SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20004
FORM 10-K
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
----- EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
----- EXCHANGE ACT OF 1934
Commission File Number 1-13237
CHARTERMAC
(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) 317-5700
Securities registered pursuant to Section 12(b)of the Act:
SHARES OF BENEFICIAL INTEREST
Name of each exchange on which registered:
NEW YORK STOCK EXCHANGE
Securities registered pursuant to Section 12(g) of the Act:
NONE
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes[X] No[ ]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes[ ] No[X]
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No[ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer or a non-accelerated filer (as defined in Rule 12b-2 of the
Exchange Act). Large Accelerated filer [X] Accelerated filer [ ] Non-accelerated
filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes[ ] No[X]
The aggregate market value of common equity held by non-affiliates of the
registrant as of June 30, 2005 was approximately $1,108,635,000.
As of February 28, 2006 there were 52,018,956 outstanding shares of the
registrant's shares of beneficial interest.
DOCUMENTS INCORPORATED BY REFERENCE
Part III: Those portions of the registrant's Proxy Statement for the Annual
Meeting to be held in June 2006 which are incorporated into Items 10, 11, 12 and
13.
TABLE OF CONTENTS
CHARTERMAC
ANNUAL REPORT ON FORM 10-K
PAGE
PART I
Item 1. Business 4
Item 1A. Risk Factors 12
Item 1B. Unresolved Staff Comments 27
Item 2. Properties 27
Item 3. Legal Proceedings 27
Item 4. Submission of Matters to a Vote of Shareholders 28
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities 29
Item 6. Selected Financial Data 31
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations 31
Item 7A. Quantitative and Qualitative Disclosures about Market Risks 50
Item 8. Financial Statements and Supplementary Data 55
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure 115
Item 9A. Disclosures Controls and Procedures 115
Item 9B. Other Information 115
PART III
Item 10. Directors and Executive Officers of the Registrant 116
Item 11. Executive Compensation 116
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters 116
Item 13. Certain Relationships and Related Transactions 116
Item 14. Principal Accounting Fees and Services 116
PART IV
Item 15. Exhibits and Financial Statement Schedules 117
SIGNATURES 122
2
CAUTIONARY STATEMENT FOR PURPOSES OF
THE "SAFE HARBOR" PROVISIONS OF
THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
This Annual Report on Form 10-K contains forward-looking statements. These
forward-looking statements are not historical facts, but rather our beliefs and
expectations and are based on our current expectations, estimates, projections,
beliefs and assumptions about our Company and industry. Words such as
"anticipates," "expects," "intends," "plans," "believes," "seeks," "estimates"
and similar expressions are intended to identify forward-looking statements.
These statements are not guarantees of future performance and are subject to
risks, uncertainties and other factors, some of which are beyond our control,
are difficult to predict and could cause actual results to differ materially
from those expressed or forecasted in the forward-looking statements. Some of
these risks include, among other things:
o adverse changes in the real estate markets including, among other
things, competition with other companies;
o interest rate fluctuations;
o general economic and business conditions, which will, among other
things, affect the availability and credit worthiness of prospective
tenants, lease rents and the terms and availability of financing for
properties financed by mortgage revenue bonds we own;
o environment/safety requirements;
o changes in applicable laws and regulations;
o our tax treatment, the tax treatment of our subsidiaries and the tax
treatment of our investments;
o risk of default associated with the mortgage revenue bonds and other
securities held by us or our subsidiaries;
o the risk that relationships with key investors and developers may not
continue;
o our ability to generate fee income may not continue; and
o risks related to the form and structure of our financing arrangements.
We caution you not to place undue reliance on these forward-looking statements,
which reflect our view only as of the date of this annual report on Form 10-K.
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PART I
ITEM 1. BUSINESS.
General
-------
We are CharterMac, a statutory trust created under the laws of Delaware. We
conduct substantially all of our business through our subsidiaries. For ease of
readership, however, the term "we" (as well as "us", "our" or "the Company") is
used throughout this document may mean a subsidiary or the business as a whole,
while the term "parent trust" refers only to CharterMac as a stand-alone entity.
We provide capital solutions to real estate developers and owners as well as
quality investment products to institutional and retail investors. Through our
subsidiary operations, we offer financing for every part of a property's capital
structure and are one of the nation's leading full-service real estate finance
companies, with a core focus on multifamily rental housing.
We commenced operations in October 1997 and have since expanded through several
acquisitions.
Additional Information
----------------------
Additional information about CharterMac beyond what is included in this Form
10-K, including our code of conduct, is available at WWW.CHARTERMAC.COM. As soon
as reasonably practicable after such material is electronically filed with, or
furnished to, the Securities and Exchange Commission ("SEC") we make available,
on or through our website, free of charge:
o our annual report on Form 10-K;
o our quarterly reports on Form 10-Q;
o our current reports on Form 8-K; and
o amendments to those reports filed or furnished pursuant to Section
13(a) or 15(d) of the Exchange Act.
You may also read and copy these materials at the SEC's Public Reference Room at
450 Fifth Street, NW, Washington, DC 20549, or obtain them by calling the SEC at
1-800-SEC-0300. The SEC also maintains an Internet website that contains
reports, proxy and information statements and other information regarding
issuers that file electronically with the SEC at WWW.SEC.GOV. We will provide a
copy of any of the foregoing documents upon request.
None of the information on our website that is not otherwise expressly set forth
or incorporated by reference in the Form 10-K is a part of this Form 10-K.
Business Overview
-----------------
Through our subsidiaries, we are a full-service real estate finance company,
with a strong core focus on the multifamily sector. Our subsidiaries have direct
financing relationships with over 800 real estate developers and owners
throughout the country. We operate from a fully integrated platform, which
enables us to originate, underwrite and manage the risk of most transactions in
which we provide debt or equity. Our platform offers us several competitive
advantages, including:
o THE ABILITY TO CROSS-SELL OUR PRODUCTS. Frequently on transactions, we
are able to offer more than one component of a property's capital
structure.
o THE ABILITY TO ORIGINATE THE TRANSACTION WHOLESALE. Our "one-stop
shopping" capability enables us to capture substantially all of the
fees associated with the transaction.
o THE ABILITY TO CONTROL THE CREDIT QUALITY OF THE UNDERLYING PROPERTY.
By working directly with the property's owner and by risk-managing the
underlying asset, our credit losses have historically been low.
Operating Segments
------------------
We operate in four business segments:
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1. PORTFOLIO INVESTING, which includes subsidiaries that invest primarily
in tax-exempt first mortgage revenue bonds issued by various state or
local governments, agencies or authorities and other investments
designed to produce federally tax-exempt income. The proceeds of
mortgage revenue bonds are used to finance the new construction,
substantial rehabilitation, acquisition, or refinancing of affordable
multifamily housing throughout the United States.
2. FUND MANAGEMENT, which includes:
o Subsidiaries that sponsor real estate investment funds that
primarily invest equity in Low-Income Housing Tax Credit
("LIHTC") properties. We receive fees for sponsoring, managing
and providing other services to these funds;
o Subsidiaries that provide advisory services to us, other
subsidiaries of ours and to American Mortgage Acceptance Company
("AMAC"), an affiliated, publicly traded real estate investment
trust that focuses on providing first mortgage, mezzanine and
bridge financing to commercial and multifamily properties; and
o Subsidiaries that participate in what we refer to as "credit
intermediation" transactions, including supporting the credit for
affiliate mortgage loans and providing specified returns to
investors in LIHTC investment funds, in exchange for fees.
3. MORTGAGE BANKING, which includes subsidiaries that originate,
underwrite and service predominantly multifamily mortgage loans on
behalf of third parties, including:
o The Federal National Mortgage Association ("Fannie Mae");
o The Federal Home Loan Mortgage Corporation ("Freddie Mac");
o The Federal Housing Authority ("FHA");
o Conduits; and
o Insurance companies.
In exchange for these origination, underwriting and servicing
activities, we receive origination and servicing fees.
4. CONSOLIDATED PARTNERSHIPS, primarily the LIHTC equity funds we sponsor
through the Fund Management segment's subsidiaries and which we are
required to consolidate in accordance with FIN 46(R), as well as other
partnerships we control but in which we have little or no equity
interest (see Note 1 to the consolidated financial statements).
Comparative segment financial information for 2005, 2004 and 2003 is presented
in Note 19 to the consolidated financial statements.
1. PORTFOLIO INVESTING
We conduct most of our portfolio investing through our CharterMac Equity Issuer
Trust ("Equity Issuer") subsidiary.
As of December 31, 2005, our revenue bond portfolio included direct and indirect
interests in mortgage revenue bonds with an aggregate fair value of
approximately $2.5 billion (prior to $227.5 million of eliminations), secured by
affordable multifamily properties containing 51,989 units located in 29 states
and the District of Columbia. While most of these mortgage revenue bonds
generate tax-exempt income, certain of them generate taxable income.
Our Portfolio Investing business generates most of its income and cash flow from
a positive spread between the interest earned from our mortgage revenue bond
portfolio and the cost of capital we use to purchase the bonds. We also receive
fees from borrowers for the origination of new mortgage revenue bonds.
We believe we have a competitive advantage in our Portfolio Investing business
due to our "Direct Purchase Program". The traditional methods of financing
affordable multifamily housing with tax-exempt bonds are complex and time
consuming and involve the participation of many intermediaries. Through the
Direct Purchase Program we have streamlined the process by removing all
intermediaries (except for the governmental issuer of the mortgage revenue bond)
and enabling the developer to deal directly with one source. Because Equity
Issuer
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purchases mortgage revenue bonds directly from the governmental issuer, our
program eliminates the need for underwriters and their counsel, rating agencies
and costly documentation. By dealing directly with our subsidiaries, we believe
developers feel more confident about the terms and timing of their financing.
The acquisition of mortgage revenue bonds requires capital. In addition to using
a portion of our operating cash flows, we obtain such capital by securitizing
most of the bonds we purchase and by issuing equity securities.
For more information on our securitization activity, see Note 9 to our
consolidated financial statements. For information regarding issuances of
preferred shares of Equity Issuer and our common and preferred shares, see Notes
13 and 14 to our consolidated financial statements.
Through this segment, we also invest in other entities, such as our preferred
and common investments in ARCap Investors, L.L.C. ("ARCap,") our participating
loan to and preferred investment in Capri Capital Advisors ("CCA") and our
investments in funds that CCA sponsors (see Note 6 to the consolidated financial
statements).
2. FUND MANAGEMENT
Our Fund Management segment includes:
o Tax Credit Fund Sponsorship;
o Advisory Services; and
o Credit Intermediation.
TAX CREDIT FUND SPONSORSHIP
---------------------------
We conduct our tax credit fund sponsorship activities through CharterMac Capital
LLC ("CharterMac Capital"), which we acquired in November 2003 (see Note 2 to
our consolidated financial statements) and which was formerly known as Related
Capital Company LLC.
CharterMac Capital is one of the nation's largest sponsors of LIHTC investment
funds, having raised nearly $7.5 billion in equity from institutional and retail
investors. As a sponsor of over 115 public and private real estate investment
programs, CharterMac Capital has provided financing for over 1,200 properties in
46 states, Puerto Rico and the District of Columbia.
In a typical LIHTC investment fund, investors acquire a direct limited
partnership interest in an "upper-tier" investment partnership. The investment
partnership, in turn, invests as a limited partner in one or more "lower-tier"
operating partnerships which own and operate the multifamily properties. Limited
partners in the upper-tier partnerships are most often corporations who are able
to utilize the tax benefits and usually derive limited economic benefit from the
investment other than the expected tax credits and tax losses from the
lower-tier partnership's operation of the properties. In some cases, in
conjunction with the final disposition of the property, the limited partners may
receive an additional return.
We often borrow the cash from a warehouse lender to acquire lower-tier
partnership investments . This arrangement enables us to obtain and hold
suitable investments for a fund until it has admitted investors and obtained
investment capital. As a result, we are better able to provide investment
opportunities to the funds we sponsor when investment capital is available. When
we admit investors to a fund, the fund simultaneously pays us an amount
sufficient to enable us to repay the monies we borrowed from the warehouse
lender, and the fund is either admitted as a limited partner of the lower-tier
operating partnership in our place or the warehouse lender releases its lien on
the fund's assets.
Tax credit fund sponsorship generates income and cash flow predominantly from:
o organization and offering fees we earn in connection with the capital
raising and sponsorship of investment programs, which we receive upon
the closing of a fund;
o fees associated with acquisition activity of each fund we sponsor,
which we receive at the time of the acquisition; and
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o partnership management and asset management fees associated with
ongoing administration of investment programs we advise, which we
receive either at the time a fund closes or over several years,
depending upon the terms of the partnership agreements.
ADVISORY SERVICES
-----------------
CharterMac Capital and its subsidiaries provide management and advisory services
to the parent trust and other subsidiaries of CharterMac as well as to AMAC.
Providing services to CharterMac subsidiaries generates income and cash flows in
this segment from:
o fees associated with asset management services provided to the
Portfolio Investing segment with regard to the investments it holds;
and
o fees associated with the origination of certain mortgages by our
Mortgage Banking segment.
While these fees are eliminated in consolidation, our segment results presented
elsewhere in this document reflect these fees as earned.
AMAC is a publicly traded real estate investment trust that focuses on providing
first mortgage, mezzanine and bridge financing to commercial and multifamily
properties. AMAC also invests in government-insured or agency guaranteed debt
securities that are predominantly secured by first mortgages on multifamily
properties. As of December 31, 2005, AMAC had $400.7 million in assets and a
total market capitalization of approximately $399.9 million.
Providing management to AMAC generates income and cash flow predominantly from:
o acquisition fees paid by the borrowers upon the closing of a loan that
AMAC originates;
o asset management fees; and
o incentive management fees received annually if AMAC achieves certain
earnings and distribution benchmarks.
CREDIT INTERMEDIATION
---------------------
We conduct our credit intermediation activities primarily through our Charter
Mac Corporation ("CM Corp.") subsidiary. What we refer to as "credit
intermediation" falls into several categories:
o using default swaps to provide a specified rate of return during the
life of an LIHTC fund we sponsor, for which we receive a fee that we
recognize over the transaction period. These transactions may be for
the construction period or the operation period of a pool of
properties, or for the combined periods. These transactions
historically have involved supporting obligations of a primary
obligor;
o supporting a developer's credit during the construction phase of a
property, for which we receive a fee which we recognize over that
period;
o supporting a developer's credit following the stabilization of a
property for the operational period for the pool of properties, for
which we receive a fee at the inception of the deal and which we
recognize over the estimated operational period of the property; and
o credit intermediation of a borrowers' obligations on either individual
or mortgage pools for a fee.
As previously announced, we plan to launch a new majority-owned subsidiary,
Centerbrook Holdings LLC ("Centerbrook") that will provide certain of our credit
intermediation services on a going forward basis. While historically CM Corp.
has supported the commitments of a primary intermediator, Centerbrook will
fulfill that role for future transactions, and we expect that it will later
fulfill the primary intermediator role. In addition, Centerbrook will provide
what is often referred to as "credit enhancement" of the mortgage revenue bonds
in our securitization programs. There is no assurance, however, that this
subsidiary will begin operations in 2006.
While initially Centerbrook will be involved in credit intermediation for
transactions in which our subsidiaries are involved, we will also seek to
provide these services to other unrelated customers.
7
3. MORTGAGE BANKING
We conduct our mortgage banking activity primarily through our subsidiary
CharterMac Mortgage Capital Corp. ("CMC"), a full-service, direct mortgage
banking firm specializing in originating, underwriting, and servicing mortgage
loans for conventional apartment properties, affordable housing, senior housing,
and commercial properties nationwide. CMC also manages the operations of another
subsidiary, CharterMac Mortgage Partners Corporation, which originates and
services certain Freddie Mac loans. Throughout this document, we will refer to
"CMC" as encompassing our entire Mortgage Banking business.
CMC is one of 26 approved Delegated Underwriters and Servicers ("DUS") in Fannie
Mae's principal multifamily loan program. Fannie Mae delegates the
responsibility for originating, underwriting, closing and delivering multifamily
mortgages to the DUS lenders and the DUS lenders share the risk of loss with
Fannie Mae and service the loans for a fee. Under the DUS program, upon
obtaining a commitment from Fannie Mae with regard to a particular loan, Fannie
Mae commits to acquire the mortgage loan based upon our underwriting, and we
agree to bear a portion of the risk of potential losses in the event of a
default. Fannie Mae commitments may be made to acquire and/or credit enhance the
mortgage loan from CMC for cash or in exchange for a mortgage-backed security
backed by the mortgage loan.
In addition to DUS originations, our mortgage banking activities include:
o closing and delivering multifamily mortgages to Freddie Mac as a
Freddie Mac Program Plus seller/servicer. Similar to the DUS program
with Fannie Mae, as a Program Plus lender, we originate mortgages
based on commitments from Freddie Mac, and we then sell those loans to
Freddie Mac. While Program Plus does not involve risk-sharing, we also
originate loans under Freddie Mac's Delegated Underwriting Initiative
("DUI") Program, which, similar to DUS, involves loss sharing ;
o acting as an approved seller/servicer for the Government National
Mortgage Association ("Ginnie Mae");
o originating and servicing loans as a leading commercial loan
correspondent for Wall Street conduits and life insurance companies;
o acting as an approved loan processor/servicer for the FHA; and
o sub-servicing loans originated by other firms.
Mortgage loans we originate for Fannie Mae, Freddie Mac or Ginnie Mae are
generally closed in CMC's name, using cash borrowed from a warehouse lender.
Approximately one week to one month following closing of a loan, the loan
documentation and an assignment are delivered to the mortgagor, or a document
custodian on its behalf, and the cash purchase price or mortgage-backed security
is delivered to us. We use the cash received to repay the warehouse loans or we
sell the mortgage-backed securities for cash pursuant to prior agreements and
use that cash to repay the warehouse loans. We do not retain any interest in any
of the mortgage loans except for mortgage servicing rights ("MSRs") and certain
contingent liabilities under the loss-sharing arrangements with Fannie Mae and
Freddie Mac.
Our mortgage banking activities generate income and cash flow predominantly
from:
o origination fees;
o ongoing fees for servicing a majority of the loans we originate as
well as other loans that we sub-service. Servicing fees include a loss
sharing premium for loans originated for Fannie Mae (and in certain
cases, Freddie Mac);
o prepayment penalties, generally associated with refinancing; and
o interest earned on amounts held in escrow.
In 2006, this segment will also be originating mortgages for sale to AMAC and
will receive fees for the originations.
4. CONSOLIDATED PARTNERSHIPS
In accordance with accounting rules requiring the consolidation of partnerships,
we consolidate the balance sheets and operations of numerous funds that we
sponsor and other partnerships that we indirectly manage. While we have little
or no equity interest in these consolidated partnerships, we effectively control
them for reasons associated with our role in managing them and the nominal
equity interests of our executive officers. While our Fund Management and
8
Portfolio Investing segments earn fees or interest from these consolidated
partnerships, we consider the partnerships as a separate business for management
purposes. For a more detailed discussion, see Note 1 to the consolidated
financial statements.
Competition
-----------
From time to time, we may be in competition with private investors, investment
banks, mortgage banking companies, lending institutions, Government Sponsored
Enterprises such as Fannie Mae and Freddie Mac, mutual funds, domestic and
foreign credit intermediators, bond insurers, investment partnerships and other
entities with objectives similar to ours. Although we operate in a competitive
environment, competitors focused on providing all of our custom-designed
programs are relatively few. Specifically:
o our Portfolio Investing business competes directly with investment
banks, real estate finance companies and others seeking to invest in
tax-exempt mortgage revenue bonds;
o our Fund Management business competes directly with others seeking to
raise capital for tax advantaged funds, some of which offer credit
intermediation for their funds, regional and national banks that
directly acquire LIHTC investments and other real estate fund
management companies; and
o our Mortgage Banking business is in competition with 25 other licensed
DUS lenders which originate multifamily mortgages on behalf of Fannie
Mae, 34 other Freddie Mac Program Plus lenders, three other companies
that participate in the DUI program as well as numerous banks, finance
companies and others that originate mortgages for resale.
We face many competitors, some of whom have substantially greater financial and
operational resources than we do. In addition, affiliates of some of our
managing trustees have formed, and may continue to form, various entities to
engage in businesses that may be competitive with us, but, at this time, there
is no other such business that has all of our financing products (see RISKS
RELATED TO INVESTING IN OUR COMPANY in Item 1A below). However, we feel we can
effectively compete due to our on-going relationships with developers. Due to
our unified product platform, we believe that we are better positioned to offer
a full range of financing programs on both affordable and market-rate
multifamily housing. Our origination groups are able to cross market all of our
financing products, thereby offering developers a single, streamlined execution.
We face increasing levels of competition both in terms of new competitors and
new competing products. We continually seek to develop new products that will
complement our existing real estate financing products.
Financing and Equity
--------------------
As noted in the segment descriptions above, we typically fund the expansion of
our business through a combination of operating cash flows, short-term
borrowings, securitizations, long-term borrowings and equity issuances. These
funding vehicles are described in detail in MANAGEMENT'S DISCUSSION AND ANALYSIS
- LIQUIDITY AND CAPITAL RESOURCES and in Notes 9, 10, 13 and 14 to our
consolidated financial statements.
Tax Matters
-----------
We are a Delaware statutory trust and a significant portion of our revenue is
non-taxable. Further, for federal income tax purposes, the parent trust and many
of our subsidiaries (including all that constitute our Portfolio Investing
segment) are treated as partnerships that are not subject to income taxes. We
pass through our income, including federally tax-exempt income, to our
shareholders for inclusion in their tax returns. We derive a substantial portion
of our income from ownership of first mortgage "Private Activity Bonds." The
interest from these bonds is generally exempt from regular federal income tax.
However, the Tax Reform Act of 1986 classified this type of interest for bonds
issued after August 7, 1986 as a tax preference item for alternative minimum tax
("AMT") purposes. The percentage of our tax-exempt interest income subject to
AMT was approximately 93% for the year ended December 31, 2005, compared to 93%
in 2004 and 88% in 2003. As a result of AMT, the percentage of our income that
is exempt from federal income tax may be different for each shareholder.
We also conduct businesses that generate taxable income through CM Corp. and its
subsidiaries, which collectively operate our Fund Management and Mortgage
Banking businesses.
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With regard to our mortgage revenue bond investing and tax credit fund
sponsorship, we operate in a regulatory environment governed primarily by two
sections of the Internal Revenue Code of 1986 (the "Code") relating to
affordable housing:
o Section 142(d), which governs the issuance of federally tax-exempt
mortgage revenue bonds for affordable multifamily housing to be owned
by private, for-profit developers; and
o Section 42, which authorizes federal LIHTCs for qualifying affordable
housing properties.
TAX-EXEMPT FINANCING
Section 142(d) provides for the issuance of federally tax-exempt revenue bonds,
the proceeds of which are to be loaned to private developers for the new
construction or acquisition and rehabilitation of multifamily rental housing.
Under the Code, in order to qualify for federally tax-exempt financing, certain
ongoing requirements must be complied with on a continual basis. The principal
requirement is that the property be operated as a rental property and that
during the Qualified Project Period (defined below) at least either:
o 20% of the units must be rented to individuals or families whose
income is less than 50% of the area median gross income (the "20/50
test"); or
o 40% of the units must be rented to individuals or families whose
income is less than 60% of the area median gross income (the "40/60
test");
in each case with adjustments for family size. The Qualified Project Period
begins when 10% of the units in the property are first occupied and ends on the
latest of the date:
(i) which is 15 years after 50% of the units are occupied;
(ii) on which all the bonds have been retired; or
(iii)on which any assistance provided under Section 8 of the U.S. Housing
Act of 1937 terminates.
If these requirements are not complied with on a continual basis, interest on
the mortgage revenue bonds could be determined to be includable in gross income
retroactively to the date such bonds were issued. There is no federal statutory
or regulatory limit on the amount of rent that may be charged. The availability
of federally tax-exempt financing for affordable multifamily housing to be owned
by private, for-profit developers in each state is limited by an annual volume
cap contained in Section 146 of the Code, which is indexed for inflation.
Bonds issued for affordable multifamily housing properties must compete with all
other types of private activity bonds (other than private activity bonds issued
for qualifying Section 501(c)(3) organizations) for an allocation of a state's
available volume cap. Non-profit organizations described in Section 501(c)(3) of
the Code whose charitable purpose is to provide low income housing may also
avail themselves of federally tax-exempt financing to construct or acquire and
rehabilitate affordable multifamily housing properties. Mortgage revenue bonds
for such charities are governed by Section 145 of the Code and may be issued
without regard to the statewide volume cap that applies to for-profit
developers. Under Section 145 of the Code at least 95% of the proceeds of the
bond issue must be used in a manner that furthers the charitable purpose of the
Section 501(c)(3) organization, or a related purpose. In Revenue Procedure
96-32, the IRS promulgated a non-exclusive safe harbor for Section 501(c)(3)
organizations whose charitable purpose is to provide affordable housing: if
either the 20/50 or 40/60 tests described above are met and, in addition, at
least 75% of all units are rented to families whose income does not exceed 80%
of area median gross income (adjusted for family size) and the Section 501(c)(3)
organization charges tenants "affordable rents", the proceeds of a revenue bond
issue will be treated as being used to further the Section 501(c)(3)
organization's charitable purpose.
FEDERAL LIHTCS
Section 42 of the Code authorizes federal LIHTCs for affordable multifamily
rental housing. Under this program, a project either receives an allocation of
federal LIHTCs from an agency designated by the government of the state in which
the project is located or the project is entitled to the LIHTCs by reason of its
being financed by volume cap mortgage revenue bonds. There are two types of
credits:
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o 4% credits - for new buildings and existing buildings financed with
mortgage revenue bonds that receive an allocation of the volume cap,
or for new and existing buildings financed with below-market federal
financing that receive an allocation of federal LIHTCs from state
agencies; and
o 9% credits - for new buildings that receive an allocation of federal
LIHTCs from state agencies.
The credits are taken over a period of 10 years, which can span over an 11-year
operating period. The credit amount is based on the qualified basis of each
building, which is based upon the adjusted basis of the building multiplied by
the percentage of units in the building leased to low-income tenants.
In order to qualify for the federal LIHTC, the property must comply with either
of the 20/50 or 40/60 tests that apply to tax-exempt bonds (see TAX-EXEMPT
FINANCING above). However, in addition, the amount of rent that may be charged
to qualifying low-income tenants cannot exceed 30% of the "imputed income" for
each unit, i.e., 30% of the imputed income of a family earning 50% or 60% of
area median income, as adjusted for family size. Failure to comply continuously
with these requirements throughout the 15 year recapture period could result in
a recapture of the federal LIHTCs. In addition, if the rents from the property
are not sufficient to pay debt service on the mortgage revenue bonds or other
financing secured by the property and a default ensues, the initial borrower
could lose ownership of the project as the result of foreclosure of the mortgage
securing the bonds. In such event, the initial equity investors would no longer
be entitled to claim the federal LIHTCs, but the foreclosing lender could claim
the remaining LIHTCs provided the project continues to be operated in accordance
with the requirements of Section 42. As a result, there is a strong incentive
for the federal LIHTC investor to ensure that the development is current on debt
service payments by making additional capital contributions or otherwise.
With respect to most of the properties that secure our mortgage revenue bonds,
all the multifamily units are rented to individuals or families at 60% of area
median income and, thus, 100% of the qualified basis may be used to determine
the amount of the federal LIHTC. This maximizes the amount of equity raised from
the purchasers of the federal LIHTCs for each development and provides for the
maximum amount of rent that can be obtained from tenants where there is
currently strong occupancy demand.
Investors in CharterMac Capital sponsored funds are usually Fortune 500
corporations that have projected long-term positive tax positions. These
investors generally become limited partners in the CharterMac Capital sponsored
fund which, in turn, invests as a limited partner in the developer/owner of the
affordable housing property. The CharterMac Capital sponsored fund contributes
to the developer/owner an amount equal to the present value of the projected
credits and other tax benefits in the form of an up-front equity contribution to
the developer. In the case of properties utilizing 4% credits, this contribution
will usually provide between 25% and 35% of the costs of the development. For
properties utilizing 9% credits, this payment will usually provide between 45%
and 55% of the cost of the development.
Governance
----------
We are governed by a board of trustees comprised of twelve managing trustees,
seven of whom are independent. Our board of trustees has six committees:
(1) Audit;
(2) Compensation;
(3) Nominating/Governance;
(4) Capital Markets;
(5) Conflicts; and
(6) Investment.
The Audit, Compensation, Nominating/Governance and Capital Markets committees
consist entirely of independent trustees.
Employees
---------
Our subsidiaries had approximately 400 employees at December 31, 2005, none of
whom were parties to any collective bargaining agreement.
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Regulatory Matters
------------------
Our Mortgage Banking business is subject to various governmental and
quasi-governmental regulations. As noted above, CMC is licensed or approved to
service and/or originate and sell mortgage 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 public
corporations. These agencies require CMC to meet minimum net worth and capital
requirements and to comply with other reporting 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, CMC 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. If CMC fails to comply with
the requirements of these programs, the agency can terminate its license or
approval. In addition, Fannie Mae and Freddie Mac have the authority under their
guidelines to terminate a lender's authority to originate and service their
loans for any reason. If CMC's authority is terminated under any of these
programs, it would prevent CMC from originating or servicing loans under that
program. As a condition for receiving Fannie Mae and Freddie Mac's approval of
our acquisitions of the businesses comprising the Mortgage Banking segment we
are required to guarantee such business' obligations under these programs
ITEM 1A. RISK FACTORS
As with any business, we face a number of risks. If any of the following risks
occur, our business, prospects, results of operations and financial condition
would likely suffer. We have grouped these risk factors into several categories,
as follows:
1. General Risks Related to Our Business
2. Risks Related to Our Portfolio Investing Business
3. Risks Related to Our Fund Management Business
4. Risks Related to Our Mortgage Banking Business
5. Risks Related to Application of Tax Laws
6. Risks Related to Investing in Our Company
1. GENERAL RISKS RELATED TO OUR BUSINESS
THERE ARE RISKS ASSOCIATED WITH THE PROPERTIES OUR PRODUCTS FINANCE THAT COULD
ADVERSELY AFFECT OUR NET INCOME AND CASH FLOWS
Through our taxable and tax-exempt subsidiaries, we derive a large portion of
our earnings by:
o investing in taxable and tax-exempt bonds;
o sponsoring funds that provide equity to LIHTC properties; and
o originating and servicing mortgages.
In many cases, we are both the sponsor of the fund and the holder of the debt
secured by the property which is indirectly owned by the fund. In addition, we
also support credit on behalf of developers, provide specified investment
returns to the investors in certain equity funds we sponsor and issue other
credit support associated with the performance of a property.
Our success depends in large part on the performance of the properties that are
the subject of our businesses and, therefore, subjects us to various types and
degrees of risk, including the following:
o the property securing debt might not generate sufficient income to
meet its operating expenses and payments on its related debt;
o the failure of a mortgage obligor to make principal payments on a loan
originated for Fannie Mae or Freddie Mac could expose us to losses
under our loss sharing agreements;
o local, regional or national economic conditions may limit the amount
of rent that can be charged for rental units at the properties and may
result in a reduction in rent payments or the timeliness of rent
payments or a reduction in occupancy levels;
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o federal LIHTCs and local, state and federal housing subsidy or similar
programs which apply to many of the properties impose rent limitations
that could adversely affect the ability to increase rents to generate
the funds necessary to maintain the properties in proper condition,
which is particularly important during periods of rapid inflation or
declining market value of such properties;
o if a bond defaults, the value of the property securing such bond
(plus, for properties that have availed themselves of the federal
LIHTC, the remaining value of such LIHTC) may be less than the
unamortized principal amount of such bond;
o there are certain types of losses (generally of a catastrophic nature,
such as earthquakes, floods, terrorism, wars and toxic mold or other
environmental conditions) which are either uninsurable or not
economically insurable;
o under various laws, ordinances and regulations, an owner or operator
of real estate is liable for damages caused by or the costs of removal
or remediation of certain hazardous or toxic substances released on,
above, under or in such real estate. These laws often impose liability
whether or not the owner knew of, or was responsible for, the presence
of such hazardous or toxic substances. As a result, the entities we
sponsor which own real estate, and the owners of the real estate
securing our investments, could be required to pay for such damages or
removal or remediation costs; and
o a guarantor may be unable to fulfill its obligations.
All of these conditions and events may increase the possibility that, among
other things:
o a property owner may be unable to meet its obligations to us as holder
of its debt;
o a fund may not be able to pay our fees;
o a fund may not generate the return that we have committed to provide
and we may be called upon to satisfy the promised return; and
o we could lose our invested capital and/or anticipated future revenue.
This could decrease the fair value of our investments, lower the fair value of
assets we pledge as collateral and affect our net income and cash flows.
WE MAY SUFFER ADVERSE CONSEQUENCES FROM CHANGING INTEREST RATES
Because a large portion of our debt is variable rate, an increase in interest
rates could negatively affect our net income and cash flows. Additionally,
increasing interest rates may:
o reduce the fair value of our investments, particularly our fixed-rate
mortgage revenue bonds and residual interests in tax-exempt
securitization transactions;
o decrease the amount we could realize on the sale of those investments;
o result in a reduction in the number of properties which are
economically feasible to finance through either tax-exempt financing
or tax credit equity;
o reduce the demand for multifamily tax-exempt and taxable financing,
which could limit our ability to invest in mortgage revenue bonds or
to structure transactions, thereby reducing fees we receive;
o increase our borrowing costs;
o restrict our access to capital;
o cause investors to find alternative investments that are more
attractive than the equity funds we sponsor; and
o adversely affect the amount of cash available for distribution to
shareholders.
Since a significant portion of our investments are residual interests in
mortgage revenue bonds or other securities whose cash flow is first used to pay
senior securities with short-term floating interest rates, any increase in
short-term interest rates will increase the amount of interest paid on the
senior securities and reduce the net cash flow in our Portfolio Investing
business. Further, increasing interest rates may reduce the likelihood of
property development or mortgage refinancing, thereby deceasing the origination
volume in our Mortgage Banking business.
Conversely, a decrease in interest rates may lead to the refinancing of some of
the debt we own if lockout periods have ended. We may not be able to reinvest
the proceeds of any such refinancing at the same interest rates as the debt
refinanced. Additionally, falling interest rates may prompt historical renters
to become homebuyers, in turn potentially reducing the demand for multifamily
rental housing. Further, a portion of our net income is generated by interest
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income we earn on mortgage escrow deposits. If interest rates were to decrease,
our net income in the Mortgage Banking segment would decrease as well.
Furthermore, strategies we may follow to address these risks carry risks of
their own, including, but not limited to:
o the ability to refinance variable-rate debt at terms that we find
acceptable;
o the risk that interest rate swap counterparties may default on their
obligations to us;
o we may not be able to match the duration or reset periods of assets
and liabilities that we want to alleviate the effect of changing
rates; and
o other efforts to manage risks related to changes in interest rates may
not be successful.
If a change in interest rates causes the consequences described above, or
otherwise negatively affects us, the result could adversely affect our ability
to generate net income or cash flows to make distributions and other payments in
respect of our shares.
THE INABILITY TO MAINTAIN OUR RECURRING FEE ARRANGEMENTS AND TO GENERATE NEW
TRANSACTION FEES COULD HAVE A NEGATIVE IMPACT ON OUR NET INCOME AND CASH FLOWS
Two taxable revenue sources in our Fund Management segment are the transaction
fees generated by our sponsorship of new investment programs and recurring fees
payable by existing and future programs. Transaction fees are generally
"up-front" fees that are generated:
o by the sponsorship of new investment programs; and
o upon investment of the capital raised in an investment program.
Recurring fees are generated by the ongoing operation of investment programs we
sponsor, some of which have finite lives. The termination of one or more of
these recurring fee arrangements, or the inability to sponsor new programs which
will generate new recurring and transaction fees, would reduce net income and
cash flows. There can be no assurance that existing recurring fee arrangements
will not be reduced or terminated or that we will be able to realize revenues
from new investment programs.
Likewise, the two principal revenue streams in our Mortgage Banking business are
fees we earn for originating loans and ongoing fees we earn for servicing loans.
A decline in origination volume or the loss or termination of a servicing
arrangement could adversely affect our results of operations and reduce our net
income and cash flows. There can be no assurance that existing recurring fee
arrangements will not be reduced or terminated or that we will be able to
realize revenues from new business.
WE RELY UPON RELATIONSHIPS WITH KEY INVESTORS AND DEVELOPERS WHICH MAY NOT
CONTINUE
We rely upon relationships with key investors and developers. If these
relationships do not continue, or if we are unable to form new relationships,
our ability to generate revenue will be adversely affected. In 2005, five key
investors provided approximately 70.1% of the equity capital raised by tax
credit syndication programs we sponsored, with Fannie Mae and Freddie Mac
together providing approximately 39.8% of the equity capital. In addition, ten
key developers provided approximately 43.7% of the LIHTC properties for which we
arranged equity financing in 2005. Further, Fannie Mae and Freddie Mac were the
purchasers of 63.5% of the loans originated by our Mortgage Banking business in
2005.
There can be no assurance that we will be able to continue to do business with
these key investors and developers or that new relationships will be formed.
Developers may also experience financial difficulties that would, in turn,
reduce the amount of business we transact with them.
By reason of their regulated status, certain of our investors have regulatory
incentives to invest in our sponsored investment programs in addition to the
economic return from such investments. A change in such regulations could result
in determinations to seek other investment opportunities.
REVENUES FROM OUR FEE-GENERATING ACTIVITIES ARE LESS PREDICTABLE THAN THOSE FROM
OUR MORTGAGE REVENUE BOND INVESTMENTS AND COULD RESULT IN A DECREASE IN NET
INCOME AND CASH FLOWS, FLUCTUATIONS IN OUR SHARE PRICE AND A REDUCTION IN THE
PORTION OF OUR INCOME THAT IS TAX-EXEMPT
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As of December 31, 2005 approximately 30% of the revenue we recognized in our
statement of income was derived from fee-generating service activities through
our taxable subsidiaries. Fee-generating businesses are inherently less
predictable than the ownership of mortgage revenue bonds, and there can be no
assurance that the fee-generating activities will be profitable. In addition,
the net income and cash flows generated by our Fund Management business has
historically fluctuated between quarters due to the typical variability in the
timing of investments in tax credit partnerships. These fluctuations could be
perceived negatively and, therefore, adversely affect our share price. Refer to
Note 18 to our consolidated financial statements for quarterly financial
information.
In addition, the portion of our distributions that is excludable from gross
income for federal income tax purposes could decrease based on the size of our
future taxable business. Our taxable subsidiaries do not currently distribute
dividend income to the parent trust but rather reinvest it in their businesses.
If we invest in a larger percentage of taxable investments, or if our taxable
subsidiaries were to distribute dividend income to the parent trust, the result
would likely be that the taxable portion of our overall income would increase,
and, therefore, the percentage of our net income distributed to shareholders
that is federally tax-exempt to them would likely decrease.
2. RISKS RELATED TO OUR PORTFOLIO INVESTING BUSINESS
WE HAVE NO RECOURSE AGAINST STATE OR LOCAL GOVERNMENTS OR PROPERTY OWNERS UPON
DEFAULT OF OUR MORTGAGE REVENUE BONDS OR UPON THE BANKRUPTCY OF AN OWNER OF
PROPERTIES SECURING OUR MORTGAGE REVENUE BONDS
Although state or local governments or their agencies or authorities issue the
mortgage revenue bonds we purchase, the mortgage revenue bonds are not general
obligations of any state or local government. No government, as an issuer of
these bonds, is liable to make payments on the mortgage revenue bonds, nor is
the taxing power of any government pledged for the payment of principal or
interest on the mortgage revenue bonds. An assignment by the issuing government
agency or authority of the mortgage loan in favor of a bond trustee on behalf of
us, or in some cases, an assignment directly to the bondholder, secures each
revenue bond we own. The mortgage loan is also secured by an assignment of
rents. Following the time that the properties securing the mortgage loans are
placed into service and achieve stabilized occupancy, the underlying mortgage
loans are non-recourse to the property owner, other than customary recourse
carve-outs for bad acts, such as fraud and breach of environmental
representations and covenants. Accordingly, the revenue derived from the
operation of the properties securing the mortgage revenue bonds that we own and
amounts derived from the sale, refinancing or other disposition of the
properties are the sole sources of funds for payment of principal and interest
on the mortgage revenue bonds.
Our revenue may also be adversely affected by the bankruptcy of an owner of
properties securing the mortgage revenue bonds that we directly or indirectly
own. An owner of properties under bankruptcy protection may be able forcibly to
restructure its debt service payments and stop making debt service payments to
us, temporarily or otherwise. Our rights in this event would be defined by
applicable law.
WE ARE SUBJECT TO CONSTRUCTION COMPLETION AND REHABILITATION RISKS THAT COULD
ADVERSELY AFFECT OUR EARNINGS
As of December 31, 2005, mortgage revenue bonds with an aggregate fair value of
approximately $313.8 million were secured by affordable multifamily housing
properties which are still in various stages of construction and mortgage
revenue bonds with an aggregate fair value of approximately $367.4 million were
secured by affordable multifamily housing properties which are undergoing
substantial rehabilitation. Construction and/or substantial rehabilitation of
such properties generally lasts approximately 12 to 24 months. The principal
risk associated with this type of lending is the risk of non-completion of
construction or rehabilitation which may arise as a result of:
o underestimated construction or rehabilitation costs;
o delays;
o failure to obtain governmental approvals; and
o adverse weather and other unpredictable contingencies beyond the
control of the developer.
If a mortgage loan is called due to construction and/or rehabilitation not being
completed as required in the mortgage loan documents, we, as the holder of the
mortgage revenue bonds secured by such mortgage, may incur certain costs and be
required to invest additional capital in order to preserve our investment.
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THE PROPERTIES SECURING CERTAIN OF OUR MORTGAGE REVENUE BONDS, WHICH ARE
CURRENTLY IN CONSTRUCTION, LEASE-UP OR REHABILITATION STAGES, MAY EXPERIENCE
FINANCIAL DISTRESS IF THEY DO NOT MEET OCCUPANCY AND DEBT SERVICE COVERAGE
LEVELS SUFFICIENT TO STABILIZE SUCH PROPERTIES, NEGATIVELY AFFECTING OUR ASSETS
AND EARNINGS
As of December 31, 2005, mortgage revenue bonds in our portfolio with a fair
value of approximately $1.5 billion were secured by mortgages on properties in
construction, lease-up or rehabilitation stages. The lease-up of these
underlying properties may not be completed on schedule or at anticipated rent
levels, resulting in a greater risk that they may go into default than bonds
secured by mortgages on properties that are fully leased-up. Should a bond go
into default, we may not receive interest income, which would reduce our net
income and cash flows. Moreover, there can be no assurance that the underlying
property will achieve expected occupancy or debt service coverage levels.
CERTAIN OF OUR MORTGAGE REVENUE BONDS WE AND OUR SUBSIDIARIES HOLD HAVE BEEN
PLEDGED
A significant portion of our revenue bond portfolio has been pledged as
collateral in connection with our securitizations and credit intermediation
activities and we may not have full access to them until we exit the related
programs. The fair value of the pledged bonds varies from time to time. As of
December 31, 2005, the fair value of all pledged bonds was approximately $2.3
billion.
OTHER PARTIES HAVE THE FIRST RIGHT TO CASH FLOW FROM OUR SECURITIZED REVENUE
BOND INVESTMENTS
Because of our utilization of securitization, our interests in a significant
portion of our revenue bond investments are subordinated or may be junior in
right of payment to other bonds, notes or instruments. There are risks in owning
"junior residual interests" that could adversely affect our net income and cash
flows, including:
o the risk that borrowers may not be able to make payments on both the
senior and junior residual interests, resulting in us, as the holder
of the junior residual interests, receiving principal and interest
payments that are less than expected or no cash flow at all;
o the risk that short-term interest rates may rise significantly,
increasing the amounts payable to the holders of the floating-rate
senior interests created through our securitizations and reducing the
amounts payable to us as holders of the junior residual interests; and
o the risk that the holders of the senior mortgage revenue bonds or
senior interests may control the ability to enforce remedies, limiting
our ability to take actions that might protect our interests.
RISK ASSOCIATED WITH SECURITIZATION COULD ADVERSELY AFFECT OUR NET INCOME AND
CASH FLOWS
Through securitizations, we seek to enhance our overall return on our
investments and to generate proceeds that, along with operating cash flows and
equity offering proceeds, facilitate the acquisition of additional investments.
In our debt securitizations, a bank or another type of financial institution
stands ready to provide liquidity to the purchasers of senior interests in our
mortgage revenue bonds. They also provide certain credit intermediation with
respect to the underlying revenue bond, which enables the senior interests to be
sold to investors seeking investments with credit ratings of at least "A" short
term and "AA" long term. The liquidity facilities are generally for one-year
terms and are renewable annually. If the credit strength of either the liquidity
or credit intermediation providers deteriorates, we anticipate that the return
on the residual interests would decrease, negatively affecting our net income
and subsequent executions. In addition, if we are unable to renew the liquidity
or credit intermediation facilities, we would be forced to find alternative
(possibly more expensive) facilities, to repurchase the underlying bonds or to
liquidate the underlying bonds and our investment in the residual interests. If
we were forced to liquidate an investment, we would recognize gains or losses on
the liquidation, which might be significant depending on market conditions. As
of December 31, 2005:
o senior interests with an aggregate amount of $482.5 million were
credit intermediated by an eight-year term facility through MBIA, a
large financial insurer. Of this amount, $382.5 million was subject to
annual "rollover" renewal for liquidity which is provided by a
consortium of banks;
o Merrill Lynch provided liquidity for senior interests with an
aggregate amount of $760.1 million in the P-FLOATs/RITES program. We
do not maintain an ongoing commitment with Merrill Lynch and,
therefore, are subject to the risk of termination of that program on
short notice;
o Merrill Lynch provided credit intermediation for senior interests with
an aggregate amount of $596.8 million in the Merrill Lynch
P-FLOATs/RITES program. We do not maintain an ongoing credit
16
intermediation commitment with Merrill Lynch and, therefore, are
subject to the risk of termination of that program on short notice;
o IXIS Financial Products provided credit intermediation for senior
interests with an aggregate amount of $163.3 million in the Merrill
Lynch P-FLOATs/RITES program. Our credit intermediation commitment
with IXIS is subject to annual renewal;
o Goldman Sachs provided liquidity for senior interests with an
aggregate amount of $187.1 million in the Goldman Sachs TIC/TOC
program. We do not maintain an ongoing liquidity commitment with
Goldman Sachs and, therefore, are subject to the risk of termination
of that program on short notice; and
o IXIS Financial Products provided credit intermediation for senior
interests with an aggregate amount of $187.1 million in the Goldman
Sachs TIC/TOC program. Our credit intermediation commitment with IXIS
is subject to annual renewal.
OUR MORTGAGE REVENUE BONDS MAY BE CONSIDERED USURIOUS
State usury laws establish restrictions, in certain circumstances, on the
maximum rate of interest that may be charged by a lender and impose penalties on
parties making usurious loans, including monetary penalties, forfeiture of
interest and unenforceability of the debt. There is a risk that our mortgage
revenue bonds could be found to be usurious as a result of uncertainties in
determining the maximum legal rate of interest in certain jurisdictions,
especially with respect to mortgage revenue bonds that bear participating or
otherwise contingent interest. Therefore, the amount of interest to be charged
and the return on our mortgage revenue bonds would be limited by state usury
laws and we may have to agree to defer or reduce the amount of interest that can
be paid in any particular year (potentially to zero). Some states may prohibit
the compounding of interest, in which case we may have to agree to forego the
compounding feature of our mortgage revenue bonds originated in those states.
OUR INVESTMENTS IN MORTGAGE REVENUE BONDS ARE ILLIQUID
Our investments in mortgage revenue bonds lack a regular trading market. There
is no limitation in our trust agreement or otherwise as to the percentage of our
investments that may be illiquid and we expect to continue to invest in assets,
substantially all of which will be illiquid securities. If a situation arises
where we require additional cash, we could be forced to liquidate some or all of
our investments on unfavorable terms (if any sale is possible) that could
substantially reduce the amount of distributions available and payments made in
respect of our shares.
MORTGAGE REVENUE BONDS MAY GO INTO DEFAULT FROM TIME TO TIME AND NEGATIVELY
IMPACT OUR NET INCOME AND CASH FLOWS
Properties underlying our mortgage revenue bonds may experience financial
difficulties from time to time, which could cause certain of our mortgage
revenue bonds to go into default. Were that to occur, we might take remedial
action such as, among other things, entering into a work-out or forbearance
agreement with the owner of the property or exercising our rights with respect
to the collateral securing such revenue bond, including the commencement of
mortgage foreclosure proceedings. In addition, in the event that we were to
successfully foreclose the mortgage on the underlying property, it is likely
that, during the period that we or an affiliate owned both the property and the
defaulted bond, we, as holder of the defaulted bond, would be deemed to be a
related party to a "substantial user" of the property underlying such bond. As a
result, during such period, the interest we receive on the bond would be
taxable. See "SUBSTANTIAL USER" LIMITATION below.
3. RISKS RELATED TO OUR FUND MANAGEMENT BUSINESS
THERE ARE RISKS ASSOCIATED WITH CREDIT INTERMEDIATION AND COMMITMENTS TO PROVIDE
SPECIFIED RATES OF RETURN THAT EXPOSE US TO LOSSES
Through our taxable subsidiaries, we provide credit intermediation to third
parties for a fee. If such third parties default on their obligations for which
we provided credit intermediation, we would be called upon to make the related
payment, which would likely be in an amount far in excess of the fee paid to us
for providing the service. We also provide specified internal rates of return to
investors in partnerships designed to pass through tax benefits, including
LIHTCs, to investors. In connection with such transactions we might be required
to advance funds to ensure that the investors do not lose their expected tax
benefits and, if the internal rate of return to investors falls below the
specified level, we would be required to make a payment so that the specified
rate of return will be achieved. Our maximum potential liability pursuant to
those transactions is detailed in MANAGEMENT'S DISCUSSION AND ANALYSIS - OFF
BALANCE SHEET ARRANGEMENTS and Note 21 to the consolidated financial statements.
17
THERE IS A RISK OF ELIMINATION OF, OR CHANGES TO, GOVERNMENTAL PROGRAMS THAT
COULD LIMIT OUR PRODUCT OFFERINGS
A significant portion of our Fund Management revenues is derived from the
syndication of partnership interests in partnerships that invest in properties
eligible for LIHTCs. Although LIHTCs are a part of the Code, Congress could
repeal or modify this legislation at any time or modify the tax laws so that the
value of LIHTC benefits is reduced. If such legislation is repealed or adversely
modified, we would no longer be able to pursue this portion of our business
strategy.
CERTAIN AGREEMENTS PURSUANT TO WHICH WE EARN FEES HAVE FINITE TERMS AND MAY NOT
BE RENEWED WHICH COULD NEGATIVELY AFFECT OUR NET INCOME AND CASH FLOWS
We receive fees pursuant to an advisory agreement with AMAC, an affiliated
company. This advisory agreement is subject to annual renewal and approval by
the independent trustees of AMAC and there is no guarantee that the agreement
will be renewed.
We also receive fees from investment funds we sponsor. These funds generally do
not require or authorize their investors to approve the funds' management
arrangements with us; instead, we will generally acquire controlling interests
in the entities which control these funds. However, these interests are subject
to the fiduciary duty of the controlling entity to the investors in those
programs, which may affect our ability to continue to collect fees from those
funds. Furthermore, the organizational documents of certain of these funds allow
for the investors, at their option, to remove the entity controlled by us as
general partner or managing member without cause. Although the funds will
generally be required to pay fair market value if they exercise this right, our
right to receive future fees would terminate and there can be no assurance that
the payment will fully compensate us for this loss. Finally, many of these funds
typically have finite periods in which they are scheduled to exist, after which
they are liquidated. The termination of a fund will result in a termination of
the fees we receive from it.
OUR ROLE AS A SPONSOR OF INVESTMENT FUNDS AND CO-DEVELOPMENTS EXPOSES US TO
RISKS OF LOSS
In connection with the sponsorship of investment funds and joint venture
activities for co-development of LIHTC properties, we act as a fiduciary to the
investors in our syndication programs and are often also required to provide
performance guarantees. We advance funds to acquire interests in property-owning
partnerships for inclusion in investment programs and, at any point in time, the
amount of funds advanced can be material. Recovery of these amounts is subject
to our ability to attract investors to new investment funds or, if investors are
not found, the sale of the partnership interests in the underlying properties.
We could also be liable to investors in investment programs and third parties as
a result of serving as general partner or special limited partner in various
investment funds. In addition, even when we are not required to do so, we may
advance funds to allow investment funds to meet their expenses and/or generate
the expected tax benefits to investors.
FUNDS MAY NOT GENERATE SUFFICIENT CASH TO PAY FEES DUE TO US, WHICH MAY
NEGATIVELY IMPACT OUR NET INCOME AND CASH FLOWS
Much of the revenue in our Fund Management business is earned from fees that
upper-tier funds we sponsor pay to our subsidiaries for services rendered. These
funds are dependent upon the cash flows of lower-tier partnerships in which they
invest to generate their own cash flows that are used to pay such fees for
services, such as asset management and advisory services. As the lower-tier
partnerships are susceptible to numerous operational risks (see "THERE ARE RISKS
ASSOCIATED WITH THE PROPERTIES OUR PRODUCTS FINANCE THAT COULD ADVERSELY AFFECT
OUR NET INCOME AND CASH FLOWS" above) the upper-tier funds may not collect
sufficient cash to pay the fees they owe to us. If we do not collect these fees,
the negative impact on our cash flows, and our net income if we determine the
fees are not collectible, could negatively impact our business.
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4. RISKS RELATED TO OUR MORTGAGE BANKING BUSINESS
THERE ARE RISKS OF LOSS ASSOCIATED WITH OUR MORTGAGE ORIGINATIONS WHICH MAY
NEGATIVELY IMPACT OUR NET INCOME AND CASH FLOWS
In our DUS program, we originate loans through one of our subsidiaries which are
thereafter purchased by Fannie Mae. We retain a first loss position with respect
to loans that we originate and sell under this program. We assume responsibility
for a portion of any loss that may result from borrower defaults, based on the
Fannie Mae loss sharing formulas, and risk Levels I, II, or III. Of the 863
loans in this program as of December 31, 2005, all but two were Level I loans.
For such loans, if a default occurs, we are 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; any remaining loss is borne by Fannie
Mae. Level II and Level III loans carry a higher loss sharing percentage.
Under the terms of our master loss sharing agreement with Fannie Mae, we are
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, we may request interim loss sharing
adjustments which allow us to fund 25% of such advances until final settlement
under the master loss sharing agreement. No interim sharing adjustments are
available for Level II and Level III loans.
We also participate in loss sharing transactions under Freddie Mac's DUI program
whereby we originate loans that are purchased by Freddie Mac.
Under the terms of our master agreement with Freddie Mac, we are obligated to
reimburse Freddie Mac for a portion of any loss that may result from borrower
defaults on DUI transactions. For such loans, if a default occurs, our share of
the loss will be the first 5% of the unpaid principal balance and 25% of the
next 20% of the remaining unpaid principal balance to a maximum of 10% of the
unpaid principal balance. The loss on a defaulted loan is calculated as the
unpaid principal amount due, unpaid interest due and default resolutions costs
(taxes, insurance, operation and foreclosure costs) less recoveries.
Our maximum "first loss" exposure under the DUS and DUI programs is detailed in
MANAGEMENT'S DISCUSSION AND ANALYSIS - OFF BALANCE SHEET ARRANGEMENTS and Note
21 to the consolidated financial statements.
CHANGES IN EXISTING GOVERNMENT SPONSORED AND FEDERAL MORTGAGE PROGRAMS COULD
NEGATIVELY AFFECT OUR MORTGAGE BANKING BUSINESS.
Our ability to generate revenue through mortgage sales to institutional
investors largely depends on programs sponsored by Fannie Mae and Freddie Mac,
which facilitate the issuance of mortgage-backed securities in the secondary
market. Any discontinuation of, or significant reduction in, the operation of
those programs could have a material adverse effect on our mortgage banking
business and results of operations. Also, any significant adverse change in the
level of activity in the secondary market or the underwriting criteria of these
entities would reduce our revenues.
THE LOSS OF OUR RELATIONSHIPS WITH GOVERNMENT AGENCIES AND RELATED ENTITIES
WOULD HAVE AN ADVERSE EFFECT ON OUR BUSINESS.
Our agreements with Fannie Mae and Freddie Mac afford us a number of advantages
and may be canceled by the counterparty for cause. Cancellation of one or more
of these agreements would have a material adverse impact on our operating
results and could result in further disqualification with other counterparties,
loss of technology and other materially adverse consequences.
AS A MORTGAGE LENDER, WE MUST COMPLY WITH NUMEROUS LICENSING REQUIREMENTS, AND
OUR INABILITY TO REMAIN IN COMPLIANCE WITH SUCH REQUIREMENTS COULD ADVERSELY
AFFECT OUR OPERATIONS AND OUR REPUTATION GENERALLY.
Like other mortgage companies, we must comply with the applicable licensing and
other regulatory requirements of each jurisdiction in which we are authorized to
lend. These requirements are complex and vary from jurisdiction to jurisdiction.
From time to time we are subject to examination by regulators, and if it is
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determined that we are not in compliance with the applicable requirements, we
may be fined, and our license to lend in one or more jurisdictions may be
suspended or revoked.
IF OUR LOAN SERVICING PORTFOLIO DECREASES, OUR NET INCOME AND CASH FLOWS WOULD
BE NEGATIVELY AFFECTED
A large portion of our revenues in the Mortgage Banking business relate to
recurring fees for servicing mortgages originated or those for which we have
sub-servicing agreements. Loans in our portfolio are subject to maturity,
prepayments, defaults and refinancing after which we may not recapture the loan.
Upon these events, our portfolio would decline, depriving us of the associated
revenue stream. This, in turn, would negatively affect our net income and cash
flows.
PROPOSED CHANGES TO ACCOUNTING RULES COULD ADVERSELY AFFECT OUR REPORTED NET
INCOME
During 2005, the Financial Accounting Standards Board issued proposed revisions
to its Standard No. 140, ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL
ASSETS AND EXTINGUISHMENTS OF LIABILITIES, which governs the accounting for,
among other things, the origination and sale of mortgage loans. One
interpretation of the proposed changes may call into question whether the
mortgages we originate and sell under the DUS and DUI programs may be recognized
as sales for accounting purposes. Should that interpretation become a part of
any final accounting standard issued, it is possible that we may have to
continue to carry such loans on our balance sheet as assets, account for the
proceeds received as debt and not recognize certain mortgage banking fees as
revenues upon the sale as we do currently. Such accounting changes would
decrease our reported net income, which may negatively affect our share price.
In addition, the potential decline in net income and the likely increase in our
level of reported debt may cause non-compliance with debt covenants.
5. RISKS RELATED TO APPLICATION OF TAX LAWS
OUR CLASSIFICATION AS A PUBLICLY TRADED PARTNERSHIP NOT TAXABLE AS A CORPORATION
IS NOT FREE FROM DOUBT AND COULD BE CHALLENGED
We, and all of our Portfolio Investing subsidiaries, operate as partnerships or
are disregarded for federal income tax purposes. This allows us to pass through
our income, including our federally tax-exempt income, and deductions to our
shareholders. The listing of our common shares on the New York Stock Exchange
causes us to be treated as a "publicly traded partnership" for federal income
tax purposes. We and our counsel, Paul, Hastings, Janofsky & Walker LLP ("Paul
Hastings"), believe that we have been and are properly treated as a partnership
for federal income tax purposes. However, the Internal Revenue Service ("IRS")
could challenge our partnership status and we could fail to qualify as a
partnership in years that are subject to audit or in future years. Qualification
as a partnership involves the application of numerous technical legal
provisions. For example, a publicly traded partnership is generally taxable as a
corporation unless 90% or more of its gross income is "qualifying" income (which
includes interest, dividends, real property rents, gains from the sale or other
disposition of real property, gain from the sale or other disposition of capital
assets held for the production of interest or dividends, and certain other
items). We have represented that in all prior years of our existence at least
90% of our gross income was qualifying income and we intend to conduct our
operations in a manner such that at least 90% of our gross income will
constitute qualifying income in the current year and in the future. In the
opinion of Paul Hastings, although the issue is not free from doubt, we have
been and are properly treated as a partnership for federal income tax purposes.
In determining whether interest is treated as qualifying income under these
rules, interest income derived from a "financial business" and income and gains
derived by a "dealer" in securities are not treated as qualifying income. We
have represented that we are acting as an investor with respect to our revenue
bond investments and that we have not engaged in, and will not engage in, a
financial business, although there is no clear guidance on what constitutes a
financial business under the tax law. We have taken the position that for
purposes of determining whether we are in a financial business, portfolio
investing activities that we are engaged in now and that we contemplate engaging
in prospectively would not cause us to be engaged in a financial business or to
be considered a "dealer" in securities. The IRS could assert that our activities
constitute a financial business. If our activities constitute (or as a result of
increased volume constitute) a financial business or cause us to be treated as a
dealer, there is a substantial risk that more than 10% of our gross income would
not constitute qualifying income. We could also be treated as if we were engaged
in a financial business if the activities of CM Corp. and its subsidiaries were
attributed to us and were determined to constitute a financial business. CM
Corp., including its principal subsidiaries CharterMac Capital and CMC, is
subject to income tax on its income. Accordingly, we believe the activities and
income of CM Corp. and its subsidiaries will not be attributed to CharterMac for
20
purposes of determining CharterMac's tax status. In addition, in determining
whether interest is treated as qualifying income, interest income that is
determined based upon the income or profits of any person is not treated as
qualifying income. A portion of the interest payable on participating interest
bonds owned by us is determined based upon the income or profits of the
properties securing our investments. Accordingly, if we were to receive more
than 10% of our gross income in any given year from such "contingent interest,"
the IRS could take the position that we should be treated as a publicly traded
partnership taxable as a corporation. There can be no assurance that such
monitoring would be effective in all events to avoid the receipt of contingent
interest and any other non-qualifying income in any given year that exceeds 10%
of our gross income because circumstances outside of our (or our subsidiaries)
control could cause such a result.
If, for any reason, less than 90% of our gross income constitutes qualifying
income, items of income and deduction would not pass through to our shareholders
and our shareholders would be treated for federal income tax purposes as
stockholders in a corporation. We would be required to pay income tax at
corporate rates on any portion of our net income that did not constitute
tax-exempt income. In addition, a portion of our federally tax-exempt income may
be included in determining our alternative minimum tax liability. Distributions
by us to our shareholders would constitute dividend income taxable to such
holders to the extent of our earnings and profits, which would include
tax-exempt income, as well as any taxable income we might have, and the payment
of these distributions would not be deductible by us. These consequences would
have a material adverse effect on us, our shareholders and the price of our
shares.
OUR TREATMENT OF INCOME FROM OUR RESIDUAL INTERESTS AS FEDERALLY TAX-EXEMPT
COULD BE CHALLENGED
We hold, indirectly, residual interests in certain federally tax-exempt mortgage
revenue bonds through securitization programs, such as the P-FLOATs/RITES
program, which entitle us to a share of the federally tax-exempt interest of
such mortgage revenue bonds. Special tax counsel have each rendered an opinion
to the effect that the issuer of the RITES and similar instruments will each be
classified as a partnership for federal income tax purposes and the holders of
the RITES and similar instruments will be treated as partners of each
partnership. Consequently, as the holder of the RITES and similar instruments,
we treat our share of the federally tax-exempt income allocated and distributed
to us as federally tax-exempt income. However, it is possible that the IRS could
disagree with those conclusions and an alternative characterization could cause
income from the RITES and similar instruments to be treated as ordinary taxable
income. If such an assertion of an alternative characterization prevailed, it
would materially adversely affect us and our shareholders.
THERE IS A RISK THAT THE IRS WILL DISAGREE WITH OUR JUDGMENT WITH RESPECT TO
ALLOCATIONS
We use various accounting and reporting conventions to determine each
shareholder's allocable share of income, including any market discount taxable
as ordinary income, gain, loss and deductions. Our allocation provisions will be
respected for federal income tax purposes only if they are considered to have
"substantial economic effect" or are in accordance with the partners' "interest
in the partnership." There is no assurance that the IRS will agree with our
various accounting methods, conventions and allocation provisions, particularly
our allocation of adjustments to shareholders attributable to the differences
between the shareholders' purchase price of common shares and their shares of
our tax basis in our assets, pursuant to an election we made.
THE TAXABILITY OF OUR INCOME DEPENDS UPON THE APPLICATION OF TAX LAWS THAT COULD
BE CHALLENGED
The following discussion relates only to the portion of our investments which
generate federally tax-exempt income.
TAX-EXEMPTION OF OUR MORTGAGE REVENUE BONDS
On the date of original issuance or re-issuance of each revenue bond,
nationally recognized bond counsel or special tax counsel rendered its
opinion to the effect that, based on the law in effect on that date,
interest on such mortgage revenue bonds is excludable from
federally-taxable gross income, except with respect to any revenue bond
(other than a revenue bond, the proceeds of which are loaned to a
charitable organization described in Section 501(c)(3) of the Code) during
any period in which it is held by a "substantial user" of the property
financed with the proceeds of such mortgage revenue bonds or a "related
person" of such a "substantial user." Each opinion speaks only as of the
date it was delivered. In addition, in the case of mortgage revenue bonds
which, subsequent to their original issuance, have been reissued for
federal tax purposes, nationally recognized bond counsel or special tax
counsel has delivered opinions that interest on the reissued bond is
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excludable from federally-taxable gross income of the holder from the date
of re-issuance or, in some cases, to the effect that the re-issuance did
not adversely affect the excludability of interest on the mortgage revenue
bonds from the gross income of the holders thereof. However, an opinion of
counsel has no binding effect and there is no assurance that the IRS will
not contest these conclusions reached or, if contested, they will be
sustained by a court.
The Code establishes certain requirements which must be met subsequent to
the issuance and delivery of tax-exempt mortgage revenue bonds for interest
on such mortgage revenue bonds to remain excludable from federally-taxable
gross income. Among these continuing requirements are restrictions on the
investment and use of the revenue bond proceeds and, for mortgage revenue
bonds the proceeds of which are loaned to a charitable organization
described in Section 501(c)(3) of the Code, the continued exempt status of
such borrower. In addition, the continuing requirements include tenant
income restrictions, regulatory agreement compliance and compliance with
rules pertaining to arbitrage. Each issuer of the mortgage revenue bonds,
as well as each of the underlying borrowers, has covenanted to comply with
certain procedures and guidelines designed to ensure satisfaction of the
continuing requirements of the Code. Failure to comply with these
continuing requirements of the Code may cause the interest on such bonds to
be includable in federally-taxable gross income retroactively to the date
of issuance, regardless of when such noncompliance occurs. Greenberg
Traurig, LLP (also referred to as "Greenberg Traurig") as our bond counsel,
and Paul Hastings, as our securities counsel (Greenberg Traurig and Paul
Hastings are collectively referred to herein as our "Counsel"), have not,
in connection with this filing, passed upon and do not assume any
responsibility for, but rather have assumed the continuing correctness of,
the opinions of bond counsel or special tax counsel (including opinions
rendered by Greenberg Traurig) relating to the exclusion from
federally-taxable gross income of interest on the mortgage revenue bonds
and have not independently verified whether any events or circumstances
have occurred since the date such opinions were rendered that would
adversely affect the conclusions set forth herein.
TREATMENT OF PARTICIPATING INTEREST BONDS AS EQUITY INVESTMENTS
At our inception, almost all of our revenue bond investments were
participating interest bonds that had been issued in the late 1980s. Since
August 1996, because of the promulgation of certain tax regulations,
participating interest tax-exempt bonds are rarely issued. Accordingly, and
because the number of participating interest bonds in our portfolio has
been shrinking on account of sales and refinancings, as of December 31,
2005, such bonds comprised only 3.5% of our total revenue bond portfolio.
Payment of a portion of the interest accruing on a participating interest
bond depends upon the cash flow from, and the proceeds upon the sale or
refinancing of, the property securing such bond. Because of this
participation feature, the IRS could assert that we are not a lender to the
owner of the underlying property, but rather an equity investor. If that
position were sustained, all or part of the interest we receive on
participating interest bonds could be treated as a taxable return on our
investment and not as tax-exempt interest.
We or our predecessors received opinions of counsel from Willkie, Farr &
Gallagher LLP or other counsel respecting each of our participating
interest bonds to the effect that, based upon assumptions described in such
opinions, which assumptions included the fair market value of the
respective properties upon completion and economic projections and
guarantees, the participating interest bonds "would" be treated for federal
tax purposes as representing debt. The implicit corollary of these opinions
is that the participating interest bonds do not constitute an equity
interest in the underlying borrower.
We will treat all interest received with respect to these bonds as
tax-exempt income, there can be no assurance that such assumptions are
correct, such treatment would not be challenged by the IRS, or that
intervening facts and circumstances have not changed the assumptions and
bases for providing such opinions. The opinions discussed above speak only
as of their respective delivery dates, and our Counsel has not passed upon
or assumed any responsibility for reviewing any events that may have
occurred subsequent to the delivery of such opinions which could adversely
affect the conclusions contained therein.
"SUBSTANTIAL USER" LIMITATION
Interest on a revenue bond we own, other than a bond the proceeds of which
are loaned to a charitable organization described in Section 501(c)(3) of
the Code, will not be excluded from gross income during any period in which
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we are a "substantial user" of the properties financed with the proceeds of
such revenue bond or a "related person" to a "substantial user."
A "substantial user" generally includes any underlying borrower and any
person or entity that uses the financed properties on other than a de
minimis basis. We would be a "related person" to a "substantial user" for
this purpose if, among other things,
o the same person or entity owned more than a 50% interest in both
us and in the properties financed with the proceeds of a bond
owned by us or one of our subsidiaries; or
o we owned a partnership or similar equity interest in the owner of
a property financed with the proceeds of a bond owned by us or
one of our subsidiaries.
Additionally, a determination that we are a partner or a joint venturer
with a mortgagor involving an equity interest, as described above under
TREATMENT OF PARTICIPATING INTEREST BONDS AS EQUITY INVESTMENTS, could
cause us to be treated as a "substantial user" of the properties securing
our investments.
Greenberg Traurig has reviewed the mortgage revenue bonds we own, the
ownership of the obligors of our mortgage revenue bonds and the ownership
of our shares and our subsidiaries' shares, and concurs in the conclusion
that we are not "substantial users" of the properties financed with the
proceeds of the mortgage revenue bonds or related parties thereto. There
can be no assurance, however, that the IRS would not challenge such
conclusion. If such challenge were successful, the interest received on any
bond for which we were treated as a "substantial user" or a "related party"
thereto would be includable in federally taxable gross income.
SECURITIZATION PROGRAMS AND REVENUE PROCEDURE 2003-84
Many of the senior interests in our securitization programs are held by
tax-exempt money-market funds. For various reasons, money market funds will
only acquire and hold interests in securitization programs that comply with
Revenue Procedure 2003-84, which provides for exemption from Schedule K-1
reporting requirements for certain partnerships. Our counsel, Greenberg
Traurig, has advised us that the partnerships we use in our securitizations
currently meet the requirements of Revenue Procedure 2003-84. It is our
intention to continue to meet those requirements, which include an income
test and an expense test, on an ongoing basis. There can be no assurance,
however, that unforeseen circumstances might cause one or more of our
securitization partnerships to fail either the income test or the expense
test, which would cause our securitization partnerships to have to comply
with all of the requirements of subchapter K of the Code. In the event one
or more of our securitization partnerships was forced to comply with the
provisions of subchapter K of the Code, it is likely that all of the
tax-exempt money market funds that hold the senior interests in those
securitizations would tender their positions. This could cause our
remarketing agent to locate new purchasers, which were not tax-exempt money
market funds, for those tendered senior interests. This would probably
result in an increase in the distributions to the holders of the senior
interests, which would reduce, dollar for dollar, the distributions on the
residual interests in the securitizations, which are owned by us through
our subsidiaries.
TAXABLE INCOME
In our Portfolio Investing business, we primarily invest in investments
that produce only tax-exempt income. However, the IRS may seek to
re-characterize a portion of our tax-exempt income as taxable income as
described above. If the IRS were successful, a shareholder's distributive
share of such income would be taxable to the shareholder, regardless of
whether an amount of cash equal to such distributive share is actually
distributed. Any taxable income would be allocated pro rata among our CRA
Preferred Shares, our CRA Shares and our common shares. We may also have
taxable income in the form of market discount or gain on the sale or other
disposition of our investments, and we expect to own investments and engage
in certain fee generating activities (through our subsidiaries) that will
generate taxable income.
STRUCTURE OF OUR ACQUISITIONS
Our acquisitions of CharterMac Capital and other subsidiaries were
structured to prevent us from realizing active income from these businesses
and to effectively receive a tax deduction (via the allocation of
subsidiary costs) for payments made to its selling principals. It is
possible that the IRS could challenge this structure, with material adverse
consequences to us. First, the IRS could assert that we, as the parent
trust, are the owner of these businesses, in which case the parent trust
23
would realize an amount of active income from them that would require it to
be treated as a corporation instead of a publicly traded partnership for
income tax purposes. If the IRS prevailed, we would be required to pay
taxes on that income, thereby reducing the amount available for us to make
distributions. As a result, it is likely that the value of our shares would
decline. Second, the IRS might assert that the Special Common Units
("SCUs") and Special Membership Units ("SMUs") held by the selling
principals of the businesses and others are actually shares of our Company.
If this position prevailed, the distributions payable on the units would
not reduce the taxable income of CM Corp. In such event, CM Corp. would be
subject to increased tax, which could reduce our net income, our cash flows
and our distributions, which could also result in a decrease in the portion
of our distributions that is excluded from gross income for federal income
tax purposes.
6. RISKS RELATED TO INVESTING IN OUR COMPANY
BECAUSE WE HOLD MOST OF OUR INVESTMENTS THROUGH OUR SUBSIDIARIES, OUR
SHAREHOLDERS ARE EFFECTIVELY SUBORDINATED TO THE LIABILITIES AND EQUITY OF OUR
SUBSIDIARIES
We hold most of our investments through our subsidiaries. Since we own only
common equity of our subsidiaries, we, and therefore holders of our shares, are
effectively subordinated to the debt obligations, preferred equity, SCUs and
SMUs of our subsidiaries, which at December 31, 2005, aggregated approximately
$2.5 billion. In particular, the holders of the preferred shares of our Equity
Issuer subsidiary are entitled to receive preferential distributions with
respect to revenues generated by mortgage revenue bonds held directly or
indirectly by it, which constitute a substantial portion of our assets.
Similarly, holders of senior interests created through our securitization
programs have a superior claim to the cash flow from the mortgage revenue bonds
deposited in such programs. Accordingly, a portion of the cash flow from our
investments will not be available for distribution on our common shares.
Likewise if we pay a common dividend:
o holders of SCUs issued by our CCC subsidiary are entitled to receive
preferential distributions with respect to the earnings of CharterMac
Capital; and
o holders of SMUs issued by our CM Investor subsidiary are entitled to
receive preferential distributions with respect to the earnings of CM
Investor.
Those earnings therefore, may not be available for distribution to our common
shareholders.
WE DEPEND UPON THE SERVICES OF OUR EXECUTIVE OFFICERS
We and our subsidiaries depend upon the services of two key executive officers
(Mr. Hirmes and Mr. Schnitzer) and other individuals who comprise our executive
management team. All decisions with respect to the management and control of our
Company and our subsidiaries, subject to the supervision of our board of
trustees (or the applicable subsidiary's board), are currently made by these key
officers. The departure or the loss of the services of either of these key
officers or a large number of senior management personnel and other employees
could have a material adverse effect on our ability to operate our business
effectively and our future results of operations.
OUR BOARD OF TRUSTEES CAN CHANGE OUR BUSINESS POLICIES UNILATERALLY
Our board of trustees may amend or revise our business plan and certain other
policies without shareholder approval. Therefore, our shareholders have no
control over changes in our policies, including our business policies with
respect to acquisitions, financing, growth, debt, capitalization and
distributions, which are determined by our board of trustees.
THERE ARE POSSIBLE ADVERSE EFFECTS ARISING FROM SHARES AVAILABLE FOR FUTURE SALE
Our board of trustees is permitted to offer additional equity or debt securities
of our Company and our subsidiaries in exchange for money, property or other
consideration. Our ability to sell or exchange such securities will depend on
conditions then prevailing in the relevant capital markets and our results of
operations, financial condition, investment portfolio and business prospects.
Subject to New York Stock Exchange rules which require shareholder approval for
certain issuances of securities and as long as the issuance is made in
accordance with our trust agreement, the issuance of such additional securities
will not be subject to the approval of our shareholders and may negatively
affect any resale price of our shares. Shareholders will not have any preemptive
rights in connection with the issuance of any additional securities we or our
24
subsidiaries may offer, and any of our equity offerings would cause dilution of
a shareholder's investment in us.
THE FORMER OWNERS OF CHARTERMAC CAPITAL HAVE SIGNIFICANT VOTING POWER ON MATTERS
SUBMITTED TO A VOTE OF OUR SHAREHOLDERS, AND THEIR INTERESTS MAY BE IN CONFLICT
WITH THE INTERESTS OF OUR OTHER SHAREHOLDERS
In connection with our acquisition of CharterMac Capital, we issued to each of
its selling principals one special preferred voting share for each SCU they
received. Our special preferred voting shares have no economic interest, but
entitle each holder to one vote per special preferred voting share on all
matters subject to a vote of the holders of our common shares. The selling
principals of CharterMac Capital who received special preferred voting shares
include members of our executive management team and a subsidiary of The Related
Companies, L.P. ("TRCLP"), which is controlled by Mr. Ross, the chairman of our
board of trustees. As a result of that special preferred voting share issuance
and additional common shares directly or indirectly owned by them, our executive
management team (Mr. Hirmes and Mr. Schnitzer) and Mr. Ross in the aggregate
directly or indirectly owned voting shares representing approximately 19.6% of
our voting power as of December 31, 2005. As such, if they vote as a block, such
shareholders will have significant voting power on all matters submitted to a
vote of our common shareholders.
Also, because three of these selling principals of CharterMac Capital serve,
along with others, as our managing trustees, there are ongoing conflicts of
interest when we are required to determine whether or not to take actions to
enforce our rights under the various agreements entered into in connection with
the CharterMac Capital acquisition. While any material decisions involving these
persons are subject to the vote of a majority of our independent trustees, such
decisions may create conflicts between us and these persons.
In addition, we have some obligations to these former owners which will require
us to make choices as to how we operate our business which may affect those
obligations. For example, we have guaranteed the payment to all holders of the
SCUs of all but $5.0 million of the distributions they would otherwise be
entitled to receive under the operating agreement of CharterMac Capital Company
LLC ("CCC"). In addition, we have agreed to share cash flow from investment
programs so that we and certain of these former owners can receive payment of
deferred fees. Further, TRCLP and its affiliates currently engage in businesses
which compete with us. The non-competition covenants contained in a future
relations agreement entered into by TRCLP and its affiliates in connection with
our acquisition of CharterMac Capital prohibit TRCLP and its affiliates from
competing with any business currently engaged in by us other than in specified
areas, including:
o providing credit intermediation on debt products secured by "80/20"
multifamily housing properties; and
o providing mezzanine financing to multifamily housing properties other
than so-called "tax credit properties."
There can be no assurance that we and TRCLP and its affiliates will not compete
for similar products and opportunities in these areas in the future.
NO ASSURANCE CAN BE GIVEN THAT OUR SHAREHOLDERS WILL BE ENTITLED TO THE SAME
LIMITATION ON PERSONAL LIABILITY AS STOCKHOLDERS OF PRIVATE CORPORATIONS FOR
PROFIT
We are governed by the laws of the State of Delaware. Under our trust agreement
and the Delaware Statutory Trust Act, as amended ("Delaware Act"), our
shareholders will be entitled to the same limitation of personal liability
extended to stockholders of private corporations for profit organized under the
General Corporation Law of the State of Delaware. In general, stockholders of
Delaware corporations are not personally liable for the payment of corporate
debts and obligations, and are liable only to the extent of their investment in
the Delaware corporation. However, a shareholder may be obligated to make
certain payments provided for in our trust agreement and bylaws. The properties
securing our investments are dispersed in numerous states and the District of
Columbia. In jurisdictions which have not adopted legislative provisions
regarding statutory trusts similar to those of the Delaware Act, questions exist
as to whether such jurisdictions would recognize a statutory trust, absent a
state statute, and whether a court in such jurisdiction would recognize the
Delaware Act as controlling. If not, a court in such jurisdiction could hold
that our shareholders are not entitled to the limitation of liability set forth
in our trust agreement and the Delaware Act and, as a result, are personally
liable for our debts and obligations.
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OUR ANTI-TAKEOVER PROVISIONS MAY DISCOURAGE THIRD-PARTY PROPOSALS
Certain provisions of our trust agreement may have the effect of discouraging a
third party from making an acquisition proposal for our Company. This could
inhibit a change in control of our Company under circumstances that could give
our shareholders the opportunity to realize a premium over then-prevailing
market prices. Such provisions include the following:
ADDITIONAL CLASSES AND SERIES OF SHARES
Our trust agreement permits our board of trustees to issue additional
classes or series of beneficial interests and to establish the preferences
and rights of any such securities. Thus, our board of trustees could
authorize the issuance of beneficial interests with terms and conditions
which could have the effect of discouraging a takeover or other
transaction.
STAGGERED BOARD
Our board of trustees is divided into three classes of managing trustees.
The terms of the first, second and third classes will expire in 2008, 2006
and 2007, respectively. Managing trustees for each class will be chosen for
a three-year term upon the expiration of the current class' term. The use
of a staggered board makes it more difficult for a third-party to acquire
control over us.
SALES IN THE PUBLIC MARKET OF OUR COMMON SHARES ISSUABLE IN EXCHANGE FOR OUR
SCUS AND SMUS COULD ADVERSELY AFFECT THE MARKET PRICE OF OUR SHARES
Future sales of substantial amounts of our common shares in the public market
could adversely affect prevailing market prices of our shares. As of December
31, 2005, approximately 14.9 million common shares remained issuable in exchange
for the SCUs we issued, approximately 539,000 common shares remained issuable in
exchange for the SMUs we issued and we have granted restricted common shares of
which approximately 255,000 were unvested at December 31, 2005. When these
shares vest and/or convert, their sale in the public market could, and depending
upon the number of involved, likely would, adversely affect prevailing market
prices of our shares and our ability to raise additional capital through equity
markets. As of December 31, 2005, TRCLP and its owners indirectly held
approximately 10.2 million SCUs and approximately 580,000 common shares which,
subject to some exceptions, are not subject to a lock-up agreement. In addition,
a former executive of our Company resigned during 2005 he held approximately 1.5
million SCUs as of December 31, 2005. These SCUs are not subject to lock-up
agreements and may be converted to common shares at any time.
IF WE HAD TO REGISTER UNDER THE INVESTMENT COMPANY ACT, THERE COULD BE NEGATIVE
CONSEQUENCES TO OUR INVESTMENT STRATEGY
Neither we nor our subsidiaries are registered under the Investment Company Act
of 1940, as amended (the "Investment Company Act") and we may not be able to
conduct our activities as we currently do if we were required to so register.
At all times, we intend to conduct our activities, and those of our
subsidiaries, so as not to become regulated as an "investment company" under the
Investment Company Act. Even if we are not an investment company under the
Investment Company Act, we could be subject to regulation under the Investment
Company Act if a subsidiary of ours were deemed to be an investment company.
There are a number of possible exemptions from registration under the Investment
Company Act that we believe apply to us and our subsidiaries and which we
believe make it possible for us not to be subject to registration under the
Investment Company Act.
For example, the Investment Company Act exempts entities that are "primarily
engaged in the business of purchasing or otherwise acquiring mortgages and other
liens on and interests in real estate," which we refer to as "qualifying
interests." Under current interpretations by the SEC staff, one of the ways in
which our subsidiaries can qualify for this exemption is to maintain at least
55% of their assets directly in qualifying interests and the balance in real
estate-type interests. We believe our subsidiaries can rely on this exemption or
another exemption from registration.
26
The requirement that our subsidiaries maintain 55% of their assets in qualifying
interests (or satisfy another exemption from registration) may inhibit our
ability to acquire certain kinds of assets or to securitize additional interests
in the future. If any of our subsidiaries fail to qualify for exemption from
registration as an investment company and we, in turn, are required to register
as an investment company, our ability to maintain our financing strategies would
be substantially reduced, and we would be unable to conduct our business as
described herein. Such a failure to qualify could have a material adverse effect
upon our ability to make distributions to our shareholders.
AN INABILITY TO RAISE CAPITAL COULD ADVERSELY AFFECT OUR GROWTH
A major aspect of our business plan includes the acquisition of additional
mortgage revenue bonds, which requires capital. In addition to funds generated
through operations (including securitizations), we raise capital by periodically
offering securities issued by us or one or more of our subsidiaries. Our ability
to raise capital through securities offerings is subject to risks, including:
o conditions then prevailing in the relevant capital markets;
o our results of operations, financial condition, investment portfolio
and business prospects;
o the timing and amount of distributions to the holders of our shares
which could negatively affect the price of a common share; and
o the amount of securities that are structurally senior to the
securities being sold.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
None
ITEM 2. PROPERTIES
We lease the office space in which our headquarters are located at 625 Madison
Avenue, New York, NY. The lease expires in 2017.
We also lease office space in other location as follows:
o Jersey City, NJ - An office facility; the lease expires in 2010.
o Bethesda, MD - An office facility; the lease expires in 2009.
o Irvine, CA - Two office facilities; the leases expire in 2006 and
2008.
o Dallas, TX - An office facility; the lease expires in 2010.
o San Rafael, CA - An office facility; the lease expires in 2008.
o San Francisco, CA - An office facility; the lease expires in 2012.
We believe that these facilities are suitable for current requirements and
contemplated future operations.
ITEM 3. LEGAL PROCEEDINGS
We are subject to routine litigation and administrative proceedings arising in
the ordinary course of business. Management does not believe that such matters
will have a material adverse impact on our financial position, results of
operations or cash flows.
27
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS
At a special meeting of shareholders held on November 30, 2005, shareholders
were asked to authorize an amendment of the Company's declaration of trust to
move the provision limiting our ability to incur debt in excess of 50% into our
bylaws, thereby giving our Board of Trustees discretion as to the level of debt
we may incur.
The proposal was approved by the shareholders. The affirmative vote of the
holders of a majority of the issued and outstanding common shares entitled to
vote at the annual meeting was required to approve the proposal and shares were
voted as follows:
For Against Abstain
---------- --------- ---------
Common Shares 25,428,889 2,314,006 749,853
Restricted Common Shares 273,573 -- 109,693
Special Preferred Voting Shares 13,388,700 -- 1,556,611*
* Pursuant to an agreement entered into prior to our acquisition of CharterMac
Capital, certain individuals could vote no more than 90% of their special
preferred voting shares until November 13, 2005. This agreement was extended
for the purpose of this vote.
28
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER
MATTERS
Market Information
------------------
Our common shares have been listed on the New York Stock Exchange since January
10, 2006 under the symbol "CHC". From October 1, 1997, until January 9, 2006,
they were traded on the American Stock Exchange under the same symbol. Prior to
October 1, 1997, there was no established public trading market for our common
shares.
The high and low prices for each quarterly period of the last two years during
which our common shares were traded were as follows:
2005 2004
----------------------- -----------------------
Quarter Ended Low High Low High
----------------------- --------- --------- --------- ---------
March 31 $ 20.65 $ 24.50 $ 21.03 $ 24.85
June 30 $ 20.30 $ 22.49 $ 17.75 $ 24.70
September 30 $ 20.43 $ 23.37 $ 18.85 $ 23.15
December 31 $ 18.50 $ 23.02 $ 21.35 $ 25.42
The last reported sale price of our common shares on the New York Stock Exchange
on February 28, 2006, was $22.07.
Holders
As of February 28, 2006, there were 2,954 registered shareholders owning
52,018,956 common shares.
Distributions
After providing for distributions to our 4.4% Convertible Preferred Shares, our
net income is allocated pro rata among the common shares and the Convertible CRA
Shares (see Note 14 to the consolidated financial statements). The Convertible
CRA Shares rank on par with the common shares with respect to rights upon
liquidation, dissolution or winding up of our Company, although both are
subordinate to our 4.4% Convertible CRA Preferred shares. Quarterly cash
distributions during the years ended December 31, 2005 and 2004 were as follows:
Total Amount
Date Per Distributed
Cash Distribution for Quarter Ended Paid Share (In thousands)
----------------------------------- -------- -------- --------------
March 31, 2005 5/13/05 $ 0.41 $23,729
June 30, 2005 8/12/05 0.41 23,766
September 30, 2005 11/14/05 0.41 23,843
December 31, 2005 2/14/06 0.42 24,587
-------- -------
Total for 2005 $ 1.65 $95,925
======== =======
March 31, 2004 5/15/04 $ 0.37 $19,217
June 30, 2004 8/14/04 0.38 21,929
September 30, 2004 11/14/04 0.41 23,649
December 31, 2004 2/14/05 0.41 23,690
-------- -------
Total for 2004 $ 1.57 $88,485
======== =======
There are no material legal restrictions upon our present or future ability to
make distributions in accordance with the provisions of our Second Amended and
Restated Trust Agreement. We do not believe that the financial covenants
contained in our and our subsidiaries' secured indebtedness or in the terms of
29
the preferred shares issued by Equity Issuer will have any adverse impact on our
ability to make distributions in the normal course of business to our common and
Convertible CRA shareholders. Future distributions will be at the discretion of
the trustees based upon evaluation of our actual cash flows, our financial
condition, capital requirements and such other factors as our trustees deem
relevant.
Securities authorized for issuance under equity compensation plans
------------------------------------------------------------------
The following table provides information related to our share incentive plans as
of December 31, 2005:
(a) (b) (c)
Number of securities
Number of remaining available for
securities to be future issuance under
issued upon exercise Weighted-average equity compensation
of outstanding exercise price of plans (excluding
options, warrants outstanding options, securities reflected in
and rights warrants and rights column a) (1)
---------------------- --------------------- -------------------------
Equity compensation plans
approved by security holders 1,510,341 $20.42 4,102,504
Equity compensation plans not
approved by security holders -- -- --
---------------------- --------------------- -------------------------
Totals 1,510,341 $20.42 4,102,504
====================== ===================== =========================
(1) Our Incentive Share Plan (see Note 15 to the consolidated financial
statements) authorizes us to issue options or other share-based
compensation equal to 10% of the total shares outstanding as of December 31
of the year preceding the issuance of new grants or options.
Securities purchased by us
The following table presents information related to our repurchases of our
equity securities during the fourth quarter of 2005 and other information
related to our repurchase program:
Purchases of Equity Securities
(a) (b) (c) (d)
Total number
Total of shares Maximum number
number of Average purchased as part of shares that may yet
shares price paid of publicly be purchased under the
Period purchased (1) per share announced program plans or program
---------------------------- --------------- --------------- ------------------ ----------------------
October 1 - 31, 2005 -- $ -- --
November 1 - 30, 2005 79,796 21.07 --
December 1 - 31, 2005 -- -- --
--------------- --------------- ------------------
Total 79,796 $ 21.07 -- 1,187,178
=============== =============== ================== ======================
(1) These repurchases were in payment of tax withholding obligations incurred by
holders of newly vested restricted shares and were outside of our share
repurchase program.
30
Other information required by this item, as well as information regarding our
share repurchase program and share compensation paid to our independent
trustees, is included in Notes 15 and 16 to our consolidated financial
statements.
ITEM 6. SELECTED FINANCIAL DATA
The information set forth below presents our selected financial data. Additional
financial information is set forth in the consolidated financial statements and
notes thereto.
For the Years Ended December 31 (in thousands, except per share amounts):
Operations 2005 (1) 2004 (2) 2003 (3) 2002 2001
----------------------------------------- ---------- ---------- ---------- ---------- ----------
Total revenues $ 295,000 $ 232,432 $ 152,240 $ 116,614 $ 74,625
Net income $ 59,014 $ 65,363 $ 66,586 $ 60,833 $ 38,985
Net income applicable to shareholders (4) $ 56,994 $ 65,363 $ 61,248 $ 55,905 $ 35,010
Net income per share (4)
Basic $ .98 $ 1.19 $ 1.31 $ 1.31 $ 1.14
Diluted $ .98 $ 1.19 $ 1.31 $ 1.31 $ 1.14
Financial position
-----------------------------------------
Total assets $6,978,828 $5,737,221 $2,581,169 $1,852,868 $1,421,059
Financing arrangements $1,429,692 $1,068,428 $ 900,008 $ 671,659 $ 541,796
Notes payable $ 304,888 $ 174,454 $ 153,350 $ 68,556 $ 56,586
Preferred shares of subsidiary:
Subject to mandatory repurchase $ 273,500 $ 273,500 $ 273,500 $ 273,500 $ 218,500
Not subject to mandatory repurchase $ 104,000 $ 104,000 $-- $-- $--
Distributions
-----------------------------------------
Distributions per share (5) $ 1.65 $ 1.57 $ 1.37 $ 1.26 $ 1.14
(1) Includes a $22.6 million non-cash pre-tax charge ($12.3 million after tax,
or $0.21 per basic and diluted share) related to the write-off of the
"Related Capital Company" trade-name intangible asset (see Note 6 to the
consolidated financial statements).
(2) Reflects adoption of Interpretation 46(R), CONSOLIDATION OF VARIABLE
INTEREST ENTITIES ("FIN 46(R)"), as of March 31, 2004 (See Note 1 to the
consolidated financial statements).
(3) Includes CharterMac Capital beginning in November 2003.
(4) Includes common shareholders and Convertible CRA shareholders.
(5) Distributions per share are the same for both common shares and Convertible
CRA shares.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following Management's Discussion and Analysis ("MD&A") is intended to help
the reader understand the results of operations and financial condition of
CharterMac. MD&A is provided as a supplement to, and should be read in
conjunction with, our financial statements and the accompanying notes.
Forward-Looking Statements
--------------------------
This MD&A contains forward-looking statements. These forward-looking statements
are not historical facts, but rather our beliefs and expectations and are based
on our current expectations, estimates, projections, beliefs and assumptions
about our Company and industry. Words such as "anticipates," "expects,"
"intends," "plans," "believes," "seeks," "estimates" and similar expressions are
intended to identify forward-looking statements. These statements are not
guarantees of future performance and are subject to risks, uncertainties and
other factors, some of which are beyond our control, are difficult to predict
and could cause actual results to differ materially from those expressed or
forecasted in the forward-looking statements. Some of these risks (described
more fully in Item 1A. of this filing on Form 10-K) include, among other things:
31
o adverse changes in the real estate markets including, among other
things, competition with other companies;
o interest rate fluctuations;
o general economic and business conditions, which will, among other
things, affect the availability and credit worthiness of prospective
tenants, lease rents and the terms and availability of financing for
properties financed by mortgage revenue bonds we own;
o environment/safety requirements;
o changes in applicable laws and regulations;
o our tax treatment, the tax treatment of our subsidiaries and the tax
treatment of our investments;
o risk of default associated with the mortgage revenue bonds and other
securities held by us or our subsidiaries;
o the risk that relationships with key investors and developers may not
continue;
o our ability to generate fee income may not continue; and
o risks related to the form and structure of our financing arrangements.
We caution you not to place undue reliance on these forward-looking statements,
which reflect our view only as of the date of this annual report on Form 10-K.
Factors Affecting Comparability
-------------------------------
CONSOLIDATED PARTNERSHIPS
Primarily due to our adoption of FIN 46(R) as of March 31, 2004, we consolidate
more than 115 partnerships (predominantly investment funds we sponsor) in our
financial statements. The operating results for 2005 include a full period of
operations for these entities, as well as the elimination of transactions
between the entities and our subsidiaries. In 2004, the operating results
include only nine months' operating results as we adopted this accounting
standard as of March 31 of that year. The results for 2003 do not include any
operating results for these entities.
ACQUISITIONS
We acquired CCLP in March 2005. Operating results in our Portfolio Investing
segment prior to the acquisition date include interest income on a loan we made
in July 2004. Following the acquisition, operating results of CCLP are included
in our Mortgage Banking segment.
Our operating results were impacted significantly by the November 2003
acquisition of CharterMac Capital, an affiliated business that, until the date
of acquisition, had acted as an external manager for our Company and our
subsidiaries. As a result of the acquisition, we generate more taxable income
and have assumed numerous expenses that had previously been covered by fees paid
to CharterMac Capital.
In addition, the issuance of new classes of subsidiary equity as part of the
purchase price of both acquisitions requires us to apportion certain earnings
and identify them as due to the holders of that equity.
ACCOUNTING CHANGES
The adoption of several accounting pronouncements has affected our financial
statements. The adoption of SFAS No. 150, ACCOUNTING FOR CERTAIN FINANCIAL
INSTRUMENTS WITH CHARACTERISTIC OF BOTH LIABILITIES AND EQUITY ("SFAS No. 150")
caused us to reclassify certain liability and expense categories. The adoption
of FIN 46(R) (as noted above) led to a significant increase in the amount of
assets and liabilities we record due to consolidation of numerous investment
partnerships (see Notes 1 and 7 to the consolidated financial statements). This
consolidation also results in the recognition of the operating results of
partnerships in which we have virtually no equity interest, the elimination of
transactions between our businesses and those partnerships and the allocation of
their results to their investor partners.
32
OTHER ITEMS
At the end of 2005, management elected to discontinue the use of the "Related
Capital Company" trade name, effective January 1, 2006. The decision resulted in
the non-cash write-off of an intangible asset recorded at the time we acquired
Related Capital (now known as CharterMac Capital). The write-off amounted to
$22.6 million and reduced net income by $12.3 million, net of tax benefit, or
$0.21 per basic and diluted share.
Results of Operations
---------------------
OVERVIEW
The following is a summary of our operations:
% Change % Change
% of % of % of 2005 vs. 2004 vs.
(In thousands) 2005 Revenues 2004 Revenues 2003 Revenues 2004 2003
-------- -------- -------- -------- -------- -------- -------- --------
Revenues $295,000 100.0% $232,432 100.0% $152,240 100.0% 26.9 % 52.7 %
Income before income taxes 30,437 10.3 48,120 20.7 60,514 39.7 (36.7) (20.5)
Net income 59,014 20.0 65,363 28.1 66,586 43.7 (9.7) (1.8)
Our consolidated results over the three-year period illustrate the impact of our
changing business from an externally managed business, primarily generating
recurring, non-taxable revenues, to one with a large proportion of fee-based
transactional income and costs associated with internal management. This
transition included:
o our acquisition of CharterMac Capital in late 2003, adding the
majority of our Fund Management revenues, and completely internalizing
our management structure;
o rapid growth of our taxable, fee-based business through sponsorship of
increasingly larger funds in 2004 and 2005; and
o approximately doubling our Mortgage Banking business through the
acquisition of CCLP in 2005.
We expect that this transition will continue in 2006 with the launching of our
expanded credit intermediation business, which will also generate taxable fee
income.
At the same time, our reported revenues do not fully reflect the growth of the
business due to the impact of consolidating sponsored investment partnerships,
as described more fully below. The underlying revenue growth stems from the
introduction of new products such as effective variable-rate bond financing,
risk-sharing mortgage loan originations for Freddie Mac and different forms of
credit intermediation.
Beyond the growth of our businesses, costs have also increased due to (among
other factors):
o increasing financing costs due to higher borrowing levels attendant to
expansion and general increases in interest rates;
o the internalization of management in 2003;
o the requirement for infrastructure to support growth, primarily in
2004 and 2005; and
o the costs associated with the creation of tax credit equity funds that
vary with the level of fund sponsorship activity, although the
majority of such costs are reimbursed and the reimbursements are
recognized as revenue.
Along with the compositional changes in the business, we are now also
increasingly subject to taxation, although tax benefits may result based upon
the annual taxable income or loss from these businesses. The increase in the
level of tax benefit recognized over the three-year period presented reflect the
increasing proportion of these taxable businesses and increased book losses of
those businesses. See INCOME TAXES below.
33
REVENUES
Our revenues for the three years ended December 31 were as follows:
% Change % Change
(In thousands) 2005 2004 2005 vs. 2004 2003 2004 vs. 2003
-----------------------------------------------------------------------------------------------------------
Mortgage revenue bond interest income $146,024 $132,075 10.6 % $113,655 16.2%
Other interest income 16,147 9,346 72.8 3,630 157.5
Fee income
Fund sponsorship 54,744 45,564 20.1 12,642 260.4
Mortgage banking 26,217 15,026 74.5 13,712 9.6
Credit intermediation 6,694 8,476 (21.0) 4,925 72.1
--------------------------------------------------------------------
Total fee income 87,655 69,066 26.9 31,279 120.8
Other revenues
Prepayment penalties 6,326 1,877 237.0 712 163.6
Construction service fees 4,583 1,445 217.1 298 384.9
Administration fees 1,832 1,381 32.7 554 149.3
Expense reimbursements 4,923 2,785 76.8 520 435.6
Other 3,414 2,244 52.1 1,592 41.0
--------------------------------------------------------------------
Total other revenues 21,078 9,732 116.6 3,676 164.7
Revenues of consolidated partnerships 24,096 12,213 97.3 -- N/A
--------------------------------------------------------------------
Total revenues $295,000 $232,432 26.9 % $152,240 52.7%
====================================================================
The substantial growth in our annual revenues in both 2005 and 2004 resulted
primarily from the rapid growth of our Fund Management segment, particularly
from the acquisition of CharterMac Capital in late 2003. CharterMac Capital has
contributed the entire amount of fund sponsorship fees and much of the "other
revenues" categories, all stemming from the sponsorship of tax credit equity
funds, while our credit intermediation business has also grown over the
three-year period.
During the same period, aggressive expansion of the Mortgage Banking businesses
has generated substantial revenue growth, particularly in 2005 with the
acquisition of CCLP. Beside the increase in mortgage banking fees, these
businesses also contributed to the increase in other interest income as rising
interest rates helped to generate revenues from escrow balances, and constitute
the bulk of prepayment penalty revenue due to refinancing and payoff activity.
The Portfolio Investing business, while not growing as rapidly in 2005,
continues to generate higher revenues due to net increases in the portfolio and
the long-term nature of the revenue stream.
Revenues of consolidated partnerships were introduced upon our adoption of FIN
46(R) in 2004 (see Note 1 to the consolidated financial statements). These
revenues increase as we sponsor additional tax credit equity funds (or assume
the general partner interests in property level partnerships), but the
consolidation also results in the elimination of revenues earned by our
Portfolio Investing and Fund Management subsidiaries for transactions with the
partnerships. The revenues eliminated were as follows:
(In thousands) 2005 2004 % Change
------------------------------------- -------- -------- ---------
Mortgage revenue bond interest income $ 3,555 $ 581 511.9 %
Fund sponsorship fees 35,945 25,531 40.8
Credit intermediation fees 3,151 1,608 96.0
Other revenues 3,105 3,480 (10.8)
------- ------- -----
Total $45,756 $31,200 46.7 %
======= ======= =====
34
On a comparable basis, including CharterMac Capital revenues for all of 2003,
including CCLP revenues for all three years and adjusting for the impact of
consolidated partnerships, our total revenues increased approximately 15.0% in
2005 and 16.9% in 2004.
The variances in mortgage revenue bond interest income and fee income are
described below in RESULTS BY SEGMENT.
Other interest income includes income from temporary investments, interest
earned on Mortgage Banking escrow balances and interest earned on our loans to
Capri (see Note 4 to the consolidated financial statements). The increase in
2005 stems primarily from:
o the expansion of the Mortgage Banking business due to the acquisition
of CCLP and the increase in origination volume; and
o higher cash balances coupled with increasing market interest rates for
temporary investments.
This growth was partially offset by a decline in the level of interest from
Capri following the conversion of a portion of the loan to an ownership
interest. The increase in 2004 over 2003 relates mostly to the original Capri
loan in the middle of 2004.
The increase in prepayment penalties is principally due to growth in Mortgage
Banking refinancing volume over the period.
Expense reimbursement income represents income for services CharterMac Capital
provides to affiliates, which became a part of our operations with the
acquisition of CharterMac Capital in November 2003. The growth in 2005 reflects
the growth in the population of entities to which services are provided.
For further discussion, see RESULTS BY SEGMENT below.
EXPENSES
Our expenses for the three years ended December 31 were as follows:
% Change % Change
2005 2004
(In thousands) 2005 2004 vs. 2004 2003 vs. 2003
-------------------------------------------------------------------------------------------------------
Interest expense $ 56,495 $ 30,932 82.6% $ 24,047 28.6 %
Interest expense - preferred shares
of subsidiary 18,898 18,898 N/A 9,448 100.0
Salaries and benefits 68,983 56,044 23.1 17,463 220.9
General and administrative 56,412 45,262 24.6 23,352 93.8
-------------------------------------------------------------------
Subtotal 125,395 101,306 23.8 40,815 148.2
-------------------------------------------------------------------
Depreciation and amortization 44,195 30,407 45.3 11,926 155.0
Write off of trade name 22,567 -- N/A -- N/A
Loss on impairment of assets 4,555 757 501.7 1,759 (57.0)
-------------------------------------------------------------------
Subtotal 272,105 182,300 49.3 87,995 107.2
Interest expense of consolidated
partnerships 26,322 21,395 23.0 -- N/A
Other expenses of consolidated
partnerships 53,573 30,519 75.5 -- N/A
-------------------------------------------------------------------
Subtotal 79,895 51,914 53.9 -- N/A
-------------------------------------------------------------------
Total expenses $352,000 $234,214 50.3% $ 87,995 166.2 %
===================================================================
The total amount of costs we recognize increased significantly over the
three-year period due to increased investment activity, the CharterMac Capital
acquisition in the fourth quarter of 2003 and the resulting recognition of
expenses due to the new ownership structure, the amortization of intangible
assets acquired with CharterMac Capital and CCLP, and costs we now recognize or
classify differently as a result of accounting rules adopted in 2003 and 2004.
35
The increase in interest expense reflects the higher borrowing levels as we
expand our various business lines. Significant borrowings during 2005 and 2004
included those related to:
o acquisitions and fundings of mortgage revenue bonds totaling
approximately $443.5 million in 2005 and $325.0 million in 2004;
o short-term investments to acquire equity interests inherent in the
fund sponsorship portion of our Fund Management business since the
CharterMac Capital acquisition in the fourth quarter of 2003;
o short-term lending for mortgage loans prior to their sale to agencies
and conduits, which increased markedly in 2005 as the business grew;
and
o a loan to Capri in the third quarter of 2004 as the first step in our
full acquisition of its mortgage banking business and obtaining an
option with respect to a partial ownership of its fund advisory
business.
In addition to higher borrowings, 2005 interest expense reflects an increase in
the average borrowing rate to 3.8% as compared to 2.6% in 2004 and 2.4% in 2003.
The increase in the average borrowing rate resulted from gradual increases in
the Bond Market Association Municipal Swap Index ("BMA") and LIBOR rates during
2005 and 2004, following sharp declines in prior years. Interest expense also
includes amounts paid pursuant to swap agreements with an aggregate notional
amount of $500.0 million (as compared to notional amounts of swaps in effect
totaling $50.0 million in 2004 and $50.0 million in 2003) as part of our risk
management strategy.
The amount reported as "interest expense - preferred shares of subsidiary"
represents dividends on Equity Issuer's preferred shares subject to mandatory
repurchase, which we reported as an allocation of income outside of operating
earnings until the adoption of new accounting rules in July 2003. See further
discussion in OTHER ITEMS below.
Salaries and benefits in 2005 and 2004 include amortization of share grants
issued as part of the CharterMac Capital acquisition transaction. The
amortization of these grants amounted to $7.6 million in 2005, $11.0 million in
2004 and $2.8 million in 2003, and the decrease in 2005 was a result of
staggered vesting terms, most of which ended throughout 2005. The underlying
increase in salary costs is directly attributable to the internalization of
management in the fourth quarter of 2003 and subsequent hiring as our businesses
have expanded. In addition, 2005 also includes approximately $3.2 million of
costs related to the departure of Stuart Boesky as our Chief Executive Officer
and an executive of one of our subsidiaries. Prior to the CharterMac Capital
acquisition, all salary costs recognized were generated by the Mortgage Banking
business.
General and administrative expenses in many categories increased in 2005 due to
the expansion of our businesses and the acquisition of CCLP, particularly with
regard to increased occupancy needs and professional fees. The increase in
occupancy is in relation to the growth of our infrastructure to accommodate the
expansion of our business lines. The growth in professional fees was due, in
part, to:
o accounting and compliance costs related to Sarbanes-Oxley
implementation;
o legal costs related to protecting our interests in properties whose
developer/contractor experienced financial problems (see Note 21 to
the consolidated financial statements) and other properties on which
we foreclosed (see Note 5 to the consolidated financial statements);
and
o legal costs associated with the start up of our credit intermediation
subsidiary.
The 2004 increase in General and Administrative expenses was predominantly due
to our acquisition of CharterMac Capital and the associated recognition of
expenses associated with management of the company and origination of tax credit
equity funds. These expenses include approximately $4.3 million in organization
and offering ("O&O") costs in 2003 and approximately $16.0 million in 2004.
Depreciation and amortization expenses were higher in the 2005 period as
compared to 2004, primarily due to the a higher level of mortgage servicing
rights amortization following the CCLP acquisition. The increase in 2004 as
compared to 2003 was almost entirely due to amortization of intangibles acquired
in the CharterMac Capital transaction.
The trade name write off in 2005 pertains to management's decision at the end of
2005 to discontinue the use of the "Related Capital Company" trade name when we
renamed the subsidiary CharterMac Capital. We had recorded an intangible asset
in 2003 as part of the acquisition of the business, and the write off represents
the unamortized balance of the asset at the time the name change was determined.
36
Of the asset impairment charge in 2005, approximately $1.1 million relates to
management's decision to discontinue construction of a property in connection
with the financial difficulties of the property developer (see Note 21 to the
consolidated financial statements). The balance of the 2005 amount and the
entirety of the 2004 and 2003 charges pertained to the planned or actual
restructuring of terms for mortgage revenue bond and mezzanine loan investments.
We did not record the expenses of the consolidated partnerships prior to April
1, 2004. The 2005 increase in the expenses generated by these entities is a
result of the non-comparable consolidation periods as well as the increase in
the number of such partnerships consolidated. Virtually all of the expenses of
the consolidated partnerships are absorbed by their equity partners.
OTHER ITEMS
% Change % Change
2005 2004
(In thousands) 2005 2004 vs. 2004 2003 vs. 2003
----------------------------------------------------------------------------------------------------------------------
Equity and other income $ 7,476 $ 3,442 117.2 % $ 2,219 55.1 %
Gain on repayment of mortgage revenue bonds $ 1,561 $ 217 619.4 % $ 1,951 (88.9)%
Gain on sale of loans 6,501 7,651 (15.0) 5,532 38.3
---------------------------------------------------------------------
Gain on repayment of mortgage revenue bonds and $ 8,062 $ 7,868 2.5 % $ 7,483 5.1%
sale of loans
Income allocated to preferred shareholders of
subsidiary $ (6,225) $ (3,942) 57.9 % $ (9,449) (58.3)%
Income allocated to SCUs $ (23,091) $ (28,174) (18.0)% $ (4,038) 597.7%
Income allocated to SMUs (330) -- N/A -- N/A
(Income) loss allocated to minority holders of
CMC -- (194) N/A 54 (459.3)
---------------------------------------------------------------------
Total income allocated to minority interests $ (23,421) $ (28,368) (17.4)% $ (3,984) 612.0%
Loss allocated to partners of consolidated
partnerships $ 349,531 $ 219,950 58.9 % -- N/A
Equity and other income is comprised of income earned from property development
joint ventures and dividends from our investment in ARCap Investors, LLC. In
2005 and 2004, this amount also includes losses from tax advantaged investment
vehicles similar to those we sponsor. The sharp increase in 2005 relates to the
level of joint venture investment activity as several ventures approached
completion, allowing us to realize our share of development income and gains on
sale. The 2005 increase also includes incremental dividends from converting a
portion of our ARCap investment from preferred to common units.
The variance in gain on sale of mortgage revenue bonds relates to the level of
repayments in the Portfolio Investing segment. Similarly, the year-to-year
variations in gains on sales of loans are attributable to the fluctuations in
the volume of mortgage originations. See RESULTS BY SEGMENT below.
The total of "income allocated to preferred shareholders of subsidiary,"
including the portion classified as interest expense (see EXPENSES above),
increased over the three-year period due to an additional preferred offering
consummated in April 2004.
The income allocation to SCUs and SMUs represents the proportionate share of
after-tax income attributable to holders of subsidiary equity as if they were
all converted to common shares. The comparatively smaller amount allocated to
SCUs in 2003 is due to their issuance upon the acquisition of CharterMac Capital
late in that year. There was no income allocated to SMUs in 2004 or 2003 as the
units were first issued in May 2005.
37
Income Taxes
------------
A large majority of our pre-tax income is derived from our Portfolio Investing
businesses, which are structured as partnership entities; as such, the income
from those investments does not subject us to income taxes. The Fund Management
and Mortgage Banking businesses are conducted in corporations and are subject to
income taxes. Because the distributions paid on the minority interests in these
corporate subsidiaries effectively provide a tax deduction, as well as other
factors within these businesses, they often have losses for book purposes. In
2005, the other factors include the $22.6 million write-off of an intangible
asset (see EXPENSES above and Note 6 to the consolidated financial statements).
We provide for income taxes for these corporate subsidiaries in accordance with
SFAS No. 109, ACCOUNTING FOR INCOME TAXES ("SFAS No. 109") which 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 bases of assets and liabilities.
The tax benefit disclosed relates to the book losses of the taxable businesses
and the tax deductible distributions on their subsidiary equity. As the
proportion of our pre-tax income contributed by the businesses generating
taxable income and losses changes, the resulting tax benefit or provision may
appear incongruous with our consolidated income before income taxes, as
illustrated in Note 11 to the consolidated financial statements.
The effective tax rate on a consolidated basis was (93.9)% in 2005, (35.8)% in
2004 and (10.0)% in 2003, due to the factors noted above. The effective rate for
our corporate subsidiaries that were subject to taxes was 58.5% in 2005, 54.4%
in 2004 and 60.9% in 2003. See Note 12 to the consolidated financial statements
for further information regarding the effective tax rate.
Results by Segment
------------------
PORTFOLIO INVESTING
The table below shows selected information regarding our Portfolio Investing
activities:
% change % change
2005 vs. 2004 vs.
(IN THOUSANDS) 2005 2004 2004 2003 2003
-------------------------------------------- ----------- ----------- ----------- ----------- -----------
New mortgage revenue bond acquisitions $ 378,746 $ 290,967 30.2 % $ 421,595 (31.0)%
Funding of mortgage revenue bonds
acquired in prior years 1,800 17,735 (89.9) -- --
Acquisitions related to prior period
forward commitments 62,971 16,395 284.1 11,320 44.8
---------- ---------- ------ ---------- ------
Total acquisition and funding activity $ 443,517 $ 325,097 36.5 % $ 432,915 (24.9)%
Forward commitments issued but not funded $ 8,000 $ 88,676 (91.0)% $ 98,555 (10.0)%
Mortgage revenue bonds repaid $ 104,279 $ 26,870 288.1 % $ 83,897 (68.0)%
Average portfolio balance (fair value) $2,197,953 $1,946,433 12.9 % $1,579,905 23.2 %
Weighted average permanent interest rate
of bonds acquired 6.19% 6.26% 6.59%
Weighted average yield of portfolio 6.64% 6.79% 7.19%
Average borrowing rate 3.65% 2.51% 2.40%
Average BMA rate 2.45% 1.22% 1.03%
----------------------------------------------------------------------
Mortgage revenue bond interest income (1) $ 149,860 $ 132,815 12.8 % $ 113,655 16.9 %
Other interest income (1) 16,029 7,100 125.8 3,961 79.2
Prepayment penalties 1,176 30 -- 244 (87.7)
Other revenues (1) 2,512 1,965 27.8 1,537 27.8
---------- ---------- ------ ---------- ------
$ 169,577 $ 141,910 19.5 % $ 119,397 18.9 %
========== ========== ====== ========== ======
Interest expense and securitization fees
(1) $ 53,670 $ 29,172 84.0 % $ 25,691 13.5 %
Loss on impairment of assets $ 4,555 $ 757 501.7 % $ 1,759 (57.0)%
Gain on repayments of mortgage revenue
bonds $ 1,561 $ 217 619.4 % $ 1,951 (88.9)%
----------------------------------------------------------------------
(1) Prior to intersegment eliminations.
38
We continued to expand our revenue bond portfolio in 2005 and 2004, although the
rate of investment slowed beginning in 2004 due to challenging market conditions
whereby some potential investments did not meet our underwriting standards.
While we saw deferments by Texas developers that shifted a substantial level of
acquisitions until just after the end of the year (thereby benefiting our 2005
volume), in 2004 we expanded our presence in California, the nation's largest
bond market, and originated investments in new markets in Arizona,
Massachusetts, Kentucky and New York. Competitive factors also drove the decline
in origination rates in both 2004 and 2005.
While the decline in interest rates for new investments has gradually lowered
the average yield of our portfolio, from an income perspective, the low interest
rate environment has been favorable for us. Although the BMA rate, the
short-term tax-exempt index, increased markedly in 2005, our weighted average
cost of debt associated with these investments, taking our hedging into effect,
continues to allow us to recognize healthy spreads between our cost of borrowing
and the interest rates earned.
Other income in this segment is predominantly interest income on investments
other than mortgage revenue bonds and intercompany interest and royalty fees
eliminated in consolidation. The increases in 2004 and 2005 over prior years are
due largely to Capri loan interest (see Note 4 to the consolidated financial
statements) and intercompany financing utilizing this segment's cash flows.
FUND MANAGEMENT
The table below shows selected information regarding our Fund Management
activities:
% Change % Change
2005 vs. 2004 vs.
(In thousands) 2005 2004 2004 2003 2003
------------------------------------------- ---------- ----------- --------- ---------- ---------
Equity raised $1,131,274 $1,143,379 (1.1)% $ 266,237 329.5 %
Equity invested by investment funds $1,082,322 $ 972,477 11.3 % $ 183,776 429.2 %
Fees based on equity raised $ 16,211 $ 11,003 47.3 % $ 2,236 392.1 %
Fees based on equity invested 45,733 41,970 9.0 8,292 406.2
Fees based on management of other entities:
Investment origination fees 592 590 0.3 5 N/A
Partnership and asset management fees 28,888 18,632 55.0 1,135 N/A
Construction fees 4,583 1,445 217.2 298 384.9
Other 60 1 N/A 56 (98.2)
---------- ---------- ------ ---------- -------
Subtotal 34,123 20,668 65.1 1,494 N/A
---------- ---------- ------ ---------- -------
Total fund sponsorship fees (1) 96,067 73,641 30.5 12,022 512.6
Credit intermediation fees (1) 9,845 10,085 (2.4) 4,925 104.8
Expense reimbursement (1) 9,409 7,142 31.7 796 797.2
Other revenues (1) 2,431 1,795 35.4 599 199.7
---------- ---------- ------ ---------- -------
Total $ 117,752 $ 92,663 27.1 % $ 18,342 405.2 %
========== ========== ====== ========== =======
(1) Prior to intersegment eliminations.
Our Fund Management activities generate origination and acquisition fees
associated with sponsoring tax credit equity investment funds and for assisting
the funds in acquiring assets, which we recognize when the equity is invested by
the investment fund. We also receive asset management fees for the services we
perform for the funds once they are operating, which we recognize over the
service periods.
39
The 2004 increase in fund sponsorship fees represents a full year of owning
CharterMac Capital, as 2003 includes only the period following the November
acquisition. On a pro forma basis, comparing the 2004 period to the full 2003
period, as if we had owned CharterMac Capital as of January 1, 2003 ("the 2003
Pro Forma Period"), originations increased 28%, equity invested increased 12%
and fund sponsorship revenues increased approximately 26%.
FEES BASED ON EQUITY RAISED
We earn O&O service and partnership management fees based upon the level of
equity we raise for tax-credit equity funds. O&O service fees are realized
immediately while we earn the partnership management fees over five-year
periods.
Fees earned for O&O services increased approximately 3.5% to $9.8 million
compared to $9.5 million in the 2004 period primarily due to the increase in the
fee rate realized, offset by a marginal decrease in equity raised. Partnership
management fees revenues increased approximately 245.6% in 2005 to $5.3 million
compared to $1.5 million for the same period in 2004. This increase is primarily
the result of ongoing revenues for fund sponsorships completed in 2004 and 2005.
In 2004, the aggregate of these fees increased approximately 40% over the 2003
Pro Forma Period. This increase exceeded the rise in equity raised due to higher
average fee rates realized as a result of the change in the mix of funds
originated in 2004 as compared to 2003.
FEES BASED ON EQUITY INVESTED
We earn property acquisition fees and acquisition allowance fees based upon the
level of fund equity invested. These fees increased to approximately $45.7
million in 2005, representing an approximate 9.0% increase compared to the 2004
results. The increase in fees is lower than the increase of equity invested
because of a decrease in the fee rate realized, stemming from changes in the mix
of funds originated.
Fees we earned in these categories during 2004 increased to approximately $42.0
million, representing an approximate 25% increase compared to the 2003 Pro Forma
Period results. This increase exceeded the 12% increase in investments due to a
higher rate of fees realized as a result of the fund composition.
FEES FOR MANAGEMENT / ADVISORY SERVICES
The increase in partnership and asset management fees is attributable to:
o the higher level of assets under management as we add to the
population of funds sponsored (with nine added in 2005 and eleven in
2004);
o a $1.9 million incentive management fee earned in 2005 for services
provided to AMAC; and
o the improvement of the cash position of certain investment funds
allowing us to collect management fees in 2005 which we did not
previously recognize until collectibility was reasonably assured.
Fees earned in these categories in 2004 represented an increase of approximately
30% over the 2003 Pro Forma Period, attributable to the growth of assets under
management due to new fund originations during that period.
CREDIT INTERMEDIATION AND OTHER
Credit intermediation fees decreased in 2005 as compared to 2004 despite
additional credit intermediated funds closed over the course of both years. The
decrease was due to the timing of the related agreements, the fees for which are
risk-weighted toward the construction periods. As we recognize the fees over
periods of two to 20 years, the sponsorship of new funds fluctuates with the
inception and expiration of the associated intermediation periods. The increase
in these fees in 2004 as compared to 2003 was caused by the timing of the
CharterMac Capital acquisition.
40
The increase in other revenues reflects the impact of the CharterMac Capital
acquisition, whereby we recorded revenues for miscellaneous services that
CharterMac Capital provides to funds it manages. On a comparable basis, these
revenues increased approximately 30.0% in 2004 over the 2003 Pro Forma Period.
We anticipate that the market for tax credit equity investing will continue to
be strong in the near term but that heightened competition in the marketplace
will lead to margin compression. We expect, however, that the launching of our
in-house credit intermediation business will offset the impact of that margin
compression from a net income perspective as we are likely to retain amounts
previously paid or shared for credit intermediation and for providing specified
rates of return to fund investors. In addition, we anticipate that planned
growth of AMAC will lead to increased partnership and asset management fees
beginning in 2006.
MORTGAGE BANKING
The table below shows selected information regarding our Mortgage Banking
activities for the three years ended December 31:
% Change % Change
2005 vs. 2004 vs.
(In thousands) 2005 2004 2004 2003 2003
------------------------------------ ---------- ---------- --------- ---------- ---------
Originations (excluding assumptions) $1,542,083 $ 964,860 59.8% $ 554,499 74.0%
Originations (including assumptions) $1,719,466 $1,011,910 69.9 $ 604,788 67.3
Mortgage portfolio at December 31 $8,947,775 $3,852,529 132.3 $3,891,493 (1.0)
Mortgage servicing rights $ 62,190 $ 32,366 92.1 $ 33,351 (3.0)
---------- ---------- ----- ---------- -----
Mortgage origination fees (1) $ 7,454 $ 5,455 36.6 $ 4,683 16.5
Mortgage servicing fees 18,928 9,571 97.8 9,029 6.0
---------- ---------- ----- ---------- -----
Total fee income 26,382 15,026 75.6 13,712 9.6
Other interest income 10,150 3,217 215.5 2,502 28.6
Prepayment penalties 5,150 1,846 179.0 469 293.6
Other revenues 1,890 939 101.3 1,007 (6.8)
---------- ---------- ----- ---------- -----
$ 43,572 $ 21,028 107.2 % $ 17,690 18.9 %
========== ========== ===== ========== =====
Gain on sale of mortgages $ 6,501 $ 7,651 (15.0)% $ 5,532 38.3 %
========== ========== ===== ========== =====
(1) Prior to intersegment eliminations.
The increase in 2005 originations over the 2004 and 2003 levels was driven
largely by the acquisition of CCLP. Including CCLP in all periods, the 2005
increase would have been approximately 15.0% over 2004, and the 2004 increase
would have been approximately 12.0% as compared to 2003.
The activity gains in 2005 stemmed from a significant increase in Fannie Mae
originations, as CCLP has traditionally conducted a large portion of its
business through Fannie Mae, and pricing changes that allowed us to garner
greater market share. Conduit originations also increased sharply as we continue
to pursue business not involving agency execution in response to market demand.
These increases were partially offset by a sharp decline in Freddie Mac
business, as the 2004 period reflects a large single-borrower pool transaction,
with no comparable transaction in the current year period. The current year also
includes a significantly higher level of assumption lending for which we receive
assumption fees rather than origination fees.
Originations in 2004 reflected a determined focus on expanding the Freddie Mac
platform, including approximately $99.3 million of affordable housing
transactions and significant levels of portfolio originations. In addition, we
diversified our funding with a higher proportion of conduit lending and other
funding avenues outside the traditional Fannie Mae and Freddie Mac funding
sources. Also, the expansion of product offerings, including early rate lock
products, and the growth of our origination team aided the growth of this
business.
41
The increase in origination fees was lower than the increase in originations
because certain of the portfolio originations in 2004 were opportunistically
priced at lower than standard fee rates. Originations for the three-years ended
December 31 are broken down as follows:
% of % of % of
2005 Total 2004 Total 2003 Total
---------- --------- ---------- --------- ---------- ---------
Fannie Mae $ 889,207 51.7% $ 387,477 38.3% $ 334,189 55.3%
Freddie Mac 202,915 11.8 350,091 34.6 109,849 18.2
FHA 6,372 0.4 27,714 2.8 -- --
Conduit and other 443,589 25.8 199,578 19.7 110,461 18.2
---------- ----- ---------- ----- ---------- -----
Subtotal 1,542,083 89.7 964,860 95.4 554,499 91.7
Assumptions 177,383 10.3 47,050 4.6 50,289 8.3
---------- ----- ---------- ----- ---------- -----
Total $1,719,466 100.0% $1,011,910 100.0% $ 604,788 100.0%
========== ===== ========== ===== ========== =====
The increase in the servicing portfolio and servicing fees in 2005 is a result
of the CCLP acquisition. Adjusting for the impact of the acquisition, servicing
fee income in 2005 declined approximately 4% as compared to the same period in
2004. The decline was caused by a higher level of payoffs and amortization as
compared to service-retained originations that led to a decrease in the
comparable-basis servicing portfolio.
Despite the high volume of originations in 2004, our servicing portfolio
declined slightly during the year due to an unusually high volume of loans paid
off during the year and a high percentage of originations for loans without
associated servicing. More than 50% of the 2004 originations were additive to
the portfolio.
Despite the decline in the year-end servicing portfolio level, the servicing
fees increase in 2004 was due to a higher average portfolio during 2004 when
compared to 2003. The higher average resulted from a large sub-servicing
agreement which began in April 2003, while the loans were included for all of
2004. Additionally, more than half of the loan payoffs during 2004 occurred in
the second half of the year.
Interest income relates primarily to that earned on escrow balances. The
increase in 2005 was due to higher origination volume and increased market rates
earned. The increase in prepayment penalties relates to a higher level of
refinancing and payoff activity in the current year. Both categories also
increased due to the CCLP acquisition.
The significant increase in prepayment penalties relates to the sharp increase
in refinancing activity in both 2004 and 2005.
Gain on sale of mortgages pertains primarily to sales of mortgages for which we
retain servicing rights. An increase in 2005 as compared to 2004 due to the
increased origination volume was offset by a higher reserve for loan losses, due
to the increased volume and the underlying debt service statistics in the
portfolio.
We anticipate that the continued growth of the securitized loan market will
result in an increase in the proportion of our conduit executions to the total
in coming years. We expect that our affiliations with pension fund advisors and
AMAC will aid this growth. In addition, the increased customer base that comes
with CharterMac's overall expansion through acquisitions and organic growth
should increase our origination volume as we further develop our integrated
infrastructure. The availability of the significant level of debt capital in the
market and general compression of fees industry-wide, however, are likely to put
pressure on our fee revenue and margins for the foreseeable future and may
offset some of the profits expected from volume gains.
CONSOLIDATED PARTNERSHIPS
The results of consolidated partnerships reflected in our financial statements
are for entities we effectively control according to the definitions of FIN
46(R), and other partnerships we control, but in which we have no equity
interest or, in the case of 18 partnerships, an insignificant equity interest.
Our Fund Management segment earns fees from many of the entities, however, and
our Portfolio Investing business earns interest on mortgage revenue bonds for
which these partnerships are the obligors. The consolidated partnerships are
42
primarily tax credit equity investment funds we sponsor and manage, while the
others are property level partnerships for which we have assumed the role of
general partner.
The results we reported in 2005 reflect twelve months of operations for the
partnerships we consolidate while 2004 includes only nine months of results as
we consolidated these entities as of March 31, 2004. The increased amounts in
2005 are also due to the origination of eight funds and the assumption of the
general partner interests in 12 property level partnerships in the past year,
all of which are included in the population.
As third party investors hold virtually all of the equity partnership interests
in these entities, we allocate all results of operations to those partners
except for approximately $10,000, representing our nominal ownership. As a
result, the consolidation of these partnerships has an insignificant impact on
our net income.
IMPACT OF HURRICANES DURING 2005
During the second half of 2005, three hurricanes struck the southern United
States. While all of our businesses are involved in properties in the areas
affected by the storms, few of those properties suffered damage severe enough to
affect our results of operations. See Note 20 to the consolidated financial
statements.
Inflation
---------
Inflation did not have a material effect on our results for the periods
presented.
Liquidity and Capital Resources
-------------------------------
We fund our short-term business needs (including investments) primarily with
cash provided by operations, securitization of investments and revolving or
warehouse credit facilities. Our primary sources of capital to meet long-term
liquidity needs (including acquisitions) are debt and various types of equity
offerings, including equity of our subsidiaries. We believe that our financing
capacity and cash flow from current operations are adequate to meet our
immediate and long term liquidity requirements. Nonetheless, as business needs
warrant, we may issue other types of debt or equity in the future.
DEBT AND SECURITIZATIONS
------------------------
Short-term liquidity provided by operations comes primarily from interest income
from mortgage revenue bonds and promissory notes in excess of the related
financing costs, mortgage origination and servicing fees, and fund sponsorship
and credit intermediation fees. We typically generate funds for investment
purposes from corresponding financing activities.
We have the following debt and securitization facilities to provide short-term
and long-term liquidity:
o $250.0 million, used for mortgage banking needs, which was reduced to
$100.0 million in February 2006, matures in May 2006, and is renewable
annually;
o $90.0 million, used to acquire equity interests in property ownership
entities prior to the inclusion of these equity interests into
investments funds, which matures in October 2006;
o $60.0 million, used to provide the interim loan to Capri, the maturity
of which has been extended pending its replacement with a new facility
from the same lender;
o $40.0 million, established in connection with the CMC acquisition,
which expires in December 2006;
o $650.0 million in MBIA credit intermediation through 2011, under which
we can complete up to $425.0 million of floating-rate securitizations
and $225.0 million of auction-rate securitizations;
o securitization through the Merrill Lynch P-FLOATs/RITES program of a
specified percentage of the fair value of mortgage revenue bonds not
otherwise securitized or pledged as collateral; and
o securitization through the Goldman Sachs TIC/TOC program of a
specified percentage of the fair value of mortgage revenue bonds not
otherwise securitized or credit intermediated, which matures in
October 2028.
As of December 31, 2005, we had approximately $302.8 million available to borrow
under these debt and securitization facilities without exceeding limits imposed
by debt covenants and our bylaws.
43
We continue to actively manage our balance sheet and our relationships to
mitigate the impact of the factors listed above and to continue to diversify our
sources of capital. Although certain of the facilities noted above mature in
2006, we expect to renew, replace or refinance them as necessary, and we are in
negotiations to replace the maturing lines listed above, all of which are owed
to the same lender, with a master credit facility from that same lender. While
we believe that we will be able to do so, there is no assurance that we will
achieve terms favorable to us. Also, while we intend to optimize our
securitization borrowing, our continued ability to do so is dependent on:
o the availability of bonds to be used in securitizations or as excess
collateral;
o the depth of the market of buyers for tax-exempt floating rate
investments; and
o our ability to maintain and expand our relationships with credit
intermediators and liquidity providers.
Our debt financing facilities are more fully described in Notes 9 and 10 to our
consolidated financial statements.
EQUITY
------
Other than our common shares, we have several classes of equity outstanding,
with varying claims upon our income and cash flows:
o Convertible Community Reinvestment Act Preferred Shares ("Convertible
CRA Shares");
o 4.4% Perpetual Convertible Community Reinvestment Act Preferred Shares
("4.4% Convertible CRA Shares");
o Preferred shares of Equity Issuer (some of which are subject to
mandatory repurchase);
o Special Common Units ("SCUs") of our subsidiary, CharterMac Capital
Company LLC ("CCC"); and
o Special Membership Units ("SMUs") of our subsidiary CM Investor, LLC.
The Convertible CRA Shares are economically equivalent to our common shares,
receiving the same dividend. Unlike the common shares, however, these shares are
not publicly traded and do not have voting rights but entitle the holders to
"credit" under the US government's Community Reinvestment Act. These shares are
convertible into common shares at the holders' option, mostly on a one-for-one
basis. We first issued Convertible CRA Shares during 2000 and the program has
since become increasingly popular with a broad range of banks that invest in our
shares to both make an investment in us and to make qualifying Community
Reinvestment Act investments.
The 4.4% Convertible CRA Shares are similar to the Convertible CRA Shares in
that they entitle the holder to CRA "credit" and are convertible into common
shares without having voting rights prior to conversion. Unlike the Convertible
CRA Shares, however, these shares carry a fixed dividend and each will be
convertible into common shares at a rate of approximately 1.81:1 beginning in
July 2008.
The preferred shares of Equity Issuer entitle their holders to a claim on the
income and cash flows of most of our Portfolio Investing business. They have no
voting rights with respect to CharterMac and are not convertible into CharterMac
common shares.
The SCUs entitle their holders to a claim on the income and cash flows of our
subsidiaries through which we operate our fund sponsorship business. The SCUs
have no direct voting rights with respect to CharterMac, but all of the holders
also have special preferred voting shares of CharterMac, which have voting
rights equivalent to our common shares. The SCUs are convertible into common
shares and are entitled to tax-adjusted dividends based on the common dividend
rate.
SMU holders are entitled to distributions at the same time as, and only if, we
pay distributions on our common shares. SMU distributions were initially $1.69
per year, subject to adjustment in the amount of 95% of the percentage increases
or decreases in the dividends paid by us on the common shares.
In October 2004, we filed a shelf registration with the SEC providing for the
issuance of up to $400.0 million in common shares, preferred shares and debt
securities. The shelf registration was declared effective on March 1, 2005 and
will be available for use on April 1, 2006. We have no current plans to draw
upon this shelf registration but may as opportunities present themselves or
business requirements dictate.
44
We have also filed a registration statement on Form S-11 providing for the
issuance of up to $100.0 million of common shares. We have not yet determined
whether we will draw upon this registration statement.
Further information about our equity instruments is included in Notes 13 and 14
to our consolidated financial statements.
SUMMARY OF CASH FLOWS
2005 vs. 2004
-------------
The higher net increase in cash and cash equivalents in 2005 as compared to 2004
resulted principally from increased financing cash flows that offset a decline
in cash provided by operating activities.
Operating cash flows decreased by $106.9 million in 2005 as compared to the 2004
level, due primarily to the high level of mortgage originations at the end of
2005. While the assets will be sold in the first quarter of 2006, the increase
in the level of mortgage assets held at the end of the year served to offset the
increase in net income exclusive of non-cash expenses and charges.
Investing outflows in 2005 were approximately the same as in 2004 despite
increased mortgage revenue bond originations (net of repayments) and restricted
cash requirements as we expanded the Mortgage Banking segment. Investing
activities in 2004 included a higher level of investing outside of our normal
business lines, most notably the loan to Capri, while 2005 included a $26.0
million co-investment with AMAC in a first mortgage loan, and other investments
that aggregated less than $10.0 million.
Financing inflows in 2005 were $182.7 million higher than in 2004. This was
primarily a result of optimizing our securitization capabilities and taking
advantage of these facilities to monetize our revenue bond investment portfolio,
the expansion of our Mortgage Banking borrowing capacity and the issuance of our
4.4% Convertible CRA Shares. These factors collectively exceeded the higher
level of equity issuances (including subsidiary equity) in 2004.
2004 vs. 2003
-------------
The net increase in cash and cash equivalents during 2004 was lower than the
increase in 2003 despite higher operating cash flows due to decreased financing
activity.
Operating cash flows were higher in the 2004 period by a margin of $9.6 million.
This increase resulted from a higher level of earnings exclusive of non-cash
expenses, which increased substantially following our acquisition of CharterMac
Capital late in 2003. Additionally, the timing of receipts and payments in
operating asset and liability accounts contributed to this increase, the most
significant being the deferred revenues associated with the Fund Management
business and higher interest and fees receivable associated with the expansion
of our businesses.
Investing outflows were approximately the same in 2004 as compared to 2003. A
lower level of revenue bond acquisition and funding activity, and significantly
lower acquisition outflows, were partially offset by our loan to Capri. In
addition, in 2003 we received a much higher level of revenue bond repayments as
compared to 2004. The level of repayments in 2003 stemmed from the expiration of
lockout periods for older mortgage revenue bonds, with no comparable occurrence
in 2004.
Financing inflows in the 2004 period were lower than in 2003 by $26.9 million.
The primary reason for the higher inflows in 2003 was the level of
securitization borrowings to finance the investment level in that year. A higher
amount of proceeds from equity offerings in 2004 were partially offset by the
resulting increase in distributions to shareholders. In addition, 2004 also
included payments to SCU holders, with none in 2003 as the SCUs were issued in
November of that year.
45
LIQUIDITY REQUIREMENTS AFTER DECEMBER 31, 2005
----------------------------------------------
During February 2006, equity distributions were paid as follows:
(In thousands)
Common/CRA shareholders $24,587
SCU/SMU holders 8,916
4.4% Convertible CRA shareholders 1,188
Equity Issuer Preferred shareholders 6,281
In connection with the formation of our Centerbrook credit intermediation
subsidiary, we will be capitalizing the entity with approximately $50.0 million
to $70.0 million in the first half of 2006, utilizing available cash.
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 (see also CONTINGENT LIABILITIES below).
CONTRACTUAL OBLIGATIONS
The following table provides our commitments as of December 31, 2005, to make
future payments under our debt agreements and other contractual obligations:
Payments due by period
----------------------------------------------------------------------
Less than More than
(In thousands) Total 1 year 1-3 years 3-5 years 5 years
----------------------------- ---------- ---------- ---------- ---------- ----------
Notes payable (1) $ 304,888 $ 304,888 $ -- $ -- $ --
Notes payable of consolidated
partnerships (2) 565,876 89,754 209,020 44,800 222,302
Operating lease obligations,
net of subleases 70,710 6,820 13,467 12,816 37,607
Unfunded loan commitments (3) 329,688 240,647 89,041 -- --
Financing arrangements (1) 1,429,692 1,429,692 -- -- --
Preferred shares of
subsidiary (subject to
mandatory repurchase) 273,500 -- -- -- 273,500
---------- ---------- ---------- ---------- ----------
Total $2,974,354 $2,071,801 $ 311,528 $ 57,616 $ 533,409
========== ========== ========== ========== ==========
(1) The amounts included in each category reflect the current expiration, reset
or renewal date of each facility or security certificate. Management has the
ability and intent to renew, refinance or remarket the borrowings as described
in LIQUIDITY AND CAPITAL RESOURCES.
(2) Of the notes payable of consolidated partnerships, $457.3 million are
guaranteed by certain equity partners of the investment funds. Per partnership
agreements, the equity partners are also obligated to pay the principal and
interest on the notes. The remaining balance of $108.6 million is collateralized
with the underlying properties of the consolidated operating partnerships. All
of this debt is non-recourse to us.
(3) Of this amount, $193.5 million represents mortgage loan origination
commitments with corresponding sale commitments.
46
Off Balance Sheet Arrangements
------------------------------
The following table reflects our maximum exposure and the carrying amounts as of
December 31, 2005:
Maximum Carrying
(In thousands) Exposure Amount
------------------------------------------- ---------- ----------
Repayment guarantees (1) $ 3,602 $ --
Completion guarantees (1) 37,980 --
Development deficit guarantees (1) 25,100 --
Operating deficit guarantees (1) 6,960 --
ACC transition guarantees (1) 3,245 --
Recapture guarantees (1) 96,324 --
Replacement reserve (1) 2,998 --
Guaranty of payment (1) 45,471 --
Mortgage pool credit intermediation (2) 7,446 --
LIHTC credit intermediation (2) 729,800 22,236
Mortgage banking loss sharing agreements (3) 834,874 12,966
---------- ----------
$1,793,800 $ 35,202
========== ==========
(1) These guarantees generally relate to business requirements for developers to
obtain construction financing. As part of our role as co-developer of certain
properties, we issue these guarantees in order to secure properties as assets
for the funds we manage. To date, we have had minimal exposure to losses under
these guarantees and anticipate no material liquidity requirements in
satisfaction of any guarantee issued.
(2) We see these transactions as opportunities to expand our Fund Management
business by offering broad capital solutions to customers. To date, we have had
minimal exposure to losses and anticipate no material liquidity requirements in
satisfaction of any arrangement. The carrying values disclosed above relate to
the fees we earn for the transactions, which we recognize as their fair values.
(3) The loss sharing agreements with Fannie Mae and Freddie Mac are a normal
part of the DUS and DUI lender programs and afford a higher level of fees than
we earn for other comparable funding sources. The carrying value disclosed above
is our estimate of potential exposure under the guarantees, although any funding
requirements for such exposure is based on the contractual requirements of the
underlying loans we sell to Fannie Mae and Freddie Mac, which vary as to amount
and duration, up to a maximum of 30 years. See also RISKS ASSOCIATED WITH OUR
MORTGAGE BANKING BUSINESS in Item 1A, Risk Factors.
The maximum exposure amount is not indicative of our expected losses under the
guarantees. For details of these transactions, see Note 21 to the consolidated
financial statements.
Application of Critical Accounting Policies
-------------------------------------------
Our consolidated financial statements are based on the selection and application
of accounting principles generally accepted in the United States of America
("GAAP"), which require us to make estimates and assumptions that affect the
reported amounts of assets, liabilities, revenues and expenses. These estimates
and assumptions sometimes involve future events that cannot be determined with
absolute certainty. Therefore, our determination of estimates requires that we
exercise our judgment. While we have used our best estimates based on the facts
and circumstances available to us at the time, different results may actually
occur and any such differences could be material to our financial statements.
We believe the following policies may involve a higher degree of judgment and
complexity and represent the critical accounting policies used in the
preparation of our financial statements:
o valuation of investments in mortgage revenue bonds;
o valuation of mortgage servicing rights;
o impairment of goodwill and intangible assets; and
o accounting for income taxes.
47
VALUATION OF INVESTMENTS IN MORTGAGE REVENUE BONDS
SFAS No. 115, ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES,
provides guidance on determining the valuation of investments owned. The initial
classification of our investments in the "available for sale" category rather
than as "held to maturity" is due to a provision in most of the mortgage revenue
bonds under which we have a right to require redemption prior to maturity,
although we can and may elect to hold them up to their maturity dates unless
otherwise modified. Because of this classification, we must carry our
investments at fair value. Since there is no ready market for these investments,
we must exercise judgment in determining what constitutes "fair value". We
estimate the fair value by calculating the present value of future payments
under the bonds. For bonds secured by non-stabilized properties, the discount
rate is based upon the average rate of new originations for the quarter leading
up to the valuation date. For bonds secured by stabilized properties, the
discount rate is reflective of the lower inherent risk. If the property
underlying the bond has substandard performance, a factor is added to the
discount rate to allow for the additional risk. Conversely, if the underlying
property is performing much better than expected, the discount rate may be
reduced to allow for the reduced risk.
In making these determinations, we evaluate, among other factors:
Bonds Secured by Properties in Construction Phase
-------------------------------------------------
o Assets where there are issues outstanding regarding timely completion
of the construction, even if there is no apparent risk of financial
loss.
Bonds Secured by Properties that are in Lease-Up or Stabilized Phases
---------------------------------------------------------------------
o Stabilization requirements (i.e., minimum occupancy level and debt
service coverage for specified periods) not yet met but all completion
requirements (i.e., timely submission of documentation regarding
certificates of occupancy, deal waivers, etc., as well as completing
construction within the budgeted cost) met. Established material
variation from anticipated operating performance, ability to meet
stabilization test within the allotted time period is in question or
material deficiencies at the collateral level, or other weaknesses
exist calling into question the viability of the project in the near
to intermediate term; or
o Project viability is in question and defaults exist and notification
of such has been delivered. Enhanced possibility of loss may exist or
has been specified.
We use these criteria to assess all of our mortgage revenue bonds. In our
valuation review, any bonds meeting these criteria are monitored and assessed
for risk of financial loss. If no financial loss is expected, the fair value of
a bond is considered to be the lower of outstanding face amount or the present
value of future cash flows, with the discount rate adjusted to provide for the
applicable risk factors. If a financial loss is expected, the bond is considered
impaired and written down to fair value as determined by the present value of
expected future cash flows.
VALUATION OF MORTGAGE SERVICING RIGHTS
SFAS No. 140, ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND
EXTINGUISHMENTS OF LIABILITIES, requires that servicing rights retained when
mortgage loans are sold be recorded as assets at fair value and amortized in
proportion to, and over the period of, estimated net servicing income.
Significant judgment is required in accounting for these assets, including:
o Determining the fair value of the asset retained when the associated
mortgage is sold and in subsequent reporting periods, including such
factors as costs to service the loans, the estimated rate of
prepayments, the estimated rate of default and an appropriate discount
rate to calculate the present value of cash flows; and
o Estimating the appropriate proportion and period for amortizing the
asset.
Changes in these estimates and assumptions could materially affect the
determination of fair value.
We assess our mortgage servicing rights for impairment based on the fair value
of the assets as compared to carrying values. We estimate the fair value by
obtaining market information from one of the primary mortgage servicing rights
brokers. To determine impairment, the mortgage servicing portfolio is stratified
by the issuer of the underlying mortgage loans and we compare the estimated fair
value of each stratum to its carrying value. When the carrying value of
capitalized servicing assets exceeds fair value, we recognize temporary
48
impairment through a valuation allowance; fair value in excess of the amount
capitalized is not recognized. In addition, we periodically evaluate our
mortgage servicing rights for other-than-temporary impairment to determine
whether the carrying value before the application of the valuation allowance is
recoverable. When we determine that a portion of the balance is not recoverable,
the asset and the valuation allowance are reduced to reflect permanent
impairment.
IMPAIRMENT OF GOODWILL AND INTANGIBLE ASSETS
SFAS No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS, requires that goodwill be
tested for impairment at the reporting unit level (operating segment or one
level below an operating segment) on an annual basis and between annual tests if
an event occurs or circumstances change that would more likely than not reduce
the fair value of a reporting unit below its carrying value. These events or
circumstances could include a significant change in the business climate, legal
factors, operating performance indicators, competition, sale or disposition of a
significant portion of a reporting unit. Application of the goodwill impairment
test requires judgment regarding the fair value of each reporting unit which is
estimated using a discounted cash flow methodology. This, in turn, requires
significant judgments including estimation of future cash flows, which is
dependent on internal forecasts, estimation of the long-term rate of growth for
our business and the life over which cash flows will occur. Changes in these
estimates and assumptions could materially affect the determination of fair
value and/or goodwill impairment.
In addition, should we determine that goodwill is impaired, we would also review
intangible assets for the same business to determine if they were impaired also.
As with goodwill, any indicators of impairment of a specific intangible asset
would also lead to a review. As the methods for determining fair values of
intangible assets are similar to those for determining the fair value of
goodwill, the same judgments and uncertainties apply to these determinations as
well.
ACCOUNTING FOR INCOME TAXES
SFAS No. 109, ACCOUNTING FOR INCOME TAXES, establishes financial accounting and
reporting standards for the effect of income taxes. The objectives of accounting
for income taxes are to recognize the amount of taxes payable or refundable for
the current year and deferred tax liabilities and assets for the future tax
consequences of events that have been recognized in an entity's financial
statements or tax returns. Judgment is required in assessing the future tax
consequences of events that have been recognized in our financial statements or
tax returns as well as the recoverability of amounts we record, including
deferred tax assets. Furthermore, these projected future tax consequences
include our assumption as to the continuing tax-free nature of a significant
portion of our earnings. Variations in the actual outcome of these future tax
consequences could materially impact our financial position or our results of
operations.
Recently Issued Accounting Standards
------------------------------------
In December 2004, the Financial Accounting Standards Board issued SFAS No.
123(R), SHARE-BASED PAYMENT, which replaced SFAS No. 123, ACCOUNTING FOR
STOCK-BASED COMPENSATION. As we already follow the fair value provisions set
forth in SFAS No. 123, this statement is expected to have an immaterial impact
on our financial statements.
In November 2005, the FASB issued Staff Position No. FAS 140-2, CLARIFICATION OF
THE APPLICATION OF PARAGRAPHS 40(B) AND 40(C) OF FASB STATEMENT NO. 140. This
staff position applies to characteristics for a securitization entity to meet
the definition of a qualified special purpose entity ("QSPE"). While the Staff
Position does not apply to our current securitization structure, it may affect
the accounting for future transactions should they involve QSPEs.
49
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We invest in certain financial instruments, primarily mortgage revenue bonds and
other bond related investments that are subject to various forms of market risk,
including interest rate risk. We seek to prudently and actively manage such
risks to earn sufficient compensation to justify the undertaking of such risks
and to maintain capital levels which are commensurate with the risks we
undertake.
The assumptions related to the following discussion of market risk involve
judgments involving future economic market conditions, future corporate
decisions and other interrelating factors, many of which are beyond our control
and all of which are difficult or impossible to predict with precise accuracy.
Although we believe 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 our representation that our objectives and plans would
be achieved.
INTEREST RATE RISK
------------------
The nature of our investments and the instruments used to raise capital for
their acquisition expose us to income and expense volatility due to fluctuations
in market interest rates. Market interest rates are highly sensitive to many
factors, including governmental policies, domestic and international economic
and political considerations and other factors beyond our control. A rising
interest rate environment could reduce the demand for multifamily tax-exempt and
taxable financing, which could limit our ability to invest in mortgage revenue
bonds or to structure transactions. Conversely, falling interest rates may
prompt historical renters to become homebuyers, in turn potentially reducing the
demand for multifamily housing.
Our exposure to interest rate is twofold:
o the potential increase in interest expense on our variable rate debt;
and
o the impact of interest rates on the fair value of our assets.
IMPACT ON EARNINGS
Our investments in mortgage 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 our variable rate securitization programs
fluctuate with market interest rates based on the BMA index and are re-set
weekly or every 35 days. In addition, we have variable rate debt related to our
acquisition financing and our warehouse facilities, with rates based on LIBOR.
Other long-term sources of capital, such as our preferred shares of Equity
Issuer and our 4.4% Convertible CRA preferred shares, carry a fixed dividend
rate and as such, are not impacted by changes in market interest rates.
With the exception of $500.0 million of debt hedged via interest rate swap
agreements, the full amount of our liabilities labeled on our consolidated
balance sheet as Financing Arrangements and Notes Payable are variable rate
debts. We estimate that an increase of 1.0% in interest rates would decrease our
annual net income by approximately $12.3 million.
Conversely, we have large escrow balances maintained by our Mortgage Banking
business and we are entitled to the interest earned on those balances. A 1.0%
increase in interest rates would therefore increase our net income by
approximately $1.8 million.
We manage this risk through the use of interest rate swaps, interest rate caps
and forward bond origination commitments, as described in Notes 11 and 21 to our
consolidated financial statements. In addition, we manage our exposure by
striving for diversification in our businesses to include those less susceptible
to interest rate changes and by managing our leverage.
50
IMPACT ON VALUATION OF ASSETS
Changes in market interest rates would also impact the estimated fair value of
our portfolio of mortgage revenue bonds. We estimate the fair value for each
revenue bond as the present value of its expected cash flows, using a discount
rate for comparable tax-exempt investments. Therefore, as market interest rates
for tax-exempt investments increase, the estimated fair value of our mortgage
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,
we estimate that, using the same methodology used to estimate the portfolio fair
value under SFAS No. 115, a 1% increase in market rates for tax-exempt
investments would reduce the estimated fair value of our portfolio of mortgage
revenue bonds by approximately $145.6 million and a 1% decrease would result in
an increase of approximately $129.7 million. Changes in the estimated fair value
of the mortgage revenue bonds do not impact our reported net income, net income
per share, distributions or cash flows, but are reported as components of other
accumulated comprehensive income and affect reported shareholders' equity, and
may affect our borrowing capability to the extent that collateral requirements
are sometimes based on our asset values.
51
MANAGEMENT'S REPORT ON THE EFFECTIVENESS OF
INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of CharterMac (the "Company") is responsible for establishing and
maintaining adequate internal control over financial reporting. Our internal
control system was designed to provide reasonable assurance to our management
and Board of Trustees regarding the preparation and fair presentation of
published financial statements.
All internal control systems, no matter how well designed, have inherent
limitations. Therefore, even those systems determined to be effective can
provide only reasonable assurance with respect to financial statement
preparation and presentation.
CharterMac management assessed the effectiveness of the Company's internal
control over financial reporting as of December 31, 2005. In making this
assessment, management used the criteria set forth by the Committee of
Sponsoring Organizations of the Treadway Commission ("COSO") in Internal Control
- Integrated Framework. Based upon our assessment we believe that, as of
December 31, 2005, our internal control over financial reporting is effective in
accordance with those criteria.
Deloitte & Touche LLP, our independent auditors, have issued an audit report on
our assessment of the Company's internal control over financial reporting, which
appears on page 53.
/s/ Marc D. Schnitzer /s/ Alan P. Hirmes
--------------------- ------------------
Marc D. Schnitzer Alan P. Hirmes
Chief Executive Officer Chief Financial Officer
March 15, 2006 March 15, 2006
52
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Trustees
And Shareholders of CharterMac
New York, New York
We have audited management's assessment, included in the accompanying
"Management's Report on the Effectiveness of Internal Controls over Financial
Reporting", that CharterMac (the "Company") maintained effective internal
control over financial reporting as of December 31, 2005, based on the criteria
established in "INTERNAL CONTROL--INTEGRATED FRAMEWORK" issued by the Committee
of Sponsoring Organizations of the Treadway Commission. The Company's management
is responsible for maintaining effective internal control over financial
reporting and for its assessment of the effectiveness of internal control over
financial reporting. Our responsibility is to express an opinion on management's
assessment and an opinion on the effectiveness of the Company's internal control
over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed by,
or under the supervision of, the company's principal executive and principal
financial officers, or persons performing similar functions, and effected by the
company's board of trustees, management, and other personnel to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial
reporting, including the possibility of collusion or improper management
override of controls, material misstatements due to error or fraud may not be
prevented or detected on a timely basis. Also, projections of any evaluation of
the effectiveness of the internal control over financial reporting to future
periods are subject to the risk that the controls may become inadequate because
of changes in conditions, or that the degree of compliance with the policies or
procedures may deteriorate.
In our opinion, management's assessment that the Company maintained effective
internal control over financial reporting as of December 31, 2005, is fairly
stated, in all material respects, based on the criteria established in "INTERNAL
CONTROL--INTEGRATED FRAMEWORK" issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Also in our opinion, the Company
maintained, in all material respects, effective internal control over financial
reporting as of December 31, 2005, based on the criteria established in
"INTERNAL CONTROL--INTEGRATED FRAMEWORK" issued by the Committee of Sponsoring
Organizations of the Treadway Commission.
53
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated financial
statements and financial statement schedules as of and for the year ended
December 31, 2005 of the Company and our report dated March 15, 2006 expressed
an unqualified opinion on those financial statements and financial statement
schedules.
/s/ DELOITTE & TOUCHE LLP
New York, New York
March 15, 2006
54
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Page
(a) 1. Financial Statements ----------
--------------------
Report of Independent Registered Public Accounting Firm 56
Consolidated Balance Sheets as of December 31, 2005 and 2004 57
Consolidated Statements of Income for the years ended December 31,
2005, 2004 and 2003 58
Consolidated Statements of Shareholders' Equity for the
years ended December 31, 2005, 2004 and 2003 59
Consolidated Statements of Cash Flows for the years ended December 31,
2005, 2004 and 2003 62
Notes to Consolidated Financial Statements 64
55
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Trustees
and Shareholders of
CharterMac
New York, New York
We have audited the accompanying consolidated balance sheets of CharterMac and
subsidiaries (the "Company") as of December 31, 2005 and 2004, and the related
consolidated statements of income, shareholders' equity, and cash flows for each
of the three years in the period ended December 31, 2005. Our audits also
included the financial statement schedules listed in the Index at Item 15(a)2.
These financial statements and financial statement schedules are the
responsibility of the Company's management. Our responsibility is to express an
opinion on the financial statements and financial statement schedules based on
our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of CharterMac and subsidiaries as of
December 31, 2005 and 2004, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 2005, in
conformity with accounting principles generally accepted in the United States of
America. Also, in our opinion, such financial statement schedules, when
considered in relation to the basic consolidated financial statements taken as a
whole, present fairly, in all material respects, the information set forth
therein.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of the Company's
internal control over financial reporting as of December 31, 2005, based on the
criteria established in INTERNAL CONTROL--INTEGRATED FRAMEWORK issued by the
Committee of Sponsoring Organizations of the Treadway Commission and our report
dated March 15, 2006 expressed an unqualified opinion on management's assessment
of the effectiveness of the Company's internal control over financial reporting
and an unqualified opinion on the effectiveness of the Company's internal
control over financial reporting.
/s/DELOITTE & TOUCHE LLP
New York, New York
March 15, 2006
56
CHARTERMAC AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands)
December 31,
----------------------------
2005 2004
----------- -----------
ASSETS
Mortgage revenue bonds-at fair value $ 2,294,787 $ 2,100,720
Other investments 298,590 187,506
Cash and cash equivalents 161,295 71,287
Restricted cash 34,025 25,879
Goodwill and intangible assets, net 439,175 416,282
Deferred costs and other assets 144,670 74,933
Loan to affiliate -- 4,600
Investments held by consolidated partnerships 3,025,762 2,527,455
Other assets of consolidated partnerships 580,524 328,559
----------- -----------
Total assets $ 6,978,828 $ 5,737,221
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Financing arrangements $ 1,429,692 $ 1,068,428
Preferred shares of subsidiary (subject to mandatory
repurchase) 273,500 273,500
Notes payable 304,888 174,454
Accounts payable, accrued expenses and other liabilities 179,275 154,086
Notes payable and other liabilities of consolidated
partnerships 1,627,556 1,307,093
----------- -----------
Total liabilities 3,814,911 2,977,561
----------- -----------
Minority interest in consolidated subsidiaries 262,274 271,419
----------- -----------
Preferred shares of subsidiary (not subject to mandatory repurchase) 104,000 104,000
----------- -----------
Limited partners' interests in consolidated partnerships 1,747,808 1,501,519
----------- -----------
Commitments and contingencies
Shareholders' equity:
Beneficial owners equity:
4.4% Convertible CRA preferred shares; no par value;
2,160 shares issued and outstanding in 2005 and none
issued and outstanding in 2004 104,498 --
Convertible CRA shares; no par value; 6,552 shares issued
and outstanding in 2005 and 2004 104,369 108,745
Special preferred voting shares; no par value (14,885
shares issued and outstanding in 2005 and 15,172 shares
issued and outstanding in 2004) 150 152
Common shares; no par value (100,000 shares authorized;
52,309 issued and 51,988 outstanding in 2005 and 51,363
issued and 51,229 outstanding in 2004) 752,042 773,165
Restricted shares granted (4,193) (7,922)
Treasury shares of beneficial interest - common, at cost
(321 shares in 2005 and 134 shares in 2004) (7,135) (2,970)
Accumulated other comprehensive income 100,104 11,552
----------- -----------
Total shareholders' equity 1,049,835 882,722
----------- -----------
Total liabilities and shareholders' equity $ 6,978,828 $ 5,737,221
=========== ===========
See accompanying notes to consolidated financial statements
57
CHARTERMAC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands except per share amounts)
Year Ended December 31,
---------------------------------------------------
2005 2004 2003
---------------------------------------------------
Revenues:
Mortgage revenue bond interest income $ 146,024 $ 132,075 $ 113,655
Other interest income 16,147 9,346 3,630
Fee income 87,655 69,066 31,279
Other revenues 21,078 9,732 3,676
Revenues of consolidated partnerships 24,096 12,213 --
---------------------------------------------------
Total revenues 295,000 232,432 152,240
---------------------------------------------------
Expenses:
Interest expense 56,495 30,932 24,047
Interest expense of consolidated partnerships 26,322 21,395 --
Interest expense - distributions to preferred
shareholders of subsidiary 18,898 18,898 9,448
General and administrative 125,395 101,306 40,815
Depreciation and amortization 44,195 30,407 11,926
Write-off of trade name 22,567 -- --
Loss on impairment of assets 4,555 757 1,759
Other expenses of consolidated partnerships 53,573 30,519 --
---------------------------------------------------
Total expenses 352,000 234,214 87,995
---------------------------------------------------
(Loss) income before other income (57,000) (1,782) 64,245
Equity and other income 7,476 3,442 2,219
Gain on sale of loans and repayment of mortgage revenue bonds 8,062 7,868 7,483
Loss on investments held by consolidated partnerships (247,986) (149,048) --
---------------------------------------------------
Loss before allocations and income taxes (289,448) (139,520) 73,947
Income allocated to preferred shareholders of subsidiary (6,225) (3,942) (9,449)
Minority interests in consolidated subsidiaries, net of tax (23,421) (28,368) (3,984)
Loss allocated to partners of consolidated partnerships 349,531 219,950 --
---------------------------------------------------
Income before income taxes 30,437 48,120 60,514
Income tax benefit 28,577 17,243 6,072
---------------------------------------------------
Net income $ 59,014 $ 65,363 $ 66,586
===================================================
Allocation of net income to:
4.4% Convertible CRA preferred shareholders $ 2,020 $ -- $ --
Common shareholders 50,558 56,786 54,608
Convertible CRA shareholders 6,436 8,577 6,640
Manager (including special distribution) -- -- 5,338
---------------------------------------------------
Total $ 59,014 $ 65,363 $ 66,586
===================================================
Net income per share:
Basic $ .98 $ 1.19 $ 1.31
===================================================
Diluted $ .98 $ 1.19 $ 1.31
===================================================
Weighted average shares outstanding:
Basic 58,018 54,786 46,653
===================================================
Diluted 58,291 55,147 46,735
===================================================
Dividends declared per share $ 1.65 $ 1.57 $ 1.37
===================================================
See accompanying notes to consolidated financial statements
58
CHARTERMAC AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(In thousands)
Beneficial Owners Equity
---------------------------------------------------------------------------------------
4.4%
Convertible
CRA Preferred Convertible Special Preferred Common
Shares CRA Shares Voting Shares Manager Shares
-------------- ------------- ----------------- ----------- -----------
Balance at January 1, 2003 $ -- $ 58,174 $ -- $ 1,126 $ 604,496
Comprehensive income:
Net income 6,640 5,338 54,608
Other comprehensive loss:
Net unrealized gain on derivatives
Unrealized holding loss on mortgage
revenue bonds
Less: reclassification to net income
Other comprehensive loss
Comprehensive income
Options exercised and other share based
compensation, net of forfeitures 21,282
Amortization of share awards
Elimination of manager interest (1,132)
Issuance of special preferred voting shares 161
Conversion of Convertible CRA shares (21,870) 21,870
Issuance of Convertible CRA shares 102,532
Repurchase of treasury shares
Distributions (6,728) (5,332) (57,615)
-------- --------- --------- -------- ---------
Balance at December 31, 2003 $ -- $ 138,748 $ 161 $ -- $ 644,641
Accumulated
Restricted Restricted Other
Shares - Shares Comprehensive Comprehensive
Common Granted Income Income Total
------------- ------------ --------------- -------------- -----------
Balance at January 1, 2003 $ (103) $ -- $ 60,975 $724,668
Comprehensive income:
Net income $ 66,586 66,586
--------
Other comprehensive loss:
Net unrealized gain on derivatives 2,607
Unrealized holding loss on mortgage
revenue bonds (33,195)
Less: reclassification to net income (1,951)
--------
Other comprehensive loss (32,539) (32,539) (32,539)
--------
Comprehensive income $ 34,047
--------
Options exercised and other share based
compensation, net of forfeitures (22,228) (946)
Amortization of share awards 2,843 2,843
Elimination of manager interest (1,132)
Issuance of special preferred voting shares 161
Conversion of Convertible CRA shares --
Issuance of Convertible CRA shares 102,532
Repurchase of treasury shares (275) (275)
Distributions (69,675)
-------- -------- -------- --------
Balance at December 31, 2003 $ (378) $(19,385) $ 28,436 $792,223
(continued)
See accompanying notes to consolidated financial statements
59
CHARTERMAC AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(In thousands)
Beneficial Owners Equity
---------------------------------------------------------------------------------------
4.4%
Convertible
CRA Preferred Convertible Special Preferred Common
Shares CRA Shares Voting Shares Manager Shares
-------------- ------------- ----------------- ----------- -----------
Balance at December 31, 2003 $ -- $138,748 $ 161 $ -- $ 644,641
Comprehensive income:
Net income 8,577 56,786
Other comprehensive loss:
Net unrealized loss on derivatives
Unrealized holding loss on
mortgage revenue bonds
Less: reclassification to net income
Other comprehensive loss
Comprehensive income
Options exercised and other share based
compensation, net of forfeitures (564)
Amortization of share awards
Conversion of Special Common Units and
redemption of Special Preferred Voting
Shares (9) 17,789
Conversion of Convertible CRA shares (27,585) 27,585
Issuance costs of Convertible CRA shares (148)
Issuance of common shares 105,541
Repurchase of treasury shares
Distributions (10,847) (78,613)
-------- -------- --------- -------- ---------
Balance at December 31, 2004 $ -- $108,745 $ 152 $ -- $ 773,165
-------- -------- --------- -------- ---------
Accumulated
Restricted Restricted Other
Shares - Shares Comprehensive Comprehensive
Common Granted Income Income Total
------------- ------------ --------------- -------------- -----------
Balance at December 31, 2003 $ (378) $(19,385) $ 28,436 $792,223
Comprehensive income:
Net income $ 65,363 65,363
--------
Other comprehensive loss:
Net unrealized loss on derivatives (1,078)
Unrealized holding loss on
mortgage revenue bonds (16,023)
Less: reclassification to net income 217
--------
Other comprehensive loss (16,884) (16,884) (16,884)
--------
Comprehensive income $ 48,479
--------
Options exercised and other share based
compensation, net of forfeitures (169) (733)
Amortization of share awards 11,632 11,632
Conversion of Special Common Units and
redemption of Special Preferred Voting
Shares 17,780
Conversion of Convertible CRA shares --
Issuance costs of Convertible CRA shares (148)
Issuance of common shares 105,541
Repurchase of treasury shares (2,592) (2,592)
Distributions (89,460)
-------- -------- -------- --------
Balance at December 31, 2004 $ (2,970) $ (7,922) $ 11,552 $882,722
-------- -------- -------- --------
(continued)
See accompanying notes to consolidated financial statements
60
CHARTERMAC AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(In thousands)
Beneficial Owners Equity
----------------------------------------------------------------------
4.4%
Convertible
CRA Preferred Convertible Special Preferred
Shares CRA Shares Voting Shares Manager
-------------- ------------- ----------------- -----------
Balance at December 31, 2004 $ -- $108,745 $ 152 $ --
Comprehensive income:
Net income 2,020 6,436
Other comprehensive income:
Net unrealized gain on derivatives
Unrealized gain on marketable securities
Unrealized holding gain on mortgage
revenue bonds
Less: reclassification to net income
Other comprehensive income
Comprehensive income
Options exercised and other share based
compensation, net of forfeitures
Amortization of share awards
Conversion of Special Common Units and
redemption of Special Preferred Voting Shares (2)
Issuance of 4.4% Convertible CRA Preferred shares 104,498
Repurchase of treasury shares
Distributions (2,020) (10,812)
--------- -------- --------- --------
Balance at December 31, 2005 $ 104,498 $104,369 $ 150 $ --
========= ======== ========= ========
-----------
Restricted Restricted
Common Shares - Shares
Shares Common Granted
----------- ------------- ------------
Balance at December 31, 2004 $ 773,165 $ (2,970) $ (7,922)
Comprehensive income:
Net income 50,558
Other comprehensive income:
Net unrealized gain on derivatives
Unrealized gain on marketable securities
Unrealized holding gain on mortgage
revenue bonds
Less: reclassification to net income
Other comprehensive income
Comprehensive income
Options exercised and other share based
compensation, net of forfeitures 8,325 (2,936)
Amortization of share awards 895 6,665
Conversion of Special Common Units and
redemption of Special Preferred Voting Shares 4,818
Issuance of 4.4% Convertible CRA Preferred share
Repurchase of treasury shares (4,165)
Distributions (85,719)
--------- -------- --------
Balance at December 31, 2005 $ 752,042 $ (7,135) $ (4,193)
========= ======== ========
Accumulated
Other
Comprehensive Comprehensive
Income Income Total
--------------- -------------- ------------
Balance at December 31, 2004 $ 11,552 $ 882,722
Comprehensive income:
Net income $ 59,014 59,014
--------
Other comprehensive income:
Net unrealized gain on derivatives 5,848
Unrealized gain on marketable securities 35
Unrealized holding gain on mortgage
revenue bonds 84,230
Less: reclassification to net income (1,561)
--------
Other comprehensive income 88,552 88,552 88,552
--------
Comprehensive income $147,566
--------
Options exercised and other share based
compensation, net of forfeitures 5,389
Amortization of share awards 7,560
Conversion of Special Common Units and
redemption of Special Preferred Voting Shares 4,816
Issuance of 4.4% Convertible CRA Preferred share 104,498
Repurchase of treasury shares (4,165)
Distributions (98,551)
-------- ----------
Balance at December 31, 2005 $100,104 $1,049,835
======== ==========
See accompanying notes to consolidated financial statements
61
CHARTERMAC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Year Ended December 31,
---------------------------------------
2005 2004 2003
--------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 59,014 $ 65,363 $ 66,586
Adjustments to reconcile net income to net cash provided by
operating activities:
Gain on repayment of mortgage revenue bonds (1,561) (217) (1,951)
Loss on impairment of assets 4,555 757 1,759
Depreciation and amortization 44,195 30,407 11,926
Equity in income of unconsolidated entities (7,476) (3,442) (2,219)
Write-off of trade name 22,567 -- --
Income allocated to preferred shareholders of subsidiary 6,225 3,942 9,449
Income allocated to minority interests in consolidated subsidiaries 23,421 28,368 3,984
Non-cash compensation expense 8,661 11,632 2,845
Other non-cash expense 3,390 4,353 (3,493)
Deferred taxes (28,178) (20,544) (9,491)
Distributions received from equity investees 3,702 2,219 2,219
Changes in operating assets and liabilities:
Mortgage servicing rights (7,520) (6,854) (4,015)
Mortgage loans receivable (125,797) (5,610) 19,424
Loan to affiliate 4,600 (4,600) --
Deferred revenues 6,207 35,122 14,693
Other assets (35,434) (32,557) (11,046)
Accounts payable, accrued expenses and other liabilities 20,010 (812) (2,768)
--------- --------- ---------
Net cash provided by operating activities 581 107,527 97,902
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Repayments of mortgage revenue bonds 133,611 39,067 99,931
Mortgage revenue bond acquisitions and fundings (443,517) (325,037) (432,915)
Investments in notes receivable (34,401) (3,900) (3,629)
Repayments of notes receivable 3,039 4,725 9,496
Acquisitions, net of cash acquired (290) (1,579) (62,662)
Loans to Capri Capital (8,011) (84,000) --
Advances to partnerships (146,977) (173,526) (18,925)
Collection of advances to partnerships 138,981 156,875 26,569
Deferred investment acquisition costs (1,935) (2,526) (615)
Decrease in cash and cash equivalents - restricted 317 6,781 14,125
Other investing activities (13,253) 15,521 3,206
--------- --------- ---------
Net cash used in investing activities (372,436) (367,599) (365,419)
--------- --------- ---------
See accompanying notes to consolidated financial statements
continued
62
CHARTERMAC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Year Ended December 31,
----------------------------------------
2005 2004 2003
----------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Distributions to shareholders (96,582) (84,395) (65,121)
Distributions to preferred shareholders of subsidiary (6,225) (2,386) (9,449)
Distributions to Special Common Unit and Special Membership (34,677) (28,411) --
Unit holders
Proceeds from financing arrangements 547,390 281,060 521,153
Repayments of financing arrangements (186,126) (112,639) (292,804)
Increase in notes payable 130,434 20,872 55,842
Issuance of preferred shares 108,000 -- --
Issuance of common or Convertible CRA shares -- 110,803 107,500
Issuance of preferred subsidiary shares -- 104,000 --
Proceeds from stock options exercised 3,804 308 1,651
(Retirement) issuance of special preferred voting shares (2) (10) 162
Deferred financing costs (4,153) (10,077) (12,882)
----------- ---------- ----------
Net cash provided by financing activities 461,863 279,125 306,052
----------- ---------- ----------
Net increase in cash and cash equivalents 90,008 19,053 38,535
Cash and cash equivalents at the beginning of the year 71,287 52,234 13,699
----------- ---------- ----------
Cash and cash equivalents at the end of the year $ 161,295 $ 71,287 $ 52,234
----------- ---------- ----------
SUPPLEMENTAL INFORMATION:
Interest paid $ 55,771 $ 31,057 $ 23,417
Taxes paid $ 768 $ 8,040 $ 137
Acquisition activity:
--------------------
Conversion of note receivable $ 70,000
Issuance of subsidiary equity 7,500 $ 284,113
Decrease in minority interest (4,200) $ (1,579)
Assets acquired (90,530) (375,726)
Liabilities assumed 16,940 28,951
----------- ---------- ----------
Net cash paid for acquisitions $ (290) $ (1,579) $ (62,662)
=========== ========== ==========
Non-cash activities relating to adoption of FIN 46(R):
Decrease in mortgage revenue bonds $ 33,821
Increase in other assets 4,731
Increase in investments held by consolidated partnerships (2,173,621)
Increase in other assets of consolidated partnerships (210,494)
Increase in notes payable and other liabilities of
consolidated partnerships 1,047,976
Increase in partners' interests of consolidated partnerships 1,297,587
----------
$ --
==========
Non-cash investing and financing activities:
Share grants and SCUs issued $ 3,706 $ 1,875 $ 15,223
Issuance of SMUs in exchange for investment or acquisition $ 11,576 $ -- $ --
Conversion of SCUs to common shares $ 4,818 $ 17,789 $ --
Conversion of CRA shares to common shares $ -- $ 27,585 $ 21,870
Treasury stock purchases via employee withholding $ 4,165 $ 2,592 $ 275
See accompanying notes to consolidated financial statements
63
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A. CONSOLIDATION AND BASIS OF PRESENTATION
The consolidated financial statements include the accounts of CharterMac, its
wholly owned and majority owned subsidiary statutory trusts, corporations which
it controls and entities consolidated pursuant to the adoption of FASB
Interpretation No. 46(R) (see 1.O. CONSOLIDATED PARTNERSHIPS below). All
intercompany accounts and transactions have been eliminated in consolidation.
Unless otherwise indicated, "the Company", "we" and "us", as used throughout
this document, refers to CharterMac and its consolidated subsidiaries.
Our consolidated financial statements are prepared on the accrual basis of
accounting in accordance with accounting principles generally accepted in the
United States of America ("GAAP"). The preparation of financial statements in
conformity with GAAP requires us 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.
B. REVENUE RECOGNITION
We derive our revenues from a variety of investments and services, summarized as
follows:
o MORTGAGE REVENUE BOND INTEREST INCOME
We recognize income as it accrues, provided collectibility of future
amounts is reasonably assured. We recognize contingent interest when
received. For bonds with modified terms, or when collectibility is
uncertain, we recognize revenue based upon expected cash receipts. For
bonds which carry a different interest rate during the construction
period than during the balance of the term, we calculate the effective
yield on the bond and use that rate to recognize income over the life
of the bond.
We place loans on a non-accrual status when any portion of the
principal or interest is 90 days past due or earlier when concern
exists as to the ultimate collectibility of principal or interest.
Loans return to accrual status when principal and interest become
current. There were eight bonds with a fair value of $49.9 million on
non-accrual status at December 31, 2005 and none at December 31, 2004.
o OTHER INTEREST INCOME
We recognize income on temporary investments (such as cash in banks
and short-term instruments) as well as longer term investments (from
promissory notes, mortgages receivable, etc.), on the accrual basis as
it becomes due.
o FEE INCOME
o FUND SPONSORSHIP FEES
o PROPERTY ACQUISITION FEES are for services we perform in
acquiring interests in property-owning partnerships which
comprise the assets of funds we sponsor. We recognize these
fees when the investor equity is invested and the properties
have been acquired by the investment fund.
o PARTNERSHIP MANAGEMENT FEES are for maintaining the books
and records of an investment fund, including requisite
investor reporting. We recognize these fees over the five
year contractual service period following the initial
closing of an investment fund.
o ACQUISITION FEES received upon acquisition of mortgage
revenue bonds are deferred and amortized over the life of
the bonds.
64
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
o ORGANIZATION, OFFERING AND ACQUISITION ALLOWANCE FEES are
for reimbursement of costs we incur for organizing the
investment funds and for providing assistance in acquiring
the properties to be included in the investment funds. We
recognize the organization and offering allowance fee when
the investor equity is raised and recognize the acquisition
allowance fee when the investment funds acquire properties.
The related expenses are included in general and
administrative expenses.
o ASSET MANAGEMENT FEES from investment funds, based on a
percentage of each investment fund's invested assets are for
monitoring the acquired property interests to ensure that
their development, leasing and operations comply with low
income housing or other tax credit requirements, and are
recorded monthly as earned, provided that collection is
reasonably assured.
o MORTGAGE BANKING FEES
o MORTGAGE ORIGINATION FEES for originating loans are recorded
upon settlement of sale to the purchaser of the loans.
o MORTGAGE SERVICING FEES are recognized on an accrual basis
as the services are performed over the servicing period.
o CREDIT INTERMEDIATION FEES
o Fees for credit intermediation transactions to provide
specified rates of return, received in advance, are deferred
and amortized over the applicable risk-weighted periods on a
straight-line basis. For those pertaining to the
construction and lease-up phase of a pool of properties, the
periods are generally one to three years. For those
pertaining to the operational phase of a pool of properties,
the period is approximately 20 years.
o Fees for other credit intermediation transactions are
received monthly and recognized as income when earned.
o OTHER INCOME
o CONSTRUCTION SERVICE FEEs from borrowers for servicing mortgage
revenue bonds during the construction period are deferred and
amortized into other income over the estimated construction
period.
o ADMINISTRATION FEES charged to the property partnerships or to
other entities we manage are recorded as the payments are
received due to the uncertainty of collectability.
o PREPAYMENT PENALTIES from early payments of mortgage revenue
bonds or serviced mortgage loans are recognized at the time of
prepayment.
o EXPENSE REIMBURSEMENTS includes amounts billed to the investment
funds and other affiliated entities ("affiliates") for the
reimbursement of salaries and certain other ongoing operating
expenditures incurred by CharterMac Capital on behalf of these
affiliates. We recognize these amounts as incurred.
o REVENUES OF CONSOLIDATED PARTNERSHIPS
Rental income for property partnerships is accrued as earned based on
underlying lease agreements. Interest income for all consolidated
partnerships is accrued as earned.
65
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
C. INVESTMENT IN MORTGAGE REVENUE BONDS
We account for our investments in mortgage revenue bonds as available-for-sale
debt securities under the provisions of SFAS No. 115, ACCOUNTING FOR CERTAIN
INVESTMENTS IN DEBT AND EQUITY SECURITIES ("SFAS No. 115") due to a provision in
most of the bonds whereby we have a right to require redemption prior to
maturity, although we can and may elect to hold them up to their maturity dates
unless otherwise modified. Accordingly, investments in mortgage revenue bonds
are carried at their estimated fair values, with unrealized gains and losses
reported in accumulated other comprehensive income.
Because mortgage revenue bonds have a limited market, we estimate 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.
Prior to the CharterMac Capital acquisition in November 2003 (see Note 2), we
paid fees to CharterMac Capital for its activities performed as our Manager (see
Note 17). The fees pertaining to acquisitions of mortgage revenue bonds were
capitalized as part of the bond cost and are amortized as a reduction to
interest income over the terms of the mortgage revenue bonds. Since the
acquisition, we ceased paying fees pertaining to acquisitions, but continue to
pay a fee for asset management which is charged to expense and eliminated in
consolidation. Direct costs relating to unsuccessful acquisitions and all
indirect costs relating to the mortgage revenue bonds are charged to operations.
We define a mortgage revenue bond as impaired when we determine it is probable
that not all required contractual payments will be made when due. Our primary
tool to determine which loans are likely to incur a loss is to evaluate the debt
service coverage ratio based on our historical experience with similar
properties and the frequency of such losses.
When a mortgage revenue bond is underperforming with respect to certain of our
standards (for example, expectations of timely construction completion, actual
occupancy levels or actual debt service coverage) but we still expect to recover
all contractual payments (either through debt service or collateral), we value
it based on our estimate of the fair value as described above, although such
fair value will not exceed the outstanding face amount. If we determine it is
probable that we will not receive all contractual payments required when they
are due, we deem a bond impaired, write it down to its estimated fair value and
record a realized loss in the statement of income.
D. OTHER INVESTMENTS
We invest in partnership interests related to the real estate equity investment
funds we sponsor. Typically, we hold these investments for a short period until
we establish a new fund.
We account for our investment in ARCap Investors, LLC ("ARCap") using the equity
method pursuant to Accounting Principles Board Opinion No. 18, THE EQUITY METHOD
OF ACCOUNTING FOR INVESTMENTS IN COMMON STOCK ("APB No. 18") as interpreted by
AICPA Statement of Position 78-9, ACCOUNTING FOR INVESTMENTS IN REAL ESTATE
VENTURES ("SOP 78-9"), EITF Issue D-46, ACCOUNTING FOR LIMITED PARTNERSHIP
INVESTMENTS and EITF 03-16, ACCOUNTING FOR INVESTMENTS IN LIMITED LIABILITY
COMPANIES. For the preferred portion of the investment, our equity in the
earnings of ARCap is accrued at the applicable cumulative dividend rate, unless
ARCap does not have earnings and cash flows adequate to meet this dividend
requirement.
Mortgage loans receivable represent amounts we are due for mortgage loans that
were sold under purchase agreements to permanent investors but for which we are
awaiting settlement of funds. The balance also includes net origination costs.
We do not retain any interest in these loans except for mortgage servicing
rights and certain contingent liabilities pursuant to loss sharing agreements.
E. CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash in banks and investments in short-term
instruments with an original maturity of three months or less. Restricted cash
includes collateral for borrowings within our securitization programs and in
accordance with Fannie Mae and Freddie Mac requirements.
66
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
F. DEFERRED COSTS
We capitalize costs incurred in connection with our securitization programs (see
Note 9) and amortize them on a straight-line basis over 10 years, which
approximates the average remaining term to maturity of the mortgage revenue
bonds in the programs.
We capitalize costs incurred in connection with the issuance of preferred shares
of our Equity Issuer subsidiary and amortize them on a straight-line basis over
the period to the mandatory repurchase date of the shares. We record costs we
incur in connection with the issuance of equity as a reduction of beneficial
owners' equity of such shares.
G. GOODWILL AND OTHER INTANGIBLE ASSETS
We test goodwill for impairment (via a third party appraisal) annually or if
circumstances indicate there may be reason to believe impairment has occurred.
Any such impairment would be charged to expense in the period in which it is
determined. Should goodwill be deemed impaired, the useful lives of identified
intangible assets may need to be reassessed and amortization accelerated, or
such intangible assets could be deemed impaired as well.
We amortize other intangible assets on a straight-line basis over their
estimated useful lives.
We recognize as assets the rights to service mortgage loans for others, whether
the Mortgage Servicing Rights ("MSRs") are acquired through a separate purchase
or through loans originated and sold. Purchased MSRs are recorded at cost. For
originated loans, we allocate total costs incurred to the loan originated and
the MSR retained based on the relative fair values as determined by a
third-party appraiser. In subsequent periods, the assets are carried at the
amortized initial basis or current fair value. All MSRs are amortized in
proportion to, and over the period of, estimated net servicing income.
MSRs are assessed for impairment based on the fair value of the assets as
compared to carrying value. When we determine that a portion of the balance is
not recoverable, we reduce the assets and the valuation allowance to reflect
permanent impairment.
H. FINANCIAL RISK MANAGEMENT AND DERIVATIVES
We account for derivative financial instruments pursuant to SFAS No. 133,
ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING Activities ("SFAS No. 133"),
as amended and interpreted. We record derivatives at fair value, with changes in
fair value of those that we classify as cash flow hedges recorded in accumulated
other comprehensive income, to the extent they are effective. If deemed
ineffective, we record the amount considered ineffective in the consolidated
statement of income.
We have determined that we will not apply hedge accounting to fair value hedges.
Any change in the fair value of these hedges is therefore included in current
period net income.
I. FAIR VALUE OF FINANCIAL INSTRUMENTS
As described above, our investments in mortgage revenue bonds, our MSRs and our
derivatives are carried at estimated fair values. We have determined that the
fair value of our remaining financial instruments, including temporary
investments, cash and cash equivalents, promissory notes receivable, mortgage
notes receivable and borrowings approximate their carrying values at December
31, 2005 and 2004, due primarily to their short term nature or variable rates of
interest.
J. INCOME TAXES
We provide for income taxes in accordance with SFAS No. 109, which requires the
recognition of deferred tax assets and liabilities for the expected future tax
consequences of temporary differences between the financial statement carrying
67
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
amounts and the tax basis of assets and liabilities. We assess the
recoverability of deferred tax assets through evaluation of carryback
availability, projected taxable income and other factors as applicable.
K. NET INCOME PER SHARE
Basic net income per share represents net income allocated to Common and
Convertible CRA shareholders (see Note 16) by the weighted average number of
Common and Convertible CRA shares outstanding during the period. Diluted net
income per share includes the weighted average number of shares outstanding
during the period and the dilutive effect of common share equivalents,
calculated using the treasury stock method.
The Convertible CRA shareholders are included in the calculation of shares
outstanding as they share the same economic benefits as common shareholders.
SCUs, SMUs and 4.4% Convertible CRA preferred shares (see Notes 13 and 14) are
not included in the calculation as they are antidilutive.
L. CREDIT INTERMEDIATION TRANSACTIONS
For guarantees and other credit intermediation transactions issued since January
1, 2003, we record liabilities (included in deferred revenues) equal to the fair
values of the obligations undertaken. For transactions for which we receive
fees, the fees received are considered the measure of fair value, in accordance
with FASB Interpretation No. 45, GUARANTOR'S ACCOUNTING AND DISCLOSURE
REQUIREMENTS FOR GUARANTEES, INCLUDING INDIRECT GUARANTEES OF INDEBTEDNESS OF
OTHERS ("FIN 45"). For completion and other guarantees issued to lenders for the
underlying financing of properties, as required by an investment fund, we
generally recognize no liability upon inception of the guarantee as the exposure
is considered minimal and no fee is received. We monitor our exposure under
these agreements and, should we determine a loss is probable, accrue a liability
in accordance with SFAS No. 5, ACCOUNTING FOR Contingencies.
M. MORTGAGE BANKING LOAN LOSS RESERVE
We account for exposure to loss under our servicing contracts with Fannie Mae
and Freddie Mac through a provision for loan losses. The exposure to loss
results from guarantees made to Fannie Mae and Freddie Mac under the DUS and DUI
programs to share the risk of loan losses. (See Note 21 for more details) The
provision recorded is considered the fair value of the guarantees. Our
determination of the adequacy of the reserve for losses on loans serviced is
based on an evaluation of the risk characteristics and exposure to loss
associated with those loans. Our assessment is based on a number of factors,
including but not limited to general economic conditions, inability of the
borrower to meet debt service requirements, or a substantial decline in the
value of the collateral.
For performing loans, we maintain a general reserve, which is based on the
stratification of the loan servicing portfolio by debt service coverage ratio
(DSCR). The probability of default and loss is higher for loans with lower DSCRs
and therefore a higher reserve is maintained for such loans. For defaulted
loans, we maintain a loan specific reserve based on an estimate of our share of
the loss.
We record the loan loss provision as an expense and as a contra-asset account on
the balance sheet under Mortgage Servicing Rights (See Note 6).
N. SHARE BASED COMPENSATION
We account for our share options in accordance with the provisions of SFAS No.
123, ACCOUNTING FOR STOCK-BASED COMPENSATION ("SFAS No. 123"). Accordingly, we
record compensation cost, based on the options' estimated fair value, on a
straight-line basis over the vesting period. The fair values of option grants
are estimated using the Black-Scholes option-pricing model.
Prior to our acquisition of CharterMac Capital in November 2003 (see Note 2),
most options granted were issued to non-employees rendering services to us under
our management agreement with CharterMac Capital. As such, we estimated the fair
value of the share options at each period-end up to the vesting date, and
68
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
adjusted the expense accordingly. Upon the acquisition of CharterMac Capital,
such option holders became employees of our subsidiary and the fair value of the
options at that date became the basis of amortization until the respective
vesting dates.
We record restricted share grants as a contra-account within shareholders'
equity. The balance recorded equals the number of shares issued multiplied by
the closing price of our common shares on the grant date. We amortize the cost
over the vesting period of the shares on a straight-line basis. Any shares
granted with immediate vesting are expensed when granted.
O. CONSOLIDATED PARTNERSHIPS
Through our acquisition of CharterMac Capital (see Note 2), and in subsequent
fund originations, we became the general partner or equivalent in more than 115
entities in which we have little or no financial investment. Typically, outside
investors acquire all partnership interest in an upper-tier, or investment
partnership, or 100% of the membership interest if structured as a limited
liability company. The investment partnership, in turn, invests as a limited
partner in one or more lower-tier (operating) partnerships that own and operate
the multifamily housing complexes. Partners in the investment partnerships are
most often corporations who are able to utilize the tax benefits, which are
comprised of operating losses and Low-Income Housing Tax Credits ("LIHTCs").
Investment partnerships in which the limited partners or limited members do not
have the right to remove us as the general partner or managing member are
variable interest entities ("VIEs") as defined by FASB Interpretation No. 46(R),
CONSOLIDATION OF VARIABLE INTEREST ENTITIES, ("FIN46(R)"). We have concluded
that, as the general partner or managing member for these type of investments,
we are the primary beneficiary as defined by FIN 46(R) because we absorb the
majority of the expected income and loss variability (as we are entitled to fees
and are the "decision maker" of the funds), and such variability is
disproportionate to our actual ownership interest, which in most cases is none
although some of our executive officers have nominal, indirect equity interests
in many of the funds. We have consolidated the assets and liabilities of these
entities in our balance sheets and have recorded their results of operations in
our statements of income beginning April 1, 2004. Upon adoption of FIN 46(R), we
recorded the assets and liabilities of the partnerships we consolidated at their
historical bases, which approximated their fair values at that date.
The balance sheets and statements of operations consolidated in our 2005
financial statements are as of and for the period ended September 30, 2005, the
latest date available. Likewise, the amounts included in the 2004 financial
statements are as of and for the period ended September 30, 2004.
In addition, we have the general partner interest in 36 lower-tier
property-level operating partnerships in which we have little or no ownership
interest. As with the investment funds described above, the limited partners or
limited members do not have the right to remove us as the general partner or
managing member. Although these entities are not VIEs, we are deemed to control
them and consolidate them pursuant to ARB No. 51, CONSOLIDATED FINANCIAL
STATEMENTS or SOP 78-9.
Throughout the financial statements, we refer to these combined groups as
"consolidated partnerships".
P. NEW ACCOUNTING PRONOUNCEMENTS
Effective March 31, 2004, we adopted FIN 46(R) which clarified 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. See
CONSOLIDATED PARTNERSHIPS, above, regarding the impact of our adopting this
standard.
In 2003, we adopted SFAS No. 150, ACCOUNTING FOR CERTAIN FINANCIAL INSTRUMENTS
WITH CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY ("SFAS No. 150"). This
statement requires that certain financial instruments that have the
characteristics of debt and equity be classified as debt. Pursuant to SFAS No.
150, we have classified mandatorily redeemable preferred securities previously
shown as mezzanine equity as a liability in our balance sheets, and the
69
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
dividends paid on such shares as interest expense; dividends related to prior
periods remain classified as income allocated to preferred shareholders of
subsidiary.
In December 2004, the FASB issued SFAS No. 123(R), SHARE-BASED PAYMENT, which
replaces SFAS No. 123 and which we are required to adopt by the first quarter of
2006. As we have been accounting for share-based payments following the fair
value provisions of SFAS No. 123, we expect the impact of our adoption of this
standard to be immaterial.
In November 2005, the FASB issued Staff Position No. FAS 140-2, CLARIFICATION OF
THE APPLICATION OF PARAGRAPHS 40(B) AND 40(C) OF FASB STATEMENT NO. 140. This
staff position applies to characteristics for a securitization entity to meet
the definition of a qualified special purpose entity ("QSPE"). While the Staff
Position does not apply to our current securitization structure, it may affect
the accounting for future transactions should they involve QSPEs.
Q. RECLASSIFICATIONS
Certain amounts from prior years have been reclassified to conform to the 2005
presentation, including the reclassification of deferred charges and deferred
revenue accounts associated with our mortgage revenue bond portfolio that are
now incorporated within the calculation of unrealized gain on investments. The
reclassification for December 31, 2004, reduced deferred charges and other
assets by $20.1 million, reduced accounts payable, accrued expenses and other
liabilities by $2.9 million, and reduced accumulated other comprehensive income
by $17.3 million.
NOTE 2 - ACQUISITIONS
A. CHARTERMAC CAPITAL LLC
On November 17, 2003, we acquired the ownership interests in and substantially
all of the businesses (other than specific excluded interests) operated by
CharterMac Capital LLC ("CharterMac Capital" which was formerly known as Related
Capital Company LLC) for approximately $346.0 million. The consideration paid
included:
o $50.0 million in cash, paid to one of the selling principals;
o acquisition costs and other adjustments totaling approximately $12.3
million;
o approximately 15.9 million Special Common Units ("SCUs") in a newly
formed subsidiary (see Note 13); and
o approximately 15.9 million special preferred voting shares associated
with the SCUs (see Note 14).
The cash portion of the acquisition and associated acquisition costs were funded
by two bridge loans. In connection with the acquisition, we also established a
restricted share program granted share options to our chairman and granted
restricted shares and SCUs to employees (see Note 15).
We accounted for the acquisition as a purchase and allocated the cost based on
the estimated fair values of the assets acquired and liabilities assumed. We
valued intangible assets based on an appraisal by an independent valuation firm.
We recorded the excess of the purchase price over the net assets acquired
(including identified intangibles) as goodwill.
Prior to the acquisition, CharterMac Capital acted as our external manager (the
"Manager"). See Note 17 regarding related party transactions prior to the
acquisition and Note 16 regarding net income per share treatment of allocations
to the Manager prior to the acquisition.
In recording our acquisition of CharterMac Capital, we ascribed approximately
$5.1 million of the purchase price to the estimated future cash flows to be
received from general partner interests in investment partnerships in which we
maintain a non-equity controlling partner. From time to time, the general
partner of the investment funds may be called upon to fund investment fund
operations. In such a case, we would advance the funds (on behalf of the general
partner, typically controlled by our executives) and would be repaid out of
future operating cash flow or sale or refinancing proceeds, if any, received by
the investment fund.
70
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
B. CHARTERMAC MORTGAGE CAPITAL CORP.
In December 2001, we acquired 80% of the common shares of CharterMac Mortgage
Capital Corp. ("CMC"). During 2002 and 2003, we acquired another 7% of the
common shares. In 2005 we purchased the remaining shares and made the final
payments under the terms of the original purchase agreement. The total purchase
price of the 2005 transactions was $7.9 million, $7.5 million of which we paid
in cash. This transaction resulted in $3.6 million of additional goodwill.
C. CAPRI CAPITAL LIMITED PARTNERSHIP
Effective March 1, 2005, we purchased 100% of the ownership interests of Capri
Capital Limited Partnership ("CCLP"). The initial purchase price was $70.0
million plus $1.8 million of acquisition costs. Subsequently, the sellers earned
$15.0 million of additional consideration based on the 2004 financial results of
CCLP's mortgage banking business. The initial purchase price of $70.0 million
was paid via conversion into equity of an existing loan to CCLP and its
affiliates (collectively "Capri") (see Note 4). Of the additional $15.0 million
contingent consideration, we issued subsidiary equity units for half of the
amount (see Note 13), and paid all but approximately $1.7 million (subject to
contractual hold backs) of the balance in cash. Operations of CCLP were merged
into those of CMC.
We accounted for the CCLP acquisition as a purchase and, accordingly, we include
its results of operations in the consolidated financial statements from the
acquisition date. We allocated our cost of the acquisition on the basis of the
estimated fair values of the assets acquired and liabilities assumed. The excess
of the purchase price over the net of the amounts assigned to the assets
acquired (including identified intangibles) and liabilities assumed was
recognized as goodwill.
The following table summarizes the assets acquired and the liabilities assumed
in connection with the CCLP acquisition:
(in thousands)
Cash $ 14,264
Restricted cash 8,464
MSRs, net 40,974
Goodwill 27,955
Other intangible assets 3,213
Other assets 7,223
--------
Total assets 102,092
Accounts payable and other liabilities (15,253)
--------
Net assets acquired $ 86,839
--------
Pro forma financial results for CCLP are not presented, as the acquisition was
not material to our assets, revenues or net income.
NOTE 3 - MORTGAGE REVENUE BONDS
A. GENERAL
All of our mortgage revenue bonds bear fixed base interest rates and, to the
extent permitted by existing regulations, may also provide for contingent
interest and other features. Terms are expected to be five to 35 years, although
we may have the right to cause repayment prior to maturity through a mandatory
redemption feature (five to seven years with up to six month's notice). In some
cases, the bonds call for amortization or "sinking fund" payments, generally at
the completion of rehabilitation or construction, of principal based on 30 to 40
year level debt service amortization schedules.
71
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The principal and interest payments on each revenue bond are payable primarily
from the cash flows of the underlying properties, including proceeds from a sale
of a property or the refinancing of the mortgage loan securing a bond. None of
the mortgage revenue bonds constitute a general obligation of any state or local
government, agency or authority. The structure of each mortgage loan mirrors the
structure of the corresponding revenue bond that it secures. In order to protect
the tax-exempt status of the mortgage revenue bonds, the owners of the
underlying properties are required to enter into agreements to own, manage and
operate the properties in accordance with requirements of the Internal Revenue
Code of 1986, as amended. If they do not comply, the interest income we receive
could be subject to taxes.
Certain mortgage revenue bonds provide for "participating interest" which is
equal to a percentage of net property cash flow of the net sale or refinancing
proceeds. Bonds that contain these provisions are referred to as "participating"
while the rest are "non-participating". Both the stated and participating
interest on the mortgage revenue bonds are exempt from federal income tax.
Participating interest included in mortgage revenue bond interest income was
approximately $2.6 million in 2005, $230,000 in 2004 and $2.0 million in 2003.
No single revenue bond provided interest income that exceeded 10% of our total
revenue for the years ended December 31, 2005, 2004, or 2003.
Mortgage revenue bonds are generally not subject to optional prepayment during
the first five to ten years of our ownership and may carry various prepayment
penalty structures. Certain mortgage revenue bonds may be purchased at a
discount from their face value.
In selected circumstances, and generally only in connection with the acquisition
of tax-exempt mortgage revenue bonds, we may acquire a small amount of taxable
bonds:
o which we may be required to acquire in order to satisfy state
regulations with respect to the issuance of tax-exempt bonds; and
o to fund certain costs associated with the issuance of the bonds, that
under current law cannot be funded by the proceeds of the bond itself.
72
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 3 - MORTGAGE REVENUE BONDS (CONTINUED)
B. SUMMARY
The following tables summarize our revenue bond portfolio at December 31, 2005:
(Dollars in Thousands)
Units Face Amount of Bond (1) Fair Value at 12/31/05
---------------------- ----------------------- -----------------------
Current
Stated
Number % of % of % of Interest
of Bonds Number Total $ Amount Total $ Amount Total Rate
-------- ---------- --------- ----------- --------- ----------- --------- ----------
BY STATE: (2)
----------------
Texas 81 14,383 27.7% $ 764,272 30.9% $ 777,831 30.8% 6.68%
Georgia 30 7,030 13.5% 362,240 14.6% 363,804 14.5% 6.43%
California 48 5,153 9.9% 245,768 9.9% 263,711 10.4% 6.75%
Florida 22 3,438 6.6% 146,030 5.9% 145,605 5.8% 7.26%
Missouri 14 2,422 4.7% 106,028 4.3% 108,388 4.3% 5.96%
All others 122 19,563 37.6% 849,767 34.4% 862,963 34.2% 6.60%
--------------------------------------------------------------------------------------------------------------------------
Subtotal 317 51,989 100.0% 2,474,105 100.0% 2,522,302 100.0% 6.63%
==========
Eliminations (3) (22) (4,476) -- (236,406) -- (227,515) --
----------------------------------------------------------------------------------------------------------
Total 295 47,513 -- $2,237,699 -- $2,294,787 --
==========================================================================================================
2004 Total 268 45,819 -- $2,140,565 -- $2,100,720 --
==========================================================================================================
BY PROPERTY
STATUS:
----------------
Stabilized 127 22,812 43.9% $ 942,187 38.1% $ 981,240 38.9% 7.12%
Lease-up 110 15,948 30.7% 859,340 34.7% 859,825 34.1% 6.87%
Construction 31 5,710 11.0% 312,225 12.6% 313,826 12.4% 5.52%
Rehab 49 7,519 14.4% 360,353 14.6% 367,411 14.6% 5.69%
--------------------------------------------------------------------------------------------------------------------------
Subtotal 317 51,989 100.0% 2,474,105 100.0% 2,522,302 100.0% 6.63%
==========
Eliminations (3) (22) (4,476) -- (236,406) -- (227,515) --
----------------------------------------------------------------------------------------------------------
Total 295 47,513 -- $2,237,699 -- $2,294,787 --
==========================================================================================================
2004 Total 268 45,819 -- $2,140,565 -- $2,100,720 --
==========================================================================================================
Pertinent Weighted Average Dates Annualized Base Interest
--------------------------------------- ------------------------
Debt
Service
Occupancy Coverage
Optional on Ratio on
Redemption % of Stabilized Stabilized
Put Date Date Maturity Date $ Amount Total Properties Properties
---------- ---------- ------------- ----------- --------- ------------ ------------
BY STATE: (2)
----------------
Texas Feb-20 Jul-19 Jul-42 52,381 31.3% 93.7% 0.92x
Georgia Aug-20 Feb-17 Jul-41 23,718 14.2% 92.9% 0.80x
California Dec-18 Jun-17 Dec-38 17,005 10.2% 96.9% 1.32x
Florida May-20 May-16 Mar-40 10,603 6.3% 95.2% 1.29x
Missouri Sep-19 Apr-19 Jun-39 6,469 3.9% 92.8% 1.38x
All others Oct-19 Aug-18 Mar-39 57,239 34.1% 93.1% 1.11x
---------------- -----------------------------------------------------------------------------------------------
Subtotal Dec-19 Jun-18 Aug-40 167,415 100.0% 94.1% 1.12x
======================================================
Eliminations (3)
----------------
Total
================
2004 Total $151,144 100.0% 90.7% 1.14x
================ ======================================================
BY PROPERTY
STATUS:
----------------
Stabilized Jan-18 Oct-15 Dec-36 $ 67,122 40.1% 94.1% 1.12x
Lease-up Mar-20 Aug-18 Nov-41 59,076 35.3% N/A N/A
Construction Feb-22 Dec-21 Aug-44 19,268 11.5% N/A N/A
Rehab Feb-22 Feb-22 Aug-43 21,949 13.1% N/A N/A
---------------- -----------------------------------------------------------------------------------------------
Subtotal Dec-19 Jun-18 Aug-40 167,415 100.0%
======================================================
Eliminations (3)
----------------
Total
================
2004 Total $151,144 100.0% 90.7% 1.14x
================ ======================================================
(1) Original principal amount at issuance.
(2) Other than those detailed, based on face amount, no state comprises more
than 10% of the total at December 31, 2005 or 2004.
(3) These bonds are either recorded as liabilities on the balance sheets of
certain consolidated partnerships or are recorded as liabilities of real estate
owned and are therefore eliminated in consolidation.
73
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 3 - MORTGAGE REVENUE BONDS (CONTINUED)
(Dollars in Thousands)
Face Amount
Units of Bond (1) Fair Value at 12/31/05
------------------- ------------------- ----------------------
Number of % of % of % of Current Stated
Bonds Number Total $ Amount Total $ Amount Total Interest Rate
-------------------------------------------------------------------------------------------
BY PUT DATE:
------------------
No put date 60 733 1.4% $ 93,582 3.8% $ 88,689 3.5% 6.78%
6 months notice 4 1,228 2.4% 48,300 2.0% 44,402 1.8% 7.24%
2006-2010 4 1,266 2.4% 42,250 1.7% 42,250 1.7% 7.18%
2011-2015 8 1,848 3.6% 74,238 3.0% 78,388 3.1% 7.02%
2016-2020 158 30,620 58.9% 1,417,196 57.3% 1,451,898 57.6% 6.97%
2021-2025 69 13,981 26.9% 689,055 27.8% 700,970 27.8% 5.80%
2026-2030 12 2,137 4.1% 101,199 4.1% 107,096 4.2% 6.80%
2031-2035 2 176 0.3% 8,285 0.3% 8,609 0.3% 6.47%
---------------------------------------------------------------------------------------------------------------
Subtotal 317 51,989 100.0% 2,474,105 100.0% 2,522,302 100.0% 6.63%
=========================
Eliminations (2) (22) (4,476) -- (236,406) -- (227,515)
-------------------------------------------------------------------------------------
Total 295 47,513 -- $2,237,699 -- $2,294,787
=====================================================================================
2004 Total 268 45,819 -- $2,140,565 -- $2,100,720 100.0% 6.75%
===============================================================================================================
BY MATURITY DATE:
------------------
2006-2010 18 400 0.8% $ 28,288 1.1% $ 25,889 1.0% 6.10%
2011-2015 26 293 0.6% 27,245 1.1% 23,459 0.9% 6.11%
2016-2020 19 1,352 2.6% 82,010 3.3% 76,035 3.0% 6.97%
2021-2025 18 336 0.6% 47,069 1.9% 45,764 1.8% 7.45%
2026-2030 9 1,262 2.4% 46,273 1.9% 48,880 1.9% 7.20%
2031-2035 12 2,597 5.0% 98,924 4.0% 105,103 4.2% 6.80%
2036-2040 58 11,415 22.0% 464,247 18.8% 483,252 19.2% 7.16%
2041-2045 128 28,252 54.3% 1,378,788 55.7% 1,414,720 56.1% 6.59%
2046 and after 29 6,082 11.7% 301,261 12.2% 299,200 11.9% 5.68%
---------------------------------------------------------------------------------------------------------------
Subtotal 317 51,989 100.0% 2,474,105 100.0% 2,522,302 100.0% 6.63%
=========================
Eliminations (2) (22) (4,476) -- (236,406) -- (227,515)
-------------------------------------------------------------------------------------
Total 295 47,513 -- $2,237,699 -- $2,294,787
=====================================================================================
2004 Total 268 45,819 -- $2,140,565 -- $2,100,720 100.0% 6.75%
===============================================================================================================
(1) Original principal amount at issuance.
(2) These bonds are either recorded as liabilities on the balance sheets of
certain consolidated partnerships or are recorded as liabilities of real estate
owned and are therefore eliminated in consolidation.
74
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The following table summarizes the maturity dates of mortgage revenue bonds we
hold as of December 31, 2005:
Outstanding Weighted
Bond Average
(In thousands) Amount Fair Value Interest Rate
------------------------------ ----------- ----------- -------------
Due in less than one year $ 15,102 $ 15,102 4.97%
Due between one and five years 10,908 10,788 7.43%
Due after five years 2,390,339 2,496,412 6.63%
----------- ----------- -------
Total/weighted average 2,416,349 2,522,302 6.63%
=======
Less: eliminations (1) (228,744) (227,515)
----------- -----------
Total $ 2,187,605 $ 2,294,787
=========== ===========
(1) These bonds are either recorded as liabilities on the balance sheets of
certain consolidated partnerships or are recorded as liabilities of real estate
owned and are therefore eliminated in consolidation.
C. PORTFOLIO ACTIVITY
Reconciliation of mortgage revenue bonds: 2005 2004
--------------------------------------------------------------------------------
(In thousands)
Balance at beginning of period $ 2,100,720 $ 1,871,009
Acquisitions and additional fundings 443,517 325,037
Repayment proceeds (104,279) (26,870)
Principal payments (22,466) (12,196)
Realized gain 1,541 217
Advance returned by Trustee (6,866) --
Impairment losses (4,555) (610)
Net change in fair value 86,323 (12,601)
Accretion/amortization of yield adjustments (5,384) (8,079)
Reclassification to other assets (34,238) (900)
----------- -----------
Subtotal 2,454,313 2,135,007
Less: change in eliminations (1) (159,526) (34,287)
----------- -----------
Balance at close of period $ 2,294,787 $ 2,100,720
=========== ===========
(1) Certain bonds are either recorded as liabilities on the balance sheets of
certain consolidated partnerships or are recorded as liabilities of real estate
owned and are therefore eliminated in consolidation.
Mortgage revenue bonds acquired and/or additional fundings made during 2005 and
2004 are summarized below:
Weighted Weighted
Average Average
Face Construction Permanent
(In thousands) Amount (1) Rate Interest Rate
-------------------------------------- ---------- ------------ -------------
2005
Construction/rehabilitation properties $429,966 5.81% 6.17%
Additional funding of existing bonds 13,551 5.36% 6.60%
-------- ------- -------
Total 2005 acquisitions $443,517 5.80% 6.18%
======== ======= =======
2004
Construction/rehabilitation properties $290,907 5.45% 6.49%
Additional funding of existing bonds 34,130 3.60% 4.28%
-------- ------- -------
Total 2004 acquisitions $325,037 5.26% 6.26%
======== ======= =======
(1) Original principal amount at issuance.
75
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Mortgage revenue bonds and notes repaid during 2005 and 2004 are summarized
below:
Net Book Realized
(In thousands) Value Proceeds Gains (Losses)
--------------------------------- -------- -------- --------------
2005
Participating, stabilized $ 29,471 $ 30,402 $ 931
Non-participating, stabilized 31,233 32,450 1,217
Non-participating, not stabilized 42,034 41,427 (607)
-------- -------- --------
Total $102,738 $104,279 $ 1,541
======== ======== ========
2004
Non-participating, stabilized $ 26,653 $ 26,870 $ 217
======== ======== ========
D. UNREALIZED GAINS AND LOSSES
The amortized cost basis of our portfolio of mortgage revenue bonds and the
related unrealized gains and losses were as follows at December 31:
(In thousands) 2005 2004
----------- -----------
Amortized cost basis $ 2,417,185 $ 2,116,213
Gross unrealized gains 116,541 41,643
Gross unrealized losses (11,424) (22,849)
----------- -----------
Subtotal/fair value 2,522,302 2,135,007
Less: eliminations (1) (227,515) (34,287)
----------- -----------
Total fair value per balance sheet $ 2,294,787 $ 2,100,720
=========== ===========
(1) These bonds are either recorded as liabilities on the balance sheets of
certain consolidated partnerships or are recorded as liabilities of real estate
owned and are therefore eliminated in consolidation.
The fair value and gross unrealized losses of our mortgage revenue bonds
aggregated by length of time that individual bonds have been in a continuous
unrealized loss position is summarized in the table below:
(Dollars in thousands) Less than 12 Months
12 Months or More Total
----------- ---------- ----------
DECEMBER 31, 2005
Number 36 55 91
Fair value $253,063 $327,183 $580,246
Gross unrealized loss $ 6,775 $ 4,649 $ 11,424
-------- -------- --------
DECEMBER 31, 2004
Number 59 82 141
Fair value $457,025 $456,475 $913,500
Gross unrealized loss $ 7,694 $ 15,155 $ 22,849
The unrealized losses related to these mortgage revenue bonds are due primarily
to changes in interest rates in that we calculate present values based upon
future cash flows from the bonds and discount these cash flows at current rates;
as rates rise, the fair value of our portfolio decreases. We have the intent and
ability to hold these bonds until recovery and have therefore concluded that
these declines in fair value are temporary. For discussion of other-than
temporary impairments, see IMPAIRMENT below.
76
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
E. SECURITIZED AND PLEDGED ASSETS
As of December 31, 2005, mortgage revenue bonds with an aggregate fair value of
approximately $2.3 billion were securitized or pledged as collateral in relation
to financing arrangements (see Note 9).
F. IMPAIRMENT
During the second quarter of 2005, we determined that construction should be
halted on a property for which we had assumed the general partner interest (see
Note 21). Based on the funds available to recover and the estimated value of the
land, we recognized an impairment of the associated mortgage revenue bond of
approximately $1.1 million. In the third quarter of 2005, we agreed in principle
to revise the terms of another mortgage revenue bond. In connection with this
agreement, we recognized an impairment of the asset and recorded a charge of
$803,000. During the fourth quarter of 2005, we determined that two bonds
secured by a property would likely require term revisions to reduce the rate of
interest and, accordingly, recorded an impairment charge of approximately $2.7
million.
In 2004, in light of the underperformance of one of our investments, which
necessitated the temporary revision of payment terms, we recognized an
impairment loss of approximately $610,000.
In 2003, because of developer defaults and a softening of the market of an
underlying property, we determined that one of our mortgage revenue bonds was
impaired, and wrote down the bond to its estimated fair value, recognizing an
impairment loss of approximately $1.8 million.
G. FORECLOSURE
In May 2005, an affiliate of ours foreclosed upon the properties underlying
three of our mortgage revenue bonds.
Following the determination in 2003 that a revenue bond was impaired (see above)
the first mortgage was foreclosed upon in October 2004. The bonds were
subsequently retired and we own the land valued at $900,000.
Foreclosed properties are included in "Real Estate Owned" within Deferred Costs
and Other Assets on the consolidated balance sheets (see Note 5).
NOTE 4 - OTHER INVESTMENTS
Investments other than mortgage revenue bonds consisted of:
(In thousands) 2005 2004
-------------------------------------------------------------- ----------- -----------
Investment in equity interests in LIHTC properties $ 46,985 $ 40,132
Investment in properties under development 4,300 3,157
Investment in ARCap 19,874 19,054
Capri loans and preferred stock 26,884 84,000
Mortgage loans receivable 153,277 27,480
Notes receivable 32,670 2,924
Other investments 14,600 10,759
-------- --------
Total other investments $298,590 $187,506
======== ========
77
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
A. INVESTMENTS IN EQUITY INTERESTS IN LIHTC PROPERTIES
Through a subsidiary, we acquire equity interests in property ownership entities
on a short-term basis for inclusion in Fund Management offerings to investors.
We expect to recapture such amounts from the proceeds of the equity and debt
financing when the investment fund has closed. The developer also guarantees
repayment of these investments. Substantially all of these investments are
pledged as collateral for our borrowings under a warehouse facility (see Note
10).
B. INVESTMENTS IN PROPERTIES UNDER DEVELOPMENT
We invest in affiliated entities that co-develop properties. Development
investments include amounts invested to fund pre-development and development
costs. Investment funds we sponsor acquire the limited partnership interests in
these properties. We expect to recapture these amounts from various sources
attributable to the properties, including capital contributions of investments
funds, cash flow from operations, and/or from co-development partners, who in
turn have cash flow notes from the properties. In connection with our
co-development agreements, affiliates of CharterMac issue construction
completion, development deficit guarantees and operating deficit guarantees to
the lender and investment funds (for the underlying financing of the properties)
on behalf of our subsidiary (see Note 21).
C. INVESTMENT IN ARCAP
We hold approximately 150,000 units of Series A Convertible Preferred Membership
Interests in ARCap Investors, LLC, a provider of portfolio management services.
We also hold 590,000 common units, which we acquired upon converting the same
number of preferred units in December 2005. The initial cost of all of the units
was $25 per unit. The preferred units carry a preferred return of 12% and the
common units receive a specified yearly dividend, currently set at $4.00 per
unit for 2006. In December 2005, we received a common distribution of $2.14 per
share following the conversion.
D. CAPRI LOANS AND PREFERRED STOCK
In July 2004, our subsidiary CM Investor LLC ("CM Investor") provided an interim
loan in the principal amount of $84.0 million ("Interim Loan") to CCLP and its
affiliates (collectively "Capri"), which bore interest at a rate of 11.5% per
year and matured in January 2005.
In the first quarter of 2005, we extended and converted the loan, adding $6.0
million to the loan amount. Upon conversion, we held two participating loans,
one of which allowed us to participate in the cash flows of, and in turn was
convertible into a 100% ownership interest in, CCLP. The other allows us to
participate in the cash flows of, and is convertible into a 49% ownership
interest in, Capri Capital Advisors LLP ("CCA"), a pension fund advisory
business.
In the first quarter of 2005, we converted the CCLP loan and acquired the
business as an addition to our Mortgage Banking segment (see Note 2).
In August 2005, in connection with an acquisition CCA consummated, we issued
approximately $4.1 million of subsidiary equity SMUs (see Note 13) and received
a preferred interest in CCA. In addition, we have advanced approximately $2.8
million to CCA through December 31, 2005, in connection with this acquisition.
See Note 22 regarding our planned acquisition of that business.
E. MORTGAGES LOANS RECEIVABLE
CMC originates mortgages pursuant to purchase agreements and holds them until
settlement of their sale is completed. We are entitled to the interest income
paid by the borrower during this holding period.
78
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
F. NOTES RECEIVABLE
The balance in 2005 includes a $26.0 million investment in a mortgage loan in
which we have co-invested with AMAC (which invested $5.0 million pursuant to a
Subordinated Participation Agreement), and which we expect to sell to AMAC in
2006 (see Note 17).
NOTE 5 - DEFERRED COSTS AND OTHER ASSETS
The components of deferred costs at December 31 were as follows:
(In thousands) 2005 2004
--------------------------------------------- ---------- ----------
Deferred financing and other costs $ 38,059 $ 39,675
Less: Accumulated amortization (14,031) (11,116)
--------- ---------
Net deferred costs 24,028 28,559
Real estate owned 35,608 1,152
Interest receivable 16,964 15,711
Fees receivable 27,897 21,242
Due from unconsolidated partnerships 10,545 2,343
Furniture, fixtures and leasehold improvements 8,178 3,096
Deferred taxes (see Note 12) 1,849 --
Other 19,601 2,830
--------- ---------
Total $ 144,670 $ 74,933
========= =========
Real estate owned consists predominantly of three properties underlying
defaulted mortgage revenue bonds for which we exercised our foreclosure rights.
We obtained valuations as of the foreclosure date indicating that the fair
values of the properties are in excess of our carrying amounts. As a result,
management has concluded that there was no impairment related to these
foreclosures. We are actively marketing the properties for sale and, as such,
the properties are classified as Held for Sale and we have not depreciated the
assets.
NOTE 6 - GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill and intangible assets consisted of the following at December 31:
(In thousands) 2005 2004
------------------------------------ ---------- ----------
Goodwill $235,684 $206,397
Other intangible assets, net 141,301 177,519
Mortgage servicing rights, net 62,190 32,366
-------- --------
Total $439,175 $416,282
======== ========
79
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
A. GOODWILL
The following table provides information regarding goodwill by segment:
Fund Mortgage
(In thousands) Management Banking Total
---------------------------- ---------- --------- ---------
Balance at December 31, 2003 $ 209,164 $ 5,581 $ 214,745
Additions 916 663 1,579
Reductions (9,927) -- (9,927)
--------- --------- ---------
Balance at December 31, 2004 200,153 6,244 206,397
Additions -- 31,503 31,503
Reductions (2,216) -- (2,216)
--------- --------- ---------
Balance at December 31, 2005 $ 197,937 $ 37,747 $ 235,684
========= ========= =========
The 2001 CMC acquisition agreement stipulated that we make periodic "true-up"
and contingent payments to the original CMC shareholders for a period of up to
three years from the acquisition date and we recorded the payments as additional
goodwill. Additions to Mortgage Banking goodwill in 2003 and 2004 related to
such payments which were based on:
o the increase in the fair value of mortgage servicing rights due to
certain loans closing;
o changes between the audited balance sheet used for the initial
purchase price and the audited balance sheet at December 31, 2001;
o payments of certain servicing fees; and
o forward conversions of previously committed loans.
The additions in 2005 pertain to the final payments under the terms of the
original purchase agreement, our purchase of CMC shares we did not previously
own and the acquisition of CCLP (see Note 2).
The reductions to Fund Management goodwill in 2004 and 2005 pertained to the
conversion of SCUs (see Note 13), the deferred tax impact of which served to
effectively lower the purchase price of CharterMac Capital, partially offset in
2004 by adjustments to estimated liabilities recorded at the time of the
acquisition.
Although partially contingent upon subsidiary equity conversions, all of our
goodwill is tax-deductible.
80
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
B. OTHER INTANGIBLE ASSETS
The components of other identified intangible assets are as follows:
Estimated
Useful
Life Gross Accumulated
(In thousands) (in Years) Carrying Amount Amortization Net
----------------------------------------- ---------- -------------------- ------------------- --------------------
2005 2004 2005 2004 2005 2004
-------- -------- ------- ------- -------- --------
Amortized identified intangible assets:
Trademarks and trade names -- $ -- $ 25,100 $ -- $ 1,338 $ -- $ 23,762
Partnership service contracts 9.4 47,300 47,300 10,718 5,661 36,582 41,639
Transactional relationships 16.7 103,000 103,000 17,864 9,436 85,136 93,564
General partner interests 9.0 5,100 5,100 1,201 634 3,899 4,466
Joint venture developer relationships 5.0 4,800 4,800 2,035 1,075 2,765 3,725
Mortgage banking broker relationships 5.0 1,080 -- 180 -- 900 --
Other identified intangibles 9.3 4,427 4,427 3,181 2,703 1,246 1,724
---- -------- -------- ------- ------- -------- --------
Subtotal/weighted average life 13.8 165,707 189,727 35,179 20,847 130,528 168,880
====
Unamortized identified intangible assets:
Mortgage banking licenses and approvals
with no expiration 10,773 8,639 -- -- 10,773 8,639
-------- -------- ------- ------- -------- --------
Total identified intangible
assets $176,480 $198,366 $35,179 $20,847 $141,301 $177,519
======== ======== ======= ======= ======== ========
2005 2004 2003
------- ------- --------
Amortization expense recorded $14,332 $16,684 $ 2,413
======= ======= ========
At the end of 2005, management decided to change the name of the subsidiary that
conducts our fund sponsorship business from "Related Capital Company" to
"CharterMac Capital," effective January 1, 2006. Accordingly, we wrote off the
unamortized balance attributed to the prior name, resulting in a pre-tax charge
of approximately $22.6 million.
The estimated amortization expense for other intangible assets for the next five
years is as follows:
(In thousands)
2006 $15,228
2007 $15,228
2008 $15,113
2009 $13,679
2010 $ 9,155
The amortization of other identified intangible assets (approximately $477,000
per year) is included as a reduction to mortgage revenue bond interest income as
they pertain to the acquisition of such bond investments.
81
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
C. MORTGAGE SERVICING RIGHTS
The components of the change in MSRs and related reserves were as follows:
Servicing Assets (In thousands)
-------------------------------------------------- --------------
Balance at December 31, 2003 $ 33,351
MSRs capitalized 6,588
Amortization (7,839)
Decrease in reserves 266
--------
Balance at December 31, 2004 32,366
MSRs acquired 45,400
MSRs capitalized 9,581
Amortization (18,670)
Increase in reserves (6,487)
--------
Balance at December 31, 2005 $ 62,190
========
Reserve for Loan Loss Reserves of Servicing Assets
--------
Balance at December 31, 2003 $ 6,745
Net reductions (266)
--------
Balance at December 31, 2004 6,479
Net additions 6,487
--------
Balance at December 31, 2005 $ 12,966
========
The estimated fair values of the MSRs, based upon third-party valuations, were
$79.8 million at December 31, 2005 and $39.3 million at December 31, 2004. The
significant assumptions used in estimating the fair values at December 31, 2005
were as follows:
Weighted average discount rate 17.50%
Weighted average pre-pay speed 10.88%
Weighted average lockout period 4.3 years
Weighted average default rate .50%
Cost to service loans $2,305
Acquisition cost (per loan) $1,456
82
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The table below illustrates hypothetical fair values of MSRs at December 31,
2005, caused by assumed immediate adverse changes to key assumptions which are
used to determine fair value.
(In thousands)
Fair value of MSRs at December 31, 2005 $79,764
Prepayment speed:
Fair value after impact of +10% change 78,855
Fair value after impact of -10% change 80,757
Fair value after impact of +20% change 77,989
Fair value after impact of -20% change 81,759
Discount rate:
Fair value after impact of +10% change 75,856
Fair value after impact of -10% change 85,682
Fair value after impact of +20% change 72,328
Fair value after impact of -20% change 88,988
Default rate:
Fair value after impact of +10% change 79,637
Fair value after impact of -10% change 79,895
Fair value after impact of +20% change 79,517
Fair value after impact of -20% change 80,027
D. IMPAIRMENT
The initial gross carrying amounts for identified intangible assets were based
on third party valuations. We review goodwill and intangible assets annually for
impairment. Through December 31, 2005, we have concluded that these assets have
not been impaired.
NOTE 7 - CONSOLIDATED PARTNERSHIPS
Assets and liabilities of consolidated partnerships consisted of the following
at December 31:
(In thousands) 2005 2004
------------------------------------ ---------- ----------
Investments in property partnerships $3,025,762 $2,527,455
Land, buildings and improvements,
net of accumulated depreciation 329,869 124,869
Cash 172,622 152,558
Other assets 78,033 51,132
---------- ----------
Subtotal 580,524 328,559
---------- ----------
Total assets $3,606,286 $2,856,014
========== ==========
Notes payable $ 565,877 $ 461,557
Due to property partnerships 896,031 700,169
Other liabilities 165,648 145,367
---------- ----------
Total liabilities $1,627,556 $1,307,093
========== ==========
Income from investments in property partnerships is recorded on the equity
basis.
83
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Of the notes payable balance, $457.3 million are guaranteed by certain equity
partners of the investment funds. Per partnership agreements, the equity
partners are also obligated to pay the principal and interest on the notes. The
remaining balance of $108.6 million is collateralized with the underlying
properties of the consolidated operating partnerships. All of this debt is
non-recourse to the Company.
NOTE 8 - ACCOUNTS PAYABLE, ACCRUED EXPENSES AND OTHER LIABILITIES
Accounts payable, accrued expenses and other liabilities consisted of the
following at December 31:
(In thousands) 2005 2004
---------------------------- -------- --------
Deferred revenues $ 70,025 $ 48,157
Distributions payable 41,080 38,859
Deferred taxes (see Note 12) -- 29,898
Accounts payable 22,314 8,611
Salaries and benefits 15,816 13,794
Other 30,040 14,767
-------- --------
Total $179,275 $154,086
======== ========
NOTE 9 - FINANCING ARRANGEMENTS
Our financing arrangements are securitization programs that effectively allow us
to borrow against the fair value of our mortgage revenue bond portfolio. They
involve the sales of senior certificates to third party investors while we
retain subordinated residual certificated interests. The net effect of these
programs is that a portion of the interest we receive from mortgage revenue
bonds is distributed to holders of the senior certificates while we receive any
remaining interest via the residual certificate after related expenses are
deducted.
Following are the components of financing arrangements at December 31:
(In thousands) 2005 2004
------------------------------ ---------- ----------
P-FLOATs/RITES $ 760,084 $ 462,928
TIC/TOC 187,108 --
MBIA:
Floater Certificates 382,500 405,500
Auction Certificates 100,000 100,000
Fixed-Rate Securitization -- 100,000
---------- ----------
Total $1,429,692 $1,068,428
========== ==========
A. P-FLOATS/RITES PROGRAM
We have securitized certain mortgage revenue bonds through the Merrill Lynch
Pierce Fenner & Smith Incorporated ("Merrill Lynch") P-FLOATs/RITES program.
There is no limit to the number or amount of bonds we can securitize through
this program. Under the program, we transfer certain mortgage revenue bonds, or
trust certificates that represent senior interests in the mortgage revenue
bonds, to Merrill Lynch and they deposit each revenue bond into an individual
special purpose trust. That trust, in turn, issues two types of securities:
o Puttable Floating Option Tax-Exempt Receipts ("P-FLOATs"), short-term
senior securities which bear interest at a floating rate reset weekly
at the lowest rate that will clear the market at par; and
o Residual Interest Tax Exempt Securities ("RITES"), subordinate
securities which receive the residual interest payment after payment
of P-FLOAT interest and ongoing transaction fees.
84
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The P-FLOATs are sold to third party investors and the RITES are generally sold
back to us. We have the right, with at least 14 days notice to the trustee, to
purchase the outstanding P-FLOATs and withdraw the underlying mortgage revenue
bonds or trust certificates from the trust. When the mortgage revenue bonds or
trust certificates are deposited into the P-FLOAT Trust, we receive the proceeds
from the sale of the P-FLOATs less certain transaction costs. In certain other
cases, Merrill Lynch may directly buy the mortgage revenue bonds from local
issuers, deposit them in the trust, sell the P-FLOAT security to investors and
then the RITES to us.
Due to the repurchase right, we account for the net proceeds received upon
transfer as secured borrowings and, accordingly, continue to account for the
mortgage revenue bonds as assets.
Credit intermediation under this program is provided by either Merrill Lynch or
IXIS Financial Products. To facilitate the securitization, we have pledged
certain additional mortgage revenue bonds (or trust certificates representing
senior interests in mortgage revenue bonds) as collateral for the benefit of the
credit intermediator or liquidity provider. At December 31, 2005, the total fair
value of such collateral was approximately $454.2 million.
B. TIC/TOC PROGRAM ("TIC/TOC")
We have securitized certain mortgage revenue bonds through the Goldman, Sachs &
Co. ("Goldman Sachs") TIC/TOC program. There is no limit to the number or amount
of bonds we can securitize through this program. Under the program, we transfer
trust certificates that represent senior interests in certain mortgage revenue
bonds to Goldman Sachs and they deposit these trust certificates into individual
special purpose trusts. Two types of securities are then issued by that trust:
o a Tender Option Certificate ("TOC"), a short-term senior security
which bears interest at a floating rate, reset weekly at the lowest
rate that will clear the market at par; and
o a Trust Inverse Certificate ("TIC"), a subordinate security which
receives the residual interest payment after payment of TOC interest
and ongoing transaction fees.
The TOCs are sold to third party investors and the TICs are generally sold back
to us. We have the right, with at least 14 days notice to the trustee, to
purchase the outstanding TOCs and withdraw the underlying trust certificates
from the trust. When the trust certificates are deposited into the TIC/TOC
Trust, we receive the proceeds from the sale of the TOCs less certain
transaction costs.
Due to the repurchase right, we account for the net proceeds received upon
transfer as secured borrowings and, accordingly, continue to account for the
mortgage revenue bonds as assets.
Credit intermediation under this program is provided by IXIS Financial Products
through a credit default swap agreement that is subject to annual renewal. To
facilitate the securitization, additional trust certificates that represent
senior interests in certain mortgage revenue bonds are pledged as collateral for
the benefit of the credit intermediator or liquidity provider. At December 31,
2005, the total fair value of such collateral was approximately $21.3 million.
C. MBIA SECURITIZATION PROGRAM
We have entered into a surety commitment through October 2011 with MBIA, a
financial insurer, whereby MBIA has agreed to provide credit intermediation for
certain pools of bonds in exchange for fees. Under the MBIA securitization
program, we contribute mortgage revenue bonds to Series Trusts, seven of which
had been created as of December 31, 2005. Two of the trusts contain only bonds
secured by properties in California while the rest are National (i.e., non-state
specific). Each Series Trust issues two equity certificates:
o a Senior Certificate which is deposited into a Certificate Trust
which, in turn, issues and sells Floater Certificates or Auction
Certificates (both described below) representing proportional
interests in the Senior Certificate and which bear interest at a
floating rate; and
85
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
o a Residual Certificate, which represents the remaining beneficial
ownership interest in each Series Trust and receives the residual
interest payment after payment of the Floater or Auction Certificate
interest and ongoing transaction fees. Generally, we retain these
Residual Certificates.
The two securities issued by the Certificate Trust are as follows:
o The Floater Certificates have an interest rate that is reset weekly.
The sale of these certificates requires liquidity due to a put option
available to the buyers of the certificates. A consortium of highly
rated banks, whose commitments are one-year renewable contracts,
currently supplies the liquidity. We expect to renew or replace such
commitments upon expiration of their terms.
o The Auction Certificates have rates that are reset periodically
through a Dutch auction process. This program does not require
liquidity, as the buyers of the securities do not have the option to
put their certificates back to the seller.
To facilitate the securitization, we have pledged certain additional mortgage
revenue bonds as collateral for the benefit of the credit intermediator or
liquidity provider. At December 31, 2005, the total fair value of this
collateral was approximately $189.8 million.
As of December 31, 2005, the maximum amount of capital we could raise under this
securitization program was $650.0 million, with a maximum of $425.0 million in
Floater Certificates and a maximum of $225.0 in Auction Certificates.
As with the other securitization programs, we account for the net proceeds
received upon transfer as secured borrowings and, accordingly, continue to
account for the mortgage revenue bonds as assets.
D. FIXED RATE SECURITIZATION
In March 2005, we terminated our $100.0 million fixed-rate securitization and
remarketed the borrowings under the P-FLOATs/RITES program.
E. RESTRICTED ASSETS
Certain of our subsidiaries hold mortgage revenue bonds which at December 31,
2005, had an aggregate fair value of approximately $2.3 billion that serve as
collateral for securitized borrowings or are securitized. The subsidiaries
holding these bonds had net assets at December 31, 2005, of approximately $824.4
million.
F. COVENANTS
We are subject to customary covenants with respect to our various debt
facilities. As of December 31, 2005, we were in compliance with all such
covenants.
86
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
G. COST OF FUNDS
Our annualized cost of funds relating to financing arrangements and the related
amount of interest expense were as follows:
2005 2004 2003
--------- --------- ---------
Cost of funds 3.65% 2.51% 2.40%
Interest expense (in millions) $ 44.8 $ 24.6 $ 17.1
Rate at December 31, excluding fees:
MBIA 3.21% 1.81%
TIC/TOC 3.29% --
P-FLOATs/RITES 3.33% 1.87%
NOTE 10 - NOTES PAYABLE
Notes payable included the following at December 31:
(In thousands) 2005 2004
--------------------------------- ---------- ----------
CMC acquisition loan $ 19,765 $ 21,809
CMC warehouse line 179,277 27,480
CharterMac Capital warehouse line 45,613 39,932
Capri acquisition lines 60,000 85,000
Other 233 233
-------- --------
Total notes payable $304,888 $174,454
======== ========
A. CMC ACQUISITION LOAN
In connection with the acquisition of CMC (See Note 2), we entered into a loan
with Bank of America which expires in December 2006 and bears interest at
six-month LIBOR plus 2.25%. The rate was 6.83% and 4.67% at December 31, 2005
and 2004, respectively. The loan requires quarterly payments of principal and
interest over a ten-year amortization period, with a balloon payment for the
balance upon expiration.
B. CMC WAREHOUSE LINE
CMC has a $250.0 million secured, revolving mortgage warehouse facility with
Bank of America that will revert to a $100.0 million facility in February 2006,
matures in May 2006, and is subject to annual renewal. The interest rate for
each warehouse advance is the Federal Funds rate at the end of each year plus
1.00%. The rate was 4.24% and 3.49% at December 31, 2005 and 2004, respectively.
C. CHARTERMAC CAPITAL WAREHOUSE LINE
CharterMac Capital has entered into a warehouse facility in the amount of $90.0
million with Bank of America, Merrill Lynch, C.D.C., Citicorp, USA, HSBC Bank
USA, N.A. and Comerica Bank. This facility matures in October 2006 and bears
interest, at our option, at either 30-day LIBOR plus 1.70% or the prime rate
plus .125%. The weighted average net rate was 6.84% and 5.13% at December 31,
2005 and 2004, respectively. This facility is collateralized by a lien on
certain limited partnership interests (See Note 4). Payments of interest only
are due on a monthly basis. We have the option to extend this facility upon its
maturity in 2006, renegotiate its terms or arrange alternate sources of
financing to repay the outstanding balance. We maintain cash collateral of
approximately $2.3 million for this facility.
87
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
D. CAPRI ACQUISITION LINES
The Capri acquisition lines with Bank of America bear interest at 60-day LIBOR
plus 1.65% and mature in March 2006. During 2005, we repaid a portion of the
balance due and the total facility amount was reduced to $60.0 million. The
weighted average interest rate on the loans was 5.81% at December 31, 2005 and
4.02% at December 31, 2004.
E. FUTURE PAYMENTS
Payments of all of the notes are due in 2006. We have the ability and intent to
refinance all of the amounts owed through new facilities or renewal of existing
facilities. As the CMC acquisition loan, the CharterMac Capital warehouse line
and the Capri acquisition lines mature in 2006, and are owed to one lender, we
are in negotiations to replace them with a master credit facility with that same
lender.
F. COVENANTS
We are subject to customary covenants with respect to our various debt
facilities. As of December 31, 2005, we were in compliance with all such
covenants.
NOTE 11 - FINANCIAL RISK MANAGEMENT AND DERIVATIVES
Our mortgage revenue bonds generally bear fixed rates of interest, but our
financing arrangements and notes payable (see Notes 9 and 10) incur interest
expense at variable rates, exposing us to interest rate risks. We have
established a policy for risk management and our objectives and strategies for
the use of derivative instruments to potentially mitigate such risks. We
currently manage a portion of our interest rate risk resulting from the exposure
to variable rates on our financing agreements through the use of interest rate
swaps indexed to the BMA rate, the most widely used tax-exempt floating rate
index. Under each swap agreement, for a specified period of time we are required
to pay a fixed rate of interest on a specified notional amount to the
transaction counterparty and we receive a floating rate of interest equivalent
to the BMA index. The average BMA rate was 2.45% in 2005, 1.22% in 2004, and
1.03% in 2003.
At inception, we designate these swaps as hedging instruments in cash flow
hedges with the hedged item being the variable interest payments on our floating
rate securitizations. We assess both at the inception of the hedge and on an
ongoing basis whether the swap agreements are effective in offsetting changes in
the cash flows of the hedged financing. Amounts in accumulated other
comprehensive income will be reclassified into earnings in the same period and
during which the hedged forcasted transaction affects earnings. Since we are
hedging the variable interest payments in our floating rate securitizations, the
forcasted transactions are the interest payments. A possible risk of such swap
agreements is the possible inability of the counterparty to meet the terms of
the contracts with us; however, there is no current indication of such an
inability.
88
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
We have entered into swap agreements as follows:
Notional
Amount
Counterparty (in millions) Inception Date Expiration Date Rate
----------------------------------------------------------------------------------------------------------------
CASH FLOW HEDGES:
Merrill Lynch Capital Services, Inc. $ 50.0 January 2001 January 2006 3.98%
Bank of America 100.0 January 2005 January 2007 2.56%
Bank of America 50.0 January 2005 January 2008 2.00% in 2005,
2.78% in 2006 and
3.27% in 2007
Bank of America 50.0 January 2005 January 2008 2.86%
Bank of America 50.0 January 2005 January 2009 3.08%
RBC Capital Markets 100.0 January 2005 January 2009 3.075%
Bank of America 100.0 January 2005 January 2010 3.265%
-------------
Subtotal cash flow hedges 500.0
-------------
FAIR VALUE SWAP:
Bank of America 26.0 November 2005 November 2014 4.92%
-------------
Total $ 526.0
=============
We evaluate our interest rate risk on an ongoing basis to determine whether it
would be advantageous to engage in any further hedging transactions.
For the cash flow hedge swaps in place and others that have expired, there was
no ineffectiveness in the hedging relationships during the three years ended
December 31, 2005. During 2004, we entered into two contracts, whereby we agreed
to enter into two interest rate swaps in January of 2005. We recorded an expense
of $3.4 million in 2004, relating to the ineffective portion of these two
derivative instruments. This expense reversed later in 2004 when the same
derivatives started passing the effectiveness assessments. For all of the swaps,
we expect that the hedging relationships will be effective in achieving
offsetting changes in cash flow throughout their terms.
Interest rate swaps for which we were in a net settlement liability position are
recorded in accounts payable, accrued expenses and other liabilities and those
for which we are in a net settlement asset position are recorded in other
assets. The amounts recorded at December 31 were as follows:
2005 2004
-------- --------
(in thousands)
Net liability position $ 208 $2,736
Net asset position $5,656 $1,050
We record net amounts payable or receivable as adjustments to interest expense.
Interest expense includes approximately $2.7 million in 2005, $1.6 million in
2004 and $4.1 million in 2003, for amounts paid or payable under the swap
agreements. Net swap receipts, if any, are taxable to us and, accordingly, to
our shareholders.
We estimate that approximately $850,000 of net unrealized gain included in
accumulated other comprehensive income will be reclassified into interest
expense within the next twelve months, due to the fact our swaps have been and
we expect they will continue to be effective.
89
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 12 - INCOME TAXES
A large majority of our pre-tax income is derived from our Portfolio Investing
businesses, which are structured as partnership entities; as such, the income
from those investments does not subject us to income taxes. The Fund Management
and mortgage banking businesses are conducted in corporations and are subject to
income taxes.
The components of our pre-tax income were as follows:
2005 2004 2003
-------- -------- --------
Not subject to tax $ 79,309 $ 80,085 $ 70,469
Subject to tax (48,872) (31,965) (9,955)
-------- -------- --------
Total income before income taxes $ 30,437 $ 48,120 $ 60,514
======== ======== ========
The income tax (benefit) provision consisted of the following components:
2005 2004 2003
-------- -------- --------
Current:
Federal $ (1,783) $ 2,279 $ 2,212
State and local 1,384 1,022 1,207
-------- -------- --------
Total current (399) 3,301 3,419
Deferred federal, state and local $(28,178) (20,544) (9,491)
-------- -------- --------
Total tax benefit $(28,577) $(17,243) $ (6,072)
======== ======== ========
The tax benefit does not include (1) the current tax benefit related to
additional tax deductions for share based compensation which was credited to
beneficial owners' equity or (2) the deferred tax benefit related to unrealized
losses on derivative contracts which was credited to other comprehensive income.
Deferred income tax assets and liabilities are computed based on temporary
differences between the financial statement and income tax bases of assets and
liabilities that existed at the balance sheet date.
A reconciliation of the statutory federal tax rate to our effective tax rate is
as follows:
2005 2004 2003
-------- -------- --------
Statutory tax rate 35.0 % 35.0 % 35.0 %
Partnership income not subject to tax (89.6) (56.4) (39.6)
State and local taxes, net of federal
benefit (19.0) (8.2) (1.8)
SCUs (see Note 13) (13.2) (3.4) (2.2)
Tax-exempt interest (6.1) -- --
Share based compensation (0.7) (1.4) (0.2)
Other (0.3) (1.4) (1.2)
----- ----- -----
Effective tax rate (93.9)% (35.8)% (10.0)%
===== ===== =====
90
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The components of the deferred tax assets and liabilities are as follows:
2005 2004
-------- --------
DEFERRED TAX ASSETS:
Deferred revenue $ 31,142 $ 19,863
Share based compensation 3,216 3,464
Bad debts 1,885 1,076
Tax credits and state operating loss carry forwards 1,026 --
Other, net 1,746 514
-------- --------
Total deferred tax assets 39,015 24,917
-------- --------
DEFERRED TAX LIABILITIES:
Intangible assets (26,575) (43,418)
Deferred costs (1,562) (135)
Originated mortgage service rights (9,029) (11,262)
-------- --------
Total deferred tax liabilities (37,166) (54,815)
-------- --------
Net deferred tax asset (liability) $ 1,849 $(29,898)
======== ========
At December 31, 2005, our corporate subsidiaries had the following carry
forwards:
Low income housing credits (expiring starting in 2024) $ 473
State net operating loss (expiring in 2025) $ 743
Alternative minimum tax credits (do not expire) $ 428
We believe that the net deferred tax asset is recoverable based on current
earnings projections for our businesses that are subject to taxation.
The Internal Revenue Service is examining the consolidated corporate federal
income tax return for our subsidiaries subject to taxes for the tax period ended
December 31, 2003. The examination is in a preliminary stage and no significant
issues have yet been raised.
NOTE 13 - SUBSIDIARY EQUITY
A. PREFERRED SHARES OF A SUBSIDIARY - SUBJECT TO MANDATORY REPURCHASE
Since June 1999, we have issued multiple series of Cumulative Preferred Shares,
which are subject to mandatory repurchase, through our Equity Issuer Trust
("Equity Issuer") subsidiary.
Liquidation
Preferred Date of Mandatory Mandatory Number of Preference per Total Face Dividend
Series Issuance Tender Repurchase Shares Share Amount Rate
---------------- ------------- -------------- --------------- ----------- --------------- -------------- -------------
(In thousands)
Series A June 1999 June 2009 June 2049 45 $2,000 $ 90,000 6.625%
Series A-1 July 2000 June 2009 June 2049 48 500 24,000 7.100%
Series A-2 October 2001 June 2009 June 2049 62 500 31,000 6.300%
Series A-3 June 2002 October 2014 October 2052 60 500 30,000 6.800%
Series B July 2000 November 2010 November 2050 110 500 55,000 7.600%
Series B-1 October 2001 November 2010 November 2050 37 500 18,500 6.800%
Series B-2 June 2002 October 2014 October 2052 50 500 25,000 7.200%
---------
Total $ 273,500
=========
91
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
We collectively refer to the Series A Cumulative Preferred Shares, Series A-1
Cumulative Preferred Shares, Series A-2 Cumulative Preferred Shares and Series
A-3 Cumulative Preferred Shares as the "Series A Shares." We collectively refer
to the Series B Subordinate Cumulative Preferred Shares, Series B-1 Subordinate
Cumulative Preferred Shares and Series B-2 Subordinate Cumulative Preferred
Shares as the "Series B Shares." We also collectively refer to the Series A
Shares and the Series B Shares as the "Preferred Shares."
The Series A Shares all have identical terms except as to the distribution
commencement date and other terms listed in the table above. Likewise, the
Series B Shares all have identical terms, except as to the distribution
commencement date and other terms listed in the table above. Equity Issuer may
not redeem the Preferred Shares before their mandatory repurchase dates. The
Preferred Shares are subject to mandatory tender for remarketing and purchase on
such dates and each remarketing date thereafter at their respective liquidation
amounts plus all distributions accrued but unpaid. Each holder of the Preferred
Shares will be required to tender its shares on the dates listed above, unless
Equity Issuer decides to remarket them. Holders of the Preferred Shares may
elect to retain their shares upon remarketing, with a new distribution rate to
be determined at that time by the remarketing agent. After the initial
remarketing dates, Equity Issuer may repurchase some or all of the Preferred
Shares, subject to certain conditions. The Preferred Shares are not convertible
into our common shares.
The Preferred Shares have annual preferred dividends payable quarterly in
arrears upon declaration by our Board of Trustees, but only to the extent of
tax-exempt net income for the particular quarter. With respect to payment of
distributions and amounts upon liquidation, dissolution or winding-up of our
Company, the Series A Shares rank, senior to:
o all classes or series of Convertible CRA Shares (see Note 14);
o all Series B shares; and
o our common shares.
With respect to payment of distributions and amounts upon liquidation,
dissolution or winding-up of our Company, the Series B Shares rank senior to our
Convertible CRA Shares and common shares.
Equity Issuer may not pay any distributions to the parent trust until it has
either paid all Preferred Share distributions, or in the case of the next
following distribution payment date, set aside funds sufficient for payment.
Since issuance of the Preferred Shares, all quarterly distributions have been
declared at each stated annualized dividend rate for each respective series and
all distributions due have been paid.
Equity Issuer is subject to, among others, the following covenants with respect
to the Preferred Shares:
TAX-EXEMPT INTEREST AND DISTRIBUTION
Equity Issuer may only acquire new investments that it reasonably believes
will generate interest and distributions excludable from gross income for
federal income tax purposes. As soon as commercially practicable, Equity
Issuer will dispose of any investment if its interest becomes includable in
gross income for federal income tax purposes, for any reason.
LEVERAGE
Equity Issuer will not, and will not permit any of its subsidiaries to,
directly or indirectly, incur any obligation unless:
o Equity Issuer is not in default under its trust agreement;
o Equity Issuer has paid or declared and set aside for payment all
accrued and unpaid distributions on the Preferred Shares; and
o the leverage ratio on the portfolio is less than 0.6 to 1 after
giving effect to the incurrence of the obligation.
92
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
FAILURE TO PAY DISTRIBUTIONS
If Equity Issuer has not paid, in full, six consecutive quarterly
distributions on the Preferred Shares, it is required to reconstitute its
board of trustees so that a majority of the board of trustees consists of
trustees who are independent with respect to Equity Issuer, CharterMac and
CharterMac Capital.
ALLOCATION OF TAXABLE INTEREST INCOME AND MARKET DISCOUNT
Equity Issuer will specially allocate taxable interest income and market
discount that is taxable as ordinary income to us. Market discount, if any,
may arise where Equity Issuer acquires a bond other than upon its original
issuance for less than its stated redemption price at maturity and the
difference is greater than a minor amount (generally 1/4 of 1% of a bond's
stated redemption price at maturity multiplied by the number of complete
years to maturity).
In accordance with SFAS No. 150, we classify the Preferred Shares as liabilities
in our balance sheet and include the dividends paid for those share as interest
expense in our statements of income.
B. PREFERRED SHARES OF A SUBSIDIARY - NOT SUBJECT TO MANDATORY REPURCHASE
In May 2004, Equity Issuer issued the following Cumulative Preferred Shares,
which are not subject to mandatory repurchase:
Liquidation
Preferred Date of Number of Preference Total Face Dividend
Series Issuance Shares per Share Amount Rate
---------------- ------------ ----------- ------------- ------------ ------------
(In thousands)
Series A-4-1 May 2004 60 $500 $ 30,000 5.75%
Series A-4-2 May 2004 58 500 29,000 6.00%
Series B-3-1 May 2004 50 500 25,000 6.00%
Series B-3-2 May 2004 40 500 20,000 6.30%
---------
Total $ 104,000
=========
Except for the absence of a mandatory repurchase feature (and for specific terms
enumerated in the table above),
o the Series A-4-1and Series A-4-2 shares have the same characteristics
as the Series A Shares described above; and
o the Series B-3-1 and Series B-3-2 shares have the same characteristics
as the Series B shares described above.
In accordance with SFAS No. 150, as these shares are not subject to mandatory
repurchase, we classify them as mezzanine equity and the associated dividends
are classified outside of interest expense in the statements of income.
C. MINORITY INTERESTS
Minority interests in consolidated subsidiaries consisted of the following at
December 31:
(In thousands) 2005 2004
-------------------------------- -------- --------
Convertible SCUs of a subsidiary $250,866 $267,025
Convertible SMUs of a subsidiary 11,408 --
CMC -- 4,394
-------- --------
Total $262,274 $271,419
======== ========
93
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Income allocated to minority interests was as follows for the years ended
December 31:
(in thousands) 2005 2004 2003
-------- -------- --------
Convertible SCUs $23,092 $28,174 $ 4,038
Convertible SMUs 330 -- --
CMC -- 194 (54)
------- ------- -------
Total $23,422 $28,368 $ 3,984
======= ======= =======
SCUS
In connection with our acquisition of CharterMac Capital (see Note 2), our
subsidiary issued membership interests in the form of 16.1 million special
common units ("SCUs"). SCU holders are entitled to distributions at the same
time as, and only if, we pay distributions on our common shares. SCU
distributions are calculated as the amount of common share distributions divided
by 0.72, to adjust for the taxable nature of the income comprising the SCU
distributions. SCU distributions are payable only to the extent of the
subsidiary's cash flow, supplemented by a loan of all but $5.0 million from the
parent trust in the event of a shortfall. Any remaining shortfall will accrue
interest at a market rate and will only be payable at the time the subsidiary
has sufficient cash flow.
Each holder of SCUs has the right to:
o exchange all or a portion of their SCUs for cash; and
o receive cash for any accrued but unpaid distributions with respect to
SCUs exchanged (not including accrued and unpaid distributions for the
quarterly period in which the exchange occurs).
Instead of cash, we may, at our discretion, exchange the SCUs (and any accrued
but unpaid distributions) for common shares on a one-for-one basis, subject to
anti-dilution adjustments. We would issue the common shares at a price equal to
the average closing market price of our common shares for the five consecutive
trading days prior to the date when we receive notice of intent to convert.
Our subsidiary may not pay any distributions to the parent trust until it has
paid all SCU distributions. Through December 31, 2005, all SCU distributions
have been paid.
As of December 31, 2005, there were approximately 14.9 million SCUs outstanding
and approximately 15.2 million were outstanding at December 31, 2004.
SMUS
A majority of the Special Membership Units ("SMUs") were issued in connection
with the CCLP acquisition (See Note 2). Additional SMUs were issued in
connection with a preferred investment in CCA (see Note 4).
SMU holders are entitled to distributions at the same time as, and only if, we
pay distributions on our common shares. SMU distributions were initially $1.69
per year, subject to adjustment in the amount of 95% of the percentage increases
or decreases in the dividends paid by us on the common shares. Distributions
paid to SMU holders consist of taxable income.
Each holder of SMUs has the right to:
o exchange all or a portion of their SMUs for cash; and
o receive cash for any accrued but unpaid distributions with respect to
SMUs exchanged (not including accrued and unpaid distributions for the
quarterly period in which the exchange occurs).
94
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Instead of cash, we may, at our discretion, exchange the SMUs (and any accrued
but unpaid distributions) for common shares on a one-for-one basis, subject to
anti-dilution adjustments. We would issue the common shares at a price equal to
the average closing market price of our common shares for the five consecutive
trading days prior to the date when we receive notice of intent to convert.
Our subsidiary may not pay any distributions to the parent trust until it has
paid all SMU distributions. Through December 31, 2005, all SMU distributions
have been paid.
As of December 31, 2005, there were approximately 539,000 SMUs outstanding, all
of which were issued in 2005 as noted above.
CMC
We purchased the outstanding minority interest in CMC during the first quarter
of 2005 (see Note 2).
NOTE 14 - SHAREHOLDERS' EQUITY
A. SPECIAL PREFERRED VOTING SHARES
In connection with our acquisition of CharterMac Capital (see Note 2), each
holder of SCUs (see Note 13) also acquired one special preferred voting share
(at a par value of $.01 per share) for each SCU received. The special preferred
voting shares have no economic interest, but entitle the holder to vote, on a
one-for-one basis, on all matters subject to a vote of our common shareholders.
We have the right to require that each special preferred voting share be
redeemed at par and cancelled simultaneously upon the exchange of an SCU by its
holder into cash or a common share. Other than the payment of $.01 per share
upon redemption of the special preferred voting shares or the liquidation of our
Company, the special preferred voting shares are not entitled to any
distributions or other economic rights.
The selling principals of CharterMac Capital entered into a voting agreement
which governs the voting of all of their:
o special preferred voting shares,
o common shares issuable upon exchange of their SCUs, and
o any other common shares currently owned or which may be acquired by
them in the future.
The voting agreement provides that the selling principals of CharterMac Capital
will:
o vote their common shares or special preferred voting shares in favor
of the election of any independent trustee approved by our board of
trustees or in the same proportion as the unaffiliated holders of our
common shares vote in such election; and
o not exercise any right as shareholder of our Company to nominate any
independent trustee.
With the exception of Stephen M. Ross (see Note 17), the voting agreement will
terminate for each of the remaining selling principals at the time he or she is
no longer an employee, officer, or trustee of our Company. The voting agreement
with respect to Mr. Ross will remain in effect as long as he owns any of our
special preferred voting shares or common shares.
B. CONVERTIBLE CRA SHARES
Our Convertible Community Reinvestment Act Preferred Shares ("Convertible CRA
Shares") enable financial institutions to receive certain regulatory benefits in
connection with their investment. We have developed a proprietary method for
allocating these regulatory benefits to specific financial institutions that
95
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
invest in the Convertible CRA Shares. Other than the preferred allocation of
regulatory benefits, the preferred investors receive the same economic benefits
as our common shareholders including:
o receipt of the same dividends per share;
o pro rata allocation of earnings between the two classes of shares; and
o equal ranking with the common shares with respect to rights upon
liquidation, dissolution or winding up of our Company.
The Convertible CRA Shares have no voting rights, except on matters relating to
the terms of the Convertible CRA Shares or to amendments to our Trust Agreement
which would adversely affect the Convertible CRA Shares.
For Convertible CRA shares issued prior to 2002, the investors have the option
to convert their shares into common shares at a predetermined conversion price,
calculated as the greater of:
o our book value per common share as set forth in our most recently
issued annual or quarterly report filed with the SEC prior to the
respective Convertible CRA Share issuance date; or
o 110% of the closing price of a common share on the respective
Convertible CRA Share's pricing date.
For Convertible CRA Shares issued in 2002 and later, conversion into common
shares is on a one-for-one basis.
Upon conversion, the investors would no longer be entitled to a special
allocation of the regulatory benefit.
At December 31, 2005 and 2004, we had the following Convertible CRA Shares
outstanding:
(In thousands)
Convertible CRA Shares issued prior to 2002 998
Convertible CRA Shares issued 2002 and later 5,554
--------
Total outstanding 6,552
========
Common shares issuable upon conversion 6,487
========
C. 4.4% CONVERTIBLE CRA PREFERRED SHARES
Our 4.4% Cumulative Perpetual Convertible Community Reinvestment Act Preferred
Shares ("4.4% Convertible CRA Preferred Shares") have the same CRA related
benefits of the Convertible CRA Shares and likewise have no voting rights except
on certain matters relating to the terms of the 4.4% Convertible CRA Preferred
Shares or to amendments to our Trust Agreement which would adversely affect the
4.4% Convertible CRA Preferred Shares.
The shares rank senior to our common shares and the Convertible CRA Shares with
respect to rights upon liquidation, dissolution or winding up of our Company.
They rank senior to our common shares and the Convertible CRA Shares with
respect to distributions, which are cumulative and fixed at 4.4% of the
liquidation amount of $50 per share. The shares have no stated maturity.
Beginning July 2008, the 4.4% Convertible CRA Preferred Shares will be
convertible into our common shares at the option of the holders thereof at any
time at a conversion rate of 1.807664 common shares each (a total of
approximately 3.9 million common shares), subject to stipulated conversion
adjustment conditions. Also beginning July 2008, we may redeem the shares at a
price equal to their liquidation amount plus any accrued and unpaid
distributions. The shares are also subject to remarketing provisions beginning
in July 2015. All distributions have been paid through December 2005.
96
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
D. ISSUANCES AND CONVERSIONS
During 2003, we issued approximately 5.8 million Convertible CRA Shares for net
proceeds of approximately $103.1 million. Also in 2003, shareholders converted
approximately 1.4 million Convertible CRA Shares into approximately the same
number of common shares. The placement agent for the offerings was Meridian
Investments, Inc.
In June 2004, we sold 5.75 million common shares to the public for net proceeds
of approximately $105.5 million after deducting underwriting discounts and
commissions. The underwriters for this offering were Wachovia Securities, UBS
Securities LLC, RBC Capital Markets Corporation and Legg Mason Wood Walker.
As noted above, we issued approximately 2.2 million of our 4.4% Convertible CRA
Preferred Shares in July 2005 for gross proceeds of $108.0 million. Net of
underwriters fees and expenses, our net proceeds were approximately $104.7
million. Meridian Investments acted as placement agent for this offering.
In 2004, shareholders converted approximately 1.6 million Convertible CRA shares
into approximately the same number of common shares and 933,000 SCUs (see Note
13) were converted into an equivalent number of common shares, and the related
special preferred voting shares were redeemed at par.
During 2005, the holders of approximately 287,000 SCUs converted the units to an
equivalent number of common shares, and the related special preferred voting
shares were redeemed at par.
E. DIVIDEND REINVESTMENT PLAN
In May 2000, we implemented a dividend reinvestment and common share purchase
plan. Under this plan, common shareholders may elect to have their distributions
automatically reinvested in additional common shares at a price equal to the
average of the high and low market price from the previous day's trading, and
make cash payments for further investment. As of December 31, 2005, there were
approximately 129,000 shares participating in the plan, which represented 370
investors.
F. REPURCHASES
The board of trustees has authorized the implementation of a common share
repurchase plan, enabling us to repurchase, from time to time, up to 1.5 million
common shares. This plan has no expiration date. The repurchases will be made in
the open market and the timing is dependent on the availability of common shares
and other market conditions. There were no repurchases made under the plan
during 2005, 2004 or 2003.
In addition to the repurchase plan, we may repurchase shares from employees in
connection with tax withholding requirements upon vesting of restricted share
grants. We account for repurchased common shares as treasury shares of
beneficial interest. During the years ended December 31, we repurchased shares
as follows:
(in thousands) 2005 2004 2003
------ ------ ------
Number of shares 187 111 14
Cost, including commissions and service charges $4,165 $2,592 $ 275
97
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
G. ACCUMULATED OTHER COMPREHENSIVE INCOME
Changes in accumulated other comprehensive income were as follows:
Net Unrealized
Gain/(Loss) on Net Unrealized Accumulated Other
Mortgage Gain/(Loss)on Comprehensive
(In thousands) Revenue Bonds Derivatives Other Income (Loss)
-------------- -------------- ---------- -----------------
Balance at January1, 2003 $ 66,541 $ (5,566) $ 60,975
Period change (35,146) 2,607 (32,539)
-------- -------- --------
Balance at December 31, 2003 31,395 (2,959) 28,436
Period change (15,806) (1,078) (16,884)
-------- -------- --------
Balance at December 31, 2004 15,589 (4,037) 11,552
Period change 79,849 8,668 $ 35 88,552
-------- -------- -------- --------
Balance at December 31, 2005 $ 95,438 $ 4,631 $ 35 $100,104
======== ======== ======== ========
NOTE 15 - SHARE BASED COMPENSATION
A. THE PLAN
As approved by shareholders in 1997 and amended and restated in 2003, we have an
Amended and Restated Incentive Share Plan (the "Plan"), the purpose of which is
to:
o attract and retain qualified persons as trustees and officers; and
o provide incentive and more closely align the financial interests of
our employees, officers and trustees with the interests of our
shareholders by providing them with a financial interest in our
success.
The Compensation Committee of our board of trustees administers the Plan.
Pursuant to the Plan, the maximum number of common shares that may be awarded is
the lesser of:
o 10% of the number of total shares outstanding as of December 31
preceding issuances of such awards; and
o the limits prescribed by the national security exchange or national
quotation system on which the shares may then be listed.
The Plan allows for the issuance of share options, restricted share grants,
share appreciation rights, restricted and deferred shares, performance units and
performance shares.
B. SHARE OPTIONS
All options granted have an exercise price equal to or greater than the market
price of our common shares on the grant date. The maximum option term is ten
years from the date of grant and options granted pursuant to the Plan may vest
immediately upon issuance or over a period determined by our compensation
committee.
We granted the following options pursuant to the Plan:
Weighted
Average Vesting
Year Number Exercise Price Term Period
-----------------------------------------------------------------------------
2000 297,830 $11.56 10 years 3 years
2002 40,000 17.56 10 years 3 years
2005 656,515 24.35 10 years 3 years
98
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
As part of a separate agreement in connection with the CharterMac Capital
acquisition (see Note 2), we granted 1.0 million options to our chairman at an
exercise price of $17.78. These options have a 10 year term and vest over a five
year period.
We used the following assumptions in the Black-Scholes option pricing model to
determine fair values of options granted (in 2005) or revalued (in 2003):
2005 2003
-------- --------
Risk free interest rate 3.01% 3.80%
Expected years until exercise 2.00 7.10
Expected stock volatility 20.38% 20.00%
Dividend yield 6.71% 6.80%
The following table summarizes share option activity in our share option plans
as of the year ended December 31:
2005 2004 2003
------------------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
------------------------------------------------------------------------------
Outstanding at beginning of year 1,075,313 $17.36 1,119,914 $ 17.33 263,509 $ 12.47
Granted 656,515 24.35 -- -- 1,000,000 17.78
Forfeited -- -- (22,167) 17.56 -- --
Exercised (221,487) 17.18 (22,434) 15.73 (143,595) 11.56
------------------------------------------------------------------------------
Outstanding at end of year 1,510,341 $20.42 1,075,313 $ 17.36 1,119,914 $ 17.33
==============================================================================
Exercisable at end of year 474,591 $20.20 275,313 $ 16.13 93,247 $ 11.56
==============================================================================
Fair value of options granted
during the year (in thousands) $ 1,196 $ -- $ 1,140
========== ========= ==========
Compensation cost recorded
(in thousands) $ 895 $ 597 $ 459
========== ========= ==========
The following table summarizes information about share options outstanding and
exercisable at December 31, 2005:
Weighted
Average
Remaining
Number Contractual Life Number
Exercise Price Outstanding (in Years) Exercisable
-------------- ----------- ---------------- -----------
$11.56 51,576 4.3 51,576
$17.56 2,250 6.7 2,250
$17.78 800,000 7.9 200,000
$21.61 20,000 9.4 --
$24.44 636,515 9.0 220,765
--------- ------ -------
1,510,341 8.3 474,591
========= ====== =======
99
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
As of December 31, 2005, there were approximately 4.1 million options or share
grants available for issuance under the Plan.
C. RESTRICTED SHARE GRANTS AND SCUS
In conjunction with the CharterMac Capital acquisition (see Note 2), we issued
restricted common shares to various individuals who are either employees of
CharterMac Capital or are one of the selling principals. Of the shares issued in
2003, 52,863 vested immediately and the remainder vest over periods ranging from
three months to four years. Grantees are entitled to dividends on their shares
during the vesting period. Any such payments are recorded as a charge to
Beneficial Owner's Equity - other common shareholders. If any grantee forfeits
an award, we reverse amounts previously amortized and credit compensation
expense.
Also, in conjunction with the CharterMac Capital acquisition, our subsidiary
issued SCUs to employees other than the selling principals. These SCUs vest over
periods ranging from three to four years.
Grants issued were as follows for the years ended December 31:
(in thousands except per share amounts) 2005 2004 2003
-------- -------- --------
Number of restricted shares granted 122 110 778
Weighted average grant-date fair value per share $22.39 $ 20.27 $ 19.33
Total restricted shares grant value $2,737 $ 2,228 $15,047
SCUs granted -- 93 217
Weighted average grant-date fair value per SCU -- $ 17.92 $ 17.92
Total SCU grant value -- $ 1,656 $ 3,863
Compensation cost recorded (net of forfeitures) $7,543 $ 11,035 $ 2,845
D. TRUSTEE GRANTS
Our independent trustees receive a portion of their annual compensation in
common shares. In 2005, we issued 7,518 shares for trustee compensation as
compared to 6,885 in 2004.
NOTE 16 - EARNINGS PER SHARE, PROFIT AND LOSS ALLOCATIONS AND DISTRIBUTIONS
Prior to our acquisition of CharterMac Capital, pursuant to our Trust Agreement
and a management agreement, CharterMac Capital was entitled to a special
distribution equal to .375% per annum of our total invested assets (which
equaled the face amount of the mortgage revenue bonds and other investments).
After payment of the special distribution, distributions were made to the
shareholders in accordance with their percentage interests (see also Note 17).
We allocated income first to CharterMac Capital for the special distribution.
After a special allocation of 0.1% to CharterMac Capital, we then allocated
remaining profits to shareholders in accordance with their percentage interests.
For periods subsequent to the CharterMac Capital acquisition, we allocate the
income of CCC (the subsidiary we created as CharterMac Capital's direct parent)
first to the holders of the SCUs for an amount based on a proportionate share of
net income. Beginning in 2005, we made a similar allocation for SMU holders.
100
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands, except per share amounts) Income Shares* Per Share
------------------------------------------------ -------- -------- ---------
2005:
----
Net income $59,014
Preferred dividends 2,020
-------
Net income allocable to shareholders (Basic EPS) 56,994 58,018 $ .98
Effect of dilutive securities -- 273
------- -------
Diluted EPS $56,994 58,291 $ .98
======= ======= =======
2004:
----
Net income allocable to shareholders (Basic EPS) $65,363 54,786 $ 1.19
Effect of dilutive securities -- 361
------- -------
Diluted EPS $65,363 55,147 $ 1.19
======= ======= =======
2003:
----
Net income allocable to shareholders (Basic EPS) $61,248 46,653 $ 1.31
Effect of dilutive securities -- 82
------- -------
Diluted EPS $61,248 46,735 $ 1.31
======= ======= =======
* Includes common and Convertible CRA Shares (see Note 14).
NOTE 17 - RELATED PARTIES
A. CHARTERMAC CAPITAL AND TRCLP
Prior to the CharterMac Capital Acquisition
-------------------------------------------
Prior to our acquisition of CharterMac Capital (see Note 2), we had engaged a
subsidiary of CharterMac Capital to provide us with management services.
Pursuant to the terms of the management agreement, CharterMac Capital, as
Manager, was entitled to receive the fees and other compensation set forth
below:
Fees/Compensation* Amount
----------------- ------
Bond selection fee 2.000% of the face amount of each asset we
invested in or acquired.
Special distributions/investment 0.375% per annum of our total invested
management fee assets.
Loan servicing fee 0.250% per annum based on the outstanding
face amount of mortgage revenue bonds and
other investments we owned.
Operating expense For direct expenses incurred by the Manager
reimbursement up to a specified annual amount (subject to
increases based on our assets and the
Consumer Price Index).
Incentive share options The Manager could receive options to
acquire common shares if our distributions
in any year exceeded $0.9517 per common
share and if our Compensation Committee
approved.
Liquidation fee 1.500% of the gross sales price of assets
sold by us in a liquidation proceeding.
* CharterMac Capital could also earn miscellaneous compensation that included
construction fees, escrow interest, property management fees, leasing
commissions and insurance brokerage fees. The payment of any such
compensation was 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 us was payable by the borrower, and not
by CharterMac.
Affiliates of CharterMac Capital provided certain financial guarantees to
facilitate leveraging by CharterMac, for which we would pay market rate fees. In
addition, affiliates of CharterMac Capital provided financial guarantees to the
101
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
owner (or partners of the owners) of the underlying properties securing our
mortgage revenue bonds, for which we would pay market rate fees.
Subsequent to the CharterMac Capital Acquisition
------------------------------------------------
Subsequent to the CharterMac Capital acquisition we revised the management
agreement and the fees included in the agreement are eliminated in
consolidation. The Related Companies, L.P., ("TRCLP"), which is majority
controlled by Stephen M. Ross (a selling principal of CharterMac Capital who is
also Chairman of our Board of Trustees), continues to provide services under a
shared services agreement. The services provided include office management,
payroll, human resources and other office services. The majority of the services
are charged to us at the direct cost incurred by TRCLP.
The selling principals of CharterMac Capital included two of our executive
officers (Alan P. Hirmes and Marc D. Schnitzer), both of whom are also members
of our board of trustees, and an affiliate of TRCLP. As a result of the equity
we issued in the CharterMac Capital acquisition, Mr. Ross and the affiliate of
TRCLP own approximately 16.1% of CharterMac and our management, trustees and
employees (excluding Mr. Ross) own approximately 4.9% at December 31, 2005.
Amounts Paid and Incurred
-------------------------
The costs, expenses and the special distributions paid or payable to CharterMac
Capital, prior to the acquisition, its affiliates, and TRCLP for the years ended
December 31, were as follows:
Paid or
Payable to
CharterMac
Capital and
Paid or Payable to TRCLP Affiliates
-----------------------------------------------------
Year Ended Year ended Nov 18 - Jan 1 -
December 31, December 31, Dec 31 Nov 17
------------ ------------ ------------ ----------
(In thousands) 2005 2004 2003 2003
------------ ------------ ------------ ----------
Shared service agreement $ 507 $ 4,252 $ 755 $ --
Bond selection fees -- -- -- 8,905
Special distribution/investment
management fee -- -- -- 3,809
Bond servicing fees -- -- -- 5,764
Expense reimbursement -- -- -- 901
------- ------- ------- -------
$ 507 $ 4,252 $ 755 $19,379
======= ======= ======= =======
B. FUND MANAGEMENT TRANSACTIONS
Substantially all fund origination revenues in the Fund Management segment are
received from investment funds we have originated and manage, many of which
comprise the partnerships that we consolidate (see Note 1). While affiliates of
our Company hold equity interests in the investment funds' general partner
and/or managing member/advisor, we have no direct investments in these entities,
and we do not guarantee their obligations. We have agreements with these
entities to provide ongoing services on behalf of the general partners and/or
managing members/advisors, and we receive all fee income to which these entities
are entitled.
102
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
As of December 31, 2005, CharterMac Capital controlled certain partnerships.
Those entities, in turn, were the general partners of investment partnerships.
These investment partnerships, in turn, were non-equity managing partners of
local partnerships that are obligors of certain of our mortgage revenue bonds.
In connection with the 2002 refinancing of a property partly owned by Stephen M.
Ross, we entered into an agreement which allows the revenue bond to be put to us
should the owner of the underlying property default on the bond. We, in turn,
entered into agreements which allow us to put the bond to the general partners
of the owner who are affiliates of the Company. This right is secured by
collateral assignments of the general partners' partnership interests in the
limited partnership which owns the underlying property.
Related Management Company ("RMC"), which is wholly-owned by TRCLP, earned fees
for performing property management services for various property partnerships
held in investment funds we manage and consolidate. The fees totaled $3.2
million in 2005, $2.2 million in 2004 and $2.9 million in 2003.
C. LOAN TO AMERICAN MORTGAGE ACCEPTANCE CORP ("AMAC")
In June 2004, we entered into an unsecured revolving credit facility with AMAC,
an affiliated real estate investment trust, to provide it up to $20.0 million,
bearing interest at LIBOR plus 3.0%, which is to be used to purchase new
investments. This facility expires in June 2006. In the opinion of management,
the terms of this facility are consistent with those of transactions with
independent third parties. As of December 31, 2005, there were no advances
outstanding, while AMAC owed $4.6 million as of December 31, 2004, at an
interest rate of 5.42%.
D. AMAC CO-INVESTMENT
We and AMAC have entered into a Subordinated Participation Agreement, under
which AMAC has acquired a subordinated participation equal to $5.0 million in a
note receivable investment we hold. Upon the inception of a new AMAC warehouse
facility (which we anticipate will occur in the first half of 2006), we expect
to sell the loan to AMAC at its $26.0 million par value.
E. AMAC SERVICE AGREEMENT
We collect asset management, incentive management, expense reimbursement and
acquisition fees from AMAC. These fees, which are included in fund sponsorship
income, totaled approximately $4.9 million in 2005, $2.2 million in 2004, and
$227,000 in 2003.
We entered into a new agreement, effective when the existing agreement expires
in March 2006. While the basis of certain of the fees we will earn will be
changed, we do not expect the fees we earn to differ significantly from the
existing agreement absent the effect of AMAC's growth.
F. OTHER
We have invested approximately $5.4 million in funds sponsored by a subsidiary
of CCA which are included in Other Investments (see Note 4).
We have acquired four revenue bonds with an aggregate face amount of
approximately $34.5 million, for which the developer is Related Apartment
Preservation, a subsidiary of TRCLP.
We have made a loan of $20,000,000 to CCA, a subsidiary of Capri Realty Advisors
Inc. which is partially owned by the CEO of CMC, one of our subsidiaries.
Additionally, one of our subsidiaries holds a preferred interest in CCA (see
Note 4). We also advanced approximately $2.8 million to CCA through December 31,
2005.
CMC services a portfolio of loans for CreditRe Mortgage Capital, which is owned
by TRCLP.
103
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 18 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
(In thousands, except per share amounts) 2005 Quarter Ended
-------------------------------------------------------
March 31 June 30 September 30 December 31 (1)
-------- --------- ------------ ---------------
Total revenues $ 58,739 $ 78,837 $ 78,318 $ 79,106
Income before income taxes $ 6,420 $ 19,109 $ 13,662 $ (8,754)
Net income $ 14,785 $ 19,444 $ 18,678 $ 6,107
Net income per share
Basic $ 0.26 $ 0.34 $ 0.31 $ 0.08
Diluted $ 0.25 $ 0.33 $ 0.31 $ 0.08
Weighted average shares outstanding
Basic 57,821 57,890 58,059 58,294
Diluted 58,236 58,274 58,366 58,532
2004 Quarter Ended
-------------------------------------------------------
March 31 June 30 September 30 December 31
-------- --------- ------------ ---------------
Total revenues $ 46,313 $ 57,287 $ 59,793 $ 69,039
Income before income taxes $ 4,029 $ 16,780 $ 10,079 $ 17,232
Net income $ 6,418 $ 24,203 $ 14,911 $ 19,831
Net income per share
Basic $ 0.12 $ 0.47 $ 0.26 $ 0.34
Diluted $ 0.12 $ 0.46 $ 0.26 $ 0.34
Weighted average shares outstanding
Basic 51,591 52,017 57,708 57,728
Diluted 51,839 52,359 58,112 58,194
(1) Includes a $22.6 million non-cash pre-tax charge (equal to $12.3 million
after tax, or $0.21 per basic and diluted share) related to the write-off
of the "Related Capital Company" trade-name intangible asset (see Note 6).
104
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 19 - BUSINESS SEGMENTS
We operate in four business segments:
1. Portfolio Investing, which includes subsidiaries that invest in primarily
tax-exempt first mortgage revenue bonds issued by various state or local
governments, agencies or authorities and other investments designed to
produce federally tax-exempt income. The proceeds of the mortgage revenue
bonds are used to finance the new construction, substantial rehabilitation,
acquisition, or refinancing of affordable multifamily housing throughout
the United States.
Through this segment, we also invest in other entities, such as our
preferred and common investments in ARCap, our participating loan to and
preferred investment in CCA and our investments in funds that CCA sponsors
(see Note 6).
2. Fund Management, which includes:
o Subsidiaries that sponsor real estate equity investment funds that
primarily invest in LIHTC properties. In exchange for sponsoring and
managing these funds, we receive fee income for providing asset
management, underwriting, origination and other services;
o A subsidiary which provides advisory services to AMAC, an affiliated,
publicly traded real estate investment trust; and
o Subsidiaries that participate in credit intermediation transactions,
including that for pools of mortgage loans and providing specified
returns to investors in LIHTC equity funds, in exchange for fees.
3. Mortgage Banking, which includes subsidiaries that originate and service
primarily multifamily mortgage loans on behalf of third parties, including:
o Fannie Mae;
o Freddie Mac;
o the FHA; and
o Insurance companies and conduits.
In exchange for these origination and servicing activities, we receive
origination and servicing fees.
4. Consolidated Partnerships, primarily the LIHTC equity funds we sponsor
through the Fund Management segment's subsidiaries and which we are
required to consolidate in accordance with FIN 46(R), as well as other
partnerships we control but in which we have little or no equity interest
(see Note 1).
Segment results include all direct and contractual revenues and expenses of each
segment and allocations of indirect expenses based on specific methodologies.
These reportable segments are strategic business units that primarily generate
revenue streams that are distinctly different and are generally managed
separately.
The table below includes Cash Available for Distribution ("CAD") as the
performance measure used by our chief decision maker to allocate resources among
the segments. This is a revision to the measure presented in prior periods and,
accordingly, segment results for 2004 and 2003 have been restated to conform to
the current year presentation.
105
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The following table provides more information regarding our segments:
(In thousands) 2005 2004 2003
----------- ----------- ----------
REVENUES
Portfolio Investing $ 169,577 $ 141,910 $ 119,397
Fund Management (1) 117,752 92,663 18,342
Mortgage Banking 43,572 21,028 17,690
Consolidated partnerships (2) 24,096 12,213 --
Elimination of intersegment transactions (59,997) (35,382) (3,189)
----------- ----------- ---------
Consolidated $ 295,000 $ 232,432 $ 152,240
=========== =========== =========
CAD
Portfolio Investing $ 102,927 $ 106,317 $ 86,155
Fund Management (1) 58,010 52,215 20,159
Mortgage Banking 14,871 4,388 3,517
Consolidated partnerships (2) -- -- --
----------- ----------- ---------
Total Segment CAD 175,808 162,920 109,831
Preferred dividends (2,020) -- --
Subsidiary equity distributions (34,666) (33,036) (4,038)
Dividends on subsidiary preferred stock (25,123) (22,840) (18,898)
Current tax benefit (expense) 711 (3,413) (2,826)
Income allocated to minority interests -- -- 54
Income allocated to Manager -- -- (5,332)
----------- ----------- ---------
Consolidated CAD 114,710 103,631 78,791
Fees deferred for GAAP (3) (23,930) (27,096) (14,924)
Depreciation and amortization expense (66,762) (30,407) (11,926)
Mortgage revenue bond yield adjustments (4) 596 85 (1,946)
Gain on sale of loans (5) 11,140 6,805 7,749
Loss on impairment of assets (4,555) (757) (1,759)
Tax adjustment (6) 27,866 20,655 8,898
Non-cash compensation (7) (8,541) (11,753) (2,282)
Difference between subsidiary equity
distributions and income allocated to
subsidiary equity holders(8) 11,245 4,862 --
Preferred dividends / allocation to
manager 2,020 -- 5,338
Other, net (4,775) (662) (1,353)
----------- ----------- ---------
Consolidated Net Income $ 59,014 $ 65,363 $ 66,586
=========== =========== =========
DEPRECIATION AND AMORTIZATION (9)
Portfolio Investing $ 5,649 $ 3,357 $ 2,405
Fund Management (1)(9) 41,335 18,974 3,095
Mortgage Banking 19,778 8,076 6,426
Consolidated partnerships (2) -- -- --
Elimination of intersegment transactions -- -- --
----------- ----------- ---------
Consolidated $ 66,762 $ 30,407 $ 11,926
=========== =========== =========
IDENTIFIABLE ASSETS AT DECEMBER 31
Portfolio Investing $ 5,487,596 $ 4,748,608
Fund Management (1) 800,684 827,179
Mortgage Banking 345,225 91,508
Consolidated partnerships (2) 3,610,031 2,856,014
Elimination of intersegment balances (3,264,708) (2,786,088)
----------- -----------
Consolidated $ 6,978,828 $ 5,737,221
=========== ===========
(1) Prior to our acquisition of CharterMac Capital in November 2003, this
segment consisted only of our credit intermediation business.
(2) Consolidated beginning April 2004 pursuant to FIN 46(R). See Notes 1 and 7.
(3) Represents the net difference between fees received at the time of a
transaction that are recognized immediately for CAD but are deferred and
recognized over time for GAAP accounting (e.g.: fund sponsorship fees recognized
over the relevant service periods) or upon a later event (such as mortgage
origination fees recognized upon settlement of a loan sale).
106
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(4) Represents the adjustment for amortization of bond discounts or premiums
that are recognized immediately for CAD but are deferred and recognized over
time for GAAP accounting, as well as the difference between actual interest
income received and income recognized under the effective yield method.
(5) Represents non-cash gain recognized on sale of mortgage loans when servicing
rights are retained and gains on sales of mortgage revenue bonds.
(6) Represents the difference between the tax benefit recorded and the net cash
amount we expect to pay or receive in relation to the current period.
(7) Represents the add-back of amortization of costs recognized for share-based
compensation and share-based trustee fees.
(8) Represents the difference between actual distributions to SCU and SMU
holders (which is based on the common share distribution rate) and accounting
allocation of earnings, which is based on the represented portion of combined
common, CRA and subsidiary equity in allocating GAAP net income.
(9) 2005 includes write-off of trade name.
NOTE 20 - IMPACT OF HURRICANES
During the third quarter of 2005, two major hurricanes struck the Gulf Coast
region of the United States. A third struck the southern United States during
the fourth quarter. All of our businesses are involved in properties in the
areas affected by the storms.
Due to limited access to certain affected properties, as well as the
complications and bureaucracy involved in the determination of insurance
coverage, we are still evaluating the extent of our financial exposure on
several properties. Based upon the information available to date, our financial
exposure is expected to be immaterial. However, it will take some time to assess
the full ramifications of the hurricanes. Other than insurance considerations
(discussed below), examples of situations that are too early to assess include:
o the effects of the likely increase in repair and construction costs;
o whether the increase in physical occupancy in the properties
underlying our investments will be permanent in nature;
o any changes that the government agencies propose for some of the
financing programs that we offer (i.e. whether the IRS will make any
proposed temporary changes to the tax code for the LIHTC program)
which if enacted could make additional capital available to the
affected properties; and
o what resources the local general partner will bring to bear.
We identified 11 properties (located in Texas, Florida, Louisiana and
Mississippi) which experienced major damage and for which one or more funds we
have sponsored have provided equity. Currently we do not expect that there will
be financial exposure related to these properties as we believe that the
properties have adequate insurance coverage, but in virtually all cases
determinations are ongoing as to:
o how the insurance companies involved will address damage with respect
to that caused by wind versus that caused by flooding;
o the level of deductibles, which is dependent upon the category
determinations;
o whether outside parties (such as state agencies) will mediate in
disputes regarding insurance; and
o the financial resources of the insurers.
Our mortgage banking subsidiaries identified six properties in our loan
servicing portfolio that have loss-sharing arrangements and which sustained
major damage. We believe that insurance is adequate to cover the damages and we
expect no financial losses with respect to these loans.
None of the mortgage revenue bonds in our portfolio are secured by properties
that suffered major damage.
107
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Due to the uncertainties noted above, we are currently unable to estimate the
extent of our direct financial exposure, if any. With respect to exposure
regarding specified rates of return obligations, as storm damage may reduce the
expected yields of the properties themselves, performance of the funds is likely
to be impacted as well. The obligations, however, provide for expected yields on
pools of properties, some of which are performing above expected levels and the
funds themselves often provide for adjustors that may mitigate the negative
impact that would arise from the construction delays over the period covered by
the agreements.
NOTE 21 - COMMITMENTS AND CONTINGENCIES
PRS / CRG
PRS Companies ("PRS") and Capitol Realty Group ("CRG") are sponsors of certain
LIHTC partnerships for which we hold mortgage revenue bonds and/or to which
investment funds we sponsor have contributed equity. Information with respect to
these partnerships is set forth in the table below. A construction company
affiliate of PRS also served as general contractor for those partnerships.
After PRS approached us to discuss financial difficulties in its construction
company, we conducted a thorough review regarding its financial condition (and
that of its guarantors) and determined that the PRS construction company was
experiencing significant financial difficulties, so that the transfer of control
of the PRS and CRG general partnership interests to entities affiliated with us
- and the orderly termination of unfulfilled construction contracts - was in our
best interest. We could then install new general contractors to complete
construction and capable property managers to complete leasing. We determined
that, if we did not obtain control of the partnerships, a bankruptcy filing by
or against PRS would be adverse to our interests as it would likely result in
the reduction or cessation of bond payments, could possibly endanger our various
tax credit equity investments, and would result in delays in construction
completion, the financial impact of which could not be quantified.
In April 2005, affiliates of ours acquired by assignment the general partnership
interests owned by PRS in seven of the "PRS Partnerships" indicated in the table
below. We sought control of the PRS Partnerships because PRS' financial
difficulties caused construction finance shortfalls that created liquidity
problems for those partnerships. As a result, settlement agreements were entered
into by and amongst the PRS Partnerships, the PRS project owners, the
guarantors, various affiliates of ours and other third parties (the "PRS
Settlements"). The PRS Settlements provide for, among other things:
o the termination of the PRS construction contracts;
o the settlement of construction claims and release of liens;
o the termination of management agreements for the PRS projects;
o the assignment of the development agreements to our affiliates;
o the assignment of the interest in the general partner of each of the
PRS Partnerships to our affiliates;
o the termination of PRS' obligations under the payment and performance
bonds for each project; and
o mutual releases by and amongst the PRS Settlement parties.
The PRS Settlement Agreements are, in essence, a complete cessation of business
between us and PRS.
Also in April 2005, affiliates of ours acquired by assignment the general
partnership interests owned by CRG in five of the "CRG Partnerships" indicated
in the table below. We sought control of the CRG Partnerships because PRS was
the construction general contractor for those partnerships and PRS' financial
difficulties caused construction finance shortfalls that have created liquidity
problems for those partnerships. We entered into settlement agreements by and
amongst the CRG Partnerships, the CRG project owners, the guarantors, various
affiliates of ours and other third parties (the "CRG Settlements"). The CRG
Settlement Agreements provide for, among other things:
108
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
o the termination of the PRS construction contracts;
o the assignment of each of the CRG project's development agreements to
an affiliate of CRG subject to reassignment to CRG as discussed below;
o a non-revolving line of credit from us to be used to stabilize the CRG
Partnerships which is collateralized by contractual rights to
development fees to CRG and its affiliates to receive fees and other
consideration. This includes interim loans to satisfy amounts due to
subcontractors, material suppliers and other vendors providing
materials and/or services on the CRG projects;
o reaffirmation of various guarantee agreements;
o the assignment of the interests in the CRG Partnerships to our
affiliates;
o an operating agreement, whereby an affiliate of CRG will operate the
CRG projects subject to our discretion; and
o various releases by and amongst the CRG Settlement parties, excluding
any reaffirmation of guaranty agreements and any other exclusions set
forth in the CRG Settlement Agreements.
The CRG Settlement Agreements also provide that the general partnership
interests will be returned to CRG if they provide us with a letter of credit to
secure advances made and/or such advances are paid in full by a date certain.
Additionally, there were two other projects, for which PRS was the construction
company--O'Fallon and Peine Lakes (the "GCG Partnerships"). With respect to the
O'Fallon project, in August 2005 the Gundaker Commercial Group, Inc and its
affiliates ("GCG") and our affiliates negotiated a letter of intent which
provides for:
o additional mortgage debt financing by an affiliate of ours;
o the assignment of a portion of our affiliates interest in the O'Fallon
Partnership to an affiliate of GCG;
o the execution of a new construction contract; and
o amendments to several fee agreements.
With respect to the Peine Lakes project, it continues to move along its
construction phase and is now approximately 95% complete. GCG has assumed the
full general partner interest and agreed to fund approximately $1.0 million into
the Peine Partnership to aid in any cost overruns and any amounts due and owing
as a result of the action of PRS on the project. Should cost overruns exceed
$1.0 million, we will share in the excess in return for a partial general
partner interest.
In addition to the PRS Partnerships, CRG Partnerships and GCG Partnerships
described above, we own bonds that finance other partnerships in which PRS was
the general partner or in which CRG is the general partner and PRS was the
construction general contractor. These partnerships are also summarized in the
table below. On those deals in which our funds are not the equity sponsor, we
will look to the respective equity investor to take control, complete
construction and stabilize the partnerships. Absent a satisfactory resolution,
we may exercise our available remedies to protect our investments. In those
situations, there is substantial equity in the form of LIHTCs in addition to the
real estate, both of which are our collateral.
There can be no assurance that a bankruptcy by or against PRS or its affiliates
may not give rise to additional claims concerning these partnerships.
Our potential exposure falls into three categories as follows:
CASH REQUIRED TO BRING THE PROPERTIES TO BREAK-EVEN OPERATION - Our
current estimate of the maximum amount of cash that we may need to
provide to bring the properties to break-even operation, taking
into account delays in construction, is approximately $15.0
million. This estimate is based upon our initial analyses and
information provided by the developer, and may increase due to
unforeseen construction delays and other factors, while the amount
may be reduced by additional contributions by investors (which may
109
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
generate additional tax credits), reserves at the property level,
syndication of state tax credits or other factors. Through
December 31, 2005, we had advanced $14.9 million either to the
partnerships or through the revolving line of credit to the CRG
partnerships. These advances, and additional loans, are assessed
periodically for collectibility and the impact on the potential
impairment of existing mortgage revenue bonds. Given existing
loan-to-value ratios and the variability of the likelihood of
funding, we cannot yet determine the ultimate amount of any such
loans. At present, we do not anticipate that any such loans would
require a charge to expense.
POTENTIAL IMPACT ON MORTGAGE REVENUE BONDS - Our current estimate,
based on available information, is that expected cash flows from
the underlying properties are sufficient to provide debt service.
As a result, we do not believe that there is other-than-temporary
impairment of any of the affected bonds, except as noted below.
POTENTIAL COST TO PROVIDE SPECIFIED YIELDS - As noted in the table
below, 10 of the partnerships in question are part of equity funds
for which we are obligated to provide specified yields. As
construction delays are likely to reduce the expected yields of
the properties themselves, performance of the funds is likely to
be impacted as well. The obligations, however, provide for
expected yields on pools of properties, some of which are
performing above expected levels and the funds themselves often
provide for adjustors that may mitigate the negative impact that
would arise from the construction delays over the guarantee period
covered by the agreements. Our current estimate given these
factors, and assuming that the property level partnerships meet
their obligations under existing partnership agreements, is that
no exposure under these agreements is probable at this time.
As a result of our analysis of the affected properties, we determined that the
development of one property in the early stages of construction should not be
continued. We plan to exercise our right to foreclosure as holder of the first
mortgage and will be able to recover much of the funds advanced through the
mortgage revenue bond as well as take ownership of the underlying land. Based
upon the funds available to recover and the estimated value of the land, we
recognized a write-down of approximately $1.1 million in the second quarter of
2005. This property was included in a credit intermediated CharterMac Capital
sponsored fund, and we exercised a right of substitution to remove it from that
fund and replaced it with other properties.
With respect to another property in the early stages if construction, we have
likewise determined that construction should not be continued. We do not hold a
bond with respect to this property, but a fund we sponsored provided equity. We
have received preliminary bids to sell our general partner and limited partner
interests that would allow us to fully recover the fund's investment. As such,
we expect no loss with respect to this property.
We have consolidated the partnerships for which we have assumed the general
partnership interests (except for the GCG Partnerships, which do not give our
affiliates operational control of the partnerships) effective April 2005. The
partnerships in question are summarized as follows:
110
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands)
Fair Value of
CharterMac CharterMac Loan Mortgage
Holds or Capital Amounts Revenue
Will Hold Sponsored Included CharterMac Third Upon Bonds
Mortgage Fund is in Credit Capital Parties Full Oustanding at
Revenue Equity Intermediated Holds GP Provided Draw December 31,
Number Bond Partner Funds Interest Equity Down 2005
-------- ---------- ---------- ------------- ---------- -------- -------- -------------
PRS
PARTNERSHIPS
Construction 3 3 2 1 2 1 $ 23,700 $ 23,718
Lease-Up 8 7 4 2 4 4 89,900 90,995
Rehab 2 2 1 1 1 1 30,400 32,071
Stabilized 2 2 -- -- -- 2 18,377 18,659
-------------------------------------------------------------------------------------------------------------
Subtotal 15 14 7 4 7 8 162,377 165,443
-------------------------------------------------------------------------------------------------------------
CRG
PARTNERSHIPS
Construction 1 1 1 -- 1 -- 7,130 --
Lease-Up 3 1 3 2 1 -- 10,550 10,550
Rehab 3 3 3 3 3 -- 71,611 75,137
Stabilized -- -- -- -- -- -- -- --
-------------------------------------------------------------------------------------------------------------
Subtotal 7 5 7 5 5 -- 89,291 85,687
-------------------------------------------------------------------------------------------------------------
GCG
PARTNERSHIPS
Construction 2 2 2 1 -- -- 27,770 15,744
Lease-Up -- -- -- -- -- -- -- --
Rehab -- -- -- -- -- -- -- --
Stabilized -- -- -- -- -- -- -- --
-------------------------------------------------------------------------------------------------------------
Subtotal 2 2 2 1 -- -- 27,770 15,744
-------------------------------------------------------------------------------------------------------------
Total 24 21 16 10 12 8 $279,438 $266,874
=============================================================================================================
Total eliminated in consolidation $157,341 $154,960
============================
FORWARD TRANSACTIONS
At December 31, 2005, our Mortgage Banking subsidiaries had forward commitments
of approximately $193.5 million for mortgages to be funded in 2006 and later. As
each lending commitment has an associated sale commitment, the fair values of
these commitments offset each other and, as a result, we record no asset or
liability. In addition, those subsidiaries had commitments to sell mortgages
totaling $245.9 million. Approximately $126.8 million of this amount was funded
as of December 31, 2005, and is included in Other Investments as Mortgage Loans
Receivable. The balance of approximately $119.1 million is to be funded in 2006.
We have entered into transactions to purchase mortgage revenue bonds at
predetermined prices and interest rates, but only if construction of the
property is completed. These forward commitments create derivative instruments
under SFAS No. 133, which have been designated as a cash flow hedge of the
anticipated funding of the mortgage revenue bonds and are recorded at fair
value, with changes in fair value recorded in other accumulated comprehensive
income until the mortgage revenue bonds are funded. The total potential amount
we could be required to fund is $135.4 million.
Additionally, we have certain other bonds that we fund on an as needed basis.
The remaining balance to be funded on these drawdown bonds is approximately
$800,000 at December 31, 2005.
111
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
MORTGAGE BANKING LOSS SHARING AGREEMENTS
Under a master loss sharing agreement with Fannie Mae, we assume responsibility
for a portion of any loss that may result from borrower defaults, based on
Fannie Mae loss sharing formulas. At December 31, 2005, all but two of our loans
sold to Fannie Mae consisted of Level I loans, meaning, in most cases, that we
are 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;
Fannie Mae bears any remaining loss. Pursuant to this agreement, we are
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, we may request interim loss sharing adjustments which allow
us to fund 25% of such advances until final settlement under the agreement.
We also participate in loss sharing transactions under Freddie Mac's Delegated
Underwriting Initiative ("DUI") program whereby we originate loans that are
purchased by Freddie Mac. The aggregate of all such loans shall not exceed
$100.0 million.
Under the terms of our Master Agreement with Freddie Mac, we are obligated to
reimburse Freddie Mac for a portion of any loss that may result from borrower
defaults on DUI transactions. For such loans, if a default occurs, our share of
the loss will be the first 5% of the unpaid principal balance and 25% of the
next 20% of the remaining unpaid principal balance to a maximum of 10% of the
unpaid principal balance. The loss on a defaulted loan is calculated as the
unpaid principal amount due, unpaid interest due and default resolutions costs
(taxes, insurance, operation and foreclosure costs) less recoveries.
Our maximum exposure at December 31, 2005, pursuant to these agreements, was
approximately $834.9 million (representing what we would owe in accordance with
the loss sharing percentages described above if every loan defaulted), although
this amount is not indicative of our actual potential losses. We maintain an
allowance for loan losses for loans originated under these product lines at a
level that, in management's judgment, is adequate to provide for estimated
losses. At December 31, 2005, that reserve was approximately $13.0 million,
which, we believe, represents our actual potential losses at that time.
Our Mortgage Banking subsidiaries maintained, as of December 31, 2005,
collateral consisting of treasury notes, and Fannie Mae and Freddie Mac
securities of approximately $13.4 million and a money market account of
approximately $1.1 million, which is included in cash and cash equivalents,
including restricted cash, in the consolidated balance sheet, to satisfy the
Fannie Mae and Freddie Mac collateral requirements of $12.7 million.
We are also required by the Master Agreement with Freddie Mac to provide a
letter of credit in the amount of 8% of the original principal balance as
collateral security for payment of the reimbursement obligation. A reimbursement
agreement with the Bank of America to provide a master letter of credit covering
the collateral requirement up to $8 million covers this requirement. At December
31, 2005, commitments under this agreement totaled $1.9 million.
MORTGAGE POOL CREDIT INTERMEDIATION
In December 2001, we completed a credit intermediation transaction with Merrill
Lynch Capital Services, Inc. ("MLCS"). Pursuant to the terms of the transaction,
we assumed MLCS's first loss position on a pool of tax-exempt weekly variable
rate multifamily mortgage loans. TRCLP has provided us with an indemnity
covering 50% of any losses that we incur as part of this transaction. As the
loans mature or prepay, the first loss exposure and the fees we receive are
reduced. The latest maturity date on any loan in the portfolio occurs in 2009.
Fannie Mae and Freddie Mac have assumed the remainder of the real estate
exposure after the first loss position. In connection with the transaction, we
have posted collateral, initially in an amount equal to 50% of the first loss
112
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
amount, which may be reduced to 40% if certain post closing conditions are met.
Our maximum exposure under the terms of the transaction as of December 31, 2005,
is approximately $7.4 million.
We 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. We analyzed the portfolio on a "stressed" basis by increasing
capitalization rates and assuming an increase in the low floater bond rate. As
of December 31, 2005, the credit-intermediated properties are performing
according to their contractual obligations and we do not anticipate any losses
to be incurred on this guarantee. Should our analysis of risk of loss change in
the future, a provision for probable loss might be required pursuant to SFAS No.
5, ACCOUNTING FOR CONTINGENCIES.
YIELD TRANSACTIONS
We have entered into several credit intermediation agreements with either IXIS
Financial Products, Inc. ("IXIS") or Merrill Lynch (each a "Primary
Intermediator") to provide agreed-upon rates of return for pools of multifamily
properties each owned by a local partnership which in turn, is majority-owned by
a fund sponsored by CharterMac Capital. In return, we have or will receive fees,
generally at the start of each credit intermediation period. There are a total
of 11 outstanding agreements to provide the specified returns:
o through the construction and lease-up phases of the properties;
o for the period from the completion of the construction and lease-up
phases through the operating phase of the properties; or
o covering both periods.
Total potential exposure pursuant to these transactions is approximately $729.8
million, assuming the funds achieve no return whatsoever. We have analyzed the
expected operations of the underlying properties and believe there is no risk of
loss at this time, as we have never yet been called upon to make payments under
these agreements. Should our analysis of risk of loss change in the future, a
provision for possible losses might be required pursuant to SFAS No. 5. The fair
value of these obligations, representing the deferral of the fee income over the
obligation periods, was $22.1 million as of December 31, 2005. This amount is
included in deferred revenues on our consolidated balance sheet. Refer also to
PRS / CRG above, regarding potential exposure under existing obligations.
Some of the property-level partnerships have financed their properties with the
proceeds of our mortgage revenue bonds. In these cases, the Primary
Intermediator has required that those mortgage revenue bonds be deposited into a
trust pursuant to which the mortgage revenue bonds were divided into senior and
subordinated interests with approximately 50% of each mortgage revenue bond
being subordinated. We have financed the senior trust interest and a portion of
certain of the subordinate trust interests using credit intermediation from the
Primary Intermediator as part of the P-FLOATs/RITES and TIC/TOC securitization
programs (see Note 9). We use the remaining subordinate trust interests as
collateral in these programs. In connection with these transactions, we have
posted $162.4 million as collateral with a Primary Intermediator in the form of
either cash or mortgage revenue bonds as of December 31, 2005.
OTHER
We have entered into several transactions pursuant to the terms of which we will
provide credit support to construction lenders for project completion and Fannie
Mae conversion. In some instances, we have also agreed to acquire subordinated
bonds to the extent the construction period bonds do not fully convert. We also
provide payment, operating deficit, recapture and replacement reserve guarantees
as business requirements for developers to obtain construction financing. Our
maximum aggregate exposure relating to these transactions is approximately
$221.7 million as of December 31, 2005. To date, we have had minimal exposure to
losses under these transactions and anticipate no material liquidity
requirements in satisfaction of any guarantee issued.
113
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
LEASE OBLIGATIONS
The future minimum payments for operating leases as of December 31, 2005, were
as follows:
(In thousands)
Minimum lease
Year Ending December 31, payments
----------------------------- -------------
2006 $ 6,820
2007 6,598
2008 6,869
2009 6,359
2010 6,457
Thereafter 37,607
-------------
Total $70,710
=============
We recorded rent expense of approximately $8.4 million in 2005, $3.3 million in
2004 and $913,000 in 2003 (including amounts paid to TRCLP in 2003 and 2004).
OTHER CONTINGENCIES
At December 31, 2005, we had unused letters of credit totaling $43.0 million,
including the $8.0 million described in MORTGAGE BANKING LOSS SHARING AGREEMENTS
above.
We are subject to routine litigation and administrative proceedings arising in
the ordinary course of business. Management does not believe that such matters
will have a material adverse impact on our financial position, results of
operations or cash flows.
NOTE 22 - SUBSEQUENT EVENTS
In February 2006, we executed an agreement to acquire Capri Real Estate Services
("CRES") from CCA, subject to investor consent. The consideration paid was the
redemption of the preferred interest we held in CCA, valued at $4.1 million as
of December 31, 2005, plus $1.1 million of advances we had made to CCA with
respect to this business (see Note 4). CRES is a manager of hedge funds and
other funds concentrating on investing in securities of publicly traded real
estate operating companies. It will be included in our Fund Management segment.
This acquisition is not material to our revenues, net income or assets.
In March 2006, Marc D. Schnitzer was named our Chief Executive officer,
succeeding Stephen M. Ross who had held that position on an interim basis
following the departure of Stuart J. Boesky in November 2005. Mr. Ross will
continue as chairman of our Board of Trustees and Mr. Schnitzer will also
continue in his role as our President.
114
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE.
None.
ITEM 9A. DISCLOSURE CONTROLS AND PROCEDURES
(a) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. Our Chief
Executive Officer and Chief Financial Officer have evaluated the
effectiveness of our disclosure controls and procedures (as such
term is defined in Rule 15(e) under the Securities Exchange Act
of 1934, as amended (the "Exchange Act")) as of the end of the
period covered by this report. Refer to MANAGEMENT'S REPORT ON
THE EFFECTIVENESS OF INTERNAL CONTROL OVER FINANCIAL REPORTING on
page 50.
(b) INTERNAL CONTROL OVER FINANCIAL REPORTING. To remediate the
material weaknesses in internal controls identified during the
Company's evaluation pursuant to Section 404 of the
Sarbanes-Oxley Act of 2002 as of the year ended December 31,
2004, during 2005, we have:
(i) hired a director of taxation, a newly created position;
(ii) increased the use of third-party tax service providers for
the more complex areas of our tax accounting and increased
formality and rigor of controls and procedures over
accounting for income taxes;
(iii) strengthened our due diligence procedures in reviewing
acquisition candidates to ensure that interaction of
accounting principles that might require prospective changes
are identified on a timely basis;
(iv) strengthened our analytical procedures with regard to the
preparation and review of all consolidation eliminations;
and
(v) completed the conversion of all subsidiaries to a unified
accounting system.
Management believes that the material weaknesses identified in the
prior year have been remediated.
ITEM 9B. OTHER INFORMATION
None.
115
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF OUR COMPANY
The information required by this item is incorporated herein by
reference to our definitive proxy statement to be filed pursuant to
Regulation 14A under the Exchange Act.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated herein by
reference to our definitive proxy statement to be filed pursuant to
Regulation 14A under the Exchange Act.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated herein by
reference to our definitive proxy statement to be filed pursuant to
Regulation 14A under the Exchange Act.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated herein by
reference to our definitive proxy statement to be filed pursuant to
Regulation 14A under the Exchange Act.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this item is incorporated herein by
reference to our definitive proxy statement to be filed pursuant to
Regulation 14A under the Exchange Act.
116
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
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(a)1. Financial Statements
Report of Independent Registered Public Accounting Firm 56
Consolidated Balance Sheets as of December 31, 2005 and 2004 57
Consolidated Statements of Income for the years ended December 31,
2005, 2004 and 2003 58
Consolidated Statements of Shareholders' Equity for the years ended
December 31, 2005, 2004 and 2003 59
Consolidated Statements of Cash Flows for the years ended December 31,
2005, 2004 and 2003 62
Notes to Consolidated Financial Statements 64
(a)2. Financial Statement Schedules
Schedule I - Condensed Financial Information of Registrant 130
Schedule II - Valuation and Qualifying Accounts 134
All other schedules have been omitted because they are not applicable
or the required information is included in the consolidated financial
statements and the notes thereto.
(a)3. Exhibits
--------
3.1(a) Certificate of Business Trust dated as of August 12, 1996
(incorporated by reference to our Registration Statement on Form 10,
filed with the Commission on August 1, 1997).
3.1(b) Certificate of Amendment of the Restated Certificate of Business
Trust (incorporated by reference to our Registration Statement on Form
S-8, filed with the Commission on November 24, 2003).
3.1(c) Second Amended and Restated Trust Agreement dated as of November 17,
2003.*
3.1(d) Amendment No. 1 to Second Amended and Restated Trust Agreement dated
as of September 20, 2005 (incorporated by referenced to our Current
Report on Form 8-K, filed with the Commission on September 22, 2005).
3.1(e) Amendment No. 2 to Second Amended and Restated Trust Agreement dated
as of November 30, 2005 (incorporated by referenced to our
Registration Statement on Form 8-A filed with the Commission on
January 3, 2006).
3.2(a) Fourth Amended and Restated Bylaws (incorporated by referenced to
our Current Report on Form 8-K, filed with the Commission on September
22, 2005).
117
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----------
3.2(b) Amendment No. 1 to Fourth Amended and Restated Bylaws*
4.1 Specimen Copy of Share Certificate for shares of our beneficial
interest (incorporated by reference to our Registration Statement on
Form S-8, filed with the Commission on November 24, 2003).
4.2 Certificate of Designation of Special Preferred Voting Shares, dated
November 17, 2003 (incorporated by reference to our Current Report on
Form 8-K, filed with the Commission on December 1, 2003).
10(a) Management Agreement dated as of November 17, 2003, between us and
Related Capital Company LLC (incorporated by reference to Exhibit
10(a) in our December 31, 2003 Annual Report on Form 10-K).
10(b) Insurance Agreement among MBIA, CharterMac, Origination Trust, Owner
Trust, CharterMac Floater Certificate Trust ("Floater Certificate
Trust"), First Tennessee Bank National Association ("First
Tennessee"), Related Charter LP, and Bayerische Landesbank
Girozentrale, New York Branch ("Bayerische") dated as of May 21, 1998
(incorporated by reference to Exhibit 10 (aaay) in our June 30, 1998
Quarterly Report on Form 10-Q).
10(c) Liquidity Agreement among Owner Trust, Floater Certificate Trust,
First Tennessee, MBIA and Bayerische dated as of May 21, 1998
(incorporated by reference to Exhibit 10 (aaaz) in our June 30, 1998
Quarterly Report on Form 10-Q).
10(d) Liquidity Pledge and Security Agreement among Origination Trust,
Owner Trust, Floater Certificate Trust, MBIA, First Tennessee and
Bayerische dated as of May 21, 1998 (incorporated by reference to
Exhibit 10 (aaaaa) in our June 30, 1998 Quarterly Report on Form
10-Q).
10(e) Fee Agreement among Wilmington Trust Company, Floater Certificate
Trust and CharterMac dated as of May 21, 1998 (incorporated by
reference to Exhibit 10 (aaaab) in our June 30, 1998 Quarterly Report
on Form 10-Q).
10(f) Certificate Placement Agreement (incorporated by reference to Exhibit
10 (aaaac) in our June 30, 1998 Quarterly Report on Form 10-Q).
10(g) Remarketing Agreement (incorporated by reference to Exhibit 10
(aaaad) in our June 30, 1998 Quarterly Report on Form 10-Q).
10(h) Contribution Agreement dated as of December 17, 2002 (incorporated by
reference to our Preliminary Proxy Statement on Schedule 14A filed on
February 2, 2003).
10(i) Amended and Restated Operating Agreement of CharterMac Capital
Company LLC, dated as of November 17, 2003 (incorporated by reference
to our Current Report on Form 8-K, filed with the Commission on
December 1, 2003).
10(j) Special Preferred Voting Shares Purchase Agreement, dated as of
November 17, 2003, by and among the Company and APH Associates L.P.,
DLK Associates L.P., Marc Associates, L.P., Related General II, L.P.
and SJB Associates L.P. (incorporated by reference to our Current
Report on Form 8-K, filed with the Commission on December 1, 2003).
118
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----------
10(k) Standstill Agreement, dated as of November 17, 2003, by and among the
Company and APH Associates L.P., DLK Associates L.P., Marc Associates,
L.P., Related General II, L.P. and SJB Associates L.P. (incorporated
by reference to our Current Report on Form 8-K, filed with the
Commission on December 1, 2003).
10(l) Voting Agreement, dated as of November 17, 2003, by and among the
Company and APH Associates L.P., DLK Associates L.P., Marc Associates,
L.P., Related General II, L.P. and SJB Associates L.P. (incorporated
by reference to our Current Report on Form 8-K, filed with the
Commission on December 1, 2003).
10(m) Exchange Rights Agreement, dated as of November 17, 2003, by and
among CharterMac Capital Company, LLC, CharterMac Corporation, APH
Associates L.P., DLK Associates L.P, Marc Associates, L.P., Related
General II, L.P. and SJB Associates L.P. (incorporated by reference to
our Current Report on Form 8-K, filed with the Commission on December
1, 2003).
10(n) Lock-up Agreement of Denise L. Kiley, dated November 17, 2003
(incorporated by reference to our Current Report on Form 8-K, filed
with the Commission on December 1, 2003).
10(o) Lock-up Agreement of Alan P. Hirmes, dated November 17, 2003
(incorporated by reference to our Current Report on Form 8-K, filed
with the Commission on December 1, 2003).
10(p) Lock-up Agreement of Marc D. Schnitzer, dated November 17, 2003
(incorporated by reference to our Current Report on Form 8-K, filed
with the Commission on December 1, 2003).
10(q) Lock-up Agreement of Stuart J. Boesky, dated November 17, 2003
(incorporated by reference to our Current Report on Form 8-K, filed
with the Commission on December 1, 2003).
10(r) Lock-Up Agreement of Stephen M. Ross, dated November 17, 2003
(incorporated by reference to our Current Report on Form 8-K, filed
with the Commission on December 1, 2003).
10(s) Employment Agreement of Alan P. Hirmes, dated November 17, 2003
(incorporated by reference to our Current Report on Form 8-K, filed
with the Commission on December 1, 2003).
10(t) Employment Agreement of Marc D. Schnitzer, dated November 17, 2003
(incorporated by reference to our Current Report on Form 8-K, filed
with the Commission on December 1, 2003)
10(u) Future Relations Agreement, dated as of November 17, 2003, by and
among Stephen Ross, Related General II L.P., RCMP Management Inc., the
Related Companies, L.P., and CharterMac Capital Company, LLC
(incorporated by reference to our Current Report on Form 8-K, filed
with the Commission on December 1, 2003).
10(v) Ross Non-Qualified Share Option Agreement (incorporated by reference
to our Registration Statement on Form S-8, filed on November 24,
2003).
119
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10(w) Registration Rights Agreement, dated as of November 17, 2003, by and
among our Company and APH Associates L.P., DLK Associates L.P., Marc
Associates, L.P., Related General II, L.P. and SJB Associates L.P.
(incorporated by reference to our Registration Statement on Form S-8,
filed on November 24, 2003).
10(x) Shared Services Agreement, dated as of November 17, 2003, by and
among The Related Companies, L.P., Related Management Company, and
CharterMac Capital Company (incorporated by reference to our Current
Report on Form 8-K, filed with the Commission on December 1, 2003).
10(y) Other Services Agreement, dated November 17, 2003, by and between
Relcap Holding Company LLC and CharterMac Capital Company, LLC
(incorporated by reference to our Current Report on Form 8-K, filed
with the Commission on December 1, 2003).
10(z) CharterMac Guaranty, dated December 17, 2002 (incorporated by
reference to our Current Report on Form 8-K, filed with the Commission
on December 1, 2003).
10(aa) Restricted Share Plan (incorporated by reference to our Registration
Statement on Form S-8, filed with the Commission on November 24,
2003).
10(ab) Amended and Restated Incentive Share Plan (incorporated by reference
to our Form S-8/A, filed with the Commission on March 2, 2004).
10(ac) Form of Non-Qualified Share Option Award Agreement. (incorporated by
reference to Exhibit 10(af) in our December 31, 2004 Annual Report on
Form 10-K).
10(ad) Form of Restricted Share Award Agreement. (incorporated by reference
to Exhibit 10(ag) in our December 31, 2004 Annual Report on Form
10-K).
10(ae) Separation and consulting agreement with Stuart J. Boesky
(incorporated by reference to our current report on Form 8-K, filed
with the Commission on November 9, 2005).
10(af) Amended And Restated Credit Agreement Dated As Of July 16, 2004 by
and among CharterMac, Charter Mac Corporation, and Fleet National
Bank, As Agent and Lenders, as amended.*
10(ag) Amended and Restated Mortgage Warehousing Credit and Security
Agreement, dated as of March 18, 2005, by and between CharterMac
Mortgage Capital Corporation, Fleet National Bank, a Bank of America
Company, as Agent and Lenders, as amended.*
10(ah) Acquisition Loan Agreement, dated as of December 24, 2001, among
Charter Mac Corporation, as Borrower, Fleet National Bank, as Agent,
and the Lenders, as amended*
10(ai) Ninth Amended and Restated Loan Agreement $90,000,000 Tax Credit
Warehouse Capital Line of Credit to RCC Credit Facility, L.L.C. as
amended*
10(aj) Investment Agreement and Acquisition of Capri Capital Limited
Partnership by CM Investor LLC dated March 11, 2005.*
10(ak) Second Amended and Restated Advisory Services Agreement between
American Mortgage Acceptance Company and CharterMac AMI Associates,
Inc.*
120
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12 Ratio of earnings to fixed charges and preferred dividends.* 124
21 Subsidiaries of our Company.* 125
23 Consent of Independent Registered Public Accounting Firm* 126
31.1 Chief Executive Officer certification pursuant to Section 302 of the
Sarbanes- Oxley Act of 2002.* 127
31.2 Chief Financial Officer certification pursuant to Section 302 of the
Sarbanes- Oxley Act of 2002.* 128
32 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.* 129
* Filed herewith.
121
SIGNATURES
----------
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, we have duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
CHARTERMAC
(COMPANY)
Date: March 15, 2006 By: /s/ Marc D. Schnitzer
---------------------
Marc D. Schnitzer
Managing Trustee, Chief Executive Officer
and President
Date: March 15, 2006 By: /s/ Alan P. Hirmes
------------------
Alan P. Hirmes
Managing Trustee, Chief Operating Officer
and Chief Financial Officer
122
POWER OF ATTORNEY
Each person whose signature appears below hereby constitutes and appoints Marc
D. Schnitzer and Alan P. Hirmes, and each or either of them, his true and lawful
attorney-in-fact with full power of substitution and resubstitution, for him and
in his name, place and stead, in any and all capacities, to sign any and all
amendments to this Annual Report, and to cause the same to be filed, with all
exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, hereby granting to said attorneys-in-fact
and agents, and each of them, full power and authority to do and perform each
and every act and thing whatsoever requisite or desirable to be done in and
about the premises, as fully to all intents and purposes as the undersigned
might or could do in person, hereby ratifying and confirming all acts and things
that said attorneys-in-fact and agents, or either of them, or their substitutes
or substitute, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended,
this report has been signed by the following persons on behalf of us and in the
capacities and on the dates indicated:
Signature Title Date
----------------------- ------------------------------- -------------
/s/ Stephen M. Ross
------------------- Managing Trustee,
Stephen M. Ross Chairman of the Board March 15, 2006
/s/ Alan P. Hirmes
------------------ Managing Trustee,
Alan P. Hirmes Chief Operating Officer and
Chief Financial Officer March 15, 2006
/s/ Peter T. Allen
------------------
Peter T. Allen Managing Trustee March 15, 2006
/s/Andrew L. Farkas
-------------------
Andrew L. Farkas Managing Trustee March 15, 2006
/s/ Thomas W. White
-------------------
Thomas W. White Managing Trustee March 15, 2006
/s/ Marc D. Schnitzer
--------------------- Managing Trustee,
Marc D. Schnitzer Chief Executive Officer
and President March 15, 2006
/s/ Jeff T. Blau
----------------
Jeff T. Blau Managing Trustee March 15, 2006
/s/ Robert A. Meister
---------------------
Robert A. Meister Managing Trustee March 15, 2006
/s/ Jerome Y. Halperin
----------------------
Jerome Y. Halperin Managing Trustee March 15, 2006
/s/ Janice Cook Roberts
-----------------------
Janice Cook Roberts Managing Trustee March 15, 2006
/s/ Nathan Gantcher
-------------------
Nathan Gantcher Managing Trustee March 15, 2006
/s/ Robert L. Loverd
--------------------
Robert L. Loverd Managing Trustee March 15, 2006
123
Exhibit 12
Ratio of Earnings to Combined Fixed Charges and Preference Dividends
(Dollars in thousands)
December 31,
--------------------------------------------------------------------
2005 2004 2003 2002 2001
--------- --------- --------- --------- ---------
Interest expense $ 82,817 $ 52,409 $ 23,919 $ 19,004 $ 16,132
Amortized capitalized costs related to
indebtedness 2,642 3,310 2,163 940 727
Preference security dividend requirements
of consolidated subsidiaries 25,123 22,840 18,897 17,266 12,578
--------- --------- --------- --------- ---------
Total fixed charges $ 110,582 $ 78,559 $ 44,979 $ 37,210 $ 29,437
========= ========= ========= ========= =========
Net income before minority interests $(295,673) $(143,462) $ 64,498 $ 62,613 $ 38,985
Add: Total fixed charges 110,582 78,559 44,979 37,210 29,437
Less: Preference security dividend
requirements of consolidated subsidiaries (25,123) (22,840) (18,897) (17,266) (12,578)
--------- --------- --------- --------- ---------
Earnings $(210,214) $ (87,743) $ 90,580 $ 82,557 $ 55,844
========= ========= ========= ========= =========
Ratio of Earnings to Combined Fixed
Charges and Preference Dividends See NOTE See NOTE 2.0:1 2.2:1 1.9:1
For the purposes of computing the ratio of earnings to fixed charges and
preference dividends, earnings were calculated using income before minority
interest adding back total fixed charges less preference security dividend
requirements of consolidated subsidiaries. Fixed charges consist of interest
expense, recurring fees and amortization of capitalized costs related to
indebtedness and preference security dividend requirements of consolidated
subsidiaries.
NOTE: Earnings (as defined in Regulation S-K) were insufficient to cover
Combined Fixed Charges and Preference Dividends (also as defined in Regulation
S-K) by $320.8 million for the year ended December 31, 2005, and by $166.3
million for the year ended December 31, 2004, yielding a ratio of earnings to
combined fixed charges and preference dividends of -1.9:1 in 2005 and -1.1:1 in
2004. These shortfalls are due to the consolidation of partnerships deemed to be
variable interest entities ("consolidated partnerships") pursuant to Financial
Interpretation 46(R) ("FIN 46(R)"). Pursuant to Regulation S-K, the definition
of Earnings does not permit the subtraction of amounts allocated to minority
interests in consolidated subsidiaries if those subsidiaries incur fixed
charges. The inclusion of the consolidated partnerships in the consolidated
financial statements affected this ratio as follows:
o Combined Fixed Charges and Preference Dividends (which, as defined,
totaled $110.6 million in 2005 and $78.6 million in 2004) includes
consolidated partnership interest expense of $26.3 million in 2005 and
$21.4 million in 2004, although these expenses are paid directly by
the consolidated partnerships; and
o Earnings (which, as defined, was a loss of $210.2 million in 2005 and
$87.7 million in 2004) includes consolidated partnership operating
losses totaling $349.5 million in 2005 and $220.0 million in 2004,
although virtually all such operating losses are absorbed by the
limited partners of the consolidated partnerships.
124
Exhibit 21
Subsidiaries of the Company as of December 31, 2005
---------------------------------------------------
CM Holding Trust, a Delaware statutory trust
CharterMac Equity Issuer Trust, a Delaware statutory trust
CharterMac Corporation, a Delaware corporation
Subsidiaries of CharterMac Equity Issuer Trust, a Delaware business trust
-------------------------------------------------------------------------
CharterMac Origination Trust I, a Delaware statutory trust
CharterMac Owner Trust I, a Delaware statutory trust
Subsidiaries of CharterMac Originatioin Trust I and CharterMac Corporation
--------------------------------------------------------------------------
CharterMac Residual Holder LLC, a Delaware limited liability company
Subsidiaries of CharterMac Corporation
--------------------------------------
CharterMac Mortgage Capital Corp., Inc. a Delaware corporation
CharterMac Capital Company, LLC, a Delaware limited liability company
CM Investor LLC, a Delaware limited liability company
CharterMac Mortgage Partners Corp., a Delaware corporation
Centerbrook Holdings LLC, a Delaware limited liability company
Subsidiaries of CharterMac Capital Company LLC
----------------------------------------------
CharterMac Capital LLC, a Delaware limited liability company (formerly known as
Related Capital Company LLC)
Subsidiaries of CharterMac Capital LLC
--------------------------------------
RCC Manager LLC, a Delaware limited liability company
RCC Credit Facility LLC, a Delaware limited liability company
Subsidiaries of RCC Manager LLC
-------------------------------
CharterMac AMI Associates Inc., a Delaware corporation (formerly known as
Related AMI Associates Inc.)
125
Exhibit 23
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We consent to the incorporation by reference
o in the Registration Statement (Form S-3/A No. 333-120077) of
CharterMac,
o in the Registration Statement (Form S-8 and its post effective
amendment on Form S-8/A No. 333-55957) pertaining to the CharterMac
(formerly known as "Charter Municipal Mortgage Acceptance Company")
Incentive Share Option Plan,
o in the Registration Statement (Form S-3 No. 333-54802) of CharterMac,
o in the Registration Statement (Form S-3 No. 333-109078) of CharterMac,
o in the Registration Statement (Form S-8 No. 333-110722) of CharterMac,
o in the Registration Statement (Form S-3/A and its post effective
amendment on Form POS AM 1 No. 333-111919) of CharterMac.
of our reports dated March 15, 2006, relating to the financial statements and
financial statement schedules of CharterMac and subsidiaries, and management's
report on the effectiveness of internal control over financial reporting
appearing in the Annual Report on Form 10-K of CharterMac and subsidiaries for
the year ended December 31, 2005.
/s/ DELOITTE & TOUCHE LLP
New York, New York
March 15, 2006
126
Exhibit 31.1
CERTIFICATION
I, Marc D. Schnitzer, hereby certify that:
1. I have reviewed this annual report on Form 10-K of CharterMac;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
in order to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal
control over financial reporting (as defined in Exchange Act Rules
13a-15(f) and 15d-15(f)) for the registrant and we have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure the material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this annual report is being prepared;
b) designed such internal control over financial reporting, or caused
such internal control over financial reporting to be designed under our
supervision, to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting
principals;
c) evaluated the effectiveness of the registrant's disclosure controls
and procedures presented in this annual report our conclusions about
the effectiveness of the disclosure controls and procedures, as of the
end of the period covered by this report based on such evaluation; and
d) disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of
registrant's board of directors or persons performing the equivalent
functions:
a) all significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: March 15, 2006 By: /s/ Marc D. Schnitzer
-------------- ---------------------
Marc D. Schnitzer
Chief Executive Officer
127
Exhibit 31.2
CERTIFICATION
I, Alan P. Hirmes, hereby certify that:
1. I have reviewed this annual report on Form 10-K of CharterMac;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
in order to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal
control over financial reporting (as defined in Exchange Act Rules
13a-15(f) and 15d-15(f)) for the registrant and we have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure the material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this annual report is being prepared;
b) designed such internal control over financial reporting, or caused
such internal control over financial reporting to be designed under our
supervision, to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting
principals;
c) evaluated the effectiveness of the registrant's disclosure controls
and procedures presented in this annual report our conclusions about
the effectiveness of the disclosure controls and procedures, as of the
end of the period covered by this report based on such evaluation; and
d) disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of
registrant's board of directors or persons performing the equivalent
functions:
a) all significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: March 15, 2006 By: /s/ Alan P. Hirmes
-------------- ------------------
Alan P. Hirmes
Chief Financial Officer
128
Exhibit 32
CERTIFICATION PURSUANT TO
18.U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of CharterMac (the "Company") on Form 10-K
for the year ending December 31, 2005, as filed with the Securities and Exchange
Commission on the date hereof (the "Report"), I, Marc D. Schnitzer, Chief
Executive Officer of the Company and I, Alan P. Hirmes, Chief Financial Officer
of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
By: /s/ Marc D. Schnitzer By: /s/ Alan P. Hirmes
--------------------- ------------------
Marc D. Schnitzer Alan P. Hirmes
Chief Executive Officer Chief Financial Officer
March 15, 2006 March 15, 2006
A signed original of this written statement required by Section 906 has been
provided to the Company and will be retained by the Company and furnished to the
Securities and Exchange Commission or its staff upon request.
129
CHARTERMAC
SCHEDULE I
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(In thousands)
Summarized condensed financial information of registrant
(not including its consolidated subsidiaries)
CONDENSED BALANCE SHEETS
December 31,
------------------------------
2005 2004
------------ -----------
ASSETS
Mortgage revenue bonds-at fair value $ 81,539 $ 113,024
Cash and cash equivalents 52,791 12,957
Deferred costs - net of amortization of $7,485 and
$5,355 5,095 6,080
Due from subsidiaries 133,162 126,546
Intangible assets - net of amortization of $2,503 and
$2,158 603 949
Investment in subsidiaries 740,289 615,625
Other investments 57,086 25,596
Other assets 9,955 5,752
Loan to affiliate -- 4,600
------------ -----------
Total Assets $1,080,520 $ 911,129
============ ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Accounts payable, accrued expenses and other
liabilities 4,802 4,492
Distributions payable 25,883 23,915
------------ -----------
Total liabilities 30,685 28,407
------------ -----------
Commitments and contingencies
Shareholders' equity:
Beneficial owners equity:
4.4% Convertible CRA preferred shares; no par value
(2,160 shares issued and outstanding in 2005 and
none issued and outstanding in 2004) 104,498 --
Convertible CRA Shares (6,552 shares issued and
outstanding in 2005 and 2004) 104,369 108,745
Special preferred voting shares; no par value
(14,885 shares issued and outstanding in 2005 and
15,172 shares issued and outstanding in 2004) 150 152
Common shares; no par value (100,000 shares
authorized; 52,309 issued and 51,988 outstanding
in 2005 and 51,363 issued and 51,229 outstanding
in 2004) 752,042 773,165
Restricted shares granted (4,193) (7,922)
Treasury shares of beneficial interest - common, at
cost (321 shares in 2005 and 134 shares in 2004) (7,135) (2,970)
Accumulated other comprehensive income 100,104 11,552
------------ -----------
Total shareholders' equity 1,049,835 882,722
------------ -----------
Total liabilities and shareholders' equity $1,080,520 $ 911,129
============ ===========
See accompanying notes to financial statements
130
CHARTERMAC
SCHEDULE I
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED STATEMENTS OF OPERATIONS
Years Ended December 31,
--------------------------------------
2005 2004 2003
---------- ---------- ----------
(In thousands)
Revenues:
Mortgage revenue bond interest income $ 7,267 $ 7,948 $ 8,309
Other revenues 8,591 4,212 4,191
---------- ---------- ----------
Total revenues 15,858 12,160 12,500
---------- ---------- ----------
Expenses:
Interest expense 4 35 --
General and administrative 8,503 6,958 7,146
Depreciation and amortization 1,895 1,630 1,140
Loss on impairment of assets 296 147 --
---------- ---------- ----------
Total expenses 10,698 8,770 8,286
---------- ---------- ----------
Income before equity in earnings of subsidiaries
and investments and loss on repayment of mortgage revenue bonds 5,160 3,390 4,214
Equity in earnings of subsidiaries 50,874 59,792 60,604
Equity in earnings of investments 3,038 2,219 2,219
Loss on repayment of mortgage revenue bonds (58) (38) (451)
---------- ---------- ----------
Net income $ 59,014 $ 65,363 $ 66,586
========== ========== ==========
Allocation of net income to:
Special distribution to Manager $ -- $ -- $ 5,332
---------- ---------- ----------
Manager $ -- $ -- $ 6
---------- ---------- ----------
4.4% Convertible CRA preferred shareholders $ 2,020 $ -- $ --
Common shareholders $ 50,558 $ 56,786 $ 54,608
Convertible CRA shareholders $ 6,436 8,577 6,640
---------- ---------- ----------
Total $ 59,014 $ 65,363 $ 61,248
---------- ---------- ----------
See accompanying notes to financial statements
131
CHARTERMAC
SCHEDULE I
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED STATEMENTS OF CASH FLOWS
Years Ended December 31,
----------------------------------------
2005 2004 2003
---------- ---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 59,014 $ 65,363 $ 66,586
Adjustments to reconcile net income to net cash used in
operating activities:
Loss on repayment of mortgage revenue bonds 58 38 451
Loss on impairment of assets 296 147 --
Depreciation and amortization 1,895 1,630 1,140
Equity in earnings of subsidiaries (50,874) (59,792) (60,604)
Non-cash compensation expense 8,661 597 --
Other non-cash expense 1,107 525 1,534
Changes in operating assets and liabilities:
Other assets (4,595) 180 (205)
Accounts payable, accrued expenses and other liabilities (3,300) (5,752) (3,354)
Loans to affiliates 4,600 (4,600) --
Due to / from subsidiaries (6,616) (25,275) (59,963)
--------- --------- ---------
Net cash provided by (used in) operating activities 10,246 (26,939) (54,415)
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Repayments of mortgage revenue bonds and notes 17,518 2,935 18,006
Mortgage revenue bond acquisitions and fundings (3,405) (2,390) (12,708)
Deferred investment acquisition costs (47) -- (767)
Investment in subsidiaries 38,398 3,108 29,135
Other investments (34,494) (742) (3,631)
--------- --------- ---------
Net cash provided by investing activities 17,970 2,911 30,035
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Distributions to shareholders (96,582) (84,395) (65,121)
Issuance of common shares and convertible CRA shares -- 110,803 107,500
Issuance of preferred shares 108,000 -- --
Proceeds from stock options exercised 3,804 308 1,651
Retirement of special preferred voting shares (2) (10) --
Deferred financing costs (3,602) (6,484) (7,261)
--------- --------- ---------
Net cash provided by financing activities 11,618 20,222 36,769
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents 39,834 (3,806) 12,389
Cash and cash equivalents at the beginning of the period 12,957 16,763 4,374
--------- --------- ---------
Cash and cash equivalents at the end of the period $ 52,791 $ 12,957 $ 16,763
========= ========= =========
Supplemental information
Supplemental disclosure of non-cash activities:
Contribution of mortgage revenue bonds to subsidiaries $ 15,715 $ -- $ 69,266
========= ========= =========
Distribution of mortgage revenue bonds from subsidiaries $ -- $ 12,664 $ --
========= ========= =========
See accompanying notes to financial statements
132
CHARTERMAC
SCHEDULE I
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
NOTES TO CONDENSED FINANCIAL STATEMENTS
1. Introduction and Basis of Presentation
Basis of Financial Information
The accompanying condensed financial statements (the "Parent Company Financial
Statements") are for CharterMac (not including its subsidiaries).
The Parent Company Financial Statements, including the notes thereto, should be
read in conjunction with our consolidated financial statements and the notes
thereto which are included in this Form 10-K.
2. Cash Dividends received from subsidiaries
The table below reflects the cash dividends received for each of the last three
fiscal years from subsidiaries and 50% or less owned persons accounted for under
the equity method.
(In thousands) 2005 2004 2003
-------- -------- --------
Consolidated subsidiaries CMC $ -- $2,200 $1,942
Equity method ARCap 2,219 2,219 2,219
3. Guarantees
In connection with the CMC warehouse line, both we and our subsidiary, CM Corp.,
have entered into guarantees for the benefit of Bank of America, 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 CMC warehouse
line.
133
Schedule II
Valuation and Qualifying Accounts
December 31, 2005
Additions
-------------------------
Charged to
Balance at Charged to Other Balance at
(in thousands) beginning of costs and Accounts - Deductions - end of
Description period expenses Describe Describe period
------------------------------- ------------ ----------- ----------- ------------- ----------
Allowance for Doubtful Accounts
2005 $ 2,379 $ 2,555 $ -- $ 537 (1) $ 4,397
2004 107 2,272 -- -- 2,379
2003 -- 107 -- -- 107
(1) Reversal of reserves for 3 investment funds.
134