UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
----- EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2006
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)
(212) 317-5700
Registrant's telephone number, including area code
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is 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]
As of October 31, 2006, there were 51,295,584 outstanding shares of the
registrant's shares of beneficial interest.
TABLE OF CONTENTS
CHARTERMAC
FORM 10-Q
PAGE
PART I
Item 1. Financial Statements 3
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 36
Item 3. Quantitative and Qualitative Disclosures about Market Risk 56
Item 4. Controls and Procedures 57
PART II
Item 1. Legal Proceedings 59
Item 1A. Risk Factors 59
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 60
Item 3. Defaults Upon Senior Securities 60
Item 4. Submission of Matters to a Vote of Security Holders 60
Item 5. Other Information 60
Item 6. Exhibits 60
SIGNATURES 61
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CHARTERMAC AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
September 30, December 31,
2006 2005
------------- -------------
(Unaudited)
ASSETS
Cash and cash equivalents $ 142,240 $ 161,295
Restricted cash 14,301 34,025
Mortgage revenue bonds-at fair value 2,505,706 2,294,787
Other investments 291,541 298,590
Goodwill and intangible assets, net 552,677 439,175
Other assets, net 185,798 144,670
Investments held by consolidated partnerships 4,577,835 3,025,762
Other assets of consolidated partnerships 730,293 580,524
----------- -----------
Total assets $ 9,000,391 $ 6,978,828
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Financing arrangements $ 1,730,629 $ 1,429,692
Preferred shares of subsidiary (subject to mandatory
repurchase) 273,500 273,500
Notes payable 399,837 304,888
Accounts payable, accrued expenses and other liabilities 244,443 179,275
Notes payable and other liabilities of consolidated
partnerships 2,369,289 1,627,556
----------- -----------
Total liabilities 5,017,698 3,814,911
----------- -----------
Minority interests in consolidated subsidiaries 251,940 262,274
----------- -----------
Preferred shares of subsidiary (not subject to mandatory
repurchase) 104,000 104,000
----------- -----------
Partners' interests in consolidated partnerships 2,627,758 1,747,808
----------- -----------
Commitments and contingencies
Shareholders' equity:
Beneficial owners equity:
4.4% Convertible CRA preferred shares; no par value;
2,160 shares issued and outstanding in 2006 and 2005 104,498 104,498
Convertible CRA shares; no par value; 6,552 shares issued
and outstanding in 2006 and 2005 99,470 104,369
Special preferred voting shares; no par value (14,825
shares issued and outstanding in 2006 and 14,885 shares
issued and outstanding in 2005) 149 150
Common shares; no par value (160,000 shares authorized;
52,603 issued and 51,315 outstanding in 2006 and 52,309
issued and 51,988 outstanding in 2005) 718,470 752,042
Restricted shares granted -- (4,193)
Treasury shares of beneficial interest - common, at cost
(1,288 shares in 2006 and 321 shares in 2005) (25,393) (7,135)
Accumulated other comprehensive income 101,801 100,104
----------- -----------
Total shareholders' equity 998,995 1,049,835
----------- -----------
Total liabilities and shareholders' equity $ 9,000,391 $ 6,978,828
=========== ===========
See accompanying notes to condensed consolidated financial statements.
3
CHARTERMAC AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -----------------------
2006 2005 2006 2005
--------- --------- --------- ---------
Revenues:
Mortgage revenue bond interest income $ 39,370 $ 36,096 $ 115,109 $ 109,524
Other interest income 7,570 3,986 20,089 10,828
Fee income 29,027 24,402 63,370 58,686
Other revenues 7,243 7,011 18,401 16,829
Revenues of consolidated partnerships 23,809 7,349 41,420 19,403
--------- --------- --------- ---------
Total revenues 107,019 78,844 258,389 215,270
--------- --------- --------- ---------
Expenses:
Interest expense 25,457 13,490 66,650 38,421
Interest expense of consolidated partnerships 12,982 6,342 25,539 19,364
Interest expense - distributions to preferred
shareholders of subsidiary 4,724 4,724 14,173 14,173
General and administrative 43,678 30,370 116,105 89,650
Depreciation and amortization 11,033 16,302 34,561 33,467
Write-off of intangible assets 2,547 -- 2,547 --
Loss on impairment of assets 394 804 2,665 1,902
Other expenses of consolidated partnerships 18,480 14,285 50,019 38,950
--------- --------- --------- ---------
Total expenses 119,295 86,317 312,259 235,927
--------- --------- --------- ---------
Loss before other income (12,276) (7,473) (53,870) (20,657)
Equity and other (loss) income (3,320) 414 738 1,490
Gain on sale or repayment of loans and mortgage
revenue bonds 8,289 3,962 16,257 10,886
Loss on investments held by consolidated partnerships (68,996) (65,353) (209,075) (181,915)
--------- --------- --------- ---------
Loss before allocations and income taxes (76,303) (68,450) (245,950) (190,196)
Income allocated to preferred shareholders of subsidiary (1,556) (1,557) (4,669) (4,669)
Minority interests in consolidated subsidiaries, net of tax (5,771) (7,626) (13,301) (21,572)
Loss allocated to partners of consolidated partnerships 105,434 91,295 301,305 255,628
--------- --------- --------- ---------
Income before income taxes 21,804 13,662 37,385 39,191
Income tax (provision) benefit (7,233) 5,016 (3,909) 13,716
--------- --------- --------- ---------
Net income
$ 14,571 $ 18,678 $ 33,476 $ 52,907
========= ========= ========= =========
Allocation of net income to:
4.4% Convertible CRA preferred shareholders $ 1,188 $ 832 $ 3,564 $ 832
Common shareholders 12,011 15,832 26,568 46,185
Convertible CRA shareholders 1,372 2,014 3,344 5,890
--------- --------- --------- ---------
Total $ 14,571 $ 18,678 $ 33,476 $ 52,907
========= ========= ========= =========
Net income per share:
Basic $ 0.23 $ 0.31 $ 0.51 $ 0.90
========= ========= ========= =========
Diluted $ 0.23 $ 0.31 $ 0.51 $ 0.89
========= ========= ========= =========
Weighted average shares outstanding:
Basic 58,015 58,059 58,409 57,927
========= ========= ========= =========
Diluted 58,396 58,366 58,830 58,234
========= ========= ========= =========
Dividends declared per share
$ 0.42 $ 0.41 $ 1.26 $ 1.23
========= ========= ========= =========
See accompanying notes to condensed consolidated financial statements.
4
CHARTERMAC AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
Nine Months Ended September 30,
-------------------------------
2006 2005
-------------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 33,476 $ 52,907
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization 34,561 33,467
Income allocated to minority interests in consolidated subsidiaries 13,301 21,572
Income allocated to preferred shareholders of subsidiary 4,669 4,669
Gain on repayment of loans and mortgage revenue bonds (1,879) (1,930)
Loss on impairment of assets 2,665 1,902
Write-off of intangible assets 2,547 --
Equity in income of unconsolidated entities (738) (1,490)
Distributions received from equity investees 4,469 1,664
Mortgage servicing rights (7,046) (9,666)
Non-cash compensation expense 12,583 5,983
Deferred taxes 3,153 (12,312)
Reserves for bad debts 28,038 16,091
Other non-cash income (1,368) (1,890)
Changes in operating assets and liabilities:
Mortgage loans held for sale 94,668 (45,794)
Deferred revenues 16,645 11,113
Interest, fees and other receivables (70,354) (63,120)
Loan to affiliate -- 4,600
Other assets (6,042) 7,322
Accounts payable, accrued expenses and other liabilities 34,290 8,012
--------- ---------
Net cash provided by operating activities 197,638 33,100
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Mortgage revenue bond acquisitions and fundings (298,285) (225,159)
Principal amortization and repayments of mortgage revenue bonds 82,091 84,210
Acquisitions, net of cash acquired (262,800) (290)
Investments in notes receivable (1,986) --
Repayments of notes receivable 48,732 --
Advances to partnerships (119,350) (97,181)
Collection of advances to partnerships 126,781 104,742
Loans to Capri Capital -- (8,011)
Decrease (increase) in cash and cash equivalents - restricted 19,881 (8,552)
Investments in marketable securities (23,428) --
Return of capital from equity investee 11,667 --
Deferred investment acquisition costs, net of reimbursements (5,334) 528
Other investing activities (23,743) (7,900)
--------- ---------
Net cash used in investing activities (445,774) (157,613)
--------- ---------
(continued)
See accompanying notes to condensed consolidated financial statements.
5
CHARTERMAC AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
Nine Months Ended September 30,
-------------------------------
2006 2005
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from financing arrangements 1,243,413 315,310
Repayments of financing arrangements (974,989) (155,360)
Increase (decrease) in notes payable 93,982 (1,082)
Distributions to shareholders (77,822) (71,747)
Distributions to minority interest holders (26,681) (25,963)
Distributions to preferred shareholders of subsidiary (4,669) (4,669)
Treasury stock purchases (17,822) (2,479)
Issuance of preferred shares -- 108,000
Minority interest contribution 3,300 --
Proceeds from stock options exercised -- 248
Retirement of minority interests (723) (2)
Deferred financing costs (8,908) (3,190)
----------- -----------
Net cash provided by financing activities 229,081 159,066
----------- -----------
Net (decrease) increase in cash and cash equivalents (19,055) 34,553
Cash and cash equivalents at the beginning of the year 161,295 71,287
----------- -----------
Cash and cash equivalents at the end of the period $ 142,240 $ 105,840
=========== ===========
Acquisition activity:
Conversion of existing investments $ 13,997 $ 70,000
Non-cash minority interests issued 4,859 7,500
Assets acquired (345,047) (90,530)
Liabilities assumed 63,391 16,940
Minority interests redeemed -- (4,200)
----------- -----------
Net cash paid for acquisitions $ (262,800) $ (290)
=========== ===========
Non-cash investing and financing activities:
Share grants $ 39,150 $ 1,494
----------- -----------
Conversion of SCUs and SMUs to common shares $ 1,954 $ 3,271
----------- -----------
Issuance of SMUs in exchange for investment $ -- $ 11,576
----------- -----------
Cancellation of acquisition - related SMUs $ (2,497) $ --
----------- -----------
Treasury stock purchases via employee withholding $ 436 $ 2,479
----------- -----------
See accompanying notes to condensed consolidated financial statements.
6
CHARTERMAC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION
The unaudited condensed consolidated financial statements include the accounts
of CharterMac, its wholly owned and majority owned subsidiary statutory trusts,
other non-trust subsidiary companies it controls and entities consolidated
pursuant to the adoption of FASB Interpretation No. 46(R) ("FIN 46(R)"). All
intercompany accounts and transactions have been eliminated in consolidation.
Unless otherwise indicated, "the Company", "we", "our" and "us", as used
throughout this document, refers to CharterMac and its consolidated
subsidiaries. For certain of the entities identified throughout this document as
"consolidated partnerships", the financial information included is as of and for
the periods ended June 30, 2006, the latest practical date available (see Note
10).
During June 2006, we created a new subsidiary, Centerbrook Financial LLC
("Centerbrook") to provide credit intermediation products to the housing finance
industry. We own 90% of Centerbrook's direct parent and IXIS Capital Markets
North America Inc. ("IXIS"), an unrelated party, owns the remainder. In August
2006, we acquired ARCap Investors, L.L.C. ("ARCap") (see Note 2).
The accompanying interim condensed consolidated financial statements have been
prepared without audit. In the opinion of management, the financial statements
contain all adjustments (consisting of only normal recurring adjustments)
necessary to present fairly the financial statements of the interim periods.
Given the seasonal nature of our business, the operating results for the interim
periods may not be indicative of the results for the full year.
Certain information and footnote disclosures normally included in the annual
consolidated financial statements prepared in accordance with accounting
principles generally accepted in the United States of America ("GAAP") have been
condensed or omitted. It is suggested that these unaudited condensed
consolidated financial statements be read in conjunction with the consolidated
financial statements and notes thereto included in our Form 10-K for the year
ended December 31, 2005. That filing on Form 10-K contains a summary of our
significant accounting policies. There have been no material changes to these
items since December 31, 2005, except with respect to policies associated with
ARCap as discussed below. New accounting pronouncements pending adoption that
may have a significant impact on our unaudited condensed consolidated financial
statements are also described below.
We are responsible for the unaudited condensed consolidated financial statements
included in this document. Our unaudited condensed consolidated financial
statements are prepared on the accrual basis of accounting in accordance with
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.
Certain amounts from prior years have been reclassified to conform to the 2006
presentation.
ADDITIONS TO SIGNIFICANT ACCOUNTING POLICIES
The following represent new significant accounting policies to the Company as a
result of the ARCap acquisition:
INVESTMENT SECURITIES
We hold investments in resecuritization certificates, and funds that we
consolidate hold commercial mortgage-backed securities ("CMBS") and
resecuritization certificates. We classify these investments as available for
sale as we may sell them or dispose of them prior to maturity. As such, we
carry these investments at their estimated fair values, and report unrealized
gains and losses in other comprehensive income. We evaluate any unrealized
losses to determine if the declines in fair value are other-than-temporary;
if so, the decline in fair value is recorded as an impairment to the security
and charged to earnings. We generally estimate the fair value of the CMBS
based on market prices provided by certain dealers who make a market in these
financial instruments. The market for the classes of CMBS that our funds hold
may lack liquidity and have limited market volume.
We adjust the amortized cost of securities for accretion of discounts to
maturity. We compute accretion using the effective-interest method over the
expected life of the securities based on our estimates regarding the timing
and amount of cash flows from the underlying collateral. The timing and
amount of actual cash flows may differ from these estimates. We include the
accretion of these discounts in other interest income on the condensed
consolidated statements of income.
7
CHARTERMAC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
The yield to maturity on CMBS and resecuritization certificates depends on,
among other things, the rate and timing of principal payments, the
pass-through rate, and interest rate fluctuations. Our subordinate CMBS
interests and resecuritization certificates provide credit support to the
more senior interests of the related commercial securitization. Cash flow
from the mortgages underlying the CMBS interests and resecuritization
certificates generally is allocated first to the senior interests and then
among the other CMBS interests and resecuritization certificates in order of
relative seniority. To the extent that there are defaults and unrecoverable
losses on the underlying mortgages that result in reduced cash flows, the
most subordinate CMBS interest and resecuritization certificate will bear
this loss first, with excess losses borne by the remaining CMBS interests and
resecuritization certificates in order of relative subordination.
DEFERRED REVENUE
We record loan commitment fees as deferred revenue net of direct costs
associated with closing the related loan and recognize them as interest
income using the effective-interest method over the life of the related loan,
in accordance with SFAS No. 91, ACCOUNTING FOR NONREFUNDABLE FEES AND COSTS
ASSOCIATED WITH ORIGINATING OR ACQUIRING LOAN AND INITIAL DIRECT COSTS OF
LEASES.
RESALE AND REPURCHASE AGREEMENTS
We account for transactions involving purchases of securities under
agreements to resell (reverse repurchase agreements or reverse repos) or
sales of securities under agreements to repurchase (repurchase agreements
or repos) as collateralized financing liabilities, except when we do not
have an agreement to sell (or purchase) the same or substantially the same
securities before maturity at a fixed or determinable price.
NEW ACCOUNTING PRONOUNCEMENTS
In November 2005, the FASB issued Staff Position 115 / 124 - 1, THE MEANING OF
OTHER-THAN-TEMPORARY IMPAIRMENT AND ITS APPLICATION TO CERTAIN INVESTMENTS. The
Staff Position clarified, among other matters, the determination as to when an
unrealized loss on debt securities should be reflected in the income statement
as opposed to accumulated other comprehensive income. The Staff Position was
effective as of the first quarter of 2006. Application of the Staff Position had
no material impact on our results of operations.
During the first quarter of 2006, we adopted Statement of Financial Accounting
Standards No. 123(R), SHARE-BASED PAYMENT ("SFAS No. 123(R)") which replaces
SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION ("SFAS No. 123"). Among
other things, SFAS No. 123(R) requires that companies record the value of stock
option grants as compensation expense, while SFAS No. 123 allowed disclosure of
the impact instead of recording the expense. As we had been accounting for
share-based payments as an expense following the fair value provisions of SFAS
No. 123, the impact of adopting this standard was not material to us. See also
Note 13.
In March 2006, the FASB issued Statement of Financial Accounting Standards No.
156, ACCOUNTING FOR SERVICING OF FINANCIAL Assets ("SFAS No. 156"). SFAS No. 156
stipulates the accounting for mortgage servicing rights ("MSRs") and requires
that they be recorded initially at fair value. SFAS No. 156 also permits, but
does not require, that we may subsequently record those MSRs at fair value with
changes in fair value recognized in the statement of operations. Alternatively,
we may continue to amortize the MSRs over their projected service periods. We
will adopt SFAS No. 156, as required, in the first quarter of 2007 and do not
expect any material impact in our financial statements as we intend to continue
amortization of our MSRs.
In June 2006, the FASB issued Interpretation 48, ACCOUNTING FOR UNCERTAINTY IN
INCOME TAXES. The Interpretation sets a standard for recognizing tax benefits in
a company's income statement based on a determination whether it is likely or
not that the position would withstand audit, without regard for the likelihood
of an audit taking place. Assuming a position meets the "more-likely-than-not"
threshold, the Interpretation also prescribes measurement standards requiring
determination of how much of the tax position would ultimately be allowed if
challenged. The Interpretation will be effective in the first quarter of 2007.
We are currently determining the impact of the Interpretation on our financial
statements.
In September 2006, the FASB issued Statement of Financial Accounting Standards
No. 157, FAIR VALUE MEASUREMENTS, which established a framework for calculating
the fair value of assets and liabilities as required by numerous other
accounting pronouncements, and expands disclosure requirements of the fair
values of certain assets and liabilities. The statement is effective as of our
2008 fiscal year. We are currently evaluating the impact, if any, that the
adoption of this Statement will have on our financial statements.
8
CHARTERMAC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
NOTE 2 - ACQUISITIONS AND DISPOSITION
A. ARCAP
On August 15, 2006, we acquired all of the membership interests in ARCap that we
had not previously owned (see Note 4). ARCap is a fund manager specializing in
the acquisition, management and servicing of high-yield CMBS. The total purchase
price of approximately $275.0 million included:
o cash of approximately $263.3 million, including transaction costs;
o 267,755 Special Common Interests ("SCIs") of a subsidiary (see Note
11) with a value of approximately $4.9 million; and
o the remaining basis of our prior investment in ARCap (approximately
$6.8 million), which had been reduced by distributions accounted for
as returns of capital.
Of the total purchase price, $22.5 million has been placed into escrow, which
amounts will be released based on certain future events, some of which are not
under our control. Should the events not under our control occur, up to $7.5
million of the amount held back could revert to us. These contingencies will
expire by 2008.
The cash portion of the acquisition and associated acquisition costs were funded
by a new credit facility (see Note 7). In connection with the acquisition, we
also issued approximately 1.7 million restricted common shares to ARCap
employees (see Note 13).
We accounted for the acquisition as a purchase, and accordingly, we included the
results of operations in the condensed 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 and liabilities assumed. We valued
intangible assets based on appraisals by independent valuation firms. The excess
of the purchase price over the net amounts assigned to the assets acquired,
including identified intangibles, and the liabilities assumed was recognized as
goodwill of approximately $111.5 million. Allocations are preliminary and will
be refined prior to August 2007.
The following table summarizes the assets acquired and the liabilities assumed
in connection with the ARCap acquisition (in thousands):
Cash and cash equivalents $ 720
Restricted cash 156
Other investments 132,746
Other intangible assets 18,908
Deferred costs and other assets 16,062
Net assets of consolidated partnerships 45,504
Financing arrangements (32,513)
Accounts payable, accrued expenses and other liabilities (18,023)
---------
Net assets acquired $ 163,560
=========
Pro Forma results of operations assuming we had consummated the acquisition on
January 1, 2005, are as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- -------------------
(In thousands, except per share amounts) 2006 2005 2006 2005
---------------------------------------- -------- -------- -------- --------
Total revenues $126,281 $110,773 $346,536 $306,977
Net income $ 26,929 $ 45,049 $ 69,493 $ 80,404
Net income per share:
Basic $ 0.44 $ 0.76 $ 1.13 $ 1.37
Diluted $ 0.42 $ 0.73 $ 1.09 $ 1.35
9
CHARTERMAC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
B. CHARTERMAC REAL ESTATE SECURITIES
Effective March 1, 2006, we acquired Capri Real Estate Services from Capri
Capital Advisors LLC ("CCA"), and renamed it CharterMac Real Estate Securities
("CRES"). CRES is a manager of hedge funds and other funds concentrating on
investing in securities of publicly traded real estate trusts operating
companies.
The consideration paid was approximately $7.3 million. The consideration
included the redemption of the preferred interest we held in CCA, valued at $4.1
million, plus approximately $3.2 million of costs and advances we had made to
CCA with respect to this business (see Note 4).
We accounted for the acquisition as a purchase and, accordingly, we included the
results of operations in the condensed 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 and liabilities assumed. The excess of
the purchase price over the net of the amounts assigned to the assets acquired
and liabilities assumed was recognized as goodwill of approximately $6.1
million.
In October 2006, we decided to cease operations at CRES. As part of an agreement
with CRES' founder, certain convertible SMUs that we had issued (see Note 11)
will be returned and others held in escrow will be cancelled. In addition, he
will assume CRES' line of credit and we will bear the cost of operating the
business until the closure is completed. In connection with this agreement, we
reduced goodwill by $2.5 million for the cancellation of the SMUs held in
escrow. We also recognized a goodwill impairment charge of approximately $0.9
million to account for the portion of our total investment in and advances to
CRES that we do not expect to recover and wrote-off the $1.6 million unamortized
balance of other intangible assets recognized at the time of the acquisition.
While we expect there will be incremental charges relating to closing this
business, the costs are not expected to be material.
Pro forma information is not presented for the acquisition or discontinuance as
this business is not material to our revenues, net income or assets.
NOTE 3 - MORTGAGE REVENUE BONDS
A. SUMMARY
The following table summarizes our mortgage revenue bond portfolio:
September 30, December 31,
(In thousands) 2006 2005
----------------------------------- ------------- ------------
Amortized cost basis $ 2,638,890 $ 2,417,185
Gross unrealized gains 122,151 116,541
Gross unrealized losses (17,804) (11,424)
----------- -----------
Subtotal/fair value 2,743,237 2,522,302
Less: eliminations (1) (237,531) (227,515)
----------- -----------
Total fair value per balance sheet $ 2,505,706 $ 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.
10
CHARTERMAC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
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:
Less than 12 Months
(Dollars in thousands) 12 Months or More Total
----------------------- --------- --------- ---------
SEPTEMBER 30, 2006
Number of bonds 52 52 104
Fair value $344,869 $372,666 $717,535
Gross unrealized loss $ 8,487 $ 9,317 $ 17,804
--------------------------------------
DECEMBER 31, 2005
Number of bonds 36 55 91
Fair value $253,063 $327,183 $580,246
Gross unrealized loss $ 6,775 $ 4,649 $ 11,424
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 the current
rate on our recent bond issuances; as rates rise, the fair value of our
portfolio decreases. We have the intent and ability to hold these bonds to
recovery and have therefore concluded that these declines in value are
temporary.
The following summarizes the maturity dates of mortgage revenue bonds we held as
of September 30, 2006:
Weighted
Outstanding Average
(In thousands) Bond Amount Fair Value Interest Rate
------------------------------ ----------- ----------- -------------
Due in less than one year $ 10,218 $ 10,223 6.36%
Due between one and five years 54,493 53,278 6.58
Due after five years 2,574,753 2,679,736 6.66
----------- ----------- -------
Total / weighted average 2,639,464 2,743,237 6.65%
=======
Less: eliminations (1) (236,797) (237,531)
----------- -----------
Total $ 2,402,667 $ 2,505,706
=========== ===========
(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.
B. PORTFOLIO ACTIVITY
The following table summarizes our acquisition activity for the nine months
ended September 30, 2006 (excluding bonds refinanced during the period):
Weighted Weighted
Average Average
Face Construction Permanent
(In thousands) Amount Interest Rate Interest Rate
-------------------------------------- -------- ------------- -------------
Construction/rehabilitation properties $285,745 6.51% 6.04%
Additional funding of existing bonds 12,540 5.30 5.36
-------- ------- -------
Total $298,285 6.46% 6.01%
======== ======= =======
11
CHARTERMAC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
The following table summarizes mortgage revenue bonds repaid during the nine
months ended September 30, 2006 (excluding bonds refinanced during the period):
Net Book Realized
(In thousands) Value Proceeds Gains (Losses)
--------------------------------- --------- --------- --------------
Participating, stabilized $17,810 $18,725 $ 915
Non-participating, stabilized 21,753 21,585 (168)
Non-participating, not stabilized 19,436 19,182 (254)
------- ------- -------
Total $58,999 $59,492 $ 493
======= ======= =======
C. SECURITIZED OR PLEDGED ASSETS
At September 30, 2006, mortgage revenue bonds with an aggregate fair value of
$2.2 billion were securitized or pledged as collateral in relation to financing
arrangements. Of these, 21 bonds with a fair value of approximately $237.5
million are eliminated in consolidation as noted in the tables above.
D. IMPAIRMENT
During 2006, we recognized approximately $2.7 million of mortgage revenue bond
impairment charges in light of substandard performance at six underlying
properties. For one of the properties, we reached an agreement with the general
partner whereby he relinquished control of the property, and for two others we
revised the terms of the bonds to reduce the interest rates.
See also Note 18 regarding the status of other mortgage revenue bonds in our
portfolio for which we have assumed the general partner interest in the
associated property-level partnership, and Note 19 regarding others for which we
will be assuming the general partnership interest.
NOTE 4 - OTHER INVESTMENTS
Investments other than mortgage revenue bonds consisted of:
September 30, December 31,
(In thousands) 2006 2005
-------------------------------------------------- ------------ -----------
Investment in equity interests in LIHTC properties $ 39,083 $ 46,985
Investment in properties under development 4,771 4,300
Investment in ARESS 1,469 --
CCA loans and preferred stock -- 26,884
Investment in CUC 238 --
Mortgage loans held for sale 58,637 153,277
Resecuritization certificates 103,922 --
Notes receivable 47,032 32,670
Marketable securities 24,731 1,249
Investment in ARCap -- 19,874
Other 11,658 13,351
-------- --------
Total other investments $291,541 $298,590
======== ========
A. ARESS
We own approximately 5% of ARCap Real Estate Special Situations Mortgage Fund,
LLC ("ARESS") which commenced operations in May 2006. We account for this
investment under the equity method due to our ability to exercise influence over
its operations.
B. CCA AND CUC
The balance of "CCA loans and preferred stock" at December 31, 2005, included a
participating loan which was convertible into a 49% ownership interest in CCA.
In September 2006, CCA repaid the loan in full and paid us an additional $6.0
million to terminate our rights relating to the conversion of the loan into an
ownership interest. As part of this agreement, CCA transferred to us its
12
CHARTERMAC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
interest in Capri Urban Capital LLC, which we renamed CharterMac Urban Capital
LLC ("CUC"). CUC is an entity through which we now provide investment advisory
services to CalPERS, focusing on investments in multifamily and commercial
properties in major urban markets. We recognized the value of the general
partner interest in CUC (approximately $900,000) as an intangible asset (see
Note 5). Our general partner interest includes a co-investment obligation
amounting to 2.5% of capital invested (see Note 18). We recorded a total gain on
the transaction of approximately $6.9 million, including the termination payment
and the value of the intangible asset.
The balance of "CCA loans and preferred stock" also included $4.1 million of
preferred stock that was redeemed and $2.7 million of advances that were
forgiven as part of the purchase price of CRES (see Note 2).
C. MORTGAGE LOANS HELD FOR SALE
The balance of mortgage loans held for sale fluctuates based on origination
volume and the timing of corresponding sales. The December 31, 2005 balance
reflects a high level of December 2005 origination volume, which mortgages were
sold in the first quarter of 2006.
D. RESECURITIZATION CERTIFICATES
Resecuritization certificates we hold (not including the certificates held at
the fund level detailed in Note 10) were comprised of the following as of
September 30, 2006:
Accreted Percentage of
(In thousands) Face Cost Fair Value Fair Value
--------------------------- -------- --------- ---------- -------------
Security rating:
AAA interest only $ -- $ 17,647 $ 23,010 22.1%
AAA 26,150 13,257 25,360 24.4
BBB+ 12,536 4,947 9,062 8.7
BBB 9,402 3,379 6,169 6.0
BBB- 9,402 2,918 5,605 5.4
BB+ 24,454 3,722 12,376 11.9
BB 8,501 1,097 3,460 3.3
BB- 11,635 1,310 4,043 3.9
B+ 13,273 701 2,836 2.7
B 11,487 570 1,772 1.7
B- 11,635 532 1,643 1.6
Non-rated 75,526 164 8,090 7.8
Non-rated interest only -- 249 496 0.5
-------- -------- -------- -------
$214,001 $ 50,493 $103,922 100.0%
======== ======== ======== =======
E. NOTES RECEIVABLE
At December 31, 2005, "Notes receivable" included a $26.0 million investment in
a mortgage loan in which we had co-invested with American Mortgage Acceptance
Company ("AMAC"), an affiliated, publicly traded real estate investment trust we
manage (which had invested an additional $5.0 million pursuant to a Subordinated
Participation Agreement). During April 2006, we sold the investment to AMAC at
its approximate par value and subsequently assigned the fair value hedge
associated with the investment (see Note 8).
Notes receivable at September 30, 2006 primarily represent the fair value of
investments in first-mortgage and mezzanine loans originated through ARCap,
including a $27.3 million co-investment with AMAC.
F. MARKETABLE SECURITIES
Marketable securities at September 30, 2006, included $23.3 million of
investments Centerbrook maintained in cash accounts with maturities in excess of
90 days.
13
CHARTERMAC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
G. INVESTMENT IN ARCAP AND OTHER
In August 2006, we acquired the interests in ARCap which we had not previously
owned (see Note 2) and incorporated our basis in the previous investment in the
purchase price.
Other investments at September 30, 2006, and December 31, 2005, included $5.0
million invested in a fund we sponsored through CRES, which we do not
consolidate in our condensed consolidated financial statements. We will
liquidate this investment in the fourth quarter of 2006 in connection with our
closure of CRES (see Note 2). See Note 19 regarding subsequent liquidation.
NOTE 5 - GOODWILL AND OTHER INTANGIBLE ASSETS, NET
Goodwill and other intangible assets consisted of the following:
September 30, December 31,
(In thousands) 2006 2005
------------------------------ ------------ ------------
Goodwill $349,418 $235,684
Other intangible assets, net 130,471 141,301
Mortgage servicing rights, net 72,788 62,190
-------- --------
Total $552,677 $439,175
======== ========
A. GOODWILL
The following table provides information regarding goodwill by segment:
Fund Mortgage
(In thousands) Management Banking Total
----------------------------- ---------- --------- ---------
Balance at December 31, 2005 $ 197,937 $ 37,747 $ 235,684
Additions 106,337 11,405 117,742
Reductions (4,008) -- (4,008)
--------- --------- ---------
Balance at September 30, 2006 $ 300,266 $ 49,152 $ 349,418
========= ========= =========
The increase in goodwill for both segments relates to the acquisitions of CRES
(in Fund Management) and ARCap (in Fund Management and Mortgage Banking) (see
Note 2). The reduction in Fund Management goodwill pertained to the conversion
of SCUs (see Note 13), as the deferred tax impact of such conversion served to
effectively lower the purchase price of CharterMac Capital LLC ("CharterMac
Capital") which we acquired in 2003. In addition, we reduced Fund Management
goodwill by approximately $3.4 million in connection with the planned closure of
CRES (see Note 2).
14
CHARTERMAC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
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
----------------------------------------- ---------- -------------------------- --------------------------
September 30, December 31, September 30, December 31,
2006 2005 2006 2005
------------ ----------- ------------ -----------
Amortized identified intangible assets:
Partnership service contracts 9.4 $ 47,300 $ 47,300 $ 14,510 $ 10,718
Transactional relationships 16.7 103,000 103,000 24,155 17,864
General partner interests 9.0 6,016 5,100 1,626 1,201
Joint venture developer relationships 5.0 4,800 4,800 2,755 2,035
Mortgage banking broker relationships 5.0 1,080 1,080 342 180
Other identified intangibles 9.3 4,427 4,427 3,537 3,181
-------- -------- -------- -------- --------
Weighted average life/subtotal 13.7 166,623 165,707 46,925 35,179
========
Unamortized identified intangible assets:
Mortgage banking licenses and
approvals with no expiration 10,773 10,773 -- --
-------- -------- -------- --------
Total identified intangible assets $177,396 $176,480 $ 46,925 $ 35,179
======== ======== ======== ========
(In thousands) Net
----------------------------------------- --------------------------
September 30, December 31,
2006 2005
------------ -----------
Amortized identified intangible assets:
Partnership service contracts $ 32,790 $ 36,582
Transactional relationships 78,845 85,136
General partner interests 4,390 3,899
Joint venture developer relationships 2,045 2,765
Mortgage banking broker relationships 738 900
Other identified intangibles 890 1,246
-------- --------
Weighted average life/subtotal 119,698 130,528
Unamortized identified intangible assets:
Mortgage banking licenses and
approvals with no expiration 10,773 10,773
-------- --------
Total identified intangible assets $130,471 $141,301
======== ========
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- --------------------
2006 2005 2006 2005
------- ------- ------- -------
Amortization expense $ 3,769 $ 4,297 $11,746 $12,637
======= ======= ======= =======
The amortization of "other identified intangibles" (approximately $476,000 per
year) is included as a reduction to mortgage revenue bond interest income as
they pertain to the acquisition of such bond investments.
In the third quarter of 2006, we wrote off approximately $1.6 million of
unamortized transactional relationships assets associated with our planned
closure of CRES (see Note 2).
15
CHARTERMAC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
NOTE 6 - OTHER ASSETS
The components of other assets were as follows:
September 30, December 31,
(In thousands) 2006 2005
------------------------------------------------------ ------------ -----------
Deferred financing and other costs $ 34,951 $ 38,059
Less: Accumulated amortization (5,499) (14,031)
--------- ---------
Net deferred costs 29,452 24,028
Real estate owned, net of accumulated depreciation of
$1.1 million in 2006 33,652 35,608
Interest receivable 22,116 16,964
Fees receivable, net 31,713 30,774
Deposits receivable 18,235 98
Due from unconsolidated partnerships, net 11,605 2,576
PRS/CRG advances 11,627 9,961
Furniture, fixtures and leasehold improvements, net 8,707 8,178
Income tax receivable 4,323 4,276
Interest rate swaps at fair value (see Note 8) 2,373 4,857
Deferred taxes -- 1,849
Other 11,995 5,501
--------- ---------
Total $ 185,798 $ 144,670
========= =========
A. DEFERRED FINANCING AND OTHER COSTS
In connection with the restructuring of our securitization programs (see Note 7)
we wrote off the unamortized balance of deferred financing costs pertaining to
the terminated programs. As a result, we recorded incremental amortization
expense of $3.4 million during the second quarter of 2006. In connection with
refinancing our lines of credit at the time of the ARCap acquisition (see Notes
2 and 7) we wrote off the unamortized balance of deferred financing costs
pertaining to the terminated lines (approximately $141,000) and recorded
deferred costs of approximately $9.3 million related to the new facilities.
B. REAL ESTATE OWNED
We had classified our real estate owned as "Held for placeCitySale" upon our
foreclosure of the properties securing mortgage revenue bonds in 2005. As GAAP
sale recognition was not achieved within one year, we reclassified them as "Held
and Used" and recorded a retroactive depreciation charge of $934,000 in the
second quarter of 2006, as if we had depreciated them since the May 2005
foreclosure. In September 2006, we sold the properties to a third-party to whom
we provided new debt financing and to whom funds that we consolidate provided
equity financing. As such, we did not consider the transaction to be a sale for
accounting purposes.
C. DEPOSITS RECEIVABLE
The balance consists primarily of collateral deposits pertaining to new debt
facilities we entered into in 2006 (see Note 7).
D. PRS/CRG ADVANCES
The advances due from PRS/CRG related to the financial difficulties of a
developer and our subsequent actions to protect our investments in the
properties that were under development (see Note 18). The above balances are net
of eliminations with liabilities of consolidated partnerships of $17.4 million
at September 30, 2006 and $3.9 million at December 31, 2005.
16
CHARTERMAC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
NOTE 7 - FINANCING ARRANGEMENTS AND NOTES PAYABLE
A. SECURITIZATION PROGRAMS
Upon the launch of Centerbrook in June 2006, we restructured several of our
securitization programs whereby Centerbrook is now the provider of credit
intermediation, as supported by IXIS. As a result, we terminated our
securitization relationship with MBIA and created a new program through Goldman
Sachs with a structure similar to our P-FLOATS program. In connection with the
termination of the MBIA program, we paid approximately $1.4 million in
termination fees (included in general and administrative expense) and $1.9
million of other costs (recorded in interest expense) in the second quarter of
2006.
In August 2006, we closed a $455.0 million fixed-rate securitization. In this
transaction, we sold fixed rate certificates secured by a pool of our mortgage
revenue bonds. These certificates have a weighted average life of 8 years and
incur interest at a weighted average fixed-rate of 4.6%. As with our other
programs, we retained residual certificates associated with the securitization.
The proceeds of this transaction were used to pay down existing securitization
liabilities.
Details of the fixed-rate securitization certificates issued are as follows:
Amount
Series (in thousands) Initial Rate Remarketing Date
--------------- -------------- ------------ ----------------
A-1 $300,000 4.54% August 2013
A-2 $155,000 4.72% August 2016
--------
Total $455,000
========
B. CMC WAREHOUSE LINE
The CharterMac Mortgage Capital ("CMC") warehouse line was amended to permit
temporary over-advances through October 2006 of up to $75.0 million (in addition
to the $100.0 million base borrowing amount) pursuant to terms arranged with
Bank of America. The term of this facility has been extended to November 14,
2006 and we expect to enter into a further extension of this line.
C. CENTERBROOK FACILITIES
Upon its launch in June 2006, Centerbrook entered into a $30.0 million senior
debt facility and a $125.0 million mezzanine debt facility, maturing in June
2036. The senior debt facility is provided by Citibank, N.A. and one of our
subsidiary companies and it generally bears interest, at our discretion, at:
(1) 1.40% plus the higher of
a. the Prime Rate, or
b. the federal funds effective rate, as defined, plus 1/2%; or
(2) LIBOR plus 0.40% depending on the type of loan.
The mezzanine debt facility is provided by Citibank, N.A. and generally bears
interest, at our discretion, at:
(1) 2.25% plus the higher of
a. the Prime Rate, or
b. the federal funds effective rate, as defined, plus 1/2%, or
(2) LIBOR plus 1.25% depending on the type of loan.
D. REVOLVING CREDIT FACILITY AND TERM LOAN
In August 2006, in connection with our acquisition of ARCap (see Note 2), we
entered into a loan commitment with various lenders. The commitment provides a
$250.0 million term loan (the "Term Loan"), which matures in August 2012, and a
$250.0 million revolving credit facility (the "Credit Facility"), which matures
in August 2009. We also have the ability, no more than twice, to increase the
maximum amounts available under either the Term Loan and/or Credit Facility by
$200.0 million. This ability expires in August 2008.
17
CHARTERMAC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
All or a portion of the Credit Facility and the Term Loan bear interest, at our
discretion, at either:
(1) the Prime Rate set by Bank of America, N.A. (the "Base Rate") plus
0.25%, or
(2) LIBOR plus 2.5% for the Term Loan, or a margin ranging from 1.625% to
1.875% depending on the ratio of "funded debt to adjusted CAD", as
defined in the credit agreement, for the Credit Facility.
Proceeds from the Term Loan and Credit Facility were used to purchase ARCap (see
Note 2) and to repay and terminate the CMC Acquisition Line, the CharterMac
Capital Warehouse Line and the Capri Acquisition Lines.
E. REPURCHASE AGREEMENTS
At September 30, 2006, we were a party to five repurchase agreements with five
counterparties that provide total commitments of $280.0 million, although the
maximum amount available to borrow under each facility is limited by the value
of the pledged collateral. As of September 30, 2006, we borrowed $48.4 million
under these agreements and had the ability to borrow $42.7 million without
pledging additional collateral. As of September 30, 2006, the fair value of
collateral pledged was $121.4 million. Interest rates range from 5.7% to 6.1%.
Of the amounts outstanding, $19.5 million matures in 24 months, and $28.9
million has no specified maturity date, although it may be called upon six
months' notice by the counterparty.
NOTE 8 - DERIVATIVE INSTRUMENTS
As of September 30, 2006, we had interest rate swaps with varying expiration
dates and an aggregate notional amount of $725.0 million, which are designated
as cash flow hedging instruments which hedge the interest payments on our
variable-rate securitizations and credit facility. In addition to the $450.0
million notional amount of swaps we had outstanding as of December 31, 2005, we
entered into a new interest rate swap at the time of refinancing our credit
facilities (see Note 7). The new swap has a notional amount of $275.0 million,
an expiration date of August 2009, a fixed rate of 5.25% and the counterparty is
Wachovia.
We record all of these swaps at fair value and record changes in fair value in
other comprehensive income to the extent the hedges are effective in achieving
offsetting cash flows. There was no ineffectiveness in the hedging relationships
during the periods reported. Amounts in accumulated other comprehensive income
will be reclassified into earnings in the same period during which the hedged
forecasted transaction affects earnings. Since we are hedging the interest
payments on our variable-rate securitizations, the forecasted transactions are
the interest payments.
We expect all of the swaps will be highly effective in achieving offsetting
changes in cash flows throughout their terms.
We also had an interest rate swap with a notional amount of $26.0 million that
hedged the change in the fair value of a $26.0 million investment. This swap was
assigned to AMAC when we sold AMAC the related investment (see Notes 4 and 16).
Prior to its assignment, we did not elect to apply hedge accounting to this swap
and, therefore, the change in its fair value was included in net income.
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 were as follows:
September 30, December 31,
------------ ------------
(In thousands) 2006 2005
------------------------------------- ------------ ------------
Net liability position $2,257 $ 208
Net asset position $2,373 $4,857
18
CHARTERMAC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
Interest expense included the following expense (income) related to our swaps:
Three months ended Nine months ended
September 30, September 30,
-------------------- --------------------
(In thousands) 2006 2005 2006 2005
------------------------------------------ -------- -------- -------- --------
Interest expense $ -- $ 798 $ 35 $ 2,684
Interest income (727) (53) (1,475) (111)
Change in fair value of free standing swap
assigned to AMAC -- -- (203) --
------- ------- ------- -------
Total $ (727) $ 745 $(1,643) $ 2,573
======= ======= ======= =======
We estimate that approximately $3.0 million of the net unrealized gain included
in accumulated other comprehensive income will reduce interest expense within
the next twelve months.
Certain of our consolidated partnerships also had interest rate swaps accounted
for as hedges as of September 30, 2006 (see Note 10).
NOTE 9 - ACCOUNTS PAYABLE, ACCRUED EXPENSES AND OTHER LIABILITIES
Accounts payable, accrued expenses and other liabilities consisted of the
following:
September 30, December 31,
(In thousands) 2006 2005
-------------------------------------- ------------ -----------
Deferred revenues $ 84,708 $ 70,025
Distributions payable 41,492 41,080
Accounts payable 58,804 22,314
Salaries and benefits 24,075 15,816
Accrued fund organization and offering
expenses 13,976 9,562
Derivatives 2,257 208
Restructuring costs 1,182 --
Other 17,949 20,270
-------- --------
Total $244,443 $179,275
======== ========
The accrued restructuring costs pertain to integration actions with respect to
the acquisition of ARCap (see Note 2). We recorded these costs in general and
administrative expenses in the second quarter of 2006. A roll forward of the
restructuring costs is as follows:
Fund Mortgage
Management Banking
(In thousands) Segment Segment Total
------------------------------------- ---------- --------- --------
Employee termination costs
Balance at June 30, 2006 $ 580 $ 1,251 $ 1,831
Payments (120) (144) (264)
Adjustments (171) (378) (549)
------- ------- -------
Balance at September 30, 2006 289 729 1,018
------- ------- -------
Lease termination costs
Balance at June 30, 2006 -- 164 164
Payments -- -- --
------- ------- -------
Balance at September 30, 2006 -- 164 164
------- ------- -------
Total $ 289 $ 893 $ 1,182
======= ======= =======
19
CHARTERMAC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
Adjustments represent the reversal of amounts due to employee attrition in
advance of severance dates or amounts reclassified as retention bonuses. We
anticipate that the restructuring will be completed by the end of the first
quarter of 2007 and do not anticipate increases to the amounts detailed above.
NOTE 10 - CONSOLIDATED PARTNERSHIPS
Consolidated Partnerships consist of three groups:
o Funds we sponsor to syndicate LIHTC Investments ("LIHTC
Partnerships");
o Property level partnerships for which we have assumed the role of
general partner ("Property Partnerships"); and
o Funds we sponsor to syndicate investments in CMBS and associated
resecuritization trusts ("CMBS Partnerships") that were associated
with the ARCap acquisition in August 2006.
Financial information for the LIHTC and Property Partnerships are as of June 30,
2006, the latest practical date. Information with respect to CMBS partnerships
is as of September 30, 2006.
Assets and liabilities of consolidated partnerships consisted of:
September 30, 2006 December 31, 2005
--------------------------------------- -----------------
LIHTC and LIHTC and
Property CMBS Property
(In thousands) Partnerships Partnerships Total Partnerships
--------------------------------------------- ------------ ------------ ----------- ------------
Investments in property partnerships $3,343,243 $ -- $3,343,243 $3,025,762
Investments in CMBS - available for sale -- 625,870 625,870 --
Investments in resecuritization
certificates - available for sale -- 594,701 594,701 --
Other investments -- 14,021 14,021 --
---------- ---------- ---------- ----------
Investments held by consolidated partnerships 3,343,243 1,234,592 4,577,835 3,025,762
---------- ---------- ---------- ----------
Land, buildings and improvements, net
of accumulated depreciation 367,327 -- 367,327 329,869
Cash 233,282 14,129 247,411 172,622
Other assets 94,898 20,657 115,555 78,033
---------- ---------- ---------- ----------
Other assets of consolidated partnerships 695,507 34,786 730,293 580,524
---------- ---------- ---------- ----------
Total assets $4,038,750 $1,269,378 $5,308,128 $3,606,286
========== ========== ========== ==========
Financing arrangements $ -- $ 687,694 $ 687,694 $ --
Notes payable 498,185 -- 498,185 565,877
Due to property partnerships 832,480 -- 832,480 896,031
Repurchase agreements -- 184,700 184,700 --
Other liabilities 156,783 9,447 166,230 165,648
---------- ---------- ---------- ----------
Total liabilities $1,487,448 $ 881,841 $2,369,289 $1,627,556
========== ========== ========== ==========
Other operating expenses of consolidated partnerships consisted of:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ ------------------------
2006 2005 2006 2005
---------- ---------- ---------- ----------
Interest expense $ 12,982 $ 6,342 $ 25,539 $ 19,364
Asset management fees 5,079 5,430 15,604 16,206
Property operating expenses 3,998 2,592 11,286 7,268
General and administrative expenses 3,586 2,725 11,684 6,837
Depreciation and amortization 5,817 3,538 12,445 8,639
---------- ---------- ---------- ----------
Total other operating expenses $ 31,462 $ 20,627 $ 76,558 $ 58,314
========== ========== ========== ==========
20
CHARTERMAC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
Investments in CMBS included within consolidated partnerships were comprised of
the following as of September 30, 2006:
Accreted Percentage of
(In thousands) Face Cost Fair Value Fair Value
-------------------------------------------------------------------------------------
Security rating:
BBB- $ 106,723 $ 100,417 $ 100,967 16.13%
BB+ 108,094 91,711 92,482 14.78
BB 129,402 106,546 106,802 17.07
BB- 131,875 92,299 93,316 14.91
B+ 67,071 41,647 42,807 6.84
B 66,323 37,629 39,649 6.33
B- 86,180 39,521 46,260 7.39
Non-rated 312,433 92,026 103,587 16.55
---------- ---------- ---------- ---------
$1,008,101 $ 601,796 $ 625,870 100.00%
========== ========== ========== =========
Investments in resecuritization certificates included within consolidated
partnerships were comprised of the following as of September 30, 2006:
Accreted Percentage of
(In thousands) Face Cost Fair Value Fair Value
-------------------------------------------------------------------------------------
Security rating:
AAA $111,900 $ 95,968 $109,215 18.36%
AA 66,600 57,541 65,756 11.06
A 47,000 40,977 46,865 7.88
A- 23,900 21,289 24,282 4.08
BBB+ 66,800 60,345 68,629 11.54
BBB 61,138 53,302 57,373 9.65
BBB- 109,781 97,906 110,951 18.66
BB+ 88,114 46,621 61,668 10.37
BB 12,158 3,547 6,770 1.14
BB- 12,157 3,187 6,092 1.02
B+ 21,073 4,890 9,372 1.58
B 11,347 1,869 3,596 0.60
B- 12,158 1,510 2,918 0.49
Non-rated 184,598 7,991 16,426 2.76
Non-rated interest only -- 4,796 4,788 0.81
-------- -------- -------- ---------
$828,724 $501,739 $594,701 100.0%
======== ======== ======== ========
At September 30, 2006, eight repurchase agreements with three counterparties
provided total commitments of $495.0 million. As of September 30, 2006, the CMBS
Partnerships had borrowed $184.7 million under these repurchase agreements and
had the ability to borrow an additional $5.9 million without pledging additional
collateral. As of September 30, 2006, the fair value of collateral pledged was
$258.5 million. Interest rates range from 5.4% to 6.1%.
Of the LIHTC Partnerships notes payable balance, at September 30, 2006, $371.9
million are guaranteed by certain equity partners of the investment funds. Under
the partnership agreements, the equity partners are also obligated to pay the
principal and interest on the notes. The remaining balance of $127.0 million is
collateralized with the underlying properties of the consolidated operating
partnerships. All of this debt is non-recourse to us.
The financing arrangements of the CMBS partnerships consist of three separate
collateralized debt obligation offerings, with weighted average interest rates
ranging from 4.7% to 8.7% and weighted average remaining maturities of 5 years
to 9 years. All of this debt is non-recourse to the CMBS funds.
The CMBS partnerships have entered into amortizing forward-starting swap
agreements to mitigate their proportionate share of the risk of changes in the
interest-related cash outflows on the next contemplated long-term debt issuance.
Some of these swaps are designated as hedges under FAS 133, while others are
not.
21
CHARTERMAC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
At September 30, 2006, those swaps not designated as hedges, had a combined
notional balance of $144.3 million, a maturity of January 1, 2017, and interest
rates ranging from 4.91% to 5.75%, and were in a net liability position of $2.9
million.
At September 30, 2006, those swaps designated as hedges had a combined notional
balance of $128.3 million, a maturity of January 1, 2017, and interest rates
ranging from 4.91% to 5.75%, and were in a net liability position, in the
aggregate, of approximately $2.7 million. These swaps were all determined to be
effective, so the entire change in the fair value of the swaps was included in
other comprehensive income of the CMBS partnerships.
NOTE 11 - MINORITY INTERESTS IN CONSOLIDATED SUBSIDIARIES
Minority interests in consolidated subsidiaries consisted of the following:
September 30, December 31,
(In thousands) 2006 2005
--------------------------------- ------------- ------------
Convertible Special Common Units
("SCUs") of a subsidiary $236,865 $250,866
Convertible Special Membership
Units ("SMUs") of a subsidiary 6,994 11,408
Convertible Special Common
Interests ("SCIs") of a
subsidiary 4,882 --
Other 3,199 --
-------- --------
Total $251,940 $262,274
======== ========
Income allocated to minority interests, net of tax, was as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- -------------------------
(In thousands) 2006 2005 2006 2005
-------------- -------- -------- -------- --------
SCUs $ 5,725 $ 7,467 $ 13,085 $ 21,358
SMUs 118 159 288 214
SCIs 29 -- 29 --
Other (101) -- (101) --
-------- -------- -------- --------
Total $ 5,771 $ 7,626 $ 13,301 $ 21,572
======== ======== ======== ========
A. SCUS
During 2006, the holder of 20,000 SCUs converted the units to an equivalent
number of common shares and the holder of an additional 40,000 SCUs converted
the units, for which we paid approximately $723,000 in cash. We also redeemed
the special preferred voting shares related to the converted SCUs at par ($0.01
per share).
B. SMUS
During 2006, the holders of approximately 75,000 SMUs converted the units to an
equivalent number of common shares.
In connection with the closure of CRES (see Note 2) we cancelled 114,000 SMUs
valued at approximately $2.5 million and reversed the balance from minority
interests to goodwill as of September 30, 2006.
C. SCIS
In connection with our acquisition of ARCap (see Note 2), our subsidiary issued
membership interests in the form of 267,755 SCIs. SCI holders are entitled to
distributions at the same time as, and only if, we pay distributions on our
common shares. SCI distributions are initially $1.72 per year, subject to an
adjustment in the amount of 95% of the percentage increases or decreases in the
dividends paid by us on our common shares.
22
CHARTERMAC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
Each holder of an SCI has the right to:
o Exchange all or a portion of their SCIs for cash; and
o Receive cash for any accrued but unpaid distributions with respect to
SCI's 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 SCIs (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 during the five
consecutive trading days immediately prior to the date when we receive notice of
intent to convert.
D. OTHER
"Other" minority interests at September 30, 2006, primarily represent the 10%
interest in Centerbrook owned by IXIS.
NOTE 12 - COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) was as follows:
Nine months Ended
September 30,
---------------------
(In thousands) 2006 2005
------------------------------------------------------------------- -------- --------
Net income $ 33,476 $ 52,907
Net unrealized gain on interest rate derivatives 579 2,296
Net unrealized gain on marketable securities and equity investments 2,513 29
Net unrealized gain (loss) on mortgage revenue bonds:
Unrealized (loss) gain during the period (432) 25,629
Reclassification adjustment for net gain included in net income (963) (1,930)
-------- --------
Comprehensive income $ 35,173 $ 78,931
======== ========
NOTE 13 - 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 (which includes equity
that is convertible into common shares) 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.
23
CHARTERMAC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
B. SHARE OPTIONS
On January 1, 2006, we adopted SFAS No. 123(R). Since we previously accounted
for our stock-based compensation plans as an expense under the fair value
provisions of SFAS No. 123, our adoption did not significantly impact our
financial position or our results of operations.
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.
In 2006, we granted the following options pursuant to the Plan:
Weighted
Weighted Average
Weighted Average Average Vesting
Number Exercise Price Term Period
---------- ---------------- --------- ---------
544,000 $21.78 7.4 years 2.1 years
We used the following weighted average assumptions in the Black-Scholes option
pricing model to determine fair values of options granted:
Risk free interest rate 4.42%
Expected years until exercise 1.71
Expected stock volatility 23.14%
Dividend yield 8.11%
The following table summarizes share option activity for the nine months ended
September 30, 2006:
Weighted
Average
Weighted Remaining Aggregate
Average Contractual Intrinsic
Exercise Term Value
Options Price (in years) (in thousands)
--------- --------- ----------- --------------
Outstanding at January 1, 2006 1,510,341 $ 20.42
Granted 544,000 21.78
Forfeited / expired -- --
Exercised -- --
-----------------------------------------------------
Outstanding at end of period 2,054,341 $ 20.78 7.3 $ 2,183
=====================================================
Vested and expected to vest at end of period 2,054,341 $ 20.78 7.3 $ 2,183
=====================================================
Exercisable at end of period 779,351 $ 21.16 6.1 $ 875
=====================================================
Fair value of options granted during the period (in thousands) $ 852
==========
Compensation cost recorded (in thousands) $ 835
==========
The aggregate intrinsic value in the table above represents the difference
between our closing common share price on September 30, 2006, and the exercise
price, multiplied by the number of "in the money" options. This amount will
change based on the fair market value of our common shares.
24
CHARTERMAC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
The following table summarizes information about share options outstanding and
exercisable at September 30, 2006:
Weighted
Average
Remaining
Number Contractual Life Number
Exercise Price Outstanding (in Years) Exercisable
-------------- ----------- ---------------- -----------
$11.56 51,576 3.6 51,576
$17.56 2,250 6.0 2,250
$17.78 800,000 7.1 200,000
$21.18 159,510 0.4 159,510
$21.61 20,000 8.7 6,667
$22.03 384,490 9.3 --
$24.44 636,515 8.3 359,348
----------- -------- -----------
2,054,341 6.1 779,351
=========== ======== ===========
C. NON-VESTED SHARES AND SCUS
The following table summarizes information about non-vested shares and SCUs for
the nine months ended September 30, 2006:
Weighted Weighted
Average Average
Non-vested Grant Date Non-vested Grant Date
shares Fair Value SCUs Fair Value
---------- ---------- ---------- ----------
Non-vested at January 1, 2006 241,194 $ 20.25 310,400 $ 17.92
Granted 2,039,731 19.64 -- --
Vested 192,966 20.17 -- --
Forfeited 15,391 20.84 -- --
---------- --------- ---------- ---------
Non-vested at September 30, 2006 2,072,568 $ 19.65 310,400 $ 17.92
========== ========= ========== =========
Compensation cost recorded (in thousands) $ 8,127
==========
The non-vested shares granted in 2006 include approximately 1.7 million
associated with the ARCap acquisition (see Note 2). In addition, we granted
approximately 56,000 that vested immediately.
D. UNAMORTIZED COSTS AND SHARES AVAILABLE FOR GRANT
As of September 30, 2006, there was $34.9 million of total unrecognized
compensation cost related to non-vested share-based compensation grants. This
unrecognized compensation is expected to be recognized over a weighted-average
period of 3.2 years.
As of September 30, 2006, there were approximately 2.2 million options or share
grants available for issuance under the Plan.
NOTE 14 - STOCK REPURCHASE PLAN
During the second quarter 2006, in connection with our existing program to
repurchase up to 1,500,000 of our common shares, we entered into a 10b5-1
trading plan to facilitate the purchases of shares under this program. During
the nine months ended September 30, 2006, we repurchased 921,060 shares at an
average price of $18.99 per share, including shares we purchased prior to
implementing the 10b5-1 plan.
25
CHARTERMAC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
NOTE 15 - EARNINGS PER SHARE
For basic EPS, the number of shares includes common and Convertible Community
Reinvestment Act Preferred Shares ("Convertible CRA Shares"), as the Convertible
CRA Shares have the same economic benefits as common shares. Income for the
calculation represents net income less dividends for the 4.4% Convertible CRA
Preferred Shares.
Diluted EPS is calculated using the weighted average number of shares
outstanding during the period plus the additional dilutive effect of common
share equivalents. The dilutive effect of outstanding share options and
non-vested share grants is calculated using the treasury stock method. The 4.4%
Convertible CRA Preferred Shares and our subsidiaries' convertible equity units
(see Note 13) are not included in the calculation as their assumed conversions
would be antidilutive.
Three Months Ended September 30, 2006 Nine months Ended September 30, 2006
------------------------------------- ------------------------------------
(In thousands, except per share amounts) Income Shares Per Share Income Shares Per Share
------------------------------------------------ ------- -------- --------- ------- ------- ---------
Net income $14,571 $33,476
Preferred dividends 1,188 3,564
------- -------
Net income allocable to shareholders (Basic EPS) 13,383 58,015 $ 0.23 29,912 58,409 0.51
======= ======
Effect of dilutive securities -- 381 -- 421
------- ------- ------- -------
Diluted EPS $13,383 58,396 $ 0.23 $29,912 58,830 0.51
======= ======= ======= ======= ======= ======
Three Months Ended September 30, 2005 Nine months Ended September 30, 2005
------------------------------------- ------------------------------------
(In thousands, except per share amounts) Income Shares Per Share Income Shares Per Share
------------------------------------------------ ------- -------- --------- ------- ------- ---------
Net income $18,678 $52,907
Preferred dividends 832 832
------- -------
Net income allocable to shareholders (Basic EPS) 17,846 58,059 $ 0.31 52,075 57,927 $ 0.90
======= ======
Effect of dilutive securities -- 307 -- 307
------- ------- ------- -------
Diluted EPS $17,846 58,366 $ 0.31 $52,075 58,234 $ 0.89
======= ======= ======= ======= ======= ======
NOTE 16 - RELATED PARTY TRANSACTIONS
A. RELATED
General and administrative expenses include shared service fees paid or payable
to Related L.P., formerly known as The Related Companies, L.P. ("Related"), a
company controlled by our chairman.
In addition, a subsidiary of Related earned fees for performing property
management services for various properties held in investment funds which we
manage and are included in "Other expenses of consolidated partnerships".
B. AMAC
We collect asset management, incentive management and expense reimbursement fees
from AMAC. These fees are included in fund sponsorship income. We entered into a
new agreement, effective as of April 2006 whereby the basis of certain of the
fees we earn have changed, although we do not expect the fees earned to differ
significantly from the previous agreement absent the effect of AMAC's growth.
In April 2006, we sold an investment to AMAC, for which AMAC had held a
subordinated co-investment interest (see Note 4). In connection with the sale,
we also transferred an interest rate swap we had accounted for as a free
standing derivative (see Note 8). We sold the investment for its par value and
recognized no gain or loss on the transaction.
In June 2004, we entered into an unsecured revolving credit facility with AMAC
to provide it up to $20.0 million, bearing interest at LIBOR plus 3.0%, which is
to be used by AMAC to purchase new investments and for general corporate
purposes. In April 2006, we increased the facility to $50.0 million. As of
September 30, 2006, there were no advances to AMAC outstanding under this
facility. Income we earn from this facility is included in "Other interest
income". In the opinion of management, the terms of this facility are consistent
with those of loan transactions with independent third parties.
During 2006, our Mortgage Banking subsidiaries originated over $347.1 million in
loans on behalf of AMAC and received approximately $1.9 million of mortgage
banking fees from the borrowers. We record these fees in "Fee income" in the
26
CHARTERMAC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
condensed consolidated statements of income.
During 2006, we funded a first mortgage note in the approximate amount of $27.3
million as part of a refinancing of one of AMAC's loans. The note is included in
other investments (see Note 4).
In connection with our acquisition of ARCap, we paid approximately $24.5 million
of the purchase price to AMAC for its membership interests in ARCap based on the
contractual price paid to all shareholders.
In August 2006, AMAC entered into a co-investment agreement with ARESS whereby
both will participate equally in investment opportunities that are originated by
our subsidiaries and which meet mutual investment criteria.
C. INCOME STATEMENT IMPACT
Fees paid to Related and income earned from AMAC was as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
(In thousands) 2006 2005 2006 2005
------------------------------------------------ ------ ------ ------ -------
Shared service fee expense $ 154 $ 122 $ 471 $ 392
Related property management services expense $1,116 $ 839 $3,216 $2,200
AMAC asset management, incentive management and
expense reimbursement fee income $3,348 $2,000 $5,128 $3,500
AMAC credit facility interest income $ 360 $ -- $1,105 $ 73
NOTE 17 - 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 invested in other entities, such as our
pre-acquisition preferred and common investments in ARCap, our
pre-termination participating loan to CCA, our preferred investment in CCA
prior to the acquisition of CRES, our co-investment in CUC and our
investment in a fund that CRES sponsors, which we are due to liquidate.
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 that provides advisory services to AMAC;
o Subsidiaries that sponsor and manage funds that invest in subordinated
interests associated with CMBS, commercial real estate mortgages and
similar investments. These subsidiaries will also sometimes hold, for
investment, investments such as the ones held by the sponsored funds.
These subsidiaries earn income from equity investments in the
sponsored funds and interest income from their investments; and
o Subsidiaries that participate in credit intermediation transactions,
including those for pools of mortgage loans and provide specified
returns to investors in LIHTC equity funds, in exchange for fees.
3. Mortgage Banking, which includes subsidiaries that originate and service
mortgage loans on behalf of third parties, including:
o Fannie Mae;
o Freddie Mac;
o the FHA;
o AMAC; and
27
CHARTERMAC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
o Insurance companies and conduits.
In exchange for these activities, we receive origination and servicing
fees.
This segment also includes subsidiaries that provide multifamily and
commercial loan servicing for third parties and we also serve as the named
special servicer on CMBS securitization in which either we, or the funds we
manage, invest. In exchange for these services, we earn a variety of fees,
including base servicing fees, liquidation fees, and assumption and
modification fees. We also earn interest income on escrow and reserve
balances held on loans we service.
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.
This segment also includes CMBS funds we sponsor in which we have minority
interests but for which our subsidiaries are general partners.
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"), and a
reconciliation from CAD to net income, as the performance measure used by our
chief decision-maker to allocate resources among the segments.
28
CHARTERMAC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
The following table provides more information regarding our segments:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ ------------------------
(In thousands) 2006 2005 2006 2005
------------------------------------------- ---------- ---------- ---------- ----------
REVENUES
Portfolio Investing $ 48,058 $ 43,278 $ 141,982 $ 125,305
Fund Management (1) 43,590 31,609 95,130 81,008
Mortgage Banking (1) 17,165 13,424 43,807 30,856
Consolidated Partnerships (2) 23,809 7,349 41,420 19,403
Elimination of intersegment transactions (25,603) (16,816) (63,950) (41,302)
--------- --------- --------- ---------
Consolidated Revenues $ 107,019 $ 78,844 $ 258,389 $ 215,270
========= ========= ========= =========
CAD
Portfolio Investing $ 29,147 $ 25,528 $ 77,645 $ 79,900
Fund Management (1) 31,106 21,055 44,757 44,814
Mortgage Banking (1) 6,839 (656) 12,870 6,637
--------- --------- --------- ---------
Total Segment CAD 67,092 45,927 135,272 131,351
Preferred dividends (1,188) (832) (3,564) (832)
Subsidiary equity distributions (8,849) (8,644) (26,614) (25,944)
Dividends on subsidiary preferred stock (6,281) (6,281) (18,842) (18,842)
Current tax benefit (expense) (7,169) 2,471 (3,627) 1,690
--------- --------- --------- ---------
Consolidated CAD 43,605 32,641 82,625 87,423
Fees deferred for GAAP (3) (14,394) (3,302) (23,814) (21,758)
Depreciation and amortization expense,
including write-off of intangible assets (13,580) (16,302) (37,108) (33,467)
Interest income yield adjustments (4) (3,651) 77 (4,098) 660
Gain on sale of loans (5) 2,188 3,718 9,001 10,367
Loss on impairment of assets (395) (803) (2,665) (1,902)
Tax adjustment (6) (63) 2,546 (282) 12,027
Non-cash compensation (7) (9,169) (1,523) (12,583) (5,299)
Difference between subsidiary equity
distributions and income allocated to
subsidiary equity holders (8) 2,978 1,018 13,212 4,372
Non-cash equity income 6,402 (200) 5,754 (234)
Preferred dividends 1,188 832 3,564 832
Other, net (538) (24) (130) (114)
--------- --------- --------- ---------
Consolidated Net Income $ 14,571 $ 18,678 $ 33,476 $ 52,907
========= ========= ========= =========
DEPRECIATION AND AMORTIZATION (9)
Portfolio Investing $ 658 $ 2,941 $ 6,412 $ 4,695
Fund Management (1)(9) 7,166 4,694 16,090 14,305
Mortgage Banking (1) 5,756 8,667 14,606 14,467
Consolidated Partnerships -- -- -- --
Elimination of intersegment transactions -- -- -- --
--------- --------- --------- ---------
Consolidated Depreciation and Amortization $ 13,580 $ 16,302 $ 37,108 $ 33,467
========= ========= ========= =========
September 30, 2006 December 31, 2005
------------------ -----------------
IDENTIFIABLE ASSETS
Portfolio Investing $ 4,981,279 $ 5,487,596
Fund Management (1) 2,644,200 800,684
Mortgage Banking (1) 299,298 345,225
Consolidated partnerships (2) 4,044,634 3,610,031
Elimination of intersegment balances (2,969,020) (3,264,708)
----------- -----------
Consolidated $ 9,000,391 $ 6,978,828
=========== ===========
(1) Includes ARCap as of August 2006.
(2) Includes funds sponsored by ARCap as of August 2006.
(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).
29
CHARTERMAC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
(4) Represents the adjustment for amortization of bond discounts or premiums
that are recognized immediately for CAD but are deferred and recognized overtime
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 non-cash compensation related to fund earnings.
(8) Represents the difference between actual distributions to SCU, SMU and SCI
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) 2006 includes write-off of intangible assets.
NOTE 18 - COMMITMENTS AND CONTINGENCIES
PRS/CRG
PRS Companies ("PRS") and Capitol Realty Group ("CRG") were 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 on page 32. A construction company
affiliate of PRS also served as general contractor for those partnerships.
Due to financial difficulties experienced by PRS, we ceased our business
dealings with them and, among other provisions of an agreement reached in April
2005, assumed the general partner interest in certain of the "PRS Partnerships"
indicated in the table on page 32.
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 on page 32. 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
that provided for, among other things:
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 operated the CRG
projects; 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 execution of a new construction contract; and
o amendments to several fee agreements.
We anticipate that we will advance approximately an additional $2.3 million to
the O'Fallon project during the fourth quarter of 2006.
With respect to the Peine Lakes project, it continues to move along its
construction phase and is now substantially 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.
30
CHARTERMAC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
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 on page 32. 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 - As of
September 30, 2006, advances outstanding totaled approximately
$29.0 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.
We currently estimate that we will not need to advance funds
materially in excess of advances outstanding at September 30,
2006. This estimate is based upon our ongoing analyses and may
increase due to unforeseen construction delays and other factors,
while the amount may be reduced by additional contributions by
investors (which may generate additional tax credits), reserves at
the property level, syndication of state tax credits or other
factors.
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.
POTENTIAL COST TO PROVIDE SPECIFIED YIELDS - As noted in the table on
page 32, ten 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.
With respect to one property in early stages of construction, we halted
construction and have since exercised our right to foreclosure as holder of the
first mortgage and plan to sell the property at our current carrying value after
recognizing a write-down in the second quarter of 2005.
With respect to another property in the early stages of construction, we
likewise determined that construction should not be continued. We did not hold a
bond with respect to this property, but a fund we sponsored provided equity.
Subsequent to September 30, 2006, we completed the sale of our general partner
and limited partner interests and have recovered the fund's investment.
We 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.
31
CHARTERMAC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
The partnerships in question are summarized as follows:
(In thousands)
-----------------------------
Fair Value of
CharterMac CharterMac Mortgage
Holds or Capital Loan Revenue
Will Hold Sponsored Included in CharterMac Third Amounts Bonds
Mortgage Fund is Credit Capital Parties Upon Full Oustanding at
Revenue Equity Intermediated Holds GP Provided Draw September 30,
Number Bond Partner Funds Interest Equity Down 2006
------ ----------- ---------- -------------- ---------- -------- --------- -------------
PRS
PARTNERSHIPS
Construction -- -- -- -- -- -- $ -- $ --
Lease-Up 10 9 5 3 5 5 103,861 102,713
Rehab 2 2 1 1 1 1 30,400 32,474
Stabilized 2 2 -- -- -- 2 18,437 18,554
-----------------------------------------------------------------------------------------------------------
Subtotal 14 13 6 4 6 8 152,698 153,741
-----------------------------------------------------------------------------------------------------------
CRG
PARTNERSHIPS
Construction 1 1 1 -- 1 -- 7,130 --
Lease-Up 4 2 4 3 2 -- 20,019 20,351
Rehab 2 2 2 2 2 -- 61,934 63,508
Stabilized -- -- -- -- -- -- -- --
-----------------------------------------------------------------------------------------------------------
Subtotal 7 5 7 5 5 -- 89,083 83,859
-----------------------------------------------------------------------------------------------------------
GCG
PARTNERSHIPS
Construction 1 1 1 1 -- -- 14,600 14,600
Lease-Up 1 1 1 -- -- -- 13,170 13,789
Rehab -- -- -- -- -- -- -- --
Stabilized -- -- -- -- -- -- -- --
-----------------------------------------------------------------------------------------------------------
Subtotal 2 2 2 1 -- -- 27,770 28,389
-----------------------------------------------------------------------------------------------------------
Total 23 20 15 10 11 8 $ 269,551 $ 265,989
===========================================================================================================
Total eliminated in consolidation $ 155,333 $ 152,502
===========================
ERC, INC.
See Note 19 for discussion of potential exposure related to the financial
difficulties of another developer.
FORWARD TRANSACTIONS
At September 30, 2006, our Mortgage Banking subsidiaries had forward commitments
of approximately $307.7 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 $69.3 million. Approximately $58.6 million of this amount was funded as
of September 30, 2006, and is included in "Other Investments" as "Mortgage Loans
Held for Sale". The balance of approximately $10.7 million is to be funded later
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 $31.9 million by the end of 2007.
32
CHARTERMAC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
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
$20.5 million at September 30, 2006.
MORTGAGE BANKING LOSS SHARING AGREEMENT
Pursuant to a master loss sharing agreement under the Fannie Mae Delegated
Underwriting and Servicing ("DUS") program, we assume responsibility for a
portion of any loss that may result from borrower defaults, based on Fannie Mae
loss sharing formulas. At September 30, 2006, all but one 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 loans we may originate under this
program can 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 September 30, 2006, pursuant to these agreements, was
approximately $821.2 million (representing what we would owe in accordance with
the loss sharing percentages with Fannie Mae and Freddie Mac 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 September 30, 2006, that reserve was
approximately $13.0 million, which, we believe, represents our actual potential
losses at that time.
As of September 30, 2006, our Mortgage Banking subsidiaries maintained,
collateral consisting of treasury notes, and Fannie Mae and Freddie Mac
securities of approximately $1.6 million and a money market account of
approximately $12.5 million, which is included in restricted cash in the
condensed consolidated balance sheet, to satisfy the Fannie Mae collateral
requirements of $13.0 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 $8.0 million covers this letter of credit
requirement. At September 30, 2006, commitments under this reimbursement
agreement totaled $2.5 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. Related 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
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 September 30,
2006, 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 September 30, 2006, 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 ("SFAS No. 5").
33
CHARTERMAC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
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 13 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 $962.9
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 $24.7 million as of September 30, 2006. This amount is
included in deferred revenues on our condensed 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 a portion of these cases, the Primary
Intermediator has required that those mortgage revenue bonds be deposited into a
trust from which senior and subordinated trust certificates were issued with
approximately 50% of these trust certificates being subordinated. We have
financed a portion of these senior and subordinated trust certificates through
our fixed rate securitization transaction (see Note 7). By placing these bonds
into this trust structure we have restricted our ability to foreclose on these
bonds without the consent of the Primary Intermediator.
OTHER CONTINGENT LIABILITIES
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
$261.2 million as of September 30, 2006. The fair value of these obligations,
representing the deferral of the fee income over the obligation periods, was
$1.1 million as of September 30, 2006. To date, we have had minimal exposure to
losses under these transactions and anticipate no material liquidity
requirements in satisfaction of any guarantee issued.
At September 30, 2006, we had unused letters of credit totaling $8.0 million
described in the MORTGAGE BANKING LOSS SHARING Agreements above.
LEGAL CONTINGENCIES
Claims have been asserted against subsidiaries of the Company in three separate
but interrelated lawsuits relating to two properties that have the same or
affiliated developers for which we have provided debt and equity financing.
Those claims allege, among other things, (i) breach of fiduciary duty; (ii)
breach of the implied covenant of good faith and fair dealing; (iii) intentional
misrepresentation, fraud and deceit; (iv) negligent misrepresentation; and (v)
tortious interference with contracts. The claims in one of the three lawsuits,
however, were voluntary dismissed without prejudice.
One of the remaining lawsuits seeks completely unspecified damages and the other
remaining lawsuit does not specify the total damages sought, but alleges
potential losses of $10.0 - 15.0 million. The Company's subsidiaries have filed
answers denying the material allegations of those claims and asserting
affirmative defenses and their own claims and counterclaims in those actions.
Although one of the lawsuits is presently scheduled for trial in January 2007,
the parties have entered into stipulations to adjourn the trial date and to
34
CHARTERMAC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
provide for coordinated pretrial proceedings in the two cases. The parties have
jointly made or will shortly be jointly making applications to each Court to
implement the parties' agreements concerning scheduling and other pretrial
proceedings.
The parties have engaged in preliminary settlement discussions and expect to
continue those discussions seeking a global resolution of all of these disputes.
If such a settlement cannot be achieved, our subsidiaries intend to defend
vigorously the claims asserted against them and to prosecute vigorously their
own claims and counterclaims.
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.
OTHER FUNDING COMMITMENTS
CUC
Our general partnership interest in CUC (see Note 4) includes a co-investment
obligation amounting to 2.5% of capital invested. Based upon the current funding
limit of CUC, our remaining commitment as of September 30, 2006, was
approximately $1.5 million which is required to be funded prior to August 31,
2007.
INVESTMENTS IN CMBS PARTNERSHIPS & ARESS
We participate as co-investor in the CMBS funds we sponsor. As of September 30,
2006, our remaining unfunded capital commitments were $16.5 million to ARESS
(see Note 4) and $4.1 million to CMBS Partnerships.
NOTE 19 - SUBSEQUENT EVENTS
CRES
In October 2006, we decided to cease operations at CRES. As part of an agreement
with CRES' founder, certain convertible SMUs that we had issued (see Note 11)
will be returned and others held in escrow will be cancelled. In addition, he
will assume CRES' line of credit and we will bear the cost of operating the
business until the closure is completed. While we expect there will be
incremental charges relating to closing this business, the costs are not
expected to be material. In November 2006, we liquidated our $5.0 million
investment (see Note 4).
ERC, INC.
In connection with the financial difficulties experienced by a developer, in
October 2006, we assumed the general partner interests in 18 property level
partnerships (in which the developer was the general partner) to protect our
investments. Funds we consolidate had provided equity for all of these property
partnerships. Of the 18 partnerships, 17 were financed by mortgage revenue bonds
we had issued and two of the properties are in the construction phase.
None of the mortgage revenue bonds in question, with an aggregate fair value of
$159.3 million as of September 30, 2006, were deemed to be impaired as of that
date nor have there been subsequent indications of impairment. We expect that
the equity of the applicable property partnerships is sufficient to cover the
estimated costs to complete the two properties under construction. We may have
to advance funds to the partnerships to cover operating costs until the
properties achieve stabilization, which amounts we do not expect to exceed $1.5
million. We anticipate that future equity payments due the partnerships will be
sufficient to repay the advances.
35
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Forward-Looking Statements
--------------------------
Certain statements made in this report may constitute "forward-looking
statements" within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended.
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, the terms and availability of financing for
properties financed by mortgage revenue bonds we own and other
properties which we may finance as well as the ability of borrowers to
service debt which we may 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 risks associated with providing credit intermediation;
o risk of loss under mortgage banking loss sharing agreements;
o risk of loss from direct and indirect investments in CMBS;
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.
These risks are more fully described in our Form 10-K for the year ended
December 31, 2005, and in Part II, Item 1.A. RISK FACTORS, in this document. We
caution you not to place undue reliance on these forward-looking statements,
which reflect our view only as of the date of this report.
Factors Affecting Comparability
-------------------------------
In August 2006, we acquired ARCap. Prior to the acquisition date, we recorded
equity earnings on our 10.7% equity investment in ARCap. Following the
acquisition, operating results of ARCap are included in our Fund Management,
Mortgage Banking and Consolidated Partnerships segments. In addition, we
incurred restructuring costs associated with planned integration activities and
incurred increased non-cash compensation costs following the acquisition due to
non-vested share grants.
In September 2006, we terminated our financial relationship with CCA. In
connection with the termination, we recognized one-time gains totaling
approximately $6.9 million. We have also decided to close our CRES subsidiary
and we recorded intangible asset impairment charges of approximately $2.5
million in the third quarter of 2006.
During June 2006, we created our Centerbrook subsidiary to provide credit
intermediation products to the affordable housing finance industry. Our majority
ownership of Centerbrook will enable us to prospectively retain a significant
portion of the fees that we would have paid to third party credit providers. We
have incurred various start-up costs in connection with this subsidiary in 2006.
We acquired Capri Capital Limited Partnership ("CCLP") in March 2005. Operating
results in our Portfolio Investing segment prior to the acquisition date include
interest income on a loan made to CCLP in July 2004. Following the acquisition,
operating results of CCLP are included in our Mortgage Banking segment.
36
RESULTS OF OPERATIONS
---------------------
THREE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005
----------------------------------------------
The following is a summary of our operations for the three months ended
September 30, 2006 and 2005:
% of % of
(In thousands) 2006 Revenues 2005 Revenues % Change
-------------------------- -------- -------- -------- -------- --------
Revenues $107,019 100.0 % $ 78,844 100.0 % 35.7 %
Income before income taxes $ 21,804 20.4 % $ 13,662 17.3 % 59.6 %
Net income $ 14,571 13.6 % $ 18,678 23.7 % (22.0)%
Fund Management and Mortgage Banking revenues increased as a result of the ARCap
acquisition as detailed in the relevant RESULTS BY SEGMENT below. All segments
of our business also experienced revenue increases over the 2005 period due to
an increased investment base and the timing of fund sponsorship activity in our
Fund Management segment.
In addition to increased revenues, income before income taxes benefited from a
$6.9 million fee paid to us by CCA to terminate our rights relating to a
participating loan which was convertible into an ownership interest in CCA.
Net income decreased despite the increase in income before income taxes as we
incurred income tax expense during the 2006 quarter compared to an income tax
benefit during 2005. The tax provision in the 2006 period relates to a higher
level of current taxable income from the Fund Management segment due to
increased fund sponsorship activity, coupled with an increase in the valuation
allowance against deferred tax assets (see INCOME TAXES).
REVENUES
Our revenues were as follows:
For the Three Months Ended September 30,
---------------------------------------
(In thousands) 2006 2005 % Change
------------------------------------- -------- -------- --------
Mortgage revenue bond interest income $ 39,370 $ 36,096 9.1 %
Other interest income 7,570 3,986 89.9
Fee income:
Mortgage banking 9,158 7,895 16.0
Fund sponsorship 18,803 15,053 24.9
Credit intermediation 1,066 1,454 (26.7)
-------- -------- -------
Total fee income 29,027 24,402 19.0
Other revenues:
Construction service fee 1,175 1,185 (0.8)
Expense reimbursements 989 1,155 (14.4)
Rental income of real estate owned 907 1,210 (25.0)
Administration fees 570 513 11.1
Prepayment penalties 2,645 2,515 5.2
Other 957 433 121.0
-------- -------- -------
Total other revenues 7,243 7,011 3.3
Subtotal 83,210 71,495 16.4
-------- -------- -------
Revenues of consolidated partnerships 23,809 7,349 224.0
-------- -------- -------
Total revenues $107,019 $ 78,844 35.7 %
======== ======== =======
A large portion of the revenue increase was due to the ARCap acquisition.
Adjusting to include ARCap in the entire 2006 period and in the 2005 quarter,
revenues would have increased approximately 14.0%
Mortgage revenue bond interest income increased due to an increase in the
average portfolio balance over the comparable period. Mortgage banking fee
income increased primarily due to mortgage servicing fees earned by the newly
acquired ARCap business. Fund sponsorship fee income variances primarily relate
to an increase in equity invested during the current quarter and are detailed in
the discussions of results for the Fund Management segment below.
37
Other interest income includes income from temporary investments, interest
earned on Mortgage Banking escrow balances and interest earned on our loan to
CCA prior to the loan repayment in September 2006. The increase compared to the
2005 period relates to:
o interest generated by CMBS resecuritization certificates we hold
through ARCap; and
o higher cash balances (predominantly the escrow accounts) coupled with
increasing market interest rates for temporary investments.
Revenues of consolidated partnerships increased due to:
o an increase in the number of LIHTC Partnerships due to fund
sponsorship activity;
o an increase in the number of Property Partnerships over the past year
which we have taken control of to protect our investments; and
o CMBS partnerships consolidated as part of the ARCap acquisition (see
Note 10).
Results of consolidated partnerships are also discussed below.
Offsetting the revenue gains is the elimination of revenues earned by our
subsidiaries in transactions with LIHTC and Property Partnerships we have
consolidated but in which we have virtually no equity interest. Although the
amounts are eliminated in consolidation, the net losses recognized by those
partnerships in connection with these transactions are absorbed by their equity
partners; as such, the elimination in consolidation has an insignificant impact
on our net income.
In the third quarters of 2006 and 2005, the following amounts were eliminated,
as they represented transactions between consolidated partnerships and our other
component businesses:
For the Three Months Ended September 30,
---------------------------------------
(In thousands) 2006 2005 % Change
--------------------------------------- ------- ------- --------
Mortgage revenue bond interest income $ 1,785 $ 1,135 57.3%
Other interest income 53 165 (67.9)
Fund sponsorship fees 14,829 9,737 52.3
Credit intermediation fees 863 731 18.1
Other revenues 1,615 902 79.0
------- ------- ------
Total $19,145 $12,670 51.1%
======= ======= ======
38
EXPENSES
Our expenses were as follows:
For the Three Months Ended September 30,
---------------------------------------
(In thousands) 2006 2005 % Change
--------------------------------------------------- --------- --------- --------
Interest expense $ 25,457 $ 13,490 88.7%
Interest expense - preferred shares of subsidiary 4,724 4,724 --
Salaries and benefits 26,842 17,077 57.2
Fund origination and property acquisition expenses 5,481 2,468 122.1
Operating costs of real estate owned 934 1,011 (7.6)
Restructuring costs (549) -- --
Other general and administrative 10,970 9,814 11.8
--------- --------- -------
Subtotal 43,678 30,370 43.8
--------- --------- -------
Depreciation and amortization 11,033 16,302 (32.3)
Write-off of intangible asset 2,547 -- --
Loss on impairment of assets 394 804 (51.0)
--------- --------- -------
Subtotal 87,833 65,690 33.7
Interest expense of consolidated LIHTC and Property
partnerships 6,199 6,342 (2.2)
Interest expense of consolidated CMBS partnerships 6,783 -- --
Other expenses of consolidated LIHTC and Property
partnerships 18,344 14,285 28.4
Other expenses of consolidated CMBS partnerships 136 -- --
--------- --------- -------
Total expenses $ 119,295 $ 86,317 38.2%
========= ========= =======
The increase in interest expense reflects the higher amount of average debt
outstanding (approximately $2.1 billion and $1.4 billion in the third quarters
of 2006 and 2005, respectively) to fund the ARCap acquisition, continuing
mortgage revenue bond and LIHTC investments and mortgage originations. In
addition, our average borrowing rate increased in 2006 as compared to 2005 as a
result of increases in the Bond Market Association Municipal Swap Index ("BMA")
and LIBOR rates in both years. The effect of rate increases was tempered,
however, by a new fixed rate securitization program and the interest rate swaps
that we have in place, most of which are "in the money". One swap that was in
effect in the 2005 period, however, has since expired. Our average borrowing
rate increased to 4.2% in the third quarter of 2006 as compared to 3.8% in the
third quarter of 2005.
The increase in salaries and benefits expense primarily relates to the
approximately 100 employees added upon the ARCap acquisition, the continued
growth of our component businesses and approximately $3.4 million of incremental
non-cash compensation cost related to shares issued in connection with the ARCap
acquisition. Of the incremental amount, approximately $1.1 million related to
shares that vested immediately. In addition, salaries and benefits includes
approximately $3.9 million for deferred participation compensation related to
CMBS funds we sponsor.
Fund origination and property acquisition expenses represent costs incurred in
connection with originating tax-credit equity investment funds and acquiring
properties for those investment funds. The increase compared to last year is the
result of a higher level of fund sponsorship activity in 2006 (see FUND
MANAGEMENT section below for related revenue discussion).
Operating costs of real estate owned relates to properties we foreclosed upon in
May 2005 in connection with three of our mortgage revenue bonds.
Restructuring costs relate to integration actions in anticipation of the ARCap
acquisition. During the quarter, an adjustment was recorded to reverse amounts
due to employee attrition in advance of severance dates as well as the amount
reclassified as retention bonuses (see Note 9). The increase in other general
and administrative expenses primarily results from management fees paid by
Centerbrook to IXIS.
Depreciation and amortization expenses were lower in the 2006 period, primarily
due to decreased amortization of mortgage servicing rights (see Mortgage Banking
section) and the absence of amortization of a sizable intangible asset that we
wrote off at the end of 2005.
Write-off of intangible assets represents a goodwill impairment charge of
approximately $0.9 million to account for the portion of our total investment in
and advances to CRES that we do not expect to recover and the write-off of $1.6
million in unamortized other CRES intangible assets recognized at the time of
its acquisition.
39
Other expenses of the consolidated LIHTC and Property partnerships increased due
to the increase in the number of consolidated entities due to the incremental
fund sponsorship activity. Virtually all of the expenses of the consolidated
LIHTC and Property partnerships are absorbed by their equity partners; as such,
they have an insignificant impact on our net income.
Expenses of consolidated CMBS partnerships represent funds we sponsor to
syndicate investments in CMBS and associated resecuritization trusts. These
items were incorporated into our financial results upon our acquisition of
ARCap.
OTHER ITEMS
For the Three Months Ended September 30,
----------------------------------------
(In thousands) 2006 2005 % Change
-------------------------------------------------- --------- --------- --------
Equity and other (loss) income $ (3,320) $ 414 (901.9)%
Gain on termination of CCA loan $ 6,916 $ -- -- %
Gain on sale or repayment of loans 1,322 2,935 (55.0)
Gain on repayment of mortgage revenue bonds 51 1,027 (95.0)
--------- --------- -------
Gain on sale or repayment of mortgage revenue
bonds and loans $ 8,289 $ 3,962 109.2 %
--------- --------- -------
Income allocated to preferred shareholders of
subsidiary $ (1,556) $ (1,557) -- %
--------- --------- -------
Income allocated to SCUs $ (5,725) $ (7,467) (23.3)%
Income allocated to SMUs (118) (159) (25.8)
Income allocated to SCIs (29) -- --
Other 101 -- --
--------- --------- -------
Total income allocated to minority interests $ (5,771) $ (7,626) (24.3)%
Loss allocated to partners of consolidated
partnerships $ 105,434 $ 91,295 15.5 %
Equity and other (loss) income decreased since we no longer recognize our
proportionate share of ARCap earnings through equity income subsequent to our
acquisition in August 2006. The loss for the quarter primarily relates to losses
from tax advantaged investment vehicles similar to those we sponsor and
revisions to second quarter earning's estimates provided by ARCap
pre-acquisition. Equity income from our investment in CMBS funds is eliminated
in consolidation but positively impacts our net income. For the third quarter of
2006, this amount was approximately $9.6 million. There is no comparable amount
in 2005 as this earnings stream began with our acquisition of ARCap.
Gain on termination of CCA loan represents the $6.0 million cash paid to us by
CCA to terminate our rights relating to participating loan and the estimated
value of the management interest in CUC that was assigned to us (see Note 4).
Gains related to mortgage revenue bonds and loans fluctuate in relation to
relative activity levels in the Portfolio Investing and Mortgage Banking
businesses. See RESULTS BY SEGMENT below.
The income allocation to SCUs, SMUs and SCIs of subsidiaries represents the
proportionate share of after-tax income attributable to holders of subsidiary
equity as if they were all converted to common shares. The decrease in 2006 as
compared to 2005 is due to the decline in period earnings and the conversion of
units during the past twelve months. The SCIs were issued in August 2006 in
connection with the ARCap acquisition. "Other" minority interest principally
represents the portion of Centerbrook owned by IXIS.
The loss allocation to partners of consolidated partnerships represents the
operating losses of LIHTC and Property partnerships, of which we have absorbed
an insignificant portion (approximately $3,000) and the majority ownership in
CMBS funds we sponsor.
40
Results by Segment
------------------
PORTFOLIO INVESTING
The table below shows selected information regarding our Portfolio Investing
activities:
For the Three Months Ended September 30,
----------------------------------------
(In thousands) 2006 2005 % Change
--------------------------------------------------------- ---------- ---------- --------
New mortgage revenue bond acquisitions $ 81,969 $ 48,978 67.4 %
Funding of mortgage revenue bonds acquired in prior years 2,450 -- --
Acquisitions related to prior period forward commitments -- 9,400 --
---------- ---------- ------
Total acquisition and funding activity $ 84,419 $ 58,378 44.6 %
Mortgage revenue bonds repaid $ 27,510 $ 46,118 (40.3)%
Average portfolio balance (fair value) $2,628,252 $2,230,974 10.9 %
Weighted average permanent interest rate of bonds
acquired 5.61 % 5.54 %
Weighted average yield of portfolio 6.57 % 6.78 %
Average borrowing rate (includes effect of swaps) 4.12 % 3.29 %
Average BMA rate 3.56 % 2.40 %
---------- ----------
Mortgage revenue bond interest income (1) $ 41,946 $ 37,430 12.1 %
Other interest income (1) 3,739 3,692 1.3
Prepayment penalties 396 317 24.9
Rental income of real estate owned 907 1,210 (25.0)
Other revenues (1) 1,070 629 70.1
---------- ---------- ------
$ 48,058 $ 43,278 11.0 %
========== ========== ======
Interest expense and securitization fees (1) $ 24,070 $ 13,797 74.5 %
Loss on impairment of assets $ 395 $ 803 (50.8)%
Gain on repayments of mortgage revenue bonds $ 49 $ 1,027 (95.2)%
Gain on termination of CCA loan $ 6,916 $ -- -- %
========== ========== ======
CAD $ 29,147 $ 25,528 14.2 %
========== ========== ======
(1) Prior to intersegment eliminations.
The increase in mortgage revenue bond interest income is primarily due to the
increased investment base resulting from new bonds funded during later quarters
of 2005 and the first nine months of 2006.
Rental income of real estate owned pertains to the operations of properties on
which we foreclosed during the second quarter of 2005.
While generally declining interest rates of bonds acquired has gradually lowered
the average yield of our portfolio, we continue to earn a positive spread on our
portfolio. Corresponding with an increase in the average portfolio balance, our
level of securitizations increased and, along with a higher average borrowing
rate, resulted in the increase in interest expense and securitization fees.
While our borrowing costs have been increasing along with market rates, we
expect the commencement of Centerbrook, our new credit intermediation
subsidiary, will help enable us to retain a significant portion of fees which we
historically have paid to third parties. In addition, we anticipate Centerbrook
will enable us to obtain better leverage against our assets and lower our
average cost of capital. In addition, the fixed rate securitization that we
entered into in the third quarter of 2006 should serve to temper our exposure to
interest rate increases (see Note 7).
The level of prepayment penalties we record as income can be expected to
increase as several older, higher-yielding mortgage revenue bonds in our
portfolio reach the end of lock out periods. We anticipate an increase in the
level of these fees (as well as participating interest sometimes associated with
older bonds) in the near future. In particular, we are in negotiations with one
borrower that may repay a bond later in 2006 and we may realize incremental
income of more than $5.0 million upon repayment.
Impairment losses pertain to the restructuring of bond terms or the
deterioration of operations that indicate that full balances may not be
recoverable. We recognized impairment on two mortgage revenue bonds in the 2006
period and one in the 2005 period.
41
Third quarter CAD for this segment increased in 2006 over the 2005 period in
large part due to the $6.0 million cash termination fee received upon the
termination of the loan to CCA. This gain served to offset the higher borrowing
costs from steadily increasing interest rates. We expect that the effect of
borrowing costs will be tempered in future periods by the expected cost savings
associated with the involvement of Centerbrook in providing credit
intermediation for our securitization programs and the impact of the fixed rate
securitization program that we closed in August 2006.
FUND MANAGEMENT
The table below shows selected information regarding our Fund Management
activities:
For the Three Months Ended September 30,
---------------------------------------
(In thousands) 2006 2005 % Change
-------------------------------------------- -------- -------- --------
Equity raised by LIHTC funds $432,801 $275,524 57.1 %
Equity invested by LIHTC funds (1) $388,268 $320,976 21.0 %
Fees based on equity raised (2) $ 4,847 $ 3,354 44.5 %
Fees based on equity invested (2) $ 17,294 $ 13,023 32.8 %
Fees based on management of other entities:
Asset management and partnership fees (2) $ 11,761 $ 8,481 38.7 %
Investment origination fees (2) 114 169 (32.5)
Other (2) 61 -- --
-------- -------- -----
Subtotal 11,936 8,650 38.0
-------- -------- -----
Total fund sponsorship fees (2) 34,077 25,027 36.2
Credit intermediation fees (2) 2,898 2,186 32.6
Expense reimbursement (2) 3,522 2,473 42.4
Construction fees (2) 1,175 1,185 (0.8)
Other interest income (2) 565 69 718.8
Other revenues (2) 1,353 669 102.2
-------- -------- -----
Total $ 43,590 $ 31,609 37.9 %
======== ======== =====
Equity income from CMBS Funds (2) $ 9,643 $ -- -- %
======== ======== =====
CAD $ 31,106 $ 21,055 47.7 %
======== ======== =====
(1) Excludes warehoused properties that have not yet closed into an investment
fund.
(2) 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 partnership and asset management fees for
the services we perform for the funds once they are operating, which we
recognize over the service periods. As many of our revenues are recognized over
time following the sponsorship of a new fund, many of the 2006 increases relate
to the funds closed since the end of the third quarter of 2005.
FEES BASED ON EQUITY RAISED
We earn Organization and Offering ("O&O") service and partnership management
fees based upon the level of equity we raise for tax-credit equity funds. O&O
fees are realized immediately while we earn the partnership management fees over
five-year periods. O&O fees increased approximately 33% in 2006 as compared to
the same period in 2005 primarily due to the increase in the amount of equity
raised, which was partially offset by a decrease in the rate realized stemming
from heightened competition relating to certain types of funds. Related O&O
acquisition expenses also increased in line with the increase in revenue.
Partnership management fees increased approximately 68% over 2005 and relate to
additional funds closed since the end of the third quarter of 2005.
FEES BASED ON EQUITY INVESTED
We earn property acquisition fees and acquisition allowance fees based upon the
level of fund equity invested, which varies due to the timing of fund closures.
While we acquire properties on an ongoing basis throughout the year, we do not
recognize revenue until we place the property in a sponsored fund. Therefore,
delays in timing of a fund closure may impact the level of revenues recognized
in a given period.
42
The increase in fees is higher than the increase of equity invested because of a
higher fee rate realized, stemming from changes in the mix of funds originated.
FEES BASED ON MANAGEMENT OF OTHER ENTITIES
Asset management and partnership fees increased in 2006, primarily attributable
to the higher level of assets under management as well as an increase in fees
earned from AMAC due to the gain AMAC realized related to the sale of its ARCap
investment to us. These increases were partially offset by the reduction of the
cash positions of certain investment funds over the prior year which prevented
us from recognizing any management fees for these funds in 2006 since
collectibility is not reasonably assured.
OTHER REVENUES
Credit intermediation, expense reimbursement and other revenues in this segment
consist largely of service fees charged to entities (including consolidated
partnerships) we manage and fluctuate with the growth of the number of those
entities and their cash flows. Credit intermediation fees also vary depending
upon the time an agreement is outstanding as we recognize a higher proportion of
revenues in the early years of an intermediation period, when the risk
associated with the agreement is greater.
EQUITY INCOME
We act as general partner of the CMBS funds we sponsor and own a portion of the
funds. Equity income in this segment primarily represents our proportionate
share of profits as well as other allocations for general partner services. This
category became a part of this segment upon the ARCap acquisition.
CAD for the third quarter of 2006 exceeded that of 2005 due predominantly to
higher fund sponsorship activity and the up-front fees received in the
transactions. In addition, the addition of equity income from CMBS funds to this
segment with the acquisition of ARCap benefited the results as a portion of the
income recognized is cash based. These gains were partially offset by higher
infrastructure costs in expanding the business and initial costs associated with
ramping up the Centerbrook business.
MORTGAGE BANKING
The table below shows selected information regarding our Mortgage Banking
activities:
For the Three Months Ended September 30,
---------------------------------------
(In thousands) 2006 2005 % Change
------------------------------------------------------- ----------- ----------- ---------
Originations $ 444,842 $ 491,593 (9.5)%
Mortgage portfolio at September 30 $ 9,039,666 $ 8,874,898 2.2 %
Fair value of mortgage servicing rights at September 30 $ 72,788 $ 69,409 (4.9)%
----------- ----------- -----
Mortgage origination fees (1) $ 2,440 $ 2,523 (3.3)%
Servicing fees (1) 6,603 5,189 27.3
Assumption fees (1) 219 183 19.7
----------- ----------- -----
Total fee income 9,262 7,895 17.3
Interest income (1) 5,477 3,206 70.8
Prepayment penalties (1) 2,249 2,198 2.3
Other revenues (1) 177 125 41.6
----------- ----------- -----
$ 17,165 $ 13,424 27.9 %
=========== =========== =====
Gain on sale of mortgages $ 1,420 $ 3,059 (53.6)%
=========== =========== =====
CAD $ 6,839 $ (656) -- %
=========== =========== =====
(1) Prior to intersegment eliminations.
Including ARCap for the full comparable periods, segment revenues for the third
quarter of 2006 would have increased approximately 7.9% from the 2005 level.
Despite lower origination volume, compression in origination fee rates and the
relatively modest growth in the servicing portfolio, overall revenues increase
due to increased interest income earned on escrow balances.
43
Originations for the three months ended September 30 are broken down as follows:
(In thousands) 2006 % of total 2005 % of total
------------------ ------------ ---------- ------------- ----------
Fannie Mae $ 127,470 28.7 % $ 294,238 59.9 %
Freddie Mac 125,450 28.2 45,255 9.2
CharterMac Direct 167,850 37.7 -- --
Conduit and other 24,072 5.4 152,100 30.9
------------ -------- ------------- --------
Total $ 444,842 100.0 % $ 491,593 100.0 %
============ ======== ============= =========
The decrease in mortgage origination fees for the quarter was generally in
proportion to the decrease in originations as well as the average rate of
origination fees being impacted by the higher proportion of non-agency
originations. Fannie Mae and Conduit originations decreased and CharterMac
Direct originations increased from the prior period because the loan production
staff focused its efforts on originating loans for AMAC's proprietary lending
program, CharterMac Direct, which was launched in late 2005. Freddie Mac
originations increased sharply because we completed three large portfolio
transactions totaling $123 million in this quarter.
Servicing fee income declined in the 2006 period as a result of steady erosion
of the servicing fee rate, also due to the higher proportion of non-agency loans
in the portfolio. This trend has also affected the level of mortgage servicing
rights, as write-offs in connection with the prepayment of mortgages at higher
servicing rates are replaced with new assets generating lower fee streams
Generally, as our prepayments have increased, our mortgage servicing rights have
decreased.
Interest income relates primarily to that earned on escrow balances. The income
increase resulted from higher account balances and increased market rates
earned. The increase in prepayment penalties relates to a higher level of
refinancing activity in the current quarter as compared to last year.
Gain on sale of mortgages relates directly to the value of mortgage servicing
rights recorded when loans are sold. The mortgage servicing rights, in turn, are
valued based on projected servicing revenues, which decreased in 2006 as
compared to 2005 due to erosion of servicing fee rates for new originations.
Segment CAD for the three months ended September 30, 2006, was higher than the
comparable 2005 period due primarily to increased servicing fees and interest
income on escrow accounts. Both of these were attributable to the expansion of
our business as well as the acquisition of ARCap, and the higher interest income
was also due in part to increasing interest rates in 2005 and 2006. These
factors were partially offset by declining origination fees stemming from the
mix of origination activity as discussed above. We expect that the continued
expansion of this business and the expected synergies from combining existing
operations with ARCap should benefit segment CAD in future periods.
CONSOLIDATED PARTNERSHIPS
The results of consolidated partnerships reflected in our financial statements
are for entities we 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 13 LIHTC and Property Partnerships, an insignificant equity interest.
LIHTC AND PROPERTY PARTNERSHIPS
Our Fund Management segment earns fees from many of the entities, and our
Portfolio Investing business earns interest on mortgage revenue bonds for
which these partnerships are the obligors. The consolidated partnerships
are 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 increased revenue, expense, equity loss and allocation amounts in 2006
are due principally to the origination of twelve funds in the past year.
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 $3,000, representing our nominal
ownership. As a result, the consolidation of these partnerships has an
insignificant impact on our net income.
CMBS PARTNERSHIPS
CMBS Partnerships were incorporated upon our acquisition of ARCap.
44
NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005
---------------------------------------------
The following is a summary of our operations for the nine months ended September
30, 2006 and 2005:
% of % of
(In thousands) 2006 Revenues 2005 Revenues % Change
-------------------------- -------- ---------- -------- ---------- -----------
Revenues $258,389 100.0 % $215,270 100.0 % 20.0 %
Income before income taxes $ 37,385 14.5 % $ 39,191 18.2 % (4.6)%
Net income $ 33,476 13.0 % $ 52,907 24.6 % (36.7)%
Compared to 2005, the 2006 period benefited from the acquisition of ARCap, the
continued expansion of all of our businesses and a full nine months of
operations for CCLP in the Mortgage Banking segment as compared to only seven
months in 2005. In addition, revenues in 2006 include $41.4 million generated by
consolidated partnerships compared to $19.4 million in 2005. Offsetting the
revenue gains is the elimination of revenues earned by our subsidiaries in
transactions with LIHTC and Property Partnerships we have consolidated but in
which we have virtually no equity interest. Although the amounts are eliminated
in consolidation, the net losses recognized by those partnerships in connection
with these transactions are absorbed by their equity partners; as such, the
elimination in consolidation has an insignificant impact on our net income.
Despite revenue gains and a higher level of pre-acquisition equity income from
ARCap, (for which we recorded our proportionate share), income before income
taxes was less than the overall revenues increase. This was caused by:
o an increase in interest expense, due to higher amount of debt as well
as an increase in our average borrowing rate period over period;
o an increase in general and administrative expenses due to the
acquisitions of ARCap and CCLP;
o start-up costs in commencing Centerbrook operations and restructuring
costs relating to integration actions with respect to the ARCap
acquisition;
o intangible assets written down in connection with our planned
disposition of CRES;
o termination fees and other costs associated with the restructuring of
our securitization programs in connection with the launch of
Centerbrook, including a write-off of deferred financing costs; and
o a retroactive depreciation charge for real estate owned.
Incremental costs in 2006 as described above related to corporate initiatives
(the majority of which were recorded in the second quarter) were as follows:
(In thousands) Where recorded
-------------- --------------
Centerbrook start-up costs $4,313 General and administrative
Restructuring costs in anticipation of ARCap acquisition 1,449 General and administrative
Restructuring of securitization programs - incremental interest expense 1,915 Interest expense
Restructuring of securitization programs - termination fees 3,695 General and administrative
Restructuring of securitization programs - write-off of deferred costs 3,398 Depreciation and amortization
----------
14,770
Tax effect (1,619)
----------
Net incremental costs $ 13,151
==========
Partially offsetting these factors, income before income taxes benefited from a
$6.9 million fee paid to us by CCA to terminate our rights relating to a
participating loan which was convertible into an ownership interest in CCA.
In addition to the above, net income decreased period over period as we incurred
income tax expense during 2006 compared to an income tax benefit during 2005.
The tax provision in the 2006 period relates to a higher level of current
taxable income from the Fund Management segment due to increased fund
sponsorship activity, coupled with a valuation allowance against deferred tax
benefits (see INCOME TAXES).
45
REVENUES
Our revenues were as follows:
For the Nine Months Ended September 30,
---------------------------------------
(In thousands) 2006 2005 % Change
------------------------------------- -------- -------- ---------
Mortgage revenue bond interest income $115,109 $109,524 5.1 %
Other interest income 20,089 10,828 85.5
Fee income:
Mortgage banking 24,756 20,050 23.5
Fund sponsorship 34,379 33,681 2.1
Credit intermediation 4,235 4,955 (14.5)
-------- -------- -------
Total fee income 63,370 58,686 8.0
Other revenues:
Construction service fee 3,425 3,017 13.5
Expense reimbursements 2,456 4,084 (39.9)
Rental income of real estate owned 4,004 2,172 84.3
Administration fees 1,546 1,359 13.8
Prepayment penalties 4,691 4,314 8.7
Other 2,279 1,883 21.0
-------- -------- -------
Total other revenues 18,401 16,829 9.3
Subtotal 216,969 195,867 10.8
-------- -------- -------
Revenues of consolidated partnerships 41,420 19,403 113.5
-------- -------- -------
Total revenues $258,389 $215,270 20.0 %
======== ======== =======
A portion of the revenue increase was due to the ARCap acquisition. Adjusting to
include ARCap in the full comparable periods, revenues would have increased
approximately 12.9%.
Mortgage revenue bond interest income increased due to an increase in the
average portfolio balance over the comparable period although the growth was
partially offset by a higher level of eliminations following the consolidation
of a group of property level partnerships in mid-2005. Fund Management and
Mortgage Banking revenues also increased as a result of the ARCap acquisition as
detailed in the relevant RESULTS BY SEGMENT below.
Other interest income includes income from temporary investments, interest
earned on Mortgage Banking escrow balances and interest earned on our loans to
CCA (and CCLP in 2005). The increase from the 2005 period relates to:
o the expansion of the Mortgage Banking business due to the acquisition
of CCLP and the increase in origination volume;
o interest generated by CMBS resecuritization certificated we hold
through ARCap; and
o higher cash balances (predominantly the escrow accounts) coupled with
increasing market interest rates for temporary investments.
Rental income of real estate owned pertains to the operations of properties on
which we foreclosed during the second quarter of 2005. The 2006 period includes
a full nine months of operations while the 2005 results represent only a partial
period.
The increase in prepayment penalties is principally due to higher refinancing
volume in the Mortgage Banking business.
Revenue of consolidated partnerships increased due to:
o an increase in the number of LIHTC Partnerships due to fund
sponsorship activity;
o an increase in the number of Property Partnerships over the past year
which we have taken control of to protect our investments; and
o CMBS partnerships consolidated as part of the ARCap acquisition.
46
In the first nine months of 2006 and 2005, the following amounts were
eliminated, as they represented transactions between consolidated partnerships
and our other component businesses:
For the Nine Months Ended September 30,
--------------------------------------
(In thousands) 2006 2005 % Change
------------------------------------- ------- ------- ---------
Mortgage revenue bond interest income $ 6,072 $ 2,915 108.3 %
Other interest income 158 268 (41.0)
Fund sponsorship fees 34,934 27,756 25.9
Credit intermediation fees 2,615 2,291 14.1
Other revenues 4,678 1,579 196.3
------- ------- -------
Total $48,457 $34,809 39.2 %
======= ======= =======
EXPENSES
Our expenses were as follows:
For the Nine Months Ended September 30,
---------------------------------------
(In thousands) 2006 2005 % Change
--------------------------------------------------- -------- -------- ---------
Interest expense $ 66,650 $ 38,421 73.5 %
Interest expense - preferred shares of subsidiary 14,173 14,173 --
Salaries and benefits 64,803 50,575 28.1
Fund origination and property acquisition expenses 11,201 9,423 18.9
Operating costs of real estate owned 3,573 1,599 123.5
Restructuring costs 1,446 -- --
Other general and administrative 35,082 28,053 25.1
-------- -------- -------
Subtotal 116,105 89,650 29.5
-------- -------- -------
Depreciation and amortization 34,561 33,467 3.3
Write-off of intangible assets 2,547 -- --
Loss on impairment of assets 2,665 1,902 40.1
-------- -------- -------
Subtotal 236,701 177,613 33.3
Interest expense of consolidated LIHTC and Property
partnerships 18,756 19,364 (3.1)
Interest expense of consolidated CMBS partnerships 6,783 -- --
Other expenses of consolidated LIHTC and Property
partnerships 49,883 38,950 28.1
Other expenses of consolidated CMBS partnerships 136 -- --
-------- -------- -------
Total expenses $312,259 $235,927 32.4 %
======== ======== =======
The increase in interest expense reflects the higher amount of average debt
outstanding (approximately $1.9 billion and $1.3 billion for the first nine
months of 2006 and 2005, respectively) to fund continuing mortgage revenue bond
and LIHTC investments and mortgage originations. In addition, our average
borrowing rate increased in 2006 as compared to 2005 as a result of increases in
BMA and LIBOR rates in both years. The effect of rate increases was tempered,
however, by a new fixed rate securitization program and the interest rate swaps
that we have in place, most of which are now "in the money". One swap in effect
in the 2005 period, however, has since expired. Our average borrowing rate
increased to 4.3% for the nine months ended September 30, 2006 as compared to
3.7% for the 2005 period.
The increase in salaries and benefits expense primarily relates to the
approximately 100 employees added upon the ARCap acquisition, the continued
growth of our component businesses and approximately $3.4 million of incremental
non-cash compensation cost related to shares issued in connection with the ARCap
acquisition. Of the incremental amount, approximately $1.1 million related to
shares that vested immediately. The 2006 period also includes approximately $1.0
million of severance related costs associated with the elimination of certain
executive positions during the first quarter. In addition, salaries and benefits
includes approximately $3.9 million for deferred participation compensation
related to CMBS funds we sponsor.
Fund origination and property acquisition expenses represent costs incurred in
connection with originating tax-credit equity investment funds and acquiring
properties for those investment funds. The increase compared to last year is the
result of a higher level of fund sponsorship activity in 2006 (see FUND
MANAGEMENT section below for related revenue discussion).
47
Operating costs of real estate owned relates to properties foreclosed upon in
May 2005 in connection with three of our mortgage revenue bonds. The 2006 period
represents a full nine months worth of operating costs compared to approximately
five months during 2005.
The increase in other general and administrative expenses primarily resulted
from start-up costs for Centerbrook operations and termination and other fees
associated with restructuring of our securitization programs. Restructuring
costs relate to integration and actions in anticipation of the ARCap acquisition
net of amounts reversed in the third quarter (see Note 9 to condensed
consolidated financial statements). These costs are as detailed in the table on
page 46.
Depreciation and amortization expenses were higher in the 2006 period, primarily
due to:
o higher amortization of mortgage servicing rights following the CCLP
acquisition and the expansion of the Mortgage Banking business;
o a write-off of previously deferred fees in connection with the
restructuring of certain securitization programs upon the launch of
Centerbrook; and
o recognizing a retroactive depreciation charge for real estate owned
which was reclassified from held for sale to held and used (see Note 6
to condensed consolidated financial statements).
These were partially offset by the absence of amortization of a sizable
intangible asset that we wrote off at the end of 2005.
The write-off of intangible assets represents a goodwill impairment charge of
approximately $0.9 million to account for the portion of our total investment in
and advances to CRES that we do not expect to recover and the write-off of $1.6
million in unamortized other CRES intangible assets recognized at the time of
its acquisition.
Other expenses of the consolidated LIHTC and Property partnerships increased due
to the increase in the number of consolidated entities due to the incremental
fund sponsorship activity. Virtually all of the expenses of the consolidated
partnerships are absorbed by their equity partners; as such, they have an
insignificant impact on our net income.
Expenses of consolidated CMBS partnerships represent funds we sponsor to
syndicate investments in CMBS and associated resecuritization trusts. These
items were incorporated into our financial results upon our acquisition of
ARCap.
OTHER ITEMS
For the Nine Months Ended September 30,
---------------------------------------
(In thousands) 2006 2005 % Change
--------------------------------------------- --------- --------- ---------
Equity and other income $ 738 $ 1,490 (50.5)%
Gain on termination of CCA loan $ 6,916 $ -- -- %
Gain on sale or repayment of loans 8,378 8,956 (6.5)
Gain on repayment of mortgage revenue bonds 963 1,930 (50.1)
--------- --------- ------
Gain on sale or repayment of mortgage revenue
bonds and loans $ 16,257 $ 10,886 49.3 %
--------- --------- ------
Income allocated to preferred shareholders of
subsidiary $ (4,669) $ (4,669) --
--------- --------- ------
Income allocated to SCUs $ (13,085) $ (21,358) (38.7)%
Income allocated to SMUs (288) (214) 34.6
Income allocated to SCIs (29) -- --
Other 101 -- --
--------- --------- ------
Total income allocated to minority interests $ (13,301) $ (21,572) (38.3)%
Loss allocated to partners of consolidated
partnerships $ 301,305 $ 255,628 17.9 %
Equity and other income primarily includes income from our pre-acquisition
investment in ARCap, offset by losses from tax advantaged investment vehicles
similar to those we sponsor. The 2006 period includes approximately $2.9 million
of pre-acquisition ARCap income, relating in large part to our proportionate
share of a resecuritization gain realized by ARCap in the second quarter. This
category now primarily includes losses from tax advantaged investment vehicles
similar to those we sponsor. Equity income from our investment in CMBS funds is
eliminated in consolidation but positively impacts our net income. For the third
quarter of 2006, this amount was approximately $9.6 million. There is no
comparable amount in 2005 as this earnings stream began with our acquisition of
ARCap.
Gain on termination of CCA loan represents the $6.0 million cash paid to us by
CCA to terminate our rights relating to participating loan and the estimated
value of the manager interest in CUC that was assigned to us (see Note 4).
48
Gains related to mortgage revenue bonds and loans fluctuate in relation to
relative activity levels in the Portfolio Investing and Mortgage Banking
businesses. See RESULTS BY SEGMENT below.
The income allocation to SCUs, SMUs SCIs of subsidiaries represents the
proportionate share of after-tax income attributable to holders of subsidiary
equity as if they were all converted to common shares. The decrease in 2006 as
compared to 2005 is due to the decline in period earnings and the conversion of
units during the past twelve months. The SCIs were issued in August 2006 in
connection with the ARCap acquisition. "Other" minority interest principally
represents the portion of Centerbrook owned by IXIS.
The loss allocation to partners of consolidated partnerships represents the
operating losses of LIHTC and Property partnerships, of which we have absorbed
an insignificant portion (approximately $8,000) and the majority ownership in
CMBS funds we sponsor.
Results by Segment
------------------
PORTFOLIO INVESTING
The table below shows selected information regarding our Portfolio Investing
activities:
For the Nine Months Ended September 30,
--------------------------------------
(In thousands) 2006 2005 % Change
-------------------------------------------------------- ---------- ---------- --------
New mortgage revenue bond acquisitions $ 237,349 $ 190,058 24.9 %
Funding of mortgage revenue bonds acquired in prior
years 12,540 11,551 8.6
Acquisitions related to prior period forward commitments 48,396 23,550 105.5
---------- ---------- --------
Total acquisition and funding activity $ 298,285 $ 225,159 32.5 %
Forward commitments issued but not funded $ -- $ 8,000 -- %
Mortgage revenue bonds repaid $ 59,492 $ 65,499 (9.2)%
Average portfolio balance (fair value) $2,523,155 $2,199,480 10.8 %
Weighted average permanent interest rate of bonds
acquired 6.01 % 5.98 %
Weighted average yield of portfolio 6.58 % 6.89 %
Average borrowing rate (includes effect of swaps) 4.03 % 3.36 %
Average BMA rate 3.40 % 2.30 %
---------- ----------
Mortgage revenue bond interest income (1) $ 123,247 $ 113,011 9.1 %
Other interest income (1) 11,921 7,203 65.5
Rental income of real estate owned 4,004 2,171 84.4
Prepayment penalties 407 441 (7.7)
Other revenues (1) 2,403 2,479 (3.1)
---------- ---------- --------
$ 141,982 $ 125,305 13.3 %
========== ========== ========
Interest expense and securitization fees (1) $ 64,413 $ 36,794 75.1 %
Loss on impairment of assets $ 2,665 $ 1,902 40.1 %
Gain on repayments of mortgage revenue bonds $ 958 $ 1,930 (50.4)%
Gain on termination of CCA loan $ 6,916 $ -- -- %
========== ========== ========
CAD $ 77,645 $ 79,900 (2.8)%
========== ========== ========
(1) Prior to intersegment eliminations.
The increase in mortgage revenue bond interest income is primarily due to the
increased investment base resulting from new bonds funded during later quarters
of 2005 and first nine months of 2006, although the volume of investment and the
decline in the interest rate of bonds acquired reflects the challenging market
conditions experienced since 2004, such as increased competition and some
potential investments not meeting our underwriting standards.
Rental income of real estate owned pertains to the operations of properties on
which we foreclosed during the second quarter of 2005. The 2006 period includes
a full nine months of operations while the 2005 results represent only a partial
period.
While generally declining interest rates of bonds acquired has gradually lowered
the average yield of our portfolio, we continue to earn a positive spread on our
49
portfolio. Corresponding with an increase in the average portfolio balance, our
level of securitizations increased and, along with a higher average borrowing
rate, resulted in the increase in interest expense and securitization fees. In
addition, the restructuring of our securitization programs in the second quarter
of 2006 resulted in incremental interest costs of $1.9 million.
While our borrowing costs have been increasing along with market rates, we
expect the commencement of Centerbrook, our new credit intermediation
subsidiary, will help enable us to retain a significant portion of fees which we
historically have paid to third parties. In addition, we anticipate Centerbrook
will enable us to obtain better leverage against our assets and lower our
average cost of capital. In addition, the fixed rate securitization that we
entered into in the third quarter of 2006 (see Note 7) should serve to temper
our exposure to interest rate increases.
The level of prepayment penalties we record as income can be expected to
increase as several older, higher-yielding mortgage revenue bonds in our
portfolio reach the end of lock out periods. We anticipate an increase in the
level of these fees (as well as participating interest sometimes associated with
older bonds) in the near future. In particular, we are in negotiations with one
borrower that may repay a bond later in 2006 and we may realize incremental
income of more than $5.0 million upon repayment.
Other interest income relates to investments other than revenue bonds and
interest earned on excess cash loaned to other subsidiaries of the company for
operational needs. The higher level of income in the 2006 period relates
primarily to increased intercompany lending, offset by a lower level of outside
investments following the conversion of loans to equity in relation to Capri
investments during 2005 and 2006.
Impairment losses pertain to the restructuring of bond terms or the
deterioration of operations that indicate that full balances may not be
recoverable. We recognized impairment on six mortgage revenue bonds in the 2006
period and three in the 2005 period.
CAD for this segment declined in 2006 from the 2005 level due to higher
borrowing costs from steadily increasing interest rates and charges recorded in
the second quarter of 2006 associated with restructuring of our securitization
programs. These factors were partially offset by the $6.0 million cash
termination fee received upon the termination of the loan to CCA. We expect that
the effect of borrowing costs will be tempered in future periods by the expected
cost savings associated with the involvement of Centerbrook in providing credit
intermediation for our securitization programs and the impact of the fixed rate
securitization program that we closed in August 2006.
FUND MANAGEMENT
The table below shows selected information regarding our Fund Management
activities:
For the Nine Months Ended September 30,
---------------------------------------
(In thousands) 2006 2005 % Change
------------------------------------------- -------- -------- ---------
Equity raised by LIHTC funds $801,758 $711,918 12.6 %
Equity invested by LIHTC funds (1) $758,944 $751,985 0.9 %
Fees based on equity raised (2) $ 11,062 $ 10,104 9.5 %
Fees based on equity invested (2) $ 32,927 $ 31,613 4.2 %
Fees based on management of other entities:
Asset management and partnership fees (2) $ 25,815 $ 19,685 31.1 %
Investment origination fees (2) 269 494 (45.5)
Other (2) 62 60 3.3
-------- -------- -------
Subtotal 26,146 20,239 29.2
-------- -------- -------
Total fund sponsorship fees (2) 70,135 61,956 13.2
Credit intermediation fees (2) 7,819 7,246 7.9
Expense reimbursement (2) 10,042 6,951 44.5
Construction fees (2) 3,425 3,017 13.5
Other interest income (2) 932 197 373.1
Other revenues (2) 2,777 1,641 69.2
-------- -------- -------
Total $ 95,130 $ 81,008 17.4 %
======== ======== =======
Equity income from CMBS Funds (2) $ 9,643 $ -- -- %
======== ======== =======
CAD $ 44,757 $ 44,814 (0.1) %
======== ======== =======
(1) Excludes warehoused properties that have not yet closed into an investment
fund.
(2) Prior to intersegment eliminations.
50
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 partnership and asset management fees for
the services we perform for the funds once they are operating, which we
recognize over the service periods. As many of our revenues are recognized over
time following the sponsorship of a new fund, many of the 2006 increases relate
to the funds closed since the end of the third quarter of 2005.
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 fees are realized immediately
while we earn the partnership management fees over five-year periods. O&O fees
were consistent in 2006 as compared to the same period in 2005. Although there
was an increase in the amount of equity raised, this was offset by a decrease in
the rate realized stemming from heightened competition relating to certain types
of funds. Related O&O acquisition expenses were also down in-line with the
decrease in revenue. Partnership management fees increased approximately 71%
over 2005 and related to additional funds closed since the end of the third
quarter of 2005.
FEES BASED ON EQUITY INVESTED
We earn property acquisition fees and acquisition allowance fees based upon the
level of fund equity invested, which varies due to the timing of fund closures.
While we acquire properties on an ongoing basis throughout the year, we do not
recognize revenue until we place the property in a sponsored fund. Therefore,
delays in timing of a fund closure may impact the level of revenues recognized
in a given period.
The increase in fees is greater than the increase of equity invested because of
a higher fee rate realized, stemming from changes in the mix of funds
originated.
FEES BASED ON MANAGEMENT OF OTHER ENTITIES
Asset management and partnership fees increased in 2006, primarily attributable
to the higher level of assets under management as well as an increase in fees
earned from AMAC due to the gain AMAC realized related to the sale of its ARCap
interest to us. These increases were partially offset due to the reduction of
the cash positions of certain investment funds over the prior year which
prevented us from recognizing any management fees for these funds in 2006 since
collectibility is not reasonably assured.
OTHER REVENUES
Credit intermediation, expense reimbursement and other revenues in this segment
consist largely of service fees charged to entities (including consolidated
partnerships) we manage and fluctuate with the growth of the number of those
entities and their cash flows. Credit intermediation fees also vary depending
upon the time an agreement is outstanding as we recognize a higher proportion of
revenues in the early years of an intermediation period, when the risk
associated with the agreement is greater.
EQUITY INCOME
We act as general partner of the CMBS funds we sponsor and own a portion of the
funds. Equity income in this segment primarily represents our proportionate
share of profits as well as other allocations for general partner services. This
category became a part of this segment upon the ARCap acquisition.
CAD for the 2006 period was lower than that of 2005 despite the higher level of
fees received in connection with increased fund sponsorship activity. The
decrease resulted from incremental costs recognized in the second quarter of
2005 in connection with the start up of Centerbrook and restructuring charges in
anticipation of the ARCap acquisition, as well as a higher level of ongoing
infrastructure costs as we grow the business. The 2006 period also included the
addition of equity income from CMBS funds to this segment with the acquisition
of ARCap as a portion of the income recognized is cash based.
51
MORTGAGE BANKING
The table below shows selected information regarding our Mortgage Banking
activities:
For the Nine Months Ended September 30,
---------------------------------------
(In thousands) 2006 2005 % Change
------------------------------------------------------- ---------- ---------- --------
Originations $1,184,045 $ 932,636 27.0 %
Mortgage portfolio at September 30 $9,039,666 $8,874,898 2.2 %
Fair value of mortgage servicing rights at September 30 $ 72,788 $ 69,409 4.9 %
---------- ---------- -------
Mortgage origination fees (1) $ 7,231 $ 5,313 36.1 %
Servicing fees (1) 16,801 13,890 21.0
Assumption fees (1) 901 847 6.4
---------- ---------- -------
Total fee income 24,933 20,050 24.4
Interest income (1) 13,739 6,511 111.0
Prepayment penalties (1) 4,284 3,873 10.6
Other revenues (1) 851 422 101.2
---------- ---------- -------
$ 43,807 $ 30,856 42.0 %
========== ========== =======
Gain on sale of mortgages $ 8,453 $ 9,382 (9.9)%
========== ========== =======
CAD $ 12,870 $ 6,637 93.9 %
========== ========== =======
(1) Prior to intersegment eliminations.
Revenues increased in this segment largely due to the acquisitions of ARCap and
CCLP. Including all businesses for the full periods, segment revenues would have
increased 12.6% in the first nine months of 2006 as compared to the 2005 period.
Originations for the nine months ended September 30 are broken down as follows:
(In thousands) 2006 % of total 2005 % of total
----------------- ---------- ---------- ---------- ----------
Fannie Mae $ 550,254 46.5 % $ 581,971 62.4 %
Freddie Mac 215,465 18.2 59,180 6.3
CharterMac Direct 319,050 26.9 -- --
Conduit and other 99,276 8.4 291,485 31.3
---------- ------- ---------- -------
Total $1,184,045 100.0 % $ 932,636 100.0 %
========== ======= ========== ======
Mortgage origination fees generally increased in proportion to the increase in
originations. Fannie Mae and Conduit originations decreased and CharterMac
Direct originations increased from the prior period because the loan production
staff focused its efforts on originating loans for AMAC's proprietary lending
program, CharterMac Direct, which was launched in late 2005. Freddie Mac
originations increased sharply because we completed three large portfolio
transactions totaling $123 million in the 2006 period.
The increase in servicing fees is partly a result of the CCLP acquisition in
March 2005 and the ARCap acquisition in August 2006. Adjusting for the impact of
the acquisition, servicing fee income in 2006 declined approximately 6.3% as
compared to the same period in 2005. The decline is due to erosion of the
servicing fee rate due to the higher proportion of non-agency loans in the
portfolio. This trend has also affected the level of mortgage servicing rights,
as write-offs in connection with the prepayment of mortgages at higher servicing
rates are replaced with new assets generating lower fee streams Generally, as
our prepayments have increased, our mortgage servicing rights have decreased.
Interest income relates primarily to that earned on escrow balances. The income
increase resulted from higher account balances and increased market rates
earned. The increase in prepayment penalties relates to a higher level of
refinancing activity in the current year. Both categories also increased due to
the CCLP acquisition.
Gain on sale of mortgages relates directly to the value of mortgage servicing
rights recorded when loans are sold. The mortgage servicing rights, in turn, are
valued based on projected servicing revenues, which decreased in 2006 as
compared to 2005 due to erosion of servicing fee rates for new originations.
52
Segment CAD for the first nine months of 2006 was higher than the same period in
2005 due primarily to increased servicing fees and interest income on escrow
accounts. Both of these were attributable to the expansion of our business as
well as the acquisition of ARCap, and the higher interest income was also due in
part to increasing interest rates in 2005 and 2006. The increase was partially
offset by restructuring costs recorded in the second quarter of 2006 in
anticipation of the ARCap acquisition, as well as a higher level of ongoing
infrastructure costs as we grow the business. We expect that the continued
expansion of this business and the expected synergies from combining existing
operations with ARCap should benefit segment CAD in future periods.
CONSOLIDATED PARTNERSHIPS
The results of consolidated partnerships reflected in our financial statements
are for entities we 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 13 partnerships, an insignificant equity interest.
LIHTC AND PROPERTY PARTNERSHIPS
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 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 increased revenue, expense, equity loss and allocation amounts in 2006
are due to the origination of nine funds in the past year and the
assumption of the general partner interests in 14 property level
partnerships which occurred in the second quarter of 2005. As a result, for
the nine months ending September 30, 2006, include a full period of
activity for these property level partnerships while the same period in
2005 only includes approximately six months.
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 $8,000, representing our nominal
ownership. As a result, the consolidation of these partnerships has an
insignificant impact on our net income.
CMBS PARTNERSHIPS
CMBS Partnerships were incorporated upon our acquisition of ARCap.
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, income from
those investments is not subject to income taxes. The Fund Management and
Mortgage Banking businesses, however, 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.
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 Company recognized an income tax provision in the three and nine months
ended September 30, 2006, compared to the income tax benefit for the comparable
periods in 2005. The effective tax rate on a consolidated basis for the nine
months ended dateMonth9Day30Year2006September 30, 2006 and 2005 was 9.8% and
(35.0)%, respectively. The effective rate for our corporate subsidiaries that
were subject to taxes was (20.5)% and 57.4% for the nine months ended
dateMonth9Day30Year2006September 30, 2006 and 2005, respectively.
The income tax provision or benefit is affected by the book income or losses of
the taxable businesses and tax deductible distributions on their subsidiary
equity. In 2006, a current tax provision (due to higher currently taxable
income) is coupled with a valuation allowance against deferred tax assets.
Management determined that, in light of projected taxable losses in the
corporate subsidiaries for the foreseeable future, all of the deferred tax
assets will likely not be realized and hence a valuation allowance was provided.
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.
RECENTLY ISSUED ACCOUNTING STANDARDS
------------------------------------
See NEW ACCOUNTING PRONOUNCEMENTS in Note 1 to the condensed consolidated
financial statements.
53
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, and fee income receipts. 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 $175.0 million, used for mortgage banking needs, which matures in
November 2006, and we expect to enter into a further extension of this
line;
o $250.0 million, used to acquire equity interests in property ownership
entities prior to the inclusion of these equity interests into
investment funds, as well as for other corporate purposes, which
matures in August 2009;
o securitizations through the Merrill Lynch P-FLOATs/RITES program and
through the Goldman Sachs Floats/Residuals program of a specified
percentage of the fair value of mortgage revenue bonds not otherwise
securitized or pledged as collateral; and
o repurchase facilities used to fund investments by ARCap and its
subsidiaries as well as for general business purposes. Of the $280.0
million maximum borrowing amount, $91.1 million is currently available
to borrow without pledging additional collateral.
As of September 30, 2006, we had approximately $319.1 million available to
borrow under these debt and securitization facilities without exceeding limits
imposed by debt covenants and our by-laws and without pledging additional
collateral. Although the mortgage banking facility matures in 2006, we expect to
renew, replace or refinance it. While we believe that we will be able to do so,
there is no assurance that we will achieve refinancing terms favorable to us.
In addition to the credit lines detailed above, we have a $455.0 million
fixed-rate mortgage revenue bond securitization program and $250.0 million term
loan, both of which began in 2006 and were fully funded as of September 30,
2006. The securitization certificates have a weighted average term of eight
years and the term loan matures in 2012.
Equity
------
We have the ability to issue $500.0 million of equity securities pursuant to
registration statements we have filed with the SEC. We currently have no plans
to issue any such securities.
Liquidity Requirements after September 30, 2006
-----------------------------------------------
During November 2006, equity distributions will be paid as follows:
(In thousands)
--------------
Common/CRA shareholders $25,175
SCU/SMU/SCI holders 8,907
4.4% CRA Preferred shareholders 1,188
Equity Issuer Preferred shareholders 6,281
-------
Total $41,551
=======
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.
54
Summary of Cash Flows
---------------------
For the nine months ended September 30, 2006, there was a net decrease in cash
and cash equivalents as compared to a net increase during the comparable 2005
period. A larger increase in 2006 in operating cash flow and cash provided by
financing activities was more than offset by a larger increase in cash used in
investing activities.
Operating cash flow in 2006 was $164.5 million higher than in 2005 due primarily
to a sharp reduction in the level of mortgage loans receivable during 2006 as a
result of the high level of December 2005 originations that were not sold until
the first quarter of 2006. Conversely, in the 2005 period, the increasing level
of originations following the CCLP acquisition resulted in a net addition to the
asset balance during the period. In addition, liabilities increased in the 2006
period to a greater extent than in 2005 due to higher collections of deferred
revenues in connection with fund origination activity.
Cash used in investing activities was higher in 2006 as compared to 2005 by a
margin of $288.2 million due to:
o the ARCap acquisition;
o a higher level of mortgage revenue bond acquisitions and fundings; and
o capitalization requirements for Centerbrook that were invested in
marketable securities.
These factors were offset in part by an investment sold to AMAC in April 2006, a
decrease in restricted cash due to reduced collateral when we restructured our
securitization programs and returns of capital from ARCap prior to our
acquisition.
Financing inflows in the 2006 period were higher than in 2005 by $70.0 million.
While we borrowed through a new credit facility to finance the ARCap
acquisition, the level of financing inflows was offset by the repayment of
warehouse line borrowings associated with 2006 mortgage loan sales as noted in
the discussion of operating cash flows above. Also included in financing
activities are the proceeds and repayments related to the restructuring of our
securitization programs and borrowings to capitalize Centerbrook, as noted in
the discussion of investing cash flow activities above.
Commitments, Contingencies and Off-Balance Sheet Arrangements
-------------------------------------------------------------
Note 18 to the condensed consolidated financial statements contains a summary of
our guarantees and off-balance sheet arrangements.
The following table reflects our maximum exposure and carrying amount as of
September 30, 2006, for guarantees we and our subsidiaries have entered into:
Maximum Carrying
(In thousands) Exposure Amount
-------------------------------------------- ---------- ----------
Stabilization guarantees (1) $ 12,912 $ --
Completion guarantees (1) 23,902 --
Development deficit guarantees (1) 37,566 679
Operating deficit guarantees (1) 7,524 198
ACC transition guarantees (1) 3,245 --
Recapture guarantees (1) 114,703 198
Replacement reserve (1) 3,120 57
Guarantee of payment (1) 58,191 --
Mortgage pool credit intermediation (2) 7,446 --
LIHTC credit intermediation (2) 962,935 24,678
Mortgage banking loss sharing agreements (3) 821,088 13,041
---------- ----------
$2,052,632 $ 38,851
========== ==========
(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. The carrying values disclosed above relate
to the fees we earn for the transactions, which we recognize as their fair
values.
(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.
55
(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.
The maximum exposure amount is not indicative of our expected losses under the
guarantees.
CONTRACTUAL OBLIGATIONS
The following table provides our commitments as of September 30, 2006, 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)(2) $ 399,837 $ 61,370 $ 95,967 $ 5,000 $ 237,500
Notes payable of consolidated
partnerships (3) 498,912 28,372 149,072 27,896 293,572
Repurchase agreements of consolidated
partnerships 871,100 184,700 6,568 152,603 527,229
Operating lease obligations 78,375 8,161 16,499 15,183 38,532
Unfunded investment commitments (4) 382,099 265,957 116,142 -- --
Financing arrangements (1)(2) 1,730,629 1,730,629 -- -- --
Preferred shares of subsidiary (subject
to mandatory repurchase) 273,500 -- -- -- 273,500
---------- ---------- ---------- ---------- ----------
Total $4,234,452 $2,279,189 $ 384,248 $ 200,682 $1,370,333
========== ========== ========== ========== ==========
(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
beyond their current due dates.
(2) Recourse debt represents principal amount only. The weighted average
interest rate at period end, including the impact of our swaps, was 5.12%.
(3) Of the notes payable of consolidated partnerships, $371.9 million relate to
equity subscriptions and 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 $127.0 million is collateralized with the underlying properties
of the consolidated operating partnerships. All of this debt is
non-recourse to us.
(4) Of this amount, $307.7 million represents mortgage loan origination
commitments with corresponding sale commitments.
ITEM 3. 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.
56
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 $725.0 million of debt hedged via interest rate swap
agreements, the full amount of our liabilities labeled on our unaudited
condensed consolidated balance sheet as Financing Arrangements and Notes Payable
are variable-rate debt. We estimate that an increase of 1.0% in interest rates
would decrease our annual pre-tax income by approximately $14.1 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 pre-tax income by
approximately $2.5 million.
We manage interest rate risk through the use of interest rate swaps, interest
rate caps and forward bond origination commitments, as described in the notes to
our unaudited condensed 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.
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 $157.4 million and a 1% decrease would result in
an increase of approximately $176.5 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
accumulated other 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.
ITEM 4. CONTROLS AND PROCEDURES
(a) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. The Company maintains
disclosure controls and procedures that are designed to ensure that
information required to be disclosed in the reports that the Company
files or submits under the Securities and Exchange Act is recorded,
processed, summarized, and reported within the time periods specified in
the SEC's rules and forms, and that such information is accumulated and
communicated to the Company's management, including its Chief Executive
Officer and Chief Financial Officer, as appropriate, to allow timely
decisions regarding required disclosures.
As of the end of the period covered by this Quarterly Report on Form
10-Q, the Company carried out an evaluation, under the supervision and
with the participation of the Company's management, including the Chief
Executive Officer and Chief Financial Officer, of the effectiveness of
the design and operation of our disclosure controls and procedures
57
pursuant to the Securities and Exchange Act Rule 13a-15. Based upon this
evaluation as of September 30, 2006, the Chief Executive Officer and
Chief Financial Officer have concluded that the Company's disclosure
controls and procedures are effective to ensure that information
required to be disclosed by the Company in the reports that the Company
files or submits under the Exchange Act is recorded, processed,
summarized and reported, within the time periods specified in the SEC
rules and forms, and to ensure that such information is accumulated and
communicated to the Company's management, including the Chief Executive
Officer and Chief Financial Officer, as appropriate, to allow timely
decisions regarding required disclosure.
Management's assessment does not include internal controls at ARCap, as
the business was acquired in August 2006. This exclusion is considered
appropriate using guidance provided by the SEC in 'Management's Report
on Internal Control Over Financial Reporting and Certification of
Disclosure in Exchange Act Periodic Reports'. We expect to grow in part
through acquisitions and joint ventures. To the extent we make
acquisitions or enter into combinations or joint ventures, we face
numerous risks and uncertainties combining or integrating the relevant
businesses and systems, including the need to combine accounting and
data processing systems and management controls and to integrate
relationships with clients and business partners. In the case of joint
ventures, we are subject to additional risks and uncertainties in that
we may be dependent upon, and subject to liability, losses or reputation
damage relating to, systems, controls and personnel that are not under
our control. In addition, conflicts or disagreements between us and our
joint venture partners may negatively impact the benefits to be achieved
by the joint venture.
(b) INTERNAL CONTROL OVER FINANCIAL REPORTING. There have not been any
significant changes in our internal control over financial reporting
during the fiscal quarter to which this report relates that have
materially affected, or are reasonably likely to materially affect, our
internal control over financial reporting.
58
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We have been named as defendants in three separate but interrelated
lawsuits relating to two properties for which we have provided debt and
equity financing, but associated with the same developers. The lawsuits
allege, among other things, (i) breach of fiduciary duty; (ii) breach
of the implied covenant of good faith and fair dealing; (iii)
intentional misrepresentation, fraud and deceit; (iv) negligent
misrepresentation; and (v) tortious interference with contracts.
Two of the lawsuits claim unspecified damages while the third claims
damages of $10.0 - 15.0 million. One suit (with unspecified damages
claimed) is scheduled for trial in January 2007. The time for us to
respond to the other suits has not yet come.
We have engaged in settlement discussions seeking a global resolution
of all of these disputes. If such a settlement cannot be achieved, we
intend to defend vigorously against the claims and to assert
counterclaims and other claims as necessary.
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.
ITEM 1A. RISK FACTORS
In addition to those detailed in our Annual Report on Form 10-K for the
year ended December 31, 2005, we are now subject to additional risks as
a result of our acquisition of ARCap.
OUR INDIRECT INVESTMENTS IN SUBORDINATED CMBS ARE SUBJECT TO LOSSES.
We manage funds that hold investments in subordinated CMBS and retain
an ownership interest in those funds. In addition we hold interests in
ReREMICs which are securitizations of subordinated CMBS.
ARCap REIT, Inc. and the funds it manages invest primarily in
below-investment grade CMBS. Typically, these below-investment grade
securities support and are subordinate to the higher rated senior
securities in the CMBS transaction. The rights of the holder of these
subordinate securities, to receive distributions on account of the
underlying mortgage loans are subordinate to the rights of the holders
of the more senior securities. The yields to maturity on subordinated
securities are extremely sensitive to the default and loss experience
of the underlying mortgage loans, the timing of any such defaults or
losses, the timing of principal payments and other factors beyond our
control. Because these types of subordinated securities generally have
no or very limited credit support, to the extent that there are
realized losses on the mortgage loans, the holder of subordinate CMBS
may not recover the full amount of or, in extreme cases, any of its
initial investments in such subordinated securities. Any losses
incurred by the mortgage pools in which we have an interest would
reduce our net income.
The market value of ARCap REIT, Inc.'s and the funds' CMBS investments
fluctuate materially over time as the result of changes in mortgage
spreads, treasury bond interest rates, capital market supply and demand
factors, and many other factors which affect high-yield fixed income
products. These factors are out of our control, and could influence our
and the funds' ability to obtain short-term financing on the CMBS.
There may be occasions when we, as the managing member of the funds,
will seek to dispose of selected holdings of the funds and/or
investments held for our own account. Non-rated or below investment
grade CMBS generally are not actively traded and may not provide the
funds with liquidity of investment. Therefore, it may be difficult or
impossible to sell the funds' securities at a price that we deem
acceptable.
Upon the occurrence of certain events generally relating to a payment
or other default on a mortgage loan or events relating to the
insolvency of the mortgage loan borrower, the special servicer will
order an updated appraisal and calculate an "appraisal reduction" with
respect to such mortgage loan. As a result of calculating one or more
appraisal reductions, the amount of any required interest advance by
the Master Servicer, upon the failure by the borrower to make such
payments with respect to such mortgage loan, will be reduced by an
amount equal to interest on the amount of the appraisal reduction. This
will have the effect of reducing the amount of interest available to
the most subordinate class of CMBS outstanding. Such reductions in
interest, if they occur, may never be recovered. Consequently, ARCap
REIT, Inc. and/or the funds may suffer reductions in the amount of
interest paid to them as holders of the high yield CMBS, and the income
we recognize would be reduced accordingly.
59
THE TAX ADVANTAGES ATTRIBUTABLE TO INVESTMENTS MADE THROUGH REITS
DEPEND ON THE CONTINUING ABILITY OF SUCH ENTITIES TO COMPLY WITH THE
REQUIREMENTS FOR QUALIFICATION AS A REIT.
ARCap REIT, Inc. and the lower tier REITs in which it invests in CMBS
through its managed investment funds are relieved of federal income tax
through qualification as real estate investment trusts. In order to so
qualify, such entities must meet numerous and complex organizational
and operational requirements, including those related to the amount and
timing of distributions, source of income and diversity and
distribution of share ownership. Continued ability to comply with such
REIT qualification requirements is not assured and failure to so
qualify (if not timely cured through available relief provisions in the
federal tax code) could result in a material federal income tax
liability that could have a material effect on the amount of
distributions available to our investors.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Securities purchased by us
--------------------------
The following table presents information related to our repurchases of
our equity securities during the third quarter of 2006 and other
information related to our repurchase program:
Purchases of Equity Securities
(a) (b) (c) (d)
Total number
of shares
Total Weighted purchased as part Maximum number
number of average of publicly of shares that may yet
shares price paid announced plans be purchased under the
Period purchased (1) per share or programs plans or programs
----------------------- ------------- ------------ ----------------- ----------------------
July 1-31, 2006 608,378 $18.87 608,300
August 1-31, 2006 299,132 19.35 283,360
September 1-30, 2006 19,529 20.15 --
------------ ---------- -----------
Total 927,039 $19.05 891,660 570,540
============ ========== =========== =============
(1) Some repurchases were in payment of tax withholding obligations incurred by
holders of newly vested restricted shares and were outside of our share
repurchase program.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES - None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - None
ITEM 5. OTHER INFORMATION - None
ITEM 6. EXHIBITS
31.1 Chief Executive Officer certification pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.*
31.2 Chief Financial Officer certification pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.*
32.1 Chief Executive Officer and Chief Financial Officer certification
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
* Filed herewith.
60
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CHARTERMAC
(Registrant)
Date: November 13, 2006 By: /s/ Marc D. Schnitzer
---------------------
Marc D. Schnitzer
Managing Trustee, Chief Executive Officer
and President
Date: November 13, 2006 By: /s/ Alan P. Hirmes
------------------
Alan P. Hirmes
Managing Trustee, Chief Financial Officer and
Chief Operating Officer