<PAGE>1
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, 1998
--------------------
Commission file number 1-10360
-------
CRIIMI MAE INC.
- --------------------------------------------------------------------------
(Exact name of registrant as specified in charter)
Maryland 52-1622022
- ------------------------------------------ ------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
11200 Rockville Pike, Rockville, Maryland 20852
- ----------------------------------------- ------------------------
(Address of principal executive offices) (Zip Code)
(301) 816-2300
- --------------------------------------------------------------------------
(Registrant's telephone number, including area code)
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 and (2) has been subject to such filing
requirements for the past 90 days. 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 23, 1998
- ---------------------------- ----------------------------------
Common Stock, $.01 par value 49,898,100
<PAGE>2
CRIIMI MAE INC.
INDEX TO FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 1998
Page
----
PART I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets - as of September 30,
1998 (unaudited) and December 31, 1997........ 3
Consolidated Statements of Income - for the
three and nine months ended September 30, 1998
and 1997 (unaudited)........................... 4
Consolidated Statement of Changes in
Shareholders' Equity - for the nine months
ended September 30, 1998 (unaudited)........... 5
Consolidated Statements of Cash Flows -
for the nine months ended September 30, 1998
and 1997 (unaudited)........................... 6
Notes to Consolidated Financial Statements
(unaudited).................................... 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations.... 41
PART II. Other Information
Item 1. Legal Proceedings................................ 61
Item 2. Changes in Securities............................ 62
Item 3. Defaults Upon Senior Notes....................... 62
Item 4. Submission of Matters to a Vote of
Security Holders................................. 62
Item 5. Other Information................................ 62
Item 6. Exhibits and Reports on Form 8-K................. 63
Signature ................................................ 64
<PAGE>3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CRIIMI MAE INC.
CONSOLIDATED BALANCE SHEETS
<TABLE><CAPTION>
September 30, December 31,
1998 1997
-------------- --------------
(unaudited)
<S> <C> <C>
Assets:
Mortgage Assets:
Subordinated CMBS, at fair value $1,440,127,153 $ 35,424,387
Subordinated CMBS, at amortized cost -- 1,079,055,459
Mortgage securities, insured loans, at
fair value 510,420,841 18,888,883
Mortgage securities, insured loans, at
amortized cost -- 586,224,858
Investment in originated loans, at
amortized cost 501,282,735 --
Equity Investments 43,359,875 46,234,269
Receivables 41,711,457 17,789,273
Other assets 84,630,845 87,579,565
Repurchase asset 48,345,000 --
Cash and cash equivalents 2,078,722 2,108,794
-------------- --------------
Total assets $2,671,956,628 $1,873,305,488
============== ==============
Liabilities:
Securitized mortgage obligations:
Collateralized bond obligations-CMBS $ 117,771,008 $ 137,061,676
Collateralized mortgage obligations -
insured loans 476,347,906 559,363,321
Collateralized mortgage obligations -
originated loans 388,526,639 --
Senior unsecured notes 99,896,352 99,877,695
Variable rate secured borrowings-CMBS 934,151,800 585,379,360
Other financing facilities 92,799,522 33,250,000
Treasury security sold, not yet repurchased 49,053,125 --
Payables and accrued expenses 18,065,824 12,460,018
-------------- --------------
Total liabilities 2,176,612,176 1,427,392,070
-------------- --------------
Minority interests in
consolidated subsidiaries 926,396 932,431
-------------- --------------
Shareholders' equity:
Convertible preferred stock 19,140 18,294
Common stock 488,104 406,703
Net unrealized (losses) gains on securities (77,267,788) 1,082,811
Additional paid-in capital 571,178,600 448,524,552
-------------- --------------
494,418,056 450,032,360
Less treasury shares, at cost-
538,635 shares as of December 31, 1997 -- (5,051,373)
-------------- --------------
Total shareholders' equity 494,418,056 444,980,987
-------------- --------------
Total liabilities and shareholders'
equity $2,671,956,628 $1,873,305,488
============== ==============
</TABLE>
The accompanying notes are an
integral part of these consolidated
financial statements.
<PAGE>4
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CRIIMI MAE INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE><CAPTION>
For the three months ended For the nine months ended
September 30, September 30,
1998 1997 1998 1997
----------- ------------ ------------ ------------
<S> <C> <C> <C> <C>
Interest income:
Subordinated CMBS $38,880,750 $20,414,449 $105,319,710 $54,694,269
Collateralized mortgage obligations -
insured loans 10,662,386 12,169,026 33,528,290 37,081,104
Collateralized mortgage obligations -
originated loans 8,869,367 -- 11,619,062 --
----------- ----------- ----------- -----------
Total interest income 58,412,503 32,583,475 150,467,062 91,775,373
----------- ----------- ----------- -----------
Interest and related expenses:
Fixed-rate collateralized bond obligations-CMBS 2,206,724 2,857,948 7,375,905 8,539,077
Fixed-rate collateralized mortgage
obligations - insured loans 9,892,249 10,642,346 30,546,774 32,235,374
Fixed-rate collateralized mortgage
obligations - originated loans 6,369,272 -- 8,367,438 --
Fixed-rate senior unsecured notes 2,429,137 -- 7,260,484 --
Variable rate secured borrowings-CMBS 17,778,579 5,690,557 43,637,039 13,417,401
Other financing facilities 998,342 144,203 1,941,800 531,202
----------- ----------- ----------- -----------
Total interest expense 39,674,303 19,335,054 99,129,440 54,723,054
----------- ----------- ----------- -----------
Net interest margin 18,738,200 13,248,421 51,337,622 37,052,319
----------- ----------- ----------- -----------
(Adjustment to)/gain on sale of securities (340,281) -- 28,800,408 --
Equity in earnings from investments (57,546) 1,172,089 2,187,150 2,717,551
Other income 1,060,595 491,838 3,872,576 1,760,934
Gain (loss) on mortgage dispositions 966,654 (90,608) 920,820 17,143,342
General and administrative expenses (4,636,806) (2,640,125) (10,667,797) (7,701,616)
Amortization of assets acquired in the Merger (719,394) (719,391) (2,158,182) (2,158,173)
Unrealized loss on repurchase obligation (4,091,346) -- (4,091,346) --
Unrealized losses on warehouse purchase
obligations (17,630,390) -- (17,630,390) --
----------- ----------- ----------- -----------
(25,448,514) (1,786,197) 1,233,239 11,762,038
----------- ----------- ----------- -----------
Net (loss) income before minority interest (6,710,314) 11,462,224 52,570,861 48,814,357
Minority interest in net loss (income) of
consolidated subsidiary 1,312 (45,200) (40,052) (7,885,607)
Dividends on preferred stock (1,942,377) (1,417,071) (5,499,881) (4,783,936)
----------- ----------- ----------- -----------
Net (loss) income available to common shareholders $(8,651,379) $ 9,999,953 $47,030,928 $36,144,814
=========== =========== =========== ===========
Net (loss) income per common share:
Basic $ (.18) $ 0.26 $ 1.02 $ 1.00
=========== =========== =========== ===========
Diluted $ (.18) $ 0.26 $ 0.98 $ 0.97
=========== =========== =========== ===========
Shares used in computing basic
earnings per share, exclusive of
shares held in treasury 48,298,007 38,304,782 46,178,885 35,998,050
=========== =========== =========== ===========
The accompanying notes are an
integral part of these consolidated
financial statements.
</TABLE>
<PAGE>5
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CRIIMI MAE INC.
CONSOLIDATED STATEMENT OF CHANGES IN
SHAREHOLDERS' EQUITY
For the nine months ended September 30, 1998
(Unaudited)
<TABLE>
<CAPTION>
Net
Preferred Common Stock Unrealized Additional Total
Stock Par Par Losses on Paid-in Undistributed Treasury Shareholders'
Value Value Securities Capital Net Income Shares Equity
---------- ------------ ------------- ------------- ------------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1997 $ 18,294 $ 406,703 $ 1,082,811 $ 448,524,552 $ -- $(5,051,373) $444,980,987
Net income -- -- -- -- 52,530,809 -- 52,530,809
Dividends paid on preferred
shares -- -- -- -- (5,499,881) -- (5,499,881)
Dividends paid on common shares -- -- -- -- (54,953,201) -- (54,953,201)
Conversion of preferred shares
into common shares (1,654) 8,545 -- (6,891) -- -- --
Stock options exercised -- 851 -- 504,797 -- -- 505,648
Adjustment to net unrealized
losses on securities -- -- (78,350,599) -- -- -- (78,350,599)
Shares issued 2,500 77,391 -- 135,124,402 -- -- 135,204,293
Treasury shares retired -- (5,386) -- (5,045,987) -- 5,051,373 --
---------- ------------ ------------- ------------- ------------- ------------ -------------
Balance, September 30, 1998 $ 19,140 $ 488,104 $ (77,267,788) $ 579,100,873 $ (7,922,273) $ -- $ 494,418,056
========== ============ ============= ============= ============= ============ =============
The accompanying notes are an
integral part of this consolidated
financial statement.
</TABLE>
<PAGE>6
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CRIIMI MAE INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE><CAPTION>
For the nine months ended
September 30,
1998 1997
-------------- ------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 52,530,809 $ 40,928,750
Adjustments to reconcile net income to net cash provided
by operating activities:
Cash gain on sale of collateralized
bond obligation (28,800,408) --
Amortization of discount and deferred financing
costs on debt 4,325,388 2,794,541
Amortization of assets acquired in the Merger 2,158,182 2,158,173
Depreciation and other amortization 1,369,592 678,792
Discount/Premium amortization on mortgages and Subordinated CMBS (938,928) 372,269
Net gains on mortgage dispositions (920,820) (17,143,342)
Equity in earnings from investments 2,167,813 (812,445)
Minority interests in earnings of consolidated subsidiary 40,052 7,885,607
Unrealized losses on warehouse purchase obligation and
repurchase obligations 21,721,736 --
Changes in assets and liabilities:
(Increase) in receivables and other assets (34,133,582) (3,102,139)
(Decrease) increase in payables and accrued expenses (707,963) 179,085
Increase in interest payable 7,247,629 936,603
-------------- ------------
Net cash provided by operating activities 26,059,500 34,875,894
-------------- ------------
Cash flows from investing activities:
Proceeds from sale of collateralized bond obligation 334,919,531 --
Proceeds from mortgage dispositions 104,613,568 78,534,735
Purchase of originated loans (495,825,576) --
Purchase of Subordinated CMBS (852,560,342) (210,521,015)
Return of loan origination reserve from securitization 71,877,560 --
Funding of loan origination reserve (75,433,979) (3,206,546)
Payment of deferred costs (9,180,193) (402,003)
Distributions received from equity investments 3,114,000 195,800
Receipt of principal payments 11,097,801 5,274,064
Servicing rights acquired and contributed to Services Partnership (3,880,235) (12,673,089)
Purchase of Real Estate Owned Property -- (4,085,109)
Purchase of mortgages and advances -- (285,430)
Collateral calls on repurchase obligation (3,383,221) --
-------------- ------------
Net cash (used in) investing activities (914,641,086) (147,168,593)
-------------- ------------
Cash flows from financing activities:
Proceeds from sale of CMO bonds 390,068,687 --
Proceeds from debt issuances 1,998,430,321 280,922,714
Principal payments on debt obligations (1,566,452,643) (186,414,743)
Increase in deferred financing costs (8,705,623) (2,587,829)
Dividends (including return of capital) paid to shareholders,
including minority interests (60,499,169) (67,771,342)
Proceeds from the issuance of convertible preferred shares 25,000,000 15,000,000
Proceeds from the issuance of common shares 110,709,941 75,653,879
-------------- ------------
Net cash provided by financing activities 888,551,514 114,802,679
-------------- ------------
Net (decrease) increase in cash and cash equivalents (30,072) 2,509,980
Cash and cash equivalents, beginning of period 2,108,794 10,966,354
-------------- ------------
Cash and cash equivalents, end of period $ 2,078,722 $ 13,476,334
============== ============
The accompanying notes are an
integral part of these
consolidated financial
statements.
</TABLE>
<PAGE>7
CRIIMI MAE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization
CRIIMI MAE Inc. ("CRIIMI MAE" or the "Company") is a fully integrated
commercial mortgage company structured as a self- administered real estate
investment trust ("REIT"). On October 5, 1998 (the "Petition Date"), the Company
and certain of its consolidated operating subsidiaries, CRIIMI MAE Management,
Inc. ("Management"), and CRIIMI MAE Holdings II, L.P. ("Holdings II")
(collectively, the "Debtors") filed for relief under Chapter 11 (so called
herein) of the U.S. Bankruptcy Code (the "Bankruptcy Code") in the United States
Bankruptcy Court for the District of Maryland, Southern Division in Greenbelt,
Maryland (the "Bankruptcy Court"). These related cases are being jointly
administered under the caption "In re CRIIMI MAE Inc., et al.," Ch. 11 Case no.
98-2-3115-DK.
In addition to Management and Holdings II, the Company owns 100% of
multiple financing and operating subsidiaries (discussed in Note 6) as well as
various interests in other entities (including, among others, the Company's
servicing affiliate CRIIMI MAE Services Limited Partnership ("CMSLP" or
"Services Partnership")) which either own or service mortgage and
mortgage-related assets (such subsidiaries and other entities, collectively, the
"Non-Debtor Affiliates"). None of the Non-Debtor Affiliates has filed a
bankruptcy petition.
Prior to the Petition Date, CRIIMI MAE's primary activities included
(i) acquiring non-investment grade subordinated securities backed by pools of
mortgage loans on multifamily, retail and other commercial real estate and by
pools of mortgage-backed securities backed, in turn, by loans on such properties
("Subordinated CMBS"), (ii) originating and underwriting mortgage loans, (iii)
securitizing pools of mortgage loans and pools of commercial mortgage-backed
securities ("CMBS"), and (iv) through CMSLP, performing servicing functions with
respect to the Company's mortgage loans and the mortgage loans underlying the
Company's Subordinated CMBS.
Prior to the Petition Date, CRIIMI MAE financed a substantial portion
of its Subordinated CMBS acquisitions with short-term variable rate borrowings
secured by the Company's Subordinated CMBS. The agreements governing these
financing arrangements typically required the Company to maintain collateral at
all times with a market value not less than a specified percentage of the
outstanding indebtedness. The agreements further provided that the lenders could
require the Company to provide additional collateral, if the value of the
existing collateral fell below this threshold amount.
As a result of the recent turmoil in the capital markets, the spreads
between CMBS rates and the rates on Treasury securities with comparable
maturities began to widen substantially and rapidly in August 1998. Due
primarily to widening CMBS spreads, the market value of the Subordinated CMBS
securing the Company's short-term financings declined. CRIIMI MAE's short-term
secured creditors perceived that the value of the Subordinated CMBS securing
their facilities with the Company had fallen below the minimum
collateral- to-loan-value ratio described above and, consequently, made demand
upon the Company to provide additional collateral with sufficient value to cure
<PAGE>8
CRIIMI MAE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization - Continued
the perceived deficiency. In August and September, the Company received and
met collateral calls from its secured creditors. At the same time, CRIIMI MAE
was in negotiations with various third parties in an effort to obtain additional
debt and equity financing that would provide the Company with additional
liquidity.
On Friday afternoon, October 2, 1998, the Company was in the closing
negotiations of a refinancing with one of its unsecured creditors that would
have provided the Company with additional borrowings, when it received a
significant collateral call from Merrill Lynch Mortgage Capital, Inc. ("Merrill
Lynch"). The basis for this collateral call, in the Company's view, was
unreasonable. After giving consideration, among other things, to this collateral
call and the Company's concern that its failure to satisfy this collateral
call would cause the Company to be in default under a substantial portion of its
financing arrangements, the Company reluctantly concluded on Sunday, October 4,
that it was in the best interests of creditors, equity holders and other parties
in interest to seek Chapter 11 protection. Accordingly, the Company filed its
bankruptcy petition on Monday, October 5.
As a result of the bankruptcy filing, the Company has been advised by
its independent public accountants that, if the reorganization plan is not
approved by the Bankruptcy Court prior to the completion of their audit of the
Company's financial statements for the year ending December 31, 1998, the
auditors' report on those financial statements will be modified due to
substantial doubt about the Company's ability to continue as a going concern.
Also as a result of the Chapter 11 filing, CRIIMI MAE does not expect
to pay a dividend during the fourth quarter. Although, as a REIT, the Company is
required to distribute 95% of its REIT taxable income to shareholders each year
to retain its REIT status (the "95% distribution requirement"), the Tax Code
does not require that the distributions actually be made during the relevant tax
year; that is, CRIIMI MAE is not required by the Tax Code to pay a dividend
during the fourth quarter of the 1998 tax year to retain its REIT status for
1998. Instead, for purposes of complying with the 95% distribution requirement,
the Tax Code allows dividends declared before September 15, 1999 and paid before
December 31, 1999, to be treated as though such distributions had been made in
1998.
However, if CRIIMI MAE fails to distribute at least 85% of its REIT
taxable income and 95% of its capital gain net income during 1998, the Company
will incur a non-deductible excise tax equal to 4% of the amount by which the
85% taxable income and 95% capital gain distribution requirement exceeds the
amount so distributed.
During the pendency of the bankruptcy proceedings, the Company is
prohibited from paying or declaring distributions without Bankruptcy Court
approval. For this and other reasons, there can be no assurance that CRIIMI MAE
will be able to comply with the 95% distribution requirement on a timely basis,
or at all. Although the Company intends to use its best efforts to retain its
<PAGE>9
CRIIMI MAE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
its REIT status for the 1998 tax year, there can be no assurance that such
efforts will succeed. If CRIIMI MAE should lose its status as a REIT for 1998,
the Company would be subject to corporate taxation on its taxable income for
the full year.
The most recent securitizations by the Company created taxable
mortgage pools ("TMPs") by placing mortgage assets (Subordinated CMBS and
mortgage loans) into trusts ("Trusts") and issuing multiple classes of
securities backed by such mortgage assets. In general, a TMP is treated as a
separate taxable entity for federal income tax purposes (i.e., bearing a
separate corporate level tax). As a REIT, CRIIMI MAE is exempt from the TMP
Rules under Section 7701(i) of the Tax Code, which would cause the Trust to
bear a separate corporate level tax, provided CRIIMI MAE owns all of the equity
intrests in the Trusts for federal income tax purposes.
Certain of the securities (the "Pledged Securities") issued by the
Trusts in its May 1998 CMBS resecuritization (CBO-2) and its June 1998
collateralized mortgage obligation securitization (CMO IV) were held by the
Company and used in certain short-term financing arrangements treated as secured
borrowings for federal income tax purposes. If the Lenders were to seize or sell
the Pledged Securities and such Pledged Securities were held to be equity
interests in the Trust (rather than debt obligations of the Trust) for federal
income tax purposes, the Trusts would be subject to paying corporate tax. In
such event, certain adverse consequences would occur unless the Company
successfully restructures the transactions or takes some other actions.
Specifically, since the Trusts would be paying corporate tax, the funds
available to pay the securities issued by the Trust would be significantly
diminished, and the related unencumbered securities retained by the Company (the
"Unencumbered Securities") would therefore be significantly impaired. In
addition, the Company could violate certain REIT requirements, and
therefore adversely affect its status as a REIT, if the Unencumbered Securities
(i) constitutes more than 10% of the voting interests of the Trusts or (ii)
are in excess of 5% of the total value of the Company's assets.
2. Investment Company Act of 1940
The Company intends to continue to conduct its business so as not to
become regulated as an investment company under the Investment Company Act of
1940, as amended (the "Investment Company Act"). Under the Investment Company
Act, a non-exempt entity that is 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. The Investment Company Act exempts entities that are "primarily
engaged in the business of purchasing or otherwise acquiring mortgages and other
liens on and interests in real estate ("Qualifying Interests"). Under current
<PAGE>10
CRIIMI MAE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. Investment Company Act of 1940 - Continued
Interpretation by the staff of the SEC, to qualify for this exemption,
CRIIMI MAE, among other things, must maintain at least 55% of its assets in
Qualifying Interests. Pursuant to such SEC staff interpretations,
CRIIMI MAE's Government Insured Mortgage Assets and originated loans are
Qualifying Interests.
Prior to the Petition Date, the Company was a leading purchaser of
Subordinated CMBS. Generally, the Company acquired such securities only when
such mortgage assets were collateralized by pools of first mortgage loans, when
the Company could monitor the performance of the underlying mortgage loans
through loan management and servicing rights, and when the Company had
appropriate workout/foreclosure rights with respect to the underlying mortgage
loans. When such arrangements exist, CRIIMI MAE believes that the related
Subordinated CMBS constitute Qualifying Interests for purposes of the Investment
Company Act. Therefore, CRIIMI MAE believes that it should not be required to
register as an "investment company" under the Investment Company Act as long as
it invests primarily in such Subordinated CMBS and/or in other Qualifying
Interests. However, if the SEC or its staff were to take a different position
with respect to whether CRIIMI MAE's Subordinated CMBS constitute Qualifying
Interests, the Company could be required to modify its business plan so that
either (i) it would not be required to register as an investment company or (ii)
it would comply with the Investment Company Act and be able to register as an
investment company. In such event, (i) modification of the Company's business
plan so that it would not be required to register as an investment company would
likely entail a disposition of a significant portion of the Company's
Subordinated CMBS or the acquisition of significant additional assets, such as
Government Insured Mortgage Assets, which are Qualifying Interests or (ii)
modification of the Company's business plan to register as an investment
company, which would result in significantly increased operating expenses and
would likely entail significantly reducing the Company's indebtedness (including
the possible prepayment of the Company's secured financing and/or the Senior
Unsecured Notes), which could also require it to sell a significant portion of
its assets. No assurances can be given that any such dispositions or
acquisitions of assets, or deleveraging, could be accomplished on favorable
terms. Consequently, any such modification of the Company's business plan could
have a material adverse effect on the Company. Further, if it were established
that the Company were an unregistered investment company, there would be a risk
that the Company would be subject to monetary penalties and injunctive relief in
an action brought by the SEC, that the Company would be unable to enforce
contracts with third parties and that third parties could seek to obtain
recission of transactions undertaken during the period it was established that
the Company was an unregistered investment company. In addition, as a result of
the Company's bankruptcy filing, the Company is limited in possible actions it
may take in response to any need to modify its business plan in order to
register as an investment company, or avoid the need to register. Any
dispositions or acquisitions of assets would require court approval. Also, any
forced sale of assets that occur after the bankruptcy stay is lifted would
<PAGE>11
CRIIMI MAE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. Investment Company Act of 1940 - Continued
change the Company's asset mix potentially resulting in the need to register as
an investment company under the Investment Company Act or take further steps
to change the asset mix. Any such results would be likely to have a material
adverse effect on the Company.
3. Basis of Presentation
In management's opinion, the accompanying unaudited consolidated
financial statements of CRIIMI MAE, Management, Holdings II, CRIIMI MAE
Financial Corporation, CRIIMI MAE Financial Corporation II, CRIIMI MAE Financial
Corporation III, CRIIMI MAE QRS 1, Inc., CRIIMI MAE Holding Inc., CRIIMI MAE
Holding L.P., CRIIMI, Inc., and CRIIMI MAE CMBS Corporation contain all
adjustments (consisting of only normal recurring adjustments and consolidating
adjustments) necessary to present fairly the consolidated financial position of
CRIIMI MAE as of September 30, 1998 and December 31, 1997, the consolidated
results of its operations for the three and nine months ended September 30, 1998
and 1997 and its cash flows for the nine months ended September 30, 1998 and
1997.
These unaudited 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 generally accepted accounting principles have been condensed or
omitted. While management believes that the disclosures presented are adequate
to make the information not misleading, it is recommended that these
consolidated financial statements be read in conjunction with the consolidated
financial statements and the notes included in CRIIMI MAE's Annual Report filed
on Form 10-K for the year ended December 31, 1997.
In addition, the financial information set forth herein is as of
September 30, 1998 and does not reflect subsequent events except as otherwise
noted. As a result of the widening CMBS spreads, general market turmoil during
the third quarter and uncertainties resulting from the bankruptcy proceedings,
the Company's results of operations at September 30, 1998, are not expected to
be indicative of results of operations for future periods during the pendency of
the bankruptcy proceedings. The Company's estimates of value for its
Subordinated CMBS are based, in most cases, upon quotes obtained from the lender
on the related security.
4. Summary of Significant Accounting Policies
Method of Accounting
--------------------
The consolidated financial statements of CRIIMI MAE are
prepared on the accrual basis of accounting in accordance with
generally accepted accounting principles ("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
<PAGE>12
CRIIMI MAE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. Summary of Significant Accounting Policies - Continued
reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Reclassifications
-----------------
Certain amounts in the consolidated financial statements as of
and for December 31, 1997 and the three and nine months ended September
30, 1997 have been reclassified to conform to the 1998 presentation.
Transfer of Financial Assets
----------------------------
The Company transfers assets (mortgages and mortgage
securities) in securitization transactions where the transferred assets
become the sole source of repayment for newly issued debt. When both
legal and control rights to a financial asset are transferred, the
transfer is treated as a sale. Transfers are assessed on an individual
component basis. In a securitization, the cost basis of the original
assets transferred is allocated to each of the new financial components
based upon the relative fair value of the new financial components. For
components where sale treatment is achieved, a gain or loss is
recognized for the difference between that component's allocated cost
basis and fair value. For components where sale treatment is not
achieved, an asset is recorded representing the allocated cost basis of
the new financial components retained and the related incurrence of
debt is also recorded. In transactions where none of the components are
sold, the Company recognizes the incurrence of debt and the character
of the collateralizing assets remain unchanged.
Subordinated CMBS
-----------------
On May 8, 1998, CRIIMI MAE consummated a transaction which
resulted in the sale of a portion of its Subordinated CMBS portfolio
(see Note 5). As a result of the May 8 transaction and in accordance
with GAAP, effective in the second quarter of 1998, the Company no
longer classifies CMBS securities as Held to Maturity, but instead
classifies CMBS as Available for Sale. CRIIMI MAE carries its
Subordinated CMBS at fair market value where changes in fair value are
recorded as a component of shareholders equity (see Note 5). Prior to
this time, such securities were carried at their amortized cost basis
as the Company had the ability and intent to hold these securities to
maturity.
CRIIMI MAE recognizes income from Subordinated CMBS using the
effective interest method, using the anticipated yield over the
projected life of the investment. Changes in anticipated yields are
generally due to revisions in estimates of future credit losses, actual
losses incurred and actual prepayments. Changes in anticipated yield
resulting from prepayments are recognized over the remaining life of
<PAGE>13
CRIIMI MAE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. Summary of Significant Accounting Policies - Continued
the investment with recognition of a cumulative catch-up at the
date of change from the original investment date. CRIIMI MAE
recognizes impairment on its Subordinated CMBS whenever it
determines that the current estimate of expected future credit
losses exceeds credit losses as originally projected. Impairment
losses are determined by comparing the fair value of a
Subordinated CMBS to its current carrying amount, the difference being
recognized as a loss. If future credit loss estimates are increased and
the fair value of the related Subordinated CMBS is in excess of its
carrying amount, the yield is adjusted accordingly on a prospective
basis. Reduced estimates of credit losses are recognized as an
adjustment to the estimated yield over the remaining life of the
Subordinated CMBS.
Investment in Originated Loans
------------------------------
This portfolio consists of commercial loans originated and
securitized by CRIIMI MAE. The origination fee income, application fee
income and costs associated with originating the loans were deferred
("deferred loan costs") and the net amount was added to the basis of
the loans on the balance sheet. Income is recognized using the
effective interest method and consists of mortgage income from the
loans and amortization of deferred loan costs. Expenses of this
portfolio consist of interest expense, discount amortization on the
bonds sold and amortization of costs incurred in conjunction with the
securitization. CRIIMI MAE has the intent to hold these loans for the
foreseeable future and therefore the mortgage security collateral is
classified as Held for Investment and recorded at amortized cost on the
balance sheet. The Company recognizes impairment on the loans when it
is probable that the Company will not be able to collect all amounts
due according to the contractual terms of the loan agreement. The
Company measures impairment based on the present value of expected
future cash flows discounted at the loan's effective interest rate or
the fair value of the collateral if the loan is collateral dependent.
Mortgage Securities - Insured Loans
-----------------------------------
CRIIMI MAE's consolidated investment in mortgage securities
consists of participation certificates evidencing a 100% undivided
beneficial interest in Government Insured Multifamily Mortgages issued
or sold pursuant to programs of the Federal Housing Administration
("FHA") ("FHA-Insured Certificates") and mortgage-backed securities
guaranteed by the Government National Mortgage Association ("GNMA")
("GNMA Mortgage-Backed Securities"). Payment of principal and interest
on FHA-Insured Certificates is insured by the United States Department
of Housing and Urban Development (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.
<PAGE>14
CRIIMI MAE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. Summary of Significant Accounting Policies - Continued
As a result of the May 8, 1998 transaction involving the sale
of a portion of its Subordinated CMBS portfolio (see Note 5), the
Company, in accordance with GAAP, no longer classifies its mortgage
securities-insured loans as Held to Maturity. The Company's mortgage
securities are now classified as Available for Sale. As a result,
the Company now carries its mortgage securities at fair value where
changes in fair value are recorded as a component of stockholders'
equity. Prior to this time, the securities were carried at their
amortized cost basis as the Company had the ability and intent to
hold these securities to maturity.
The difference between the cost and the unpaid principal
balance at the time of purchase is carried as a discount or premium and
amortized over the remaining contractual life of the mortgage using the
effective interest method. The effective interest method provides a
constant yield of income over the term of the mortgage.
Mortgage income is comprised of amortization of the discount
plus the stated mortgage interest payments received or accrued less
amortization of the premium.
Interest Rate Protection Agreements
-----------------------------------
CRIIMI MAE acquires interest rate protection agreements to
reduce its exposure to interest rate risk. The costs of such agreements
which qualify for hedge accounting are amortized over the interest rate
agreement term. To qualify for hedge accounting, the interest rate
protection agreement must meet two criteria: (1) the debt to be hedged
exposes CRIIMI MAE to interest rate risk and (2) the interest rate
protection agreement reduces CRIIMI MAE's exposure to interest rate
risk. In the event that interest rate protection agreements are
terminated, the associated gain or loss is deferred over the remaining
term of the agreement, provided that the underlying hedged asset or
liability still exists. Amounts to be paid or received under interest
rate protection agreements are accrued currently and are netted with
interest expense for financial statement presentation purposes.
Additionally, in the event that interest rate protection agreements do
not qualify as hedges, such agreements are reclassified to be
investments accounted for at fair value, with any gain or loss included
as a component of income.
Consolidated Statements of Cash Flows
-------------------------------------
Cash payments made for interest during the nine months ended
September 30, 1998 and 1997 were $87,556,423 and $50,991,910,
respectively.
Per Share Amounts
-----------------
Basic earnings per share amounts for the three and nine months
ended September 30, 1998 and 1997 represent net income (loss) available
<PAGE>15
CRIIMI MAE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. Summary of Significant Accounting Policies - Continued
to common shareholders divided by the weighted average common shares
outstanding during each period. However, SFAS 128 states that when
earnings are negative, dilutive common stock equivalents are not
included in the diluted calculation. Therefore, diluted earnings per
share are the same as basic earnings per share for the three months
ended September 30, 1998. Diluted earnings per share amounts for the
three months ended September 30, 1997 and for the nine months ended
September 30, 1998 and 1997 are adjusted for dilutive common stock
equivalents for which CRIIMI MAE includes stock options and certain
classes of preferred stock. See Note 13 for a reconciliation of basic
earnings per share to diluted earnings per share.
New Accounting Statements
-------------------------
During 1997, FASB Issued SFAS No. 130 "Reporting Comprehensive
Income" ("FAS 130"). FAS 130 states that all items that are required to
be recognized under accounting standards as components of comprehensive
income are to be reported in the statement of income. This would
include net income as currently reported by CRIIMI MAE adjusted for
unrealized gains and losses related to CRIIMI MAE's Subordinated CMBS
and mortgages accounted for as "available for sale" (as discussed in
Note 5). Net unrealized gains and losses are currently reported in the
shareholders' equity section of the balance sheet. FAS 130 is effective
beginning January 1, 1998. Comprehensive (loss) income under FAS 130
for the three months ended September 30, 1998 and 1997 is
$(201,928,230) and $11,491,672, respectively, and for the nine months
ended September 30, 1998 and 1997 would be $(25,819,790) and
$32,208,893, respectively.
During 1997, FASB issued SFAS 131 "Disclosures about Segments
of an Enterprise and Related Information" ("FAS 131"). FAS 131
establishes standards for the way that public business enterprises
report information about operating segments and related disclosures
about products and services, geographical areas and major customers.
FAS 131 is effective for the year ending December 31, 1998.
During 1998, FASB issued SFAS 133 "Accounting for Derivative
Instruments and for Hedging Activities" ("FAS 133"). FAS 133
establishes accounting and reporting standards for derivative
investments and for hedging activities. It requires that an entity
recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair
value. If certain conditions are met, a derivative may be specifically
designated as a hedge. The accounting for the changes in the fair value
of a derivative depends on the intended use of the derivative and the
resulting designation. FAS 133 is effective for the Company beginning
January 1, 2000. The Company is evaluating its eventual impact on its
financial statements.
<PAGE>16
CRIIMI MAE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. Summary of Significant Accounting Policies - Continued
During 1998, FASB issued SFAS 134, Accounting for Mortgage-
Backed Securities Retained After the Securitization of Mortgage Loans
Held for Sale by a Mortgage Banking Enterprise ("FAS 134"). This
Statement further amends previous FASB Statements to require that after
the securitization of mortgage loans held for sale, an entity engaged
in mortgage banking activities classify the resulting mortgage-backed
securities or other retained interests based on its ability and intent
to sell or hold those investments. This Statement conforms the
subsequent accounting for securities retained after the securitization
of mortgage loans by a mortgage banking enterprise with the subsequent
accounting for securities retained after the securitization of other
types of assets by a non-mortgage banking enterprise. The adoption of
this Statement is not expected to impact CRIIMI MAE since the Company
does not hold mortgage loans for sale and accounts for its
securitizations of loans as financings.
5. Mortgage Assets - Subordinated CMBS
Since mid 1994 and until October 5, 1998, CRIIMI MAE has been in the
business of purchasing Subordinated CMBS. Through March 31, 1998, CRIIMI MAE had
acquired 112 individual securities collateralized by 30 mortgage securitization
pools. In December 1996, 35 of these securities from 12 separate mortgage
securitization pools were resecuritized by CRIIMI MAE aggregating $449 million
face amount ("CBO-1"). CBO-1 involved CRIIMI MAE's public issuance of investment
grade securities with a face amount of $142 million. In CBO-1, CRIIMI MAE
retained investment grade securities with a face amount of $307 million. Through
CBO-1, CRIIMI MAE obtained a higher overall weighted average credit rating for
its new securities than the weighted average credit rating on the related CMBS
collateral. CBO-1 was initially accounted for as a financing of the
resecuritized assets. However, in conjunction with the 1998 resecuritization
discussed below, a portion of the retained securities from CBO-1 have
subsequently been sold and the remaining amortized cost basis of those CMBS
assets has been allocated to the securities retained.
During 1997, FAS 125 "Accounting for Transfers and Servicing of
Financial Assets" became effective. This statement significantly changed the
accounting treatment for transfers of financial assets. FAS 125 changed
accounting standards to require transfers of assets to be accounted for on a
component basis instead of as an entire unit. Accordingly, in a securitization
or resecuritization, components (securities) are treated as sales or retained
interests based upon CRIIMI MAE's ability to control the component. Components
where control is not retained are treated as sales and those where control is
retained are treated as retained interests.
As previously discussed, in May 1998, CRIIMI MAE completed its second
resecuritization of CMBS assets, with a combined face value of approximately
$1.8 billion involving 75 individual securities collateralized by 19 mortgage
securitization pools and three of the retained securities from CBO-1 ("CBO-2").
CBO-2 involved CRIIMI MAE's private placement of securities with a face amount
<PAGE>17
CRIIMI MAE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. Mortgage Assets - Subordinated CMBS - Continued
of $468 million. In CBO-2, CRIIMI MAE retained securities with a face amount of
approximately $1.3 billion. Certain securities included call provisions to
enable CRIIMI MAE to 1) call bonds if market conditions warrant, and 2) call
bonds when it is no longer cost effective to service them. As a result,
CBO-2 resulted in a sale of certain securities and the retention of new
securities. In accordance with FAS 125, the assets collateralizing the
resecuritization are "derecognized" and the combined amortized cost basis of
the collateralizing assets was allocated to the new securities issued.
CRIIMI MAE received $335 million for the $345 face amount of investment grade
securities sold without call provisions which had an allocated cost basis of
$306 million, resulting in a gain of approximately $28.8 million. CRIIMI MAE
recorded retained assets totaling $926 million representing the allocated
amortized cost basis for the $123 million face amount of investment grade
securities issued with call provisions and the $1.3 billion face amount of
non-investment grade retained securities in CBO-2. CBO-2 generated $160 million
of excess proceeds primarily as a result of a higher overall weighted average
credit rating for its new securities as compared to the weighted average credit
rating on the related CMBS collateral. These excess proceeds were used to
acquire additional Subordinated CMBS during the second quarter of 1998.
The sale of certain securities requires reclassification of CRIIMI
MAE's entire portfolio of mortgage securities (consisting of mortgage security
collateral and CMBS) from Held to Maturity to Available for Sale. Therefore,
CRIIMI MAE's securities, effective second quarter of 1998, are reflected on the
balance sheet at fair market value. At June 30, 1998, the fair market value of
the mortgage securities exceeded the amortized cost by approximately $118
million and was reflected as an increase in shareholder's equity. At September
30, 1998, the amortized cost of the mortgage securities exceeded the fair market
value by approximately $77 million (a $195 million decrease from June 30, 1998)
and is reflected as a decrease in shareholders' equity.
Additionally, as part of CBO-2, CMSLP sold trustee servicing rights on
CBO-2 for $4.2 million, resulting in a gain of approximately $400,000 for
financial reporting purposes, which is included in equity in earnings from
investments on the consolidated statements of income, and gain of $4.2 million
for tax purposes.
<PAGE>18
CRIIMI MAE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. Mortgage Assets - Subordinated CMBS - Continued
At September 30, 1998, CRIIMI MAE held the following securities:
<TABLE><CAPTION>
Original 9/30/98
Anticipated Anticipated
Unleveraged Unleveraged
Yield to Yield to
Pool(3) Maturity (1) Maturity (1)(2)
- ------------ ------------ ------------
<S> <C> <C>
Retained Securities from
CRIIMI 1996 C1 (CBO1) 19.5% 21.0%(5)
DLJ Mortgage Acceptance Corp.
Series 1997 CF2 Tranche B-30C 8.2% 8.2%
Nomura Asset Securities Corp.
Series 1998-D6 Tranche B7 12.0% 12.0%
Retained Securities from
CRIIMI 1998 C1 (CBO2) 10.3% 10.3%(4)
Mortgage Capital Funding, Inc.
Series 1998-MC1 8.9% 8.9%
Chase Commercial Mortgage Securities
Corp.
Series 1998-1 8.8% 8.8%
First Union/Lehman Brothers
Series 1998 C2 8.9% 8.9%
Morgan Stanley Commercial Inc.
Series 1998-WF2 8.5% 8.5%(4)
Mortgage Capital Funding, Inc.
Series 1998-MC2 8.7% 8.7%
Weighted Average 9.7%(3) 10.1%(3)
(1) Represents the anticipated weighted average unleveraged yield over the
expected average life of the Company's Subordinated CMBS portfolio as of the
date of acquisition and September 30, 1998, respectively, based on management's
estimate of the timing and amount of future credit losses and prepayments. As
discussed below these yields may decrease as a result of certain adversarial
actions taken by the Company's lenders.
(2) Unless otherwise noted, changes in the September 30, 1998 anticipated yield
to maturity from that originally anticipated are primarily the result of changes
in prepayment assumptions relating to mortgage collateral.
(3) CRIIMI MAE services a total CMBS pool of approximately $29 billion.
Approximately 0.67% of the total CMBS pool is specially serviced by CRIIMI
MAE, of which 0.25% of the total CMBS pool are specially serviced due to
payment default and the remainder is specially serviced due to nonfinancial
covenant default. Despite the volatility in the capital markets, the mortgage
assets underlying the Company's portfolio of CMBS continue to experience no
losses of principal from default.
See Note 14 for discussion of subsequent transfer of special servicing.
(4) On October 6, 1998 Morgan Stanley and Co. International Limited ("Morgan
Stanley") advised CRIIMI MAE that it was exercising ownership rights over
certain classes of CMBS it held as collateral pursuant to a May 8, 1998
variable-rate secured borrowing agreement with CRIIMI MAE. On October 6, 1998,
Morgan Stanley purported the fair value of such securities to be $183.1 million.
The recorded fair value of such securities as of September 30, 1998 was $246.7
million. On October 16, 1998, Morgan Stanley advised CRIIMI MAE that it intended
to sell CRIIMI MAE's CMBS. On October 20, 1998, CRIIMI MAE filed a complaint
against Morgan Stanley seeking damages and turnover of the subject CMBS. This
matter is presently pending.
(5) The increase in the anticipated yield resulted from reallocation of CBO-1
asset basis in conjunction with the CBO-2 resecuritization.
</TABLE>
<PAGE>19
CRIIMI MAE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. Mortgage Assets - Subordinated CMBS - Continued
The aggregate investment by the underlying rating of the Subordinated CMBS is as
follows:
<TABLE>
<CAPTION>
Face Amount Fair Value
as of as of Amortized Cost as of
September 30, 1998 September 30, 1998 September 30, 1998 December 31, 1997
Security Rating(2) (in millions) % (in millions)(1) (in millions) (in millions)
- --------------- ------------------- -------- ---------------- ------------------ -----------------
<S> <C> <C> <C> <C> <C>
AA- $ -- -- $ -- $ -- $ 5.6
A 62.6 2.7 62.8 56.9 --
BBB 150.6 6.6 143.9 126.7 4.0
BBB- 115.2 5.0 105.1 92.6 --
BB+ 394.6 17.3 318.6 317.5 8.6
BB 275.0 12.0 238.5 258.5 445.0
BB- 89.1 4.0 65.7 72.5 89.8
B+ 128.8 5.6 81.4 92.7 --
B 300.2 13.1 180.4 208.6 357.4
B- 198.7 8.7 97.9 106.5 44.6
CCC 92.0 4.0 24.6 36.0 10.9
Unrated 478.1 21.0 121.2 162.7 113.2
-------- ------ --------- -------- ---------
Total(3) $2,284.9 100.0% $ 1,440.1(4) $1,531.2 $ 1,079.1
======== ====== ========= ======== =========
</TABLE>
(1) The estimated fair values of Subordinated CMBS represent the carrying
value of the assets.
(2) During the nine months ended September 30, 1998, CRIIMI MAE
purchased Subordinated CMBS that have an
aggregate face value of approximately $1.2 billion and an aggregate
purchase price of approximately $853 million.
(3) Refer to Footnote 7 for additional information regarding the total face
amount and purchase price of Subordinated CMBS for tax purposes.
(4) The fair value of the Company's Subordinated CMBS is approximately $91
million less than the amortized cost basis at September 30, 1998.
The fair market value of the Company's portfolio is based upon quotes
obtained from, in most cases, the lender to which the security is pledged. The
lender will also quote the related unrated bonds even though the bonds do not
serve as collateral for CRIIMI MAE's obligations. The Company obtained "ask"
quotes as compared to "bid" quotes because it is the owner of the securities.
Because of market conditions that existed at September 30, 1998, there is
variability in the quotes for similarly rated securities as received from
different lenders. Fair values are estimated based on spreads to comparably
maturing treasury securities, and quotes on similarly rated securities
varied in most cases. Since September 30, 1998 because of current market
conditions and the Chapter 11 filing, the Company does not have reliable
fair market value for its CMBS securities. As such, there can be no
assurance that the value of these securities has not changed materially.
<PAGE>20
CRIIMI MAE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. Mortgage Assets - Subordinated CMBS - Continued
As of September 30, 1998, the mortgage loans underlying CRIIMI MAE's
Subordinated CMBS portfolio were secured by properties of the types and at the
locations identified below:
Property Type Percentage(1) Geographic(2) Percentage(1)
- ------------- ------------ ------------ -------------
Multifamily 31% California 16%
Retail 28% Texas 12%
Office 15% Florida 7%
Hotel 13% New York 6%
Other 13% Other (3) 59%
(1) Based on a percentage of the total unpaid principal balance of the
underlying loans.
(2) No significant concentration by region.
(3) No other individual state makes up more than 5% of the total.
The Subordinated CMBS tranches owned by CRIIMI MAE provide credit
support to the more senior tranches of the related commercial securitization.
Cash flow from the underlying mortgages generally is allocated first to the
senior tranches, with the most senior tranche having a priority right to cash
flow. Then, any remaining cash flow is generally allocated among the other
tranches in order of their relative seniority. To the extent there are defaults
and unrecoverable losses on the underlying mortgages, resulting in reduced cash
flows, the subordinate tranche will bear this loss first. To the extent there
are losses in excess of the most subordinate tranche's stated right to principal
and interest, then the remaining tranches will bear such losses in order of
their relative subordination.
The accounting treatment under GAAP requires that the income on
Subordinated 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 GAAP income recognition which is greater than or less than cash
received. For the three and nine months ended September 30, 1998, the amount of
income recognized (less than) or in excess of due to the effective interest rate
method was approximately $(494,000) and approximately $1.7 million,
respectively. For the three and nine months ended September 30, 1997, the amount
of income recognized in excess of cash due to the effective interest rate method
was approximately $760,000 and approximately $88,000, respectively.
Since the Petition Date, CRIIMI MAE and certain secured creditors have
disagreed about the effect of the stay provisions of the Bankruptcy Code on such
secured lenders and the subject assets. Since filing, CRIIMI MAE has acted to
defend its ownership of its CMBS. On October 13, 1998, Citicorp Securities, Inc.
("Citicorp") requested from the indenture trustee, Norwest Bank Minnesota, N.A.
("Norwest"), the immediate transfer of five classes of bonds issued pursuant to
the June 1, 1998 indenture trust agreements with Norwest. From a financial
reporting perspective (as discussed in Note 4) the certificates issued are
recorded as investments in originated loans. The subject assets are collateral
for amounts advanced to CRIIMI MAE by Citicorp under August 1, 1997 and
<PAGE>21
CRIIMI MAE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. Mortgage Assets - Subordinated CMBS - Continued
June 4, 1998 financing arrangements. On October 15, 1998, CRIIMI MAE filed an
emergency motion to enforce the automatic stay against Norwest and Citicorp
Securities, Inc. Pursuant to an order dated October 23, 1998, the bankruptcy
court prohibited Citicorp from selling the subject assets, without further ordeR
of the Court. On October 23, 1998, Citicorp requested an emergency hearing
regarding the October 23 order and on November 2, 1998 CRIIMI MAE filed a
complaint against Citicorp seeking a declaratory judgment as to, among
other things, whether the automatic stay applies to actions taken by Citicorp
with respect to the subject assets. The issues raised by the complaint and
motion are now set for an evidentiary hearing on March 8, 1999. If the bonds
are transferred and the transfer causes the securitization to be treated as a
taxable mortgage pool, CRIIMI MAE's status as a REIT could be adversely
effected (See Note 1).
As discussed in Note 1, on October 2, 1998, Merrill Lynch, which
provides financing on certain Subordinated CMBS (with a face amount of
approximately $558.3 million and an amortized cost of approximately $394.8
million), in conjunction with a collateral call quoted the value of those bonds
to be $341.7 million while another institution who lends against those same
securities quoted the value to be approximately $382.5 million as of September
30, 1998. On October 16, 1998, Merrill Lynch filed for relief from the
automatic stay seeking authority to immediately liquidate the CMBS, which are
collateral for approximately $275 million advanced to CRIIMI MAE by Merrill
Lynch pursuant to a September 1997 loan agreement. CRIIMI MAE is opposing
Merrill's motion. In addition, Merrill has withheld a payment of
approximately $3.3 million due on CMBS assets held by CRIIMI MAE which was
reflected as a receivable at September 30, 1998. On October 21, 1998, CRIIMI MAE
filed a complaint against Merrill Lynch seeking turnover of the earnings of the
subject CMBS to CRIIMI MAE. Recently, Merrill Lynch has suggested a
negotiated resolution of its motion in the form of an agreed cash collateral
order. There can be no assurance that the parties will be able to reach an
agreement concerning any such order or that the terms of any order agreed to,
will be favorable to the Company.
On October 6, 1998, Morgan Stanley advised CRIIMI MAE that it was
exercising ownership rights over certain classes of CMBS it held as collateral
for approximately $182.4 million advanced to CRIIMI MAE pursuant to a May 8,
1998 financing agreement with CRIIMI MAE. The recorded fair value of these
securities, as of September 30, 1998, was $246.7 million, based upon quotes
received from Morgan Stanley on some of the bonds and quotes from another party
on other bonds. On October 6, 1998, Morgan Stanley seized these securities,
and quoted the fair value of those same securities to be $183.1 million. On
October 16, 1998, Morgan Stanley advised CRIIMI MAE that it intended to sell
these CMBS. On October 20, 1998, CRIIMI MAE filed a complaint against Morgan
Stanley seeking damages and turnover of the subject CMBS.
The Company's CMBS portfolio (excluding those securities that are
match-funded) currently generates approximately $13 million of monthly cash
flow. As of November 16, 1998, certain lenders have withheld payment to CRIIMI
MAE of approximately $18.7 million, including approximately $6.7 million
accrued as of September 30, 1998. The realizability of these receivables, and
whether or not this triggers impairment losses on any of the Company's
Subordinated CMBS, is therefore uncertain and will be determined in the fourth
quarter as the bankruptcy case evolves.
<PAGE>22
CRIIMI MAE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. Mortgage Assets - Subordinated CMBS - Continued
Impairment could occur if the lender fails to remit interest payments or does
not remit the interest payment on a timely basis. In either case the Company's
yield could be reduced which would result in an impairment loss (if the
fair value of the security at the time such a determination is made is less
than the securities amortized cost basis). Furthermore, it is possible that
CRIIMI MAE may have to record impairment losses during the fourth quarter
as a result of adverse actions taken against CRIIMI MAE by its lenders.
6. Loan Origination Program
Included in CRIIMI MAE's portfolio of mortgage assets are loans
originated through its mortgage loan conduit programs with two major financial
institutions (the "Programs"). The Programs are designed to create pools of
multifamily and commercial mortgage loans, either through origination or
acquisition, for the purpose of issuing commercial mortgage-backed securities.
On October 5, 1998, the lender under one of the Programs, Citicorp Real Estate,
Inc. ("Citibank") sent the Company a letter alleging that the Company was in
default under the Program and that it was terminating the Program which, as
discussed below, could result in a loss to the Company. The Company has
contested this purported termination. There can be no assurance that the
Company will prevail in its position.
The agreements for both Programs provide that during the warehouse
period, the financial institution will fund and originate in its name all
mortgage loans under the Program, and CRIIMI MAE is required to deposit a
portion of each loan amount in a reserve account. In both facilities, the
respective financial institution is responsible for executing an interest rate
hedging strategy and providing timely written hedge position reporting.
The Citibank Program, by its terms, obligates CRIIMI MAE to purchase
the warehoused loans at their face value plus or minus any hedging loss or gain
upon the earlier of achieving a sufficient quantity of loans for securitization
or December 31, 1998. CRIIMI MAE's obligation to purchase these loans is secured
by the reserve account for this program. At September 30, 1998, the reserve
account for this program was approximately $31.8 million. In conjunction with
the Citibank Program, the Company could also make mezzanine loans which have a
second priority position in the same property. In such case, CRIIMI MAE would
require a form of participation interest in the property as consideration for
making the mezzanine loan. The Company funded mezzanine loans in the amount of
$7.6 million through September 30, 1998.
Under the second Program, which is with Prudential Securities
Incorporated and Prudential Securities Credit Corporation (together
"Prudential"), the Company has an option to buy the loans at the earlier of June
30, 1999 or the date of achieving a stated quantity of loans for securitization.
The agreement provides that the amount in the reserve account for this Program,
which was approximately $2 million at September 30, 1998, is deemed the
<PAGE>23
CRIIMI MAE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. Loan Origination Program - Continued
purchase price for this option and upon exercise of the option, the amount in
the reserve account is to be applied against the purchase price of the loans.
The Company's obligation to purchase the loans under the Citibank
Program was $14.8 million in excess of the fair value of the loans and the
Company's option to purchase the loan under the Prudential program was $2.8
million in excess of the fair value of the loan principally because of the
unrest in the bond and CMBS markets and the ineffectiveness of the hedging
programs employed by Citibank and Prudential. As a result, CRIIMI MAE recorded a
$17.6 million unrealized loss on their purchase obligations as of September 30,
1998. The Company has calculated the unrealized losses based upon an estimated
value of the loans (based on proceeds that could be raised in a securitization
using market spreads for bonds that would be issued if such a transaction
occurred on September 30, 1998) as well as hedging losses as of that date.
Timely written hedge position reporting, as required under both Programs, was
not provided at September 30, 1998. In the absence of such reports, the Company
has based its loss estimates, in part, upon oral communications from these
parties. Depending on market conditions, including interest rate movements,
these losses could materially increase or decrease in subsequent reporting
periods.
As a result of CRIIMI MAE's bankruptcy filing on October 5, 1998, the
Company may not have the ability to fulfill its purchase obligation under the
Citibank program or to exercise its purchase option under the Prudential
program. Therefore it is possible that each lender may sell the loans on its
terms (which could include a liquidation-type sale) and seek to recover any loss
incurred on the sale from the Company in bankruptcy proceedings. This could
result in a larger loss than if CRIIMI MAE had the ability to acquire and sell
the loans on its terms. The amount of the loss under the Citibank program is
limited to the amount of the reserve account plus an additional recourse
obligation amount equal to 5% of the original principal balance of the mortgage
loans. If the Company is unable to buy the loans under the Prudential program,
the Company would forfeit the amount of the reserve account. Additionally, if
CRIIMI MAE is unable to securitize the loans and they are sold at a loss, the
Company will be required to write-off net deferred costs of approximately $2
million related to these loans.
In June 1998, the Company securitized $496 million of its "No- Lock"
commercial mortgage product originated or acquired through the Citibank Program,
and through CRIIMI MAE CMBS Corp., issued Commercial Mortgage Loan Trust
Certificates, Series 1998-1. The loans have a weighted average net interest rate
of 7.3%, a weighted average maturity of approximately 10.4 years and at
September 30, 1998, a fair value of approximately $496 million. The basis of the
loans includes approximately $8 million of deferred loan costs that will be
amortized over the life of the securitization and recognized against income
using the effective interest rate method.
<PAGE>24
CRIIMI MAE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. Loan Origination Program - Continued
Through this securitization, CRIIMI MAE sold $397 million face amount
of fixed-rate investment grade securities (see also Note 11). CRIIMI MAE
retained the remaining principal and interest cash flows from the mortgage loans
that collateralize the securitization. CRIIMI MAE has call rights on each of the
issued securities and therefore has not surrendered control of the collateral,
thus requiring the transaction to be accounted for as a financing of the
mortgage loans.
7. Mortgage Securities
CRIIMI MAE's consolidated portfolio of mortgage security collateral and
mortgages is comprised of FHA-Insured Loans and GNMA Mortgage-Backed Securities.
Additionally, mortgage security collateral includes Federal Home Loan Mortgage
Corporation (Freddie Mac) participation certificates which are collateralized by
GNMA Mortgage-Backed Securities, as discussed below. As of September 30, 1998,
approximately 19% of CRIIMI MAE's investment in mortgage security collateral and
mortgages were FHA-Insured Loans and approximately 81% were GNMA Mortgage-Backed
Securities (including loans which collateralize Freddie Mac participation
certificates). FHA-Insured Loans and GNMA Mortgage-Backed Securities are
collectively referred to as mortgages herein.
Through its wholly owned subsidiaries, CRIIMI MAE owns the following
mortgages directly and indirectly:
<PAGE>25
CRIIMI MAE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. Mortgage Securities - Continued
<TABLE><CAPTION>
As of September 30, 1998
------------------------
Weighted
Average
Number of Fair Amortized Effective Weighted Average
Mortgages Value(a)(d) Cost Interest Rate Remaining Term
--------- ------------ ------------ ------------- ----------------
<S> <C> <C> <C> <C> <C>
CRIIMI MAE (c) 1 $ 5,699,568 $ 5,550,362 7.66% 36 years
CRIIMI MAE Financial Corporation(b) 41 167,616,213 162,015,227 8.23% 31 years
CRIIMI MAE Financial Corporation II(b) 55 237,210,629 232,596,369 7.21% 28 years
CRIIMI MAE Financial Corporation III(b) 29 99,894,431 97,236,109 7.99% 31 years
--------- ------------ ------------
126 $510,420,841 $497,398,067
========= ============ ============
As of December 31, 1997
-------------------------
Weighted
Average
Number of Fair Amortized Effective Weighted Average
Mortgages Value(a) Cost Interest Rate Remaining Term
--------- ------------ ------------ ------------- ----------------
<S> <C> <C> <C> <C> <C>
CRIIMI MAE 5 $ 18,888,883 $ 18,447,382 8.09% 34 years
CRIIMI MAE Financial Corporation 48 196,619,210 189,759,543 8.39% 31 years
CRIIMI MAE Financial Corporation II 59 252,208,500 247,614,722 7.19% 29 years
CRIIMI MAE Financial Corporation III 37 154,535,482 148,850,593 8.05% 31 years
--------- ------------ ------------
149 $622,252,075 $604,672,240
========= ============ ============
(a) The estimated fair values of CRIIMI MAE's mortgages are presented in
accordance with generally accepted accounting principles which define fair value
as the amount at which a financial instrument could be exchanged in a current
transaction between willing parties, other than in a forced or liquidation sale.
These estimated fair values, however, do not represent the liquidation value or
the market value of CRIIMI MAE. The fair value of the Government Insured
Multifamily Mortgages is based on quoted market prices. At December 31, 1997,
CRIIMI MAE mortgages were classified as Available for Sale and carried at fair
value on the balance sheet, the remaining mortgages were carried at amortized
cost.
(b) During the nine months ended September 30, 1998, there were nineteen
prepayments of mortgages held by CRIIMI MAE and its financing subsidiaries.
These prepayments generated net proceeds of approximately $91.2 million and
resulted in net financial statement gains of approximately $390,000, which are
included in gains on mortgage dispositions on the accompanying consolidated
statement of income for the nine months ended September 30, 1998.
(c) During the three months ended September 30, 1998, CRIIMI MAE sold four loans
and a portion of a fifth loan. This sale generated net proceeds of $13.4 million
and resulted in net financial statement gains of $531,000.
(d) As of September 30, 1998, the fair value of the mortgage securities (insured
loans) is approximately $13 million in excess of their amortized cost.
</TABLE>
<PAGE>26
CRIIMI MAE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. Reconciliation of Financial Statement Net Income (Loss) to Tax
Basis Income
Reconciliations of the financial statement net income (loss) to the
tax basis income for the three and nine months ended September 30, 1998 and 1997
are as follows:
<TABLE><CAPTION>
For the three months ended For the nine months ended
September 30, September 30,
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Consolidated financial statement net (loss) income $(6,709,002) $ 11,417,024 $ 52,530,809 $ 40,928,750
Adjustment to/(gain) on sale of collateralized
bond obligation 340,281 -- (28,800,408) --
Reamortization of Subordinated CMBS 13,515,127 1,640,613 24,831,302 4,278,965
Unrealized loss on repurchase asset 4,091,346 -- 4,091,346 --
Unrealized losses on warehouse purchase obligations 17,630,390 -- 17,630,390 --
Interest expense adjustments for collateralized
bond obligation (8,873,340) -- (13,901,373) --
Amortization of assets acquired in the Merger 719,394 719,391 2,158,182 2,158,173
Equity in earnings from investments 1,662,382 (90,760) 5,085,122 351,529
Amortization and other interest expense
adjustments (451,070) (237,927) (1,281,602) (1,177,085)
Mortgage dispositions 255,850 62,338 465,832 154,188
Adjustment to gain on Installment Note (331,831) -- -- --
Adjustment due to accounting for subsidiary
as a pooling for financial statement
purposes and a purchase for tax purposes -- -- -- (2,132,614)
Other (6,209) (8,977) (33,351) 1,447
------------ ------------ ------------ ------------
Tax basis income $ 21,843,318 $ 13,501,702 $ 62,776,249 $ 44,563,353
============ ============ ============ ============
Dividends paid on preferred shares (1,942,377) (1,417,071) (5,499,881) (4,783,936)
------------ ------------ ------------ ------------
Tax basis income available to
common shareholders $ 19,900,941 $ 12,084,631 $ 57,276,368 $ 39,779,417
============ ============ ============ ============
Tax basis income per share:
Income before gains from CFR $ 0.41 $ 0.31 $ 1.22 $ 0.88
Capital gain from CFR -- -- -- 0.21
------------ ------------ ------------ ------------
Total tax basis income per share $ 0.41 $ 0.31 $ 1.22 $ 1.09
============ ============ ============ ============
Tax Basis Shares Outstanding 48,504,819 38,583,857 46,919,645 36,391,281
============ ============ ============ ============
</TABLE>
Differences between financial statement net income (loss) and tax basis
income available to common shareholders principally relate to differences
in the methods of accounting for the sale of securities in conjunction with
the CBO transaction, Subordinated CMBS (see also Note 5), unrealized losses on
warehouse purchase obligation and repurchase asset, amortization of certain
deferred costs, merger of the CRI Mortgage Businesses, and, prior to 1998, the
merger of the CRIIMI Funds.
The entire CBO-2 transaction was accounted for as a financing for tax
purposes. As such, the Company will recognize income for tax purposes from the
entire group of mortgage securitization pools (35 total) with an aggregate face
amount of $2.8 billion and purchase price of $2.0 billion.
<PAGE>27
CRIIMI MAE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. Common Shares
CRIIMI MAE filed with the Securities and Exchange Commission a Shelf
Registration Statement on Form S-3 to register for sale, Debt Securities,
Preferred Shares, Warrants and Common Shares of CRIIMI MAE to the public. In May
1998, CRIIMI MAE increased the aggregate public offering price of the S-3 shelf
filing to $350 million, with a balance available at September 30, 1998 of $350
million.
In January 1998, CRIIMI MAE completed an offering of 2.389 million
common shares at a price of $15 1/8 per share, resulting in net proceeds of
approximately $34 million. These proceeds were used to paydown a working capital
line, purchase Subordinated CMBS and to fund a portion of the loan origination
program.
In March 1998, CRIIMI MAE completed an offering of 2.6 million common
shares at an offering price of $15 5/16 per share, which resulted in net
offering proceeds of approximately $38 million. Net proceeds of the offering
were used to fund a portion of the loan origination program and to purchase
Subordinated CMBS.
In July 1998, the Company's Articles of Incorporation were amended at a
special shareholders meeting to increase the number of common shares authorized
from 60 million to 120 million.
In December 1997, CRIIMI MAE registered with the Securities and
Exchange Commission up to 3 million shares of CRIIMI MAE common stock in
connection with a new Dividend Reinvestment and Stock Purchase Plan (the
"Plan"). Subsequently, in May 1998, the shareholders approved the issuance of up
to 4.7 million common shares in connection with the Plan. The Plan allows
investors the opportunity to purchase additional CRIIMI MAE common shares
through the reinvestment of CRIIMI MAE's dividends, optional cash payments and
initial cash investments. During the nine months ended September 30, 1998,
2,764,063 common shares were issued in conjunction with the Plan, resulting in
net proceeds of approximately $39 million. In October 1998, due to the filing
under Chapter 11, the Company suspended the initial cash investment and optional
cash payment portion of the Plan until further notice.
For the nine months ended September 30, 1998, dividends of $1.17 per
share were paid to common shareholders. These dividends, which included
long-term capital gains, are as follows:
Record
Dividend Date
-------- ------
Quarter ended March 31, 1998 $ 0.37 March 20, 1998
Quarter ended June 30, 1998 $ 0.40 June 19, 1998
Quarter ended September 30, 1998 $ 0.40 September 18, 1998
------
$ 1.17
======
<PAGE>28
CRIIMI MAE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. Common Shares - Continued
As previously discussed in Note 1, CRIIMI MAE does not expect to pay a
dividend in the fourth quarter. See Note 1 for a discussion of the effect on the
Company's REIT status for the 1998 tax year should CRIIMI MAE not make a fourth
quarter distribution.
10. Preferred Stock
CRIIMI MAE's charter authorizes the issuance of up to 25,000,000 shares
of preferred stock, of which 150,000 shares have been classified as Series A
Preferred Shares, 3,000,000 shares have been classified as Series B Preferred
Shares, 300,000 shares have been classified as Series C Preferred Shares and
300,000 shares have been classified as Series D Preferred Shares as of September
30, 1998. As of September 30, 1998 and 1997, there were no Series A Preferred
Shares outstanding.
During the nine months ended September 30, 1998, 65,394 Series B
Cumulative Convertible Preferred Shares were converted into 149,384 common
shares resulting in 1,613,982 Series B Preferred Shares outstanding as of
September 30, 1998. Dividends paid and accrued on Series B Preferred Shares
totaled $4,344,858 for the nine months ended September 30, 1998.
In March 1997, CRIIMI MAE entered into an agreement with an
institutional investor pursuant to which the Company had the right to sell, and
such investor was obligated to purchase, up to 300,000 shares of Series C
Cumulative Convertible Preferred Stock at a price of $100 per share. The
preferred stock is convertible into common shares at the option of the holders
and is subject to redemption by CRIIMI MAE. During the nine months ended
September 30, 1998, 100,000 Series C Preferred Shares were converted into
705,187 common shares. Additionally, in February 1998, the Company issued the
remaining 150,000 shares, generating proceeds of $15 million. As of September
30, 1998, 200,000 Series C Preferred Shares were outstanding. Dividends paid and
accrued on Series C Preferred Shares totaled $1,045,943 for the nine months
ended September 30, 1998. In November 1998, 17,000 Series C Preferred Shares
were converted into 1,046,154 common shares.
In July 1998, CRIIMI MAE entered into an agreement with an
institutional investor pursuant to which the Company had the right to sell, and
such investor was obligated to purchase, up to 300,000 shares of Series D
Cumulative Convertible Preferred Stock at a price of $100 per share. The
preferred stock is convertible at the option of the holder and is subject to
redemption by CRIIMI MAE. In July 1998 the Company issued 100,000 shares of
Series D Preferred Shares, generating proceeds of $10 million. As of September
30, 1998, 100,000 shares of Series D Preferred Shares were outstanding.
Dividends paid and accrued on Series D Preferred Shares totaled $109,080 for the
nine months ended September 30, 1998.
Due to CRIIMI MAE filing for bankruptcy protection, as previously
discussed, the Company may not be able to declare or pay preferred dividends
without first obtaining bankruptcy court approval.
<PAGE>29
CRIIMI MAE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. Obligations under Financing Facilities
Default Declarations
- --------------------
As a result of the bankruptcy petition filed on October 5, 1998,
lenders have declared defaults under a number of CRIIMI MAE's financing
facilities. If the declared defaults are found to be valid, then under certain
of the agreements, default interest (and other charges such as attorneys fees)
may be due to the lender. CRIIMI MAE is contesting the validity of these default
declarations and their consequences.
The following table summarizes CRIIMI MAE's debt outstanding as of
September 30, 1998 and December 31, 1997:
<TABLE><CAPTION>
Nine months ended September 30, 1998
-------------------------------------------------------------------------------------
Balance at Eff. rate Average Average Maturity
Type of Debt quarter end at qtr. end Balance Eff. Rate Date
- ------------ ------------ ----------- ------------ --------- -----------
<S> <C> <C> <C> <C> <C>
Securitized Mortgage Obligations:
FHLMC Funding Note (1) 221,254,709 7.4% 231,836,642 7.4% September 2031
FNMA Funding Note (2) 94,322,158 7.3% 165,982,810 7.3% March 2035
CMOs (3) 160,771,039 7.4% 169,994,540 7.4% January 2033
CMO - Loan Originations(6) 388,526,639 6.5% 166,938,952 6.5% October 2001-
May 2008
Subordinated CMBS(7) 117,771,008 7.5% 61,655,146 7.5% November 2006-
November 2011
Variable-Rate secured borrowings-
Subordinated CMBS(9) 934,151,800 6.7% 731,870,991 6.8% March 1999 -
December 2000
Bank Term Loan(5) 3,050,000 4.8% 3,562,274 4.2% December 1998-
July 1999
Working line of credit 40,000,000 7.4% 15,964,100 7.5% December 1998
Bridge Loan 49,749,522 7.8% 9,770,811 7.8% February 1999
Senior unsecured notes 99,896,352 9.1% 99,887,023 9.1% December 2002
--------------
Total $2,109,493,227(8)
==============
</TABLE>
<PAGE>30
CRIIMI MAE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. Obligations under Financing Facilities - Continued
<TABLE><CAPTION>
Year ended December 31, 1997
-------------------------------------------------------------
Balance Eff. Rate Average Average
Type of Debt at year end at year end Balance Eff. Rate
- ------------ -------------- ------------ ------------ ---------
<S> <C> <C> <C> <C>
Securitized Mortgage Obligations:
FHLMC Funding Note (1) $ 235,773,439 7.4% $236,752,371 7.4%
FNMA Funding Note (2) 145,527,438 7.3% 150,431,262 7.3%
CMOs (3) 178,062,444 7.4% 187,986,472 7.4%
Subordinated CMBS(4) 137,061,676 7.7% 141,382,710 7.7%
Variable-Rate secured borrowings -
Subordinated CMBS 585,379,360 7.2% 280,516,984 7.0%
Bank Term Loans(5) 3,250,000 1.8% 5,006,078 2.2%
Working line of credit 30,000,000 7.2% 1,032,609 7.2%
Senior unsecured notes 99,877,695 9.1% 10,869,565 9.1%
--------------
Total $1,414,932,052
==============
(1) As of September 30, 1998 and December 31, 1997, the face amount of the note
was $229,609,106 and $244,429,739, respectively, with unamortized discount of
$8,354,397 and $8,656,300, respectively. During the nine months ended September
30, 1998 and 1997, discount amortization of $301,903 and $255,476, respectively,
was recorded as interest expense.
(2) As of September 30, 1998 and December 31, 1997, the face amount of the note
was $96,435,120 and $147,927,688, respectively, with unamortized discount of
$2,112,962 and $2,400,250, respectively. During the nine months ended September
30, 1998 and 1997, discount amortization of $287,288 and $177,103, respectively,
were recorded as interest expense.
(3) As of September 30, 1998 and December 31, 1997, the face amount of the note
was $165,236,271 and $182,848,907, respectively, with unamortized discount of
$4,465,232 and $4,786,463, respectively. During the nine months ended September
30, 1998 and 1997, discount amortization of $321,231 and $263,097, respectively,
were recorded as interest expense.
(4) Balance represents face amount of notes, as the issuance did not include any
bond discount.
(5) The effective interest rate as of September 30, 1998 and December 31, 1997
includes the impact of a rate reduction agreement which was in place from July
1995 through September 30, 1998, providing for a reduction in the rate on a
portion of the loans based on balances maintained at the bank.
(6) As of September 30, 1998, the face amount of the debt was $394,783,908 with
unamortized discount of $6,257,269. During the nine months ended September 30,
1998 discount amortization of $334,505 was recorded in interest expense.
(7) As of September 30, 1998, the face amount of the debt was $122,612,000 with
an unamortized discount of $4,840,992. During the nine months ended September
30, 1998 discount amortization of $96,396 was recorded in interest expense.
(8) Excludes off-balance sheet debt of $477 million in connection with the May
1998 collateralized bond obligation transaction.
(9) On October 6, 1998 Morgan Stanley and Co. International Limited ("Morgan
Stanley") advised CRIIMI MAE that it was exercising ownership rights over
certain classes of CMBS it held as collateral pursuant to a May 8, 1998
variable-rate secured borrowing agreement with CRIIMI MAE. On October 6, 1998,
Morgan Stanley purported the fair value of such securities to be $183.1 million.
The recorded fair value of such securities as of September 30, 1998 was $246.7
million. On October 16, 1998, Morgan Stanley advised CRIIMI MAE that it intended
to sell CRIIMI MAE's CMBS. On October 20, 1998, CRIIMI MAE filed a complaint
against Morgan Stanley seeking damages and turnover of the subject CMBS. This
matter is presently pending.
</TABLE>
Securitized Mortgage Obligations - Subordinated CMBS
- ----------------------------------------------------
In May 1998, CRIIMI MAE, through its wholly-owned subsidiary CRIIMI MAE
CMBS Corp., issued an aggregate of $468 million of longer-term, fixed-rate
<PAGE>31
CRIIMI MAE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. Obligations under Financing Facilities - Continued
investment grade securities to reduce an equivalent amount of short-term,
floating rate secured borrowings used to initially fund the CMBS acquisitions.
The transaction was classified as follows: of the total $468 million
investment grade securities, $345 million were non-callable securities
and $123 million were callable securities. As a result of the
implementation of FAS 125, this classification results in sale treatment for
those securities where control was transferred, and financing treatment for
those securities where control was not transferred. Control as of September 30,
1998 was retained because CRIIMI MAE has the right to call certain securities.
Accordingly, the $345 million of investment grade securities that were sold and
the corresponding debt was de-recognized from the balance sheet and the $123
million of investment grade securities and the corresponding debt are recorded
on the balance sheet.
Collateralized Mortgage Obligations - Originated Loans
- ------------------------------------------------------
In June 1998, through the securitization of $496 million of originated
or acquired commercial mortgage loans, CRIIMI MAE sold $397 million face amount
of fixed-rate investment grade securities. The discount on the collateralized
mortgage obligations is being amortized on a level yield basis. Transaction
costs of selling the bonds were capitalized and are included in deferred
financing fees on the accompanying balance sheet as of September 30, 1998. The
tranches not sold to the public were partially financed with secured borrowings.
The secured lending agreements are secured by No-Lock CMO tranches with an
aggregate fair value of approximately $94 million as of September 30, 1998.
The Company intended to sell certain of the No-Lock CMO tranches that
were not initially sold to the public. In anticipation of this sale, the
Company entered into a transaction to hedge the value of those tranches. As a
result, CRIIMI MAE borrowed and then sold a 10-year Treasury Note in the
amount of $44 million. This transaction does not qualify for hedge accounting
purposes because it involves the purchase and sale of a cash instrument and
therefore is required to be marked to market with unrealized gains or
losses reflected in the Company's income statement. Because treasury rates
have declined, the Company's liability is approximately $4.1 million in excess
of the initial sales proceeds received from the short sale. Therefore, the
Company has recorded this amount as an unrealized loss in the income
statement. Depending on the movements in treasury rates this amount could
materially increase or decrease in subsequent reporting periods.
Variable Rate Secured Borrowings-CMBS
- -------------------------------------
As previously discussed, when CRIIMI MAE purchased Subordinated CMBS,
it initially financed (generally through secured borrowings) a portion of the
respective fair values of Subordinated CMBS. These secured borrowings were
either provided by the issuer of the CMBS pool or through master secured
borrowing agreements, as discussed below. As of September 30, 1998, the secured
borrowings on Subordinated CMBS have maturity dates ranging from March 1999 to
December 2000 and have interest rates that are generally based on the one-month
<PAGE>32
CRIIMI MAE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. Obligations under Financing Facilities - Continued
London Interbank Offered Rate (LIBOR), plus a spread ranging from 0.5% to 1.5%.
In September 1997, CRIIMI MAE entered into a three-year master
assignment agreement with a lender to finance up to $200 million of additional
and/or existing investments in lower rated Subordinated CMBS. In early 1998,
this agreement was amended to provide up to $350 million in secured borrowings.
As of September 30, 1998 and December 31, 1997, approximately $275 million, and
$152 million, respectively, in borrowings were outstanding under this facility.
Outstanding borrowings under this master assignment agreement are secured by the
financed Subordinated CMBS.
In addition, in early 1996, CRIIMI MAE entered into a three-year master
secured borrowing agreement with a lender to finance up to $200 million of
additional and/or existing investments in lower rated Subordinated CMBS. In
1998, this agreement was amended to provide for additional secured
borrowings. As of September 30, 1998 and December 31, 1997,
approximately $178 million and $180 million, respectively, in borrowings were
outstanding under this facility. Outstanding borrowings under this master
secured borrowing agreement are secured by the financed Subordinated CMBS.
The secured borrowing agreements are secured by certain rated CMBS
security tranches with an aggregate fair value of approximately $1.3 billion as
of September 30, 1998 and $891 million as of December 31, 1997. At September 30,
1998, CRIIMI MAE had secured borrowing agreements with German American Capital
Corporation, Lehman ALI, Inc. First Union National Bank of North Carolina,
Morgan Stanley, Merrill Lynch Mortgage Capital Inc. and Citicorp Securities,
Inc. ("Citi Services") (see Note 5 for discussion of actions taken by certain
lenders). These secured borrowing agreements qualify as financings under FAS 125
because CRIIMI MAE is required to purchase the same securities collateralizing
the borrowing before their maturity. Citi Services and Morgan Stanley have taken
the position that their respective borrowing arrangements with the Company
constitute "repurchase agreements" and are, therefore, not subject to the
automatic stay provisions contained in the Bankruptcy Code. The Company,
however, contends that both of these borrowing arrangements are merely secured
financing and, consequently, are subject to the automatic stay. There can be no
assurance that the Company's position will prevail.
Senior Unsecured Notes
- ----------------------
In November 1997, CRIIMI MAE issued senior unsecured notes ("Notes")
due on December 1, 2002 in an aggregate principal amount of $100 million. The
Notes are effectively subordinated to the claims of any secured lender to the
extent of the value of the collateral securing such indebtedness. Interest on
the Notes is payable semi-annually in arrears on June 1 and December 1,
commencing June 1, 1998 at a fixed annual rate of 9.125%. The Notes are
redeemable at any time, in whole or in part, at the option of CRIIMI MAE.
<PAGE>33
CRIIMI MAE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. Obligations under Financing Facilities - Continued
The Indenture contains certain covenants which, among other things,
restricted the ability of the Company and its subsidiaries to incur additional
indebtedness, pay dividends, or make distributions in respect of the Company's
or such subsidiaries capital stock, make other restricted payments, enter into
transactions with affiliates or related persons, or consolidate, merge or sell
all or substantially all of their assets. These covenants were subject to
exceptions and qualifications.
Under the terms of the Indenture, the Company could not incur
additional indebtedness (except for Permitted Debt, which included secured
borrowings, working capital lines of credit, borrowings under facilities in
place as of November 21, 1997), unless at the time of such incurrence either (a)
the ratio of Adjusted Earnings Available for Fixed Charges to Adjusted fixed
charges giving proforma effect for the new borrowings is greater than 1.75 to
1.0 or (b) the Adjusted Debt to Capital Ratio on a proforma basis after giving
effect to the incurrence of the new debt is less than 2.0 to 1.0.
Bank Term Loans
- ---------------
In connection with the 1995 Merger, CRIIMI Management assumed certain
debt of the CRI Mortgage Businesses in the principal amount of $9.1 million
(Bank Term Loan). The Bank Term Loan is secured by certain cash flows generated
by CRIIMI MAE's direct and indirect interests in the AIM Funds and is guaranteed
by CRIIMI MAE. The loan requires quarterly principal payments of $650,000 and
matures on December 31, 1998. The amount outstanding as of September 30, 1998
and December 31, 1997 is $1.3 million and $3.2 million, respectively. Interest
on the loan is based on CRIIMI MAE's choice of one, two or three-month LIBOR,
plus a spread of 1.25%.
Working Capital Line of Credit
- ------------------------------
In late 1996, CRIIMI MAE entered into an unsecured working capital line
of credit provided by two lenders with a termination date of December 31, 1998,
which provides for up to $40 million in borrowings. Outstanding borrowings under
this line of credit bear interest at one-month LIBOR, plus a spread of 1.75%. As
of September 30, 1998 and December 31, 1997, $40 million and $30 million,
respectively, in borrowings were outstanding under this facility.
Bridge Loan
- -----------
In August 1998, CRIIMI MAE entered into a bridge loan for $50 million
provided by a lender. The total unpaid principal balance and accrued interest is
due February 1999. However, mandatory prepayments of principal are set forth in
the loan document and the agreement provides that the Company may voluntarily
prepay any portion of the principal and accrued interest at any time pending
approval by the lender. Outstanding borrowings under this facility bear interest
at one-month LIBOR, plus a spread of 2.25%. As of September 30, 1998,
<PAGE>34
CRIIMI MAE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. Obligations under Financing Facilities - Continued
approximately $50 million in borrowings were outstanding under this agreement.
Other Debt Related Information
- ------------------------------
Changes in interest rates will have no impact on the cost of funds or
the collateral requirements on CRIIMI MAE's fixed-rate debt, which approximates
51% of CRIIMI MAE's consolidated debt as of September 30, 1998. Fluctuations in
interest rates will continue to impact the value of that portion of CRIIMI MAE's
mortgage assets which are not match-funded and could impact potential returns to
shareholders through increased cost of funds on the floating-rate debt in place.
CRIIMI MAE has a series of interest rate cap agreements in place in order to
partially limit the adverse effects of rising interest rates on the remaining
floating-rate debt. When CRIIMI MAE's cap agreements expire, CRIIMI MAE will
have interest rate risk to the extent interest rates increase on any
floating-rate borrowings unless the caps are replaced or other steps are taken
to mitigate this risk. However, CRIIMI MAE's investment policy requires that at
least 75% of floating-rate debt be hedged. As of September 30, 1998, 79% of
CRIIMI MAE's floating-rate debt is hedged.
For the nine months ended September 30, 1998, CRIIMI MAE's weighted
average cost of borrowing, including amortization of discounts and deferred
financing fees of approximately $4.3 million, was approximately 7.45%. As of
September 30, 1998, CRIIMI MAE's debt-to-equity ratio was approximately 4.2 to
1.0 and CRIIMI MAE's non- match-funded debt-to-equity ratio was approximately
2.3 to 1.0. Under certain of CRIIMI MAE's existing debt facilities, CRIIMI MAE's
debt-to-equity ratio, as defined, may not exceed 5.0 to 1.0.
12. Interest Rate Hedge Agreements
CRIIMI MAE has entered into interest rate protection ("caps")
agreements to partially limit the adverse effects of rising interest rates on
its floating-rate borrowings. Interest rate caps provide protection to CRIIMI
MAE to the extent interest rates, based on a readily determinable interest rate
index, increase above the stated interest rate cap, in which case, CRIIMI MAE
will receive payments based on the difference between the index and the cap.
None of CRIIMI MAE's caps are held for trading purposes. As of September 30,
1998, CRIIMI MAE held caps with a notional amount of approximately $810 million.
The caps are used to hedge the Company's variable rate debt.
The counterparty to one of the interest rate caps has notified CRIIMI
MAE that its Chapter 11 filing constitutes an event of default under the
agreement. The Company is currently investigating the legality and impact of
such notification.
<PAGE>35
CRIIMI MAE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. Interest Rate Hedge Agreements - Continued
<TABLE><CAPTION>
Notional
Amount Effective Date Maturity Date(b) Cap Index
- ------------ -------------------- ----------------- ------ -------
<S> <C> <C> <C> <C>
$ 35,000,000 February 2, 1994 February 2, 1999 6.1250% 1M LIBOR
100,000,000 April 8, 1997 April 10, 2000 6.6875% 1M LIBOR
100,000,000 September 22, 1997 September 22, 2000 6.6563% 1M LIBOR
100,000,000 December 7, 1997 November 7, 2000 6.6563% 1M LIBOR
50,000,000 December 23, 1997 December 23, 2000 6.9688% 1M LIBOR
100,000,000 March 11, 1998 March 10, 2001 6.6875% 1M LIBOR
100,000,000 March 31, 1998 March 31, 2001 6.6875% 1M LIBOR
100,000,000 June 4, 1998 June 4, 2001 6.6563% 1M LIBOR
100,000,000 June 26, 1998 June 26, 2001 6.6563% 1M LIBOR
25,000,000 September 6, 1998 August 6, 2001 6.6523% 1M LIBOR
- ------------
$810,000,000(a)
============
(a) CRIIMI MAE's designated interest rate protection agreements hedge CRIIMI
MAE's floating-rate borrowing costs. (b) The weighted average strike price of
approximately 6.6% and a weighted average remaining term for these interest rate
cap agreements is approximately 2.2 years.
</TABLE>
CRIIMI MAE is exposed to credit loss in the event of nonperformance by
the counterparties to the interest rate protection agreements should interest
rates exceed the caps. However, management does not anticipate nonperformance by
any of the counterparties. All of the counterparties have long-term debt ratings
of A+ or above by Standard and Poor's and A1 or above by Moody's. Although none
of CRIIMI MAE's caps 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.
<PAGE>36
CRIIMI MAE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
13. Earnings Per Share
The following table reconciles basic and diluted earnings per share
under FAS 128 for the three and nine months ended September 30, 1998 and 1997:
<TABLE><CAPTION>
For the nine months ended September 30, 1998 For the nine months ended September 30, 1997
-------------------------------------------- ----------------------------------------------
Per Share Per Share
Income Shares Amount Income Shares Amount
---------- ------------ --------- ---------- ------------ ---------
<S> <C> <C> <C> <C> <C> <C>
Basic EPS
- ---------
Net Income Available
to Common
Shareholders $ 47,030,928 46,178,885 $1.02 $36,144,814 35,998,050 $ 1.00
Effect of Dilutive
Securities
- ------------------
Net effect of assumed
exercise of stock
options -- 870,767 -- 1,060,972
Convertible Preferred
Stock(1) 1,155,023 2,064,193 4,783,936 4,949,354
----------- ----------- ----------- -----------
Diluted EPS
- -----------
Income available to
Common Shareholders
and assumed
conversions $48,185,951 49,113,845(3) $ 0.98 $40,928,750 42,008,376 $ 0.97
=========== =========== ========= =========== =========== =========
<PAGE>37
CRIIMI MAE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
13. Earnings Per Share - Continued
For the three months ended September 30, 1998 For the three months ended September 30, 1997
--------------------------------------------- ---------------------------------------------
Per Share Per Share
Income Shares Amount Income Shares Amount
---------- ------------ --------- ---------- ------------ ---------
<S> <C> <C> <C> <C> <C> <C>
Basic EPS
- ---------
Net (loss) Income Available
to Common
Shareholders $(8,651,379) 48,298,007 $ (0.18) $ 9,999,953 38,304,782 $ 0.26
Effect of Dilutive
Securities (2)
- ------------------
Net effect of assumed
exercise of stock
options -- -- -- 1,138,430
Convertible Preferred
Stock(1) -- -- 1,417,071 4,424,481
----------- ----------- ----------- -----------
Diluted EPS
- -----------
(Loss) Income available to
Common Shareholders
and assumed
conversions $ (8,651,379) 48,298,007(3) $ (0.18) $11,417,024 43,867,693 $ 0.26
=========== =========== ========= =========== =========== =========
(1) Series B are anti-dilutive for the nine months ended September 30, 1998 and
are therefore not included in the diluted calculation.
(2) SFAS 128 states that no common stock equivalents should be considered in the
calculation of diluted EPS in a period that there is a net loss.
(3) Subsequent to September 30, 1998, 17,000 shares of Series C converted into
1,046,154 common shares.
</TABLE>
14. Transactions with Related Parties
Below is a summary of the related party transactions which occurred
during the three and nine months ended September 30, 1998 and 1997. These items
are described further in the text which follows:
<PAGE>38
CRIIMI MAE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
14. Transactions with Related Parties - Continued
<TABLE><CAPTION>
For the three months ended For the nine months ended
September 30, September 30,
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
AMOUNTS RECEIVED OR ACCRUED FROM RELATED PARTIES
- ------------------------------------------------
CRIIMI,Inc.
- -----------
Income (c) $ 303,523 $ 407,647 $ 979,677 $ 1,214,932
Return of capital (d) 981,028 614,332 3,322,092 1,064,428
------------ ------------ ------------ ------------
Total $ 1,284,551 $ 1,021,979 $ 4,301,769 $ 2,279,360
============ ============ ============ ============
CRI/AIM Investment Limited
Partnership (d) $ 122,632 $ 165,797 $ 431,347 $ 501,628
============ ============ ============ ============
CRIIMI MAE Services Limited Partnership(i) $ -- $ -- $ 3,114,000 $ --
============ ============ ============ ============
Expense Reimbursements to CRIIMI Management(b)
- -------------------------------------------
AIM Funds and CRI Liquidating $ 55,313 $ 70,858 $ 179,765 $ 220,477
============ ============ ============ ============
PAYMENTS TO CRI:
- --------------------
Expense reimbursement - CRIIMI MAE
Management Inc. (g) $ 101,572 $ 90,483 $ 259,859 $ 294,662
============ ============ ============ ============
PAYMENTS TO THE ADVISER
- -----------------------
Annual fee - CRI Liquidating (a)(f) $ -- $ -- $ -- $ 11,468
Incentive fee - CRI Liquidating (e) -- -- -- 958,081
------------ ------------ ------------ ------------
Total $ -- $ -- $ -- $ 969,549
============ ============ ============ ============
Capitol Hotel Group (h) $ 17,563 $ 20,826 $ 42,860 $ 20,826
============ ============ ============ ============
Other (j) $ -- $ -- $ -- $ --
============ ============ ============ ============
<FN>
(a) Included in the accompanying consolidated statements of income
as fees to related party.
(b) Included as general and administrative expenses on the
accompanying consolidated statements of income.
(c) Included as equity in earnings from investments on the
accompanying consolidated statements of income.
(d) Included as a reduction of equity investments on the
accompanying consolidated balance sheets.
(e) Netted with gains on mortgage dispositions on the accompanying
consolidated statements of income. Due to the final
liquidation of CRI liquidating in 1997, no incentive fees are
due for 1998.
(f) As a result of reaching the carryover CRIIMI I target yield
during the first quarter of 1997, CRI Liquidating paid
deferred annual fees. Due to the final liquidation of CRI
Liquidating in 1997, no annual fees are due for 1998.
(g) Pursuant to an agreement between CRIIMI MAE and CRI (the CRI
Administrative Services Agreement), CRI provides CRIIMI MAE
with certain administrative and office facility services and
other services, at cost, with respect to certain aspects of
CRIIMI MAE's business. CRIIMI MAE uses the services provided
under the CRI Administrative Services Agreement to the extent
such services are not performed by CRIIMI Management or
provided by another service provider. The CRI Administrative
Services Agreement is terminable on 30 days notice at any time
by CRIIMI MAE.
(h) Included as a reduction of net income earned from Real Estate
Owned property which is included in other investment income on
the accompanying consolidated statements of income.
(i) This is a distribution included in balance sheet as a decrease
in investment in equity investments.
<PAGE>39
CRIIMI MAE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(j) The Chairman and President of CRIIMI MAE have certain
management interests and equity investments in two borrowers
whose mortgage loans have an aggregate balance of
approximately $22 million which were included in CRIIMI MAE's
June 1998 Commercial Mortgage Obligation transaction. These
two mortgage loans were originated and underwritten by
Citicorp Real Estate, Inc. and were made to CRI Hotel Income
Partners, L.P. (the "CRI Hotel Loan") and Arboretum
Village, L.P. (the "Arboretum Village Loan"). The Chairman
and President of CRIIMI MAE are the Chairman and President,
respectively, of, and holders of a 100% equity interest in
C.R.I., Inc., which is the general partner of CRICO Hotel
Associates I, L.P., the general partner of CRI Hotel Income
Partners, L.P. C.R.I., Inc. is also the managing general
partner of Capital Realty Investors III Limited Partnership
which is a limited partner in Arboretum Villages, L.P. The
Chairman and President of CRIIMI MAE are also the Chairman and
President, respectively and holders of a 100% equity interest
in C.R.H.C. Incorporated which is the general partner of
Arboretum Villages, L.P.
</FN>
</TABLE>
Services Partnership did not file for bankruptcy protection. However,
because of the related party nature of its relationship with CRIIMI MAE,
Services Partnership has been under a high degree of scrutiny from its
servicing rating agencies, and as a result of CRIIMI MAE's bankruptcy filing
was declared in default under certain agreements. In order to repay all
such loans and to increase its liquidity, Services Partnership arranged
for Banc One Mortgage Capital Markets, LLC ("BOMCM") to succeed it as Master
Servicer on two commercial mortgage pools on October 30, 1998. This
arrangement resulted in a loss of approximately $955,000 from the recorded
value of the rights of which substantially all of the loss will flow through
to CRIIMI MAE through equity in earnings in the fourth quarter. In
addition, in order to allay rating agency concerns stemming from CRIIMI MAE's
bankruptcy filing, in November 1998, CRIIMI MAE designated BOMCM as special
servicer on approximately $29 billion of CMBS subject to certain requirements
contained in the respective servicing agreements. Services Partnership will
continue to perform special servicing as sub-servicer for BOMCM. CRIIMI MAE
remains the owner of the lowest rated tranche of the related Subordinated CMBS
and, as such, retains all rights pertaining to ownership including the right to
replace the special servicer. Services Partnership lost the right to specially
service the DLJ 95 CF-2 transaction when the majority holder of the lowest rated
tranche replaced Services Partnership as special servicer.
15. Litigation
For a discussion of CRIIMI MAE's bankruptcy filing and related secured
lender actions, see Notes 1 and 5, respectively.
Additionally, CRIIMI MAE is aware of the filing of at least twenty-one
(21) separate class action civil lawsuits (the "Complaints") against certain
officers and directors of CRIIMI MAE between October 7, 1998 and through the
date of this report. The Complaints name as defendants William B. Dockser as
Chairman of the Board of Directors of CRIIMI MAE and H. William Willoughby as
a member of the Board of Directors and/or officer of CRIIMI MAE. In addition, a
majority of the Complaints name Cynthia O. Azzara as a defendant as an officer
of CRIIMI MAE. Several of the Complaints also name Garrett G. Carlson, Sr., G.
Richard Dunnells and Robert J. Merrick as defendants as members of both the
Board of Directors and the Audit Committee of CRIIMI MAE. Although CRIIMI MAE
<PAGE>40
CRIIMI MAE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
15. Litigation - Continued
has not been named as a defendant, it is under an obligation to indemnify
the defendants under the terms and conditions outlined in its by-laws.
In addition, CRIIMI MAE has a directors and officers liability insurance policy
that has a coverage limit of $20 million.
A majority of the Complaints were filed in the United States District
Court for the District of Maryland. One of the Complaints was filed in the
United States District Court for the Eastern District of New York and another
Complaint was filed in the United States District Court for the Central District
of California.
The Complaints generally allege that the named defendants violated
Section 10(b) of the Securities Exchange Act of 1934, by, among other things,
making false statements of material facts and failing to disclose certain
material facts concerning, among other things, CRIIMI MAE's ability to meet the
earnings estimates of analysts and to meet collateral calls from lenders. The
Complaints also generally allege that the named defendants violated Section
20(a) of the Securities and Exchange Act of 1934, because each named defendant
was allegedly a "controlling person" as that term is defined under Section
20(a).
CRIIMI MAE and the defendants are in the process of investigating the
allegations in the Complaints. The defendants believe the allegations set forth
in the Complaints are without merit and intend to defend vigorously the claims
asserted in the Complaints. CRIIMI MAE cannot predict with any degree of
certainty the ultimate outcome of such litigation.
<PAGE>41
PART I. FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Introduction and Business Strategy
- ----------------------------------
Introduction
- ------------
CRIIMI MAE Inc.'s ("CRIIMI MAE" or the "Company") Management's
Discussion and Analysis of Financial Condition and Results of Operations
contains statements that may be considered forward looking. These statements
contain a number of risks and uncertainties as discussed herein and in CRIIMI
MAE's other reports filed with the Securities and Exchange Commission that could
cause actual results to differ materially (See further discussion under "Forward
Looking Statements" on page 62).
CRIIMI MAE is a fully integrated commercial mortgage company structured
as a self-administered real estate investment trust ("REIT"). On October 5, 1998
(the "Petition Date"), the Company and certain of its consolidated operating
subsidiaries, CRIIMI MAE Management, Inc. ("Management"), and CRIIMI MAE
Holdings II, L.P. ("Holdings II") (collectively, the "Debtors") filed for relief
under Chapter 11 (so called herein) of the U.S. Bankruptcy Code (the "Bankruptcy
Code") in the United States Bankruptcy Court for the District of Maryland,
Southern Division in Greenbelt, Maryland (the "Bankruptcy Court"). These related
cases are being jointly administered under the caption "In re CRIIMI MAE Inc.,
et al.," Ch. 11 Case no. 98-2-3115-DK.
In addition to Management and Holdings II, the Company owns 100% of
multiple financing and operating subsidiaries (discussed in Note 6) as well as
various interests in other entities (including, among others, the Company's
servicing affiliate CRIIMI MAE Services Limited Partnership ("CMSLP" or
"Services Partnership")) which either own or service mortgage and
mortgage-related assets (such subsidiaries and other entities, collectively, the
"Non-Debtor Affiliates"). None of the Non-Debtor Affiliates has filed a
bankruptcy petition.
Prior to the Petition Date, CRIIMI MAE's primary activities included
(i) acquiring non-investment grade subordinated securities backed by pools of
mortgage loans on multifamily, retail and other commercial real estate and by
pools of mortgage-backed securities backed, in turn, by loans on such properties
("Subordinated CMBS"), (ii) originating and underwriting mortgage loans, (iii)
securitizing pools of mortgage loans and pools of commercial mortgage-backed
securities ("CMBS"), and (iv) through CMSLP, performing servicing functions with
respect to the Company's mortgage loans and mortgage loans underlying the
Company's Subordinated CMBS.
Prior to the Petition Date, CRIIMI MAE financed a substantial portion
of its Subordinated CMBS acquisitions with short-term variable rate borrowings
secured by the Company's Subordinated CMBS. The agreements governing these
financing arrangements typically required the Company to maintain collateral at
all times with a market value not less than a specified percentage of the
outstanding indebtedness. The agreements further provided that the lenders could
require the Company to provide additional collateral, typically within one or
<PAGE>42
PART I. FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - Continued
two business days following demand, if the value of the existing collateral fell
below this threshold amount.
As a result of the recent turmoil in the capital markets, the spreads
between CMBS rates and the rates on Treasury securities with comparable
maturities began to widen substantially and rapidly in August 1998. Due
primarily to widening CMBS spreads, the market value of the Subordinated CMBS
securing the Company's short-term financings declined. CRIIMI MAE's short-
term secured creditors perceived that the value of the Subordinated CMBS
securing their facilities with the Company had fallen below the minimum
collateral- to-loan value ratio described above and, consequently, made demand
upon the Company to provide additional collateral with sufficient value to cure
the perceived deficiency. In August and September, the Company received and met
collateral calls from its secured creditors. At the same time, CRIIMI MAE
was in negotiations with various third parties in an effort to obtain
additional debt and equity financing that would provide the Company with
additional liquidity.
On Friday afternoon, October 2, 1998, the Company was in the closing
negotiations of a refinancing with one of its unsecured creditors that would
have provided the Company with additional borrowings, when it received a
significant collateral call from Merrill Lynch. The basis for this collateral
call, in the Company's view, was unreasonable. After giving consideration, among
other things, to this collateral call and the Company's concern that its
failure to satisfy this collateral call would cause the Company to be in
default under a substantial portion of its financing arrangements, the
Company reluctantly concluded on Sunday, October 4, that it was in the best
interests of creditors, equity holders and other parties in interest
to seek Chapter 11 protection. Accordingly, the Company filed its
bankruptcy petition on Monday, October 5.
As a result of the bankruptcy filing, the Company has been advised by
its independent public accountants that, if the reorganization plan is not
approved by the Bankruptcy Court prior to the completion of their audit of the
Company's financial statements for the year ending December 31, 1998, the
auditors' report on those financial statements will be modified due to
substantial doubt about the Company's ability to continue as a going concern.
Also as a result of the Chapter 11 filing, CRIIMI MAE does not expect
to pay a dividend during the fourth quarter of 1998. See Note 1 and "REIT
Status" below for a discussion of the effect of the Company's REIT status for
the 1998 tax year should CRIIMI MAE not make a distribution in the fourth
quarter of 1998.
CRIIMI MAE conducts its mortgage loan servicing and advisory operations
through its affiliate, Services Partnership. As of September 30, 1998, Services
Partnership was responsible for certain servicing functions on a mortgage loan
portfolio of approximately $32 billion, as compared to approximately $16.5
billion as of December 31, 1997. Prior to the Petition Date, CRIIMI MAE
increased its mortgage advisory and servicing activities primarily through its
purchases of Subordinated CMBS by acquiring certain servicing rights for the
<PAGE>43
PART I. FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - Continued
mortgage loans collateralizing the Subordinated CMBS, as well as providing
servicing on the loans closed through the CRIIMI MAE loan origination program.
As of September 30, 1998, CRIIMI MAE master serviced five CMBS portfolios
totaling $3.6 billion, as well as its own portfolio of originated loans not yet
securitized.
Services Partnership did not file for bankruptcy protection.
However, because of the related party nature of its relationship with
CRIIMI MAE, Services Partnership has been under a high degree of scrutiny from
its servicing rating agencies, and as a result of CRIIMI MAE's bankruptcy
filing was declared in default under certain agreements. In order to repay
all such loans and to increase its liquidity, Services Partnership
arranged for Banc One Mortgage Capital Markets, LLC ("BOMCM") to succeed it
as Master Servicer on two commercial mortgage pools on October 30, 1998. This
arrangement resulted in a loss of approximately $955,000 from the recorded
value of the rights of which substantially all of the loss will flow through
to CRIIMI MAE through equity in earnings in the fourth quarter. In
addition, in order to allay rating agency concerns stemming from CRIIMI MAE's
bankruptcy filing, in November 1998, CRIIMI MAE designated BOMCM as special
servicer on approximately $29 billion of CMBS subject to certain requirements
contained in the respective servicing agreements. Services Partnership will
continue to perform special servicing as sub-servicer for BOMCM. CRIIMI MAE
remains the owner of the lowest rated tranche of the related Subordinated CMBS
and, as such, retains all rights pertaining to ownership including the right to
replace the special servicer. Services Partnership lost the right to specially
service the DLJ 95 CF-2 transaction when the majority holder of the lowest rated
tranche replaced Services Partnership as special servicer.
The Company does not anticipate originating new loans or acquiring CMBS
in the near term. Accordingly, in an effort to streamline its operations and
reduce operating expenses, the Company has significantly reduced the number of
employees in its originations and underwriting operations. In connection with
these reductions, the Company has closed its five regional loan origination and
underwriting offices, retaining only a small presence in Boston, Houston,
Chicago and San Francisco.
Business Strategy
- -------------------
Prior to the Petition Date, CRIIMI MAE was a leading purchaser of
Subordinated CMBS, commercial loan servicer and originator of commercial loans.
Since filing for Chapter 11 protection, CRIIMI MAE has suspended its loan
securitization, loan underwriting and loan origination businesses. The Company
continues to hold a substantial portfolio of Subordinated CMBS and, through
CMSLP, performs servicing functions with respect to the Company's mortgage loans
and the mortgage loans underlying the Company's Subordinated CMBS. Significant
elements of CRIIMI MAE's business strategy prior to October 5, 1998 are
summarized below:
<PAGE>44
PART I. FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - Continued
o CRIIMI MAE purchased approximately $853 million of
Subordinated CMBS during the nine months ended
September 30, 1998.
o In June 1998, CRIIMI MAE securitized $496 million of
commercial loans originated or acquired through the
"No Lock" conduit loan program
o During May 1998, CRIIMI MAE completed its second
resecuritization of Subordinated CMBS with a face
amount of $1.8 billion (CBO-2).
o CRIIMI MAE raised capital through a variety of
sources during the first nine months of 1998. The
Company raised $136 million through equity offerings,
comprised of $72 million from two common share
offerings, $39 million from common shares issued in
connection with the Dividend Reinvestment and Stock
Purchase Plan and $25 million from the issuance of
preferred shares. Additionally, during the second
quarter 1998, the Company generated excess proceeds
of $160 million in connection with CBO-2.
Results of Operations
- ---------------------
1998 versus 1997
- ----------------
Tax Basis Income
----------------
For the three months ended September 30 1998, CRIIMI MAE earned income
available to common shareholders of approximately $19.9 million or $0.41 per
share, compared to income available to common shareholders of $12.1 million or
$0.31 per share for the three months ended September 30, 1997. For the nine
months ended September 30 1998, income available to common shareholders was
approximately $57.3 million or $1.22 per share, compared to income available to
common shareholders of $39.8 million or $1.09 per share for the nine months
ended September 30, 1997. Total tax basis income for the nine months ended
September 30, 1997 of $1.09 per share included $0.21 per share of non-recurring
income from the mortgage dispositions of a subsidiary that completed its
scheduled liquidation in late 1997.
The primary factors resulting in the increase in tax basis income were
the increases associated with growth in CRIIMI MAE's portfolio of Subordinated
CMBS and earnings from the June 1998 securitization of originated loans. Also
contributing to the increase was a $4.2 million gain on the sale of the trustee
servicing rights associated with the resecuritization described in Note 5.
Partially offsetting these increases to tax basis income were increases in
interest expense and general and administrative expenses as further discussed
under Financial Statement Net Income and a decrease in mortgage interest income
earned due to the prepayment of certain CRIIMI MAE mortgages during 1998 and
1997.
<PAGE>45
PART I. FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - Continued
Financial Statement Net Income (Loss)
------------------------------------
Net loss to common shareholders for financial statement purposes was
approximately $8.7 million for the three months ended September 30, 1998,
compared to net income available to common shareholders of approximately $10.0
million for the corresponding period in 1997. Net income available to common
shareholders for financial statement purposes was approximately $47.0 million
for the nine months ended September 30, 1998, a 30% increase from approximately
$36.1 million for the corresponding period in 1997. On a basic earnings per
share basis, financial statement net loss for the three months ended September
30, 1998 was $(0.18) per weighted average common share compared to net income of
$0.26 per weighted average common share for the corresponding period in 1997. On
a basic earnings per share basis, financial statement net income for the nine
months ended September 30, 1998 was $1.02 per weighted average common share
compared to $1.00 per weighted average common share for the corresponding period
in 1997. The primary reason for the net loss for the three months ended
September 30, 1998 is primarily due to unrealized losses aggregating $21.7
million on commitments related to commercial mortgage loans in the Company's
securitization pipeline and losses on certain hedge positions. Descriptions of
these commitments and other significant changes in financial statement net
income are discussed below.
Interest Income - Subordinated CMBS
- -----------------------------------
Interest income from Subordinated CMBS increased by approximately $18.5
million or 90% to $38.9 million for the three months ended September 30, 1998
from $20.4 million for the corresponding period in 1997. Interest income from
Subordinated CMBS increased by approximately $50.6 million or 93% to $105.3
million for the nine months ended September 30, 1998 from $54.7 million for the
corresponding period in 1997. This increase was primarily the result of the
acquisition of Subordinated CMBS at purchase prices aggregating approximately
$853 million for the nine months ended September 30, 1998 and $554 million
during the twelve months ended December 31, 1997. This increase includes a
partial offset due to the reduction in basis of CMBS assets in connection with
the sale treatment of the non-callable securities sold in the resecuritization
described in Note 5. Statement of Financial Accounting Standards 125 "Accounting
for Transfers of Servicing of Financial Assets" (FAS 125) allows the
resecuritization to be treated in component parts; therefore some parts may be
accounted for as financings and other parts may be accounted for as sales.
GAAP requires that the income on Subordinated CMBS be recorded based on
the effective interest method using the anticipated yield over the expected life
of these mortgage assets. This currently results in income which is lower for
financial statement purposes than for tax purposes. Based on the timing and
amount of future credit losses and certain other assumptions estimated by
management, as discussed below, the anticipated weighted average unleveraged
yield over the expected average life of CRIIMI MAE's Subordinated CMBS for
financial statement purposes as of September 30, 1998 was approximately 10.1%.
<PAGE>46
PART I. FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - Continued
CRIIMI MAE has applied its experience in underwriting multifamily and
other commercial real estate to perform extensive due diligence on the
properties collateralizing the loans underlying the Subordinated CMBS. It has
been CRIIMI MAE's practice to "re-underwrite" or review, a significant portion
of the mortgage loans in a prospective pool by reviewing historical and current
operating records of the underlying real estate assets, appraisals,
environmental studies, market studies and architectural and engineering studies,
all to independently assess the stabilized performance level of the underlying
properties. In addition, the Company has conducted site visits at a substantial
number of the properties. The Company has stressed the adjusted net operating
incomes of the properties to simulate certain recessionary scenarios and applies
market or greater capitalization rates to assess loan quality. As a result of
the bankruptcy filing for CRIIMI MAE, the Company has suspended acquisitions of
additional Subordinated CMBS.
Interest Income Collateralized Mortgage Obligations - Insured Loans
- -------------------------------------------------------------------
Interest income from collateralized mortgage obligations-insured loans
("insured loans") decreased by approximately $1.5 million or 12% to $10.7
million for the three months ended September 30, 1998 from $12.2 million for the
corresponding period in 1997. Interest income from insured loans decreased by
approximately $3.6 million or 10% to $33.5 million for the nine months ended
September 30, 1998 from $37.1 million for the corresponding period in 1997. The
decrease in mortgage income results primarily from the prepayment of insured
mortgages held by CRIIMI MAE and its wholly owned subsidiaries. The prepayments
aggregated approximately $91 million and $27 million of amortized cost for the
nine months ended September 30, 1998 and the twelve months ended December 31,
1997, respectively. Additionally, in September 1998, CRIIMI MAE sold four
unencumbered loans and a part of a fifth unencumbered loan that were held in the
portfolio. The sale generated net proceeds of $13.4 million on assets with an
amortized cost of $12.8 million, resulting in a gain of approximately $531,000
for financial reporting purposes.
Interest Income - Collateralized Mortgage Obligations -
Originated Loans
- -------------------------------------------------------
Interest income from collateralized mortgage obligations originated
loans ("originated loans") increased for the three and nine months ended
September 30, 1998. Interest income from originated loans of approximately $8.9
million for the three months and $11.6 million for the nine months ended
September 30, 1998 was derived from originated loans acquired in the first
securitization of CRIIMI MAE's "No Lock" conduit loan product. The
securitization, totaling $496 million, was completed in June 1998.
Interest Expense
- ----------------
Interest expense increased by approximately $20.3 million or 105% to
approximately $39.7 million for the three months ended September 30, 1998 from
<PAGE>47
PART I. FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - Continued
approximately $19.3 million for the corresponding period in 1997. Interest
expense increased by approximately $44.4 million or 81% to
approximately $99.1 million for the nine months ended September 30, 1998 from
approximately $54.7 million for the corresponding period in 1997. These
increases were principally a result of additional amounts borrowed in connection
with the acquisition of Subordinated CMBS during 1997 and the first nine months
of 1998. Additionally, CRIIMI MAE incurred interest expense in connection with
the senior unsecured notes issued during fourth quarter 1997 and the
collateralized mortgage obligations issued in June 1998. These increases are net
of the impact of $477 million of debt derecognized on the financial statements
in conjunction with the CBO-2 transaction. If the declared defaults are found to
be valid then under certain of the agreements, default interest (and other
charges such as attorneys fees) may be due to the lender. (See Note 11)
Net Interest Margin
- -------------------
Net interest margin increased by approximately $5.5 million or 41% for
the three months ended September 30, 1998 to approximately $18.7 million from
approximately $13.2 million for the corresponding period in 1997. For the nine
months ended September 30, 1998, net interest margin increased approximately
$14.3 or 39% to approximately $51.3 million from approximately $37.1 million for
the corresponding period in 1997. Net interest margin increased for the three
and nine months ended September 30, 1998, due primarily to the increase in
Subordinated CMBS and income from originated loans, as previously discussed.
Gain on Sale of Securities
- --------------------------
As previously discussed, in May 1998, CRIIMI MAE completed the sale of
$468 million of investment grade securities created through the resecuritization
of approximately $1.8 billion of its Subordinated CMBS. CRIIMI MAE recognized a
gain of approximately $28.8 million on the sale of $345 million face amount
investment grade securities sold without call provisions, recognizing CRIIMI
MAE's transfer of control on those securities. The sale of $123 million face
amount investment grade securities with significant call provisions was treated
as a financing and resulted in an unrealized gain of approximately $26 million.
Certain securities included call provisions to enable CRIIMI MAE to 1)
repurchase bonds if market conditions warrant, and 2) call bonds when it is no
longer cost effective to service them. The sold investment grade securities
treated as financing, as well as approximately $1.3 billion face amount of
investment grade and non-investment grade securities retained by CRIIMI MAE, are
now required to be reflected on CRIIMI MAE's balance sheet at their fair market
value. Additionally, due to the sale treatment under FAS 125, all remaining
Subordinated CMBS and government insured mortgage securities are required to be
carried at fair market value. This reclassification currently results in a
cumulative net decrease to shareholders' equity of approximately $77 million (a
$195 million decrease from June 30, 1998).
<PAGE>48
PART I. FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - Continued
Additionally, as part of CBO-2, the Services Partnership sold
trustee servicing rights for $4.2 million, resulting in a gain of $4.2
million for tax purposes, and approximately $400,000 for financial
reporting purposes.
Equity In Earnings From Investments
- -----------------------------------
Equity in earnings from investments decreased by approximately $1.2
million or 105% to approximately $(58,000) for the three months ended September
30, 1998 as compared to $1.2 million for the corresponding period in 1997.
Equity in earnings from investments decreased by approximately $530,000 or 20%
to approximately $2.2 million for the nine months ended September 30, 1998 as
compared to $2.7 million for the corresponding period in 1997. This decrease is
primarily due to recognizing impairment losses on purchased mortgage servicing
rights in Services Partnership due to prepayments in the mortgage pools and the
general market turmoil during the third quarter, as previously discussed,
thereby causing the fair value of certain servicing rights to be less than the
amortized cost. This decrease is partially offset by increases in servicing fee
streams and float income earned on escrow balances derived from the steadily
expanding servicing portfolio. The servicing portfolio grew to approximately $32
billion as of September 30, 1998, as compared to approximately $16.5 billion as
of December 31, 1997. The increased float income and servicing fees were
partially offset by increased general and administrative expenses associated
with the growth in the servicing portfolio, as well as amortization of certain
purchased servicing rights. Additionally, as previously discussed, Services
Partnership recognized a GAAP gain of approximately $400,000 on the sale of a
trustee servicing strip in conjunction with the CBO-2 transaction completed in
May 1998.
Other Income
- ------------
Other income increased by approximately $569,000 or 116% to
approximately $1.1 million for the three months ended September 30, 1998 as
compared to approximately $492,000 for the corresponding period in 1997. Other
income increased by approximately $2.1 million or 120% to approximately $3.9
million for the nine months ended September 30, 1998 as compared to
approximately $1.8 million for the corresponding period in 1997. This increase
was primarily attributable to an increase in short-term interest and other
income earned during the first three quarters of 1998 on the amounts deposited
in the loan origination reserve account, which had an average balance of
approximately $28 million and approximately $40 million during the three and
nine months ended September 30, 1998, respectively. Approximately $498,000 and
approximately $1.9 million of short-term interest income and net-carry income
were earned on these deposits for the three and nine months ended September 30,
1998, respectively. Amounts earned on the origination reserve account for the
period ended September 30, 1997 were immaterial.
Gain(Loss) on Mortgage Dispositions
- -----------------------------------
For the three months ended September 30, 1998 and 1997, gains (losses)
on mortgage dispositions were approximately $967,000 and $(91,000),
<PAGE>49
PART I. FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - Continued
respectively. For the nine months ended September 30, 1998 and 1997, gains on
mortgage dispositions were approximately $921,000 and $17.1 million,
respectively. The following table summarizes the mortgage dispositions for the
three and nine months ended September 30, 1998 and 1997 for GAAP purposes:
<TABLE><CAPTION>
1998
Amortized GAAP
Face Value Cost Gain/(Loss)(2)
---------- ---------- --------------
<S> <C> <C> <C>
For the quarter ended
September 30 $ 70,859,257 $ 70,826,910 $ 966,654
==========-= ==-========= =========
For the nine months ended
September 30 $103,362,291 $103,607,446 $ 920,820
==-========= =-=========- =========
1997
Amortized GAAP
Face Value Cost Gain/(Loss)(1)(2)
---------- ---------- --------------
<S> <C> <C> <C>
For the quarter ended
September 30 $9,287,219 $9,303,494 $ (90,608)
========== ========== ==========
For the nine months ended
September 30 $75,553,277 $61,201,155 $17,143,342
=-========= =-========= ==-========
(1) For the nine month period and quarter ended September 30, 1997, gains from
the sales of CRI Liquidating assets totaled approximately $17.3 million and
$95,000, respectively. This entity was fully liquidated as of December 31, 1997
and therefore no gains or losses from CRI Liquidating will be recognized for
1998 or future periods.
(2) GAAP gain/(loss) is calculated generally, based on the difference between
the face value of the mortgage and the amortized cost, plus or minus the
difference between the stated interest received less the effective interest due,
plus prepayment penalties (if any).
</TABLE>
General and Administrative Expenses
- -----------------------------------
General and administrative expenses increased by approximately $2.0
million or 76% to approximately $4.6 million for the three months ended
September 30, 1998 as compared to approximately $2.6 million for the
corresponding period in 1997. General and administrative expenses increased by
approximately $3.0 million or 39% to approximately $10.7 million for the nine
months ended September 30, 1998 as compared to approximately $7.7 million for
the corresponding period in 1997. The increase in general and administrative
expenses during these periods is primarily the result of the significant growth
of CRIIMI MAE's commercial mortgage operations during these periods.
Unrealized Losses on Repurchase and Warehouse Purchase Obligations
- ------------------------------------------------------------------
During the three and nine months ended September 30, 1998, the Company
recorded unrealized losses aggregating $21.7 million primarily due to the impact
of financial market volatility on commitments
<PAGE>50
PART I. FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - Continued
related to commercial mortgage loans in the Company's securtization pipeline and
losses on hedge positions. The parties who fund the Company's loan originations
are required under the relevant agreements to hedge the related loans and to
provide timely written hedge position reporting. The Company's obligation to
purchase the loans under the Citibank Program was $14.8 million in excess of the
fair value of the loans and the Company's option to purchase the loan under the
Prudential program was $2.8 million in excess of the fair value of the loan
principally because of the unrest in the bond and CMBS markets and the
ineffectiveness of the hedging programs employed by Citibank and Prudential. As
a result, CRIIMI MAE recorded a $17.6 million unrealized loss on their purchase
obligations as of September 30, 1998. The Company has calculated the unrealized
losses based upon an estimate of value of the loans (based on proceeds that
could be raised in a securitization using market spreads for bonds that would be
issued if such a transaction occurred on September 30, 1998) as well as hedging
losses as of that date. Timely written hedge position reporting, as required
under both Programs, was not provided at September 30, 1998. In the absence of
such reports, the Company has based its loss estimates, in part, upon oral
communications from these parties. Depending on market conditions including
interest rate movements these losses could materially increase or decrease in
subsequent reporting periods.
Additionally, the Company intended to sell certain of the security
tranches that were not initially sold to the public. In anticipation of this
sale, the Company entered into a transaction to hedge the value of those
securities. As a result CRIIMI MAE borrowed and then sold a 10-year Treasury
Note in the amount of $44 million. This transaction does not qualify for hedge
accounting purposes because it involves the purchase and sale of a cash
instrument and therefore is required to be marked to market with unrealized
gains or losses reflected in the Company's income statement. Because treasury
rates have declined, the Company's liability is approximately $4.1 million in
excess of the initial sales proceeds received from the short sale. Therefore the
Company has recorded this amount as an unrealized loss in the income statement.
Depending on market conditions including movements in interest rates these
unrealized losses could materially increase or decrease in subsequent reporting
periods.
Cash Flow
- ---------
1998 versus 1997
- ----------------
Net cash provided by operating activities decreased for the nine months
ended September 30, 1998 as compared to the corresponding period in 1997
primarily due to the increase in receivables and other assets of approximately
$34.1 million. The increase in receivables is due largely to the interest
receivable on Subordinated CMBS which has increased as a result of acquisitions
during 1997 and the first half of 1998. Also included in the net change in
receivables and other assets is interest income receivable due on the
collateralized mortgage obligation-originated loans, which closed June 1998 and
$7.6 million of mezzanine loans funded during the first nine months of 1998.
<PAGE>51
PART I. FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - Continued
This increase is partially offset by an increase in interest payable due to
financings of Subordinated CMBS acquisitions and interest payable on
collateralized mortgage-obligation originated loans.
Net cash used in investing activities increased for the nine months
ended September 30, 1998 as compared to the corresponding period in 1997
principally as a result of the increased purchases of Subordinated CMBS. Also
contributing to the increase in cash used in investing activities was the
purchase of the commercial loans, approximately $496 million, for CRIIMI MAE's
"No-Lock" originated loan securitization. These increases were partially offset
by approximately $335 million of proceeds received from the sale of
collateralized bond obligations in conjunction with CBO-2 and funding the
increase in the Company's repurchase obligation of the Treasury position, as
previously discussed.
Net cash provided by financing activities increased for the nine months
ended September 30, 1998 as compared to the corresponding period in 1997. Net
cash provided by financing activities increased primarily due to proceeds from
debt issuances related to the sale of the collateralized mortgage obligation and
variable-rate secured borrowing debt, net of principal payments, and increased
proceeds from equity offerings. These increases were partially offset by
payments made in connection with collateral calls made by lenders primarily in
the latter part of the third quarter.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
Prior to the Petition Date, to meet the capital requirements of its
business plan, CRIIMI MAE used proceeds from long-term, fixed-rate match-funded
debt refinancings, secured borrowings, securitizations, other borrowings,
issuances of common and preferred shares and unsecured borrowings.
Prior to the Petition Date, CRIIMI MAE financed a substantial portion
of its Subordinated CMBS acquisitions with short-term variable rate borrowings
secured by the Company's Subordinated CMBS. The agreements governing these
financing arrangements typically required the Company to maintain collateral at
all times with a market value not less than a specified percentage of the
outstanding indebtedness. The agreements further provided that the lenders could
require the Company to post additional collateral if the value of the existing
collateral fell below this threshold amount.
In May 1998, CRIIMI MAE completed the second resecuritization of its
Subordinated CMBS portfolio, which under FAS 125, qualified for both sale and
financing accounting. Through the May 1998 transaction, CRIIMI MAE refinanced
$468 million of its variable rate debt with fixed-rate match-funded debt. As
previously stated, the transaction also generated net excess proceeds of
approximately $160 million, which were used primarily to fund additional CMBS
purchases. In June 1998, CRIIMI MAE securitized $496 million of originated or
acquired commercial mortgage loans by selling $397 million face amount of
fixed-rate investment grade securities. The tranches not sold to the public
were partially financed with secured financing agreements.
<PAGE>52
PART I. FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - Continued
As a result of the recent turmoil in the capital markets, the spreads
between CMBS rates and the rates on Treasury securities with comparable
maturities began to widen substantially and rapidly in August 1998. Due
primarily to widening CMBS spreads, the market value of the Subordinated CMBS
securing the Company's short-term financings declined. CRIIMI MAE's short-
term secured creditors perceived that the value of the Subordinated CMBS
securing their facilities with the Company had fallen below the minimum
collateral-to-loan value ratio described above and, consequently, made demand
upon the Company to provide additional collateral with sufficient value to cure
the perceived deficiency. In August and September, the Company received and met
collateral calls from its secured creditors. At the same time, CRIIMI MAE was
in negotiations with various third parties in an effort to obtain additional
debt and equity financing that would provide the Company with additional
liquidity.
At September 30, 1998, CRIIMI MAE had secured financing agreements with
German American Capital Corporation, Lehman ALI, Inc., First Union National Bank
of North Carolina, Morgan Stanley International Co., Ltd., Merrill Lynch
Mortgage Capital Inc., and the pledged security in its own name to help secure
its interest in the collateral. As a result, the trustee makes payments on each
security to the registered holder. Certain registered holders are currently
withholding payments related to securities not registered to CRIIMI MAE. The
Company is in negotiation with certain lenders to receive a portion of these
payments but no agreement has been finalized, nor is it certain the lenders will
enter into such an agreement. The Company's CMBS portfolio (excluding those
securities that are match-funded) currently generates approximately $13
million of monthly cash flow. As of November 16, 1998, certain lenders have
withheld payment to CRIIMI MAE of approximately $18.7 million, including
approximately $6.7 million accrued as of September 30, 1998. The
realizability of these receivables, and whether or not this triggers impairment
losses on any of the Company's Subordinated CMBS, is therefore uncertain and
will be determined in the fourth quarter as the bankruptcy case evolves.
The Company's obligation to purchase the loans under the Citibank
Program was $14.8 million in excess of the fair value of the loans and the
Company's option to purchase the loan under the Prudential program was $2.8
million in excess of the fair value of the loan principally because of the
unrest in the bond and CMBS markets and the ineffectiveness of the hedging
programs employed by Citibank and Prudential. As a result, CRIIMI MAE recorded a
$17.6 million unrealized loss on their purchase obligations as of September 30,
1998. The Company has calculated the unrealized losses based upon an estimate of
value of the loans (based on proceeds that could be raised in a securitization
using market spreads for bonds that would be issued if such a transaction
occurred on September 30, 1998) as well as hedging losses as of that date.
Timely written hedge position reporting, as required under both Programs, was
not provided at September 30, 1998. In the absence of such reports, the Company
has based its loss estimates, in part, upon oral communications from these
parties.
Additionally, the Company intended to sell certain of the No-Lock
CMO tranches that were not initially sold to the public. In anticipation of
this sale, the Company entered into a transaction to hedge the value of
those tranches. As a result, CRIIMI MAE borrowed and then sold a 10-year
Treasury Note in the amount of $44 million. This transaction does not qualify
for hedge accounting purposes because it involves the purchase and sale
of a cash instrument and therefore is required to be marked to market with
unrealized gains or losses reflected in the Company's income statement.
<PAGE>53
PART I. FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - Continued
Because treasury rates have declined, the Company's liability is approximately
$4.1 million in excess of the initial sales proceeds received from the short
sale. Therefore the Company has recorded this amount as an unrealized loss in
the income statement. Depending on market conditions as well as movements in
interest rates, the unrealized loss could materially increase or decrease in
subsequent reporting periods.
The Company's ability to execute its business strategy and to resume the
acquisition of Subordinated CMBS, as well as its loan origination and
securitization program, depends to a significant degree on its ability to obtain
additional capital and emerge from bankruptcy as a successfully reorganized
company. Factors which could affect the Company's access to the capital markets,
or the costs of such capital, include changes in interest rates, general
economic conditions and perception in the capital markets of the Company's
business, covenants under the Company's current and future debt securities and
credit facilities, results of operations, leverage, financial conditions and
business prospects. Currently, CRIIMI MAE is exploring a variety of
capital sources, including possible Debtor in Possession financing and/or other
longer-term financing or equity capital. However, the Company can give no
assurances as to whether it will obtain such capital or financing, the terms
upon which such capital or financing can be obtained.
CRIIMI MAE has a series of interest rate cap agreements in place in order
to partially limit the adverse effects of rising interest rates on the
floating-rate debt. When CRIIMI MAE's cap agreements expire, CRIIMI MAE will
have interest rate risk to the extent interest rates increase on any
floating-rate borrowings unless the caps are replaced or other steps are taken
to mitigate this risk. CRIIMI MAE's investment policy requires that at least 75%
of floating-rate debt be hedged; however, there can be no assurance that the
Company will be able to do so. As of September 30, 1998, 79% of CRIIMI MAE's
outstanding floating-rate debt is hedged with interest rate cap agreements that
have weighted average strike price of approximately 6.6% and a weighted average
remaining term of 2.2 years. The counterparty to one of the interest rate caps
has notified CRIIMI MAE that its Chapter 11 filing constitutes an event of
default under the agreement. The Company is currently investigating the legality
and impact of such notification.
Dividends
- ---------
Tax basis income increased for the nine months ended September 30, 1998
as compared to the corresponding periods in 1997 and, as a result, total
dividends increased. Dividends paid per share are summarized below:
<PAGE>54
PART I. FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - Continued
<TABLE><CAPTION>
For the three months ended For the nine months ended
September 30, (1) September 30, (1)
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Common Shares .40 .35 1.17 1.05
Series B Preferred Shares .915 .797 2.675 2.391
(1) In addition to the per share amounts as described above,
Series A Preferred Shares were paid $50,866 for the nine
months ended September 30, 1997, Series C Preferred Shares
paid $1,476,794 and $4,344,858, respectively for the three and
nine months ended September 30, 1998 and Series D Preferred
Shares paid $109,080 for the three and nine months ended
September 30, 1998.
</TABLE>
During the pendency of the bankruptcy proceedings, the Company may not
be able to declare or pay distributions without first obtaining Bankruptcy Court
approval. (See Note 1 and "REIT Status" below for a discussion of the effect on
the Company's REIT status for the 1998 tax year should CRIIMI MAE not make a
fourth quarter distribution.) As discussed in Note 1, the Company does not
expect to pay a dividend in the fourth quarter of 1998. Among the other factors
which impact CRIIMI MAE's dividend are (i) the level of income earned on
uninsured mortgage assets, such as Subordinated CMBS and, to the extent
applicable, originated loans, which varies depending on prepayments, defaults,
etc., (ii) the level of income earned on CRIIMI MAE's or its subsidiaries'
insured mortgage security collateral depending on prepayments, defaults, etc.,
(iii) the fluctuating yields on short-term debt and the rate at which CRIIMI
MAE's LIBOR-based debt is priced, as well as the rate CRIIMI MAE pays on its
other borrowings, (iv) the rate at which cash flows from mortgage assets,
mortgage dispositions, and, to the extent applicable, loan origination
reserves, escrow deposits and distributions from its subsidiaries can be
reinvested, (v) changes in operating expenses (including those related to
the Chapter 11 filing), and (vi) to the extent applicable, dividends paid on
preferred shares. CRIIMI MAE's dividends will also be impacted by the timing
and amounts of cash flows attributable to its other lines of business -
mortgage servicing, advisory and, to the extent applicable, origination
services.
REIT STATUS
- -----------
CRIIMI MAE has elected to qualify as a REIT for tax purposes under
Sections 856-860 of the Internal Revenue Code for the 1998 tax year. To qualify
for tax treatment as a REIT under the Internal Revenue Code, CRIIMI MAE must
satisfy certain criteria, including certain requirements regarding the nature of
their ownership, assets, income and distributions of taxable income.
As a result of the Chapter 11 filing, CRIIMI MAE does not expect to pay
a dividend during the fourth quarter. Although, as a REIT, the Company is
required to distribute 95% of its REIT taxable income to shareholders each year
to retain its REIT status (the "95% distribution requirement"), the Tax Code
does not require that the distributions actually be made during the relevant tax
year; that is, CRIIMI MAE is not required by the Tax Code to pay a dividend
<PAGE>55
PART I. FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - Continued
during the fourth quarter of the 1998 tax year to retain its REIT status for
1998. Instead, for purposes of complying with the 95% distribution requirement,
the Tax Code allows dividends declared before September 15, 1999 and paid
before December 31, 1999, to be treated as though such distributions had been
made in 1998.
However, if CRIIMI MAE fails to distribute at least 85% of its REIT
taxable income and 95% of its capital gain net income during 1998, the Company
will incur a non-deductible excise tax equal to 4% of the amount by which the
85% taxable income and 95% capital gain distribution requirement exceeds the
amount actually distributed.
During the pendency of the bankruptcy proceedings, the Company may not
be able to pay or declare distributions without first obtaining Bankruptcy Court
approval. For this and other reasons, there can be no assurance that CRIIMI MAE
will be able to comply with the 95% distribution requirement on a timely basis,
if at all. Although the Company intends to use its best efforts to ensure that
CRIIMI MAE retains its REIT status for the 1998 tax year, there can be no
assurance that such efforts will succeed. If CRIIMI MAE should lose its status
as a REIT for 1998, the Company would be subject to corporate taxation on its
taxable income for the full year.
The most recent securitizations by the Company, created taxable
mortgage pools ("TMPs") by placing mortgage assets (Subordinated CMBS and
mortgage loans) into trusts ("Trusts") and issuing multiple classes of
securities backed by such mortgage assets. In general, a TMP is treated as a
separate taxable entity for federal income tax purposes (i.e., bearing a
separate corporate level tax). As a REIT, CRIIMII MAE is exempt from the TMP
Rules under Section 7701(i) of the Tax Code, which would cause the Trust to bear
a separate corporate level tax, provided CRIIMI MAE owns all of the equity
intrests in the Trusts for federal income tax purposes.
Certain of the securities (the "Pledged Securities") issued by the
Trusts in the May 1998 CMBS resecuritization (CBO-2) and the June 1998
collateralized mortgage obligation securitization (CMO IV) were held by the
Company and used in certain short-term financing arrangements treated as secured
borrowings for federal income tax purposes. If the Lenders were to seize or sell
the Pledged Securities and such Pledged Securities were held to be equity
interests in the Trust (rather than debt obligations of the Trust) for federal
income tax purposes, the Trusts would be subject to paying corporate tax. In
such event, certain adverse consequences would occur unless the Company
successfully restructures the transactions or takes some other actions.
Specifically, since the Trusts would be paying corporate tax, the funds
available to pay the securities issued by the Trust would be significantly
diminished, and the related unencumbered securities retained by the Company (the
"Unencumbered Securities") could therefore be significantly impaired. In
addition, the Company could violate certain REIT requirements, and
therefore adversely affect its status as a REIT, if the Unencumbered Securities
(i) constitutes more than 10% of the voting interests of the Trusts or
(ii) are in excess of 5% of the total value of the Company's assets.
<PAGE>56
PART I. FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - Continued
Investment Company Act
- ----------------------
The Company intends to continue to conduct its business so as not to
become regulated as an investment company under the Investment Company Act of
1940, as amended (the "Investment Company Act"). Under the Investment Company
Act, a non-exempt entity that is 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. The Investment Company Act exempts entities that are "primarily
engaged in the business of purchasing or otherwise acquiring mortgages and other
liens on and interests in real estate" ("Qualifying Interests"). Under current
interpretation by the staff of the SEC, to qualify for this exemption, CRIIMI
MAE, among other things, must maintain at least 55% of its assets in Qualifying
Interests. Pursuant to such SEC staff interpretations, CRIIMI MAE's Government
Insured Mortgage Assets and originated loans are Qualifying Interests.
Prior to the Petition Date, the Company was a leading purchaser of
Subordinated CMBS. Generally, the Company acquired such securities only when
such mortgage assets were collateralized by pools of first mortgage loans, when
the Company could monitor the performance of the underlying mortgage loans
through loan management and servicing rights, and when the Company had
appropriate workout/foreclosure rights with respect to the underlying mortgage
loans. When such arrangements exist, CRIIMI MAE believes that the related
Subordinated CMBS constitute Qualifying Interests for purposes of the Investment
Company Act. Therefore, CRIIMI MAE believes that it should not be required to
register as an "investment company" under the Investment Company Act as long as
it invests primarily in such Subordinated CMBS and/or in other Qualifying
Interests. However, if the SEC or its staff were to take a different position
with respect to whether CRIIMI MAE's Subordinated CMBS constitute Qualifying
Interests, the Company could be required to modify its business plan so that
either (i) it would not be required to register as an investment company or (ii)
it would comply with the Investment Company Act and be able to register as an
investment company. In such event, (i) modification of the Company's business
plan so that it would not be required to register as an investment company would
likely entail a disposition of a significant portion of the Company's
Subordinated CMBS or the acquisition of significant additional assets, such as
Government Insured Mortgage Assets, which are Qualifying Interests or (ii)
modification of the Company's business plan to register as an investment
company, which would result in significantly increased operating expenses and
would likely entail significantly reducing the Company's indebtedness (including
the possible prepayment of the Company's secured financing and/or the Senior
Unsecured Notes), which could also require it to sell a significant portion of
its assets. No assurances can be given that any such dispositions or
acquisitions of assets, or deleveraging, could be accomplished on favorable
terms and as a result of the bankruptcy filing the Company is further limited
<PAGE>57
PART I. FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - Continued
in possible actions it could take. Consequently, any such modification of
the Company's business plan could have a material adverse effect on the
Company. Further, if it were established that the Company were an
unregistered investment company, there would be a risk that the Company
would be subject to monetary penalties and injunctive relief in an action
brought by the SEC, that the Company would be unable to enforce contracts with
third parties and that third parties could seek to obtain recission of
transactions undertaken during the period it was established that the
Company was an unregistered investment company. In addition, as a result
of the Company's bankruptcy filing, the Company is limited in possible actions
it may take in response to any need to modify its business plan in order to
register as an investment company, or avoid the need to register. Any
dispositions or acquisitions of assets would require court approval.
Also, any forced sale of assets that occur after the bankruptcy stay is lifted
would change the Company's asset mix potentially resulting in the need to
register as an investment company under the Investment Company Act or take
further steps to change the asset mix. Any such results would be likely to have
a material adverse effect on the Company.
Other Events
- ------------
For a discussion of CRIIMI MAE's bankruptcy filing and related secured
lender actions, see Notes 1 and 5, respectively.
Additionally, CRIIMI MAE is aware of the filing of at least twenty-one
(21) separate class action civil lawsuits (the "Complaints") against certain
officers and directors of CRIIMI MAE between October 7, 1998 and through the
date of this report. The Complaints name as defendants William B. Dockser as
Chairman of the Board of Directors of CRIIMI MAE and H. William Willoughby as
a member of the Board of Directors and/or officer of CRIIMI MAE. In addition, a
majority of the Complaints name Cynthia O. Azzara as a defendant as an
officer of CRIIMI MAE. Several of the Complaints also name Garrett G. Carlson,
Sr., G. Richard Dunnells and Robert J. Merrick as defendants as members of
both the Board of Directors and the Audit Committee of CRIIMI MAE. Although
CRIIMI MAE has not been named as a defendant, it is under an obligation to
indemnify the defendants under the terms and conditions outlined in its
by-laws. In addition, CRIIMI MAE has a directors and officers liability
insurance policy that has a coverage limit of $20 million.
A majority of the Complaints were filed in the United States District
Court for the District of Maryland. One of the Complaints was filed in the
United States District Court for the Eastern District of New York and another
Complaint was filed in the United States District Court for the Central District
of California.
The Complaints generally allege that the named defendants violated
Section 10(b) of the Securities Exchange Act of 1934, by, among other things,
making false statements of material facts and failing to disclose certain
material facts concerning, among other things, CRIIMI MAE's ability to meet the
earnings estimates of analysts and to meet collateral calls from lenders. The
Complaints also generally allege that the named defendants violated Section
<PAGE>58
PART I. FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - Continued
20(a) of the Securities and Exchange Act of 1934, because each named defendant
was allegedly a "controlling person" as that term is defined under Section
20(a).
CRIIMI MAE and the defendants are in the process of investigating the
allegations in the Complaints. The defendants believe the allegations set forth
in the Complaints are without merit and intend to defend vigorously the claims
asserted in the Complaints. CRIIMI MAE cannot predict with any degree of
certainty the ultimate outcome of such litigation.
Forward-Looking Statements
- --------------------------
In accordance with the Private Securities Litigation Reform Act of
1995, the Company can obtain a "Safe Harbor" for forward-looking statements by
identifying those statements and by accompanying those statements with
cautionary statements which identify factors that could cause actual results to
differ from those in the forward-looking statements. Accordingly, the following
information contains or may contain forward-looking statements: (1) information
included or incorporated by reference in this Quarterly Report on Form 10-Q,
including, without limitation, statements made under Item 2, Management's
Discussion and Analysis of Financial Condition and Results of Operations and in
the notes to the financial statements, (2) information included or incorporated
by reference in future filings by the Company with the Securities and Exchange
Commission including, without limitation, statements with respect to the
Company's Chapter 11 filing, growth, projected revenues, earnings, returns and
yields on its portfolio of mortgage assets, the impact of interest rates,
interest rate spreads, costs, business strategies and plans, statements
regarding raising capital, discussions with creditors, streamlining and
restructuring business activities, reducing operating expenses and successfully
emerging from bankruptcy, (3) information contained in written material,
releases and oral statements issued by or on behalf of, the Company, including,
without limitation, statements with respect to the Company's Chapter 11 filing,
growth, projected revenues, earnings, returns and yields on its portfolio of
mortgage assets, the impact of interest rates, costs, business strategies and
plans, statements regarding raising capital, discussions with creditors,
streamlining and restructuring business activities, reducing operating expenses
and successful emerging from bankruptcy. The Company's actual results may differ
materially from those contained in the forward-looking statements identified
above. Factors which may cause such a difference to occur include, but are not
limited to, (i) the ability of the Debtors to successfully reorganize and the
timing and outcome of the bankruptcy proceedings including provisions of any
plan of reorganization approved by the Bankruptcy Court and the outcome of
litigation to which the Company is a party; (ii) actions that may be taken by
creditors; (iii) the ability of the Company to obtain debtor-in-possession
financing and other capital and the terms of any such capital; (iv) the
continued instability in the capital markets and trends in the CMBS market, (v)
the effect of future losses on CRIIMI MAE's needs for liquidity, (vi) the effect
of the bankruptcy proceeding on CRIIMI MAE's ongoing business activities;
<PAGE>59
PART I. FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - Continued
(vii) heightened competition, including increased competition for
acceptable mortgage asset purchase opportunities with financial institutions,
including banks, insurance companies, savings and loan associations,
pension funds, and other real estate investment trusts and investors in
real estate and mortgage assets which have investment objectives similar to
those of the Company and some of which may have greater financial resources
than the Company, (viii) the availability of suitable opportunities for the
acquisition, ownership and disposition of mortgage assets, and yields
available from time to time on such mortgage assets, (which, in turn, depend to
a large extent on the type of mortgage asset involved, prevailing interest
rates, the nature and geographical location of the property, competition and
other factors, none of which can be predicted with certainty), (ix) regulatory
and litigation matters, (x) interest rates, (xi) imbalances in cash available
for distribution caused by an unanticipated level of defaults and/or prepayments
on the Company's portfolio of mortgage assets, (xii) the Company's ability to
refinance debt on terms that are comparable to current terms when such debt
becomes due, and (xiii) trends in the economy which affect confidence and demand
for the Company's portfolio of mortgage assets, particularly trends affecting
the Company's assets.
Year 2000 Issue
- ---------------
The Year 2000 issue is a programming issue that may affect many
electronic processing systems. Until relatively recently, in order to minimize
the length of data fields, most date-sensitive programs eliminated the first two
digits of the year. This issue could affect information technology ("IT")
systems and date-sensitive embedded technology that controls certain systems
(such as telecommunications systems, security systems, etc.) leaving them unable
to properly recognize or distinguish dates in the twentieth and twenty-first
centuries. This treatment could result in significant miscalculations when
processing critical date-sensitive information relating to dates after December
31, 1999.
CRIIMI MAE is currently in the process of assessing Year 2000
compliance of its IT systems, which include software systems to service mortgage
loans, administer securitizations and manage mortgage assets, as well as
software systems used for internal accounting purposes. A majority of the IT
systems used by the Company are licensed from third parties. These third parties
have either provided upgrades to the existing systems or have indicated to
CRIIMI MAE that their systems are Year 2000 compliant. CRIIMI MAE anticipates
performing and completing compliance testing of its IT systems by March 31,
1999. There can be no assurance, however, that the Company's IT systems will be
Year 2000 compliant by December 31, 1999.
The Year 2000 issue may also affect CRIIMI MAE's date-sensitive
embedded technology, which controls systems such as the telecommunications
systems, security systems, etc. CRIIMI MAE does not believe that the cost to
modify or replace such technology to make it Year 2000 compliant will be
material. The failure of any such systems to be Year 2000 compliant could be
material to the Company.
<PAGE>60
PART I. FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - Continued
The potential impact of the Year 2000 issue depends not only on the
corrective measures CRIIMI MAE undertakes, but also on the ways in which the
Year 2000 issue is addressed by third parties with whom CRIIMI MAE directly
interfaces or whose financial condition or operations are important to CRIIMI
MAE, including government agencies, financial institutions, creditors, borrowers
and others involved in the CMBS industry. CRIIMI MAE has initiated
communications with third parties with which it directly interfaces to evaluate
the risk of their failure to be Year 2000 compliant and the extent to which
CRIIMI MAE may be vulnerable to such failure. There can be no assurance that the
systems of these third parties will be Year 2000 compliant by December 31, 1999.
The failure of these third parties to be Year 2000 compliant could have a
material adverse effect on the operations of CRIIMI MAE.
The Company believes that its greatest risk with respect to the Year
2000 issue relates to failures by third parties to be Year 2000 compliant. In
addition to risks posed by third parties with which the Company interfaces
directly, risks are created by third parties providing services to large
segments of society. The failure of third parties to be Year 2000 compliant
could, among other things, cause disruptions in the capital and real estate
markets and borrower defaults on real estate loans and mortgage-backed
securities as well as the pools of mortgage loans underlying such securities.
With respect to the systems used directly by the Company, the Company
believes that its greatest exposure to the Year 2000 issue involves the
Company's loan servicing operations which rely on computers to process and
manage loans. A failure of these systems to be Year 2000 compliant could have a
material adverse effect on the Company's loan servicing operations.
The cost of IT and embedded technology systems testing and upgrades is
not expected to be material to CRIIMI MAE's consolidated operating results.
Through March 31, 1999, the Company estimates incurring costs of approximately
$300,000 for the Year 2000 assessment and compliance testing, which will be
recorded as noninterest expense. Currently, the Company also estimates the cost
of system upgrades purely in relation to the Year 2000 issue will be immaterial.
Because CRIIMI MAE is still in the process of assessing the Year 2000
issue, it is also in the process of developing contingency plans for the risks
of the failure of the Company or third parties to be Year 2000 compliant.
Management intends to complete contingency plans for the Year 2000 issue by
March 31, 1999. Due to the inability to predict all of the potential problems
that may arise from the Year 2000 issue, there can be no assurance that all
contingencies will be adequately addressed by such plans.
<PAGE>61
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Reference is made to Note 1 and Note 15 of the notes to the
consolidated financial statements of CRIIMI MAE Inc., which is incorporated
herein by reference.
<PAGE>62
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES
Reference is made to Note 9 of the notes to the consolidated financial
statements of CRIIMI MAE Inc., which is incorporated herein by reference.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Reference is made to Notes 5 and 11 of the notes to consolidated
financial statements of CRIIMI MAE which are incorporated herein by reference.
Such Notes contain a description of certain alleged defaults asserted by
certain of the Company's secured lenders. The Company is currently analyzing
the relevant facts and law to determine its position as to the existence and
validity of any material default under the applicable governing agreements.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5. OTHER INFORMATION
Not applicable.
<PAGE>63
PART II. OTHER INFORMATION
ITEM 6(a). EXHIBITS
The exhibits filed as part of this report are listed below:
Exhibit No. Description
---------- -----------
27 Financial Data Schedule (filed herewith)
99(a) United States Bankruptcy Court Voluntary Petition
#9823115 filed on October 5, 1998 for CRIIMI MAE
Inc. (filed herewith)
99(b) United States Bankruptcy Court Voluntary Petition
#9823116 filed on October 5, 1998 for CRIIMI MAE
Management, Inc. (filed herewith)
99(c) United States Bankruptcy Court Voluntary Petition
#9823117 filed on October 5, 1998 for CRIIMI MAE
Holdings II, L.P. (filed herewith)
ITEM 6(b). REPORTS ON FORM 8-K
Date Purpose
---- -------
June 11, 1998 The Company announced its securitization of
$496 million of commercial mortgage loans
originated or acquired through the Company's
network of regional offices. The Company
sold $397 million in fixed rate investment
grade securities.
August 3, 1998 The Company issued 100,000 shares of Series D
Cumulative Convertible Preferred Stock
pursuant to its registration statement on
Form S-3 (Commission File number 333-54031)
as supplemented by the Prospectus Supplement
dated July 29, 1998.
August 11, 1998 The Company issued its monthly report on
origination, securitization and servicing
activities for July 1998.
September 3, 1998 The Company issued its monthly report on
origination, securitization and servicing
activities for August 1998.
<PAGE>64
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, Registrant has duly caused this Report to be signed on its
behalf by the undersigned, thereunto duly authorized.
CRIIMI MAE INC.
/s/ November 23, 1998 /s/ Cynthia O. Azzara
- ----------------------- -----------------------------
Cynthia O. Azzara
Senior Vice President,
Principal Accounting Officer
and Chief Financial Officer
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<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
THE QUARTERLY REPORT ON FORM 10-Q AND IS QUALIFIED IN ITS ENTIRETY
BY REFERENCE TO SUCH QUARTERLY REPORT ON FORM 10-Q.
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<PERIOD-START> JAN-01-1998
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<SECURITIES> 1,950,548
<RECEIVABLES> 126,342
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<TOTAL-LIABILITY-AND-EQUITY> 2,671,957
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