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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------------------------
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _______TO_________
Commission file number 001-11981
MUNICIPAL MORTGAGE & EQUITY, LLC
(Exact name of Registrant as Specified in Its Charter)
Delaware 52-1449733
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
218 North Charles Street, Suite 500
Baltimore, Maryland 21201
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (443) 263-2900
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of Each Exchange on Which Registered
------------------- -----------------------------------------
Common Shares New York Stock Exchange, Inc.
Securities registered pursuant to
Section 12(g) of the Act: Preferred Shares
Preferred Capital Distribution Shares
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 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the Company's Common Shares held by
non-affiliates of the registrant as of March 22, 2002 (computed by reference to
the closing price of such shares on the New York Stock Exchange) was
$605,000,208. The Company had 25,208,342 Common Shares outstanding as of March
22, 2002.
Portions of the Company's Proxy Statement with respect to the 2002 Annual
Meeting of Shareholders to be filed subsequent to the date hereof are
incorporated by reference Items 10, 11, 12 and 13 of Part III.
Forward Looking Information
Assumptions relating to various portions of the Company's Annual Report on Form
10_K involve judgments with respect to, among other things, future economic
market conditions and future business decisions, all of which are difficult or
impossible to predict accurately and many of which are beyond the control of the
Company. Although the Company believes that the assumptions underlying the
forward-looking information included herein are reasonable, any of the
assumptions could be inaccurate and, therefore there can be no assurance that
such forward-looking information will prove to be accurate. In light of the
significant uncertainties inherent in forward-looking information, the inclusion
of such information should not be regarded as a representation by the Company or
any other person that the objectives and plans of the Company will be achieved.
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MUNICIPAL MORTGAGE & EQUITY, LLC
INDEX TO FORM 10-K
Part I
Item 1. Description of Business ........................................ Page 4
Item 2. Properties ..................................................... Page 16
Item 3. Legal Proceedings .............................................. Page 17
Item 4. Submission of Matters to a Vote of Security Holders ............ Page 17
Part II
Item 5. Market for Registrant's Equity Securities and
Related Stockholder Matters .......................................... Page 18
Item 6. Selected Financial Data ........................................ Page 21
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations ........................ Page 23
Item 7A. Quantitative and Qualitative Disclosures
about Market Risk .................................................... Page 43
Item 8. Financial Statements and Supplementary Data .................... Page 47
Item 9. Changes in and Disagreements on Accounting and
Financial Disclosure ................................................. Page 47
Part III
Item 10. Directors and Executive Officers of the Registrant ............ Page 48
Item 11. Executive Compensation ........................................ Page 48
Item 12. Security Ownership of Certain Beneficial
Owners and Management ................................................ Page 48
Item 13. Certain Relationships and Related Transactions ................ Page 48
Part IV
Item 14. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K .................................................. Page 49
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Part I
Item 1. Description of Business.
General Development of Business.
Municipal Mortgage & Equity, LLC ("MuniMae") and its subsidiaries (together
with MuniMae, the "Company") are principally engaged in originating, investing
in and servicing investments related to multifamily housing and other real
estate financings. A significant portion of the Company's investments are
tax-exempt bonds, or interests in bonds, issued by state and local governments
or their agencies or authorities to finance multifamily housing developments.
Interest income from the majority of these investments is exempt for federal
income tax purposes. Multifamily housing developments, as well as the rents paid
by the tenants, secure these investments. Midland Financial Holdings, Inc.
("Midland"), a corporate subsidiary, is a fully integrated real estate
investment firm that specializes in originating, investing in and servicing
investments in the affordable multifamily housing industry. These investments
generate taxable, not tax-exempt, income.
MuniMae is a Delaware limited liability company and is the successor to the
business of SCA Tax Exempt Fund Limited Partnership (the "Partnership"), a
closed-end limited partnership that was merged into MuniMae on August 1, 1996.
As a limited liability company, the Company combines the limited liability,
governance and management characteristics of a corporation with the pass-through
income features of a partnership. Since MuniMae is classified as a partnership
for federal income tax purposes, no recognition of income taxes is made at the
corporate level (except for income earned through subsidiaries of the Company
organized as corporations). Instead, the distributive share of MuniMae's income,
deductions and credits is included in each shareholder's income tax return.
The Predecessor
The Partnership commenced operations in 1986 when it sold two series of
Beneficial Assignee Certificates ("BACs"), representing the assignment of its
limited partnership interests. The Partnership invested the $296 million of
proceeds from the sale in 22 tax-exempt bonds (the "original bonds") and related
working capital loans held in two separate pools, "Series I" and "Series II,"
corresponding with the related series of BACs. In a February 1995 financing (the
"1995 Financing"), the Partnership raised $67.7 million through the sale of
multifamily revenue bond receipts (the "Receipts") secured by newly refunded
bonds (the "Refunding") issued in exchange for 11 of the original bonds and the
cash stream from one additional bond. Effective December 31, 1997, the
additional bond was released as additional collateral. Of the $67.7 million of
proceeds, $5.0 million was invested in demand notes and the remainder, after
expenses and working capital reserves, of $56.8 million has been principally
invested in additional tax-exempt bonds and other bond related investments.
The Merger
In connection with the August 1, 1996 merger of the Partnership into
MuniMae (the "Merger"), the Partnership's BAC holders were given the opportunity
to elect among three different securities of the Company for which to exchange
their BACs: Preferred Shares, Preferred Capital Distribution Shares
(collectively the "Preferred Shares") or Common Shares. The Preferred Shares
were structured to give BAC holders a security substantially the same as their
BACs as if the 1995 Financing had not occurred. Thus, the Preferred Shares
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participate in their pro rata share of income from the 22 original bonds as they
existed immediately after the Refunding and before the 1995 Financing. The
Preferred Capital Distribution Shares (the "Preferred CD Shares") were
structured to give their holders the income they would have received from their
original BACs, but provided for a distribution of their pro rata share of the
proceeds of the 1995 Financing. Thus, the Preferred CD Shares participate in
their pro rata share of income from the 22 original bonds as they existed
immediately after the Refunding and the 1995 Financing. The Common Shares,
unlike either the Preferred Shares or Preferred CD Shares, were structured to
enable their holders to participate in all of the income from investment of the
proceeds of the 1995 Financing, as well as future financings, in addition to
their pro rata share of the income from the original bonds as they existed
immediately after the 1995 Financing. As a result of the election process, the
holders of 8.09% of the outstanding BACs received Preferred Shares, the holders
of 4.29% of the outstanding BACs received Preferred CD Shares and the holders of
86.62% of the outstanding BACs received Common Shares of the Company.
The Company is required to distribute to the holders of Preferred Shares
and Preferred CD Shares cash flow attributable to such shares (as defined in the
Company's Amended and Restated Certificate of Formation and Operating Agreement,
the "Operating Agreement"). The Company is required to distribute 2.0% of the
net cash flow to the holders of Term Growth Shares. Term Growth Shares were
issued to the former general partners of the Partnership in exchange for their
general partnership interests and to a Merrill Lynch Pierce Fenner & Smith
Incorporated ("Merrill Lynch") affiliate in exchange for their subordinated
BACs. The balance of the Company's cash flow is available for distribution to
Common Shares and the Company's current policy is to distribute to Common
Shareholders at least 80% of the cash flow associated with this income.
Preferred Share Redemptions
In accordance with the Company's Operating Agreement, the Preferred Shares
and the Preferred CD Shares must be partially redeemed when any bond
attributable to the shares is sold or, beginning in the year 2000, when any bond
attributable to the shares reaches par value (which includes accrued but unpaid
base interest under the original bond terms and accrued but unpaid interest
under the then current bond terms) based on receipt of an appraisal securing the
bond. The Company must redeem the Preferred Shares and Preferred CD Shares
within six months of the occurrence of a redemption event. Four bonds
attributable to Series I Preferred Shares and Preferred CD Shares and four bonds
attributable to Series II Preferred Shares and Preferred CD Shares reached par
value in December 2000. As a result, in June of 2001, the Company redeemed
approximately 26% and 56% of the Series I and Series II Preferred Shares and
Preferred CD Shares, respectively.
In addition to the bonds that reached par value in December 2000, the
remaining bonds attributable to the shares were either paid off, sold and/or
reached par value during the last four months of 2001 and in January 2002. As a
result, in March 2002, the Company redeemed the remaining Series I and Series II
Preferred Shares and Preferred CD Shares at an aggregate cost of approximately
$19.3 million. The Operating Agreement also requires that the Term Growth shares
be redeemed after the last Preferred Share is redeemed. As a result, the Term
Growth shares which had no residual value, were also redeemed in 2002.
5
Subsidiaries
MuniMae TE Bond Subsidiary, LLC
In 1999, the Company placed a substantial portion of its tax-exempt bonds
and bond related investments in MuniMae TE Bond Subsidiary, LLC ("TE Bond Sub"),
an indirect subsidiary of the Company. In May1999, TE Bond Sub sold to
institutional investors $84 million of Series A Cumulative Preferred Shares
("Series A Preferred Shares"). In June 2000, TE Bond Sub sold to institutional
investors $60 million of Series B Cumulative Preferred Shares ("Series B
Preferred Shares"). In October 2001, TE Bond Sub sold to institutional investors
$16 million of Series A-1 Cumulative Preferred Shares ("Series A-1 Preferred
Shares") and $8 million of Series B-1 Subordinate Cumulative Preferred Shares
("Series B-1 Preferred Shares"; all four Series, collectively, the "TE Bond
Preferred Shares").
The Series A and A-1 Preferred Shares bear interest at 6.875% and 6.30% per
annum, respectively, or, if lower, the aggregate net income of the issuing
company, TE Bond Sub. The Series A and A-1 Preferred Shares have a senior claim
to the income derived from the investments owned by TE Bond Sub. The Series A-1
Preferred Shares are equal in priority of payment to the Series A Preferred
Shares. The Series B and B-1 Preferred Shares bear interest at 7.75% and 6.80%
per annum, respectively, or, if lower, the aggregate net income of the issuing
company, TE Bond Sub, after payment of distributions to the Series A and Series
A-1 Preferred Shares. The TE Bond Preferred Shares have a senior claim to the
income derived from the investments owned by TE Bond Sub. Any income from TE
Bond Sub available after payment of the cumulative distributions of the TE Bond
Preferred Shares is allocated to the Company. The assets of TE Bond Sub and its
subsidiaries, while indirectly controlled by MuniMae and thus included in the
consolidated financial statements of MuniMae, are legally owned by TE Bond Sub
and are not available to the creditors of MuniMae.
Midland
In October 1999 the Company acquired Midland for approximately $45 million.
Of this amount, the Company paid approximately $23 million in cash and
approximately $12 million in Common Shares at the closing of the transaction. In
addition, $3.3 million in MuniMae Common Shares was payable annually over a
three year period if Midland met certain performance targets, including an
annual contribution to cash available for distribution ("CAD"). In December
2000, MuniMae paid approximately $3.3 million in Common Shares in consideration
for Midland meeting its first year performance targets. In 2001, in order to
increase MuniMae's flexibility in operating Midland, MuniMae agreed with the
former owners of Midland that the payment of the 2001 and 2002 installments
would no longer be conditioned on Midland meeting certain performance targets.
In December 2001, MuniMae paid approximately $3.3 million in Common Shares and,
subject to certain conditions, MuniMae expects to make the final payment of
Common Shares having a value of approximately $3.3 million in December 2002.
Midland is a fully integrated real estate investment firm specializing in
providing financing to the affordable multifamily housing industry. Midland
provides construction and permanent debt financing, mortgage servicing and asset
management services to the multifamily housing industry. Midland is a Federal
National Mortgage Association ("Fannie Mae") Delegated Underwriter and Servicer
("DUS") and a Federal Housing Administration approved mortgagee. Midland
syndicates equity for investment in low income housing tax credits. Midland also
syndicates equity and originates debt for investment in student/conventional
housing, a unique and growing segment of the multifamily housing industry. A
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subsidiary of Midland is a registered investment advisor with the Securities and
Exchange Commission and a wholly owned special purpose subsidiary of Midland
provides advisory services to pension funds. Midland currently manages
approximately $350 million of pension fund money.
Business Segments
In October 1999, as a result of the Midland acquisition, the Company
restructured its operations into two business segments: (1) an investing segment
consisting of subsidiaries holding investments producing primarily tax-exempt
interest income; and (2) an operating segment that primarily generates taxable
interest income and, through corporate subsidiaries, fee income by providing
servicing, loan origination and tax credit equity syndication services. The
revenues associated with the investing segment consist of interest earned on
tax-exempt bonds, other bond related investments and certain short-term taxable
loans and investments. The revenues associated with the operating segment
consist of loan servicing and loan origination fees for the Company's own
portfolio and for portfolios of third parties, syndication and brokerage fees
associated with the origination of tax credit syndications, taxable interest and
fees earned on construction lending activities and other fee income. Segment
results include all direct revenues and expenses of each segment and allocations
of indirect expenses based on specific methodologies. The Company's reportable
segments are strategic business units that primarily generate different income
streams and are managed separately. The majority of the income generated by the
operating segment was acquired as a unit and the management of such unit was
retained.
For the years ended December 31, 2001 and 2000, the Company's revenues, net
income and identifiable assets have been distributed among the following
segments (in thousands):
2001 2000
---- ----
Investing Operating Adjustments(1) Total Investing Operating Adjustments(1) Total
--------- --------- -------------- ----- --------- --------- -------------- -----
Revenues $ 57,914 $ 68,669 ($820) $ 125,763 $ 46,064 $ 56,333 ($1,545) $100,852
Net Income
Identifiable 19,312 7,390 ($820) 25,882 29,136 3,984 ($1,545) 31,575
Assets 791,199 498,077 -- 1,289,276 616,376 371,506 -- 987,882
(1) Represents origination fees on purchased investments that are deferred and
amortized into income over the life of the investment.
Prior to October 1999, all of the Company's operations were attributable to
the investing segment.
Raising Capital
Capital is the raw material that enables the Company to fund its
investments. In order to facilitate growth, the Company will require additional
capital to pursue acquisition opportunities. The Company has primarily used two
sources of capital: securitizations and equity offerings from MuniMae and
certain subsidiaries. The most economically efficient way to fund future
acquisitions is through securitizations, which the Company uses to leverage its
investments; however, our securitizations can limit our flexibility in managing
our assets and additional leverage increases the risk in our investment
portfolio. As a result, the Company has decided that a conservative capital
structure that avoids over-leveraging is the most prudent course to take.
Therefore, the Company, through equity offerings, periodically decreases its
outstanding off-balance-sheet debt to reduce leverage. Also, as a result of the
Midland acquisition, the
7
Company has expanded its access to capital. Midland's syndication and pension
fund investors are essentially alternative financing sources to securitizations,
as are Fannie Mae and the Federal Home Mortgage Corporation ("Freddie Mac")
through their multifamily securitization programs.
Securitizations
Through securitizations, the Company seeks to enhance its overall return on
its investments and to generate proceeds that, along with equity offering
proceeds, facilitate the acquisition of additional investments. The Company uses
various programs to facilitate the securitization and credit enhancement of its
bond investments. At December 31, 2001, the Company had on-balance sheet
obligations of $213.4 million and off-balance sheet obligations of $334.2
million related to securitization transactions.
In order to facilitate the securitization of certain assets at higher
leverage ratios than otherwise would be available to the Company without the
posting of additional collateral, the Company has pledged additional bonds and
taxable loans to a pool that acts as collateral for senior interests in certain
securitization trusts and credit enhancement facilities. At December 31, 2001,
the total carrying amount of the bonds and taxable loans pledged as collateral
was $361.8 million.
The following is a description of the Company's various credit enhancement
and securitization investment vehicles and a discussion of the activity in these
programs during 2001.
The Company securitizes mortgage bonds in its portfolio through the
Residual Interest Tax-Exempt Securities Receipts ("RITESSM")/Puttable Floating
Option Tax-Exempt Receipts ("P-FLOATsSM") program offered by Merrill Lynch
Pierce Fenner & Smith Incorporated ("Merrill Lynch"). Through this program, the
Company sells bonds to Merrill Lynch or structures a transaction whereby Merrill
Lynch buys bonds from third parties. Merrill Lynch deposits the bonds into
trusts, which are created to hold these assets. Subsequently, these bonds are
credit enhanced by Merrill Lynch. Two types of securities, P-FLOATsSM and
RITESSM, are created for each asset deposited into the trusts. The P-FLOATsSM
are short-term floating rate interests in the trusts that have priority on the
cash flows of the deposited bonds and bear interest at rates that are reset
weekly by the remarketing agent, Merrill Lynch. The P-FLOATsSM are sold to
qualified third party investors. When Merrill Lynch buys the bond directly, the
Company purchases the RITESSM. The RITESSM are the subordinate security and
receive the residual interest on the bond after the payment of all fees and the
P-FLOATsSM interest. To the extent these transactions create interest rate
risks, the Company enters into interest rate swap contracts designed to reduce,
but not eliminate such risks.
During 2001 and 2000, the Company raised $180 million and $155 million,
respectively, through securitizations of 12 and 11 tax-exempt bonds,
respectively. The Company's effective annual costs of its P-FLOATsSM
securitization was approximately 4.4% and 5.6%, at December 31, 2001 and 2000,
respectively.
In March 1999, the Company consummated a transaction with an affiliate of
Merrill Lynch that converted a $67.8 million portion of the Company's investment
in the securitization trusts discussed above into a longer-term securitization
facility. This transaction enabled the Company to (a) reduce its exposure to
credit and annual renewal risks associated with the liquidity and credit
enhancement features of the securitization ?trusts and the swap agreements, (b)
reduce the annual financing costs and (c) eliminate the risk of receiving
taxable net swap payments which serve to hedge tax-exempt investments (see
discussion in Note 5 to the consolidated financial statements included herein).
In July 2001, TE Bond Sub refinanced this longer-term securitization facility.
8
The result of the refinancing was a reduction of the outstanding debt by $22.0
million while all other terms of the debt remained the same (see further
discussion in Note 5 to the consolidated financial statements). As a result of
certain call provisions available to the subordinate certificate holders, the
Company has accounted for this transaction as a borrowing. Accordingly, the
senior certificates were recorded as long-term debt and the bonds associated
with this transaction are included in investments in tax-exempt bonds. Prior to
this transaction, these assets and liabilities had received sale treatment and
therefore were off-balance sheet financing.
In December 2000 the Company closed a $100 million credit enhancement
facility through Fannie Mae. The facility refinanced the short-term credit
enhancement on approximately $70 million of the Company's existing
securitization portfolio with long-term credit enhancement through Fannie Mae.
The facility also provided credit enhancement to two of our previously
unenhanced tax-exempt bonds having an aggregate fair market value of
approximately $10 million at December 31, 2000. The new facility also replaced
the credit enhancement on approximately $20 million of tax-exempt bonds that
were previously credit enhanced by a credit facility provided through MMA Cap,
LLC prior to December 2000.
The $100 million credit enhancement facility, which was completed through
MMA Cap, LLC, a wholly owned subsidiary of the Company, is an open ended
facility and will facilitate the placement of long term securitization capital,
thereby enabling the Company to securitize its mortgage bonds at a fixed rate
and for a term that more closely matches the term of the underlying bond. The
MMA Cap credit enhancement facility was arranged through Midland and enables the
Company to diversify its securitization capabilities. In order to provide credit
enhancement to the bonds secured by this facility, the Company pledged
additional investments to this facility.
In December 2001, the Company developed a tender option bond program with
Freddie Mac. Through this program, the Company securitized 12 bonds with an
aggregate unpaid principal balance of approximately $91.0 million and deposited
the bonds into 12 trusts. Prior to this transaction, approximately $34.3 million
of these bonds had been securitized through the P-FLOATsSM program. The trusts
issued approximately $69.0 million of fixed-rate senior certificates and
approximately $22.0 million of fixed-rate subordinate certificates. The Company
purchased the subordinate certificates and the senior certificates were sold to
third party investors. The net proceeds to the Company upon completion of this
transaction were approximately $34.7 million. Which represents $69.0 million in
proceeds from the sale of the fixed-rate senior certificates less $34.3 million
for the purchase of the bonds in the P-FLOATsSM program. To increase the
attractiveness of the senior certificates to outside investors, Freddie Mac
provided credit enhancement through a standby guaranty of payment and agreed to
provide liquidity by lending the Company the money to repurchase the senior
certificates at the remarketing date (if they are not successfully remarketed),
which is five years from issuance. The Company agreed to pay Freddie Mac for the
first $22.0 million of losses if any of the bonds fail to generate sufficient
income to pay the senior certificate holders, and the Company pledged our
subordinate certificates to Freddie Mac to secure this obligation. Freddie Mac's
recourse to the Company for losses on the credit enhancement is limited to its
right to liquidate the subordinate certificates.
Recent Public Offerings
On February 8, 2002, the Company sold to the public 3.0 million Common
Shares at a price of $24.70 per share and granted the underwriters an option to
purchase up to an aggregate of 450,000 Common Shares to cover over-allotments at
the same price. Net proceeds on the 3.0 million shares approximated $70.5
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million. On February 15, 2002, the underwriters exercised their option to
purchase 300,000 Common Shares generating net proceeds of approximately $7.1
million. The net proceeds from this offering will be used for general corporate
purposes, including new investments and working capital.
On February 6, 2001, the Company sold to the public 3.8 million Common
Shares at a price of $23.07 per share. The net proceeds from this offering have
been used for general corporate purposes, including new investments and working
capital.
The Tax-Exempt Bonds
The proceeds of the tax-exempt bonds held by the Company are used to make
mortgage loans for the construction, acquisition or refinancing of multifamily
housing developments and other real estate financings through out the United
States. The underlying developments are "qualified residential rental
properties" under section 142(d) of the Internal Revenue Code of 1986, as
amended (the "Code"), which requires that a specified percentage of their rental
units be rented to persons whose incomes do not exceed specified percentages of
local median income levels. Certain of the mortgage bonds qualify as 501(c)(3)
bonds under Section 145 of the Code, which requires that the owner of the
underlying property be a 501(c)(3) organization or a governmental unit that
meets certain additional requirements. Accordingly, the bonds are "qualified
bonds" within the meaning of section 141(e) of the Code, and the interest paid
on the bonds is exempt from federal income taxes.
Each tax-exempt bond is secured by an assignment to the Company of the
related mortgage loan, which in turn is secured by a mortgage on the underlying
property and assignment of rents. Although the bonds are issued by state or
local governments or their agencies or authorities, the bonds are not general
obligations of any state or local government, no government is liable under the
bonds, nor is the taxing power of any government pledged to the payment of
principal or interest under the bonds. In addition, the underlying mortgage
loans are nonrecourse, which means that the owners of the underlying properties,
who are also the borrowers under the mortgage loans, are not liable for the
payment of principal and interest under the loans. Accordingly, the sole source
of funds for payment of principal and interest under the bonds is the revenue
derived from operation of the mortgaged properties and amounts derived from the
sale, typically refinancing or other disposition of such properties.
As of December 31, 2001, the Company held $616.5 million of bonds or
certificates of participation ("COPs") of which $83.6 million were
participating, $460.0 million were non-participating, $55.7 million were
participating subordinate and $17.2 million were non-participating subordinate.
(See Note 4 to the Company's consolidated financial statements included herein
for a complete discussion.)
Other Bond Related Investments
The Company holds investments in RITESSM (as discussed above under the
caption "Securitizations"), a security offered by Merrill Lynch through its
P-FLOATsSM Program. In conjunction with the purchase of the RITESSM with respect
to fixed rate bonds, the Company enters into interest rate swap contracts to
hedge against interest rate exposure on the Company's investment in the RITESSM.
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Loans Receivable
The Company's investment in construction loans primarily consists of
short-term taxable loans originated by Midland. The proceeds of these loans are
used to build low-to-moderate income apartment communities. These construction
loans are typically underwritten so as to facilitate a permanent takeout through
Fannie Mae's DUS program. The Company, through Midland, is able to provide
funding for the construction of these properties by utilizing capital it manages
for various pension funds. The Company also provides taxable second loans and
parity working capital loans to certain properties in conjunction with the
purchase of tax-exempt bonds.
Acquisitions
Investment Acquisition Program
Through the investing segment, the Company seeks to acquire investments
that primarily generate tax-exempt interest income and that are available on
attractive terms. The Company believes that currently there are a substantial
number of tax-exempt bonds and similar investments available at attractive
prices including:
o Tax-exempt bonds that are used to finance development or rehabilitation of
multifamily properties, in conjunction with the affordable housing tax
credit.
o Existing bonds as the underlying mortgages are refinanced. There are a
significant number of mortgage bonds backed by multifamily properties that
were originated in the late 1980s. The Company believes, in light of the
current interest rate environment, that many of the obligors on these
mortgage bonds may consider refinancing them.
o Bonds issued for the benefit of charitable organization obligors (otherwise
referred to as 501(c)(3) developers) that own and manage multifamily
housing. These properties generally serve moderate-income families with
incomes between 50% and 80% of a region's median income.
o Revenue bonds issued to finance development of large scale real estate
developments, including single-family housing developments. These bonds are
generally not secured by a mortgage on real property, but by assessment
payments imposed by residents of the development or other specific payments
pledged by the local government or special assessment district issuing the
bonds.
o Other portfolios of bonds and related investments backed by multifamily
housing properties that meet the Company's underwriting criteria and target
risk-adjusted returns.
The Company will focus its efforts on supplying tax-exempt financing to
quality, multifamily housing owned or developed by tax credit and 501(c)(3)
developers as well as refinancings of existing mortgage bonds.
Competition
The need for capital for multifamily housing developments continues to
grow, especially in the affordable housing sector. Mature properties need to be
recapitalized and new properties are being built to meet increasing demands in
various markets. State and federal government programs, which provide
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incentives and/or subsidies to build and reinvest in multifamily housing,
motivate continuous activity in multifamily development. Increasingly, these
needs are being financed with tax-exempt bonds and affordable housing tax
credits.
The Company actively seeks investment opportunities throughout the United
States and is encouraged by the business opportunities that exist. Although the
Company operates in a competitive environment, there are only a handful of
competitors that are primarily focused on providing tax-exempt financing for
multifamily housing consistent with the Company's acquisition programs. As a
result, the Company is able to offer financing programs that are custom-tailored
to meet the customer's needs. The 1999 acquisition of Midland extended the
Company's lending reach and product offerings by providing access to new forms
of debt and equity capital. When MuniMae's tax-exempt lending is coupled with
Midland's debt and equity capital, the Company has the ability to provide one
stop shopping to borrowers seeking debt and equity financing for affordable
multifamily housing communities.
The primarily competitive factors in originating new investments are
pricing, service, ease of execution and certainty of execution. The Company's
ability to follow through on these factors is the key to continued growth.
Property Performance
The Company structured $468.4 million in tax-exempt investment transactions
during 2001, of which $99.6 million were retained by the Company as bonds or
other bond related investments. The properties collateralizing the mortgage
loans underlying the investments are geographically dispersed and include new
construction projects and acquisition or refinancing of existing properties.
Aggregate occupancy for all of the properties collateralizing the Company's
bonds and other bond related investments was 92.2% at December 31, 2001, as
compared with 93.1% at December 31, 2000.
The 22 original bonds held by the Partnership at the time of the 1995
Financing had been acquired by the Partnership in 1986 and 1987. Due to an
imbalance in the real estate markets in the late 1980's and early 1990's, many
of the mortgage properties collateralized by the original bonds were unable to
achieve the rent increases originally anticipated and, consequently, the net
cash flow from most of the properties was insufficient to pay the base interest
due. Consequently, the former managing general partners were forced to draw
funds from project level sources such as reserves and guarantees or declare
monetary defaults and initiate loan workout discussions in instances where no
project level sources existed.
Construction starts for new apartment units declined significantly
throughout the United States during the mid-1980s and fell to a record low in
1993. This decline in construction starts coupled with a general economic
recovery brought about tightening markets, stabilized and higher occupancies,
and an ability to realize greater rent increases. Apartment starts bottomed in
1993 and grew dramatically before leveling off in the late 1990's, with relative
balance between new supply and marginal demand for existing housing in most
markets.
As of December 31, 2001, the Company held $616.5 million of bonds or COPs,
of which $83.6 million were participating, $460.0 million were
non-participating, $55.7 million were participating subordinate and $17.2
million were non-participating subordinate. Participating bonds have additional
interest features that allow the Company to participate in the growth of the
underlying property. These participating bonds provide for payment of additional
interest from available cash flow of the property in addition to the base
12
interest. The terms of the additional interest to be received on a bond are
specific to that bond and are set forth in the bond documents. Other bonds
provide for payment of a fixed rate of interest but are not non-participating
and do not contain additional interest features. Certain participating and
non-participating bonds are considered "subordinate" bonds as the payment of
interest and principal on the bonds occurs only after payment of principal and
interest on a bond that has priority to the cash flow of the underlying
collateral.
The following table provides certain information for the months ended
December 31, 2001, September 30, 2001 and December 31, 2000 with respect to the
properties collateralizing the mortgage loans underlying the bond and other bond
related investments held by the Company at December 31, 2001.
13
Occupancy
-------------------------------------------
Month Ended Month Ended Month Ended
Month/Year Apartment December 31, September 30, December 31,
Apartment Community Acquired Units 2001 2001 2000
------------------- -------- ----- -------------------------------------------
Participating Mortgage Bonds:
Alban Place Sep-86 194 90.7% 92.3% 86.1%
Cobblestone Aug-99 184 94.0% 98.9% 95.7%
Creekside Village Nov-87 296 99.7% 99.7% 98.6%
Crossings Jan-97 200 95.5% 95.5% 92.5%
Jefferson Commons Dec-00 173 94.8% 96.4% N/A
Lakeview Sep-87 180 97.2% 97.8% 97.2%
North Pointe Sep-86 540 96.9% 94.3% 95.6%
Timber Ridge Dec-00 168 96.4% 97.6% 96.4%
Villas at LaRiviera Jun-99 199 96.5% 96.0% 95.5%
-----------
Subtotal Participating Mortgage Bonds 2,134
-----------
Mortgage Bonds
Applewood (a.k.a. Paola) Jul-99 48 91.7% 87.5% 95.8%
Buchanan Bay Mar-01 228 71.5% 86.4% N/A
Cielo Vista Aug-99 378 89.7% 91.5% 90.7%
Charter House (2) Dec-96 -- N/A N/A N/A
Country Club Jul-99 101 87.1% 89.1% 92.0%
Delta Village Jun-99 80 93.8% 95.0% 93.8%
Elmbrooke Aug-00 54 100.0% 100.0% 77.8%
Florida A&M Feb-00 96 69.8% 69.8% 96.0%
Gannon (Broward) Feb-98 315 97.5% 97.8% 91.1%
Gannon (Dade) (3) Feb-98 1,252 95.1% 95.0% 97.5%
Gannon (St. Louis) Feb-98 336 91.1% 94.0% 93.8%
Gannon A Bond Feb-98 -- N/A N/A N/A
Hidden Valley Dec-96 82 87.8% 91.5% 92.4%
Honey Creek Mar-99 656 91.6% 93.3% 93.8%
Hunter's Glen Mar-01 383 91.1% 92.3% N/A
Lake Piedmont Apr-98 648 85.0% 82.2% 79.3%
Monroe (Oakmont, Towne Oak) Dec-98 364 98.4% 99.4% 92.2%
Mountain View (Willowgreen) Nov-86 241 92.5% 97.5% 96.9%
Northridge Park II Aug-87 128 97.7% 96.9% 96.3%
Oakbrook Dec-96 170 95.9% 99.4% 94.7%
Orangevale Apr-98 64 100.0% 96.9% 100.0%
Parkwood Jun-99 180 97.2% 98.9% 93.8%
Riverset II (1) Jan-96 -- N/A N/A N/A
Sahuarita Jun-99 52 75.0% 92.3% 95.0%
Santa Fe Springs Jun-00 310 88.4% 89.4% 95.0%
Shadowbrook Jun-99 193 96.4% 97.9% 98.0%
Torries Chase Dec-96 99 99.0% 99.0% 96.0%
Villa Hialeah Nov-87 245 97.1% 94.3% 95.6%
Village at Stone Mountain Oct-97 722 93.1% 93.5% 95.8%
Village Green Feb-00 200 90.5% 94.0% 89.0%
Western Hills Dec-98 80 100.0% 97.5% 91.7%
Willow Key Mar-99 384 99.0% 99.2% 97.0%
Woodmark Jun-99 173 97.7% 96.0% 90.2%
-----------
Subtotal Mortgage Bonds 8,262
-----------
Participating Subordinate Mortgage Bonds:
Barkley Place May-87 156 92.9% 95.5% 96.5%
Gilman Meadows Mar-87 125 94.4% 90.4% 95.8%
Hamilton Chase Feb-87 300 94.0% 92.7% 96.5%
Mallard Cove I & II Feb-87 198 87.4% 91.9% 94.3%
Meadows Jan-88 200 98.5% 94.0% 93.7%
Montclair Oct-86 159 90.6% 95.6% 96.6%
Newport Village Dec-86 220 95.9% 97.7% 99.8%
Nicollet Ridge Dec-87 339 90.0% 97.6% 96.2%
Riverset II Jan-96 148 88.2% 89.0% 94.6%
Steeplechase Oct-88 450 96.2% 96.2% 93.0%
Whispering Lake Oct-87 384 88.3% 92.4% 88.6%
-----------
Subtotal Participating Subordinate Mortgage Bonds 2,679
-----------
Avg. Monthly Rent
Per Apartment Unit
----------------------------------------------
Month Month Month
Ended Ended Ended
December 31, September 30, December 31,
Apartment Community 2001 2001 2000
------------------- ----------------------------------------------
Participating Mortgage Bonds:
Alban Place $895 $886 $854
Cobblestone 568 570 548
Creekside Village 513 501 497
Crossings 742 739 735
Jefferson Commons 1,331 1,322 N/A
Lakeview 684 669 660
North Pointe 664 657 632
Timber Ridge 491 493 N/A
Villas at LaRiviera 653 644 593
Subtotal Participating Mortgage Bonds
Mortgage Bonds
Applewood (a.k.a. Paola) $557 $553 $494
Buchanan Bay 678 677 N/A
Cielo Vista 424 423 426
Charter House (2) N/A N/A N/A
Country Club 443 442 432
Delta Village 562 544 511
Elmbrooke 716 705 591
Florida A&M 1,384 1,384 1,352
Gannon (Broward) 651 649 629
Gannon (Dade) (3) 731 728 705
Gannon (St. Louis) 557 554 543
Gannon A Bond N/A N/A N/A
Hidden Valley 538 538 519
Honey Creek 563 555 529
Hunter's Glen 568 564 N/A
Lake Piedmont 472 472 461
Monroe (Oakmont, Towne Oak) 478 477 452
Mountain View (Willowgreen) 618 610 583
Northridge Park II 1,022 1,023 971
Oakbrook 446 446 446
Orangevale 957 915 896
Parkwood 455 449 442
Riverset II (1) N/A N/A N/A
Sahuarita 546 546 540
Santa Fe Springs 593 592 581
Shadowbrook 476 475 460
Torries Chase 488 488 472
Villa Hialeah 671 666 651
Village at Stone Mountain 722 716 698
Village Green 635 634 628
Western Hills 506 497 517
Willow Key 639 633 616
Woodmark 696 684 671
Subtotal Mortgage Bonds
Participating Subordinate Mortgage Bonds:
Barkley Place $2,097 $2,110 $2,021
Gilman Meadows 1,032 1,022 976
Hamilton Chase 607 605 590
Mallard Cove I & II 762 744 713
Meadows 606 602 596
Montclair 1,841 1,841 1,786
Newport Village 824 817 772
Nicollet Ridge 939 923 892
Riverset II 705 705 702
Steeplechase 587 565 578
Whispering Lake 648 648 644
Subtotal Participating Subordinate Mortgage Bonds
14
Occupancy
-------------------------------------------
Month Ended Month Ended Month Ended
Month/Year Apartment December 31, September 30, December 31,
Apartment Community Acquired Units 2001 2001 2000
------------------- -------- ----- -------------------------------------------
Subordinate Mortgage Bonds:
CAPREIT Sep-99 -- N/A N/A N/A
Cinnamon Ridge Jan-99 -- N/A N/A N/A
Farmington Meadows Aug-99 69 100.0% 100.0% 100.0%
Independence Ridge Aug-96 336 83.9% 77.4% 85.5%
Locarno Aug-96 110 92.7% 98.2% 89.2%
Olde English Manor Nov-99 -- N/A N/A N/A
Peaks of Conyer Sep-01 260 N/A N/A N/A
Rillito Village Jul-00 -- N/A N/A N/A
Winter Oaks Nov-99 460 86.1% 88.5% 92.5%
-----------
Subtotal Subordinate Mortgage Bonds 1,235
-----------
Other Bond Related Investments:
Briarwood Dec-98 600 97.3% 95.5% 93.3%
Cinnamon Ridge Dec-97 264 95.8% 90.5% 94.2%
Golfside Villas (f.k.a. Club West) Mar-99 194 99.0% 99.0% 99.0%
Park Center Oct-01 325 92.9% 97.5% N/A
Park at Landmark Sep-00 396 94.7% 97.0% 100.0%
Poplar Glen Jun-97 191 98.4% 94.8% 98.2%
RITES - Charter House Dec-96 280 89.3% 96.4% 93.2%
RITES - Indian Lakes Jul-97 296 91.9% 100.0% 93.6%
RITES - LaPaloma Apr-99 120 100.0% 96.7% 95.4%
RITES - LeMirador (Coleman Senior) Apr-98 141 96.5% 97.9% 99.1%
RITES - Museum Towers Apr-01 286 89.5% 96.9% N/A
RITES - Oklahoma City (4) Aug-98 772 88.1% 89.0% 92.0%
RITES - Olde English Manor Jun-98 264 91.3% 93.6% 90.5%
RITES - Palisades Park Feb-98 304 99.3% 99.3% 95.5%
RITES - Pavillion Apr-99 132 99.2% 99.2% 98.5%
RITES - Queen Anne IV Jul-98 110 99.1% 97.3% 92.7%
RITES - Rancho/Villas May-00 417 85.8% 86.6% 89.7%
RITES - Rillito Village Aug-98 272 86.8% 86.4% 90.3%
RITES - Riverset (1) Aug-88 352 88.2% 89.0% 95.3%
RITES - Riverset II (1) Jan-96 -- N/A N/A N/A
RITES - Sienna (a.k.a. Italian Gardens) Apr-98 140 95.0% 97.1% 100.0%
RITES - Sonterra May-98 156 76.3% 84.6% 90.7%
RITES - Southgate Crossings Jun-97 215 100.0% 97.2% 96.7%
RITES - Southwood Nov-97 1,286 82.0% 85.4% 83.4%
-----------
Subtotal Other Bond Related Investments 7,513
-----------
Total Units/Weighted Average Investments 21,823 91.9% 93.1% 93.1%
===========
Total/Same Stores (6) 20,168 92.2% 93.1% 93.1%
Construction/Substantial Rehab Properties
and Other Investments
Arlington Dec-00 176 N/A N/A N/A
Barrington at Beach Street Oct-00 398 N/A N/A N/A
Bedford Park Oct-00 312 41.0% 37.8% 63.1%
CAPREIT (5) Mar-01 2,942 93.7% 94.3% N/A
Chancellor Nov-01 101 N/A N/A N/A
Cool Springs Aug-00 124 17.7% 9.7% N/A
Fort Branch Dec-00 250 N/A N/A N/A
Hidden Brooks Sep-01 201 87.1% N/A N/A
Lincoln Corner Dec-01 134 N/A N/A N/A
Meridian at Bridgewater Nov-99 90 52.2% 30.0% N/A
North White Road Nov-01 157 N/A N/A N/A
Oak Grove Commons Dec-01 168 N/A N/A N/A
Penn Valley Dec-01 42 N/A N/A N/A
Riverview Jun-00 224 17.0% N/A N/A
Silver Springs Dec-99 250 86.4% 81.6% 2.0%
Southwind Aug-00 88 96.6% 95.5% 65.9%
Village Apartments May-00 210 84.8% 74.3% N/A
Village at Sun Valley May-00 276 32.6% 9.8% N/A
Weatherstone Sep-00 100 40.0% 14.0% N/A
Woodglen Dec-99 250 92.4% 77.2% N/A
-----------
Subtotal Construction/Rehab Properties 6,493
-----------
Total Units 28,316
===========
Avg. Monthly Rent
Per Apartment Unit
----------------------------------------------
Month Month Month
Ended Ended Ended
December 31, September 30, December 31,
Apartment Community 2001 2001 2000
------------------- ----------------------------------------------
Subordinate Mortgage Bonds:
CAPREIT N/A N/A N/A
Cinnamon Ridge N/A N/A N/A
Farmington Meadows $814 $814 $814
Independence Ridge 550 545 532
Locarno 866 861 836
Olde English Manor N/A N/A N/A
Peaks of Conyer N/A N/A N/A
Rillito Village N/A N/A N/A
Winter Oaks 547 541 520
Subtotal Subordinate Mortgage Bonds
Other Bond Related Investments:
Briarwood $589 $586 $570
Cinnamon Ridge 916 933 885
Golfside Villas (f.k.a. Club West) 587 581 546
Park Center 1,429 1,389 N/A
Park at Landmark 1,046 1,015 954
Poplar Glen 919 915 875
RITES - Charter House 611 613 609
RITES - Indian Lakes 774 766 738
RITES - LaPaloma 620 583 589
RITES - LeMirador (Coleman Senior) 814 799 832
RITES - Museum Towers 1,355 1,355 N/A
RITES - Oklahoma City (4) 472 470 462
RITES - Olde English Manor 473 472 474
RITES - Palisades Park 525 525 505
RITES - Pavillion 655 659 619
RITES - Queen Anne IV 1,085 1,073 957
RITES - Rancho/Villas 792 792 474
RITES - Rillito Village 447 450 450
RITES - Riverset (1) 699 701 702
RITES - Riverset II (1) N/A N/A N/A
RITES - Sienna (a.k.a. Italian Gardens) 807 787 832
RITES - Sonterra 844 845 864
RITES - Southgate Crossings 943 925 892
RITES - Southwood 489 489 480
Subtotal Other Bond Related Investments
Total Units/Weighted Average Investments $678 $670 $611
Total/Same Stores (6) $637 $629 $611
Construction/Substantial Rehab Properties and Other Investments
Arlington N/A N/A N/A
Barrington at Beach Street N/A N/A N/A
Bedford Park $526 $519 $459
CAPREIT (5) 638 629 N/A
Chancellor N/A N/A N/A
Cool Springs 1,958 1,953 N/A
Fort Branch N/A N/A N/A
Hidden Brooks 1,050 N/A N/A
Lincoln Corner N/A N/A N/A
Meridian at Bridgewater 3,100 3,150 N/A
North White Road N/A N/A N/A
Oak Grove Commons N/A N/A N/A
Penn Valley N/A N/A N/A
Riverview 676 N/A N/A
Silver Springs 783 780 N/A
Southwind 680 666 N/A
Village Apartments 474 479 N/A
Village at Sun Valley 643 643 N/A
Weatherstone 800 810 N/A
Woodglen 631 647 N/A
Subtotal Construction/Rehab Properties
Total Units
(1) The Company owns a participating bond, a participating subordinate bond and
a RITES interest collateralized by the Riverset property.
(2) The Company owns a non-participating bond and a RITES interest
collateralized by the Charter House property.
(3) The Dade Gannon Portfolio represents eight properties.
(4) The Oklahoma City Portfolio represents three properties.
(5) The CAPREIT Portfolio represents eleven properties.
(6) Same Stores includes properties reporting for each of the past three
quarters.
15
Portfolio Management
The Company is responsible for a full range of loan servicing and asset
management functions for its own investments and for others. Through Midland,
the Company is a Fannie Mae approved DUS lender authorized to process loans and
collect origination and servicing fees. The Company, through Midland, also
manages equity syndication financings.
The Company monitors the timely receipt of all debt service payments and
promptly notifies a borrower of any delinquency, deficiency or default.
Reporting systems are in place that allow the Company to review and analyze the
revenue, expenses and leasing activity of each property on a periodic basis. In
addition, the Company inspects each property and market area on a regular basis.
The loan servicing and asset management oversight is designed to enable the
Company to track the performance of each property and to alert management to
potential problems. While actions will vary depending upon the nature of an
individual problem, the Company generally notifies borrowers of any problems or
concerns and recommends corrective action.
The Company responds to defaults on tax-exempt bonds and construction loans
on a case-by-case basis. After sending requisite default notices, the Company
typically holds discussions with the property owner/developer. In the event the
Company determines that the owner/developer remains committed to the project and
capable of successful operations, a workout or other forbearance arrangement may
be negotiated. Whenever the Company determines that successful operation by the
current owner/developer is not feasible, negotiations for the transfer of a
deed, in lieu of foreclosure, to an affiliated entity may be undertaken. In the
absence of reserves or operating deficit guarantees, the Company may face
additional risk from operations with respect to properties so transferred, which
may require subsidies from Company reserves to cover potential operating
deficits before debt service. The Company does not currently anticipate that any
such operating deficits before debt service will occur in 2002.
Employees
As of December 31, 2001, the Company had 218 employees. The Company is not
a party to any collective bargaining agreement.
Item 2. Properties.
The Company leases office space as follows:
Baltimore, Maryland. In November 1998, the Company assumed the office lease
agreement from an affiliate for office space. The office space contains 11,124
square feet and the lease expires in March 2003. In June 2001, the Company
entered into a lease agreement for additional space in the same office building.
The new office space contains 2,939 square feet and the lease expires in March
2003.
Clearwater, Florida. In June 1996, Midland entered into a seven-year lease for a
14,876 square feet office facility. In September 1998, Midland negotiated a new
lease for an additional 6,180 square feet of space in the same location with an
expiration coinciding with the original lease. In December 2000, Midland
negotiated a new lease that brings the space rented to a total of 36,004 square
feet. The lease expires in December 2005.
16
The Company, through Midland, also leases office space for its regional
offices in Dallas, Texas, San Francisco, California, Los Angeles, California,
Chicago, Illinois, and Detroit, Michigan. The Company believes its facilities
are suitable for its requirements and are adequate for its current and
contemplated future operations.
Item 3. Legal Proceedings.
None.
Item 4. Submission of Matters to a Vote of Security Holders.
No matter was submitted to a vote of the Company's? shareholders during the
three months ended December 31, 2001.
17
Part II
Item 5. Market for Registrant's Equity Securities and Related Stockholder
Matters
The following table sets forth the high and low sale prices per share of
the Common Shares as reported by the NYSE for each calendar quarter in 2001 and
2000 and the distributions declared with respect to such shares allocable to
such period.
Distributions
High Low Declared
------------- ------------- -------------
2001:
First Quarter $ 24.33 $ 21.75 $0.4250
Second Quarter 23.50 22.00 0.4275
Third Quarter 25.25 25.80 0.4300
Fourth Quarter 25.80 23.11 0.4325
2000:
First Quarter 20.00 18.19 $0.4125
Second Quarter 20.63 18.88 0.4175
Third Quarter 21.88 20.13 0.4200
Fourth Quarter 23.50 20.25 0.4225
As of March 18, 2002, there were approximately 17,511 holders of record of
Common Shares.
The Company's current policy is to distribute to holders of Common Shares
at least 80% of cash available for distribution to Common Shares. The Company
pays distributions to its holders of Common Shares quarterly in February, May,
August and November.
The Preferred Shares and the Preferred CD Shares which were redeemed in
March 2002 are not listed for trading on any national securities exchange and
there is no established public trading market for those shares.
Description of Shares
As of December 31, 2001 there were 16,737 Preferred Shares (10,995 Series I
and 5,742 Series II), 4,567 Preferred CD Shares (3,176 Series I and 1,391 Series
II), 2,000 Term Growth Shares and 21,857,312 Common Shares outstanding.
Shareholder approval may not be required for the Company to issue additional
shares in the future. Although the Company will not issue additional Preferred
Shares or Preferred CD Shares, it may from time to time issue additional Common
Shares depending upon market conditions. In addition, the Company is authorized
to issue new classes of shares, which may be senior to the Common Shares but
cannot be senior to the Preferred Shares or Preferred CD Shares. No shareholders
have pre-emptive rights.
The rights of the holders of each class of shares of the Company, including
the distributions to which each class is entitled, are set forth in full in the
Company's Operating Agreement, a copy of which is filed as an exhibit to this
report. The following is a summary of the rights, privileges and preferences of
the holders of each class of shares outstanding at December 31, 2001.
18
Preferred Shares. The performance of, and distributions with respect to,
each series of Preferred Shares (which were redeemed in March 2002) is based
solely upon the performance of that portion of the original bonds attributable
to such series as they existed immediately following the Refunding and prior to
the 1995 Financing. Accordingly, the holders of the Preferred Shares are
entitled to their proportionate share of distributions with respect to the 11
original bonds and 11 refunded Series B Bonds held by the Company, as well as
the distributions they would have received with respect to the 11 refunded
Series A Bonds had the 1995 Financing not occurred. Distributions to the holders
of the Preferred Shares are satisfied, however, on a basis having priority over
all payments with respect to the Common Shares, Term Growth Shares and any other
equity class (other than Preferred CD Shares), out of all of the resources of
the Company, including revenue from investment of the proceeds from the 1995
Financing. None of the expenses incurred in connection with the 1995 Financing
or any future financings are borne by the holders of the Preferred Shares.
The Preferred Shares must be partially redeemed upon (i) the sale or
repayment of a bond attributable to such shares, (ii) the sale of a related
mortgaged property, or (iii) beginning in the year 2000, an appraisal of a
related mortgaged property indicating that its fair market value exceeds the sum
of (a) the face value of the bond secured by the property and (b) unpaid accrued
interest on such bond. Upon liquidation, the holders of the Preferred Shares are
entitled to receive, after payment of creditors, the appraised value of the
Company's assets attributable to such shares, together with all unpaid accrued
distributions, before any distribution is made to the holders of Common Shares
or other shares ranking junior to the Preferred Shares. The Preferred
Shareholders shall be permitted to convert such shares to either Common Shares
or cash (at the discretion of the Board of Directors) once every two years
beginning in June 2004. Third party independent appraisals will be obtained to
determine the conversion value for each share.
The holders of the Preferred Shares do not have voting rights with respect
to the election of the Company's directors, but do have voting rights with
respect to any merger or consolidation of the Company in which it is not the
surviving entity or the sale of substantially all of its assets, the removal of
a director, and any alteration of the rights, privileges or preferences of the
Preferred Shares under the Operating Agreement. The voting power of the
Preferred Shares, relative to all of the Company's outstanding shares, is
equivalent to the relative voting power, immediately prior to the Merger, of the
BACs exchanged therefor. Such protection from loss of relative voting power,
however, does not extend to issuances of additional shares of the Company
subsequent to the Merger.
Preferred CD Shares. The performance of, and distributions with respect to,
each series of Preferred CD Shares is based solely upon the performance of that
portion of the original bonds attributable to such series as they existed
immediately following the 1995 Financing. Accordingly, the holders of the
Preferred CD Shares are entitled to their proportionate share of distributions
with respect to the 11 original bonds and 11 refunded Series B Bonds held by the
Company. Because the holders of the Preferred CD Shares received a distribution
of their pro rata share of the proceeds of the 1995 Financing, however, they,
unlike the holders of the Preferred Shares, (i) receive no distribution relating
to the performance of the 11 refunded Series A Bonds the receipts for which were
sold in the 1995 Financing and (ii) bear their pro rata share of the expenses of
the 1995 Financing and any future financings utilizing any of the original
bonds.
The rights, privileges and preferences of the Preferred CD Shares are
otherwise substantially the same as those of the Preferred Shares.
19
Term Growth Shares. The holders of the Term Growth Shares are entitled to
distribution of 2% of the Company's cash flow. Except with respect to
distributions and various redemption features as defined in the Operating
Agreement, the rights and privileges of the Term Growth Shares are substantially
the same as those of the Common Shares. Term Growth Shares will be redeemed when
Preferred and Preferred CD Shares are fully redeemed or converted (subject to
certain conditions defined in the Company's Operating Agreement).
Common Shares. The holders of the Common Shares are entitled to
distributions as and when declared by the Board of Directors out of funds
legally available therefor. As of December 31, 2001, the Company's policy was to
distribute to the holders of the Common Shares at least 80% of its cash flow
from operations (exclusive of capital-related items and reserves) after payment
of distributions to the holders of the Preferred Shares, Preferred CD Shares and
Term Growth Shares. No distributions may be declared or paid with respect to the
Common Shares, however, so long as there remains unpaid any required
distribution or redemption payment with respect to the Preferred Shares and
Preferred CD Shares.
The Common Shares are not redeemable (except pursuant to certain
anti-takeover provisions) and upon liquidation share ratably in any assets
remaining after payment of creditors and the liquidation preferences of the
Preferred Shares and Preferred CD Shares. The holders of the Common Shares
voting as a single class have the right to elect the directors of the Company
and, voting together with the holders of the Preferred Shares and Preferred CD
Shares, have voting rights with respect to a merger or consolidation of the
Company in which it is not the surviving entity or the sale of substantially all
of its assets, the removal of a director, the dissolution of the Company, and
certain anti-takeover provisions. Each Common Share entitles its holder to cast
one vote on each matter presented for shareholder vote. Because of provisions
providing limited protection against dilution of the voting rights of the
holders of the Preferred Shares and Preferred CD Shares, each Series I Preferred
Share and Series I Preferred CD Share and each Series II Preferred and Series II
Preferred CD Share currently entitles its holders to cast 38.10 and 43.95 votes,
respectively, on each matter on which the Preferred and Preferred CD Shares vote
along with the Common Shares presented for a vote of the holders of those
shares.
20
Item 6. Selected Financial Data.
As of and for the year ended December 31, 2001 2000 1999 1998 1997
------------ ------------ ------------ ----------- -----------
INCOME STATEMENT DATA (000s):
Interest on tax-exempt bonds
and other bond related
investments $ 53,443 $ 43,077 $ 35,435 $ 23,241 $ 17,219
Interest on loans 33,340 31,757 6,543 4,563 3,500
Net gain on sales 8,222 2,121 2,680 4,743 2,824
Other income 30,758 23,897 8,888 2,911 1,796
------------ ------------ ------------ ----------- -----------
Total income 125,763 100,852 53,546 35,458 25,339
Operating expenses 35,918 26,636 10,112 6,002 3,962
Interest expense 30,696 31,152 6,665 -- --
Other-than-temporary
impairments related to
investments in tax-exempt
bonds and other bond related
investments 3,256 1,008 1,120 2,049 2,580
------------ ------------ ------------ ----------- -----------
Total expenses 69,870 58,796 17,897 8,051 6,542
Net holding losses on trading
securities (5,572) -- -- -- --
Net income before income taxes,
income allocated to preferred
shareholders in a subsidiary
company, and cumulative effect
of accounting change 50,321 42,056 35,649 27,407 18,797
Income tax expense 1,383 2,006 703 -- --
------------ ------------ ------------ ----------- -----------
Net income before income
allocated to preferred
shareholders in a subsidiary
company and cumulative effect
of accounting change 48,938 40,050 34,946 27,407 18,797
Income allocated to preferred
shareholders in a subsidiary
company 10,779 8,475 3,433 -- --
------------ ------------ ------------ ----------- -----------
Net income before cumulative
effect of accounting change 38,159 31,575 31,513 27,407 18,797
Cumulative effect on prior years
of change in accounting for
derivative financial instruments (12,277) -- -- -- --
------------ ------------ ------------ ----------- -----------
Net income $ 25,882 $ 31,575 $ 31,513 $ 27,407 $ 18,797
============ ============ ============ =========== ===========
NET INCOME PER SHARE:
Preferred shares
Series I $ 57.05 $ 56.25 $ 68.44 $ 67.80 $ 43.07
Series II $ 22.51 $ 65.31 $ 68.76 $ 64.74 $ 64.84
Preferred capital distribution
shares
Series I $ 49.22 $ 43.34 $ 55.96 $ 56.23 $ 32.59
Series II $ 7.44 $ 46.73 $ 49.81 $ 48.97 $ 49.70
Common shares (diluted net
income per share) $ 1.09 $ 1.62 $ 1.67 $ 1.60 $ 1.50
Weighted average common shares
outstanding (diluted) 21,804,186 18,088,366 17,740,671 15,938,249 12,537,517
BALANCE SHEET DATA (000s):
Investments in tax-exempt bonds,
other bond related investments
and derivative financial
instruments, net $ 606,042 $ 495,663 $ 391,633 $ 310,093 $ 220,961
Loans receivable 440,031 349,291 286,489 17,246 11,491
Total assets 1,289,276 987,882 801,746 359,411 243,101
Notes payable 420,063 329,159 261,956 -- --
Long-term debt 134,881 70,899 67,000 -- --
Preferred shareholders' equity
in a subsidiary company 160,465 137,664 80,159 -- --
Total shareholders' equity 436,708 364,783 363,611 355,452 241,399
CASH DISTRIBUTIONS PER SHARE:
Preferred shares:
Series I:
For the year ended December
31, paid quarterly (1) $ 43.98 (5),(6) $ 52.00 $ 108.97 (3) $ 80.77 (2) $ 53.57
Series II:
For the year ended December
31, paid quarterly (1) $ 32.55 (6) $ 174.88 (4) $ 217.93 (3) $ 68.52 $ 62.87
21
ITEM 6. SELECTED FINANCIAL DATA (continued)
2001 2000 1999 1998 1997
------------ ------------ ------------ ----------- -----------
Preferred capital distribution shares:
Series I:
For the year ended December
31, paid quarterly (1) $ 33.58 (5),(6) $ 40.00 $ 99.21 (3) $ 79.44 (2) $ 43.79
Series II:
For the year ended December
31, paid quarterly (1) $ 10.15 (6) $ 155.91 (4) $ 21.83 (3) $ 53.36 $ 50.64
Common shares:
For the year ended December
31, paid quarterly (1) $ 1.7150 $ 1.6725 $ 1.6075 $ 1.53 $ 1.43
(1) This amount represents total dividends declared for the year. Quarterly
distributions were paid to all preferred shareholders beginning with the third
quarter of 1997; the first semiannual distribution for 1997 was paid in August
1997.
(2) The 1998 distributions for the Series I Preferred Shares and the
Series I Preferred Capital Distribution Shares include a special distribution of
$24.93 and $33.88, respectively, for their proportionate share of the Company's
net proceeds from the sale of three consolidated demand notes in December 1998.
(3) The distributions for the Series I and Series II Preferred and Preferred
Capital Distribution Shares include two special distributions. The first
distribution relates to their proportionate share of the Company's net proceeds
from the sale of eight consolidated demand notes in March 1999 as follows:
Preferred Series I, $16.24; Preferred Series II, $25.59; Preferred Capital
Distribution Series I, $19.96 and Preferred Capital Distribution Series II,
$41.89. The second distribution relates to their pro- rata portion of the return
of capital from the refunding of the bond secured by the Riverset property as
follows: Preferred Series I, $38.51; Preferred Series II; $133.24; Preferred
Capital Distribution Series I, $37.60 and Preferred Capital Distribution Series
II, $131.84.
(4) The distributions for the Series II Preferred and the Series II Preferred
Capital Distributions Shares includes a special distribution of $127.13 and
$127.16, respectively. The special distribution represents their pro rata
portion of the return of capital resulting from the pay-off of a bond secured by
a property known as Southfork Village.
(5) The distributions for the Series I Preferred Shares and Preferred Capital
Distribution Shares include a special distribution of $1.48 which represents
their pro rata portion of the proceeds from the sale of a taxable loan secured
by the property known as Mountain View.
(6) In June 2001, approximately 26% of Series I Preferred Shares and Preferred
Capital Distribution Shares and approximately 56% of Series II Preferred Shares
and Preferred Capital Distribution Shares were redeemed. The effect of this
redemption was a decrease in the number of shares outstanding, which, in turn
caused the per share distribution to increase.
SHARES OUTSTANDING AND NUMBER OF HOLDERS
AS FOLLOWS:
As of December 31, Preferred shares:
Series I
Shares outstanding 10,995 14,933 14,933 15,590 16,329
Number of shareholders 783 779 780 803 873
Series II
Shares outstanding 3,176 7,226 7,226 7,350 7,637
Number of shareholders 344 349 350 356 365
Preferred capital distribution shares:
Series I
Shares outstanding 5,742 7,798 7,798 8,325 8,909
Number of shareholders 378 377 379 378 425
Series II
Shares outstanding 1,391 3,164 3,164 3,535 3,809
Number of shareholders 169 167 168 170 194
Common Shares:
Shares outstanding 21,820,236 17,655,737 17,392,064 16,791,050 11,106,150
Number of shareholders 17,960 11,094 15,536 15,772 13,405
22
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
General Business
Municipal Mortgage & Equity, LLC ("MuniMae") and its subsidiaries (together
with MuniMae, the "Company") are principally engaged in originating, investing
in and servicing investments related to multifamily housing and other real
estate financings. A significant portion of the Company's investments consists
of tax-exempt bonds and interests in bonds issued by state and local governments
or their agencies or authorities to finance multifamily housing developments.
Interest income from the majority of these investments is exempt for federal
income tax purposes. Multifamily housing developments, as well as the rents paid
by the tenants, secure these investments. Midland Financial Holdings, Inc.
("Midland"), a wholly owned corporate subsidiary, is a fully integrated real
estate investment firm that specializes in originating, investing in and
servicing investments in the affordable multifamily housing industry. These
investments generate taxable, not tax-exempt, income.
In October 1999 the Company acquired Midland for approximately $45 million.
Of this amount, the Company paid approximately $23 million in cash and
approximately $12 million in Common Shares at the closing of the transaction. In
addition, $3.3 million in MuniMae Common Shares was payable annually over a
three year period if Midland met certain performance targets, including an
annual contribution to cash available for distribution ("CAD"). In December
2000, MuniMae paid approximately $3.3 million in Common Shares in consideration
for Midland meeting its first year performance targets. In 2001, in order to
increase MuniMae's flexibility in operating Midland, MuniMae agreed with the
former owners of Midland that the payment of the 2001 and 2002 installments
would no longer be conditioned on Midland meeting certain performance targets.
In December 2001, MuniMae paid approximately $3.3 million in Common Shares and,
subject to certain conditions, MuniMae expects to make the final payment of
Common Shares having a value of approximately $3.3 million in December 2002.
In October 1999, as a result of the Midland acquisition, the Company
restructured its operations into two business segments: (1) an investing segment
that primarily holds investments producing tax-exempt interest income; and (2)
an operating segment that primarily generates taxable interest income and,
through corporate subsidiaries, fee income by providing servicing, loan
origination and tax credit equity syndication services. The revenues associated
with the investing segment consist primarily of interest earned on tax-exempt
bonds, other bond related investments and certain short-term taxable loans and
investments. The revenues associated with the operating segment consist
primarily of loan servicing and loan origination fees for the Company's own
portfolio and for portfolios of third parties, syndication and brokerage fees
associated with the origination of tax credit syndications, taxable interest and
fees earned on construction lending activities and other fee income.
In 1999, the Company placed a substantial portion of its tax-exempt bonds
and bond related investments in TE Bond Sub, an indirect subsidiary of the
Company. TE Bond Sub then sold Series A, Series B and Series A-1 and B-1
Cumulative Preferred Shares (collectively, the "TE Bond Preferred Shares") to
institutional investors in May 1999, June 2000 and October 2001, respectively
(see further discussion under Liquidity and Capital Resources). The TE Bond
Preferred Shares have a senior claim to the income derived from the investments
owned by TE Bond Sub and thus the assets of TE Bond Sub are not available to
MuniMae's creditors. Any income from TE Bond Sub available after payment of the
cumulative distributions of the TE Bond Preferred Shares is allocated to the
Company.
23
Results of Operations
Year Ended December 31, 2001 Compared with Year Ended December 31, 2000
Total income for the year ended 2001 increased $24.9 million over the same
period last year due primarily to: (1) an increase in collections of interest
totaling $11.9 million on bonds, other bond related investments and loans; (2) a
$6.1 million increase in gain on sale which includes an increase of $1.6 million
on the sale of taxable loans, a $2.3 million gain on tax credit equity
re-syndication, and a $2.2 million gain on the payoff of Newport-On-Seven; (3)
an increase in loan servicing fees, loan origination and brokerage fees, and
syndication fees of $5.3 million due primarily to an increase in syndication
fees and an increase in loan production; (4) an increase in other income of $2.9
million of which $3.3 million was associated with income earned on the
assumption of a purchase obligation with respect to the Hunter's Glen and
Buchanan Bay bonds; (5) offset in part by $1.3 million decrease in interest on
short-term investments.
Total expenses for the year ended 2001 increased $11.1 million over the
same period last year due primarily to: (1) an increase in salary and related
benefits expense of $6.1 million, including additional bonuses associated with
increased syndication production; (2) an increase in operating expenses of $1.9
million primarily associated with commissions paid on equity syndication funds;
(3) an increase in professional fees of $0.7 million associated with various
information system initiatives; (4) an increase in goodwill and other
intangibles amortization of $0.6 million; (5) a decrease in interest expense of
$0.5 million primarily associated with the $22 million reduction in our long
term debt facility; and (6) an other-than-temporary impairment of $3.3 million
on two investments (Hunter's Glenn and Buchanan Bay).
As a result of the adoption of FAS 133, the Company recorded a negative
cumulative effect adjustment of $12.3 million on January 1, 2001 and net holding
losses for mark to market adjustments on derivative financial instruments of
$5.6 million for the year ended December 31, 2001.
Income allocable to preferred shareholders of TE Bond Sub increased to
$10.8 million from $8.5 million in 2000 as a result of the sale in October 2001
of Series A-1 and B-1 Preferred Shares and recording of a full year of income
allocable to the Series B Preferred Shares sold in June 2000 (see further
discussion under Liquidity and Capital Resources).
As discussed above, the operating segment consists primarily of
subsidiaries of the Company that are subject to income taxes. The effective tax
rate for 2001 was 41.6% versus 49.4% for 2000. The 2001 rate reflects a
provision for deferred taxes, and the effects of a charitable contribution and
low-income housing tax credits.
For the year ended December 31, 2001, the net adjustment to other
comprehensive income for unrealized holding gains on tax-exempt bonds and other
bond related investments available for sale was $7.0 million. After a
reclassification adjustment for losses of $8.1 million included in net income,
other comprehensive income for the year ended December 31, 2001 was $1.1 million
and total comprehensive income was $27.0 million.
Net income for the year ended December 31, 2001 decreased by $5.7 million
as compared with 2000, due primarily to (1) a cumulative effect adjustment of
$12.3 million upon adoption of FAS 133 and net holding losses for mark-to-market
adjustments on derivative financial instruments of $5.6 million recorded in
24
earnings, which were recorded through other comprehensive income in 2000,
partially offset by (2) an increase in the Company's operating income (total
income excluding net gain on sale less total expenses excluding
other-than-temporary impairments) of $10.0 million due to growth in the
Company's loan production volume and investments, and (3) an increase of $6.1
million in gain on sales which includes an increase of $1.6 million on the sale
of taxable loans, a $2.3 million gain on tax credit equity re-syndication, and a
$2.2 million gain on the payoff of Newport-On-Seven.
Year Ended December 31, 2000 Compared with Year Ended December 31, 1999
Total income for the year ended December 31, 2000 increased by
approximately $47.3 million from the same period last year due primarily to an
increase in collections of interest totaling $7.2 million on bonds, other bond
related investments and loans and an increase of $40.0 million due to the
inclusion of a full year of Midland income in 2000 versus a partial year of
Midland income in 1999.
The Company recognized net gain on sales of $2.1 million for the year ended
December 31, 2000. Of this amount, $1.9 million related to Midland's sale of
loans to Fannie Mae and other third parties in which Midland retained the
mortgage servicing rights on the loans. In conjunction with the recognition of
the net gain on sales, the Company recorded an investment in mortgage servicing
rights. The Company recognized net gain on sales of $2.7 million in 1999 related
to the sale of bonds and loans.
Salaries and benefits, professional fees and operating expenses for the
year ended December 31, 2000 increased by approximately $14.9 million over the
prior year due primarily to (1) an increase of $11.9 million due to the
inclusion of a full year of Midland expenses in 2000 versus a partial year of
Midland expenses in 1999, (2) an increase of $0.6 million in salary and benefits
expense as a result of an increase in the number of employees and an increase in
the incentive compensation earned, (3) an increase of $1.0 million in
professional fees related to consulting expenses as a result of growing the
Company's information infrastructure and legal expenses related to various
transactions and (4) an increase of $0.9 million in operating expenses related
to an increase in allowance for loan losses.
For the year ended December 31, 2000, the Company recorded a full year of
amortization of goodwill and other intangibles associated with the Midland
acquisition and the capitalization of mortgage servicing rights. This accounted
for a $1.6 million increase in amortization expense over the prior year.
Interest expense for the year ended December 31, 2000 increased by
approximately $24.5 million over the same period last year due primarily to an
increase of $22.8 million due to the inclusion of a full year of interest
expense from short-term borrowings associated with construction lending activity
at Midland and an increase of $1.7 million in interest expense related to
securitization transactions accounted for as borrowings.
Income allocable to preferred shareholders of TE Bond Sub increased to $8.5
million from $3.4 million in 1999 as a result of the June 2000 Series B
Preferred Equity Offering and recording of a full year of income allocable to
the sale in May 1999 of the Series A Preferred Shares (see further discussion
under Liquidity and Capital Resources).
The Company recorded other-than-temporary impairments aggregating $1.0
million on one investment in 2000. This type of non-cash charge does not affect
the cash flow generated from the operation of the underlying properties,
distributions to shareholders, the tax-exempt status of the income,
25
or the financial obligations under the bonds.
As discussed above, the operating segment consists primarily of
subsidiaries of the Company that are subject to income taxes. The effective tax
rate for 2000 was 49.4% versus 52.2% for 1999. The 2000 rate reflects a
provision for deferred taxes associated with the capitalization of mortgage
servicing rights.
For the year ended December 31, 2000, the net adjustment to other
comprehensive income for unrealized holding losses on tax-exempt bonds and other
bond related investments available for sale was $2.1 million. After a
reclassification adjustment for gains of $0.2 million included in net income,
other comprehensive loss for the year ended December 31, 2000 was $2.3 million
and total comprehensive income was $29.3 million.
Net income for the year ended December 31, 2000 was $31.6 million compared
to $31.5 million in 1999. Net income for 2000 includes a full year of Midland
income of $40.0 million, offset by a full year of Midland operating and interest
expense of $34.7 million. The increase in net income from the inclusion of
Midland was offset by an increase of $5.1 million in income allocable to
preferred shareholders in TE Bond Sub.
Critical Accounting Policies
The Company's discussion of its financial condition and results of
operations is based upon the Company's consolidated financial statements, which
are prepared on the accrual basis of accounting in accordance with generally
accepted accounting principles. The Company believes the following critical
accounting policies contain significant estimates used in the preparation of its
consolidated financial statements.
Investment in tax-exempt bonds and other bond related investments
Investment in tax-exempt bonds and other bond related investments is
accounted for under the provisions of Statement of Financial Accounting
Standards No. 115, "Accounting for Certain Investments in Debt and Equity
Securities"("FAS 115"). All investments in tax-exempt bonds and other bond
related investments are classified and accounted for as available-for-sale debt
securities and carried at fair value; unrealized holding gains or losses arising
during the period are recorded through other comprehensive income in
shareholders' equity, while realized gains and losses and other-than-temporary
impairments are recorded through operations. The Company evaluates on an
on-going basis the credit risk exposure associated with these assets to
determine whether any other-than-temporary impairments exist in accordance with
the Company's policy discussed under the Other-than-Temporary Impairment section
of this discussion. Future adverse changes in market conditions or poor
operating results from the underlying real estate could result in losses or an
inability to recover the carrying value of the investments.
The Company determines the fair value of participating bonds (i.e., bonds
that participate in the net cash flow and net capital appreciation of the
underlying properties) that are wholly collateral dependent and for which only a
limited market exists by discounting the underlying collateral's expected future
cash flows using current estimates of discount rates and capitalization rates.
The Company engages an independent real estate valuation firm to assist the
Company in reviewing the reasonableness of the estimates of discount rates,
capitalization rates and other variables used to estimate the fair value of
these bonds on an annual basis.
26
The Company bases the fair value of non-participating bonds and other bond
related investments, which also have a limited market, on quotes from external
sources, such as brokers, for these or similar bonds or investments.
Because the Company's investment in tax-exempt bonds and other bond related
investments are secured by non-recourse mortgage loans on real estate
properties, the value of the Company's assets is subject to all of the factors
affecting bond and real estate values, including macro-economic conditions,
interest rate changes, demographics, local real estate markets and individual
property performance. Further, many of the Company's investments are
subordinated to the claims of other senior interests and uncertainties may exist
as to a borrower's ability to meet principal and interest payments.
Securitization Transactions
For financial reporting purposes, transactions where the Company
securitizes a bond and subsequently purchases a residual interest are accounted
for in accordance with Statement of Financial Accounting Standards No. 140,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities" ("FAS 140"). Under FAS 140, the accounting for these
transactions is partially dependent on certain call provisions. If the residual
interest holder is granted a call provision under the terms of the transaction,
then effective control over the transferred assets has not been relinquished and
the transaction is accounted for as a borrowing. When the residual interest
holder is not granted a call provision and effective control has been
relinquished, the transaction is accounted for as a sale and the Company
recognizes gains and losses on the sale of its bonds. The portion of the
unrealized gain or loss on a bond that is recognized as a result of the sale is
determined by allocating the net amortized cost at the time of sale between the
corresponding senior interest and residual interest based upon their relative
fair values, in accordance with FAS 140. The Company may also structure
transactions whereby a third party buys bonds directly from a seller and the
Company subsequently purchases residual investments related to the bonds. In
this case, the Company may retain the call provision associated with its
investment in the residual interest position without requiring borrowing
treatment because the Company does not own the bond.
Investment in Derivative Financial Instruments
Investment in derivative financial instruments is accounted for under the
provisions of Statement of Financial Accounting Standards No. 133, "Accounting
for Derivative Instruments and Hedging Activities" and Financial Accounting
Standards Board Statement No. 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities." These statements (collectively,
"FAS 133") establish accounting and reporting standards for derivative financial
instruments, including certain derivative financial instruments embedded in
other contracts, and for hedging activity. FAS 133 requires the Company to
recognize all derivatives as either assets or liabilities in its financial
statements and record these instruments at their fair values. In order to
achieve hedge accounting treatment, hedging activities must be appropriately
designated, documented and proven to be effective as a hedge pursuant to the
provisions of FAS 133. The Company has elected, as permitted by FAS 133, not to
prove the hedging effectiveness of its derivative investments due to the cost
and administrative burden of complying with FAS 133. As a result, changes in
fair value of derivatives are recorded through current earnings.
The Company has several types of financial instruments that meet the
definition of a derivative
27
financial instrument under FAS 133, including interest rate swaps, put option
contracts and total return swaps. Under FAS 133, the Company's investment in
these derivative financial instruments is recorded on the balance sheet with
changes in fair value of these instruments, as well as changes in fair value of
other instruments which are deemed to be derivative financial instruments,
recorded in current earnings. The Company bases the fair value of its derivative
financial instruments, which also have a limited market, on quotes from external
sources, such as brokers, for these or similar investments. These estimates
involve uncertainties and matters of judgment and therefore cannot be determined
with precision. The assumptions and methodologies selected by the Company were
intended to estimate the amounts at which the investments could be exchanged in
a current transaction between willing parties, other than in a forced or
liquidation sale. Changes in assumptions and market conditions could
significantly affect estimates. These estimated values may differ significantly
from the values that would have been used had a ready market for the investments
existed, and the differences could be material.
Loans Receivable
The Company carries loans receivable at net realizable value. The Company
evaluates on an on-going basis the credit risk exposure associated with these
assets to determine whether any impairment exists in accordance with the
Company's policy discusse