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