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 September 30, 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 Item 1. Financial Statements CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Dollars in thousands) ================= ================= September 30, December 31, 2003 2002 ----------------- ----------------- (Unaudited) ASSETS Revenue bonds-at fair value $1,712,897 $1,579,590 Other investments 39,908 44,096 Mortgage servicing rights 32,803 35,595 Cash and cash equivalents 83,115 13,699 Cash and cash equivalents-restricted 84,005 46,785 Interest receivable - net 10,019 9,020 Promissory notes and mortgages receivable 17,636 53,278 Deferred costs - net of amortization of $11,495 and $8,451 55,125 48,693 Goodwill 5,560 4,793 Other intangible assets - net of amortization of $2,107 and $1,750 10,959 11,316 Other assets 6,388 6,003 ---------- ---------- Total assets $2,058,415 $1,852,868 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Financing arrangements $ 863,621 $ 671,659 Preferred shares of subsidiary (subject to mandatory repurchase) 273,500 -- Notes payable 83,695 68,556 Interest rate hedges 3,453 5,504 Accounts payable, accrued expenses and other liabilities 14,041 32,378 Deferred income 14,067 8,998 Due to Manager and affiliates 3,965 4,126 Deferred tax liability 6,567 10,790 Distributions payable 20,936 19,020 ---------- ---------- Total liabilities 1,283,845 821,031 --------- ---------- Preferred shares of subsidiary (subject to mandatory repurchase) -- 273,500 ---------- ---------- Minority interest in consolidated subsidiary 5,788 4,822 ---------- ---------- Commitments and contingencies Shareholders' equity: Beneficial owners' equity - convertible CRA share- holders (6,074,767 and 3,835,002 shares, issued and outstanding in 2003 and 2002, respectively) 112,412 58,174 Beneficial owner's equity-manager 1,130 1,126 Beneficial owners' equity-other common shareholders (100,000,000 shares authorized; 42,089,694 shares issued and 42,081,294 outstanding and 41,168,618 shares issued and 41,160,218 outstanding in 2003 and 2002, respectively) 608,539 604,496 Treasury shares of beneficial interest (8,400 shares) (103) (103) Accumulated other comprehensive income 46,804 89,822 ---------- ---------- Total shareholders' equity 768,782 753,515 ---------- ---------- Total liabilities and shareholders' equity $2,058,415 $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 Nine Months Ended September 30, September 30, ----------------------------- ---------------------------- 2003 2002 2003 2002 -------------- -------------- -------------- ------------- Revenues: Interest income: Revenue bonds $ 30,353 $ 22,819 $ 83,528 $ 67,764 Other interest income 686 1,141 2,342 4,189 Promissory notes 82 166 363 489 Mortgage banking fees 898 594 3,072 3,644 Mortgage servicing fees 2,273 2,050 6,639 5,912 Other income 1,556 1,314 5,033 2,949 --------- --------- --------- --------- Total revenues 35,848 28,084 100,977 84,947 --------- --------- --------- --------- Expenses: Interest expense 4,889 3,850 13,592 11,634 Interest expense - distributions to preferred shareholders of subsidiary 4,724 -- 14,173 -- Recurring fees - securitizations 1,039 811 3,021 2,289 Bond servicing 1,123 875 3,185 2,519 General and administrative 6,550 4,166 17,477 14,939 Depreciation and amortization 2,242 2,024 6,844 6,024 Loss on impairment of revenue bonds 1,758 532 1,758 532 --------- --------- --------- --------- Total expenses 22,325 12,258 60,050 37,937 --------- --------- --------- --------- Income before gain on repayment of revenue bonds, sale of loans and equity in earnings of ARCap 13,523 15,826 40,927 47,010 Equity in earnings of ARCap 555 555 1,665 1,664 Gain on sales of loans 444 1,465 2,994 7,871 Gain on repayment of revenue bonds 557 -- 2,797 3,979 --------- --------- --------- --------- Income before allocation to preferred shareholders of subsidiary and minority interest 15,079 17,846 48,383 60,524 Income allocated to preferred shareholders of subsidiary -- (4,724) -- (12,541) (Income) loss allocated to minority interest 147 (124) 186 (377) --------- --------- --------- --------- Income before benefit (provision) for income taxes 15,226 12,998 48,569 47,606 Benefit (provision) for income taxes 689 656 3,453 (983) --------- --------- --------- --------- Net income $ 15,915 $ 13,654 $ 52,022 $ 46,623 ========= ========= ========= ========= Allocation of net income to: Special distribution to Manager $ 1,583 $ 1,294 $ 4,453 $ 3,622 ========= ========= ========= ========= Manager $ 2 $ 124 $ 5 $ 430 ========= ========= ========= ========= Common shareholders $ 12,727 $ 11,327 $ 43,132 $ 40,266 Convertible CRA shareholders 1,603 909 4,432 2,305 --------- --------- --------- --------- Total for shareholders $ 14,330 $ 12,236 $ 47,564 $ 42,571 ========= ========= ========= ========= Net income per share Basic $ 0.31 $ 0.28 $ 1.05 $ 1.01 --------- --------- --------- --------- Diluted $ 0.31 $ 0.28 $ 1.04 $ 1.01 --------- --------- --------- --------- Weighted average shares outstanding: Basic 46,331,385 44,209,982 45,484,538 42,030,318 ========== ========== ========== ========== Diluted 46,366,342 44,282,733 45,517,942 42,099,407 ========== ========== ========== ========== 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 Owners' Equity Beneficial Beneficial Treasury Accumulated - Convertible Owner's Owners' Equity- Shares of Other CRA Equity - Other Common Beneficial Comprehensive Comprehensive Shareholders Manager Shareholders Interest Income Income (Loss) Total ------------ ------- ------------ -------- ------ ------------ ----- Balance at January 1, 2003 $ 58,174 $ 1,126 $604,496 $(103) $ 89,822 $753,515 Comprehensive income: Net income 4,432 4,458 43,132 $ 52,022 52,022 -------- Other comprehensive gain (loss): Net unrealized gain on interest rate derivatives 2,073 Net unrealized loss on revenue bonds: Unrealized holding loss arising during the period (42,294) Less: Reclassification adjustment for net loss included in net income (2,797) -------- Total other comprehensive loss: (43,018) (43,018) (43,018) -------- Total comprehensive income $ 9,004 ======== Issuance of Convertible CRA Shares 53,783 53,783 Options exercised 2,456 2,456 Distributions (3,977) (4,454) (41,545) (49,976) --------- -------- -------- ---- -------- ------- Balance at September 30, 2003 $112,412 $ 1,130 $608,539 $(103) $ 46,804 $768,782 ======= ======= ======= ==== ======== ======= 4 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands) (Unaudited) ================================== Nine Months Ended September 30, ---------------------------------- 2003 2002 ---------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 52,022 $ 46,623 Adjustments to reconcile net income to net cash provided by operating activities: Gain on repayment of revenue bonds (2,797) (3,979) Loss on impairment of revenue bonds 1,758 532 Other amortization 2,062 815 Amortization of other intangible assets 357 357 Amortization of bond selection costs 1,587 1,354 Amortization of mortgage servicing rights 4,688 4,944 Distributions to preferred shareholders of subsidiary 14,173 -- Income allocated to preferred shareholders of subsidiary -- 12,541 Equity in earnings of ARCap, in excess of distributions received -- (104) Increase in mortgage servicing rights (1,897) (7,498) Increase in provision for loss under FNMA DUS product line -- 596 Income (loss) allocated to minority interest (186) 377 Issuance of shares of subsidiary - compensation expense 1,152 498 Decrease in mortgages receivable 28,439 -- Changes in operating assets and liabilities: Interest receivable (1,042) (1,191) Other assets 3,257 (64) Deferred income 5,099 4,809 Accounts payable, accrued expenses and other liabilities (18,339) 1,774 Deferred tax liability (4,223) 143 Due to Manager and affiliates (340) 156 Fair value of interest rate cap 22 (100) --------- --------- Net cash provided by operating activities 85,792 62,583 --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from repayments of revenue bonds 72,276 86,130 Periodic principal payments of revenue bonds 12,793 4,179 Proceeds from repayment of note -- 6,600 Purchase/advances to revenue bonds (265,796) (279,018) Other investments 4,188 (5,263) Increase in deferred bond selection costs (6,928) (6,629) Increase in promissory notes -- (3,409) Increase in cash and cash equivalents - restricted (37,219) (41,726) Decrease in notes receivable -- 10,562 Goodwill (767) (2,983) Loans made to properties (1,879) -- Principal payments received from loans made to properties 9,082 1,939 -------- -------- Net cash used in investing activities (214,250) (229,618) -------- -------- Continued 5 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands) (Unaudited) ================================== Nine Months Ended September 30, 2003 2002 ---------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Distributions paid to the Manager and Common shareholders (44,232) (39,319) Distributions paid to preferred shareholders of subsidiary (14,173) (11,510) Distributions paid to Convertible CRA shareholders (3,617) (1,732) Proceeds from financing arrangements 192,699 54,500 Principal repayments of financing arrangements (737) (67,282) Increase (decrease) in notes payable 15,139 (10,562) Increase in deferred costs relating to the Private Label Tender Option Program (554) (636) Options exercised and stock compensation 2,426 -- Issuance of Convertible CRA Shares 53,783 -- Issuance of common shares -- 92,353 Retirement of Convertible CRA Shares -- 22,938 Issuance of preferred stock of subsidiary -- 55,000 Increase in deferred costs relating to the preferred shares offering -- (2,068) Increase in other deferred costs (2,860) (2,002) ---------- ---------- Net cash provided by financing activities 197,874 89,680 -------- --------- Net increase (decrease) in cash and cash equivalents 69,416 (77,355) Cash and cash equivalents at the beginning of the period 13,699 105,364 --------- -------- Cash and cash equivalents at the end of the period $ 83,115 $ 28,009 ========= ========= SUPPLEMENTAL INFORMATION: Interest paid $ 28,600 $ 21,757 ========= ========= Taxes paid $ 135 $ 582 ========= ========= See accompanying notes to consolidated financial statements. 6 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 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 multifamily 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 certain other guarantees, and originates loans for multifamily 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. 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 which will be retained by the principals of Related). The acquisition will enable the Company to terminate its outside management agreement with the Manager and to become an internally-managed company. The annual meeting to vote on the acquisition of Related, originally scheduled for October 29, 2003, was rescheduled to November 17, 2003, due to the low number of votes received. The consolidated financial statements include the accounts of CharterMac and five subsidiary statutory trusts which it controls: CM Holding Trust, CharterMac Equity Issuer Trust, CharterMac Origination Trust I, CharterMac Owner Trust I and Tax-Exempt Multifamily Housing Trust and one wholly-owned corporation, CM Corp. CM Corp. owns approximately 85% of the economics of and has voting control over 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. 7 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 2003 (Unaudited) Certain amounts in the 2002 financial statements have been reclassified to conform to the 2003 presentation. Significant Accounting Policies ------------------------------- Investment in Revenue Bonds 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") due to a provision in most of its Revenue Bonds under which 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 Revenue 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 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. For certain Revenue Bonds, management believes that certain factors have impacted the near-term fair value. In these instances, the Revenue Bonds are valued at either the outstanding face amount of the bond or management's estimate of the fair value, whichever is lower. 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 Federal National Mortgage Association ("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 property. The rate lock forward commitment provided by Fannie Mae exists for a maximum 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 is paid from the interest on the guaranteed investment contract and the negative arbitrage paid by the borrower. The interest rate on the note is equivalent to the fixed rate committed to on the permanent loan. At the close of the construction phase, the Company unwinds the guaranteed investment contract to repay the note to Fannie Mae. The Company originates the permanent loan to the borrower at the rate 8 locked amount, which is subsequently purchased from the Company by Fannie Mae. The Company has commitments from Fannie Mae under this program of approximately $5.2 million as of September 30, 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 within our existing securitization programs. Mortgage Banking Activities PWF is an approved seller/servicer of multifamily mortgage loans for 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 which 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 to Fannie Mae, Freddie Mac, 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 origination services, included in mortgage banking fees in the Consolidated Statements of Income. Neither the Company nor PWF retains any interest in any of the mortgage loans, except for MSRs and certain liabilities under the loss-sharing arrangement with Fannie Mae. 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 loan and 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. The Company has two areas of loss exposure related to its lending activities. First, while a loan is recorded on the balance sheet, there is exposure to potential loss if a loan becomes impaired and defaults. Second, the Company has exposure to loss due to its retention of a portion of credit risk within its servicing contract under the Fannie Mae DUS program. 9 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 2003 (Unaudited) When a loan is owned by PWF and recorded on the balance sheet, PWF identifies loans that are impaired and evaluates the allowance for loss on a specific loan basis for losses believed to currently exist in the recorded loan portfolio. An impaired loan is defined, as noted within accounting guidance, when contractual payments are not made. PWF's primary tool for determining which loans are likely to currently have a loss associated with them is to evaluate the debt service coverage ratio based on PWF's historical experience of similar properties and the frequency of such losses. Loans that are impaired and specific loans that are not impaired but have debt service coverage ratios below a certain threshold as having a high likelihood of future foreclosure and currently have an existing loss, are evaluated. The estimate of currently existing loss, includes the estimated severity of the loss which would include any advances made or existing property loss. Property maintenance costs (when foreclosure occurs) are expensed when incurred and not included in the loss estimate. However, as most loans are sold very quickly after origination, there typically is not a significant amount of loan loss allowance recorded. The Company has exposure to loss due to its retention of a portion of credit risk within PWF's servicing contract under the Fannie Mae DUS program. For loans which have been sold as commercial mortgage-backed securities for which PWF retains the servicing under Fannie Mae's DUS program, PWF's share of loss is associated with the servicing contract and determined in accordance with the loss sharing provisions under the program. Prior to the issuance of Interpretation No. 45, "Guarantors' Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" ("FIN 45"), because the loss sharing on these serviced loans was associated with the servicing contract, they are valued within the servicing right and the anticipated cash flows that are associated with such servicing activities. The Com-pany has determined that these potential losses are guarantees under the definition of FIN 45 and therefore, will record an asset and a corresponding liability based on the Company's estimate of the portion of the servicing cash flows deemed to represent compensation to the Company for its guarantee for loans originated on/or after January 1, 2003. On an ongoing basis, the Company will account for the asset by offsetting cash received for the guarantee against the asset and crediting interest income for the change in asset due to the passage of time. The portion of the liability representing an accrual for probable losses under SFAS No. 5, "Accounting for Contingencies" ("FAS 5") will be adjusted as loss estimates change; the portion representing the Company's willingness to stand by as guarantor will be amortized over the expected life of the guarantee. The components of the change in MSRs are as follows: Servicing Assets (Dollars in millions) --------------------------------------------------- ---------------------- Balance at December 31, 2002 $35.5 MSR's capitalized during the nine months ended September 30, 2003 4.3 Amortization (4.6) Increase in reserves (2.4) ------- Balance at September 30, 2003 $32.8 ==== Reserve for Loan Loss Reserves of Servicing Assets --------------------------------------------------- Balance at December 31, 2002 $ 4.3 Additions 2.4 ----- Balance at September 30, 2003 $ 6.7 ===== The estimated fair values of the MSRs were $37.8 million and $36.7 million, at September 30, 2003 and December 31, 2002, respectively. 10 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 2003 (Unaudited) The significant assumptions used by the third party valuation firm in estimating the fair value of the servicing assets at September 30, 2003 were as follows: Fannie Mae FHA Freddie Mac --------------- -------------- --------------- Weighted average discount rate 17.07% 16.86% 16.99% Weighted average pre-pay speed 12.12% 10.58% 15.09% Weighted average lockout period 56 months 31 months 73 months Cost to service loans $2,493 $1,365 $1,942 Acquisition cost (per loan) $1,500 $ 471 $1,480 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 different interest rates during the construction and permanent financing periods. In these cases, the Company calculates the effective yield on the Revenue Bond and uses that rate to recognize interest income 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. Other Interest Income - 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 is accrued at the preferred dividend rate of 12% on the preferred shares held by the Company, 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. Credit Enhancement and Guarantee Fees - The Company receives fees for providing credit enhancement and for backing up primary guarantors' obligations to guarantee agreed upon internal rates of return to the investors in programs sponsored by Related (see Note 5). 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 periods. Mortgage Banking Fees - PWF fees earned for arranging financings under the Fannie Mae DUS product line on behalf of Freddie Mac, insurance companies and banks or other lenders are recorded at the point the financing commitment is accepted by the mortgagor and the interest rate of the mortgage loan is fixed. 11 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 2003 (Unaudited) Mortgage Servicing Fees - PWF receives fees for servicing the loans it has originated or purchased. This income is recognized on an accrual basis over the estimated life of the loans being serviced. 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 Private Label Tender Option Program ("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 the Equity Issuer Trust 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 Community Reinvestment Act ("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 several forward commitments, all of which are accounted for under the Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"), 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 (described in Note 8). Accordingly, the interest rate swaps are recorded at their respective fair market value each accounting period, with changes in market value 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 forward commitments (see Note 7) create derivative instruments under SFAS 133, which have been designated as cash flow hedges 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 September 30, 2003 and December 31, 2002. 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 fee-generating activities in which the Company may engage and provide management services to CharterMac and its other subsidiaries. The Company 12 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. 13 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 2003 (Unaudited) 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 FIN 45. FIN 45 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 FIN 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The Company entered into one credit enhancement transaction and two yield guarantee transactions prior to December 31, 2002. The fee for the credit enhancement transaction is received monthly and recognized as income when due. The fees for the yield guarantee transactions, received in advance, were deferred and amortized over the guarantee periods. During the third quarter of 2003, the Company entered into its second yield guarantee transaction. The Company believes the fee received for this guarantee approximates the fair value of the obligation undertaken in issuing the guarantee and has recorded a liability included in deferred income equal to the fair value of the obligation. 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 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 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 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"). FIN 46 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 is required to apply its provisions to any existing variable interests in variable interest entities beginning December 31, 2003. The Company does not believe that it currently has any variable interests in variable interest entities requiring consolidation, however, the Company is evaluating whether such variable interests may exist should the proposed acquisition of Related be completed. 14 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 2003 (Unaudited) In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." SFAS 149 amends and clarifies the accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS 133. SFAS 149 is generally effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. The adoption of SFAS No. 149 on July 1, 2003, as required, had no impact on the Company's consolidated financial statements. In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity." This statement requires that certain financial instruments that have the characteristics of debt and equity be classified as debt. SFAS No. 150 was effective for financial instruments entered into or modified after May 31, 2003, and otherwise was effective at the beginning of the first interim period beginning after June 15, 2003. Pursuant to SFAS No. 150, on July 1, 2003 the Company classified the $273.5 million previously shown in the "mezzanine" (between liabilities and equity) in the consolidated balance sheets as "preferred shares of subsidiary subject to mandatory redemption" into the liability section, and the dividends paid on such shares (approximately $4.7 million and $14.1 million for the three and nine month periods ended September 30, 2003) has been classified as interest expense; dividends related to prior periods continue to be classified as income allocated to preferred shareholders of subsidiary. NOTE 2 - Revenue Bonds Total interest income from Revenue Bonds, including participating interest, was approximately $83,528,000 and $67,764,000, for the nine months ended September 30, 2003 and 2002, which represents an average annual yield of 7.14% and 7.48% based on weighted average face amounts of approximately $1,559,869,000 and $1,208,528,000, respectively. The amortized cost basis of the Company's portfolio of Revenue Bonds at September 30, 2003 and December 31, 2002 was $1,662,600,968 and $1,484,202,610, respectively. The net unrealized gain on Revenue Bonds in the amount of $50,296,031 at September 30, 2003 consisted of gross unrealized gains and losses of $58,888,083 and $8,592,052, 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 summarizing the maturity dates of the Company's Revenue Bonds. Outstanding Weighted Average (Dollars in thousands) Bond Amount Fair Value Interest Rate ----------------------------------------------------------------------------------------------------------- Due in less than one year $ 3,174 $ 2,982 9.22% Due between one and five years 30,994 30,086 6.81% Due after five years 1,640,859 1,679,829 7.02% ----------------------------------------------------------------------------------------------------------- Total $1,675,027 $1,712,897 7.02% ----------------------------------------------------------------------------------------------------------- All of the Company's Revenue Bonds have fixed interest rates. 15 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 2003 (Unaudited) 2003 Transactions ----------------- The following table summarizes the Company's acquisition activity for the nine months ended September 30, 2003. Weighted Weighted Aggregate Average Average Number of Purchase Construction Permanent Revenue (Dollars in thousands) Face Amount Price Interest Rate Interest Rate Bonds ------------------------------------------------------------------------------------------------------------------- Non-participating Revenue Bonds Construction/rehabilitation properties $265,796 $271,512 5.98% 6.37% 33 During the nine months ended September 30, 2003 the Company advanced additional funds of approximately $11,320,000 to Revenue Bonds which were previously acquired. During the nine months ended September 30, 2003, nine Revenue Bonds were repaid. The Company received net proceeds of approximately $72.3 million. The bonds had a net carrying value of approximately $69.5 million, resulting in a gain of approximately $2.8 million. The original developer of Waterford Place Phase II, is in the process of divesting its assets and unwinding its business, which triggered defaults under the Company's guarantees with the developer. Additionally, the Company has determined there has been a softening of this market. The equity investor, an affiliate of the Manager, has agreed to release and transfer its ownership to a nominee of the Company, who will foreclose on the underlying property. The Company has determined this bond is impaired, has stopped accruing interest, and wrote down the bond to its estimated fair value of approximately $900,000, taking a loss on impairment of approximately $1.8 million during the quarter ended September 30, 2003. The Company determined the fair value of the property as equal to the appraised value of the land plus the cost of certain improvements made to date, discounted for the softening in the market. 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, has stopped accruing interest, 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. During the fourth quarter of 2002, the Company began marketing the underlying property for sale, and the Company wrote this bond down to its estimated fair value of $4.5 million resulting in a recorded loss of $932,000. The Company continues to actively pursue the disposition of this property. NOTE 3 - Deferred Costs The components of deferred costs are as follows: (Dollars in thousands) September 30, December 31, 2003 2002 --------------- ------------------ Deferred bond selection costs (1) $ 40,871 $ 34,810 Deferred financing costs 8,584 8,030 Deferred costs relating to the issuance of preferred shares of subsidiary 10,445 10,445 Deferred costs relating to acquisition of Related 3,945 2,483 Other deferred costs 2,775 1,376 ------- --------- 66,620 57,144 Less: Accumulated amortization (11,495) (8,451) -------- --------- 16 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 2003 (Unaudited) $ 55,125 $ 48,693 ======== ======== 17 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 2003 (Unaudited) (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 nine months ended September 30, 2003, the Company, pursuant to the original acquisition agreement, paid approximately $3.0 and $.7 million, respectively, in "true-up" payments representing payments due to the original PWF stockholders which was recorded as additional goodwill during the fourth quarter of 2002 and the first nine months of 2003. These true-up payments were based on i) the increase in the value of MSRs due to certain loans closing, ii) positive changes between PWF's 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. The following table provides further information regarding the Company's intangible assets: (Dollars in thousands) Other Identifiable PWF Intangible Assets Licenses Total ---------------------------------------------------------- Balance at December 31, 2002 $ 4,427 $ 8,639 $ 13,066 Accumulated amortization (1,750) - (1,750) ------- ------- ------- Net balance at December 31, 2002 2,677 8,639 11,316 Amortization expense 357 - 357 ------- ------- ------- Balance at September 30, 2003 $ 2,320 $ 8,639 $ 10,959 ====== ======= ======= Amortization expense for the nine months ended September 30, 2003 $ 357 $ - $ 357 ======= ====== ======= Estimated amortization expense per year for next five years $ 477 $ - $ 477 ======= ====== ======= 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 September 30, 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. The Company will perform the required annual impairment test in the fourth quarter of 2003. 18 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 2003 (Unaudited) 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 Distributions/Investment 0.375% per annum of the total invested Management Fee assets of CharterMac or its subsidiaries. Loan Servicing Fee 0.25% per annum based on the outstanding face amount of revenue bonds and other investments owned by CharterMac or its subsidiaries. Operating Expense Reimbursement For direct expenses incurred by the Manager in an amount not to exceed $1,027,206 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 Options The Manager may receive options to acquire additional 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. * 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 term 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 management agreements which were due to expire on September 30, 2003 were renewed for the earlier of the date the acquisition of Related is completed or December 31, 2003. 19 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 2003 (Unaudited) The costs, expenses and the special distributions incurred to the Manager and its affiliates for the three and nine months ended September 30, 2003 and 2002 were as follows: Three Months Ended Nine Months Ended September 30, September 30, ------------------------- ------------------------ (Dollars in thousands) (Dollars in thousands) ------------------------- ------------------------ 2003 2002 2003 2002 --------- ----------- --------- --------- Bond selection fees $ 2,670 $ 1,681 $ 5,274 $ 5,662 Special distribution/Investment management fee 1,690 1,336 4,712 3,747 Bond servicing 1,123 875 3,185 2,519 Expense reimbursement 269 200 748 547 -------- -------- -------- -------- $ 5,752 $ 4,092 $13,919 $12,475 ======= ======= ====== ====== 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. On September 24, 2003, the Company completed its second yield guarantee transaction, agreeing to back up a primary guarantor's obligation to guarantee an agreed-upon internal rate of return ("IRR") to the investor in Related Capital Guaranteed Corporate Partners II, L.P. - Series B ("RCGCP - Series B"). RCGCP - Series B is a fund sponsored by Related, which is an affiliate 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. 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. 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. Effective April 1, 2003, PWF took on the day-to-day responsibility of a $598 million portfolio of loans subserviced by CreditRe Mortgage Servicing Company, L.L.C. ("CMC"), an affiliate of The Related Companies L.P. 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 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 20 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 2003 (Unaudited) 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. The dilutive effect of these outstanding share options is calculated using the treasury stock method. During the nine months ended September 30, 2003, 137,943 of the Company's stock options were exercised. 21 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 2003 (Unaudited) (Dollars in thousands) (Dollars in thousands) Three Months Ended September 30, 2003 Nine Months Ended September 30, 2003 ------------------------------------------- ------------------------------------------- Income Shares Per Share Income Shares Per Share Numerator Denominator Amount Numerator Denominator Amount --------------- ----------- ---------- ------------ ----------- ---------- Net income allocable to share- holders (Basic EPS) $ 14,330 46,331,385 $ .31 $ 47,564 45,484,538 $ 1.05 ======= ======= Effect of dilutive securities 125,566 share options -- 34,957 -- 33,404 ------------- ---------- --------- --------- Diluted net income allocable to shareholders (Diluted EPS) $ 14,330 46,366,342 $ .31 $ 47,564 45,517,942 $ 1.04 ============= ========== ======= ========= ========== ======= (Dollars in thousands) (Dollars in thousands) Three Months Ended September 30, 2003 Nine Months Ended September 30, 2003 ------------------------------------------- ------------------------------------------- Income Shares Per Share Income Shares Per Share Numerator Denominator Amount Numerator Denominator Amount --------------- ----------- ---------- ------------ ----------- ---------- Net income allocable to share- holders (Basic EPS) $ 12,236 44,209,982 $ .28 $ 42,571 42,030,318 $ 1.01 ======= ======= Effect of dilutive securities 223,509 stock options -- 72,751 -- 69,089 ------------- ---------- --------- --------- Diluted net income allocable to shareholders (Diluted EPS) $ 12,236 44,282,733 $ .28 $ 42,571 42,099,407 $ 1.01 ============== ========== ======= ========= =========== ======= * Includes Common and Convertible CRA Shares. 22 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 2003 (Unaudited) NOTE 7 - Commitments and Contingencies Litigation On October 24, 2003, the New York Supreme Court for Nassau County issued a final judgment approving the stipulation of compromise and settlement of the class and derivative action entitled Dulitz v. Hirmes, which had challenged certain aspects of the Company's acquisition of Related. Pursuant to that settlement, certain terms of the acquisition will be modified, as fully detailed in the Company's proxy statement that was previously mailed to shareholders and filed with the Commission on September 5, 2003, together with the Notice of Pendency of Class and Derivative Action. Although the defendants in the action denied all wrongdoing and believe they had meritorious defenses, the settlement eliminates the cloud of litigation over the acquisition in connection with Dulitz and provides the Company and its shareholders with certain benefits described in the proxy statement and Notice. The Court also approved an award pursuant to the settlement of $400,000 for attorney's fees and expenses payable by the Company to the plaintiff's attorneys. 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. Mortgage Banking Activities Through PWF, the Company originates and services multifamily mortgage loans for Fannie Mae, Freddie Mac and FHA. PWF's mortgage lending business is subject to various governmental and quasi-governmental regulation. PWF, collectively, is 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 September 30, 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 accrued liability for probable losses under FAS 5 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 September 30, 2003, that liability was approximately $6.7 million, which the Company believes represents its probable liability at this time. Unlike loans originated 23 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 2003 (Unaudited) 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 National Bank ("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 September 30, 2003, treasury notes of approximately $5.6 million and a money market account of approximately $209,000, which is included in restricted cash and securities in the consolidated balance sheet, to satisfy the Fannie Mae collateral requirements of $5.7 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 September 30, 2003. At September 30, 2003, PWF had commitments of approximately $18.5 million to six borrowers. Credit Enhancement Transaction In December 2001, the Company completed a credit enhancement transaction with Merrill Lynch 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 has met its obligation to post collateral, in an amount equal to 40% of the first loss amount. 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 September 30, 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 and nine months ended September 30, 2003, included in other income, were approximately $250,673 and $874,482, respectively. Income is recognized monthly as the monthly fees are received. Yield Guarantee Transactions On September 24, 2003, the Company entered into two agreements with Merrill Lynch (the "Primary Guarantor") to guarantee an agreed-upon IRR for a pool of 14 multifamily properties each owned by a local partnership which in turn, is majority-owned by RCGCP - Series B for which the Company will receive two guarantee fees totaling approximately $5.9 million. The transaction was structured as two separate guarantees, one primarily guaranteeing the IRR through the lease-up phase of the properties and the other guaranteeing the IRR through the operating phase of the properties. The fee for the first guarantee, in the amount of approximately $3.6 million, was paid in September 2003 at closing. The fee for the second guarantee will be paid in two installments. The first installment, in the amount of approximately $1.7 million, will be paid in 24 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 2003 (Unaudited) July 2004, and the final installment, in the amount of approximately $562,000, will be paid in January 2005. These fees will be recognized in income on a straight line basis over the period of the respective guarantees. The total potential liability to the Company pursuant to these guarantees is approximately $74 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 possible losses might be required; such provision could be material. Of the 14 local partnerships, 13 financed their properties with the proceeds of Revenue Bonds acquired by an affiliate of CharterMac. In connection with the transaction, the Primary Guarantor required that those Revenue Bonds be deposited into a trust pursuant to which the Revenue Bonds were divided into senior and subordinated interests with 50% of each Revenue Bond being subordinated. The Company has financed the senior trust interest as part of the Merrill Lynch P-FloatsSM/RitesSM program. The subordinate trust interests are being used as collateral in other of the Company's financing programs. In connection with the transaction, the Company posted $14.5 million of Revenue Bonds as collateral to the Primary Guarantor in the form of either cash or Revenue Bonds. On July 18, 2002, the Company entered into two agreements with Merrill Lynch (the "Primary Guarantor") to guarantee an agreed-upon IRR for a pool of 11 multifamily properties each owned by a local partnership which in turn, is majority-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. The structure of the guaranteed transaction that closed on July 18, 2002, was reorganized on September 24, 2003, to conform to the structure of the Company's second guaranteed transaction, which simultaneously closed on September 24, 2003. The new structure requires the Company to subordinate 50% of each of the Revenue Bonds it acquired that are secured by the properties involved in that transaction. The Senior and the Junior Certificates are available to the Company to be used as collateral in the Company's securitization programs. Before the restructuring, the Company only subordinated 25% of the Revenue Bonds. In connection with this transaction, the Company was able to lower the required collateral posted to the Primary Guarantor from $18.2 million to $11.0 million. 25 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 2003 (Unaudited) Revenue Bond Forward Transactions During July 2003, the Company entered into a transaction to purchase two series of Revenue Bonds related to a property named Middle Creek Village Apartments. Pursuant to the terms of the transaction, a third party, unrelated lender will advance funds to the developer, as needed, at a floating rate. At the earlier of stabilization or conversion to permanent financing, as long as completion is achieved, the Company is obligated to acquire Series A Revenue Bonds at a predetermined price and interest rate. The Company is only obligated to buy the Series B Revenue Bonds if, at the date the Series A bonds are stabilized, the property's cash flow is sufficient to provide debt service coverage of 1.15x for both the Series A and B bonds. 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 are recorded at fair value, with changes in fair value recorded in other comprehensive income until the Revenue Bonds are funded. The Series A Revenue Bond is expected to be approximately $15.8 million and the Series B Revenue Bond is expected to be $350,000, which combined represents the Company's maximum purchase commitment. At September 30, 2003, the fair value of these forward transactions is not significant. 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 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 reimburse the construction lender for 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, should the need arise, reimburse the full amount of the letter of credit. The Company closely monitors these two properties, and believes there is no need currently, to provide for any potential loss. Should the Company's analysis of risk of loss change in the future, a provision for loss might be required; such provision could be material. 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 Fannie Mae 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 are 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 combined represents the Company's maximum purchase commitment. At September 30, 2003, the fair value of these forward transactions is not significant. 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. The Company is also exposed to interest rate risks due to its borrowings under a $75 million warehouse facility with Fleet Securities, Inc. and Wachovia Securities, Inc. (the "Facility") (see Note 11). Various financial 26 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 2003 (Unaudited) 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 nine months ended September 30, 2003 and 2002, were 1.02% and 1.35%, 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 September 30, 2003, these two interest rate swaps were recorded as a liability with a combined fair market value of approximately $3.5 million, included in interest rate hedges on the Consolidated Balance Sheets. Interest paid or payable under the terms of the swaps, of approximately $3,066,000, is included in interest expense. 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 September 30, 2003, this interest rate cap was recorded as an asset with a fair market value of $39,443 included in interest rate hedges 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 ($21,611) for the nine months ended September 30, 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 September 30, 2003, had an aggregate carrying amount of approximately $1.46 billion that serve as collateral for securitized borrowings or are securitized. The total securitized borrowings at September 30, 2003 were approximately $864 million. Equity Issuer's net assets at September 30, 2003 were approximately $559 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 27 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 2003 (Unaudited) primarily tax-exempt interest income. 28 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 2003 (Unaudited) 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 September 30, 2003 and December 31, 2002, approximately $1.98 billion and $1.73 billion, respectively, are attributable to the investing segment and approximately $77 million and $124 million, respectively, are attributable to the operating segment. 29 The following tables provide more information regarding the Company's segments: (Dollars in thousands) (Dollars in thousands) Three Months Ended September 30, 2003 Three Months Ended September 30, 2002 --------------------------------------------- ------------------------------------------ Investing Operating Total Investing Operating Total --------- --------- ----- --------- --------- ----- Revenues $31,755 $ 4,093 $35,848 $24,204 $ 3,880 $28,084 Interest Revenue 30,586 535 31,121 23,174 952 24,126 Interest Expense 9,468 145 9,613 8,225 1,128 9,353 Depreciation and Amortization expense 626 1,616 2,242 479 1,545 2,024 Equity in the income of investees accounted for under the equity method 555 -- 555 555 -- 555 Income tax or benefit 345 344 689 214 442 656 Net income (loss) 16,870 (955) 15,915 13,036 618 13,654 (Dollars in thousands) (Dollars in thousands) Nine Months Ended September 30, 2003 Nine Months Ended September 30, 2002 --------------------------------------------- ------------------------------------------ Investing Operating Total Investing Operating Total --------- --------- ----- --------- --------- ----- Revenues $88,280 $ 12,697 $ 100,977 $ 71,707 $ 13,240 $ 84,947 Interest Revenue 84,372 1,861 86,233 69,573 2,869 72,442 Interest Expense 27,159 606 27,765 23,047 1,128 24,175 Depreciation and Amortization expense 2,040 4,804 6,844 974 5,050 6,024 Equity in the income of investees accounted for under the equity method 1,665 -- 1,665 1,664 - 1,664 Income tax (provision) or benefit 2,588 865 3,453 214 (1,197) (983) Net income (loss) 53,191 (1,169) 52,022 44,739 1,884 46,623 30 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 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 Facility size 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 plus 1.5%, or prime plus .25%, at the Company's option. During the third quarter of 2003, Citibank became the third lender under this Facility. The outstanding balance of this Facility at September 30, 2003 was approximately $45.6 million. NOTE 12 - PWF Acquisition As part of the PWF acquisition, the purchase agreement provided that CharterMac has the right but not obligation, to purchase the remaining 15% of the economics of PWF shares within the 37 months following the close of the acquisition, (the "Call Option"). The agreement also gives the owners of the remaining PWF shares 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 purchased 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 - Financing Arrangements In addition to other Company borrowings, on April 1, 2003, the Company closed on its sale of Tax-Exempt Multifamily 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 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 is being accounted for as a secured borrowing. NOTE 14 - Shareholders' Equity In August 2003, the Company issued approximately 3.1 million of its Convertible CRA Shares, at $18.48 per share, raising proceeds net of underwriter's discount of approximately $54.2 million. The Company intends to use the proceeds to invest in additional Revenue Bonds and for general corporate purposes, including reduction of the Company's indebtedness. In September 2003, the Company, at the shareholders request, converted 817,589 of outstanding Convertible CRA Shares to 776,033 Common Shares. The conversion was based on a conversion ratio of .9217 for 530,728 Convertible CRA Shares which were purchased by the holder, thereof on May 10, 2000 and a one to one ratio for the remaining 286,861 Convertible CRA Shares which were 31 CHARTER MUNICIPAL MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 2003 (Unaudited) purchased by the holder, thereof on July 15, 2002. NOTE 15 - Subsequent Events New Acquisitions ---------------- Subsequent to September 30, 2003, CharterMac has acquired four Revenue Bonds with a total aggregate face amount of approximately $98.9 million, secured by 2,659 multifamily units. The Company has also advanced additional funds to Revenue Bonds which were previously acquired totaling approximately $8.2 million. Convertible CRA Shares ---------------------- Subsequent to the close of the third quarter, CharterMac completed two additional offerings of its CRA Preferred Shares to another twelve financial institutions. During October, CharterMac raised gross proceeds of approximately $36.0 million through the offering of 1,687,194 CRA Preferred Shares and 238,599 CRA Preferred Shares priced at $18.67 and $18.86 respectively. Year-to-date, CharterMac has raised gross proceeds totaling over $92.5 million through this unique security. Conversion of Convertible CRA Shares to Common Shares ----------------------------------------------------- On October 10, 2003, the Company converted 575,705 of outstanding Convertible CRA Shares to Common Shares. The conversion was based on a one to one conversion ratio for the Convertible CRA Shares which were purchased on November 12, 2002. Sale of Taxable Revenue Bonds ----------------------------- On October 10, 2003, the Company sold nine taxable Revenue Bonds at a price of 99% of par value to American Mortgage Acceptance Company ("AMAC"), which is an affiliate of the Manager, for approximately $7.6 million. These Revenue Bonds, which are each secured by a first mortgage position on a multifamily property, carried a weighted average interest rate of 8.69%. The sale price was determined by an independent third party valuation. This transaction was approved by the Company's Board of Trustees. Auction Rate Securitization --------------------------- On October 30, 2003, the Company entered into a new form of securitization, under which auction rate certificates secured by an open pool of Revenue Bonds were auctioned through UBS Financial Services Inc. to corporations as an alternative to tax-exempt money market funds. The Company placed Revenue Bonds with an aggregate par value of approximately $141 million into CharterMac Auction Rate Certificate Trust I, ("ARCSI"). A portion of these bonds, approximately $79 million, had been previously securitized under TOPS in the Nat-1 Series Trust. In order to move the bonds to ARCSI, the Company redeemed low-floater certificates aggregating approximately $118 million. On October 30, 2003, ARCSI issued $100 million of auction rate certificates. These certificates have an initial rate of 1% which will be reset every 35 days through a dutch auction process. The Company intends to account for this transaction as a secured borrowing. LIHTC Guarantee --------------- On October 31, 2003, the Company completed its third transaction to guarantee tax benefits to an investor in a partnership designed to earn LIHTCs. The Company entered into two agreements with Merrill Lynch (the "Primary Guarantor") to guarantee an agreed-upon IRR to the investor in Related Capital Guaranteed Corporate Partners II, L.P. - Series C ("RCGCP - Series C") for which the Company will receive guarantee fees totaling approximately $3.4 million in three installments. 32 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 statutory trust principally engaged in the acquisition and ownership (directly or indirectly) of tax-exempt multifamily 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 multifamily 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 multifamily 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 multifamily 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."), owns approximately 87% of the outstanding capital stock (85% of the economics) of PW Funding, Inc. ("PWF"), a national mortgage banking firm specializing in multifamily housing. CM Corp. expects to acquire the remaining outstanding capital stock of PWF over the next 6 to 18 months. 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 multifamily 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. 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 which will be retained by the principals of Related). The acquisition will enable the Company to terminate its outside management agreement with the Manager and to become an internally-managed company. The potential acquisition is structured so that the ownership interests held by the principals of Related 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 CM Corp. (the "CharterMac Sub"). The Company anticipates paying total consideration to the principals of Related of up to $338 million, as follows: o The Initial Payment--$210 million consisting of $160 million in special common units of the CharterMac Sub and $50 million in cash (with the cash portion being paid only to TRCLP). These special common units will be issued at $17.78 per unit, which was the 33 average closing price of the Company's common shares for the 30 calendar days prior to the announcement of the acquisition (the "Initial Payment SCUs"); o The Contingent Payment--up to $128 million of additional special common units (the "Contingent Payment SCUs"), which is 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 proposed acquisition, the Company also intends to establish a restricted share award plan which will permit the Company to grant restricted common shares to the employees of Related. At the option of the principals of Related, on or prior to the closing of the acquisition, the amount of restricted common shares may be increased to up to $20.2 million, in which event the amount of the contingent payment payable to the principals of Related will be reduced by the amount by which the value of the restricted common shares issued exceeds $15 million. Following the completion of the proposed acquisition, the economic interest in the Company of (i) TRCLP will equal approximately 17.7% and (ii) the Company's management and the principals of Related (other than TRCLP) will equal approximately 8.7%. The proposed acquisition of Related is still subject to customary conditions, including receipt of the affirmative vote of the holders of a majority of the Company's issued and outstanding common shares. Holders of the Company's common shares of record on August 1, 2003 are entitled to vote on the proposed acquisition of Related and other matters described below at the annual meeting of shareholders, which was originally scheduled to occur on October 29, 2003 and adjourned to November 17, 2003. Definitive proxy materials relating to the proposed acquisition of Related and other matters to be voted on were filed with the SEC on September 5, 2003 and mailed to common shareholders entitled to vote at the annual meeting on or about September 9, 2003. In addition to asking the holders of the Company's common shares to approve the issuance of securities in connection with the proposed acquisition, the Company is also asking for their approval of the following proposals: (a) Amending and restating the Company's trust agreement to (i) reflect the terms of the proposed acquisition, (ii) accommodate the Company's internalized management structure and expansion of the Company's business resulting from the proposed acquisition and (iii) bring the Company's organizational structure in line with other internally-managed, public companies; (b) Expanding the Company's existing incentive share option plan to enable the Company to continue to attract and retain qualified individuals to serve as the Company's officers and trustees and to provide incentives to and more closely align the financial interests of the Company's management team with the interests of the Company's shareholders; (c) Electing two trustees to the Company's board of trustees, each for a term of three years; and (d) Amending the Company's trust agreement to clarify that preferred shares already issued at the date of the acquisition by the Company's subsidiary, which contain mandatory redemption features would not be considered "financing or leverage" under the terms of the Company's trust agreement to clarify any confusion due to the reclassification of those amounts due to FAS 150. Results of Operations --------------------- Interest income from Revenue Bonds increased approximately $7.5 million and $15.8 million for the three and nine months ended September 30, 2003 as compared to 2002. This increase was primarily due to an increase in interest income of approximately $21.8 million from new Revenue Bonds acquired during 2002 and 2003, partially off-set by a decrease in interest income due to the sale or repayment of Revenue Bonds of approximately $4.6 million and a decrease in contingent interest of approximately $1.1 million. 34 Other income for the three and nine months ended September 30, 2003, increased by approximately $242,000 and $2.1 million as compared to 2002. This increase was primarily due to the Yield Guarantee Transaction completed in July 2002. Total revenues for the three and nine months ended September 30, 2003, increased by approximately $7.8 million and $16.0 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 $1.8 million in other interest income, due to decrease in other investments and promissory notes, and a decrease of approximately $572,000 in mortgage banking fees due to lower origination volume. General and administrative expenses increased approximately $2.4 million and $2.5 million for the three and nine months ended September 30, 2003 as compared to 2002 primarily due to increases in legal expenses, litigation costs, compensation expenses, accounting fees, overhead and travel reimbursements and D and O insurance. During the three and nine months ended September 30, 2003, the Company recorded a loss on impairment of Revenue Bond of approximately $1.8 million, associated with the write-down of the Waterford Place Revenue Bond. Amortization increased approximately $218,000 and $820,000 for the three and nine months ended September 30, 2003 primarily due to the increase of amortization of PW Funding acquisition expense and deferred finance cost for LIHTC guarantee deal and PW Funding acquisition and warehouse loans. Interest expense for the three and nine months ended September 30, 2003 increased approximately $1.0 million and $2.0 million, primarily due to increased secured borrowings and interest payments on the Merrill Lynch two-year securitization and the Facility. Interest expense - distributions to preferred shareholders of subsidiary increased approximately $1.6 million for the nine months ended September 30, 2003 when compared to 2002 reclassified amounts of income allocated to preferred shareholders of subsidiary, due to the preferred offering consummated on June 4, 2002. During the three and nine months ended September 30, 2003, the Company recorded a benefit for income taxes of approximately $689,000 and $3.5 million, primarily due to a large increase in deferred tax assets representing the deferred income associated with the yield guarantee transaction. During the three and nine months ended September 30, 2003, the Company recognized a net gain on repayments of Revenue Bonds of approximately $557,000 and $2.8 million. For the nine months ended September 30, 2002, the Company recognized a gain of approximately $4.0 million. These amounts vary due to the number and size of Revenue Bonds repaid or sold. Additionally, during the three and nine months ended September 30, 2003, the Company recognized gains on sales of loans of approximately $444,000 and $3.0 million versus approximately $1.5 million and $7.9 million for 2002, relating to PWF's origination activities. Liquidity and Capital Resources ------------------------------- The Company has primarily used three sources of capital: collateralized debt securitization, various types of equity offerings and a Credit Facility 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 Facility size 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 plus 1.5%, or prime plus .25%, at the Company's option. During the third quarter of 2003, Citibank became the third liquidity provider under this Facility. On April 1, 2003, the Company closed on its sale of Tax-Exempt Multifamily 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- 35 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. In August 2003, the Company issued approximately 3.1 million of its Convertible CRA Shares, at $18.48 per share, raising proceeds net of underwriters discount of approximately $54.2 million. The Company intends to use the proceeds to invest in additional Revenue Bonds and for general corporate purposes, including reduction of the Company's indebtedness. During the nine months ended September 30, 2003, cash and cash equivalents of the Company and its consolidated subsidiaries increased approximately $69.4 million. The increase was primarily due to cash provided by operating activities of approximately $85.0 million, proceeds from the repayment of nine Revenue Bonds of approximately $75.9 million, principal payments on Revenue Bonds of approximately $12.8 million, principal payments received from loans made to properties of approximately $9.1 million, proceeds from financing arrangements of approximately $192.7 million, increase in notes payable of approximately $15.1 million and proceeds from issuance of CRA Shares of approximately $53.8 million, partially offset by distribution payments of approximately $62.0 million, purchases of/advances to Revenue Bonds of approximately $265.8 million, purchases of other investments of approximately $10.2 million, an increase in restricted cash of approximately $37.2 million and an increase in deferred bond selection costs and other deferred costs of approximately $9.8 million. In October 2003, distributions declared in September 2003 were paid to Preferred Shareholders as shown in the table below: Liquidation Value Series Dividend Rate Distribution per Share Total Distribution per 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 November 2003, were distributions of approximately $16,213,000 ($.35 per share) to holders of common and convertible CRA shares, which were declared in September 2003. Management is not aware of any trends or events, commitments or uncertainties, which have not 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 except for the Company's accounting treatment of MSRs (see Note 1, Mortgage Banking Activities and Mortgage Servicing Rights for a description of the current accounting policies). Acquisitions ------------ During the period January 1, 2003 through September 30, 2003, the Company acquired 29 tax-exempt Revenue Bonds and four taxable Revenue Bonds with an aggregate face amount of approximately $254.5 million, not including bond selection fees and expenses of approximately $5.7 million. The Company also advanced additional funds to Revenue Bonds which were previously 36 acquired totaling approximately $11.3 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. On September 24, 2003, the Company completed its second yield guarantee transaction, agreeing to back up a primary guarantor's obligation to guarantee an agreed-upon internal rate of return ("IRR") to the investor in Related Capital Guaranteed Corporate Partners II, L.P. - Series B ("RCGCP - Series B"). RCGCP - Series B is a fund sponsored by Related, which is an affiliate 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, 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. 37 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 nine months ended September 30, 2003, the Company's cost to borrow funds through the TOP and P-FLOATS programs on an annualized basis, averaged 2.08% and 2.02%, 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 floating rate $614 million outstanding under these financing programs at September 30, 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 $6.1 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. 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 September 30, 2003 value of $1,712,897,000 to approximately $1,603,741,780. A 1% decline in interest rates would increase the value of the September 30, 2003 portfolio to approximately 38 $1,843,496,857. 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-15 and 15d-15 under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of the end of the period covered by this report. Based on such evaluation, such officers have concluded that, as of the end of such period, the Company's disclosure controls and procedures are effective . (b) Internal Control over Financial Reporting. There have not been any significant changes in the Company's internal control over financial reporting during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. 39 PART II. OTHER INFORMATION Item 1. Legal Proceedings Shareholders Action - Related On October 24, 2003, the New York Supreme Court for Nassau County issued a final judgment approving the stipulation of compromise and settlement of the class and derivative action entitled Dulitz v. Hirmes, which had challenged certain aspects of the Company's acquisition of Related. Pursuant to that settlement, certain terms of the acquisition will be modified, as fully detailed in the Company's proxy statement that was previously mailed to shareholders and filed with the Commission on September 5, 2003, together with the Notice of Pendency of Class and Derivative Action. Although the defendants in the action denied all wrongdoing and believe they had meritorious defenses, the settlement eliminates the cloud of litigation over the acquisition in connection with Dulitz and provides the Company and its shareholders with certain benefits described in the proxy statement and Notice. The Court also approved an award pursuant to the settlement of $400,000 for attorney's fees and expenses payable by the Company to the plaintiff's attorneys. Item 2. Changes in Securities and Use of Proceeds - None. 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: 10.1 Acquisition Loan Agreement, dated as of December 24, 2001, among Charter Mac Corporation, as Borrower, Fleet National Bank, as Agent, and the Lenders. 10.2 Mortgage Warehousing Credit and Security Agreement, dated as of December 24, 2001, among PW Funding Inc., Cambridge Healthcare Funding Inc. and Larson Financial Resources, Inc., as Borrowers, Fleet National Bank, as Agent, and the Lenders. 10.3 Amended and Restated Reimbursement Agreement, dated as of March 31, 2003, among Charter Mac Equity Issuer Trust, Fleet National Bank, as Agent, Fleet National Bank, as Issuing Bank, and the Participants. 10.4 Tax-Exempt Bond Line of Credit and Security Agreement, dated as of March 26, 2003, among Charter Mac Equity Issuer Trust, Fleet National Bank, Wachovia Bank, National Association, Fleet Securities Inc. and Wachovia Securities, Inc., and the Lenders. 31.1 Chief Executive Officer certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Chief Financial Officer certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 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. 32.2 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 8-K reports were filed or furnished, as noted in the applicable Form 8-K, for the quarter ended September 30, 2003. 40 Current report on Form 8-K relating to filing an exhibit for the Notice of Class and Derivative Action and Settlement dated September 8, 2003. Current report on Form 8-K relating to the Company making available unaudited supplemental data regarding its operations for the quarter ended June 30, 2003, dated August 15, 2003. Current report on Form 8-K relating to a press release issued by the Company reporting its financial results for the second quarter ended June 30, 2003, dated August 12, 2003. 41 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: November 14, 2003 By: /s/ Stuart J. Boesky ------------------------------------------ Stuart J. Boesky Managing Trustee, President and Chief Executive Officer Date: November 14, 2003 By: /s/ Stuart A. Rothstein ------------------------------------------ Stuart A. Rothstein Chief Financial Officer and Chief Accounting Officer