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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
__________________
FORM 10-K/A
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
__________________
For the fiscal year ended December 31, 2000 Commission file number 1-10360
CRIIMI MAE INC.
(Exact name of registrant as specified in its charter)
Maryland 52-1622022
(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification No.)
11200 Rockville Pike
Rockville, Maryland 20852
(301) 816-2300
(Address, including zip code, and telephone number,
Including area code, of registrant's principal executive offices)
__________________
Securities Registered Pursuant to Section 12(b) of the Act:
Name of each exchange on
Title of each class which registered
- ------------------- ----------------------------
Common Stock New York Stock Exchange, Inc.
Series B Cumulative Convertible New York Stock Exchange, Inc.
Preferred Stock
Series F Redeemable Cumulative Dividend New York Stock Exchange, Inc.
Preferred Stock
Series G Redeemable Cumulative Dividend New York Stock Exchange, Inc.
Preferred Stock
Securities registered pursuant to Section 12(g) of the Act:
None
__________________
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark 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 April 13, 2001, 99,049,850 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 April
13, 2001) of the shares of CRIIMI MAE Inc. common stock (voting) held by non-
affiliates was approximately $69,334,895. (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.
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CRIIMI MAE INC.
2000 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
Page
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PART I
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Item 1. Business...................................................................... 2
Item 2. Properties.................................................................... 22
Item 3. Legal Proceedings............................................................. 22
Item 4. Submission of Matters to a Vote of Security Holders........................... 30
PART II
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Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters...... 30
Item 6. Selected Financial Data....................................................... 33
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations........................................................ 36
Item 7A. Quantitative and Qualitative Disclosures About Market Risks................... 50
Item 8. Financial Statements and Supplementary Data................................... 52
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure......................................................... 52
PART III
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Item 10. Directors and Executive Officers of the Registrant............................ 53
Item 11. Executive Compensation........................................................ 57
Item 12. Security Ownership of Certain Beneficial Owners and Management................ 62
Item 13. Certain Relationships and Related Transactions................................ 63
PART IV
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Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.............. 64
Signatures
Exhibit Index
PART I
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 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" or
"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. As
previously stated, 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"). On November 22, 2000, the United States Bankruptcy Court
for the District of Maryland, entered an order confirming the Debtors'
reorganization plan (the "Reorganization Plan").
The Company also 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. See Note 3 to
the Notes to Consolidated Financial Statements. With the exception of CM
Management and Holdings II, none of these affiliates filed for bankruptcy
protection on the Petition Date.
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. ("CRI") were
merged into CRIIMI MAE (the "Merger"). The Company is not a government sponsored
entity or 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.
2
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, 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 one of its secured creditors. 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 Bankruptcy Court.
On August 24, 2000, the Bankruptcy Court entered an order approving the
Debtors' Disclosure Statement and other proposed solicitation materials. All
impaired classes which voted on the Reorganization Plan voted overwhelmingly to
accept the Reorganization Plan.
On September 21, 2000, CRIIMI MAE, Salomon Smith Barney Inc. (as successor
to Citicorp Securities, Inc. ("SSB")), German American Capital Corporation
("GACC"), ORIX Real Estate Capital Markets, LLC ("ORIX"), the CMI Equity
Committee and the Unsecured Creditors Committee filed a Stipulation and Consent
Order (the "Stipulation and Consent") with the Bankruptcy Court providing for,
among other matters, the terms of an agreement with respect to the sale of the
Company's interest in CMO-IV and certain other CMBS to ORIX. On October 12,
2000, an order was entered by the Bankruptcy Court approving the Stipulation and
Consent. On October 30, 2000, the Court entered an amendment to the Stipulation
and Consent with respect to the agreed proceeds in connection with the sale to
ORIX (the "Order"). Pursuant to the Stipulation and consent as amended by the
Order, the Company sold its interest in CMO-IV and certain other CMBS to ORIX.
The CMI Equity Committee and Unsecured Creditors' Committee were deemed to have
agreed to such sale. The sale was completed on November 6, 2000 resulting in
total proceeds of approximately $189 million. The proceeds were used to pay off
$141 million of financing owed to SSB and $4 million to Citicorp Real Estate,
Inc. in full satisfaction of all asserted and unasserted claims of such
claimants. Additionally, approximately $14.2 million of the proceeds were used
to pay down secured financing provided by GACC. The Company will use the net
proceeds of approximately $30 million to help fund the Company's emergence from
Chapter 11.
As stated before, on November 22, 2000, the Bankruptcy Court entered an
order confirming the Reorganization Plan under which the Debtors' anticipated
emerging from Chapter 11 by March 15, 2001.
On March 9, 2001, the Bankruptcy Court, after notice and a hearing,
approved an extension of the effective date of the Reorganization Plan to April
13, 2001 and on April 13, 2001, the Bankruptcy Court approved a further
extension of the effective date of the Reorganization Plan until April 17, 2001.
The Company expects to sign all remaining closing documents, disburse funds, and
consummate the effective date by April 17, 2001. However, there can be no
assurance that the Company will emerge by such date.
The Reorganization Plan
The Reorganization Plan includes the payment in full of all of the allowed
claims of the Debtors primarily through recapitalization financing (including
proceeds from certain asset sales) aggregating $847 million (the
"Recapitalization Financing"). The sales of select CMBS (the "CMBS Sale") and
the Company's interest in CMO-IV (the "CMO-IV Sale") generated aggregate
proceeds of approximately $418.3 million toward the Recapitalization Financing
(see Notes 5 and 7), of which approximately $342.3 million was used to pay
related borrowings and approximately $76.0 million will be used to help fund the
Reorganization Plan. Included in the balance of the Recapitalization Financing
is approximately $262 million anticipated to be provided by affiliates of
Merrill Lynch Mortgage Capital Inc. ("Merrill Lynch" or "Merrill") and GACC
through a new secured financing facility (in the form of a repurchase
transaction), and approximately
3
$167 million anticipated to be provided through new secured notes issued to
certain of the Company's unsecured creditors (collectively, the "New Debt").
In connection with the Reorganization Plan, substantially all cash flows
relating to existing assets are expected to be used to satisfy principal,
interest and fee obligations under the New Debt. The approximate $262 million
secured financing would provide for (i) interest at a rate of one month London
Interbank Offered Rate ("LIBOR") plus 3.25%, (ii) principal
repayment/amortization obligations, (iii) extension fees after two years and
(iv) maturity on the fourth anniversary of the effective date of the
Reorganization Plan. The approximate $167 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 repayment/amortization
obligations, (iii) extension fees after four years and (iv) maturity on the
fifth anniversary of the effective date of the Reorganization Plan. The second
series of secured notes, representing an aggregate principal amount of
approximately $62 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 Reorganization Plan. The New Debt
described above is anticipated to be secured by substantially all of the
existing assets of the Company. It is contemplated that there will be
restrictive covenants, including financial covenants and certain restrictions
and requirements with respect to cash accounts and the collection, management,
use and application of funds, in connection with the New Debt.
The Company anticipates that the litigation with First Union National Bank
("First Union") will not be settled or resolved on or prior to the effective
date of the Reorganization Plan; and therefore, the classification of First
Union's claim under the Reorganization Plan will not be determined until after
the effective date (see "LEGAL PROCEEDINGS-Bankruptcy Related Litigation-First
Union" for further information regarding (a) the status of the First Union
litigation and (b) the treatment of First Union's Claim on the effective date of
the Reorganization Plan).
Under the Reorganization Plan, the holders of the Company's equity will
retain their stock. Pursuant to the terms of the anticipated New Debt, limited,
if any, dividends, other than if such dividend payments are required to maintain
REIT status (and assuming the Company has the cash available to make the
distributions), can be paid to existing shareholders. Under the Reorganization
Plan, cash dividends required to maintain REIT status would be paid first to
holders of certain of the New Debt who convert their notes into one or two new
series of preferred stock, which new series of preferred stock would be senior
to all other series of preferred stock of the Company, in the form of redemption
payments. The Reorganization Plan also includes certain amendments to the
Company's articles of incorporation, anticipated on the effective date of the
Reorganization Plan, including an increase in authorized shares from 145 million
(consisting of 120 million of common shares and 25 million of preferred shares)
to 375 million (consisting of 300 million of common shares and 75 million of
preferred shares). These amendments to the articles of incorporation will not be
effective until the Reorganization Plan is effective. (See Notes 11 and 12 to
the Notes to Consolidated Financial Statements for further discussion regarding
the Company's common stock and preferred stock.)
Reference is made to the Reorganization Plan and Disclosure Statement,
previously filed with the Bankruptcy Court (and with the Securities and Exchange
Commission (the "SEC") as exhibits to a Current Report on Form 8-K filed on
September 22, 2000), for a more detailed description of the financing
contemplated to be obtained under the Reorganization Plan from the respective
existing creditors including, without limitation, payment terms, restrictive
covenants and collateral, and a more detailed description of the treatment of
preferred stockholders.
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 believes that it
has satisfied the REIT requirements for all years through, and including, 1999
and 2000, as discussed below. However, there can be no assurance that CRIIMI
MAE will maintain its REIT status for 2001 or subsequent years. If the Company
fails to maintain 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. Depending on
the amount of any such federal and state income tax, the Company may have
insufficient funds to pay any such tax and also may be unable to comply with its
obligations under the New Debt.
4
As of March 15, 2001, the Company and three of its subsidiaries have
jointly elected to treat such three subsidiaries as Taxable REIT Subsidiaries
("TRS") effective January 1, 2001. There are limitations on the activities and
asset bases of a TRS, some of which are as follows:
. The deductible amount of interest paid or accrued by a TRS to its REIT
parent is limited under the interest stripping rules. The interest
stripping rules are designed to prevent the excessive reduction or
elimination of taxable income of a TRS through the use of interest
expense from loans made to the TRS by the REIT parent.
. A 100% excise tax is imposed when a REIT and a TRS engage in certain
transactions that do not reflect arm's length amounts. The 100% tax is
imposed on redetermined rents, redetermined deductions, and excess
interest, subject to certain safe harbors.
. No more than 20% of a REIT's total assets may be composed of securities
of TRSs.
The Company's 2000 Taxable Loss/Taxable Distribution Requirements
During 2000, the Company traded in both short and longer duration fixed
income securities, primarily subordinated and investment grade CMBS and
investment grade residential mortgage backed securities (such securities traded
and all other securities of the type described constituting the "Trading
Assets"), which, for financial reporting purposes, are classified as
Subordinated CMBS and Other MBS on the balance sheet. The Company seeks maximum
total return through short term trading, consistent with prudent investment
management. Returns from such activities consist primarily of capital
appreciation/depreciation resulting from changes in interest rates and spreads,
if any, and other arbitrage opportunities.
Internal Revenue Service Revenue procedure 99-17 provides securities and
commodities traders with the ability to elect mark-to-market treatment for the
2000 tax year and for all future tax years, unless the election is revoked with
the consent of the Internal Revenue Service. On March 15, 2000, CRIIMI MAE
elected for tax purposes to be classified as a trader in securities effective
January 1, 2000.
As a result of its trader election, CRIIMI MAE recognized a mark-to market
tax loss on its Trading Assets on January 1, 2000 of approximately $478 million
(the "January 2000 Loss"). This does not impact the GAAP financial statements.
Such loss is expected to be recognized evenly over four years beginning with the
year 2000 (i.e., approximately $120 million per year). The Company expects such
loss to be ordinary. Additionally, as a result of its trader election, the
Company is required to mark-to-market its Trading Assets on a tax basis at the
end of each tax year. Any increase or decrease in the value of the Trading
Assets as a result of the year-end mark-to-market requirement will generally
result in either a tax gain (if an increase in value) or a tax loss (if a
decrease in value). Such tax gains or losses, as well as any realized gains or
losses from the disposition of Trading Assets during each year, are also
expected to be ordinary gains or losses.
Since gains and losses associated with trading activities are expected to
be ordinary, any gains will generally increase taxable income and any losses
will generally decrease taxable income. Since the Company is a REIT which is
generally required to distribute 95% of its taxable income to shareholders for
years ending on or before December 31, 2000, and 90% for years beginning after
2000, any increases in taxable income from trading activities will generally
result in an increase in REIT distribution requirements and any decreases in
taxable income from trading activities will generally result in a decrease in
REIT distribution requirements (or, if taxable income is reduced to zero,
eliminate REIT distribution requirements).
Gains and losses from the mark-to-market requirement (including the January
2000 Loss) are unrealized. This creates a mismatch between REIT distribution
requirements and cash flow since the REIT distribution requirements will
generally fluctuate due to the mark-to-market adjustments, but the cash flow
from the Company's Trading Assets will not fluctuate as a result of the mark-to-
market adjustments.
For the year ended December 31, 2000, the Company recognized an unrealized
mark-to-market tax gain (or increase) of approximately $50 million on its
Trading Assets. Additionally, during the year ended December 31, 2000, realized
net gains on Trading Assets were approximately $1.5 million for financial
reporting purposes and
5
approximately $12.6 million for tax purposes. As discussed in Note 10 to the
Notes to Consolidated Financial Statements, the Company generated a net
operating loss of approximately $50 million for the year ended December 31,
2000. As such, the Company's taxable income was reduced to zero and,
accordingly, the Company's REIT distribution requirements were eliminated for
2000.
Any accumulated and unused net operating losses, subject to certain
limitations, generally may be carried forward for up to 20 years to offset
taxable income until fully utilized. Accumulated and unused net operating
losses cannot be carried back. If a security is marked down because of an
increase in interest rates, rather than from credit losses, such mark-to-market
losses may be recovered over time through taxable income. Any recovered mark-
to-market losses will generally be recognized as taxable income, although there
is expected to be no corresponding increase in cash flow.
There is no assurance that the Company's position with respect to its
election as a trader in securities will not be challenged by the IRS, and, if
challenged, will be defended successfully by the Company. As such, there is a
risk that the January 2000 Loss will be limited or disallowed, resulting in
higher tax basis income and a corresponding increase in REIT distribution
requirements.
If CRIIMI MAE is required to make taxable income distributions to its
shareholders to satisfy required REIT distributions, all or a substantial
portion of these distributions, if any, are expected to be in the form of
non-cash dividends. There is no assurance that such non-cash dividends would
satisfy the REIT distribution requirements and, as such, the Company could lose
its REIT status or may not be able to satisfy its New Debt obligations.
It is possible that the Company could experience an "ownership change"
within the meaning of Section 382 of the Tax Code. Consequently, its use of net
operating losses generated before the ownership change to reduce taxable income
after the ownership change may be subject to substantial limitation under
Section 382. Generally, the use of net operating losses 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.
The Company's 1999 Taxable Income. For purposes of REIT distribution
requirements, 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. Unlike the 95%
distribution requirement or 90% for years beginning after 2000, the calculation
of the Company's federal income tax liability does not exclude excess noncash
income such as OID.
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 were considered as dividends paid for the
year ended December 31, 1999. On September 11, 2000, the Company declared a
dividend payable to common shareholders of approximately 3.75 million shares of
a new series of preferred stock with a face value of $10 per share (the "Series
G Preferred Stock") (see Note 12 to the Notes to Consolidated Financial
Statements). The purpose of the dividend was to distribute approximately $37.5
million in undistributed 1999 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 to the extent of noncash
income. There can be no assurance that the Company's tax liability was
eliminated by payment of such Series G Preferred Stock dividend. The Series G
Preferred Stock dividend was paid on November 13, 2000 to common shareholders of
record as of October 27, 2000. The Series G Preferred Stock dividend was
taxable to common shareholder recipients. The Series G Preferred Stock
shareholders were permitted to convert their shares of Series G Preferred Stock
into common shares during the period from February 21, 2001 through March 6,
2001. During that conversion period, an aggregate 2,496,535 shares of Series G
Preferred Stock were converted into 32,547,041 shares of common stock.
6
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 (the "Series F Preferred Stock"). The purpose of the dividend was to
distribute approximately $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 was eliminated
by payment of such Series F Preferred Stock dividend. The Company paid the
Series F Preferred Stock dividend on November 5, 1999 to common shareholders of
record on October 20, 1999. The Series F Preferred Stock dividend was taxable
to common shareholder recipients. The Series F Preferred Stock shareholders
were permitted to convert their shares of Series F Preferred Stock into common
shares during two separate conversion periods. During these conversion periods,
an aggregate 1,020,241 shares of Series F Preferred Stock were converted into
8,798,009 shares of common stock.
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 two trusts that
constitute TMPs (CBO-1 and CBO-2, collectively the "Trusts"). See "BUSINESS-
Resecuritizations" and "BUSINESS-Loan Originations and Securitizations" and Note
5 to the Notes to Consolidated Financial Statements. 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
currently serve as collateral (the "Pledged Bonds") for short-term variable rate
borrowings used by the Company to finance their initial purchase and are
expected to serve as collateral for the New Debt. 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.
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 $48.9 billion in 2000, $58.3 billion in 1999 and $77.7
billion in 1998.
7
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"). 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.
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 typically 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 through 2000 with the issuance
of newly created CMBS totaling approximately $48.9 billion and $58.3 billion for
2000 and 1999, respectively. 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 to the spring 1998 levels. 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 current transaction between a willing buyer and a willing seller in other than
a forced sale or liquidation.
Subordinated CMBS Acquisitions
As of December 31, 2000, the Company's $1.6 billion portfolio of assets
included $853 million of Subordinated CMBS (representing approximately 55% of
the Company's total consolidated assets).
CRIIMI MAE Inc. did not acquire any Subordinated CMBS in 2000 or 1999. In
1998, CRIIMI MAE acquired Subordinated CMBS, from offerings which aggregated
$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
8
CMBS in 1998. As of December 31, 2000, approximately 33% of the Company's CMBS
(based on fair value) were rated BB+, BB or BB-, 24% were B+, B, B- or CCC and
10% were unrated. The remaining approximately 33% 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 8 to the Notes
to Consolidated Financial Statements.
The Company generally enters into interest rate protection agreements to
mitigate the adverse effects of a possible rise in short-term interest rates on
the interest payments due on its variable-rate financing facilities. The
Company follows an investment policy to hedge at least 75% 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. Interest rate caps provide protection to the
Company to the extent interest rates, based on a readily determinable interest
rate index, increase above the stated interest rate cap, in which case the
Company 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 8 and 9 to 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.
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 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
9
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.
As of December 31, 2000, the Company's total debt was approximately $1.2
billion, of which approximately 54% was fixed-rate, match-funded debt and
approximately 46% was short-term, variable-rate or fixed-rate debt that was
recourse to the Company and not match-funded. See Note 8 to the Notes to
Consolidated Financial Statements regarding the Company's anticipated debt
structure after the effective date of the Reorganization Plan. For the year
ended December 31, 2000, the Company's weighted average cost of borrowing
(including amortization of discounts and deferred financing fees of
approximately $8.5 million) was approximately 8.1%. See "BUSINESS-Subordinated
CMBS Acquisitions," "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS" and Notes 5, 8 and 9 to 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.
Also 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 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"). 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 had call rights on each of the issued securities and therefore
had 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. The Company sold its
remaining interest in CMO-IV in November 2000. See "MANAGEMENT DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS-Liquidity and Capital
Resources" and Notes 5 and 8 to the Notes to Consolidated Financial Statements
for additional information regarding this securitization, including the 1999
sales of the two remaining investment grade tranches, the sale of the Company's
interest in CMO-IV and certain financial and accounting effects of such sales.
At the time it filed for protection under Chapter 11, 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").
10
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.
On August 5, 1999, all but three 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" and Notes 7 and 9 to 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. During the year ended December 31, 1998, the Company recorded
an unrealized loss of $2 million for its loss exposure under the Prudential
Program. The Company calculated the Prudential loss based upon the assumption
that the Company would not exercise its option with Prudential.
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. 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.
CMSLP was formed under a limited partnership agreement in which CM
Management holds the limited partner interest and CRIIMI MAE Services, Inc.
("CMSI") is the general partner. As of December 31, 2000 and 1999, the limited
partnership interest and the general partnership interest in CMSLP were 73% and
27%, respectively. Therefore, all servicing activity of CMSLP is reflected in
Equity in Earnings (Losses) of Investments on a consolidated basis.
The Reorganization Plan included the sale of certain CMBS owned by CRIIMI
MAE. As a result of these CMBS sales, CMSLP is no longer the special servicer
related to such sold CMBS. Due to the nature of its relationship with CRIIMI
MAE and CRIIMI MAE Management, Inc., its limited partner, and as a result of the
CRIIMI MAE Management, Inc.'s Chapter 11 filing, in 1998 CMSLP was declared in
default under certain credit agreements with First Union National Bank. CMSLP
has also been under a high degree of scrutiny from servicing rating agencies.
In order to repay all such credit agreement obligations and to increase its
liquidity, CMSLP sold to ORIX its master servicing rights on two commercial
mortgage pools effective October 1998. CMSLP also sold master servicing rights
on two CMBS effective December 2000. In addition, in order to allay rating
agency concerns stemming from the CRIIMI MAE Management's Chapter 11 filing, in
October 1998, CRIIMI MAE designated ORIX as special servicer on approximately 33
separate CMBS securitizations totaling $29 billion, subject to certain
requirements contained in the respective servicing agreements. As of December
31, 2000, ORIX remains the special servicer on 27 of these CMBS securitizations.
This decrease is due to the sale in 2000 of six CMBS by CRIIMI MAE in which
CRIIMI MAE owned the lowest rated tranche and had named CMSLP as the special
servicer. CMSLP currently performs the special servicing as sub-servicer for
11
ORIX on all but four of the 27 transactions in which CRIIMI MAE has financial
interest. The servicing agreements on these four CMBS securitizations do not
permit a sub-special servicing agreement in which CRIIMI MAE has a financial
interest. The fee due to ORIX for its services performed under this agreement
is approximately 33 percent of certain ancillary income. Ancillary income is
primarily assumption, modification, and extension fees received by CMSLP.
CRIIMI MAE remains the owner of the lowest rated tranche of the related CMBS
and, as such, retains all rights pertaining to ownership, including the right to
replace the special servicer.
The Company is considering the transfer of its limited partnership interest
in CMSLP to a new, wholly owned TRS sometime in 2001. The REIT Modernization
Act of 1999 allows REITs to own up to 100% of a taxable "C" Corporation as long
as the subsidiary makes an election to be treated as a TRS. This law is
effective for years beginning after December 31, 2000. A TRS may conduct some
types of business that are prohibited to a REIT, and the income from a TRS is
not included in the income tests of the parent REIT. The Company is also
considering several restructuring options with respect to its interest in CRIIMI
MAE Services, Inc. ("CMSI" and CMSLP's general partner) and CMSI's interest in
CMSLP.
CMSLP's principal servicing activities are described below. For a summary
and discussion of the financial results of these activities, see
"ITEM 7-MANAGEMENT'S DISCUSSION AND ANALYSIS AND RESULTS OF OPERATIONS-Equity
in Earnings (Losses) from Investments".
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.
As of December 31, 2000, CMSLP was designated as the special servicer (or sub-
special servicer) for approximately 3,444 commercial mortgage loans,
representing an aggregate principal amount of approximately $19 billion, or 95%
of its servicing portfolio. See "The Portfolio-CMBS" and Note 5 to the Notes to
Consolidated Financial Statements regarding mortgage loans included in the
special servicing portfolio.
As of December 31, 2000, CMSLP had a special servicer rating of "CSS2" from
Fitch IBCA and had received indication from Moody's that CMSLP would be approved
on a transactional basis. 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.
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
typically has more direct and regular contact with borrowers than the special
servicer. As of December 31, 2000, CMSLP
12
remained master servicer on one CMBS portfolio representing commercial mortgage
loans with an aggregate principal amount of approximately $768 million.
As of December 31, 2000, CMSLP had a master servicer rating of "CMS3" from
Fitch IBCA and had received indication from Moody's that CMSLP would be approved
on a transactional basis. CMSLP lost an acceptable master servicer rating from
S&P in October 1998 as a result of the Chapter 11 filing of CRIIMI MAE.
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, 2000, CMSLP was designated direct
servicer for approximately 316 commercial mortgage loans, representing an
aggregate principal amount of approximately $1.6 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. As of December 31, 2000, CMSLP
had a primary servicer rating of "CPS3" from Fitch IBCA and had received
indication from Moody's that CMSLP would be approved on a transactional basis.
CMSLP lost an acceptable primary servicer rating from S&P in October 1998 as a
result of the Chapter 11 filing of CRIIMI MAE.
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 analyses
performed by other servicers. This allows CMSLP to identify and resolve
potential issues that could result in losses. As of December 31, 2000, CMSLP
served as contractual loan manager for approximately 1,737 commercial mortgage
loans representing an aggregate principal amount of approximately $8.2 billion.
As of December 31, 2000, CMSLP reviewed analyses performed by other servicers
for approximately 1,731 commercial mortgage loans, representing an aggregate
principal amount of $11.1 billion.
Underwriting Procedures
CRIIMI MAE believes that its experience in underwriting has enabled it to
properly manage certain of the risks associated with mortgage loans underlying
acquired Subordinated CMBS. 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.
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
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
13
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, 2001, the Company had 37 employees, and CMSLP had 101
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 provided for retention
payments aggregating up to approximately $3.5 million, including payments to
certain executives. Retention payments were 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 was paid on April 14, 2000. The fourth and final retention payment of
approximately $639,000 vested on October 5, 2000, $367,000 of which was paid on
October 13, 2000 and the final payment was made on January 31, 2001. William B.
Dockser, Chairman of the Board of Directors, and H. William Willoughby,
President and Secretary, did not 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. For a discussion of the Employee
Retention Plan as it related to named key executives of the Company, see
"EXECUTIVE COMPENSATION-Employment Agreements."
14
The Portfolio
CMBS
As of December 31, 2000, 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 $853 million (representing
approximately 55% of the Company's total consolidated assets), an aggregate
amortized cost of approximately $850 million, and an aggregate face amount of
approximately $1.6 billion. Such CMBS represent investments in CBO-1, CBO-2 and
Nomura Securities Corp. Series 1998-D6 (Nomura). The weighted average pass
through interest rate of these CMBS as of December 31, 2000 was 6.9% and the
weighted average life was 13 years.
The Company's unrated bonds from CBO-1, CBO-2 and Nomura, respectively,
experienced cumulative principal write-downs due to realized losses related to
certain underlying mortgage loans, from inception through March 31, 2001, of
approximately $4.0 million, $4.7 million and $0, respectively. Of the $20
billion and $20.2 billion, respectively, of underlying mortgage loans as of
March 31, 2001 and December 31, 2000, $443.5 million and $310.6 million,
respectively, were included in special servicing. For additional information
regarding the Company's CMBS portfolio and the performance of the underlying
mortgage loans, refer to Note 5 to the Notes to Consolidated Financial
Statements.
Insured Mortgage Securities
As of December 31, 2000 and 1999, the Company had $385.8 million
(representing approximately 25% of the Company's total consolidated assets) and
$394.9 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, 2000, approximately 16% of
CRIIMI MAE's investment in mortgage securities were FHA-Insured Certificates and
84% were GNMA Mortgage-Backed Securities (including certificates that
collateralize Freddie Mac participation certificates). See Notes 3 and 6 to the
Notes to Consolidated Financial Statements for further discussion.
Equity Investments
As of December 31, 2000 and 1999, the Company had approximately $33.8
million and $34.9 million, respectively, in investments accounted for under the
equity method of accounting. Included in equity investments are (a) the general
partnership interests (2.9% to 4.9% ownership interests) in 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 to the Notes
to Consolidated Financial Statements for further discussion.
Investment in Originated Loans
As of December 31, 2000 and 1999, the Company had $0 and $470.2 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. The loans were sold as of November 6, 2000
and as such are no longer on the balance sheet. See "BUSINESS-Loan Originations
and Securitizations" and Notes 3 and 7 to the Notes to Consolidated Financial
Statements for further discussion.
15
Risk Factors
The risk factors enumerated below (other than "Risks Relating to the
Necessary New Debt"), generally assume consummation of the Reorganization Plan.
Risks Relating to the Necessary New Debt
Consummation of the Reorganization Plan is conditioned upon, among other
matters, the Company obtaining the New Debt. Although the Company has agreed to
terms with respect to the New Debt and is currently finalizing definitive
documentation for the New Debt, there can be no assurance that the Company will
obtain the New Debt and, if obtained, be able to satisfy all terms and
conditions of the New Debt.
Substantial Indebtedness; Leverage
The Company is now highly leveraged and will continue to be highly
leveraged after giving effect to the Reorganization Plan. As of December 31,
2000, the Company's total consolidated indebtedness was $1.2 billion, (of which
$559 million was recourse debt to the Company (i.e. not match-funded debt)). As
of December 31, 2000, the Company's stockholders' equity was $268 million. See
"MANAGEMENT'S DISCUSSION AND ANALYSIS AND RESULTS OF OPERATIONS" and the
Consolidated Financial Statements of the Company and the accompanying notes
thereto.
Assuming the Reorganization Plan becomes effective, there can be no
assurance that the Company will have sufficient cash resources to pay interest,
scheduled principal and any other required payments on its outstanding
indebtedness for any specified period of time. If the Reorganization Plan is
consummated, the Company's ability to meet its debt service obligations will
depend on a number of factors, including management's ability to maintain cash
flow (which is impacted by, among other things, the credit performance of the
underlying mortgage loans) and to generate capital internally from operating and
investing activities and expected reductions in REIT distribution requirements
to shareholders due to expected net operating losses for tax purposes, in each
case consistent with the terms agreed to with Merrill and GACC and the Unsecured
Creditors' Committee as set forth in the Reorganization Plan. There can be no
assurance that targeted levels of cash flow will actually be achieved, that
reductions in REIT distribution requirements will be realized, or that, if
required, new capital will be available to the Company. The Company's ability to
maintain or increase cash flow and access new capital will depend upon, among
other things, interest rates, prevailing economic conditions and other factors,
many of which are beyond the control of the Company.
The Company's high level of debt limits its ability to obtain additional
capital, reduces income available for distributions, restricts the Company's
ability to react quickly to changes in its business and makes the Company more
vulnerable to economic downturns. In addition, the agreements governing the New
Debt may impose significant operating and financial restrictions on the Company.
See Note 1 and Note 8 to the Notes to Consolidated Financial Statements.
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 and restrictions and requirements with respect to the collection,
management, use and application of funds. 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 interest payments, and restrictions
and requirements with respect to the use of funds.
16
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.
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, 2000, 93% 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, 2000, the weighted average remaining term for the interest
rate protection agreements was approximately four months with a weighted average
strike price of 6.67%. The highest rate for one-month LIBOR during 2000 was
6.80%. In February 2001, the Company purchased a 2-year, 1-month LIBOR indexed,
amortizing interest cap with an original notional amount of $200 million and a
strike price of 5.25%, which was purchased to hedge the variable rate
Merrill/GACC anticipated New Debt. 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. During 2000 and 1999, the Company did not hedge
against 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 expects to increase its hedging activity in connection with the
Merrill/GACC New Debt and, thus, increase its hedging costs during such periods.
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
17
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 or expected credit losses are greater than originally anticipated. 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 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. (See Note 5 to the Notes to Consolidated Financial Statements
and Management's Discussion and Analysis of Financial Condition and Results of
Operations for information regarding the performance of the underlying
commercial mortgage loans.)
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 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.
Effect of Economic Slowdown and/or Recession on Losses and Defaults
Economic slowdown and/or recession has resulted in defaults on and may
continue to increase the risk of further defaults on commercial mortgage loans
and correspondingly increase losses and the risk of further losses on the
Subordinated CMBS backed by such loans. An economic recession may also cause the
values of commercial real estate securing the outstanding mortgage loans to
decline, 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 real estate securing the mortgage loans (See Note
5 to the Notes to Consolidated Financial Statements and Management's Discussion
and Analysis of Financial Condition and Results of Operations for information
regarding the performance of the underlying commercial 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
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.
While the Company may resume more significant Subordinated CMBS
acquisitions and, possibly, its mortgage origination and securitization programs
at some time in the future based on the Company's ability to access capital,
prevailing industry conditions and the general business climate, and subject to
all applicable restrictions contained in financing agreements, there can be no
assurance of such resumption. All decisions concerning resumption of business
activities will be made by the Board of Directors of the Company, as determined
to be in the best interests of the Company. Consequently, there can be no
certainty as to the business decisions that will be made by the Board of
Directors of the Company. Failure to resume Subordinated CMBS acquisitions,
mortgage originations and/or securitizations could adversely impact the
Company's results of operations.
18
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 flat or slightly positively sloped
yield curve environment, borrowing costs could exceed the interest income and
operating losses would be incurred.
Phantom Income May Result in 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
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.
Risk of NYSE Delisting
On January 11, 2001, the Company received written notice from the New York
Stock Exchange that it was "below criteria" for continued listing on the
Exchange because the average closing price of its common stock was less than $1
over a consecutive thirty (30) trading-day period. The Company has six (6)
months from January 11,
19
2001 to raise its common stock price above the $1 level and the failure of the
common stock to average $1 over the 30 trading days preceding the expiration of
the six (6) month cure period will result in commencement of suspension and
delisting procedures.
Risks of Loss of REIT Status and Other Tax Matters
See "BUSINESS-Chapter 11 Filing and REIT Status and Other Tax Matters" for
a discussion.
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-Risk of Loss of REIT Status and
Other Tax Matters" 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 the Company 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 it is possible it could 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 2000 and subsequent years, taxable income (loss) is, and will
likely 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.
Failure to Manage Mismatch Between Long-Term Assets and Short-Term Funding
The Company's operating results will depend in large part on differences
between the income from its CMBS and its borrowing costs. If the Company
resumes the acquisition of Subordinated CMBS, the Company intends to fund a
significant portion of its CMBS with borrowings having interest rates (i.e.,
borrowing rates) that reset more frequently, usually monthly or quarterly. If
interest rates rise, borrowing rates (and borrowing costs) of the Company are
expected to rise more quickly that coupon rates (and investment income) on the
Company's CMBS. This would decrease both the Company's net income, potentially
resulting in a net loss, and the mark-to-market value of the Company's net
assets, and would be expected to decrease the market price of the Company's
common stock and to slow future acquisitions of assets. Although the Company
intends to invest primarily in fixed-rate CMBS, the Company also may own
adjustable rate CMBS. The coupon rates of adjustable rate CMBS normally
fluctuate with reference to specific rate indices. The Company may fund these
adjustable rate CMBS with borrowings having borrowing rates which reset monthly
or quarterly. To the extent that there is a difference between (i) the interest
rate index used to determine the coupon rate of the adjustable rate CMBS (asset
index) and (ii) the interest rate index used to determine the borrowing rate for
the Company's related financing (borrowing index), the Company will bear a
"basis" interest rate risk. Typically, if the borrowing index rises more than
the asset index, the net income of the Company would be decreased all other
things being constant. Additionally, the Company's adjustable rate CMBS may be
subject to periodic rate adjustment limitations and periodic and lifetime rate
caps which limit the amount that the coupon rate can change during any given
period. No assurance can be given as to the amount or timing of changes in
interest rates or their effect on the Company's CMBS, their valuation or income
derived therefrom. During periods of changing interest rates, coupon rate and
borrowing rate mismatches could negatively impact the Company's net income,
distributions and the market price of the common stock.
Competition
20
If the Company resumes the acquisition of Subordinated CMBS following its
reorganization, the Company would compete with mortgage REITs, specialty finance
companies, banks, hedge funds, investment banking firms, other lenders, and
other entities purchasing Subordinated CMBS. Many of the Company's competitors
for Subordinated CMBS may have greater access to capital and other resources (or
the ability to obtain capital at a lower cost) and may have other advantages
over the Company.
There can be no assurance that the Company would be able to obtain
financing at borrowing rates below the asset yields of its Subordinated CMBS.
In such event, the Company may incur losses or may be forced to further reduce
the size of its Subordinated CMBS portfolio. The Company would face competition
for financing sources which may limit the availability of, and affect the cost
of, funds to the Company.
Taxable Mortgage Pool Risks
See "BUSINESS-Chapter 11 Filing and REIT Status and Other Tax Matters" for
a discussion.
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.
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 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, 2000, the Company believes that it was
in compliance with the 55% Requirement. In the fourth quarter of 2000, the
Company fell below the 25% Requirement in a transient manner by approximately
one half of one percent due to accumulated cash required to be retained while
the Company is in Chapter 11. The Company's retention of cash in this regard was
incidental to its approved Reorganization Plan and the effectuation thereof.
Upon distributions of cash on the effective date of the Reorganization Plan,
expected to be April 17, 2001, to holders of allowed claims entitled to receive
cash, the Company believes it will exceed 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, unless the
court found under the circumstances enforcement (or denial of rescission) would
produce a more equitable result than nonenforcement (or grant of rescission) and
would not be inconsistent with the Investment Company Act. 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
21
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.
Pending Litigation
The Company is involved in certain material litigation. See "Item 3-LEGAL
PROCEEDINGS" for descriptions of such litigation and other legal proceedings.
ITEM 2. PROPERTIES
CRIIMI MAE leases its corporate offices at 11200 Rockville Pike, Rockville,
Maryland. As of March 15, 2001, these offices occupy approximately 68,500
square feet.
ITEM 3. LEGAL PROCEEDINGS
Bankruptcy Proceedings
On the Petition Date, the Debtors each filed voluntary petitions for relief
under Chapter 11 of the Bankruptcy Code in the Bankruptcy Court. These cases
are being jointly administered for procedural purposes. None of the cases has
been substantively consolidated. Under the Bankruptcy Code, the Debtors are
authorized to manage their respective affairs and operate their business as
debtors-in-possession while they attempt to confirm and consummate their plan of
reorganization that will restructure their financial affairs and allow them to
emerge from bankruptcy. As a debtor-in-possession under the Bankruptcy Code, no
Debtor may engage in any transaction outside the ordinary course of business
without the approval of the Bankruptcy Court. The following discussion
describes certain aspects of the Chapter 11 cases of the Debtors (the "Chapter
11 Cases"), but it is not intended to be a complete summary.
Pursuant to the Bankruptcy Code, the commencement of the Chapter 11 Cases
created an automatic stay, applicable generally to creditors and other parties
in interest, but subject to certain limited exceptions, of: (i) the
commencement or continuation of judicial, administrative or other actions or
proceedings against the Debtors that were or could have been commenced prior to
the commencement of the Chapter 11 Cases; (ii) the enforcement against the
Debtors or their property of any judgments obtained prior to the commencement of
the Chapter 11 Cases; (iii) the taking of any action to obtain possession of
property of the Debtors or to exercise control over such property; (iv) the
creation, perfection or enforcement of any lien against the property of the
bankruptcy estates of the Debtors; (v) any act to create, perfect or enforce
against the property of the Debtors any lien that secures a claim that arose
prior to the commencement of the Chapter 11 Cases; (vi) the taking of any action
to collect, assess or recover claims against the Debtors that arose before the
commencement of the Chapter 11 Cases; (vii) the set-off of any debt owing to the
Debtors that arose prior to the commencement of the Chapter 11 Cases against any
claim against the Debtors; or (viii) the commencement or continuation of a
proceeding before the United States Tax Court concerning the Debtors.
As noted above, the Debtors are authorized to manage their respective
properties and operate their respective businesses pursuant to the Bankruptcy
Code. During the course of the Chapter 11 Cases, the Debtors will be subject to
the jurisdiction and supervision of the Bankruptcy Court. The United States
Trustee appointed (i) the Unsecured Creditors' Committee, (ii) the Official
Committee of Unsecured Creditors in the CM Management Chapter 11 Case (the "CMM
Creditors' Committee") and (iii) the CMI Equity Committee (collectively, the
"Committees"). The Committees participated in the formation of the
Reorganization Plan. The Debtors are required to pay certain expenses of the
Committees, including professional fees, to the extent allowed by the Bankruptcy
Court.
Under the Bankruptcy Code, for 120 days following the Petition Date, only
the debtor-in-possession has the right to propose and file a plan of
reorganization with the Bankruptcy Court. If a debtor-in-possession files a
plan of reorganization during this exclusivity period, no other party may file a
plan of reorganization until 180 days following the Petition Date, during which
period the debtor-in-possession has the exclusive right to solicit
22
acceptances of the plan. If a debtor-in-possession fails to file a plan during
the exclusivity period or such additional exclusivity period as may be ordered
by the Bankruptcy Court or, after such plan has been filed, fails to obtain
acceptance of such plan from impaired classes of creditors and equity security
holders during the exclusive solicitation period, any party in interest,
including a creditors' committee, an equity security holders' committee, a
creditor or an equity security holder may file a plan of reorganization for such
debtor. Additionally, if the Bankruptcy Court were to appoint a trustee, the
exclusivity period, if not previously terminated, would terminate.
The Debtors' initial exclusivity period to file a plan of reorganization
ended on February 2, 1999. The Bankruptcy Court extended this period through
August 2, 1999 and again through September 10, 1999. The Debtors sought a third
extension of exclusivity through November 10, 1999 and on September 20, 1999,
the Bankruptcy Court entered an order (i) extending the Debtors' right to file a
plan of reorganization through October 16, 1999, (ii) providing the Unsecured
Creditors' Committee and the CMI Equity Committee the right to jointly file a
plan of reorganization through October 16, 1999 and (iii) providing that any
party in interest may file a plan of reorganization after October 16, 1999. 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, (iii) a Second Amended Joint Plan of Reorganization and
proposed Amended Joint Disclosure Statement on March 31, 2000, and (iv) a Third
Amended Joint Plan of Reorganization and proposed Second Amended Joint
Disclosure Statement with respect thereto on April 25, 2000, which plan and
disclosure statement were amended and supplemented by praecipes filed with the
Bankruptcy Court on July 13, 14, 21, August 18, and November 22, 2000. The
Debtors' Third Amended Joint Plan of Reorganization is fully supported by the
CMI Equity Committee, which was a co-proponent of the Reorganization Plan.
Subject to the completion of mutually acceptable Unsecured Creditor Debt
Documentation, the Unsecured Creditors' Committee has agreed to support
confirmation of the Debtors' Reorganization Plan.
On December 20, 1999, the Unsecured Creditors' Committee filed its own plan
of reorganization and proposed disclosure statement with the Bankruptcy Court.
On January 11, 2000 and on February 11, 2000, the Unsecured Creditors' Committee
filed its first and second amended plans of reorganization, respectively, with
the Bankruptcy Court and its amended proposed disclosure statements with respect
thereto. However, as a result of the successful negotiations, the Unsecured
Creditors' Committee supported confirmation of the Debtors' Reorganization Plan
and asked the Bankruptcy Court to defer consideration of its plan pending
approval of the Debtors' Reorganization Plan and the completion of mutually
acceptable Unsecured Creditor Debt Documentation. Accordingly, the Debtors, the
CMI Equity Committee and the Unsecured Creditors' Committee together presented
the Debtors' Reorganization Plan for approval by all holders of claims and
interests in impaired classes.
The Bankruptcy Court held a hearing on April 25, 2000 on the proposed
Disclosure Statement. During that hearing, the bankruptcy judge requested the
filing of additional legal briefs by May 9, 2000 on two issues raised at the
hearing. The issues raised related to an objection to the proposed Disclosure
Statement filed by Salomon Smith Barney Inc./Citicorp Securities, Inc. and
Citicorp Real Estate, Inc. (together "Citigroup"). On July 12, 2000, the
Bankruptcy Court entered an order overruling the objections raised by Citigroup
as set forth in the Memorandum Opinion and Order filed and entered on that date
by the Bankruptcy Court. The Citigroup objections were the only objections to
the proposed Disclosure Statement pending before the Bankruptcy Court. On July
21, 2000, CRIIMI MAE and Citigroup reached a settlement regarding the treatment
of Citigroup's claims under the Plan. This accord resolved Citigroup's
objections to the proposed Disclosure Statement and resulted in the dismissal of
all outstanding litigation between the parties.
The Bankruptcy Court scheduled a hearing on August 23, 2000 with respect to
the proposed ballots submitted to the Bankruptcy Court to be sent to members of
all classes of impaired creditors and equity security holders in connection with
the Reorganization Plan. On August 24, 2000, the Bankruptcy Court entered an
order approving the proposed Disclosure Statement and other proposed
solicitation materials. The Bankruptcy Court scheduled a confirmation hearing
on the Reorganization Plan for November 15, 2000 and set September 5, 2000 as
the voting record date for determining the holders of common stock, preferred
stock, 9 1/8% senior notes and general unsecured creditors entitled to vote to
accept or reject the Reorganization Plan. The Company distributed copies of the
Reorganization Plan, the Disclosure Statement and other solicitation materials,
including ballots during the week of September 10, 2000 to members of all
classes of impaired creditors and all equity security holders for acceptance or
rejection. All impaired classes which voted on the Reorganization Plan voted
overwhelmingly to accept the Reorganization Plan.
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On November 22, 2000, the Bankruptcy Court entered an order (the
"Confirmation Order") confirming the Reorganization Plan before it. To confirm
a plan, the Bankruptcy Court is required to find among other things: (i) with
respect to each class of impaired creditors and equity security holders, that
each holder of a claim or interest of such class either (a) will, pursuant to
the plan, receive or retain property of a value as of the effective date of the
Reorganization Plan, that is at least as much as such holder would have received
in a liquidation on such date of the Debtors or (b) has accepted the plan, (ii)
with respect to each class of claims or equity security holders, that such class
has accepted the Reorganization Plan or is not impaired under the plan, and
(iii) confirmation of the Reorganization Plan is not likely to be followed by
the liquidation or need for further financial reorganization of the Debtors or
any successor unless such liquidation or reorganization is proposed in the
Reorganization Plan. The Confirmation Order stated that the effective date of
the Reorganization Plan shall occur no later than March 15, 2001 or such later
date as may be (i) agreed to by the Debtors, Merrill Lynch, GACC, the Unsecured
Creditors' Committee, the CMM Creditors' Committee and the CMI Equity Committee
and approved by the Bankruptcy Court, or (ii) extended by further order of the
Bankruptcy Court upon notice and a hearing (each party reserving its right to
support or oppose any such extension).
On March 9, 2001, the Bankruptcy Court, after notice and a hearing,
approved an extension of the effective date of the Reorganization Plan to April
13, 2001, and on April 13, 2001, the Bankruptcy Court approved a further
extension of the effective date of the Reorganization Plan until April 17, 2001.
The Company expects to sign all remaining closing documents, disburse funds, and
consummate the effective date by April 17, 2001. However, there can be no
assurance that the Company will emerge by such date.
Bankruptcy Related Litigation
The following is a summary of material litigation matters between the
Company and certain of its secured creditors since the Petition Date. The
Company has reached agreement with all but one creditor, as set forth in greater
specificity below.
Merrill Lynch
As of the Petition Date, the Company owed Merrill Lynch approximately
$274.8 million with respect to advances to the Company under an assignment
agreement pursuant to which the Company pledged Subordinated CMBS. Borrowings
under this assignment agreement are secured by a first priority security
interest in certain CMBS issued in connection with CBO-2, together with all
proceeds, distributions and amounts realized therefrom (the "Distributions")
(the CMBS pledged to Merrill Lynch and the Distributions are hereafter referred
to collectively as the "Merrill Collateral").
On October 16, 1998, Merrill Lynch filed a motion with the Bankruptcy Court
for relief from the automatic stay or, in the alternative, for entry of an order
directing the Company to provide adequate protection for its interest in the
Merrill Collateral. On October 21, 1998, the Company filed a complaint against
Merrill Lynch for turnover of Distributions remitted to Merrill Lynch on October
2, 1998 by LaSalle National Bank, as well as other relief.
On December 4, 1998, the Bankruptcy Court approved a consent order entered
into between the Company and Merrill Lynch. Among other things, pursuant to the
consent order, the pending litigation with Merrill Lynch was dismissed without
prejudice. The consent order also preserved the portfolio of CMBS pledged as
collateral to Merrill Lynch and provided for the Company to receive
distributions of 50 percent of the monthly cash flow from those CMBS net of
interest payable to Merrill Lynch (the "Company's Distribution Share"). The 50
percent of distributions received by Merrill Lynch is to be applied to reduce
principal. Such arrangement will remain in effect until the earlier of a
further order of the Bankruptcy Court affecting the arrangement or the effective
date of the Reorganization Plan.
On September 7, 1999, the Company filed a Motion to Approve Stipulation and
Consent Order Providing for Adequate Protection. On or about September 27,
1999, the Unsecured Creditors' Committee and the CMI Equity Committee filed a
joint objection to the Motion. On December 3, 1999, the Bankruptcy Court
entered the Stipulation and Consent Order Providing For Adequate Protection (the
"Adequate Protection Order"), certain provisions of which were effective
retroactively. Pursuant to the Adequate Protection Order, a segregated interest
bearing debtor-in-possession account was created (the "Cash Collateral Account")
into which the Company's Distribution Share was deposited during the months of
August through December 1999. An additional 50 percent of the Company's
Distribution Share has been deposited into such account since January and absent
a further ruling by the Bankruptcy Court, or the occurrence of certain market
events detailed in the Adequate Protection Order, will
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continue to be deposited into such account through the effective date of the
Reorganization Plan. The Adequate Protection Order provides Merrill Lynch with a
first priority lien on the Cash Collateral Account. (See Note 1 to the Notes to
Consolidated Financial Statements for information with respect to the New Debt
anticipated to be provided by affiliates of Merrill Lynch and GACC pursuant to
the Reorganization Plan.)
Citicorp and Citibank
In addition to the Citibank Program pursuant to which the Company
originated loans, as previously discussed, the Company also has a financing
arrangement with Citicorp pursuant to which the Company pledged CMBS.
On October 13, 1998, Citicorp demanded from Norwest Bank Minnesota, N.A.
("Norwest") the immediate transfer of certain CMBS (the "Retained Bonds") issued
pursuant to CMO-IV. Norwest served as indenture trustee. The Retained Bonds
are collateral for amounts advanced to the Company by Citicorp under the
financing arrangement. As of the Petition Date, t