Back to GetFilings.com
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
------------------
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
------------------
For the fiscal year ended December 31, 1998 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
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. /X/
As of March 29, 1999, 53,551,161 shares of CRIIMI MAE Inc. common stock
(voting) with a par value of $.01 were outstanding. The aggregate market value
(based upon the last reported sale price on the New York Stock Exchange on March
29, 1999) of the shares of CRIIMI MAE Inc. common stock (voting) held by
non-affiliates was approximately $141,189,974. (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.
CRIIMI MAE INC.
1998 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
PART I
PAGE
Item 1. Business ............................................................ 1
Item 2. Properties............................................................ 19
Item 3. Legal Proceedings..................................................... 19
Item 4. Submission of Matters to a Vote of Security Holders................... 24
PART II
Item 5. Market for the Registrant's Common Stock and Related Stockholder
Matters............................................................. 25
Item 6. Selected Financial Data............................................... 26
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations........................................... 29
Item 7A. Quantitative and Qualitative Disclosures About Market Risks........... 41
Item 8. Financial Statements and Supplementary Data........................... 42
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure............................................. 42
PART III
Item 10. Directors and Executive Officers of the Registrant.................... 43
Item 11. Executive Compensation................................................ 46
Item 12. Security Ownership of Certain Beneficial Owners and Management........ 49
Item 13. Certain Relationships and Related Transactions........................ 50
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8K....... 52
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" AND SIMILAR EXPRESSIONS ARE INTENDED
TO IDENTIFY FORWARD-LOOKING STATEMENTS. STATEMENTS LOOKING FORWARD IN TIME ARE
INCLUDED IN THIS ANNUAL REPORT ON FORM 10-K PURSUANT TO THE "SAFE HARBOR"
PROVISION OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. SUCH
STATEMENTS ARE SUBJECT TO CERTAIN RISKS AND UNCERTAINTIES, WHICH COULD CAUSE
ACTUAL RESULTS TO DIFFER MATERIALLY, INCLUDING, BUT NOT LIMITED TO, THE RISK
FACTORS CONTAINED UNDER THE HEADINGS "RISK FACTORS", AND "MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" SET
FORTH BELOW. READERS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON THESE
FORWARD-LOOKING STATEMENTS, WHICH SPEAK ONLY AS OF THE DATE HEREOF. THE COMPANY
UNDERTAKES NO OBLIGATION TO PUBLICLY REVISE THESE FORWARD-LOOKING STATEMENTS TO
REFLECT EVENTS OR CIRCUMSTANCES OCCURRING AFTER THE DATE HEREOF OR TO REFLECT
THE OCCURRENCE OF UNANTICIPATED EVENTS.
GENERAL
CRIIMI MAE Inc. (together with its consolidated subsidiaries, unless the
context otherwise indicates, "CRIIMI MAE" or the "Company") is a fully
integrated commercial mortgage company structured as a self-administered real
estate investment trust ("REIT"). Prior to the filing by CRIIMI MAE Inc.
(unconsolidated) and two of its operating subsidiaries 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
mortgage loans on multifamily, retail and other commercial real estate
("Subordinated CMBS"), (ii) originating and underwriting commercial mortgage
loans, (iii) securitizing pools of commercial mortgage loans and resecuritizing
pools of Subordinated CMBS, and (iv) through the Company's servicing affiliate,
CRIIMI MAE Services Limited Partnership ("CMSLP"), performing servicing
functions with respect to the mortgage loans underlying the Company's
Subordinated CMBS.
Since filing for Chapter 11 protection, CRIIMI MAE has suspended its
Subordinated CMBS acquisition, origination and securitization programs. The
Company continues to hold a substantial portfolio of Subordinated CMBS,
originated loans and mortgage securities and, through CMSLP, acts as a servicer
for its own as well as third party securitized mortgage loan pools. Despite the
turmoil in the capital markets commencing in late summer of 1998, the mortgage
loans underlying CRIIMI MAE's portfolio of Subordinated CMBS have experienced no
losses of principal from defaults.
In addition to the two operating subsidiaries which filed for Chapter 11
protection with the Company, the Company owns 100% of multiple financing and
operating subsidiaries as well as various interests in other entities (including
CMSLP) which either own or service mortgage and mortgage-related assets (the
"Non-Debtor Affiliates"). See Note 3 to Notes to Consolidated Financial
Statements. None of the Non-Debtor Affiliates has filed for bankruptcy
protection.
The Company was incorporated in Delaware in 1989 under the name CRI Insured
Mortgage Association, Inc. ("CRI Insured"). In July 1993, CRI Insured changed
its name to CRIIMI MAE Inc. and reincorporated in Maryland. In June 1995,
certain mortgage businesses affiliated with C.R.I., Inc. were merged into CRIIMI
MAE (the "Merger"). The Company is not a government sponsored entity 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.
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
1
substantially and rapidly. Due to this widening of CMBS spreads, the market
value of the CMBS securing the Company's short-term, variable-rate financing
facilities declined. CRIIMI MAE's short-term secured creditors perceived that
the value of the CMBS securing their facilities with the Company had fallen
below the minimum loan-to-value ratio described above and, consequently, made
demand upon the Company to provide cash or additional collateral with sufficient
value to cure the perceived value deficiency. In August and September of 1998,
the Company received and met collateral calls from its secured creditors. At the
same time, CRIIMI MAE was in negotiations with various third parties in an
effort to obtain additional debt and equity financing that would provide the
Company with additional liquidity.
On Friday afternoon, October 2, 1998, the Company was in the closing
negotiations of a refinancing with one of its unsecured creditors that would
have provided the Company with additional borrowings when it received a
significant collateral call from Merrill Lynch Mortgage Capital, Inc. ("Merrill
Lynch"). The basis for this collateral call, in the Company's view, was
unreasonable. After giving consideration to, among other things, this collateral
call and the Company's concern that its failure to satisfy this collateral call
would cause the Company to be in default under a substantial portion of its
financing arrangements, the Company reluctantly concluded on Sunday, October 4,
1998 that it was in the best interests of creditors, equity holders and other
parties in interest to seek Chapter 11 protection.
On October 5, 1998, CRIIMI MAE (unconsolidated) and two of its consolidated
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") filed for relief under Chapter 11 of the U.S.
Bankruptcy Code in the United States Bankruptcy Court for the District of
Maryland, Southern Division, in Greenbelt, Maryland (the "Bankruptcy Court").
These related cases are being jointly administered under the caption "In re
CRIIMI MAE Inc., et al.," Ch. 11 Case No. 98-2-3115-DK.
The Company is working diligently toward the preparation of a plan of
reorganization. The Bankruptcy Court has entered an order extending the
Company's exclusive right to file a plan of reorganization through May 11, 1999
and has set a hearing on such date with respect to the extension of the
exclusivity periods through August 2, 1999 for filing a plan of reorganization
and through October 3, 1999 for soliciting acceptances thereof. See "LEGAL
PROCEEDINGS." A number of parties have indicated potential opposition to any
such extension. Management expects to file a plan of reorganization during the
summer of 1999, which would contemplate the Company's emergence from bankruptcy
later in 1999. There can be no assurance at this time, however, that the Company
will propose a plan of reorganization during such time or that such plan will be
confirmed and consummated. See "LEGAL PROCEEDINGS" for a general discussion of
the bankruptcy process.
While in bankruptcy, CRIIMI MAE has been streamlining its operations in an
effort to reduce operating expenses. The Company significantly reduced the
number of employees in its origination and underwriting operations in October
1998, but has retained key employees in each of these operational areas. In
connection with these reductions, the Company closed its five regional loan
origination offices, retaining only a core presence in Rockville, Boston,
Houston, Chicago and San Francisco. See "BUSINESS - Employees."
Although the Company has significantly reduced its work force, the Company
recognizes that retention of its executives and other remaining employees is
essential to the efficient operation of its business and to its reorganization
efforts. Accordingly, the Company has, with Bankruptcy Court approval, adopted
an employee retention plan. See "BUSINESS - Employee Retention Plan."
EFFECT OF CHAPTER 11 FILING ON REIT STATUS AND OTHER TAX MATTERS
REIT STATUS. CRIIMI MAE is required to meet income, asset, ownership and
distribution tests to maintain its REIT status. The Company has satisfied the
REIT requirements for all years through, and including, 1998. However, due to
the uncertainty resulting from its Chapter 11 filing, there can be no
assurance that CRIIMI MAE will retain its REIT status for 1999 or subsequent
years. If the Company fails to retain its REIT status for any taxable year,
it will be taxed as a regular
2
domestic corporation subject to federal and state income tax in the year of
disqualification and for at least the four subsequent years.
THE COMPANY'S 1998 TAXABLE INCOME. In determining its federal income tax
liability, CRIIMI MAE, as a result of its REIT status, is entitled to deduct
from its taxable income dividends paid to its shareholders. Accordingly, to
the extent the Company distributes its net income to shareholders, it
effectively reduces taxable income, on a dollar-for-dollar basis, and
eliminates the "double taxation" that normally occurs when a corporation
earns income and distributes that income to shareholders in the form of
dividends. The Company, however, still must pay corporate level tax on any
1998 taxable income not distributed to shareholders by December 31, 1999. For
1998, the Company could have up to approximately $18 million in undistributed
taxable income, resulting in a potential tax liability of up to $7 million
for state and federal taxes. Notwithstanding this significant amount of
undistributed taxable income, CRIIMI MAE has fully complied with the
requirement for 1998 that it distribute at least 95% of its "REIT taxable
income" for the year in order to maintain REIT status (the "required
distribution"), because the calculation of the required distribution may
exclude certain excess noncash income such as original issue discount ("OID").
As noted in the preceding paragraph, the Company's taxable income for a
given year is generally reduced by the amount of distributions made in that year
to its shareholders. The Tax Code, however, permits the Company to deduct
against its 1998 taxable income dividends declared by the Company through
September 15, 1999 if such dividends are paid no later than December 31, 1999.
The Company, however, is currently exploring a variety of methods for
distributing some or all of its remaining 1998 taxable income by December 31,
1999, including the potential distribution of securities or other noncash
dividend payments. As a result of the Chapter 11 filing, there can be no
assurance that the Company will be able to make additional distributions with
respect to its 1998 taxable income. The failure to make further distributions
will result in a tax obligation of up to $7 million, but will have no effect on
CRIIMI MAE's 1998 REIT status.
1998 EXCISE TAX LIABILITY. Apart from the requirement that the Company
distribute at least 95% of its REIT taxable income to maintain REIT status,
CRIIMI MAE is also required each calendar year to distribute an amount ("the
excise tax avoidance amount") at least equal to the sum of 85% of its "REIT
ordinary income" and 95% of its "REIT capital gain income" to avoid incurring
a nondeductible excise tax. Unlike the 95% distribution requirement, the 85%
distribution requirement is not reduced by excess noncash income items such
as OID. Because the Company did not pay a dividend in the fourth quarter, its
actual distributions fell short of the excise tax avoidance amount by
approximately $7 million, resulting in an excise tax of approximately
$300,000. This $300,000 excise tax has been accrued and paid by the Company.
TAXABLE MORTGAGE POOL RISKS. An entity that constitutes a "taxable
mortgage pool" as defined in the Tax Code ("TMP") is treated as a separate
corporate level taxpayer for federal income tax purposes. In general, for an
entity to be treated as a TMP (i) substantially all of the assets must
consist of debt obligations and a majority of those debt obligations must
consist of mortgages; (ii) the entity must have more than one class of debt
securities outstanding with separate maturities and (iii) the payments on the
debt securities must bear a relationship to the payments received from the
mortgages. The Company currently owns all of the equity interests in three
trusts that constitute TMPs (CBO-1, CB0-2 and CMO-IV, collectively the
"Trusts"). See "Resecuritizations" and "Loan Originations and
Securitizations" for descriptions of CBO-1, CBO-2 and CMO-IV. The Company
also owns certain securities structured as bonds (the "Bonds") issued by each
of the Trusts. 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.
Certain of the Bonds owned by the Company serve as collateral (the "Pledged
Bonds") for short-term, variable-rate borrowings used by the Company to finance
their initial purchase. If the creditors holding the Pledged Bonds were to seize
or sell this collateral and the Pledged Bonds were deemed to
3
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.
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. Consequently, the supply of private sector multifamily and other CMBS
has increased dramatically over recent years. According to COMMERCIAL MORTGAGE
ALERT, CMBS issuance's in the U.S. equaled approximately $78.3 billion in 1998
compared to approximately $44.3 billion in 1997, $30.0 billion in 1996 and $19.0
billion in 1995.
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 C) and unrated. The first step in the process of
creating CMBS is loan origination. Loan origination occurs when a financial
institution lends money to a borrower to refinance or to purchase a commercial
real estate property, and secures the loan with a mortgage on the property that
the borrower owns or purchases. Commercial mortgage loans are typically
non-recourse to the borrower. A pool of these commercial real estate-backed
mortgage loans is then accumulated, often by a large commercial bank or other
financial institution. One or more rating agencies then analyze the loans and
the underlying real estate to determine their credit quality. The mortgage loans
are then deposited into an entity that is not subject to taxation, often a real
estate mortgage investment conduit ("REMIC") or, in the case of the Company, a
TMP. The investment vehicle then issues securities backed by the commercial
mortgage loans, or CMBS.
The CMBS are divided into tranches, which are afforded certain priority
rights to the cash flow from the underlying mortgage loans. Principal payments
typically flow first 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.
The Company has primarily focused on acquiring or retaining non-investment grade
and unrated tranches, issued by mortgage conduits, where the Company believes
its market knowledge and real estate expertise allow it to earn attractive
risk-adjusted returns. 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 right to payment of principal. The CMBS are then
sold to investors through either a public offering or a private placement.
At the time of a securitization, one or more entities are appointed as
"servicers" for the pool of mortgage loans, and are responsible for performing
servicing duties which include collecting payments (master or direct servicing),
monitoring performance (loan management) and working out or foreclosing on
defaulted loans (special servicing). Each servicer receives a fee and other
financial incentives based on the type and extent of servicing duties.
4
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. The market for
Subordinated CMBS has, however, been slower to recover and trading in this
market is less liquid. It is difficult, if not impossible, to predict when or
if the CMBS market and, in particular, the Subordinated CMBS market, will
fully recover. Therefore, management's estimate of the value of the
securities 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, 1998, the Company's $2.4 billion portfolio of assets
included $1.3 billion of Subordinated CMBS (representing approximately 52% of
the Company's total consolidated assets).
In 1998, CRIIMI MAE acquired Subordinated CMBS from offerings with a
total face amount of $13.5 billion. These offerings comprised 17.2% of the
total ($78.3 billion face amount, according to Commercial Mortgage Alert)
CMBS market for 1998. For the year ended December 31, 1998, the Company
acquired Subordinated CMBS with an aggregate face amount of approximately
$1.2 billion, making the Company a leading purchaser of Subordinated CMBS in
1998. As of December 31, 1998, approximately 44% of the Company's CMBS (based
on fair value) were rated BB+, BB or BB-, 27% were B+, B, B- or CCC and 9%
were unrated. The remaining approximately 20% represents investment grade
securities that the Company reflects on its balance sheet as a result of the
May 1998 resecuritization of certain Subordinated CMBS. See "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 liabilities and assets through the refinancing of short-term,
variable-rate, recourse financing with long-term, fixed-rate, non-recourse
financing. See "BUSINESS - Resecuritizations," "MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS," and Notes 5 and 9 to
Notes to Consolidated Financial Statements.
The Company generally enters into interest rate protection agreements to
mitigate the adverse effects of rising short-term interest rates on its
variable-rate financing facilities. It is the Company's policy to hedge at least
75% of its variable-rate debt with interest rate protection agreements. As of
December 31, 1998, approximately 79% of the Company's variable-rate debt was
hedged by caps, a form of interest rate protection agreement. Interest rate caps
provide protection to CRIIMI MAE to the extent interest rates, based on a
readily determinable interest rate index, increase above the stated interest
rate cap, in which case CRIIMI MAE would receive payments based on the
difference between the index and the cap. See "MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" and Notes 9 and 10 to
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
mitigate the Company's exposure to interest rate risk, the Company's business
strategy was to periodically refinance a significant portion of this debt with
5
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
variable-rate secured borrowings which were used with additional new
variable-rate secured borrowings and, to a lesser extent, cash, to purchase
additional Subordinated CMBS. Although the Company's resecuritizations have
mitigated the Company's exposure to interest rate risk through match-funding,
the Company's variable-rate secured borrowings have increased from December
31, 1996 to December 31, 1998, as a result of the Company's continued
acquisitions of Subordinated CMBS.
In December 1996, the Company completed its first resecuritization of
Subordinated CMBS ("CBO-1") with a combined face value of approximately $449
million involving 35 individual securities collateralized by 12 mortgage
securitization pools. The Company sold in a private placement securities with a
face amount of $142 million and retained securities with a face amount of
approximately $307 million. Through CBO-1, the Company refinanced approximately
$142 million of short-term, variable-rate, secured borrowings with fixed-rate,
non-recourse, match-funded debt. CBO-1 generated excess borrowing capacity of
approximately $22 million primarily as a result of a higher overall weighted
average credit rating for the new CMBS, as compared to the weighted average
credit rating on the related CMBS collateral.
In May 1998, the Company completed its second resecuritization of
Subordinated CMBS ("CBO-2") with a combined face value of approximately $1.8
billion involving 75 individual securities collateralized by 19 mortgage
securitization pools and three of the retained securities from CBO-1. In CBO-2,
the Company sold in a private placement securities with a face amount of $468
million and retained securities with a face amount of approximately $1.3
billion. Through CBO-2, the Company refinanced approximately $468 million of
short-term, variable-rate secured borrowings with fixed-rate, non-recourse,
match-funded debt. CBO-2 generated net excess borrowing capacity of
approximately $160 million primarily as a result of a higher overall weighted
average credit rating for the new CMBS, as compared to the weighted average
credit rating on the related CMBS collateral.
As of December 31, 1998, the Company's total debt was approximately $2.1
billion, of which approximately 46% was fixed-rate, match-funded debt and
approximately 54% was short-term, variable-rate or fixed-rate debt that was not
match-funded. For the year ended December 31, 1998, the Company's weighted
average cost of borrowing (including amortization of discounts and deferred
financing fees of approximately $6.5 million) was approximately 7.37%. See
"BUSINESS - Subordinated CMBS Acquisitions," "MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" and Notes 5, 9 and 10
to Notes to Consolidated Financial Statements for further information regarding
the Company's resecuritizations, short-term variable-rate secured financings,
and caps.
6
LOAN ORIGINATIONS AND SECURITIZATIONS
Prior to the Petition Date, the Company originated mortgage loans
principally through mortgage loan conduit programs with major financial
institutions for the primary purpose of pooling such loans for securitization.
The Company viewed a securitization as a means of extracting the maximum value
from the mortgage loans originated. A portion of the mortgage loans originated
was financed through the creation and sale of investment-grade CMBS to third
parties in connection with the securitization. The Company received net cash
flow on the CMBS not sold to third parties after payment of amounts due to
secured creditors who had provided acquisition financing. Additionally, the
Company received origination and servicing fees related to the mortgage loan
conduit programs.
A majority of the mortgage loans originated under the Company's loan
conduit programs were "No Lock" mortgage loans. Unlike most commercial mortgage
loans originated for the CMBS market which contain "lock-out" clauses (that is,
provisions which prohibit the prepayment of a loan for a specified period after
the loan is originated or impose costly yield maintenance provisions), the
Company's No Lock loans allowed borrowers the ability to prepay loans at any
time by paying a prepayment penalty. Since the inception of these origination
programs, the Company has originated over $900 million in aggregate principal
amount of loans and securitized approximately $496 million in aggregate
principal amount of mortgage 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"). A majority of these mortgage loans were "No Lock" loans. In CMO-IV,
CRIIMI MAE sold $397 million face amount of fixed-rate, investment-grade CMBS.
The Company originally intended to sell all of the investment grade tranches of
CMO-IV; however, two investment grade tranches of CMO-IV have not yet been sold.
It is the Company's intent to sell these tranches in the future pursuant to an
agreement with Citicorp Securities, Inc. ("Citicorp") approved by the Bankruptcy
Court. CRIIMI MAE has call rights on each of the issued securities and therefore
has not surrendered control of the collateral, thus requiring the transaction to
be accounted for as a financing of the mortgage loans collateralizing the
investment-grade CMBS sold in the securitization. See "MANAGEMENT'S DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS-Liquidity and
Capital Resources" and Note 6 to Notes to Consolidated Financial Statements for
additional information regarding this securitization.
At the time it filed for bankruptcy, the Company had a mortgage loan
conduit program with Citibank (the "Citibank Program") as well as a loan conduit
program with Prudential Securities Incorporated and Prudential Securities Credit
Company (the "Prudential Program") (together the "Programs").
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.
At December 31, 1998, this reserve account was approximately $31.8 million.
Under the Prudential Program, the Company has 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 has been made. Under the Prudential Program, the Company was
required to fund a reserve account, which was approximately $2 million at
December 31, 1998. If the Company is unable to exercise its option under the
Prudential Program, the Company will forfeit the amount of the reserve account.
On October 5, 1998, Citibank sent the Company a letter alleging that the
Company was in default under the Citibank Program and that it was terminating
the Citibank Program. The Company and Citibank
7
negotiated a Stipulation and Consent Order (the "Order"), entered by the
Bankruptcy Court on April 5, 1999, regarding the Citibank Program. The Order
provides that Citibank will, with CRIIMI MAE's cooperation, sell the loans
originated under the Citibank Program, provided that the sale results in CRIIMI
MAE receiving minimum net proceeds of not less than $3.5 million, after
satisfying certain amounts due to Citibank, from the amount held in the
reserve account. The minimum net proceeds provision may be waived by agreement
of the Company, the Official Committee of Unsecured Creditors in the Company's
Chapter 11 case (the "Unsecured Committee") and the Official Committee of Equity
Security Holders in the Company's Chapter 11 case (the "Equity Committee").
CRIIMI MAE is also discussing with Prudential the sale of the loan originated
under the Prudential Program. There can be no assurance that an agreement will
be reached with Prudential or, if reached, that such agreement would be approved
by the Bankruptcy Court.
As of December 31, 1998, the Company's obligation under the Citibank
Program was $28.4 million (based primarily on information provided by
Citibank) in excess of the fair value of the loans and the Company's loss
exposure under the Prudential Program was $2 million if the Company does not
exercise its option. As a result, CRIIMI MAE recorded an aggregate $30.4
million unrealized loss on its obligations as of December 31, 1998. The
unrealized loss of $28.4 million relating to the Citibank Program as of
December 31, 1998 is based on the estimated market value of the loans offset
by the unpaid principal balance of the loans at December 31, 1998, hedge
losses and certain estimated fees and other costs. Depending on market
conditions, including interest rate movements, these losses could materially
increase or decrease in subsequent reporting periods. The Company has
calculated the Prudential loss based upon the assumption that the Company
will 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 billion, as compared to approximately $16.5 billion as of
December 31, 1997. Prior to the Petition Date, CRIIMI MAE increased its mortgage
loan servicing and advisory operations primarily through its purchases of
Subordinated CMBS by acquiring certain servicing rights for the mortgage loans
collateralizing the Subordinated CMBS, as well as providing servicing on the
loans originated through the CRIIMI MAE loan origination programs. At the time
of the Chapter 11 filing, CRIIMI MAE, through CMSLP, master serviced five CMBS
portfolios totaling $3.6 billion, as well as loans originated, but not yet
securitized, under its loan origination programs.
CMSLP did not file for Chapter 11 protection. However, because of its
relationship with CRIIMI MAE, CMSLP has been under a high degree of scrutiny
from servicing rating agencies. As a result of CRIIMI MAE's Chapter 11 filing,
CMSLP was also declared in default under its credit agreements with First Union
National Bank. In order to repay these credit agreement obligations and to
increase its liquidity, CMSLP arranged for Banc One Mortgage Capital Markets,
LLC ("BOMCM") to succeed it, on October 30, 1998, as master servicer on two
commercial mortgage pools for a payment of $6.9 million, resulting in a loss to
CMSLP of approximately $1.4 million from the recorded value of the rights.
Substantially all of the loss flowed through to CRIIMI MAE through equity in
earnings in the fourth quarter of 1998. In addition, in order to allay rating
agency concerns stemming from CRIIMI MAE's Chapter 11 filing, in November 1998,
CRIIMI MAE designated BOMCM as special servicer on 33 separate CMBS
securitizations totaling approximately $29 billion, subject to certain
requirements contained in the respective servicing agreements. CMSLP continues
to perform special servicing as sub-servicer for BOMCM on all but five of these
securitizations. CRIIMI MAE remains the owner of the lowest rated tranche of the
related Subordinated CMBS and, as such, retains all rights pertaining to
ownership, including the right to replace the special servicer. CMSLP also lost
the right to specially service the DLJ MAC 95 CF-2 securitization when the
majority holder of the lowest rated tranche replaced CMSLP as special servicer.
At December 31, 1998 CMSLP's remaining servicing portfolio was $31 billion.
CMSLP's principal servicing activities are described below.
8
SPECIAL SERVICING. A special servicer typically provides asset
management and resolution services with respect to nonperforming or
underperforming loans within a pool of mortgage loans. When acquiring
Subordinated CMBS, CRIIMI MAE typically required that it retain the right to
appoint the special servicer for the related mortgage pools. When serving as
special servicer of a CMBS pool, CMSLP has the authority to deal directly
with any borrower that fails to perform under certain terms of its mortgage
loan, including the failure to make payments, and to manage any loan workouts
and foreclosures. As special servicer, CMSLP earns fee income on services
provided in connection with any loan servicing function transferred to it
from the master servicer. CRIIMI MAE believes that because it owns the lowest
rated or unrated tranche (first loss position) of the Subordinated CMBS,
CMSLP has an incentive to quickly resolve any loan workouts. During the year
ended December 31, 1998, CMSLP successfully resolved $138.7 million of CMBS
loan workouts without a loss to principal. As of December 31, 1998, CMSLP was
designated as the special servicer (or sub-servicer) for approximately 5,000
commercial mortgage loans representing an aggregate principal amount of
approximately $27.4 billion. Such 5,000 commercial mortgage loans represent
substantially all of the mortgage loans underlying CRIIMI MAE'S Subordinated
CMBS portfolio.
As of December 31, 1998, CMSLP had a special servicer rating of "above
average" from Fitch IBCA and had been approved on a transactional basis by
Moody's Investors Service, Inc. ("Moody's") and Duff & Phelps Credit Rating
Co. However, CMSLP lost an "acceptable" special servicer rating by Standard &
Poor's ("S&P") in October 1998 as a result of the Chapter 11 filing of CRIIMI
MAE. Also, as a result of the Chapter 11 filing, Fitch IBCA placed CMSLP's
special servicing rating on "rating watch".
MASTER SERVICING. A master servicer typically provides administrative and
reporting services to the trustee with respect to a particular issuance of CMBS.
Mortgage loans underlying CMBS generally are serviced by a number of primary
servicers. Under most master servicing arrangements, the primary servicers
retain primary responsibility for administering the mortgage loans and the
master servicer acts as an intermediary in overseeing the work of the primary
servicers, monitoring their compliance with the standards of the issuer of the
related CMBS and consolidating the servicers' respective periodic accounting
reports for transmission to the trustee. When serving 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 float and fee income, the master servicer
typically has more direct and regular contact with borrowers than the special
servicer. As of December 31, 1998, CMSLP remained master servicer on three CMBS
portfolios representing commercial mortgage loans with an aggregate principal
amount of approximately $2.3 billion.
As of December 31, 1998, CMSLP had a master servicer rating of "acceptable"
from Fitch IBCA and had been approved on a transactional basis by Moody's.
However, CMSLP lost an acceptable master servicer rating from S&P in October
1998 as a result of the Chapter 11 filing of CRIIMI MAE. Also, as a result of
the Chapter 11 filing, Fitch IBCA placed CMSLP's Master Servicer rating on
"rating watch".
DIRECT (OR PRIMARY) SERVICING. Direct (or primary) servicers typically
perform certain functions for the master servicer. Direct serviced loans are
those loans for which CMSLP collects loan payments directly from the borrower
(including tax and insurance escrows and replacement reserves). The loan
payments are remitted to the master servicer for the loan (which may be the same
entity as the direct servicer), usually on a fixed date each month. The direct
servicer is usually paid a fee to perform these services, and is eligible to
earn float income on the deposits held. In addition to this fee and float
income, the direct servicer, like the master servicer, typically has more direct
and regular contact with borrowers than the special servicer. As of December 31,
1998, CMSLP was designated direct servicer for approximately 374 commercial
mortgage loans representing an aggregate principal amount of approximately $2.1
billion. This number excludes loans that are both direct and master serviced,
which are included in the master servicing figures above.
LOAN MANAGEMENT. In certain cases, CMSLP acts as loan manager and monitors
the ongoing performance of properties securing the mortgage loans underlying its
Subordinated CMBS portfolio by
9
continuously reviewing the property level operating data and regular site
inspections. For many of these loans, CMSLP performs these duties directly; for
the remaining loans, as part of its routine asset monitoring process, it reviews
the analysis performed by other servicers. This allows CMSLP to identify and
resolve potential issues that could result in losses. As of December 31, 1998,
CMSLP served as loan manager for approximately 4,800 commercial mortgage loans
representing an aggregate principal amount of approximately $26.6 billion. This
number excludes loans that are both direct and master serviced which are
included in the master servicing figures above.
UNDERWRITING PROCEDURES
CRIIMI MAE believes that its experience in underwriting has enabled it to
maintain the overall quality of assets underlying its CMBS portfolio and to
properly manage certain of the risks associated with mortgage loans underlying
acquired Subordinated CMBS and loan originations. Since the Company generally
acquired CMBS through privately negotiated transactions and originated
commercial mortgage loans through its regional offices, it was able to perform
extensive due diligence on each mortgage loan as well as the underlying real
estate prior to consummating any purchase or origination. The Company underwrote
every loan it originated and re-underwrote a substantial portion of the loans
underlying the Subordinated CMBS it acquired. Furthermore, the Company's credit
committee, composed of members of senior management, reviewed originated loans
and Subordinated CMBS acquisitions. The Company also placed underwriting
personnel in its regional origination offices, not only to provide a timely
response to the originators but also to achieve a thorough understanding of
local markets and demographic trends.
CRIIMI MAE's underwriting guidelines were designed to assess the adequacy
of the real property as collateral for the loan and the borrower's
creditworthiness. The underwriting process entailed a full independent review of
the operating records, appraisals, environmental studies, market studies and
architectural and engineering reports, as well as site visits to properties
representing a majority of the CMBS portfolio. The Company then tested the
historical and projected financial performance of the properties to determine
their resiliency to a market downturn and applied varying capitalization rates
to assess collateral value. To assess the borrower's creditworthiness, the
Company reviewed the borrower's financial statements, credit history, bank
references and managerial experience. The Company purchased Subordinated CMBS
when the loans it believed to be problematic (i.e., that did not meet its
underwriting criteria) were excluded from the CMBS pool and when satisfactory
arrangements existed that enabled the Company to closely monitor the underlying
mortgage loans and provided the Company with appropriate workout and foreclosure
rights.
EMPLOYEES
As of December 31, 1998, the Company had 65 full-time employees, and
CSMLP had 118 full-time employees. Prior to the Petition Date on September
30, 1998, the Company had 170 full-time employees, and CMSLP had 113
full-time employees. Most of these staff reductions were in the Company's
origination and underwriting areas, which were reduced by 57 full-time and 43
full-time employees, respectively.
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
10
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 in March 1999, subject to certain limitations, and to grant
options to its employees after the Petition Date, up to certain limits. The
Employee Retention Plan also provides for retention payments aggregating
approximately $4.6 million, including payments to certain executives.
Retention payments are payable semiannually over a two-year period. The first
retention payment vested on April 5, 1999, and will be paid on April 15,
1999. The entire unpaid portion of the retention payments will become due and
payable (i) upon the effective date of a plan of reorganization of the
Company and, with respect to certain key executives, court approval or (ii)
upon termination without cause. William B. Dockser, Chairman of the Board of
the Company, and H. William Willoughby, President, are not currently entitled
to receive any retention payments. Subject to the terms of their respective
employment agreements, certain key executives will be entitled to severance
benefits if they resign or their employment is terminated following a change
of control. The other employees will be entitled to severance benefits if
they are terminated subsequent to a change of control of the Company, but,
with the exception of certain key executives, only if such change of control
results in the successful emergence of the Company and CM Management from
Chapter 11. In addition, all options granted by the Company after October 5,
1998 shall immediately become exercisable upon a change of control. For a
discussion of the Employee Retention Plan as it relates to named key
executives of the Company, see "EXECUTIVE COMPENSATION--Employment
Agreements".
THE PORTFOLIO
CMBS
FAIR VALUE
As of December 31, 1998, the Company owned CMBS rated from A to CCC and
Unrated with a total fair value amount of approximately $1.3 billion
(representing approximately 52% of the Company's total consolidated assets) and
an aggregate amortized cost of approximately $1.5 billion.
Amortized Amortized
Face Amount Weighted Range of Discount Cost Cost
as of Average Weighted Fair Value Rates Used to as of as of
Security 12/31/98 Pass- Average as of 12/31/98 Calculate Fair 12/31/98 12/31/97
Rating (in millions) Through Rate Life (2) (in millions)(1) Value (1) (in millions) (in millions)
- --------- ------------- ------------ -------- ---------------- -------------- ------------- -------------
AA- $ -- -- -- -- -- $ -- $ 5.6
A (5) 62.6 7.0% 7 years $ 57.2 8.7% 57.0 --
BBB (5)(6) 150.6 7.0% 13 years 121.9 9.7% 126.9 4.0
BBB-(6) 115.2 7.0% 13 years 85.6 10.7% 92.8 --
BB+ 394.6 6.9% 14 years 286.8 9.3%-11.5% 317.9 8.6
BB 275.8 6.9% 15 years 212.7 10.3%-12.3% 259.1 445.0
BB- 89.1 6.8% 15 years 58.0 11.1%-13.3% 72.6 89.8
B+ 128.7 6.7% 17 years 72.9 12.1%-14.0% 93.0 --
B 300.2 6.6% 17 years 159.7 12.1%-15.3% 208.9 357.4
B- 198.7 6.7% 18 years 87.4 15.1%-18.8% 106.7 44.6
CCC 92.0 6.8% 20 years 22.8 25.0% 36.0 10.9
Unrated 478.1 6.7% 21 years 109.2 27.0%-33.0% 159.0 113.2
--------- ---- -------- --------- ----------- --------- ---------
Total (3)(4) $ 2,285.6 6.8% 16 years $ 1,274.2 $ 1,529.9 $ 1,079.1
--------- ---- -------- --------- --------- ---------
--------- ---- -------- --------- --------- ---------
- -------------------------------
(1) The estimated fair values of Subordinated CMBS represent the carrying value
of these assets. Due to the Chapter 11 filing, the Company's lenders were not
willing to provide fair value quotes for the 1998 portfolio. As a result, the
11
Company calculated the estimated fair market value of its Subordinated CMBS
portfolio as of December 31, 1998. The Company used a discounted cash flow
methodology to estimate the fair value of its Subordinated CMBS portfolio.
The projected cash flows used by the Company were the same collateral cash
flows used to calculate the anticipated weighted average unleveraged yield to
maturity. (See Note 5 to Notes to Consolidated Financial Statements.) The
cash flows were then discounted using a discount rate that, in the Company's
view, was commensurate with the market's perception of risk and value. The
Company used a variety of sources to determine its discount rate including:
(i) institutionally-available research reports, (ii) a relative comparison of
dealer provided discount rates from the previous quarter to those disclosed
in recent research reports and incorporating adjustments to reflect changes
in the market as they relate to each of the Company's CMBS from September 30,
1998 to December 31, 1998, and (iii) communications with dealers and active
Subordinated CMBS investors regarding the year-end valuation of comparable
securities. Since the Company calculated the estimated fair market value of
its Subordinated CMBS portfolio as of December 31, 1998, it has disclosed in
the table the range of discount rates by rating category used in determining
these fair market values.
(2) Weighted average life represents the weighted average expected life of the
Subordinated CMBS prior to consideration of losses, extensions or prepayments
other than those factored in the assumed prepayment rate used at the time of
acquisition, which ranged from 0% to 4%, depending upon the portfolio.
(3) Refer to Note 8 to Notes to Consolidated Financial Statements for additional
information regarding the total face amount and purchase price of Subordinated
CMBS for tax purposes.
(4) Similar to the Company's other sponsored CMO's, CMO-IV, as further
described below in Investment in Originated Loans, resulted in the creation
of CMBS, of which the Company sold certain tranches. Since the Company
retained call options on the sold bonds, the Company did not surrender
control of the assets for purposes of FAS 125 and thus the entire transaction
is accounted for as a financing and not a sale. Since the entire transaction
is recorded as a financing, the CMBS are not reflected in the Company's CMBS
portfolio and the mortgage assets are reflected in Investment in Originated
Loans on the balance sheet.
(5) In connection with CBO-2, $62.6 million (A rated) and $60.0 million (BBB
rated) face amount of investment grade securities were issued with call
options and $345 million (A rated) face amount were issued without call
options. Since the Company retained call options on certain sold bonds, the
Company did not surrender control of those assets pursuant to the
requirements of FAS 125 and thus these securities are accounted for as a
financing and not a sale. Since the transaction is recorded as a partial
financing and a partial sale, CRIIMI MAE has retained the securities with
call options in its CMBS portfolio reflected on its balance sheet.
(6) In connection with CBO-2, the Company retained $90.6 million (BBB rated)
and $115.2 million (BBB- rated) face amount of securities, with the intention
to sell the securities at a later date. These securities were sold on March
5, 1999 in a transaction accounted for as a financing by the Company rather
than a sale and the related debt will be reflected as Secured Mortgage
Obligations. See "LEGAL PROCEEDINGS".
TYPE AND GEOGRAPHIC LOCATION OF LOANS. As of December 31, 1998 and 1997,
the mortgage loans underlying the Company's CMBS portfolio were secured by
properties of the types and at the locations identified below:
Property Type 1998(1) 1997(1) Geographic Location(2) 1998(1) 1997(1)
- ------------- ------- ------- ---------------------- ------- -------
Multifamily............... 31% 37% California.............. 16% 14%
Retail.................... 28% 28% Texas................... 12% 15%
Office.................... 15% 10% Florida................. 7% 9%
Hotel..................... 13% 14% New York................ 6% 4%
Other..................... 13% 11% Other(3)................ 59% 58%
--- --- --- ---
Total................... 100% 100% Total................. 100% 100%
--- --- --- ---
--- --- --- ---
(1) Based on a percentage of the total unpaid principal balance of the
underlying loans.
(2) No significant concentration by region.
(3) No other individual state makes up more than 5% of the total.
12
CMBS POOLS. The following table summarizes information relating to the
Company's CMBS on an aggregate basis by pool as of December 31, 1998. See
also Note 5 to Notes to Consolidated Financial Statements.
Original December 31, 1998
Anticipated Anticipated
Unleveraged Unleveraged
Amortized Yield to Yield to
Pool Face Amount Fair Value (6) Cost Maturity(1) Maturity(1)(2)
- ---- ----------- -------------- --------- ------------ --------------
(in millions) (in millions) in millions)
Retained Securities from
CRIIMI 1996 C1 (CBO-1) $ 112.1 $ 43.9 $ 46.6 19.5% 20.9%(5)
DLJ Mortgage Acceptance Corp.
Series 1997 CF2 Tranche B-30C 3.8 18.2 23.3 8.2% 8.1%
Nomura Asset Securities Corp.
Series 1998-D6 Tranche B7 46.5 9.9 17.6 12.0% 12.0%
Retained Securities from
CRIIMI MAE Commercial Mortgage
Trust Series 1998 C1 (CBO-2)
(4) 1,427.2 793.0 926.6 10.3% 10.2%
Mortgage Capital Funding, Inc.
Series 1998-MC1 151.8 97.1 116.1 8.9% 8.9%
Chase Commercial Mortgage
Securities Corp.
Series 1998-1 81.8 48.2 61.1 8.8% 8.8%
First Union/Lehman Brothers
Series 1998 C2 289.7 159.0 207.4 8.9% 8.9%
Morgan Stanley Capital I Inc.
Series 1998-WF2 (4) 86.9 53.2 65.5 8.5% 8.5%
Mortgage Capital Funding, Inc.
Series 1998-MC2 85.8 51.7 65.7 8.7% 8.7%
-------- -------- -------- --- -- ---- --
$2,285.6 $1,274.2 $1,529.9 9.7% (3) 10.1% (3)
-------- -------- -------- --- -- ---- --
-------- -------- -------- --- -- ---- --
- --------------------
(1) Represents the anticipated weighted average unleveraged yield over the
expected average life of the Company's Subordinated CMBS portfolio as of the
date of acquisition and December 31, 1998, respectively, based on management's
estimate of the timing and amount of future credit losses and prepayments. As
discussed in (4) below these yields may decrease as a result of certain
adversarial actions taken by the Company's lenders.
(2) Unless otherwise noted, changes in the December 31, 1998 anticipated yield
to maturity from that originally anticipated are primarily the result of changes
in prepayment assumptions relating to mortgage collateral.
(3) CRIIMI MAE, through CMSLP, performs servicing functions on a total CMBS
pool of approximately $30.0 billion. Of the $30.0 billion of mortgage loans,
approximately $195.4 million are currently being specially serviced, of which
approximately $45.0 million are being specially serviced due to payment
default and the remainder are being specially serviced due to nonfinancial
covenant default. Despite the volatility in the capital markets, the mortgage
assets underlying the Company's portfolio of CMBS experienced no losses of
principal from default. See "BUSINESS-Servicing" and Note 5 to Notes to
Consolidated Financial Statements for a discussion of the transfer of special
servicing.
(4) On October 6, 1998, Morgan Stanley and Co. International Limited ("Morgan
Stanley") advised CRIIMI MAE that it was exercising alleged ownership rights
over certain classes of CMBS it held as collateral. Subsequent to year end, the
Company agreed to cooperate on selling two classes of investment grade CMBS
issued by CBO-2 ("CBO-2 BBB Bonds") and to suspend litigation with Morgan
Stanley with respect to these CMBS. CRIIMI MAE and Morgan Stanley also agreed to
a standstill period,
13
now extended through April 15, 1999, regarding seven classes of Subordinated
CMBS issued by Morgan Stanley Capital I Inc. Series 1998-WF2. On March 5,
1999, the CBO-2 BBB Bonds with $205.8 million face amount and a coupon rate
of 7% were sold in a transaction accounted for as a financing by the Company
rather than a sale. Of the $159.0 million of net sale proceeds, $141.2
million was used to repay borrowings under the agreement with Morgan Stanley
and $17.8 million was paid to CRIIMI MAE.
(5) The increase in the anticipated yield resulted from the reallocation of a
portion of the CBO-1 asset basis in conjunction with the CBO-2
resecuritization.
(6) Fair value has been calculated as described above in footnote (1) to the
table on CMBS Fair Value.
INSURED MORTGAGE SECURITIES
As of December 31, 1998, the Company had $488.1 million (at fair value )
invested in mortgage securities and insured loans, consisting of GNMA
Mortgage-Backed Securities and FHA-Insured Loans, as well as Federal Home Loan
Mortgage Company (Freddie Mac) participation certificates that are
collateralized by GNMA Mortgage-Backed Securities. As of December 31, 1998,
approximately 18% of CRIIMI MAE's investment in mortgage securities were
FHA-Insured Certificates and 82% were GNMA Mortgage-Backed Securities (including
certificates that collateralize Freddie Mac participation certificates). See
Notes 1 and 7 to Notes to Consolidated Financial Statements.
INVESTMENT IN ORIGINATED LOANS
As of December 31, 1998, the Company had $499.1 million (at amortized
cost) invested in commercial mortgage loans primarily originated through the
Company's mortgage loan conduit programs and subsequently securitized in
CMO-IV. Because the bonds sold in CMO-IV are subject to certain call options,
under FAS 125, the entire transaction is accounted for as a financing instead
of a sale and the mortgage loans are reflected on the Company's balance
sheet. See "BUSINESS-Loan Originations and Securitizations" and Notes 1 and 6
to Notes to Consolidated Financial Statements.
As of December 31, 1998, the originated mortgage loans were secured by
properties of the types and at the locations identified below:
Property Type Percentage(1) Geographic Location(2) Percentage(1)
- ------------- ------------- ---------------------- -------------
Multifamily........... 38% Michigan..................... 20%
Hotel................. 26% Texas........................ 8%
Retail................ 20% Illinois..................... 7%
Office................ 11% Connecticut.................. 6%
Other................. 5% California................... 6%
--- Maryland..................... 6%
Other(3)..................... 47%
---
Total.................. 100% Total..................... 100%
--- ---
--- ---
- ---------------
(1) Based on a percentage of the total unpaid principal balance of the loans.
(2) No significant concentration by region.
(3) No other state makes up more than 5% of the total.
EQUITY INVESTMENTS
As of December 31, 1998, the Company had approximately $42.9 million in
investments accounted for under the equity method of accounting. Included in
equity investments are (a) CRIIMI, Inc., a wholly owned subsidiary of CRIIMI
MAE, which owns all of the general partnership interests in American Insured
Mortgage Investors L.P., American Insured Mortgage Investors L.P.-Series 85,
American Insured Mortgage Investors L.P.-Series 86 and American Insured
Mortgage Investors L.P.-Series 88 (collectively the "AIM Funds"), (b) CRIIMI
MAE and CM Management each own 50% of the limited partnership interest that
owns a 20% limited partnership interest in the adviser to the AIM Funds, (c)
CRIIMI MAE's interest in CRIIMI MAE Services Inc., and (d) CRIIMI MAE's
interest in CMSLP. See Note 1 to Notes to Consolidated Financial Statements.
14
RISK FACTORS. THE FOLLOWING RISK FACTORS ADDRESS RISKS RELATING PRIMARILY TO THE
COMPANY AND ITS OPERATIONS DURING THE PENDENCY OF THE BANKRUPTCY. BECAUSE IT IS
NOT POSSIBLE TO PREDICT THE OUTCOME OF THE CHAPTER 11 FILING AND THERE CAN BE NO
ASSURANCE AS TO WHEN OR IF THE COMPANY WILL RESUME BUSINESS ACTIVITIES THAT IT
HAS SUSPENDED DURING THE BANKRUPTCY, THE FOLLOWING DISCUSSION DOES NOT ADDRESS
RISKS RELATING TO THE RESUMPTION OF THE COMPANY'S SUBORDINATED CMBS ACQUISITION,
LOAN ORIGINATION OR SECURITIZATION PROGRAMS.
EFFECT OF BANKRUPTCY FILING; ABILITY TO CONTINUE AS A GOING CONCERN
Since filing for bankruptcy, CRIIMI MAE has suspended its Subordinated CMBS
acquisition, origination and securitization operations, but continues to service
mortgage loans through CMSLP. Accordingly, the Company's results of operations
during the pendency of the bankruptcy are expected to differ materially from the
Company's performance prior to bankruptcy. Moreover, depending upon when and if
any of these activities is resumed by the Company, the Company's future
performance will differ materially from its present operations.
The Company's ability to resume the acquisition of Subordinated CMBS, as
well as its loan origination and securitization programs, depends to a
significant degree on its ability to obtain additional capital and emerge from
bankruptcy as a successfully reorganized company. The Company's ability to
access the necessary additional capital will be affected by a number of factors,
many of which are not in the Company's control. These include the cost of such
capital, changes in interest rates and interest rate spreads, changes in the
commercial mortgage industry and the commercial real estate market, general
economic conditions, perceptions in the capital markets of the Company's
business, covenants under the Company's current and future debt securities and
credit facilities, results of operations, leverage, financial condition and
business prospects. Currently, CRIIMI MAE is exploring a variety of possible
capital sources, including bank debt, high yield bond financing and equity
capital. However, the Company can give no assurances as to whether or when it
will obtain the necessary capital or the terms upon which such capital can be
obtained.
The Bankruptcy Court has entered an order extending the Company's exclusive
right to file a plan of reorganization through May 11, 1999 and has set a
hearing for such date with respect to the extension of the exclusivity periods
through August 2, 1999 for filing a plan of reorganization and through October
3, 1999 for soliciting acceptances thereof. A number of parties have indicated
potential opposition to any such extension. Management expects to file a plan of
reorganization during the summer of 1999, which would contemplate the Company's
emergence from bankruptcy later in 1999. There can be no assurance at this time,
however, that a plan of reorganization will be proposed by the Company during
such time or that such plan will be confirmed and consummated. After the
expiration of the exclusivity period, any party-in-interest has the right to
propose alternative plans of reorganization. The consummation of a plan of
reorganization will require the requisite vote of impaired creditors and
shareholders under the Bankruptcy Code (unless the proponent of the plan invokes
the so-called "cramdown" provisions of the Bankruptcy Code) and confirmation of
the plan by the Bankruptcy Court. See "LEGAL PROCEEDINGS-Bankruptcy
Proceedings."
At this time, it is not possible to predict the outcome of the Chapter 11
filing, in general, or its effects on the business of the Company or on the
claims and interests of creditors and shareholders. In addition, the Company's
independent public accountants have issued a report expressing substantial doubt
about the Company's ability to continue as a going concern. See "REPORT OF
INDEPENDENT PUBLIC ACCOUNTANTS."
RISK OF LOSS OF REIT STATUS
See "BUSINESS-Effect of Chapter 11 Filing on REIT Status and Other Tax
Matters" for a discussion.
TAXABLE MORTGAGE POOL RISK
See "BUSINESS-Effect of Chapter 11 Filing on REIT Status and Other Tax
Matters" for a discussion.
15
SUBSTANTIAL INDEBTEDNESS; LEVERAGE
The Company has substantial indebtedness. As of December 31, 1998, the
Company's total consolidated indebtedness was $2.1 billion, of which $1.1
million was recourse debt to the Company (i.e. not match-funded debt). This high
level of debt limits the Company's ability to obtain additional financing,
reduces income available for distributions to the extent income from assets
purchased with borrowed funds fails to cover the cost of the borrowings,
restricts the Company's ability to react quickly to changes in its business and
makes the Company more vulnerable to economic downturns.
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 changes in CMBS pricing spreads.
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 principal is not fully recovered. These
changes can result in permanent changes in the value of the CMBS and the
Company's anticipated yield if the losses are in excess of those previously
estimated. CMBS securities are priced as a spread above the Treasury rate
with a comparable maturity. The value of CMBS securities can be affected by
changes in interest rates, as well as changes in the spread between such CMBS
and the comparable Treasury security. For example, the spread to a comparable
Treasury of a CMBS security may have increased from 400 basis points to 500
basis points. If the Treasury security with a comparable maturity had a yield
of 5% then, in this example, the yield on a CMBS security would have changed
from 9% to 10% and accordingly, the value of such CMBS security would have
declined. Generally, increases in interest rates or spreads will result in
temporary changes in the value of the Subordinated CMBS assuming that the
Company has the ability to hold its CMBS investments until their maturity.
However, 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 financing with
match-funded financing or a decline in the value of the collateral securing
such short-term indebtedness could result in a situation where the Company is
required to sell CMBS securities or provide additional collateral, which
could have an adverse effect on the Company and its financial position and
results of operations.
LIMITED PROTECTION FROM HEDGING TRANSACTIONS
To minimize the risk of interest rate changes on its variable-rate debt,
the Company follows a policy to hedge at least 75% 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, 1998, 79%
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, 1998, the weighted average remaining term for the interest
rate protection agreements was approximately two years with a weighted average
strike price of 6.6%. There can be no assurance that the Company will be able to
maintain interest rate protection agreements to meet its 75% hedge policy on
satisfactory terms or to adequately protect against rising interest rates. In
addition, the Company does not currently hedge against all interest rate risks,
including increases in interest rate spreads, which adversely affect the value
of its CMBS assets.
16
RISK OF FORECLOSURE ON PLEDGED CMBS
Additionally, changes in interest rates, as well as changes in market
spreads, may cause the value of the Company's CMBS portfolio to decrease. A
decrease in the market value of these assets may cause lenders to seek relief
from the automatic stay provision of the Bankruptcy Code to foreclose on the
collateral or to take other action.
LIMITED LIQUIDITY OF SUBORDINATED CMBS MARKET
There is currently no active secondary trading market for Subordinated
CMBS. This limited liquidity results in uncertainty in the valuation of the
Company's portfolio of Subordinated CMBS. In addition, even if the market for
Subordinated CMBS fully recovers, during adverse market conditions, the
liquidity of such market may again be severely limited, which would impair
the amount the Company could realize if it were required to sell a portion of
its Subordinated CMBS. Furthermore, management's estimate of the value of its
securities 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.
PENDING LITIGATION
Since the Petition Date, material litigation has commenced before the
Bankruptcy Court between the Company and certain of its secured creditors,
including Merrill Lynch, Morgan Stanley and Citicorp. In addition, the Company
is aware that certain plaintiffs filed 20 separate class action civil lawsuits.
On March 9, 1999, the District Court ordered the consolidation of the complaints
in the United States District Court for the District of Maryland filed against
certain officers and directors of the Company between October 7, 1998 and
November 30, 1998. Although CRIIMI MAE was not named as a defendant in such
suits, the Company has an obligation to indemnify the officer and director
defendants. The Company intends to defend vigorously the claims asserted in all
of the foregoing lawsuits; however, there can be no assurance of, nor can CRIIMI
MAE predict with any degree of certainty, the ultimate outcome of such
litigation. See "LEGAL PROCEEDINGS."
INVESTMENT COMPANY ACT RISK
Under the Investment Company Act of 1940, as amended (the "Investment
Company Act"), an investment company is required to register with the SEC and is
subject to extensive restrictive and potentially adverse regulation relating to,
among other things, operating methods, management, capital structure, dividends
and transactions with affiliates. However, as described below, companies that
are primarily engaged in the business of acquiring mortgages and other liens on
and interests in real estate ("Qualifying Interests") are exempted by the
Investment Company Act.
To qualify for the Investment Company Act exemption, 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 (the "25% Requirement") or other real estate-related assets
("Other Real Estate Interests"). According to current SEC staff interpretations,
CRIIMI MAE believes that its government insured mortgage securities and
originated loans constitute Qualifying Interests. In accordance with current SEC
staff interpretations, the Company believes that all of its Subordinated CMBS
constitute Other Real Estate Interests and that certain of its Subordinated CMBS
also constitute Qualifying Interests. On certain of the Company's Subordinated
CMBS, the Company, along with other rights, has the unilateral right to direct
foreclosure with respect to the underlying mortgage loans. As a result of
obtaining such right, the Company believes that the related Subordinated CMBS
constitute Qualifying Interests. As of December 31, 1998, the Company believes
that it was in compliance with both the 55% Requirement and the 25% Requirement.
If the SEC or its staff were to take a different position with respect to
whether such Subordinated CMBS constitute Qualifying Interests, the Company
could, among other things, be required either (i) to change the manner in which
it conducts its operations to avoid being required to register as an investment
company or (ii) to register as an investment company, either of which could have
a material adverse effect on the Company. If the Company were required to change
the manner in which it conducts its business, it would likely have to dispose of
a significant portion of its Subordinated CMBS or acquire significant additional
assets that are Qualifying Interests. Alternatively, if the Company were
required to register as an investment company, it expects that its operating
expenses would significantly increase and that the Company would have to reduce
significantly its indebtedness,
17
which could also require it to sell a significant portion of its assets. No
assurances can be given that any such dispositions or acquisitions of assets, or
deleveraging, could be accomplished on favorable terms.
Further, if the Company were deemed an unregistered investment company, the
Company could be subject to monetary penalties and injunctive relief. The
Company would be unable to enforce contracts with third parties and third
parties could seek to obtain rescission of transactions undertaken during the
period the Company was deemed an unregistered investment company. In addition,
as a result of the Company's Chapter 11 filing, the Company is limited in
possible actions it may take in response to any need to modify its business plan
in order to register as an investment company, or avoid the need to register.
Certain dispositions or acquisitions of assets would require Bankruptcy Court
approval. Also, any forced sale of assets that occurs after the bankruptcy stay
is lifted would change the Company's asset mix, potentially resulting in the
need to register as an investment company under the Investment Company Act or
take further steps to change the asset mix. Any such results would be likely to
have a material adverse effect on the Company.
EFFECT OF ECONOMIC RECESSION ON LOSSES AND DEFAULTS
Economic recession may increase the risk of default on commercial mortgage
loans and correspondingly increase the risk of losses on the Subordinated CMBS
backed by such loans. Economic recession may also cause reduced demand for
commercial mortgage loans. This in turn may cause declining values of commercial
real estate securing the outstanding mortgage loans, weakening collateral
coverage and increasing the possibility of losses in the event of a default.
YEAR 2000
The Year 2000 issue is a computer programming issue that may affect many
electronic processing systems. Until relatively recently, in order to minimize
the length of data fields, most date-sensitive programs eliminated the first two
digits of the year. This issue could affect information technology ("IT")
systems and date sensitive embedded technology that controls certain systems
(such as telecommunications systems, security systems, etc.) leaving them unable
to properly recognize or distinguish dates in the twentieth and twenty-first
centuries. This treatment could result in significant miscalculations when
processing critical date-sensitive information relating to dates after December
31, 1999.
CRIIMI MAE is currently in the process of assessing and testing Year 2000
compliance of its IT systems, which include software systems to service mortgage
loans, administer securitizations and manage mortgage assets, as well as
software systems used for internal accounting purposes. A majority of the IT
systems used by the Company are licensed from third parties. These third parties
have either provided upgrades to existing systems or have indicated that their
systems are Year 2000 compliant. CRIIMI MAE has applied upgrades and has
completed a substantial amount of compliance testing as of March 31, 1999. The
Company anticipates that all year 2000 testing will be completed in the second
quarter of 1999. There can be no assurance, however, that the Company's IT
systems will be Year 2000 compliant by December 31, 1999.
The Year 2000 issue may also affect CRIIMI MAE's date-sensitive embedded
technology, which controls systems such as the telecommunications systems,
security systems, etc. The failure of any such systems to be Year 2000 compliant
could be material to the Company. The Company does not currently anticipate that
any material expenditure will be necessary to remediate the Company's embedded
technology systems.
The potential impact of the Year 2000 issue depends not only on the
corrective measures CRIIMI MAE has undertaken and will undertake, but also on
the ways in which the Year 2000 issue is addressed by third parties with whom
CRIIMI MAE directly interfaces or whose financial condition or operations are
important to CRIIMI MAE, including government agencies, financial institutions,
creditors, borrowers and others involved in the CMBS industry. CRIIMI MAE has
initiated communications with third parties with which it directly interfaces to
evaluate the risk of their failure to be Year 2000 compliant and the extent to
which CRIIMI MAE may be vulnerable to such failure. Although the Company has
received positive responses from those third parties that have been contacted,
there can be no assurance that the systems of these third parties or those who
have not yet been contacted will be Year 2000 compliant by December 31, 1999.
The failure of these third parties to be Year 2000 compliant could have a
material adverse effect on the operations of CRIIMI MAE.
18
The Company believes that its greatest risk with respect to the Year 2000
issue relates to failures by third parties to be Year 2000 compliant. In
addition to risks posed by third parties with which the Company interfaces
directly, risks are created by third parties providing services to large
segments of society. The failure of third parties to be Year 2000 compliant
could, among other things, cause disruptions in the capital and real estate
markets and borrower defaults on real estate loans underlying mortgage-backed
securities. With respect to the systems used directly by the Company, the
Company believes that its greatest exposure to the Year 2000 issue involves the
Company's loan servicing operations, which rely on computers to process and
manage loans. The Company has applied a vendor upgrade and has substantially
completed compliance testing on the upgrade. However, any failure of these
systems to be Year 2000 compliant could have a material adverse effect on the
Company's loan servicing operations.
The cost of IT and embedded technology systems testing and upgrades is not
expected to be material to CRIIMI MAE's consolidated operating results. The
Company estimates incurring total costs of approximately $300,000 for the Year
2000 assessment and compliance testing, which will be recorded as noninterest
expense. Currently, the Company also estimates the cost of system upgrades
purely in relation to the Year 2000 issue will be immaterial.
Although CRIIMI MAE has substantially completed its compliance testing
and remediation, it is also in the process of developing contingency plans
for the risks of the failure of the Company or third parties to be Year 2000
compliant. Management intends to complete contingency plans for the Year 2000
issue during the second quarter of 1999. Due to the inability to predict all
of the potential problems that may arise from the Year 2000 issue, there can
be no assurance that all contingencies will be adequately addressed by such
plans.
ITEM 2. PROPERTIES
CRIIMI MAE leases its corporate offices at 11200 Rockville Pike, Rockville,
Maryland. As of March 29, 1999, 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 businesses as
debtors-in-possession while they attempt to develop a reorganization plan 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
19
the Debtors. Any entity may apply to the Bankruptcy Court, upon appropriate
showing of cause, for relief from the automatic stay.
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 has appointed (i) an official committee of Unsecured Creditors in the
CRIIMI MAE Chapter 11 case, (ii) an official committee of Unsecured Creditors in
the Management Chapter 11 case and (iii) an official committee of Equity
Security Holders in the CRIIMI MAE Chapter 11 case (collectively, the
"Committees"). The Committees are expected to participate in the formulation of
the plans of reorganization for the respective Debtors. 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 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 did not file a plan of reorganization during the initial
exclusivity period; however, the Bankruptcy Court has entered an order extending
the Company's exclusive right to file a plan of reorganization through May 11,
1999. The Bankruptcy Court has set a hearing for May 11, 1999 with respect to a
further extension of the exclusivity periods through August 2, 1999 for filing a
plan of reorganization and through October 3, 1999 for soliciting acceptances
thereof. A number of parties have indicated potential opposition to any such
extension.
After a plan of reorganization has been filed with the Bankruptcy Court, it
will be sent, together with a disclosure statement approved by the Bankruptcy
Court after notice and a hearing, to members of all classes of impaired
creditors and equity security holders for acceptance or rejection. Following
acceptance or rejection of any plan by impaired classes of creditors and equity
security holders, the Bankruptcy Court, after notice and a hearing, will
consider whether to confirm the plan. 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 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 plan or is not impaired under
the plan, and (iii) confirmation of the 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 plan.
If any impaired class of creditors or equity security holders does not
accept a plan, the proponent of the plan may invoke the so-called "cramdown"
provisions of the Bankruptcy Code. Under these provisions, the Bankruptcy Court
may confirm a plan, notwithstanding the non-acceptance of the plan by an
impaired class of creditors or equity security holders, if certain requirements
of the Bankruptcy Code are met. These requirements include: (i) the plan does
not discriminate unfairly and (ii) the plan is fair and equitable, with respect
to each class of claims or interests that is impaired under, and has not
accepted, the plan. As used in the Bankruptcy Code, the phrases "discriminate"
and "fair and equitable" have narrow and specific meanings and their use herein
is qualified in its entirety by reference to the Bankruptcy Code.
20
BANKRUPTCY RELATED LITIGATION
The following is a summary of material litigation matters between the
Company and certain of its secured creditors that was commenced since the
Petition Date. The Company has reached agreement with certain of these
creditors, 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 by CMO-IV, 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 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 a plan of reorganization of the
Company.
MORGAN STANLEY
As of the Petition Date, the Company owed Morgan Stanley approximately
$182.4 million with respect to advances to the Company under an agreement
pursuant to which the Company pledged CMBS. The borrowings under this agreement
are secured by certain CMBS, including (i) CRIIMI MAE Commercial Mortgage Trust,
Series 1998-C1, Class B and C Certificates (collectively or any portion thereof,
the "CBO-2 BBB Bonds") and (ii) Morgan Stanley Capital I Inc., Series 1998-W2,
Class F, G, H, J, K, L and M Certificates (collectively or any portion thereof,
the "Wells Fargo Bonds" and, together with the CBO-2 BBB Bonds, the "Morgan
Collateral").
On October 6, 1998, Morgan Stanley advised the Company that it was
exercising alleged ownership rights over the Morgan Collateral. On October 20,
1998, the Company filed an adversary proceeding against Morgan Stanley alleging,
among other things, that Morgan Stanley violated the automatic stay and seeking
turnover of the Morgan Collateral.
On January 12, 1999, the Company and Morgan Stanley agreed upon and filed
with the Bankruptcy Court a stipulation and consent order, which was approved by
the Bankruptcy Court and entered on January 26, 1999. The consent order
provided, among other things, for the following: (i) an agreed sale procedure
for the CBO-2 BBB Bonds during a specified sale period; (ii) the payment of a
portion of the sale proceeds of the CBO-2 BBB Bonds to the Company; (iii) a
standstill period relating to the Wells Fargo Bonds through March 31, 1999
unless otherwise extended by the Company and Morgan Stanley, during which time
Morgan Stanley may not sell, pledge, encumber or otherwise transfer the Wells
Fargo Bonds and (iv) the postponement of the litigation with Morgan Stanley
while the parties seek a permanent resolution of their disputes. On March 5,
1999, the CBO-2 BBB Bonds were sold. Of the $159.0 million in net sale proceeds,
$141.2 million was used to repay the Company's borrowings under the agreement
with Morgan Stanley, and $17.8 million was paid to CRIIMI MAE. As a result of
the transaction, CRIIMI MAE's litigation against Morgan Stanley has been
resolved with respect to the CBO-2 BBB Bonds to the satisfaction of both
parties. The Company and Morgan Stanley have agreed to extend the standstill
period with
21
respect to the Wells Fargo Bonds through April 15, 1999. At the end of this
standstill period, Morgan Stanley has until April 25, 1999 to respond to the
Company's complaint and resume litigation with respect to the Wells Fargo Bonds,
unless the standstill period is further extended by the parties or an
agreement between the parties is reached.
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, the Company owed Citicorp $79.1 million
under the facility.
On October 15, 1998, the Company filed an emergency motion to enforce the
automatic stay against Norwest and Citicorp. Pursuant to an Order dated October
23, 1998, the Bankruptcy Court prohibited Citicorp from selling the Retained
Bonds without further order of the Bankruptcy Court. On October 23, 1998,
Citicorp requested an emergency hearing regarding the October 23 Order, and on
November 2, 1998, the Company filed a complaint against Citicorp seeking, among
other things, a declaratory judgment as to whether the automatic stay applies to
actions taken by Citicorp with respect to the Retained Bonds.
On March 11, 1999, the Company finalized agreements with Citicorp and
Citibank pursuant to which the parties agreed to adjourn the pending
litigation for a four month period. One of the agreements also provides that
Salomon Smith Barney, in cooperation with CRIIMI MAE, will sell two classes
of investment grade CMBS from CMO-IV constituting a portion of the collateral
securing advances under the Citicorp financing arrangements. In addition,
Citibank, in cooperation with CRIIMI MAE, will sell commercial mortgages
originated last year under the Citibank Program, provided that the sale
results in CRIIMI MAE receiving minimum net proceeds of not less than $3.5
million, after satisfying certain amounts due to Citibank, from the amount
held in the reserve account. The minimum net proceeds provision may be waived
by agreement of the Company, the Unsecured Committee and the Equity
Committee. The agreements with Citicorp and Citibank were approved by the
Bankruptcy Court by stipulations and consent orders entered on April 5, 1999.
A related interpleader action between Norwest, the Company and Citicorp,
which was initiated on October 20, 1998 by Norwest to determine whether the
Company or Citicorp is the rightful owner of funds that were to have been paid
by Norwest, as indenture trustee, remains pending before the Bankruptcy Court.
During the pendency of this matter, certain payments on the related bonds are
held in an account controlled by the Bankruptcy Court. No trial date has been
set for this matter.
ARRANGEMENTS WITH OTHER CREDITORS
In addition to the foregoing, the Company has had discussions with other
secured creditors against whom the Company was not engaged in litigation. One
such creditor is German American Capital Corporation ("GACC"). On February 3,
1999, the Bankruptcy Court approved an Amended Consent Order between the
Company and GACC that provides for the following: (a) acknowledgement that
GACC has a valid perfected security interest in its collateral; (b) authority
for GACC to hedge its loan, subject to a hedge cost cap; and (c) as adequate
protection, sharing of cash collateral on a 50/50 basis, after payment of
interest expense, with the percentage received by GACC to be applied to
reduce principal and pay certain hedge costs, if any. In addition, the
Company is prohibited from using GACC's cash collateral for certain purposes,
including loan originations and Subordinated CMBS acquisitions.
The Company has also had discussions with First Union National Bank ("First
Union"). First Union, a creditor of both the Company and CM Management, is
asserting substantial secured and unsecured claims. On or about March 23, 1999,
First Union filed in each of the Company's and CM Management's Chapter 11 cases
a motion for relief from the automatic stay pursuant to section 362(d) of the
United States Bankruptcy Code. On or about March 26, 1999, First Union requested
that the Court dismiss without prejudice both motions. The Company
22
and First Union continue to have discussions aimed at resolving the open issues
between the parties, including, but not limited to, the validity of First
Union's liens, adequate protection of First Union's interests and an appropriate
sharing of what First Union asserts is its cash collateral. There can, however,
be no assurance that the Company and First Union will reach an agreement.
SHAREHOLDER LITIGATION
The Company is aware that certain plaintiffs (collectively, the
"Plaintiffs") filed 20 separate class action civil lawsuits (the "Complaints")
in the United States District Court for the District of Maryland (the "District
Court") against certain officers and directors of the Company between October 7,
1998 and November 30, 1998. Two additional complaints filed in other Federal
Courts have been dismissed without prejudice. The Complaints name as defendants
William B. Dockser, as Chairman of the Board of Directors of CRIIMI MAE, and H.
William Willoughby as a member of the Board of Directors and/or an officer of
CRIIMI MAE. In addition, a majority of the Complaints name Cynthia O. Azzara as
a defendant as an officer of CRIIMI MAE. Several of the Complaints also name
Garrett G. Carlson, Sr., G. Richard Dunnells and Robert J. Merrick as defendants
as members of both the Board of Directors and the Audit Committee of CRIIMI MAE.
Although CRIIMI MAE and CM Management have not been named as defendants, both
companies are subject to indemnity obligations to the defendants under the
provisions of their respective constituent documents and applicable state law
and, with respect to Messrs. Dockser and Willoughby and Ms. Azzara, their
employment contracts. CRIIMI MAE has directors and officers liability insurance
policies that have a combined coverage limit of $20 million.
Each Complaint alleges generally that the named defendants violated Section
10(b) of the Securities and Exchange Act of 1934, as amended (the "Exchange
Act") by, among other things, making false statements of material facts and
failing to disclose certain material facts concerning, among other things,
CRIIMI MAE's ability to meet the earnings estimates of analysts and to meet
collateral calls from lenders. The Complaints also generally allege that the
named defendants violated Section 20(a) of the Exchange Act because each named
defendant was allegedly a "controlling person" as that term is defined under
Section 20(a).
The relief sought in each Complaint includes all or substantially all of
the following: (i) certification of a class under Rule 23 of the Federal Rules
of Civil Procedure; (ii) certification of the named plaintiff as a class
representative and/or as lead plaintiff and its counsel as lead counsel and/or
class counsel; (iii) entry of a finding that the defendants violated federal
law, including federal securities laws; (iv) award of monetary damages,
including compensatory and rescissionary damages against all defendants jointly
and severally, including punitive damages where appropriate, and pre-judgment
and post-judgment interest running from the date of the wrongs alleged to the
date of judgment; (v) award to the plaintiff of costs, expenses and
disbursements incurred in the action, including reasonable attorneys' fees and
experts' fees; (vi) award to the plaintiff of extraordinary, equitable and/or
injunctive relief as permitted by law, equity, and federal statutory provisions
and state law remedies to attach, impound or otherwise restrict the defendants'
assets; (vii) award to the plaintiff of such other relief as the District Court
deems just and proper or as the District Court otherwise requires; and (viii)
trial by jury.
A group of putative members of the class of individuals who allegedly
suffered damages, as described in the Complaints, filed a motion requesting the
District Court to appoint a group of 13 individual Plaintiffs as lead plaintiffs
under the Private Securities Litigation Reform Act of 1995 (the "Motion"). The
Motion also requests the District Court, to approve, among other things, certain
law firms as counsel to the lead plaintiffs and the consolidation of the twenty
(20) pending law suits into a single action. Defendants Dockser, Willoughby and
Azzara have opposed the Motion to the extent that it seeks appointment of lead
plaintiffs and approval of their selection of counsel. On March 9, 1999, the
District Court ordered the consolidation of the Complaints. The District Court
deferred a decision on the Motion, to the extent that it seeks the appointment
of lead plaintiffs and approval of their selection of counsel, until a later
date.
CRIIMI MAE and the defendants are continuing to investigate the allegations
in the Complaints. The defendants intend to defend vigorously the claims
asserted in the Complaints. CRIIMI MAE cannot predict with any degree of
certainty the ultimate outcome of such litigation.
23
EDGE PARTNERS SETTLEMENT
In February 1996, Edge Partners, L.P. ("Edge Partners"), on behalf of
CRIIMI MAE, filed a First Amended Class and Derivative Complaint (the
"Derivative Complaint") in the United States District Court for the District of
Maryland, Southern Division (the "District Court"). The Derivative Complaint
named as defendants each of the individuals who served on the CRIIMI MAE board
of directors at the time of the Merger and CRIIMI MAE as a nominal defendant.
The Company was subject to indemnity obligations to the directors under
provisions of its constituent documents. In addition, the Company had directors
and officers liability insurance policies with a combined coverage limit of $5
million.
Count I of the Derivative Complaint alleged violations of Section 14(a) of
the Exchange Act for issuing a materially false and misleading proxy in
connection with the Merger and alleged derivatively on behalf of CRIIMI MAE a
breach of fiduciary duty owed to CRIIMI MAE and its shareholders. Edge Partners
sought, among other relief, that unspecified damages be accounted to CRIIMI MAE,
that the shareholder vote in connection with the Merger be null and void and
that certain salaries and other remuneration paid to the directors be returned
to the Company.
On June 16, 1998, the District Court approved a settlement agreement (the
"Settlement Agreement"). Under the terms of the Settlement Agreement, the
Company agreed to make certain disclosures relating to alleged conflicts between
two directors and the Company in connection with the Merger transaction and
adopted a non-binding policy relating generally to the approval of certain
interested transactions. Among other things, the non-binding policy adopted by
the Company's board of directors imposes certain conditions on the board's
approval of transactions between the Company and any director, officer or
employee who owns greater than 1% of the outstanding common shares of the
Company. Such conditions generally include: (1) approval by written resolution
of any transaction involving an amount in excess of $5 million in any year
adopted by a majority of the members of the board having no personal stake in
the transaction; and (2) in the case of any such transaction in excess of $15
million in any year, consideration by the board as to the formation of a special
committee of the board, to be comprised of at least two directors having no
personal stake in such transaction.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to the security holders to be voted on during the
fourth quarter of 1998.
24
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS
MARKET DATA
CRIIMI MAE's common stock is listed on the New York Stock Exchange (symbol
CMM). As of March 16, 1999, there were approximately 2,282 holders of record
of the Company's common stock. The following table sets forth the high and low
closing sales prices and the dividends per share for CRIIMI MAE's common stock
during the periods indicated:
1998
- ---------------------------------------------------------------------------------------------
Sales Price Dividends
Quarter Ended High Low per Share
- ------------------ ------------ ------------ ----------------------
March 31 $16 1/16 $ 14 7/8 $ 0.37
June 30 15 3/4 13 7/8 0.40
September 30 14 15/16 8 5/8 0.40
December 31 7 1/8 1 1/4 -(1)
---------
$ 1.17
---------
---------
1997
- ---------------------------------------------------------------------------------------------
Sales Price