds and 11 refunded Series B Bonds held by the Company, as well as
the distributions they would have received with respect to the 11 refunded
Series A Bonds had the 1995 Financing not occurred. Distributions to the holders
of the Preferred Shares are satisfied, however, on a basis having priority over
all payments with respect to the Common Shares, Term Growth Shares and any other
equity class (other than Preferred CD Shares), out of all of the resources of
the Company, including revenue from investment of the proceeds from the 1995
Financing. None of the expenses incurred in connection with the 1995 Financing
or any future financings are borne by the holders of the Preferred Shares.
The Preferred Shares must be partially redeemed upon (i) the sale or
repayment of a bond attributable to such shares, (ii) the sale of a related
mortgaged property, or (iii) beginning in the year 2000, an appraisal of a
related mortgaged property indicating that its fair market value exceeds the sum
of (a) the face value of the bond secured by the property and (b) unpaid accrued
interest on such bond. Upon liquidation, the holders of the Preferred Shares are
entitled to receive, after payment of creditors, the appraised value of the
Company's assets attributable to such shares, together with all unpaid accrued
distributions, before any distribution is made to the holders of Common Shares
or other shares ranking junior to the Preferred Shares. The Preferred
Shareholders shall be permitted to convert such shares to either Common Shares
or cash (at the discretion of the Board of Directors) once every two years
beginning in June 2004. Third party independent appraisals will be obtained to
determine the conversion value for each share.
The holders of the Preferred Shares do not have voting rights with respect
to the election of the Company's directors, but do have voting rights with
respect to any merger or consolidation of the Company in which it is not the
surviving entity or the sale of substantially all of its assets, the removal of
a director, and any alteration of the rights, privileges or preferences of the
Preferred Shares under the Operating Agreement. The voting power of the
Preferred Shares, relative to all of the Company's outstanding shares, is
equivalent to the relative voting power, immediately prior to the Merger, of the
BACs exchanged therefor. Such protection from loss of relative voting power,
however, does not extend to issuances of additional shares of the Company
subsequent to the Merger.
Preferred CD Shares. The performance of, and distributions with respect to,
each series of Preferred CD Shares is based solely upon the performance of that
portion of the original bonds attributable to such series as they existed
immediately following the 1995 Financing. Accordingly, the holders of the
Preferred CD Shares are entitled to their proportionate share of distributions
with respect to the 11 original bonds and 11 refunded Series B Bonds held by the
Company. Because the holders of the Preferred CD Shares received a distribution
of their pro rata share of the proceeds of the 1995 Financing, however, they,
unlike the holders of the Preferred Shares, (i) receive no distribution relating
to the performance of the 11 refunded Series A Bonds the receipts for which were
sold in the 1995 Financing and (ii) bear their pro rata share of the expenses of
the 1995 Financing and any future financings utilizing any of the original
bonds.
The rights, privileges and preferences of the Preferred CD Shares are
otherwise substantially the same as those of the Preferred Shares.
19
Term Growth Shares. The holders of the Term Growth Shares are entitled to
distribution of 2% of the Company's cash flow. Except with respect to
distributions and various redemption features as defined in the Operating
Agreement, the rights and privileges of the Term Growth Shares are substantially
the same as those of the Common Shares. Term Growth Shares will be redeemed when
Preferred and Preferred CD Shares are fully redeemed or converted (subject to
certain conditions defined in the Company's Operating Agreement).
Common Shares. The holders of the Common Shares are entitled to
distributions as and when declared by the Board of Directors out of funds
legally available therefor. As of December 31, 2001, the Company's policy was to
distribute to the holders of the Common Shares at least 80% of its cash flow
from operations (exclusive of capital-related items and reserves) after payment
of distributions to the holders of the Preferred Shares, Preferred CD Shares and
Term Growth Shares. No distributions may be declared or paid with respect to the
Common Shares, however, so long as there remains unpaid any required
distribution or redemption payment with respect to the Preferred Shares and
Preferred CD Shares.
The Common Shares are not redeemable (except pursuant to certain
anti-takeover provisions) and upon liquidation share ratably in any assets
remaining after payment of creditors and the liquidation preferences of the
Preferred Shares and Preferred CD Shares. The holders of the Common Shares
voting as a single class have the right to elect the directors of the Company
and, voting together with the holders of the Preferred Shares and Preferred CD
Shares, have voting rights with respect to a merger or consolidation of the
Company in which it is not the surviving entity or the sale of substantially all
of its assets, the removal of a director, the dissolution of the Company, and
certain anti-takeover provisions. Each Common Share entitles its holder to cast
one vote on each matter presented for shareholder vote. Because of provisions
providing limited protection against dilution of the voting rights of the
holders of the Preferred Shares and Preferred CD Shares, each Series I Preferred
Share and Series I Preferred CD Share and each Series II Preferred and Series II
Preferred CD Share currently entitles its holders to cast 38.10 and 43.95 votes,
respectively, on each matter on which the Preferred and Preferred CD Shares vote
along with the Common Shares presented for a vote of the holders of those
shares.
20
Item 6. Selected Financial Data.
As of and for the year ended December 31, 2001 2000 1999 1998 1997
------------ ------------ ------------ ----------- -----------
INCOME STATEMENT DATA (000s):
Interest on tax-exempt bonds
and other bond related
investments $ 53,443 $ 43,077 $ 35,435 $ 23,241 $ 17,219
Interest on loans 33,340 31,757 6,543 4,563 3,500
Net gain on sales 8,222 2,121 2,680 4,743 2,824
Other income 30,758 23,897 8,888 2,911 1,796
------------ ------------ ------------ ----------- -----------
Total income 125,763 100,852 53,546 35,458 25,339
Operating expenses 35,918 26,636 10,112 6,002 3,962
Interest expense 30,696 31,152 6,665 -- --
Other-than-temporary
impairments related to
investments in tax-exempt
bonds and other bond related
investments 3,256 1,008 1,120 2,049 2,580
------------ ------------ ------------ ----------- -----------
Total expenses 69,870 58,796 17,897 8,051 6,542
Net holding losses on trading
securities (5,572) -- -- -- --
Net income before income taxes,
income allocated to preferred
shareholders in a subsidiary
company, and cumulative effect
of accounting change 50,321 42,056 35,649 27,407 18,797
Income tax expense 1,383 2,006 703 -- --
------------ ------------ ------------ ----------- -----------
Net income before income
allocated to preferred
shareholders in a subsidiary
company and cumulative effect
of accounting change 48,938 40,050 34,946 27,407 18,797
Income allocated to preferred
shareholders in a subsidiary
company 10,779 8,475 3,433 -- --
------------ ------------ ------------ ----------- -----------
Net income before cumulative
effect of accounting change 38,159 31,575 31,513 27,407 18,797
Cumulative effect on prior years
of change in accounting for
derivative financial instruments (12,277) -- -- -- --
------------ ------------ ------------ ----------- -----------
Net income $ 25,882 $ 31,575 $ 31,513 $ 27,407 $ 18,797
============ ============ ============ =========== ===========
NET INCOME PER SHARE:
Preferred shares
Series I $ 57.05 $ 56.25 $ 68.44 $ 67.80 $ 43.07
Series II $ 22.51 $ 65.31 $ 68.76 $ 64.74 $ 64.84
Preferred capital distribution
shares
Series I $ 49.22 $ 43.34 $ 55.96 $ 56.23 $ 32.59
Series II $ 7.44 $ 46.73 $ 49.81 $ 48.97 $ 49.70
Common shares (diluted net
income per share) $ 1.09 $ 1.62 $ 1.67 $ 1.60 $ 1.50
Weighted average common shares
outstanding (diluted) 21,804,186 18,088,366 17,740,671 15,938,249 12,537,517
BALANCE SHEET DATA (000s):
Investments in tax-exempt bonds,
other bond related investments
and derivative financial
instruments, net $ 606,042 $ 495,663 $ 391,633 $ 310,093 $ 220,961
Loans receivable 440,031 349,291 286,489 17,246 11,491
Total assets 1,289,276 987,882 801,746 359,411 243,101
Notes payable 420,063 329,159 261,956 -- --
Long-term debt 134,881 70,899 67,000 -- --
Preferred shareholders' equity
in a subsidiary company 160,465 137,664 80,159 -- --
Total shareholders' equity 436,708 364,783 363,611 355,452 241,399
CASH DISTRIBUTIONS PER SHARE:
Preferred shares:
Series I:
For the year ended December
31, paid quarterly (1) $ 43.98 (5),(6) $ 52.00 $ 108.97 (3) $ 80.77 (2) $ 53.57
Series II:
For the year ended December
31, paid quarterly (1) $ 32.55 (6) $ 174.88 (4) $ 217.93 (3) $ 68.52 $ 62.87
21
ITEM 6. SELECTED FINANCIAL DATA (continued)
2001 2000 1999 1998 1997
------------ ------------ ------------ ----------- -----------
Preferred capital distribution shares:
Series I:
For the year ended December
31, paid quarterly (1) $ 33.58 (5),(6) $ 40.00 $ 99.21 (3) $ 79.44 (2) $ 43.79
Series II:
For the year ended December
31, paid quarterly (1) $ 10.15 (6) $ 155.91 (4) $ 21.83 (3) $ 53.36 $ 50.64
Common shares:
For the year ended December
31, paid quarterly (1) $ 1.7150 $ 1.6725 $ 1.6075 $ 1.53 $ 1.43
(1) This amount represents total dividends declared for the year. Quarterly
distributions were paid to all preferred shareholders beginning with the third
quarter of 1997; the first semiannual distribution for 1997 was paid in August
1997.
(2) The 1998 distributions for the Series I Preferred Shares and the
Series I Preferred Capital Distribution Shares include a special distribution of
$24.93 and $33.88, respectively, for their proportionate share of the Company's
net proceeds from the sale of three consolidated demand notes in December 1998.
(3) The distributions for the Series I and Series II Preferred and Preferred
Capital Distribution Shares include two special distributions. The first
distribution relates to their proportionate share of the Company's net proceeds
from the sale of eight consolidated demand notes in March 1999 as follows:
Preferred Series I, $16.24; Preferred Series II, $25.59; Preferred Capital
Distribution Series I, $19.96 and Preferred Capital Distribution Series II,
$41.89. The second distribution relates to their pro- rata portion of the return
of capital from the refunding of the bond secured by the Riverset property as
follows: Preferred Series I, $38.51; Preferred Series II; $133.24; Preferred
Capital Distribution Series I, $37.60 and Preferred Capital Distribution Series
II, $131.84.
(4) The distributions for the Series II Preferred and the Series II Preferred
Capital Distributions Shares includes a special distribution of $127.13 and
$127.16, respectively. The special distribution represents their pro rata
portion of the return of capital resulting from the pay-off of a bond secured by
a property known as Southfork Village.
(5) The distributions for the Series I Preferred Shares and Preferred Capital
Distribution Shares include a special distribution of $1.48 which represents
their pro rata portion of the proceeds from the sale of a taxable loan secured
by the property known as Mountain View.
(6) In June 2001, approximately 26% of Series I Preferred Shares and Preferred
Capital Distribution Shares and approximately 56% of Series II Preferred Shares
and Preferred Capital Distribution Shares were redeemed. The effect of this
redemption was a decrease in the number of shares outstanding, which, in turn
caused the per share distribution to increase.
SHARES OUTSTANDING AND NUMBER OF HOLDERS
AS FOLLOWS:
As of December 31, Preferred shares:
Series I
Shares outstanding 10,995 14,933 14,933 15,590 16,329
Number of shareholders 783 779 780 803 873
Series II
Shares outstanding 3,176 7,226 7,226 7,350 7,637
Number of shareholders 344 349 350 356 365
Preferred capital distribution shares:
Series I
Shares outstanding 5,742 7,798 7,798 8,325 8,909
Number of shareholders 378 377 379 378 425
Series II
Shares outstanding 1,391 3,164 3,164 3,535 3,809
Number of shareholders 169 167 168 170 194
Common Shares:
Shares outstanding 21,820,236 17,655,737 17,392,064 16,791,050 11,106,150
Number of shareholders 17,960 11,094 15,536 15,772 13,405
22
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
General Business
Municipal Mortgage & Equity, LLC ("MuniMae") and its subsidiaries (together
with MuniMae, the "Company") are principally engaged in originating, investing
in and servicing investments related to multifamily housing and other real
estate financings. A significant portion of the Company's investments consists
of tax-exempt bonds and interests in bonds issued by state and local governments
or their agencies or authorities to finance multifamily housing developments.
Interest income from the majority of these investments is exempt for federal
income tax purposes. Multifamily housing developments, as well as the rents paid
by the tenants, secure these investments. Midland Financial Holdings, Inc.
("Midland"), a wholly owned corporate subsidiary, is a fully integrated real
estate investment firm that specializes in originating, investing in and
servicing investments in the affordable multifamily housing industry. These
investments generate taxable, not tax-exempt, income.
In October 1999 the Company acquired Midland for approximately $45 million.
Of this amount, the Company paid approximately $23 million in cash and
approximately $12 million in Common Shares at the closing of the transaction. In
addition, $3.3 million in MuniMae Common Shares was payable annually over a
three year period if Midland met certain performance targets, including an
annual contribution to cash available for distribution ("CAD"). In December
2000, MuniMae paid approximately $3.3 million in Common Shares in consideration
for Midland meeting its first year performance targets. In 2001, in order to
increase MuniMae's flexibility in operating Midland, MuniMae agreed with the
former owners of Midland that the payment of the 2001 and 2002 installments
would no longer be conditioned on Midland meeting certain performance targets.
In December 2001, MuniMae paid approximately $3.3 million in Common Shares and,
subject to certain conditions, MuniMae expects to make the final payment of
Common Shares having a value of approximately $3.3 million in December 2002.
In October 1999, as a result of the Midland acquisition, the Company
restructured its operations into two business segments: (1) an investing segment
that primarily holds investments producing tax-exempt interest income; and (2)
an operating segment that primarily generates taxable interest income and,
through corporate subsidiaries, fee income by providing servicing, loan
origination and tax credit equity syndication services. The revenues associated
with the investing segment consist primarily of interest earned on tax-exempt
bonds, other bond related investments and certain short-term taxable loans and
investments. The revenues associated with the operating segment consist
primarily of loan servicing and loan origination fees for the Company's own
portfolio and for portfolios of third parties, syndication and brokerage fees
associated with the origination of tax credit syndications, taxable interest and
fees earned on construction lending activities and other fee income.
In 1999, the Company placed a substantial portion of its tax-exempt bonds
and bond related investments in TE Bond Sub, an indirect subsidiary of the
Company. TE Bond Sub then sold Series A, Series B and Series A-1 and B-1
Cumulative Preferred Shares (collectively, the "TE Bond Preferred Shares") to
institutional investors in May 1999, June 2000 and October 2001, respectively
(see further discussion under Liquidity and Capital Resources). The TE Bond
Preferred Shares have a senior claim to the income derived from the investments
owned by TE Bond Sub and thus the assets of TE Bond Sub are not available to
MuniMae's creditors. Any income from TE Bond Sub available after payment of the
cumulative distributions of the TE Bond Preferred Shares is allocated to the
Company.
23
Results of Operations
Year Ended December 31, 2001 Compared with Year Ended December 31, 2000
Total income for the year ended 2001 increased $24.9 million over the same
period last year due primarily to: (1) an increase in collections of interest
totaling $11.9 million on bonds, other bond related investments and loans; (2) a
$6.1 million increase in gain on sale which includes an increase of $1.6 million
on the sale of taxable loans, a $2.3 million gain on tax credit equity
re-syndication, and a $2.2 million gain on the payoff of Newport-On-Seven; (3)
an increase in loan servicing fees, loan origination and brokerage fees, and
syndication fees of $5.3 million due primarily to an increase in syndication
fees and an increase in loan production; (4) an increase in other income of $2.9
million of which $3.3 million was associated with income earned on the
assumption of a purchase obligation with respect to the Hunter's Glen and
Buchanan Bay bonds; (5) offset in part by $1.3 million decrease in interest on
short-term investments.
Total expenses for the year ended 2001 increased $11.1 million over the
same period last year due primarily to: (1) an increase in salary and related
benefits expense of $6.1 million, including additional bonuses associated with
increased syndication production; (2) an increase in operating expenses of $1.9
million primarily associated with commissions paid on equity syndication funds;
(3) an increase in professional fees of $0.7 million associated with various
information system initiatives; (4) an increase in goodwill and other
intangibles amortization of $0.6 million; (5) a decrease in interest expense of
$0.5 million primarily associated with the $22 million reduction in our long
term debt facility; and (6) an other-than-temporary impairment of $3.3 million
on two investments (Hunter's Glenn and Buchanan Bay).
As a result of the adoption of FAS 133, the Company recorded a negative
cumulative effect adjustment of $12.3 million on January 1, 2001 and net holding
losses for mark to market adjustments on derivative financial instruments of
$5.6 million for the year ended December 31, 2001.
Income allocable to preferred shareholders of TE Bond Sub increased to
$10.8 million from $8.5 million in 2000 as a result of the sale in October 2001
of Series A-1 and B-1 Preferred Shares and recording of a full year of income
allocable to the Series B Preferred Shares sold in June 2000 (see further
discussion under Liquidity and Capital Resources).
As discussed above, the operating segment consists primarily of
subsidiaries of the Company that are subject to income taxes. The effective tax
rate for 2001 was 41.6% versus 49.4% for 2000. The 2001 rate reflects a
provision for deferred taxes, and the effects of a charitable contribution and
low-income housing tax credits.
For the year ended December 31, 2001, the net adjustment to other
comprehensive income for unrealized holding gains on tax-exempt bonds and other
bond related investments available for sale was $7.0 million. After a
reclassification adjustment for losses of $8.1 million included in net income,
other comprehensive income for the year ended December 31, 2001 was $1.1 million
and total comprehensive income was $27.0 million.
Net income for the year ended December 31, 2001 decreased by $5.7 million
as compared with 2000, due primarily to (1) a cumulative effect adjustment of
$12.3 million upon adoption of FAS 133 and net holding losses for mark-to-market
adjustments on derivative financial instruments of $5.6 million recorded in
24
earnings, which were recorded through other comprehensive income in 2000,
partially offset by (2) an increase in the Company's operating income (total
income excluding net gain on sale less total expenses excluding
other-than-temporary impairments) of $10.0 million due to growth in the
Company's loan production volume and investments, and (3) an increase of $6.1
million in gain on sales which includes an increase of $1.6 million on the sale
of taxable loans, a $2.3 million gain on tax credit equity re-syndication, and a
$2.2 million gain on the payoff of Newport-On-Seven.
Year Ended December 31, 2000 Compared with Year Ended December 31, 1999
Total income for the year ended December 31, 2000 increased by
approximately $47.3 million from the same period last year due primarily to an
increase in collections of interest totaling $7.2 million on bonds, other bond
related investments and loans and an increase of $40.0 million due to the
inclusion of a full year of Midland income in 2000 versus a partial year of
Midland income in 1999.
The Company recognized net gain on sales of $2.1 million for the year ended
December 31, 2000. Of this amount, $1.9 million related to Midland's sale of
loans to Fannie Mae and other third parties in which Midland retained the
mortgage servicing rights on the loans. In conjunction with the recognition of
the net gain on sales, the Company recorded an investment in mortgage servicing
rights. The Company recognized net gain on sales of $2.7 million in 1999 related
to the sale of bonds and loans.
Salaries and benefits, professional fees and operating expenses for the
year ended December 31, 2000 increased by approximately $14.9 million over the
prior year due primarily to (1) an increase of $11.9 million due to the
inclusion of a full year of Midland expenses in 2000 versus a partial year of
Midland expenses in 1999, (2) an increase of $0.6 million in salary and benefits
expense as a result of an increase in the number of employees and an increase in
the incentive compensation earned, (3) an increase of $1.0 million in
professional fees related to consulting expenses as a result of growing the
Company's information infrastructure and legal expenses related to various
transactions and (4) an increase of $0.9 million in operating expenses related
to an increase in allowance for loan losses.
For the year ended December 31, 2000, the Company recorded a full year of
amortization of goodwill and other intangibles associated with the Midland
acquisition and the capitalization of mortgage servicing rights. This accounted
for a $1.6 million increase in amortization expense over the prior year.
Interest expense for the year ended December 31, 2000 increased by
approximately $24.5 million over the same period last year due primarily to an
increase of $22.8 million due to the inclusion of a full year of interest
expense from short-term borrowings associated with construction lending activity
at Midland and an increase of $1.7 million in interest expense related to
securitization transactions accounted for as borrowings.
Income allocable to preferred shareholders of TE Bond Sub increased to $8.5
million from $3.4 million in 1999 as a result of the June 2000 Series B
Preferred Equity Offering and recording of a full year of income allocable to
the sale in May 1999 of the Series A Preferred Shares (see further discussion
under Liquidity and Capital Resources).
The Company recorded other-than-temporary impairments aggregating $1.0
million on one investment in 2000. This type of non-cash charge does not affect
the cash flow generated from the operation of the underlying properties,
distributions to shareholders, the tax-exempt status of the income,
25
or the financial obligations under the bonds.
As discussed above, the operating segment consists primarily of
subsidiaries of the Company that are subject to income taxes. The effective tax
rate for 2000 was 49.4% versus 52.2% for 1999. The 2000 rate reflects a
provision for deferred taxes associated with the capitalization of mortgage
servicing rights.
For the year ended December 31, 2000, the net adjustment to other
comprehensive income for unrealized holding losses on tax-exempt bonds and other
bond related investments available for sale was $2.1 million. After a
reclassification adjustment for gains of $0.2 million included in net income,
other comprehensive loss for the year ended December 31, 2000 was $2.3 million
and total comprehensive income was $29.3 million.
Net income for the year ended December 31, 2000 was $31.6 million compared
to $31.5 million in 1999. Net income for 2000 includes a full year of Midland
income of $40.0 million, offset by a full year of Midland operating and interest
expense of $34.7 million. The increase in net income from the inclusion of
Midland was offset by an increase of $5.1 million in income allocable to
preferred shareholders in TE Bond Sub.
Critical Accounting Policies
The Company's discussion of its financial condition and results of
operations is based upon the Company's consolidated financial statements, which
are prepared on the accrual basis of accounting in accordance with generally
accepted accounting principles. The Company believes the following critical
accounting policies contain significant estimates used in the preparation of its
consolidated financial statements.
Investment in tax-exempt bonds and other bond related investments
Investment in tax-exempt bonds and other bond related investments is
accounted for under the provisions of Statement of Financial Accounting
Standards No. 115, "Accounting for Certain Investments in Debt and Equity
Securities"("FAS 115"). All investments in tax-exempt bonds and other bond
related investments are classified and accounted for as available-for-sale debt
securities and carried at fair value; unrealized holding gains or losses arising
during the period are recorded through other comprehensive income in
shareholders' equity, while realized gains and losses and other-than-temporary
impairments are recorded through operations. The Company evaluates on an
on-going basis the credit risk exposure associated with these assets to
determine whether any other-than-temporary impairments exist in accordance with
the Company's policy discussed under the Other-than-Temporary Impairment section
of this discussion. Future adverse changes in market conditions or poor
operating results from the underlying real estate could result in losses or an
inability to recover the carrying value of the investments.
The Company determines the fair value of participating bonds (i.e., bonds
that participate in the net cash flow and net capital appreciation of the
underlying properties) that are wholly collateral dependent and for which only a
limited market exists by discounting the underlying collateral's expected future
cash flows using current estimates of discount rates and capitalization rates.
The Company engages an independent real estate valuation firm to assist the
Company in reviewing the reasonableness of the estimates of discount rates,
capitalization rates and other variables used to estimate the fair value of
these bonds on an annual basis.
26
The Company bases the fair value of non-participating bonds and other bond
related investments, which also have a limited market, on quotes from external
sources, such as brokers, for these or similar bonds or investments.
Because the Company's investment in tax-exempt bonds and other bond related
investments are secured by non-recourse mortgage loans on real estate
properties, the value of the Company's assets is subject to all of the factors
affecting bond and real estate values, including macro-economic conditions,
interest rate changes, demographics, local real estate markets and individual
property performance. Further, many of the Company's investments are
subordinated to the claims of other senior interests and uncertainties may exist
as to a borrower's ability to meet principal and interest payments.
Securitization Transactions
For financial reporting purposes, transactions where the Company
securitizes a bond and subsequently purchases a residual interest are accounted
for in accordance with Statement of Financial Accounting Standards No. 140,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities" ("FAS 140"). Under FAS 140, the accounting for these
transactions is partially dependent on certain call provisions. If the residual
interest holder is granted a call provision under the terms of the transaction,
then effective control over the transferred assets has not been relinquished and
the transaction is accounted for as a borrowing. When the residual interest
holder is not granted a call provision and effective control has been
relinquished, the transaction is accounted for as a sale and the Company
recognizes gains and losses on the sale of its bonds. The portion of the
unrealized gain or loss on a bond that is recognized as a result of the sale is
determined by allocating the net amortized cost at the time of sale between the
corresponding senior interest and residual interest based upon their relative
fair values, in accordance with FAS 140. The Company may also structure
transactions whereby a third party buys bonds directly from a seller and the
Company subsequently purchases residual investments related to the bonds. In
this case, the Company may retain the call provision associated with its
investment in the residual interest position without requiring borrowing
treatment because the Company does not own the bond.
Investment in Derivative Financial Instruments
Investment in derivative financial instruments is accounted for under the
provisions of Statement of Financial Accounting Standards No. 133, "Accounting
for Derivative Instruments and Hedging Activities" and Financial Accounting
Standards Board Statement No. 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities." These statements (collectively,
"FAS 133") establish accounting and reporting standards for derivative financial
instruments, including certain derivative financial instruments embedded in
other contracts, and for hedging activity. FAS 133 requires the Company to
recognize all derivatives as either assets or liabilities in its financial
statements and record these instruments at their fair values. In order to
achieve hedge accounting treatment, hedging activities must be appropriately
designated, documented and proven to be effective as a hedge pursuant to the
provisions of FAS 133. The Company has elected, as permitted by FAS 133, not to
prove the hedging effectiveness of its derivative investments due to the cost
and administrative burden of complying with FAS 133. As a result, changes in
fair value of derivatives are recorded through current earnings.
The Company has several types of financial instruments that meet the
definition of a derivative
27
financial instrument under FAS 133, including interest rate swaps, put option
contracts and total return swaps. Under FAS 133, the Company's investment in
these derivative financial instruments is recorded on the balance sheet with
changes in fair value of these instruments, as well as changes in fair value of
other instruments which are deemed to be derivative financial instruments,
recorded in current earnings. The Company bases the fair value of its derivative
financial instruments, which also have a limited market, on quotes from external
sources, such as brokers, for these or similar investments. These estimates
involve uncertainties and matters of judgment and therefore cannot be determined
with precision. The assumptions and methodologies selected by the Company were
intended to estimate the amounts at which the investments could be exchanged in
a current transaction between willing parties, other than in a forced or
liquidation sale. Changes in assumptions and market conditions could
significantly affect estimates. These estimated values may differ significantly
from the values that would have been used had a ready market for the investments
existed, and the differences could be material.
Loans Receivable
The Company carries loans receivable at net realizable value. The Company
evaluates on an on-going basis the credit risk exposure associated with these
assets to determine whether any impairment exists in accordance with the
Company's policy discussed below. When the Company believes that it is probable
that it will not collect all amounts due, including principal and interest,
under the terms of a loan, it records a valuation allowance.
Mortgage Servicing Rights
The Company accounts for its mortgage servicing rights under FAS 140. FAS
140 requires servicing rights retained by the Company after the origination and
sale of the related loan to be capitalized by allocating the carrying amount
between the loan and the servicing rights based on their relative fair values.
The fair value of the mortgage servicing rights is based on the expected future
net cash flow to be received over the estimated life of the loan discounted at
market discount rates. The capitalization of the mortgage servicing rights is
reported in the income statement as a gain or loss on sale and results in an
offsetting asset or liability. Mortgage servicing rights are amortized over the
estimated life of the serviced loans. The amortization expense is included in
goodwill and other intangibles amortization in the consolidated statements of
income.
The Company evaluates all capitalized mortgage servicing rights for
impairment when changes indicate that impairment is probable, but no less than
at each reporting date. The mortgage servicing rights are considered to be
impaired when the carrying amount exceeds the fair value of the expected future
net cash flows to be received under the servicing contract. Impairment, if any,
is recognized through a valuation allowance.
Other-than-Temporary Impairments
The Company evaluates on an on-going basis the credit risk exposure
associated with its assets to determine whether other-than-temporary impairments
exist or a valuation allowance is needed. When the Company believes that it is
probable that it will not collect all amounts due, including principal and
interest, under the terms of an investment, it records an other-than-temporary
impairment or valuation allowance. The Company bases its measure of impairment
of an investment on the present value of expected future cash flows discounted
at the investment's effective interest rate, or the fair value of the
28
collateral if the investment is collateral dependent.
Use of Estimates
The use of estimates is inherent in the preparation of all financial
statements, but is especially important in the case of the Company, which is
required under FAS 115 to carry a substantial portion of its assets at fair
value, even though only a limited market exists for them. Because only a limited
market exists for most of the Company's investments, fair value is estimated by
the Company in accordance with the Company's valuation procedures discussed
above. These estimates involve uncertainties and matters of judgment and
therefore cannot be determined with precision. The assumptions and methodologies
selected by the Company were intended to estimate the amounts at which the
investments could be exchanged in a current transaction between willing parties,
other than in a forced or liquidation sale. Changes in assumptions and market
conditions could significantly affect estimates. These estimated values may
differ significantly from the values that would have been used had a ready
market for the investments existed, and the differences could be material.
New Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board approved Statements
of Financial Accounting Standards No. 141 "Business Combinations" ("FAS 141")
and No. 142 "Goodwill and Other Intangible Assets" ("FAS 142"), which are
effective July 1, 2001 and January 1, 2002, respectively, for the Company. FAS
141 requires that the purchase method of accounting be used for all business
combinations consummated after June 30, 2001. Under FAS 142, amortization of
goodwill, including goodwill recorded in past business combinations, will be
discontinued upon adoption of this standard. In addition, goodwill recorded as a
result of business combinations completed during the six-month period ending
December 31, 2001 will not be amortized. All goodwill and intangible assets will
be tested for impairment in accordance with the provisions of the Statement. The
Company is currently reviewing the provisions of FAS 141 and FAS 142 and
assessing the impact of adoption.
Liquidity and Capital Resources
The Company's primary objective is to maximize shareholder value through
increases in CAD to common shares and appreciation in the value of its common
shares. The Company seeks to achieve its growth objectives by growing its
investing and operating business segments. The Company grows its investment
segment by acquiring diversified portfolios of tax-exempt bonds and other bond
related investments. Growth in the operating segment is derived from increasing
levels of fees generated by affordable housing equity syndications, loan
servicing and origination and brokerage services. The Company's business plan
includes structuring $1.4 billion to $1.6 billion in investment transactions in
2002. The Company expects to finance its acquisitions through a financing
strategy that (1) takes advantage of attractive financing available in the
tax-exempt securities markets, (2) minimizes exposure to fluctuations of
interest rates, and (3) maintains maximum flexibility to manage the Company's
short-term cash needs. To date, the Company has primarily used two sources,
securitizations and equity offerings, to finance its acquisitions. Through
Midland's management of capital for others, including Fannie Mae, the Company
has expanded its access to capital.
For the year ended December 31, 2001, the Company structured $468.4 million
in tax-exempt bond transactions. Of this amount, $99.6 million represented
investments retained by the Company. In addition,
29
MuniMae originated $175.8 million of construction loans, $294.9 million of
taxable permanent loans and equity investments totaling $146.6 million.
The Company's investing segment relies primarily on securitization
transactions and equity offerings to finance the growth in this business
segment. The operating segment relies on a variety of financing sources,
including pension funds, short-term bank warehousing and other credit lines, and
the Company's working capital.
The Company pension fund relationships have historically been a significant
source of capital for its construction and construction/permanent lending
activities. A number of pension funds, through the Midland Affordable Housing
Group Trust (the "Group Trust"), have provided short-term credit to finance a
variety of the Company's loan products. In 2000, these same pension funds
established the Midland Multifamily Equity REIT ("MMER"), a $70 million Maryland
real estate investment trust, in order to participate as equity investors in a
portfolio of income-producing multifamily real estate properties. MMER has also
extended working capital lines of credit to the Company in order to increase
MMER's return on its capital base pending the investment of those funds in
equity real estate. As of December 31, 2001, the various facilities extended by
the Group Trust and MMER are as follows:
Group Trust MMER
----------- ----
Borrowing Balance Due at Borrowing Balance Due at
Purpose Facility December 31, 2001 Facility December 31, 2001
- ------- -------- ----------------- -------- -----------------
Finance interim construction and $50.0 million $5.0 million $20.0 $44,000
permanent lending warehouse million line
activities facility of credit
Finance working capital and $30.0 million $27.5 million $20.0 $7.4 million
carry over loans warehouse million line
facility of credit
Fund syndication advances to $10.0 million $2.8 million -- --
limited partnerships line of credit
Finance interim construction -- -- $20.0 $0
lending million line
of credit
Fund syndication advances to $30.0 million $30.0 million $20.0 $0
limited partnerships line of credit million line
of credit
The following discussion outlines the Company's liquidity and capital
resources with respect to these segments followed by a discussion of the
economic factors that influence these items and the Company. This discussion is
followed by a summary of the Company's off-balance sheet financings and
commitments and contingencies and cash flow.
Investing Segment
As noted above, the Company's investing segment relies primarily on
securitization transactions and equity offerings to finance its growth. The
Company grows its investment segment by acquiring
30
diversified portfolios of tax-exempt bonds and other bond related investments.
In 2001, the Company completed a Common Share equity offering and a TE Bond
Preferred Share offering. In addition, the Company completed securitization
transactions with Merrill Lynch and Freddie Mac.
Common Share Offerings
On February 8, 2002, the Company sold to the public 3.0 million Common
Shares at a price of $24.70 per share and granted the underwriters an option to
purchase up to an aggregate of 450,000 Common Shares to cover over-allotments at
the same price. Net proceeds on the 3.0 million shares approximated $70.5
million. On February 15, 2002, the underwriters exercised their option to
purchase 300,000 Common Shares generating net proceeds of approximately $7.1
million. The net proceeds from this offering will be used for general corporate
purposes, including new investments and working capital.
On February 6, 2001, the Company sold to the public 3.8 million common
shares at a price of $23.07 per share and granted the underwriters an option to
purchase up to an aggregate of 570,000 common shares to cover over-allotments at
the same price. The net proceeds from this offering were used for general
corporate purposes, including new investments and working capital.
Preferred Share Equity Offerings
In May 1999, TE Bond Sub sold to institutional investors $84 million of
Series A Cumulative Preferred Shares ("Series A Preferred Shares"). In June
2000, TE Bond Sub sold to institutional investors $60 million of Series B
Cumulative Preferred Shares ("Series B Preferred Shares"). In October 2001, TE
Bond Sub sold to institutional investors $16 million of Series A-1 Cumulative
Preferred Shares ("Series A-1 Preferred Shares") and $8 million of Series B-1
Subordinate Cumulative Preferred Shares ("Series B-1 Preferred Shares"; all four
Series, collectively, the "TE Bond Preferred Shares"). The net proceeds
generated from the October 2001 offering were approximately $22.8 million.
The Series A and A-1 Preferred Shares bear interest at 6.875% and 6.30% per
annum, respectively, or, if lower, the aggregate net income of the issuing
company, TE Bond Sub. The Series A and A-1 Preferred Shares have a senior claim
to the income derived from the investments owned by TE Bond Sub. The Series A-1
Shares are equal in priority of payment to the Series A Preferred Shares. The
Series B and B-1 Preferred Shares bear interest at 7.75% and 6.80% per annum,
respectively, or, if lower, the aggregate net income of the issuing company, TE
Bond Sub, after payment of distributions to the Series A and Series A-1
Preferred Shares. The Series B-1 Shares are equal in priority of payment to the
Series B Preferred Shares. Any income from TE Bond Sub available after payment
of the cumulative distributions of the TE Bond Sub Preferred Shares is allocated
to the Company, which holds all of the common equity interests. Cash
distributions on the TE Bond Sub Preferred Shares will be paid quarterly on each
January 31, April 30, July 31 and October 31. The TE Bond Sub Preferred Shares
are subject to remarketing on specified dates. On the remarketing date, the
remarketing agent will seek to remarket the shares at the lowest distribution
rate that would result in a resale of the TE Bond Sub Preferred Shares at a
price equal to par plus all accrued but unpaid distributions. The TE Bond Sub
Preferred Shares will be subject to mandatory tender on specified dates, and on
all subsequent remarketing dates at a price equal to par plus all accrued but
unpaid distributions.
31
Securitizations
Through securitizations, the Company seeks to enhance its overall return on
its investments and to generate proceeds that, along with equity offering
proceeds, facilitate the acquisition of additional investments. The Company uses
various programs to facilitate the securitization and credit enhancement of its
bond investments.
Through the use of securitizations, the Company expects to employ leverage
and maintain overall leverage ratios in the 50% to 65% range, with certain
assets at significantly higher ratios, up to approximately 99%, while not
leveraging other assets at all. The Company calculates leverage by dividing
on-balance sheet debt plus the total amount of third party owned senior
interests in its investments, which it considers the equivalent of off-balance
sheet financing, by the sum of total assets owned by the Company plus senior
interests owned by others adjusted for reserves equal to the net assets of the
operating segment. Under this method, the Company's leverage ratio was
approximately 53% both at December 31, 2001 and at December 31, 2000.
In order to facilitate the securitization of certain assets at higher
leverage ratios than otherwise available to the Company without the posting of
additional collateral, the Company has pledged additional bonds to a pool that
acts as collateral for senior interests in certain securitization trusts and
credit enhancement facilities. At December 31, 2001 and 2000, the total carrying
amount of the tax-exempt bonds and taxable loans pledged as collateral was
$361.8 million and $311.8 million, respectively.
Following is a description of the Company's various credit enhancement and
securitization investment vehicles.
Merrill Lynch P-FLOATs(SM) program
The Company securitizes tax-exempt bonds in its portfolio through the
Residual Interest Tax-Exempt Securities Receipts ("RITESSM")/Puttable Floating
Option Tax-Exempt Receipts ("P-FLOATsSM") program offered by Merrill Lynch
Pierce Fenner & Smith Incorporated ("Merrill Lynch"). Through this program, the
Company sells bonds to Merrill Lynch or structures a transaction whereby Merrill
Lynch buys bonds from third parties. Merrill Lynch in turn, deposits the bonds
into trusts, which are created to hold these assets. Subsequently, these bonds
are credit enhanced by Merrill Lynch. Two types of securities, P-FLOATsSM and
RITESSM, are created for each asset deposited into the trusts. The P-FLOATsSM
are short-term floating rate interests in the trusts that have priority on the
cash flows of the tax-exempt bonds and bear interest at rates that are reset
weekly by the remarketing agent, Merrill Lynch. The P-FLOATsSM are sold to
qualified third party investors. When the Company sells a bond to Merrill Lynch,
the Company receives the proceeds from the sale of the P-FLOATsSM, less certain
transaction costs, and retains the residual interests in the trusts, the
RITESSM. When Merrill Lynch buys the bond directly, the Company purchases the
RITESSM from a Merrill Lynch sponsored trust. The RITESSM are the subordinate
security and receive the residual interest on the bond after the payment of all
fees and the P-FLOATsSM interest.
Since the bonds securitized generally bear fixed rates of interest, the
floating rate residual interests in the trust created by the securitization may
subject the Company to interest rate risks. To reduce the Company's exposure to
interest rate risks on residual interests retained, the Company may enter into
interest rate swaps. Net swap payments received, if any, will be taxable income,
even though the
32
investment being hedged pays tax-exempt interest. Although these swaps act as
hedges, the Company does not designate them as hedges for accounting purposes
under FAS 133; therefore, changes in fair value are reflected in earnings.
The terms of the securitization trusts are generally based on the
anticipated prepayment of the underlying bond in the trust. If a bond prepayment
occurs as anticipated, the Company will receive its pro rata share of proceeds
from the prepayment. However, there is no certainty that bond prepayment will
occur at the end of the term of the securitization trust. If the bond does not
prepay before the securitization trust terminates, the Company would be forced
to liquidate its residual investment or, if the Company wished to retain this
investment, it would be forced to purchase the remaining interests in the bond.
Term Securitization Facility
In March 1999, the Company consummated a transaction with Merrill Lynch
that converted a portion of its investment in the P-FLOATsSM trusts discussed
above into a longer-term securitization facility. As a result, this transaction
enabled the Company to (a) reduce its exposure to credit and annual renewal
risks associated with the liquidity and credit enhancement features of the
securitization? trusts and the swap agreements, (b) reduce the annual financing
costs, (c) eliminate the risk of receiving taxable net swap payments which serve
to hedge tax-exempt investments, and (d) reduce the Company's exposure to
changes in swap values that may result in margin calls. In July 2001, TE Bond
Sub refinanced this facility. The result of the refinancing was a reduction of
the outstanding debt from $67 million to $45 million. Substantially all other
terms of the debt remained the same.
Fannie Mae Credit Enhancement
During December 2000, the Company closed a $100 million credit enhancement
facility through Fannie Mae. The facility refinanced the short-term credit
enhancement on approximately $70 million of the Company's existing P-FLOATsSM
with long-term credit enhancement through Fannie Mae. The facility also provided
credit enhancement to two of the Company's previously unenhanced tax-exempt
bonds having an aggregate face value of approximately $10 million at December
31, 2000. The new facility also included the credit enhancement on approximately
$20 million of tax-exempt bonds that were previously credit enhanced through MMA
Cap, LLC ("MMA Cap") prior to December 2000.
The $100 million credit enhancement facility, which was completed through
MMA Cap, is an open ended facility and will facilitate the placement of long
term securitization capital, thereby enabling the Company to securitize its
tax-exempt bonds at a fixed rate and for a term that more clearly matches the
term of the underlying bond. The MMA Cap credit enhancement facility was
arranged through Midland and enables the Company to diversify its securitization
capabilities. In order to provide credit enhancement to the bonds secured by
this facility, the Company pledged additional investments of $29.7 million (face
amount) to this facility as collateral.
Freddie Mac Tender Option Bond Program
In December 2001, the Company developed a tender option bond program with
the Federal Home Loan Mortgage Corporation ("Freddie Mac"). Through this
program, the Company securitized 12 bonds with an aggregate unpaid principal
balance of approximately $91.0 million and deposited the bonds in 12 trusts.
Prior to this transaction, approximately $34.3 million of these bonds had been
securitized through
33
the P-FLOATs(SM) program. The trusts issued approximately $69.0 million of
fixed-rate senior certificates and approximately $22.0 million of fixed-rate
subordinate certificates. The Company purchased the subordinate certificates and
the senior certificates were sold to third party investors. The net proceeds to
the Company upon completion of this transaction approximated $34.7 million,
which represents $69.0 million in proceeds from the sale of the fixed-rate
senior certificates less $34.3 million for the purchase of the bonds in the
P-FLOATsSM program. To increase the attractiveness of the senior certificates to
outside investors, Freddie Mac provided credit enhancement through a standby
guaranty of payment and agreed to provide liquidity by lending the Company the
money to repurchase the senior certificates at the remarketing date (if they are
not successfully remarketed), which is five years from issuance. The Company
agreed to pay Freddie Mac for the first $22.0 million of losses if any of the
bonds fail to generate sufficient income to pay the senior certificate holders,
and the Company pledged the subordinate certificates to Freddie Mac to secure
this obligation. Freddie Mac's recourse to the Company for losses on the credit
enhancement is limited to its right to liquidate the subordinate certificates.
Operating Segment
As noted above, the Company's operating segment relies on the availability
of capital from pension funds, both directly and indirectly through the Group
Trust and MMER, in addition to the capital provided by government sponsored
entities, such as Fannie Mae and Freddie Mac, to maintain and grow its
operations. Through the operating segment, the Company originates construction
loans to the affordable multifamily housing industry. The Company's sources of
capital to fund these lending activities include notes payable to the Group
Trust, warehousing facilities with the Group Trust, MMER and a commercial bank,
various short-term bank lines of credit, and working capital. The Company earns
income from the difference between the interest charged on its construction
loans and the interest due under its notes payable and other funding sources.
The Company also earns origination and construction administration fees from
originating the loans and servicing the loans during the construction period.
Midland is a Fannie Mae Delegated Underwriter and Servicer ("DUS") and a
Freddie Mac approved mortgagee. As a result, for its construction/permanent
loans, the Company sells the loans to Fannie Mae, Freddie Mac or the Group Trust
as or shortly after the loans are converted to permanent loans. The Company
earns a brokerage fee for selling the loans and generally retains the mortgage
servicing rights on these loans. The proceeds of the sale of permanent loans are
reinvested in new loans.
As a Fannie Mae DUS lender, Midland may share in losses relating to
underperforming real estate mortgage loans delivered to Fannie Mae. More
specifically, Midland may be required to make servicing advances to pay taxes or
insurance premiums or delinquency advances to pay principal or interest (if the
borrower fails to make payment). Also, Midland may participate in a deficiency
after foreclosure. In connection with this obligation, Midland must maintain a
minimum net worth and collateral with a custodian. Its financial exposure,
however, is subject to certain deductibles and loss limits. The servicing
portfolio balance originated through the DUS program was $584.6 million and
$403.9 million at December 31, 2001 and 2000, respectively. Midland is
indemnified by the Group Trust against losses it may incur in connection with
its servicing of $271.0 million of these loans. As of December 31, 2001, the
Company had not incurred any losses on this portfolio.
The Company sells interests in partnerships that provide low-income housing
tax credits for investors. The Company earns syndication fees on the placement
of these interests with investors. In conjunction with the selling of these
partnership interests, the Company may provide certain performance guarantees on
34
the underlying properties owned by the partnerships. The maximum exposure under
these guarantees at December 31, 2001 was $23.8 million, and as of December 31,
2001, the Company does not expect to have to perform under these guarantees and
does not believe that any loss is likely.
Factors that Could Affect Future Results
In seeking out attractive multifamily and other housing-related investment
opportunities, the Company competes directly against a large number of lenders
- -- including banks, finance companies and other financial intermediaries - and
providers of related services such as portfolio loan servicing. Certain of the
Company's competitors, including GMAC, Prudential Mortgage Finance and Lend
Lease Mortgage Capital Co., have substantially greater financial and operational
resources than the Company. While the Company has historically been able to
compete effectively against such competitors on the basis of its service,
longstanding relationships with developers and a broad array of product
offerings, many of our competitors benefit from substantial economies of scale
in their business and have other competitive advantages.
In addition, in seeking permanent financing for their developments, the
Company's customers generally evaluate a wide array of taxable and tax-exempt
financing options. While tax-exempt financings offer specific attractions for
developers, they can be more complicated than taxable financings and can involve
ongoing restrictions on the owner's use of the property. Consequently, the
relative attractiveness of tax-exempt permanent financing may increase or
decrease over time based on the availability and cost of taxable financing.
While our strategic emphasis on tax-exempt financing will continue, the Company
does offer taxable permanent debt financing options and, with financing from
pension funds through MMER, offers taxable equity financing as well.
The Company's results of operations could also be materially affected by
changes in the performance of the properties underlying its investments. We
might receive less income from our investments than we expect due to any number
of factors, including:
o Adverse economic conditions, either local, regional or national,
limiting the amount of rent that can be charged for units at the
properties. Adverse economic conditions may also result in a reduction
in timely rent payments or a reduction in occupancy levels.
o Occupancy and rent levels may decrease due to the construction of
additional housing units or the establishment of rent stabilization or
rent control laws or similar agreements.
o A decline in the level of mortgage interest rates may encourage
tenants in multifamily rental properties to purchase housing, reducing
the demand for rental housing.
o Expenses at the property level, including but not limited to capital
needs, real estate taxes and insurance, may increase.
Periods of economic slowdown or recession that result in declining
properties or property performance, particularly declines in the value or
performance of multifamily properties, may adversely affect our business. Any
material decline in property values weakens the collateral value of the
properties we invest in, and prolonged poor performance in the affordable
housing market segment could result in a decline in demand for financing.
Additionally, some of our income comes from contingent interest on participating
tax-exempt bonds. A decline in the performance of the related multifamily
property would likely have a negative effect on our cash available for
distribution.
35
The Company's business prospects are directly impacted by governmental
policy decisions relating to investments in affordable housing which affect the
supply of tax-exempt bonds and low-income housing tax credits ("LIHTC"). For
example, in late 2000 Congress passed legislation increasing the LIHTC, which is
determined on a state-by-state basis according to each state's population, from
$1.25 in 2000 to $1.50 in 2001 and $1.75 in 2002. This increase contributed to
the Company's $114.7 million of tax credit equity originations in 2001 (an
increase of $17.1 million, or 18%, over 2000) and is expected to facilitate
higher production volume in 2002. Also in 2000, Congress approved a 50% increase
in allocations for tax-exempt and other "private activity" bonds, from $50.00
per state resident for 2000 to $75.00 for 2002. Current legislation provides for
inflation-based adjustments to the LIHTC and tax-exempt bond allocations
starting in 2003.
Our future results are also dependent on the Company's maintenance of its
relationships with the government sponsored entities ("GSEs") participating in
the affordable housing market, particularly Fannie Mae and Freddie Mac. The
maintenance of the Company's DUS license with Fannie Mae is critical to the
continued productivity and growth of the Company's operating segment. As a DUS
Lender, the Company is subject to periodic reviews by Fannie Mae and must comply
with a variety of underwriting and servicing guidelines imposed by Fannie Mae
contractually. Noncompliance or failure to adhere to these guidelines could
result in loss of delegated authority and most severely a revocation of the
Company's DUS license. Alternatively, Fannie Mae could impact the value of the
DUS license to the Company by either (i) issuing new DUS licenses to the
Company's competitors or (ii) changing the delegated authority of its DUS
lenders or making it more costly or otherwise more difficult for DUS lenders to
underwrite and service loans on Fannie Mae's behalf. Of the $175.8 million of
construction loans originated in the operating segment in 2001, 93% of the total
were for projects underwritten and structured so as to be eligible for permanent
financing through one of the GSEs.
The Company also relies on the GSEs as a source of liquidity and credit
enhancement. (See "Liquidity and Capital Resources -- Fannie Mae Credit
Enhancement and "--Freddie Mac Tender Option Bond Program" above.) Consequently,
our results may be impacted by changes in the strategic direction of the GSEs,
particularly those which diminish their appetite for investment in affordable
housing.
The pension fund participants in the Group Trust and MMER provide
significant financial support to the Company's operating segment. While the
Company believes its relations with these pension funds are good, it is possible
that these funds will reduce or withdraw their financing commitments in the
future. At December 31, 2001, the Group Trust and MMER together accounted for
$200 million, or 64% of the operating segment's borrowing capacity.
As described in "Investing Segment--Merrill Lynch P-FLOATs(SM) Program"
above, the Company regularly purchases RITESSM, which are floating rate residual
interests in securitization trusts established through Merrill Lynch. The
Company attempts to mitigate its floating rate risks by investing in interest
rate swaps. At December 31, 2001, the Company was party to interest rate swaps
in the aggregate notional amount of $422.2 million. The Company's floating rate
exposure at any point in time may not have been fully mitigated by hedging
instruments and, as a result, changes in interest rates could result in either
an increase or decrease in the Company's interest income and cash flows
associated with these investments. See Note 7 to the Company's consolidated
financial statements for a more detailed discussion of this issue.
In addition, the effectiveness of the Company's strategy to mitigate
interest rate risk could be
36
impacted by factors affecting the creditworthiness of the Company's swap
counterparties. Credit downgrades of the Company's swap counterparties or other
factors may limit their participation in interest rate swaps, which could make
it more costly for the Company to continue its interest rate risk management
strategy. The Company has recently begun to distribute its interest rate swap
portfolio among several counterparties in order to limit counterparty credit
risk. At December 31, 2001, Merrill Lynch was the swap counterparty on $171.7
million, or 41%, of the Company's interest rate swaps.
The Company also relies on the GSEs as a source of liquidity and credit
enhancement. (See "Liquidity and Capital Resources -- Fannie Mae Credit
Enhancement and "--Freddie Mac Tender Option Bond Program" above.) Consequently,
our results may be impacted by changes in the strategic direction of the GSEs,
particularly those which diminish their appetite for investment in affordable
housing. The Company's future results could also be impacted by deterioration in
the credit quality of Fannie Mae and Freddie Mac, which provide credit
enhancement and liquidity support which facilitates the securitization of the
Company's assets. See "Quantitative and Qualitative Disclosures about Market
Risk--Risks Associated with Securitizations" below. If Fannie Mae and Freddie
Mac ceased to provide such support, the Company would have to seek alternative
forms of credit and liquidity support in order to continue to leverage its
assets. The Company does not have any reason to believe that either entity will
cease to provide such support; nevertheless, the Company is negotiating with
other prospective providers of credit enhancement in order to limit this risk.
Fannie Mae and Freddie Mac also benefit from a number of
government-confirmed benefits; including, for example, the following: (1) their
earnings are exempt from state and local corporate income taxes; (2) their
securities are exempt from SEC registration requirements; and (3) their
securities are eligible for unlimited investment by federally insured thrifts,
national banks and state bank members of the Federal Reserve system. These
advantages, coupled with the size and prominence of Fannie Mae and Freddie Mac
in the mortgage-backed security market, have led to recent scrutiny of their
role in the mortgage market. A number of sizeable financial services companies
and trade associations have launched a concerted effort to limit the growth of
the GSEs and spur close examination of how the benefits of their GSE status are
being employed. While it is impossible to predict the ultimate impact of this
lobbying effort, it could conceivably result in a contraction of the GSEs'
support of the affordable housing market.
In 2001 the Company embarked on a comprehensive overhaul of its information
systems infrastructure in an effort to: (i) standardize the Company's hardware
and internal communications platforms; (ii) upgrade the Company's accounting and
financial systems to an enterprise resource planning (ERP) system; and (iii)
develop scalable, integrated loan underwriting, deal management and loan
servicing systems tailored to the Company's needs and expected growth profile.
As of December 31, 2001, the Company had: implemented the accounting modules;
replaced our local-area networks and implemented a five-year outsourcing
arrangement with an application services provider for wide-area network
connectivity, secure internet access and application hosting; and upgraded and
unified the Company's basic office productivity software on a Microsoft Office
2000 platform. Management expects these information systems upgrades to continue
through 2003. The Company believes that successful implementation of the
upgrades will increase the Company's efficiency in future years; however, delays
or complications in implementation may have an adverse impact on the Company's
operations.
37
Cash Flow
At December 31, 2001 and 2000, the Company had cash and cash equivalents of
approximately $97.4 million and $27.5 million, respectively.
Cash flow from operating activities was $31.5 million, $29.0 million and
$30.7 million for the years ended December 31, 2001, 2000 and 1999,
respectively. The increase in cash flow for 2001 versus 2000 is due primarily to
an increase in income from new investments and an increase in other income
attributable to Midland. The decrease in cash flow for 2000 versus 1999 is due
primarily to an increase in other receivables at Midland.
The Company uses CAD as the primary measure of its ability to pay
distributions. CAD differs from net income because of slight variations between
generally accepted accounting principles ("GAAP") income and actual cash
received. There are three primary differences between CAD and GAAP income. The
first is the treatment of loan origination fees, which for CAD purposes are
recognized as income when received but for GAAP purposes are amortized into
income over the life of the associated investment. The second difference is the
non-cash gain and loss recognized for GAAP associated with valuations, sales of
investments and capitalization of mortgage servicing rights net of deferred
taxes, which are not included in the calculation of CAD. The third difference is
the treatment of goodwill and other intangibles, which are amortized into
expense for GAAP, but not included in the calculation of CAD.
Until the redemption of the Company's preferred shares in 2002, the Company
was required to distribute to the holders of its preferred shares the cash flow
attributable to such shares (as defined in the Company's Amended and Restated
Certificate of Formation and Operating Agreement). The Company was also required
to distribute 2.0% of the Company's net cash flow to the holders of term growth
shares. The balance of the Company's net cash flow is available for distribution
to the common shares and the Company's current policy is to distribute to common
shareholders at least 80% of the annual CAD to common shares. For the years
ended December 31, 2001 and 2000, cash available for distribution to common
shares was $41.6 million and $32.6 million, respectively. The Company's
distribution per common share for 2001 of $1.7150 represents a payout ratio of
89.2% of CAD. The Company's common share distribution for 2000 of $1.6725
represents a payout ratio of 90.0% of CAD.
Regular cash distributions to shareholders attributable to the years ended
December 31, 2001, 2000 and 1999 were $38.8 million, $31.5 million and $29.7
million, respectively.
The Company expects to meet its cash needs in the short-term, which consist
primarily of funding new investments, operating expenses and distributions on
the common shares and other equity, from cash on hand, operating cash flow,
equity offering proceeds and securitization proceeds.
Related Party Transactions
Pension Fund Advisory Business
A subsidiary of the Company functions as an investment advisor for several
pension funds and profit-sharing trusts. Since 1991, these funds and trusts have
provided short-term debt financing to the Company through the Group Trust. The
Group Trust was formed by these pension funds in order to facilitate their
lending to the Company in accordance with their internal policy requirements. In
2000,
38
these same pension funds established the MMER in order to participate as equity
investors in a portfolio of income-producing multifamily real estate properties.
MMER has also extended working capital lines of credit to the Company in order
to increase MMER's return on its capital base pending the investment of those
funds in equity real estate.
The various credit lines established by the Group Trust and MMER are
described in detail in "Liquidity and Capital Resources" section above. As of
December 31, 2001, these credit lines totaled $200.0 million, and loans
outstanding to various subsidiaries of the Company totaled $72.8 million.
The Group Trust and MMER engage in business transactions exclusively with
the Company. Four of the five trustees of the Group Trust (Mr. Falcone, Mr.
Mentesana, Mr. Robert J. Banks, and Mr. Keith J. Gloeckl) are officers of the
Company. In addition, three of the five trustees of MMER (Mr. Falcone, Mr. Banks
and Mr. Gloeckl) are Company officers. Consequently, the Group Trust and MMER
are deemed to be affiliates of the Company.
Management believes that the Group Trust and MMER were established on arm's
length terms with the pension funds and that all transactions between the
Company and the Group Trust and the Company and MMER are arm's length
transactions. Management further believes that the facilities bear market rates
of interest and that the collateral requirements are substantially equivalent to
the requirements of the Company's lenders which have no other affiliation with
the Company. None of the Company's officers who serve as trustees of the Group
Trust or MMER receives compensation from the Group Trust or MMER for serving in
that capacity.
In addition to the liquidity provided by the Group Trust and MMER working
capital lines of credit, the Company earns placement and management fees from
them. For the years ended December 31, 2001, 2000, and 1999, respectively, the
Company's fees from the Group Trust totaled $2.0 million, $1.0 million and $1.6
million. For the year ended December 31, 2001 the Company's fees from MMER
totaled $30,000.
The Company believes that special purpose entities such as the Group Trust
and MMER are attractive investment vehicles for pension funds and other
sophisticated institutional investors because they enable those investors to
benefit from the Company's specialized real estate experience while permitting
them to tailor collateral, reporting and other features of the investment
vehicle to their specific interests. Accordingly, the Company intends to
continue to market its services to such investors. In addition, the Company and
the investors in the Group Trust and MMER may agree to increase or decrease the
size, or change the investment purposes, of those investment vehicles from time
to time.
The Shelter Group
Mr. Joseph controls and is an officer of Shelter Development Holdings, Inc.
("Shelter Holdings") which, together with its affiliates (collectively, the
"Shelter Group"), engages in real estate development and provides property
management services to a wide variety of commercial and residential properties.
One of the Shelter Group companies provides property management functions for a
number of properties that serve as collateral for the Company's bond
investments. Mr. Falcone had an ownership interest in and was a board member of
this entity until he relinquished these positions in 2000.
The Shelter Group receives fees pursuant to management contracts for
properties which it manages. During 2001, Shelter had 12 property management
contracts for properties that collateralize the Company's investments with fees
at or below market value. During 2000, there were 12 affiliated
39
property management contracts for properties that collateralize the Company's
investments with fees at or below market value. During the years ended December
31, 2001, 2000 and 1999, these fees approximated $1.1 million, $1.3 million, and
$1.1 million, respectively. Of the 12 property management contracts with the
Shelter Group in effect as of December 31, 2001, seven were for properties which
had been under the management of the Shelter Group since prior to the formation
of the Company, and three were for properties whose prior managers were replaced
due to poor performance.
Consistent with the Company's Amended and Restated Certificate of Formation
and Operating Agreement (the "Operating Agreement"), each affiliate property
management contract is presented to the independent members of the Board of
Directors for approval with information documenting the comparability of the
proposed fees to those in the market area of the property.
Mr. Joseph has agreed to abstain from any involvement, as a partner in the
Shelter Group, in the structuring or review of any contracts or transactions
between the Shelter Group and the Company. He has likewise agreed to recuse
himself from review or involvement, as an officer or director of the Company, in
contracts and transactions involving the Shelter Group. The Company's Board of
Directors has approved all contracts and transactions involving the Shelter
Group and conducts an annual review of all property management contracts between
the Shelter Group and any properties that collateralize the Company's
investments.
Management of Defaulted Assets
In certain circumstances involving the Company's tax-exempt bonds,
borrowers have defaulted on their debt obligations to the Company. In such
circumstances the Company has, after evaluating its options, chosen not to
foreclose on the property. Instead, the Company has negotiated the transfer of a
property's deed in lieu of foreclosure to, or replaced the general partner of a
property with, an entity affiliated with the Company. The Company has done so in
order to preserve the original tax-exempt bond obligations and its participation
in cash flow from the property, consistent with its overall goal of providing
tax-exempt income to its shareholders.
Following the transfer of the property's deed to an affiliated entity, that
entity controls the collateral for certain investments held by the Company.
These affiliated entities are controlled by or managed by certain officers of
the Company. The following table outlines these affiliate relationships at
December 31, 2001:
Number of Properties Owned Carrying Value of Company's
Affiliate Entity (directly or indirectly) Investment at December 31, 2001
- ---------------- ------------------------ -------------------------------
SCA Successor, Inc. (1) 4 $ 43,540,000
SCA Successor II, Inc. (1) 11 54,958,000
MMA Affordable Housing Corporation (2) 2 45,649,000
MuniMae Foundation, Inc (3) /
MMA Successor I., Inc. (1) 3 23,872,000
------ ------------
Total 20 $168,019,000
====== ============
(1) These corporations are general partners of the operating partnerships
whose property collateralizes the Company's investments. Mr. Joseph controls the
general partners of these operating partnerships and Mr. Falcone serves as
director in three such general partners. Ms. Angela A. Barone, the Company's
Vice President of Finance and Budgeting, serves as an officer in one such
general partner.
(2) MMA Affordable Housing Corporation ("MMAHC") is a 501(c)(3) non-profit
entity organized to provide charitable donations on behalf of the Company. Mr.
40
Joseph is the Chairman and one of five directors of the MMAHC. Mr. Falcone, Mr.
Gary A. Mentesana and Mr. Earl W. Cole, III, Senior Vice President of the
Company, are also officers and directors of the MMAHC.
(3) MuniMae Foundation, Inc.is a private non-profit entity organized to provide
charitable donations on behalf of the Company. Mr. Joseph is the President and
one of four directors of the MuniMae Foundation. Mr. Falcone and Mr. Mentesana,
the Company's Chief Capital Officer, are also directors of the MuniMae
Foundation.
None of the officers of the Company who serve as directors or officers of
the affiliated entities listed above is compensated for his services as officer
or director thereof or derives any other economic benefit from those entities
except for Mr. Joseph, who controls the general partner of SCA Successor I,
Inc., SCA Successor II, Inc. and MMA Successor I, Inc.
Such entities could have interests that do not fully coincide with, or even
are adverse to, the interests of the Company. Such entities could choose to act
in accordance with their own interests, which could adversely affect the
Company. Among the actions such entities could desire to take might be selling a
property, thereby causing a redemption event, at a time and under circumstances
that would not be advantageous to the Company.
Certain other related party relationships are discussed in Note 16 to the
Company's Consolidated Financial Statements.
Income Tax Considerations
MuniMae is organized as a limited liability company. This structure allows
MuniMae to combine the limited liability, governance and management
characteristics of a corporation with the pass-through income features of a
partnership. MuniMae does not pay tax at the corporate level. Instead, the
distributive share of MuniMae's income, deductions and credits is included in
each shareholder's income tax return. In addition, the tax-exempt income derived
from certain investments remains tax-exempt when it is passed through to the
shareholders. The Company records cash dividends received from subsidiaries
organized as corporations as dividend income for tax purposes. Approximately
100%, 93% and 83% of MuniMae's tax basis net income for the years ended December
31, 2001, 2000 and 1999, respectively, was tax-exempt for federal income tax
purposes.
As a result of the Midland acquisition, in October 1999, the Company
restructured its operations into two segments, an operating segment and an
investing segment as discussed above. The operating segment, which is directly
or indirectly wholly owned by MuniMae, consists primarily of entities subject to
income taxes. The Company provides for income taxes in accordance with Statement
of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("FAS
109"). FAS 109 requires the recognition of deferred tax assets and liabilities
for the expected future tax consequences of temporary differences between the
financial statement carrying amounts and the tax basis of assets and
liabilities.
The Company has elected under Section 754 of the Internal Revenue Code to
adjust the basis of the Company's property on the transfer of shares to reflect
the price each shareholder paid for their shares. While the bulk of the
Company's recurring income is tax-exempt, from time to time, the Company may
sell or securitize various assets, which may result in capital gains and losses
for tax purposes. Since the Company is taxed as a partnership, these capital
gains and losses are passed through to shareholders and are reported on each
shareholder's Schedule K-1. The capital gain and loss allocated from the Company
may be different for each shareholder due to the Company's 754 election and is a
function of, among other
41
things, the timing of the shareholder's purchase of shares and the timing of
transactions, which generate gains or losses for the Company. This means that
for assets purchased by the Company prior to a shareholder's purchase of shares,
the shareholder's basis in the assets may be significantly different than the
Company's basis in those same assets. Although the procedure for allocating the
basis adjustment is complex, the result of the election is that each share is
homogeneous, while each shareholder's basis in the assets of the Company may be
different. Consequently, the capital gains and losses allocated to shareholders
may be significantly different than the capital gains and losses recorded by the
Company.
A portion of the Company's interest income is derived from private activity
bonds that for income tax purposes are considered tax preference items for
purposes of alternative minimum tax ("AMT"). AMT is a mechanism within the
Internal Revenue Code to ensure that all taxpayers pay at least a minimum amount
of taxes. All taxpayers are subject to the AMT calculation requirements although
the vast majority of taxpayers will not actually pay AMT. As a result of AMT,
the percentage of the Company's income that is exempt from federal income tax
may be different for each shareholder depending on that shareholder's individual
tax situation.
42
Item 7A. Quantitative and Qualitative Disclosures about Market Risk.
The Company invests in certain financial instruments, primarily
available-for-sale investments in tax-exempt bonds and other bond related
investments that are subject to various forms of market risk including real
estate risk, interest rate risk, credit and liquidity risk and prepayment risk.
The Company seeks to prudently and actively manage such risks, to earn
sufficient compensation to justify the undertaking of such risks and to maintain
capital levels consistent with the risks the Company undertakes.
The following is a discussion of various categories of risk that the
Company may be subject to in the foreseeable future.
Real Estate Risk
The Company's investments in bonds and other bond related investments are
primarily collateralized by non-recourse mortgage loans on real estate
properties. One of the major risks of owning investments collateralized by
multifamily residential properties is the possibility that the owner of a
property collateralizing the investment will not make the payments due to the
Company and therefore defaults on the debt obligation. Defaults are subject to a
wide variety of factors, including, but not limited to, property performance,
property management, supply and demand forces, economic trends, interest rates
and other factors beyond the control of the Company. Adverse economic conditions
may limit the amounts of rent that can be charged for rental units at the
properties or may reduce a property's occupancy level. Occupancy and rent levels
may decrease due to the construction of additional housing units. City, state or
federal housing programs that subsidize many of the properties may impose rent
limitations and may limit the ability of a property to increase rents. The
property may experience an increase in expenses, including but not limited to
capital needs, real estate taxes and insurance. All of these conditions and
events may increase the possibility that a property owner may be unable to meet
its obligations to the Company under its tax-exempt bond. This could affect the
Company's cash available for distribution to shareholders. The Company manages
this risk through a diligent underwriting process and by carefully monitoring
loan performance.
The Company may be adversely affected by periods of economic slowdown or
recession that result in declining property values or property performance,
particularly declines in the value or performance of multifamily properties. Any
material decline in property values weakens the value of the properties as
collateral for the Company's investments and increases the possibility of a loss
in the event of a default. Additionally, some of our income comes from
additional interest on participating tax-exempt bonds. The collection of
additional interest may decrease in times of economic slowdown due to lower cash
available from the properties. Further, many of the Company's investments are
subordinated to the claims of other senior interests and uncertainties may exist
as to a borrower's ability to meet principal and interest payments. As a result
of these factors, debt service on the investments, and therefore cash flow
available for distribution to shareholders, is dependent upon the performance of
the underlying properties. Accordingly, a decline in the performance of the
related multifamily property could have a negative effect on our cash available
for distribution to shareholders.
Interest Rate Risk
Interest rate risk is highly sensitive to many factors, including
governmental, monetary and tax policies, domestic and international economic and
political considerations and other factors beyond the
43
Company's control. The interest income collected on investments that bear
interest at fixed rates or pay interest based on the cash flow available from
the underlying property are not directly impacted by fluctuations in interest
rates, unless the investment is prepaid as discussed below. In contrast, the
Company's investments in other bond related investments, which bear interest at
floating rates, are directly impacted by fluctuations in market interest rates.
If interest rates had changed by 100 basis points and 200 basis points at
December 31, 2001, the Company's annual interest income on these investments
would have changed by $95,000 and $200,000, respectively.
The majority of Company's loans receivable and notes payable related to
Midland's operations are generally not expected to be directly subject to
interest rate risk. The Company typically provides loans to borrowers (loans
receivable) by borrowing from third parties (notes payable). The Company earns
net interest income that represents the difference between the interest charged
to borrowers and the interest paid to the Company's lenders. The Company
typically attempts to match the terms and rates of its loans receivable and
notes payable to fix the interest income the Company will receive.
It is important to note that changing interest rate environments could
reduce the demand for multifamily tax-exempt and taxable financing, which could
limit the Company's ability to structure transactions. Conversely, falling
interest rates may prompt historical renters to become first time homebuyers, in
turn potentially reducing the demand for multifamily housing. In addition, in a
falling interest rate environment, demand for taxable financing could increase
relative to tax-exempt financing.
Developing an effective interest rate management strategy can be complex,
and no strategy can insulate the Company from all potential risks associated
with interest rate changes. The Company manages its interest rate exposure on
its investments in RITESSM, which are inverse floaters, through the use of
interest rate swaps in the notional amount of the outstanding senior interests
in the securitization trusts. Historically, the Company has attempted to hedge
substantially all of its floating interest rate exposure; however, from time to
time, a portion of the Company's floating rate exposure may not be fully
mitigated by hedging instruments. As a result, changes in interest rates could
result in either an increase or decrease in the Company's interest income and
cash flows associated with these investments. Also, the interest rate swap
agreements are subject to risk of early termination on the annual optional
termination date by the counterparty, possibly at times unfavorable to the
Company. There can be no assurance that the Company will be able to acquire
hedging instruments at favorable prices, or at all, when the existing
arrangements expire or are terminated. In this case, the Company would be fully
exposed to interest rate risk to the extent the hedging instruments are
terminated by the counterparty while the securitization trust remains in
existence.
In addition, there is no guarantee that the securitization trust will be in
existence for the duration of the hedge, as these securitization trusts would be
collapsed if the related credit enhancement or liquidity facilities are not
renewed.
To generate short-term financing proceeds, the Company occasionally enters
into total return swaps with Merrill Lynch. Similar to the RITESSM, these
investments are subject to interest rate risk. To date the Company has not
always entered into hedging instruments to mitigate this exposure. As a result,
changes in interest rates could result in either an increase or decrease in the
Company's interest income and cash flows associated with these investments.
The Company's investments in tax-exempt bonds and other bond related
investments and
44
investments in derivative financial instruments are carried at fair value.
Significant changes in market interest rates could affect the amount and timing
of unrealized and realized gains or losses on these investments. If interest
rates had changed by 100 basis points and 200 basis points at December 31, 2001,
the market value of these investments would have changed by 5% and 9%,
respectively. However, for the participating tax-exempt bonds for which the fair
value is determined by discounting the underlying collateral's expected future
cash flows using current estimates of discount rates and capitalization rates,
changes in market interest rates do not have a strong enough correlation to
discount and capitalization rates from which to draw a conclusion. There are
many mitigating factors to consider in determining what causes discount and
capitalization rates to change, such as macroeconomic issues, real estate
capital markets, economic events and conditions, and investor risk perceptions.
Credit and Liquidity Risks
Substantially all of the Company's bonds and other bond related investments
lack a regular trading market and are illiquid. This lack of liquidity could be
exacerbated during turbulent market conditions or if any of the tax-exempt bonds
become taxable or go into default. In the event that the Company may require
additional cash during a turbulent market, the Company may have to liquidate its
investments on unfavorable terms. In addition, the illiquidity associated with
the Company's bond and other bond related investments can result in increased
volatility in the fair value of the Company's investments, which could impact
the Company's balance sheet and other comprehensive income.
There can also be significant credit risk assigned by investors in the
securitization trusts to the types of investments held by the Company. The
illiquid assets held by the Company trade at yields that can be traced to
spreads over "investment grade" instruments. On occasion there may be periods of
market volatility during which the market investors demand an increased credit
spread to "investment grade" investments for the investments owned by the
Company. During these times, the market value of the Company's investments may
decline significantly. If the investors' required rate of return on the
Company's investments had changed 100 basis points and 200 basis points at
December 31, 2001, the market value of these investments would have changed by
6% and 12%, respectively.
Under the terms of the Company's interest rate swap agreements and total
return swaps with Merrill Lynch, the Company is required to maintain cash
deposits with Merrill Lynch (margin call deposits). There is a risk that the
Company could be required to liquidate investments to satisfy margin calls on
its interest rate swap contracts and total return swap contracts if interest
rates rise or fall dramatically. Additionally, the Company is exposed to the
credit risks of the Company's counterparties in the interest rate swap contracts
and total return swap contracts. The Company's counterparties, under certain
circumstances, may not pay or perform under the contracts or they may terminate
the contract at times unfavorable to the Company.
In order to facilitate the securitization of certain assets at higher than
normal leverage ratios, the Company has pledged additional bonds that act as
collateral for the senior interests in the securitization trusts. In the event
that a securitization trust cannot meet its obligations, all or a portion of the
bonds pledged as collateral may be sold to satisfy the obligations of the senior
interest in the securitization trust. In addition, if short-term tax-exempt
interest rates rise dramatically and exceed the coupon rate of the underlying
fixed rate bond in a securitization trust, the securitization trust would be
collapsed as a result of insufficient interest from the underlying fixed rate
bond available to service the floating senior interest obligation.
45
Prepayment Risk
A decrease in market interest rates may result in the redemption of an
investment or a borrower prepaying or refinancing the investment prior to its
stated maturity. The Company may not be able to reinvest the proceeds of the
redeemed investment at an attractive rate of return. This may affect the
Company's ability to generate sufficient income to pay distributions.
Risk Associated with Securitizations
Through securitizations, the Company seeks to enhance its overall return on
its investments and to generate proceeds that, along with equity offering
proceeds, facilitate the acquisition of additional investments. In the
securitization trusts, the investment bank (the "credit enhancer") provides
liquidity to the trust and credit enhancement to the bonds, which enables the
senior interests to be sold to certain accredited third party investors seeking
investments rated "AA" or better. The liquidity and credit enhancement
facilities are generally for one-year terms and are renewable annually by the
credit enhancer. To the extent that the credit enhancer is downgraded below
"AA", either an alternative credit enhancement provider would be substituted to
reinstate the desired investment rating or the senior interests would be
marketed to other accredited investors. In either case, it is anticipated that
the return on the residual interests would decrease, which would negatively
impact the Company's income. If the credit enhancer does not renew the liquidity
or credit enhancement facilities, the Company would be forced to find
alternative liquidity or credit enhancement facilities, repurchase the
underlying bonds or liquidate the underlying bond and its investment in the
residual interests. If the Company is forced to liquidate its investment in the
residual interests and potentially the related interest rate swaps (discussed
above), the Company would recognize gains or losses on the liquidation, which
may be significant depending on market conditions. As of December 31, 2001,
$412.7 million and $346.7 million of the senior interests were subject to annual
"rollover" renewal for liquidity and credit enhancement, respectively. Of the
$346.7 million, $66.0 million is credit enhanced by Fannie Mae and therefore not
subject to annual "rollover" renewal for credit enhancement (see further
discussion under Fannie Mae Credit Enhancement). The Company has already
extended, in advance, the liquidity and credit enhancement of the senior
interests for a period of one year on each trust. The expiration of each
facility is staggered for the trusts so that the annual renewals are not
concentrated in any one month. In addition, the Company entered an agreement
whereby the liquidity and credit enhancement facilities will be automatically
extended for six month increments on each six month anniversary thereafter
unless notified by the credit enhancer six months in advance of their
termination of the facilities. The extension and renewal of the liquidity and
credit enhancement facilities have the same terms as the original facilities.
The Company continues to review alternatives that would reduce and diversify
credit risks.
46
Item 8. Financial Statements and Supplementary Data.
The consolidated financial statements of the Company, together with the
report thereon of PricewaterhouseCoopers LLP dated March 22, 2002, are listed in
Item 14(a)(1) and included at the end of this report.
Item 9. Changes in and Disagreements on Accounting and Financial Disclosure.
None.
47
Part III
Item 10. Directors and Executive Officers of the Registrant.
The information required by Item 10 is contained in the Company's proxy
statement for its 2002 annual shareholders meeting under the captions "Election
of Directors," "Identification of Executive Officers," and "Compliance with
Section 16(a) of the Securities Exchange Act of 1934" and is incorporated herein
by reference.
Item 11. Executive Compensation.
The information required by Item 11 is contained in the Company's proxy
statement for its 2002 annual shareholders meeting under the heading "Report of
the Compensation Committee of the Board of Directors" and is incorporated herein
by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information required by Item 12 is contained in the Company's proxy
statement for its 2002 annual shareholders meeting under the same caption and is
incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions.
The information required by Item 13 is contained in the Company's proxy
statement for its 2002 annual shareholders meeting under the same caption and is
incorporated herein by reference.
48
Part IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a) (1) List of Financial Statements. The following is a list of the
consolidated financial statements included at the end of this
report:
Report of Independent Accountants
Consolidated Balance Sheets as of December 31, 2001 and 2000
Consolidated Statements of Income for the Years Ended December 31,
2001, 2000 and 1999
Consolidated Statements of Comprehensive Income for the Years Ended
December 31, 2001, 2000 and 1999
Consolidated Statements of Cash Flows for the Years Ended December
31, 2001, 2000 and 1999
Consolidated Statement of Shareholders' Equity for the Years Ended
December 31, 2001, 2000 and 1999 Notes to
Consolidated Financial Statements
(2) List of Financial Statement Schedules.
All schedules prescribed by Regulation S-X have been omitted
as the required information is inapplicable or the information
is presented elsewhere in the consolidated financial
statements or related notes.
(3) List of Exhibits. The following is a list of exhibits
furnished.
3.1 Amended and Restated Certificate of Formation and Operating
Agreement of the Company (filed as Exhibit 4.1 to the
Company's Registration Statement on Form S-3/A, File No.
333-56049, and incorporated by reference herein).
3.2 By-laws of the Company (filed as Exhibit 4.2 to the Company's
Registration Statement on Form S-3/A, File No. 333-56049, and
incorporated by reference herein).
10.4 Master Repurchase Agreement among the Registrant, Trio
Portfolio Investors, L.L.C., Rio Portfolio Partners, L.P.,
Blackrock Capital Finance, L.P., Brazos Fund, L.P. and M.F.
Swapco, Inc. dated June 30, 1997 (filed as Item 7 (c) Exhibit
10.4 to the Company's report on Form 8-K, filed with the
Commission on January 28, 1998 and incorporated by reference
herein).
10.5 Stock Purchase and Contribution Agreement among the Registrant
and Messrs. Robert J. Banks, Keith J. Gloeckl and Ray F.
Mathis dated September 30, 1999 (filed as Item 7 (c) Exhibit
2.1 to the Company's report on Form 8-K, filed with the
Commission on November 8, 1999 and incorporated by reference
herein).
10.6 Registration Rights Agreement among the Registrant and Messrs.
Robert J. Banks, Keith J. Gloeckl and Ray F. Mathis dated
October 20, 1999 (filed as Item 16 Exhibit 2.2 to the
Company's report on Form S-3, File No. 333-56049, filed with
the Commission on January 24, 2000 and incorporated by
reference herein).
49
10.7 Employment Agreement between the Registrant and Robert J.
Banks, dated October 20, 1999 (filed as part of the Company's
Form 10-K for the fiscal year ended December 31, 1999 and
incorporated by reference herein).
10.8 Employment Agreement between the Registrant and Keith J.
Gloeckl, dated October 20, 1999 (filed as part of the
Company's Form 10-K for the fiscal year ended December 31,
1999 and incorporated by reference herein).
10.10 Employment Agreement between the Registrant and Mark K.
Joseph, dated December 31, 1999 (filed as part of the
Company's Form 10-K, as amended, for the fiscal year ended
December 31, 1999 and incorporated by reference herein).
10.11 Employment Agreement between the Registrant and Michael L.
Falcone, dated December 31, 1999 (filed as part of the
Company's Form 10-K, as amended, for the fiscal year ended
December 31, 1999 and incorporated by reference herein).
10.12 Employment Agreement between the Registrant and Gary A.
Mentesana, dated December 31, 1999 (filed as part of the
Company's Form 10-K, as amended, for the fiscal year ended
December 31, 1999 and incorporated by reference herein).
10.13 Employment Agreement between the Registrant and William S.
Harrison, dated April 9, 2001 (filed as Item 6 (a) Exhibit
10.13 to the Company's report on Form 8-K, filed with the
Commission on May 15, 2001.
10.14 Employment Agreement between the Registrant and Keith J.
Gloeckl, dated August 30, 2001 (filed as Item 6 (a) Exhibit
10.1 to the Company's report on Form 8-K, filed with the
Commission on August 14, 2001.
10.15 Employment Agreement between the Registrant and Robert J.
Banks, dated August 30, 2001 (filed as Item 6 (a) Exhibit 10.1
to the Company's report on Form 8-K, filed with the Commission
on November 13, 2001.
21 Subsidiaries
23 Consent of PricewaterhouseCoopers LLP
(b) Reports on Form 8-K.
None.
50
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Municipal Mortgage & Equity, LLC
By: /s/ Mark K. Joseph
-----------------------------------
Mark K. Joseph
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons, in the capacities and on the
dates indicated.
Signature Title Date
- --------- ----- ----
/s/ Mark K. Joseph Chairman of the Board, Chief Executive Officer March 29, 2002
- ------------------------ (Principal Executive Officer), and Director
Mark K. Joseph
/s/ Robert J. Banks Executive Vice Chairman, Senior Vice President March 29, 2002
- ------------------------ and Director
Robert J. Banks
/s/ Michael L. Falcone President, Chief Operating Officer and Director March 29, 2002
- ------------------------
Michael L. Falcone
/s/ William S. Harrison Senior Vice President, Chief Financial Officer March 29, 2002
- ------------------------ and Secretary
William S. Harrison
/s/ Charles Baum Director March 29, 2002
- ------------------------
Charles Baum
/s/ Richard O. Berndt Director March 29, 2002
- ------------------------
Richard O. Berndt
/s/ Robert S. Hillman Director March 29, 2002
- ------------------------
Robert S. Hillman
/s/ William L. Jews Director March 29, 2002
- ------------------------
William L. Jews
/s/ Douglas A. McGregor Director March 29, 2002
- ------------------------
Douglas A. McGregor
/s/ Carl W. Stearn Director March 29, 2002
- ------------------------
Carl W. Stearn
51
Report of Independent Accountants
To the Shareholders and Board of Directors
of Municipal Mortgage & Equity, LLC:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income, comprehensive income, cash flows and
shareholders' equity present fairly, in all material respects, the financial
position of Municipal Mortgage & Equity, LLC and its subsidiaries at December
31, 2001 and 2000, and the results of their operations and their cash flows for
each of the three years in the period ended December 31, 2001 in conformity with
accounting principles generally accepted in the United States of America. These
financial statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of America, which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
As discussed in Notes 1 and 7 to the financial statements, the Company adopted
Statement of Financial Accounting Standards No. 133 in 2001.
PricewaterhouseCoopers LLP
Baltimore, Maryland
February 22, 2002
52
MUNICIPAL MORTGAGE & EQUITY, LLC
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
December 31, 2001 December 31, 2000
----------------- -----------------
ASSETS
Cash and cash equivalents $ 97,373 $ 27,504
Interest receivable 15,859 9,978
Investment in tax-exempt bonds, net (Note 4) 616,460 500,190
Investment in other bond related investments (Notes 5 and 6) 13,295 13,457
Investment in derivative financial instruments (Note 7) 2,912 --
Loans receivable, net (Note 8) 440,031 349,291
Restricted assets (Note 9) 16,710 25,212
Other assets 45,749 27,694
Mortgage servicing rights, net (Note 10) 9,161 6,876
Property and equipment 2,721 1,012
Goodwill and other intangible assets (Note 2) 29,005 26,668
----------- ---------
Total assets $ 1,289,276 $ 987,882
=========== =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Notes payable (Note 11) $ 420,063 $ 329,159
Accounts payable, accrued expenses and other liabilities 29,014 23,497
Investment in derivative financial instruments (Note 7) 18,646 --
Investment in other bond related investments (Notes 5 and 6) 7,979 17,984
Distributions payable 2,960 2,606
Short-term debt (Notes 5 and 8) 78,560 41,290
Long-term debt (Notes 5 and 8) 134,881 70,899
----------- ---------
Total liabilities 692,103 485,435
----------- ---------
Commitments and contingencies (Note 12) -- --
Preferred shareholders' equity in a subsidiary company (Note 3) 160,465 137,664
Shareholders' equity:
Preferred shares:
Series I (10,995 and 14,933 shares issued and outstanding, respectively) 6,914 9,594
Series II (3,176 and 7,226 shares issued and outstanding, respectively) 2,326 4,868
Preferred capital distribution shares:
Series I (5,742 and 7,798 shares issued and outstanding, respectively) 2,552 3,489
Series II (1,391 and 3,164 shares issued and outstanding, respectively) 411 1,268
Term growth shares (2,000 shares issued and outstanding) 229 197
Common shares (21,879,566 shares, including 21,857,312 shares issued, and 22,254
deferred shares at December 31, 2001 and 17,716,576 shares, including
17,700,745 shares issued, and 15,831 deferred shares at December 31, 2000) 406,733 328,990
Less common shares held in treasury at cost (59,330 shares and
60,839 shares, respectively) (912) (944)
Less unearned compensation (deferred shares) (Note 17) (4,145) (4,144)
Accumulated other comprehensive income 22,600 21,465
----------- ---------
Total shareholders' equity 436,708 364,783
----------- ---------
Total liabilities and shareholders' equity $ 1,289,276 $ 987,882
=========== =========
The accompanying notes are an integral part of these financial statements.
53
MUNICIPAL MORTGAGE & EQUITY, LLC
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except share and per share data)
For the year ended December 31,
-------------------------------------------
2001 2000 1999
------------ ----------- -----------
INCOME:
Interest on tax-exempt bonds and other bond related investments $ 53,443 $ 43,077 $ 35,435
Interest on loans 33,340 31,757 6,543
Loan origination and brokerage fees 5,592 3,758 1,580
Syndication fees 7,036 4,918 2,345
Loan servicing fees 6,982 5,621 1,759
Interest on short-term investments 3,081 4,391 1,848
Other income 8,067 5,209 1,356
Net gain on sales (Notes 5 and 10) 8,222 2,121 2,680
------------ ----------- -----------
Total income 125,763 100,852 53,546
------------ ----------- -----------
EXPENSES:
Salaries and benefits 21,381 15,300 6,746
Professional fees 4,186 3,477 1,698
Operating expenses 7,842 5,972 1,371
Goodwill and other intangibles amortization 2,509 1,887 297
Interest expense 30,696 31,152 6,665
Other-than-temporary impairments related to investments in mortgage
revenue bonds and other bond related investments (Note 4) 3,256 1,008 1,120
------------ ----------- -----------
Total expenses 69,870 58,796 17,897
Net holding losses on trading securities (Note 2) (5,572) -- --
------------ ----------- -----------
Net income before income taxes, income allocated to
preferred shareholders in a subsidiary company,
and cumulative effect of accounting change 50,321 42,056 35,649
Income tax expense 1,383 2,006 703
------------ ----------- -----------
Net income before income allocated to preferred shareholders
in a subsidiary company and cumulative effect of
accounting change 48,938 40,050 34,946
Income allocable to preferred shareholders in a subsidiary company (Note 3) 10,779 8,475 3,433
------------ ----------- -----------
Net income before cumulative effect of accounting change 38,159 31,575 31,513
Cumulative effect on prior years of change in
accounting for derivative financial instruments (12,277) -- --
------------ ----------- -----------
Net income $ 25,882 $ 31,575 $ 31,513
============ =========== ===========
Net income allocated to:
Preferred shares:
Series I $ 720 $ 840 $ 1,022
============ =========== ===========
Series II 109 472 497
============ =========== ===========
Preferred capital distribution shares:
Series I $ 324 $ 338 $ 436
============ =========== ===========
Series II 16 148 158
============ =========== ===========
Term growth shares $ 866 $ 701 $ 604
============ =========== ===========
Common shares $ 23,847 $ 29,076 $ 28,796
============ =========== ===========
54
MUNICIPAL MORTGAGE & EQUITY, LLC
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except share and per share data)
For the year ended December 31,
-------------------------------------------
2001 2000 1999
------------ ----------- -----------
Basic net income per share:
Preferred shares:
Series I $ 57.05 $ 56.25 $ 68.44
============ =========== ===========
Weighted average shares outstanding 12,624 14,933 14,933
Series II $ 22.51 $ 65.31 $ 68.76
============ =========== ===========
Weighted average shares outstanding 4,851 7,226 7,226
Preferred capital distribution shares:
Series I $ 49.22 $ 43.34 $ 55.96
============ =========== ===========
Weighted average shares outstanding 6,592 7,798 7,798
Series II $ 7.44 $ 46.73 $ 49.81
============ =========== ===========
Weighted average shares outstanding 2,124 3,164 3,164
Common shares:
Income before cumulative effect of accounting change $ 1.70 $ 1.67 $ 1.70
Cumulative effect on prior years of change in
accounting for derivative financial instruments $ (0.58) $ -- $ --
------------ ----------- -----------
Basic net income per common share $ 1.12 $ 1.67 $ 1.70
============ =========== ===========
Weighted average common shares outstanding 21,204,209 17,459,829 16,922,788
Diluted net income per share:
Common shares:
Income before cumulative effect of accounting change $ 1.66 $ 1.62 $ 1.67
Cumulative effect on prior years of change in
accounting for derivative financial instruments $ (0.57) $ -- $ --
------------ ----------- -----------
Diluted net income per common share $ 1.09 $ 1.62 $ 1.67
============ =========== ===========
Weighted average common shares outstanding 21,804,186 18,088,366 17,740,671
The accompanying notes are an integral part of these financial statements.
55
MUNICIPAL MORTGAGE & EQUITY, LLC
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
For the year ended December 31,
----------------------------------
2001 2000 1999
-------- -------- --------
Net income $ 25,882 $ 31,575 $ 31,513
-------- -------- --------
Other comprehensive income (loss):
Unrealized gains (losses) on investments:
Unrealized holding losses arising during the period (6,951) (2,093) (3,466)
Reclassification adjustment for (gains) losses
included in net income 8,086 (181) (216)
-------- -------- --------
Other comprehensive income (loss) 1,135 (2,274) (3,682)
-------- -------- --------
Comprehensive income $ 27,017 $ 29,301 $ 27,831
======== ======== ========
The accompanying notes are an integral part of these financial statements.
56
MUNICIPAL MORTGAGE & EQUITY, LLC
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(In thousands, except share data)
Preferred Capital
Preferred Shares Distribution Shares Term
----------------------- ---------------------- Growth
Series I Series II Series I Series II Shares
-------- --------- -------- --------- ------
Balance, January 1, 1999 $ 10,985 $ 5,970 $ 4,351 $ 1,958 $ 105
Net income 1,022 497 436 158 604
Unrealized losses on investments, net of
reclassifications -- -- -- -- --
Distributions (1,439) (646) (756) (279) (544)
Retirement of preferred shares (463) (101) (275) (205) --
Purchase of treasury shares (Note 18) -- -- -- -- --
Reissuance of treasury shares -- -- -- -- --
Options exercised -- -- -- -- --
Issuance of common shares (Note 2)
Deferred shares issued under the
Non-Employee Directors' Share Plans (Note 17) -- -- -- -- --
Deferred share grants (Note 17) -- -- -- -- --
Amortization of deferred compensation (Note 17) -- -- -- -- --
-------- ------- ------- ------- -----
Balance, December 31, 1999 10,105 5,720 3,756 1,632 165
Net income 840 472 338 148 701
Unrealized losses on investments, net of
reclassifications -- -- -- -- --
Distributions (1,351) (1,324) (605) (512) (669)
Purchase of treasury shares (Note 18) -- -- -- -- --
Reissuance of treasury shares -- -- -- -- --
Options exercised -- -- -- -- --
Issuance of common shares (Note 2) -- -- -- -- --
Deferred shares issued under the
Non-Employee Directors' Share Plans (Note 17) -- -- -- -- --
Deferred share grants (Note 17) -- -- -- -- --
Amortization of deferred compensation (Note 17) -- -- -- -- --
-------- ------- ------- ------- -----
Balance, December 31, 2000 9,594 4,868 3,489 1,268 197
Net income 720 109 324 16 866
Unrealized gains on investments, net of
reclassifications -- -- -- -- --
Distributions (602) (1,101) (237) (440) (834)
Redemption of preferred shares (2,798) (1,550) (1,024) (433) --
Reissuance of treasury shares -- -- -- -- --
Options exercised -- -- -- -- --
Issuance of common shares (Notes 2 and 14) -- -- -- -- --
Deferred shares issued under the
Non-Employee Directors' Share Plans (Note 17) -- -- -- -- --
Deferred share grants (Note 17) -- -- -- -- --
Amortization of deferred compensation (Note 17) -- -- -- -- --
Tax benefit from exercise of options and
vesting of deferred shares -- -- -- -- --
-------- ------- ------- ------- -----
Balance, December 31, 2001 $ 6,914 $ 2,326 $ 2,552 $ 411 $ 229
======== ======= ======= ======= =====
Accumulated
Other
Common Treasury Unearned Comprehensive
Shares Shares Compensation Income (Loss) Total
--------- -------- ------------ ------------- ---------
Balance, January 1, 1999 $ 310,109 $ (2,555) $(2,892) $ 27,421 $ 355,452
Net income 28,796 -- -- -- 31,513
Unrealized losses on investments, net of
reclassifications -- -- -- (3,682) (3,682)
Distributions (26,801) -- -- -- (30,465)
Retirement of preferred shares 117 -- -- -- (927)
Purchase of treasury shares (Note 18) -- (581) -- -- (581)
Reissuance of treasury shares (640) 655 -- -- 15
Options exercised 72 -- -- -- 72
Issuance of common shares (Note 2) 11,275 -- -- -- 11,275
Deferred shares issued under the
Non-Employee Directors' Share Plans (Note 17) 72 -- -- -- 72
Deferred share grants (Note 17) 1,443 -- (1,443) -- --
Amortization of deferred compensation (Note 17) -- -- 867 -- 867
--------- -------- ------- -------- ---------
Balance, December 31, 1999 324,443 (2,481) (3,468) 23,739 363,611
Net income 29,076 -- -- -- 31,575
Unrealized losses on investments, net of
reclassifications -- -- -- (2,274) (2,274)
Distributions (29,011) -- -- -- (33,472)
Purchase of treasury shares (Note 18) -- (191) -- -- (191)
Reissuance of treasury shares (1,707) 1,728 -- -- 21
Options exercised 895 -- -- -- 895
Issuance of common shares (Note 2) 3,415 -- -- -- 3,415
Deferred shares issued under the
Non-Employee Directors' Share Plans (Note 17) 115 -- -- -- 115
Deferred share grants (Note 17) 1,764 -- (1,764) -- --
Amortization of deferred compensation (Note 17) -- -- 1,088 -- 1,088
--------- -------- ------- -------- ---------
Balance, December 31, 2000 328,990 (944) (4,144) 21,465 364,783
Net income 23,847 -- -- -- 25,882
Unrealized gains on investments, net of
reclassifications -- -- -- 1,135 1,135
Distributions (35,195) -- -- -- (38,409)
Redemption of preferred shares (1,363) -- -- -- (7,168)
Reissuance of treasury shares (32) 32 -- -- --
Options exercised 2,558 -- -- -- 2,558
Issuance of common shares (Notes 2 and 14) 85,992 -- -- -- 85,992
Deferred shares issued under the
Non-Employee Directors' Share Plans (Note 17) 151 -- -- -- 151
Deferred share grants (Note 17) 1,418 -- (1,418) -- --
Amortization of deferred compensation (Note 17) -- -- 1,417 -- 1,417
Tax benefit from exercise of options and
vesting of deferred shares 367 -- -- -- 367
--------- -------- ------- -------- ---------
Balance, December 31, 2001 $ 406,733 $ (912) $(4,145) $ 22,600 $ 436,708
========= ======== ======= ======== =========
The accompanying notes are an integral part of these financial statements.
57
MUNICIPAL MORTGAGE & EQUITY, LLC
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(In thousands, except share data)
Preferred Capital
Preferred Shares Distribution Shares Term
-------------------- -------------------- Growth Common Treasury
SHARE ACTIVITY: Series I Series II Series I Series II Shares Shares Shares
-------- --------- -------- --------- ------ ----------- --------
Balance, January 1, 1999 15,590 7,350 8,325 3,535 2,000 16,791,050 153,832
Retirement of preferred shares (657) (124) (527) (371) -- -- --
Purchase of treasury shares -- -- -- -- -- (30,000) 30,000
Reissuance of treasury shares -- -- -- -- -- 33,256 (33,256)
Options exercised -- -- -- -- -- 4,500 (4,500)
Issuance of common shares (Note 2) -- -- -- -- -- 589,565 --
Deferred shares issued under the
Non-Employee Directors' Share Plans (Note 17) -- -- -- -- -- 3,693 --
------- ------ ------ ------ ----- ----------- --------
Balance, December 31, 1999 14,933 7,226 7,798 3,164 2,000 17,392,064 146,076
Purchase of treasury shares -- -- -- -- -- (9,042) 9,042
Reissuance of treasury shares -- -- -- -- -- 59,745 (59,745)
Options exercised -- -- -- -- -- 52,034 (34,534)
Issuance of common shares (Note 2) -- -- -- -- -- 155,234 --
Deferred shares issued under the
Non-Employee Directors' Share Plans (Note 17) -- -- -- -- -- 5,702 --
------- ------ ------ ------ ----- ----------- --------
Balance, December 31, 2000 14,933 7,226 7,798 3,164 2,000 17,655,737 60,839
Redemption of preferred shares (3,938) (4,050) (2,056) (1,773) -- -- --
Reissuance of treasury shares -- -- -- -- -- 1,509 (1,509)
Options exercised -- -- -- -- -- 147,800 --
Issuance of common shares (Notes 2 and 14) -- -- -- -- -- 3,933,920 --
Issuance of common shares under
employee share incentive plans -- -- -- -- -- 74,847 --
Deferred shares issued under the
Non-Employee Directors' Share Plans (Note 17) -- -- -- -- -- 6,423 --
------- ------ ------ ------ ----- ----------- --------
Balance, December 31, 2001 10,995 3,176 5,742 1,391 2,000 21,820,236 59,330
======= ====== ====== ====== ===== =========== ========
The accompanying notes are an integral part of these financial statements.
58
MUNICIPAL MORTGAGE & EQUITY, LLC
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
For the year ended December 31,
-------------------------------------
2001 2000 1999
--------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 25,882 $ 31,575 $ 31,513
Adjustments to reconcile net income to net cash provided by operating activities:
Income allocated to preferred shareholders in a subsidiary company 10,779 8,475 3,433
Cumulative effect of accounting change 12,277 -- --
Net holding losses on trading securities 3,457 -- --
Other-than-temporary impairments related to investments in
mortgage revenue bonds 3,256 1,008 1,120
Increase (decrease) in valuation allowance on parity working capital loans (103) 495 (649)
Net gain on sales (5,558) (2,121) (2,680)
Net amortization of premiums, discounts and fees on investments 248 302 298
Depreciation and amortization 2,883 2,087 405
Loss on disposal of fixed assets 12 3 --
Tax benefit from deferred share benefit 367 -- --
Deferred share compensation expense 1,417 1,088 867
Common and deferred shares issued under the Non-Employee Directors' Share Plans 178 115 72
Director fees paid and share awards made by reissuance of treasury shares -- 21 15
Increase in interest receivable (5,881) (1,860) (3,194)
Increase in other assets (23,228) (14,222) (2,271)
Increase in accounts payable, accrued expenses and other liabilities 5,465 2,082 1,726
--------- --------- ---------
Net cash provided by operating activities 31,451 29,048 30,655
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of tax-exempt bonds and other bond related investments (159,969) (148,838) (121,399)
Loan originations (459,253) (364,559) (105,002)
Acquisition of Midland net of cash acquired -- -- (24,365)
Purchases of property and equipment (2,096) (321) (123)
Net reduction (investment) in restricted assets 8,502 (9,379) (10,466)
Principal payments received 397,304 292,101 24,769
Net proceeds from sales of investments 5,188 50,303 137,250
--------- --------- ---------
Net cash used in investing activities (210,324) (180,693) (99,336)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings from credit facilities 674,030 422,274 88,697
Repayment of credit facilities (578,542) (360,155) (35,032)
Proceeds from short-term debt 48,970 41,290 --
Repayment of short-term debt (11,700) -- --
Proceeds from long-term debt 131,130 4,023 --
Repayment of long-term debt (67,148) (124) --
Issuance of common shares 82,645 -- --
Issuance of preferred shares in a subsidiary company 22,801 57,604 80,159
Redemption of preferred shares (7,168) -- (927)
Proceeds from stock options exercised 2,558 895 72
Purchase of treasury shares -- (191) (581)
Distributions (38,409) (33,472) (30,465)
Distributions to preferred shares in a subsidiary company (10,425) (7,412) (1,989)
--------- --------- ---------
Net cash provided by financing activities 248,742 124,732 99,934
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents 69,869 (26,913) 31,253
Cash and cash equivalents at beginning of period 27,504 54,417 23,164
--------- --------- ---------
Cash and cash equivalents at end of period $ 97,373 $ 27,504 $ 54,417
========= ========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid $ 33,727 $ 30,192 $ 4,682
========= ========= =========
Income taxes paid 1,173 1,579 735
========= ========= =========
DISCLOSURE OF NON-CASH ACTIVITIES:
Investments and long-term debt recorded under SFAS No. 125 upon conversion
of P-FLOATS to Term Securitization Facility (see Note 5) $ -- $ -- $ 67,000
========= ========= =========
Investment in partnership under a note payable obligation -- 5,084 --
========= ========= =========
Contribution of investment in partnership to a subsidiary 4,584 -- --
========= ========= =========
Issuance of common stock in connection with Midland acquisition 3,320 3,415 11,275
========= ========= =========
The accompanying notes are an integral part of these financial statements.
59
MUNICIPAL MORTGAGE & EQUITY, LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
Municipal Mortgage & Equity, LLC ("MuniMae") and its subsidiaries (together
with MuniMae, the "Company") are principally engaged in originating, investing
in and servicing investments related to multifamily housing and other real
estate financings. A significant portion of the Company's investments are
tax-exempt bonds and interests in bonds issued by state and local governments or
their agencies or authorities to finance multifamily housing developments.
Interest income from the majority of these investments is exempt for federal
income tax purposes. Multifamily housing developments, as well as the rents paid
by the tenants, secure these investments. Midland Financial Holdings, Inc.
("Midland"), a wholly owned corporate subsidiary, is a fully integrated real
estate investment firm that specializes in originating, investing in and
servicing investments in the affordable multifamily housing industry. These
investments generate taxable , not tax-exempt, income.
The assets of MuniMae TE Bond Subsidiary, LLC and its subsidiaries
(collectively, "TE Bond Sub"), are solely those of TE Bond Sub and are not
available to creditors of MuniMae. Because MuniMae indirectly owns all of the
common equity interests of TE Bond Sub, TE Bond Sub's assets are consolidated on
MuniMae's financial statements. The equity interest in TE Bond Sub held by
MuniMae is subject to the claims of creditors of the Company and in certain
circumstances could be foreclosed upon.
The consolidated financial statements of the Company are prepared on the
accrual basis of accounting in accordance with generally accepted accounting
principles ("GAAP"). Certain 2000 and 1999 amounts have been reclassified to
conform to the 2001 presentation.
The following is a summary of the Company's significant accounting
policies:
Principles of Consolidation
The consolidated financial statements include the accounts of MuniMae, its
wholly owned subsidiaries and its majority owned subsidiaries. All significant
intercompany balances and transactions have been eliminated. Preferred
shareholders' equity in TE Bond Sub, a majority owned subsidiary, represents a
minority interest in the Company (see further discussion in Note 3). The
consolidated earnings of Midland are included in the Company's results of
operations from the date of the Company's acquisition of Midland in October
1999.
Cash and Cash Equivalents
Cash and cash equivalents consist principally of investments in money
market mutual funds, short-term marketable securities and reverse repurchase
agreements with original maturities of 90
60
days or less, all of which are readily convertible to known amounts of cash in
seven days or less. Cash equivalents are carried at cost, which approximates
fair value.
Investment in Tax-Exempt Bonds
Investment in tax-exempt bonds is accounted for under the provisions of
Statement of Financial Accounting Standards No. 115, "Accounting for Certain
Investments in Debt and Equity Securities" ("FAS 115"). All investments in
tax-exempt bonds are classified and accounted for as available-for-sale debt
securities and carried at fair value; unrealized gains or losses arising during
the period are recorded through other comprehensive income in shareholders'
equity, while realized gains and losses and other-than-temporary impairments are
recorded through operations. The Company evaluates on an on-going basis the
credit risk exposure associated with these assets to determine whether any
impairment exists in accordance with the Company's policy discussed in the
Other-than-Temporary Impairments section of this Note.
The Company determines the fair value of participating bonds (i.e., bonds
that participate in the net cash flow and net capital appreciation of the
underlying properties) that are wholly collateral dependent and for which only a
limited market exists by discounting the underlying collateral's expected future
cash flows using current estimates of discount rates and capitalization rates.
The Company engages an independent real estate valuation firm to assist the
Company in reviewing the reasonableness of the estimates of discount rates,
capitalization rates and other variables used to estimate the fair value of
these bonds on an annual basis.
The Company bases the fair value of non-participating bonds, which also
have a limited market, on quotes from external sources, such as brokers, for
these or similar bonds.
The Company recognizes base interest on the bonds as revenue as it accrues.
Interest income in excess of the base interest may be available to the Company
through participation features of a bond. Participation interest is recognized
as income when received. Delinquent bonds are placed on non-accrual status for
financial reporting purposes when collection of interest is in doubt which is
generally considered to be after 90 days of non-payment. The Company applies
interest payments on non-accrual bonds first to previously recorded accrued
interest and, once previously accrued interest is satisfied, as interest income
when received. The accrual of interest income would be reinstated once a bond's
ability to perform is adequately demonstrated and all interest has been paid.
For tax purposes, the Company recognizes base interest as income as it
accrues. For certain investments, in accordance with the terms of the bond
document, the Company may also recognize participation interest as income as it
accrues for tax reporting. Base interest and participation interest in certain
bonds is accrued for tax purposes even when the interest income is not
collected. Base interest recognized on the bonds is exempt from federal income
tax purposes for the shareholders. In accordance with the terms and conditions
of the underlying bond documents and tax regulations, participation interest in
certain bonds may be taxable to the shareholders for federal income tax
purposes.
61
Investment in RITES(SM)
The Company owns Residual Interest Tax-Exempt Securities Receipts
("RITES(SM)"), a security offered by Merrill Lynch Pierce Fenner & Smith
Incorporated ("Merrill Lynch") through its RITES(SM)/Puttable Floating Option
Tax-Exempt Receipts ("P-FLOATs(SM)") program discussed more fully in Notes 5 and
6. The Company classifies the RITES(SM) as available-for-sale debt securities
under FAS 115 and carries the RITES(SM) at fair value with unrealized gains or
losses included in accumulated other comprehensive income. The Company records
unrealized holding gains or losses arising during the period through other
comprehensive income while other-than-temporary impairments are recorded through
operations. The Company evaluates the credit risk exposure associated with these
assets to determine whether any impairment exists in accordance with the
Company's policy discussed in the Other-than-Temporary Impairments section of
this Note. The Company determines the fair value of the RITES(SM), which also
have a limited market, based on quotes from external sources, such as brokers,
for these or similar investments. The fair value of a RITESSM investment is
derived from the quote on the underlying bond reduced by the outstanding face
amount of the corresponding P-FLOATs(SM). Accordingly, the value of the
RITES(SM) may represent a liability to the Company in the event that the fair
value of the underlying bond is exceeded by the face amount of the corresponding
P-FLOATs(SM). Any such liabilities are reflected as a liability in the
accompanying consolidated balance sheets (see the Other Bond Related Investments
table in Note 6). The Company recognizes interest income on the RITES(SM) as
revenue as it accrues. Interest recognized on the RITES(SM) is exempt from
federal income tax purposes for the shareholders.
Securitization Transactions
For financial reporting purposes, transactions where the Company
securitizes a bond and subsequently purchases a residual interest are accounted
for in accordance with Statement of Financial Accounting Standards No. 140,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities" ("FAS 140"). Under FAS 140, the accounting for these
transactions is partially dependent on certain call provisions. If the residual
interest holder is granted a call provision under the terms of the transaction,
then effective control over the transferred assets has not been relinquished and
the transaction is accounted for as a borrowing. When the residual interest
holder is not granted a call provision and effective control has been
relinquished, the transaction is accounted for as a sale and the Company
recognizes gains and losses on the sale of its bonds. The portion of the
unrealized gain or loss on a bond that is recognized as a result of the sale is
determined by allocating the net amortized cost at the time of sale between the
corresponding senior interest and residual interest based upon their relative
fair values, in accordance with FAS 140. The Company may also structure
transactions whereby a third party buys bonds directly from a seller and the
Company subsequently purchases residual investments related to the bonds. In
this case, the Company may retain the call provision associated with its
investment in the residual interest position without requiring borrowing
treatment because the Company does not own the bond.
Investment in Derivative Financial Instruments
Investment in derivative financial instruments is accounted for under the
provisions of Statement of Financial Accounting Standards No. 133, "Accounting
for Derivative Instruments and Hedging Activities" and Financial Accounting
Standards Board Statement No. 138, "Accounting for
62
Certain Derivative Instruments and Certain Hedging Activities." These statements
(collectively, "FAS 133") establish accounting and reporting standards for
derivative financial instruments, including certain derivative financial
instruments embedded in other contracts, and for hedging activity. FAS 133
requires the Company to recognize all derivatives as either assets or
liabilities in its financial statements and record these instruments at their
fair values. In order to achieve hedge accounting treatment, hedging activities
must be appropriately designated, documented and proven to be effective as a
hedge pursuant to the provisions of FAS 133. The Company has elected, as
permitted by FAS 133, not to prove the hedging effectiveness of its derivative
investments due to the cost and administrative burden of complying with FAS 133.
As a result, changes in fair value of derivatives are recorded through current
earnings.
The Company has several types of financial instruments that meet the
definition of a derivative financial instrument under FAS 133, including
interest rate swaps, put option contracts and total return swaps (discussed more
fully in Notes 5, 6 and 7). Under FAS 133, the Company's investment in these
derivative financial instruments is recorded on the balance sheet with changes
in the fair value of these instruments recorded in current earnings.
The adoption of FAS 133 does not affect cash available for distribution,
the Company's ability to pay distributions, the characterization of the
tax-exempt income or the financial obligations under the bonds. Upon adoption,
the Company's interest rate swaps and total return swaps were reclassified to
trading securities and those with a negative balance were reflected as
liabilities on the balance sheet. As of January 1, 2001, the Company's put
option contracts were recorded on the balance sheet with a fair value of zero.
The cumulative effect of adopting FAS 133 was a decrease to net income of
approximately $12.3 million as of January 1, 2001, and is reflected in the
income statement as a cumulative effect of accounting change . The Company
recognized a decrease in net income of $5.6 million for the year ended December
31, 2001, due to the change in fair value of its derivative instruments. This
change is reflected in net holding losses on trading securities in the
consolidated statement of income.
Prior to the adoption of FAS 133, the interest rate swap contracts were
accounted for as hedges and were carried at fair value and included in other
bond related investments, with unrealized gains or losses included in
accumulated other comprehensive income. Total return swaps were marked to market
and included in other bond related investments on the balance sheet with
unrealized gains or losses included in accumulated other comprehensive income.
The Company determines the fair value of its investment in derivatives
based on quotes from external sources, such as brokers, for these or similar
investments. Investments in derivatives with market values below $0 are
reflected as liabilities in the accompanying consolidated balance sheets. The
Company recognizes the differential paid or received under these agreements as
an adjustment to interest income. Net swap payments received by the Company, if
any, will be taxable income, even though the investment being hedged pays
tax-exempt interest.
Loans Receivable
The Company carries loans receivable at net realizable value. The Company
evaluates on an on-going basis the credit risk exposure associated with these
assets to determine whether any
63
impairment exists in accordance with the Company's policy discussed in this
Note. When the Company believes that it is probable that it will not collect all
amounts due, including principal and interest, under the terms of a loan, it
records a valuation allowance.
The Company recognizes base interest on loans as revenue as it accrues;
participation interest is recognized when received. The Company places
delinquent loans on non-accrual status for financial reporting purposes when
collection of interest is in doubt, which is generally considered to be after 90
days of non-payment. The Company applies interest payments on non-accrual loans
first to previously recorded accrued interest and then, once previously accrued
interest has been satisfied, as interest income when received. The accrual of
interest income would be reinstated once a loan's ability to perform is
adequately demonstrated. Interest income is also recognized for the portion of
any principal payments received in excess of GAAP basis, including payments for
previously unaccrued interest. For tax purposes, the Company recognizes interest
income on the loans at rates negotiated at the time such investments were made
and, with respect to participation interest, when received. Interest recognized
on the loans is taxable to the shareholders when earned by MuniMae or
subsidiaries organized as partnerships. Interest recognized on the loans is
taxable to the Company and to the shareholders when earned by subsidiaries
organized as corporations.
Mortgage Servicing Rights
The Company accounts for its mortgage servicing rights under FAS 140. FAS
140 requires servicing rights retained by the Company after the origination and
sale of the related loan to be capitalized by allocating the carrying amount
between the loan and the servicing rights based on their relative fair values.
The fair value of the mortgage servicing rights is based on the expected future
net cash flow to be received over the estimated life of the loan discounted at
market discount rates. The capitalization of the mortgage servicing rights is
reported in the income statement as a gain or loss on sale and results in an
offsetting asset or liability. Mortgage servicing rights are amortized over the
estimated life of the serviced loans. The amortization expense is included in
goodwill and other intangibles amortization in the consolidated statements of
income.
The Company evaluates all capitalized mortgage servicing rights for
impairment when changes indicate that impairment is probable, but no less than
at each reporting date. The mortgage servicing rights are considered to be
impaired when the carrying amount exceeds the fair value of the expected future
net cash flows to be received under the servicing contract. Impairment, if any,
is recognized through a valuation allowance.
Other Assets
The Company's investment in other assets includes prepaid expenses, other
receivables, debt issue costs, investment in partnerships and certain
investments in interest-only securities. Prepaid expenses and debt issue costs
are amortized over the contract period or the estimated life of the related
debt. The Company's investments in partnerships are accounted for using the
equity method.
The Company holds interest-only securities (see further discussion in Note
12), which represent the right to receive the excess interest on certain
mortgage loans sold to Fannie Mae (defined in Note 2). These rights result from
the contractual right to receive the difference between
64
the interest paid at the borrower's loan rate and interest paid to Fannie Mae at
the rate at which the loan was sold to Fannie Mae. The Company classifies these
investments as available-for-sale securities under FAS 115 and carries them at
fair value with unrealized gains and losses included in accumulated other
comprehensive income. The fair value of the interest-only securities is
estimated by discounting the expected future cash flows. Due to the existence of
a related obligation to pay all or a portion of these cash flows to the Group
Trust (defined in Note 11), a corresponding liability is reflected on the
balance sheet in other liabilities.
Property and Equipment
Property and equipment consisting primarily of furniture, fixtures, and
computer hardware and software is stated at cost. The Company computes
depreciation over the estimated useful lives, ranging from five to ten years, on
the 150% declining balance method. Accumulated depreciation was $1.4 million and
$1.0 million at December 31, 2001 and 2000, respectively.
Goodwill and Other Intangible Assets
Goodwill and other intangible assets represent the excess of cost over the
fair value of the net assets acquired from the acquisition of Midland (see Note
2) and are being amortized over 20 years using the straight-line method.
Accumulated amortization was $3.0 million and $1.4 million at December 31, 2001
and 2000, respectively. As discussed under New Accounting Pronouncements,
amortization of goodwill, including goodwill recorded in past business
combinations, will discontinue upon adoption of Statements of Financial
Accounting Standards No. 142 "Goodwill and Other Intangible Assets" ("FAS 142")
beginning in 2002. The Company assesses goodwill for impairment when events
arise that may indicate impairment has occurred.
Other-than-Temporary Impairments of Investments
The Company evaluates on an on-going basis the credit risk exposure
associated with its assets to determine whether other-than-temporary impairments
exist or a valuation allowance is needed. When the Company believes that it is
probable that it will not collect all amounts due, including principal and
interest, under the terms of an investment, it records an other-than-temporary
impairment or valuation allowance. The Company bases its measure of impairment
of an investment on the present value of expected future cash flows discounted
at the investment's effective interest rate, or the fair value of the collateral
if the investment is collateral dependent.
Loan Servicing Fees
Loan servicing fees are recognized into income over the period in which the
Company performs the associated services.
Brokerage and Syndication Fees
Brokerage fees and syndication fees are recognized into income at the time
the earnings process associated with the related transactions is complete and
collectibility is reasonably assured.
65
Other Income
The Company's other income includes asset management fees, income from put
options, guarantee fees and other miscellaneous income. Asset management fees
are recognized into income over the period in which the Company performs the
associated services. Put option and guarantee income is recognized ratably over
the term of the associated put option and guarantee agreements.
Origination Fees and Premiums and Discounts on Purchased Investments
Origination fees and premiums and discounts on purchased investments are
deferred and amortized into income to approximate a level yield over the
estimated lives of the related investments. The unamortized balance of
origination fees and premiums and discounts was $3.0 million and $4.4 million at
December 31, 2001 and 2000, respectively, and is reported as part of the
amortized cost of the related investments. Upon the sale of an investment, the
unamortized balance of origination fees and premiums and discounts are recorded
as income through the calculation of gains and losses on the sale of
investments.
Earnings per Share
The Company calculates earnings per share in accordance with the provisions
of Statement of Financial Accounting Standards No. 128, "Earnings per Share"
("FAS 128"). FAS 128 requires the dual presentation of basic and diluted
earnings per share on the face of the income statement for all entities with
complex capital structures.
Income Taxes
MuniMae is organized as a limited liability company. This structure allows
MuniMae to combine the limited liability, governance and management
characteristics of a corporation with the pass-through income features of a
partnership. MuniMae does not pay tax at the corporate level (although income
earned by corporate subsidiaries is taxed at the entity levels). Instead, the
distributive share of MuniMae's income, deductions and credits is included in
each shareholder's income tax return. In addition, the tax-exempt income derived
from certain investments remains tax-exempt when it is passed through to the
shareholders. The Company records cash dividends received from subsidiaries
organized as corporations as dividend income for tax purposes.
In October 1999, as a result of the Midland acquisition, the Company
restructured its operations into two business segments: (1) an investing segment
consisting of subsidiaries holding investments producing primarily tax-exempt
interest income; and (2) an operating segment that primarily generates taxable
interest income and, through corporate subsidiaries, fee income by providing
servicing, loan origination and tax credit equity syndication services. The
operating segment, which is directly or indirectly owned by MuniMae, consists
primarily of entities subject to income taxes. The Company provides for income
taxes in accordance with Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes" ("FAS 109"). FAS 109 requires the recognition of
deferred tax assets and liabilities for the expected future tax consequences of
temporary differences between the financial statement carrying amounts and the
tax basis of assets and liabilities.
66
The Company has elected under Section 754 of the Internal Revenue Code to
adjust the basis of the Company's property on the transfer of shares to reflect
the price each shareholder paid for their shares. While the bulk of the
Company's recurring interest income is tax-exempt, from time to time the Company
may sell or securitize various assets, which may result in capital gains and
losses for tax purposes. Since the Company is taxed as a partnership, these
capital gains and losses are passed through to shareholders and are reported on
each shareholder's Schedule K-1. The capital gain and loss allocated from the
Company may be different for each shareholder due to the Company's 754 election
and is a function of, among other things, the timing of the shareholder's
purchase of shares and the timing of transactions that generate gains or losses
for the Company. This means that for assets purchased by the Company prior to a
shareholder's purchase of shares, the shareholder's basis in the assets may be
significantly different than the Company's basis in those same assets. Although
the procedure for allocating the basis adjustment is complex, the result of the
election is that each share is homogeneous, while each shareholder's basis in
the assets of the Company may be different. Consequently, the capital gains and
losses allocated to individual shareholders may be significantly different than
the capital gains and losses recorded by the Company.
New Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board approved Statements
of Financial Accounting Standards No. 141 "Business Combinations" ("FAS 141")
and No. 142 "Goodwill and Other Intangible Assets," which are effective July 1,
2001 and January 1, 2002, respectively, for the Company. FAS 141 requires that
the purchase method of accounting be used for all business combinations
consummated after June 30, 2001. FAS 141 did not have an impact on the Company
for the year ended December 31, 2001. Under FAS 142, amortization of goodwill,
including goodwill recorded in past business combinations, will be discontinued
upon adoption of this standard. For the year ended December 31, 2001, the
Company recorded amortization expense of $1.6 million. In addition, goodwill
recorded as a result of business combinations completed during the six-month
period ending December 31, 2001 will not be amortized. All goodwill and
intangible assets will be tested for impairment in accordance with the
provisions of the Statement. The Company is currently reviewing the provisions
of FAS 141 and FAS 142 and assessing the impact of adoption.
Significant Risks and Uncertainties
Because the Company's assets consist primarily of bonds and other bond
related investments secured by non-recourse mortgage loans on real estate
properties, the value of the Company's assets is subject to all of the factors
affecting bond and real estate values, including macro-economic conditions,
interest rate changes, demographics, local real estate markets and individual
property performance. Further, many of the Company's investments are
subordinated to the claims of other senior interests and uncertainties may exist
as to a borrower's ability to meet principal and interest payments.
67
Use of Estimates
The use of estimates is inherent in the preparation of all financial
statements, but is especially important in the case of the Company, which is
required under FAS 115 to carry a substantial portion of its assets at fair
value even though only a limited market exists for them. Because only a limited
market exists for most of the Company's investments, fair value is estimated by
the Company in accordance with the Company's valuation procedures discussed
above. These estimates involve uncertainties and matters of judgment and
therefore cannot be determined with precision. The assumptions and methodologies
selected by the Company were intended to estimate the amounts at which the
investments could be exchanged in a current transaction between willing parties,
other than in a forced or liquidation sale. Changes in assumptions and market
conditions could significantly affect estimates. These estimated values may
differ significantly from the values that would have been used had a ready
market for the investments existed, and the differences could be material.
NOTE 2 - MIDLAND ACQUISITION
In October 1999 the Company acquired Midland for approximately $45 million.
Of this amount, the Company paid approximately $23 million in cash and
approximately $12 million in Common Shares at the closing of the transaction. In
addition, $3.3 million in MuniMae Common Shares was payable annually over a
three year period if Midland met certain performance targets, including an
annual contribution to cash available for distribution ("CAD"). In December
2000, MuniMae paid approximately $3.3 million in Common Shares in consideration
for Midland meeting its first year performance targets. In 2001, in order to
increase MuniMae's flexibility in operating Midland, MuniMae agreed with the
former owners of Midland that the payment of the 2001 and 2002 installments
would no longer be conditioned on Midland meeting certain performance targets.
In December 2001, MuniMae paid approximately $3.3 million in Common Shares and,
subject to certain conditions, MuniMae expects to make the final payment of
Common Shares having a value of approximately $3.3 million in December 2002.
Through Midland, the Company is a fully integrated real estate investment
firm specializing in providing financing to the affordable multifamily housing
industry. Midland provides construction and permanent debt financing, mortgage
servicing and asset management services to the multifamily housing industry.
Midland is a Federal National Mortgage Association ("Fannie Mae") Delegated
Underwriter and Servicer ("DUS") and a Federal Housing Administration approved
mortgagee. Midland syndicates equity for investment in low income housing tax
credits. Midland also syndicates equity and originates debt for investment in
student/conventional housing, a unique and growing segment of the multifamily
housing industry. A subsidiary of Midland is a registered investment advisor
with the Securities and Exchange Commission and a wholly owned special purpose
subsidiary of Midland provides advisory services to pension funds. Midland
currently manages approximately $350 million of pension fund money.
The acquisition is being accounted for as a purchase. The total purchase
price incurred during 1999, 2000 and 2001 was $42.6 million, which includes
acquisition costs but excludes MuniMae Common Shares issuable in December 2002.
The cost of the acquisition was allocated on the basis of the estimated fair
value of the net assets acquired, which totaled $7.7 million. The results of
operations of Midland are included in the consolidated financial statements of
the Company subsequent to October 19, 1999.
68
NOTE 3 - PREFERRED SHAREHOLDERS' EQUITY IN A SUBSIDIARY COMPANY
In May 1999, TE Bond Sub sold to institutional investors $84 million of
Series A Cumulative Preferred Shares ("Series A Preferred Shares"). In June
2000, TE Bond Sub sold to institutional investors $60 million of Series B
Cumulative Preferred Shares ("Series B Preferred Shares"). In October 2001, TE
Bond Sub sold to institutional investors $16 million of Series A-1 Cumulative
Preferred Shares ("Series A-1 Preferred Shares") and $8 million of Series B-1
Subordinate Cumulative Preferred Shares ("Series B-1 Preferred Shares"; all four
Series, collectively, the "TE Bond Preferred Shares"). The net proceeds
generated from the October 2001 offering were approximately $22.8 million.
The Series A and A-1 Preferred Shares bear interest at 6.875% and 6.30% per
annum, respectively, or, if lower, the aggregate net income of the issuing
company, TE Bond Sub. The Series A and A-1 Preferred Shares have a senior claim
to the income derived from the investments owned by TE Bond Sub. The Series A-1
Shares are equal in priority of payment to the Series A Preferred Shares. The
Series B and B-1 Preferred Shares bear interest at 7.75% and 6.80% per annum,
respectively, or, if lower, the aggregate net income of the issuing company, TE
Bond Sub, after payment of distributions to the Series A and Series A-1
Preferred Shares. The Series B-1 Shares are equal in priority of payment to the
Series B Preferred Shares. Any income from TE Bond Sub available after payment
of the cumulative distributions of the TE Bond Sub Preferred Shares is allocated
to the Company, which holds all of the common equity interests. Cash
distributions on the TE Bond Sub Preferred Shares will be paid quarterly on each
January 31, April 30, July 31 and October 31. The TE Bond Sub Preferred Shares
are subject to remarketing on specified dates as indicated in the table below.
On the remarketing date, the remarketing agent will seek to remarket the shares
at the lowest distribution rate that would result in a resale of the TE Bond Sub
Preferred Shares at a price equal to par plus all accrued but unpaid
distributions. The TE Bond Sub Preferred Shares will be subject to mandatory
tender on specified dates, as indicated below, and on all subsequent remarketing
dates at a price equal to par plus all accrued but unpaid distributions. The
following table provides a summary of certain terms of the TE Bond Sub Preferred
Shares.
69
Series A Series A-1 Series B Series B-1
Preferred Shares Preferred Shares Preferred Shares Preferred Shares
---------------- ---------------- ---------------- ----------------
Issue date May 27, 1999 October 9, 2001 June 2, 2000 October 9, 2001
Number of shares 42 8 30 4
Par amount per share $2,000,000 $2,000,000 $2,000,000 $2,000,000
Dividend rate 6.875% 6.30% 7.75% 6.80%
First remarketing date June 30, 2009 June 30, 2009 November 1, 2010 November 1, 2010
Mandatory tender date June 30, 2009 June 30, 2009 November 1, 2010 November 1, 2010
Redemption date June 30, 2049 June 30, 2049 June 30, 2050 June 30, 2050
The following table reflects the composition of the TE Bond Sub Preferred
Shareholders' equity in TE Bond Sub.
Series A Series A-1 Series B Series B-1 Total
------------ ------------ ------------ ------------ ------------
Balance, January 1, 1998 $ -- $ -- $ -- $ -- $ --
Issuance of preferred shares 80,159 -- -- -- 80,159
Income allocable to preferred shares 3,433 -- -- -- 3,433
Distributions (3,433) -- -- -- (3,433)
-------- -------- -------- ------- ---------
Balance, December 31, 1999 80,159 -- -- -- 80,159
Issuance of preferred shares -- -- 57,604 -- 57,604
Income allocable to preferred shares 5,775 -- 2,700 -- 8,475
Distributions (5,874) -- (2,700) -- (8,574)
-------- -------- -------- ------- ---------
Balance, December 31, 2000 80,060 -- 57,604 -- 137,664
Offering costs adjustment -- -- (9) -- (9)
Issuance of preferred shares -- 15,206 -- 7,604 22,810
Income allocable to preferred shares 5,775 230 4,650 124 10,779
Distributions (5,775) (230) (4,650) (124) (10,779)
-------- -------- -------- ------- ---------
Balance, December 31, 2001 $ 80,060 $ 15,206 $ 57,595 $ 7,604 $ 160,465
======== ======== ======== ======= =========
The assets of TE Bond Sub and its subsidiaries, while indirectly controlled
by MuniMae and thus included in the consolidated financial statements of the
Company, are legally owned by TE Bond Sub and are not available to the creditors
of the Company. The assets owned by TE Bond Sub and its subsidiaries are
identified in footnotes to the Investment in Tax-exempt Bonds table in Note 4
and in footnotes to the Other Bond Related Investments table in Note 6. The fair
value of such assets aggregated $501.4 million and $447.8 million at December
31, 2001 and 2000, respectively. The equity interest in TE Bond Sub held by
MuniMae is subject to the claims of creditors of MuniMae and in certain
circumstances could be foreclosed.
70
NOTE 4 - INVESTMENT IN TAX-EXEMPT BONDS
The Company holds a portfolio of tax-exempt bonds and certificates of
participation in grantor trusts holding tax-exempt bonds ("COPs"). The
tax-exempt bonds are issued by state and local government authorities to finance
multifamily housing developments or other real estate financings. The bonds are
typically secured by nonrecourse mortgage loans on the underlying properties.
The COPs represent a pro rata interest in a trust that holds a tax-exempt bond.
As of December 31, 2001, the Company held $616.5 million of bonds or COPs,
of which $83.6 million were participating, $460.0 million were
non-participating, $55.7 million were participating subordinate and $17.2
million were non-participating subordinate. The following discussion outlines
the general terms of the tax-exempt bonds owned by the Company. The actual terms
of each tax-exempt bond vary and are specifically outlined directly and
indirectly in the loan documents relating to that bond. A detailed listing of
the tax-exempt bonds at December 31, 2001 and 2000 is presented in a table at
the end of this note.
General Mortgage Loan Terms
The Company's rights under the bonds it holds are defined by the terms of
the related mortgage loans, which are pledged to the Company to secure the
payment of principal and interest under the bonds. The Company's rights under
the COPs are defined by the terms of the trust agreements. The Company's COPs
are secured through its interest in the trust that holds the underlying bonds
and the associated pledge of the mortgage loan. These pledges include
assignments of mortgages on the underlying properties and of rents. The mortgage
loans are generally first or second lien position loans on multifamily housing
developments and are generally nonrecourse, except upon the occurrence of
certain events. The mortgage loans bear interest at rates determined by
arm's-length negotiations that reflect market conditions existing at the time
the bonds were acquired or originated by the Company. Participating bonds have
additional interest features that allow the Company to participate in the growth
of the underlying property. These participating bonds provide for payment of
additional interest from available cash flow of the property in addition to the
base interest. The terms of the additional interest to be received on a bond are
specific to that bond and are set forth in the bond documents. Other bonds
provide for payment of a fixed rate of interest but are not non-participating
and do not contain additional interest features. Certain participating and
non-participating bonds are considered "subordinate" bonds as the payment of
interest and principal on the bonds occurs only after payment of principal and
interest on a bond that has priority to the cash flow of the underlying
collateral.
Principal amortization on the bonds, if any, is received in accordance with
amortization tables set forth in the bond documents. If no principal
amortization is required during the bond term, the outstanding principal balance
will be required to be repaid or refinanced in a lump sum payment at the end of
the holding period or at such earlier time as the Company may require. The
mortgage loans are non-assumable except with the consent of the Company. The
bonds contain provisions that prohibit prepayment of the bond for a specified
period of time.
At December 31, 2001, there were no participating bonds, four
non-participating bonds, twelve participating subordinate mortgage bonds, and
four subordinate non-participating bonds on
71
non-accrual status. The specific bonds on non-accrual status are noted in the
footnotes on the investment in tax-exempt bond table at the end of this note.
Interest income recognized on these bonds was $10.2 million, $11.0 million and
$10.1 million for the years ended December 31, 2001, 2000, and 1999,
respectively. Additional interest income that would have been recognized by the
Company had these bonds not been placed on non-accrual status was approximately
$1.2 million, $0.5 million and $0.6 million for the years ended December 31,
2001, 2000 and 1999, respectively.
Tax-Exempt Bonds Pledged
In order to facilitate the securitization (see Note 5) of certain assets at
higher leverage ratios than otherwise available to the Company without the
posting of additional collateral, the Company has pledged additional bonds to a
pool that acts as collateral for senior interests in certain securitization
trusts. At December 31, 2001 and 2000, the total carrying amount of the
tax-exempt bonds pledged as collateral was $358.4 million and $311.8 million,
respectively.
2001 Transactions
In 2001, the Company acquired $94.3 million in tax-exempt bonds
collateralized by multifamily apartment communities and other real estate. The
breakdown of these investments is summarized below:
Face Weighted Average
(In thousands) Amount Cost Permanent InterestRate
------- ------- ----------------------
Non-participating bonds $98,285 $94,282 6.88%
Of these investments, six are to-be-built communities, five are existing
communities and one is an existing communities that is undergoing
rehabilitation. The Company received $0.6 million in construction administration
and origination fees related to these transactions. These fees are recognized
into income over the life of the investment or the services provided.
During the third quarter, the Company repurchased all the P-FLOATs(SM)
outstanding in the Village Green securitization trust. The Company then
collapsed the securitization trust and deposited the Village Green bond into the
restructured Term Securitization Facility discussed in Note 5.
During the fourth quarter, the Company purchased $34.3 million of
P-FLOATs(SM) outstanding in five trusts in conjunction with the collapsing of
these trusts to place the bonds into the Freddie Mac Tender Offer Bond program
discussed in Note 5. The Company also repurchased all the P-FLOATs(SM)
outstanding in the Oklahoma securitization trust and retained the whole bond
during the fourth quarter.
2000 Transactions
In 2000, the Company acquired $124.8 million in tax-exempt tax-exempt bonds
collateralized by multifamily apartment communities. The breakdown of these
investments is summarized below:
72
Face Weighted Average
(In thousands) Amount Cost Permanent InterestRate
------- ------- ----------------------
Participating bonds $52,212 $51,595 8.03%
Non-participating bonds 77,580 73,208 7.14%
Of these investments, four are to-be-built communities, four are existing
communities and four are existing communities that are undergoing
rehabilitation. The Company received $2.0 million in construction administration
and origination fees related to these transactions. These fees are recognized
into income over the life of the investment or the services provided.
Valuation Adjustments
For the years ended December 31, 2001, 2000 and 1999, the net increase
(decrease) to other comprehensive income from unrealized holding gains and
losses on tax-exempt bonds available for sale was $(8.3) million, $2.7 million
and $(0.7) million, respectively.
In the first quarter the Company assumed the obligation to purchase two
bonds for their face amount ($21.5 million). In consideration for assuming this
obligation, the Company received $1.9 million in cash and a $2.0 million (face
amount) taxable note with a fair value of $1.4 million. The Company recognized a
$3.3 million other-than-temporary impairment upon the assumption of this
obligation. This amount represented the difference between the fair value of the
bonds and the face amount of the bonds at the time the Company assumed the
purchase obligation. Upon the purchase of the bonds, the Company recognized $3.3
million in income that represented the value of the cash and taxable loan
consideration received.
The Company recorded an other-than-temporary impairment totaling $1.0
million on the Lake Piedmont COP in 2000. The Company recorded an
other-than-temporary impairment totaling $1.1 million on the interest-only
certificate representing the participation interest on the Stone Mountain bond
in 1999.
The other-than-temporary impairments (and the unrealized gains and losses)
discussed above do not affect the cash flow generated from property operations,
distributions to shareholders, the characterization of the tax-exempt income or
the financial obligations under the bonds. The Company will continue to evaluate
the need for other-than-temporary impairments in the future as circumstances
dictate.
73
December 31, 2001
--------------------------------------------------
Base Face Amortized Unrealized Fair
Investment in Tax-Exempt Year Interest Maturity Amount Cost Gain (Loss) Value
Bonds Acquired Rate (12) Date (000s) (000s) (000s) (000s)
- ------------------------ ---------- ----------- --------- ----------- ----------- ------------ -----------
Participating Bonds (1):
Alban Place (2),(8) 1986 7.875 Oct. 2008 $ -- $ -- $ -- $ --
Arlington (9),(10) 2000 8.100 Jan. 2031 12,625 12,562 63 12,625
Cobblestone (9) 1999 7.125 Aug. 2039 6,800 6,732 (340) 6,392
Cool Springs (4),(10) 2000 7.750 Aug. 2030 14,472 14,313 159 14,472
Creekside Village (2),(8) 1987 7.500 Nov. 2009 -- -- -- --
Crossings (4),(19) 1997 8.000 Jul. 2007 6,795 6,709 589 7,298
Emerald Hills (2),(16) 1988 7.750 Apr. 2008 -- -- -- --
Jefferson Commons (15) 2000 8.200 Jan. 2031 19,857 19,559 894 20,453
Lakeview Garden (2),(8) 1987 7.750 Aug. 2007 -- -- -- --
Newport On Seven (2),(16) 1986 8.125 Aug. 2008 -- -- -- --
North Pointe (2),(8) 1986 7.875 Aug. 2006 -- -- -- --
Northridge Park (2),(8) 1987 7.500 Jun. 2012 -- -- -- --
Palisades Park (9) 2001 7.125 Aug. 2028 8,470 8,458 13 8,471
Stone Mountain (8) 1997 7.875 Oct. 2027 -- -- -- --
Timber Ridge (4),(10) 2000 7.950 Jan. 2036 5,215 5,119 (8) 5,111
Villas at LaRiveria (4),(10) 1999 7.125 Jun. 2034 8,844 8,738 18 8,756
-------- -------- -------- --------
Subtotal participating
bonds 83,078 82,190 1,388 83,578
-------- -------- -------- --------
Non-Participating Bonds:
Alban Place (2),(4),(5),(8) 1986 7.150 Oct. 2008 10,065 10,065 1,014 11,079
Baytown (4),(10) 2000 7.750 Jun. 2030 5,000 4,950 (250) 4,700
Bedford Park (9) 2000 8.000 Nov. 2032 9,325 9,232 140 9,372
Buchanan Bay (9) 2001 5.830 Dec. 2031 10,725 9,098 876 9,974
Canterberry Crossing A 2001 6.700 Dec. 2031 10,430 10,222 -- 10,222
Canterberry Crossing B 2001 6.700 Dec. 2021 2,000 1,960 -- 1,960
Chancellor (4),(10) 2001 7.200 Jul. 2043 5,610 5,554 56 5,610
Charter House 1996 7.450 Jul. 2026 25 25 3 28
Cielo Vista (4),(10) 1999 7.125 Sep. 2034 9,458 9,385 (873) 8,512
Club West (9) 2001 6.580 (20) 7,960 7,910 (269) 7,641
Country Club (10) 1999 7.250 Aug. 2029 2,472 2,440 (129) 2,311
Creekside Village (2),(4),(5),(6) 1987 7.750 Nov. 2009 11,760 7,396 497 7,893
Delta Village (10) 1999 7.125 Jun. 2035 2,011 1,976 (96) 1,880
Elmbrook-Golden (4),(10) 2000 7.800 May. 2035 2,794 2,740 (2) 2,738
Gannon - Cedar Run (4),(10) 1998 7.125 Dec. 2025 13,200 13,238 94 13,332
Gannon - Dade (17) 1998 7.125 Dec. 2029 54,883 55,111 (141) 54,970
Gannon - Whispering Palms (4),(10) 1998 7.125 Dec. 2029 12,473 12,534 (29) 12,505
Gannon Bond (4),(10) 1998 7.125 Dec. 2029 3,500 3,500 9 3,509
Harmony Hills Series 2000 2001 6.750 May. 2003 100 100 (2) 98
Harmony Hills Series 2001 (4) 2001 7.250 May. 2032 17,700 17,346 177 17,523
Hidden Valley (4),(10) 1996 8.250 Jan. 2026 1,620 1,620 -- 1,620
Hunter's Glen (9) 2001 6.350 Dec. 2029 10,740 9,111 1,629 10,740
Honey Creek (9) 2000 7.625 Jul. 2035 20,485 20,277 (816) 19,461
La Paloma (9) 2001 6.710 May. 2030 4,378 4,378 (438) 3,940
Lakeview Garden (2),(4),(5),(6),(8) 1987 7.750 Aug. 2007 9,003 4,918 1,399 6,317
Lake Piedmont (4),(6),(10) 1998 7.725 Apr. 2034 19,118 18,017 (5,590) 12,427
Mountain View
(Willowgreen) (2),(9) 2000 8.000 Dec. 2010 9,275 6,769 2,691 9,460
North Pointe (2),(4),(6),(8) 1986 7.300 Aug. 2006 25,185 12,739 11,366 24,105
Northridge Park (2),(4),(8) 1987 7.500 Jun. 2012 8,815 8,815 176 8,991
Oakbrook (9) 1996 8.200 Jul. 2026 3,065 3,094 (60) 3,034
Oakgrove (10) 2001 7.000 Dec. 2041 7,000 6,913 (123) 6,790
Oaklahoma (4) 2001 7.125 Jul. 2028 19,500 19,538 (6,551) 12,987
Oakmont/Towne Oaks (9) 1998 7.200 Jan. 2034 11,208 11,186 (871) 10,315
Orangevale (4),(10) 1998 7.000 Oct. 2013 2,213 2,212 (44) 2,168
Queen Anne (9) 2001 7.088 Aug. 2013 6,168 6,168 31 6,199
Paola (10) 1999 7.250 Aug. 2029 1,042 1,029 (70) 959
Parkwood (4),(10) 1999 7.125 Jun. 2035 3,910 3,842 850 4,692
Pavilion (9) 2001 6.710 May. 2030 5,100 5,100 (255) 4,845
Penn Valley (10) 2001 7.816 Aug. 2033 2,360 2,338 22 2,360
Riverset Phase II 1996 9.500 Oct. 2019 110 105 7 112
Sahuarita (4),(10) 1999 7.125 Jun. 2029 2,114 2,102 (149) 1,953
Santa Fe Springs (4) 2000 (14) Jun. 2025 11,700 11,455 (1,042) 10,413
Shadowbrook (4),(10) 1999 6.850 Jun. 2029 5,780 5,767 (392) 5,375
Silver Spring (9) 2001 7.375 Dec. 2029 10,270 10,298 382 10,680
Southwinds (4),(10) 2000 8.000 Sept.2030 4,344 4,258 -- 4,258
Stone Mountain (4),(8),(10) 1997 7.875 Oct. 2027 33,900 34,061 (839) 33,222
Torries Chase (9) 1996 8.150 Jan. 2026 1,985 1,985 50 2,035
University Courtyard (9) 2000 7.250 Mar. 2040 9,850 9,750 (195) 9,555
Village Green (9) 2001 7.625 Feb. 2035 6,441 6,460 (470) 5,990
Villa Hialeah - refunded (2),(4),(5),(10) 1999 6.000 Aug. 2019 10,250 8,005 1,323 9,328
Western Hills (4),(10) 1998 7.000 Dec. 2029 3,021 3,021 (272) 2,749
Wheeler Creek (16) 1998 (13) Jan. 2003 -- -- -- --
Willow Key (9) 2001 6.717 (18) 17,440 17,440 (523) 16,917
Woodmark (4),(10) 1999 7.125 Jun. 2039 10,200 10,072 26 10,098
-------- -------- -------- --------
Subtotal non-participating
bonds 489,081 457,625 2,327 459,952
-------- -------- -------- --------
December 31, 2000
-------------------------------------------------
Face Amortized Unrealized Fair
Investment in Tax-Exempt Amount Cost Gain (Loss) Value
Bonds (000s) (000s) (000s) (000s)
- ------------------------ ----------- ----------- ------------- -----------
Participating Bonds (1):
Alban Place $ 10,065 $ 10,065 $ 68 $ 10,133
Arlington 12,625 12,562 63 12,625
Cobblestone 6,800 6,732 102 6,834
Cool Springs 14,472 14,313 87 14,400
Creekside Village 11,760 7,396 501 7,897
Crossings 6,838 6,746 494 7,240
Emerald Hills 6,725 6,725 2,027 8,752
Jefferson Commons 19,900 19,602 298 19,900
Lakeview Garden 9,003 4,918 1,066 5,984
Newport On Seven 10,125 7,898 2,889 10,787
North Pointe 25,185 12,739 8,918 21,657
Northridge Park 8,815 8,815 1,125 9,940
Palisades Park -- -- -- --
Stone Mountain 33,900 34,080 (10) 34,070
Timber Ridge 5,215 5,119 96 5,215
Villas at LaRiveria 8,850 8,744 150 8,894
-------- -------- -------- --------
Subtotal participating
bonds 190,278 166,454 17,874 184,328
-------- -------- -------- --------
Non-Participating Bonds:
Alban Place -- -- -- --
Baytown 5,000 4,950 (100) 4,850
Bedford Park 9,325 9,232 (274) 8,958
Buchanan Bay -- -- -- --
Canterberry Crossing A -- -- -- --
Canterberry Crossing B -- -- -- --
Chancellor -- -- -- --
Charter House 25 25 -- 25
Cielo Vista 9,500 9,427 (22) 9,405
Club West -- -- -- --
Country Club 2,485 2,454 (93) 2,361
Creekside Village -- -- -- --
Delta Village 2,011 1,976 (85) 1,891
Elmbrook-Golden 2,800 2,746 (2) 2,744
Gannon - Cedar Run 13,200 13,238 (302) 12,936
Gannon - Dade 54,999 55,277 (1,137) 54,140
Gannon - Whispering Palms 12,676 12,737 (362) 12,375
Gannon Bond 3,500 3,500 (53) 3,447
Harmony Hills Series 2000 -- -- -- --
Harmony Hills Series 2001 -- -- -- --
Hidden Valley 1,640 1,640 16 1,656
Hunter's Glen -- -- -- --
Honey Creek 20,485 20,277 (509) 19,768
La Paloma -- -- -- --
Lakeview Garden -- -- -- --
Lake Piedmont 19,118 18,016 (4,439) 13,577
Mountain View
(Willowgreen) 9,275 6,769 2,598 9,367
North Pointe -- -- -- --
Northridge Park -- -- -- --
Oakbrook 3,105 3,134 95 3,229
Oakgrove -- -- -- --
Oaklahoma -- -- -- --
Oakmont/Towne Oaks 11,249 11,227 (203) 11,024
Orangevale 2,328 2,328 (58) 2,270
Queen Anne -- -- -- --
Paola 1,048 1,035 (71) 964
Parkwood 3,910 3,842 604 4,446
Pavilion -- -- -- --
Penn Valley -- -- -- --
Riverset Phase II 110 105 8 113
Sahuarita 2,120 2,108 (200) 1,908
Santa Fe Springs 15,100 11,455 (281) 11,174
Shadowbrook 5,780 5,767 13 5,780
Silver Spring -- -- -- --
Southwinds 4,350 4,263 43 4,306
Stone Mountain -- -- -- --
Torries Chase 2,010 2,010 60 2,070
University Courtyard 9,850 9,749 (47) 9,702
Village Green -- -- -- --
Villa Hialeah - refunded 10,250 8,005 1,630 9,635
Western Hills 3,033 3,033 (227) 2,806
Wheeler Creek 8,633 8,521 (350) 8,171
Willow Key -- -- -- --
Woodmark 10,200 10,072 (229) 9,843
-------- -------- -------- --------
Subtotal non-participating
bonds 259,115 248,918 (3,977) 244,941
-------- -------- -------- --------
74
December 31, 2001
--------------------------------------------------
Base Face Amortized Unrealized Fair
Investment in Tax-Exempt Year Interest Maturity Amount Cost Gain (Loss) Value
Bonds Acquired Rate (12) Date (000s) (000s) (000s) (000s)
- ------------------------ ---------- ----------- --------- ----------- ----------- ------------ -----------
Participating Subordinate
Bonds (1):
Barkley Place (3),(4),(6),(10) 1995 16.000 Jan. 2030 3,480 2,445 3,559 6,004
Gilman Meadows (3),(4),(6),(10) 1995 3.000 Jan. 2030 2,875 2,530 2,680 5,210
Hamilton Chase (3),(4),(6),(10) 1995 3.000 Jan. 2030 6,250 4,140 (621) 3,519
Mallard Cove I (3),(4),(6),(10) 1995 3.000 Jan. 2030 1,670 798 474 1,272
Mallard Cove II (3),(4),(6),(10) 1995 3.000 Jan. 2030 3,750 2,429 1,185 3,614
Meadows (3),(4),(6),(10) 1995 16.000 Jan. 2030 3,635 3,716 355 4,071
Montclair (3),(4),(6),(10) 1995 3.000 Jan. 2030 6,840 1,691 1,654 3,345
Newport Village (3),(4),(6),(10) 1995 3.000 Jan. 2030 4,175 2,973 3,477 6,450
Nicollet Ridge (3),(4),(6),(10) 1995 3.000 Jan. 2030 12,415 6,075 4,611 10,686
Riverset Phase II (6) 1996 10.000 Oct. 2019 1,489 -- 725 725
Steeplechase (3),(4),(6),(10) 1995 16.000 Jan. 2030 5,300 4,223 (1,108) 3,115
Whispering Lake (3),(4),(6),(10) 1995 3.000 Jan. 2030 8,500 4,779 2,892 7,671
-------- -------- -------- --------
Subtotal participating
subordinate bonds 60,379 35,799 19,883 55,682
-------- -------- -------- --------
Non-Participating
Subordinate Bonds:
CapReit B 2000 11.000 Sept.2005 -- -- -- --
Cinnamon Ridge 1999 5.000 Jan. 2015 1,832 1,218 28 1,246
Farmington Meadows (10) 1999 8.000 Aug. 2039 1,983 1,938 45 1,983
Independence Ridge (10) 1996 12.500 Dec. 2015 1,045 1,045 94 1,139
Locarno (10) 1996 12.500 Dec. 2015 675 675 34 709
Olde English Manor (6),(11) 1998 10.570 Nov. 2033 1,273 1,268 (173) 1,095
Oxford C Bond 2001 9.125 May. 2039 5,420 5,250 (6) 5,244
Penn Valley B Bond 2001 8.200 Apr. 2003 800 793 -- 793
Rillito B Series (6),(7) 2000 13.000 Dec. 2033 1,054 1,241 (334) 907
Winter Oaks B bond (6),(10) 1999 7.500 Jul. 2022 2,184 2,133 29 2,162
Winter Oaks C bond (6),(10) 1999 10.000 Jul. 2022 2,141 1,654 316 1,970
-------- -------- -------- --------
Subtotal non-participating
subordinate bonds 18,407 17,215 33 17,248
-------- -------- -------- --------
Total investment in mortgage
revenue bonds $650,945 $592,829 $ 23,631 $616,460
======== ======== ======== ========
December 31, 2000
-------------------------------------------------
Face Amortized Unrealized Fair
Investment in Tax-Exempt Amount Cost Gain (Loss) Value
Bonds (000s) (000s) (000s) (000s)
- ------------------------ ----------- ----------- ------------- -----------
Participating Subordinate
Bonds (1):
Barkley Place 3,480 2,445 3,407 5,852
Gilman Meadows 2,875 2,530 2,221 4,751
Hamilton Chase 6,250 4,140 (468) 3,672
Mallard Cove I 1,670 798 309 1,107
Mallard Cove II 3,750 2,429 758 3,187
Meadows 3,635 3,716 276 3,992
Montclair 6,840 1,691 1,958 3,649
Newport Village 4,175 2,973 2,016 4,989
Nicollet Ridge 12,415 6,075 3,267 9,342
Riverset Phase II 1,489 -- 1,863 1,863
Steeplechase 5,300 4,224 (591) 3,633
Whispering Lake 8,500 4,779 3,839 8,618
-------- -------- -------- --------
Subtotal participating
subordinate bonds 60,379 35,800 18,855 54,655
-------- -------- -------- --------
Non-Participating
Subordinate Bonds:
CapReit B 5,000 4,950 100 5,050
Cinnamon Ridge 1,832 1,218 28 1,246
Farmington Meadows 1,991 1,946 55 2,001
Independence Ridge 1,045 1,045 105 1,150
Locarno 675 675 41 716
Olde English Manor 1,273 1,268 (173) 1,095
Oxford C Bond -- -- -- --
Penn Valley B Bond -- -- -- --
Rillito B Series 1,044 1,241 (343) 898
Winter Oaks B bond 2,184 2,133 7 2,140
Winter Oaks C bond 2,141 1,654 316 1,970
-------- -------- -------- --------
Subtotal non-participating
subordinate bonds 17,185 16,130 136 16,266
-------- -------- -------- --------
Total investment in mortgage
revenue bonds $526,957 $467,302 $ 32,888 $500,190
======== ======== ======== ========
Notes:
(1) These bonds also contain additional interest features contingent on
available cash flow.
(2) One of the original 22 bonds.
(3) Series B Bonds derived from original 22 bonds.
(4) These assets were pledged as collateral as of December 31, 2001.
(5) TE Bond Sub or its subsidiaries own an 87% interest in these
investments.
(6) At December 31, 2001 these bonds were on non-accrual status.
(7) The underlying bonds are held in a trust; TE Bond Sub owns an 18%
subordinate interest in the trust.
(8) These bonds were reissued or refunded during 2001. Prior to the
reissuance or refunding the bonds were participating. Following the
transaction, the new bonds are non-participating.
(9) The underlying bonds are held in a trust; TE Bond Sub owns a
certificate in the trust which represents the residual cash flows
generated on the underlying bonds.
(10) Investments held by TE Bond Sub or its subsidiaries.
(11) The underlying bonds are held in a trust; TE Bond Sub owns an 81%
senior interest in the trust.
(12) The base interest rate represents the permanent base interest rate on
the investment as of December 31, 2001.
(13) The permanent interest rate resets monthly based on 90% of the 30 day
treasury bill.
(14) The interest rate on the Santa Fe bond will reset in May 2002. At
that time the bond will be remarketed at par or a rate not exceeding a
rate that will allow the property to perform at a 1.05 debt service
coverage on the bond.
(15) The underlying bonds are held in a trust; TE Bond Sub owns a
certificate in the trust which represents the residual cash flows
generated on 81% of underlying bond. TE Bond Sub also owns the 19%
certificate which is pledged as collateral at December 31, 2001.
(16) This bond was paid off during 2001.
(17) The underlying bonds are held in a trust; TE Bond Sub owns a
certificate in the trust which represents the residual cash flows
generated on 53% of underlying bond. TE Bond Sub also owns the 47%
certificate which is pledged as collateral at December 31, 2001.
(18) This investment is comprised of two bonds. The 1998 Series I-1 bond
has a face amount of $1,565 and a maturity date of June 11, 2009. The 1998
Series I-2 bond has a face amount of $15,875 and a maturity date of June
11, 2033.
(19) The underlying bond is held in a trust; TE Bond Sub owns the
principal and base interest trust certificate.
(20) This investment is comprised of two bonds. The Series A-1 bond has a
face of $725,000 and a maturity date of July 2009. The Series A-2 bond has
a face of $7,235,000 and a maturity date of July 2033.
75
NOTE 5 - SECURITIZATION TRANSACTIONS
Through securitizations, the Company seeks to enhance its overall return on
its investments and to generate proceeds that, along with equity offering
proceeds, facilitate the acquisition of additional investments. The Company uses
various programs to facilitate the securitization and credit enhancement of its
bond investments.
In order to facilitate the securitization of certain assets at higher
leverage ratios than otherwise available to the Company without the posting of
additional collateral, the Company has pledged additional bonds and taxable
loans to a pool that acts as collateral for senior interests in certain
securitization trusts and credit enhancement facilities. At December 31, 2001
and 2000, the total carrying amount of the bonds and taxable loans pledged as
collateral was $361.8 million and $311.8 million, respectively.
The following is a description of the Company's various credit enhancement
and securitization investment vehicles and a discussion of the activity in these
programs during 2001.
Merrill Lynch P-FLOATs(SM) program
The Company securitizes mortgage bonds in its portfolio through the Merrill
Lynch P-FLOATs(SM) program. Through this program, the Company sells bonds to
Merrill Lynch or structures a transaction whereby Merrill Lynch buys bonds from
third parties. Merrill Lynch, deposits the bonds into trusts, which are created
to hold these assets. Subsequently, these bonds are credit enhanced by Merrill
Lynch. Two types of securities, P-FLOATs(SM) and RITES(SM), are created for each
asset deposited into the trusts. The P-FLOATs(SM) are short-term floating rate
interests in the trusts that have priority on the cash flows of the deposited
mortgage bonds and bear interest at rates that are reset weekly by the
remarketing agent, Merrill Lynch. The P-FLOATs(SM) are sold to qualified third
party investors. The RITES(SM) are the subordinate security and receive the
residual interest on the bond after the payment of all fees and the P-FLOATs(SM)
interest. When the Company sells a bond to Merrill Lynch, the Company receives
the proceeds from the sale of the P-FLOATs(SM), less certain transaction costs,
and retains the residual interests in the trusts, the RITES(SM). When Merrill
Lynch buys the bond directly, the Company purchases the RITES(SM).
In 2001 the Company securitized seven bonds with a face amount of $100.7
million with Merrill Lynch through the P-FLOATs(SM) program. Two of these
transactions representing bonds with a face amount of $21.5 million were
accounted for as borrowings in 2001. Accordingly, the Company recorded $20.0
million as short-term debt and the related bonds remained in investments in
tax-exempt bonds.
In addition, the Company structured five transactions whereby Merrill Lynch
bought bonds from third parties with a face amount of $79.2 million. The Company
purchased RITES(SM) interests with a par value of $1.3 million for $0.2 million
in 2001 related to these transactions. The Company recognized $0.7 million in
origination fees on these structured transactions.
In 2000 the Company securitized four bonds with a face amount of $55.6
million with Merrill Lynch through the P-FLOATs(SM) program. Three of these
transactions were accounted for as borrowings in 2000. Accordingly, the Company
76
recorded $41.3 million as short-term debt and the related bonds remained in
investments in tax-exempt bonds. The remaining transaction representing bonds
with a face amount of $10.7 million was accounted for as a sale as a result of
no call provision being granted to the RITES(SM) holder. Accordingly, the
Company derecognized its $10.7 million (face amount) investment in this bond and
recorded a $5,000 (par value) RITES(SM) investment. The Company recognized a net
gain of $0.1 million on this sale transaction.
In addition, the Company structured seven transactions whereby Merrill
Lynch bought bonds from third parties with a face amount of $99.7 million. The
Company purchased seven RITES(SM) interests with a par value of $38,000 for $0.6
million in 2000 related to these transactions. The Company also purchased two
RITES(SM) interests with a par value of $10,000 for $1.2 million related to two
bonds sold to Merrill Lynch in December 1999. The Company recognized $1.7
million in origination fees on these structured transactions.
Term Securitization Facility
In March 1999, the Company consummated a refinancing transaction with an
affiliate of Merrill Lynch that converted a portion of its investment in the
P-FLOATs(SM) program into a longer-term securitization facility. As a result,
this facility enabled the Company to reduce its exposure to credit and annual
renewal risks associated with the liquidity and credit enhancement features of
the P-FLOATs(SM) trusts and the swap agreements. In order to facilitate this
transaction, the Company sold to Merrill Lynch its $0.7 million par-value
RITES(SM) investments in two P-FLOATs(SM) trusts containing the Gannon-Dade bond
(face amount of $55.1 million) and the Whispering Palms bond (face amount of
$12.7 million) for $1.0 million. Merrill Lynch then terminated the Gannon-Dade
and Whispering Palms P-FLOATs(SM) trusts and deposited the bonds (face amount of
$67.8 million) into a new securitization trust (the "Term Securitization
Facility").
Two classes of certificates, Class A and Class B, were sold out of the Term
Securitization Facility. The $67.0 million par-value Class A certificates, which
are senior to the Class B certificates, were sold to qualified third party
investors and bear interest at a fixed tax-exempt rate of 4.95% per annum
through the remarketing date, August 15, 2005. The interest rate will be reset
on the remarketing date to the lowest rate that would result in the sale of the
Class A certificates at par plus any appreciation in the value of the underlying
bonds attributable to the Class A certificates. TE Bond Sub purchased the $0.8
million par value Class B certificates. The Class B certificates receive the
residual interest from the Term Securitization Facility after payment of (1)
trustee fees and expenses, (2) all interest and any principal due on the Class A
certificates in accordance with the terms of the documents and (3) servicing
fees. The Term Securitization Facility is subject to optional liquidation in
whole, but not in part, on each February 15, May 15, August 15 or November 15,
at the direction of a majority of the Class B certificate holders. The Class A
certificates are subject to mandatory tender on the remarketing date. The Term
Securitization Facility terminates on August 1, 2008. The Company receives a fee
of 0.15% of the weighted average balance of the trust certificates outstanding
per annum for acting as the servicer of the Term Securitization Facility.
In July 2001, TE Bond Sub refinanced its Term Securitization Facility. The
result of the refinancing was a reduction of the outstanding debt from $67
million to $45 million. Substantially all other terms of the debt remained the
same. TE Bond Sub now holds a $5,000 Class B certificate in the facility and the
77
$45.0 million Class A certificates are held by a third party investor. In order
to accomplish the refinancing, the Company removed the Gannon-Dade bond (face
amount of $55.1 million) and the Whispering Palms bond (face amount of $12.7
million) from the Term Securitization Facility. These assets were replaced with
four new assets with a total face amount of $45.0 million. The new assets in the
trust are: Jefferson Commons (face amount of $16.1 million), Florida A&M (face
amount of $9.9 million), Village Green (face amount of $6.4 million) and
Arlington (face amount of $12.6 million).
In conjunction with this transaction, after the Gannon-Dade bond was
removed from the Term Securitization Facility, the Company securitized a $29.0
million (face amount) interest in the bond through the Merrill Lynch
P-FLOATs(SM) program. The Company purchased a $5,000 par value RITES(SM)
interest in the Gannon-Dade securitization trust for $331,000.
In conjunction with this transaction, a subsidiary of TE Bond Sub provides
credit enhancement for the bonds and liquidity support for the Class A
certificates in the Term Securitization Facility. In fulfillment of this
obligation, the Company pledged assets as collateral to the Term Securitization
Facility.
This transaction was accounted for in accordance with FAS 140. As a result
of certain call provisions available to the Class B certificate holders, the
Company has accounted for this transaction as a borrowing. Accordingly, the
Company recorded the Class A certificates as long-term debt and the trust assets
are included in investment in tax-exempt bonds. In conjunction with the
recording of the long-term debt, the Company capitalized $500,000 in debt issue
costs. The Company is amortizing these debt issue costs over the life of the
Term Securitization Facility, based on the amount of outstanding debt, using the
effective interest method.
Fannie Mae Credit Enhancement
In 1997, the Company purchased $1.3 million in cash and securities held in
a Fannie Mae risk-sharing collateral account. The collateral account was part of
a structured finance program developed by Fannie Mae to facilitate the credit
enhancement of bonds for which there is shared risk. The risk-sharing collateral
account provided additional security for three enhanced bonds within a
cross-collateralized pool. In the event any of the bonds in the pool cannot fund
their debt service payments, the money in the collateral account can be used to
fund debt service shortfalls. The collateral account will not be released to the
Company until the interest and principal obligations on all the bonds are
fulfilled. The release of the collateral account is anticipated to be in 2006
when the bonds are expected to be refunded. The Company had the option to
replace the collateral with a letter of credit in which event the cash and
securities in the account would be released to the Company concurrently. In the
interim, the Company received the interest earned on the balance of the
collateral reserve account. The $0.3 million discount on the purchase has been
recorded as unearned revenue and was being amortized into income over the
expected period in which cash and securities will remain in the collateral
account.
In March 2000, the Company replaced the collateral with a letter of credit,
causing $1.3 million of cash and securities in the account to be released to the
Company concurrently. Upon release of the cash collateral, the Company
recognized the $230,000 unamortized balance of the discount on the purchase into
78
other income.
As part of the purchase of this collateral account, the Company assumed a
Master Recourse Agreement with Fannie Mae. Under this agreement, the Company can
add additional assets to the existing pool discussed above. This will enable the
Company to securitize bonds with Fannie Mae credit enhancement.
During December 2000, the Company worked with Fannie Mae to amend the
existing Master Recourse Agreement and then deposited an additional $80 million
in bonds to this credit enhancement facility. This transaction immediately
refinanced the short-term credit enhancement on approximately $70 million of our
existing P-FLOATs(SM) with long-term credit enhancement through Fannie Mae. The
facility also provided credit enhancement to two of our previously unenhanced
tax-exempt bonds having an aggregate fair market value of approximately $10
million at December 31, 2000. The facility also includes the credit enhancement
on approximately $20 million of tax-exempt bonds that were previously credit
enhanced through the facility prior to December 2000. The $100 million credit
enhancement facility is an open ended facility and will facilitate the placement
of long term securitization capital, thereby enabling the Company to securitize
its mortgage bonds at a fixed rate and for a term that more closely matches the
term of the underlying bond. In order to provide credit enhancement to the bonds
secured by this facility, the Company pledged additional investments to this
facility.
Freddie Mac Tender Option Bond Program
In December 2001, the Company developed a tender option bond program with
the Federal Home Loan Mortgage Corporation ("Freddie Mac"). Through this
program, the Company securitized 12 bonds with an aggregate unpaid principal
balance of approximately $91.0 million and deposited the bonds in 12 trusts.
Prior to this transaction, approximately $34.3 million of these bonds had been
securitized through the P-FLOATs(SM) program. The trusts issued approximately
$69.0 million of fixed-rate senior certificates and approximately $22.0 million
of fixed-rate subordinate certificates. The Company purchased the subordinate
certificates and the senior certificates were sold to third party investors. The
net proceeds to the Company upon completion of this transaction approximated
$34.7 million, which represents $69.0 million in proceeds from the sale of the
fixed-rate senior certificates less $34.3 million for the purchase of the bonds
in the P-FLOATs(SM) program. To increase the attractiveness of the senior
certificates to third party investors, Freddie Mac provided credit enhancement
through a standby guaranty of payment and agreed to provide liquidity by lending
the Company the money to repurchase the senior certificates at the remarketing
date (if they are not successfully remarketed), which is five years from
issuance. The Company agreed to pay Freddie Mac for the first $22.0 million of
losses if any of the bonds fail to generate sufficient income to pay the senior
certificate holders, and the Company pledged the subordinate certificates to
Freddie Mac to secure this obligation. Freddie Mac's recourse to the Company for
losses on the credit enhancement is limited to its right to liquidate the
subordinate certificates.
This transaction was accounted for in accordance with FAS 140. As a result
of certain call provisions available to the subordinate certificate holders, the
Company has accounted for this transaction as a borrowing. Accordingly, the
Company recorded the senior certificates as long-term debt and the trust assets
are included in investment in tax-exempt bonds. In conjunction with the
79
recording of the long-term debt, the Company capitalized $1.8 million in debt
issue costs. The Company is amortizing these debt issue costs over the life of
the facility, based on the amount of outstanding debt, using the effective
interest method.
NOTE 6 - OTHER BOND RELATED INVESTMENTS
At December 31, 2001, the Company's other bond related investments are
primarily investments in RITES(SM). At December 31, 2000, the Company's other
bond related investments also included investments in interest rate swaps and
total return swaps. In conjunction with the adoption of FAS 133 on January 1,
2001, the Company's investments in interest rate swaps and total return swaps
were reclassified to investments in derivative financial instruments (see
further discussion in Note 7). The table at the end of this note provides
certain information with respect to the other bond related investments held by
the Company at December 31, 2001 and 2000.
The Company holds investments in RITES(SM), a security offered by Merrill
Lynch through its P-FLOATs(SM) Program. At December 31, 2001 and 2000, the
Company held $5.7 million and $5.0 million (face value) in RITES(SM),
respectively. The P-FLOATs(SM) outstanding, which are not reflected in the
Company's consolidated balance sheet were $334.2 million at December 31, 2001.
In conjunction with the purchase of the RITES(SM) with respect to fixed rate
bonds, the Company enters into interest rate swap contracts to hedge against
interest rate exposure on the Company's investment in the RITES(SM) (see Note
7). In order to facilitate the securitization of certain assets at higher
leverage ratios than otherwise available, the Company has pledged additional
bonds to a pool that collateralizes the senior interests in the P-FLOATs(SM)
trusts.
From time to time the Company may purchase or sell in the open market
interests in bonds that it has securitized depending on the Company's capital
position and needs. During the year ended December 31, 2001, the Company
purchased and/or sold interests in seven bonds ($60.1 million face amount) that
it had previously securitized.
Valuation Adjustments
For the years ended December 31, 2001, 2000 and 1999, the net decrease to
other comprehensive income from unrealized holding gains and losses on other
bond related investments available-for-sale was approximately $1.9 million, $5.8
million and $3.9 million, respectively.
RITES(SM) Valuation Analysis
The fair value of a RITES(SM) investment is derived from the quote on the
underlying bond reduced by the outstanding corresponding P-FLOATs(SM) face
amount. The Company bases the fair value of the underlying bond, which has a
limited market, on quotes from external sources, such as brokers, for these or
similar bonds. The fair value of the underlying bond includes a prepayment risk
factor. The prepayment risk factor is reflected in the fair value of the bond by
assuming the bond will prepay at the most adverse time to the Company given
current market rates and estimates of future market rates. Based on this, an
adverse change in prepayment risk would not have an effect on the fair value of
the Company's RITES(SM) investments. In addition, the RITES(SM) investments are
not subject to prepayment risk as the term of the securitization trusts is only
for a period during which the underlying bond cannot be prepaid. Based on
80
historical information, credit losses were estimated to be zero.
At December 31, 2001 and 2000, a 10% and 20% adverse change in key
assumptions used to estimate the fair value of the Company's RITES(SM) would
have the following impact:
(In thousands) 2001 2000
---- ----
Fair value of retained interests $5,316 $7,750
Residual cash flows discount rate (annual rate) 4.5% - 12.9% 4.9% - 8.5%
Impact on fair value of 10% adverse change $22,821 $17,996
Impact on fair value of 20% adverse change $43,783 $34,263
The sensitivity analysis presented above is hypothetical in nature and
presented for information purposes only. The analysis shows the effect on fair
value of a variation in one assumption and is calculated without considering the
effect of changes in any other assumption. In reality, changes in one assumption
may affect the others, which may magnify or offset the sensitivities.
81
December 31, 2001
----------------------------------------------------------------------
Face Amortized Unrealized
Year Amount Cost Gain (Loss) Assets Liabilities (4)
Other Bond Related Investments: Acquired (000s) (000s) (000s) (000s) (000s)
- --------------------------------- -------- ------ --------- ----------- ------ ---------------
Investment in RITES:
Barrington (1) 2000 $ 5 $ 5 $ -- $ 5 $ --
Briarwood (1) 1999 135 104 164 268 --
Charter House (1) 1996 80 199 830 1,029 --
Cinnamon Ridge (1) 2000 5 327 1,681 2,008 --
Fort Branch (1) 2000 8 8 370 378 --
Hidden Brooks (1) 2001 5 65 (1,075) -- (1,010)
Indian Lakes (1) 1997 3,170 3,254 641 3,895 --
LaPaloma (1) 1999 -- -- -- -- --
LeMirador (Coleman Senior) (1) 1999 165 3 227 230 --
Lincoln Corner (1) 2001 10 32 (470) -- (438)
Meridian at Bridgewater (1) 1999 5 37 (316) -- (279)
Museum Towers 2001 5 5 105 110 --
North White Road (1) 2001 5 44 (39) 5 --
Oklahoma City 1998 -- -- -- -- --
Olde English Manor (1) 1999 76 95 (382) -- (287)
Palisades Park 1999 -- -- -- -- --
Park at Landmark 2000 5 12 330 342 --
Park Center (1) 2001 1,270 74 (232) -- (158)
Pavilion 1999 -- -- -- -- --
Queen Anne IV 1998 -- -- -- -- --
Rancho Mirage/Castle Hills (1) 2000 5 5 (255) -- (250)
Rillito Village (1) 1999 65 63 (312) -- (249)
Riverset Phase I (1) 2000 5 1,069 1,596 2,665 --
Riverset Phase II (1) 1996 5 120 35 155 --
Riverview (1) 2000 5 5 213 218 --
Sienna (Italian Gardens) (1) 1999 160 (1) 106 105 --
Silver Springs 2000 -- -- -- -- --
Sonterra (1) 1998 5 32 (3,062) -- (3,030)
Southgate Crossings (1) 1997 71 432 1,445 1,877 --
Southwood (1) 1997 420 321 (2,497) -- (2,176)
Village at Sun Valley (1) 2000 5 5 -- 5 --
Village Green (1) 2000 -- -- -- -- --
Woodglen (1) 1999 5 32 (134) -- (102)
------ ------- ------- ------- -------
Subtotal investment in RITES $5,700 6,347 (1,031) 13,295 (7,979)
------ ------- ------- ------- -------
Interest rate agreements (2),(5) Various -- -- -- --
------- ------- ------- -------
Investment in total return swaps (3),(5):
Club West (3/30/99 - 7/19/02) 1999 -- -- -- -- --
Willow Key (3/30/99 - 7/19/02) 1999 -- -- -- -- --
------ ------- ------- ------- -------
Total investment in total return swaps -- -- -- -- --
------ ------- ------- ------- -------
Total other bond related investments $ 6,347 $(1,031) $13,295 $(7,979)
======= ======= ======= =======
December 31, 2000
----------------------------------------------------------------------
Face Amortized Unrealized
Year Amount Cost Gain (Loss) Assets Liabilities (4)
Other Bond Related Investments: Acquired (000s) (000s) (000s) (000s) (000s)
- --------------------------------- -------- ------ --------- ----------- ------ ---------------
Investment in RITES:
Barrington (1) 2000 $ 5 $ 4 $ 1 $ 5 $ --
Briarwood (1) 1999 135 104 618 722 --
Charter House (1) 1996 80 242 684 926 --
Cinnamon Ridge (1) 2000 5 330 1,573 1,903 --
Fort Branch (1) 2000 8 8 123 131 --
Hidden Brooks (1) 2001 -- -- -- -- --
Indian Lakes (1) 1997 3,250 3,356 864 4,220 --
LaPaloma (1) 1999 8 8 (263) -- (255)
LeMirador (Coleman Senior) (1) 1999 165 4 71 75 --
Lincoln Corner (1) 2001 -- -- -- -- --
Meridian at Bridgewater (1) 1999 5 44 (181) -- (137)
Museum Towers 2001 -- -- -- -- --
North White Road (1) 2001 -- -- -- -- --
Oklahoma City 1998 195 239 (2,384) -- (2,145)
Olde English Manor (1) 1999 76 95 (201) -- (106)
Palisades Park 1999 100 92 (276) -- (184)
Park at Landmark 2000 5 20 69 89 --
Park Center (1) 2001
Pavilion 1999 5 5 (357) -- (352)
Queen Anne IV 1998 65 65 (145) -- (80)
Rancho Mirage/Castle Hills (1) 2000 5 5 192 197 --
Rillito Village (1) 1999 65 64 (407) -- (343)
Riverset Phase I (1) 2000 5 1,076 1,717 2,793 --
Riverset Phase II (1) 1996 75 189 73 262 --
Riverview (1) 2000 5 4 1 5 --
Sienna (Italian Gardens) (1) 1999 160 -- 30 30 --
Silver Springs 2000 5 34 (29) 5 --
Sonterra (1) 1998 5 32 (672) -- (640)
Southgate Crossings (1) 1997 83 501 1,503 2,004 --
Southwood (1) 1997 430 309 (1,561) -- (1,252)
Village at Sun Valley (1) 2000 5 5 70 75 --
Village Green (1) 2000 5 26 (16) 10 --
Woodglen (1) 1999 5 35 (243) -- (208)
------- ------ -------- ------- --------
Subtotal investment in RITES $ 4,960 6,896 854 13,452 (5,702)
------- ------ -------- ------- --------
Interest rate agreements (2),(5) Various -- (10,438) 5 (10,443)
------ -------- ------- --------
Investment in total return swaps (3),(5):
Club West (3/30/99 - 7/19/02) 1999 $ 7,960 -- (680) -- (680)
Willow Key (3/30/99 - 7/19/02) 1999 17,440 -- (1,159) -- (1,159)
------- ------ -------- ------- --------
Total investment in total return swaps $25,400 -- (1,839) -- (1,839)
------- ------ -------- ------- --------
Total other bond related investments $6,896 $(11,423) $13,457 $(17,984)
====== ======== ======= ========
(1) Investment held by TE Bond Sub or its subsidiaries at December 31, 2001.
(2) The Company enters into interest rate swap contracts to hedge against
interest rate exposure on the Company's investment in RITES. The amounts
disclosed represent the net fair values of all the Company's swaps at the
reporting date.
(3) Face amount represents notional amount of swap agreements and the dates
represent the effective date and the termination date of the swap.
(4) The aggregate negative fair value of the investments is included in
liabilities for financial reporting purposes. The negative fair value of these
investments is considered temporary and is not indicative of the future earnings
on these investments.
(5) Upon the adoption of FAS 133 on January 1, 2001, the Company's investment in
interest rate swaps and total return swaps was reclassified to investment in
derivative financial instruments (see Note 7).
82
NOTE 7 - INVESTMENT IN DERIVATIVE FINANCIAL INSTRUMENTS
AND FINANCIAL RISK MANAGEMENT
Upon adoption of FAS 133 on January 1, 2001, the Company's investment in
interest rate swaps, total return swaps and put option contracts was
reclassified from investment in other bond related investments to investment in
derivative financial instruments (see further discussion in Note 1). The
following table provides certain information with respect to the derivative
financial instruments held by the Company at December 31, 2001.
December 31, 2001
--------------------------------
Notional Fair Value
Amount (4) Assets Liabilities (2)
Investment in derivative financial instruments (3): (000s) (000s) (000s)
- --------------------------------------------------- ----------------- -------------- ----------------
Interest rate agreements (1) $ 422,230 $2,912 $(18,646)
========= ------ --------
Total investment in derivative financial instruments $2,912 $(18,646)
====== ========
(1) The Company enters into interest rate swap contracts to offset against
interest rate exposure on the Company's investment in RITES(SM). The amounts
disclosed represent the net fair values of all the Company's swaps at the
reporting date.
(2) The aggregate negative fair value of the investments is included in
liabilities for financial reporting purposes. The negative fair value of these
investments is considered temporary and is not indicative of the future earnings
on these investments.
(3) Upon the adoption of FAS 133 on January 1, 2001, Company's investment in
interest rate swaps and total return swaps was reclassified to investment in
derivative financial instruments.
(4) Notional amount represents total amount of the Company's interest rate swaps
contracts less the total amount of the Company's reverse interest rate swap
contracts.
Interest rate swaps
Since the bonds securitized generally bear fixed rates of interest, the
floating rate residual interests in the trusts created by the securitization may
subject the Company to interest rate risks. To reduce the Company's exposure to
interest rate risks on residual interests retained, the Company may enter into
interest rate swaps. Historically, the Company has attempted to offset
substantially all of its floating interest rate exposure; however, from time to
time, a portion of the Company's floating rate exposure may not have been fully
mitigated by hedging instruments. As a result, changes in interest rates could
result in either an increase or decrease in the Company's interest income and
cash flows associated with these investments.
From time to time, the Company may enter into interest rate swap contracts
which offset certain of the Company's existing swaps ("reverse interest rate
swaps") or the Company may terminate interest rate swaps. The Company may do
this in anticipation of or conjunction with converting portions of the Company's
short-term floating rate debt to into longer term, fixed rate facilities or to
take advantage of lower interest rate environments to lower the annual cost of
the
83
Company's interest rate management strategy.
Under the interest rate swap agreements, the Company is obligated to pay
the counterparty a fixed rate. In return, the counterparty will pay the Company
a floating rate equivalent to the BMA Municipal Swap Index, an index of weekly
tax-exempt variable rate issues. Under the reverse interest rate swap
agreements, the counterparty is obligated to pay the Company a fixed rate. In
return, the Company will pay the counterparty a floating rate equivalent to the
BMA Municipal Swap Index. Net swap payments received, if any, will be taxable
income, even though the investment being hedged pays tax-exempt interest. The
Company recognizes taxable capital gains or losses upon the termination of an
interest rate swap contract. The average BMA rate for 2001, 2000 and 1999 was
approximately 2.63%, 4.14% and 3.29%, respectively. The swap contracts, in
conjunction with the RITES(SM), are intended to produce a relatively constant
yield over the effective duration of the RITES(SM). Risks arise from the
possible inability of the counterparty to meet the terms of the contracts with
the Company. However, there is no current indication of any such inability. The
fair value of the interest rate swap agreements is determined based on quotes
from external sources, such as brokers, for these or similar investments.
The interest rate swap agreements are also subject to risk of early
termination on the annual optional termination date by the counterparty,
possibly at times unfavorable to the Company. There can be no assurance that the
Company will be able to acquire hedging instruments at favorable prices, or at
all, when the existing arrangements expire or are terminated. In this case, the
Company would be fully exposed to interest rate risk to the extent the hedging
instruments are terminated by the counterparty while the securitization trust
remains in existence.
Total Return Swaps
To generate short-term financing proceeds, the Company occasionally enters
into total return swaps with Merrill Lynch that replicate the total return on a
bond or loan financed at a then current market interest rate ("financing rate").
During the term of the swaps, the Company receives net taxable income equal to
the excess of the interest rate on the underlying investment over the financing
rate. To the extent that the financing rate exceeds the interest rate on the
underlying investment, the Company is obligated to pay Merrill Lynch the excess
of the financing rate over the interest rate on the underlying investment. In
addition to the net taxable income received, total return swaps include a cash
settlement at termination, whereby the Company will pay to (receive from)
Merrill Lynch an amount equal to the decline (increase) in the market value of
the underlying bond or loan. The Company had investments in total return swaps
valued at $0 and ($1.8) million with notional amounts of $0 and $25.4 million at
December 31, 2001 and 2000, respectively.
Put Options
The Company has occasionally entered into put option agreements with
counterparties whereby the counterparty has the right to sell to the Company,
and the Company has the obligation to buy, an underlying investment at a
specified price. Under the put options, the Company may receive an annual
payment for assuming the purchase obligation and providing asset management
services on the underlying investments. The purchase price can be reduced in the
event of a material adverse change (as defined in the put agreements). At
December 31, 2001, the Company had four put options with a fair value of zero.
The Company's aggregate obligation under these put options is
84
$107.3 million at December 31, 2001. The Company received $1.0 million, $1.2
million, and $0.6 million in income from the put options in 2001, 2000 and 1999,
respectively.
NOTE 8 - LOANS RECEIVABLE
The Company's loans receivable primarily consist of construction loans,
permanent loans, taxable loans and other loans. The general terms of the loans
owned by the Company are discussed below. The following table summarizes loans
receivable by loan type at December 31, 2001 and 2000.
(In thousands)
Loan Type 2001 2000
--------- --------- ---------
Taxable construction loans $ 271,383 $ 270,481
Taxable permanent loans 86,182 39,821
Taxable loans 30,959 18,416
Other loans 52,405 21,424
--------- ---------
440,929 350,142
Allowance for loan losses (898) (851)
--------- ---------
Total $ 440,031 $ 349,291
========= =========
Taxable Construction Loans
The Company's construction loans are short-term taxable loans, the proceeds
of which are used to build low-to-moderate income apartment communities.
Interest rates on the fixed rate loans range from 6.00% to10.00% and interest
rates on the adjustable interest rate loans range from money center bank prime
to 2.00% over money center bank prime (4.75% at December 31, 2001). Due to
floors, actual rates on variable rate loans range from 6.00% to 11.00% at
December 31, 2001. The loans have various maturities through 2004. The loans are
collateralized by the properties under construction and guaranteed by the
borrowers. Repayment of the loans is expected at the loan's maturity by the
proceeds from the permanent lenders upon successful completion of the community.
Taxable Permanent Loans
The Company's taxable permanent loans consist of construction loans that
were recently converted to permanent status. The Company anticipates these loans
will be delivered to Fannie Mae or other third party permanent lenders in the
near future. Interest rates on the fixed rate loans range from 6.50% to 7.25%
and interest rates on the adjustable interest rate loans range from 2.25% over
the London Interbank Offered Rate ("LIBOR"), to 0.50% over money center bank
prime. Due to floors on the LIBOR rate, the actual rate on certain loans is
5.25% at December 31, 2001. The loans are collateralized by the underlying
properties.
Taxable Loans
In conjunction with the purchase of certain tax-exempt bonds or structuring
of certain investments, the Company has made taxable loans and taxable bonds to
85
certain of the borrowers. As of December 31, 2001, the Company held 40 taxable
loans and bonds. The carrying value of these loans was $28.5 million ($29.1
million par value) at December 31, 2001. The base interest rates on these loans
range from 7.15% to 14.00% and the maturity dates range from 2003 to 2039. Of
the 40 taxable loans, 14 are equal in priority of payment with the tax-exempt
bonds to which they relate, while the remaining loans are subordinate to the
related tax-exempt bonds. Certain loans also contain additional interest
features that allow the Company to participate in the growth of the underlying
property collateral. At December 31, 2001, six taxable loans were on non-accrual
status. Interest income recognized was approximately $232,000, $137,000 and
$164,000 for the years ended December 31, 2001, 2000 and 1999, respectively.
Additional interest income that would have been recognized had these loans not
been placed on non-accrual status was approximately $56,000, $37,000 and $16,000
for the years ended December 31, 2001, 2000 and 1999, respectively.
The Company sold six taxable loans with a par value of $9.2 million for
$9.4 million in 2001. Under the terms of the sale agreement, the Company has the
right to repurchase the loans if the Company pays a yield maintenance penalty to
the seller. As a result of the repurchase feature available to the Company, the
Company has accounted for these transactions as a borrowing. Accordingly, the
Company recorded $9.4 million in long-term debt equal to the face amount of the
outstanding loans plus the premium paid to the Company for the loans. The
taxable loans are included in loans receivable. The Company is amortizing the
premium on the loans over the period that the loans could not be repurchased
without paying the yield maintenance penalty.
Other Loans
The Company's other loans consist primarily of working capital loans and
short-term taxable loans. In conjunction with the origination of construction
loans and syndication of tax credits, the Company has made working capital loans
to borrowers. Interest rates on the fixed rate loans range from 9.00% to 10.00%
and interest rates on the adjustable interest rate loans range from 1.00% to
5.50% over money center bank prime or LIBOR. The loans have various maturities
through 2006. Due to floors, actual rates on variable rate loans range from
6.00% to 11.00% at December 31, 2001. The loans are guaranteed by the borrowers
and repayment is expected from construction profits and syndication proceeds.
The short-term loans are made as interim financing pending the issuance of
tax-exempt mortgage bonds and other loans and advances collateralized by limited
partnership's notes receivable and other loans to properties.
Allowance for Loan Losses
The Company's allowance for loan losses is based on the Company's
continuing evaluation of the loans receivable and is intended to maintain an
allowance adequate to absorb probable losses on these loans. The Company
assesses individual loans for impairment based on the Company's policy on
other-than-temporary impairments (see Note 1). Adjustments to the allowance due
to changes in measurement of impaired loans are recorded in the provision for
loan loss. The allowance for loan losses was $898,000 and $851,000 at December
31, 2001 and 2000, respectively.
Taxable Loans Pledged
In order to facilitate the securitization of certain assets at higher
leverage ratios than
86
otherwise available to the Company without the posting of additional collateral,
the Company has pledged additional taxable loans to a pool that acts as
collateral for senior interests in certain securitization trusts and credit
enhancement facilities. At December 31, 2001, the total carrying amount of the
taxable loans pledged as collateral was $3.4 million. There were no taxable
loans pledged as collateral at December 31, 2000.
NOTE 9 - RESTRICTED ASSETS
Restricted Cash Deposits
Under the terms of the Company's interest rate swap agreements and total
return swaps with counterparties, the Company is required to maintain cash
deposits ("margin call deposits"). The margin call deposit requirements are
specific to each counterparty. The Company must make margin call deposits when
the total fair value of the Company's outstanding swap obligations to any one
counterparty is greater than $1.0 million. In certain cases, the Company is also
required to post up-front collateral on the swap contracts. At December 31, 2001
and 2000, the balances in the Company's margin call deposit accounts were $15.1
million and $20.9 million, respectively.
In conjunction with a guaranty provided by the Company related to the sale
of certain taxable notes to Merrill Lynch in December 1998 and March 1999, the
Company deposited $1.3 million in cash in an account with Merrill Lynch. This
money serves as collateral for the Company's obligation under the guaranty;
however, the Company's obligation under the guaranty is not limited to this
deposit. In the event that any of the properties cannot fund their payments on
the loan, the money in this account can be used to fund any shortfalls. The
Company does not believe that any loss is likely. These funds will not be
released to the Company until the interest and principal obligations on all the
loans are fulfilled. The Company does not believe it will have to perform under
the guaranty.
P-FLOATs(SM) Pledged as Collateral
From time to time, the Company may purchase in the open market P-FLOATs(SM)
interests in bonds in order to pledge these interests to a pool that
collateralizes the senior interests in the P-FLOATs(SM) trusts (see Note 5).
These P-FLOATs(SM) interests in bonds may or may not be related to bonds that
the Company has previously securitized. These investments are reflected on the
balance sheet as restricted assets and had a carrying amount of $3.0 million at
December 31, 2000. The Company had no investments in these P-FLOATs(SM) at
December 31, 2001.
NOTE 10 - MORTGAGE SERVICING RIGHTS
Mortgage Servicing Rights
At December 31, 2001 and 2000, the Company had capitalized mortgage
servicing rights with a carrying value of $9.0 million and $6.8 million,
respectively, net of accumulated amortization of $1.7 million and $0.8 million,
respectively. The December 31, 2001 balance of $9.0 million represents $9.2
million in mortgage servicing right assets offset by $0.2 million in mortgage
servicing rights liabilities (included in other liabilities). The December 31,
2000 balance of $6.8 million represents $6.9 million in mortgage servicing right
assets offset by $0.1 million in mortgage servicing rights liabilities. The
87
following table shows the activity for the years ended December 31, 2001 and
2000.
(In thousands)
Balance, December 31, 1999 $ --
Capitalized fees reclassified from goodwill and other intangible
assets 5,624
Capitalized mortgage servicing rights 1,931
Amortization (779)
Valuation allowance --
-------
Balance, December 31, 2000 $6,776
Capitalized mortgage servicing rights 3,168
Amortization (936)
Valuation allowance --
-------
Balance, December 31, 2001 $9,008
======
At December 31, 2001 and 2000, the fair value of the mortgage servicing
rights approximated the carrying amount. The fair value of the mortgage
servicing rights was estimated by discounting estimated net servicing income
over the future life of the related loan using a market discount rate. The
market discount rate was estimated to be 12% and 15% at December 31, 2001 and
2000, respectively. The estimated lives of the loans were determined by
considering yield maintenance periods and contractual prepayment penalties, if
any. Credit losses were estimated to be zero based on historical performance of
the underlying loans.
NOTE 11 - NOTES PAYABLE AND DEBT
The Company's notes payable primarily consist of notes payable and advances
under line of credit arrangements. The notes payable are borrowings by Midland
used to finance construction lending and working capital needs. The general
terms of the Company's notes payable are discussed below. The following table
summarizes notes payable at December 31, 2001 and 2000.
88
(000s) 2001 2000
-------- --------
Notes payable $235,420 $234,830
Group Trust Warehouse Facilities and Lines of Credit 65,318 26,225
Midland Multifamily Equity REIT Credit Line 7,459 --
Residential Funding Warehouse Facility 98,033 54,481
Bank Lines of Credit 13,521 8,539
Other 312 5,084
-------- --------
$420,063 $329,159
======== ========
The Company's short and long-term debt of $213.4 million and $112.2 million
at December 31, 2001 and 2000, respectively, relates to securitization
transactions that the Company has recorded as borrowings (see Notes 1 and 5).
Annual maturities of notes payable and debt are as follows:
(000s)
2002 $423,180
2003 64,508
2004 7,620
2005 6,602
2006 1,102
Thereafter 130,492
--------
$633,504
========
The weighted average interest rate on notes payable due in one year was
6.26% and 8.96% at December 31, 2001 and 2000, respectively.
Notes payable
Notes payable of $235.4 million at December 31, 2001, represent borrowings
used to finance construction lending activities. Of this amount $105.3 million
is payable to the Midland Affordable Housing Group Trust ("Group Trust"), an
affiliated entity (see Note 16). At December 31, 2001, interest rates on the
notes payable range from 4.5% to 10.0% for fixed rate loans and from 0.75% under
to 1.75% over money center bank prime (4.75% at December 31, 2001). Due to
floors, actual rates on variable rate loans range from 4.75% to 10.25% at
December 31, 2001. The notes payable mature at various dates through 2004 and
are collateralized by the related construction loans receivable. For the year
ended December 31, 2001, maximum borrowings under the notes were $235.4 million
and average borrowings were $207.7 million at a weighted average interest rate
of 7.75%.
Notes payable of $234.8 million at December 31, 2000, represent borrowings
used to finance construction lending activities. Of this amount $104.1 million
is payable to the Group Trust. Interest rates on the notes payable range from
6.69% to 10.50% for fixed rate loans and from 0.95% under to 1.75% over money
center bank prime (9.5% at December 31, 2000). The notes payable mature at
various dates through 2003 and are collateralized by the related construction
loans receivable. For the year ended December 31, 2000, maximum borrowings under
the notes were $261.7 million and average borrowings were $243.5 million at a
weighted average interest rate of 9.08%.
89
Group Trust Warehouse Facilities and Lines of Credit
$50.0 million Warehouse Facility
The Company has a $50.0 million warehouse facility with the Group Trust to
finance interim construction and permanent lending activities. At December 31,
2001 the balance due on the facility was $5.0 million. Fixed interest rates on
the line of credit range from 6.10% to 6.75% and variable interest is at 1.00%
under money center bank prime. Individual borrowings under the facility mature
separately and are collateralized by the related loan receivable. For the year
ended December 31, 2001, maximum borrowings under the warehouse facility were
$40.6 million and average borrowings were $16.5 million. At December 31, 2001
the weighted average interest rate on the line was 5.08%. For the year ended
December 31, 2000, maximum borrowings under the warehouse facility were $33.6
million and average borrowings were $12.1 million. At December 31, 2000 the
weighted average interest rate on the line was 8.24%.
$30.0 million Warehouse Facility
The Company has a $30.0 million line of credit with the Group Trust to
finance working capital and carryover loans. At December 31, 2001 the balance
due on the line was $27.5 million. Interest on the line of credit is 0.25% under
money center bank prime. The line is collateralized by a security interest in
the related loan receivable. Principal on the line is due in 2002. For the year
ended December 31, 2001, maximum borrowings under the line were $27.5 million
and average borrowings were $17.6 million. At December 31, 2001 the weighted
average interest rate was 4.50%. For the two months ended December 31, 2000,
maximum borrowings under the line were $11.6 million and average borrowings were
$8.8 million. At December 31, 2000 the weighted average interest rate was 9.25%.
$10.0 million Line of Credit
The Company has a $10.0 million line of credit with the Group Trust to fund
syndication advances to limited partnerships. At December 31, 2001 the balance
due on the line was $2.8 million. Interest on the line of credit is equal to
money center bank prime. The line is collateralized by a security interest in a
promissory note given by a limited partnership. Principal on the line is due in
2002. For the year ended December 31, 2001 maximum borrowings under the line
were $4.6 million and average borrowings were $1.3 million. At December 31, 2001
the weighted average interest rate was 4.75%. For the month ended December 31,
2000 maximum borrowings under the line were $6.5 million and average borrowings
were $6.5 million. At December 31, 2000 the weighted average interest rate was
9.50%.
$30.0 million Line of Credit
The Company has a $30.0 million line of credit with the Group Trust to fund
syndication advances to limited partnerships. At December 31, 2001 the balance
due on the line was $30.0 million. Interest on the line of credit is equal to
money center bank prime. The line is collateralized by a guarantee from the
Company. Principal on the line is due in 2002. For the year ended December 31,
2001 maximum borrowings under the line were $30 million and average borrowings
90
were $21.5 million. At December 31, 2001 the weighted average interest rate was
4.75%. For the three months ended December 31, 2000 maximum borrowings under the
line were $6.9 million and average borrowings were $3.6 million. At December 31,
2000 the weighted average interest rate was 9.50%.
Midland Multifamily Equity REIT Lines of Credit
$20.0 million Line of Credit
The Company has a $20.0 million line of credit with the Midland Multifamily
Equity Real Estate Investment Trust ("MMER"), an affiliated entity (see Note
16), to finance interim construction and permanent lending activities. At
December 31, 2001 the balance due on the line was approximately $44,000.
Interest on the line of credit is equal to money center bank prime. The line is
collateralized by a security interest in the related loan receivable. Principal
on the line is due in 2002. For the three months ended December 31, 2001 maximum
borrowings under the line were $6.8 million and average borrowings were $3.4
million. At December 31, 2001 the weighted average interest rate was 4.75%.
$20.0 million Line of Credit
The Company has a $20.0 million line of credit with MMER to finance working
capital and carryover loans. At December 31, 2001 the balance due on the line
was $7.4 million. Interest on the line of credit is equal to money center bank
prime. The line is collateralized by a security interest in the related loan
receivable. Principal on the line is due in 2002. For the three months ended
December 31, 2001 maximum borrowings under the line were $7.4 million and
average borrowings were $5.9 million. At December 31, 2001 the weighted average
interest rate was 4.75%.
$20.0 million Line of Credit
The Company has a $20.0 million line of credit with MMER to fund
syndication advances to limited partnerships. Interest on the line of credit is
equal to money center bank prime. The line is collateralized by a guarantee from
the Company. There were no borrowings under this line in 2001.
$20.0 million Line of Credit
The Company has a $20.0 million line of credit with MMER to finance interim
construction lending. At December 31, 2001 there was no balance due on the line.
Interest on the line is equal to money center bank prime. The line is
collateralized by a security interest in the related loan receivable. Principal
on the line is due in 2002. For the three months ended December 31, 2001 maximum
borrowings under the line were $0.3 million and average borrowings were $0.2
million. At December 31, 2001 the weighted average interest rate was 4.75%.
Residential Funding Warehouse Facility
The Company has a $100.0 million warehouse facility with Residential
Funding Corporation to finance interim construction and permanent lending
activities until funded by a permanent lender or security holder. Interest on
the line of credit is (a) LIBOR + 1.75% with a floor of 4.75% or (b) LIBOR +
91
1.25% with a floor of 4.25%. The interest rate is determined by the type of loan
project warehoused. Borrowings under the line are collateralized by the related
loan receivable. The facility agreement expires on August 31, 2002. For the year
ended December 31, 2001, maximum borrowings under the facility were $98.0
million and average borrowings were $55.2 million. At December 31, 2001 the
weighted average interest rate on the line was 4.52%. For the year ended
December 31, 2000, maximum borrowings under the facility were $54.5 million and
average borrowings were $40.2 million. At December 31, 2000 the weighted average
interest rate on the line was 8.39%.
Bank Lines of Credit
The Company has a $4.0 million line of credit to finance working capital
and lending activities. At December 31, 2001 the balance due on the line was
$3.7 million. Interest on the line of credit is the higher of (a) bank prime
rate (5.73% at December 31, 2001) less 2.25% or (b) 1.25% above the weekly
average one-year Treasury Index. The line is collateralized by the related
working capital loan or note receivable. The line expires upon 180 days written
notice by the bank. For the year ended December 31, 2001, maximum borrowings
under the line were $4.0 million and average borrowings were $3.6 million. At
December 31, 2001, the weighted average interest rate on the line was 3.53%. For
the year ended December 31, 2000 average borrowings were $1.5 million. At
December 31, 2000, the weighted average interest rate was 8.13%.
The Company has a $10.0 million line of credit to finance working capital
and lending activities. At December 31, 2001 the balance due on the line was
$9.9 million. Interest on the line of credit is equal to money center bank
prime. The line is collateralized by the related working capital loan or note
receivable. The line expires upon 180 days written notice by the bank. For the
year ended December 31, 2001, maximum borrowings under the line were $10.0
million and average borrowings were $4.0 million. At December 31, 2001 the
weighted average interest rate on the line was 4.75%. For the two months ended
December 31, 2000, average borrowings were $2.9 million. At December 31, 2000
the weighted average interest rate on the line was 9.50%.
Other
At December 31, 2001 other notes payable primarily of amounts due for the
partnerships interests in a subsidiary.
Covenants and Guarantees
Under the terms of the various credit facilities, the Company is required
to comply with various covenants including net worth, interest coverage,
collateral and other terms and conditions. The Company is in compliance with its
debt covenants at December 31, 2001. In addition, the Company, or its
subsidiaries, provide payment or performance guarantees for certain borrowings
included in this note.
Certain of the Company's lines of credit contain cross-default provisions.
The $100.0 million line between Residential Finding Corporation and Midland
Mortgage Investment Corporation ("MMI") includes an event of default upon any
breach by MMI or any subsidiary of any material term of any indebtedness if the
effect of the breach is to cause, or to permit the holder thereof to cause, the
92
acceleration of indebtedness of $250,000 or more.
The $4.0 million bank line of credit between United Bank of Pinellas
and Midland Capital Corporation ("MCC") is subject to acceleration in the event
MCC fails to pay any indebtedness to any third party or permits a default or
event of default to exist under any agreement to which MCC is a party.
In addition, two bank lines of credit, totaling $10 million, between
Midland Financial Holdings, Inc. ("MFH") and First National Bank of Florida
("FNB") contain cross-defaults triggered by any contractual default between MFH,
MCC, MMI or Midland Equity Corporation and any third party if the effect of the
default is to materially affect the ability of any of those Midland entities to
repay loans due to FNB or to perform their other obligations under the loan
agreements and related documentation.
Finally, MMI has granted Bank of America a first priority security interest
in certain construction loans and related assets in connection with a $70.0
million loan agreement between Bank of America, other lenders and the Group
Trust. If an event of default were to occur under the Bank of America facility,
the lenders would be entitled to foreclose upon the collateral pledged by MMI.
Events of default under this facility include, among others, any payment default
of the Group Trust or MMI under any third party indebtedness and the occurrence
of any event that would permit the holder of debt of the Group Trust or MMI to
accelerate the maturity of any such indebtedness.
NOTE 12 - COMMITMENTS AND CONTINGENCIES
Lease Commitments
The Company has entered into non-cancelable operating leases for office
space and equipment. These leases expire on various dates through 2005. Rental
expense was approximately $1.4 million and $1.0 million for the years ended
December 31, 2001 and 2000, respectively. At December 31, 2001, the minimum
aggregate rental commitments are as follows:
Operating Leases
(In thousands)
----------------
2002 $1,466
2003 1,179
2004 186
2005 10
2006 --
------
Total $2,841
======
Unfunded Loan Commitments
Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract. At
December 31, 2001 and 2000, the aggregate total of unfunded construction loan
commitments were approximately $137.6 million and $176.8 million, respectively.
93
The Company has unfunded commitments from investors in a like amount. The
commitments are not reflected in the financial statements. The Company uses the
same credit policies in making commitments and conditional obligations as it
does for on-balance sheet instruments. There are no significant concentrations
of credit risk with any individual counterparty to originate loans.
Fannie Mae Participation Strips
As of December 31, 2001 and 2000, the Company owned interest only
securities resulting from participations in a percentage of interest received on
mortgage loans sold to Fannie Mae with a fair value of $5.5 million and $5.5
million, respectively. The Company is obligated to pay the income received from
these assets to the Group Trust; therefore, a corresponding liability is
reflected on the balance sheet in other liabilities.
Risk-Sharing Agreements with Fannie Mae
As a Fannie Mae DUS lender, Midland may share in losses relating to
under-performing real estate mortgage loans delivered to Fannie Mae. More
specifically, Midland may be required to make servicing advances to pay taxes or
insurance premiums or delinquency advances to pay principal or interest (if the
borrower fails to make payment). Also, Midland may participate in a deficiency
after foreclosure. In connection with this obligation, Midland must maintain a
minimum net worth and collateral with a custodian. Its financial exposure,
however, is subject to certain deductibles and loss limits. The total loans
originated through the DUS program during 2001 were $192.0 million. The
servicing portfolio balance originated through the DUS program was $584.6
million and $403.9 million at December 31, 2001 and 2000, respectively. Midland
is indemnified by the Group Trust against losses it may incur in connection with
its servicing of $271.0 million of these loans. As of December 31, 2001, the
Company had not incurred any losses on this portfolio.
Tax Credit Guarantees
In conjunction with the selling of interest in partnerships that provide
low-income tax credits for investors, the Company may provide certain
performance guarantees on the underlying properties owned by the partnership.
The maximum exposure under these guarantees at December 31, 2001 was $23.8
million. As of December 31, 2001, the Company does not expect to have to perform
under these guarantees and does not believe that any loss is likely.
NOTE 13 - INCOME TAXES
Certain subsidiaries of MuniMae are corporations and are therefore subject
to federal and state income taxes. The following table summarizes the provision
for income taxes at December 31, 2001, 2000 and 1999:
94
(In thousands) 2001 2000 1999
------ ------ -----
Federal income tax expense (benefit)
Current $ 862 $1,177 $ 815
Deferred 175 536 (216)
State income tax expense (benefit):
Current 250 201 140
Deferred 96 92 (36)
------ ------ -----
Total $1,383 $2,006 $ 703
====== ====== =====
In 2001, the Company recognized approximately $368,000 of benefits for
deductions associated with the exercise of employee stock options and vesting of
deferred shares. These benefits were added directly to capital surplus, and are
not reflected in the provision for income taxes.
The reconciliation of the difference between the effective income tax rate
and the statutory federal income tax rate is as follows for the years ended
December 31, 2001, 2000 and 1999:
(In thousands) 2001 2000 1999
------- ------- ----
Provision for income taxes computed using
the statutory federal income tax rate $ 1,131 $ 1,381 $458
State income taxes, net of federal tax effect 263 262 68
Goodwill amortization 546 377 101
Difference in deferred share expense -- (44) 61
Minority interest 97 -- --
Tax credits (729) -- --
Other 75 30 15
------- ------- ----
Provision for income taxes $ 1,383 $ 2,006 $703
======= ======= ====
Components of the Company's deferred tax assets and liabilities, included
in other assets and liabilities, are as follows at December 31, 2001 and 2000:
(In thousands) 2001 2000
------ ------
Deferred tax assets:
Deferred loan fees $ -- $ 12
Tax credit carryover 383 --
Rental expenses 68 --
Mortgage servicing rights 58 38
Other 140 21
------ ------
Total deferred tax assets $ 649 $ 71
====== ======
Deferred tax liabilities:
Depreciable assets $ 35 $ 53
Mortgage servicing rights 3,448 2,588
Deferred loan fees 85 127
Other 90 40
------ ------
Total deferred tax liabilities $3,658 $2,808
====== ======
At December 31, 2001, the Company had an unused low-income housing tax
credit carryforward for federal income tax purposes of approximately $383,000,
which expires in 2016. This credit is subject to recapture based upon a
qualifying disposition. The Company is in the process of posting a qualified
disposition bond to avoid the recapture provisions. Additionally, a component of
other deferred tax assets is a charitable contribution carryforward of
approximately
95
$328,000, which expires in 2006.
NOTE 14 - SHAREHOLDERS' EQUITY
As a result of the merger of the SCA Tax-Exempt Fund, LP (the
"Partnership") into the Company in August 1996, shareholders were able to elect
among three types of equity in the Company. The shareholders had the choice of
electing to exchange their Partnership interests for Preferred Shares, Preferred
Capital Distribution Shares ("Preferred CD Shares") or Common Shares in the
Company. The Company's Preferred Shares, Preferred CD Shares, Term Growth Shares
and Common Shares differ principally with respect to allocation of income and
cash distributions, as provided by the terms of the Operating Agreement (defined
in Note 16) as summarized below. Prior to their redemption in March 2002, the
Preferred Shares and Preferred CD Shares, which are divided in two series, had
priority over the Common Shares and Term Growth Shares with respect to
distributions and redemptions.
Preferred Shares
Taking into account their respective series distinctions, the Preferred
Shares are allocated their proportionate share of the income generated by the 22
original bonds and related parity working capital loans held by the Partnership
(collectively, the "Original Bonds") including income attributable to the
portion of certain bonds no longer held by the Company. While the Preferred
Shares bore their proportionate share of expenses related to a February 1995
refunding of 11 of the Original Bonds and will bear their share of the expenses
of any future refunding of the Original Bonds, the Preferred Shares are not
allocated any income or expense related to the securitization of those bonds or
the investment of the proceeds therefrom or from any future financings. The
Company is required to distribute to the holders of the Preferred Shares cash
flow attributable to such shares, as defined by the Operating Agreement. The
Preferred Shares must be partially redeemed when any bond attributable to the
shares is sold or, beginning in the year 2000, when any bond attributable to the
shares reaches par value (which includes accrued but unpaid base interest under
the original bond terms and accrued but unpaid interest under the then-current
bond terms) based on receipt of an appraisal of the property securing the bond.
Preferred CD Shares
The Preferred CD Shares are allocated their proportionate share of income
on the same basis as the Preferred Shares, except that in addition the Preferred
CD Shares received a one-time special distribution of their proportionate share
of the net proceeds from the securitization of 11 of the Original Bonds in
February 1995, will receive a similar distribution with respect to any future
financings or securitization of the Original Bonds, are not allocated any income
attributable to the refunded Series A Bonds and are allocated their
proportionate share of the annual costs of the securitization (and any such
future securitizations utilizing any of the Original Bonds). The Company is
required to distribute to the holders of the Preferred CD Shares cash flow
attributable to such shares, as defined by the Operating Agreement. The
Preferred CD Shares must be partially redeemed and the Preferred CD Shareholders
may exchange their shares on the same basis as the Preferred Shares discussed
above.
96
Term Growth Shares
The Term Growth Shares are allocated an aggregate of 2% of the Company's
net cash flow after allocation to the Preferred Shares and Preferred CD Shares,
and the holders of the Term Growth Shares are entitled to distribution of the
cash flow attributable to such allocable income before any distributions to the
holders of the Common Shares. Term Growth Shares will be redeemed when Preferred
and Preferred CD Shares are fully redeemed or converted (subject to certain
conditions defined in the Operating Agreement).
Common Shares
The Common Shares (formerly known as Growth Shares) are allocated the
balance of the Company's income after allocation to the Preferred Shares,
Preferred CD Shares and Term Growth Shares. As of December 31, 2001, it is the
Company's policy to distribute to the holders of the Common Shares at least 80%
of cash available for distribution to Common Shares. The Common Shares have no
par value. At December 31, 2001, 24,594,597 Common Shares were authorized.
The following table reflects distributions for the year ended December 31,
2001 and includes distributions declared and paid in 2002 for the quarter ended
December 31, 2001.
97
Preferred Capital
Preferred Shares Distribution Shares
Common -------------------------- ------------------------
Shares Series I Series II Series I Series II
-------- -------- --------- -------- ---------
Distributions paid on May 11, 2001
to holders of record on April 30, 2001:
For the three months ended
March 31, 2001 (1) $ 0.4250 $ 10.08 $ 5.00 $ 7.78 $ 1.75
Distributions paid on August 10, 2001
to holders of record on July 30, 2001:
For the three months ended
June 30, 2001 (2) 0.4275 11.70 11.40 8.60 3.95
Distributions paid on November 9, 2001
to holders of record on October 29, 2001:
For the three months ended
September 30, 2001 0.4300 11.70 11.40 8.60 3.95
Distributions paid on February 8, 2002
to holders of record on January 28, 2002:
For the three months ended
December 31, 2001 0.4325 10.50 4.75 8.60 0.50
-------- ------- ------- ------- -------
Total Distributions $ 1.7150 $ 43.98 $ 32.55 $ 33.58 $ 10.15
======== ======= ======= ======= =======
(1) The distributions for the Series I Preferred Shares and Preferred Capital
Distribution Shares include a special distribution of $1.48 which
represents their pro rata portion of the proceeds from the sale of a
taxable loan secured by the property known as Mountain View.
(2) In June 2001, approximately 26% of Series I Preferred Shares and Preferred
Capital Distribution Shares and approximately 56% of Series II Preferred
Shares and Preferred Capital Distribution Shares were redeemed. The effect
of this redemption was a decrease in the number of shares outstanding,
which, in turn caused the per share distribution to increase.
98
February 2001 Common Share Offering
On February 6, 2001, the Company sold to the public 3.8 million Common
Shares at a price of $23.07 per share. Net proceeds on the 3.8 million shares
approximated $82.6 million. The net proceeds from this offering will be used for
general corporate purposes, including new investments and working capital.
Preferred Share Redemption
In accordance with the Company's operating agreement, the Preferred Shares
and the Preferred CD Shares must be partially redeemed when any bond
attributable to the shares is sold, or beginning in the year 2000, when any bond
attributable to the shares reaches par value (which includes accrued but unpaid
base interest under the original bond terms and accrued but unpaid interest
under the then current bond terms) based on receipt of an appraisal securing the
bond. The Company must redeem the Preferred Shares and Preferred CD Shares
within six months of the occurrence of a redemption event. Four bonds
attributable to Series I Preferred Shares and Preferred CD Shares and four bonds
attributable to Series II Preferred Shares and Preferred CD Shares reached par
value in December 2000. As a result, in June 2001, the Company redeemed
approximately 26% and 56% of the Series I and Series II Preferred Shares and
Preferred CD Shares, respectively.
NOTE 15 - EARNINGS PER SHARE
A single presentation of basic earnings per share ("EPS") is presented for
Preferred Shares and Preferred CD Shares because there were no potentially
dilutive shares outstanding during the periods presented. EPS for Preferred
Shares and Preferred CD Shares is calculated by dividing net income allocable to
the shares by the weighted-average number of shares outstanding.
A dual presentation of basic and diluted EPS is presented for Common
Shares. Basic EPS is calculated by dividing net income allocable to Common
Shares by the weighted-average number of common shares outstanding. The
calculation of diluted EPS is similar to that of basic EPS except that the
denominator is increased to include the number of additional shares that would
have been outstanding if the deferred shares had vested, options granted had
been exercised and the Preferred Shares and Preferred CD Shares had been
converted to Common Shares. Accordingly, the numerator is adjusted to add back
the income allocable to the Preferred Shares and Preferred CD Shares, as well as
the Term Growth Shares, which would have been allocated to Common Shares as a
result of the conversion of these shares. The diluted EPS calculation does not
assume conversion if the conversion would have an anti-dilutive effect on EPS.
The tables at the end of this note reconcile the numerators and denominators in
the basic and diluted EPS calculations for 2001, 2000 and 1999.
At December 31, 2000 and 1999, options to purchase 12,500 and 25,000 Common
Shares, respectively, were not included in the computation of diluted EPS
because the options' exercise prices were greater than the average price of the
Common Shares for the period.
99
Municipal Mortgage & Equity, LLC
Reconciliation of Basic and Diluted EPS
For the year ended December 31, 2001 For the year ended December 31, 2000
Income Shares Per Share Income Shares Per Share
(Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
----------- ------------- --------- ----------- ------------- ---------
(In thousands, except share
and per share data)
Basic EPS
Income allocable to common shares $ 23,847 21,204,209 $ 1.12 $ 29,076 17,459,829 $ 1.67
====== ======
Effect of Dilutive Securities
Options and deferred shares -- 496,450 -- 408,560
Earnings contingency -- 69,266 -- 39,216
Convertible preferred shares
to the extent dilutive 3 34,261 309 180,761
-------- ---------- -------- ----------
Diluted EPS
Income allocable to common shares
plus assumed conversions $ 23,850 21,804,186 $ 1.09 $ 29,385 18,088,366 $ 1.62
======== ========== ====== ======== ========== ======
For the year ended December 31, 1999
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ---------
(In thousands, except share
and per share data)
Basic EPS
Income allocable to common shares $ 28,796 16,922,788 $ 1.70
======
Effect of Dilutive Securities
Options and deferred shares -- 262,010
Earnings contingency -- --
Convertible preferred shares
to the extent dilutive 864 555,873
-------- ----------
Diluted EPS
Income allocable to common shares
plus assumed conversions $ 29,660 17,740,671 $ 1.67
======== ========== ======
100
NOTE 16 - RELATED PARTY TRANSACTIONS
Pension Fund Advisory Business
A subsidiary of the Company functions as an investment advisor for several
pension funds and profit-sharing trusts. Since 1991, these funds and trusts have
provided short-term debt financing to Midland through the Group Trust. The Group
Trust was formed by these pension funds in order to facilitate their lending to
Midland in accordance with their internal policy requirements. In 2000, these
same pension funds established MMER in order to participate as equity investors
in a portfolio of income-producing multifamily real estate properties. MMER has
also extended working capital lines of credit to Midland in order to increase
MMER's return on its capital base pending the investment of those funds in
equity real estate.
The various credit lines established by the Group Trust and MMER are
described in detail in Note 11. As of December 31, 2001, these credit lines
totaled $200.0 million, and loans outstanding to various subsidiaries of the
Company totaled $105.3 million. For the years ended December 31, 2001, 2000 and
1999, the Company recorded interest expense on these borrowing arrangements of
$11.3 million, $ 13.0 million, and $11.7 million, respectively.
The Group Trust and MMER engage in business transactions exclusively with
the Company. Three of the five trustees of the Group Trust (Mr. Michael L.
Falcone, the Company's President and Chief Operating Officer, Mr. Robert J.
Banks, the Company's Vice Chairman, and Mr. Keith J. Gloeckl, the Company's
Chief Investment Officer) are officers of the Company. In addition, three of the
five trustees of MMER (Messrs. Falcone, Banks and Gloeckl) are Company officers.
Consequently, the Group Trust and MMER are deemed to be affiliates of the
Company.
In addition to the liquidity provided by the Group Trust and MMER working
capital lines of credit, the Company earns advisory and management fees from
them. For the years ended December 31, 2001, 2000, and 1999, respectively, the
Company's fees from the Group Trust totaled $2.0 million, $1.0 million and $1.6
million. For the years ended December 31, 2001, the Company's fees from MMER
totaled $30,000.
The Company believes that special purpose entities such as the Group Trust
and MMER are attractive investment vehicles for pension funds and other
sophisticated institutional investors because they enable those investors to
benefit from the Company's specialized real estate experience while permitting
them to tailor collateral, reporting and other features of the investment
vehicle to their specific interests. Accordingly, the Company intends to
continue to market its services to such investors. In addition, the Company and
the investors in the Group Trust and MMER may agree to increase or decrease the
size, or change the investment purposes, of those investment vehicles from time
to time.
The Shelter Group
Mr. Mark K. Joseph, the Company's Chief Executive Officer and Chairman of
its Board of Directors, controls and is an officer of Shelter Development
Holdings, Inc. ("Shelter Holdings") which, together with its affiliates
(collectively, the "Shelter Group"), engages in real estate development and
provides property management services to a wide variety of commercial and
residential properties. One of the Shelter Group companies provides property
management functions for a number of properties that serve as collateral for the
Company's bond investments. Mr. Falcone
101
had an ownership interest in and was board member of this entity until he
relinquished these positions in 2000.
The Shelter Group receives fees pursuant to management contracts for
properties which it manages. During 2001, Shelter had 12 property management
contracts for properties that collateralize the Company's investments with fees
at or below market rates. During 2000, there were 12 affiliated property
management contracts for properties that collateralize the Company's investments
with fees at or below market rates. During the years ended December 31, 2001,
2000 and 1999, these fees approximated $1.1 million, $1.3 million, and $1.1
million, respectively. Of the 12 property management contracts with the Shelter
Group in effect as of December 31, 2001, seven were for properties which had
been under the management of the Shelter Group since prior to the formation of
the Company, and three were for properties whose prior managers were replaced
due to poor performance.
Consistent with the Company's Amended and Restated Certificate of Formation
and Operating Agreement (the "Operating Agreement"), each affiliate property
management contract is presented to the independent members of the Board of
Directors for approval with information documenting the comparability of the
proposed fees to those in the market area of the property.
Mr. Joseph has agreed to abstain from any involvement, as a partner in the
Shelter Group, in the structuring or review of any contracts or transactions
between the Shelter Group and the Company. He has likewise agreed to recuse
himself from review or involvement, as an officer or director of the Company, in
contracts and transactions involving the Shelter Group. The Company's Board of
Directors has approved all contracts and transactions involving the Shelter
Group and conducts an annual review of all property management contracts between
the Shelter Group and any properties that collateralize the Company's
investments.
Management of Defaulted Assets
In certain circumstances involving the Company's tax-exempt bonds,
borrowers have defaulted on their debt obligations to the Company. In such
circumstances the Company has, after evaluating its options, chosen not to
foreclose on the property. Instead, the Company has negotiated the transfer of a
property's deed in lieu of foreclosure to, or replaced the general partner of a
property with, an entity affiliated with the Company. The Company has done so in
order to preserve the original tax-exempt bond obligations and its participation
in cash flow from the property, consistent with its overall goal of providing
tax-exempt income to its shareholders.
Following the transfer of the property's deed to an affiliated entity, that
entity controls the collateral for certain investments held by the Company.
These affiliated entities are controlled by or managed by certain officers of
the Company. The following table outlines these affiliate relationships at
December 31, 2001:
102
Number of Properties Owned Carrying Value of Company's
Affiliate Entity (directly or indirectly) Investment at December 31, 2001
- ---------------- ------------------------ -------------------------------
SCA Successor, Inc. (1) 4 $ 43,540,000
SCA Successor II, Inc. (1) 11 54,958,000
MMA Affordable Housing Corporation (2) 2 45,649,000
MuniMae Foundation, Inc (3) /
MMA Successor I, Inc. (1) 3 23,872,000
-- ----------
Total 20 $168,019,000
== ============
(1) These corporations are general partners of the operating partnerships whose
property collateralizes the Company's investments. Mr. Joseph controls the
general partners of these operating partnerships and Mr. Falcone serves as
director in three such general partners. Ms. Angela A. Barone, the Company's
Vice President of Finance and Budgeting, serves as an officer in one such
general partner.
(2) MMA Affordable Housing Corporation ("MMAHC") is a 501(c)(3) non-profit
entity organized to provide charitable donations on behalf of the Company. Mr.
Joseph is the Chairman and one of five directors of the MMAHC. Mr. Falcone, Mr.
Gary A. Mentesana, the Company's Chief Capital Officer, and Mr. Earl W. Cole,
III, Senior Vice President of the Company, are also officers and directors of
MMAHC.
(3) MuniMae Foundation Inc., is a private non-profit entity organized to provide
charitable donations on behalf of the Company. Mr. Joseph is the President and
one of four directors of the MuniMae Foundation. Mr. Falcone and Mr. Mentesana
are the other directors of the MuniMae Foundation.
None of the officers of the Company who serve as directors or officers of
the affiliated entities listed above is compensated for his services as officer
or director thereof or derives any other economic benefit from those entities
except for Mr. Joseph, who controls the general partner of SCA Successor I,
Inc., SCA Successor II, Inc. and MMA Successor I, Inc.
Such entities could have interests that do not fully coincide with, or even
are adverse to, the interests of the Company. Such entities could choose to act
in accordance with their own interests, which could adversely affect the
Company. Among the actions such entities could desire to take might be selling a
property, thereby causing a redemption event, at a time and under circumstances
that would not be advantageous to the Company.
Other Relationships
The Company leases office space from an affiliate. Mr. Joseph and a member
of the Company's Board of Directors have ownership interests in the partnership
that leases the office space to the Company. For the years ended December 31,
2001, 2000 and 1999, the Company paid $208,000, $178,000 and $178,000,
respectively, in rental lease payments under the lease agreement.
In 1998 and 1999, the Company sold certain taxable demand notes related to
11 operating partnerships whose general partners are controlled by Mr. Joseph
(discussed above). In order to facilitate the sale of the demand notes, the
Company provided a guaranty on behalf of the operating partnerships for the full
and punctual payment of interest and principal due under the demand notes.
Shelter Development Holdings, Inc. (the "Special Shareholder") is
personally liable for the obligations and liabilities of the Company. Mr. Joseph
owns 100% of the Special Shareholder. In the event that a business combination
or change in control occurs, and the Special Shareholder does not approve of
such transaction, the Special Shareholder has the right to terminate its status
as the
103
Special Shareholder. In the event of such termination, the Company would be
obligated to pay the Special Shareholder $1.0 million.
In 2000 and 2001, prior to his employment with the Company, Mr. William S.
Harrison, Senior Vice President and Chief Financial Officer of the Company,
provided consulting services to the Company through a corporation wholly owned
by Mr. Harrison. The Company paid approximately $31,000 and $79,000 in 2001 and
2000, respectively, for these services.
A member of the Company's Board of Directors is the managing general
partner of the law firm of Gallagher, Evelius and Jones LLP ("GEJ"), which
provides corporate and real estate legal services to the Company. For the year
ended December 31, 2001, $1.6 million in legal fees to GEJ was generated by
transactions structured by the Company of which $1.0 million was directly
incurred by the Company. The total amount of $1.6 million represented 12.6% of
GEJ's total revenues for 2001.
An affiliate of Merrill Lynch owns 1,250 Term Growth Shares of the Company.
The Company may from time to time enter into various investment banking,
financial advisory and other commercial services with Merrill Lynch for which
Merrill Lynch receives and will receive customary compensation. The Company also
enters into various RITES(SM) and interest rate swap transactions with Merrill
Lynch on terms generally available in the marketplace.
The Company is the general partner in various partnerships that provide
low-income tax credits for investors. The Company sells the limited partner
interests in these partnerships to third party investors. In addition, the
Company may provide certain performance guarantees on the underlying properties
owned by the partnerships. The Company receives management fees from these
partnerships. For the year ended December 31, 2001, 2000, and 1999, the Company
earned $2.4 million, $1.9 million and $1.4 million in management fees,
respectively.
For the year ended December 31, 2001, the Company made a $600,000
charitable contribution to the MMA Affordable Housing Corporation discussed
above.
NOTE 17 - NON-EMPLOYEE DIRECTORS' SHARE PLAN AND EMPLOYEE INCENTIVE PLANS
Non-Employee Directors' Share Plans
At December 31, 2001, the total number of shares authorized to be granted
under the non-employee directors' share plans was 250,000 shares. The
non-employee directors' plans provide a means to attract and retain highly
qualified persons to serve as non-employee directors of the Company. Under the
directors' plans, an option to purchase 7,000 Common Shares is granted to each
director when first elected or appointed to the Board of Directors and an option
to purchase 5,000 common shares on the date of each annual meeting of
shareholders. The exercise price of such options will be equal to 100% of the
fair market value of the Common Shares on the date of grant. Options expire at
the earlier of ten years after the date of grant or one year after the date a
director ceases to serve as such. The options become exercisable in full on the
first anniversary of the date of grant. At December 31, 2001, 107,500 options
were outstanding under the directors' plans with exercise prices of $14.875 to
$23.51. The weighted average remaining contractual life for these outstanding
104
options was 7.7 years at December 31, 2001. The following table summarizes the
activity relating to options issued under the directors' plans for the years
ended December 31, 2001, 2000 and 1999:
Non-Employee Directors' Share Plans
Number of Weighted Average
Shares Exercise Price
-------- ----------------
Options outstanding at December 31, 1998 37,000 $ 17.81
Granted 15,000 19.58
Exercised (4,500) 15.95
Expired -- --
-------- -------
Options outstanding at December 31, 1999 47,500 18.47
Granted 30,000 19.75
Exercised -- --
Expired -- --
-------- -------
Options outstanding at December 31, 2000 77,500 $ 19.03
Granted 30,000 23.51
Exercised -- --
Expired -- --
-------- -------
Options outstanding at December 31, 2001 107,500 $ 20.28
======== =======
Options exercisable at:
December 31, 1999 32,500 $16.07
December 31, 2000 47,500 18.58
December 31, 2001 77,500 19.03
105
The directors' plans also entitle each director to elect to receive payment
of director's fees in the form of Common Shares, based on their fair market
value on the date of payment, in lieu of cash payment of such fees. Such shares
may also be paid on a deferred basis, whereby the shares payable are credited to
the account of the director, and future distributions payable with respect
thereto are paid in the form of additional share credits based upon the fair
market value of the Common Shares on the record date of the distribution
payment. As of December 31, 2001, 5,061 Common Shares and 22,254 deferred shares
had been issued to directors in lieu of cash payments for director fees. As of
December 31, 2001, there were 110,185 shares available under the directors'
plans.
Share Incentive Plans
At December 31, 2001, 2,622,033 shares were authorized to be issued under
the share incentive plans. The Company's share incentive plans provide a means
to attract, retain and reward executive officers and other key employees of the
Company, to link employee compensation to measures of the Company's performance
and to promote ownership of a greater proprietary interest in the Company. The
plans authorize grants of a broad variety of awards, including non-qualified
stock options, share appreciation rights, restricted shares, deferred shares and
shares granted as a bonus or in lieu of other awards. Shares issued as
restricted shares and as awards, other than options (including restricted
shares), may not exceed 20% and 40% of the total reserved under the plans. As of
December 31, 2001, there were 991,655 shares available under the plans.
Common Share Options
The exercise price of Common Share options granted under the plans is equal
to 100% of the fair market value of the Common Shares on the date of grant. The
options vest over three years. In the event of a change in control of the
Company (as defined in the plans), the options shall become immediately and
fully exercisable. In addition, the Company may, at any time, accelerate the
exercisability of all or a specified portion of the options. Generally, the
options expire ten years from the date of grant. However, options will expire
immediately upon the termination of employment for cause and three months after
termination of employment for reasons other than death, disability or normal or
early retirement. In the event of death, disability or retirement, the options
will expire one year after the date of such event. At December 31, 2001, 996,970
options were outstanding under the plans with exercise prices of $16.875 to
$22.55. The weighted average remaining contractual life for these outstanding
options was 6.9 years at December 31, 2001. The following table summarizes the
activity relating to options issued under the plans for the years ended December
31, 2001, 2000 and 1999:
106
Employee Share Incentive Plans
Number of Weighted Average
Shares Exercise Price
---------- ----------------
Options outstanding at December 31, 1997 677,470 $ 16.99
Granted 122,500 18.43
Exercised (16,666) 16.88
Expired/Forfeited (74,000) 16.99
--------- -------
Options outstanding at December 31, 1998 709,304 17.24
Granted -- --
Exercised -- --
Expired/Forfeited -- --
--------- -------
Options outstanding at December 31, 1999 709,304 17.24
Granted 420,000 18.75
Exercised (52,034) 17.20
Expired/Forfeited (5,000) 19.00
--------- -------
Options outstanding at December 31, 2000 1,072,270 $ 17.82
Granted 75,000 22.35
Exercised (147,800) 17.28
Expired/Forfeited (2,500) 17.38
--------- -------
Options outstanding at December 31, 2001 996,970 $ 18.25
========= =======
Options exercisable at:
December 31, 1999 401,814 $ 17.14
December 31, 2000 615,103 17.16
December 31, 2001 637,970 17.68
Common Share Appreciation Rights
On November 11, 1997, 3,000 Common Share appreciation rights ("SARs") were
awarded to certain employees under the plans. The exercise price of the SARs was
equal to 100% of the fair market value of the Common Shares ($19 per share) on
the date of grant and are exercisable for cash only. The SARs vest over three
years and generally expire ten years from the date of grant. In the event of a
change in control of the Company (as defined in the plans), the SARs shall
become immediately and fully exercisable. In addition, the Company may, at any
time, accelerate the exercisability of all or a specified portion of the SARs.
However, the SARs will expire immediately upon the termination of employment for
cause and three months after termination of employment for reasons other than
death, disability or normal or early retirement. In the event of death,
disability or retirement, the SARs will expire one year after such event. As of
December 31, 2001, 3,000 SARs had vested.
107
Deferred Shares
The Company granted 63,050, 93,500, and 78,000 deferred share awards with a
total fair value of $1.4 million, $1.8 million, and $1.4 million for the years
ended December 31, 2001, 2000 and 1999, respectively. The deferred shares vest
over three to ten years, as outlined in the individual award agreements. The
deferred share awards also provide for accelerations of vesting on a
discretionary basis, upon a change in control and death or disability. As of
December 31, 2001, 191,148 deferred shares had vested. The Company recorded
unearned compensation equal to the fair market value of the awards, which is
shown as a separate component of shareholders' equity. Unearned compensation is
being amortized into expense over the vesting period. For the years ended
December 31, 2001, 2000 and 1999, the Company recognized compensation expense of
$1.4 million, $1.1 million and $0.9 million, respectively, relating to the
deferred shares.
Compensation Expense
The Company applies Accounting Principles Board Opinion No. 25, "Accounting
for Stock issued to Employees," in accounting for both the non-employee director
plan and the employee share incentive plan. Accordingly, no compensation expense
has been recognized for the options issued under either plan during 2001, 2000
or 1999. Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("FAS 123"), requires the Company to make certain disclosures as
if the compensation expense for the Company's plans had been determined based on
the fair market value on the date of grant for awards under those plans.
Accordingly, the Company estimated the grant-date fair value of each option
awarded in 2001, 2000 and 1999 using the Black-Scholes option-pricing model with
the following weighted-average assumptions: dividend yield of 6.8%, 7.5% and
8.7% for 2001, 2000 and 1999, respectively, expected volatility of 19%, 19% and
16% for 2001, 2000 and 1999, respectively, risk-free interest rate of 5%, 5% and
6% for 2001, 2000 and 1999, respectively, and expected lives of 7.5 years. Had
2001, 2000 and 1999 compensation expense been determined including the
weighted-average estimate of the fair value of each option granted of $2.67,
$2.72 and $0.77, respectively, the Company's net income allocable to Common
Shares would be reduced to a pro forma amount of $23.6 million, $27.9 million
and $28.8 million, respectively. Pro forma basic and diluted earnings per Common
Share would be $1.11 and $1.08, respectively for 2001, $1.60 and $1.56,
respectively for 2000 and $1.70 and $1.67, respectively, for 1999.
NOTE 18 - MUNIMAE COMPENSATION TRUST
In December 1998, the Company established a $2.25 million newly formed
grantor trust, Municipal Mortgage & Equity, LLC Employee Compensation Trust
("MuniMae Compensation Trust"). The MuniMae Compensation Trust was established
to pre-fund future share related obligations of the Company's employee and
director share plans. The MuniMae Compensation Trust supports existing,
previously approved share plans and does not change those plans or the amount of
shares expected to be issued under those plans.
For financial reporting purposes, MuniMae Compensation Trust is
consolidated with the Company. The Common Shares held by the MuniMae
Compensation Trust are included in the Treasury Shares. All distributions
between the Company and the MuniMae Compensation Trust are eliminated. The
MuniMae Compensation Trust did not purchase any Common Shares during 2001.
108
In 2001, 1,509 Common Shares were issued to employees and directors in
accordance with award agreements granted under the Company's share plans (see
Note 17). During 2000, the MuniMae Compensation Trust purchased 9,042 Common
Shares at an average price of $21.09. In 2000, 94,279 Common Shares were issued
to employees and directors in accordance with award agreements granted under the
Company's share plans. During 1999, the MuniMae Compensation Trust purchased
30,000 Common Shares at an average price of $19.37. In 1999, 37,756 Common
Shares were issued to employees and directors in accordance with award
agreements granted under the Company's share plans.
NOTE 19 - SERVICING PORTFOLIO
Trust and Escrow Funds
The Company maintains certain escrow accounts and trust accounts related to
principal and interest payments and to escrow funds received but not yet
remitted to investors or others on loans serviced by the Company. These accounts
are segregated into special accounts and are excluded from the Company's assets
and liabilities.
Loans and Bonds Serviced
The Company serviced loans and bonds totaling $2.2 billion, $1.9 billion
and $1.6 billion in outstanding principal at December 31, 2001, 2000 and 1999,
respectively. The fees earned by the Company for servicing these loans are based
on a percentage of the unpaid principal balance of the loans. These loans
include approximately $584.6 million and $403.9 million in loans where the
Company has a risk-sharing agreement with certain lenders at December 31, 2001
and 2000, respectively. Under the risk-sharing agreement, the Company is
responsible for up to 20% of the loan loss on all the loans covered by the
agreement. The Company monitors the loans in the servicing portfolio for
potential losses. If the Company determines a loss is probable and can be
reasonably estimated, a loss reserve is recorded through a charge to the income
statement. At December 31, 2001 and 2000, management determined that no
allowance for possible loan losses on the servicing portfolio was necessary. The
Company will continue to evaluate the need for allowance for loan losses in the
future as circumstances dictate.
NOTE 20 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of the Company's financial instruments are
included in the table at the end of this note.
The carrying amounts in the table correspond to amounts included in the
accompanying balance sheets. The following methods or assumptions were used by
the Company in estimating the fair values of financial statement instruments:
Cash and cash equivalents, investment in mortgage bonds and investment in other
bond related investments - The carrying amounts reported in the balance sheet
approximate the assets' fair value.
Loans receivable - The fair value of the Company's fixed rate loans was
calculated by discounting the expected cash flows. The discount rates are based
on the interest rate charged to current customers for comparable loans. The
Company's adjustable rate loans reprice frequently at current
109
market rates. Therefore, the fair value of these loans has been estimated to
approximate their carrying value.
Other investments - The estimated fair value of other investments was calculated
by discounting contractual cash flows for current prepayment estimates using a
market discount rate.
Notes payable - The estimated fair value of the Company's fixed rate notes
payable was calculated by discounting contractual cash flows. The discount rates
were based on the interest rates paid to current lenders for comparable notes
payable. The Company's adjustable rate notes payable reprice frequently at
current market rates. Therefore, the fair value of these notes payable has been
estimated to approximate their carrying value.
Commitments to extend credit - Fair value of commitments to extend credit are
based on interest rates currently charged to enter into similar agreements,
taking into account the remaining terms of the agreements and the
counterparties' credit standing.
Put options written - Fair value is based on quoted market price of financial
instruments with similar terms adjusted for differences in risk characteristics.
Interest rate swap agreements - Fair value is based on the estimated amount that
the Company would pay or receive to terminate the swap agreement at the balance
sheet date.
Total return swaps - Fair value is based on the estimated amount that the
Company would pay or receive to terminate the swap agreement at the balance
sheet date.
Limitations
The fair value estimates are made at a discrete point in time based on
relevant market information and information about the financial instrument.
Because no market or limited markets exist for a significant portion of the
Company's financial instruments, fair value estimates are based on judgments
regarding future expected loss experience, current economic conditions, risk
characteristics of various financial instruments, and other factors. These
estimates are subjective in nature and involve uncertainties and matters of
significant judgment and therefore cannot be determined with precision. Changes
in assumptions could significantly affect the estimates. In addition, the fair
value estimates are based on existing on- and off-balance sheet financial
instruments without attempting to estimate the value of anticipated future
business and the value of assets and liabilities that are not considered
financial instruments.
110
Municipal Mortgage & Equity, LLC
Summary of Fair Values
(in thousands) December 31, 2001 December 31, 2000
---------------------- -------------------------
Carrying Carrying
Amount Fair Value Amount Fair Value
-------- ---------- --------- ----------
Assets:
Cash and cash equivalents $ 97,373 $ 97,373 $ 27,504 $ 27,504
Investment in tax-exempt bonds, net 616,460 616,460 500,190 500,190
Investment in other bond related investments 13,295 13,295 13,452 13,452
Loans receivable - fixed 417,281 415,943 95,493 92,032
Loans receivable - adjustable 22,750 22,750 253,798 253,798
Other investments 5,488 5,488 5,531 5,531
Restricted assets 16,710 16,710 25,212 25,212
Mortgage servicing rights 9,161 9,161 6,876 6,876
Liabilities:
- ------------
Notes payable - fixed 320,720 321,857 75,295 74,848
Notes payable - adjustable 99,343 99,343 253,864 253,864
Investment in other bond related investments 7,979 7,979 5,702 5,702
Derivative Financial Instruments:
- ---------------------------------
Commitments to extend credit -- 138,054 -- 176,804
Put options written -- -- -- --
Interest rate swaps 15,734 15,734 (10,438) (10,438)
Total return swaps -- -- (1,839) (1,839)
111
NOTE 21 - BUSINESS SEGMENT REPORTING
In the fourth quarter of 1999, the Company adopted Financial Accounting
Standards Board Statement No. 131, "Disclosures About Segments of an Enterprise
and Related Information," which establishes standards for reporting information
about a company's operating segments. In October 1999, as a result of the
Midland acquisition, the Company restructured its operations into two business
segments: (1) an operating segment consisting of Midland and other subsidiaries
that primarily generate taxable fee income by providing loan servicing, loan
origination and other related services and (2) an investing segment consisting
primarily of subsidiaries holding investments producing tax-exempt interest
income. The accounting policies of the segments are the same as those described
in the summary of significant accounting policies.
The revenues associated with the investing segment consist primarily of
interest earned on tax-exempt bonds, other bond related investments and certain
short-term taxable loans and investments. The revenues associated with the
operating segment consist primarily of loan servicing and loan origination fees
for the Company's own portfolio and for portfolios of third parties, syndication
and brokerage fees associated with tax credit syndications, taxable interest and
fees earned on construction lending activities and other fee income associated
with highly leveraged transactions such as put options. Segment results include
all direct revenues and expenses of each segment and allocations of indirect
expenses based on specific methodologies. The Company's reportable segments are
strategic business units that primarily generate different income streams and
are managed separately. The majority of the income generated by the operating
segment was acquired as a unit and the management of such unit was retained.
112
Municipal Mortgage & Equity, LLC
Segment Reporting for the years ended December 31, 2001, 2000, and 1999
(in thousands)
2001
----------------------------------------------------
Total
Investing Operating Adjustments Consolidated
--------- --------- ----------- ------------
INCOME:
Interest on tax-exempt bonds and
other bond related investments $ 50,732 $ 2,711 $ -- $ 53,443
Interest on loans 2,798 30,542 -- 33,340
Loan origination and brokerage fees -- 6,412 (820)(1) 5,592
Syndication fees -- 7,036 -- 7,036
Loan servicing fees -- 6,982 -- 6,982
Interest on short-term investments 2,045 1,036 -- 3,081
Other income -- 8,067 -- 8,067
Net gain on sales 2,339 5,883 -- 8,222
-------- ------- ----- ---------
Total income 57,914 68,669 (820) 125,763
-------- ------- ----- ---------
EXPENSES:
Salaries and benefits 1,996 19,385 -- 21,381
Professional Fees 1,094 3,092 -- 4,186
Operating expenses 831 7,011 -- 7,842
Goodwill and other intangibles amortization -- 2,509 -- 2,509
Interest expense 6,053 24,643 -- 30,696
Other-than-temporary impairments related to investments in
tax-exempt bonds and other bond related investments -- 3,256 -- 3,256
-------- ------- ----- ---------
Total expenses 9,974 59,896 -- 69,870
-------- ------- ----- ---------
Net holding losses on trading securities (5,572) -- -- (5,572)
Net income before income taxes, income allocated to
preferred shareholders in a subsidiary company, and
cumulative effect of accounting change 42,368 8,773 (820) 50,321
Income taxes -- 1,383 -- 1,383
-------- ------- ----- ---------
Net income before income allocated to preferred
shareholders in a subsidiary company and cumulative
effect of accounting change 42,368 7,390 (820) 48,938
Income allocable to preferred shareholders in a subsidiary company 10,779 -- -- 10,779
-------- ------- ----- ---------
Net income before cumulative effect of accounting
change 31,589 7,390 (820) 38,159
Cumulative effect on prior year changes in accounting for
derivative financial instruments (12,277) -- -- (12,277)
-------- ------- ----- ---------
Net income $ 19,312 $ 7,390 $(820) $ 25,882
======== ======= ===== =========
2000
----------------------------------------------------
Total
Investing Operating Adjustments Consolidated
--------- --------- ----------- ------------
INCOME:
Interest on tax-exempt bonds and
other bond related investments $41,316 $ 1,761 $ -- $ 43,077
Interest on loans 1,451 30,306 -- 31,757
Loan origination and brokerage fees -- 5,303 (1,545)(1) 3,758
Syndication fees -- 4,918 -- 4,918
Loan servicing fees -- 5,621 -- 5,621
Interest on short-term investments 3,106 1,285 -- 4,391
Other income -- 5,209 -- 5,209
Net gain on sales 191 1,930 -- 2,121
------- ------- ------- --------
Total income 46,064 56,333 (1,545) 100,852
------- ------- ------- --------
EXPENSES:
Salaries and benefits 1,533 13,767 -- 15,300
Professional Fees 820 2,657 -- 3,477
Operating expenses 997 4,975 -- 5,972
Goodwill and other intangibles amortization -- 1,887 -- 1,887
Interest expense 4,095 27,057 -- 31,152
Other-than-temporary impairments related to investments in
tax-exempt bonds and other bond related investments 1,008 -- -- 1,008
------- ------- ------- --------
Total expenses 8,453 50,343 -- 58,796
------- ------- ------- --------
Net holding losses on trading securities -- -- -- --
Net income before income taxes, income allocated to
preferred shareholders in a subsidiary company, and
cumulative effect of accounting change 37,611 5,990 (1,545) 42,056
Income taxes -- 2,006 -- 2,006
------- ------- ------- --------
Net income before income allocated to preferred
shareholders in a subsidiary company and cumulative
effect of accounting change 37,611 3,984 (1,545) 40,050
Income allocable to preferred shareholders in a subsidiary company 8,475 -- -- 8,475
------- ------- ------- --------
Net income before cumulative effect of accounting
change 29,136 3,984 (1,545) 31,575
Cumulative effect on prior year changes in accounting for
derivative financial instruments -- -- -- --
------- ------- ------- --------
Net income $29,136 $ 3,984 $(1,545) $ 31,575
======= ======= ======= ========
1999
----------------------------------------------------
Total
Investing Operating Adjustments Consolidated
--------- --------- ----------- ------------
INCOME:
Interest on tax-exempt bonds and
other bond related investments $35,281 $ 154 $ -- $35,435
Interest on loans 1,901 4,642 -- 6,543
Loan origination and brokerage fees 763 1,238 (421)(1) 1,580
Syndication fees -- 2,345 -- 2,345
Loan servicing fees 794 965 -- 1,759
Interest on short-term investments 1,649 199 -- 1,848
Other income 505 851 -- 1,356
Net gain on sales 2,680 -- -- 2,680
------- ------- ----- -------
Total income 43,573 10,394 (421) 53,546
------- ------- ----- -------
EXPENSES:
Salaries and benefits 3,646 3,100 -- 6,746
Professional Fees 1,285 413 -- 1,698
Operating expenses 661 710 -- 1,371
Goodwill and other intangibles amortization -- 297 -- 297
Interest expense 2,591 4,074 -- 6,665
Other-than-temporary impairments related to investments in
tax-exempt bonds and other bond related investments 1,120 -- -- 1,120
------- ------- ----- -------
Total expenses 9,303 8,594 -- 17,897
------- ------- ----- -------
Net holding losses on trading securities
Net income before income taxes, income allocated to
preferred shareholders in a subsidiary company, and
cumulative effect of accounting change 34,270 1,800 (421) 35,649
Income taxes -- 703 -- 703
------- ------- ----- -------
Net income before income allocated to preferred
shareholders in a subsidiary company and cumulative
effect of accounting change 34,270 1,097 (421) 34,946
Income allocable to preferred shareholders in a subsidiary compan 3,433 -- -- 3,433
------- ------- ----- -------
Net income before cumulative effect of accounting
change 30,837 1,097 (421) 31,513
Cumulative effect on prior year changes in accounting for
derivative financial instruments -- -- -- --
------- ------- ----- -------
Net income $30,837 $ 1,097 $(421) $31,513
======= ======= ===== =======
Notes:
(1) Adjustments represent origination fees on purchased investments which are
deferred and amortized into income over the life of the investment.
(2) The Operating segments represents activity from October 1, 1999 through
December 31, 1999 as segment reporting was adopted in the fourth quarter of
1999.
113
NOTE 22 - SUBSEQUENT EVENTS
February 2002 Common Share Offering
On February 8, 2002, the Company sold to the public 3.0 million Common
Shares at a price of $24.70 per share and granted the underwriters an option to
purchase up to an aggregate of 450,000 Common Shares to cover over-allotments at
the same price. Net proceeds on the 3.0 million shares approximated $70.5
million. On February 15, 2002, the underwriters exercised their option to
purchase 300,000 Common Shares generating net proceeds of approximately $7.1
million. The net proceeds from this offering will be used for general corporate
purposes, including new investments and working capital.
Preferred Share Redemption
In accordance with the Company's Operating Agreement, the Preferred Shares
and the Preferred CD Shares must be partially redeemed when any bond
attributable to the shares is sold or repaid or, beginning in the year 2000,
when any bond attributable to the shares reaches par value based on receipt of
an appraisal securing the bond. The Company must redeem the Preferred Shares and
Preferred CD Shares within six months of the occurrence of a redemption event.
In addition to the bonds that reached par value in December 2000 (discussed
in Note 14), the remaining bonds attributable to the shares were either paid
off, sold and/or reached par value during the last four months of 2001 and in
January 2002. As a result, in March 2002, the Company redeemed the remaining
Series I and Series II Preferred Shares and Preferred CD Shares at an aggregate
cost of approximately $19.3 million. The Operating Agreement also requires that
the Term Growth shares be redeemed after the last Preferred Share is redeemed.
As a result, the Term Growth shares, which had no residual value were redeemed
in 2002.
114
NOTE 23 - QUARTERLY RESULTS (unaudited)
(in thousands, except per share data)
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
----------- ----------- ----------- -----------
Year ended December 31, 2001:
Total income $ 29,268 $ 30,374 $ 32,289 $ 33,832
Net income (loss) (8,565) 12,326 7,119 15,002
Net income (loss) per share:
Preferred shares:
Series I 11.00 13.21 23.19 10.99
Series II 6.28 8.34 0.04 4.59
Preferred capital distribution shares:
Series I 9.10 9.27 22.91 9.75
Series II 3.50 0.82 2.10 (0.21)
Common shares:
Basic (0.45) 0.55 0.30 0.67
Diluted (0.44) 0.54 0.29 0.65
Common share Market Price Data:
High 24.31 23.50 25.25 25.80
Low 21.75 22.09 22.96 23.10
Year ended December 31, 2000:
Total income $ 21,245 $ 21,959 $ 25,872 $ 31,776
Net income 7,617 7,035 7,773 9,150
Net income per share:
Preferred shares:
Series I 14.94 13.65 12.97 14.69
Series II 12.80 11.61 10.68 30.22
Preferred capital distribution shares:
Series I 11.54 10.50 9.78 11.52
Series II 8.31 6.67 6.12 25.63
Common shares:
Basic 0.40 0.37 0.41 0.49
Diluted 0.40 0.36 0.40 0.46
Common share Market Price Data:
High 20.00 20.63 21.88 23.50
Low 18.19 18.88 20.13 20.25
115
INDEX TO EXHIBITS
Exhibit
Number Document
- ------ --------
21 Subsidiaries of the Registrant
23 Consent of PricewaterhouseCoopers LLP
116