-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, MB+g93OTmKr90QweZoxfqO07/+vzphgst4fQUZk17RYIlqGV2DCRKwH6p29BG+OE ln0IGKELtC1hwoM0qNZf/g== 0000847322-00-000009.txt : 20000421 0000847322-00-000009.hdr.sgml : 20000421 ACCESSION NUMBER: 0000847322-00-000009 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000420 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CRIIMI MAE INC CENTRAL INDEX KEY: 0000847322 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE INVESTMENT TRUSTS [6798] IRS NUMBER: 521622022 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: SEC FILE NUMBER: 001-10360 FILM NUMBER: 605906 BUSINESS ADDRESS: STREET 1: 11200 ROCKVILLE PIKE CITY: ROCKVILLE STATE: MD ZIP: 20852 BUSINESS PHONE: 3018162300 FORMER COMPANY: FORMER CONFORMED NAME: CRI INSURED MORTGAGE ASSOCIATION INC DATE OF NAME CHANGE: 19920703 10-K/A 1 CRIIMI MAE INC. UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 __________________ FORM 10-K/A 1 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 __________________ For the fiscal year ended December 31, 1999 Commission file number 1-10360 CRIIMI MAE INC. (Exact name of registrant as specified in its charter) Maryland 52-1622022 (State or other jurisdiction of (I.R.S. Employer Incorporation or organization) Identification No.) 11200 Rockville Pike Rockville, Maryland 20852 (301) 816-2300 (Address, including zip code, and telephone number, Including area code, of registrant's principal executive offices) __________________ Securities Registered Pursuant to Section 12(b) of the Act: Name of each exchange on Title of each class which registered - ------------------- ----------------------------- Common Stock New York Stock Exchange, Inc. Series B Cumulative Convertible New York Stock Exchange, Inc. Preferred Stock Series F Redeemable Cumulative Dividend New York Stock Exchange, Inc. Preferred Stock Securities registered pursuant to Section 12(g) of the Act: None __________________ Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10K or any amendment to this Form 10K. [ ] As of March 15, 2000, 62,353,170 shares of CRIIMI MAE Inc. common stock (voting) with a par value of $0.01 were outstanding. The aggregate market value (based upon the last reported sale price on the New York Stock Exchange on March 15, 2000) of the shares of CRIIMI MAE Inc. common stock (voting) held by non-affiliates was approximately $61,807,108. (For purposes of calculating the previous amount only, all directors and executive officers of the registrant are assumed to be affiliates.) __________________ Documents Incorporated By Reference None. 2 ITEM 1. BUSINESS FORWARD-LOOKING STATEMENTS. When used in this Annual Report on Form 10-K, the words "believes," "anticipates," "expects," "contemplates" and similar expressions are intended to identify forward-looking statements. Statements looking forward in time are included in this Annual Report on Form 10-K pursuant to the "safe harbor" provision of the Private Securities Litigation Reform Act of 1995. Such statements are subject to certain risks and uncertainties, which could cause actual results to differ materially, including, but not limited to the risk factors contained under the headings "Risk Factors" and "Management's Discussion and Analysis of Financial Condition and Results of Operations" set forth below. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The Company undertakes no obligation to publicly revise these forward-looking statements to reflect events or circumstances occurring after the date hereof or to reflect the occurrence of unanticipated events. General CRIIMI MAE Inc. (together with its consolidated subsidiaries, unless the context otherwise indicates, "CRIIMI MAE" or the "Company") is a fully integrated commercial mortgage company structured as a self-administered real estate investment trust ("REIT"). Prior to the filing by CRIIMI MAE Inc. (unconsolidated) and two of its operating subsidiaries, CRIIMI MAE Management, Inc. ("CM Management"), and CRIIMI MAE Holdings II, L.P. ("Holdings II" and, together with CRIIMI MAE and CM Management, the "Debtors"), for relief under Chapter 11 of the U.S. Bankruptcy Code on October 5, 1998 (the "Petition Date") as described below, CRIIMI MAE's primary activities included (i) acquiring non-investment grade securities (rated below BBB- or unrated) backed by pools of commercial mortgage loans on multifamily, retail and other commercial real estate ("Subordinated CMBS"), (ii) originating and underwriting commercial mortgage loans, (iii) securitizing pools of commercial mortgage loans and resecuritizing pools of Subordinated CMBS, and (iv) through the Company's servicing affiliate, CRIIMI MAE Services Limited Partnership ("CMSLP"), performing servicing functions with respect to the mortgage loans underlying the Company's Subordinated CMBS. Since filing for Chapter 11 protection, CRIIMI MAE has suspended its Subordinated CMBS acquisition, origination and securitization programs. The Company continues to hold a substantial portfolio of Subordinated CMBS, originated loans and mortgage securities and, through CMSLP, acts as a servicer for its own as well as third party securitized mortgage loan pools. In addition to the two operating subsidiaries which filed for Chapter 11 protection along with the Company, the Company owns 100% of multiple financing and operating subsidiaries as well as various interests in other entities (including CMSLP) which either own or service mortgage and mortgage-related assets (the "Non-Debtor Affiliates"). See Note 3 of the Notes to Consolidated Financial Statements. None of the Non-Debtor Affiliates has filed for bankruptcy protection. The Company was incorporated in Delaware in 1989 under the name CRI Insured Mortgage Association, Inc. ("CRI Insured"). In July 1993, CRI Insured changed its name to CRIIMI MAE Inc. and reincorporated in Maryland. In June 1995, certain mortgage businesses affiliated with C.R.I., Inc. were merged into CRIIMI MAE (the "Merger"). The Company is not a government sponsored entity nor in any way affiliated with the United States government or any United States government agency. Chapter 11 Filing Prior to the Petition Date, CRIIMI MAE financed a substantial portion of its Subordinated CMBS acquisitions with short-term, variable-rate financing facilities secured by the Company's CMBS. The agreements governing these financing arrangements typically required the Company to maintain collateral with a market value not less than a specified percentage of the outstanding indebtedness ("loan-to-value ratio"). The agreements further provided that the creditors could require the Company to provide cash or additional collateral if the market value of the existing collateral fell below this minimum amount. As a result of the turmoil in the capital markets commencing in late summer of 1998, the spreads between CMBS yields and yields on Treasury securities with comparable maturities began to widen substantially and rapidly. Due to this 3 widening of CMBS spreads, the market value of the CMBS securing the Company's short-term, variable-rate financing facilities declined. CRIIMI MAE's short-term secured creditors perceived that the value of the CMBS securing their facilities with the Company had fallen, creating a value deficiency as measured by the loan-to-value ratio described above and, consequently, made demand upon the Company to provide cash or additional collateral with sufficient value to cure the perceived value deficiency. In August and September of 1998, the Company received and met collateral calls from its secured creditors. At the same time, CRIIMI MAE was in negotiations with various third parties in an effort to obtain additional debt and equity financing that would provide the Company with additional liquidity. On Friday afternoon, October 2, 1998, the Company was in the closing negotiations of a refinancing with one of its unsecured creditors that would have provided the Company with additional borrowings when it received a significant collateral call from Merrill Lynch Mortgage Capital, Inc. ("Merrill Lynch"). The basis for this collateral call, in the Company's view, was unreasonable. After giving consideration to, among other things, this collateral call and the Company's concern that its failure to satisfy this collateral call would cause the Company to be in default under a substantial portion of its financing arrangements, the Company reluctantly concluded on Sunday, October 4, 1998 that it was in the best interests of creditors, equity holders and other parties in interest to seek Chapter 11 protection. On October 5, 1998, the Debtors filed for relief under Chapter 11 of the U.S. Bankruptcy Code in the United States Bankruptcy Court for the District of Maryland, Southern Division, in Greenbelt, Maryland (the "Bankruptcy Court"). These related cases are being jointly administered under the caption "In re CRIIMI MAE Inc., et al.," Ch. 11 Case No. 98-2-3115-DK. While in bankruptcy, CRIIMI MAE has streamlined its operations. The Company has significantly reduced the number of employees in its origination and underwriting operations. In connection with these reductions, the Company closed its five regional loan origination offices. See "BUSINESS-Employees." Although the Company has significantly reduced its work force, the Company recognizes that retention of its executives and other remaining employees is essential to the efficient operation of its business and to its reorganization efforts. Accordingly, the Company has, with Bankruptcy Court approval, adopted an employee retention plan. See "BUSINESS-Employee Retention Plan" and Note 15 of the Notes to Consolidated Financial Statements. CRIIMI MAE is working diligently toward emerging from bankruptcy as a successfully reorganized company. In furtherance of such effort, the Debtors filed (i) a Joint Plan of Reorganization on September 22, 1999, (ii) an Amended Joint Plan of Reorganization and proposed Joint Disclosure Statement on December 23, 1999, and (iii) a Second Amended Joint Plan of Reorganization (the "Plan") and proposed Amended Joint Disclosure Statement (the "Proposed Disclosure Statement") on March 31, 2000. The Plan was filed with the support of the Official Committee of Equity Security Holders of CRIIMI MAE (the "Equity Committee"), which is a co-proponent of the Plan. Subject to the completion of mutually acceptable documentation evidencing the secured financing to be provided by the unsecured creditors (the "Unsecured Creditor Debt Documentation"), the Official Committee of Unsecured Creditors of CRIIMI MAE (the "Unsecured Creditors' Committee") has agreed to support confirmation of the Debtors' Plan. The Company, the Equity Committee and the Unsecured Creditors' Committee are now all proceeding toward confirmation of the Plan. Under the Plan, Merrill Lynch and German American Capital Corporation ("GACC"), two of the Company's largest secured creditors, would provide a significant portion of the recapitalization financing contemplated by the Plan. The Bankruptcy Court has scheduled a hearing for April 25 and 26, 2000 on approval of the Proposed Disclosure Statement. On December 20, 1999, the Unsecured Creditors' Committee filed its own plan of reorganization and proposed disclosure statement with the Bankruptcy Court which, in general, provided for the liquidation of the assets of the Debtors. On January 11, 2000 and February 11, 2000, the Unsecured Creditors' Committee filed its first and second amended plans of reorganization, respectively, with the Bankruptcy Court and amended proposed disclosure statements with respect thereto. However, as a result of successful negotiations between the Debtors and the Unsecured Creditors' Committee, the Unsecured Creditors' Committee has agreed to the treatment of unsecured claims under the Debtors' Plan, subject to completion of mutually acceptable Unsecured Creditor Debt Documentation, and has 4 asked the Bankruptcy Court to defer consideration of its second amended plan of reorganization and second amended proposed disclosure statement. The Plan of Reorganization The Plan contemplates the payment in full of all of the allowed claims of the Debtors primarily through recapitalization financing (including proceeds from CMBS sales) aggregating at least $856 million (the "Recapitalization Financing"). Approximately $275 million of the Recapitalization Financing would be provided by Merrill Lynch and GACC through a secured financing facility, approximately $155 million would be provided through new secured notes issued to some of the Company's major unsecured creditors, and another $35 million would be obtained from another existing creditor in the form of an additional secured financing facility (collectively, the "New Debt"). The sale of select CMBS (the "CMBS Sale"), the proceeds of which are expected to be used to pay down existing debt, is contemplated to provide the balance of the Recapitalization Financing. The Company may seek new equity capital from one or more investors to partially fund the Plan, although new equity is not required to fund the Plan. In connection with the Plan, substantially all cash flows are expected to be used to satisfy principal, interest and fee obligations under the New Debt. The $275 million secured financing would provide for (i) interest at a rate of one month LIBOR plus 3.25%, (ii) principal prepayment/amortization obligations, (iii) extension fees after two years and (iv) maturity on the fourth anniversary of the effective date of the Plan. The Plan contemplates that the $35 million secured financing would provide for terms similar to those referenced in the preceding sentence; however, the proposed lender has not agreed to any terms of the $35 million secured financing and there can be no assurance that an agreement for this financing will be obtained or that, if obtained, the terms will be as referenced above. The approximate $155 million secured financing would be effected through the issuance of two series of secured notes under two separate indentures. The first series of secured notes, representing an aggregate principal amount of approximately $105 million, would provide for (i) interest at a rate of 11.75% per annum, (ii) principal prepayment/amortization obligations, (iii) extension fees after four years and (iv) maturity on the fifth anniversary of the effective date of the Plan. The second series of secured notes, representing an aggregate principal amount of approximately $50 million, would provide for (i) interest at a rate of 13% per annum with additional interest at the rate of 7% per annum accreting over the debt term, (ii) extension fees after four years, and (iii) maturity on the sixth anniversary of the effective date of the Plan. The New Debt described above will be secured by substantially all of the assets of the Company. It is contemplated that there will be restrictive covenants, including financial covenants, in connection with the New Debt. The Plan also contemplates that the holders of the Company's common stock will retain their stock. Under the Plan, no cash dividends, other than a maximum of $4.1 million to preferred shareholders, can be paid to existing shareholders. See "BUSINESS-Effect of Chapter 11 on REIT Status and Other Tax Matters-Taxable Income Distributions" for further discussion. Subject to the respective approvals by the holders of the Company's Series B Cumulative Convertible Preferred Stock (the "Series B Preferred Stock") and the Series F Redeemable Cumulative Dividend Preferred Stock (the "Series F Preferred Stock" or "junior preferred stock"), the Plan contemplates an amendment to their respective relative rights and preferences to permit the payment of accrued and unpaid dividends in cash or common stock, at the Company's election. The Plan further contemplates amendments to the relative rights and preferences of the Series D Cumulative Convertible Preferred Stock (the "Series D Preferred Stock"), through an exchange of Series D Preferred Stock for Series E Cumulative Convertible Preferred Stock (the "Series E Preferred Stock"), similar to those amendments effected in connection with the recent exchange of the former Series C Cumulative Convertible Preferred Stock (the "Series C Preferred Stock") for Series E Preferred Stock. See "MARKET FOR THE REGISTRANT'S COMMON STOCK AND OTHER RELATED STOCKHOLDER MATTERS-Exchange of Series C Preferred Stock for Series E Preferred Stock" for a discussion of the exchange of Series C Preferred Stock for Series E Preferred Stock. Reference is made to the Plan and Proposed Disclosure Statement, previously filed with the Securities and Exchange Commission (the "SEC") as exhibits to a Form 8-K, for a complete description of the financing contemplated to be obtained under the Plan from the respective existing creditors including, without limitation, payment terms, restrictive covenants and collateral, and a complete description of the treatment of preferred stockholders. Although the Company has commitments for substantially all of the New Debt and has sold certain of the CMBS contemplated to be sold in connection with the CMBS Sale, there can be no assurance that the Company will obtain the Recapitalization 5 Financing, that the Plan will be confirmed by the Bankruptcy Court, or that the Plan, if confirmed, will be consummated. The Plan also contemplates certain amendments to the Company's articles of incorporation, including an increase in authorized shares from 120 million to 375 million (consisting of 300 million of common shares and 75 million of preferred shares). Effect of Chapter 11 Filing on REIT Status and Other Tax Matters REIT Status CRIIMI MAE is required to meet income, asset, ownership and distribution tests to maintain its REIT status. The Company has satisfied the REIT requirements for all years through, and including, 1998. However, due to the uncertainty resulting from its Chapter 11 filing, there can be no assurance that CRIIMI MAE will retain its REIT status for 1999 or subsequent years. If the Company fails to retain its REIT status for any taxable year, it will be taxed as a regular domestic corporation subject to federal and state income tax in the year of disqualification and for at least the four subsequent years. The Company's 1999 Taxable Income As a REIT, CRIIMI MAE is generally required to distribute at least 95% of its "REIT taxable income" to its shareholders each tax year. For purposes of this requirement, REIT taxable income excludes certain excess noncash income such as original issue discount ("OID"). In determining its federal income tax liability, CRIIMI MAE, as a result of its REIT status, is entitled to deduct from its taxable income dividends paid to its shareholders. Accordingly, to the extent the Company distributes its net income to shareholders, it effectively reduces taxable income, on a dollar-for-dollar basis, and eliminates the "double taxation" that normally occurs when a corporation earns income and distributes that income to shareholders in the form of dividends. The Company, however, still must pay corporate level tax on any 1999 taxable income not distributed to shareholders. Unlike the 95% distribution requirement, the calculation of the Company's federal income tax liability does not exclude excess noncash income such as OID. Should CRIIMI MAE terminate or fail to maintain its REIT status during the year ended December 31, 1999, the taxable income for the year ended December 31, 1999 of approximately $37.5 million would generate a tax liability of up to $15.0 million. In determining the Company's taxable income for 1999, distributions declared by the Company on or before September 15, 2000 and actually paid by the Company on or before December 31, 2000 will be considered as dividends paid for the year ended December 31, 1999. The Company anticipates distributing all, or a substantial portion of, its 1999 taxable income in the form of non-cash taxable dividends. There can be no assurance that the Company will be able to make such distributions with respect to its 1999 taxable income. 1999 Excise Tax Liability Apart from the requirement that the Company distribute at least 95% of its REIT taxable income to maintain REIT status, CRIIMI MAE is also required each calendar year to distribute an amount at least equal to the sum of 85% of its "REIT ordinary income" and 95% of its "REIT capital gain income" to avoid incurring a nondeductible excise tax. Unlike the 95% distribution requirement, the 85% distribution requirement is not reduced by excess noncash income items such as OID. In addition, in determining the Company's excise tax liability, only dividends actually paid in 1999 will reduce the amount of income subject to this excise tax. The Company has accrued $1,105,000 for the excise tax payable for 1999. The accrual was calculated based on the taxable income for the year ended December 31, 1999. The Company's 1998 Taxable Income On September 14, 1999, the Company declared a dividend payable to common shareholders of approximately 1.61 million shares of a new series of junior convertible preferred stock with a face value of $10 per share. See Note 12 of the Notes to Consolidated Financial Statements for further discussion. The purpose of the dividend was to distribute approximately $15.7 million in undistributed 1998 taxable income. To the extent that it is determined such amount was not distributed, the Company would bear a corporate level income tax on the undistributed amount. There can be no assurance that all of the 6 Company's tax liability was eliminated by payment of such junior preferred stock dividend. The Company paid the junior preferred stock dividend on November 5, 1999. The junior preferred stock dividend was taxable to common shareholder recipients. Junior preferred shareholders were permitted to convert their shares of junior preferred stock into common shares during two separate conversion periods. During these conversion periods, an aggregate 1,020,241 shares of junior preferred stock were converted into 8,798,009 shares of common stock. Taxable Income Distributions The recently issued Internal Revenue Service Revenue Procedure 99-17 provides securities and commodities traders with the ability to elect mark-to-market treatment for 2000 by including an election with their timely filed 1999 federal tax extension. The election applies to all future years as well, unless revoked with the consent of the Internal Revenue Service. On March 15, 2000, the Company determined to elect mark-to-market treatment as a securities trader for 2000 and, accordingly, will recognize gains and losses prior to the actual disposition of its securities. Moreover, some if not all of those gains and losses, as well as some if not all gains or losses from actual dispositions of securities, will be treated as ordinary in nature and not capital, as they would be in the absence of the election. Therefore, any net operating losses generated by the Company's trading activity will offset the Company's ordinary taxable income, and thereby reduce required distributions to shareholders by a like amount. See "BUSINESS-Risk Factors-Risks Associated with Trader Election" for further discussion. If the Company does have a REIT distribution requirement (and such distributions would be permitted under the Plan), a substantial portion of the Company's distributions would be in the form of non-cash taxable dividends. Taxable Mortgage Pool Risks An entity that constitutes a "taxable mortgage pool" as defined in the Tax Code ("TMP") is treated as a separate corporate level taxpayer for federal income tax purposes. In general, for an entity to be treated as a TMP (i) substantially all of the assets must consist of debt obligations and a majority of those debt obligations must consist of mortgages; (ii) the entity must have more than one class of debt securities outstanding with separate maturities and (iii) the payments on the debt securities must bear a relationship to the payments received from the mortgages. The Company currently owns all of the equity interests in three trusts that constitute TMPs (CBO-1, CBO-2 and CMO-IV, collectively the "Trusts"). See "BUSINESS-Resecuritizations," "BUSINESS-Loan Originations and Securitizations" and Notes 5 and 6 of the Notes to Consolidated Financial Statements for descriptions of CBO-1, CBO-2 and CMO-IV. The statutory provisions and regulations governing the tax treatment of TMPs (the "TMP Rules") provide an exemption for TMPs that constitute "qualified REIT subsidiaries" (that is, entities whose equity interests are wholly owned by a REIT). As a result of this exemption and the fact that the Company owns all of the equity interests in each Trust, the Trusts currently are not required to pay a separate corporate level tax on income they derive from their underlying mortgage assets. The Company also owns certain securities structured as bonds (the "Bonds") issued by each of the Trusts. Certain of the Bonds owned by the Company serve as collateral (the "Pledged Bonds") for short-term, variable-rate borrowings used by the Company to finance their initial purchase. If the creditors holding the Pledged Bonds were to seize or sell this collateral and the Pledged Bonds were deemed to constitute equity interests (rather than debt) in the Trusts, then the Trusts would no longer qualify for the exemption under the TMP Rules provided for qualified REIT subsidiaries. The Trusts would then be required to pay a corporate level federal income tax. As a result, available funds from the underlying mortgage assets that would ordinarily be used by the Trusts to make payments on certain securities issued by the Trust (including the equity interests and the Pledged Bonds) would instead be applied to tax payments. Since the equity interests and Bonds owned by the Company are the most subordinated securities and, therefore, would absorb payment shortfalls first, the loss of the exemption under the TMP rules could have a material adverse effect on their value and the payments received thereon. In addition to causing the loss of the exemption under the TMP Rules, a seizure or sale of the Pledged Bonds and a characterization of them as equity for tax purposes could also jeopardize the Company's REIT status if the value of the remaining ownership interests in any Trust held by the Company (i) exceeded 5% of the total value of the Company's assets or (ii) constituted more than 10% of the Trust's voting interests. Although it is possible that the election by the TMPs to be treated as taxable REIT subsidiaries could prevent the loss of CRIIMI MAE's REIT status, there can be no assurance that a valid election could be made given the timing of a seizure or sale of the Pledged Bonds. 7 The CMBS Market Historically, traditional lenders, including commercial banks, insurance companies and savings and loans have been the primary holders of commercial mortgages. The real estate market of the late 1980s and early 1990s created business and regulatory pressure to reduce the real estate assets held on the books of these institutions. As a result, there has been significant movement of commercial real estate debt from private institutional holders to the public markets. According to Commercial Mortgage Alert, CMBS issuances in the U.S. equaled approximately $58.3 billion in 1999, $77.7 billion in 1998, $40.4 billion in 1997 and $28.8 billion in 1996. CMBS are generally created by pooling commercial mortgage loans and directing the cash flow from such mortgage loans to various tranches of securities. The tranches consist of investment grade (AAA to BBB-), non-investment grade (BB+ to CCC) and unrated securities. The first step in the process of creating CMBS is loan origination. Loan origination occurs when a financial institution lends money to a borrower to refinance or to purchase a commercial real estate property, and secures the loan with a mortgage on the property that the borrower owns or purchases. Commercial mortgage loans are typically non-recourse to the borrower. A pool of these commercial real estate-backed mortgage loans is then accumulated, often by a large commercial bank or other financial institution. One or more rating agencies then analyze the loans and the underlying real estate to determine their credit quality. The mortgage loans are then deposited into an entity that is not subject to taxation, often a real estate mortgage investment conduit ("REMIC") or, in the case of the Company, a TMP. The investment vehicle then issues securities backed by the commercial mortgage loans, CMBS. The CMBS are divided into tranches, which are afforded certain priority rights to the cash flow from the underlying mortgage loans. Interest payments typically flow first to the most senior tranche until it receives all of its accrued interest and then to the junior tranches in order of seniority until all available interest is exhausted. Principal payments typically flow to the most senior tranche until it is retired. Tranches are then retired in order of seniority, based on available principal. Losses, if any, are generally first applied against the principal balance of the lowest rated or unrated tranche. Losses are then applied in reverse order of seniority. Each tranche is assigned a credit rating by one or more rating agencies based on the agencies' assessment of the likelihood of the tranche receiving its stated payment of principal. The CMBS are then sold to investors through either a public offering or a private placement. The Company has primarily focused on acquiring or retaining non-investment grade and unrated tranches, issued by mortgage conduits, where the Company believed its market knowledge and real estate expertise allowed it to earn attractive risk-adjusted returns. At the time of a securitization, one or more entities are appointed as "servicers" for the pool of mortgage loans, and are responsible for performing servicing duties which include collecting payments (master or direct servicing), monitoring performance (loan management) and working out or foreclosing on defaulted loans (special servicing). Each servicer receives a fee and other financial incentives based on the type and extent of servicing duties. The CMBS market was adversely affected by the turmoil which occurred in the capital markets commencing in late summer of 1998 that caused spreads between CMBS yields and the yields on U.S. Treasury securities with comparable maturities to widen, resulting in a decrease in the value of CMBS. As a result, the creation of new CMBS and the trading of existing CMBS came to a near standstill. In late November 1998, buying and trading activity in the CMBS market began to recover, increasing liquidity in the CMBS market; however, these improvements mostly related to investment grade CMBS. New issuances of CMBS also returned in late November 1998 and continued throughout 1999 with the issuance of newly created CMBS totaling approximately $58.3 billion for 1999. The market for Subordinated CMBS has, however, been slower to recover. It is difficult, if not impossible, to predict when, or if, the CMBS market and, in particular, the Subordinated CMBS market, will recover. Even if the market for Subordinated CMBS recovers, the liquidity of such market has historically been limited. Additionally, during adverse market conditions, the liquidity of such market has been severely limited. Therefore, management's estimate of the value of the Company's CMBS could vary significantly from the value that could be realized in a transaction between a willing buyer and a willing seller in other than a forced sale or liquidation. 8 Subordinated CMBS Acquisitions As of December 31, 1999, the Company's $2.3 billion portfolio of assets included $1.2 billion of Subordinated CMBS (representing approximately 51% of the Company's total consolidated assets). The Company did not acquire any Subordinated CMBS in 1999. In 1998, CRIIMI MAE acquired Subordinated CMBS from offerings with a total face amount of $13.5 billion. These offerings comprised approximately 17.2% of the total ($58.3 billion face amount according to Commercial Mortgage Alert) CMBS market for 1998. For the year ended December 31, 1998, the Company acquired Subordinated CMBS with an aggregate face amount of approximately $1.2 billion, making the Company a leading purchaser of Subordinated CMBS in 1998. As of December 31, 1999, approximately 42% of the Company's CMBS (based on fair value) were rated BB+, BB or BB-, 27% were B+, B, B- or CCC and 10% were unrated. The remaining approximately 21% represents investment grade securities that the Company reflects on its balance sheet as a result of CBO-2. See "BUSINESS-Resecuritizations" and "BUSINESS-The Portfolio-CMBS." The Company generally acquired Subordinated CMBS in privately negotiated transactions, which allowed it to perform due diligence on a substantial portion of the mortgage loans underlying the Subordinated CMBS as well as the underlying real estate prior to consummating the purchase. In connection with its Subordinated CMBS acquisitions, the Company targeted diversified mortgage loan pools with a mix of property types, geographic locations and borrowers. CRIIMI MAE financed a substantial portion of its Subordinated CMBS acquisitions with short-term, variable-rate financing facilities secured by the Company's CMBS. The Company's business strategy was to periodically refinance a substantial portion of the Subordinated CMBS in its portfolio through a resecuritization of such Subordinated CMBS primarily to attain a better matching of the maturities of its assets and liabilities through the refinancing of short-term, variable-rate, recourse financing with long-term, fixed-rate, non-recourse financing. See "BUSINESS-Resecuritizations," "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS," and Notes 5 and 9 of the Notes to Consolidated Financial Statements. The Company generally enters into interest rate protection agreements to mitigate the adverse effects of rising short-term interest rates on the interest payments due on its variable-rate financing facilities. It is the Company's policy to hedge at least 75% of the principal balance of its variable-rate debt with interest rate protection agreements that limit the cash flow exposure to increases in interest rates beyond a certain level on the amount of interest expense the Company must pay. As of December 31, 1999, approximately 94% of the Company's variable-rate debt was hedged by interest rate caps, a form of interest rate protection agreement. Interest rate caps provide protection to CRIIMI MAE to the extent interest rates, based on a readily determinable interest rate index, increase above the stated interest rate cap, in which case CRIIMI MAE would receive payments based on the difference between the index and the cap. These payments would serve to reduce the interest payments due under the variable-rate financing facilities. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" and Notes 9 and 10 of the Notes to Consolidated Financial Statements for a further discussion of the Company's short-term, variable-rate secured financing facilities and interest rate protection agreements. If treasury rates increase and/or spreads widen from the December 31, 1999 levels, the value of the Company's portfolio of securities would decrease. Resecuritizations The Company initially funded a substantial portion of its Subordinated CMBS acquisitions with short-term, variable-rate secured financing facilities. To further mitigate the Company's exposure to interest rate risk, the Company's business strategy was to periodically refinance a significant portion of this short-term, variable-rate debt with fixed-rate, non-recourse debt having maturities that matched those of the Company's mortgage assets securing such debt ("match-funded"). The Company effected such refinancing by pooling Subordinated CMBS, once a sufficient pool of Subordinated CMBS had been accumulated, and issuing newly created CMBS backed by the pooled Subordinated CMBS. The CMBS issued in such resecuritizations were fixed-rate obligations with maturities that matched the maturities of the Subordinated CMBS backing the new CMBS. These resecuritizations also increased the amount of borrowings available to the Company due to the increased collateral value of the new CMBS relative to the pooled Subordinated CMBS. The increase in collateral value was principally attributable to the seasoning of the underlying mortgage loans and the diversification that occurred when such Subordinated CMBS were pooled. The Company generally used the cash proceeds from the investment grade CMBS that were sold in the resecuritization to reduce the amount of its short-term, variable-rate secured borrowings. The Company then used the net excess borrowing 9 capacity created by the resecuritization to obtain new short-term, variable-rate secured borrowings which were used with additional new short-term, variable-rate secured borrowings typically provided by the Subordinated CMBS seller and, to a lesser extent, cash, to purchase additional Subordinated CMBS. Although the Company's resecuritizations mitigated the Company's exposure to interest rate risk through match-funding, the Company's short-term, variable-rate secured borrowings increased from December 31, 1996 to December 31, 1998, as a result of the Company's continued acquisitions of Subordinated CMBS during that period. In December 1996, the Company completed its first resecuritization of Subordinated CMBS ("CBO-1") with a combined face value of approximately $449 million involving 35 individual securities collateralized by 12 mortgage securitization pools. The Company sold, in a private placement, securities with a face amount of $142 million and retained securities with a face amount of approximately $307 million. Through CBO-1, the Company refinanced approximately $142 million of short-term, variable-rate, secured borrowings with fixed-rate, non-recourse, match-funded debt. CBO-1 generated excess borrowing capacity of approximately $22 million primarily as a result of a higher overall weighted average credit rating for the new CMBS, as compared to the weighted average credit rating on the related CMBS collateral. In May 1998, the Company completed its second resecuritization of Subordinated CMBS ("CBO-2") with a combined face value of approximately $1.8 billion involving 75 individual securities collateralized by 19 mortgage securitization pools and three of the retained securities from CBO-1. In CBO-2, the Company sold, in a private placement, securities with a face amount of $468 million and retained securities with a face amount of approximately $1.3 billion. Through CBO-2, the Company refinanced approximately $468 million of short-term, variable-rate secured borrowings with fixed-rate, non-recourse, match-funded debt. CBO-2 generated net excess borrowing capacity of approximately $160 million primarily as a result of a higher overall weighted average credit rating for the new CMBS, as compared to the weighted average credit rating on the related CMBS collateral. See "LEGAL PROCEEDINGS" for information regarding the sale of additional CBO-2 CMBS. As of December 31, 1999, the Company's total debt was approximately $2.0 billion, of which approximately 53% was fixed-rate, match-funded debt and approximately 47% was short-term, variable-rate or fixed-rate debt that was recourse to the Company and not match-funded. For the year ended December 31, 1999, the Company's weighted average cost of borrowing (including amortization of discounts and deferred financing fees of approximately $8.7 million) was approximately 7.64%. See "BUSINESS-Subordinated CMBS Acquisitions," "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" and Notes 5, 9 and 10 of the Notes to Consolidated Financial Statements for further information regarding the Company's resecuritizations, short-term, variable-rate secured financings, and interest rate caps. Loan Originations and Securitizations Prior to the Petition Date, the Company originated mortgage loans principally through mortgage loan conduit programs with major financial institutions for the primary purpose of pooling such loans for securitization. The Company viewed a securitization as a means of extracting the maximum value from the mortgage loans originated. A portion of the mortgage loans originated was financed through the creation and sale of investment grade CMBS to third parties in connection with the securitization. The Company received net cash flow on the CMBS not sold to third parties after payment of amounts due to secured creditors who had provided acquisition financing. Additionally, the Company received origination and servicing fees related to the mortgage loan conduit programs. A majority of the mortgage loans originated under the Company's loan conduit programs were "No Lock" mortgage loans. Unlike most commercial mortgage loans originated for the CMBS market which contain "lock-out" clauses (that is, provisions which prohibit the prepayment of a loan for a specified period after the loan is originated or impose costly yield maintenance provisions), the Company's No Lock loans allowed borrowers the ability to prepay loans at any time by paying a prepayment penalty. Prior to the Petition Date, the Company had originated over $900 million in aggregate principal amount of loans. In June 1998, the Company securitized approximately $496 million of the commercial mortgage loans originated or 10 acquired through a mortgage loan conduit program with Citicorp Real Estate, Inc. ("Citibank"), and through CRIIMI MAE CMBS Corp., issued Commercial Mortgage Loan Trust Certificates, Series 1998-1 ("CMO-IV"). A majority of these mortgage loans were "No Lock" loans. In CMO-IV, CRIIMI MAE sold $397 million face amount of fixed-rate, investment grade CMBS. The Company originally intended to sell all of the investment grade tranches of CMO-IV; however, two investment grade tranches were not sold until 1999. CRIIMI MAE has call rights on each of the issued securities and therefore has not surrendered control of the bonds, thus requiring the transaction to be accounted for as a financing of the mortgage loans collateralizing the investment grade CMBS sold in the securitization. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS-Liquidity and Capital Resources" and Notes 6 and 9 of the Notes to Consolidated Financial Statements for additional information regarding this securitization, including the 1999 sales of the two remaining investment grade tranches and certain financial and accounting effects of such sales. At the time it filed for bankruptcy, the Company had a second mortgage loan conduit program with Citicorp Real Estate, Inc. (the "Citibank Program") and a loan conduit program with Prudential Securities Incorporated and Prudential Securities Credit Corporation (collectively, "Prudential") (the "Prudential Program"). Each Program provided that during the warehouse period, the financial institution party would fund and originate in its name all mortgage loans under the Program, and CRIIMI MAE would deposit a portion of each loan amount in a reserve account. In each Program, the financial institution was responsible for executing an interest rate hedging strategy. The Citibank Program provided for CRIIMI MAE to pay to Citibank the face value of the loans originated through the Program, which were funded by Citibank and not otherwise securitized, plus or minus any hedging loss or gain, on December 31, 1998. To secure this obligation, CRIIMI MAE was required to deposit a portion of the principal amount of each originated loan in a reserve account. On April 5, 1999, the Bankruptcy Court entered a Stipulation and Consent Order (the "Order"), negotiated by the Company and Citibank. The negotiations were in response to a letter Citibank sent to the Company on October 5, 1998 alleging that the Company was in default under the Citibank Program and that it was terminating the Citibank Program. The Order provided that Citibank would, with CRIIMI MAE's cooperation, sell the loans originated under the Citibank Program pursuant to certain specified terms and conditions. All of the commercial loans originated under the Citibank Program were sold in 1999 at a loss to the Company. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS-Liquidity and Capital Resources" and Notes 6 and 9 of the Notes to Consolidated Financial Statements for a further discussion of these commercial loan sales and certain financial and accounting effects of such sales. Under the Prudential Program, the Company had an option to pay to Prudential the face value of the loan plus or minus any hedging loss or gain, at the earlier of June 30, 1999, or the date by which a stated quantity of loans for securitization had been made. Under the Prudential Program, the Company was required to fund a reserve account of approximately $2 million for the sole loan originated under this Program. Since CRIIMI MAE was unable to exercise its option under the Prudential Program, the Company forfeited the amount of the reserve account. CRIIMI MAE intends to sell the loan originated under the Prudential Program. There can be no assurance that an agreement will be reached with Prudential or, if reached that such agreement would be approved by the Bankruptcy Court. Servicing CRIIMI MAE conducts its mortgage loan servicing and advisory operations through its affiliate, CMSLP. At the time of the Chapter 11 filing, CMSLP was responsible for certain servicing functions on a mortgage loan portfolio of approximately $32.0 billion, as compared to approximately $16.5 billion as of December 31, 1997. Prior to the Petition Date, CRIIMI MAE increased its mortgage loan servicing and advisory operations primarily through its purchases of Subordinated CMBS by acquiring certain servicing rights for the mortgage loans collateralizing the Subordinated CMBS, as well as providing servicing on the loans originated through the CRIIMI MAE loan origination programs. 11 CMSLP did not file for protection under Chapter 11. However, because of the related party nature of its relationship with CRIIMI MAE, CMSLP has been under a high degree of scrutiny from servicing rating agencies. As a result of CRIIMI MAE's Chapter 11 filing, CMSLP was also declared in default under certain credit agreements with First Union National Bank ("First Union"). In order to repay all such credit agreement obligations and to increase its liquidity, CMSLP arranged for ORIX Real Estate Capital Markets, LLC ("ORIX"), formerly known as Banc One Mortgage Capital Markets, LLC, to succeed it as master servicer on two commercial mortgage pools on October 30, 1998. In addition, in order to allay rating agency concerns stemming from CRIIMI MAE's Chapter 11 filing, in November 1998, CRIIMI MAE designated ORIX as special servicer on 33 separate CMBS securitizations totaling approximately $29 billion, subject to certain requirements contained in the respective servicing agreements. As of December 31, 1999, CMSLP continued to perform special servicing as sub-servicer for ORIX on all but five of these securitizations. As of December 31, 1999, CRIIMI MAE remained the owner of the lowest rated tranche of the related Subordinated CMBS and, as such, retains rights pertaining to ownership, including the right to replace the special servicer. CMSLP also lost the right to specially service the DLJ MAC 95 CF-2 securitization when the majority holder of the lowest rated tranches replaced CMSLP as special servicer. As of December 31, 1999 and 1998, CMSLP's remaining servicing portfolio was approximately $28 billion and $31 billion, respectively. As part of CRIIMI MAE's Plan, certain of the Company's non-resecuritized CMBS are intended to be sold. As such, CMSLP will lose its special servicing rights related to these CMBS. In 1999, CMSLP generated gross revenues of $1.1 million in fees on these CMBS. CMSLP's principal servicing activities are described below. Special Servicing A special servicer typically provides asset management and resolution services with respect to nonperforming or underperforming loans within a pool of mortgage loans. When acquiring Subordinated CMBS, CRIIMI MAE typically required that it retain the right to appoint the special servicer for the related mortgage pools. When serving as special servicer of a CMBS pool, CMSLP has the authority to deal directly with any borrower that fails to perform under certain terms of its mortgage loan, including the failure to make payments, and to manage any loan workouts and foreclosures. As special servicer, CMSLP earns fee income on services provided in connection with any loan servicing function transferred to it from the master servicer. CRIIMI MAE believes that because it owns the lowest rated or unrated tranche (first loss position) of the Subordinated CMBS, CMSLP has an incentive to quickly resolve any loan workouts. During the year ended December 31, 1999, CMSLP successfully resolved approximately $174.1 million of CMBS loan workouts. As of December 31, 1999, CMSLP was designated as the special servicer (or sub-special servicer) for approximately 4,978 commercial mortgage loans, representing an aggregate principal amount of approximately $27 billion. Such commercial mortgage loans represent substantially all of the mortgage loans underlying CRIIMI MAE's Subordinated CMBS portfolio. As of December 31, 1999, CMSLP had a special servicer rating of "above average" from Fitch IBCA and had been approved on a transactional basis by Moody's Investors Service, Inc. ("Moody's") and Duff & Phelps Credit Rating Co. However, CMSLP lost an "acceptable" special servicer rating by Standard & Poor's ("S&P") in October 1998 as a result of the Chapter 11 filing of CRIIMI MAE. Also, as a result of the Chapter 11 filing, Fitch IBCA placed CMSLP's special servicing rating on "rating watch". Master Servicing A master servicer typically provides administrative and reporting services to the trustee with respect to a particular issuance of CMBS. Mortgage loans underlying CMBS generally are serviced by a number of primary servicers. Under most master servicing arrangements, the primary servicers retain primary responsibility for administering the mortgage loans and the master servicer acts as an intermediary in overseeing the work of the primary servicers, monitoring their compliance with the standards of the issuer of the related CMBS and consolidating the servicers' respective periodic accounting reports for transmission to the trustee. When acting as master servicer of a CMBS pool, CMSLP has greater control over the mortgage assets underlying its Subordinated CMBS, including the authority to (i)-collect monthly principal and interest payments (either from a direct servicer or directly from borrowers)-on loans comprising a CMBS pool and remit such amounts to the pool trustee, (ii)-oversee the performance of sub-servicers and (iii)-report to trustees. As master servicer, CMSLP is usually paid a fee and can earn float income on the deposits it holds. In addition to this fee and float income, the master servicer 12 typically has more direct and regular contact with borrowers than the special servicer. As of December 31, 1999, CMSLP remained master servicer on three CMBS portfolios representing commercial mortgage loans with an aggregate principal amount of approximately $2.3-billion. As of December 31, 1999, CMSLP had a master servicer rating of "acceptable" from Fitch IBCA and had been approved on a transactional basis by Moody's. However, CMSLP lost an acceptable master servicer rating from S&P in October 1998 as a result of the Chapter 11 filing of CRIIMI MAE. Also, as a result of the Chapter 11 filing, Fitch IBCA placed CMSLP's master servicer rating on "rating watch". Direct (or Primary) Servicing Direct (or primary) servicers typically perform certain functions for the master servicer. Direct serviced loans are those loans for which CMSLP collects loan payments directly from the borrower (including tax and insurance escrows and replacement reserves). The loan payments are remitted to the master servicer for the loan (which may be the same entity as the direct servicer), usually on a fixed date each month. The direct servicer is usually paid a fee to perform these services, and is eligible to earn float income on the deposits held. In addition to this fee and float income, the direct servicer, like the master servicer, typically has more direct and regular contact with borrowers than the special servicer. As of December 31, 1999, CMSLP was designated direct servicer for approximately 502 commercial mortgage loans, representing an aggregate principal amount of approximately $2.4 billion. This number of loans excludes loans that are both direct and master serviced by CMSLP, which are included in the master servicing figures above. Loan Management In certain cases, CMSLP acts as loan manager and monitors the ongoing performance of properties securing the mortgage loans underlying its Subordinated CMBS portfolio by continuously reviewing the property level operating data and regular site inspections. For approximately half of these loans, CMSLP performs these duties on a contractual basis; for the remaining loans, as part of its routine asset monitoring process, it reviews the analysis performed by other servicers. This allows CMSLP to identify and resolve potential issues that could result in losses. As of December 31, 1999, CMSLP served as contractual loan manager for approximately 2,464 commercial mortgage loans representing an aggregate principal amount of approximately $12.0 billion. As of December 31, 1999, CMSLP performed surveillance on analyses performed by other servicers for approximately 2,456 commercial mortgage loans, representing an aggregate principal amount of $14.8 billion. Underwriting Procedures CRIIMI MAE believes that its experience in underwriting has enabled it to maintain the overall quality of assets underlying its CMBS portfolio and to properly manage certain of the risks associated with mortgage loans underlying acquired Subordinated CMBS and loan originations. Since the Company generally acquired CMBS through privately negotiated transactions and originated commercial mortgage loans through its regional offices, it was able to perform extensive due diligence on a majority of the mortgage loans as well as the underlying real estate prior to consummating any purchase or origination. The Company underwrote every loan it originated and re-underwrote a substantial portion of the loans underlying the Subordinated CMBS it acquired. Furthermore, the Company's credit committee, composed of members of senior management, reviewed originated loans and Subordinated CMBS acquisitions. The Company also placed underwriting personnel in its regional origination offices, not only to provide a timely response to the originators but also to achieve a thorough understanding of local markets and demographic trends. CRIIMI MAE's underwriting guidelines were designed to assess the adequacy of the real property as collateral for the loan and the borrower's creditworthiness. The underwriting process entailed a full independent review of the operating records, appraisals, environmental studies, market studies and architectural and engineering reports, as well as site visits to properties representing a majority of the CMBS portfolio. The Company then tested the historical and projected financial performance of the properties to determine their resiliency to a market downturn and applied varying capitalization rates to assess collateral value. To assess the borrower's creditworthiness, the Company reviewed the borrower's financial statements, credit history, bank references and managerial experience. The Company purchased Subordinated CMBS 13 when the loans it believed to be problematic (i.e., that did not meet its underwriting criteria) were excluded from the CMBS pool, and when satisfactory arrangements existed that enabled the Company to closely monitor the underlying mortgage loans and provided the Company with appropriate workout and foreclosure rights. Employees As of March 15, 2000, the Company had 44 full-time employees, and CMSLP had 110 full-time employees. Prior to the Petition Date on September 30, 1998, the Company had 170 full-time employees, and CMSLP had 113 full-time employees. Employee Retention Plan Upon commencement of the Chapter 11 cases, the Company believed it was essential to both the efficient operation of the Company's business and the reorganization effort that the Company maintain the support, cooperation and morale of its employees. The Company obtained Bankruptcy Court approval to pay certain pre-petition employee obligations in the nature of wages, salaries and other compensation and to continue to honor and pay all employee benefit plans and policies. In addition, to ensure the Company's continued retention of its executives and other employees and to provide meaningful incentives for these employees to work toward the Company's financial recovery and reorganization, the Company's management and Board of Directors developed a comprehensive and integrated program to retain its executives and other employees throughout the reorganization. On December 18, 1998, the Company obtained Bankruptcy Court approval to adopt and implement an employee retention program (the "Employee Retention Plan") with respect to all employees of the Company other than certain key executives. On February 28, 1999, the Company received Bankruptcy Court approval authorizing it to extend the Employee Retention Plan to the key executives initially excluded, including modifying existing employment agreements and entering into new employment agreements with such key executives. The Employee Retention Plan permitted the Company to approve ordinary course employee salary increases beginning in March 1999, subject to certain limitations, and to grant options to its employees after the Petition Date, up to certain limits. The Employee Retention Plan also provides for retention payments aggregating up to approximately $3.5 million, including payments to certain executives. Retention payments are payable semiannually over a two-year period. The first retention payment of approximately $909,000 vested on April 5, 1999, and was paid on April 15, 1999. The second retention payment of approximately $865,000 vested on October 5, 1999, and was paid on October 15, 1999. The third retention payment of approximately $653,000 vested on April 5, 2000 and will be paid on April 14, 2000. The entire unpaid portion of the retention payments will become due and payable (i) upon the effective date of a plan of reorganization of the Company and, with respect to certain key executives, court approval or (ii) upon termination without cause. William B. Dockser, Chairman of the Board of Directors, and H. William Willoughby, President, are not currently entitled to receive any retention payments. Subject to the terms of their respective employment agreements, certain key executives will be entitled to severance benefits if they resign or their employment is terminated following a change of control. The other employees will be entitled to severance benefits if they are terminated without cause subsequent to a change of control of the Company and CM Management. In addition, options granted by the Company after October 5, 1998 will, subject to Bankruptcy Court approval, become exercisable upon a change of control. For a discussion of the Employee Retention Plan as it relates to named key executives of the Company, see "EXECUTIVE COMPENSATION-Employment Agreements." 14 The Portfolio CMBS Fair Value. As of December 31, 1999, the Company owned, for purposes of generally accepted accounting principles ("GAAP"), CMBS rated from A to CCC and unrated with a total fair value amount of approximately $1.2 billion (representing approximately 51% of the Company's total consolidated assets) and an aggregate amortized cost of approximately $1.4 billion.
Weighted Range of Amortized Amortized Face Average Weighted Fair Value Discount Rates Cost as Cost as Amount as Pass-Through Average as of Used to of of Security of 12/31/99 Rate Life (1) 12/31/99 Calculate Fair 12/31/99 12/31/98 Rating (in (in Value (2) (in (in millions) millions) millions) millions) (2) - ----------- ------------ ----------- --------- ------------- ---------------- ----------- ----------- A (3) $ 62.6 7.0% 6 years $ 54.5 9.8% $ 57.4 $ 57.0 BBB (3) 150.6 7.0% 12 years 116.1 10.5% 127.7 126.9 BBB-(3) 115.2 7.0% 12 years 82.6 11.4% 93.5 92.8 BB+ 394.6 7.0% 13 years 255.3 11.4%-13.2% 305.5 317.9 BB 279.0 6.9% 14 years 192.8 11.8%-13.9% 206.1 259.1 BB- 89.1 6.8% 14 years 51.2 13.2%-14.9% 58.6 72.6 B+ 128.7 6.7% 16 years 63.7 14.5%-15.9% 82.1 93.0 B 300.2 6.6% 16 years 141.3 15.5%-17.2% 178.2 208.9 B- 198.7 6.7% 17 years 84.9 16.0%-19.4% 98.1 106.7 CCC 92.0 6.8% 19 years 23.2 25.0%-30.0% 32.5 36.0 Unrated (4) 477.4 5.9% 20 years 113.7 26.0%-32.0% 134.4 159.0 ------------ ----------- ----------- ------------- --------------- ----------- ---------- Total (5) (6) $2,288.1 6.7% 15 years $1,179.3 $1,374.1 (7) $1,529.9 ============= ============ =========== ============= ============ ===========
(1) Weighted average life represents the weighted average expected life of the Subordinated CMBS prior to consideration of losses, extensions or prepayments. (2) The estimated fair values of Subordinated CMBS represent the carrying value of these assets. Due to the Chapter 11 filing, the Company's lenders were not willing to provide fair value quotes for the portfolio as of December 31, 1999. As a result, the Company calculated the estimated fair market value of its Subordinated CMBS portfolio as of December 31, 1999. The Company used a discounted cash flow methodology to estimate the fair value of its Subordinated CMBS portfolio. The cash flows for each bond were projected assuming no prepayments and no losses, as is the market convention. The cash flows were then discounted using a discount rate that, in the Company's view, was commensurate with the market's perception of risk and value. The Company used a variety of sources to determine its discount rate, including institutionally available research reports and communications with dealers and active Subordinated CMBS investors regarding the valuation of comparable securities. Since the Company calculated the estimated fair market value of its Subordinated CMBS portfolio as of December 31, 1999, it has disclosed in the table the range of discount rates by rating category used in determining these fair market values. 15 (3) In connection with CBO-2, $62.6 million (A rated) and $60.0 million (BBB rated) face amount of investment grade securities were sold with call options and $345 million (A rated) face amount were sold without call options. In connection with CBO-2, in May 1998, the Company initially retained $90.6 million (BBB rated) and $115.2 million (BBB- rated) face amount of securities, both with call options, with the intention to sell the securities at a later date. Such sale occurred March 5, 1999. See "LEGAL PROCEEDINGS". Since the Company retained call options on certain sold bonds, the Company did not surrender control of those assets pursuant to the requirements of FAS 125 and thus these securities are accounted for as a financing and not a sale. Since the transaction is recorded as a partial financing and a partial sale, CRIIMI MAE has retained the securities with call options in its Subordinated CMBS portfolio reflected on its balance sheet. (4) The unrated bond from CBO-1 experienced an approximately $1.6 million principal write down in 1999 due to a loss on the foreclosure of two underlying loans. Management believes that the current loss estimates used to recognize income related to this bond remain adequate to cover losses. (5) Refer to Note 8 of the Notes to Consolidated Financial Statements for additional information regarding the total face amount and purchase price of Subordinated CMBS for tax purposes. (6) Similar to the Company's other sponsored CMOs, CMO-IV, as further described in "BUSINESS-Loan Originations and Securitizations" and Note 6 of the Notes to Consolidated Financial Statements, resulted in the creation of CMBS, of which the Company sold certain tranches. Since the Company retained call options on the sold bonds, the Company did not surrender control of the assets for purposes of FAS 125 and thus the entire transaction is accounted for as a financing and not a sale. Since the entire transaction is recorded as a financing, the Subordinated CMBS are not reflected in the Company's Subordinated CMBS portfolio. Instead, the underlying mortgage loans contributed to CMO-IV are reflected in Investment in Originated Loans on the balance sheet (7) Amortized cost reflects the $156.9 million impairment loss write-down related to the CMBS subject to the CMBS Sale. See Note 5 of the Notes to Consolidated Financial Statements. Type and Geographic Location of Loans. As of December 31, 1999 and 1998, the mortgage loans underlying the Company's CMBS portfolio were secured by properties of the types and at the locations identified below:
Property Type 1999(1) 1998(1) Geographic Location(2) 1999(1) 1998(1) - -------------------------- ------- ------- ---------------------- ------- ------- Multifamily............... 32% 31% California.............. 17% 16% Retail.................... 29% 28% Texas................... 13% 12% Office.................... 13% 15% Florida................. 8% 7% Hotel..................... 14% 13% New York................ 5% 6% Other..................... 12% 13% Other(3)................ 57% 59% ------- ------- ------- ------- Total................... 100% 100% Total................. 100% 100% ======== ======== ======== ========
(1) Based on a percentage of the total unpaid principal balance of the underlying loans. (2) No significant concentration by region. (3) No other individual state makes up more than 5% of the total. 16 CMBS Pools. The following table summarizes information relating to the Company's CMBS on an aggregate basis by pool as of December 31, 1999. See also Note 5 of the Notes to Consolidated Financial Statements.
Amortized Original December. 31, 1999 Face Amount Fair Value (2) Cost Anticipated Yield Anticipated Yield Pool (1) (in millions) (in millions) (in millions) to Maturity (3) to Maturity (3)(4) - ------------------------------ ------------- -------------- ------------ ----------------- --------------------- Retained Securities from CRIIMI 1996 C1 (CBO-1) $ 111.3 $ 42.4 $ 45.0 19.5% 20.6%(5) DLJ Mortgage Acceptance Corp. Series 1997 CF2 Tranche B-30C (7) 6.2 17.4 17.4 8.2% 8.2% Nomura Asset Securities Corp. Series 1998-D6 Tranche B7 46.5 10.8 16.9 12.0% 12.0% Retained Securities from CRIIMI 1998 C1 (CBO-2) 1,427.2 741.0 927.1 10.3% 10.2%(6) Mortgage Capital Funding, Inc. Series 1998-MC1 (7) 151.8 89.8 89.8 8.9% 9.0% Chase Commercial Mortgage Securities Corp. Series 1998-1 (7) 81.8 44.3 44.3 8.8% 8.8% First Union/Lehman Brothers Series 1998 C2 (7) 289.7 141.3 141.3 8.9% 9.0% Morgan Stanley Capital I., Inc. Series 1998-WF2 (7) 87.0 47.2 47.2 8.5% 8.6%(6) Mortgage Capital Funding, Inc. Series 1998-MC2 (7) 85.8 45.1 45.1 8.7% 8.8% ------------- -------------- ------------ ----------------- ------------------ $2,287.3 $1,179.3 $1,374.1 9.7%(1) 10.1%(1) ============= ============== ============ ================= ==================
(2) CRIIMI MAE, through CMSLP, performs servicing functions on a total CMBS pool of approximately $28 billion as of December 31, 1999. Of the $28 billion of mortgage loans, approximately $273.3 million are being specially serviced, of which approximately $167.5 million are being specially serviced due to payment default (including $26.8 million of Real Estate Owned) and the remainder is being specially serviced due to non-financial covenant default. Through December 31, 1999, CMSLP has resolved and transferred out of special servicing approximately $439.9 million of the approximately $713.1 million that has been transferred into special servicing. Through December 31, 1999, actual losses on mortgage loans underlying the CMBS transactions are lower than the Company's original loss estimates. See "BUSINESS-Servicing" and Note 5 of the Notes to Consolidated Financial Statements for a discussion of the transfer of special servicing to ORIX. 17 (3) Fair value has been calculated as described above in footnote (1) to the table on CMBS Fair Value. (4) Represents the anticipated weighted average unleveraged yield over the expected average life of the Company's Subordinated CMBS portfolio as of the date of acquisition and December 31, 1999, respectively, based on management's estimate of the timing and amount of future credit losses and prepayments. (5) Unless otherwise noted, changes in the December 31, 1999 anticipated yield to maturity from that originally anticipated are primarily the result of changes in prepayment assumptions relating to mortgage collateral. (6) The increase in the anticipated yield resulted from the reallocation of a portion of the CBO-1 asset basis in conjunction with the CBO-2 resecuritization. In addition, while it had no impact on the anticipated yield, the unrated bond from CBO-1 experienced an approximately $1.6 million principal write-down in 1999 due to a loss on the foreclosure of two underlying loans. (7) On October 6, 1998, Morgan Stanley and Co. International Limited ("Morgan Stanley") advised CRIIMI MAE that it was exercising alleged ownership rights over certain classes of CMBS it held as collateral. In the first quarter of 1999, the Company agreed to cooperate in selling two classes of investment grade CMBS issued by CRIIMI MAE Commercial Mortgage Trust Series 1998-C1 (the "CBO-2 BBB Bonds") and to suspend litigation with Morgan Stanley with respect to these CMBS. On March 5, 1999, the CBO-2 BBB Bonds with a $205.8 million face amount and a coupon rate of 7% were sold in a transaction that was accounted for as a financing by the Company rather than a sale. Of the $159.0 million in proceeds, $141.2 million was used to repay amounts due under the agreement with Morgan Stanley, and $17.8 million was paid to CRIIMI MAE. CRIIMI MAE and Morgan Stanley reached an agreement that called for the sale of seven classes of subordinated CMBS and a related unrated bond, issued by Morgan Stanley Capital Inc. Series 1998-WF2 (the "Wells Fargo Bonds"). The agreement was approved by the Bankruptcy Court on February 24, 2000. On February 29, 2000, the Wells Fargo Bonds were sold. Of the approximately $45.9 million in net sale proceeds, $37.5 million was used to pay off all outstanding borrowings owed to Morgan Stanley and the remaining proceeds of approximately $8.4 million will be used primarily to help fund CRIIMI MAE's Plan. (8) As discussed further in Note 5 of the Notes to Consolidated Financial Statements, under the Plan the Company intends to sell these CMBS pools and as such, impairment was recognized as of December 31, 1999 related to these CMBS. The impairment resulted in the cost basis being written down to fair value as of December 31, 1999. As a result of this new basis, these bonds have new yields effective the first quarter of 2000. Insured Mortgage Securities As of December 31, 1999 and 1998, the Company had $394.9 million and $488.1 million (at fair value), respectively, invested in mortgage securities, consisting of GNMA Mortgage-Backed Securities and FHA-Insured Certificates, as well as Freddie Mac participation certificates that are collateralized by GNMA Mortgage-Backed Securities. As of December 31, 1999, approximately 15% of CRIIMI MAE's investment in mortgage securities were FHA-Insured Certificates and 85% were GNMA Mortgage-Backed Securities (including certificates that collateralize Freddie Mac participation certificates). See Notes 3 and 7 of the Notes to Consolidated Financial Statements for further discussion. Investment in Originated Loans As of December 31, 1999 and 1998, the Company had $470.2 million and $499.1 million (at amortized cost), respectively, invested in commercial mortgage loans primarily originated through the Company's mortgage loan conduit programs and subsequently securitized in CMO-IV. Because the bonds sold in CMO-IV are subject to certain call options, under FAS 125, the entire transaction is accounted for as a financing instead of a sale and the mortgage loans are reflected on the Company's balance sheet. See "BUSINESS-Loan Originations and Securitizations" and Notes 3 and 6 of the Notes to Consolidated Financial Statements for further discussion. 18 As of December 31, 1999 and 1998, the originated mortgage loans were secured by properties of the types and at the locations identified below:
Property Type 1999(1) 1998(1) Geographic Location(2) 1999(1) 1998(1) - ---------------------------- ------- ------- ---------------------- ------- ------- Multifamily................. 37% 38% Michigan............. 20% 20% Hotel....................... 26% 26% Texas................ 7% 8% Retail...................... 20% 20% Illinois............. 7% 7% Office...................... 11% 11% California........... 6% 6% Other....................... 6% 5% Maryland............. 6% 6% ------- -------- Total....................... 100% 100% Connecticut.......... 6% 6% Florida.............. 5% 5% Other(3)............. 43% 42% -------- -------- Total.............. 100% 100%
(1) Based on a percentage of the total unpaid principal balance of the related loans. (2) No significant concentration by region. (3) No other state makes up more than 5% of the total. Equity Investments As of December 31, 1999 and 1998, the Company had approximately $34.9 million and $42.9 million, respectively, in investments accounted for under the equity method of accounting. Included in equity investments are (a) the general partnership interests in American Insured Mortgage Investors, American Insured Mortgage Investors-Series 85, L.P., American Insured Mortgage Investors L.P.-Series 86 and American Insured Mortgage Investors L.P.-Series 88 (collectively the "AIM Funds"), owned by CRIIMI, Inc., a wholly owned subsidiary of CRIIMI MAE, (b) a 20% limited partnership interest in the adviser to the AIM Funds, 50% of which is owned by CRIIMI MAE and 50% of which is owned by CM Management, (c) CRIIMI MAE's interest in CRIIMI MAE Services Inc., and (d) CRIIMI MAE's interest in CMSLP. See Note 3 of the Notes to Consolidated Financial Statements for further discussion. Risk Factors The following risk factors address risks relating primarily to the Company and its operations during the pendency of the bankruptcy. Because it is not possible to predict the outcome of the Chapter 11 filing and there can be no assurance as to when or if the Company will resume business activities that it has suspended during the bankruptcy, the following discussion does not address risks relating to the resumption of the Company's Subordinated CMBS acquisition, loan origination or securitization programs. Reference is made to the Company's Plan and Proposed Disclosure Statement for risks related to the Recapitalization Financing and to confirmation and consummation of the Plan, which are generally not addressed below. Effect of Bankruptcy Filing; Ability to Continue as a Going Concern Since filing for bankruptcy, CRIIMI MAE has suspended its Subordinated CMBS acquisition, origination and securitization operations, but continues to service mortgage loans through CMSLP. Accordingly, the Company's results of operations during the pendency of the bankruptcy are expected to differ materially from the Company's performance prior to the bankruptcy. Moreover, depending upon when and if any of these activities are resumed by the Company, the Company's future performance will differ materially from its present operations. The Company's ability to resume the acquisition of Subordinated CMBS, as well as its loan origination and securitization programs, depends to a significant degree on its ability to obtain additional capital and emerge from bankruptcy as a successfully reorganized company. The Company's ability to access the necessary additional capital will be affected by a number of factors, many of which are not in the Company's control. These include the cost of such capital, changes in interest rates and interest rate spreads, changes in the commercial mortgage industry and the commercial real estate market, general economic conditions, perceptions in the capital markets of the Company's business, covenants under the Company's current and future debt securities and 19 credit facilities, results of operations, leverage, financial condition and business prospects. The Company can give no assurances as to whether or when it will obtain the necessary capital or the terms upon which such capital can be obtained. On March 31, 2000, the Debtors filed their Plan and Proposed Disclosure Statement with the Bankruptcy Court. The Plan was filed with the support of the Equity Committee, which is a co-proponent of the Plan. Subject to the completion of mutually acceptable Unsecured Creditor Debt Documentation, the Unsecured Creditors' Committee has agreed to support confirmation of the Debtors' Plan. Merrill Lynch and GACC, two of the Company's largest secured creditors, would provide a significant portion of the Recapitalization Financing contemplated by the Plan. The Bankruptcy Court has scheduled a hearing for April 25 and April 26, 2000 on the Proposed Disclosure Statement filed by the Debtors. On December 20, 1999, the Unsecured Creditors' Committee filed its own plan of reorganization and disclosure statement, which generally provided for the liquidation of the assets of the Debtors. Such plan and disclosure statement were amended on January 11, 2000 and February 11, 2000. However, as a result of successful negotiations between the Debtors and the Unsecured Creditors' Committee, the Unsecured Creditors' Committee has agreed to the treatment of unsecured claims under the Debtors' Plan, subject to completion of mutually acceptable Unsecured Creditor Debt Documentation, and has asked the Bankruptcy Court to defer consideration of its second amended plan of reorganization and second amended proposed disclosure statement. At this time, it is not possible to predict the outcome of the Chapter 11 filing, in general, nor its effects on the business of the Company or on the claims and interests of creditors and shareholders. In addition, the Company's independent public accountants have issued a report expressing substantial doubt about the Company's ability to continue as a going concern. Risks Relating to the Necessary Recapitalization Financing Consummation of the Plan is conditioned upon, among other matters, the Company obtaining New Debt and completing the CMBS Sale. Although the Company has sold certain CMBS in connection with the CMBS Sale, is engaged in negotiating additional commitments for the CMBS Sale, and has agreed to terms with respect to substantially all of the New Debt, there can be no assurance that the Company will complete the CMBS Sale or obtain and satisfy all terms and conditions of the New Debt. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" and Note 5 of the Notes to Consolidated Financial Statements for a discussion of certain CMBS sold in February 2000 constituting a portion of the CMBS Sale. Risk of Loss of REIT Status and Other Tax Matters See "BUSINESS-Effect of Chapter 11 Filing on REIT Status and Other Tax Matters" for a discussion. Taxable Mortgage Pool Risks See "BUSINESS-Effect of Chapter 11 Filing on REIT Status and Other Tax Matters" for a discussion. Phantom Income May Result in Additional Tax Liability The Company's investment in Subordinated CMBS and certain other types of mortgage related assets may cause it, under certain circumstances, to recognize taxable income in excess of its economic income ("phantom income") and to experience an offsetting excess of economic income over its taxable income in later years. As a result, stockholders, from time to time, may be required to treat distributions that economically represent a return of capital as taxable dividends. Such distributions would be offset in later years by distributions representing economic income that would be treated as returns of capital for federal income tax purposes. Accordingly, if the Company recognizes phantom income, its stockholders may be required to pay federal income tax with respect to such income on an accelerated basis (i.e., before such income is realized by the stockholders in an economic sense). Taking into account the time value of money, such an acceleration of federal income tax liabilities would cause stockholders to receive an after-tax rate of return on an investment in the Company that would be less than the after-tax rate of return on an investment with an identical before-tax rate of return that did not generate phantom 20 income. As the ratio of the Company's phantom income to its total income increases, the after-tax rate of return received by a taxable stockholder of the Company will decrease. Effect of Rate Compression on Market Price of Stock The Company's actual earnings performance as well as the market's perception of the Company's ability to achieve earnings growth may affect the market price of the Company's common stock. In the Company's case, the level of earnings (or losses) depends to a significant extent upon the width and direction of the spread between the net yield received by the Company on its income earning assets (principally, the long term, fixed-rate assets comprising its CMBS portfolio) and its floating rate cost of borrowing. In periods of narrowing or compressing spreads, the resulting pressure on the Company's earnings may adversely affect the market value of its common stock. Spread compression can occur in high or low interest rate environments and typically results when net yield on the long term assets adjusts less frequently than the current rate on debt used to finance their purchase. For example, if the Company relies on short term, floating rate borrowings to finance the purchase of long term fixed-rate CMBS assets, the Company may experience rate compression, and a resulting diminution of earnings, if the interest rate on the debt increases while the coupon and yield measure for the financed CMBS remain constant. In such an event, the market price of the common stock may decline to reflect the actual or perceived decrease in value of the Company resulting from the spread compression. In an effort to mitigate this risk, the Company as a matter of policy generally hedges at least 75% of the principal amount of its variable-rate debt with interest-rate protection agreements to protect interest cash flow against a significant rise in interest rates. Substantial Indebtedness; Leverage The Company has substantial indebtedness. As of December 31, 1999, the Company's total consolidated indebtedness was $2.0 billion, of which $926 million was recourse debt to the Company (i.e. not match-funded debt), and stockholders' equity of $219 million. This high level of debt limits the Company's ability to obtain additional financing, reduces income available for distributions to the extent income from assets purchased with the borrowed funds fails to cover the cost of the borrowings, restricts the Company's ability to react quickly to changes in its business and makes the Company more vulnerable to economic downturn. Risks of Owning Subordinated CMBS As an owner of the most subordinate tranches of CMBS, the Company will be the first to bear any loss and the last to have a priority right to the cash flow of the related mortgage pool. For example, if the Company owns a $10 million subordinated interest in an issuance of CMBS consisting of $100 million of mortgage loan collateral, a 7% loss on the underlying mortgage loans will result in a 70% loss on the subordinated interest. The Company's Subordinated CMBS can change in value due to a number of economic factors. These factors include changes in the underlying real estate, fluctuations in Treasury rates, and supply/demand mismatches which are reflected in CMBS pricing spreads. For instance, changes in the credit quality of the properties securing the underlying mortgage loans can result in interest payment shortfalls, to the extent there are mortgage payment delinquencies, and principal losses, to the extent that there are payment defaults and the amounts are not fully recovered. These losses may result in a permanent decline in the value of the CMBS, and the losses may change the Company's anticipated yield to maturity if the losses are in excess of those previously estimated. CMBS are priced at a spread above the current Treasury security with a maturity that most closely matches the CMBS' weighted average life. The value of CMBS can be affected by changes in Treasury rates, as well as changes in the spread between such CMBS and the Treasury security with a comparable maturity. For example, the spread to Treasury of a CMBS may have increased from 400 basis points to 500 basis points. If the Treasury security with a comparable maturity had a constant yield of 5% then, in this example, the yield on the CMBS would have changed from 9% to 10% and accordingly, the value of such CMBS would have declined. Generally, increases and decreases in both Treasury rates or spreads will result in temporary changes in the value of the Subordinated CMBS assuming that the Company has the ability and intent to hold its CMBS investments until maturity. However, such temporary changes in the value of Subordinated CMBS become permanent changes realized through the income statement when the Company no longer intends or fails to have the ability to hold such Subordinated CMBS to maturity. The Company has historically been unable to obtain financing at the time of acquisition that matches the maturity of the related investments, resulting in a periodic need to obtain short-term financing secured by the 21 Company's CMBS. The inability to refinance this short-term floating-rate financing with long-term fixed-rate financing or a decline in the value of the collateral securing such short-term floating-rate indebtedness could result in a situation where the Company is required to sell CMBS or provide additional collateral, which could have, and has had, an adverse effect on the Company and its financial position and results of operations. The Company's ability to borrow amounts in the future may be impacted by, among other things, the credit performance of the underlying pools of commercial mortgage loans, and other factors affecting the Subordinated CMBS that it owns. Limited Protection from Hedging Transactions To minimize the risk of interest rate increases on interest expense as it relates to its short-term, variable-rate debt, the Company follows a policy to hedge at least 75% of the principal amount of its variable-rate debt with interest rate protection agreements in order to provide a ceiling on the amount of interest expense payable by the Company. As of December 31, 1999, 94% of the Company's outstanding variable-rate debt was hedged with interest rate protection agreements that partially limit the impact of rising interest rates above a certain defined threshold, or strike price. When these interest rate protection agreements expire, the Company will have increased interest rate risk unless it is able to enter into replacement interest rate protection agreements. As of December 31, 1999, the weighted average remaining term for the interest rate protection agreements was approximately one year with a weighted average strike price of 6.7%. The highest rate for one-month LIBOR during 1999 was 6.5%. There can be no assurance that the Company will be able to maintain interest rate protection agreements to meet its hedge policy on satisfactory terms or to adequately protect against rising interest rates on the Company's debt. In addition, the Company does not currently hedge against any interest rate risks, including increases in interest rate spreads and increases in Treasury rates, which adversely affect the value of its CMBS. Moreover, hedging involves risk and typically involves costs, including transaction costs. Such costs increase dramatically as the period covered by the hedging increases and during periods of rising and volatile interest rates. The Company may increase its hedging activity and, thus, increase its hedging costs during such periods when interest rates are volatile or rising and hedging costs have increased. Risk of Foreclosure on Pledged CMBS Additionally, changes in interest rates, as well as changes in market spreads, may cause the value of the Company's CMBS portfolio to decrease. A decrease in the market value of these assets may cause lenders to seek relief from the automatic stay provision of the Bankruptcy Code to foreclose on the collateral or take other action. Limited Liquidity of Subordinated CMBS Market There is currently no active secondary trading market for Subordinated CMBS. This limited liquidity results in uncertainty in the valuation of the Company's portfolio of Subordinated CMBS. In addition, even if the market for Subordinated CMBS fully recovers, the liquidity of such market has historically been limited; and furthermore, during adverse market conditions the liquidity of such market has been severely limited, which would impair the amount the Company could realize if it were required to sell a portion of its Subordinated CMBS. Pending Litigation The Company is involved in material litigation. See "LEGAL PROCEEDINGS" for descriptions of such litigation and other legal proceedings. Investment Company Act Risk Under the Investment Company Act of 1940, as amended (the "Investment Company Act"), an investment company is required to register with the SEC and is subject to extensive restrictive and potentially adverse regulation relating to, among other things, operating methods, management, capital structure, dividends and transactions with affiliates. However, as described below, companies that are primarily engaged in the business of acquiring mortgages and other liens on and interests in real estate ("Qualifying Interests") are excluded from the requirements of the Investment Company Act. 22 To qualify for the Investment Company Act exclusion, CRIIMI MAE, among other things, must maintain at least 55% of its assets in Qualifying Interests (the "55% Requirement") and is also required to maintain an additional 25% in Qualifying Interests or other real estate-related assets ("Other Real Estate Interests" and such requirement, the "25% Requirement"). According to current SEC staff interpretations, CRIIMI MAE believes that its government insured mortgage securities and originated loans constitute Qualifying Interests. In accordance with current SEC staff interpretations, the Company believes that all of its Subordinated CMBS constitute Other Real Estate Interests and that certain of its Subordinated CMBS also constitute Qualifying Interests. On certain of the Company's Subordinated CMBS, the Company, along with other rights, has the unilateral right to direct foreclosure with respect to the underlying mortgage loans. Based on such rights and its economic interest in the underlying mortgage loans, the Company believes that the related Subordinated CMBS constitute Qualifying Interests. As of December 31, 1999, the Company believes that it was in compliance with both the 55% Requirement and the 25% Requirement. If the SEC or its staff were to take a different position with respect to whether such Subordinated CMBS constitute Qualifying Interests, the Company could, among other things, be required either (i) to change the manner in which it conducts its operations to avoid being required to register as an investment company or (ii) to register as an investment company, either of which could have a material adverse effect on the Company. If the Company were required to change the manner in which it conducts its business, it would likely have to dispose of a significant portion of its Subordinated CMBS or acquire significant additional assets that are Qualifying Interests. Alternatively, if the Company were required to register as an investment company, it expects that its operating expenses would significantly increase and that the Company would have to reduce significantly its indebtedness, which could also require it to sell a significant portion of its assets. No assurances can be given that any such dispositions or acquisitions of assets, or deleveraging, could be accomplished on favorable terms. Further, if the Company were deemed an unregistered investment company, the Company could be subject to monetary penalties and injunctive relief. The Company would be unable to enforce contracts with third parties and third parties could seek to obtain rescission of transactions undertaken during the period the Company was deemed an unregistered investment company. In addition, as a result of the Company's Chapter 11 filing, the Company is limited in possible actions it may take in response to any need to modify its business plan in order to register as an investment company, or avoid the need to register. Certain dispositions or acquisitions of assets would require Bankruptcy Court approval. Also, any forced sale of assets that occurs after the bankruptcy stay is lifted would change the Company's asset mix, potentially resulting in the need to register as an investment company under the Investment Company Act or take further steps to change the asset mix. Any such results would be likely to have a material adverse effect on the Company. Effect of Economic Recession on Losses and Defaults Economic recession may increase the risk of default on commercial mortgage loans and correspondingly increase the risk of losses on the Subordinated CMBS backed by such loans. Economic recession may also cause declining values of commercial real estate securing the outstanding mortgage loans, weakening collateral coverage and increasing the possibility of losses in the event of a default. In addition, an economic recession may cause reduced demand for commercial mortgage loans. Results of Operations Adversely Affected by Factors Beyond Company's Control The Company's results of operations can be adversely affected by various factors, many of which are beyond the control of the Company, and will depend on, among other things, the level of net interest income generated by, and the market value of, the Company's CMBS portfolio. The Company's net interest income and results of operations will vary primarily as a result of fluctuations in interest rates, CMBS pricing, and borrowing costs. The Company's results of operations also will depend upon the Company's ability to protect against the adverse effects of such fluctuations as well as credit risks. Interest rates, credit risks, borrowing costs and credit losses depend upon the nature and terms of the CMBS, conditions in financial markets, the fiscal and monetary policies of the U.S. government, international economic and financial conditions and competition, none of which can be predicted with any certainty. Because changes in interest rates may significantly affect the Company's CMBS and other assets, the operating results of the Company will depend, in large part, upon the 23 ability of the Company to manage its interest rate and credit risks effectively while maintaining its status as a REIT. See "BUSINESS-Risk Factors-Limited Protection from Hedging Transactions" for further discussion. Borrowing Risks A substantial portion of the Company's borrowings is, and is expected to continue to be, in the form of collateralized borrowings. The terms of the New Debt contemplated to be provided by Merrill and GACC will be collateralized by first-priority liens and security interests in certain assets, and will be subject to a number of terms, conditions and restrictions including, without limitation, scheduled principal and interest payments, accelerated principal payments, restrictions and requirements with respect to the collection, management, use and application of funds, and certain approval rights with respect to Board of Directors. Certain events, including, without limitation, the failure to satisfy certain payment obligations will result in further restrictions on the ability of the Company to take certain actions including, without limitation, to pay cash dividends to preferred or common shareholders. The unsecured creditor New Debt will be collateralized by first or second priority liens or security interests in certain assets or proceeds, and will be subject to a number of terms, conditions and restrictions including, without limitation, scheduled principal and interests payments, and restrictions and requirements with respect to the use of funds. A substantial portion of the Company's borrowings are, and a limited portion of the Company's borrowings in the future, if CMBS acquisitions are resumed, may be, in the form of collateralized, short-term floating-rate secured borrowings. The amount borrowed under such agreements is typically based on the market value of the CMBS pledged to secure specific borrowings. Under adverse market conditions, the value of pledged CMBS would decline, and lenders could initiate margin calls (in which case the Company could be required to post additional collateral or to reduce the amount borrowed to restore the ratio of the amount of the borrowing to the value of the collateral). The Company may be required to sell CMBS to reduce the amount borrowed. If these sales were made at prices lower than the carrying value of the CMBS, the Company would experience losses. A default by the Company under its collateralized borrowings could result in a liquidation of the collateral. If the Company is forced to liquidate CMBS that qualify as qualified real estate assets (under the REIT Provisions of the Internal Revenue Code) to repay borrowings, there can be no assurance that it will be able to maintain compliance with the REIT Provisions of the Internal Revenue Code regarding asset and source of income requirements. Shape of the Yield Curve Adversely Affects Income The relationship between short-term and long-term interest rates is often referred to as the "yield curve." Ordinarily, short-term interest rates are lower than long-term interest rates. If short-term interest rates rise disproportionately relative to long-term interest rates (a flattening of the yield curve), the borrowing costs of the Company may increase more rapidly than the interest income earned on its assets. Because borrowings will likely bear interest at short-term rates (such as LIBOR) and CMBS will likely bear interest at medium-term to long-term rates (such as those calculated based on the Ten-Year U.S. Treasury Rate), a flattening of the yield curve will tend to decrease the Company's net income, assuming the Company's short-term borrowing rates bear a strong relationship to short-term Treasury rates. Additionally, to the extent cash flows from long-term assets are reinvested in other long-term assets, the spread between the coupon rates of long-term assets and short-term borrowing rates may decline and also may tend to decrease the net income and mark-to-market value of the Company's net assets. It is also possible that short-term interest rates may adjust relative to long-term interest rates such that the level of short-term rates exceeds the level of long-term rates (a yield curve inversion). In this case, as well as in a positively sloped yield curve environment, borrowing costs could exceed the interest income and operating losses would be incurred. Year 2000 During the transition from 1999 to 2000, the Company did not experience any significant problems or errors in its information technology ("IT") systems or date-sensitive embedded technology that controls certain systems. Based on operations since January 1, 2000, the Company does not expect any significant impact to its business, operations, or financial condition as a result of the Year 2000 issue. However, it is possible that the full impact of the date change 24 has not been fully recognized. The Company is not aware of any significant Year 2000 problems affecting third parties with which the Company interfaces directly or indirectly. Risks Associated with Trader Election On March 15, 2000, the Company determined to elect mark-to-market treatment as a securities trader for 2000. See "BUSINESS-Effect of Chapter 11 Filing on REIT Status and Other Tax Matters-Taxable Income Distributions" for further discussion. There is no assurance, however, that the Company's election will not be challenged on the ground that it is not in fact a trader in securities, or that it is only a trader with respect to some, but not all, of its securities. As such, there is a risk that the Company will be limited in its ability to recognize certain losses if it is not able to mark-to-market its securities. The election to be treated as a trader will result in net operating losses ("NOLs") that generally may be carried forward for 20 years. The Company believes that it may experience an "ownership change" within the meaning of Section 382 of the Code. Consequently, its use of NOLs generated before the ownership change to reduce taxable income after the ownership change may be subject to limitation under Section 382. Generally, the use of NOLs in any year is limited to the value of the Company's stock on the date of the ownership change multiplied by the long-term tax exempt rate (published by the IRS) with respect to that date. For the year ended December 31, 2000, taxable income (loss) may be different from the net income (loss) as calculated according to GAAP as a result of, among other things, differing treatment of the unrealized gains and losses on securities transactions as well as other timing differences. For the Company's tax purposes, unrealized gains (losses) will be recognized at the end of the year and will be aggregated with operating gains (losses) to produce total taxable income (loss) for the year. 25 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. CRIIMI MAE INC. March 24, 2000 /s/ William B. Dockser -------------------------- William B. Dockser Chairman of the Board and Principal Executive Officer 26 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated: March 24, 2000 /s/ William B. Dockser --------------------------- William B. Dockser Chairman of the Board and Principal Executive Officer April 11, 2000 /s/ H. William Willoughby ----------------------- H. William Willoughby Director, President and Secretary April 14, 2000 /s/ Cynthia O. Azzara ------------------------------- Cynthia O. Azzara Senior Vice President, Chief Financial Officer and Principal Accounting Officer March 24, 2000 /s/ Garrett G. Carlson, Sr. ----------------------- Garrett G. Carlson, Sr. Director March 24, 2000 /s/ G. Richard Dunnells ------------------- G. Richard Dunnells Director March 24, 2000 /s/ Robert Merrick -------------- Robert Merrick Director March 24, 2000 /s/ Robert E. Woods --------------- Robert E. Woods Director 27 CRIIMI MAE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION General CRIIMI MAE Inc. (together with its consolidated subsidiaries, unless the context otherwise indicates, "CRIIMI MAE" or the "Company") is a fully integrated commercial mortgage company structured as a self-administered real estate investment trust ("REIT"). Prior to the filing by CRIIMI MAE Inc. (unconsolidated) and two of its operating subsidiaries, CRIIMI MAE Management, Inc. ("CM Management"), and CRIIMI MAE Holdings II, L.P. ("Holdings II" and, together with CRIIMI MAE and CM Management, the "Debtors"), for relief under Chapter 11 of the U.S. Bankruptcy Code on October 5, 1998 (the "Petition Date") as described below, CRIIMI MAE's primary activities included (i) acquiring non-investment grade securities (rated below BBB- or unrated) backed by pools of commercial mortgage loans on multifamily, retail and other commercial real estate ("Subordinated CMBS"), (ii) originating and underwriting commercial mortgage loans, (iii) securitizing pools of commercial mortgage loans and resecuritizing pools of Subordinated CMBS, and (iv) through the Company's servicing affiliate, CRIIMI MAE Services Limited Partnership ("CMSLP"), performing servicing functions with respect to the mortgage loans underlying the Company's Subordinated CMBS. Since filing for Chapter 11 protection, CRIIMI MAE has suspended its Subordinated CMBS acquisition, origination and securitization programs. The Company continues to hold a substantial portfolio of Subordinated CMBS, originated loans and mortgage securities and, through CMSLP, acts as a servicer for its own as well as third party securitized mortgage loan pools. The Company's business is subject to a number of risks and uncertainties including, but not limited to: (1) the effect of the Chapter 11 filing and substantial doubt as to the Company's ability to continue as a going concern; (2) risks related to the necessary Recapitalization Financing under the Company's Second Amended Joint Plan of Reorganization; (3) risk of loss of REIT status; (4) taxable mortgage pool risk; (5) risk of phantom income resulting in additional tax liability; (6) the effect of rate compression on the market price of the Company's stock; (7) substantial leverage; (8) inherent risks in owning Subordinated CMBS; (9) the limited protection provided by hedging transactions; (10) risk of foreclosure on CMBS assets; (11) the limited liquidity of the CMBS market; (12) pending litigation; (13) risk of being considered an investment company; (14) possible effects of an economic recession on losses and defaults; (15) borrowing risks; (16) the shape of the yield curve could adversely affect income; and (17) risks associated with the trader election. In addition to the two operating subsidiaries which filed for Chapter 11 protection with the Company, the Company owns 100% of multiple financing and operating subsidiaries as well as various interests in other entities (including CMSLP) which either own or service mortgage and mortgage-related assets (the "Non-Debtor Affiliates"). See Note 3. None of the Non-Debtor Affiliates has filed for bankruptcy protection. The Company was incorporated in Delaware in 1989 under the name CRI Insured Mortgage Association, Inc. ("CRI Insured"). In July 1993, CRI Insured changed its name to CRIIMI MAE Inc. and reincorporated in Maryland. In June 1995, certain mortgage businesses affiliated with C.R.I., Inc. were merged into CRIIMI MAE (the "Merger"). The Company is not a government sponsored entity nor in any way affiliated with the United States government or any United States government agency. Chapter 11 Filing Prior to the Petition Date, CRIIMI MAE financed a substantial portion of its Subordinated CMBS acquisitions with short-term, variable-rate financing facilities secured by the Company's CMBS. The agreements governing these financing arrangements typically required the Company to maintain collateral with a market value not less than a specified percentage of the outstanding indebtedness ("loan-to-value ratio"). The agreements further provided that the 28 creditors could require the Company to provide cash or additional collateral if the market value of the existing collateral fell below this minimum amount. As a result of the turmoil in the capital markets commencing in late summer of 1998, the spreads between CMBS yields and yields on Treasury securities with comparable maturities began to widen substantially and rapidly. Due to this widening of CMBS spreads, the market value of the CMBS securing the Company's short-term, variable-rate financing facilities declined. CRIIMI MAE's short-term secured creditors perceived that the value of the CMBS securing their facilities with the Company had fallen below the minimum value required in the loan-to-value ratio described above and, consequently, made demand upon the Company to provide cash or additional collateral with sufficient value to cure the perceived value deficiency. In August and September of 1998, the Company received and met collateral calls from its secured creditors. At the same time, CRIIMI MAE was in negotiations with various third parties in an effort to obtain additional debt and equity financing that would provide the Company with additional liquidity. On Friday afternoon, October 2, 1998, the Company was in the closing negotiations of a refinancing with one of its unsecured creditors that would have provided the Company with additional borrowings when it received a significant collateral call from Merrill Lynch Mortgage Capital, Inc. ("Merrill Lynch"). The basis for this collateral call, in the Company's view, was unreasonable. After giving consideration to, among other things, this collateral call and the Company's concern that its failure to satisfy this collateral call would cause the Company to be in default under a substantial portion of its financing arrangements, the Company reluctantly concluded on Sunday, October 4, 1998 that it was in the best interests of creditors, equity holders and other parties in interest to seek Chapter 11 protection. On October 5, 1998, the Debtors filed for relief under Chapter 11 of the U.S. Bankruptcy Code in the United States Bankruptcy Court for the District of Maryland, Southern Division, in Greenbelt, Maryland (the "Bankruptcy Court"). These related cases are being jointly administered under the caption "In re CRIIMI MAE Inc., et al.," Ch. 11 Case No. 98-2-3115-DK. While in bankruptcy, CRIIMI MAE has streamlined its operations. The Company has significantly reduced the number of employees in its origination and underwriting operations. In connection with these reductions, the Company closed its five regional loan origination offices. Although the Company has significantly reduced its work force, the Company recognizes that retention of its executives and other remaining employees is essential to the efficient operation of its business and to its reorganization efforts. Accordingly, the Company has, with Bankruptcy Court approval, adopted an employee retention plan. See Note 15 for further discussion. CRIIMI MAE is working diligently toward emerging from bankruptcy as a successfully reorganized company. In furtherance of such effort, the Debtors filed (i) a Joint Plan of Reorganization on September 22, 1999, (ii) an Amended Joint Plan of Reorganization and proposed Joint Disclosure Statement on December 23, 1999, and (iii) a Second Amended Joint Plan of Reorganization (the "Plan") and proposed Amended Joint Disclosure Statement (the "Proposed Disclosure Statement") on March 31, 2000. The Plan was filed with the support of the Official Committee of Equity Security Holders of CRIIMI MAE (the "Equity Committee"), which is a co-proponent of the Plan. Subject to the completion of mutually acceptable documentation evidencing the secured financing to be provided by the unsecured creditors (the "Unsecured Creditor Debt Documentation"), the Official Committee of Unsecured Creditors of CRIIMI MAE (the "Unsecured Creditors' Committee") has agreed to support confirmation of the Debtors' Plan. The Company, the Equity Committee and the Unsecured Creditors' Committee are now all proceeding toward confirmation of the Plan. Under the Plan, Merrill Lynch and German American Capital Corporation ("GACC"), two of the Company's largest secured creditors, would provide a significant portion of the recapitalization financing contemplated by the Plan. The Bankruptcy Court has scheduled a hearing for April 25 and 26, 2000 on approval of the Proposed Disclosure Statement. On December 20, 1999, the Unsecured Creditors' Committee filed its own plan of reorganization and proposed disclosure statement with the Bankruptcy Court which, in general, provided for the liquidation of the assets of the Debtors. On January 11, 2000 and February 11, 2000, the Unsecured Creditors' Committee filed its first and second amended plans of reorganization, respectively, with the 29 Bankruptcy Court and amended proposed disclosure statements with respect thereto. However, as a result of successful negotiations between the Debtors and the Unsecured Creditors' Committee, the Unsecured Creditors' Committee has agreed to the treatment of unsecured claims under the Debtors' Plan, subject to completion of mutually acceptable Unsecured Creditor Debt Documentation, and has asked the Bankruptcy Court to defer consideration of its second amended plan of reorganization and second amended proposed disclosure statement. The Plan of Reorganization The Plan contemplates the payment in full of all of the allowed claims of the Debtors primarily through recapitalization financing (including proceeds from CMBS sales) aggregating at least $856 million (the "Recapitalization Financing"). Approximately $275 million of the Recapitalization Financing would be provided by Merrill Lynch and GACC through a secured financing facility, approximately $155 million would be provided through new secured notes issued to some of the Company's major unsecured creditors, and another $35 million would be obtained from another existing creditor in the form of an additional secured financing facility (collectively, the "New Debt"). The sale of select CMBS (the "CMBS Sale"), the proceeds of which are expected to be used to pay down existing debt, is contemplated to provide the balance of the Recapitalization Financing. The Company may seek new equity capital from one or more investors to partially fund the Plan, although new equity is not required to fund the Plan. In connection with the Plan, substantially all cash flows are expected to be used to satisfy principal, interest and fee obligations under the New Debt. The $275 million secured financing would provide for (i) interest at a rate of one month LIBOR plus 3.25%, (ii) principal prepayment/amortization obligations, (iii) extension fees after two years and (iv) maturity on the fourth anniversary of the effective date of the Plan. The Plan contemplates that the $35 million secured financing would provide for terms similar to those referenced in the preceding sentence; however, the proposed lender has not agreed to any terms of the $35 million secured financing and there can be no assurance that an agreement for this financing will be obtained or that, if obtained, the terms will be as referenced above. The approximate $155 million secured financing would be effected through the issuance of two series of secured notes under two separate indentures. The first series of secured notes, representing an aggregate principal amount of approximately $105 million, would provide for (i) interest at a rate of 11.75% per annum, (ii) principal prepayment/amortization obligations,(iii) extension fees after four years and (iv) maturity on the fifth anniversary of the effective date of the Plan. The second series of secured notes, representing an aggregate principal amount of approximately $50 million, would provide for (i) interest at a rate of 13% per annum with additional interest at the rate of 7% per annum accreting over the debt term,(ii) extension fees after four years, and (iii) maturity on the sixth anniversary of the effective date of the Plan. The New Debt described above will be secured by substantially all of the assets of the Company. It is contemplated that there will be restrictive covenants, including financial covenants, in connection with the New Debt. The Plan also contemplates that the holders of the Company's common stock will retain their stock. Under the Plan, no cash dividends, other than a maximum of $4.1 million to preferred shareholders, can be paid to existing shareholders. See "Effect of Chapter 11 on REIT Status and Other Tax Matters-Taxable Income Distributions" below for further discussion. Subject to the respective approvals by the holders of the Company's Series B Cumulative Convertible Preferred Stock (the "Series B Preferred Stock") and the Series F Redeemable Cumulative Dividend Preferred Stock (the "Series F Preferred Stock" or "junior preferred stock"), the Plan contemplates an amendment to their respective relative rights and preferences to permit the payment of accrued and unpaid dividends in cash or common stock, at the Company's election. The Plan further contemplates amendments to the relative rights and preferences of the Series D Cumulative Convertible Preferred Stock (the "Series D Preferred Stock"), through an exchange of Series D Preferred Stock for Series E Cumulative Convertible Preferred Stock (the "Series E Preferred Stock"), similar to those amendments effected in connection with the recent exchange of the former Series C Cumulative Convertible Preferred Stock (the "Series C Preferred Stock") for Series E Preferred Stock. See "MARKET FOR THE REGISTRANT'S COMMON STOCK AND OTHER RELATED STOCKHOLDER MATTERS-Exchange of Series C Preferred Stock for Series E Preferred Stock" for a discussion of the exchange of Series C Preferred Stock for Series E Preferred Stock. Reference is made to the Plan and Proposed Disclosure Statement, previously filed with the Securities and Exchange Commission (the "SEC") as exhibits to a Form 8-K, for a complete description of the financing contemplated to be obtained under the Plan from the respective existing creditors including, 30 without limitation, payment terms, restrictive covenants and collateral, and a complete description of the treatment of preferred stockholders. Although the Company has commitments for substantially all of the New Debt and has certain of the CMBS contemplated to be sold in connection with the CMBS Sale, there can be no assurance that the Company will obtain the Recapitalization Financing, that the Plan will be confirmed by the Bankruptcy Court, or that the Plan, if confirmed, will be consummated. The Plan also contemplates certain amendments to the Company's articles of incorporation, including an increase in authorized shares from 120 million to 375 million (consisting of 300 million of common shares and 75 million of preferred shares). Effect of Chapter 11 Filing on REIT Status and Other Tax Matters REIT Status CRIIMI MAE is required to meet income, asset, ownership and distribution tests to maintain its REIT status. The Company has satisfied the REIT requirements for all years through, and including, 1998. However, due to the uncertainty resulting from its Chapter 11 filing, there can be no assurance that CRIIMI MAE will retain its REIT status for 1999 or subsequent years. If the Company fails to retain its REIT status for any taxable year, it will be taxed as a regular domestic corporation subject to federal and state income tax in the year of disqualification and for at least the four subsequent years. The Company's 1999 Taxable Income As a REIT, CRIIMI MAE is generally required to distribute at least 95% of its "REIT taxable income" to its shareholders each tax year. For purposes of this requirement, REIT taxable income excludes certain excess noncash income such as original issue discount ("OID"). In determining its federal income tax liability, CRIIMI MAE, as a result of its REIT status, is entitled to deduct from its taxable income dividends paid to its shareholders. Accordingly, to the extent the Company distributes its net income to shareholders, it effectively reduces taxable income, on a dollar-for-dollar basis, and eliminates the "double taxation" that normally occurs when a corporation earns income and distributes that income to shareholders in the form of dividends. The Company, however, still must pay corporate level tax on any 1999 taxable income not distributed to shareholders. Unlike the 95% distribution requirement, the calculation of the Company's federal income tax liability does not exclude excess noncash income such as OID. Should CRIIMI MAE terminate or fail to maintain its REIT status during the year ended December 31, 1999, the taxable income for the year ended December 31, 1999 of approximately $37.5 million would generate a tax liability of up to $15.0 million. In determining the Company's taxable income for 1999, distributions declared by the Company on or before September 15, 2000 and actually paid by the Company on or before December 31, 2000 will be considered as dividends paid for the year ended December 31, 1999. The Company anticipates distributing all, or a substantial portion of, its 1999 taxable income in the form of non-cash taxable dividends. There can be no assurance that the Company will be able to make such distributions with respect to its 1999 taxable income. 1999 Excise Tax Liability Apart from the requirement that the Company distribute at least 95% of its REIT taxable income to maintain REIT status, CRIIMI MAE is also required each calendar year to distribute an amount at least equal to the sum of 85% of its "REIT ordinary income" and 95% of its "REIT capital gain income" to avoid incurring a nondeductible excise tax. Unlike the 95% distribution requirement, the 85% distribution requirement is not reduced by excess noncash income items such as OID. In addition, in determining the Company's excise tax liability, only dividends actually paid in 1999 will reduce the amount of income subject to this excise tax. The Company has accrued $1,105,000 for the excise tax payable for 1999. The accrual was calculated based on the taxable income for the year ended December 31, 1999. The Company's 1998 Taxable Income On September 14, 1999, the Company declared a dividend payable to common shareholders of approximately 1.61 million shares of a new series of junior preferred stock with a face value of $10 per share. See Note 12 for further discussion. The purpose of the dividend was to distribute approximately 31 $15.7 million in undistributed 1998 taxable income. To the extent that it is determined that such amount was not distributed, the Company would bear a corporate level income tax on the undistributed amount. There can be no assurance that all of the Company's tax liability will be eliminated by payment of such junior preferred stock dividend. The Company paid the junior preferred stock dividend on November 5, 1999. The junior preferred stock dividend was taxable to common shareholder recipients. Taxable Income Distributions The recently issued Internal Revenue Service Revenue Procedure 99-17 provides securities and commodities traders with the ability to elect mark-to-market treatment for 2000 by including an election with their timely filed 1999 federal tax extension. The election applies to all future years as well, unless revoked with the consent of the Internal Revenue Service. On March 15, 2000, the Company determined to elect mark-to-market treatment as a securities trader for 2000 and, accordingly, will recognize gains and losses prior to the actual disposition of its securities. Moreover, some if not all of those gains and losses, as well as some if not all gains or losses from actual dispositions of securities, will be treated as ordinary in nature and not capital, as they would be in the absence of the election. Therefore, any net operating losses generated by the Company's trading activity will offset the Company's ordinary taxable income, and thereby reduce required distributions to shareholders by a like amount. See "BUSINESS-Risk Factors-Risks Associated with Trader Election" for further discussion. If the Company does have a REIT distribution requirement (and such distributions would be permitted under the Plan), a substantial portion of the Company's distributions would be in the form of non-cash taxable dividends. Taxable Mortgage Pool Risks An entity that constitutes a "taxable mortgage pool" as defined in the Tax Code ("TMP") is treated as a separate corporate level taxpayer for federal income tax purposes. In general, for an entity to be treated as a TMP (i) substantially all of the assets must consist of debt obligations and a majority of those debt obligations must consist of mortgages; (ii) the entity must have more than one class of debt securities outstanding with separate maturities and (iii) the payments on the debt securities must bear a relationship to the payments received from the mortgages. The Company currently owns all of the equity interests in three trusts that constitute TMPs (CBO-1, CBO-2 and CMO-IV, collectively the "Trusts"). See Notes 5 and 6 for descriptions of CBO-1, CBO-2 and CMO-IV. The statutory provisions and regulations governing the tax treatment of TMPs (the "TMP Rules") provide an exemption for TMPs that constitute "qualified REIT subsidiaries" (that is, entities whose equity interests are wholly owned by a REIT). As a result of this exemption and the fact that the Company owns all of the equity interests in each Trust, the Trusts currently are not required to pay a separate corporate level tax on income they derive from their underlying mortgage assets. The Company also owns certain securities structured as bonds (the "Bonds") issued by each of the Trusts. Certain of the Bonds owned by the Company serve as collateral (the "Pledged Bonds") for short-term, variable-rate borrowings used by the Company to finance their initial purchase. If the creditors holding the Pledged Bonds were to seize or sell this collateral and the Pledged Bonds were deemed to constitute equity interests (rather than debt) in the Trusts, then the Trusts would no longer qualify for the exemption under the TMP Rules provided for qualified REIT subsidiaries. The Trusts would then be required to pay a corporate level federal income tax. As a result, available funds from the underlying mortgage assets that would ordinarily be used by the Trusts to make payments on certain securities issued by the Trust (including the equity interests and the Pledged Bonds) would instead be applied to tax payments. Since the equity interests and Bonds owned by the Company are the most subordinated securities and, therefore, would absorb payment shortfalls first, the loss of the exemption under the TMP rules could have a material adverse effect on their value and the payments received thereon. In addition to causing the loss of the exemption under the TMP Rules, a seizure or sale of the Pledged Bonds and a characterization of them as equity for tax purposes could also jeopardize the Company's REIT status if the value of the remaining ownership interests in any Trust held by the Company (i) exceeded 5% of the total value of the Company's assets or (ii) constituted more than 10% of the Trust's voting interests. Although it is possible that the election by the TMPs to be treated as taxable REIT subsidiaries could prevent the loss of CRIIMI MAE's REIT status, there can be no assurance that a valid election could be made given the timing of a seizure or sale of the Pledged Bonds. 32 SIGNATURE Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Registrant has duly caused this Form 10-K/A 1 to be signed on its behalf by the undersigned, thereunto duly authorized. CRIIMI MAE INC. April 20, 2000 /s/ William B. Dockser --------------------------- William B. Dockser Chairman of the Board and Principal Executive Officer -----END PRIVACY-ENHANCED MESSAGE-----