SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE ----- SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2003 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE ----- SECURITIES EXCHANGE ACT OF 1934 Commission File Number 1-13237 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY --------------------------------------------- (Exact name of Registrant as specified in its Trust Agreement) Delaware 13-3949418 ------------------------------- ------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 625 Madison Avenue, New York, New York 10022 --------------------------------------- ------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (212) 421-5333 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 whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes X No --- --- PART I - FINANCIAL INFORMATION Item 1. Financial Statements CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Dollars in thousands) =============== =============== March 31, December 31, 2003 2002 --------------- --------------- (Unaudited) ASSETS Revenue bonds-at fair value $1,551,808 $1,579,590 Other investments 29,782 44,096 Mortgage servicing rights 36,072 35,595 Cash and cash equivalents 74,923 55,227 Cash and cash equivalents-restricted 5,444 5,257 Interest receivable - net 8,550 9,020 Promissory notes and mortgages receivable 50,463 53,278 Deferred costs - net of amortization of $9,468 and $8,451 48,880 48,693 Goodwill 4,793 4,793 Other intangible assets - net of amortization of $1,867 and $1,750 11,199 11,316 Other assets 9,390 6,003 --------- --------- Total assets $1,831,304 $1,852,868 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Financing arrangements $ 671,164 $ 671,659 Notes payable 71,349 68,556 Interest rate derivatives 4,936 5,504 Accounts payable, accrued expenses and other liabilities 12,511 32,378 Deferred income 8,274 8,998 Due to Manager and affiliates 3,054 4,126 Deferred tax liability 9,586 10,790 Distributions payable 19,367 19,020 --------- --------- Total liabilities 800,241 821,031 --------- --------- Preferred shares of subsidiary (subject to mandatory repurchase) 273,500 273,500 --------- --------- Minority interest in consolidated subsidiary 5,718 4,822 --------- --------- Commitments and contingencies Shareholders' equity: Beneficial owners' equity - convertible CRA share-holders (3,835,002 shares, issued and outstanding in 2003 and 2002, respectively) 58,332 58,174 Beneficial owner's equity-manager 1,128 1,126 Beneficial owners' equity-other common shareholders (100,000,000 shares authorized; 41,228,527 issued and 41,220,127 outstanding and 41,168,618 shares issued and 41,160,218 outstanding in 2003 and 2002, respectively) 606,867 604,496 Treasury shares of beneficial interest (8,400 shares) (103) (103) Accumulated other comprehensive income 85,621 89,822 --------- --------- Total shareholders' equity 751,845 753,515 --------- --------- Total liabilities and shareholders' equity $1,831,304 $1,852,868 ========= ========= See accompanying notes to consolidated financial statements 2 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Dollars in thousands except per share amounts) (Unaudited) ========================= Three Months Ended March 31, ------------------------- 2003 2002 ------------------------- Revenues: Interest income: Revenue bonds $ 26,250 $ 22,920 Other interest income 837 1,625 Promissory notes and mortgages receivable 181 163 Mortgage banking fees 941 1,656 Mortgage servicing fees 2,126 1,853 Other income 1,586 586 ------------ ---------- Total revenues 31,921 28,803 ------------ ---------- Expenses: Interest expense 3,816 3,991 Recurring fees relating to the Private Label Tender Option Program 963 727 Bond servicing 1,015 766 General and administrative 6,039 5,599 Depreciation and amortization 1,687 2,240 ------------ ---------- Total expenses 13,520 13,323 ------------ ---------- Income before gain (loss) on repayment of revenue bonds, gain on sales of loans and equity in earnings of ARCap 18,401 15,480 Equity in earnings of ARCap 555 547 Gain on sales of loans 2,139 3,287 Gain (loss) on repayment of revenue bonds (412) 3,757 ------------ ---------- Income before allocation to preferred shareholders of subsidiary and minority interest 20,683 23,071 Income allocated to preferred shareholders of subsidiary (4,724) (3,764) Income allocated to minority interest (28) (302) ------------ ---------- Income before benefit (provision) for income taxes 15,931 19,005 Benefit (provision) for income taxes 1,976 (181) ------------ ---------- Net income $ 17,907 $ 18,824 ============ ========== Allocation of net income to: Special distribution to manager $ 1,411 $ 1,088 ============ ========== Manager $ 2 $ 177 ============ ========== Common shareholders $ 15,089 $ 16,707 Convertible CRA shareholders 1,405 852 ------------ ---------- Total for shareholders $ 16,494 $ 17,559 ============ ========== Net income per share Basic $ .37 $ .45 ============ ========== Diluted $ .37 $ .45 ============ ========== Weighted average shares outstanding: Basic 45,013,292 38,781,464 ============ ========== Diluted 45,070,595 38,845,985 ============ ========== See accompanying notes to consolidated financial statements 3 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (Dollars in thousands) (Unaudited) Beneficial Beneficial Owners' Owners' Treasury Accumulated Equity Beneficial Equity- Shares Other Convertible Owner's Other of Comprehensive CRA Equity Common Beneficial Comprehensive Income Shareholders Manager Shareholders Interest Income (Loss) Total ------------ ----------- ------------ ---------- ------------- ------------- -------- Balance at January 1, $ 58,174 $ 1,126 $ 604,496 $ (103) $ 89,822 $753,515 2003 Comprehensive income: Net income 1,405 1,413 15,089 $ 17,907 17,907 ------- Other comprehensive gain (loss): Net unrealized gain 602 on interest rate derivatives Net unrealized loss on revenue bonds: Unrealized holding (5,215) loss arising during the period Less: Reclassification adjustment for net loss included in net income 412 ------- Total other comprehensive loss (4,201) (4,201) (4,201) ------- Total comprehensive $ 13,706 income ======= Options exercised 679 679 Distributions (1,247) (1,411) (13,397) (16,055) -------- ------- ------- ---- ------- ------ Balance at March 31, 2003 $ 58,332 $ 1,128 $606,867 $(103) $ 85,621 $751,845 ======== ======= ======= ==== ======= ======= See accompanying notes to consolidated financial statements 4 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands) (Unaudited) ============================== Three Months Ended March 31, ------------------------------ 2003 2002 ------------- ------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 17,907 $ 18,824 Adjustments to reconcile net income to net cash provided by operating activities: Loss (gain) on repayment of revenue bonds 412 (3,757) Other amortization 370 200 Amortization of other intangible assets 118 118 Amortization of bond selection costs 650 599 Amortization of mortgage servicing rights 1,335 1,968 Income allocated to preferred shareholders of subsidiary 4,724 3,764 Equity in earnings of ARCap, in excess of distributions received -- (97) Increase in mortgage servicing rights (1,812) (2,682) Income allocated to minority interest 28 302 Issuance of shares of subsidiary-compensation expense 867 -- Increase in mortgages receivable (2,793) (17,551) Changes in operating assets and liabilities: Interest receivable 470 (388) Other assets (3,387) (61) Increase in goodwill -- (27) Guaranteed investment contracts 14,314 47 Deferred income (724) -- Accounts payable, accrued expenses and other liabilities (19,858) 1,074 Deferred tax liability (1,204) 181 Due to Manager and affiliates (1,203) 49 Fair value of interest rate cap 34 (216) ---------- ----------- Net cash provided by operating activities 10,248 2,347 ---------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from repayments of revenue bonds 18,853 75,650 Periodic principal payments of revenue bonds 6,750 968 Purchase/advances to revenue bonds (3,050) (28,375) Increase in deferred bond selection costs (63) (859) Increase in temporary investments -- (88,570) (Increase) decrease in cash and cash equivalents - restricted (187) 141 Loans made to properties (1,839) (862) Principal payments received from loans made to properties 7,448 809 ---------- ----------- Net cash provided by (used in) investing activities 27,912 (41,098) ---------- ----------- Continued 5 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands) (Unaudited) ============================== Three Months Ended March 31, ------------------------------ 2003 2002 ------------- ------------- CASH FLOWS FROM FINANCING ACTIVITIES: Distributions paid to the Manager and Common shareholders (14,421) (11,476) Distributions paid to preferred shareholders of subsidiary (4,724) (3,693) Distributions paid to Convertible CRA shareholders (1,125) (565) Principal repayments of financing arrangements (495) (15,603) Increase in notes payable 2,793 17,551 Increase in deferred costs relating to the Private Label Tender Option Program (290) (35) Options exercised 649 92,587 Increase in other deferred costs (851) (218) -------- --------- Net cash (used in) provided by financing activities (18,464) 78,548 -------- --------- Net increase in cash and cash equivalents 19,696 39,797 Cash and cash equivalents at the beginning of the period 55,227 105,364 -------- --------- Cash and cash equivalents at the end of the period $ 74,923 $ 145,161 ======== ========= SUPPLEMENTAL INFORMATION: Interest paid $ 4,414 $ 2,502 ======== ========= Taxes paid $ 103 $ 9 ======== ========= See accompanying notes to consolidated financial statements 6 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2003 (Unaudited) NOTE 1 - General Charter Municipal Mortgage Acceptance Company ("CharterMac"), along with its consolidated subsidiaries (the "Company"), is a Delaware statutory trust principally engaged in the acquisition and ownership (directly or indirectly) of tax-exempt multi-family housing revenue bonds ("Revenue Bonds") and other investments that produce tax-exempt income, issued by various state or local governments, agencies, or authorities. The Company is also engaged in providing credit enhancements and yield guarantees, and originates loans for multi-family housing through its subsidiary PW Funding Inc. ("PWF"). Revenue Bonds are primarily secured by participating and non-participating first mortgage loans on underlying properties ("Underlying Properties"). In some cases the Company also acquires smaller taxable loans in conjunction with acquiring a Revenue Bond. The Company is governed by a board of trustees comprised of three independent managing trustees and five managing trustees who are affiliated with Related Capital Company ("Related"), a nationwide, fully integrated real estate financial services firm. CharterMac, through CharterMac Corporation ("CM Corp."), a wholly-owned subsidiary, has engaged Related Charter L.P. (the "Manager"), an affiliate of Related, to manage its day-to-day affairs. CharterMac has also directly engaged the Manager to provide additional management services. The consolidated financial statements include the accounts of CharterMac and four subsidiary statutory trusts which it controls: CM Holding Trust, CharterMac Equity Issuer Trust, CharterMac Origination Trust I and CharterMac Owner Trust I, and one wholly-owned corporation, CM Corp. CM Corp. owns 80% of PW Funding Inc. ("PWF"), which is also included in the consolidated financial statements. All intercompany accounts and transactions have been eliminated in consolidation. Unless otherwise indicated, the "Company", as hereinafter used, refers to Charter Municipal Mortgage Acceptance Company and its consolidated subsidiaries. The accompanying interim financial statements have been prepared without audit. In the opinion of management, the financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the financial statements of the interim periods. However, the operating results for the interim periods may not be indicative of the results for the full year. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") have been condensed or omitted. It is suggested that these financial statements should be read in conjunction with the financial statements and notes thereto included in the Company's Form 10-K for the year ended December 31, 2002. The consolidated financial statements of the Company are prepared using the accrual method of accounting in conformity with GAAP, which requires the Manager to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates in the financial statements include the valuation of the Company's investments in Revenue Bonds, mortgage servicing rights ("MSRs") and interest rate derivatives. On December 18, 2002, the Company announced it had entered into an agreement to acquire 100% of the ownership interests in and substantially all of the businesses operated by Related (other than specific excluded interests). The acquisition will enable the Company to terminate its outside management agreement with the Manager and to become an internally-managed company. Certain amounts in the 2002 financial statements have been reclassified to conform to the 2003 presentation. 7 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2003 (Unaudited) Significant Accounting Policies ------------------------------- Investment in Revenue Bonds and Promissory Notes Receivable The Company accounts for its investments in Revenue Bonds as available-for-sale debt securities under the provisions of Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115"). Accordingly, the Revenue Bonds are carried at their estimated fair values, with unrealized gains and losses reported in other comprehensive income. In most cases, the Company has a right to require redemption of the Revenue Bonds prior to their maturity, although it can and may elect to hold them up to their maturity dates unless otherwise modified. As such, SFAS 115 requires the Company to classify these investments as "available-for-sale." Accordingly, investments in Revenue Bonds are carried at their estimated fair values, with unrealized gains and losses reported in other comprehensive income. Unrealized gains or losses do not affect the cash flow generated from property operations, distributions to shareholders, the characterization of the tax-exempt income stream or the financial obligations under the Revenue Bonds. If, in the judgment of the manager, it is determined probable that the Company will not receive all contractual payments required, when they are due, the bond is deemed impaired and is written down to its then estimated fair value, with the amount of the write-down accounted for as a realized loss. Because Revenue Bonds have a limited market, the Company estimates fair value for each bond as the present value of its expected cash flows using a discount rate for comparable tax-exempt investments. This process is based upon projections of future economic events affecting the real estate collateralizing the bonds, such as property occupancy rates, rental rates, operating cost inflation, market capitalization rates and determination of an appropriate market rate of interest, all of which are based on good faith estimates and assumptions developed by the Manager. Changes in market conditions and circumstances may occur which would cause these estimates and assumptions to change; therefore, actual results may vary from the estimates and the variance may be material. Occasionally, the Company has advanced funds to owners of certain Underlying Properties in order to preserve the underlying asset due to difficulties including construction completion, past due real estate taxes and/or deferred maintenance. Such advances are typically secured by promissory notes and/or second mortgages and are carried at cost less a valuation allowance as may be periodically deemed appropriate. In some cases, an actual note was issued which was recorded as a separate note receivable. In each of these instances, the ability of the borrower to repay was examined and appropriate allowances were established. At March 31, 2003, each of these notes was fully reserved. Alternatively, when a cash advance is made, the Company establishes a contra-income account, which was reduced as cash payments for interest income were received. The Company currently has no outstanding advances that utilize this method. Other Investments Other investments include the following items: Investment in ARCap - The Company's preferred equity investment in ARCap Investors, L.L.C. ("ARCap") is accounted for using the equity method because the Company has the ability to exercise significant influence, but not control, over ARCap's operating and financial policies. Guaranteed Investment Contracts - The Company, through PWF, is participating in the Fannie Mae "Guaranteed Investment Agreement Rate Lock Loan Financing" program for properties which are in the construction phase. Under this program, Fannie Mae commits to a fixed interest rate on a permanent loan, which will be closed at the completion of the construction phase of the project. The rate lock forward commitment provided by Fannie Mae exists for a maximum 8 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2003 (Unaudited) period of twenty-four months. Fannie Mae loans the Company the amount of the future permanent loan, which is required to be deposited in a guaranteed investment contract during the construction phase. In exchange for such loan, the Company issues Fannie Mae a promissory note whose interest will be paid from the interest on the guaranteed investment contract and the negative arbitrage paid by the borrower. The interest rate on the note will be equivalent to the fixed rate committed to on the permanent loan. At the close of the construction phase, the Company will unwind the guaranteed investment contract to repay the note to Fannie Mae. The Company will originate the permanent loan to the borrower at the rate locked amount, which will be subsequently purchased from the Company by Fannie Mae. The Company has commitments from Fannie Mae under this program of approximately $5.3 million as of March 31, 2003. Temporary Investments - Temporary investments may consist of puttable floating option tax-exempt receipts, short-term senior securities which bear interest at a floating rate that is reset weekly and other short-term investments that generate tax-exempt and taxable interest income. These investments are recorded at cost which is equal to market value. Cash and Cash Equivalents Cash and cash equivalents includes cash in banks and investments in short-term instruments with an original maturity of three months or less. Certain amounts of cash and cash equivalents are restricted and serve as additional collateral for borrowings under securitizations. Mortgage Banking Activities PWF is an approved seller/servicer of multifamily mortgage loans for Federal National Mortgage Association ("Fannie Mae"), Federal Home Loan Mortgage Corporation ("Freddie Mac") and the Government National Mortgage Association ("Ginnie Mae"). For Fannie Mae, PWF is approved under the Delegated Underwriting and Servicing ("DUS") program. Under DUS, upon obtaining a commitment from Fannie Mae with regard to a particular loan, Fannie Mae commits to acquire the mortgage loan based upon PWF's underwriting and PWF agrees to bear a portion of the risk of potential losses in the event of a default. Fannie Mae commitments may be made to acquire the mortgage loan for cash or in exchange for a mortgage backed security backed by the mortgage loan. As a Program Plus lender for Freddie Mac, Freddie Mac agrees to acquire for cash from PWF loans for which PWF has issued commitments. Ginnie Mae agrees to exchange FHA-insured mortgages originated by PWF for Ginnie Mae securities. Mortgage loans originated for Fannie Mae, Freddie Mac or Ginnie Mae are closed in the name of PWF and PWF uses corporate cash obtained by borrowing from a warehouse lender to fund the loans. Approximately a week to a month following closing of a loan, loan documentation and an assignment are delivered Fannie Mae, Freddie Mac or Ginnie Mae, or a document custodian on its behalf, and the cash purchase price or mortgage backed security is delivered to PWF. Cash is used to repay warehouse loans and mortgage backed securities are sold pursuant to prior agreements for cash which is used to repay warehouse loans. PWF also underwrites and originates multifamily and commercial mortgages for insurance companies and banks. PWF receives a fee ranging from 50bps to 100bps for its underwriting and origination services, included in mortgage servicing fees in the Consolidated Statements of Income. Neither the Company nor PWF retains any interest in any of the mortgage loans, except for mortgage servicing rights and certain liabilities under the loss-sharing arrangement with Fannie Mae. 9 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2003 (Unaudited) Since the inception of the Fannie Mae DUS product line in 1988, PWF has closed over $2.9 billion of mortgage loans. At March 31, 2003, PWF serviced Fannie Mae loans of approximately $1.9 billion and had received commitments from Fannie Mae on two loans totaling approximately $11.7 million. A substantial portion of the underlying properties subject to these mortgages are located in California. PWF also services loans with face values of approximately $108.4 million under other Fannie Mae non-risk sharing programs. As of March 31, 2003, PWF serviced approximately $375.3 million of loans under the FHA 223(f), 232, and 242 Programs, of which approximately $129.1 million had GNMA securities outstanding. At March 31, 2003, PWF serviced approximately $613.7 million of Freddie Mac loans in its portfolio. A substantial portion of the underlying properties subject to these mortgages are located in New Jersey. At March 31, 2003, PWF serviced approximately $165.2 million of loans made on behalf of banks or insurance companies in its portfolio. The Company does not hold any of the mortgages serviced by PWF. Mortgage Servicing Rights The Company recognizes as assets the rights to service mortgage loans for others, whether the MSRs are acquired through a separate purchase or through loan origination, by allocating total costs incurred between the MSRs retained based on their relative fair value. MSRs are being carried at their adjusted cost basis. MSRs are amortized in proportion to, and over the period of, estimated net servicing income. SFAS No. 140 also requires an entity to record the impairment of MSRs based on the difference between the carrying amount of the MSRs and their current fair value. Impairment of MSRs is recognized in the Consolidated Statements of Income during the applicable period through additions to a valuation allowance. The amount of impairment recognized is the amount by which the capitalized MSRs exceed their fair value. Subsequent to the initial measurement of impairment, the valuation allowance is adjusted to reflect changes in impairment. Fair value in excess of the amount capitalized as MSRs (net of amortization), however, is not recognized. For the purpose of evaluating and measuring impairment of capitalized MSRs, the Company stratifies those rights based on the predominant risk characteristics of the underlying loans. The Company maintains an allowance for loan losses for loans originated by PWF under the Fannie Mae DUS product line at a level that, in management's judgment, is adequate to provide for estimated losses. This reserve was approximately $4.5 million and $4.3 million at March 31, 2003 and December 31, 2002, respectively. Loss reserves are only recorded for loans for which PWF has a potential loss obligation, i.e., DUS loans. The monthly amount of reserves recorded is initially a mechanical calculation - 25bp for each DUS loan. The level of the reserve is reviewed quarterly by PWF management to identify any significant misstatement. On an annual basis, PWF utilizes the results of the current year's Financial Analysis of Operations to stratify the at-risk portfolio by debt service coverage ("DSC"). The entire DUS portfolio is used, including loans that have been closed but are not yet settled. The totals in each DSC category are multiplied by a default percentage and then further by an expected loss percentage to result in the minimum required reserve. The default percentage is an estimate made by management; it has an inverse relationship with the DSC (the higher the DSC, the lower the default percentage). The expected loss percentage is also a 10 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2003 (Unaudited) management estimate, but it is based upon the actual loss experience of the company. Historically, for Level 1 loans, (see Note 7), the average loss size has been approximately 11%. The expected loss percentages are distributed so that a loan with a DSC just under the origination minimum (1.25 DSC) will have an expected loss percentage equal to this historical average. Lower DSC loans are anticipated to have higher losses since it is likely that the properties are performing below expectations, that PWF has made significant advances, and that the appraisal will be lower for loss calculation purposes. In order to test the adequacy of the reserve resulting from the above calculation, PWF performs sensitivity analysis to develop a "worst case" scenario. In this analysis, the default percentages are raised dramatically for low DSC loans. In fact, any loan below 1.0 DSC is assumed to have a default percentage of 100%. Only those loans with a DSC above 1.3 are not changed from the original set of assumptions. This "worst case" scenario provides a ceiling for the reserve. Based upon the annual calculation of reserves and the "worst case" scenario developed above, management, determines the appropriate amount of reserves to be recorded. In using this valuation model, the Company incorporated assumptions that market participants would use in estimating future net servicing income. The Company estimates the term of servicing for each loan by assuming that servicing would not end prior to the yield maintenance date, at which point the prepayment penalty expires. The Company provides an estimated default amount to be deducted in each year based on the borrower's debt service ratio. The debt service ratio is a measurement of the amount of excess cash flow a borrower has to make monthly mortgage payments. Purchased MSRs are measured initially at the price paid, which approximates fair value At March 31, 2003, the Company has not provided for impairment on any MSRs. Revenue Recognition The Company derives its revenues from a variety of investments and guarantees, summarized as follows: Interest Income from Revenue Bonds - Interest income is recognized at the stated rate as it accrues and when collectibility of future amounts is reasonably assured. Participating interest is recognized when received. Interest income from Revenue Bonds with modified terms or where the collectibility of future amounts is uncertain is recognized based upon expected cash receipts. Certain construction Revenue Bonds carry a higher interest rate during the construction period, which declines to a lower rate for the balance of the term. In these cases, the Company calculates the effective yield on the Revenue Bond and uses that rate to recognize interest over the life of the bond. Interest Income from Promissory Notes and Mortgages Receivable - Interest on mortgage loans and notes receivable is recognized on the accrual basis as it becomes due. Deferred loan origination costs and fees are amortized over the life of the applicable loan as an adjustment to interest income, using the interest method. Interest which was accrued is reversed out of income if deemed to be uncollectible. Interest Income on Temporary Investments - Interest income from temporary investments, such as cash in banks and short-term instruments, is recognized on the accrual basis as it becomes due. Equity in Earnings of ARCap - The Company's equity in the earnings of ARCap Investors, LLC ("ARCap") is accrued at the Company's preferred dividend rate of 12%, unless ARCap does not have earnings and cash flows adequate to meet this dividend requirement. Construction Service Fees - The Company receives fees, in advance, from borrowers for servicing Revenue Bonds during the construction period. These fees are deferred and amortized into other income over the anticipated construction period. 11 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2003 (Unaudited) Credit Enhancement and Guarantee Fees - The Company receives fees for providing credit enhancement and guaranteed yields. The credit enhancement fees are received monthly and recognized in other income when received. The guarantee fees are deferred and recognized in other income on a prorata basis over the guarantee period. Mortgage Banking Fees - PWF fees earned for arranging financings under the FNMA DUS product line as well as Freddie Mac, insurance and banking or other programs are recorded at the point the financing commitment is accepted by the mortgagor and the interest rate of the mortgage loan is fixed. Mortgage Servicing Fees - PWF receives fees for servicing the loans it has originated. This income is recognized on an accrual basis. Deferred Costs Fees paid to the Manager (see Note 5) for its activities performed to originate Revenue Bonds, including their evaluation and selection, negotiation of mortgage loan terms, coordination of property developers and government agencies, and other direct expenditures of acquiring or investing in Revenue Bonds, are capitalized and amortized as a reduction to interest income over the terms of the Revenue Bonds. Direct costs relating to unsuccessful acquisitions and all indirect costs relating to the Revenue Bonds are charged to operations. Costs incurred in connection with the Company's TOP, such as legal, accounting, documentation and other direct costs, have been capitalized and are being amortized using the straight-line method over 10 years, which approximates the average remaining term to maturity of the Revenue Bonds in this program. Costs incurred in connection with the issuance of cumulative preferred shares of subsidiary, such as legal, accounting, documentation and other direct costs, have been capitalized and are being amortized using the straight line method over the period to the mandatory repurchase date of the shares, approximately 50 years. Costs incurred in connection with the issuance of Convertible CRA Shares, such as legal, accounting, documentation and other direct costs, have been accounted for as an offset to beneficial owners' equity of such shares. Financial Risk Management and Derivatives The Company has entered into two interest rate swaps, an interest rate cap and two forward commitments, all of which are accounted for under the Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities", as amended and interpreted. The Company designated the two interest rate swaps as cash flow hedges on the variable interest payments in the floating rate financing. Accordingly, the interest rate swaps are recorded at their fair market values each accounting period, with changes in market values being recorded in other comprehensive income to the extent the hedges are effective in achieving offsetting cash flows. These hedges have been highly effective, so there has been no ineffectiveness included in earnings. The interest rate cap, although designed to mitigate the Company's exposure to rising interest rates, was not designated as a hedging derivative; therefore, any change in fair market value flows through the Consolidated Statements of Income, where it is included in interest income. The two forward commitments create derivative instruments under SFAS No. 133, which have been designated as a cash flow hedge of the anticipated funding of the Revenue Bonds and will be recorded at fair value, with changes in fair value recorded in other comprehensive income until the Revenue Bonds are funded. Fair Value of Financial Instruments As described above, the Company's investments in Revenue Bonds, its MSRs and its liability under the interest rate derivatives are carried at estimated fair values. The Company has determined that the fair value of its remaining financial instruments, including its temporary investments, cash and cash equivalents, promissory notes receivable, mortgage notes receivable and borrowings approximate their carrying values at March 31, 2003 and December 31, 2002. 12 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2003 (Unaudited) Income Taxes Effective July 1, 2001, the Company began operation of a new wholly-owned, taxable subsidiary -- CM Corp., which on December 31, 2001, purchased PWF. CM Corp. will conduct most of the Company's taxable business, including any fee-generating activities in which the Company may engage and provide management services to CharterMac and its other subsidiaries. The Company provides for income taxes in accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("FAS 109"). FAS 109 requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial statement carrying amounts and the tax basis of assets and liabilities. New Pronouncements ------------------ In April 2002, the FASB issued SFAS No. 145 "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical Corrections". SFAS No. 145, among other things, rescinds SFAS No. 4, "Reporting Gains and Losses from Extinguishment of Debt", and accordingly, the reporting of gains or losses from the early extinguishments of debt as extraordinary items will only be required if they meet the specific criteria of extraordinary items included in Accounting Principles Board Opinion No. 30, "Reporting the Results of Operations". The revision of SFAS No. 4 became effective January 2003. The implementation of SFAS No. 145 did not have a material impact on the Company's consolidated financial statements. In July 2002, the FASB issued SFAS No. 146 "Accounting for Costs Associated with Exit or Disposal Activities". SFAS No. 146 replaces current accounting literature and requires the recognition of costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. SFAS No. 146 became effective January 1, 2003. The implementation of SFAS No. 146 did not have a material impact on the Company's consolidated financial statements. In November 2002, the FASB issued Interpretation No. 45, "Guarantors' Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." The Interpretation elaborates on the disclosures to be made by a guarantor in its financial statements about its obligations under certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. This Interpretation does not prescribe a specific approach for subsequently measuring the guarantor's recognized liability over the term of the related guarantee. The initial recognition and initial measurement provisions of this Interpretation are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The Company has entered into one credit enhancement transaction and two yield guarantee transactions. The fee for the credit enhancement transaction is received monthly and recognized as income when due. The fee for the first yield guarantee transaction was received in advance, was deferred and is being amortized over the guarantee period. The Company believes that the fees received approximate the fair value of the obligations undertaken in issuing the guarantees; therefore, for any such similar transactions entered into after December 31, 2002, the Company will record the fair market value of the guarantee, when entered into. In December 2002, the FASB issued SFAS No. 148 "Accounting for Stock-Based Compensation-Transition and Disclosure," an amendment of FASB statement No. 123. This statement amends SFAS No. 123, "Accounting for Stock-Based Compensation" to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employer compensation. Because the Company currently accounts for its share options using the fair value method, implementation of this statement did not have an impact on the Company's consolidated financial statements. The Company has adopted the provisions of SFAS No. 123, "Accounting for Stock-Based Compensation" for its share options issued to non-employees. Accordingly, compensation cost is accrued based on the estimated fair value of the options issued, and amortized over the vesting period. Because vesting of the options is contingent upon the recipient continuing to provide services to the Company until the vesting date, the Company estimates the fair value of the non-employee options at each period-end up to the vesting date, and 13 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2003 (Unaudited) adjusts expensed amounts accordingly. The fair value of each option grant is estimated using the Black-Scholes option-pricing model. In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"). This Interpretation clarifies the application of existing accounting pronouncements to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The provision of FIN 46 will be immediately effective for all variable interests in variable interest entities created after January 31, 2003, and the Company will need to apply its provisions to any existing variable interests in variable interest entities by no later than July 1, 2003. The Company believes at this time, it has no variable interests in variable interest entities requiring consolidation. In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities". This Statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities and is effective for contracts entered into or modified after June 20, 2003. The Company is currently evaluating the impact that this Statement may have on its financial position and results of operations. NOTE 2 - Revenue Bonds Total interest income from Revenue Bonds, including participating interest, for the three months ended March 31, 2003 and 2002, were 6.99% and 8.02% based on weighted average face amounts of approximately $1,501,876,963 and $1,142,812,000, respectively. The amortized cost basis of the Company's portfolio of Revenue Bonds at March 31, 2003 and December 31, 2002 was $1,461,224,032 and $1,484,202,610, respectively. The net unrealized gain on Revenue Bonds in the amount of $90,583,968 at March 31, 2003 consisted of gross unrealized gains and losses of $98,640,060 and $8,056,092, respectively. The net unrealized gain on Revenue Bonds of $95,387,390 at December 31, 2002 consisted of gross unrealized gains and losses of $100,964,090 and $5,576,700, respectively. The following is a table reflecting the maturity dates of the Company's Revenue Bonds. (Dollars In Outstanding Fair thousands) Bond Amount Value -------------------------------------------------------------------------------- Due in less than one year $ 10,117 $ 11,480 Due between one and five years 38,979 36,727 Due after five years 1,424,131 1,503,601 -------------------------------------------------------------------------------- Total $ 1,473,227 $ 1,551,808 -------------------------------------------------------------------------------- All of the Company's Revenue Bonds have fixed interest rates. 2003 Transactions ----------------- During the three months ended March 31, 2003 the Company did not acquire any new Revenue Bonds, but did advance additional funds of approximately $3,050,000 to Revenue Bonds which were previously acquired. During the three months ended March 31, 2003, two Revenue Bonds were repaid. The Company received net proceeds of approximately $19.0 million. The bonds had a carrying value of approximately $19.4 million, resulting in a loss of approximately $412,000. During the second quarter of 2001, the borrowers of Lexington Trails failed to make the regular interest payments. As a result, the Company determined the bond was impaired, and wrote down the bond to its estimated fair value of approximately $5.5 million and took a loss on impairment of $400,000. During the fourth quarter of 2001, the Company caused the trustee, for the benefit of the Company, to foreclose on the underlying property. Negotiations for the sale of the underlying property began during the fourth quarter of 2002 at a sales price of approximately $4.5 million and the Company wrote this bond down to its fair value of $4.5 million in the fourth quarter of 2002, taking a loss of $932,000. In May 2002, the Company entered into a contract with an unaffiliated third party, to sell the underlying property securing the Lexington Trails Revenue Bond for a sales price of approximately $4.5 million. The Company expects the sale transaction to be completed, 14 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2003 (Unaudited) however, there can be no assurance that the Company will complete the transaction. NOTE 3 - Deferred Costs The components of deferred costs are as follows: (Dollars in Thousands) March 31, December 31, 2003 2002 ----------------- ----------------- Deferred bond selection costs (1) $ 34,873 $ 34,810 Deferred financing costs 8,320 8,030 Deferred costs relating to the issuance of preferred shares of subsidiary 10,445 10,445 Deferred costs relating to acquisition of Related 3,334 2,483 Other deferred costs 1,376 1,376 -------- -------- 58,348 57,144 Less: Accumulated amortization (9,468) (8,451) -------- -------- $ 48,880 $ 48,693 ======== ======== (1) This primarily represents the 2% bond selection fee paid to the Manager (see Note 5). NOTE 4 - Goodwill and Intangible Assets The Company adopted SFAS 141 on July 1, 2001 and SFAS 142, on January 1, 2002. The Company has determined that the amounts previously capitalized as goodwill relating to the initial formation of the Company and to the merger of American Tax Exempt Bond Trust, meet the criteria in SFAS 141 for recognition as intangible assets apart from goodwill, and accordingly will continue to be amortized over their remaining useful lives, subject to impairment testing. During the quarter ended June 30, 2002, PWF engaged a third party valuation firm to evaluate PWF's licenses with Fannie Mae, Freddie Mac, FHA, GNMA and various private investors. As a result of this process approximately $8.6 million has been reclassified from goodwill to intangible assets, representing the estimated market value of PWF's licenses. These licenses have an indefinite life and, as a result, are not being amortized. During 2002 and the three months ended March 31, 2003, the Company, pursuant to the original acquisition agreement, paid approximately $3.6 million in "true-up" payments representing payments due to the original PWF stockholders which was recorded as additional goodwill during the fourth quarter of 2002 . These true-up payments were based on i) the increase in the value of MSRs due to certain loans closing, ii) positive changes between the audited balance sheet used for the initial purchase price and the audited balance sheet at December 31, 2001, iii) payments of certain servicing fees, and iv) forward conversions of loans previously committed. The acquisition agreement stipulates additional true-up payments to be made periodically for a period of up to three years from the acquisition date. 15 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2003 (Unaudited) The following table provides further information regarding the Company's intangible assets: (Dollars in Thousands) Identifiable Other Intangible PWF Assets Licenses Total ------------- -------- ----- Balance at March 31, 2003 $ 4,427 $ 8,639 $ 13,066 Accumulated Amortization (1,867) - (1,867) ------ ------- ------ Net balance at March 31, 2003 $ 2,560 $ 8,639 $ 11,199 ======= ======= ======== Amortization Expense for the three months ended March 31, 2003 $ 118 $ - $ 118 ======= ======= ======== Estimated amortization expense per year for next five years $ 472 $ - $ 472 ======= ======= ======== The amortization is included as a reduction to Revenue Bond interest income. The amount indicated as goodwill in the accompanying consolidated financial statements as of March 31, 2003 is related to the acquisition, on December 31, 2001 of PWF. This amount represents goodwill under SFAS 142, and therefore, is not being amortized. In accordance with SFAS 142, the Company tested this goodwill for impairment during the fourth quarter of 2002 and determined there was no impairment. NOTE 5 - Related Party Transactions The Manager is entitled to subcontract its obligations under the Management Agreements to an affiliate. In accordance with the foregoing, the Manager has assigned its rights and obligations to Related. Pursuant to the terms of the Management Agreements, the Manager is entitled to receive the fees and other compensation set forth below: Fees/Compensation * Amount ----------------- ------ Bond Selection Fee 2.00% of the face amount of each asset invested in or acquired by CharterMac or its subsidiaries. Special 0.375% per annum of the total invested assets of Distributions/ CharterMac or its subsidiaries. Investment Management Fee Loan 0.25% per annum based on the outstanding face amount of Servicing Fee revenue bonds and other investments owned by CharterMac or its subsidiaries. Operating Expense For direct expenses incurred by the Manager Reimbursement in an amount not to exceed $950,978 per annum (subject to increase based on increases in CharterMac's and its subsidiaries' assets and to annual increases based upon increases in the Consumer Price Index). Incentive Share The Manager may receive options to acquire additional Options Common Shares pursuant to the Share Option Plan only if CharterMac's distributions in any year exceed $0.9517 per Common Share and the Compensation Committee of the Board of Trustees determines to grant such options. Liquidation Fee 1.50% of the gross sales price of the assets sold by CharterMac in connection with a liquidation of CharterMac assets supervised by the Manager. 16 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2003 (Unaudited) * The Manager is also permitted to earn miscellaneous compensation which may include, without limitation, construction fees, escrow interest, property management fees, leasing commissions and insurance brokerage fees. The payment of any such compensation is generally limited to the competitive rate for the services being performed. A bond placement fee of 1.0% to 1.5% of the face amount of each asset invested in or acquired by CharterMac or its subsidiaries is payable to the Manager by the borrower, and not by CharterMac or its subsidiaries. The terms of each of the management agreements is one year. The management agreements may be renewed, subject to evaluation of the performance of the Manager by CharterMac's Board of Trustees. Both agreements may be terminated (i) without cause by the Manager; or (ii) for cause by a majority of CharterMac's Board of Trustees, in each case without penalty and each upon 60 days prior written notice to the non-terminating party. The costs, expenses and the special distributions incurred to the Manager and its affiliates for the three months ended March 31, 2003 and 2002 were as follows: Three Months Ended March 31, ---------------------- (Dollars in thousands) ---------------------- 2003 2002 -------- -------- Bond selection fees $ -- $ 568 Special distribution/Investment Management fee 1,483 1,088 Bond servicing fees 1,015 766 Expense reimbursement 233 309 -------- ------- $ 2,731 $ 2,731 ======== ======= Certain of the Revenue Bonds held by the Company are supported by various guarantees including, but not limited to, construction and operating guarantees from affiliates of the Manager. During the quarter ended September 30, 2002, the Company agreed to back up a primary guarantor's obligation to guarantee an agreed-upon internal rate of return to the investor in Related Capital Guaranteed Corporate Partners II, L.P. ("RCGCP"). RCGCP is a fund sponsored by Related, which is an affiliate of the Manager. The Company is the beneficiary of a guarantee against losses associated with construction and operating stabilization for each of the properties in RCGCP, which is capped at $15 million. The guarantee has been provided by The Related Companies, L.P. ("TRCLP"), an affiliate of Related. If the Company's acquisition of Related is completed, then this guarantee will no longer be in force. In connection with the refinancing of River Run, the general partners of which are affiliates of the Manager, the Company entered into an agreement which allows the Revenue Bond to be put to the Company should the owner of the underlying property default on the bond. The Company, in turn, entered into agreements which allow the Company to put the bond to the general partners. The Company's put right is secured by collateral assignments of the general partners' partnership interests in the limited partnership which owns the underlying property. The Company has entered into a credit enhancement transaction with Merrill Lynch Capital Services ("MLCS"). TRCLP has provided the Company with an indemnity covering 50% of any losses incurred by the Company. NOTE 6 - Earnings Per Share Net income per share is computed in accordance with SFAS No. 128, "Earnings Per Share". Basic income per share is calculated by dividing income allocated to Common and Convertible CRA Shareholders ("Shareholders") by the weighted average number of Common and Convertible CRA Shares outstanding during the period. The Convertible CRA Shares are included in the calculation 17 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2003 (Unaudited) of shares outstanding as they share the same economic benefits as Common Shares, including payment of the same dividends per share as Common Shares. Diluted income per share is calculated using the weighted average number of shares outstanding during the period plus the additional dilutive effect of common share equivalents. The dilutive effect of outstanding share options is calculated using the treasury stock method. Pursuant to the Company's Trust Agreement and the Management Agreements with the Manager, the Manager is entitled, in its capacity as the general partner of the Company, to a special distribution equal to .375% per annum of the Company's total invested assets (which equals the face amount of the Revenue Bonds and other investments), payable quarterly. Income is allocated first to the Manager in an amount equal to the special distribution. The net remaining profits or losses, after a special allocation of .01% to the Manager, are then allocated to shareholders in accordance with their percentage interests. During the quarter ended September 30, 2002, the Company issued 40,000 options at a strike price of $17.56. These options vest equally, in thirds, in September 2003, 2004 and 2005 and expire in 10 years. These options were antidilutive for the three months ended March 31, 2003, so were not taken into account in the calculation of diluted shares. (Dollars in thousands) Three Months Ended March 31, 2003 ------------------------------------------ Income Shares Per Share Numerator Denominator * Amount ----------- ------------ --------- Net income allocable to share- holders (Basic EPS) 16,494 45,013,292 $ .37 ======== Effect of dilutive securities 168,136 stock options -- 57,303 ---------- ---------- Diluted net income allocable to shareholders (Diluted EPS) 16,494 45,070,595 $ .37 ========== ========== ======== (Dollars in thousands) Three Months Ended March 31, 2003 ------------------------------------------ Income Shares Per Share Numerator Denominator * Amount ----------- ------------ --------- Net income allocable to share- holders (Basic EPS) $ 17,559 38,781,464 $ .45 ======== Effect of dilutive securities 228,262 stock options - 64,521 ---------- ---------- Diluted net income allocable to shareholders (Diluted EPS) $ 17,559 38,845,985 $ .45 ========== ========== ======== * Includes Common and Convertible CRA Shares. NOTE 7 - Commitments and Contingencies Litigation The Company is subject to routine litigation and administrative proceedings arising in the ordinary course of business. Management does not believe that such matters will have a materially adverse impact on the Company's financial position, results of operations or cash flows. 18 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2003 (Unaudited) Mortgage Banking Activities Through PWF, the Company originates and services multifamily mortgage loans for Fannie Mae, Freddie Mac and FHA. PWF and its subsidiaries' mortgage lending business is subject to various governmental and quasi-governmental regulation. PWF and/or its subsidiaries, collectively, are licensed or approved to service and/or originate and sell loans under Fannie Mae, Freddie Mac, Ginnie Mae and FHA programs. FHA and Ginnie Mae are agencies of the Federal government and Fannie Mae and Freddie Mac are federally-chartered investor-owned corporations. These agencies require PWF and its subsidiaries to meet minimum net worth and capital requirements and to comply with other requirements. Mortgage loans made under these programs are also required to meet the requirements of these programs. In addition, under Fannie Mae's DUS program, PWF has the authority to originate loans without a prior review by Fannie Mae and is required to share in the losses on loans originated under this program. The DUS program is Fannie Mae's principal loan program. Under the Fannie Mae DUS Product Line, the Company, through PWF, originates, underwrites and services mortgage loans on multifamily residential properties and sells the project loans directly to Fannie Mae. The Company assumes responsibility for a portion of any loss that may result from borrower defaults, based on the Fannie Mae loss sharing formulas, Levels I, II or III. At March 31, 2003, all of the Company's loans consisted of Level I loans. For such loans, the Company is responsible for the first 5% of the unpaid principal balance and a portion of any additional losses to a maximum of 20% of the original principal balance. Level II and Level III loans carry a higher loss sharing percentage. Fannie Mae bears any remaining loss. Under the terms of the Master Loss Sharing Agreement between Fannie Mae and the Company, the Company is responsible for funding 100% of mortgagor delinquency (principal and interest) and servicing (taxes, insurance and foreclosure costs) advances until the amounts advanced exceed 5% of the unpaid principal balance at the date of default. Thereafter, for Level I loans, the Company may request interim loss sharing adjustments which allow the Company to fund 25% of such advances until final settlement under the Master Loss Sharing Agreement. No interim loss sharing adjustments are available for Level II and Level III loans. The Company maintains an allowance for loan losses for loans originated under the Fannie Mae DUS product line at a level that, in management's judgment, is adequate to provide for estimated losses. At March 31, 2003, that reserve was approximately $4.5 million, which the Company believes represents its maximum liability at this time. Unlike loans originated for Fannie Mae, The Company does not share the risk of loss for loans PWF originates for Freddie Mac or FHA. In connection with the PWF warehouse line, both CharterMac and CM Corp. have entered into guarantees for the benefit of Fleet, guaranteeing the total advances drawn under the line, up to the maximum of $100 million, together with interest, fees, costs, and charges related to the PWF warehouse line. PWF maintains, as of March 31, 2003, treasury notes of approximately $5.0 million and a money market account of approximately $400,000, which is included in restricted cash and securities in the consolidated balance sheet, to satisfy the Fannie Mae collateral requirements of $5.4 million. Due to the nature of PWF's mortgage banking activities, PWF is subject to supervision by certain regulatory agencies. Among other things, these agencies require PWF to meet certain minimum net worth requirements, as defined. PWF met these requirements for all agencies, as applicable, as of March 31, 2003. At March 31, 2003, PWF had commitments to lend approximately $44.1 million to twelve borrowers. Credit Enhancement Transaction In December 2001, the Company completed a credit enhancement transaction with Merrill Lynch 19 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2003 (Unaudited) Capital Services, Inc. ("MLCS"), as described above. Pursuant to the terms of the transaction, CM Corp. assumed MLCS's $46.9 million first loss position on a $351.9 million pool of tax-exempt weekly variable rate multifamily mortgage loans. The Related Companies, L.P. has provided CM Corp. with an indemnity covering 50% of any losses that are incurred by CM Corp. as part of this transaction. As the loans mature or prepay, the first loss exposure and the fees paid to CM Corp. will both be reduced. The latest maturity date on any loan in the portfolio occurs in 2009. The remainder of the real estate exposure after the $46.9 million first loss position has been assumed by Fannie Mae and Freddie Mac. In connection with the transaction, CharterMac has guaranteed the obligations of CM Corp., and as security therefore, has posted collateral, initially in an amount equal to 50% of the first loss amount, which may be reduced to 40% if certain post closing conditions are met. The Company's maximum exposure under the terms of this transaction is approximately $23.5 million. CM Corp. performed due diligence on each property in the pool, including an examination of loan-to-value and debt service coverage both on a current and "stressed" basis. CM Corp. analyzed the portfolio on a "stressed" basis by increasing capitalization rates and assuming an increase in the low floater bond rate. As of March 31, 2003, the credit enhanced pool of properties are performing according to their contractual obligations and the Company does not anticipate any losses to be incurred on its guaranty. Should the Company's analysis of risk of loss change in the future, a provision for probable loss might be required; such provision could be material. Fees related to the credit enhancement transaction for the three months ended March 31, 2003, included in other income, was approximately $312,000. Income is recognized monthly as the fees are received. Yield Guarantee Transaction On July 18, 2002, the Company entered into two agreements with Merrill Lynch (the "Primary Guarantor") to guarantee an agreed-upon internal rate of return ("IRR") for a pool of 11 multi-family properties owned by RCGCP. The total potential liability to the Company pursuant to these guarantees is approximately $44 million. The Company has analyzed the expected operations of the underlying properties and believes there is no risk of loss at this time. Should the Company's analysis of risk of loss change in the future, a provision for probable losses might be required; such provision could be material. In connection with the transaction, the Company posted $18.2 million of Revenue Bonds as collateral to the Primary Guarantor, which will be reduced to $1.4 million over a period of up to 20 years as the properties reach certain operating benchmarks. In addition, the Company agreed to subordinate 25% of each of the bonds it acquired that are secured by the properties and to not use the subordinated portion of such bonds as collateral in connection with any borrowings. To mitigate risk, the Company is the beneficiary of a guarantee against losses associated with construction and operating stabilization for each of the properties in RCGCP, which is capped at $15 million. The guarantee has been provided by TRCLP. If the Company's acquisition of Related is completed, then this guarantee will no longer be in force. As of December 31, 2002, TRCLP had a GAAP net worth of approximately $175.0 million with liquid assets of approximately $70.1 million. In addition, the developers of each of the properties have also been required to give recourse completion, stabilization and operating deficit guarantees. TRCLP has also agreed, if needed, after construction completion and property stabilization, to fund up to the first $2.5 million of operating deficits of the underlying properties or any amounts required to pay the guaranteed IRR to the investor. Bond Forward Transactions During December 2002, the Company entered into two transactions related to two properties, Coventry Place and Canyon Springs. Pursuant to the terms of these transactions, the Company will provide credit support to the construction lender for project completion and Fannie Mae permanent 20 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2003 (Unaudited) loan conversion and acquire subordinated bonds to the extent the construction period bonds do not fully convert. Up until the point of completion, the Company will guaranty the construction lender reimbursement of any draw on its construction letter of credit up to 40% of the stated amount of the letter of credit. Following completion, up until the project loan converts to permanent loan status, the Company will guarantee the full amount of the letter of credit. The developer has also issued several guarantees to the construction lender, each of which would be called upon before the Company's guarantees, and each of which would be assigned to the Company should its guarantees be called. Once the construction loans convert to permanent loans, the Company is obligated to acquire subordinated loans for the amount by which each construction loan exceeds the corresponding permanent loan, if any. The subordinated bonds will bear interest at 10%. Under FNMA guidelines, the size of the subordinated bonds will be limited to a 1.0x debt service coverage based on 75% of the cash flow after the senior debt. The Company's maximum exposure, related to these two transactions, is 40% of the stated amount of the letter of credit of approximately $27 million. Also, during December 2002, the Company entered into two transactions related to properties known as Auburn Glenn and Cottonwood. Pursuant to the terms of the transactions, a third party, unrelated lender will advance funds to the developers, as needed, at a floating rate. At the completion of construction, the Company is obligated to acquire the permanent Revenue Bonds at a predetermined price and interest rate. The two forward commitments create derivative instruments under SFAS No. 133, which have been designated as a cash flow hedge of the anticipated funding of the Revenue Bonds, and will be recorded at fair value, with changes in fair value recorded in other comprehensive income until the Revenue Bonds are funded. The Revenue Bonds are expected to be $18.8 million for Auburn Glenn and $12.4 million for Cottonwood, which together represents the Company's maximum liability. NOTE 8 - Financial Risk Management and Derivatives The Company's Revenue Bonds generally bear fixed rates of interest, but the P-FLOATS and TOP financing programs incur interest expense at variable rates re-set weekly, so the Company is exposed to interest rate risks. Various financial vehicles exist which allow the Company's management to hedge against the impact of interest rate fluctuations on the Company's cash flows and earnings. The Company has entered into two interest rate swaps in order to reduce the Company's exposure to increases in the floating interest rate on its TOP and P-FLOATS programs. Under such interest rate swap agreements, the Company is required to pay MLCS (the "Counterparty") a fixed rate on a notional amount of debt. In return, the Counterparty will pay the Company a floating rate equivalent to The BMA Municipal Swap Index, an index of weekly tax-exempt variable rate issues on which the Company's variable rate financing programs are based. On January 5, 2001, the Company entered into a five-year interest rate swap that fixes the BMA index to 3.98% on a notional amount of $50 million. On February 5, 2001, the Company entered into a three-year interest rate swap that fixes the BMA index to 3.64% on an additional notional amount of $100 million. The average BMA rates for the three months ended March 31, 2003 and 2002, were 1.07% and 1.27%, respectively. Net swap payments received by the Company, if any, will be taxable income to the Company and, accordingly, to shareholders. A possible risk of such swap agreements is the possible inability of the Counterparty to meet the terms of the contracts with the Company; however, there is no current indication of such an inability. At March 31, 2003, these two interest rate swaps were recorded as a liability with a combined fair market value of approximately $4.96 million, included in interest rate derivatives on the consolidated balance sheets. Interest paid or payable under the terms of the swaps, of approximately $884,000, is included in interest expense. 21 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2003 (Unaudited) During January 2002, the Company entered into an interest rate cap agreement with Fleet Bank, with a cap of 8% on a notional amount of $30 million. Although this transaction is designed to mitigate the Company's exposure to rising interest rates, the Company has not designated this interest rate cap as a hedging derivative. At March 31, 2003, this interest rate cap was recorded as an asset with a fair market value of $27,316 included in interest rate derivatives in the Consolidated Balance Sheets. Because the Company has not designated this derivative as a hedge, the change in fair market value flows through the Consolidated Statements of Income, where it is included in interest income, in the amount of $33,738 for the three months ended March 31, 2003. NOTE 9 - Dividends and Restricted Assets CharterMac may not receive any distributions from its subsidiary, Equity Issuer, until Equity Issuer has either paid all accrued but unpaid distributions related to its preferred shares, or in the case of the next following distribution payment date, set aside funds sufficient for payment. The distributions related to the preferred shares are payable only from Equity Issuer's quarterly net income, defined as the tax-exempt income (net of expenses) for the particular calendar quarter. Equity Issuer is required, under the terms of its preferred share issuance, to meet certain leverage ratios calculated as its total obligations divided by the gross fair value of investments. This could limit the ability of Equity Issuer to distribute cash or Revenue Bonds to the Company or to make loans or advances to the Company. Equity Issuer and its subsidiaries hold Revenue Bonds which at March 31, 2003, had an aggregate par amount of approximately $1.03 billion that serve as collateral for securitized borrowings or are securitized. The total securitized borrowings at March 31, 2003 were approximately $671 million. Equity Issuer's net assets at March 31, 2003 were approximately $761 million. NOTE 10 - Business Segments As a result of the December 2001 acquisition of PWF, the Company has two reportable business segments: an investing segment and an operating segment. The investing segment consists of subsidiaries holding investments in Revenue Bonds producing primarily tax-exempt interest income. The operating segment generates taxable interest and fee income. Taxable interest income is generated through the ownership of taxable bonds, certain taxable loans and other investments. Taxable fee income includes loan origination and loan servicing fees (through PWF) on portfolios for third parties, fees earned and associated with the acquisition or origination of Revenue Bonds, and fees for credit enhancement and guaranty services. Segment results include all direct and contractual revenues and expenses of each segment and allocations of indirect expenses based on specific methodologies. The reportable segments are strategic business units that primarily generate revenue streams that are distinctly different and are generally managed separately. Segment reporting is applicable beginning with the acquisition of PWF on December 31, 2001; prior to December 31, 2001, all of the Company's operations were attributable to the investing segment. Of the total assets for the Company at March 31, 2003 and December 31, 2002, approximately $1.72 billion and $1.73 billion, respectively, are attributable to the investing segment and approximately $111 million and $124 million, respectively, are attributable to the operating segment. 22 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2003 (Unaudited) The following table provides more information regarding the Company's segments: Three Months Ended Three Months Ended March 31, 2003 March 31, 2002 ---------------------------------------------------------------------- (Dollars in thousands) Investing Operating Total Investing Operating Total ---------------------- --------- --------- ----- --------- --------- ----- Revenues $ 27,884 $ 4,037 $ 31,921 $ 23,943 $ 4,860 $ 28,803 Interest Revenues 26,550 718 27,268 23,357 1,351 24,708 Interest Expense 3,562 254 3,816 3,488 503 3,991 Depreciation and Amortization expense 316 1,371 1,687 240 2,000 2,240 Equity in the income of investees accounted for under the equity method 28 -- 28 302 -- 302 Income tax expense or benefit (1,873) (103) (1,976) -- 181 181 Net Income 17,769 138 17,907 17,614 1,210 18,824 23 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2003 (Unaudited) NOTE 11 - Warehouse Facility On March 31, 2003, the Company entered into a $75 million secured revolving tax-exempt bond warehouse line of credit with Fleet Securities, Inc. and Wachovia Securities, Inc. (the "Facility"). The Facility has a built in accordion feature allowing up to a $25 million increase for a total of $100 million and a term of two years, plus a one year extension at the Company's option. The Facility bears interest at either 31, 60, 90, or 180-day reserve adjusted LIBOR, or prime plus .25%, at the Company's option. NOTE 12 - PWF Acquisition As part of the PWF acquisition, the purchase agreement provided that CharterMac has the right to purchase the remaining 20% of PWF shares of stock within the 37 months following the close of the acquisition, (the "Call Option"). The agreement also gives the owners of the remaining 20% of PWF's shares of stock the right to put those shares to CharterMac (the "Put Option"), within the 34 months following the close of the acquisition. The Company considers these two options to be a single unit (a forward contract), due to the fact the Put Option and Call Option were entered into at the same time, have the same counter parties, have the same risk, and could have been accomplished in a single transaction. The price at which the shares of stock are to be repurchased is based on many factors, determined in the future including the performance of the underlying revenues of PWF, the value of PWF's servicing portfolio and other factors which are not currently determinable. The Company determined the forward contract should not be recorded until the contract is settled and the associated shares transferred to the Company. During the period of the forward contract, the Company will allocate subsidiary income or loss to the minority interest on a pro-rata basis, determined by its ownership percentage. NOTE 13 - Subsequent Events On April 1, 2003, the Company closed on its sale of Tax-Exempt Multi-Family Housing Trust Certificates Series 2003A (the "Trust"). Pursuant to the terms of the Trust, the Company contributed 19 fixed-rate, tax-exempt multifamily housing and senior housing Revenue Bonds collateralized by 16 different properties totaling approximately $196.8 million in aggregate principal into a trust out of which was sold $100 million in Class A Certificates to various institutional investors. A wholly-owned indirect subsidiary of CharterMac retained the subordinated Class B Certificates totaling approximately $96.8 million. CharterMac has agreed that it will hold the Class B Certificates until the Trust is terminated. The Class A Certificates will accrue interest at the fixed rate of 3.25% per annum for two years. Distributions to the Class A Certificate holders are expected to be made on the 15th day of each month, commencing on May 15, 2003. The Class A Certificates will be subject to mandatory tender for purchase at a price equal to the outstanding Certificate Balance thereof plus accrued interest thereon on March 15, 2005. If CharterMac does not exercise its option to terminate the Trust on March 15, 2005, the Class A Certificates will be subject to remarketing. The Class A Certificates will be subject to mandatory tender for purchase and cancellation on the Final Distribution Date from proceeds of the liquidation of the bonds on March 15, 2007. This financing arrangement will be accounted for as a secured borrowing. Subsequent to March 31, 2003, CharterMac has acquired twelve Revenue Bonds with a total aggregate face amount of approximately $53.1 million, secured by 1,013 multifamily units. 24 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. General ------- Charter Municipal Mortgage Acceptance Company ("CharterMac"), along with its consolidated subsidiaries (the "Company"), is a Delaware business trust principally engaged in the acquisition and ownership (directly or indirectly) of tax-exempt multi-family housing revenue bonds ("Revenue Bonds") and other investments that produce tax-exempt income, issued by various state or local governments, agencies, or authorities. Revenue Bonds are primarily secured by participating and non-participating first mortgage loans on underlying properties ("Underlying Properties"). The Company believes that it can earn above market rates of interest on its Revenue Bond acquisitions by focusing its efforts primarily on affordable housing. The Manager estimates that nearly 30% of all new multi-family development contains an affordable component which produces tax credits pursuant to Section 42 of the Internal Revenue Code. The traditional methods of financing affordable housing with tax-exempt Revenue Bonds are complex and time consuming, and involve the participation of many intermediaries. Through the Manager, the process has been streamlined with the "Direct Purchase Program". The Company's Direct Purchase Program removes all intermediaries from the financing process (except the governmental issuer of the Revenue Bond) and enables developers to deal directly with one source. Because the Company purchases its Revenue Bonds directly from the governmental issuer, the need for underwriters and their counsel, rating agencies and costly documentation is eliminated. This reduces the financing life cycle, often by several months, and also reduces the bond issuance costs, usually by 30% or more. In dealing directly with the Company, developers feel more certain about the terms and timing of their financing. The Company believes the savings in time and up-front costs and the certainty of execution that the Direct Purchase Program offers to developers allows the Company to receive above-market rates of interest on the Company's Revenue Bonds. The Company believes that it is well positioned to market its Direct Purchase Program as a result of the Manager's affiliation with Related Capital Company ("Related"), a nationwide, fully integrated real estate financial services firm, because the Manager is able to utilize Related's resources and relationships in the multi-family affordable housing finance industry to source potential borrowers of Revenue Bonds. Related and its predecessor companies have specialized in offering debt and equity products to mid-market multi-family owners and developers for over 30 years. According to the 2001 National Multi Housing Council survey, Related is the second largest owner of apartments in the United States. The Company, through its wholly-owned subsidiary CharterMac Corporation ("CM Corp."), acquired 80% of the outstanding capital stock of PW Funding, Inc. ("PWF"). As a result of the acquisition of PWF, the Company has diversified the range of its investment products and is able to offer developers fixed and floating rate tax-exempt and taxable financing through Fannie Mae, Freddie Mac and FHA for affordable and market rate multi-family properties. Combining this with the Company's core business of investing in Revenue Bonds and its affiliation with Related, the Company is able to provide developers with financing for all aspects of their property's capital structure. In addition, the Company has diversified its revenues with a fee business that may grow in value over time and is expected to insulate the Company from the vagaries of the capital markets. On January 14, 2002, the Company announced that its Board of Trustees had formed a special committee to explore strategic alternatives for the Company's future management structure, including internalization of management, and ways to further diversify the Company's revenue sources. The special committee consists of the independent members of the Board of Trustees, Peter T. Allen, Arthur P. Fisch and Charles L. Edson. On December 18, 2002, the Company announced it had entered into an agreement to acquire 100% of the ownership interests in and substantially all of the businesses operated by Related (other than specific excluded interests). The acquisition will enable the Company to terminate its outside management agreement with the Manager and to become an internally-managed company. The acquisition will be structured so that the ownership interests held by the Related principals in both Related and the other entities which control other aspects of Related's business will be contributed into a newly-formed, wholly-owned subsidiary of CharterMac (the "CharterMac Sub"). 25 The selling principals of Related include the four executive managing partners (Stuart J. Boesky, Alan P. Hirmes, Marc D. Schnitzer and Denise L. Kiley) and an affiliate of The Related Companies, L.P. ("TRCLP"), which is majority owned by Stephen M. Ross (the "Related Principals"). Messrs. Boesky, Hirmes and Schnitzer and Ms. Kiley have managed RCC over the past 15 years. CharterMac will pay total consideration to the Related Principals of up to $338 million. The consideration will be paid as follows: The Initial Payment - $210 million consisting of $160 million in special common units of the CharterMac Sub ("SCUs") and $50 million in cash (with the cash position being paid only to TRCLP). The Initial Payment SCUs will be issued at $17.78 per unit, which was the average closing price of CharterMac Common Shares, for the 30 calendar days prior to this announcement (the "Initial Payment SCUs"); The Contingent Payment - $128 million of additional SCUs (the "Contingent Payment SCUs"), based on 7.73x Related's adjusted audited earnings before interest, taxes, depreciation and amortization, as well as certain other adjustments, for the year ended December 31, 2002. The Contingent Payment SCUs are expected to be issued at the same price as the Initial Payment SCUs, subject to a 17.5% symmetrical collar. In connection with the acquisition, CharterMac will establish a restricted share award plan and will broadly issue to employees of Related, other than the Related Principals, at least $15 million of CharterMac Common Shares and, at the option of the Related Principals, up to $20.2 million, in which event the Contingent Payment payable to the Related Principals will be reduced by the amount by which the value of the Common Shares issued exceeds $15 million. Following the completion of the acquisition, TRCLP's economic interest in CharterMac will equal approximately 17.7% and management and Related Principals (other than TRCLP) economic interest in CharterMac will equal approximately 8.7%. On February 28, 2003, the Company filed a preliminary proxy regarding this proposed acquisition and has received comments from the SEC. On May 8, 2003, the Company filed a revised proxy with the SEC. Results of Operations --------------------- Interest income from Revenue Bonds increased approximately $3.3 million for the three months ended March 31, 2003 as compared to 2002. This increase was primarily due to an increase in interest income of approximately $7.2 million from new Revenue Bonds acquired during 2002, partially off-set by a decrease in interest income due to the sale or repayment of Revenue Bonds of approximately $3.1 million and a decrease in participating interest. Total revenues for the three months ended March 31, 2003, increased by approximately $3.1 million including the increases in interest income from Revenue Bonds noted above, increases in mortgage servicing fees and other income offset by a decrease of approximately $700,000, investment in mortgage banking fees due to lower origination volume. General and administrative expenses increased approximately $440,000 for the three months ended March 31, 2003 as compared to 2002 primarily due to an increase in stock based compensation to PWF employees, mostly offset by decreases in other forms of compensation to PWF employees. Amortization decreased approximately $553,000 for the three months ended March 31, 2003 primarily due to a decrease of amortization of MSRs at PWF, primarily due to the write-off of the remaining MSR asset for loans that paid-off prior to their term expiration. Income allocated to preferred shareholders of subsidiary for the three months ended March 31, 2003 increased approximately $960,000 due to the preferred offerings consummated on June 4, 2002. During the three months ended March 31, 2003, the Company recorded a benefit for income taxes of approximately $1,976,000, relating to a decrease in the provision for income taxes. During the three months ended March 31, 2003, the Company recognized a net loss on repayments of Revenue Bonds of approximately $412,000, versus a gain of approximately $3.8 million for 2002, 26 due to the number and size of Revenue Bonds repaid or sold. Additionally, during the three months ended March 31, 2003, the Company recognized gains on sales of loans of approximately $2.1 million versus approximately $3.3 million for 2002, relating to PWF's origination activities. Liquidity and Capital Resources ------------------------------- The Company has primarily used two sources of capital: collateralized debt securitization and various types of equity offerings to fund its investments and facilitate growth. On March 31, 2003, the Company entered into a $75 million secured revolving tax-exempt bond warehouse line of credit with Fleet Securities, Inc. and Wachovia Securities, Inc. (the "Facility"). The Facility has a built- in accordion feature allowing up to a $25 million increase for a total of $100 million and a term of two years, plus a one- year extension at the Company's option. The Facility bears interest at either 31, 60, 90, or 180-day reserve adjusted LIBOR, or prime plus .25%, at the Company's option. On April 1, 2003, the Company closed on its sale of Tax-Exempt Multi-Family Housing Trust Certificates Series 2003A (the "Trust"). Pursuant to the terms of the Trust, the Company contributed 19 fixed-rate, tax-exempt multifamily housing and senior housing revenue bonds collateralized by 16 different properties totaling approximately $196.8 million in aggregate principal into a trust out of which was sold $100 million in Class A Certificates to various institutional investors. A wholly-owned indirect subsidiary of CharterMac retained the subordinated Class B Certificates totaling approximately $96.8 million. CharterMac has agreed that it will hold the Class B Certificates until the Trust is terminated. The Class A Certificates will accrue interest at the fixed rate of 3.25% per annum for two years. Distributions to the Class A Certificate holders are expected to be made on the 15th day of each month, commencing on May 15, 2003. The Class A Certificates will be subject to mandatory tender for purchase at a price equal to the outstanding Certificate Balance thereof plus accrued interest thereon on March 15, 2005. If CharterMac does not exercise its option to terminate the Trust on March 15, 2005, the Class A Certificates will be subject to remarketing. The Class A Certificates will be subject to mandatory tender for purchase and cancellation on the Final Distribution Date from proceeds of the liquidation of the bonds on March 15, 2007. During the three months ended March 31, 2003 cash and cash equivalents of the Company and its consolidated subsidiaries increased approximately $19.7 million. The increase was primarily due to cash provided by operating activities of approximately $13 million, proceeds from the repayment of two Revenue Bonds of approximately $19.0 million, principal payments on Revenue Bonds of approximately $6.8 million and principal payments received from loans made to properties of approximately $7.4 million, partially offset by distribution payments of approximately $20.3 million, advances made to Revenue Bonds of approximately $3.1 million and an increase in mortgages receivable held at PWF of approximately $2.8 million. In April 2003, distributions declared in March 2003 were paid to Preferred Shareholders as shown in the table below: Liquidation Value Dividend Distribution Total per Series Rate per Share Distribution share ------ -------- ------------ ------------ ------------ A 6.625% $33,125 $1,490,625 $2,000,000 A-1 7.100% 8,875 426,000 500,000 A-2 6.300% 7,875 488,250 500,000 A-3 6.800% 8,500 510,000 500,000 B 7.600% 9,500 1,045,000 500,000 B-1 6.800% 8,500 314,500 500,000 B-2 7.200% 9,000 450,000 500,000 Also paid, during May 2003, were distributions of $14,642,929 ($.325 per share) to holders of common and convertible CRA shares, which were also declared in May. Management is not aware of any trends or events, commitments or uncertainties, which have not 27 otherwise been disclosed that will or are likely to impact liquidity in a material way. Critical Accounting Policies ---------------------------- The Company's critical accounting policies are described in its Form 10-K for the year ended December 31, 2002 and in Note 1 of the footnotes of the accompanying financial statements. These critical accounting policies have not changed during 2003. Acquisitions ------------ During the period January 1, 2003 through March 31, 2003, the Company did not acquire any new Revenue Bonds, but did advance additional funds to Revenue Bonds which were previously acquired totaling approximately $3.1 million. Forward-Looking Statements -------------------------- Certain statements made in this report may constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such forward-looking statements include statements regarding the intent, belief or current expectations of the Company and its management and involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, among other things, the following: general economic and business conditions, which will, among other things, affect the availability and creditworthiness of prospective tenants, lease rents and the terms and availability of financing for properties financed by Revenue Bonds owned by the Company; adverse changes in the real estate markets including, among other things, competition with other companies; risks of real estate development and acquisition; governmental actions and initiatives; and environment/safety requirements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. Inflation --------- Inflation did not have a material effect on the Company's results for the periods presented. Related Parties --------------- The Company's day-to-day affairs are handled under the terms of the Management Agreements with the Manager. The Company has invested in, and may in the future invest in, Revenue Bonds secured by properties in which either direct or indirect affiliates of Related own equity interests in the borrower. The Company's trust agreement contains a limitation, equal to 15% of total market value, on the aggregate amount of Revenue Bonds the Company may hold where the borrowers under such Revenue Bonds are either direct or indirect affiliates of Related and Related generally has a controlling economic interest. In some cases, Related or its affiliates may own a partnership or joint venture interest merely to facilitate an equity financing on behalf of one of Related's investment funds. These instances are not considered in the above 15% limitation. This type of transaction with an affiliated borrower would be structured as a limited partnership as follows: the general partner would be an unaffiliated third party with a 1% general partnership interest and the 99% limited partner would itself be a limited partnership in which an affiliate of Related would own a 1% general partnership interest and one or more Fortune 500 companies would own a 99% limited partnership interest. Affiliates of the Manager may provide certain financial guarantees to facilitate leveraging by CharterMac, for which they could be paid market rate fees. In addition, affiliates of the Manager may provide certain financial guarantees to the owner (or partners of the owners) of the underlying properties securing CharterMac's revenue bonds, for which they could be paid market rate fees. Certain of the Revenue Bonds held by the Company are supported by various guarantees including, but not limited to, construction and operating guarantees from affiliates of the Manager. 28 During the quarter ended September 30, 2002, the Company agreed to back up a primary guarantor's obligation to guarantee an agreed-upon internal rate of return to the investor in Related Capital Guaranteed Corporate Partners II, L.P. ("RCGCP"). RCGCP is a fund sponsored by Related, who is an affiliate of the Manager. The Company is the beneficiary of a guarantee against losses associated with construction and operating stabilization for each of the properties in RCGCP, which is capped at $15 million. The guarantee has been provided by The Related Companies, L.P. ("TRCLP"), an affiliate of Related. If the Company's acquisition of Related is completed, then this guarantee will no longer be in force. In connection with the refinancing of River Run, the Company entered into an agreement which allows the Revenue Bond to be put to the Company should the owner of the underlying property default on the bond. The Company, in turn, entered into agreements which allow the Company to put the bond to the general partners of the owner who are affiliates of the Manager. The Company's put right is secured by collateral assignments of the general partners' partnership interests in the limited partnership which owns the underlying property. The Company has entered into a credit enhancement transaction with Merrill Lynch Capital Services. TRCLP has provided the Company with an indemnity covering 50% of any losses incurred by the Company. Item 3. Quantitative and Qualitative Disclosures About Market Risk The nature of the Company's investments and the instruments used to raise capital for their acquisition expose the Company to gains and losses due to fluctuations in market interest rates. Market interest rates are highly sensitive to many factors, including governmental policies, domestic and international political considerations and other factors beyond the control of the Company. Revenue Bonds generally bear interest at fixed rates, or pay interest according to the cash flows of the Underlying Properties, which do not fluctuate with changes in market interest rates. In contrast, payments required under the TOP program and on the secured borrowings under the P-FLOATS program vary based on market interest rates based on the Bond Market Association ("BMA") and are re-set weekly. Various financial vehicles exist which would allow Company management to mitigate the impact of interest rate fluctuations on the Company's cash flows and earnings. Beginning in 2001, and upon management's analysis of the interest rate environment and the costs and risks of such strategies, the Company entered into two interest rate swaps in order to hedge against increases in the floating interest rate on its TOP and P-FLOATS programs. Under such interest rate swap agreements, the Company is required to pay Merrill Lynch Capital Services (the "Counterparty") a fixed rate on a notional amount of debt. In return, the Counterparty will pay the Company a floating rate equivalent to the BMA Municipal Swap Index, an index of weekly tax-exempt variable rate issues on which the Company's variable rate financing programs are based. On January 5, 2001, the Company entered into a five-year interest rate swap that fixes the BMA index to 3.98% on a notional amount of $50 million. On February 5, 2001, the Company entered into a three-year interest rate swap that fixes the BMA index to 3.64% on a notional amount of an additional $100 million. This effectively fixes $50 million and $100 million of the Company's secured borrowings at 3.98% and 3.64%, respectively, protecting the Company in the event the BMA Municipal Swap Index rises. For the quarter ended March 31, 2003, the Company's cost to borrow funds through the TOP and P-FLOATS programs averaged 2.08% and 2.0%, respectively, which does not include the effect of the Company's hedging activities. With respect to the portion of the Company's floating rate financing programs which are not hedged, a change in the BMA rate would result in increased or decreased payments under these financing programs, without a corresponding change in cash flows from the investments in Revenue Bonds. For example, based on the unhedged $521 million outstanding under these financing programs at March 31, 2003, the Company estimates that an increase of 1.0% in the BMA rate would increase interest expense and therefore decrease annual net income by approximately $5.2 million. Conversely, a decrease in market interest rates would generally benefit the Company in the same amount described above, as a result of decreased allocations to the minority interest and interest expense without corresponding decreases in interest received on the Revenue Bonds. 29 Changes in market interest rates would also impact the estimated fair value of the Company's portfolio of Revenue Bonds. The Company estimates the fair value for each Revenue Bond as the present value of its expected cash flows, using a discount rate for comparable tax-exempt and taxable investments. Therefore, as market interest rates for tax-exempt and taxable investments increase, the estimated fair value of the Company's Revenue Bonds will generally decline, and a decline in interest rates would be expected to result in an increase in their estimated fair values. For example, the Company projects, using the same methodology used to estimate the portfolio's fair market value under FAS 115, that a 1% increase in market rates for tax-exempt and taxable investments would decrease the estimated fair value of its portfolio of Revenue Bonds from its March 31, 2003 value of $1,551,808,000 to approximately $1,364,862,000. A 1% decline in interest rates would increase the value of the March 31, 2003 portfolio to approximately $1,803,163,000. Changes in the estimated fair value of the Revenue Bonds do not impact the Company's reported net income, earnings per share, distributions or cash flows, but are reported as components of other comprehensive income and affect reported shareholders' equity. The assumptions related to the foregoing discussion of market risk involve judgments involving future economic market conditions, future corporate decisions and other interrelating factors, many of which are beyond the control of the Company and all of which are difficult or impossible to predict with accuracy. Although the Company believes that the assumptions underlying the forward-looking information are reasonable, any of the assumptions could be inaccurate and, therefore, there can be no assurance that the forward-looking information included herein will prove to be accurate. Due to the significant uncertainties inherent in forward-looking information, the inclusion of such information should not be regarded as a representation of the Company that the objectives and plans of the Company would be achieved. Item 4. Controls and Procedures (a) Evaluation of Disclosure Controls and Procedures. The Company's Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the Company's disclosure controls and procedures (as such term is defined in Rules 13a-14(c) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"). Based on such evaluation, such officers have concluded that, as of the Evaluation Date, the Company's disclosure controls and procedures are effective in alerting them on a timely basis to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company's reports filed or submitted under the Exchange Act. (b) Changes in Internal Controls. Since the Evaluation Date, there have not been any significant changes in the Company's internal controls or in other factors that could significantly affect such controls. 30 PART II. OTHER INFORMATION Item 1. Legal Proceedings The Company is not a party to any material pending legal proceedings. Item 2. Changes in Securities and Use of Proceeds - As previously disclosed, during the quarter ended June 30,2002, a subsidiary of the Company issued preferred shares for gross proceeds of approximately $55 million. The following disclosure supplements the disclosure made in the Company's Form 10Q for that period. These preferred shares were sold to qualified institutional investors under a Rule 144A private placement. The underwriter was Merrill Lynch and Co. Item 3. Defaults Upon Senior Securities - None Item 4. Submission of Matters to a Vote of Security Holders - None Item 5. Other Information - None Item 6. Exhibits and Reports on Form 8-K Exhibits: Chief Executive Officer certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Chief Financial Officer certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (b) Reports on Form 8-K The following Form 8-K's were filed or furnished, as noted in the applicable Form 8-K, for the quarter ended March 31, 2003. Current report on Form 8-K relating to a press release issued by the Company reporting fourth quarter and year-end 2002 financial results, dated February 27, 2003. Current report on Form 8-K relating to the Company making available unaudited supplemental data regarding its operations for the quarter ended December 31, 2002, dated March 4, 2003. Current report on Form 8-K relating to hosting a conference call to discuss the Company's fourth quarter and year-end 2002 earnings, dated February 27, 2003. 31 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY (Registrant) Date: May 15, 2003 By: ------------------------- Stuart J. Boesky Managing Trustee, President and Chief Executive Officer Date: May 15, 2003 By: ------------------------- Stuart A. Rothstein Chief Financial Officer and Chief Accounting Officer 32 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY (Registrant) Date: May 15, 2003 By:/s/ Stuart J. Boesky -------------------- Stuart J. Boesky Managing Trustee, President and Chief Executive Officer Date: May 15, 2003 By:/s/Stuart A. Rothstein ---------------------- Stuart A. Rothstein Chief Financial Officer and Chief Accounting Officer 33 CERTIFICATION I, Stuart J. Boesky, hereby certify that: 1. I have reviewed this quarterly report on Form 10-Q of Charter Municipal Mortgage Acceptance Company; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure the material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors or persons performing the equivalent functions: a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 15, 2003 By: ------------ ---------------------- Stuart J. Boesky Chief Executive Officer 34 CERTIFICATION I, Stuart J. Boesky, hereby certify that: 1. I have reviewed this quarterly report on Form 10-Q of Charter Municipal Mortgage Acceptance Company; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure the material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors or persons performing the equivalent functions: a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 15, 2003 By:/s/Stuart J. Boesky ------------ ------------------ Stuart J. Boesky Chief Executive Officer 35 CERTIFICATION I, Stuart A. Rothstein, hereby certify that: 1. I have reviewed this quarterly report on Form 10-Q of Charter Municipal Mortgage Acceptance Company; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure the material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors or persons performing the equivalent functions: a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 15, 2003 By: ------------ ------------------------ Stuart A. Rothstein Chief Financial Officer 36 CERTIFICATION I, Stuart A. Rothstein, hereby certify that: 1. I have reviewed this quarterly report on Form 10-Q of Charter Municipal Mortgage Acceptance Company; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure the material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors or persons performing the equivalent functions: a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 15, 2003 By:/s/Stuart A. Rothstein ------------ ---------------------- Stuart A. Rothstein Chief Financial Officer 37