-----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, B4QemZAeCsdZ9gDR8HG+8/oEV7VVenpxU17yrwO3rx0/zFkZ5WQ8xF7wruL7wY+s Ux7apUT5+KIzhzYbVEcOYw== 0000847322-03-000049.txt : 20031114 0000847322-03-000049.hdr.sgml : 20031114 20031114131044 ACCESSION NUMBER: 0000847322-03-000049 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 11 CONFORMED PERIOD OF REPORT: 20030930 FILED AS OF DATE: 20031114 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-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-10360 FILM NUMBER: 031002445 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-Q 1 sept_2003-10q.txt CMM SEPTEMBER 2003 10Q - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ------------------ FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 ------------------ For the quarter ended September 30, 2003 Commission file number 1-10360 CRIIMI MAE INC. (Exact name of registrant as specified in its charter) Maryland 52-1622022 (State or other jurisdiction of (I.R.S. Employer Incorporation or organization) Identification No.) 11200 Rockville Pike Rockville, Maryland 20852 (301) 816-2300 (Address, including zip code, and telephone number, including area code, of registrant's principal executive offices) ------------------ Securities Registered Pursuant to Section 12(b) of the Act: Name of each exchange on Title of each class which registered - ------------------- ----------------------------- Common Stock New York Stock Exchange, Inc. Series B Cumulative Convertible New York Stock Exchange, Inc. Preferred Stock Series F Redeemable Cumulative Dividend New York Stock Exchange, Inc. Preferred Stock Series G Redeemable Cumulative Dividend New York Stock Exchange, Inc. Preferred Stock Securities Registered Pursuant to Section 12(g) of the Act: None ------------------ Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15 (d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes [X] No[ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes [X] No [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class Outstanding as of November 11, 2003 ----- ----------------------------------- Common Stock, $0.01 par value 15,307,932 2 CRIIMI MAE INC. Quarterly Report on Form 10-Q Page ---- PART I. Financial Information Item 1. Financial Statements Consolidated Balance Sheets as of September 30, 2003 (unaudited) and December 31, 2002............................... 3 Consolidated Statements of Income for the three and nine months ended September 30, 2003 and 2002 (unaudited).................... 4 Consolidated Statements of Changes in Shareholders' Equity for the nine months ended September 30, 2003 (unaudited)........ 5 Consolidated Statements of Cash Flows for the nine months ended September 30, 2003 and 2002 (unaudited)............ 6 Notes to Consolidated Financial Statements (unaudited)........... 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............................. 40 Item 3. Quantitative and Qualitative Disclosures about Market Risk....... 67 Item 4. Controls and Procedures.......................................... 69 PART II. Other Information Item 6. Exhibits and Reports on Form 8-K................................. 70 Signature ................................................................ 72 3 PART I ITEM 1. FINANCIAL STATEMENTS CRIIMI MAE INC. CONSOLIDATED BALANCE SHEETS
September 30, December 31, 2003 2002 ---------------------- ---------------------- (Unaudited) Assets: Mortgage assets: Subordinated CMBS pledged to secure recourse debt, at fair value $ 528,257,275 $ 535,507,892 CMBS pledged to secure Securitized Mortgage Obligations - CMBS, at fair value 332,062,684 326,472,580 Other MBS, at fair value 3,904,944 5,247,771 Insured mortgage securities, at fair value 168,293,213 275,340,234 Equity investments 3,955,591 6,247,868 Other assets 26,643,950 24,987,348 Receivables 17,649,861 16,293,489 Servicing other assets 9,540,349 13,775,138 Servicing cash and cash equivalents 2,489,700 12,582,053 Other cash and cash equivalents 14,461,302 16,669,295 Restricted cash and cash equivalents - 7,961,575 ---------------------- ---------------------- Total assets $ 1,107,258,869 $ 1,241,085,243 ====================== ====================== Liabilities: Bear Stearns variable rate secured debt $ 297,500,000 $ - BREF senior subordinated secured note 31,266,667 - Securitized mortgage obligations: Collateralized bond obligations-CMBS 288,377,418 285,844,933 Collateralized mortgage obligations- insured mortgage securities 157,217,861 252,980,104 Mortgage payable 7,303,276 7,214,189 Payables and accrued expenses 11,472,312 26,675,724 Servicing liabilities 2,268,213 756,865 Exit variable-rate secured borrowing - 214,672,536 Series A senior secured notes - 92,788,479 Series B senior secured notes - 68,491,323 ---------------------- ---------------------- Total liabilities 795,405,747 949,424,153 ---------------------- ---------------------- Shareholders' equity: Preferred stock, $0.01 par; 75,000,000 shares authorized; 3,424,992 shares issued and outstanding 34,250 34,250 Common stock, $0.01 par; 300,000,000 shares authorized; 15,263,006 and 13,945,068 shares issued and outstanding, respectively 152,630 139,451 Accumulated other comprehensive income 114,803,213 102,122,057 Deferred compensation (642,857) (19,521) Warrants outstanding 2,564,729 - Additional paid-in capital 632,661,204 620,411,938 Accumulated deficit (437,720,047) (431,027,085) ---------------------- ---------------------- Total shareholders' equity 311,853,122 291,661,090 ---------------------- ---------------------- Total liabilities and shareholders' equity $ 1,107,258,869 $ 1,241,085,243 ====================== ======================
The accompanying notes are an integral part of these consolidated financial statements. 4 CRIIMI MAE INC. CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
For the three months For the nine months ended September 30, ended September 30, 2003 2002 2003 2002 --------------- -------------- --------------- -------------- (as adjusted- Note 2) Interest income: CMBS $ 22,121,471 $ 25,678,715 $ 66,307,216 $ 76,815,219 Insured mortgage securities 3,486,162 5,829,458 12,413,163 18,468,181 --------------- -------------- --------------- -------------- Total interest income 25,607,633 31,508,173 78,720,379 95,283,400 --------------- -------------- --------------- -------------- Interest and related expenses: Bear Stearns variable rate secured debt 3,550,104 - 10,047,040 - BREF senior subordinated secured note 1,261,084 - 3,519,973 - Exit variable-rate secured borrowing - 3,700,424 859,106 11,397,375 Series A senior secured notes - 2,889,054 2,130,722 8,781,875 Series B senior secured notes - 3,480,499 2,697,006 10,289,704 Fixed-rate collateralized bond obligations-CMBS 7,032,898 6,397,966 19,775,900 19,337,866 Fixed-rate collateralized mortgage obligations - insured securities 5,353,098 5,642,316 15,028,861 18,297,034 Hedging expense 274,167 353,085 900,655 749,412 Other interest expense 240,179 245,984 711,556 743,966 --------------- -------------- --------------- -------------- Total interest expense 17,711,530 22,709,328 55,670,819 69,597,232 --------------- -------------- --------------- -------------- Net interest margin 7,896,103 8,798,845 23,049,560 25,686,168 --------------- -------------- --------------- -------------- General and administrative expenses (3,027,061) (2,782,419) (8,815,893) (8,588,203) Deferred compensation expense (23,810) (16,732) (43,331) (93,422) Depreciation and amortization (131,472) (312,388) (450,296) (920,928) Servicing revenue 2,425,138 2,976,371 7,314,725 8,233,944 Servicing general and administrative expenses (2,500,850) (2,222,008) (6,824,975) (6,847,992) Servicing amortization, depreciation, and impairment expenses (293,090) (508,000) (1,180,842) (1,418,810) Servicing restructuring expenses (6,301) - (150,672) (141,240) Servicing gain on sale of servicing rights - 34,309 - 4,851,907 Income tax benefit (expense) 323,704 481,256 509,934 (427,520) Equity in earnings from investments 91,006 98,005 212,341 330,747 Other income, net 292,549 711,923 988,208 2,142,354 Net losses on mortgage security dispositions (749,305) (310,722) (522,805) (567,014) Impairment on CMBS (4,704,878) (29,884,497) (13,652,756) (35,035,588) BREF maintenance fee (434,000) - (1,229,667) - Executive contract termination costs (2,875,699) - (2,875,699) - Hedging ineffectiveness (1,930,198) - (1,930,198) - Recapitalization expenses - (438,889) (3,148,841) (683,333) Gain on extinguishment of debt - - 7,337,424 - --------------- -------------- --------------- -------------- (13,544,267) (32,173,791) (24,463,343) (39,165,098) --------------- -------------- --------------- -------------- Net loss before cumulative effect of change in accounting principle (5,648,164) (23,374,946) (1,413,783) (13,478,930) Cumulative effect of adoption of SFAS 142 - - - (9,766,502) --------------- -------------- --------------- -------------- Net loss before dividends paid or accrued on preferred shares (5,648,164) (23,374,946) (1,413,783) (23,245,432) Dividends paid or accrued on preferred shares (1,726,560) (1,726,560) (5,279,179) (7,602,537) --------------- -------------- --------------- -------------- Net loss to common shareholders $ (7,374,724) $ (25,101,506) $ (6,692,962) $ (30,847,969) =============== ============== =============== ============== Earnings per common share: Basic - before cumulative effect of change in accounting principle $ (0.49) $ (1.80) $ (0.44) $ (1.55) =============== ============== =============== ============== Basic - after cumulative effect of change in accounting principle $ (0.49) $ (1.80) $ (0.44) $ (2.26) =============== ============== =============== ============== Diluted - before cumulative effect of change in accounting principle $ (0.49) $ (1.80) $ (0.44) $ (1.55) =============== ============== =============== ============== Diluted - after cumulative effect of change in accounting principle $ (0.49) $ (1.80) $ (0.44) $ (2.26) =============== ============== =============== ============== Shares used in computing basic earnings per share 15,204,913 13,926,600 15,114,173 13,635,656 =============== ============== =============== ==============
The accompanying notes are an integral part of these consolidated financial statements. 5 CRIIMI MAE INC. CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY For the nine months ended September 30, 2003 (Unaudited)
Preferred Common Accumulated Stock Stock Additional Other Total Par Par Paid-in Accumulated Comprehensive Warrants Deferred Shareholders' Value Value Capital Deficit Income Outstanding Comp. Equity -------- ----- ---------- ------------ ------------- ----------- -------- ------------- Balance at December 31, 2002 as previously reported $34,250 $ 139,451 $619,197,711 $(429,812,858) $102,122,057 $ - $(19,521)$291,661,090 Adjustment for preferred stock issuance costs (Note 2) - - 1,214,227 (1,214,227) - - - - -------- -------- -------------- -------------- ------------- ---------- ------ ------------ Adjusted balance at December 31, 2002 34,250 139,451 620,411,938 (431,027,085) 102,122,057 - (19,521) 291,661,090 Net income before dividends paid or accrued on preferred shares - - - (1,413,783) - - - (1,413,783) Adjustment to unrealized gains and losses on mortgage assets - - - - 8,327,381 - - 8,327,381 Adjustment to unrealized gains and losses on derivative financial instruments - - - - 4,353,775 - - 4,353,775 Dividends paid on preferred share - - - (5,279,179) - - - (5,279,179) Common stock issued - 12,599 13,600,308 - - - - 13,612,907 Restricted stock issued - 580 666,087 - - - (666,667) - Amortization of deferred compensation - - - - - - 43,331 43,331 Accelerated vesting of stock options - - 547,600 - - - - 547,600 Warrants issued - - (2,564,729) - - 2,564,729 - - -------- --------- ------------- -------------- ------------ ---------- -------- ------------ Balance at September 30, 2003 $ 34,250 $ 152,630 $632,661,204 $(437,720,047) $114,803,213 $2,564,729$(642,857)$311,853,122 ======== ========= ============= ============== ============ ========== ======== ============
The accompanying notes are an integral part of these consolidated financial statements. 6 CRIIMI MAE INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
For the nine months ended September 30, 2003 2002 --------------------- ------------------- Cash flows from operating activities: Net loss before dividends paid or accrued on preferred shares $ (1,413,783) $ (23,245,432) Adjustments to reconcile net loss before dividends paid or accrued on preferred shares to net cash provided by operating activities: Gain on extinguishment of debt (non-cash portion) (7,787,370) - Amortization of discount and deferred financing costs on debt 8,181,400 4,351,381 Discount amortization on mortgage assets, net (7,925,150) (8,784,389) Accrual of extension fees related to Exit Debt 336,921 3,189,836 Depreciation and other amortization 450,296 920,928 Net losses on mortgage security dispositions 522,803 567,014 Equity in earnings from investments (212,341) (330,747) Servicing amortization, depreciation and impairment 1,180,842 1,418,810 Hedging expense 900,655 749,412 Recapitalization expenses (non-cash portion) 1,079,463 - Amortization of deferred compensation 43,331 93,422 Impairment on CMBS 13,652,756 35,035,588 Interest accreted to debt 1,266,667 2,237,808 Hedging ineffectiveness expense 1,930,198 - Gain on sale of servicing rights - (4,851,907) Cumulative effect of adoption of SFAS 142 - 9,766,502 Changes in assets and liabilities: Decrease in restricted cash and cash equivalents 7,961,575 30,338,328 Increase in receivables and other assets (137,456) (2,439,587) Decrease in payables and accrued expenses (3,105,145) (3,569,388) (Increase) decrease in servicing other assets (182,260) 3,623,587 Increase (decrease) in servicing liabilities 1,511,348 (2,565,072) Sales (purchases) of other MBS, net 1,358,699 (348,882) --------------------- ------------------- Net cash provided by operating activities 19,613,449 46,157,212 --------------------- ------------------- Cash flows from investing activities: Proceeds from mortgage security prepayments and dispositions 104,793,816 51,467,197 Proceeds from prepayment of mezzanine loan 1,696,749 - Distributions received from AIM Limited Partnerships 2,101,912 2,190,497 Receipt of principal payments from insured mortgage securities 2,231,261 2,783,761 Cash received in excess of income recognized on subordinated CMBS 4,270,088 2,448,171 Proceeds from sale of servicing rights by CMSLP - 8,180,561 Purchases of investment-grade CMBS by CMSLP - (9,905,520) Sales of investment-grade CMBS by CMSLP 3,316,508 - --------------------- ------------------- Net cash provided by investing activities 118,410,334 57,164,667 --------------------- ------------------- Cash flows from financing activities: Principal payments on securitized mortgage debt obligations (98,651,367) (51,803,306) Principal payments on recourse debt (378,452,338) (27,668,184) Principal payments on secured borrowings and other debt obligations (79,910) (74,160) Proceeds from issuance of debt 330,000,000 - Payment of debt issuance costs (6,294,562) - Payment of dividends on preferred shares (10,458,859) - Proceeds from the issuance of common stock, net 13,612,907 43,431 Redemption of Series E Preferred Stock, including accrued dividends - (18,733,912) --------------------- ------------------- Net cash used in financing activities (150,324,129) (98,236,131) --------------------- ------------------- Net (decrease) increase in other cash and cash equivalents (12,300,346) 5,085,748 Cash and cash equivalents, beginning of period (1) 29,251,348 17,298,873 --------------------- ------------------- Cash and cash equivalents, end of period (1) $ 16,951,002 $ 22,384,621 ===================== ===================
(1) Comprised of Servicing cash and cash equivalents and Other cash and cash equivalents. The accompanying notes are an integral part of these consolidated financial statements. 7 CRIIMI MAE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. ORGANIZATION General CRIIMI MAE Inc. (together with its consolidated subsidiaries, unless the context otherwise indicates, We or CRIIMI MAE) is a commercial mortgage company structured as a self-administered real estate investment trust (or REIT). We currently own, and manage, primarily through our servicing subsidiary, CRIIMI MAE Services Limited Partnership (CMSLP or CRIIMI MAE Services), a significant portfolio of commercial mortgage-related assets. We have focused primarily on non-investment grade (rated below BBB- or unrated) commercial mortgage-backed securities (subordinated CMBS). As the holder of the most subordinate tranches, we are exposed to a higher risk of losses. Our core holdings are subordinated CMBS ultimately backed by pools of commercial mortgage loans on retail, multifamily, hotel, and other commercial real estate. We also own directly and indirectly government-insured mortgage backed securities and a limited number of other assets. We also are a trader in CMBS, residential mortgage-backed securities, agency debt securities and other fixed income securities. January 2003 Recapitalization On January 23, 2003, we completed a recapitalization of the secured debt incurred upon our emergence from Chapter 11 in April 2001 (the Exit Debt). This recapitalization was funded with approximately $344 million in proceeds from debt and equity financings and a portion of our available cash and liquid assets. The recapitalization included: o BREF Equity and Secured Debt. - We issued approximately $14 million in common equity and $30 million in secured subordinated debt to Brascan Real Estate Finance Fund I L.P., a private asset management fund established by Brascan Corporation and a New York-based management team. We refer to the secured subordinated debt as the BREF Debt and Brascan Real Estate Finance Fund I L.P. as BREF Fund. o Bear Stearns Secured Financing. - We received $300 million in secured financing in the form of a repurchase transaction from a unit of Bear, Stearns & Co., Inc. We refer to the secured financing as the Bear Stearns Debt and the unit of Bear Stearns & Co., Inc. as Bear Stearns. o New Leadership. - Barry S. Blattman joined CRIIMI MAE as Chairman of the Board, Chief Executive Officer and President. Mr. Blattman has more than 15 years of experience in commercial real estate finance, which included overseeing the real estate debt group at Merrill Lynch from 1996 to 2001. Mr. Blattman is also the managing member of Brascan Real Estate Financial Partners LLC, which owns 100% of the general partner of BREF Fund. In addition, on September 15, 2003, Mark R. Jarrell, a director, assumed the position of President and Chief Operating Officer. Upon appointment as President, Mr. Jarrell resigned as director. Mr. Blattman continues as our Chairman of the Board and Chief Executive Officer. See Notes 6 and 12 for a further discussion of these debt and equity financings. Other We were incorporated in Delaware in 1989 under the name CRI Insured Mortgage Association, Inc. In July 1993, we changed our name to CRIIMI MAE Inc. and reincorporated in Maryland. In June 1995, certain mortgage businesses affiliated with C.R.I., Inc. (CRI) were merged into CRIIMI MAE Inc. (the Merger). We are not a government sponsored entity or in any way affiliated with the United States government or any United States government agency. 8 REIT Status/Net Operating Loss for Tax Purposes REIT Status. We have elected to qualify as a REIT for tax purposes under sections 856-860 of the Internal Revenue Code. We are required to meet income, asset, ownership and distribution tests to maintain our REIT status. Although there can be no assurance, we believe that we have satisfied the REIT requirements for all years through, and including 2002. There can also be no assurance that we will maintain our REIT status for 2003 or subsequent years. If we fail to maintain our REIT status for any taxable year, we will be taxed as a regular domestic corporation subject to federal and state income tax in the year of disqualification and for at least the four subsequent years. Depending on the amount of any such federal and state income tax, we may have insufficient funds to pay any such tax and also may be unable to comply with some or all of our obligations, including the Bear Stearns and BREF Debt. We and two of our subsidiaries incorporated in 2001 jointly elected to treat such two subsidiaries as taxable REIT subsidiaries (TRS) effective January 1, 2001. The TRSs allow us to earn non-qualifying REIT income while maintaining our REIT status. These two subsidiaries hold all of the partnership interests of CMSLP. Net Operating Loss for Tax Purposes/Trader Election. For tax purposes we have elected to be classified as a trader in securities. We trade in both short and longer duration fixed income securities, including CMBS, residential mortgage-backed securities and agency debt securities (such securities traded and all other securities of the type described constituting the "Trading Assets" to the extent owned by us or any qualified REIT subsidiary, meaning generally any wholly owned subsidiary that is not a taxable REIT subsidiary). Such Trading Assets are classified as Other MBS on our balance sheet. As a result of our election in 2000 to be taxed as a trader, we recognized a mark-to-market tax loss on our Trading Assets on January 1, 2000 of approximately $478 million (the January 2000 Loss). Such loss is being recognized evenly for tax purposes over four years beginning with the year 2000 and ending in 2003. We expect such loss to be ordinary, which allows us to offset our ordinary income. We generated a net operating loss (or NOL) for tax purposes of approximately $83.6 million during the year ended December 31, 2002. As such, our taxable income was reduced to zero and, accordingly, our REIT distribution requirement was eliminated for 2002. As of December 31, 2002, our accumulated and unused net operating loss (or NOL) was $223.8 million. Any accumulated and unused net operating losses, subject to certain limitations, generally may be carried forward for up to 20 years to offset taxable income until fully utilized. Accumulated and unused net operating losses cannot be carried back because we are a REIT. There can be no assurance that our position with respect to our election as a trader in securities will not be challenged by the Internal Revenue Service (or IRS) and, if challenged, will be defended successfully by us. As such, there is a risk that the January 2000 Loss will be limited or disallowed, resulting in higher tax basis income and a corresponding increase in REIT distribution requirements. It is possible that the amount of any under-distribution for a taxable year could be corrected with a "deficiency dividend" as defined in Section 860 of the Internal Revenue Code, however, interest may also be due to the IRS on the amount of this under-distribution. If we are required to make taxable income distributions to our shareholders to satisfy required REIT distributions, all or a substantial portion of these distributions, if any, may be in the form of non-cash dividends. There can be no assurance that such non-cash dividends would satisfy the REIT distribution requirements and, as such, we could lose our REIT status or may not be able to satisfy some or all of our obligations, including the Bear Stearns and BREF Debt. Our future use of NOLs for tax purposes could be substantially limited in the event of an "ownership change" as defined under Section 382 of the Internal Revenue Code. As a result of these limitations imposed by Section 382 of the Internal Revenue Code, in the event of an ownership change, our ability to use our NOL carryforwards in future years may be limited and, to the extent the NOL carryforwards cannot be fully utilized under these limitations within the carryforward periods, the NOL carryforwards would expire unutilized. Accordingly, after any ownership change, our ability to use our NOLs to reduce or offset taxable income would be substantially limited or not available under Section 382. In general, a company reaches the "ownership change" threshold if the "5% shareholders" increase their aggregate ownership interest in the company over a three-year testing period by more than 50 percentage points. The ownership interest is measured in terms of total market value of the company's capital stock. If an "ownership change" occurs under Section 382 of the Internal Revenue Code, our prospective use 9 of our accumulated and unused NOL and the remaining January 2000 Loss of a combined total amount of approximately $317.0 million as of September 30, 2003 will be limited. We do not believe BREF Fund's investment in our common stock and warrant to purchase common stock has created an "ownership change" under Section 382. In addition, we are not aware of any other acquisition of shares of our capital stock that has created an "ownership change" under Section 382. We have adopted a shareholder rights plan and amended our charter to minimize the chance of an ownership change within the meaning of Section 382 of the Internal Revenue Code; however there can be no assurance that an ownership change will not occur. Investment Company Act Under the Investment Company Act of 1940, as amended, an investment company is required to register with the Securities and Exchange Commission (SEC) and is subject to extensive restrictive and potentially adverse regulation relating to, among other things, operating methods, management, capital structure, dividends and transactions with affiliates. However, as described below, companies primarily engaged in the business of acquiring mortgages and other liens on and interests in real estate (Qualifying Interests) are excluded from the requirements of the Investment Company Act. To qualify for the Investment Company Act exclusion, we, among other things, must maintain at least 55% of our assets in Qualifying Interests (the 55% Requirement) and are also required to maintain an additional 25% in Qualifying Interests or other real estate-related assets (Other Real Estate Interests and such requirement, the 25% Requirement). According to current SEC staff interpretations, we believe that all of our government-insured mortgage securities constitute Other Real Estate Interests and that certain of our government insured mortgage securities also constitute Qualifying Interests. In accordance with current SEC staff interpretations, we believe that all of our subordinated CMBS constitute Other Real Estate Interests and that certain of our subordinated CMBS also constitute Qualifying Interests. On certain of our subordinated CMBS, we, along with other rights, have the unilateral right to direct foreclosure with respect to the underlying mortgage loans. Based on such rights and our economic interest in the underlying mortgage loans, we believe that the related subordinated CMBS constitute Qualifying Interests. As of September 30, 2003, we believe that we were in compliance with both the 55% Requirement and the 25% Requirement. If the SEC or its staff were to take a different position with respect to whether such subordinated CMBS constitute Qualifying Interests, we could, among other things, be required either (i) to change the manner in which we conduct our operations to avoid being required to register as an investment company or (ii) to register as an investment company, either of which could have a material adverse effect on us. If we were required to change the manner in which we conduct our business, we would likely have to dispose of a significant portion of our subordinated CMBS or acquire significant additional assets that are Qualifying Interests. Alternatively, if we were required to register as an investment company, we expect that our operating expenses would significantly increase and that we would have to significantly reduce our indebtedness, which could also require us to sell a significant portion of our assets. No assurances can be given that any such dispositions or acquisitions of assets, or deleveraging, could be accomplished on favorable terms, or at all. There are restrictions under certain of the operative documents evidencing our obligations, which could limit possible actions we may take in response to any need to modify our business plan in order to register as an investment company or avoid the need to register. Certain dispositions or acquisitions of assets could require approval or consent of certain holders of these obligations. Any such results could have a material adverse effect on us. Further, if we were deemed an unregistered investment company, we could be subject to monetary penalties and injunctive relief. We would be unable to enforce contracts with third parties and third parties could seek to obtain rescission of transactions undertaken during the period we were deemed an unregistered investment company, unless the court found that under the circumstances, enforcement (or denial of rescission) would produce a more equitable result than nonenforcement (or grant of rescission) and would not be inconsistent with the Investment Company Act. 10 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation Our consolidated financial statements are prepared on the accrual basis of accounting in accordance with accounting principles generally accepted in the United States (or GAAP). The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. In our opinion, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of only normal recurring adjustments and consolidating adjustments) necessary to present fairly the consolidated balance sheets as of September 30, 2003 and December 31, 2002 (audited), the consolidated results of operations for the three and nine months ended September 30, 2003 and 2002, and the consolidated cash flows for the nine months ended September 30, 2003 and 2002. The accompanying consolidated financial statements include the financial results of CRIIMI MAE and all of our majority-owned and controlled subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. These consolidated financial statements have been prepared pursuant to the rules and regulations of the SEC. Certain information and note disclosures normally included in annual financial statements prepared in accordance with GAAP have been condensed or omitted. While management believes that the disclosures presented are adequate to make the information not misleading, these consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes included in our Annual Report on Form 10-K for the year ended December 31, 2002. Reclassifications Certain 2002 amounts have been reclassified to conform to the 2003 presentation. Income Recognition and Carrying Basis Subordinated CMBS We recognize income on our subordinated CMBS in accordance with Emerging Issues Task Force (EITF) Issue No. 99-20, "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets". Under EITF 99-20, we calculate a revised yield based on the current amortized cost of the investment and the revised future cash flows when there has been a change in estimated future cash flows from the cash flows previously projected (generally due to credit losses and/or prepayment speeds). This revised yield is applied prospectively to recognize interest income. We classify our subordinated CMBS as "available for sale" and carry them at fair market value and temporary changes in fair value are recorded as a component of shareholders' equity. Insured Mortgage Securities Our consolidated investment in insured mortgage securities consists of participation certificates generally evidencing a 100% undivided beneficial interest in government-insured multifamily mortgages issued or sold pursuant to programs of the Federal Housing Administration, or FHA, and mortgage-backed securities guaranteed by the Government National Mortgage Association, or GNMA. Payment of principal and interest on FHA-insured certificates is insured by the U.S. Department of Housing and Urban Development, or HUD, pursuant to Title 2 of the National Housing Act. Payment of principal and interest on GNMA mortgage-backed securities is guaranteed by GNMA pursuant to Title 3 of the National Housing Act. Our insured mortgage securities are classified as "available for sale." As a result, we carry our insured mortgage securities at fair value and changes in fair value are recorded as a component of shareholders' equity. Insured mortgage securities income consists of amortization of the discount or premium plus the stated mortgage interest payments received or accrued. The difference between the cost and the unpaid principal balance at the time of purchase is carried as a discount or premium and amortized over the remaining contractual life of the 11 mortgage using the effective interest method. The effective interest method provides a constant yield of income over the term of the mortgage security. Other Mortgage-Backed Securities Interest income on other mortgage-backed securities (or Other MBS) consists of amortization of the discount or premium on primarily investment-grade securities, plus the stated investment interest payments received or accrued on Other MBS. The difference between the cost and the unpaid principal balance at the time of purchase is carried as a discount or premium and amortized over the remaining contractual life of the investment using the effective interest method. The effective interest method provides a constant yield of income over the term of the investment. Our Other MBS are classified as "available for sale." As a result, we carry these securities at fair value and changes in fair value are recorded as a component of shareholders' equity. Upon the sale of such securities, any gain or loss is recognized in the income statement. Impairment Subordinated CMBS We assess each subordinated CMBS for other than temporary impairment when the fair market value of the asset declines below amortized cost and when one of the following conditions also exists: (1) our revised projected cash flows related to the subordinated CMBS and the subordinated CMBS's current cost basis result in a decrease in the yield compared to what was previously used to recognize income, or (2) fair value has been below amortized cost for a significant period of time and we conclude that we no longer have the ability or intent to hold the security for the period that fair value is expected to be below amortized cost through the period of time we expect the value to recover to amortized cost. This decrease in yield would be primarily a result of the credit quality of the security declining and a determination that the current estimate of expected future credit losses exceeds credit losses as originally projected or that expected credit losses will occur sooner than originally projected. The amount of impairment loss is measured by comparing the fair value, based on available market information and management's estimates, of the subordinated CMBS to its current amortized cost basis; the difference is recognized as a loss in the income statement. We assess current economic events and conditions that impact the value of our subordinated CMBS and the underlying real estate in making judgments as to whether or not other than temporary impairment has occurred. During the three months ended September 30, 2003 and 2002, we recognized impairment charges of $4.7 million and $29.9 million on our subordinated CMBS, respectively. During the nine months ended September 30, 2003 and 2002, we recognized approximately $13.7 million and $35.0 million of impairment charges on our subordinated CMBS, respectively. See Note 4 for further discussion of the impairment charges. Insured Mortgage Securities We assess each insured mortgage security for other than temporary impairment when the fair market value of the asset declines below amortized cost for a significant period of time and we conclude that we no longer have the ability to hold the security through the market downturn. The amount of impairment loss is measured by comparing the fair value of an insured mortgage security to its current amortized cost basis, with the difference recognized as a loss in the income statement. We did not recognize any impairment on our insured mortgage securities during the three and nine months ended September 30, 2003 and 2002. Equity Investments We recognize impairment on our investments accounted for under the equity method if a decline in the market value of the investment below its carrying basis is judged to be "other than temporary". During 2003, American Insured Mortgage Investors, American Insured Mortgage Investors - Series 85, L.P., American Insured Mortgage Investors L.P. - Series 86 and American Insured Mortgage Investors L.P. - Series 88 (collectively referred to as the AIM Limited Partnerships for which we serve through a subsidiary as the general partner, own a partnership interest from 2.9% to 4.9% in each of the partnerships, and own a 20% interest in the advisor to each partnership) experienced a significant amount of prepayments of their insured mortgages. These prepayments reduced cash flows on our 20% investment in the advisor to the AIM Limited Partnerships. As a result, in accordance with SFAS No. 142, "Goodwill and Other Intangible Assets," and SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," the advisor to the AIM Limited Partnerships evaluated its investment in the advisory contracts for impairment. The estimated future undiscounted cash flows from this investment were projected to be less than the book value of the investment as of June 30, 2003. As a result, the 12 advisor believed that its investment in the advisory contracts was impaired at June 30, 2003. The advisor estimated the fair value of its investment using a discounted cash flow methodology. The advisor wrote down the value of its investment in the advisory contracts to the AIM Limited Partnerships and recorded an impairment charge. We recorded our portion of the impairment charge, totaling approximately $109,000, during the second quarter of 2003. This impairment charge is included in Equity in earnings from investments in our Consolidated Statement of Income. This investment is included in our Portfolio Investment segment. We did not recognize any impairment charges on our equity investments during the three months ended September 30, 2003 or the three and nine months ended September 30, 2002. As a result of the significant prepayments experienced by the AIM Limited Partnerships, CMSLP's cash flows from its subadvisory contracts with the AIM Limited Partnerships have been reduced. As a result, in accordance with SFAS No. 142 and SFAS No. 144, we evaluated CMSLP's investment in the subadvisory contracts for impairment. Our estimated future undiscounted cash flows from this investment were projected to be less than the book value on the investment at June 30, 2003. As a result, we believed that CMSLP's investment in the subadvisory contracts was impaired at June 30, 2003. We estimated the fair value of the investment using a discounted cash flow methodology. We wrote down the value of CMSLP's investment in the subadvisory contracts with the AIM Limited Partnerships and recorded an impairment charge of approximately $198,000 during the second quarter of 2003, which is included in Servicing amortization, depreciation and impairment expenses in our Consolidated Statement of Income. We made no adjustments for the three months ended September 30, 2003. Consolidated Statements of Cash Flows The following is the supplemental cash flow information:
Three months ended September 30, Nine months ended September 30, 2003 2002 2003 2002 ------------- -------------- ------------ ------------- Cash paid for interest $12,425,296 $15,854,513 $47,247,682 $53,009,882 Cash paid for income taxes (26,144) 190,500 254,856 924,800 Non-cash investing and financing activities: Restricted stock issued 666,667 -- 666,667 129,675 Preferred stock dividends paid in shares of common stock -- -- -- 3,444,792
Comprehensive Income The following table presents comprehensive income for the three and nine months ended September 30, 2003 and 2002:
Three months ended September 30, Nine months ended September 30, 2003 2002 2003 2002 ------------- ----------------- -------------- --------------- Net loss before dividends paid or accrued on preferred shares $ (5,648,164) $(23,374,946) $(1,413,783) $(23,245,432) Adjustment to unrealized gains and losses on mortgage assets (10,436,860) 52,816,904 8,327,381 89,484,932 Adjustment to unrealized gains and losses on derivative financial instruments 3,794,618 (164,679) 4,353,775 (906,153) ------------- ----------------- --------------- --------------- Comprehensive (loss) income $(12,290,406) $ 29,277,279 $11,267,373 $ 65,333,347 ============= ================= =============== ===============
The following table summarizes our accumulated other comprehensive income:
September 30, December 31, 2003 2002 --------------- -------------- Unrealized gains on mortgage assets $ 111,437,203 $ 103,109,822 Unrealized gains (losses) on derivative financial instruments 3,366,010 (987,765) --------------- -------------- Accumulated other comprehensive income $ 114,803,213 $ 102,122,057 =============== ==============
13 Stock-Based Compensation We account for our stock-based compensation arrangements in accordance with the intrinsic value method as defined by Accounting Principles Board Opinion (APB) No. 25, "Accounting for Stock Issued to Employees". SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure", which was effective January 1, 2003 for us, requires certain disclosures related to our stock-based compensation arrangements. The following table presents the effect on net income and earnings per share if we had applied the fair value recognition provisions of SFAS No. 123, "Accounting for Stock-Based Compensation", to our stock-based compensation (in thousands, except per share amounts):
Three months ended September 30, Nine months ended September 30, 2003 2002 2003 2002 ---------- ------------ ------------ ----------- Net loss to common shareholders (1) $ (7,375) $ (25,101) $ (6,693) $ (30,848) Less: Stock-based compensation expense determined under the fair value based method for all awards (114) (170) (327) (845) ---------- ----------- ----------- ------------ Pro forma net loss to common shareholders $ (7,489) $ (25,271) $ (7,020) $ (31,693) ========== =========== =========== ============ Earnings (loss) per share: Basic and diluted - as reported $ (0.49) $ (1.80) $ (0.44) $ (2.26) ========== ============ =========== ============ Basic and diluted - pro forma $ (0.49) $ (1.81) $ (0.46) $ (2.32) ========== ============ =========== ============
(1) Includes approximately $24 and $17 of stock-based compensation expense during the three months ended September 30, 2003 and 2002, respectively, and approximately $591 and $93 during the nine months ended September 30, 2003 and 2002, respectively. Adjustment for Initial Preferred Stock Issuance Costs At the July 31, 2003 Emerging Issues Task Force meeting, the SEC Observer clarified the application of Topic D-42 related to preferred stock issuance costs. According to the clarification, all preferred stock issuance costs, regardless of where in the stockholders' equity section the costs were initially recorded, should be charged to income available to common shareholders for the purpose of calculating earnings per share at the time the preferred stock is redeemed. The SEC Observer indicated that preferred stock issuance costs not previously charged to income available to common shareholders should be reflected retroactively in financial statements for reporting periods ending after September 15, 2003 by restating the financial statements of prior periods on an as filed basis. As the result of this guidance, we have charged to income available to common shareholders approximately $1.2 million in preferred stock offering costs related to our Series E preferred stock redeemed in March 2002. The following is a summary of the effect of this change in accounting principle on our Consolidated Statement of Income during the nine months ended September 30, 2002:
As reported Adjustment Adjusted --------------- --------------- -------------- Dividends paid or accrued on preferred shares $ (6,388,310) $ (1,214,227) $ (7,602,537) Net loss to common shareholders (29,633,742) (1,214,227) (30,847,969) Earnings (loss) per common share: Basic and diluted - before cumulative effect of change in accounting principle (1.46) (0.09) (1.55) Basic and diluted - after cumulative effect of change in accounting principle (2.17) (0.09) (2.26)
All applicable 2002 disclosures have been adjusted to reflect this change in accounting principle. The effect on shareholders' equity is reflected on our Consolidated Statement of Changes in Stockholders' Equity. Recent Accounting Pronouncements In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," which replaces Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." The new standard requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. The statement is to be 14 applied prospectively to exit or disposal activities initiated after December 31, 2002. See Notes 9 and 11 for a discussion of the effect of this pronouncement on our financial statements. In January 2003, the FASB issued FASB Interpretation (or FIN) No. 46, "Consolidation of Variable Interest Entities", an interpretation of Accounting Research Bulletin No. 51, "Consolidated Financial Statements." FIN No. 46 explains how to identify variable interest entities and how an enterprise assesses its interests in a variable interest entity to decide whether to consolidate that entity. This Interpretation requires existing unconsolidated variable interest entities to be consolidated by their primary beneficiaries if the entities do not effectively disperse risks among parties involved. FIN No. 46 is effective immediately for variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. According to FASB Staff Position No. 46-6 issued on October 9, 2003, the Interpretation applies at the end of the first fiscal year or interim period ending after December 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. We do not expect the adoption of FIN No. 46 to have a material effect on our financial position or results of operations. 3. FAIR VALUE OF FINANCIAL INSTRUMENTS The following estimated fair values of our consolidated financial instruments are presented in accordance with GAAP, which define fair value as the amount at which a financial instrument could be exchanged in a current transaction between willing parties, in other than a forced sale or liquidation. These values do not represent our liquidation value or the value of the securities under a portfolio liquidation.
As of September 30, 2003 As of December 31, 2002 (in thousands) Amortized Cost Fair Value Amortized Cost Fair Value - -------------- -------------- ---------- -------------- ---------- ASSETS: Subordinated CMBS pledged to secure recourse debt (1) $ 461,147 $ 528,257 $ 473,571 $ 535,508 CMBS pledged to secure Securitized Mortgage Obligations - CMBS (1) 289,504 332,063 287,040 326,473 Other MBS (1) 3,949 3,905 5,308 5,248 Insured mortgage securities (1) 166,676 168,293 273,655 275,340 Derivative financial instruments (1) 91 1,527 992 4 Servicing other assets See footnote (2) See footnote (2) See footnote (2) See footnote (2) Servicing cash and cash equivalents 2,490 2,490 12,582 12,582 Other cash and cash equivalents 14,461 14,461 16,669 16,669 Restricted cash and cash equivalents -- -- 7,962 7,962 LIABILITIES: BREF senior subordinated secured note 31,267 34,638 -- -- Bear Stearns variable rate secured debt 297,500 297,500 -- -- Exit variable-rate secured borrowing -- -- 214,673 214,673 Series A senior secured notes -- -- 92,788 92,788 (3) Series B senior secured notes -- -- 68,491 68,491 (3) Securitized mortgage obligations: Collateralized bond obligations-CMBS 288,377 332,063 285,845 326,473 Collateralized mortgage obligations-insured mortgage securities 157,218 162,891 252,980 266,367 Mortgage payable 7,303 7,391 7,214 7,341
(1) Recorded at fair value in the accompanying Consolidated Balance Sheet. (2) CMSLP owned subordinated CMBS and interest-only strips with an aggregate amortized cost basis of approximately $1.6 million and $1.9 million and a fair value of approximately $1.8 million and $2.1 million as of September 30, 2003 and December 31, 2002, respectively. Additionally, as of December 31, 2002, CMSLP owned investment-grade CMBS with an aggregate cost basis and fair value of approximately $3.3 million. The investment-grade CMBS were sold in January 2003 in connection with our recapitalization. (3) Since these notes were redeemed in January 2003 at face value, we disclosed the face value as the fair value as of December 31, 2002. 15 The following methods and assumptions were used to estimate the fair value of each class of financial instruments: CMBS Our determination of fair values for our CMBS portfolio is a subjective process. The process begins with the compilation and evaluation of pricing information (such as nominal spreads to U.S. Treasury securities or nominal yields) that, in our view, is commensurate with the market's perception of value and risk of comparable assets. We use a variety of sources to compile such pricing information including: (i) recent offerings and/or secondary trades of comparable CMBS (i.e., securities comparable to our CMBS or to the CMBS (or collateral) underlying our CMBS issued in connection with CBO-1 and CBO-2), (ii) communications with dealers and active CMBS investors regarding the pricing and valuation of comparable securities, (iii) institutionally available research reports, (iv) analyses prepared by the nationally recognized rating organizations responsible for the initial rating assessment and on-going surveillance of such CMBS, and (v) other qualitative and quantitative factors that may impact the value of the CMBS such as the market's perception of the issuers of the CMBS and the credit fundamentals of the commercial properties securing each pool of underlying commercial mortgage loans. We make further fair value adjustments to such pricing information based on our specific knowledge of our CMBS and the impact of relevant events, which is then used to determine the fair value of our CMBS using a discounted cash flow approach. Expected future gross cash flows are discounted at assumed market yields for our CMBS rated A+ through B+, depending on the rating. The fair value for those CMBS incurring principal losses and interest shortfalls (i.e., B rated bonds through our unrated/issuer's equity) based on our overall expected loss estimate are valued at a loss adjusted yield to maturity that, in our view, is commensurate with the market's perception of the value and risk of comparable securities, using a discounted cash flow approach. Such anticipated principal losses and interest shortfalls, as well as the timing and amount of potential recoveries of such shortfalls, are critical estimates and have been taken into consideration in the calculation of fair values and yields to maturity used to recognize interest income as of September 30, 2003. We have disclosed the range of discount rates by rating category used in determining the fair values as of September 30, 2003 in Note 4. The liquidity of the subordinated CMBS market has historically been limited. Additionally, during adverse market conditions, the liquidity of such market has been severely limited. For this reason, among others, management's estimate of the value of our subordinated CMBS could vary significantly from the value that could be realized in a current transaction. Other MBS The fair value of the Other MBS is an estimate based on the indicative market price from publicly available pricing services, as well as management estimates. Insured Mortgage Securities We calculated the estimated fair value of the insured mortgage securities portfolio as of September 30, 2003 and December 31, 2002, using a discounted cash flow methodology. The cash flows were discounted using a discount rate and other assumptions that, in our view, was commensurate with the market's perception of risk and value. We used a variety of sources to determine the discount rate including (i) institutionally available research reports and (ii) communications with dealers and active insured mortgage security investors regarding the valuation of comparable securities. Servicing, Restricted and Other Cash and Cash Equivalents The carrying amount approximates fair value because of the short maturity of these instruments. Obligations Under Financing Facilities The fair values of the securitized mortgage obligations as of September 30, 2003 and December 31, 2002 were calculated using a discounted cash flow methodology similar to that discussed for CMBS above. The carrying amount of the Bear Stearns Debt (and at December 31, 2002, the Exit Variable-Rate Secured Borrowing) approximates fair value because the current rate on the debt resets monthly based on market rates. The fair value of the BREF Debt was estimated by applying a discount rate to the debt's future cash flows. The discount rate was 16 determined by considering the BREF Debt's relative position in our capital structure in relation to our other capital. The fair value of the mortgage payable is estimated based on current market interest rates of commercial mortgage debt. As of December 31, 2002, the fair values of the Series A and Series B Senior Secured Notes are the same as the face values since the notes were redeemed in January 2003. Derivative Financial Instruments The fair values of our interest rate swaps and interest rate cap are the estimated amounts that we would realize to terminate the agreements as of September 30, 2003 and December 31, 2002, taking into account current interest rates and the current creditworthiness of the counterparties. The amounts were determined based on valuations received from the counterparties to the agreements. 4. CMBS As of September 30, 2003, our assets, in accordance with GAAP, include CMBS with an aggregate face amount of approximately $1.5 billion rated from A+ to CCC and unrated. Such CMBS had an aggregate fair value of approximately $860 million (representing approximately 78% of our total consolidated assets) and an aggregate amortized cost of approximately $751 million. Such CMBS represent investments in securities issued in connection with CBO-1, CBO-2 and Nomura Asset Securities Corporation Series 1998-D6 (or Nomura). See Note 3 for a discussion of the determination of CMBS fair values. The following is a summary of the ratings of our CMBS as of September 30, 2003 (in millions): Rating (1) Fair Value % of CMBS ---------- ---------- --------- A+, BBB+ or BBB (2) $332.1 39% BB+, BB or BB- $337.2 39% B+, B, B- or CCC $166.1 19% Unrated/Issuer's Equity $ 24.9 3% (1) Ratings are provided by Standard & Poor's. (2) Represents investment grade securities that we reflect as assets on our balance sheet as a result of CBO-2. As indicated in footnote 4 to the table below, GAAP requires both these assets (reflected as "CMBS pledged to Secure Securitized Mortgage Obligations-CMBS") and their related liabilities (reflected as "Collateralized Bond Obligations - CMBS") to be reflected on our balance sheet. As of September 30, 2003, the fair value of these assets, as reflected in our balance sheet, was approximately $332.1 million and the amortized cost of the debt, as reflected in our balance sheet, was approximately $288.4 million. All cash flows related to the investment grade CMBS are used to service the corresponding securitized mortgage obligations. As a result, we currently receive no cash flows from the investment grade CMBS. 17 As of September 30, 2003, the weighted average pay rate and the loss adjusted weighted average life (based on face amount) of the investment grade securities was 7.0% and 8.0 years, respectively. The weighted average interest rate and the loss adjusted weighted average life (based on face amount) of the BB+ through unrated CMBS securities, sometimes referred to as the retained portfolio, was 5.4% and 11.5 years, respectively. The aggregate investment by the rating of the CMBS is as follows:
Discount Rate or Range of Weighted Loss Discount Rates Face Amount Average Adjusted Fair Value Used to Amortized Cost Amortized Cost as of Pay Weighted as of Calculate Fair as of 09/30/03 as of 12/31/02 Security Rating 09/30/03 (in Rate as of Average 09/30/03 (in Value as of (in millions) (in millions) millions) 9/30/03 Life (1) millions) 09/30/03 (5) (6) - ------------------------------------------------------------------------------------------------------------------------------ Investment Grade Portfolio - -------------------------- A+ (4) $ 62.6 7.0% 3 years $ 66.0 4.3% $ 60.0 $ 59.4 BBB+ (4) 150.6 7.0% 9 years 154.0 6.6% 133.3 132.3 BBB (4) 115.2 7.0% 10 years 112.1 7.4% 96.2 95.3 Retained Portfolio - ------------------ BB+ 319.0 7.0% 11 years 259.8 9.9%-10.3% 226.1 223.0 BB 70.9 7.0% 13 years 53.8 11.0% 47.3 46.8 BB- 35.5 7.0% 14 years 23.6 12.8% 21.1 20.8 B+ 88.6 7.0% 14 years 50.1 15.1% 46.7 46.0 B 177.2 7.0% 20 years 98.0 12.7%(9) 85.9 85.1 B- (2)(10)(11) 118.3 7.9% 24 years 18.0 15.0%(9) 16.8 28.1 CCC (2) 70.9 0.0% 1 year - 15.0%(9) - 3.8 Unrated/Issuer's Equity (2)(3) 270.9 1.5% 1 year 24.9 15.0%(9) 17.2 20.0 --------- -------- --------- --------- Total $ 1,479.7 5.7% 11 years $ 860.3(8) $ 750.6(7) $ 760.6 ========= ======== ========= =========
(1) The loss adjusted weighted average life represents the weighted average expected life of the CMBS based on our current estimate of future losses. As of September 30, 2003, the fair values of the B, B-, CCC and the unrated/issuer's equity in Nomura, CBO-1, and CBO-2 were derived primarily from interest cash flow anticipated to be received since our current loss expectation assumes that the full principal amount of these securities will not be recovered. See also "Advance Limitations, Appraisal Reductions and Losses on CMBS" below. (2) The CBO-1, CBO-2 and Nomura CMBS experience interest shortfalls when the weighted average net coupon rate on the underlying CMBS is less than the weighted average stated coupon payments on our subordinated CMBS. Such interest shortfalls will continue to accumulate until they are repaid through either excess interest and/or recoveries on the underlying CMBS or a recharacterization of principal cash flows, in which case they may be realized as a loss of principal on the subordinated CMBS. Such anticipated losses, including shortfalls, have been taken into consideration in the calculations of fair market values and yields to maturity used to recognize interest income as of September 30, 2003. (3) The unrated/issuer's equity subordinated CMBS from CBO-1 and CBO-2 currently do not have a stated coupon rate since these securities are only entitled to the residual cash flow payments, if any, remaining after paying the securities with a higher payment priority. As a result, effective coupon rates on these securities are highly sensitive to the effective coupon rates and monthly cash flow payments received from the underlying CMBS that represent the collateral for CBO-1 and CBO-2. (4) In connection with CBO-2, $62.6 million (originally A rated, currently A+ rated) and $60.0 million (originally BBB rated, currently BBB+ rated) face amount of investment grade CMBS were sold with call options and $345 million (originally A rated, currently A+ rated) face amount were sold without call options. Also in connection with CBO-2, in May 1998, we initially retained $90.6 million (originally BBB rated, currently BBB+ rated) and $115.2 million (originally BBB- rated, currently BBB rated) face amount of CMBS, both with call options, with the intention to sell these CMBS at a later date. Such sale occurred March 5, 1999. Since we retained call options on certain sold CMBS (currently rated A+, BBB+ and BBB bonds), we did not surrender control of these CMBS pursuant to the requirements of SFAS No. 125, and thus these CMBS are accounted for as a financing and not a sale. Since the CBO-2 transaction is recorded as a partial financing and a partial sale, we are deemed to have retained these CMBS with call options issued in connection with CBO-2, from which we currently receive no cash flows, and are required to reflect them in our CMBS on the balance sheet. (5) Amortized cost reflects approximately $13.7 million of impairment charges related to the unrated/issuer's equity bonds, the CCC bond and the B- bond in CBO-2, which were recognized during the nine months ended September 30, 2003. These impairment charges are in 18 addition to the cumulative impairment charges of approximately $248.4 million that were recognized through December 31, 2002. The impairment charges are discussed later in this Note 4 of Notes to Consolidated Financial Statements. (6) Amortized cost reflects approximately $248.4 million of cumulative impairment charges related to certain CMBS (all bonds except those rated A+ and BBB+), which were recognized through December 31, 2002. (7) See Notes 1 and 8 to Notes to Consolidated Financial Statements for information regarding the subordinated CMBS for tax purposes. (8) As of September 30, 2003, the aggregate fair values of the CBO-1, CBO-2 and Nomura bonds were approximately $24.1 million, $828.7 million and $7.5 million, respectively. (9) As a result of the estimated loss of principal on these CMBS, the fair values and discount rates of these CMBS are based on a loss adjusted yield to maturity. (10) Although the principal balance of the B- bond in CBO-2 is expected to be outstanding for approximately 25 years, the bond is not expected to receive any cash flows beyond the next 18 months. (11) In November 2003, the B- bond in CBO-2, with fair value of approximately $11.4 million, was downgraded to D by Standard & Poor's. Mortgage Loan Pool We have approximately $15.8 billion and $17.4 billion of seasoned commercial mortgage loans underlying our subordinated CMBS portfolio as of September 30, 2003 and December 31, 2002, respectively, secured by properties of the types and in the geographic locations identified below:
09/30/03 12/31/02 Geographic 09/30/03 12/31/02 Property Type Percentage(i) Percentage(i) Location(ii) Percentage(i) Percentage(i) - ------------- ------------- ------------- ----------- ------------- ------------- Retail....... 31% 31% California........ 16% 17% Multifamily.. 27% 28% Texas............. 12% 12% Hotel........ 15% 15% Florida........... 8% 8% Office....... 14% 13% Pennsylvania...... 6% 5% Other (iv)... 13% 13% New York.......... 4% 4% ---- ---- Other(iii)........ 54% 54% Total.... 100% 100% ---- ---- ==== ==== Total............. 100% 100% ==== ====
(i) Based on a percentage of the total unpaid principal balance of the underlying loans. (ii) No significant concentration by region. (iii) No other individual state makes up more than 5% of the total. (iv) Our ownership interest in one of the 20 CMBS transactions underlying CBO-2 includes subordinated CMBS in which our exposure to losses arising from certain healthcare and senior housing mortgage loans is limited by other subordinated CMBS (referred to herein as the Subordinated Healthcare/Senior-Housing CMBS). These other CMBS are not owned by us and are subordinate to our CMBS in this transaction. As a result, our investment in such underlying CMBS will only be affected if interest shortfalls and/or realized losses on such healthcare and senior housing mortgage loans are in excess of the Subordinated Healthcare/Senior-Housing CMBS. We currently estimate that the interest shortfalls and/or realized losses on such healthcare and senior housing mortgage loans will exceed the Subordinated Healthcare/Senior Housing CMBS. The principal balance of the Subordinated Healthcare/Senior Housing CMBS as of September 30, 2003 is approximately $3.4 million. As of October 2003, the aggregate principal balance of healthcare and senior housing mortgage loans, underlying the Subordinated Healthcare/Senior Housing CMBS, that are specially serviced by another special servicer, and therefore not in our special servicing loan balance, is approximately $83 million. 19 Specially Serviced Mortgage Loans CMSLP performs special servicing on the loans underlying our subordinated CMBS portfolio. A special servicer typically provides asset management and resolution services with respect to nonperforming or underperforming loans within a pool of mortgage loans. When serving as special servicer of a mortgage loan pool, CMSLP has the authority, subject to certain restrictions in the applicable CMBS pooling and servicing documents, to deal directly with any borrower that fails to perform under certain terms of its mortgage loan, including the failure to make payments, and to manage any loan workouts and foreclosures. As special servicer, CMSLP earns fee income on services provided in connection with any loan servicing function transferred to it from the master servicer. We believe that because we own the first loss unrated or lowest rated bond of virtually all of the CMBS transactions related to our subordinated CMBS, CMSLP has an incentive to efficiently and effectively resolve any loan workouts. As of September 30, 2003 and December 31, 2002, specially serviced mortgage loans included in the commercial mortgage loans described above were as follows:
09/30/03 12/31/02 --------------- --------------- Specially serviced loans due to monetary default (a) $ 935.7 million $736.1 million Specially serviced loans due to covenant default/other 44.8 million 74.7 million --------------- ---------------- Total specially serviced loans (b) $ 980.5 million $810.8 million =============== ================ Percentage of total mortgage loans (b) 6.2% 4.7% =============== ================
(a) Includes $111.3 million and $130.5 million, respectively, of real estate owned by the underlying securitization trusts. See also the table below regarding property type concentrations for further information on real estate owned by underlying trusts. (b) As of October 31, 2003, total specially serviced loans were approximately $969.6 million, or 6.2% of the total mortgage loans. The specially serviced mortgage loans as of September 30, 2003 were secured by properties of the types and located in the states identified below:
Property Type $ (in millions) Percentage Geographic Location $ (in millions) Percentage - ------------- --------------- ---------- ------------------- --------------- ---------- Hotel........ $ 486.9 (1) 50% Florida............ $ 151.2 15% Retail....... 255.7 (2) 26% Texas.............. 114.6 12% Healthcare... 81.5 8% Oregon............. 93.3 9% Multifamily.. 81.1 8% California......... 46.9 5% Office....... 45.3 5% Massachusetts...... 45.5 5% Industrial... 20.7 2% Other.............. 529.0 54% Other........ 9.3 1% ---------- ---- -------- ---- Total............ $ 980.5 100% Total.... $ 980.5 100% ========== ==== ======== ====
(1) Approximately $78.1 million of these loans in special servicing are real estate owned by the underlying securitization trusts. (2) Approximately $21.8 million of these loans in special servicing are real estate owned by the underlying securitization trusts. The following table provides a summary of the change in the balance of specially serviced loans from July 1, 2003 to September 30, 2003 and from April 1, 2003 to June 30, 2003 (in millions):
July - September April - June 2003 2003 --------------- ------------- Specially Serviced Loans, beginning of period $1,168.8 $1,154.0 Transfers in due to monetary default 131.5 166.3 Transfers in due to covenant default and other 1.4 7.4 Transfers out of special servicing (314.9) (153.2) Loan amortization (1) (6.3) (5.7) ------------- ----------- Specially Serviced Loans, end of period $ 980.5 $1,168.8 ============= ===========
(1) Represents the reduction of the scheduled principal balances due to borrower payments or, in the case of loans in monetary default, advances made by master servicers. As reflected above, as of September 30, 2003, approximately $486.9 million, or 50%, of the specially serviced mortgage loans were secured by mortgages on hotel properties. The hotel properties that secure the mortgage loans underlying our CMBS are geographically diverse, with a mix of hotel property types and franchise 20 affiliations. The following table summarizes the hotel mortgage loans underlying our CMBS as of September 30, 2003:
Total Outstanding Percentage of Amount in Principal Balance Total Hotel Loans Special Servicing ----------------- ----------------- ----------------- Full service hotels (1) $ 1.3 billion 58% $ 192.9 million Limited service hotels (2) 1.0 billion 42% 294.0 million ------------- --- --------------- Totals $ 2.3 billion 100% $ 486.9 million ============= ==== ===============
(1) Full service hotels are generally mid-price, upscale or luxury hotels with restaurant and lounge facilities and other amenities. (2) Limited service hotels are generally hotels with room-only operations or hotels that offer a bedroom and bathroom, but limited other amenities, and are often in the budget or economy group. Of the $486.9 million of hotel loans in special servicing as of September 30, 2003, approximately $272.1 million, or 56%, relate to six borrowing relationships more fully described as follows: o Twenty-seven loans with scheduled principal balances as of September 30, 2003 totaling approximately $135 million spread across three CMBS transactions secured by hotel properties in the western and Pacific northwestern states. As of September 30, 2003, our total exposure, including advances of approximately $30 million, on these loans was approximately $165 million. The total exposure is prior to the application of payments made to date by the borrower under the terms of our consensual settlement agreement; however, the total exposure is expected to be reduced by the application of such payments at closing. The borrower initially filed for bankruptcy protection in February 2002 and indicated that the properties had experienced reduced operating performance due to new competition, the economic recession, and reduced travel resulting from the September 11, 2001 terrorist attacks. We subsequently entered into a consensual settlement agreement dated February 25, 2003 pursuant to which the loan terms were amended and modified. This agreement was subsequently approved and confirmed by the bankruptcy court on March 28, 2003. The parties are currently proceeding toward closing a comprehensive loan modification, which is expected to occur in the fourth quarter of 2003 and is expected to return the loans to performing status. The borrower continues to make payments under the modified terms. As of September 30, 2003, the borrower has made principal and interest payments totaling approximately $6.9 million, the majority of which represents interest paid (as compared to principal amortization) on the modified loan balances. During the nine months ended September 30, 2003, the borrower also sold one of the properties that secured these loans. In addition, as of September 30, 2003, the borrower has remitted approximately $1.5 million in funds from debtor-in-possession accounts, which is expected to be applied to arrearages at closing. If we are not successful in resolving this loan favorably, our annual cash received from CMBS could be significantly reduced. o Five loans with scheduled principal balances as of September 30, 2003 totaling approximately $45.1 million secured by hotel properties in Florida and Texas. As of September 30, 2003, our total exposure, including advances, on these loans was approximately $50.2 million. Four of the five loans are past due for the November 2002 and all subsequent payments. One of the loans is past due for the October 2002 and all subsequent payments. The borrower has not been able to perform under a preliminary modification agreement due to decreased demand in the Orlando hospitality market. We expect the properties to become real estate owned by the underlying securitization trusts. o Six real estate owned properties with scheduled principal balances as of September 30, 2003 totaling approximately $20.0 million secured by hotel properties. As of September 30, 2003, our total exposure, including advances, on these loans was approximately $25.3 million. The loans were transferred into special servicing in December 2001 due to the bankruptcy filing of each special purpose borrowing entity and their parent company. As part of a consensual plan, eight properties were foreclosed and became real estate owned by underlying securitization trusts. During the three months ended September 30, 2003, two of these eight properties with an aggregate unpaid balance of $5.9 million were sold. o One loan with a scheduled principal balance as of September 30, 2003 totaling approximately $27.6 million, secured by nine limited service hotels located in eight states. As of September 30, 2003 the loan was current. The loan is currently in special servicing due to an unauthorized transfer of the properties to an entity which assumed the controlling interest in the borrowing entity. Subsequent to the transfer, the new controlling party in interest has made an application for the assumption of the debt, which is anticipated to close in the fourth quarter of 2003. 21 o One loan with a scheduled principal balance as of September 30, 2003 of approximately $25.5 million, secured by a full service hotel in Boston, Massachusetts. As of September 30, 2003, our total exposure, including advances, on this loan was approximately $27.0 million. This loan was transferred into special servicing in March 2003. The borrower has stated an inability to make payments, and has requested a loan restructuring due to reduced operating performance at the property. o Nine loans with scheduled principal balances as of September 30, 2003 totaling approximately $18.6 million secured by limited service hotels in midwestern states. As of September 30, 2003, our total exposure, including advances, on these loans was approximately $22.3 million. The loans are past due for the April 2002 and all subsequent payments. The borrower cites reduced occupancy related to the downturn in travel as the cause for a drop in operating performance at the properties. We were attempting to negotiate a workout with the borrower when the borrower filed for bankruptcy protection in February 2003. The exposure amounts included above are as of September 30, 2003. The amounts are not necessarily indicative of the exposures as of the projected resolution dates. During the three months ended September 30, 2003, two significant hotel loans in special servicing, included in our June 30, 2003 disclosure of significant borrowing relationships, were transferred out of special servicing as follows: o One hotel loan, with a scheduled principal balance of approximately $128.4 million as of June 30, 2003, and secured by 93 limited service hotels located in 29 states, was paid off. o One hotel loan, with a scheduled principal balance of approximately $80.7 million as of June 30, 2003, and secured by 13 extended stay hotels located throughout the U.S., was sold to a third party. For each of the borrowing relationships described in the paragraphs above, we believe that we have made an appropriate estimate of losses that we may incur in the future, which are used in determining our CMBS yields and fair values. There can be no assurance that any of the loans described above will return to performing status or otherwise be satisfactorily resolved. Circumstances which could prevent them from returning to performing status or otherwise being satisfactorily resolved include, but are not limited to, changes in workout negotiations, a more pronounced downturn in the economy or in the real estate market, a change in local market conditions, a drop in performance of the property, an increase in interest rates, and terrorist attacks. There can be no assurance that the losses incurred in the future will not exceed our current estimates (also see discussion below regarding the increase in loss estimates). Advance Limitations, Appraisal Reductions and Losses on CMBS We experience shortfalls in expected cash flow on our CMBS prior to the recognition of a realized loss primarily due to servicing advance limitations resulting from appraisal reductions. An appraisal reduction event can result in reduced master servicer principal and interest advances based on the amount by which the sum of the unpaid principal balance of the loan, accumulated principal and interest advances and other expenses exceeds 90% (in most cases) of the newly appraised value of the property underlying the mortgage loan. As the holder of the lowest rated and first loss bonds, our bonds are the first to experience interest shortfalls as a result of the reduced advancing requirement. In general, the master servicer can advance up to a maximum of the difference between 90% of the property's appraised value and the sum of accumulated principal and interest advances and expenses. As an example, assuming a weighted average coupon of 6% on a first loss subordinated CMBS, a $1 million appraisal reduction would reduce our net cash flows by up to $60,000 on an annual basis, assuming that the total exposure was equal to or greater than 90% of the appraised value immediately prior to receipt of the new appraisal (appraisal reduction). The ultimate disposition or work-out of the mortgage loan may result in a higher or lower realized loss on our subordinated CMBS than the calculated appraisal reduction amount. Appraisal reductions for the CMBS transactions in which we retain an ownership interest as reported by the underlying trustees or as calculated by CMSLP* were as follows (in thousands): 22
CBO-1 CBO-2 Nomura Total ----- ------ ------ ----- Year 2000 $1,872 $18,871 $ -- $ 20,743 Year 2001 15,599 31,962 874 48,435 Year 2002 9,088 48,953 13,530 71,571 January 1, 2003 through September 30, 2003 30,146 40,640 9,455 80,241 ------- -------- ------- --------- Cumulative Appraisal Reductions through September 30, 2003 $56,705 $140,426 $23,859 $ 220,990 ======= ======== ======= =========
* Not all underlying CMBS transactions require the calculation of an appraisal reduction; however, when CMSLP obtains a third-party appraisal, it calculates one. As previously discussed, certain securities from the CBO-1, CBO-2 and Nomura transactions are expected to experience principal write-downs over their expected lives. The following tables summarize the actual realized losses on our CMBS through September 30, 2003 (including realized mortgage loan losses expected to pass through to our CMBS during the next month) and the expected future real estate losses underlying our CMBS (in thousands):
CBO-1 CBO-2 Nomura Total ----- ------ ------- ------ Year 1999 actual realized losses $ 738 $ -- $ -- $ 738 Year 2000 actual realized losses 3,201 1,087 -- 4,288 Year 2001 actual realized losses 545 8,397 238 9,180 Year 2002 actual realized losses 11,554 25,113 563 37,230 Actual realized losses, January 1 through September 30, 2003 10,041 46,880 662 57,583 -------- -------- ------- --------- Cumulative actual realized losses through September 30, 2003 $ 26,079 $ 81,477 $ 1,463 $ 109,019 ======== ======== ======= ========= Cumulative expected realized loss estimates (including cumulative actual realized losses) through the year 2003 $ 26,079 $ 91,243 $ 1,463 $ 118,785 Expected loss estimates for the year 2004 51,503 147,007 13,425 211,935 Expected loss estimates for the year 2005 30,019 89,882 10,514 130,415 Expected loss estimates for the year 2006 3,523 18,188 3,372 25,083 Expected loss estimates for the year 2007 1,908 14,643 3,292 19,843 Expected loss estimates for the year 2008 1,784 10,623 2,608 15,015 Expected loss estimates for the remaining life of CMBS 7,972 31,998 6,647 46,617 -------- -------- ------- --------- Cumulative expected loss estimates (including cumulative actual realized losses) through life of CMBS $122,788 $403,584 $41,321 $ 567,693 ======== ======== ======= =========
We revised our overall expected loss estimate related to our subordinated CMBS from $503 million at December 31, 2002 to $559 million at June 30, 2003 to $568 million at September 30, 2003, with such total losses occurring or expected to occur through the life of the subordinated CMBS portfolio. These revisions to the overall expected loss estimate are primarily the result of increased projected losses due to lower internal estimates of values on properties underlying certain mortgage loans and real estate owned by underlying trusts, and changes in the timing of resolution and disposition of certain specially serviced assets, which when combined, has resulted in higher projected loss severities on loans and real estate owned by underlying trusts currently or anticipated to be in special servicing. The primary reasons for lower estimates of value include the poor performance of certain properties and related markets and changes to workout negotiations due, in large part, to the softness in the economy, the continued slowdown in travel and, in some cases, over-supply of hotel properties, and a shift in retail activity in some markets. There can be no assurance that our revised overall expected loss estimate of $568 million will not be exceeded as a result of additional or existing adverse events or circumstances. Such events or circumstances include, but are not limited to, the receipt of new or updated appraisals or internal values at lower than anticipated amounts, legal proceedings (including bankruptcy filings) involving borrowers, unforeseen reductions in cash received from our subordinated CMBS, a deterioration in the economy or recession generally, or in certain industries or sectors specifically, continued hostilities in the Middle East or elsewhere, terrorism, unexpected delays in the disposition or other resolution of specially serviced mortgage loans, additional defaults, or an unforeseen reduction in expected recoveries, any of which could result in additional future credit losses, impact our cash received from subordinated CMBS and/or result in further impairment to our subordinated CMBS, the effect of which could be materially adverse to us. As of September 30, 2003, we determined that there had been an adverse change in expected future cash flows for the B- and CCC bonds in CBO-2 due to the factors mentioned in the paragraph above. As a result, we believed these bonds had been impaired under EITF 99-20 and SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," as of September 30, 2003. As the fair values of these impaired bonds aggregated approximately $4.7 million below the amortized cost basis as of September 30, 2003, we recorded other than temporary impairment charges through the income statement of that same amount during the three months ended September 30, 2003. 23 As of June 30, 2003, we determined that there had been an adverse change in expected future cash flows for the unrated/issuer's equity bonds, the CCC bond and the B- bond in CBO-2 due to the factors mentioned in the paragraphs above. As a result, we believed these bonds had been impaired as of June 30, 2003. As the fair values of these impaired bonds aggregated approximately $8.9 million below the amortized cost basis as of June 30, 2003, we recorded other than temporary impairment charges through the income statement of that same amount during the three months ended June 30, 2003. Yield to Maturity The following table summarizes yield-to-maturity information relating to our CMBS on an aggregate pool basis:
Current Anticipated Anticipated Anticipated Anticipated Yield-to- Yield-to- Yield-to- Yield-to- Maturity Maturity Maturity Maturity Pool as of 1/1/02 (1) as of 1/1/03 (1) as of 7/1/03 (1) as of 10/1/03 (1) ---- ---------------- ---------------- ---------------- ------------------ CBO-2 CMBS 12.1% 11.6% 11.5% 11.3% CBO-1 CMBS 14.3% 11.6% 21.6% 36.8% Nomura CMBS 28.7% 8.0% 16.9% 27.9% ------ ----- ----- ----- Weighted Average (2) 12.4% 11.6% 11.7% 12.0%
(1) Represents the anticipated weighted average yield over the expected average life of the CMBS based on our estimate of the timing and amount of future credit losses and other significant items that are anticipated to affect future cash flows. (2) GAAP requires that the income on CMBS be recorded based on the effective interest method using the anticipated yield over the expected life of these mortgage assets. This method can result in accounting income recognition which is greater than or less than cash received. During the nine months ended September 30, 2003, we recognized approximately $8.0 million of discount amortization, partially offset by approximately $4.3 million of cash received in excess of income recognized on subordinated CMBS due to the effective interest method. During the nine months ended September 30, 2002, we recognized approximately $8.8 million of discount amortization, partially offset by approximately $2.4 million of cash received in excess of income recognized on subordinated CMBS due to the effective interest method. Determining Fair Value of CMBS We use a discounted cash flow methodology for determining the fair value of our subordinated CMBS. See Note 3 for a discussion of our fair value methodology. Key Assumptions in Determining Fair Value The gross mortgage loan cash flows from each commercial mortgage loan pool and their corresponding distribution on the CMBS may be affected by numerous assumptions and variables including: (i) changes in the timing and/or amount of credit losses on the commercial mortgage loans (credit risk), which are a function of: o the percentage of mortgage loans that experience a default either during the mortgage term or at maturity (referred to in the industry as a default percentage); o the recovery period represented by the time that elapses between the default of a commercial mortgage loan and the subsequent foreclosure and liquidation of the corresponding real estate (a period of time referred to in the industry as a lag); and, o the percentage of mortgage loan principal lost as a result of the deficiency in the liquidation proceeds resulting from the foreclosure and sale of the commercial real estate (referred to in the industry as a loss severity); (ii) the discount rate used to derive fair value, which is comprised of the following: o a benchmark risk-free rate, calculated by using the current, "on-the-run" U.S. Treasury curve and interpolating a comparable risk-free rate based on the weighted-average life of each CMBS; plus, o a credit risk premium; plus, o a liquidity premium; (iii) changes in cash flows related to principal losses and interest shortfalls, as well as the timing and amount of potential recoveries of such shortfalls, based on our overall expected loss estimate for our CMBS, the fair value of which is determined using a loss adjusted yield to maturity; 24 (iv) delays and changes in monthly cash flow distributions relating to mortgage loan defaults and/or extensions in the loan's term to maturity (see Extension Risk below); and (v) the receipt of mortgage payments earlier than projected (prepayment). Sensitivities of Key Assumptions Since we use a discounted cash flow methodology to derive the fair value of our CMBS, changes in the timing and/or the amount of cash flows received from the underlying commercial mortgage loans, and their allocation to the CMBS, will directly impact the value of such securities. Accordingly, delays in the receipt of cash flows and/or decreases in future cash flows resulting from higher than anticipated credit losses will result in an overall decrease in the fair value of our CMBS. Furthermore, any increase/(decrease) in the required rate of return for CMBS will result in a corresponding (decrease)/increase in the value of such securities. We have included the following narrative and numerical disclosures to demonstrate the sensitivity of such changes to the fair value of our CMBS. Key Assumptions Resulting in an Adverse Impact to Fair Value Factors which could adversely affect the valuation of our CMBS include: (i) the receipt of future cash flows less than anticipated due to higher credit losses (i.e., higher credit losses resulting from a larger percentage of loan defaults, and/or losses occurring greater or sooner than projected, and/or longer periods of recovery between the date of default and liquidation, (see also "Key Assumptions in Determining Fair Values" and "Sensitivity of Fair Value to Changes in Credit Losses" below), (ii) an increase in the required rate of return (see "Sensitivity of Fair Value to Changes in the Discount Rate" below) for CMBS, and/or (iii) the receipt of cash flows later than anticipated (see "Sensitivity of Fair Value to Extension Risk" below). Sensitivity of Fair Value to Changes in Credit Losses For purposes of this disclosure, we used a market convention for simulating the impact of increased credit losses on CMBS. Generally, the industry uses a combination of an assumed percentage of loan defaults (referred to in the industry as a Constant Default Rate or "CDR"), a lag period and an assumed loss severity. For purposes of this disclosure, we assumed the following loss scenarios, each of which was assumed to begin immediately following September 30, 2003: (i) 3.0% per annum of the commercial mortgage loans were assumed to default and 30% of the then outstanding principal amount of the defaulted commercial mortgage loans were assumed to be lost (referred to in the industry as a 3.0% CDR and 30% loss severity, and referred to herein as the "3%/30% CDR Loss Scenario"), and (ii) 3.0% per annum of each commercial mortgage was assumed to default and 40% of the then outstanding principal amount of each commercial mortgage loan was assumed to be lost (referred to in the industry as a 3.0% CDR and 40% loss severity, and referred to herein as the "3%/40% CDR Loss Scenario"). The reduction in amount of cash flows resulting from the 3%/30% CDR Loss Scenario and the 3%/40% CDR Loss Scenario would result in a corresponding decline in the fair value of our aggregate CMBS by approximately $76.7 million (or 8.9%) and $179.6 million (or 20.9%), respectively. The reduction in amount of cash flows resulting from the 3%/30% CDR Loss Scenario and the 3%/40% CDR Loss Scenario would result in a corresponding decline in the fair value of our subordinated CMBS (BB+ through unrated/issuer's equity) by approximately $73.9 million (or 14.0%) and $174.1 million (or 33.0%), respectively. The aggregate amount of credit losses assumed under the 3%/30% CDR Loss Scenario and the 3%/40% CDR Loss Scenario totaled approximately $815 million and $1.1 billion, respectively. These amounts are in comparison to the aggregate amount of anticipated credit losses estimated by us as of September 30, 2003 of approximately $568 million used to calculate GAAP income yields. It should be noted that the amount and timing of the anticipated credit losses assumed by us related to the GAAP income yields are not directly comparable to those assumed under the 3%/30% CDR Loss Scenario and the 3%/40% CDR Loss Scenario. Sensitivity of Fair Value to Changes in the Discount Rate The required rate of return used to determine the fair value of our CMBS is comprised of many variables, such as a risk-free rate, a liquidity premium and a credit risk premium. These variables are combined to determine a total rate that, when used to discount the CMBS's assumed stream of future cash flows, results in a net present value of such cash flows. The determination of such rate is dependent on many quantitative and qualitative factors, such as, but not limited to, the market's perception of the issuers and the credit fundamentals of the commercial real 25 estate underlying each pool of commercial mortgage loans. For purposes of this disclosure, we assumed that the discount rate used to determine the fair value of our CMBS increased by 100 basis points and 200 basis points. The increase in the discount rate by 100 and 200 basis points, respectively, would result in a corresponding decline in the value of our aggregate CMBS by approximately $49.1 million (or 5.7%) and $94.2 million (or 11.0%), respectively, and our subordinated CMBS by approximately $32.3 million (or 6.1%) and $61.7 million (or 11.7%), respectively. The sensitivities above are hypothetical and should be used with caution. As the figures indicate, changes in fair value based on variations in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, the effect of a variation in a particular assumption on the fair value of the retained interest is calculated without changing any other assumption; in reality, changes in one factor may result in changes in another (for example, increases in market interest rates may result in lower prepayments and increased credit losses), which might magnify or counteract the sensitivities. Sensitivity of Fair Value to Extension Risk For purposes of this disclosure, we assumed that the maturity date of each commercial mortgage loan underlying the CMBS was extended for a period of 12 months and 24 months beyond the contractual maturity date specified in each mortgage loan. The delay in the timing and receipt of such cash flows for an extended period of time consisting of 12 months and 24 months, respectively, would result in a corresponding decline in the value of our aggregate CMBS by approximately $8.2 million (or 0.8%) and $16.0 million (or 1.5%), respectively, and our subordinated CMBS by approximately $6.8 million (or 1.0%) and $12.6 million (or 1.8%), respectively. Impact of Prepayment Risk on Fair Value Our investments in subordinated CMBS are purchased at a discount to their face amount due to their subordinated claim to principal and interest cash flows and priority of allocation of realized losses. As a result of the discounted purchase price, the return of principal sooner than anticipated from prepayments, and/or in amounts greater than initially assumed when determining the discounted purchase price, would result in an increase in the value of our subordinated CMBS. Such appreciation in value would result from the higher subordination level of the CMBS transaction relative to comparable CMBS and the potential for an upgrade in the ratings category of the security. Since the effects of prepayments would enhance the value of our subordinated CMBS, other than if high-coupon mortgage loans underlying our subordinated CMBS are prepaid thus reducing the excess interest available to our subordinated CMBS, the effects of increased prepayments were excluded from the sensitivity analysis above. It should be noted that the effects of a decline in prepayments is reflected in the Sensitivity of Fair Value to Extension Risk above. 26 5. INSURED MORTGAGE SECURITIES We own the following insured mortgage securities directly or indirectly through wholly owned subsidiaries (in thousands):
As of September 30, 2003 ------------------------ Number of Weighted Mortgage Average Effective Weighted Average Securities Fair Value Amortized Cost Interest Rate Remaining Term (4) ---------- ----------- --------------- ----------------- ------------------ CRIIMI MAE Financial Corporation 16 $ 63,274 $62,619 8.41% 25 years CRIIMI MAE Financial Corporation II 17 74,186 73,604 7.21% 21 years CRIIMI MAE Financial Corporation III (3) 12 30,833 30,453 8.02% 25 years -- --------- -------- ----- -------- 45 (1) $ 168,293 $166,676 7.81% (2) 23 years (2) == ========= ======== ===== ========
As of December 31, 2002 ----------------------- Number of Weighted Mortgage Average Effective Weighted Average Securities Fair Value Amortized Cost Interest Rate Remaining Term (4) ---------- ----------- --------------- ----------------- ------------------ CRIIMI MAE 1 $ 5,730 $ 5,340 8.00% 32 years CRIIMI MAE Financial Corporation 22 77,454 76,653 8.40% 25 years CRIIMI MAE Financial Corporation II 28 145,576 145,396 7.19% 23 years CRIIMI MAE Financial Corporation III 16 46,580 46,266 7.92% 27 years -- -------- -------- ------ -------- 67 $275,340 $273,655 7.67% (2) 25 years (2) == ======== ======== ===== ========
(1) During the nine months ended September 30, 2003, twenty-one mortgage loans underlying our mortgage securities were prepaid. These prepayments generated net proceeds of approximately $98.5 million and resulted in a financial statement net loss of approximately $(880,000), primarily due to the write-off of unamortized costs, which is included in net losses on mortgage security dispositions in the accompanying consolidated statement of income for the nine months ended September 30, 2003. In addition, we sold one insured mortgage security that was owned by CRIIMI MAE Inc. for approximately $5.7 million, which resulted in a gain of approximately $357,000 during the nine months ended September 30, 2003. Approximately 38% (based on amortized cost) of our insured mortgage loans prepaid or were sold during the nine months ended September 30, 2003. (2) Weighted averages were computed using total face value of the mortgage securities. It is possible that some of the underlying mortgage loans may prepay due to the low current mortgage interest rates. (3) We currently have the option of prepaying the CRIIMI MAE Financial Corporation III debt since the current face value of the debt is less than 20% of the original face value. (4) The weighted average lives are one year or less based on our prepayment assumptions. 27 6. OBLIGATIONS UNDER FINANCING FACILITIES The following table summarizes our debt outstanding as of September 30, 2003 and December 31, 2002 and for the nine months ended September 30, 2003 (in thousands):
As of and for the nine months ended September 30, 2003 ---------------------------------------------------------- Effective Average Rate at Average Effective December 31, 2002 Ending Balance Quarter End Balance Rate Ending Balance -------------- ----------- ------- ---- -------------- Recourse to CRIIMI MAE: - ----------------------- Bear Stearns debt (1) $ 297,500 4.7% $ 284,510 4.7% $ -- BREF debt (2) 31,267 16.2% 28,937 16.2% -- Exit variable-rate secured borrowing (3) -- -- 17,227 6.7% 214,673 Series A senior secured notes (3) -- -- 23,963 11.9% 92,789 Series B senior secured notes (3) -- -- 17,757 20.3% 68,491 Non-Recourse to CRIIMI MAE: - --------------------------- Securitized mortgage obligations: CMBS (4) 288,377 9.1% 286,947 9.2% 285,845 Freddie Mac funding note (5) 70,334 7.7% 110,314 10.2% 139,550 Fannie Mae funding note (6) 29,491 7.4% 35,447 9.9% 44,902 CMO (7) 57,393 7.6% 61,357 8.7% 68,527 Mortgage payable (8) 7,303 12.0% 7,253 12.0% 7,214 --------- --------- --------- Total debt $ 781,665 7.4% $ 873,712 8.4% $ 921,991 ========= ========= =========
(1) The effective interest rate includes the amortization of deferred financing fees. During the nine months ended September 30, 2003, we recognized $1.1 million of interest expense related to the amortization of the deferred financing fees. (2) The effective interest rate includes the amortization of deferred financing fees. During the nine months ended September 30, 2003, we recognized $252,000 of interest expense related to the amortization of the deferred financing fees. (3) The effective interest rate during the nine months ended September 30, 2003 includes the accrual of estimated extension fees through January 23, 2003. During the nine months ended September 30, 2003 and 2002, we recognized aggregate interest expense of $337,000 and $3.2 million related to estimated extension fees on these facilities, respectively. The exit variable-rate secured borrowing was repaid in full on January 23, 2003 and the Series A and B senior secured notes were repaid in full on March 10, 2003. The cumulative accrued extension fees (from April 17, 2001 through January 23, 2003) were reversed into income in gain on extinguishment of debt in 2003. (4) As of September 30, 2003 and December 31, 2002, the face amount of the debt was $328.4 million with unamortized discount of $40.1 million and $42.6 million, respectively. During the nine months ended September 30, 2003 and 2002, discount amortization of $2.5 million and $2.1 million, respectively, was recorded as interest expense. (5) As of September 30, 2003 and December 31, 2002, the face amount of the note was $71.8 million and $143.1 million, respectively, with unamortized discount of $1.5 million and $3.5 million, respectively. During the nine months ended September 30, 2003 and 2002, discount amortization of $2.0 million and $974,000, respectively, was recorded as interest expense. The average effective interest rate includes approximately $1.7 million and $661,000 of additional interest expense during the nine months ended September 30, 2003 and 2002, respectively, due to the mortgages underlying the insured mortgage securities prepaying at a faster rate than anticipated and an adjustment in 2003 to the assumed prepayment speeds. Under the effective interest method of recognizing interest expense, the prepayments of the debt required an adjustment to cumulative interest expense related to the amortization of discount and deferred fees. (6) As of September 30, 2003 and December 31, 2002, the face amount of the note was $30.0 million and $45.8 million, respectively, with unamortized discount of $462,000 and $847,000, respectively. During the nine months ended September 30, 2003 and 2002, discount amortization of $386,000 and $98,000, respectively, was recorded as interest expense. The average effective interest rate includes approximately $501,000 and $20,000 of additional interest expense during the nine months ended September 30, 2003 and 2002, respectively, due to the mortgages underlying the insured mortgage securities prepaying at a faster rate than anticipated and an adjustment in 2003 to the assumed prepayment speeds. Under the effective interest method of recognizing interest expense, the prepayments of the debt required an adjustment to cumulative interest expense related to the amortization of discount and deferred fees. We currently have the option of prepaying the CRIIMI MAE Financial Corporation III debt since the current face value of the debt is less than 20% of the original face value. (7) As of September 30, 2003 and December 31, 2002, the face amount of the note was $58.4 million and $70.0 million, respectively, with unamortized discount of $963,000 and $1.5 million, respectively. During the nine months ended September 30, 2003 and 2002, discount amortization of $492,000 and $403,000, respectively, was recorded as interest expense. The average effective interest rate includes approximately $466,000 and $284,000 of additional interest expense during the nine months ended September 30, 2003 and 2002, 28 respectively, due to the mortgages underlying the insured mortgage securities prepaying at a faster rate than anticipated and an adjustment in 2003 to the assumed prepayment speeds. Under the effective interest method of recognizing interest expense, the prepayments of the debt required an adjustment to cumulative interest expense related to the amortization of discount and deferred fees. (8) As of September 30, 2003 and December 31, 2002, the unpaid principal balance of this mortgage payable was $8.6 million and $8.7 million, respectively, and the unamortized discount was $1.3 million and $1.5 million, respectively. The coupon rate on the mortgage payable is 7.34%. The effective interest rate on the mortgage payable is 12.00% as a result of the discount amortization. The discount is being amortized to interest expense through maturity in 2008. During the nine months ended September 30, 2003 and 2002, discount amortization of $169,000 and $153,000, respectively, was recorded as interest expense. Debt Incurred in Connection with January 2003 Recapitalization Bear Stearns Debt Bear Stearns provided $300 million in secured financing to two of our subsidiaries, in the form of a repurchase transaction under the January 2003 recapitalization. The Bear Stearns Debt matures in 2006, bears interest at a per annum rate equal to one-month LIBOR plus 3%, payable monthly, and currently requires quarterly principal payments of $1.25 million. The principal payments will increase to $1.875 million per quarter if a collateralized debt obligation transaction (or CDO) is not completed by January 23, 2004. The interest rate will increase by 1%, to one-month LIBOR plus 4% and we will have to pay Bear Stearns an additional $2 million in cash, if Bear Stearns structures a CDO that meets certain rating requirements and we decline to enter into such transaction. Although CRIIMI MAE Inc. (unconsolidated) is not a primary obligor of the Bear Stearns Debt, it has guaranteed all obligations under the debt. We paid a commitment fee of 0.5% of the Bear Stearns Debt to Bear Stearns. We also paid $250,000 of Bear Stearns' legal expenses. On the effective date of our January 2003 recapitalization, we effected an affiliate reorganization principally to indirectly secure the Bear Stearns Debt with the equity interests in CBO-1 and CBO-2. As a result of the affiliate reorganization, our REIT subsidiary (CBO REIT II), owns all bonds previously pledged to secure the Exit Debt and indirectly owns all of the equity interests in CBO-1 and CBO-2 (through its ownership of the two qualified REIT subsidiaries which hold the equity interests in CBO-1 and CBO-2). The Bear Stearns Debt is collateralized by first direct and/or indirect liens on all of our subordinated CMBS, and is subject to a number of terms, conditions and restrictions including, without limitation, scheduled principal and interest payments, and restrictions and requirements with respect to the collection and application of funds. The indirect first liens are first liens on the equity interests of three of our subsidiaries that hold certain subordinated CMBS. If the outstanding loan amount under the Bear Stearns Debt exceeds 85% of the aggregate market value of the collateral securing the Bear Stearns Debt, as determined by Bear Stearns in its sole good faith discretion, then Bear Stearns, if, and as, permitted after the application of the terms of a netting agreement entered into in connection with an interest rate swap (as described below), can require us to transfer cash, cash equivalents or securities so that the outstanding loan amount will be less than or equal to 80% of the aggregate market value of the collateral (including any additional collateral provided). Failure to meet any margin call could result in an event of default which would enable Bear Stearns to exercise various rights and remedies including acceleration of the maturity date of the Bear Stearns Debt and the sale of the collateral. In order to meet a margin call, we may be required to sell assets at prices lower than their carrying value which could result in losses. Under the Bear Stearns Debt, we are required to obtain interest rate protection in the form of a cap, swap or other derivative. BREF Debt In connection with the January 2003 recapitalization, BREF Fund purchased $30 million of our newly issued subordinated debt and, at our option, BREF Fund will purchase up to an additional $10 million of subordinated debt prior to January 23, 2004. The BREF Debt matures on January 23, 2006 and bears interest at an annual rate of 15%. The interest on the BREF Debt is payable semi-annually and there are no principal payments until maturity. If we decide to sell the additional $10 million of subordinated debt to BREF Fund, it will bear interest at an annual rate of 20% and mature on January 23, 2006. We have a right to defer two-thirds of the interest on the BREF Debt, which we are currently deferring, (and half on the additional $10 million, if sold to BREF Fund) during its term. The BREF Debt is secured by first liens on the equity interests of two of our subsidiaries. Although these liens effectively provide BREF Fund with an indirect lien on all of our subordinated CMBS that are held by three of our other lower-tier subsidiaries, Bear Stearns has first direct liens on the equity interests of these three lower tier subsidiaries and on certain of the subordinated CMBS held by one of these lower tier subsidiaries. Pursuant to an intercreditor agreement between Brascan Real Estate Financial Investments LLC, which we refer to as BREF Investments, and Bear Stearns, BREF Investments has agreed generally that the BREF Debt is subordinate 29 and junior to the prior payment of the Bear Stearns Debt and has further agreed to contractual restrictions on its ability to realize upon its liens. We paid BREF Investments an origination fee of $200,000, equal to 0.5% of the $30 million in subordinated debt it had acquired plus the additional $10 million in subordinated debt that, at our option, it may acquire. We also paid BREF Investments an aggregate of $1 million for expenses in connection with the transactions. Pursuant to the Investment Agreement with BREF Investments, we are also obligated to pay BREF Investments a quarterly maintenance fee of $434,000 through January 2006. Interest Rate Swap Agreement and Netting Agreement During the second quarter of 2003, two of our subsidiaries (the primary obligors of the Bear Stearns Debt) entered into an interest rate swap agreement for the purpose of hedging the variability of expected future interest payments on our anticipated CDO, as more fully described under Note 7. In the second and third quarters of 2003, we entered into a total of three interest rate swap transactions under this agreement in which we have agreed to pay Bear Stearns a weighted average fixed interest rate of 4.15% per annum in exchange for floating payments based on one-month LIBOR on the total notional amount of $100 million. These swaps are effective on October 15, 2003, terminate on October 15, 2013 and provide for monthly interest payments commencing November 15, 2003. On November 15, 2003 we will begin making monthly payments to Bear Stearns equal to the difference between the weighted average swap rate of 4.15% and the then current one-month LIBOR rate, which was 1.12% on October 15, 2003, on the notional amount of $100 million. See further discussion in Note 7. We anticipate that the interest rate swaps will be terminated or otherwise disposed of, in each case subject to the consent of Bear Stearns, upon issuance of the CDO. Under the interest rate swap documents, our two subsidiaries have granted to Bear Stearns a security interest in all of their rights, title and interest in certain assets, including property now or hereafter held by Bear Stearns in connection with the Bear Stearns Debt or the interest rate swap documents and certain contract rights under the Bear Stearns Debt and interest rate swap documents (including the subsidiaries' rights to any "margin excess" related to the collateral securing the Bear Stearns Debt, with margin excess as defined in the Bear Stearns Debt documents), to secure their obligations under the interest rate swap documents and the Bear Stearns Debt. This security interest constitutes additional collateral for the Bear Stearns Debt. Also under the interest rate swap documents, on any day on which there exists any obligation for us to deliver cash or additional eligible collateral under either the interest rate swap or the Bear Stearns Debt, such obligation will be deemed satisfied to the extent there exists a margin excess under the Bear Stearns Debt or an obligation for Bear Stearns to deliver cash or eligible collateral under the interest rate swap. CRIIMI MAE Inc. has guaranteed all of its subsidiaries' obligations under the interest rate swap documents, as well as the Bear Stearns Debt. Bear Stearns $200 Million Secured Borrowing Facility On August 28, 2003, one of our subsidiaries finalized and executed (effective as of June 26, 2003) a $200 million secured borrowing facility, in the form of a repurchase transaction, with Bear Stearns. This facility may be used for the acquisition of subordinated CMBS and for financing certain other transactions involving securities. The securities to be transferred to Bear Stearns in each transaction under this facility will be subject to the approval of Bear Stearns in its sole discretion. The debt will be secured by the securities transferred to Bear Stearns, and if the market value of the collateral declines we may be required to pay down the debt or post additional collateral. This facility may be used for one or more transactions. The financing available for a subordinated CMBS purchased under this facility ranges from 80% to 15% of the market value of the CMBS. The applicable percentage depends primarily upon the ratings category of the CMBS and, to a lesser extent, upon the number of issuer trusts from which we have purchased CMBS. The maturity date of each transaction will be determined at the time the transaction is closed and, in each case, will be on or before August 14, 2005. As to each transaction, accrued and unpaid interest will be payable monthly at an annual rate ranging from one-month LIBOR plus 0.8% to one-month LIBOR plus 2% and all unpaid principal and accrued and unpaid interest will be payable at maturity. Commencing on the date of the closing of the first transaction under this facility, we will be required to maintain liquidity of at least $10 million in cash and investment grade securities. Since the CDO was not closed by October 14, 2003, this liquidity requirement will increase by $2.5 million per calendar quarter subsequent to October 14, 2003. The liquidity requirement will terminate upon the closing of the CDO or repayment in full of the Bear Stearns Debt. CRIIMI MAE Inc. has guaranteed the obligations of its subsidiary under this facility. If we do a CDO transaction with securities purchased under the Bear Stearns secured borrowing facility and Bear Stearns is not a lead manager, then we may be required to pay Bear Stearns an exit and/or disappointment fee. There were no borrowings outstanding under this facility at September 30, 2003. 30 Exit Debt The Exit Debt consisted of the Exit Variable-Rate Secured Borrowing, the Series A Senior Secured Notes and the Series B Senior Secured Notes. The annual interest rate on the Exit Variable-Rate Secured Borrowing, Series A Senior Secured Notes and Series B Senior Secured Notes was LIBOR plus 3.25%, 11.75% and 20%, respectively. The Exit Debt was repaid in full during the three months ended March 31, 2003. Gain on Extinguishment of Exit Debt During the three months ended March 31, 2003, we reversed approximately $7.8 million of accrued extension fees related to the Exit Debt since the debt was repaid and the extension fees were no longer payable. This reversal is reflected as a gain on extinguishment of debt in our consolidated statement of income. This reversal was partially offset by approximately $403,000 of breakage fee paid to the lender of the Exit Variable-Rate Secured Borrowing and legal fees of approximately $47,000, resulting in a net gain on extinguishment of debt of approximately $7.3 million. Other Debt Related Information Fluctuations in interest rates will continue to impact the value of our mortgage assets and could result in margin calls and impact the net interest margin through increased cost of funds on our variable rate debt and anticipated CDO. We have an interest rate cap and swaps to partially limit the adverse effects of rising interest rates on our variable rate debt and the anticipated CDO. When the cap expires, we will have interest rate risk to the extent interest rates increase on our variable rate debt unless the cap is replaced with another hedge or other steps, including the anticipated CDO, are taken to mitigate this risk. Furthermore, with respect to the cap, we currently have interest rate risk to the extent that the LIBOR interest rate increases between the current rate and the cap rate. See Note 7 for further discussion of our derivative financial instruments. As of September 30, 2003, our debt-to-equity ratio was approximately 2.5 to 1 and our non-match-funded debt-to-equity ratio was approximately 1.1 to 1. The following table lists the fair market value of the collateral related to our securitized mortgage obligations (in millions): Collateral Fair Value as of Securitized Mortgage Obligations September 30, 2003 December 31, 2002 - -------------------------------- ------------------ ----------------- CMBS $ 332 $ 326 Freddie Mac Funding Note 74 146 Fannie Mae Funding Note 31 47 CMO 63 77 7. DERIVATIVE FINANCIAL INSTRUMENTS In the second and third quarters of 2003, we entered into a total of three interest rate swaps to hedge the variability of the future interest payments on the anticipated CDO attributable to changes in interest rates. Our obligations to Bear Stearns under the interest rate swap documents are collateralized by certain assets as described in Note 6. These swaps are treated as cash flow hedges for GAAP. Under these swaps, we agreed to pay Bear Stearns a weighted average fixed interest rate of 4.15% per annum in exchange for floating payments based on one-month LIBOR on the total notional amount of $100 million. These swaps are effective on October 15, 2003, terminate on October 15, 2013 and provide for monthly interest payments commencing November 15, 2003. On November 15, 2003 we will begin making monthly payments to Bear Stearns equal to the difference between the weighted average swap rate of 4.15% per annum and the then current one-month LIBOR rate, which was 1.12% per annum on October 15, 2003, on the notional amount of $100 million. The interest rate swaps were designated to hedge future interest payments on the proposed CDO. As the expected date of the CDO has been changed, we recognized approximately $1.9 million of hedging ineffectiveness during the three months ended September 30, 2003, in accordance with SFAS No. 133. The $1.9 million expense represents the present value of the expected payments during the period of delay. We have an asset of approximately $1.5 million in Other Assets as of September 30, 2003, representing the aggregate fair value of the interest rate swaps. We intend to terminate the swaps simultaneously with the issuance of the CDO. 31 We maintain an interest rate cap indexed to one-month LIBOR to partially limit the adverse effects of potential rising interest rates on our variable-rate debt. The interest rate cap provides protection to the extent interest rates, based on a readily determinable interest rate index, increase above the stated interest rate cap, in which case, we would receive payments based on the difference between the index and the cap. At September 30, 2003, our interest rate cap had a notional amount of $175 million, capped one-month LIBOR at 3.25% and had a fair value of $0. This cap matured on November 3, 2003. On October 31, 2003, we purchased an interest rate cap for $45,000 with a notional amount of $50 million, an effective date of November 4, 2003, maturity on November 4, 2004, and capping one-month LIBOR at 2.25%. We designated both of these interest rate caps, in accordance with SFAS No. 133, to hedge the Bear Stearns Debt. We are exposed to credit loss in the event of non-performance by the counterparties to the interest rate cap and interest rate swaps should interest rates exceed the cap rate, or if the floating rate exceeds the fixed swap rates respectively, however, we do not anticipate non-performance by the counterparties. The counterparties (or the parent to the counterparty in the case of the interest rate swaps) have long-term debt ratings of A or above by Standard and Poor's and A2 or above by Moody's. Although neither the cap nor swaps are exchange-traded, there are a number of financial institutions which enter into these types of transactions as part of their day-to-day activities. 8. DIFFERENCES BETWEEN FINANCIAL STATEMENT NET INCOME (LOSS) AND TAXABLE LOSS The differences between financial statement (GAAP) net income (loss) and taxable income (loss) are generally attributable to differing treatment of unrealized/realized gains and losses associated with certain assets; the bases, income, impairment, and/or credit loss recognition related to certain assets; and amortization of various costs. The distinction between GAAP net income (loss) and taxable income (loss) is important to our shareholders because dividends or distributions, if any, are declared and paid on the basis of taxable income or taxable loss. We do not pay Federal income taxes as long as we satisfy the requirements for exemption from taxation pursuant to the REIT requirements of the Internal Revenue Code. We calculate our taxable income or taxable loss, as if we were a regular domestic corporation. This taxable income or taxable loss level determines the amount of dividends, if any, we are required to distribute over time in order to eliminate our tax liability. As a result of our trader election in early 2000, we recognized a mark-to-market tax loss of approximately $478 million on certain trading securities on January 1, 2000. The January 1, 2000 mark-to-market loss is expected to be recognized evenly over four years through 2003 for tax purposes (i.e., approximately $120 million per year) beginning with the year 2000. A summary of our year-to-date net operating loss as of September 30, 2003 is as follows (in millions):
January 2000 Loss $ (478.2) LESS: Amounts recognized in 2002, 2001 and 2000 358.6 LESS: Amounts recognized during the nine months ended September 30, 2003 89.7 --------- Balance remaining of January 2000 Loss to be recognized during the remainder of 2003 $ (29.9) ========= Taxable income for the nine months ended September 30, 2003 before recognition $ 26.4 of January 2000 Loss LESS: January 2000 Loss recognized during the nine months ended September 30, 2003 (89.7) --------- Net Operating Loss for the nine months ended September 30, 2003 $ (63.3) ========= Accumulated Net Operating Loss through December 31, 2002 $ (223.8) Net Operating Loss for the nine months ended September 30, 2003 (63.3) Net Operating Loss utilization - --------- Net Operating Loss carried forward for use in future periods $ (287.1) ========= Accumulated and unused net operating loss and remaining January 2000 Loss $ (317.0) =========
32 9. SERVICING RESTRUCTURING AND SALE OF CMBS MASTER AND DIRECT SERVICING RIGHTS In April 2003, CMSLP restructured its property servicing group. In connection with the restructuring, 15 employee positions were eliminated in the second and third quarters of 2003. The elimination of these positions resulted in the termination of 11 employees. We recognized approximately $151,000 of servicing restructuring expenses, representing employee severance and related benefits, during the nine months ended September 30, 2003. In conjunction with this restructuring, we have outsourced substantially all of our property servicing duties on a considerable portion of the properties underlying our mortgage assets to another servicer, effective October 2003. We expect to outsource the balance of our property servicing duties, excluding consents and assumptions, by the end of the fourth quarter of 2003. This outsourcing will not relieve us of any of our obligations or reduce any of our rights as property servicer since CMSLP remains the property servicer of record. The table below provides a summary of the change in the liability balance associated with the restructuring of our property servicing group. All amounts in the accrual are severance and other employee benefits. Balance, April 1, 2003 $ -- Amounts accrued 150,672 Amounts paid (148,878) -------- Balance, September 30, 2003 $ 1,794 ======== In February 2002, CMSLP sold all of its rights and obligations under its CMBS master and direct servicing contracts because the contracts were not profitable, given the relatively small volume of master and direct CMBS servicing that CMSLP was performing. In connection with this restructuring, 34 employee positions were eliminated. During the nine months ended September 30, 2002, approximately $1.0 million of income tax expense was recognized as a result of the income taxes on the gain on the sale by CMSLP of its master and direct servicing rights. The income tax expense was incurred by us through our wholly-owned taxable REIT subsidiaries ("TRSs") that own partnership interests in CMSLP. These TRSs are separately taxable entities that cannot use our NOL to reduce their taxable income. As a result of this sale and related restructuring, CMSLP recorded restructuring expenses in the fourth quarter of 2001. During the nine months ended September 30, 2002, CMSLP recorded additional restructuring expenses of $141,000 primarily related to rent on vacant office space that was taking longer to sublease than originally anticipated. 10. EXECUTIVE CONTRACT TERMINATION COSTS In August 2003, the employment contracts for David Iannarone, Cynthia Azzara and Brian Hanson expired and were not renewed. These contracts were put into place in 2001 to ensure management continuity following our emergence from Chapter 11 proceedings and through our January 2003 recapitalization. In connection with the contract terminations, we recognized approximately $1.0 million of expenses for each of Mr. Iannarone and Ms. Azzara and approximately $847,000 of expense related to severance and related benefit payments for Mr. Hanson. Mr. Iannarone and Ms. Azzara were each paid their contract termination payments during the three months ended September 30, 2003. Approximately $306,000 of Mr. Hanson's payments were made during the three months ended September 30, 2003. The remaining $542,000 related to Mr. Hanson will be paid over 17 months in accordance with the terms of his terminated employment agreement. Ms. Azzara has agreed to continue with us as an "at will" employee and has been promoted to Executive Vice President, Chief Financial Officer and Treasurer. Mr. Hanson is no longer employed by us, but has agreed to a short-term consulting arrangement. Mr. Iannarone subsequently resigned his position as Executive Vice President, Legal and Deal Management effective October 24, 2003. Mr. Iannarone was granted 13,055 shares of restricted common stock on October 3, 2003, valued at approximately $140,000 based on the closing price of our common stock on October 3, 2003, under our 2001 Stock Incentive Plan. Mr. Iannarone's restricted common stock was forfeited effective upon his resignation. 11. RECAPITALIZATION EXPENSES We consolidated our office space in connection with our January 2003 recapitalization and, as a result, we recorded approximately $532,000 of expense for vacant office space during the second quarter of 2003. We reduced our accrual by approximately $9,000 during the three months ended September 30, 2003, which represents the expense amortization for the period. 33 The accrual for the vacant space represents the fair value of lease payments through 2007, a tenant improvement allowance and a broker commission, all net of estimated sublease revenue in accordance with SFAS No. 146. In addition, as discussed in Note 15, we recognized approximately $2.6 million of expenses related to the termination of our former Chairman and former President during the three months ended March 31, 2003. 12. COMMON STOCK We had 300,000,000 authorized shares and 15,263,006 and 13,945,068 issued and outstanding shares of $0.01 par value common stock as of September 30, 2003 and December 31, 2002, respectively. In connection with the January 2003 recapitalization, BREF Fund acquired 1,212,617 shares of our newly issued common stock, or approximately 8% of our outstanding common stock after giving effect to the share acquisition, at $11.50 per share, or approximately $13.9 million. The following table summarizes the common stock activity through September 30, 2003:
Common Shares Balance of Common Date Description Issued Shares Outstanding - ------------------------- ----------------------------------------- ----------------- ------------------- December 31, 2002 Beginning balance 13,945,068 Shares issued to BREF Fund 1,212,617 Stock options exercised 5,000 - ------------------------------------------------------------------------------------------------------------- March 31, 2003 Balance 15,162,685 - ------------------------------------------------------------------------------------------------------------- Stock options exercised 39,000 - ------------------------------------------------------------------------------------------------------------- June 30, 2003 Balance 15,201,685 - ------------------------------------------------------------------------------------------------------------- Stock options exercised 3,300 Restricted stock granted 58,021 - ------------------------------------------------------------------------------------------------------------- September 30, 2003 Balance 15,263,006 - -------------------------------------------------------------------------------------------------------------
In connection with the January 2003 recapitalization, BREF Fund also received seven-year warrants to purchase up to 336,835 additional shares of common stock at $11.50 per share. The fair value of the warrants was calculated as approximately $2.6 million using the Black-Scholes option pricing model. The assumptions we used to value the warrants are consistent with the assumptions used to value our stock options. The warrants are a component of equity. 13. PREFERRED STOCK As of September 30, 2003 and December 31, 2002, 75,000,000 shares of preferred stock were authorized. As of September 30, 2003 and December 31, 2002, 3,000,000 shares were designated as Series B Cumulative Convertible Preferred Stock, 1,610,000 shares were designated as Series F Redeemable Cumulative Dividend Preferred Stock, 3,760,000 shares were designated as Series G Redeemable Cumulative Dividend Preferred Stock and 45,000 shares were designated as Series H Junior Preferred Stock. As of September 30, 2003, there were no accrued and unpaid dividends for any series of our preferred stock. On November 11, 2003, the Board of Directors declared cash dividends of $0.68, $0.30 and $0.375 per share of Series B, Series F and Series G Preferred Stock, respectively, payable on December 31, 2003 to shareholders of record on December 16, 2003. Series B Cumulative Convertible Preferred Stock As of September 30, 2003 and December 31, 2002, there were 1,593,982 shares of Series B Preferred Stock issued and outstanding. The Series B Preferred Stock provides for a dividend in an amount equal to the sum of (i) $0.68 per share per quarter plus (ii) the product of the excess over $3.00, if any, of the quarterly cash dividend declared and paid with respect to each share of common stock times a conversion ratio of 0.4797 times one plus a conversion premium of 3%, subject to further adjustment upon the occurrence of certain events. The following table summarizes the 2003 dividend payment activity for the Series B Preferred Stock: 34
Time Period for Dividends per Amount of Dividends which dividends Declaration Date Payment Date Series B Share were accrued ------------------------------------------------------------------------------------------------- March 5, 2003 March 31, 2003 $ 0.68 $ 1,083,908 4/01/02-6/30/02 May 15, 2003 June 30, 2003 $ 0.68 $ 1,083,908 7/01/02-9/30/02 June 3, 2003 June 30, 2003 $ 2.04 $ 3,251,723 10/01/02-6/30/03 August 14, 2003 September 30, 2003 $ 0.68 $ 1,083,908 7/01/03-9/30/03
As of September 30, 2003, each share of Series B Preferred Stock was convertible into 0.4797 shares of common stock. Series E Cumulative Convertible Preferred Stock In March 2002, we redeemed all 173,000 outstanding shares of the Series E Preferred Stock at the stated redemption price of $106 per share in cash plus accrued and unpaid dividends through and including the date of redemption. The total redemption price was $18,734,000 ($396,000 of which represented accrued and unpaid dividends for the period October 1, 2001 through March 21, 2002). The $2,252,000 difference between the aggregate liquidation value, including the initial preferred stock issuance costs, and the redemption price is reflected as a dividend on preferred stock during the nine months ended September 30, 2002. Series F Redeemable Cumulative Dividend Preferred Stock As of September 30, 2003 and December 31, 2002, there were 586,354 shares of Series F Preferred Stock issued and outstanding. The Series F Preferred Stock provides for dividends at a fixed annual rate of 12%. The following table summarizes the 2003 dividend payment activity for the Series F Preferred Stock:
Time Period for Dividends per Amount of Dividends which dividends Declaration Date Payment Date Series F Share were accrued ------------------------------------------------------------------------------------------------- March 5, 2003 March 31, 2003 $ 0.30 $ 175,906 4/01/02-6/30/02 May 15, 2003 June 30, 2003 $ 0.30 $ 175,906 7/01/02-9/30/02 June 3, 2003 June 30, 2003 $ 0.90 $ 527,719 10/01/02-6/30/03 August 14, 2003 September 30, 2003 $ 0.30 $ 175,906 7/01/03-9/30/03
Series G Redeemable Cumulative Dividend Preferred Stock As of September 30, 2003 and December 31, 2002, there were 1,244,656 shares of Series G Preferred Stock issued and outstanding. The Series G Preferred Stock provides for dividends at a fixed annual rate of 15%. The following table summarizes the 2003 dividend payment activity for the Series G Preferred Stock:
Time Period for Dividends per Amount of Dividends which dividends Declaration Date Payment Date Series G Share were accrued ------------------------------------------------------------------------------------------------- March 5, 2003 March 31, 2003 $ 0.375 $ 466,746 4/01/02-6/30/02 May 15, 2003 June 30, 2003 $ 0.375 $ 466,746 7/01/02-9/30/02 June 3, 2003 June 30, 2003 $ 1.125 $ 1,400,238 10/01/02-6/30/03 August 14, 2003 September 30, 2003 $ 0.375 $ 466,746 7/01/03-9/30/03
Series H Junior Preferred Stock As of September 30, 2003 and December 31, 2002, there were no issued and outstanding shares of Series H Preferred Stock. 35 14. EARNINGS PER SHARE The following tables reconcile basic and diluted earnings per share for the three and nine months ended September 30, 2003 and 2002.
For the three months ended September 30, 2003 For the three months ended September 30, 2002 Per Share Per Share Income Shares Amount Income Shares (2) Amount -------------- --------------- ------------- ------------- ------------ ----------- Basic and diluted earnings per share (1): - ---------------------------------------- Net loss to common shareholders $ (7,374,724) 15,204,913 $ (0.49) $(25,101,506) 13,926,600 $(1.80) ============== =============== ============= ============= ============ =========== For the nine months ended September 30, 2003 For the nine months ended September 30, 2002 Per Share Per Share Income Shares Amount Income Shares (2) Amount -------------- --------------- ------------ ------------- ------------ ------------ Net loss to common shareholders before cumulative effect of change in accounting principle $ (6,692,962) 15,114,173 $ (0.44) $(21,081,467) 13,635,656 $(1.55) Cumulative effect of change in accounting principle related to SFAS 142 -- -- -- (9,766,502) 13,635,656 (0.71) -------------- --------------- ------------- ------------- ------------ ----------- Basic and diluted earnings per share (1): - ---------------------------------------- Net loss to common shareholders $ (6,692,962) 15,114,173 $ (0.44) $(30,847,969) 13,635,656 $(2.26) ============== ============== ============= ============= ============ ===========
(1) The common stock equivalents for stock options, the preferred stock that is convertible and the warrants outstanding are not included in the calculation of diluted EPS because the effect would be anti-dilutive. (2) Includes the weighted average number of common shares payable or paid to preferred stockholders related to dividends as of the respective dividend declaration dates. 15. TRANSACTIONS WITH RELATED PARTIES The following is a summary of the related party transactions which occurred during the three and nine months ended September 30, 2003 and 2002:
Three months ended September 30, Nine months ended September 30, 2003 2002 2003 2002 ---- ---- ---- ---- Amounts received or accrued from the AIM Limited Partnerships - ------------------------------------------------ Income(1) $ 83,436 $ 129,249 $ 306,126 $ 419,880 Return of capital(2) 1,116,759 538,778 2,071,161 1,590,826 ----------- --------- ----------- ----------- Total $ 1,200,195 $ 668,027 $ 2,377,287 $ 2,010,706 =========== ========= =========== =========== Amounts received or accrued from AIM Acquisition Limited Partnership (1) $ 36,456 $ 58,397 $ 127,337 $ 179,791 =========== ========= =========== =========== Expense reimbursements from AIM Limited Partnerships (3) (5) $ 49,992 $ 47,851 $ 161,099 $ 143,078 =========== ========= =========== =========== Expense reimbursements to affiliates of BREF Fund and employees of those affiliates (3) $ 12,365 $ - $ 30,477 $ - =========== ========= =========== =========== Expense reimbursement (to) from CRI: - ----------------------------------- Expense reimbursement to CRI (3) (4) $ (7,316) $(156,100) $ (83,307) $ (245,862) Expense reimbursement from CRI (3) (4) 8,388 69,415 80,867 145,853 =========== ========== =========== =========== Net expense reimbursement from (to) CRI $ 1,072 $ (86,685) $ (2,440) $ (100,009) =========== ========== =========== ===========
(1) Included as equity in earnings from investments on the accompanying consolidated statements of income. (2) Included as a reduction of equity investments on the accompanying consolidated balance sheets. (3) Included in general and administrative expenses on the accompanying consolidated statements of income. (4) Pursuant to an administrative services agreement between us and CRI, CRI provided us with certain administrative and office facility services and other services, at cost, with respect to certain aspects of our business. We used the services provided under the administrative services agreement to the extent such services were not performed by CRIIMI MAE Management or provided by 36 another service provider. The majority of such services under this agreement were terminated in March 2003. Our former Chairman, who is currently one of our directors, is a director, executive officer and principal shareholder of CRI. (5) During the three months ended September 30, 2003, CMSLP accrued approximately $150,000 as a payable to AIM 84 and AIM 85 due to an obligation incurred related to servicing a loan. As previously discussed, Barry Blattman, our Chairman and CEO, is affiliated with BREF Fund and BREF Investments. The Board's Compensation and Stock Option Committee is considering various alternatives with respect to the employment arrangement for Mr. Blattman. We have accrued approximately $550,000 in estimated compensation, subject to the approval of the Compensation and Stock Option Committee, as of September 30, 2003 which is expected to be payable in connection with Mr. Blattman's employment. Additional compensation may be payable in connection with such employment arrangement in the form of restricted stock or other equity-like compensation. As discussed in Note 6, we paid BREF Investments an origination fee of $200,000 related to the BREF Debt and an aggregate of $1.0 million for expenses in connection with the January 2003 recapitalization transactions. Pursuant to the Investment Agreement with BREF Investments, we are obligated to pay BREF Investments a quarterly maintenance fee of $434,000. As discussed in Note 12, in connection with the January 2003 recapitalization, we issued seven-year warrants to BREF Fund to purchase up to 336,835 shares of our common stock at $11.50 per share. There are also other existing and potential relationships, transactions and agreements with BREF Fund and/or certain of its affiliates (including BREF Investments) relating to the composition of our Board of Directors, additional subordinated debt financing, non-competition and other matters. In conjunction with the hiring of Mark Jarrell on September 15, 2003 as our President and Chief Operating Officer, Mr. Jarrell was granted 58,021 shares of restricted common stock on September 15, 2003, valued at $666,667 based on the closing price of our common stock on August 12, 2003, under our 2001 Stock Incentive Plan. This initial grant will vest 25% on December 31, 2003 and 75% on December 31, 2004. In addition, Mr. Jarrell will be granted shares of common stock equivalent to $500,000 on each of December 31, 2005 and 2006, provided he is employed by us on those dates and subject to certain terms of his Employment Offer Letter Agreement dated August 11, 2003. We expect to recognize approximately $143,000 of deferred compensation expense related to the restricted common stock award during the remainder of 2003 and approximately $500,000 of deferred compensation expense during 2004. On October 3, 2003, Cynthia Azzara, our Executive Vice President, Chief Financial Officer and Treasurer, was granted 13,055 shares of restricted common stock, valued at approximately $140,000 based on the closing price of our common stock on October 3, 2003, under our 2001 Stock Incentive Plan. This grant will vest 33% on each of December 31, 2004, 2005 and 2006. On October 29, 2003, Stephen Abelman was hired as Executive Vice President of Asset Management. In connection with his employment, Mr. Abelman was granted 12,500 shares of restricted stock on 2003, valued at approximately $142,000 based on the closing price of our common stock on November 6, 2003 under our 2001 Stock Incentive Plan. This grant will vest 33% on each of December 31, 2004, 2005 and 2006. In connection with the January 2003 recapitalization, we amended the employment contracts of our former Chairman, William B. Dockser, and former President, H. William Willoughby, to provide for their termination on January 23, 2003. During the three months ended March 31, 2003, we recognized approximately $2.6 million of expenses related to severance and related benefit payments, and accelerated vesting of certain outstanding stock options held by Messrs. Dockser and Willoughby. These expenses are reflected as recapitalization expenses in our consolidated statement of income. In addition to the transactions listed above, in connection with the Merger in 1995, we entered into a deferred compensation arrangement with William Dockser, Chairman until January 23, 2003 (a Director after January 23, 2003), and H. William Willoughby, President and a Director until January 23, 2003, in an original aggregate amount of $5,002,183 pursuant to which we agreed to pay Messrs. Dockser and Willoughby for services performed in connection with the structuring of the Merger. Our obligation to pay the deferred compensation is limited, with certain exceptions, to the creation of an irrevocable grantor trust for the benefit of Messrs. Dockser and Willoughby and the transfer to such trust of the right to receive such deferred compensation (the Note Receivable) in the original aggregate principal amount of $5,002,183. The deferred compensation is fully vested and payable only to the extent that payments are made by CRI on the Note Receivable. Payments of principal and interest on the Note 37 Receivable/deferred compensation are payable quarterly and terminate in June 2005. The Note Receivable/deferred compensation bears interest at the prime rate (4.00% as of September 30, 2003) plus 2% per annum. During the nine months ended September 30, 2003 and 2002, aggregate payments of approximately $434,000 and $466,000, respectively, were made on the Note Receivable/deferred compensation. These aggregate payments were split approximately equally among Messrs. Dockser and Willoughby. The unpaid aggregate principal balance on the note receivable/deferred compensation was $1,000,423 at September 30, 2003. The financial statement impact of these transactions is immaterial. 16. SEGMENT REPORTING Management assesses our performance and allocates capital principally on the basis of two lines of business: portfolio investment and mortgage servicing. These two lines of business are managed separately as they provide different sources and types of revenues. Portfolio investment primarily includes (i) acquiring subordinated CMBS, (ii) securitizing pools of mortgage loans and pools of CMBS, (iii) direct and indirect investments in government insured mortgage securities and entities that own government insured mortgage securities and mezzanine loans and (iv) securities trading activities. Our income from this segment is primarily generated from these assets. Mortgage servicing, which consists of all the operations of CMSLP, primarily includes performing servicing functions with respect to the mortgage loans underlying our CMBS. CMSLP performs a variety of servicing including special servicing and loan management. For these services, CMSLP earns a servicing fee which is calculated as a percentage of the principal amount of the servicing portfolio typically paid when the related service is rendered. These services may include either routine monthly services, non-monthly periodic services or event-triggered services. In acting as a servicer, CMSLP also earns other income which includes, among other things, assumption fees and modification fees. Overhead expenses, such as administrative expenses, are allocated either directly to each business line or through estimates based on factors such as number of personnel or square footage of office space. The following tables detail the financial performance of these operating segments for the three and nine months ended September 30, 2003 and 2002. The basis of accounting used in the tables is GAAP. 38
As of and for the three months ended September 30, 2003 ------------------------------------------------------------------------------------ Elimination of Portfolio Mortgage Intercompany Investment Servicing Transactions Consolidated ------------------- ---------------- ------------------- ------------------ Interest income $ 25,607,633 $ - $ - $ 25,607,633 Interest expense (17,711,530) - - (17,711,530) ------------------- ---------------- ------------------- ------------------ Net interest margin 7,896,103 - - 7,896,103 ------------------- ---------------- ------------------- ------------------ General and administrative expenses (2,629,658) - (397,403) (3,027,061) Deferred compensation expense (23,810) - - (23,810) Depreciation and amortization (131,472) - - (131,472) Impairment on CMBS (4,704,878) - - (4,704,878) Servicing revenue - 2,425,138 - 2,425,138 Servicing general and administrative expenses - (2,898,253) 397,403 (2,500,850) Servicing amortization, depreciation and impairment - (293,090) - (293,090) Servicing restructuring expenses - (6,301) - (6,301) Income tax benefit (expense) - 323,704 - 323,704 Equity in earnings from investments 91,006 - - 91,006 Other, net (456,756) - - (456,756) BREF maintenance fee (434,000) - - (434,000) Executive contract termination costs (2,028,343) (847,356) - (2,875,699) Recapitalization expenses - - - - Gain on extinguishment debt - - - - Hedging ineffectiveness (1,930,198) - - (1,930,198) ------------------- ---------------- ------------------- ------------------ (12,248,109) (1,296,158) - (13,544,267) ------------------- ---------------- ------------------- ------------------ Net income (loss) before changes in accounting principles $ (4,352,006) $ (1,296,158) $ - $ (5,648,164) =================== ================ =================== ================== Total assets $ 1,095,408,313 $ 11,850,556 $ - $ 1,107,258,869 =================== ================ =================== ================== As of and for the three months ended September 30, 2002 ------------------------------------------------------------------------------------ Elimination of Portfolio Mortgage Intercompany Investment Servicing Transactions Consolidated ------------------- ---------------- ------------------- ------------------ Interest income $ 31,508,173 $ - $ - $ 31,508,173 Interest expense (22,719,404) - 10,076 (22,709,328) ------------------- ---------------- ------------------- ------------------ Net interest margin 8,788,769 - 10,076 8,798,845 ------------------- ---------------- ------------------- ------------------ General and administrative expenses (2,766,584) - (15,835) (2,782,419) Deferred compensation expense (16,732) - - (16,732) Depreciation and amortization (312,388) - - (312,388) Impairment on CMBS (29,884,497) - - (29,884,497) Servicing revenue - 3,110,378 (134,007) 2,976,371 Servicing general and administrative expenses - (2,361,774) 139,766 (2,222,008) Servicing amortization, depreciation and impairment - (508,000) - (508,000) Servicing restructuring expenses - - - - Servicing gain on sale of servicing rights - 34,309 - 34,309 Income tax benefit (expense) 326,998 154,258 - 481,256 Equity in earnings from investments 98,005 - - 98,005 Other, net 401,201 - - 401,201 Recapitalization expenses (438,889) - - (438,889) ------------------- ---------------- ------------------- ------------------ (32,592,886) 429,171 (10,076) (32,173,791) ------------------- ---------------- ------------------- ------------------ Net income (loss) before changes in accounting principles $ (23,804,117) $ 429,171 $ - $ (23,374,946) =================== ================ =================== ================== Total assets $ 1,258,335,741 $ 27,333,329 $ (458,133) $ 1,285,210,937 =================== ================ =================== ==================
39
As of and for the nine months ended September 30, 2003 ------------------------------------------------------------------------------------ Elimination of Portfolio Mortgage Intercompany Investment Servicing Transactions Consolidated ------------------- ---------------- ------------------- ------------------ Interest income $ 78,720,379 $ - $ - $ 78,720,379 Interest expense (55,673,521) - 2,702 (55,670,819) ------------------- ---------------- ------------------- ------------------ Net interest margin 23,046,858 - 2,702 23,049,560 ------------------- ---------------- ------------------- ------------------ General and administrative expenses (8,003,063) - (812,830) (8,815,893) Deferred compensation expense (43,331) - - (43,331) Depreciation and amortization (450,296) - - (450,296) Impairment on CMBS (13,652,756) - - (13,652,756) Servicing revenue - 7,317,427 (2,702) 7,314,725 Servicing general and administrative expenses - (7,637,805) 812,830 (6,824,975) Servicing amortization, depreciation and impairment - (1,180,842) - (1,180,842) Servicing restructuring expenses - (150,672) - (150,672) Income tax benefit (expense) - 509,934 - 509,934 Equity in earnings from investments 212,341 - - 212,341 Other, net 465,403 - - 465,403 BREF maintenance fee (1,229,667) - - (1,229,667) Executive contract termination costs (2,028,343) (847,356) - (2,875,699) Recapitalization expenses (3,148,841) - - (3,148,841) Gain on extinguishment debt 7,337,424 - - 7,337,424 Hedging ineffectiveness (1,930,198) - - (1,930,198) ------------------- ---------------- ------------------- ------------------ (22,471,327) (1,989,314) (2,702) (24,463,343) ------------------- ---------------- ------------------- ------------------ Net income (loss) before changes in accounting principles $ 575,531 $ (1,989,314) $ - $ (1,413,783) =================== ================ =================== ================== Total assets $ 1,095,408,313 $ 11,850,556 $ - $ 1,107,258,869 =================== ================ =================== ================== As of and for the nine months ended September 30, 2002 ------------------------------------------------------------------------------------ Elimination of Portfolio Mortgage Intercompany Investment Servicing Transactions Consolidated ------------------- ---------------- ------------------- ------------------ Interest income $ 95,283,400 $ - $ - $ 95,283,400 Interest expense (69,607,308) - 10,076 (69,597,232) ------------------- ---------------- ------------------- ------------------ Net interest margin 25,676,092 - 10,076 25,686,168 ------------------- ---------------- ------------------- ------------------ General and administrative expenses (8,697,969) - 109,766 (8,588,203) Deferred compensation expense (93,422) - - (93,422) Depreciation and amortization (920,928) - - (920,928) Impairment on CMBS (35,035,588) - - (35,035,588) Servicing revenue - 8,692,686 (458,742) 8,233,944 Servicing general and administrative expenses - (7,186,892) 338,900 (6,847,992) Servicing amortization, depreciation and impairment - (1,418,810) - (1,418,810) Servicing restructuring expenses (141,240) (141,240) Servicing gain on sale of servicing rights 4,851,907 4,851,907 Income tax benefit (expense) 326,998 (754,518) - (427,520) Equity in earnings from investments 330,747 - - 330,747 Other, net 1,575,340 - - 1,575,340 Recapitalization expenses (683,333) - - (683,333) ------------------- ---------------- ------------------- ------------------ (43,198,155) 4,043,133 (10,076) (39,165,098) ------------------- ---------------- ------------------- ------------------ Net income (loss) before changes in accounting principles $ (17,522,063) $ 4,043,133 $ - $ (13,478,930) =================== ================ =================== ================== Total assets $ 1,258,335,741 $ 27,333,329 $ (458,133) $ 1,285,210,937 =================== ================ =================== ==================
40 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS. When used in this Quarterly Report on Form 10-Q, in future filings with the Securities and Exchange Commission (the SEC or the Commission), in our press releases or in our other public or shareholder communications, the words "believe," "anticipate," "expect," "contemplate," "may," "will" and similar expressions are intended to identify forward-looking statements. Statements looking forward in time are included in this Quarterly Report on Form 10-Q pursuant to the "safe harbor" provision of the Private Securities Litigation Reform Act of 1995. Such statements are subject to certain risks and uncertainties, which could cause actual results to differ materially, including, but not limited to, the risk factors contained or referenced herein and in our reports filed with the SEC pursuant to the Securities Exchange Act of 1934, as amended, including our Annual Report on Form 10-K for the year ended December 31, 2002. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. We undertake no obligation to publicly revise these forward-looking statements to reflect events or circumstances occurring after the date hereof or to reflect the occurrence of anticipated or unanticipated events. Business CRIIMI MAE Inc. (together with its consolidated subsidiaries, unless the context otherwise indicates, We or CRIIMI MAE) is a commercial mortgage company structured as a self-administered real estate investment trust (or REIT). We currently own, and manage, primarily through our servicing subsidiary, CRIIMI MAE Services Limited Partnership (CMSLP or CRIIMI MAE Services), a significant portfolio of commercial mortgage-related assets. We have focused primarily on non-investment grade (rated below BBB- or unrated) commercial mortgage-backed securities (subordinated CMBS). As the holder of the most subordinate tranches, we are exposed to a higher risk of losses. Our core holdings are subordinated CMBS ultimately backed by pools of commercial mortgage loans on retail, multifamily, hotel, and other commercial real estate. We also own directly and indirectly government-insured mortgage backed securities and a limited number of other assets. We also are a trader in CMBS, residential mortgage-backed securities, agency debt securities and other fixed income securities. January 2003 Recapitalization On January 23, 2003, we completed a recapitalization of the secured debt incurred upon our emergence from Chapter 11 in April 2001 (the Exit Debt). This recapitalization was funded with approximately $344 million in proceeds from debt and equity financings and a portion of our available cash and liquid assets. The recapitalization included: o BREF Equity and Secured Debt. - We issued approximately $14 million in common equity and $30 million in secured subordinated debt to Brascan Real Estate Finance Fund I L.P., a private asset management fund established by Brascan Corporation and a New York-based management team. We refer to the secured subordinated debt as the BREF Debt and Brascan Real Estate Finance Fund I L.P. as BREF Fund. o Bear Stearns Secured Financing. - We received $300 million in secured financing in the form of a repurchase transaction from a unit of Bear, Stearns & Co., Inc. We refer to the secured financing as the Bear Stearns Debt and the unit of Bear Stearns & Co., Inc. as Bear Stearns. o New Leadership. - Barry S. Blattman joined CRIIMI MAE as Chairman of the Board, Chief Executive Officer and President. Mr. Blattman has more than 15 years of experience in commercial real estate finance, which included overseeing the real estate debt group at Merrill Lynch from 1996 to 2001. Mr. Blattman is also the managing member of Brascan Real Estate Financial Partners LLC, which owns 100% of the general partner of BREF Fund. In addition on September 15, 2003, Mark R. Jarrell, a director, assumed the position of President and Chief Operating Officer. Upon appointment as President, Mr. Jarrell resigned as director. Mr. Blattman continues as our Chairman of the Board and Chief Executive Officer. 41 The recapitalization increases our financial flexibility primarily through the elimination of the requirement to use virtually all of our net cash flow to pay down principal on the Exit Debt. This, along with the elimination of REIT distribution requirements due to our net operating losses (NOLs), provides us with additional liquidity for mortgage-related investments and acquisitions and other corporate purposes. We presently intend to use substantially all of our net cash flow for acquisitions and investments, hedging activities and general working capital purposes. See "Financial Condition, Liquidity and Capital Resources" for a more complete description of the recapitalization. Risks Our business is subject to a number of risks and uncertainties including, but not limited to: (1) risks associated with substantial indebtedness or leverage; (2) borrowing and refinancing risks; (3) risks associated with potential margin or collateral calls under the Bear Stearns financings and interest rate swap documents; (4) the limited protection provided by hedging transactions; (5) inherent risks in owning subordinated CMBS; (6) the limited liquidity of the subordinated CMBS market; (7) continuing adverse effects of terrorist attacks, threats of further terrorist attacks, acts of war, economic slowdown and/or recession and other matters on defaults, servicer advances and losses and the related cash flow impact related to the mortgages underlying our CMBS portfolio; (8) risks associated with our ability to implement business strategies and achieve business goals; (9) failure to manage the mismatch between long-term assets and short-term funding; (10) risk of loss of REIT status and other tax matters; (11) the effect of interest rate compression on the market price of our stock; (12) the effect of the yield curve on borrowing costs; (13) results of operations adversely affected by factors beyond our control; (14) competition; (15) risk of becoming subject to the requirements of the Investment Company Act of 1940; (16) the effect of phantom (non-cash) income on total income; and (17) taxable mortgage pool risk. Business Segments Management assesses our performance and allocates resources principally on the basis of two lines of business: portfolio investment and mortgage servicing. 2003 compared to 2002 Results of Operations Financial statement net loss to common shareholders for the three months ended September 30, 2003 and 2002 was approximately $(7.4) million, $(0.49) per diluted share, and approximately $(25.1) million, or $(1.80) per diluted share, respectively. Results for the three months ended September 30, 2003, which are discussed in further detail below, includes approximately $4.7 million of impairment charges related to certain subordinated CMBS, approximately $2.9 million of executive contract termination expenses, approximately $1.9 million of hedging ineffectiveness expense and approximately $1.6 million of additional non-cash amortization expense on collateralized mortgage obligations. Results for the three months ended September 30, 2002, which are discussed in further detail below, include, approximately $29.9 million of impairment charges related to certain subordinated CMBS. Financial statement net loss to common shareholders for the nine months ended September 30, 2003 and 2002 was approximately $(6.7) million, or $(0.44) per diluted share, and approximately $(30.8) million, or $(2.26) per diluted share, respectively. Results for the nine months ended September 30, 2003, which are discussed in further detail below, include: o approximately $13.7 million of impairment charges related to certain subordinated CMBS; o approximately $7.3 million of gain on extinguishment of debt; o approximately $3.1 million of recapitalization expenses; o approximately $3.1 million of additional interest expense during the 45 day redemption notice period for the Series A and Series B Senior Secured Notes; o approximately $2.9 million in executive contract termination expenses; o approximately $2.6 million of additional non-cash amortization expense on collateralized mortgage obligations; and o approximately $1.9 million in hedging ineffectiveness expense. 42 Results for the nine months ended September 30, 2002, which are discussed in further detail below, include: o approximately $35.0 million of impairment charges related to certain subordinated CMBS; o an approximate $9.8 million charge to write-off goodwill upon the adoption of Statement of Financial Accounting Standards (or SFAS) No. 142; o approximately $4.9 million from the gain on the sale of master and direct servicing rights by CMSLP; and o approximately $2.2 million reflected as an additional dividend on preferred stock in connection with the redemption of the Series E Preferred Stock (representing the difference between the aggregate liquidation value, including the initial preferred stock issuance costs, and the redemption price). Interest Income - CMBS Interest income from CMBS decreased by approximately $3.6 million, or 14%, to $22.1 million during the three months ended September 30, 2003 as compared to $25.7 million during the three months ended September 30, 2002. Interest income from CMBS decreased by approximately $10.5 million, or 14%, to $66.3 million during the nine months ended September 30, 2003 as compared to $76.8 million during the nine months ended September 30, 2002. These decreases in interest income were primarily due to changes in our loss estimates related to CMBS during 2002 and 2003 and the resulting reduction in interest income on CMBS. Accounting principles generally accepted in the United States, or GAAP, require that interest income earned on CMBS be recorded based on the effective interest method using the anticipated yield over the expected life of the CMBS. Based upon assumptions as to the timing and amount of future credit losses and certain other items estimated by management, the weighted average anticipated unleveraged yield for our CMBS for financial statement purposes was approximately 12.4% as of January 1, 2002, approximately 12.5% as of July, 2002, approximately 11.6% as of January 1, 2003, approximately 11.7% as of July 1, 2003 and approximately 12.0% as of October 1, 2003. These yields were determined based on the anticipated yield over the expected life of our CMBS, which considers, among other things, anticipated losses and any other than temporary impairment. The effective interest method of recognizing interest income on CMBS results in income recognition that differs from cash received. During the nine months ended September 30, 2003, we recognized approximately $8.0 million of discount amortization, partially offset by approximately $4.3 million of cash received in excess of income recognized on subordinated CMBS due to the effective interest method. During the nine months ended September 30, 2002, we recognized approximately $8.8 million of discount amortization, partially offset by approximately $2.4 million of cash received in excess of income recognized on subordinated CMBS due to the effective interest method. Interest Income - Insured Mortgage Securities Interest income from insured mortgage securities decreased by approximately $2.3 million, or 40%, to $3.5 million for the three months ended September 30, 2003 from $5.8 million for the three months ended September 30, 2002. This decrease was due to the prepayment or sale of 28 mortgages underlying the insured mortgage securities, representing approximately 43% of the total insured mortgage portfolio, from September 30, 2002 through September 30, 2003. Interest income from insured mortgage securities decreased by approximately $6.1 million, or 33%, to $12.4 million for the nine months ended September 30, 2003 from $18.5 million for the nine months ended September 30, 2002. As discussed above, this decrease was primarily due to the prepayment of mortgages underlying the insured mortgage securities. During the nine months ended September 30, 2003, 21 mortgages prepaid resulting in net proceeds of $98.5 million. The prepayment activity corresponds with the relatively low mortgage interest rate environment during this period and the expiration of prepayment lock-out periods on many of the underlying mortgages. These prepayments result in corresponding reductions in the outstanding principal balances of the collateralized mortgage obligations-insured mortgage securities and the related interest expense. In addition, in January 2003 we sold an unencumbered GNMA security for approximately $5.7 million. 43 Interest Expense Interest expense of approximately $17.7 million for the three months ended September 30, 2003 was approximately $5.0 million lower than interest expense of approximately $22.7 million for the same period in 2002. The net decrease is primarily attributable to a lower average debt balance during the third quarter of 2003 ($805 million) compared to 2002 ($964 million) and a lower average effective interest rate on the total debt outstanding during the third quarter of 2003 (8.6%) compared to 2002 (9.3%). These decreases were partially offset by additional amortization on the collateralized mortgage obligations as discussed below. Interest expense of approximately $55.7 million for the nine months ended September 30, 2003 was approximately $13.9 million lower than interest expense of approximately $69.6 million for the same period in 2002. The net decrease is primarily attributable to a lower average debt balance during the nine months ended September 30, 2003 ($874 million) compared to 2002 ($987 million) and a lower average effective interest rate on the total debt outstanding during 2003 (8.4%), including approximately $3.1 million of additional interest as discussed below, compared to 2002 (9.3%). These decreases were partially offset by additional amortization on the collateralized mortgage obligations as discussed below. Interest expense on the collateralized mortgage obligations-insured mortgage securities decreased following significant prepayments of mortgages underlying the insured mortgage securities, as discussed previously. The decrease in interest expense on the collateralized mortgage obligations-insured mortgage securities was partially offset by approximately $1.6 million and $2.6 million of additional discount and deferred fees amortization expenses during the three and nine months ended September 30, 2003, respectively, which are reflected as interest expense, compared to approximately $205,000 and $964,000 of additional amortization expenses during the three and nine months ended September 30, 2002, respectively. The increase in amortization is the result of the mortgages prepaying faster than anticipated which, under the effective interest method of recognizing interest expense, required an adjustment to cumulative interest expense. In addition, we adjusted our assumed prepayment speed for the amortization of the discount and deferred financing fees during the three months ended September 30, 2003. The overall weighted average effective interest rate on the Bear Stearns and BREF Debt was 5.8% for the three and nine months ended September 30, 2003, and the weighted average coupon (pay) rate on the Bear Stearns and BREF Debt was 4.2% during the same periods. The difference in the weighted average effective interest rate and the weighted average coupon (pay) rate primarily relates to the deferral of two-thirds of the interest on the BREF Debt. The weighted average effective interest rate on the Exit Debt was 10.4% and 10.3% for the three and nine months ended September 30, 2002, respectively. The weighted average coupon (pay) rate on the Exit Debt was 8.1% and 8.0% during the same periods. On January 23, 2003, amounts were deposited with the indenture trustee to pay all principal and interest on our outstanding Series A and Series B Senior Secured Notes on the March 10, 2003 redemption date. This redemption required 45 days prior notice. These notes were not considered repaid for GAAP purposes until the March 10, 2003 redemption date. The 45 day notice period resulted in approximately $3.1 million of additional interest expense during the period January 23, 2003 through March 10, 2003 since the Bear Stearns Debt, BREF Debt, and the senior secured notes were outstanding at the same time. During the three months ended September 30, 2003 and 2002, we recognized hedging expense of approximately $274,000 and $353,000 on our interest rate caps, respectively. During the nine months ended September 30, 2003 and 2002, we recognized hedging expense of approximately $901,000 and $749,000 on our interest rate caps, respectively. Our interest rate cap which matured on November 3, 2003 (which we purchased in April 2002) set one-month LIBOR at a rate of 3.25%. The fair value of this interest rate cap was $0 as of September 30, 2003. On October 31, 2003, we purchased an interest rate cap for $45,000 with a notional amount of $50 million, an effective date of November 4, 2003, maturity on November 4, 2004, and capping one-month LIBOR at 2.25%. As of September 30, 2003, the one-month LIBOR rate was 1.12%. General and Administrative Expenses General and administrative expenses increased by approximately $245,000 to $3.0 million during the three months ended September 30, 2003 as compared to $2.8 million during the three months ended September 30, 2002 primarily due to an increase in legal fees incurred in connection with the interest rate swap and netting agreement. 44 General and administrative expenses increased by approximately $228,000 to $8.8 million during the nine months ended September 30, 2003 as compared to $8.6 million during the nine months ended September 30, 2002 primarily due to vacant office space during 2003. Depreciation and Amortization Depreciation and amortization was approximately $131,000 and $312,000 during the three months ended September 30, 2003 and 2002, respectively, and approximately $450,000 and $921,000 during the nine months ended September 30, 2003 and 2002, respectively. The decreases in depreciation and amortization are primarily attributable to a lower balance of depreciable assets in 2003 as compared to 2002. Mortgage Servicing The following is a summary of the consolidated results of operations of CMSLP (in thousands):
Three months ended September 30, Nine months ended September 30, Description 2003 2002 2003 2002 ----------- ---- ---- ---- ---- Servicing revenue $ 2,425 $ 2,976 $ 7,315 $ 8,234 Servicing general and administrative expenses (2,501) (2,222) (6,825) (6,848) Servicing amortization, depreciation and impairment (293) (508) (1,181) (1,419) Servicing restructuring expenses (6) -- (151) (141) Servicing gain on sale of servicing rights -- 34 -- 4,852 -------- -------- --------- -------- GAAP net (loss) income from CMSLP $ (375) $ 280 $ (842) $ 4,678 ======== ======== ========= ========
The net loss from CMSLP of approximately $(375,000) for the three months ended September 30, 2003 compares to net income of approximately $280,000 for the three months ended September 30, 2002. CMSLP's total revenue decreased by approximately $551,000 to approximately $2.4 million during the three months ended September 30, 2003 compared to $3.0 million during the three months ended September 30, 2002. This decrease is primarily the result of several large principal recovery fees that were collected in 2002. General and administrative expenses were $2.5 million during the three months ended September 30, 2003 compared to $2.2 million during the three months ended September 30, 2002 due to increased expenses related to additional resources dedicated to special servicing resolutions. During the three months ended September 30, 2003, amortization, depreciation and impairment expenses were approximately $293,000 as compared to $508,000 in 2002. This decrease was primarily the result of a lower balance of depreciable assets in 2003 as compared to 2002. The net loss from CMSLP of approximately $(842,000) for the nine months ended September 30, 2003 compares to net income of approximately $4.7 million for the nine months ended September 30, 2002. CMSLP's 2002 results include a $4.9 million gain from the sale of certain servicing rights. CMSLP's total revenue decreased by approximately $919,000 to approximately $7.3 million during the nine months ended September 30, 2003 compared to $8.2 million during the nine months ended September 30, 2002. This decrease is primarily the result of several large principal recovery fees that were collected in 2002 and CMSLP's sale of its master and direct servicing contracts in February 2002 which reduced mortgage servicing income and interest income earned on the escrow balances, partially offset by a recovery of $285,000 of legal fees during 2003 that were paid in a previous year. General and administrative expenses were $6.8 million during the nine months ended September 30, 2003 and 2002, respectively. During the nine months ended September 30, 2003, amortization, depreciation and impairment expenses aggregated approximately $1.2 million as compared to $1.4 million in 2002. This decrease was primarily the result of the sale of servicing rights in February 2002 and a lower balance of depreciable assets in 2003, partially offset by an impairment charge of approximately $198,000 during 2003 related to the subadvisory contracts with the AIM Limited Partnerships, as discussed below. During 2003, the AIM Limited Partnerships have experienced a significant amount of prepayments of their insured mortgages (which corresponded with the low interest rate environment). These prepayments reduced CMSLP's cash flow from its subadvisory contracts with the AIM Limited Partnerships. As a result, in accordance with SFAS No. 142, "Goodwill and Other Intangible Assets," and SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," we evaluated CMSLP's investment in the subadvisory contracts for impairment. Our estimated future undiscounted cash flows from this investment were projected to be less than the book value on the investment as of June 30, 2003. As a result, we believed that CMSLP's investment in the subadvisory contracts was impaired at June 30, 2003. We estimated the fair value of the investment using a discounted cash flow 45 methodology. We wrote down the value of CMSLP's investment in the subadvisory contracts with the AIM Limited Partnerships and recorded an impairment charge of approximately $198,000 as of June 30, 2003. In April 2003, CMSLP restructured its property servicing group. In connection with the restructuring, 15 employee positions were eliminated in the second and third quarters of 2003. The elimination of these positions resulted in the termination of 11 employees. We recognized approximately $151,000 of servicing restructuring expenses, representing employee severance and related benefits, during the nine months ended September 30, 2003. In conjunction with this restructuring, we have outsourced substantially all of our property servicing duties on a considerable portion of the properties underlying our mortgage assets to another servicer, effective October 2003. We expect to outsource the balance of our property servicing duties, excluding consents and assumptions, by the end of the fourth quarter of 2003. This outsourcing will not relieve us of any of our obligations or reduce any of our rights as property servicer since CMSLP remains the property servicer of record. Equity in Earnings from Investments Total equity in earnings from investments of approximately $91,000 and $98,000 for the three months ended September 30, 2003 and 2002, respectively, and approximately $212,000 and $331,000 for the nine months ended September 30, 2003 and 2002, respectively, includes our net equity from the AIM Limited Partnerships (which are four publicly traded limited partnerships that hold insured mortgages and whose general partner is one of our subsidiaries) and the net equity from our 20% limited partnership interest in the advisor to the AIM Limited Partnerships. The results for the nine months ended September 30, 2003 also include an impairment charge on our equity investment in the advisor to the AIM Limited Partnerships. During 2003, the AIM Limited Partnerships have experienced a significant amount of prepayments of their insured mortgages. These prepayments reduced cash flows on our 20% investment in the advisor to the AIM Limited Partnerships. As a result, in accordance with SFAS No. 142, "Goodwill and Other Intangible Assets," and SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," the advisor to the AIM Limited Partnerships evaluated its investment in the advisory contracts for impairment. The estimated future undiscounted cash flows from this investment were projected to be less than the book value of the investment as of June 30, 2003. As a result, the advisor believed that its investment in the advisory contracts was impaired at June 30, 2003. The advisor estimated the fair value of its investment using a discounted cash flow methodology. The advisor wrote down the value of its investment in the advisory contracts to the AIM Limited Partnerships and recorded an impairment charge. We recorded our portion of the impairment charge, totaling approximately $109,000, during the second quarter of 2003. This impairment charge is included in Equity in earnings from investments in our Consolidated Statement of Income. This investment is included in our Portfolio Investment segment. We did not recognize any impairment changes on our equity investments during the three months ended September 30, 2003 or during the three and nine months ended September 30, 2002. Income Tax Benefit (Expense) During the three and nine months ended September 30, 2003, we recorded an income tax benefit of approximately $324,000 and $510,000, respectively. During the three months ended September 30, 2002, we recorded income tax benefit of approximately $481,000. During the nine months ended September 30, 2002, we recorded income tax expense of approximately $428,000. The income tax benefit (expense) was recognized by our taxable REIT subsidiaries (TRSs) that own all of the partnership interests in CMSLP. These TRSs are separately taxable entities. The income tax benefit (expense) that was recognized by our TRSs was the result of CMSLP's financial results. The expense during the nine months ended September 30, 2002 was primarily the result of the gain on the sale of servcing rights by CMSLP. Other Income Other income decreased by approximately $419,000 to approximately $293,000 during the three months ended September 30, 2003 from approximately $712,000 during the three months ended September 30, 2002. Other income decreased by approximately $1.2 million to approximately $988,000 during the nine months ended September 30, 2003 from approximately $2.1 million during the nine months ended September 30, 2002. These decreases were primarily attributable to lower interest income earned on reduced cash balances during 2003 as compared to 2002, a decrease in income from trading activities and a decrease in net income (before interest expense and depreciation expense) from a shopping center that we account for as real estate owned, as discussed below. 46 We own a shopping center in Orlando, Florida, which we account for as real estate owned. The following is a summary of the financial results of the shopping center (in thousands):
Three months ended September 30, Nine months ended September 30, 2003 2002 2003 2002 ------------ --------------- -------------- ---------------- Interest expense $ (218) $ (215) $ (652) $ (642) Depreciation expense (41) (35) (116) (114) Other, net 25 93 79 247 ------------ --------------- -------------- ---------------- Net loss $ (234) $ (157) $ (689) $ (509) ============ =============== ============== ================
The other, net amount is included in other income. Interest expense and depreciation expense are included in their respective captions in our Consolidated Statements of Income. We hope to reposition and stabilize this asset to increase its value, although there can be no assurance. Impairment on CMBS The following table provides a summary of the changes in the overall expected loss estimates on subordinated CMBS from January 1, 2002 through September 30, 2003:
Overall Impairment Expected Recorded During ($ in millions) Loss Estimate Quarter Ended Impaired CMBS - --------------- ------------- ------------- ------------- June 30, 2002 $ 351 $5.2 Nomura and CBO-2 unrated/issuer's equity bonds September 30, 2002 448 29.9 All unrated/issuer's equity bonds, and the CCC bond and the B- bond in CBO-2 December 31, 2002 503 35.1 All unrated/issuer's equity bonds, and the CCC bond and the B- bond in CBO-2 June 30, 2003 559 8.9 Unrated/issuer's equity bonds, CCC bond and the B- bond in CBO-2 September 30, 2003 568 4.7 B- bond and CCC bond in CBO-2
The projected loss severities of the underlying mortgage loans have increased (including a change in the estimated resolution and disposition dates of certain specially serviced loans) which has resulted in an increase in our overall expected loss estimate related to our subordinated CMBS from $503 million as of December 31, 2002 to $559 million as of June 30, 2003 to $568 million as of September 30, 2003. These revisions to the overall expected loss estimate are primarily the result of increased projected losses due to lower internal estimates of values on properties underlying certain mortgage loans and real estate owned by underlying trusts, and changes in the timing of resolution and disposition of certain specially serviced assets, which when combined, has resulted in higher projected loss severities on loans and real estate owned by underlying trusts currently or anticipated to be in special servicing. The primary reasons for lower estimates of value include the poor performance of certain properties and related markets and changes to workout negotiations due, in large part, to the softness in the economy, the continued slowdown in travel and, in some cases, over-supply of hotel properties, and a shift in retail activity in some markets. There can be no assurance that our revised overall expected loss estimate of $568 million will not be exceeded as a result of additional or existing adverse events or circumstances. Such events or circumstances include, but are not limited to, the receipt of new or updated appraisals or internal values at lower than anticipated amounts, legal proceedings (including bankruptcy filings) involving borrowers, unforeseen reductions in cash received from our subordinated CMBS, a deterioration in the economy or recession generally or in certain industries or sectors specifically, continued hostilities in the Middle East or elsewhere, terrorism, unexpected delays in the disposition or other resolution of specially serviced mortgage loans, additional defaults, or an unforeseen reduction in expected recoveries, any of which could result in additional future credit losses, impact our cash received from subordinated CMBS and/or result in further impairment to our subordinated CMBS, the effect of which could be materially adverse to us. During 2002, we revised our overall expected loss estimate related to our subordinated CMBS portfolio as detailed in the table above. The revisions to the overall expected loss estimate during 2002 were primarily the result of the same factors as those listed in the paragraph above. As we determined that there had been an adverse change 47 in expected future cash flows, we believed some of our CMBS had been impaired under EITF 99-20 and SFAS No. 115 as of June 30, 2002 and September 30, 2002. As the fair value of the impaired subordinated CMBS was approximately $5.2 million and $29.9 million below the amortized cost as of June 30, 2002 and September 30, 2002, respectively, we recorded other than temporary impairment charge through the income statement of this same amount during the second and third quarters of 2002. Net Losses on Mortgage Security Dispositions The following is a summary of mortgage security dispositions:
Three months ended September 30, Nine months ended September 30, 2003 2002 2003 2002 ---------------- --------------- -------------- ---------------- Net loss recognized $ (749,305) $ (310,722) $ (522,805) $ (567,014) Number of dispositions 8 6 22 19 Percentage of amortized cost (1) 18.7% 4.1% 38.3% 14.7%
(1) Based on amortized cost as of December 31 of the previous year. The net losses were primarily due to the write-off of unamortized costs associated with the disposed mortgages at the disposition dates, partially offset by prepayment penalties, if applicable. For any period, gains or losses on mortgage dispositions are based on the number, carrying amounts and proceeds of mortgages disposed of during the period. BREF Maintenance Fee Pursuant to the Investment Agreement with BREF Investments, we are obligated to pay BREF Investments a quarterly maintenance fee of $434,000 through January 2006. The expense of approximately $434,000 and $1.2 million during the three and nine months ended September 30, 2003, respectively, represents the maintenance fee for the period January 14 through September 30, 2003. Executive Contracts In August 2003, the employment contracts for David Iannarone, Cynthia Azzara and Brian Hanson expired and were not renewed. These contracts were put into place in 2001 to ensure management continuity following our emergence from Chapter 11 proceedings and through our January 2003 recapitalization. In connection with the contract terminations, we recognized approximately $1.0 million of executive contract termination expenses for each of Mr. Iannarone and Ms. Azzara and approximately $847,000 of executive contract termination expense related to severance and related benefit payments for Mr. Hanson during the three months ended September 30, 2003. Mr. Iannarone and Ms. Azzara were each paid their contract termination payments during the three months ended September 30, 2003. Approximately $306,000 of Mr. Hanson's payments were made during the three months ended September 30, 2003. The remaining $542,000 related to Mr. Hanson will be paid over 17 months in accordance with the terms of his terminated employment agreement. Ms. Azzara has agreed to continue with us as an "at will" employee and has been promoted to Executive Vice President, Chief Financial Officer and Treasurer. Mr. Hanson is no longer employed by us, but has agreed to a short-term consulting arrangement. Mr. Iannarone subsequently resigned his position as Executive Vice President, Legal and Deal Management effective October 24, 2003. Ms. Azzara and Mr. Iannarone were each granted 13,055 shares of restricted common stock on October 3, 2003, valued at approximately $140,000 based on the closing price of our common stock on October 3, 2003, under our 2001 Stock Incentive Plan. Mr. Iannarone's restricted common stock was forfeited effective upon his resignation. Ms. Azzara's grant will vest 33% on each of December 31, 2004, 2005 and 2006. In conjunction with the hiring of Mark Jarrell on September 15, 2003 as our President and Chief Operating Officer, Mr. Jarrell was granted 58,021 shares of restricted common stock on September 15, 2003, valued at $666,667 based on the closing price of our common stock on August 12, 2003, under our 2001 Stock Incentive Plan. This initial grant will vest 25% on December 31, 2003 and 75% on December 31, 2004. In addition, Mr. Jarrell will be granted shares of common stock equivalent to $500,000 on each of December 31, 2005 and 2006, provided he is employed by us on those dates and subject to certain terms of his Employment Offer Letter Agreement dated August 11, 2003. We expect to recognize approximately $143,000 of deferred compensation 48 expense related to the restricted common stock award during the remainder of 2003 and approximately $500,000 of deferred compensation expense during 2004. On October 29, 2003, Stephen Abelman was hired as Executive Vice President of Asset Management. Mr. Abelman will be responsible for all asset management functions, including special servicing, surveillance and loan management. In connection with his employment, Mr. Abelman was granted 12,500 shares of restricted stock on 2003, valued at approximately $142,000 based on the closing price of our common stock on November 6, 2003, under our 2001 stock incentive plan. This grant will vest 33% on each of December 31, 2004, 2005 and 2006. Effective November 13, 2003, Craig Lieberman, our Senior Vice President - Strategic Asset Resolutions, was no longer employed by us. Hedging Ineffectiveness Expense In the second and third quarters of 2003, we entered into a total of three interest rate swaps to hedge the variability of the future interest payments on the anticipated CDO attributable to changes in interest rates. Our obligations to Bear Stearns under the interest rate swap documents are collateralized by certain assets as described in "Financial Condition, Liquidity and Capital Resources - Interest Rate Swap Agreement and Netting Agreement." These swaps are treated as cash flow hedges for GAAP. Under these swaps, we agreed to pay Bear Stearns a weighted average fixed interest rate of 4.15% per annum in exchange for floating rate payments based on one-month LIBOR on the total notional amount of $100 million. These swaps are effective on October 15, 2003, terminate on October 15, 2013 and provide for monthly interest payments commencing November 15, 2003. On November 15, 2003 we will begin making monthly payments to Bear Stearns equal to the difference between the weighted average swap rate of 4.15% per annum and the then current one-month LIBOR rate, which was 1.12% per annum on October 15, 2003, on the notional amount of $100 million. The interest rate swaps were designated to hedge future interest payments on the proposed CDO. As the expected date of the CDO has been changed, we recognized approximately $1.9 million of hedging ineffectiveness during the three months ended September 30, 2003, in accordance with SFAS No. 133. The $1.9 million expense represents the present value of the expected payments during the period of delay. If we had completed the CDO by the original anticipated date of October 15, 2003, we would have terminated the swap and recognized the $1.5 million fair value as of September 30, 2003 as a reduction to interest expense over the term of the CDO. We have an asset of approximately $1.5 million in Other Assets as of September 30, 2003, representing the aggregate fair value of the interest rate swaps. Recapitalization Expenses In connection with the January 2003 recapitalization, we amended the employment contracts of our former Chairman, William B. Dockser, and former President, H. William Willoughby, to provide for their termination on January 23, 2003. During the three months ended March 31, 2003, we recognized approximately $2.6 million of expenses related to severance and related benefit payments, and accelerated vesting of certain outstanding stock options held by Messrs. Dockser and Willoughby. We consolidated our office space in connection with our January 2003 recapitalization and, as a result, we recorded approximately $532,000 of expense for vacant office space during the three months ended June 30, 2003. We reduced our accrual by approximately $9,000 during the three months ended September 30, 2003, which represents the expense amortization for the period. The accrual for the vacant space represents the fair value of lease payments through 2007, a tenant improvement allowance and a broker commission, all net of estimated sublease revenue in accordance with SFAS No. 146. During the three and nine months ended September 30, 2002, we recognized approximately $439,000 and $683,000, respectively, of recapitalization expenses related to the services performed by our investment banking firm during the initial stages of our exploration of strategic alternatives. Gain on Extinguishment of Debt During the three months ended March 31, 2003, we reversed approximately $7.8 million of accrued extension fees related to the Exit Debt since the debt was repaid and the extension fees were no longer payable. This reversal is reflected as a gain on extinguishment of debt in our consolidated statement of income. This reversal was partially offset by approximately $403,000 of breakage fee paid to the lender of the Exit Variable-Rate Secured Borrowing and legal fees of approximately $47,000, resulting in a net gain on extinguishment of debt of $7.3 million. 49 Dividends Paid or Accrued on Preferred Shares At the July 31, 2003 Emerging Issues Task Force meeting, the SEC Observer clarified the application of Topic D-42 related to preferred stock issuance costs. According to the clarification, all preferred stock issuance costs, regardless of where in the stockholders' equity section the costs were initially recorded, should be charged to income available to common shareholders for the purpose of calculating earnings per share at the time the preferred stock is redeemed. The SEC Observer indicated that preferred stock issuance costs not previously charged to income available to common shareholders should be reflected retroactively in financial statements for reporting periods ending after September 15, 2003 by restating the financial statements of prior periods on an as filed basis. As the result of this guidance, we have charged to income available to common shareholders approximately $1.2 million in preferred stock offering costs related to our Series E preferred stock redeemed in March 2002. The following is a summary of the effect of this change in accounting principle on our Consolidated Statement of Income during the nine months ended September 30, 2002:
As reported Adjustment Adjusted ----------- ---------- -------- Dividends paid or accrued on preferred shares $ (6,388,310) $ (1,214,227) $ (7,602,537) Net loss to common shareholders (29,633,742) (1,214,227) (30,847,969) Earnings (loss) per common share: Basic and diluted - before cumulative effect of change in accounting principle (1.46) (0.09) (1.55) Basic and diluted - after cumulative effect of change in accounting principle (2.17) (0.09) (2.26)
All applicable 2002 disclosures have been adjusted to reflect this change in accounting principle. The effect on shareholders' equity is reflected on our Consolidated Statement of Changes is Stockholders' Equity. Cumulative effect of adoption of SFAS 142 In June of 2001, the Financial Accounting Standards Board issued SFAS No. 142, "Goodwill and Other Intangible Assets". SFAS No. 142, among other things, prohibits the amortization of existing goodwill and certain types of other intangible assets and establishes a new method of testing goodwill for impairment. Under SFAS No. 142, the method for testing goodwill for impairment occurs at the reporting unit level (as defined in SFAS No. 142) and is performed using a fair value based approach. SFAS No. 142 was effective for us on January 1, 2002. Effective upon adoption on January 1, 2002, we wrote off our goodwill and recorded a resulting impairment charge of approximately $9.8 million for this change in accounting principle. The goodwill relates to the Portfolio Investment reporting unit (as defined in Note 16 of the Notes to Consolidated Financial Statements). The fair value of the reporting unit was determined using a market capitalization approach, and the impairment was primarily a result of the significant decrease in the price of our common stock price since the Merger in 1995. This change in accounting principle reduced our annual amortization expense by approximately $2.8 million through June 2005. REIT Status and Other Tax Matters REIT Status. We have elected to qualify as a REIT for tax purposes under sections 856-860 of the Internal Revenue Code. We are required to meet income, asset, ownership and distribution tests to maintain our REIT status for federal and state tax purposes. We believe that we have satisfied the REIT requirements for all years through, and including 2002, although there can be no assurance. There can also be no assurance that we will maintain our REIT status for 2003 or subsequent years. If we fail to maintain our REIT status for any taxable year, we will be taxed as a regular domestic corporation subject to federal and state income tax in the year of disqualification and for at least the four subsequent years. Depending on the amount of any such federal and state income tax, we may have insufficient funds to pay any such tax and also may be unable to comply with some or all of our obligations, including the Bear Stearns and BREF Debt. Net Operating Loss for Tax Purposes/Trader Election. For tax purposes we have elected to be classified as a trader in securities. We trade in both short and longer duration fixed income securities, including CMBS, residential mortgage-backed securities and agency debt securities (such securities traded and all other 50 securities of the type described constituting the "Trading Assets" to the extent owned by us or any qualified REIT subsidiary, meaning generally any wholly owned subsidiary that is not a taxable REIT subsidiary). Such Trading Assets are classified as Other MBS on our balance sheet. As a result of our election in 2000 to be taxed as a trader, we recognized a mark-to-market tax loss on our Trading Assets on January 1, 2000 of approximately $478 million (the January 2000 Loss). Such loss is being recognized evenly for tax purposes over four years beginning with the year 2000 and ending in 2003. We expect such loss to be ordinary, which allows us to offset our ordinary income. We generated a net operating loss for tax purposes of approximately $83.6 million during the year ended December 31, 2002. As such, our taxable income was reduced to zero and, accordingly, our REIT distribution requirement was eliminated for 2002. As of December 31, 2002, our accumulated and unused net operating loss (or NOL) was $223.8 million. Any accumulated and unused net operating losses, subject to certain limitations, generally may be carried forward for up to 20 years to offset taxable income until fully utilized. Accumulated and unused net operating losses cannot be carried back because we are a REIT. There can be no assurance that our position with respect to our election as a trader in securities will not be challenged by the Internal Revenue Service (or IRS) and, if challenged, will be defended successfully by us. As such, there is a risk that the January 2000 Loss will be limited or disallowed, resulting in higher tax basis income and a corresponding increase in REIT distribution requirements. It is possible that the amount of any under-distribution for a taxable year could be corrected with a "deficiency dividend" as defined in Section 860 of the Internal Revenue Code, however, interest may also be due to the IRS on the amount of this under-distribution. If we are required to make taxable income distributions to our shareholders to satisfy required REIT distributions, all or a substantial portion of these distributions, if any, may be in the form of non-cash dividends. There can be no assurance that such non-cash dividends would satisfy the REIT distribution requirements and, as such, we could lose our REIT status or may not be able to satisfy some or all of our obligations, including the Bear Stearns and BREF Debt. Our future use of NOLs for tax purposes could be substantially limited in the event of an "ownership change" as defined under Section 382 of the Internal Revenue Code. As a result of these limitations imposed by Section 382 of the Internal Revenue Code, in the event of an ownership change, our ability to use our NOL carryforwards in future years may be limited and, to the extent the NOL carryforwards cannot be fully utilized under these limitations within the carryforward periods, the NOL carryforwards would expire unutilized. Accordingly, after any ownership change, our ability to use our NOLs to reduce or offset taxable income would be substantially limited or not available under Section 382. In general, a company reaches the "ownership change" threshold if the "5% shareholders" increase their aggregate ownership interest in the company over a three-year testing period by more than 50 percentage points. The ownership interest is measured in terms of total market value of the company's capital stock. If an "ownership change" occurs under Section 382 of the Internal Revenue Code, our prospective use of our accumulated and unused NOL and the remaining January 2000 Loss of a combined total amount of approximately $317.0 million as of September 30, 2003 will be limited. We do not believe BREF Fund's investment in our common stock and warrant to purchase common stock has created an "ownership change" under Section 382. In addition, we are not aware of any other acquisition of shares of our capital stock that has created an "ownership change" under Section 382. We have adopted a shareholder rights plan and amended our charter to minimize the chance of an ownership change within the meaning of Section 382 of the Internal Revenue Code; however there can be no assurance that an ownership change will not occur. 51 Net Operating Loss for Tax Purposes-Nine months ended September 30, 2003. We generated a net operating loss for tax purposes of approximately $63.3 million during the nine months ended September 30, 2003. A summary of our year-to-date net operating loss as of September 30, 2003 is as follows (in millions):
January 2000 Loss $ (478.2) LESS: Amounts recognized in 2002, 2001 and 2000 358.6 LESS: Amounts recognized during the nine months ended September 30, 2003 89.7 --------- Balance remaining of January 2000 Loss to be recognized during the remainder of 2003 $ (29.9) ========= Taxable income for the nine months ended September 30, 2003 before recognition $ 26.4 of January 2000 Loss LESS: January 2000 Loss recognized during the nine months ended September 30, 2003 (89.7) --------- Net Operating Loss for the nine months ended September 30, 2003 $ (63.3) ========= Accumulated Net Operating Loss through December 31, 2002 $ (223.8) Net Operating Loss for the nine months ended September 30, 2003 (63.3) Net Operating Loss utilization - --------- Net Operating Loss carried forward for use in future periods $ (287.1) ========= Accumulated and unused net operating loss and remaining January 2000 Loss $ (317.0) =========
Cash Flow 2003 compared to 2002 Net cash provided by operating activities decreased by approximately $26.5 million to $19.6 million during the nine months ended September 30, 2003 from $46.2 million during the nine months ended September 30, 2002. The decrease was primarily attributable to a decrease in cash received from our subordinated CMBS, a decrease in interest income from insured mortgages, $2.3 million paid to certain executives for contract terminations, and $2.1 million of severance paid to our former Chairman and former President. Net cash provided by investing activities increased by approximately $61.2 million to $118.4 million during the nine months ended September 30, 2003 from $57.2 million during the nine months ended September 30, 2002. The increase was primarily attributable to: o a $53.3 million increase in proceeds from mortgage security prepayments and a sale of a GNMA security; o $3.3 million of proceeds from the sale of investment-grade CMBS by CMSLP during 2003; o a $1.8 million increase in cash received in excess of income recognized on subordinated CMBS; o $1.7 million of proceeds from the prepayment of a mezzanine loan; and o $9.9 million of purchases of investment-grade CMBS by CMSLP during 2002; partially offset by o $8.2 million of proceeds from the sale of servicing rights during 2002. Net cash used in financing activities increased by approximately $52.1 million to $150.3 million during the nine months ended September 30, 2003 from $98.2 million during the nine months ended September 30, 2002. The increase is primarily attributable to the January 2003 recapitalization. We repaid approximately $373.6 million of Exit Debt through the incurrence of an aggregate $330.0 million of Bear Stearns and BREF Debt, the net proceeds of $13.5 million from the issuance of common stock to BREF Fund, and used $30.1 million of our available cash and liquid assets. The total transaction costs of approximately $10.1 million includes $5.9 million of debt issuance costs, $478,000 of equity issuance costs, $2.6 million of executive severance costs and $1.0 million of costs expensed during the year ended December 31, 2002. The increase in cash used in financing activities was also affected by the payment of approximately $10.5 million in preferred stock dividends during the nine months ended September 30, 2003 and a $46.8 million increase in principal payments on the securitized mortgage debt obligations (due to higher insured mortgage security prepayments as discussed previously). During 2002, we paid $18.7 million (approximately $396,000 of which represented accrued and unpaid dividends) to redeem the Series E Preferred Stock. We redeemed all 173,000 outstanding shares of the Series E Preferred Stock at the stated redemption price of $106 per share plus accrued and unpaid dividends through and including the date of redemption. The approximate $2.2 million difference between the aggregate liquidation value, including preferred stock issuance costs, and the redemption price is reflected as a dividend on preferred stock in 2002. 52 The cash flows described above include the following cash generated by our assets: o Approximately $14.6 million and $17.5 million of cash that we received from our CMBS rated BB+ through unrated during the three months ended September 30, 2003 and 2002, respectively, and approximately $45.7 million and $53.6 million during the nine months ended September 30, 2003 and 2002, respectively; o Cash distributions (which are primarily a return of investment) from the AIM Limited Partnerships of approximately $872,000 and $351,000 during the three months ended September 30, 2003 and 2002, respectively, and approximately $2.1 million and $1.9 million during the nine months ended September 30, 2003 and 2002, respectively; o Cash received from the insured mortgage securities after the related debt was serviced of approximately $576,000 and $842,000 during the three months ended September 30, 2003 and 2002, respectively, and approximately $1.7 million and $2.6 million during the nine months ended September 30, 2003 and 2002, respectively; and o Approximately $1.9 million and $261,000 of cash received from our investment in mezzanine loans during the three months ended September 30, 2003 and 2002, respectively, and approximately $2.5 million and $780,000 during the nine months ended September 30, 2003 and 2002, respectively. The 2003 amounts include approximately $1.7 million from the payoff of one of the mezzanine loans in August 2003. Our cash flows described above also reflect the following cash used to service our recourse debt: o Principal payments (excluding the retirement of recourse debt) on our recourse debt of approximately $1.3 million and $8.8 million during the three months ended September 30, 2003 and 2002, respectively, and approximately $4.9 and $27.7 million during the nine months ended September 30, 2003 and 2002, respectively; and o Interest payments on our recourse debt of approximately $3.2 million and $7.9 million during the three months ended September 30, 2003 and 2002, respectively, and approximately $16.7 million and $24.0 million during the nine months ended September 30, 2003 and 2002, respectively. We also made preferred dividend payments of approximately $1.7 million and $0 during the three months ended September 30, 2003 and 2002, respectively, and approximately $10.5 million and $396,000 during the nine months ended September 30, 2003 and 2002, respectively, which are included in our Consolidated Statement of Cash Flows. Our Consolidated Statement of Income includes approximately $3.0 million and $2.8 million of corporate general and administrative expenses during the three months ended September 30, 2003 and 2002, respectively, and approximately $8.8 and $8.6 million during the nine months ended September 30, 2003 and 2002, respectively. In addition, our Consolidated Statement of Income includes approximately $434,000 and $1.2 million of expense related to the BREF maintenance fee during the three and nine months ended September 30, 2003, respectively. Financial Condition, Liquidity and Capital Resources Limited Summary of January 2003 Recapitalization On January 23, 2003, we completed a recapitalization of all of the Exit Debt, which was funded with approximately $44 million from common equity and secured subordinated debt issuances to BREF Fund, $300 million in secured financing in the form of a repurchase transaction from Bear Stearns and a portion of our available cash and liquid assets. BREF Fund acquired 1,212,617 shares of our newly issued common stock, or approximately 8% of our outstanding common stock after giving effect to the share acquisition, at $11.50 per share, or approximately $13.9 million. BREF Fund received seven year warrants to purchase up to 336,835 additional shares of common stock at $11.50 per share. BREF Fund also purchased $30 million of the BREF Debt and, at our option, BREF Fund will purchase up to an additional $10 million of subordinated debt prior to January 23, 2004. The BREF Debt matures on January 23, 2006 and bears interest at an annual rate of 15%. The interest on the BREF Debt is payable semi-annually and there are no principal payments until maturity. If we decide to sell the additional $10 million of subordinated debt to BREF Fund, it will bear interest at an annual rate of 20% and mature on January 23, 2006. We have a right to defer two-thirds of the interest on the BREF Debt, which we are currently deferring, (and half on the 53 additional $10 million if sold to BREF Fund) during its term. The operative documents evidencing the BREF Debt restrict our ability to take certain actions such as prepay the BREF Debt, prepay any indebtedness that is expressly subordinated to the BREF Debt, incur indebtedness, sell assets and engage in business other than that expressly permitted. We are required to make an offer to repurchase all of the BREF Debt in the event of a change of control. The BREF Debt is secured by first liens on the equity interests of two of our subsidiaries. Although these liens effectively provide BREF Fund with an indirect lien on all of our subordinated CMBS that are held by three of our other lower tier subsidiaries, Bear Stearns has first direct liens on the equity interests of these three lower tier subsidiaries and on certain of the subordinated CMBS held by one of these lower tier subsidiaries. Pursuant to an intercreditor agreement between BREF Investments and Bear Stearns, BREF Investments has agreed generally that the BREF Debt is subordinate and junior to the prior payment of the Bear Stearns Debt and has further agreed to contractual restrictions on its ability to realize upon its liens. We paid BREF Investments an origination fee of $200,000, equal to 0.5% of the $30 million in subordinated debt it had acquired plus the additional $10 million in subordinated debt that, at our option, it may acquire. We also paid BREF Investments an aggregate of $1 million for expenses in connection with the transactions. Pursuant to the Investment Agreement with BREF Investments, we are also obligated to pay BREF Investments a quarterly maintenance fee of $434,000 through January 2006. Please refer to our definitive proxy statement relating to our 2003 annual shareholders meeting for a discussion of existing and potential relationships, transactions and agreements (including a non-competition agreement) with BREF Fund and/or certain of its affiliates (including BREF Investments). As previously stated, BREF Fund is a principal stockholder and a creditor of ours, and Barry Blattman, our Chairman and CEO, is an affiliate of BREF Fund and BREF Investments. All transactions between us and BREF Fund and BREF Investments or any of its affiliates will be approved by disinterested directors and will be on terms no less favorable than those which could have been obtained from unrelated third parties. Bear Stearns provided $300 million in secured financing to two of our subsidiaries, in the form of a repurchase transaction under the January 2003 recapitalization. The Bear Stearns Debt matures in 2006, bears interest at a per annum rate equal to one-month LIBOR plus 3%, payable monthly, and currently requires quarterly principal payments of $1.25 million. The principal payments will increase to $1.875 million per quarter if a collateralized debt obligation transaction (or CDO) is not completed by January 23, 2004. The interest rate will increase by 1%, to one-month LIBOR plus 4% and we will have to pay Bear Stearns an additional $2 million in cash, if Bear Stearns structures a CDO that meets certain rating requirements and we decline to enter into such transaction. Although CRIIMI MAE Inc. (unconsolidated) is not a primary obligor of the Bear Stearns Debt, it has guaranteed all obligations under the debt. We paid a commitment fee of 0.5% of the Bear Stearns Debt to Bear Stearns. We also paid $250,000 of Bear Stearns' legal expenses. The Bear Stearns Debt is collateralized by first direct and/or indirect liens on all of our subordinated CMBS, and is subject to a number of terms, conditions and restrictions including, without limitation, scheduled principal and interest payments, and restrictions and requirements with respect to the collection and application of funds. The indirect first liens are first liens on the equity interests of three of our subsidiaries that hold certain subordinated CMBS. If the outstanding loan amount under the Bear Stearns Debt exceeds 85% of the aggregate market value of the collateral securing the Bear Stearns Debt, as determined by Bear Stearns in its sole good faith discretion, then Bear Stearns, if, and as permitted after the application of the terms of a netting agreement entered into in connection with an interest rate swap (as described below), can require us to transfer cash, cash equivalents or securities so that the outstanding loan amount will be less than or equal to 80% of the aggregate market value of the collateral (including any additional collateral provided). Failure to meet any margin call could result in an event of default which would enable Bear Stearns to exercise various rights and remedies including acceleration of the maturity date of the Bear Stearns Debt and the sale of the collateral. In order to meet a margin call, we may be required to sell assets at prices lower than their carrying value which could result in losses. Under the Bear Stearns Debt, we are required to obtain interest rate protection in the form of a cap, swap or other derivative. Interest Rate Swap Agreement and Netting Agreement In the second and third quarters of 2003, we entered into a total of three interest rate swaps to hedge the variability of the future interest payments on the anticipated CDO attributable to changes in interest rates as discussed in "Hedging Ineffectiveness Expense." Under the interest rate swap documents, our two subsidiaries have granted to Bear Stearns a security interest in all of their rights, title and interest in certain assets, including property now or hereafter held by Bear Stearns in connection with the Bear Stearns Debt or the interest rate swap documents and certain contract rights under the Bear Stearns Debt and interest rate swap documents (including the subsidiaries' rights to any "margin 54 excess" related to the collateral securing the Bear Stearns Debt, with margin excess as defined in the Bear Stearns Debt documents), to secure their obligations under the interest rate swap documents and the Bear Stearns Debt. This security interest constitutes additional collateral for the Bear Stearns Debt. Also under the interest rate swap documents, on any day on which there exists any obligation for us to deliver cash or additional eligible collateral under either the interest rate swap or the Bear Stearns Debt, such obligation will be deemed satisfied to the extent there exists a margin excess under the Bear Stearns Debt or an obligation for Bear Stearns to deliver cash or eligible collateral under the interest rate swap. CRIIMI MAE Inc. has guaranteed all of its subsidiaries' obligations under the interest rate swap documents, as well as the Bear Stearns Debt. Bear Stearns $200 Million Secured Borrowing Facility On August 28, 2003, one of our subsidiaries finalized and executed (effective as of June 26, 2003) a $200 million secured borrowing facility, in the form of a repurchase transaction, with Bear Stearns. This facility may be used for the acquisition of subordinated CMBS and for financing certain other transactions involving securities. The securities to be transferred to Bear Stearns in each transaction under this facility will be subject to the approval of Bear Stearns in its sole discretion. The debt will be secured by the securities transferred to Bear Stearns, and if the market value of the collateral declines we may be required to pay down the debt or post additional collateral. This facility may be used for one or more transactions. The financing available for a subordinated CMBS purchased under this facility ranges from 80% to 15% of the market value of the CMBS. The applicable percentage depends primarily upon the ratings category of the CMBS and, to a lesser extent, upon the number of issuer trusts from which we have purchased CMBS. The maturity date of each transaction will be determined at the time the transaction is closed and, in each case, will be on or before August 14, 2005. As to each transaction, accrued and unpaid interest will be payable monthly at an annual rate ranging from one-month LIBOR plus 0.8% to one-month LIBOR plus 2% and all unpaid principal and accrued and unpaid interest will be payable at maturity. Commencing on the date of the closing of the first transaction under this facility, we will be required to maintain liquidity of least $10 million in cash and investment grade securities. Since the CDO was not closed by October 14, 2003, this liquidity requirement will increase by $2.5 million per calendar quarter subsequent to October 14, 2003. The liquidity requirement will terminate upon the closing of the CDO or repayment in full of the Bear Stearns Debt. CRIIMI MAE Inc. has guaranteed the obligations of its subsidiary under this facility. If we do a CDO transaction with securities purchased under the Bear Stearns secured borrowing facility and Bear Stearns is not a lead manager, then we may be required to pay Bear Stearns an exit and/or disappointment fee. There were no borrowings outstanding under this facility at September 30, 2003. Other Our ability to meet our debt service obligations will depend on a number of factors, including management's ability to maintain cash flow (which is impacted by, among other things, the credit performance of the mortgage loans underlying our subordinated CMBS and changes in interest rates and spreads) and to generate capital internally from operating and investing activities and expected reductions in REIT distribution requirements to shareholders due to net operating losses for tax purposes, in each case consistent with the terms and conditions of the operative documents evidencing our obligations. There can be no assurance that targeted levels of cash flow will actually be achieved, that reductions in REIT distribution requirements will be realized, or that, if required, new capital will be available to us. Our ability to maintain or increase cash flow and access new capital will depend upon, among other things, interest rates (including hedging costs and margin calls), prevailing economic conditions, the credit performance of the mortgage loans underlying our subordinated CMBS, restrictions under the operative documents evidencing our obligations, and other factors, many of which are beyond our control. Our cash flow will also be negatively affected by realized losses, interest payment shortfalls, master servicer advances and appraisal reduction amounts on properties securing the mortgage loans underlying our subordinated CMBS. We expect realized losses on our CMBS to continue to increase in 2003, resulting, generally, in decreased CMBS cash flows as compared to 2002. In addition, if we are not successful in resolving one of the significant hotel loans in special servicing (see "Summary of CMBS"), our annual cash flow could be significantly reduced. Our cash flows are also likely to decrease as a result of any prepayments of mortgage loans underlying our insured mortgage securities and any prepayments of mortgage loans held by the AIM Limited Partnerships. Prepayments of these mortgage loans will result in reductions in the respective mortgage bases and corresponding reductions in amounts paid to us from our interests in the advisor and subadvisor to the AIM Limited Partnerships. As a result, the net cash flows to us are likely to decrease over time. Our net cash flows will also decrease due to the failure to close the anticipated CDO transaction prior to January 23, 2004, or if we refinance the Bear Stearns Debt with debt which has a higher interest rate and/or greater amortization requirements. In addition, our net cash flows may be adversely affected by the anticipated CDO transaction, if and when closed and depending on the terms of such transaction, and our swap transactions including required payments under such transactions. Cash flows are also likely to be affected if we 55 incur further debt, under our new secured borrowing facility or otherwise, to acquire additional CMBS or for other corporate purposes. See "QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK." Our high level of debt limits our ability to obtain additional capital, significantly reduces income available for other activities, restricts our ability to react quickly to changes in our business, limits our ability to hedge our assets and liabilities, and makes us more vulnerable to general adverse economic and industry conditions. Our ability to make mortgage related investments and acquisitions depends on, among other things, our ability to engage in such activities under the terms and conditions of the operative documents evidencing our obligations, our internally generated cash flows, available liquidity, and our ability to access additional capital. Factors which could affect our ability to access additional capital include, among other things, the cost and availability of such capital, the availability of investment product at attractive rates of return, changes in interest rates and interest rate spreads, changes in the commercial mortgage industry and the commercial real estate market, the effects of terrorism, general economic conditions, perceptions in the capital markets of our business, restrictions under the operative documents evidencing our obligations, results of our operations, and our financial leverage, financial condition, and business prospects. There can be no assurance that we will be able to resume mortgage related investments and acquisitions or obtain additional capital, or that the terms of any such capital will be favorable to us. Summary of Cash Position and Shareholders' Equity As of September 30, 2003, our cash and cash equivalents aggregated approximately $17.0 million, including cash and cash equivalents of approximately $2.5 million held by CMSLP. In addition to our cash, we had additional liquidity at September 30, 2003 comprised of $3.9 million in Other MBS, which is included elsewhere in our balance sheet. As of November 7, 2003, our liquidity included approximately $25.0 million of cash and cash equivalents and approximately $4.3 million of Other MBS. As of September 30, 2003 and December 31, 2002, shareholders' equity was approximately $311.9 million or $16.26 per diluted share and approximately $291.7 million or $16.32 per diluted share, respectively. These diluted book value per share amounts are based on shareholders' equity presented in accordance with GAAP. These amounts include, among other things, approximately $43.7 million of net assets related to our CMBS rated A+ through BBB, which we do not actually own, but they are required by GAAP to be included on our balance sheet (see "Summary of CMBS" below for a further discussion). These investment grade CMBS, which aggregate approximately $332.1 million at September 30, 2003, are reflected at fair value and the related match-funded debt, which aggregates approximately $288.4 million at September 30, 2003, is reflected at amortized cost, in each case in accordance with GAAP. The increase in total shareholders' equity is primarily the result of the issuance of common stock to BREF Fund as previously discussed. Although total shareholder's equity increased, book value per share decreased due to an increase in the number of shares outstanding as a result of the January 2003 recapitalization. Summary of CMBS As of September 30, 2003, our assets, in accordance with GAAP, include CMBS with an aggregate face amount of approximately $1.5 billion rated from A+ to CCC and unrated. Such CMBS had an aggregate fair value of approximately $860 million (representing approximately 78% of our total consolidated assets) and an aggregate amortized cost of approximately $751 million. Such CMBS represent investments in securities issued in connection with CBO-1, CBO-2 and Nomura Asset Securities Corporation Series 1998-D6 (or Nomura). The following is a summary of the ratings of our CMBS as of September 30, 2003 (in millions): Rating (1) Fair Value % of CMBS ---------- ---------- --------- A+, BBB+ or BBB (2) $332.1 39% BB+, BB or BB- $337.2 39% B+, B, B- or CCC $166.1 19% Unrated/Issuer's Equity $ 24.9 3% (1) Ratings are provided by Standard & Poor's. (2) Represents investment grade securities that we reflect as assets on our balance sheet as a result of CBO-2. As indicated in footnote 4 to the table below, GAAP requires both these assets (reflected as "CMBS pledged to Secure Securitized Mortgage Obligations-CMBS") and their related liabilities (reflected as "Collateralized bond obligations - CMBS") to be reflected on our balance sheet. As of September 30, 2003, the fair value of these assets as reflected in our balance sheet was approximately $332.1 million and the amortized cost of the debt as reflected in our balance sheet was approximately $288.4 million. All cash 56 flows related to the investment grade CMBS are used to service the corresponding securitized mortgage obligations. As a result, we currently receive no cash flows from the investment grade CMBS. As of September 30, 2003, the weighted average pay rate and the loss adjusted weighted average life (based on face amount) of the investment grade securities was 7.0% and 8.0 years, respectively. The weighted average interest rate and the loss adjusted weighted average life (based on face amount) of the BB+ through unrated CMBS securities, sometimes referred to as the retained portfolio, were 5.4% and 11.5 years, respectively. The aggregate investment by the rating of the CMBS is as follows:
Discount Rate or Range of Weighted Loss Discount Rates Face Amount Average Adjusted Fair Value Used to Amortized Cost Amortized Cost as of Pay Weighted as of Calculate Fair as of 09/30/03 as of 12/31/02 Security Rating 09/30/03 (in Rate as of Average 09/30/03 (in Value as of (in millions) (in millions) millions) 9/30/03 Life (1) millions) 09/30/03 (5) (6) - ------------------------------------------------------------------------------------------------------------------------------ Investment Grade Portfolio - -------------------------- A+ (4) $ 62.6 7.0% 3 years $ 66.0 4.3% $ 60.0 $ 59.4 BBB+ (4) 150.6 7.0% 9 years 154.0 6.6% 133.3 132.3 BBB (4) 115.2 7.0% 10 years 112.1 7.4% 96.2 95.3 Retained Portfolio - ------------------ BB+ 319.0 7.0% 11 years 259.8 9.9%-10.3% 226.1 223.0 BB 70.9 7.0% 13 years 53.8 11.0% 47.3 46.8 BB- 35.5 7.0% 14 years 23.6 12.8% 21.1 20.8 B+ 88.6 7.0% 14 years 50.1 15.1% 46.7 46.0 B 177.2 7.0% 20 years 98.0 12.7%(9) 85.9 85.1 B- (2)(10)(11) 118.3 7.9% 24 years 18.0 15.0%(9) 16.8 28.1 CCC (2) 70.9 0.0% 1 year - 15.0%(9) - 3.8 Unrated/Issuer's Equity (2)(3) 270.9 1.5% 1 year 24.9 15.0%(9) 17.2 20.0 --------- -------- --------- --------- Total $ 1,479.7 5.7% 11 years $ 860.3(8) $ 750.6(7) $ 760.6 ========= ======== ========= =========
(1) The loss adjusted weighted average life represents the weighted average expected life of the CMBS based on our current estimate of future losses. As of September 30, 2003, the fair values of the B, B-, CCC and the unrated/issuer's equity in Nomura, CBO-1, and CBO-2 were derived primarily from interest cash flow anticipated to be received since our current loss expectation assumes that the full principal amount of these securities will not be recovered. See also "Advance Limitations, Appraisal Reductions and Losses on CMBS" below. (2) The CBO-1, CBO-2 and Nomura CMBS experience interest shortfalls when the weighted average net coupon rate on the underlying CMBS is less than the weighted average stated coupon payments on our subordinated CMBS. Such interest shortfalls will continue to accumulate until they are repaid through either excess interest and/or recoveries on the underlying CMBS or a recharacterization of principal cash flows, in which case they may be realized as a loss of principal on the subordinated CMBS. Such anticipated losses, including shortfalls, have been taken into consideration in the calculations of fair market values and yields to maturity used to recognize interest income as of September 30, 2003. (3) The unrated/issuer's equity subordinated CMBS from CBO-1 and CBO-2 currently do not have a stated coupon rate since these securities are only entitled to the residual cash flow payments, if any, remaining after paying the securities with a higher payment priority. As a result, effective coupon rates on these securities are highly sensitive to the effective coupon rates and monthly cash flow payments received from the underlying CMBS that represent the collateral for CBO-1 and CBO-2. (4) In connection with CBO-2, $62.6 million (originally A rated, currently A+ rated) and $60.0 million (originally BBB rated, currently BBB+ rated) face amount of investment grade CMBS were sold with call options and $345 million (originally A rated, currently A+ rated) face amount were sold without call options. Also in connection with CBO-2, in May 1998, we initially retained $90.6 million (originally BBB rated, currently BBB+ rated) and $115.2 million (originally BBB- rated, currently BBB rated) face amount of CMBS, both with call options, with the intention to sell these CMBS at a later date. Such sale occurred March 5, 1999. Since we retained call options on certain sold CMBS (currently rated A+, BBB+ and BBB bonds), we did not surrender control of these CMBS pursuant to the requirements of SFAS No. 125, and thus these CMBS are accounted for as a financing and not a sale. Since the CBO-2 transaction is recorded as a partial financing and a partial sale, we are deemed to have retained these CMBS with call options issued in connection with CBO-2, from which we currently receive no cash flows, and are required to reflect them in our CMBS on the balance sheet. 57 (5) Amortized cost reflects approximately $13.7 million of impairment charges related to the unrated/issuer's equity bonds, the CCC bond and the B- bond in CBO-2, which were recognized during the nine months ended September 30, 2003. These impairment charges are in addition to the cumulative impairment charges of approximately $248.4 million that were recognized through December 31, 2002. See discussion of the impairment charges in "Impairment on CMBS". (6) Amortized cost reflects approximately $248.4 million of cumulative impairment charges related to certain CMBS (all bonds except those rated A+ and BBB+), which were recognized through December 31, 2002. (7) See Notes 1 and 8 to Notes to Consolidated Financial Statements for information regarding the subordinated CMBS for tax purposes. (8) As of September 30, 2003, the aggregate fair values of the CBO-1, CBO-2 and Nomura bonds were approximately $24.1 million, $828.7 million and $7.5 million, respectively. (9) As a result of the estimated loss of principal on these CMBS, the fair values and discount rates of these CMBS are based on a loss adjusted yield to maturity. (10) Although the principal balance of the B- bond in CBO-2 is expected to be outstanding for approximately 25 years, the bond is not expected to receive any cash flows beyond the next 18 months. (11) In November 2003, the B- bond in CBO-2, with fair value of approximately $11.4 million, was downgraded to D by Standard & Poor's. Determination of Fair Value of CMBS Our determination of fair values for our CMBS portfolio is a subjective process. The process begins with the compilation and evaluation of pricing information (such as nominal spreads to U.S. Treasury securities or nominal yields) that, in our view, is commensurate with the market's perception of value and risk of comparable assets. We use a variety of sources to compile such pricing information including: (i) recent offerings and/or secondary trades of comparable CMBS (i.e., securities comparable to our CMBS or to the CMBS (or collateral) underlying our CMBS issued in connection with CBO-1 and CBO-2), (ii) communications with dealers and active CMBS investors regarding the pricing and valuation of comparable securities, (iii) institutionally available research reports, (iv) analyses prepared by the nationally recognized rating organizations responsible for the initial rating assessment and on-going surveillance of such CMBS, and (v) other qualitative and quantitative factors that may impact the value of the CMBS such as the market's perception of the issuers of the CMBS and the credit fundamentals of the commercial properties securing each pool of underlying commercial mortgage loans. We make further fair value adjustments to such pricing information based on our specific knowledge of our CMBS and the impact of relevant events, which is then used to determine the fair value of our CMBS using a discounted cash flow approach. Expected future gross cash flows are discounted at assumed market yields for our CMBS rated A+ through B+, depending on the rating. The fair value for those CMBS incurring principal losses and interest shortfalls (i.e., B rated bonds through our unrated/issuer's equity) based on our overall expected loss estimate are valued at a loss adjusted yield to maturity that, in our view, is commensurate with the market's perception of the value and risk of comparable securities, using a discounted cash flow approach. Such anticipated principal losses and interest shortfalls, as well as the timing and amount of potential recoveries of such shortfalls, are critical estimates and have been taken into consideration in the calculation of fair values and yields to maturity used to recognize interest income as of September 30, 2003. We have disclosed the range of discount rates by rating category used in determining the fair values as of September 30, 2003 in the table above. The liquidity of the subordinated CMBS market has historically been limited. Additionally, during adverse market conditions, the liquidity of such market has been severely limited. For this reason, among others, management's estimate of the value of our subordinated CMBS could vary significantly from the value that could be realized in a current transaction. 58 Mortgage Loan Pool We have $15.8 billion and $17.4 billion of seasoned commercial mortgage loans underlying our subordinated CMBS portfolio as of September 30, 2003 and December 31, 2002, respectively, secured by properties of the types and in the geographic locations identified below:
09/30/03 12/31/02 Geographic 09/30/03 12/31/02 Property Type Percentage(i) Percentage(i) Location(ii) Percentage(i) Percentage(i) - ------------- ------------- ------------- ----------- ------------- ------------- Retail....... 31% 31% California........ 16% 17% Multifamily.. 27% 28% Texas............. 12% 12% Hotel........ 15% 15% Florida........... 8% 8% Office....... 14% 13% Pennsylvania...... 6% 5% Other (iv)... 13% 13% New York.......... 4% 4% ---- ---- Other(iii)........ 54% 54% Total.... 100% 100% ---- ---- ==== ==== Total............. 100% 100% ==== ====
(i) Based on a percentage of the total unpaid principal balance of the underlying loans. (ii) No significant concentration by region. (iii) No other individual state makes up more than 5% of the total. (iv) Our ownership interest in one of the 20 CMBS transactions underlying CBO-2 includes subordinated CMBS in which our exposure to losses arising from certain healthcare and senior housing mortgage loans is limited by other subordinated CMBS (referred to herein as the Subordinated Healthcare/Senior-Housing CMBS). These other CMBS are not owned by us and are subordinate to our CMBS in this transaction. As a result, our investment in such underlying CMBS will only be affected if interest shortfalls and/or realized losses on such healthcare and senior housing mortgage loans are in excess of the Subordinated Healthcare/Senior-Housing CMBS. We currently estimate that the interest shortfalls and/or realized losses on such healthcare and senior housing mortgage loans will exceed the Subordinated Healthcare/Senior Housing CMBS. The principal balance of the Subordinated Healthcare/Senior Housing CMBS as of September 30, 2003 is approximately $3.4 million. As of October 2003, the aggregate principal balance of healthcare and senior housing mortgage loans, underlying the Subordinated Healthcare/Senior Housing CMBS, that are specially serviced by another special servicer, and therefore not in our special servicing loan balance, is approximately $83 million. Specially Serviced Mortgage Loans CMSLP performs special servicing on the loans underlying our subordinated CMBS portfolio. A special servicer typically provides asset management and resolution services with respect to nonperforming or underperforming loans within a pool of mortgage loans. When serving as special servicer of a mortgage loan pool, CMSLP has the authority, subject to certain restrictions in the applicable CMBS pooling and servicing documents, to deal directly with any borrower that fails to perform under certain terms of its mortgage loan, including the failure to make payments, and to manage any loan workouts and foreclosures. As special servicer, CMSLP earns fee income on services provided in connection with any loan servicing function transferred to it from the master servicer. We believe that because we own the first loss unrated or lowest rated bond of virtually all of the CMBS transactions related to our subordinated CMBS, CMSLP has an incentive to efficiently and effectively resolve any loan workouts. As of September 30, 2003 and December 31, 2002, specially serviced mortgage loans included in the commercial mortgage loans described above were as follows:
09/30/03 12/31/02 --------------- --------------- Specially serviced loans due to monetary default (a) $ 935.7 million $736.1 million Specially serviced loans due to covenant default/other 44.8 million 74.7 million --------------- -------------- Total specially serviced loans (b) $ 980.5 million $810.8 million =============== ============== Percentage of total mortgage loans (b) 6.2% 4.7% =============== ==============
(a) Includes $111.3 million and $130.5 million, respectively, of real estate owned by the underlying securitization trusts. See also the table below regarding property type concentrations for further information on real estate owned by underlying trusts. (b) As of October 31, 2003, total specially serviced loans were approximately $969.6 million, or 6.2% of the total mortgage loans. 59 The specially serviced mortgage loans as of September 30, 2003 were secured by properties of the types and located in the states identified below:
Property Type $ (in millions) Percentage Geographic Location $ (in millions) Percentage - ------------- --------------- ---------- ------------------- --------------- ---------- Hotel........ $ 486.9 (1) 50% Florida............ $ 151.2 15% Retail....... 255.7 (2) 26% Texas.............. 114.6 12% Healthcare... 81.5 8% Oregon............. 93.3 9% Multifamily.. 81.1 8% California......... 46.9 5% Office....... 45.3 5% Massachusetts...... 45.5 5% Industrial... 20.7 2% Other.............. 529.0 54% Other........ 9.3 1% ---------- ---- -------- ---- Total............ $ 980.5 100% Total.... $ 980.5 100% ========== ==== ======== ====
(1) Approximately $78.1 million of these loans in special servicing are real estate owned by the underlying securitization trusts. (2) Approximately $21.8 million of these loans in special servicing are real estate owned by the underlying securitization trusts. The following table provides a summary of the change in the balance of specially serviced loans from July 1, 2003 to September 30, 2003 and from April 1, 2003 to June 30, 2003 (in millions):
July - September April - June 2003 2003 --------------- ------------- Specially Serviced Loans, beginning of period $1,168.8 $1,154.0 Transfers in due to monetary default 131.5 166.3 Transfers in due to covenant default and other 1.4 7.4 Transfers out of special servicing (314.9) (153.2) Loan amortization (1) (6.3) (5.7) ------------- ----------- Specially Serviced Loans, end of period $ 980.5 $1,168.8 ============= ===========
(1) Represents the reduction of the scheduled principal balances due to borrower payments or, in the case of loans in monetary default, advances made by master servicers. As reflected above, as of September 30, 2003, approximately $486.9 million, or 50%, of the specially serviced mortgage loans were secured by mortgages on hotel properties. The hotel properties that secure the mortgage loans underlying our CMBS are geographically diverse, with a mix of hotel property types and franchise affiliations. The following table summarizes the hotel mortgage loans underlying our CMBS as of September 30, 2003:
Total Outstanding Percentage of Amount in Principal Balance Total Hotel Loans Special Servicing ----------------- ----------------- ----------------- Full service hotels (1) $ 1.3 billion 58% $ 192.9 million Limited service hotels (2) 1.0 billion 42% 294.0 million ------------- --- --------------- Totals $ 2.3 billion 100% $ 486.9 million ============= ==== ===============
(1) Full service hotels are generally mid-price, upscale or luxury hotels with restaurant and lounge facilities and other amenities. (2) Limited service hotels are generally hotels with room-only operations or hotels that offer a bedroom and bathroom, but limited other amenities, and are often in the budget or economy group. Of the $486.9 million of hotel loans in special servicing as of September 30, 2003, approximately $272.1 million, or 56%, relate to six borrowing relationships more fully described as follows: o Twenty-seven loans with scheduled principal balances as of September 30, 2003 totaling approximately $135 million spread across three CMBS transactions secured by hotel properties in the western and Pacific northwestern states. As of September 30, 2003, our total exposure, including advances of approximately $30 million, on these loans was approximately $165 million. The total exposure is prior to the application of payments made to date by the borrower under the terms of our consensual settlement agreement; however, the total exposure is expected to be reduced by the application of such payments at closing. The borrower initially filed for bankruptcy protection in February 2002 and indicated that the properties had experienced reduced operating performance due to new competition, the economic recession, and reduced travel resulting from the September 11, 2001 terrorist attacks. We subsequently entered into a consensual settlement agreement dated February 25, 2003 pursuant to which the loan terms were amended 60 and modified. This agreement was subsequently approved and confirmed by the bankruptcy court on March 28, 2003. The parties are currently proceeding toward closing a comprehensive loan modification, which is expected to occur in the fourth quarter of 2003 and is expected to return the loans to performing status. The borrower continues to make payments under the modified terms. As of September 30, 2003, the borrower has made principal and interest payments totaling approximately $6.9 million, the majority of which represents interest paid (as compared to principal amortization) on the modified loan balances. During the nine months ended September 30, 2003, the borrower also sold one of the properties that secured these loans. In addition, as of September 30, 2003, the borrower has remitted approximately $1.5 million in funds from debtor-in-possession accounts, which is expected to be applied to arrearages at closing. If we are not successful in resolving this loan favorably, our annual cash received from CMBS could be significantly reduced. o Five loans with scheduled principal balances as of September 30, 2003 totaling approximately $45.1 million secured by hotel properties in Florida and Texas. As of September 30, 2003, our total exposure, including advances, on these loans was approximately $50.2 million. Four of the five loans are past due for the November 2002 and all subsequent payments. One of the loans is past due for the October 2002 and all subsequent payments. The borrower has not been able to perform under a preliminary modification agreement due to decreased demand in the Orlando hospitality market. We expect the properties to become real estate owned by the underlying securitization trusts. o Six real estate owned properties with scheduled principal balances as of September 30, 2003 totaling approximately $20.0 million secured by hotel properties. As of September 30, 2003, our total exposure, including advances, on these loans was approximately $25.3 million. The loans were transferred into special servicing in December 2001 due to the bankruptcy filing of each special purpose borrowing entity and their parent company. As part of a consensual plan, eight properties were foreclosed and became real estate owned by underlying securitization trusts. During the three months ended September 30, 2003, two of these eight properties with an aggregate unpaid balance of $5.9 million were sold. o One loan with a scheduled principal balance as of September 30, 2003 totaling approximately $27.6 million, secured by nine limited service hotels located in eight states. As of September 30, 2003 the loan was current. The loan is currently in special servicing due to an unauthorized transfer of the properties to an entity which assumed the controlling interest in the borrowing entity. Subsequent to the transfer, the new controlling party in interest has made an application for the assumption of the debt, which is anticipated to close in the fourth quarter of 2003. o One loan with a scheduled principal balance as of September 30, 2003 of approximately $25.5 million, secured by a full service hotel in Boston, Massachusetts. As of September 30, 2003, our total exposure, including advances, on this loan was approximately $27.0 million. This loan was transferred into special servicing in March 2003. The borrower has stated an inability to make payments, and has requested a loan restructuring due to reduced operating performance at the property. o Nine loans with scheduled principal balances as of September 30, 2003 totaling approximately $18.6 million secured by limited service hotels in midwestern states. As of September 30, 2003, our total exposure, including advances, on these loans was approximately $22.3 million. The loans are past due for the April 2002 and all subsequent payments. The borrower cites reduced occupancy related to the downturn in travel as the cause for a drop in operating performance at the properties. We were attempting to negotiate a workout with the borrower when the borrower filed for bankruptcy protection in February 2003. The exposure amounts included above are as of September 30, 2003. The amounts are not necessarily indicative of the exposures as of the projected resolution dates. During the three months ended September 30, 2003, two significant hotel loans in special servicing, included in our June 30, 2003 disclosure of significant borrowing relationships, were transferred out of special servicing as follows: o One hotel loan, with a scheduled principal balance of approximately $128.4 million as of June 30, 2003, and secured by 93 limited service hotels located in 29 states, was paid off. o One hotel loan, with a scheduled principal balance of approximately $80.7 million as of June 30, 2003, and secured by 13 extended stay hotels located throughout the U.S., was sold to a third party. 61 For each of the borrowing relationships described in the paragraphs above, we believe that we have made an appropriate estimate of losses that we may incur in the future, which are used in determining our CMBS yields and fair values. There can be no assurance that any of the loans described above will return to performing status or otherwise be satisfactorily resolved. Circumstances which could prevent them from returning to performing status or otherwise being satisfactority resolved include, but are not limited to, changes in workout negotiations, a more pronounced downturn in the economy or in the real estate market, a change in local market conditions, a drop in performance of the property, an increase in interest rates, and terrorist attacks. There can be no assurance that the losses incurred in the future will not exceed our current estimates (also see discussion below regarding the increase in loss estimates). Advance Limitations, Appraisal Reductions and Losses on CMBS We experience shortfalls in expected cash flow on our CMBS prior to the recognition of a realized loss primarily due to servicing advance limitations resulting from appraisal reductions. An appraisal reduction event can result in reduced master servicer principal and interest advances based on the amount by which the sum of the unpaid principal balance of the loan, accumulated principal and interest advances and other expenses exceeds 90% (in most cases) of the newly appraised value of the property underlying the mortgage loan. As the holder of the lowest rated and first loss bonds, our bonds are the first to experience interest shortfalls as a result of the reduced advancing requirement. In general, the master servicer can advance up to a maximum of the difference between 90% of the property's appraised value and the sum of accumulated principal and interest advances and expenses. As an example, assuming a weighted average coupon of 6% on a first loss subordinated CMBS, a $1 million appraisal reduction would reduce our net cash flows by up to $60,000 on an annual basis, assuming that the total exposure was equal to or greater than 90% of the appraised value immediately prior to receipt of the new appraisal (appraisal reduction). The ultimate disposition or work-out of the mortgage loan may result in a higher or lower realized loss on our subordinated CMBS than the calculated appraisal reduction amount. Appraisal reductions for the CMBS transactions in which we retain an ownership interest as reported by the underlying trustees or as calculated by CMSLP* were as follows (in thousands):
CBO-1 CBO-2 Nomura Total ----- ------ ------ ----- Year 2000 $1,872 $18,871 $ -- $ 20,743 Year 2001 15,599 31,962 874 48,435 Year 2002 9,088 48,953 13,530 71,571 January 1, 2003 through September 30, 2003 30,146 40,640 9,455 80,241 ------- -------- ------- --------- Cumulative Appraisal Reductions through September 30, 2003 $56,705 $140,426 $23,859 $ 220,990 ======= ======== ======= =========
* Not all underlying CMBS transactions require the calculation of an appraisal reduction; however, when CMSLP obtains a third-party appraisal, it calculates one. As previously discussed, certain securities from the CBO-1, CBO-2 and Nomura transactions are expected to experience principal write-downs over their expected lives. The following tables summarize the actual realized losses on our CMBS through September 30, 2003 (including realized mortgage loan losses expected to pass through to our CMBS during the next month) and the expected future real estate losses underlying our CMBS (in thousands):
CBO-1 CBO-2 Nomura Total ----- ------ ------- ------ Year 1999 actual realized losses $ 738 $ -- $ -- $ 738 Year 2000 actual realized losses 3,201 1,087 -- 4,288 Year 2001 actual realized losses 545 8,397 238 9,180 Year 2002 actual realized losses 11,554 25,113 563 37,230 Actual realized losses, January 1 through September 30, 2003 10,041 46,880 662 57,583 -------- -------- ------- --------- Cumulative actual realized losses through September 30, 2003 $ 26,079 $ 81,477 $ 1,463 $ 109,019 ======== ======== ======= ========= Cumulative expected realized loss estimates (including cumulative actual realized losses) through the year 2003 $ 26,079 $ 91,243 $ 1,463 $ 118,785 Expected loss estimates for the year 2004 51,503 147,007 13,425 211,935 Expected loss estimates for the year 2005 30,019 89,882 10,514 130,415 Expected loss estimates for the year 2006 3,523 18,188 3,372 25,083 Expected loss estimates for the year 2007 1,908 14,643 3,292 19,843 Expected loss estimates for the year 2008 1,784 10,623 2,608 15,015 Expected loss estimates for the remaining life of CMBS 7,972 31,998 6,647 46,617 -------- -------- ------- --------- Cumulative expected loss estimates (including cumulative actual realized losses) through life of CMBS $122,788 $403,584 $41,321 $ 567,693 ======== ======== ======= =========
62 We revised our overall expected loss estimate related to our subordinated CMBS from $503 million at December 31, 2002 to $559 million at June 30, 2003 to $568 million at September 30, 2003, with such total losses occurring or expected to occur through the life of the subordinated CMBS portfolio. These revisions to the overall expected loss estimate are primarily the result of increased projected losses due to lower internal estimates of values on properties underlying certain mortgage loans and real estate owned by underlying trusts, and changes in the timing of resolution and disposition of certain specially serviced assets, which when combined, has resulted in higher projected loss severities on loans and real estate owned by underlying trusts currently or anticipated to be in special servicing. The primary reasons for lower estimates of value include the poor performance of certain properties and related markets and changes to workout negotiations due, in large part, to the softness in the economy, the continued slowdown in travel and, in some cases, over-supply of hotel properties, and a shift in retail activity in some markets. There can be no assurance that our revised overall expected loss estimate of $568 million will not be exceeded as a result of additional or existing adverse events or circumstances. Such events or circumstances include, but are not limited to, the receipt of new or updated appraisals or internal values at lower than anticipated amounts, legal proceedings (including bankruptcy filings) involving borrowers, unforeseen reductions in cash received from our subordinated CMBS, a deterioration in the economy or recession generally or in certain industries or sectors specifically, continued hostilities in the Middle East or elsewhere, terrorism, unexpected delays in the disposition or other resolution of specially serviced mortgage loans, additional defaults, or an unforeseen reduction in expected recoveries, any of which could result in additional future credit losses, impact our cash received from subordinated CMBS and/or result in further impairment to our subordinated CMBS, the effect of which could be materially adverse to us. As of September 30, 2003, we determined that there had been an adverse change in expected future cash flows for the B- and CCC bonds in CBO-2 due to the factors mentioned in the paragraph above. As a result, we believed these bonds had been impaired under EITF 99-20 and SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," as of September 30, 2003. As the fair values of these impaired bonds aggregated approximately $4.7 million below the amortized cost basis as of September 30, 2003, we recorded other than temporary impairment charges through the income statement of that same amount during the three months ended September 30, 2003. As of June 30, 2003, we determined that there had been an adverse change in expected future cash flows for the unrated/issuer's equity bonds, the CCC bond and the B- bond in CBO-2 due to the factors mentioned in the paragraphs above. As a result, we believed these bonds had been impaired as of June 30, 2003. As the fair values of these impaired bonds aggregated approximately $8.9 million below the amortized cost basis as of June 30, 2003, we recorded other than temporary impairment charges through the income statement of that same amount during the three months ended June 30, 2003. Yield to Maturity The following table summarizes yield-to-maturity information relating to our CMBS on an aggregate pool basis:
Current Anticipated Anticipated Anticipated Anticipated Yield-to- Yield-to- Yield-to- Yield-to- Maturity Maturity Maturity Maturity Pool as of 1/1/02 (1) as of 1/1/03 (1) as of 7/1/03 (1) as of 10/1/03 (1) ---- ---------------- ---------------- --------------- ----------------- CBO-2 CMBS 12.1% 11.6% 11.5% 11.3% CBO-1 CMBS 14.3% 11.6% 21.6% 36.8% Nomura CMBS 28.7% 8.0% 16.9% 27.9% ------ ----- ----- ------ Weighted Average (2) 12.4% 11.6% 11.7% 12.0%
(1) Represents the anticipated weighted average yield over the expected average life of the CMBS based on our estimate of the timing and amount of future credit losses and other significant items that are anticipated to affect future cash flows. (2) GAAP requires that the income on CMBS be recorded based on the effective interest method using the anticipated yield over the expected life of these mortgage assets. This method can result in accounting income recognition which is greater than or less than cash received. During the nine months ended September 30, 2003, we recognized approximately $8.0 million of discount amortization, partially offset by approximately $4.3 million of cash received in excess of income recognized on subordinated CMBS due to the effective interest method. During the nine months ended September 30, 2002, we recognized approximately $8.8 million of discount amortization, partially offset by approximately $2.4 million of cash received in excess of income recognized on subordinated CMBS due to the effective interest method. 63 Summary of Other Assets Portfolio Investment As of September 30, 2003 and December 31, 2002, our other assets consisted primarily of insured mortgage securities, equity investments, mezzanine loans, Other MBS, cash and cash equivalents (as previously discussed), principal and interest receivables and real estate owned. We had $168.3 million and $275.3 million (in each case, at fair value) invested in insured mortgage securities as of September 30, 2003 and December 31, 2002, respectively. The reduction in total fair value is primarily attributable to the prepayment or sale of approximately 38% (based on amortized cost) of the insured mortgages during the nine months ended September 30, 2003. As of September 30, 2003, 84% of our investments in insured mortgage securities were GNMA mortgage-backed securities and approximately 16% were FHA-insured certificates. As of September 30, 2003 and December 31, 2002, we had approximately $4.0 million and $6.2 million, respectively, in investments accounted for under the equity method of accounting. Included in equity investments are (a) the general partnership interests (2.9% to 4.9% ownership interests) in the AIM Limited Partnerships, and (b) a 20% limited partnership interest in the advisor to the AIM Limited Partnerships. The decrease in these investments is primarily the result of partner distributions declared by the AIM Limited Partnerships due to loan pay-offs and normal cash flow distributions, and impairment of approximately $109,000 that we recognized on our investments in the adviser to the AIM Limited Partnerships during the second quarter of 2003 (see discussion in "Equity in Income from Investments"). The carrying values of our equity investments are expected to continue to decline over time as the AIM Limited Partnerships' asset bases decrease and proceeds are distributed to partners. During the three months ending September 30, 2003, we had one mezzanine loan prepay. This prepayment resulted in a decrease in Other Assets of approximately $1.7 million. As of September 30, 2003 we have approximately $4.2 million in mezzanine loans. Our Other MBS primarily include investment grade CMBS, investment grade residential mortgage-backed securities, agency debt securities and other fixed income securities. As of September 30, 2003 and December 31, 2002, the fair values of our Other MBS were approximately $3.9 million and $5.2 million, respectively. As previously discussed, we own a shopping center in Orlando, Florida, which we account for as real estate owned. As of September 30, 2003 and December 31, 2002, we had approximately $8.8 million, respectively, in real estate owned assets included in other assets ($8.4 million relating to the actual building and land). In addition, we had $7.3 million and $7.2 million of mortgage payable (net of discount) related to the real estate as of September 30, 2003 and December 31, 2002, respectively. We hope to reposition and stabilize this asset to increase its value, although there can be no assurance we will be able to do so. Mortgage Servicing As of September 30, 2003 and December 31, 2002, CMSLP's other assets consisted primarily of advances receivable, investments in CMBS, fixed assets, investments in interest-only strips and investments in subadvisory contracts. The servicing other assets have decreased by approximately $4.2 million from $13.8 million at December 31, 2002 to $9.5 million at September 30, 2003. The decrease is primarily the result of the sale of investment grade CMBS in January 2003 in connection with our recapitalization, which had a fair value of approximately $3.3 million as of December 31, 2002, and a $512,000 decrease in fixed assets due to depreciation. In October 2003, we received approximately $2.5 million in advances receivable reimbursement related to one loan, which resulted in a corresponding decrease in advances receivable. Summary of Liabilities Portfolio Investment As of September 30, 2003 and December 31, 2002, our liabilities consisted primarily of debt, accrued interest and accrued payables. Total recourse debt decreased by approximately $47.2 million to $328.8 million as of September 30, 2003 from $376.0 million as of December 31, 2002 primarily due to the repayment of the Exit Debt 64 during the first quarter of 2003 principally through the incurrence of the Bear Stearns and BREF Debt. Total non-recourse debt decreased by approximately $93.1 million to $452.9 million at September 30, 2003 from $546.0 million at December 31, 2002. This decrease is primarily attributable to significant prepayments of mortgages underlying the insured mortgage securities during the nine months ended September 30, 2003, which resulted in a corresponding reduction in the principal balances of the securitized mortgage obligations. Our payables and accrued liabilities decreased by approximately $15.2 million to $11.5 million as of September 30, 2003 from $26.7 million as of December 31, 2002 primarily due to the January 2003 recapitalization and the payment of preferred stock dividends that were previously deferred. During the three months ended March 31, 2003, we reversed approximately $7.5 million of extension fees that were accrued at December 31, 2002 on the Exit Debt since they were no longer payable. In addition, we paid $2.9 million of interest that was accrued, as of December 31, 2002, on the Series B Senior Secured Notes. As of December 31, 2002, we had accrued approximately $5.2 million of preferred stock dividends. As of September 30, 2003, there were no accrued and unpaid dividends on our preferred stock. Mortgage Servicing As of September 30, 2003 and December 31, 2002, CMSLP's liabilities consisted primarily of operating accounts payable and accrued expenses. The servicing liabilities increased by approximately $1.5 million to $2.3 million as of September 30, 2003 from $757,000 as of December 31, 2002 primarily due to the accrual of executive contract termination costs and other normal operating expenses. Dividends/Other On August 14, 2003, the Board of Directors declared a cash dividend for the third quarter of 2003 on our Series B, Series F and Series G Preferred stock payable on September 30, 2003 to shareholders of record on September 17, 2003. No cash dividends were paid to common shareholders during the nine months ended September 30, 2003. Based on current taxable income estimates, it is expected that preferred or common dividends paid in 2004 and thereafter will be taxable to the shareholders. Dividends paid in 2001, 2002, and 2003 were, or are expected to be, considered "return of capital" for tax purposes. On November 11, 2003, the Board of Directors declared cash dividends of $0.68, $0.30 and $0.375 per share of Series B, Series F and Series G Preferred Stock, respectively, payable on December 31, 2003 to shareholders of record on December 16, 2003. Other factors which could impact dividends, if any, include (i) the level of income earned on uninsured mortgage assets, such as subordinated CMBS (including, but not limited to, the amount of original issue discount income, interest shortfalls and realized losses on subordinated CMBS), (ii) net operating losses, (iii) the fluctuating yields on short-term, variable-rate debt and the rate at which our LIBOR-based debt is priced, as well as the rate we pay on our other borrowings and fluctuations in long-term interest rates, (iv) changes in operating expenses, including hedging costs, (v) margin calls, (vi) the level of income earned on our insured mortgage securities depending primarily on prepayments and defaults, (vii) the rate at which cash flows from mortgage assets, mortgage dispositions, and, to the extent applicable, distributions from our subsidiaries can be reinvested, (viii) cash dividends paid on preferred shares, (ix) to the extent applicable, whether our taxable mortgage pools continue to be exempt from corporate level taxes, (x) realized losses on certain transactions, and (xi) the timing and amounts of cash flows attributable to our other lines of business - mortgage servicing. Cash dividends on our common stock are subject to the prior payment of all accrued and unpaid dividends on our preferred stock, and cash dividends on our junior classes of preferred stock are subject to the prior payment of all accrued and unpaid dividends on our senior preferred stock. Investment Company Act Under the Investment Company Act of 1940, as amended, an investment company is required to register with the Securities and Exchange Commission (SEC) and is subject to extensive restrictive and potentially adverse regulation relating to, among other things, operating methods, management, capital structure, dividends and transactions with affiliates. However, as described below, companies primarily engaged in the business of acquiring mortgages and other liens on and interests in real estate (Qualifying Interests) are excluded from the requirements of the Investment Company Act. 65 To qualify for the Investment Company Act exclusion, we, among other things, must maintain at least 55% of our assets in Qualifying Interests (the 55% Requirement) and are also required to maintain an additional 25% in Qualifying Interests or other real estate-related assets (Other Real Estate Interests and such requirement, the 25% Requirement). According to current SEC staff interpretations, we believe that all of our government-insured mortgage securities constitute Other Real Estate Interests and that certain of our government insured mortgage securities also constitute Qualifying Interests. In accordance with current SEC staff interpretations, we believe that all of our subordinated CMBS constitute Other Real Estate Interests and that certain of our subordinated CMBS also constitute Qualifying Interests. On certain of our subordinated CMBS, we, along with other rights, have the unilateral right to direct foreclosure with respect to the underlying mortgage loans. Based on such rights and our economic interest in the underlying mortgage loans, we believe that the related subordinated CMBS constitute Qualifying Interests. As of September 30, 2003, we believe that we were in compliance with both the 55% Requirement and the 25% Requirement. If the SEC or its staff were to take a different position with respect to whether such subordinated CMBS constitute Qualifying Interests, we could, among other things, be required either (i) to change the manner in which we conduct our operations to avoid being required to register as an investment company or (ii) to register as an investment company, either of which could have a material adverse effect on us. If we were required to change the manner in which we conduct our business, we would likely have to dispose of a significant portion of our subordinated CMBS or acquire significant additional assets that are Qualifying Interests. Alternatively, if we were required to register as an investment company, we expect that our operating expenses would significantly increase and that we would have to significantly reduce our indebtedness, which could also require us to sell a significant portion of our assets. No assurances can be given that any such dispositions or acquisitions of assets, or deleveraging, could be accomplished on favorable terms, or at all. There are restrictions under certain of the operative documents evidencing our obligations, which could limit possible actions we may take in response to any need to modify our business plan in order to register as an investment company or avoid the need to register. Certain dispositions or acquisitions of assets could require approval or consent of certain holders of these obligations. Any such results could have a material adverse effect on us. Further, if we were deemed an unregistered investment company, we could be subject to monetary penalties and injunctive relief. We would be unable to enforce contracts with third parties and third parties could seek to obtain rescission of transactions undertaken during the period we were deemed an unregistered investment company, unless the court found that under the circumstances, enforcement (or denial of rescission) would produce a more equitable result than nonenforcement (or grant of rescission) and would not be inconsistent with the Investment Company Act. Critical Accounting Estimates The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. We continually evaluate the estimates we use to prepare the consolidated financial statements, and update those estimates as necessary. In general, management's estimates are based on historical experience, on information from third party professionals, and other various assumptions that are believed to be reasonable under the facts and circumstances. Actual results could differ materially from those estimates. Management considers an accounting estimate to be critical if: o it requires assumptions to be made that were uncertain at the time the estimate was made; and o changes in the estimate or different estimates that could have been selected could have a material impact on our consolidated results of operations or financial condition. We believe our critical accounting estimates include the determination of fair value of our subordinated CMBS and interest income recognition related to our CMBS. o Fair value of CMBS - Due to the limited liquidity of the subordinated CMBS market and the resulting lack of a secondary market, the values of our subordinated CMBS are based on available market information and management's estimates. These estimates require significant judgment regarding assumptions for defaults on the underlying commercial mortgage loan collateral, timing of loss realization and resultant loss severity, timing and amount of principal losses and interest shortfalls, 66 timing and amount of potential recoveries of such shortfalls and discount rates. Notes 3 and 4 to Notes to Consolidated Financial Statements contain a detailed discussion of the methodology used to determine the fair value of our subordinated CMBS as well as a sensitivity analysis related to the fair value of these subordinated CMBS due to changes in assumptions related to losses on the underlying commercial mortgage loan collateral and discount rates. o Interest income recognition related to subordinated CMBS - Interest income recognition under EITF No. 99-20 requires us to make estimates regarding expected prepayment speeds as well as expected losses on the underlying commercial mortgage loan collateral (which directly impact the cash flows on our subordinated CMBS in the form of interest shortfalls and loss of principal) and the impact these factors would have on future cash flow. Note 4 to Notes to Consolidated Financial Statements details the expected realized losses by year that we expect to incur related to our subordinated CMBS. The cash flows we project to arrive at the effective interest rate to recognize interest income are adjusted for these expected losses. The judgment regarding future expected credit losses is subjective as credit performance is particular to an individual deal's specific underlying commercial mortgage loan collateral. In general, if we increase our expected losses or determine such losses will occur sooner than previously projected and the CMBS's fair value is below cost, then the CMBS will be considered impaired and adjusted to fair value with the impairment charge recorded through earnings. Recent Accounting Pronouncements We adjusted certain 2002 amounts due to recent SEC guidance as discussed in "Dividends Paid or Accrued on Preferred Shares". See "Recent Accounting Pronouncements" in Note 2 to Notes to Consolidated Financial Statements for further discussion of recent accounting pronouncements. 67 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our principal market risk is exposure to changes in interest rates related to the U.S. Treasury market as well as the LIBOR market. We will have fluctuations in the amount of interest expense paid on our variable rate debt primarily due to changes in one-month LIBOR. We will also experience fluctuations in the market value of our mortgage assets related to changes in the yields of U.S. Treasury securities as well as changes in the spread between U.S. Treasury securities and the mortgage assets and overall required returns. The combination of the risk free rate (U.S. Treasury yields) and the related spread is the discount rate used to determine the fair value of our mortgage assets. The U.S. Treasury yield used to determine the fair value of our mortgage assets, that are not expected to experience losses, is the current yield on a U.S. Treasury which has the same weighted average life of the related mortgage asset. As of September 30, 2003, the average U.S. Treasury rate used to price our CMBS, excluding the B through unrated/issuer's equity CMBS, had increased by 12 basis points, compared to December 31, 2002. As of September 30, 2003, credit spreads used to price our investment grade CMBS tightened and there was no significant change in credit spreads used to price our subordinated CMBS not expected to experience losses, excluding BB-, compared to December 31, 2002. The fair values of our B- and CCC CMBS in CBO-2 and our unrated/issuer's equity are determined using a loss adjusted yield to maturity, which is commensurate with the market's perception of value and risk of comparable assets. As described, interest rates impact the fair values of our CMBS, which affects our collateral coverage. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS-Financial Condition, Liquidity and Capital Resources" for a discussion of our collateral coverage requirements under the Bear Stearns Debt. CMBS The required rate of return used to determine the fair values of our CMBS is comprised of many variables, such as a risk-free rate, a liquidity premium and a credit risk premium. These variables are combined to determine a total rate that, when used to discount the CMBS's assumed stream of future cash flows, results in the fair value of such cash flows. The determination of such rate is dependent on many quantitative and qualitative factors, such as, but not limited to, the market's perception of the issuers of the CMBS and the credit fundamentals of the commercial properties underlying each underlying pool of commercial mortgage loans. If we assumed that the discount rate used to determine the fair values of our CMBS (A+ through unrated bonds) increased by 100 basis points and 200 basis points, the increase in the discount rate would have resulted in a corresponding decrease in the fair values of our CMBS (A+ through unrated bonds) by approximately $49.1 million (or 5.7%) and approximately $94.2 million (or 11.0%), respectively, as of September 30, 2003. A 100 basis point and 200 basis point increase in the discount rate would have resulted in a corresponding decrease in the value of our subordinated CMBS (BB+ through unrated bonds) by approximately $32.3 million (or 6.1%) and $61.7 million (or 11.7%), respectively, as of September 30, 2003. See also Note 4 of Notes to Consolidated Financial Statements for a discussion of other factors that could affect the fair values of our CMBS, including changes in the timing and/or amount of credit losses on underlying mortgage loans, the receipt of mortgage payments earlier than projected due to prepayments, and delays in the receipt of monthly cash flow distributions on CMBS due to mortgage loan defaults and/or extensions in loan maturities. Interest Rate Swap In the second and third quarters of 2003, we entered into three interest rate swaps to hedge the variability of the future interest payments on the anticipated CDO attributable to changes in interest rates. Our obligations to Bear Stearns under the interest rate swap documents are collateralized by certain assets as described in Note 6 to Notes to Consolidated Financial Statements. These swaps are treated as cash flow hedges for GAAP. Under these swaps, we have agreed to pay Bear Stearns a weighted average interest fixed rate of 4.15% per annum in exchange for floating payments based on one-month LIBOR on the total notional amount of $100 million. These swaps were effective on October 15, 2003. The swaps are intended to protect our cost of financing in connection with our anticipated CDO transaction. We intend to terminate the swaps simultaneously with the issuance of the CDO. As of September 30, 2003, the aggregate fair value of the interest rate swaps was an asset of approximately $1.5 million. A 100 basis point decrease in the 10 year swap rates would result in an approximate $8 million decrease in the fair value of our interest rate swaps, with an aggregate notional amount of $100 million. 68 Variable Rate Debt We maintain an interest rate cap to mitigate the adverse effects of rising interest rates on the amount of interest expense payable under our variable rate debt. Our interest rate cap, which was effective on May 1, 2002, was for a notional amount of $175.0 million, capped LIBOR at 3.25%, and matured on November 3, 2003. As of September 30, 2003, this interest rate cap had a fair value of $0. On October 31, 2003, we purchased an interest rate cap for $45,000 with a notional amount of $50 million, an effective date of November 4, 2003, maturity on November 4, 2004, and capping one-month LIBOR at 2.25%. Our cap provides protection to the extent interest rates, based on a readily determinable interest rate index (typically one-month LIBOR), increase above the stated interest rate cap, in which case, we would receive payments based on the difference between the index and the cap. The term of the cap as well as the stated interest rate of the cap, which is currently above the current rate of the index, would limit the amount of protection that the cap offers. The average one-month LIBOR index was 1.24% during the nine months ended September 30, 2003, which was a 14 basis point decrease from December 31, 2002. A 100 basis point change in the one-month LIBOR index would have changed our interest expense on our Bear Stearns Debt by approximately $760,000 and $2.2 million during the three and nine months ended September 30, 2003, respectively. Insured Mortgage Securities There would not be a material change in the fair values of our insured mortgage securities if we assumed that the discount rate used to determine the fair values increased by 100 basis points and 200 basis points as of September 30, 2003. 69 ITEM 4. CONTROLS AND PROCEDURES Within the 90 days prior to the filing date of this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Securities Exchange Act Rule 15d-15. Our management, including the Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. Our Chief Executive Officer and Chief Financial Officer have concluded, based on our evaluation of our disclosure controls and procedures, that our disclosure controls and procedures under Rule 13a-14(c) and Rule 15d-14(c) of the Securities Exchange Act of 1934 are effective. Subsequent to our evaluation, there were no significant changes in internal controls or other factors that could significantly affect these internal controls; however, we intend to continue to implement certain actions in the current quarter designed to improve our credit loss estimation process, as discussed below. Although we believe our overall credit loss estimate is reasonable and correct, based upon our evaluation of our internal controls in connection with our recent Annual Report on Form 10-K and written observations, recommendations and a report received from our independent auditors, we commenced implementing actions to improve our credit loss estimation process. This process is important to our CMBS income recognition, CMBS fair value determination and CMBS impairment assessment. We and our independent auditors determined that significant improvement was needed in this process, particularly in connection with mortgage loan valuation and credit loss estimation. To address these matters, we have completed the initial re-underwriting of the mortgage loans underlying our CMBS and are continuing with the implementation of additional actions designed to improve our credit loss estimation process including (a) employing an underwriting internal valuation group, (b) developing additional policies and procedures to better standardize our process, and (c) employing, as appropriate, additional resources and expertise related to our credit loss and valuation processes. Our independent auditors were not specifically engaged to evaluate or assess the internal controls over our overall loss estimate. 70 PART II ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS Exhibit No. Description ----------- ----------- 10.1 Termination of Employment Agreement, dated as of August 26, 2003, by and between David B. Iannarone and CRIIMI MAE Inc. (incorporated by reference to Exhibit 10.1 to Form 8-K filed with the SEC on September 5, 2003). 10.2 Employment Offer Letter, dated as of August 26, 2003, by and among David B. Iannarone, CRIIMI MAE Inc. and CRIIMI MAE Management, Inc. (incorporated by reference to Exhibit 10.2 to Form 8-K filed with the SEC on September 5, 2003). 10.3 Termination of Employment Agreement, dated as of August 26, 2003, by and between Cynthia O. Azzara and CRIIMI MAE Inc. (incorporated by reference to Exhibit 10.3 to Form 8-K filed with the SEC on September 5, 2003). 10.4 Employment Offer Letter, dated as of August 26, 2003, by and among Cynthia O. Azzara, CRIIMI MAE Inc. and CRIIMI MAE Management, Inc. (incorporated by reference to Exhibit 10.4 to Form 8-K filed with the SEC on September 5, 2003). 10.5 Master Repurchase Agreement, executed on August 28, 2003 to be effective as of June 26, 2003, by and between Bear, Stearns & Co. Inc., as Agent for Bear, Stearns International Limited, and CRIIMI MAE Asset Acquisition Corp. (incorporated by reference to Exhibit 10.5 to Form 8-K filed with the SEC on September 5, 2003). 10.6 Annex I to Master Repurchase Agreement, executed on August 28, 2003 to be effective as of June 26, 2003, by and between Bear, Stearns & Co. Inc., as Agent for Bear, Stearns International Limited and CRIIMI MAE Asset Acquisition Corp. (incorporated by reference to Exhibit 10.6 to Form 8-K filed with the SEC on September 5, 2003). 10.7 Side Letter Agreement , executed on August 28, 2003 to be effective as of June 26, 2003, by and between Bear, Stearns & Co. Inc., CRIIMI MAE Asset Acquisition Corp. and CRIIMI MAE Inc. (incorporated by reference to Exhibit 10.7 to Form 8-K filed with the SEC on September 5, 2003). 10.8 Restricted Stock Award Agreement, dated as of September 15, 2003, by and between CRIIMI MAE Inc. and Mark Jarrell (filed herewith). 10.9 Restricted Stock Award Agreement, dated as of October 3, 2003, by and between CRIIMI MAE Inc. and Cynthia O. Azzara (filed herewith). 10.10 Consulting Agreement and Release, dated as of August 25, 2003, by and between CRIIMI MAE Inc. and Brian L. Hanson (filed herewith). 10.11 Employment Offer Letter, dated as of October 29, 2003, by and among Stephen M. Abelman, CRIIMI MAE Inc. and CRIIMI MAE Services Limited Partnership (filed herewith). 71 10.12 Restricted Stock Award Agreement, dated as of November 6, 2003, by and between CRIIMI MAE Inc. and Stephen M. Abelman (filed herewith). 31.1 Certification of Chief Executive Officer pursuant to Exchange Act Rule 13a-14(a) (filed herewith). 31.2 Certification of Chief Financial Officer pursuant to Exchange Act Rule 13a-14(a) (filed herewith). 32.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith). 32.2 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith). 99.1 Special Serviced Loan Report relating to specially serviced loans underlying the Company's CMBS as of September 30, 2003 (filed herewith). (b) REPORTS ON FORM 8-K Date Purpose ---- ------- August 14, 2003 To report: (1) a press release dated August 14, 2003 announcing the election of Mark R. Jarrell as our President and Chief Operating Officer effective September 15, 2003, (2) a press release dated August 14, 2003 announcing the declaration of cash dividends for the third quarter of 2003 on our Series B, Series F, and Series G Preferred Stock, and (3) a press release dated August 13, 2003 announcing our financial results for the three and six months ended June 30, 2003. September 5, 2003 To report: (1) a press release dated September 3, 2003 announcing a charge in the third quarter of 2003 as a result of payments in connection with the termination of employment contracts of three of our senior executive officers, and (2) the execution of a $200 million secured financing facility in the form of a repurchase agreement. 72 Signature Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this Quarterly Report on Form 10-Q to be signed on its behalf by the undersigned, thereunto duly authorized. CRIIMI MAE INC. November 14, 2003 /s/Cynthia O. Azzara - --------------------------- ---------------------------------------- DATE Cynthia O. Azzara Executive Vice President, Chief Financial Officer and Treasurer (Principal Accounting Officer) EX-10 3 res_stkaagmt-0903.txt RESTRICTED STOCK AWARD AGMT Exhibit 10.8 Exhibit A RESTRICTED STOCK AWARD AGREEMENT This Restricted Stock Award Agreement (the "Agreement"), made as of the 15th day of September, 2003 (the "Grant Date") by and between CRIIMI MAE Inc. (the "Company"), and Mark Jarrell (the "Grantee"), evidences the grant by the Company of a stock award of restricted Shares (the "Award") to the Grantee on such date and the Grantee's acceptance of the Award in accordance with the provisions of the Company's 2001 Stock Incentive Plan, as amended or restated from time to time (the "Plan"). The Company and the Grantee agree as follows: 1. Basis for Award. This Award is made under the Plan pursuant to Section 6 thereof for services to be rendered to the Company by the Grantee. 2. Stock Awarded. (a) The Company hereby awards to the Grantee, in the aggregate, 58,021 Shares ("Restricted Stock"), which shall be subject to the restrictions and conditions set forth in the Plan and in this Agreement. (b) Each certificate issued in respect of the Restricted Stock shall be registered in the Grantee's name and deposited by him, together with a share power endorsed in blank, with the Company and shall bear the following (or a similar) legend: "THE TRANSFERABILITY OF THIS CERTIFICATE AND THE COMMON STOCK REPRESENTED HEREBY ARE SUBJECT TO THE TERMS AND CONDITIONS (INCLUDING FORFEITURE) CONTAINED IN THE RESTRICTED STOCK AWARD AGREEMENT DATED AS OF SEPTEMBER 15, 2003, ENTERED INTO BETWEEN THE REGISTERED OWNER AND CRIIMI MAE INC" At the expiration of the restrictions, the Company shall redeliver to the Grantee (or his legal representative, beneficiary or heir) share certificates for the Shares deposited with it without any legend except as otherwise provided by the Plan, this Agreement or as otherwise required by applicable law. The Grantee shall have the right to receive dividends on and to vote the Restricted Stock while it is held in custody except as otherwise provided by the Plan. Notwithstanding the foregoing, the Company shall retain custody of all Retained Distributions made or declared with respect to the Restricted Stock and such Retained Distributions shall be subject to the same restrictions on terms and conditions as are applicable to the Restricted Stock. (c) Except as provided in the Plan or this Agreement, including without limitation, Section 3 below, the restrictions on the Restricted Stock are that the stock will be forfeited by the Grantee and all of the Grantee's rights to such stock shall immediately terminate without any payment or consideration by the Company, in the event of any sale, assignment, transfer, hypothecation, pledge or other alienation of such Restricted Stock made or attempted, whether voluntary or involuntary, and if involuntary whether by process of law in any civil or criminal suit, action or proceeding, whether in the nature of an insolvency or bankruptcy proceeding or otherwise, without the written consent of the Committee, excluding the Grantee if he so serves on the Committee. 3. Vesting. The restrictions described in Section 2 of this Agreement will lapse with respect to one-quarter (1/4) of the Restricted Stock on December 31, 2003 and with respect to an additional three-quarters (3/4) of the Restricted Stock on December 31, 2004, provided the Grantee is still employed by the Company (or any Parent or Subsidiary) on such vesting dates, except as set forth in the following sentences of this section. All restrictions will lapse with respect to 100% of the Restricted Stock still subject to restriction upon Grantee's death, separation from service due to Disability, or termination of employment by the Company without Cause which occurs at any time on or prior to December 31, 2004. If the Grantee ceases to be employed by the Company (or any Parent or Subsidiary) for any other reason at any time prior to the vesting dates, the unvested Restricted Stock shall automatically be forfeited upon such cessation of service. 4. Compliance with Laws and Regulations. The issuance and transfer of Shares shall be subject to compliance by the Company and the Grantee with all applicable requirements of securities laws and with all applicable requirements of any stock exchange on which the Shares may be listed at the time of such issuance or transfer. The Grantee understands that the Company is under no obligation to register or qualify the Shares with the Securities and Exchange Commission ("SEC"), any state securities commission or any stock exchange to effect such compliance. 5. Tax Withholding. (a) The Grantee agrees that, subject to clause 5(b) below, no later than the date as of which the restrictions on the Restricted Stock shall lapse with respect to all or any of the Restricted Stock covered by this Agreement, the Grantee shall pay to the Company (in cash or to the extent permitted by the Committee, Shares held by the Grantee whose Fair Market Value on the day preceding the date the Restricted Stock vests is equal to the amount of the Grantee's minimum tax withholding liability) any federal, state or local taxes of any kind required by law to be withheld, if any, with respect to the Restricted Stock for which the restrictions shall lapse. The Company or its affiliates shall, to the extent permitted by law, have the right to deduct from any payment of any kind otherwise due to the Grantee any federal, state or local taxes of any kind required by law to be withheld with respect to the shares of Restricted Stock. (b) If the Grantee properly elects, within thirty (30) days of the Grant Date, to include in gross income for federal income tax purposes an amount equal to the Fair Market Value as of the Grant Date of the Restricted Stock granted hereunder pursuant to Section 83(b) of the Internal Revenue Code of 1986, as amended, the Grantee shall pay to the Company, or make other arrangements satisfactory to the Committee to pay to the Company in the year of such grant, any federal, state or local taxes required to be withheld with respect to such Shares. If the Grantee fails to make such payments, the Company or its affiliates shall, to the extent permitted by law, have the right to deduct from any payment of any kind otherwise due to the Grantee any federal, state or local taxes of any kind required by law to be withheld with respect to such Shares. 6. No Right to Continued Employment. Nothing in this Agreement shall be deemed by implication or otherwise to impose any limitation on any right of the Company or any of its affiliates to terminate the Grantee's employment at any time, in the absence of a specific written agreement to the contrary. 7. Representations and Warranties of Grantee. The Grantee represents and warrants to the Company that: (a) Agrees to Terms of the Plan. The Grantee has received a copy of the Plan and has read and understands the terms of the Plan and this Agreement, and agrees to be bound by their terms and conditions. The Grantee acknowledges that there may be adverse tax consequences upon the vesting of Restricted Stock or disposition of the Shares once vested, and that the Grantee should consult a tax adviser prior to such time. (b) Cooperation. The Grantee agrees to sign such additional documentation as may reasonably be required from time to time by the Company. 8. Adjustment Upon Changes in Capitalization. In the event of a Change in Capitalization, the Committee may make appropriate adjustments to the number and class of shares relating to Restricted Stock as it deems appropriate, in its sole discretion, to preserve the value of this Award in accordance with the terms of the Plan. 9. Governing Law; Modification. This Agreement shall be governed by the laws of the State of Maryland without regard to the conflict of law principles. The Agreement may not be modified except in writing signed by both parties. 10. Defined Terms. Except as otherwise provided herein, or unless the context clearly indicates otherwise, capitalized terms used but not defined herein have the definitions as provided in the Plan. The terms and provisions of the Plan are incorporated herein by reference, and the Grantee hereby acknowledges receiving a copy of the Plan. In the event of a conflict or inconsistency between the discretionary terms and provisions of the Plan and the provisions of this Agreement, this Agreement shall govern and control. 11. Miscellaneous. The masculine pronoun shall be deemed to include the feminine, and the singular number shall be deemed to include the plural unless a different meaning is plainly required by the context. IN WITNESS WHEREOF, the parties hereto have signed this Agreement as of the date first above written. CRIIMI MAE Inc. By:/s/Barry S. Blattman ----------------------------------- Name: Barry S. Blattman Title: Chairman of the Board, Chief Executive Officer and President /s/Mark Jarrell ----------------------------------- Grantee EX-10 4 rest_stkagmt-coa0903.txt RESTRICTED STOCK AWARD AGMT COA Exhibit 10.9 RESTRICTED STOCK AWARD AGREEMENT This Restricted Stock Award Agreement (the "Agreement"), made as of the 3rd day of October, 2003 (the "Grant Date") by and between CRIIMI MAE Inc. (the "Company"), and Cynthia O. Azzara (the "Grantee"), evidences the grant by the Company of a stock award of restricted Shares (the "Award") to the Grantee on such date and the Grantee's acceptance of the Award in accordance with the provisions of the Company's 2001 Stock Incentive Plan, as amended or restated from time to time (the "Plan"). The Company and the Grantee agree as follows: 1. Basis for Award. This Award is made under the Plan pursuant to Section 6 thereof for services to be rendered to the Company by the Grantee. 2. Stock Awarded. (a) The Company hereby awards to the Grantee, in the aggregate, 13,055 Shares ("Restricted Stock"), which shall be subject to the restrictions and conditions set forth in the Plan and in this Agreement. (b) Each certificate issued in respect of the Restricted Stock shall be registered in the Grantee's name and deposited by him, together with a share power endorsed in blank, with the Company and shall bear the following (or a similar) legend: "THE TRANSFERABILITY OF THIS CERTIFICATE AND THE COMMON STOCK REPRESENTED HEREBY ARE SUBJECT TO THE TERMS AND CONDITIONS (INCLUDING FORFEITURE) CONTAINED IN THE RESTRICTED STOCK AWARD AGREEMENT DATED AS OF OCTOBER 3, 2003, ENTERED INTO BETWEEN THE REGISTERED OWNER AND CRIIMI MAE INC" At the expiration of the restrictions, the Company shall redeliver to the Grantee (or his legal representative, beneficiary or heir) share certificates for the Shares deposited with it without any legend except as otherwise provided by the Plan, this Agreement or as otherwise required by applicable law. The Grantee shall have the right to receive dividends on and to vote the Restricted Stock while it is held in custody except as otherwise provided by the Plan. Notwithstanding the foregoing, the Company shall retain custody of all Retained Distributions made or declared with respect to the Restricted Stock and such Retained Distributions shall be subject to the same restrictions on terms and conditions as are applicable to the Restricted Stock. (c) Except as provided in the Plan or this Agreement, including without limitation, Section 3 below, the restrictions on the Restricted Stock are that the stock will be forfeited by the Grantee and all of the Grantee's rights to such stock shall immediately terminate without any payment or consideration by the Company, in the event of any sale, assignment, transfer, hypothecation, pledge or other alienation of such Restricted Stock made or attempted, whether voluntary or involuntary, and if involuntary whether by process of law in any civil or criminal suit, action or proceeding, whether in the nature of an insolvency or bankruptcy proceeding or otherwise, without the written consent of the Committee, excluding the Grantee if she so serves on the Committee. 3. Vesting. The restrictions described in Section 2 of this Agreement will lapse with respect to 33-1/3% of Restricted Stock on December 31, 2004 and as to an additional 33-1/3% on each of December 31, 2005 and December 31, 2006, provided the Grantee is still employed by the Company (or any Parent or Subsidiary) on such vesting dates, except as set forth in the following sentences of this section. All restrictions will lapse with respect to 100% of the Restricted Stock still subject to restriction upon Grantee's death, separation from service due to Disability, or termination of employment by the Company without Cause which occurs on or prior to December 31, 2006. If the Grantee ceases to be employed by the Company (or any Parent or Subsidiary) for any other reason at any time prior to the vesting dates, the unvested Restricted Stock shall automatically be forfeited upon such cessation of service. 4. Compliance with Laws and Regulations. The issuance and transfer of Shares shall be subject to compliance by the Company and the Grantee with all applicable requirements of securities laws and with all applicable requirements of any stock exchange on which the Shares may be listed at the time of such issuance or transfer. The Grantee understands that the Company is under no obligation to register or qualify the Shares with the Securities and Exchange Commission ("SEC"), any state securities commission or any stock exchange to effect such compliance. 5. Tax Withholding. (a) The Grantee agrees that, subject to clause 5(b) below, no later than the date as of which the restrictions on the Restricted Stock shall lapse with respect to all or any of the Restricted Stock covered by this Agreement, the Grantee shall pay to the Company (in cash or to the extent permitted by the Committee, Shares held by the Grantee whose Fair Market Value on the day preceding the date the Restricted Stock vests is equal to the amount of the Grantee's minimum tax withholding liability) any federal, state or local taxes of any kind required by law to be withheld, if any, with respect to the Restricted Stock for which the restrictions shall lapse. The Company or its affiliates shall, to the extent permitted by law, have the right to deduct from any payment of any kind otherwise due to the Grantee any federal, state or local taxes of any kind required by law to be withheld with respect to the shares of Restricted Stock. (b) If the Grantee properly elects, within thirty (30) days of the Grant Date, to include in gross income for federal income tax purposes an amount equal to the Fair Market Value as of the Grant Date of the Restricted Stock granted hereunder pursuant to Section 83(b) of the Internal Revenue Code of 1986, as amended, the Grantee shall pay to the Company, or make other arrangements satisfactory to the Committee to pay to the Company in the year of such grant, any federal, state or local taxes required to be withheld with respect to such Shares. If the Grantee fails to make such payments, the Company or its affiliates shall, to the extent permitted by law, have the right to deduct from any payment of any kind otherwise due to the Grantee any federal, state or local taxes of any kind required by law to be withheld with respect to such Shares. 6. No Right to Continued Employment. Nothing in this Agreement shall be deemed by implication or otherwise to impose any limitation on any right of the Company or any of its affiliates to terminate the Grantee's employment at any time, in the absence of a specific written agreement to the contrary. 7. Representations and Warranties of Grantee. The Grantee represents and warrants to the Company that: (a) Agrees to Terms of the Plan. The Grantee has received a copy of the Plan and has read and understands the terms of the Plan and this Agreement, and agrees to be bound by their terms and conditions. The Grantee acknowledges that there may be adverse tax consequences upon the vesting of Restricted Stock or disposition of the Shares once vested, and that the Grantee should consult a tax adviser prior to such time. (b) Cooperation. The Grantee agrees to sign such additional documentation as may reasonably be required from time to time by the Company. 8. Adjustment Upon Changes in Capitalization. In the event of a Change in Capitalization, the Committee may make appropriate adjustments to the number and class of shares relating to Restricted Stock as it deems appropriate, in its sole discretion, to preserve the value of this Award in accordance with the terms of the Plan. 9. Governing Law; Modification. This Agreement shall be governed by the laws of the State of Maryland without regard to the conflict of law principles. The Agreement may not be modified except in writing signed by both parties. 10. Defined Terms. Except as otherwise provided herein, or unless the context clearly indicates otherwise, capitalized terms used but not defined herein have the definitions as provided in the Plan. The terms and provisions of the Plan are incorporated herein by reference, and the Grantee hereby acknowledges receiving a copy of the Plan. In the event of a conflict or inconsistency between the discretionary terms and provisions of the Plan and the provisions of this Agreement, this Agreement shall govern and control. 11. Miscellaneous. The masculine pronoun shall be deemed to include the feminine, and the singular number shall be deemed to include the plural unless a different meaning is plainly required by the context. IN WITNESS WHEREOF, the parties hereto have signed this Agreement as of the date first above written. CRIIMI MAE Inc. By:/s/Mark Jarrell ---------------------------------------- Name: Mark Jarrell Title: President and Chief Operating Officer /s/Cynthia O. Azzara ---------------------------------------- Grantee EX-10 5 cont_rel-agmt0803.txt CONSENT AGREEMENT AND RELEASE BLH 0803 Exhibit 10.10 CONSULTING AGREEMENT AND RELEASE THIS CONSULTING AGREEMENT ("Consulting Agreement" or "Agreement")) is made and entered into effective as of the 25th day of August, 2003 at 5:30 P.M. EST ("Effective Date"), by and between CRIIMI MAE, Inc., a Maryland corporation (the "Company") and Brian L. Hanson ("Consultant"). W I T N E S S E T H: ------------------- WHEREAS, Consultant previously served as a Senior Vice President of the Company (the "Employment"); and WHEREAS, the Company desires to secure the services of Consultant as a consultant on the terms and conditions herein provided. NOW, THEREFORE, for and in consideration of the mutual promises, covenants and obligations contained herein, the Company and Consultant agree as follows: 1. RETENTION OF CONSULTANT Company hereby engages the services of Consultant to provide consulting services as described herein. 2. TERM This Consulting Agreement shall commence on the Effective Date and end on the earlier of: (A) December 31, 2003; (B) thirty (30) days after the commencement of employment of the Company's new head of asset management; or (C) a material breach by Consultant or Company in the performance of their respective duties under this Consulting Agreement which goes uncured for a period of five (5) business days after written notice of such breach has been delivered (the "Consulting Period"). 3. OBLIGATIONS OF CONSULTANT A. Consultant's duties and powers shall include such projects as may be reasonably requested by the Company and which are reasonably consistent with his duties and responsibilities as existed with the Company immediately prior to the termination of Consultant's Employment as an executive with the Company (the "Services"). Consultant shall work on a full-time basis during the Consulting Period. Consultant will use reasonable diligence in performing the Services. B. Consultant shall meet with and advise Company on matters relating to the Services at such times as reasonably requested by the Company. 1 4. COMPENSATION During the Consulting Period, the Company shall pay to Consultant, in consideration of his Services and the Release contemplated hereunder, a monthly consulting fee in an amount equal to $30,000 (pro-rated for partial months during the Consulting Period based on the business days worked by Consultant during such month over the number of business days in such month) (the "Fee"). The Fee for any month shall be paid on the last day of such month. In addition to the Fee, Consultant shall be entitled to business expense reimbursement during the Consulting Period in accordance with the business expense reimbursement policy of the Company as it may exist from time to time. 5. RELATIONSHIP OF PARTIES In performing services hereunder, Consultant will at all times and for all purposes, constitute an independent contractor and not an employee, officer or agent of the Company or any of its subsidiaries or affiliates. In no event will Consultant be, or represent himself to be, an officer, employee or agent of the Company or any subsidiary or affiliate of the Company nor will Consultant bind, or attempt to bind, the Company or any subsidiary or affiliate of the Company to any contract, agreement, liability or obligation of any nature. The Company will not be required to provide any Company benefits to Consultant which it provides to its employees including without limitation retirement plans, insurance programs and vacation whether or not Consultant is determined to actually be an employee by any agency, court or tribunal during the Consulting Period. In addition, unless otherwise determined by the Company, the Company shall be under no obligation to withhold any taxes or other amounts to be paid to Consultant in the form of Fees for his service as a consultant. 6. NOTICE AND PAYMENT A. Any notice required to be given under the terms of this Consulting Agreement shall be in writing and delivered personally to the other designated party at the above stated address or mailed by certified, registered (return receipt requested) or by Federal Express. B. Either party may change the address to which notice or payment is to be sent by written notice to the other under any provision of this paragraph. 7. JURISDICTION/DISPUTES This Consulting Agreement shall be governed in accordance with the laws of the State of Maryland without giving effect to that state's conflict of law principles. Any controversy or claim arising out of or relating to this Agreement, or the breach thereof, shall be settled by binding arbitration in Montgomery County, Maryland in accordance with the Commercial Arbitration Rules of the American Arbitration Association. Either party may provide the other a written request for binding arbitration ("Request for Arbitration"). Arbitration shall commence within thirty days of the date of the Request for Arbitration. A judgment upon the award rendered by the arbitrator or arbitrators may be entered in any court having jurisdiction thereof. The arbitrator or arbitrators shall be deemed to possess the powers to issue mandatory orders and restraining orders in connection with such arbitration. The expenses of the arbitration shall be borne equally by the parties to the arbitration, provided that each party 2 shall pay for and bear costs of its own experts and counsel's fees; provided, that, the arbitrator shall have the right to award payment of reasonable legal fees and expenses to the prevailing party in such arbitration. 8. CONSULTING AGREEMENT BINDING ON SUCCESSORS The provisions herein shall be binding upon and shall inure to the benefit of the Parties hereto, their heirs, administrators, and permitted successors and assigns. 9. ASSIGNABILITY The rights and obligations hereunder may not be assigned by any act without the prior written consent of the other Party hereto. 10. WAIVER No waiver by either Party of any default shall be deemed as a waiver of prior or subsequent default of the same or other provisions of this Consulting Agreement. 11. SEVERABILITY If any term, clause or provision hereof is held invalid or unenforceable by a court of competent jurisdiction, such invalidity shall not affect the validity or operation of any other term, clause or provision and such invalid term, clause or provision shall be deemed to be severed from this Consulting Agreement. 12. INTEGRATION This Consulting Agreement constitutes the entire understanding of the Parties and is intended as a final expression of their agreement with respect to the subject matter hereof. It shall not be modified or amended except in writing signed by the Parties hereto and specifically referring to this Consulting Agreement. 13. COUNTERPARTS This Consulting Agreement may be executed in one or more counterparts, each of which shall be deemed to be an original, but all of which together will constitute one and the same agreement. 14. JOINT DRAFTING The Parties acknowledge and agree that this Agreement was jointly drafted by the Company on the one side and by Consultant on the other side and in the case of any ambiguity contained in this Agreement, such ambiguity shall not be interpreted against the drafter. 15. NO WARRANTIES; LIMITATION ON LIABILITY OF CONSULTANT The Parties acknowledge and agree that Consultant does not make any warranty, express or implied, with respect to the Services rendered by Consultant or the results obtained from work performed by Consultant. In no event shall Consultant be liable for consequential, incidental, special or indirect damages, or for acts of negligence which are not intentional or gross in nature, regardless of whether either party has been advised of the possibility of such damages. If Consultant is adjudicated by a court of competent jurisdiction and found to have engaged in gross 3 negligence or willful or intentional misconduct, Company hereby agrees that Consultant's liability hereunder for damages, regardless of the form of action, shall not exceed the total amount of the Fees actually paid by the Company to Consultant under the terms of this Consulting Agreement. Company hereby agrees that any breach by Consultant of this Agreement shall not be the basis for Company to claim any right to refuse to perform its obligations under the Employment Agreement, dated July 25, 2001, between CRIIMI and Executive as it has been amended from time to time (the "Employment Agreement"), and that Company shall not be entitled by reason of Consultant's breach hereunder to take or claim any setoff or recoupment against any rights which Consultant may have under the terms of the Employment Agreement. 16. RELEASE Consultant hereby acknowledges that the termination of his employment with the Company was due to the failure of the parties to reach a mutual agreement on an extension of the Term (as defined in the Employment Agreement) thereof and was not a wrongful termination by the Company and its affiliates or by Consultant. In consideration of the benefits provided in this Agreement, including, without limitation, payment of the Fees, Consultant agrees to the limited release of the Company and its respective current and former officers, directors, shareholders, employees, representatives, heirs, attorneys and agents, as well as its respective predecessors, parent companies, subsidiaries, affiliates divisions, successors and assigns and their respective current and former officers, directors, shareholders, employees, representatives, attorneys and agents (the "Released Parties") from all claims, liabilities, and causes of action which Consultant had, now has or may have against the Released Parties related to his employment and the termination thereof and arising under: (i) any claim, tort or cause of action for wrongful or unlawful discharge or demotion, violation of public policy, invasion of privacy, intentional or negligent infliction of emotional distress, defamation, unlawful effort to prevent employment, discrimination on the basis of race, color, sex, national origin, ancestry, religion, age, disability, handicap, medical condition or marital status; (ii) Title VII of the Civil Rights Act of 1964, as amended; (iii) The National Labor Relations Act, as amended; (iv) The Civil Rights Act of 1991; (v) Sections 1981 through 1988 of Title 42 of the United States Code, as amended; (vi) The Immigration Reform Control Act, as amended; (vii) The Americans With Disabilities Act of 1990, as amended; (viii) The Age Discrimination in Employment Act of 1967, as amended; (iv) The Occupational Safety and Health Act, as amended; (x) The Family and Medical Leave Act of 1993; (xi) Maryland Occupational Health and Safety Laws; (xii) Maryland Fair Employment Practice Act; and (xiii) Montgomery County Discrimination Laws. This release shall not include any claim arising under any national, state or local statute, law, or ordinance other than those herein delineated, and shall specifically exclude any claims, liabilities, causes of action or attorneys' fees arising from the Company's obligations under the Employment Agreement including Consultant's right to receive all wages and benefits thereunder, Consultant's rights under the Employee Retirement Income Security Act of 1974, as amended, and Consultant's rights to receive all insurance, including indemnification and defense rights and benefits he is eligible to receive. This limited release is solely for the benefit of the Released Parties and shall in no way release any rights or benefits to which Consultant may be entitled from any other entity or person. 4 [the next page is the signature page] 5 IN WITNESS WHEREOF, the parties hereto have executed this Consulting Agreement as of the date first written above. CRIIMI MAE, INC. 11200 Rockville Pike Rockville, Maryland, 20852 By:/s/Barry S. Blattman ----------------------------------- Barry S. Blattman Chairman of the Board, Chief Executive Officer and President /s/Brian L. Hanson ---------------------------------- Brian L. Hanson 18522 Viburnum Way Olney, Maryland 20832 6 EX-10 6 ablmn_ltr-102903.txt STEPHEN ABELMAN EMPLOYMENT LETTER Exhibit 10.11 CRIIMI MAE Inc. 11200 Rockville Pike, Suite 400 Rockville, MD 20852 October 28, 2003 Stephen M. Abelman 11708 Ibsen Drive Rockville, MD 20852 Dear Mr. Abelman: On behalf of CRIIMI MAE Inc. (the "Company"), we are delighted to offer you ("you") employment in the position of Executive Vice President of Asset Management of the Company and as an employee of CRIIMI MAE Services Limited Partnership (the "Employer", together with the Company, "CRIIMI"), in accordance with and pursuant to the following terms and conditions of this letter (the "Agreement"): Provision Agreement 1. Effective Date October 29, 2003 (the "Effective Date"). 2. Term The term of your employment under this Agreement (the "Term") shall commence on the Effective Date and shall have no specific time period and you shall be an "at will" employee of CRIIMI such that CRIIMI or you may terminate your employment with CRIIMI at any time and for any reason (or no reason). Upon your termination of employment with CRIIMI, if requested by the Chairman or the President of the Company, you shall resign all other officerships and directorships you hold with CRIIMI and their affiliates. 3. Position, Reports and Duties During the Term, you shall serve as an employee of the Employer and as the Executive Vice President of Asset Management and shall report to the President and Chief Operating Officer of the Company (the "COO"). You shall have those powers and duties normally associated with your position and such other powers and duties as may be prescribed by the COO and/or the Board of Directors of the Company (the "Board"). You shall devote all of your working time, attention and energies to the performance of your duties for CRIIMI. 4. Base Salary Beginning on the Effective Date, you shall be paid a base salary of $300,000 annually, subject to annual increase (but not 1 decrease) to be paid in accordance with the CRIIMI's payroll practices ("Base Salary"). 5. Annual Bonus Target Commencing on January 1, 2004 and for each calendar year thereafter during the Term, you shall be eligible for an annual bonus upon the achievement of objective financial goals established by CRIIMI (the "Annual Bonus") prior to the start of each calendar year during the Term. CRIIMI shall establish the target amount of the Annual Bonus for which you are eligible prior to the start of each calendar year during the Term. Provided you are still employed by CRIIMI, your guaranteed minimum Annual Bonus for the 2004, 2005 and 2006 calendar years shall be $100,000. Any such Annual Bonus earned during a calendar year shall be paid at such time as CRIIMI customarily pays annual bonuses, but you shall receive the entirety of the Annual Bonus to which you are entitled if you are employed with CRIIMI as of December 31 of such calendar year. If your employment is terminated (i) by CRIIMI for any reason other than Cause (as defined below) or (ii) due to your death or permanent and total disability within the meaning of Section 22(e)(3) of the Internal Revenue Code of 1986, as amended (the "Code"), you shall be paid a pro-rated portion of your guaranteed minimum Annual Bonus for the year of termination based on the number of days you worked during the relevant calendar year divided by 365 or 366 in the case of a leap year (e.g., if you are terminated without Cause by CRIIMI on April 30, 2005, you shall be paid a pro-rated portion of the guaranteed minimum Annual Bonus that would have been paid for the year of termination equal to $100,000 X 120/365 or $32,876.71). If your employment should be terminated by you for any reason or by CRIIMI for Cause during any calendar year, no Annual Bonus, including a guaranteed minimum Annual Bonus, will be paid for such calendar year or any future calendar year. 6. Restricted Stock On the Effective Date, or as soon as feasible thereafter, subject to the approval of the Compensation and Stock Option Committee of the Board of Directors of the Company (the "Committee"), you shall be granted a restricted stock award of common stock, $.01 par value per share, of the Company ("Common Stock") in an amount of whole shares equal to 2 12,500 (the "2003 Stock Award"). The 2003 Stock Award shall be granted under the terms of the Company's stock incentive plan as evidenced by a restricted stock award agreement substantially in the form attached hereto as Exhibit A. Provided you are still then employed by CRIIMI, on each of December 31, 2004, December 31, 2005 and December 31, 2006, subject to the approval of the Committee, you shall be granted a stock award in an amount of whole shares (fractional shares to be settled in cash) equal to $50,000 divided by the closing price of the Common Stock on the relevant December 31 (the "Additional Awards"). Each such Additional Award shall vest as to 33-1/3% of the shares subject thereto on each of the first three anniversaries of the date of grant of the relevant Additional Award; provided, that, you are still then employed by CRIIMI on the relevant vesting dates. If your employment is terminated at any time due to your death or permanent and total disability within the meaning of Section 22(e)(3) of the Internal Revenue Code of 1986, as amended (the "Code") or your employment is terminated by CRIIMI without Cause, then, with respect to each Additional Award that has been granted to you prior to such date of termination of employment, all restrictions on any such Additional Award(s) shall automatically lapse as of such date. If your employment with CRIIMI terminates for any other reason, each Additional Award, or portion thereof, still subject to restriction, shall be forfeited. For purposes of this Agreement, CRIIMI shall have "Cause" to terminate your employment upon your (i) conviction of, or plea of guilty or nolo contendere to, a felony; or (ii) material breach of the Agreement which is not cured, if curable, within ten (10) days following CRIIMI's written notice to you of the event giving rise to such breach; or (iii) willful misconduct that is materially injurious to CRIIMI; or (iv) habitual drug or alcohol use which materially impairs your ability to perform your duties for CRIIMI; or (v) engaging in fraud, embezzlement or any other illegal conduct with respect to CRIIMI or any of their affiliates which is materially injurious to CRIIMI. 7. Employee Benefits During the Term, you shall be eligible to participate in all of CRIIMI's benefit plans, in accordance with their terms, at a level equal to or greater than that made available to all other executives or employees of CRIIMI generally, except the Chief Executive Officer and President and COO. 3 8. Termination Except as provided in Sections 5 and 6 of this Agreement, upon your termination of employment with CRIIMI for any reason, you shall be paid any earned, but yet unpaid Base Salary through the date of termination of employment with CRIIMI, all accrued, but unused vacation pay through the date of termination of employment with CRIIMI and you shall not receive any other payments or benefits from CRIIMI except as otherwise required by (i) applicable law; (ii) the terms and conditions of any CRIIMI employee benefit or compensation plans (other than as noted in Section 2); or (iii) any other CRIIMI policy or practice (e.g., officer indemnification). 9. Governing Law This Agreement is governed by, and is to be construed and enforced in accordance with, the laws of the State of Maryland without regard to principles of conflicts of laws. 10. Miscellaneous (a) Counterparts. This Agreement may be executed in two or more-counterparts, each of which shall be deemed to be an original but all of which together will constitute one and the same instrument. (b) Entire Agreement. This Agreement sets forth the entire agreement of the parties hereto in respect of the subject matter contained herein and supersede all prior agreements, promises, covenants, arrangements, communications, representations or warranties, whether oral or written, by any officer, employee or representative of any party hereto in respect of such subject matter. Any prior agreement of the parties hereto in respect of the subject matter contained herein, including, without limitation, the Independent Contractor Agreement between CRIIMI MAE Services Limited Partnership and you, dated as of August 12, 2003, upon payment of all amounts due and owing to you thereunder, is hereby terminated and canceled as of the Effective Date. In consideration for entering into this Agreement, you hereby agree to waive any right to receive compensation from any third party for any services related to the restructuring, modification, disposition, transfer, assignment or assumption of the mortgage loan related to, or the underlying property known as Sheraton Orlando North. (c) Section Headings. The section headings in this Agreement are for convenience of reference only, and they form no part of this Agreement and shall not affect its interpretation. 4 (d) Withholding. All payments hereunder shall be subject to any required withholding of Federal, state and local taxes pursuant to any applicable law or regulation. 11. D&O Insurance During the Term, you shall be covered by any directors and officers insurance the Company maintains from time to time by the Company for its directors and officers. In addition, you shall be entitled throughout the Term in your capacity as an officer and/or director of the Company the benefit of the indemnification provisions contained in the Certificate of Incorporation and/or By-laws of the Company as in effect from time to time, to the extent not prohibited by applicable law at the time of the assertion of any liability against you. 12. Place of Performance Your principal place of employment shall be at the Company's offices in Rockville, Maryland. 5 If you are in agreement with the terms and conditions of this Agreement, please execute and date both copies and return one to me at the address set forth above. Sincerely, CRIIMI MAE Inc. /s/Mark R. Jarrell ------------------------------------- Mark R. Jarrell President and Chief Operating Officer CRIIMI MAE SERVICES Limited Partnership By: CMSLP Management Company, Inc., its general partner /s/Mark R. Jarrell ------------------------------------- Mark R. Jarrell President and Chief Operating Officer Accepted and agreed to: /s/Stephen M. Abelman October 29, 2003 - ------------------------------ ------------------------------ Stephen M. Abelman Date 6 EX-10 7 ablmn_stkagmt-110603.txt RESTRICTED STOCK AWARD AGMT S. ABELMAN 110603 Exhibit 10.12 RESTRICTED STOCK AWARD AGREEMENT This Restricted Stock Award Agreement (the "Agreement"), made as of the 6th day of November, 2003 (the "Grant Date") by and between CRIIMI MAE Inc. (the "Company"), and Stephen M. Abelman (the "Grantee"), evidences the grant by the Company of a stock award of restricted Shares (the "Award") to the Grantee on such date and the Grantee's acceptance of the Award in accordance with the provisions of the Company's 2001 Stock Incentive Plan, as amended or restated from time to time (the "Plan"). The Company and the Grantee agree as follows: 1. Basis for Award. This Award is made under the Plan pursuant to Section 6 thereof for services to be rendered to the Company by the Grantee. 2. Stock Awarded. (a) The Company hereby awards to the Grantee, in the aggregate, 12,500 Shares ("Restricted Stock"), which shall be subject to the restrictions and conditions set forth in the Plan and in this Agreement. (b) Each certificate issued in respect of the Restricted Stock shall be registered in the Grantee's name and deposited by him, together with a share power endorsed in blank, with the Company and shall bear the following (or a similar) legend: "THE TRANSFERABILITY OF THIS CERTIFICATE AND THE COMMON STOCK REPRESENTED HEREBY ARE SUBJECT TO THE TERMS AND CONDITIONS (INCLUDING FORFEITURE) CONTAINED IN THE RESTRICTED STOCK AWARD AGREEMENT DATED AS OF NOVEMBER 6, 2003, ENTERED INTO BETWEEN THE REGISTERED OWNER AND CRIIMI MAE INC" At the expiration of the restrictions, the Company shall redeliver to the Grantee (or his legal representative, beneficiary or heir) share certificates for the Shares deposited with it without any legend except as otherwise provided by the Plan, this Agreement or as otherwise required by applicable law. The Grantee shall have the right to receive dividends on and to vote the Restricted Stock while it is held in custody except as otherwise provided by the Plan. Notwithstanding the foregoing, the Company shall retain custody of all Retained Distributions made or declared with respect to the Restricted Stock and such Retained Distributions shall be subject to the same restrictions on terms and conditions as are applicable to the Restricted Stock. (c) Except as provided in the Plan or this Agreement, including without limitation, Section 3 below, the restrictions on the Restricted Stock are that the stock will be forfeited by the Grantee and all of the Grantee's rights to such stock shall immediately terminate without any payment or consideration by the Company, in the event of any sale, assignment, transfer, hypothecation, pledge or other alienation of such Restricted Stock made or attempted, 2 whether voluntary or involuntary, and if involuntary whether by process of law in any civil or criminal suit, action or proceeding, whether in the nature of an insolvency or bankruptcy proceeding or otherwise, without the written consent of the Committee, excluding the Grantee if he so serves on the Committee. 3. Vesting. The restrictions described in Section 2 of this Agreement will lapse with respect to 33-1/3% of Restricted Stock on December 31, 2004 and as to an additional 33-1/3% on each of December 31, 2005 and December 31, 2006, provided the Grantee is still employed by the Company (or any Parent or Subsidiary) on such vesting dates. All restrictions will lapse with respect to 100% of the Restricted Stock still subject to restriction upon Grantee's death, separation from service due to Disability, or termination of employment by the Company without Cause which occurs on or prior to December 31, 2006. If the Grantee ceases to be employed by the Company (or any Parent or Subsidiary) for any other reason at any time prior to the vesting dates, the unvested Restricted Stock shall automatically be forfeited upon such cessation of service. 4. Compliance with Laws and Regulations. The issuance and transfer of Shares shall be subject to compliance by the Company and the Grantee with all applicable requirements of securities laws and with all applicable requirements of any stock exchange on which the Shares may be listed at the time of such issuance or transfer. The Grantee understands that the Company is under no obligation to register or qualify the Shares with the Securities and Exchange Commission ("SEC"), any state securities commission or any stock exchange to effect such compliance. 5. Tax Withholding. (a) The Grantee agrees that, subject to clause 5(b) below, no later than the date as of which the restrictions on the Restricted Stock shall lapse with respect to all or any of the Restricted Stock covered by this Agreement, the Grantee shall pay to the Company (in cash or to the extent permitted by the Committee, Shares held by the Grantee whose Fair Market Value on the day preceding the date the Restricted Stock vests is equal to the amount of the Grantee's minimum tax withholding liability) any federal, state or local taxes of any kind required by law to be withheld, if any, with respect to the Restricted Stock for which the restrictions shall lapse. The Company or its affiliates shall, to the extent permitted by law, have the right to deduct from any payment of any kind otherwise due to the Grantee any federal, state or local taxes of any kind required by law to be withheld with respect to the shares of Restricted Stock. (b) If the Grantee properly elects, within thirty (30) days of the Grant Date, to include in gross income for federal income tax purposes an amount equal to the Fair Market Value as of the Grant Date of the Restricted Stock granted hereunder pursuant to Section 83(b) of the Internal Revenue Code of 1986, as amended, the Grantee shall pay to the Company, or make other arrangements satisfactory to the Committee to pay to the Company in the year of such grant, any federal, state or local taxes required to be withheld with respect to such Shares. If the Grantee fails to make such payments, the Company or its affiliates shall, to the extent permitted by law, have the right to deduct from any payment of any kind otherwise due to the 3 Grantee any federal, state or local taxes of any kind required by law to be withheld with respect to such Shares. 6. No Right to Continued Employment. Nothing in this Agreement shall be deemed by implication or otherwise to impose any limitation on any right of the Company or any of its affiliates to terminate the Grantee's employment at any time, in the absence of a specific written agreement to the contrary. 7. Representations and Warranties of Grantee. The Grantee represents and warrants to the Company that: (a) Agrees to Terms of the Plan. The Grantee has received a copy of the Plan and has read and understands the terms of the Plan and this Agreement, and agrees to be bound by their terms and conditions. The Grantee acknowledges that there may be adverse tax consequences upon the vesting of Restricted Stock or disposition of the Shares once vested, and that the Grantee should consult a tax adviser prior to such time. (b) Cooperation. The Grantee agrees to sign such additional documentation as may reasonably be required from time to time by the Company. 8. Adjustment Upon Changes in Capitalization. In the event of a Change in Capitalization, the Committee may make appropriate adjustments to the number and class of shares relating to Restricted Stock as it deems appropriate, in its sole discretion, to preserve the value of this Award in accordance with the terms of the Plan. 9. Governing Law; Modification. This Agreement shall be governed by the laws of the State of Maryland without regard to the conflict of law principles. The Agreement may not be modified except in writing signed by both parties. 10. Defined Terms. Except as otherwise provided herein, or unless the context clearly indicates otherwise, capitalized terms used but not defined herein have the definitions as provided in the Plan. The terms and provisions of the Plan are incorporated herein by reference, and the Grantee hereby acknowledges receiving a copy of the Plan. In the event of a conflict or inconsistency between the discretionary terms and provisions of the Plan and the provisions of this Agreement, this Agreement shall govern and control. 11. Miscellaneous. The masculine pronoun shall be deemed to include the feminine, and the singular number shall be deemed to include the plural unless a different meaning is plainly required by the context. 4 IN WITNESS WHEREOF, the parties hereto have signed this Agreement as of the date first above written. CRIIMI MAE Inc. By:/s/Mark R. Jarrell ----------------------------------------------- Name: Mark R. Jarrell Title: President and Chief Operating Officer /s/Stephen M. Abelman -------------------------------------- Grantee EX-31 8 cert_31bsb-1103.txt BARRY S. BLATTMAN CERTIFICATION Exhibit 31.1 CERTIFICATION I, Barry S. Blattman, certify that: 1. I have reviewed this quarterly report on Form 10-Q of CRIIMI MAE Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 14, 2003 /s/Barry S. Blattman ------------------------ ----------------------------------- Barry S. Blattman Chairman of the Board and Chief Executive Officer EX-31 9 cert_31coa-1103.txt CYNTHIA O. AZZARA CERTIFICATION Exhibit 31.2 CERTIFICATION I, Cynthia O. Azzara, certify that: 1. I have reviewed this quarterly report on Form 10-Q of CRIIMI MAE Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 14, 2003 /s/Cynthia O. Azzara ------------------------ --------------------------------- Cynthia O. Azzara Executive Vice President, Chief Financial Officer and Treasurer EX-32 10 cert2_32bsb-1103.txt BARRY S. BLATTMAN CERTIFICATION EXH 32 Exhibit 32.1 Certification This certification is provided pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and accompanies the quarterly report on Form 10-Q (the "Form 10-Q") for the quarter ended September 30, 2003 of CRIIMI MAE Inc. (the"Issuer"). I, Barry S. Blattman, Chief Executive Officer, certify that to the best of my knowledge: (i) the Form 10-Q fully complies with the requirements of Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m(a) or 78o(d)); and (ii) the information contained in the Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of the Issuer. November 14, 2003 /s/Barry S. Blattman - --------------------------- ------------------------------------- DATE Barry S. Blattman Chairman of the Board and Chief Executive Officer EX-32 11 cert2_32coa-1103.txt CYNTHIA O. AZZARA CERTIFICATION EXH 32 Exhibit 32.2 Certification This certification is provided pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and accompanies the quarterly report on Form 10-Q (the "Form 10-Q") for the quarter ended September 30, 2003 of CRIIMI MAE Inc. (the "Issuer"). I, Cynthia O. Azzara, Chief Financial Officer, certify that to the best of my knowledge: (i) the Form 10-Q fully complies with the requirements of Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m(a) or 78o(d)); and (ii) the information contained in the Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of the Issuer. November 14, 2003 /s/Cynthia O. Azzara - --------------------------- ------------------------------------- DATE Cynthia O. Azzara Executive Vice President, Chief Financial Officer and Treasurer EX-99 12 sp_ser-sept03.txt SPECIAL SERVICING EXHIBIT Exhibit 99.1 Special Serviced Loan Detail Report as of September 2003
Special # of Scheduled Service Underlying Months Balance as Asset Type Prop Type Transaction PROPERTY NAME CITY ST Delinq of Sept 2003 CBO1 REO Healthcare NASC 1994-C3 Fallon Fallon NV 29 3,512,867 CBO1 Monetary Hotel NASC 1994-C3 Super 8 Florence KY 0 1,371,736 CBO1 Monetary Healthcare NASC 1994-C3 Oakwood Manor Dyersburg TN 1 1,059,891 CBO1 Monetary Healthcare NASC 1994-C3 Briarwood Manor Lexington TN 1 1,218,308 CBO1 Monetary Healthcare NASC 1994-C3 Whitehaven Manor Memphis TN 1 1,858,741 CBO1 Monetary Healthcare NASC 1994-C3 Parkview Manor Humboldt TN 1 1,526,284 CBO1 REO Healthcare ASC 1995-D1 Golden Age Lyons IL 38 3,174,844 CBO1 REO Hotel ASC 1995-D1 Days Inn - Airport Savannah GA 23 3,652,490 CBO1 REO Hotel ASC 1995-D1 Days Inn - Abercorn Savannah GA 23 2,364,719 CBO1 Monetary Hotel ASC 1995-D1 SREE-Cmfrt Inn-Spartansburg Spartansburg SC 5 1,603,696 CBO1 Monetary Healthcare ASC 1995-D1 Colonial Manor Rehab Center Weymouth MA 1 4,981,960 CBO1 Monetary Hotel ASC 1996-D2 American Inn, Independence Independence MO 16 2,980,738 CBO1 Monetary Hotel ASC 1996-D2 American Motel, Kansas City Kansas City KS 16 2,627,272 CBO1 Monetary Hotel ASC 1996-D2 American Motel, Wheat Ridge Wheat Ridge CO 16 2,213,127 CBO1 Monetary Hotel ASC 1996-D2 Interstate Inn, Cncl Bluffs Council Bluffs IA 16 2,066,480 CBO1 Monetary Hotel ASC 1996-D2 American Inn, Springfield Springfield MO 16 1,935,228 CBO1 Monetary Hotel ASC 1996-D2 Interstate Inn, Blue Springs Blue Springs MO 16 1,906,211 CBO1 Monetary Hotel ASC 1996-D2 American Inn, Hammond Hammond IN 16 1,904,602 CBO1 Monetary Hotel ASC 1996-D2 American Inn, Blue Springs Blue Springs MO 16 1,605,865 CBO1 Monetary Hotel ASC 1996-D2 Interstate Inn, Wheat Ridge Wheat Ridge CO 16 1,407,681 CBO1 REO Hotel ASC 1996-D2 Homegate - El Paso El Paso TX 34 8,215,498 CBO1 REO Hotel ASC 1996-D2 Homegate - Fiesta Park San Antonio TX 34 8,215,498 CBO1 REO Hotel ASC 1996-D2 Harvey Hotel, LBJ Dallas TX 3 5,626,261 CBO1 Monetary Hotel ASC 1996-D2 Woodfin Suites Rockville MD 0 11,199,020 CBO1 REO Hotel ASC 1996-D2 Ramada Inn-Mobile Mobile AL 22 6,196,629 CBO1 Monetary Hotel ASC 1996-D2 Sheraton-Shreveport Shreveport LA 7 5,176,792 CBO1 Monetary Hotel ASC 1996-D2 Quality Inn Center-Seattle Seattle WA 3 1,988,930 CBO1 Monetary Hotel ASC 1996-D2 Days Inn Westhaven West Haven CT 0 2,265,397 CBO1 Monetary Hotel ASC 1996-D2 Richmond-Super 8 Richmond VA 0 821,716 CBO1 Monetary Hotel ASC 1996-D2 Martinsburg-Super 8 Martinsburg WV 0 663,694 CBO1 Monetary Hotel SASCO(LBCMT)1995-C2 Holiday Inn North Fort Worth Fort Worth TX 9 8,502,874 CBO1 Monetary Hotel SASCO(LBCMT)1995-C2 Holiday Inn South Fort Worth Fort Worth TX 9 6,470,030 CBO1 Monetary Retail SASCO(LBCMT)1995-C2 Wheaton Plaza Shpng Center Millville NJ 15 2,835,692 CBO1 Monetary Retail DLJMAC 1995-CF2 Columbia Mall Hemlock PA 0 22,223,999 CBO1 Monetary Retail DLJMAC 1995-CF2 Huntsville West Shpng Center Huntsville AL 0 9,160,430 CBO1 REO Hotel MLMI 1995-C3 Ramada Inn Nashville Nashville TN 23 2,250,056 CBO1 REO Hotel MLMI 1995-C3 Memphis Econolodge Airport Memphis TN 20 1,381,941 CBO1 Monetary Hotel MLMI 1995-C3 Ramada Inn Montgomery Montgomery AL 3 791,729 CBO1 Monetary Retail MLMI 1995-C3 7340 International Drive Orlando FL 9 7,282,780 CBO1 Monetary Retail MLMI 1995-C3 Kmart Plaza (Cadillac, MI) Cadillac MI 4 4,302,902 CBO2 Monetary Multifamily DLJMAC 1996-CF2 Las Cortes Apartments Dallas TX 0 5,387,631 CBO2 Monetary Multifamily DLJMAC 1996-CF2 Vista Villas Rtrmt Community New Braunfels TX 3 1,219,480 CBO2 Monetary Retail DLJMAC 1996-CF2 Northland Mall Shpng Center Carol Stream IL 0 4,483,237 CBO2 REO Retail DLJMAC 1996-CF2 Eagle Country Market Clinton IA 38 3,224,010 CBO2 Monetary Healthcare DLJMAC 1997-CF2 Abington Manor Westland MI 3 8,590,868 CBO2 Monetary Multifamily DLJMAC 1997-CF2 Willowdaile Apartments Durham NC 8 4,548,266
Special Serviced Loan Detail Report as of September 2003
Special # of Scheduled Service Underlying Months Balance as Asset Type Prop Type Transaction PROPERTY NAME CITY ST Delinq of Sept 2003 CBO2 Monetary Retail DLJMAC 1997-CF2 Mercado Mediterranean Vllg Orlando FL 17 16,533,942 CBO2 Monetary Retail DLJMAC 1997-CF2 Washington Prk Plz Shpng Ctr Homewood IL 8 4,105,639 CBO2 Monetary Office DLJMAC 1997-CF2 Tropicana Plaza Office Park Las Vegas NV 0 2,731,797 CBO2 Covenant Office DLJMAC 1997-CF2 Research & Development Bldg Mountain View CA 0 2,468,245 CBO2 Monetary Retail DLJMAC 1997-CF2 Fenton Park Mall Fenton MO 0 2,568,155 CBO2 Monetary Hotel DLJMAC 1997-CF2 Four Points Riverwalk N.(G) San Antonio TX 10 12,223,248 CBO2 Monetary Hotel DLJMAC 1997-CF2 Ramada Resort - Maingate(G) Kissimmee FL 10 9,115,643 CBO2 Monetary Hotel DLJMAC 1997-CF2 Holiday Inn - Maingate W.(G) Kissimmee FL 11 8,586,199 CBO2 Monetary Hotel DLJMAC 1997-CF2 EconoLodge-Hawaiian Rsrt(G) Kissimmee FL 10 8,425,063 CBO2 Monetary Hotel DLJMAC 1997-CF2 Holiday Inn Express (G) Orlando FL 10 6,767,674 CBO2 Monetary Retail FULB 1997-C1 The Sports Authority Pembroke Pines FL 0 12,553,679 CBO2 Monetary Multifamily FULB 1997-C1 Landmark Apartments Tuscaloosa AL 1 4,658,240 CBO2 Monetary Multifamily FULB 1997-C1 Broadmoor Apartments Meridian MS 1 4,546,441 CBO2 Monetary Hotel FULB 1997-C1 Days Inn - Atlanta Airport College Park GA 23 3,845,200 CBO2 Monetary Multifamily FULB 1997-C1 Lake Mist Charlotte NC 11 3,509,032 CBO2 Monetary Hotel FULB 1997-C1 Comfort Inn Bensalem PA 5 3,221,109 CBO2 Monetary Hotel FULB 1997-C1 Crestview Holiday Inn Crestview FL 10 3,157,431 CBO2 Monetary Hotel FULB 1997-C1 Best Western Patio Motel New Orleans LA 7 2,920,735 CBO2 Monetary Multifamily FULB 1997-C1 Renaissance Parc Apartments San Antonio TX 7 2,898,344 CBO2 Monetary Healthcare FULB 1997-C1 Country Gardens Norcross GA 19 2,319,435 CBO2 Monetary Industrial FULB 1997-C1 1000 West Crosby Carrollton TX 1 1,943,749 CBO2 Monetary Hotel FULB 1997-C1 Holiday Inn Bay City Bay City MI 6 1,954,604 CBO2 Monetary Healthcare FULB 1997-C1 Gaulden Manor Nursing Center Baltimore OH 43 933,619 CBO2 Monetary Retail SASCO(LBCMT)1996-C2 Newington Plaza Newington CT 0 6,923,744 CBO2 REO Hotel SASCO(LBCMT)1996-C2 Hilton Hotel Sioux City Sioux City IA 20 5,019,702 CBO2 REO Hotel SASCO(LBCMT)1996-C2 Holiday Inn Wichita Wichita KS 20 4,415,753 CBO2 REO Hotel SASCO(LBCMT)1996-C2 Holiday Inn Augusta Augusta GA 20 3,383,397 CBO2 REO Hotel SASCO(LBCMT)1996-C2 Best Western Des Moines Des Moines IA 20 2,771,734 CBO2 REO Hotel SASCO(LBCMT)1996-C2 Holiday Inn Richfield Richfield OH 20 2,599,335 CBO2 Monetary Hotel SASCO(LBCMT)1996-C2 Hampton Inn Austell Austell GA 7 2,422,791 CBO2 Monetary Healthcare SASCO(LBCMT)1996-C2 Franciscan Manor Lompoc CA 14 2,534,803 CBO2 REO Hotel SASCO(LBCMT)1996-C2 Sheraton Omaha Omaha NE 20 1,833,643 CBO2 Monetary Hotel SASCO(LBCMT)1996-C2 Comfort Inn Duncan Duncan SC 10 2,003,065 CBO2 Monetary Retail MCFI 1997-MC1 Plymouth K-Mart Plymouth MA 4 6,717,596 CBO2 Monetary Retail MCFI 1997-MC1 Tillmans Square Shpng Center Mobile AL 17 5,893,510 CBO2 Monetary Retail MCFI 1997-MC1 Fairmont Junction Pasadena TX 1 3,544,288 CBO2 REO Retail MCFI 1997-MC1 Whispering Pines Shpng Ctr Manchester TN 19 1,915,345 CBO2 Monetary Multifamily MCFI 1997-MC1 Diplomat Apartments Jackson MS 8 3,934,460 CBO2 Monetary Multifamily MCFI 1997-MC1 Parkside Commons Apartments Portland OR 1 2,502,448 CBO2 Monetary Hotel MCFI 1997-MC1 Radisson Htl&Sts-Buffalo Air Cheektowaga NY 24 6,952,067 CBO2 Monetary Retail MLMI 1996-C1 Post Falls Factory Otlt Ctr Post Falls ID 2 3,954,252 CBO2 Monetary Hotel MLMI 1996-C1 Cmfrt Inn-Arprt-Little Rock Little Rock AR 0 1,525,339 CBO2 REO Retail MLMI 1996-C1 West Kentucky Outlet Center Eddyville KY 50 8,485,858 CBO2 Monetary Multifamily MLMI 1996-C1 Cedar Creek Apartments Santa Fe NM 0 3,536,387 CBO2 Monetary Industrial MLMI 1996-C1 Quality Logistics Hutchins TX 2 3,435,480 CBO2 Monetary Retail MLMI 1996-C1 Village @ Eland Phoenixville PA 6 1,959,542
Special Serviced Loan Detail Report as of September 2003
Special # of Scheduled Service Underlying Months Balance as Asset Type Prop Type Transaction PROPERTY NAME CITY ST Delinq of Sept 2003 CBO2 REO Retail MLMI 1996-C2 Market Place Shopping Center Shelby NC 0 6,065,766 CBO2 Monetary Multifamily MLMI 1996-C2 Lakewood Village Apartments Nacogdoches TX 4 996,944 CBO2 Monetary Multifamily MLMI 1996-C2 1212 Westheimer Apartments Austin TX 0 2,678,118 CBO2 Monetary Multifamily MLMI 1996-C2 BCM-Westheimer Court Apts. Austin TX 0 646,523 CBO2 Monetary Multifamily MLMI 1996-C2 Westheimer House Austin TX 5 1,077,540 CBO2 Monetary Hotel MLMI 1996-C2 Homestead Lodge Charlotte NC 9 1,757,500 CBO2 Monetary Industrial MLMI 1996-C2 Tiger Industrial Plaza Phoenix AZ 2 1,612,109 CBO2 Monetary Hotel MLMI 1996-C2 Shilo Inn-Salem Suites Salem OR 23 4,574,684 CBO2 Monetary Hotel MLMI 1996-C2 Shilo Inn-Tacoma Tacoma WA 23 5,661,903 CBO2 Monetary Hotel MLMI 1996-C2 Shilo Inn-Seaside Ocnfrt Rst Seaside OR 23 7,953,427 CBO2 Monetary Hotel MLMI 1996-C2 Shilo Inn-Prtld Arprt/I-205 Portland OR 23 12,335,757 CBO2 Monetary Hotel MLMI 1996-C2 Howard Johnson - Delk Road Marietta GA 8 2,109,139 CBO2 Monetary Industrial MLMI 1996-C2 Naugatuck Industrial Naugatuck CT 0 2,897,255 CBO2 Monetary Hotel MLMI 1996-C2 Horwitz-Ramada Inn-Corvallis Corvallis OR 9 4,931,874 CBO2 REO Hotel MLMI 1996-C2 Horwitz-Ramada Inn-Portland Portland OR 47 6,640,313 CBO2 Monetary Hotel MLMI 1996-C2 Ramada Inn - Seattle Seattle WA 7 6,825,628 CBO2 Covenant Hotel MLMI 1997-C1 PP-Days Inn-Cody Cody WY 2 1,367,635 CBO2 Monetary Hotel MLMI 1997-C1 Days Inn-Norfolk Norfolk NE 0 1,376,183 CBO2 Monetary Hotel MLMI 1997-C1 Ramada Limited - Austin Austin TX 8 1,176,120 CBO2 Monetary Hotel MLMI 1997-C1 Shilo Inn-Bend Bend OR 20 5,549,739 CBO2 Monetary Hotel MLMI 1997-C1 Shilo Inn-Coeur d'Alene Coeur d'Alene ID 20 4,790,300 CBO2 Monetary Hotel MLMI 1997-C1 Shilo Inn-Nampa Nampa ID 19 3,738,771 CBO2 Monetary Hotel MLMI 1997-C1 Shilo Inn-Tillamook Tillamook OR 20 4,206,117 CBO2 Monetary Hotel MLMI 1997-C1 Shilo Inn-Salt Lake City Salt Lake City UT 21 9,346,927 CBO2 Monetary Hotel MLMI 1997-C1 Shilo Inn-Elko Elko NV 21 2,870,843 CBO2 Monetary Hotel MLMI 1997-C1 Best Wstrn-Fdrl Way Executel Federal Way WA 8 4,055,374 CBO2 Monetary Multifamily MLMI 1997-C1 Woodley Downs Apartments Montgomery AL 11 1,316,759 CBO2 Monetary Hotel MLMI 1997-C1 Quality Inn/Airport Salt Lake City UT 16 5,377,015 CBO2 Monetary Hotel MLMI 1997-C1 Best Western - Park Suites Plano TX 4 2,349,335 CBO2 Monetary Hotel MLMI 1997-C1 Budgetel Inn-Atlanta Arprt College Park GA 8 2,007,785 CBO2 Monetary Multifamily MLMI 1997-C1 Spring Ridge Apartments Dallas TX 2 1,445,396 CBO2 Monetary Multifamily MLMI 1997-C1 Tahoe North Aptmnts-Phase I Roswell GA 5 5,460,713 CBO2 Monetary Multifamily MLMI 1997-C1 Tahoe North Aptmnts-PhaseII Roswell GA 5 7,787,005 CBO2 REO Retail MLMI 1997-C1 Apopka Square Center Apopka FL 31 2,083,751 CBO2 Monetary Retail MLMI 1997-C1 Holden Crossing Greensboro NC 3 7,374,257 CBO2 Monetary Multifamily MSCI 1997-WF1 King Star Apartments Columbus OH 2 7,698,102 CBO2 REO Hotel ASC 1996-D3 Barcelona Court Lubbock TX 33 4,280,316 CBO2 Covenant Healthcare ASC 1996-D3 Santa Rita Care Center Green Valley AZ 0 3,460,245 CBO2 Monetary Hotel ASC 1996-D3 Hampton Inn - Memphis Memphis TN 10 3,453,723 CBO2 Covenant Healthcare ASC 1996-D3 Westwood Plaza Westwood CA 0 2,343,979 CBO2 Monetary Hotel ASC 1996-D3 Holiday Inn-Denton Denton TX 3 2,276,786 CBO2 REO Healthcare ASC 1996-D3 Medford Nursing Home Medford OK 21 2,316,336 CBO2 Monetary Hotel ASC 1996-D3 Days Inn-San Jose San Jose CA 2 2,073,839 CBO2 Monetary Hotel ASC 1996-D3 Country Hearth Inn - Auburn Auburn IN 21 1,536,314 CBO2 Monetary Hotel ASC 1996-D3 Comfort Inn - North Carolina Washington NC 4 1,365,732 CBO2 Monetary Multifamily MLMI 1997-C2 Fountains of Wdmdw Aptmnts Dallas TX 5 5,246,448
Special Serviced Loan Detail Report as of September 2003
Special # of Scheduled Service Underlying Months Balance as Asset Type Prop Type Transaction PROPERTY NAME CITY ST Delinq of Sept 2003 CBO2 Monetary Retail MLMI 1997-C2 Franklin Township Shpng Ctr Franklin Twnshp NJ 2 3,285,694 CBO2 Monetary Hotel MLMI 1997-C2 Fairfield Inn - Jacksonville Jacksonville FL 7 2,964,891 CBO2 Monetary Retail MLMI 1997-C2 Shoppes at Taylor Ranch Albuquerque NM 3 2,855,980 CBO2 Monetary Hotel MLMI 1997-C2 Days Inn Dwntwn-Indnpls Indianapolis IN 12 2,523,706 CBO2 Monetary Hotel MLMI 1997-C2 Super 8 - Raleigh Raleigh NC 2 2,210,147 CBO2 Monetary Multifamily MLMI 1997-C2 Stonywood Terrace Apartments Philadelphia PA 0 1,584,388 CBO2 Monetary Hotel MLMI 1997-C2 Days Inn - Orange Orange TX 1 1,280,752 CBO2 Monetary Healthcare FULB 1997-C2 Cypress Palms Asstd Lvng Ctr Largo FL 0 10,138,342 CBO2 Monetary Healthcare FULB 1997-C2 Sabal Palms Health Care Ctr Largo FL 0 11,966,107 CBO2 Monetary Hotel FULB 1997-C2 Sheraton Orlando North Maitland FL 20 16,578,985 CBO2 Monetary Healthcare FULB 1997-C2 Royal Palms Senior Residence Largo FL 0 13,893,941 CBO2 Monetary Retail FULB 1997-C2 Brandon Crossings Shpng Ctr Brandon FL 14 12,680,589 CBO2 Monetary Hotel FULB 1997-C2 NorthPark Executive Sts Htl Austin TX 7 11,149,064 CBO2 Monetary Other FULB 1997-C2 FEL Facility Farmingdale NJ 43 6,740,061 CBO2 Monetary Healthcare FULB 1997-C2 CumberLand Retirement Vllg Lowell MI 6 2,286,231 CBO2 Monetary Healthcare FULB 1997-C2 Fountain View - Portage Portage MI 6 2,275,377 CBO2 Monetary Healthcare FULB 1997-C2 Fountain View - Fremont Fremont MI 6 1,138,716 CBO2 Monetary Retail FULB 1997-C2 International Outlet Center Orlando FL 0 3,884,129 CBO2 Monetary Multifamily FULB 1997-C2 Nassau Eden Club Apartments Cincinnati OH 0 3,363,325 CBO2 Monetary Hotel FULB 1997-C2 Holiday Inn - Dalton Dalton GA 2 3,045,479 CBO2 Monetary Multifamily FULB 1997-C2 Apple Creek Kansas City MO 6 2,574,077 CBO2 REO Multifamily FULB 1997-C2 Westgate Hills Jackson MS 23 2,476,208 CBO2 Monetary Retail MCFI 1997-MC2 Victorville Valley Rtl Ctr Victorville CA 3 9,121,317 CBO2 Monetary Retail MCFI 1997-MC2 USA Outlet Center Opelika AL 0 4,137,786 CBO2 REO Hotel MCFI 1997-MC2 Sioux City Holiday Inn Sioux City IA 19 2,282,268 CBO2 Monetary Hotel CMAC 1997-ML1 Shilo Inn-Lincoln City Lincoln City OR 23 16,504,483 CBO2 Monetary Hotel CMAC 1997-ML1 Shilo Inn-Newport Newport OR 23 12,051,622 CBO2 Monetary Hotel CMAC 1997-ML1 Shilo Inn-Portland/Beaverton Portland OR 23 6,096,161 CBO2 Monetary Hotel CMAC 1997-ML1 Shilo Inn-Idaho Falls Idaho Falls ID 23 5,427,703 CBO2 Monetary Hotel CMAC 1997-ML1 Shilo Inn-Yuma Yuma AZ 23 4,811,092 CBO2 Monetary Hotel CMAC 1997-ML1 Shilo Inn-Richland Richland WA 23 4,086,806 CBO2 Monetary Hotel CMAC 1997-ML1 Shilo Inn-Boise/Riverside Boise ID 23 3,232,533 CBO2 Monetary Hotel CMAC 1997-ML1 Shilo Inn-The Dalles The Dalles OR 23 3,025,704 CBO2 Monetary Hotel CMAC 1997-ML1 Shilo Inn-Warrenton Warrenton OR 23 3,186,561 CBO2 Monetary Hotel CMAC 1997-ML1 Shilo Inn-Washington Square Tigard OR 23 2,760,521 CBO2 Monetary Hotel CMAC 1997-ML1 Shilo Inn-Spokane Spokane WA 23 3,422,109 CBO2 Monetary Hotel CMAC 1997-ML1 Shilo Inn-Oakhurst Oakhurst CA 23 2,233,619 CBO2 Monetary Hotel CMAC 1997-ML1 Shilo Inn-Pomona Pomona CA 23 2,316,562 CBO2 Monetary Hotel CMAC 1997-ML1 Shilo Inn-Casper Casper WY 23 2,328,747 CBO2 Monetary Hotel CMAC 1997-ML1 Shilo Inn-Nampa Boulevard Nampa ID 23 1,404,309 CBO2 Monetary Hotel CMAC 1997-ML1 Shilo Inn-Grants Pass Grants Pass OR 23 975,467 CBO2 Monetary Hotel CMAC 1997-ML1 Shilo Inn-Delano Delano CA 23 382,661 CBO2 Monetary Hotel MSCI 1998-WF1 Holiday Inn Bstn Logan Arpt Boston MA 6 25,518,726 CBO2 Monetary Retail MSCI 1998-WF1 K-Mart Kissimmee FL 4 3,026,126 CBO2 Covenant Industrial MSCI 1998-WF1 Lapham Drive Modesto CA 0 2,948,738 CBO2 Monetary Other MSCI 1998-WF1 Council Rck Greens Ofc Cmplx Rochester NY 16 2,594,668
Special Serviced Loan Detail Report as of September 2003
Special # of Scheduled Service Underlying Months Balance as Asset Type Prop Type Transaction PROPERTY NAME CITY ST Delinq of Sept 2003 CBO2 Monetary Retail MSCI 1998-WF1 Eagle Country Market Princeton IL 1 2,030,941 CBO2 Monetary Retail JPMC 1998-C6 Costco Center Honolulu HI 3 25,890,726 CBO2 Monetary Office JPMC 1998-C6 Parkridge Three Reston VA 4 14,380,171 CBO2 Monetary Hotel JPMC 1998-C6 Benjamin Franklin Hotel San Mateo CA 1 9,092,045 CBO2 Monetary Industrial JPMC 1998-C6 Alford Refrigrtd Warehouses Dallas TX 21 6,965,698 NASC 1998-D6 Monetary Hotel NASC 1998-D6 Hampton Inn - Greensboro Greensboro NC 0 4,917,661 NASC 1998-D6 Monetary Hotel NASC 1998-D6 Hampton Inn - Albuquerque Albuquerque NM 0 4,146,469 NASC 1998-D6 Monetary Hotel NASC 1998-D6 Hampton Inn - Roswell Roswell GA 0 3,987,093 NASC 1998-D6 Monetary Hotel NASC 1998-D6 Hampton Inn - Greenville Greenville SC 0 3,811,362 NASC 1998-D6 Monetary Hotel NASC 1998-D6 Hampton Inn - San Antonio San Antonio TX 0 2,736,051 NASC 1998-D6 Monetary Hotel NASC 1998-D6 Hampton Inn - Eden Prairie Eden Prairie MN 0 2,444,164 NASC 1998-D6 Monetary Hotel NASC 1998-D6 Hampton Inn - Amarillo Amarillo TX 0 2,356,031 NASC 1998-D6 Monetary Hotel NASC 1998-D6 Hampton Inn - Spartanburg Spartanburg SC 0 1,598,957 NASC 1998-D6 Monetary Hotel NASC 1998-D6 Hampton Inn - Syracuse East Syracuse NY 0 1,595,359 NASC 1998-D6 Monetary Office NASC 1998-D6 Commerce Point Arlington Hghts IL 6 17,424,624 NASC 1998-D6 Monetary Retail NASC 1998-D6 Best Buy - City of Industry Cty of Industry CA 0 9,065,969 NASC 1998-D6 Monetary Retail NASC 1998-D6 Best Buy - Beaver Creek Beaver Creek OH 0 3,912,681 NASC 1998-D6 Monetary Retail NASC 1998-D6 After Six Philadelphia PA 14 10,374,375 NASC 1998-D6 Monetary Retail NASC 1998-D6 Pennrose Mall Reidsville NC 1 4,445,678 NASC 1998-D6 Monetary Retail NASC 1998-D6 Cornerstone Plaza Maryville TN 1 2,922,665 NASC 1998-D6 Monetary Retail NASC 1998-D6 Crestview Crestview FL 1 1,542,906 NASC 1998-D6 Monetary Retail NASC 1998-D6 Rock Springs Ford Rock Springs WY 1 310,587 NASC 1998-D6 Monetary Retail NASC 1998-D6 Grocer Supply Ft. Worth TX 1 290,941 NASC 1998-D6 Covenant Retail NASC 1998-D6 Levitz Plaza Las Vegas NV 0 9,479,105 NASC 1998-D6 Monetary Office NASC 1998-D6 *Lancaster Mills Clinton MA 17 8,243,495 NASC 1998-D6 Monetary Retail NASC 1998-D6 Tower Center Sacremento CA 5 2,278,259 NASC 1998-D6 Monetary Hotel NASC 1998-D6 Comfort Inn-Galax/Hillsville Hillsville VA 18 1,851,192 NASC 1998-D6 Monetary Industrial NASC 1998-D6 Portland Warehouse L.P. Portland TN 7 893,842
Hotel Mortgage Loans in CRIIMI MAE's Portfolio as of September 30, 2003 (in millions) ---------------------------------------------- Limited Service (i) Full Service (ii) Top 5 State Concentrations: Florida...................... $ 123 Texas................. $ 217 Oregon....................... 83 California............ 179 Texas........................ 74 Georgia............... 157 Virginia..................... 52 Virginia.............. 93 California................... 52 Massachusetts......... 83 Top 5 MSA (iii) Orlando, FL.................. 43 Atlanta, GA........... 129 Concentrations: Atlanta, GA.................. 29 Washington, DC-MD-VA-WV 83 Portland-Vancouver, OR-WA.... 29 San Antonio, TX....... 77 Norfolk-VA Beach-Newport News 24 Phoenix-Mesa, AZ...... 69 Washington, DC-MD-VA-WV...... 22 Santa Barbara-Santa 62 Maria, CA Franchise Affiliation 914 1,119 No Franchise Affiliation 72 215 Near Airport (iv) 191 485
(i) There are loans representing a total outstanding principal amount of $986 million secured by limited service hotels in the Company's portfolio. Of these, $294.0 million, or 30% are in special servicing as of September 30, 2003. Limited service hotels are generally hotels with room-only operations or hotels that offer a bedroom and bathroom, but very few other amenities. These hotels are often in the budget or economy group and do not report food and beverage revenue. (ii) There are loans representing a total outstanding principal amount of $1.33 billion secured by full service hotels in the Company's portfolio. Of these, $192.9 million, or 14% , are in special servicing as of September 30, 2003. Full service hotels are generally mid-price, upscale or luxury hotels with a restaurant, lounge facilities and meeting space as well as minimum service levels, often including bell service and room service. These hotels generate food and beverage revenue. (iii) "MSA" denotes a Metropolitan Statistical Area, as determined by the United States Office of Management and Budget, with a core area or city population estimate of at least 50,000 inhabitants. (iv) Within approximately 2 miles of an airport -----END PRIVACY-ENHANCED MESSAGE-----