UNITED STATES SECURITIES
AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 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)
Registrant's telephone number, including area code (212) 317-5700
Securities registered pursuant to Section 12(b) of the Act:
SHARES OF BENEFICIAL INTEREST
Name of each exchange on which registered:
NEW YORK STOCK EXCHANGE
Securities registered pursuant to Section 12(g) of the Act:
NONE
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes[X] No [ ]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [X]
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer or a non-accelerated filer (as defined in Rule 12b-2 of the
Exchange Act). Large Accelerated filer [X] Accelerated filer [ ] Non-accelerated
filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
The aggregate market value of common equity held by non-affiliates of the
registrant as of June 30, 2006 was approximately $950,633,340.
As of February 23, 2007 there were 51,404,234 outstanding shares of the
registrant's shares of beneficial interest.
DOCUMENTS INCORPORATED BY REFERENCE
Part III: Those portions of the registrant's Proxy Statement for the Annual
Meeting to be held in June 2007 which are incorporated into Items 10, 11, 12, 13
and 14.
TABLE OF CONTENTS
CHARTERMAC
ANNUAL REPORT ON FORM 10-K
PAGE
PART I
Item 1. Business 4
Item 1A. Risk Factors 12
Item 1B. Unresolved Staff Comments 30
Item 2. Properties 30
Item 3. Legal Proceedings 30
Item 4. Submission of Matters to a Vote of Security Holders 30
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities 31
Item 6. Selected Financial Data 33
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations 33
Item 7A. Quantitative and Qualitative Disclosures about Market Risks 55
Item 8. Financial Statements and Supplementary Data 60
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure 131
Item 9A. Controls and Procedures 131
Item 9B. Other Information 131
PART III
Item 10. Directors, Executive Officers and Corporate Governance 132
Item 11. Executive Compensation 132
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters 132
Item 13. Certain Relationships and Related Transactions, and Director
Independence 132
Item 14. Principal Accounting Fees and Services 132
PART IV
Item 15. Exhibits and Financial Statement Schedules 133
SIGNATURES 139
2
CAUTIONARY STATEMENT FOR PURPOSES OF
THE "SAFE HARBOR" PROVISIONS OF
THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
This Annual Report on Form 10-K contains forward-looking statements. These
forward-looking statements are not historical facts, but rather our beliefs and
expectations and are based on our current expectations, estimates, projections,
beliefs and assumptions about our Company and industry. Words such as
"anticipates," "expects," "intends," "plans," "believes," "seeks," "estimates"
and similar expressions are intended to identify forward-looking statements.
These statements are not guarantees of future performance and are subject to
risks, uncertainties and other factors, some of which are beyond our control,
are difficult to predict and could cause actual results to differ materially
from those expressed or forecasted in the forward-looking statements. Some of
these risks include, among other things:
o adverse changes in real estate markets;
o competition with other companies;
o interest rate fluctuations;
o general economic and business conditions;
o environmental/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.
We caution you not to place undue reliance on these forward-looking statements,
which reflect our view only as of the date of this annual report on Form 10-K.
3
PART I
ITEM 1. BUSINESS.
General
-------
We are CharterMac, a statutory trust created under the laws of Delaware. We
conduct substantially all of our business through our subsidiaries. For ease of
readership, however, the term "we" (as well as "us", "our" or "the Company") as
used throughout this document may mean a subsidiary or the business as a whole,
while the term "parent trust" refers only to CharterMac as a stand-alone entity.
Through our subsidiaries and funds which they manage, we are one of the nation's
leading real estate finance and investing companies. We are strategically
positioned in the center of users of capital and providers of capital in the
commercial and multifamily real estate industry. We provide capital solutions to
real estate developers and owners, as well as investment products to retail and
institutional investors.
We commenced operations in October 1997 and have since expanded through several
acquisitions.
Additional Information
----------------------
Additional information about CharterMac beyond what is included in this Form
10-K, including our CODE OF BUSINESS CONDUCT AND ETHICS, is available at
www.chartermac.com. As soon as reasonably practicable after such material is
electronically filed with, or furnished to, the Securities and Exchange
Commission ("SEC") we make available, on or through our website, free of charge:
o our annual report on Form 10-K;
o our quarterly reports on Form 10-Q;
o our current reports on Form 8-K; and
o amendments to those reports filed or furnished pursuant to Section
13(a) or 15(d) of the Exchange Act.
You may also read and copy these materials at the SEC's Public Reference Room at
450 Fifth Street, NW, Washington, DC 20549, or obtain them by calling the SEC at
1-800-SEC-0300. The SEC also maintains an Internet website that contains
reports, proxy and information statements and other information regarding
issuers that file electronically with the SEC at www.sec.gov. We will provide a
copy of any of the foregoing documents upon request.
None of the information on our website that is not otherwise expressly set forth
or incorporated by reference in the Form 10-K is a part of this Form 10-K.
Business Overview
-----------------
Through our subsidiaries and funds which they manage, we are a full-service real
estate finance and investing company. Our subsidiaries have direct financing
relationships with approximately 875 real estate developers and owners
throughout the country and we have strong relationships with various
institutional investors, pension funds and endowments. We provide an array of
products and operate from a fully integrated platform, which enables us to
originate, underwrite and manage the risk of most transactions in which we
provide debt or equity. Our platform offers us several competitive advantages,
including:
o THE ABILITY TO CROSS-SELL FINANCING PRODUCTS. Frequently on
transactions, we offer more than one component of a property's
capital;
o THE ABILITY TO ORIGINATE THE TRANSACTION WHOLESALE, which enables us
to capture substantially all of the financing fees associated with
each transaction;
o THE ABILITY TO CONTROL THE CREDIT QUALITY OF THE UNDERLYING PROPERTY.
By working directly with the property's owner and by managing the
risks of the underlying asset, our credit losses have historically
been low; and
o THE ABILITY TO PROVIDE PRODUCTS AND SERVICES THROUGHOUT THE PROPERTY'S
FINANCING LIFE CYCLE.
4
Operating Segments
------------------
We operate in four business segments:
1. PORTFOLIO INVESTING, which includes subsidiaries that invest primarily
in tax-exempt first mortgage revenue bonds issued by various state or
local governments, agencies or authorities and other investments. The
proceeds of mortgage revenue bonds are used by the borrowers to
finance the new construction, substantial rehabilitation, acquisition,
or refinancing of affordable multifamily housing throughout the United
States.
This segment may also include loans to and other investments in other
business or funds involved in real estate or real estate finance. Such
investments have included our pre-acquisition investment in ARCap
Investors, LLC ("ARCap").
2. FUND MANAGEMENT, which includes:
o Tax Credit Fund Sponsorship - Subsidiaries that sponsor real
estate investment funds that primarily invest equity in
Low-Income Housing Tax Credit ("LIHTC") properties. Many of these
partnerships are included in our Consolidated Partnerships
segment. In exchange for sponsoring and managing these funds, we
receive fee income for providing asset management, underwriting,
origination and other services;
o High Yield CMBS Fund Sponsorship - Subsidiaries that sponsor and
manage funds that invest in high yield real estate instruments
including B-Notes, bridge loans, mezzanine loans and subordinated
interests associated with Commercial Mortgage Backed Securities
("CMBS"), commercial real estate mortgages and similar
investments, which partnerships are included in our Consolidated
Partnerships segment. These subsidiaries also hold, for
investment, investments like the ones held by sponsored funds.
These subsidiaries earn income and promotes from equity
investments in the sponsored funds and interest income from their
investments;
o Direct Loan Fund Sponsorship - Equity investment in ARCap Real
Estate Special Situations Mortgage Fund, LLC ("ARESS") from which
we earn income and promotes from our equity investment. We also
manage the operations of ARESS, which is included in our
Consolidated Partnerships segment;
o Equity Fund Sponsorship -Membership interest in CharterMac Urban
Capital LLC ("CUC"), an investment fund with the California
Public Employees Retirement System ("CalPERS") as majority
investor, focusing on investments in multifamily properties in
major urban markets. Our membership interest in CUC includes a
co-investment obligation amounting to 2.5% of capital invested.
The CUC fund generates income and cash flow predominantly from
asset management fees and promote income;
o Advisory Services - Subsidiaries that provide advisory services
to the parent trust, other subsidiaries of ours and to American
Mortgage Acceptance Company ("AMAC"), an affiliated, publicly
traded real estate investment trust; and
o Credit Intermediation - Subsidiaries that participate in credit
intermediation transactions, including those that provide
specified returns to investors in LIHTC equity funds and credit
intermediation to our Portfolio Investing businesses, in exchange
for fees.
3. MORTGAGE BANKING, which includes subsidiaries that originate and
underwrite predominantly multifamily mortgage loans on behalf of third
parties, including:
o The Federal National Mortgage Association ("Fannie Mae");
o The Federal Home Loan Mortgage Corporation ("Freddie Mac");
o The Federal Housing Authority ("FHA");
o The Government National Mortgage Association ("GNMA");
o ARESS and AMAC; and
o Insurance companies and conduits.
In exchange for these activities, we receive origination fees.
This segment also includes subsidiaries that provide multifamily and
commercial loan servicing for third parties and special servicing on
CMBS securitizations 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
5
modification fees. We also earn interest income on escrow and reserve
balances held on loans we service.
4. CONSOLIDATED PARTNERSHIPS, which include primarily the LIHTC equity
funds and debt funds we sponsor through the Fund Management segment's
subsidiaries and which we are required to consolidate in accordance
with FIN 46(R), as well as other partnerships we control but in which
we have little or no equity interest (see Note 1 to the consolidated
financial statements). This segment also includes CMBS and Direct Loan
funds we sponsor in which we have minority interests but for which our
subsidiaries are general partners.
Comparative segment financial information for 2006, 2005 and 2004 is presented
in Note 20 to the consolidated financial statements.
1. PORTFOLIO INVESTING
We conduct most of our portfolio investing through our CharterMac Equity Issuer
Trust I and CharterMac Equity Issuer Trust II subsidiaries. Throughout this
document, we will refer to both of these subsidiaries collectively as "Equity
Issuer".
As of December 31, 2006, our revenue bond portfolio includes direct and indirect
interests in mortgage revenue bonds with an aggregate fair value of
approximately $2.8 billion (prior to $397.3 million of eliminations related to
bonds issued by partnerships we consolidate), secured by affordable multifamily
properties containing 56,048 units located in 30 states and the District of
Columbia. While most of these mortgage revenue bonds generate tax-exempt income,
certain of them generate taxable income. The taxable mortgage revenue bonds are
held at the parent trust.
Our Portfolio Investing business generates most of its income and cash flow from
a positive spread between the interest earned from our mortgage revenue bond
portfolio and the cost of capital we use to purchase the bonds. We occasionally
receive participating interest on certain mortgage revenue bonds which is equal
to a percentage of net property cash flow of the net sale or refinancing
proceeds. We also receive fees from borrowers for the acquisition of new
mortgage revenue bonds.
The acquisition of mortgage revenue bonds requires capital. In addition to using
a portion of our operating cash flows, we obtain such capital by securitizing
most of the bonds we purchase and by issuing equity securities.
For more information on our securitization activity, see Note 8 to our
consolidated financial statements. For information regarding issuances of
preferred shares of Equity Issuer and our common and preferred shares, see Notes
13 and 14 to our consolidated financial statements.
This segment may also include loans to and other investments in other businesses
or funds involved in real estate or real estate finance. Such investments have
included our pre-acquisition investment in ARCap.
2. FUND MANAGEMENT
Our Fund Management segment includes:
o Tax Credit Fund Sponsorship;
o High Yield CMBS Fund Sponsorship;
o Direct Loan Fund Sponsorship;
o Equity Fund Sponsorship;
o Advisory Services; and
o Credit Intermediation.
TAX CREDIT FUND SPONSORSHIP
---------------------------
We conduct our tax credit fund sponsorship activities through our CharterMac
Capital LLC ("CharterMac Capital") subsidiary.
6
CharterMac Capital is one of the nation's largest sponsors of LIHTC investment
funds, having raised nearly $8.1 billion in equity from institutional and retail
investors. As a sponsor of over 130 public and private real estate investment
programs, CharterMac Capital has provided financing for over 1,300 properties in
46 states, Puerto Rico and the District of Columbia.
In a typical LIHTC investment fund, investors acquire a direct limited
partnership interest in an "upper-tier" investment partnership. The investment
partnership, in turn, invests as a limited partner in one or more "lower-tier"
operating partnerships which own and operate multifamily properties. Limited
partners in the upper-tier partnerships are most often corporations, which are
able to utilize the tax benefits associated with the LIHTC granted to the
lower-tier partnership and usually derive limited economic benefit from the
investment other than these expected tax credits and tax losses from the
lower-tier partnership's operation of the properties. In some cases, in
conjunction with the disposition of the funds' investments, the limited partners
may receive an additional return.
We often borrow cash from our credit facility lender to acquire lower-tier
partnership investments. This arrangement enables us to obtain and hold suitable
investments for a fund until it has admitted investors and obtained investment
capital. As a result, we are better able to provide investment opportunities to
the funds we sponsor when investment capital is available. When we admit
investors to a fund, the fund simultaneously (in most cases) pays us an amount
sufficient to enable us to repay the monies we borrowed, and the fund is either
admitted as a limited partner of the lower-tier operating partnership in our
place or the credit facility lender releases its lien on the fund's assets.
Tax credit fund sponsorship generates income and cash flow predominantly from:
o organization and offering fees we earn in connection with the capital
raising and sponsorship of investment programs, which we receive upon
the closing of a fund;
o fees associated with acquisition activity of each fund we sponsor,
which we receive at the time of the acquisition; and
o partnership management and asset management fees associated with
ongoing administration of investment programs we advise, which we
receive either at the time a fund closes or over several years,
depending upon the terms of the partnership agreements.
HIGH YIELD CMBS FUND SPONSORSHIP
--------------------------------
We conduct our high yield CMBS fund sponsorship activities through ARCap which
we wholly acquired in August 2006. ARCap serves as managing member for four
funds which invest in high yield real estate instruments ("CMBS Partnerships").
CMBS are publicly and privately traded bond issues backed by pools of commercial
real estate mortgages. These securities are rated by nationally recognized
rating agencies such as Fitch Ratings Ltd. ("Fitch"), Standard & Poor's ("S&P")
and Moody's Investor Services ("Moody's"). The senior tranche of a bond issue is
the highest rated security, typically "AAA" while more junior tranches receive
lower ratings down to the most junior class which is not rated. "High yield
CMBS" is the component of CMBS issues rated "BB+" and lower (including
non-rated) tranches. The purchase of high yield CMBS is similar to the
acquisition of real estate equity investments in that there is a heavy emphasis
on the performance and expected cash flows of the real estate. In the case of
high yield CMBS, a CMBS offering includes hundreds of individual loans secured
by hundreds of discrete real estate projects. Our funds provide access to this
market to investors without requiring the investors to incur the cost to develop
the infrastructure and personnel needed to make knowledgeable investments in the
high yield CMBS market.
High yield CMBS fund sponsorship generates income and cash flow predominantly
from:
o participating income from our equity interest in the funds; and
o promotes we earn, based on certain events in the fund life-cycle.
DIRECT LOAN FUND SPONSORSHIP
----------------------------
We own 5% of ARESS and we manage its operations. ARESS commenced operations in
May 2006 and our management and partial ownership commenced upon our acquisition
of ARCap.
7
ARESS invests in bridge loans secured by first mortgages for the refinance of
commercial properties with existing loans, subordinate interests in first
mortgages ("B-notes") and subordinate loans secured by interests in the
borrowing entity ("mezzanine loans"). Bridge loans are typically utilized to
provide financing to a borrower who intends to reposition its property, whether
through rehabilitation or preparation for sale. These loans typically carry a
variable rate of interest, although fixed rate bridge loans may be made in
certain circumstances. The spread will vary depending upon the market, the risk,
the borrower and the security. B-notes and mezzanine loans are a growing
component of real estate capitalization and access to them on the open market is
extremely competitive.
Direct Loan fund sponsorship generates income and cash flow predominantly from:
o participating income we earn from our equity interest in the funds;
and
o promotes we earn, based on certain events in the fund life-cycle.
EQUITY FUND SPONSORSHIP
-----------------------
CUC is an investment fund with CalPERS as the majority investor, focusing on
investments in multifamily properties in major urban markets. Our membership
interest in CUC includes a co-investment obligation amounting to 2.5% of capital
invested. As of December 31, 2006, CUC had $121.9 million in assets.
Our investment in and management of the CUC fund generates income and cash flow
predominantly from asset management fees and promote income.
ADVISORY SERVICES
-----------------
CharterMac Capital and its subsidiaries provide management and advisory services
to the parent trust and other subsidiaries of CharterMac, as well as to AMAC.
Providing services to CharterMac subsidiaries generates income and cash flows in
this segment from:
o fees associated with asset management services provided to the
Portfolio Investing segment with regard to the investments it holds;
and
o fees associated with the origination of certain mortgages by our
Mortgage Banking segment.
While these fees are eliminated in consolidation, our segment results presented
elsewhere in this document reflect these fees as earned (see MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS and
Note 20 to the consolidated financial statements).
AMAC is a publicly traded real estate investment trust that focuses on
originating and acquiring mortgage loans secured by multifamily and commercial
properties throughout the United States. AMAC also invests in uninsured
mezzanine loans, construction loans, first mortgage loans, subordinated
interests in first mortgage loans and bridge loans. As of December 31, 2006,
AMAC had $721.0 million in assets and a total market capitalization of
approximately $140.8 million.
Providing management to AMAC generates income and cash flow predominantly from:
o acquisition fees paid by the borrowers upon the closing of a loan that
we originate for AMAC;
o management fees based on shareholders' equity; and
o incentive management fees received annually if AMAC achieves certain
earnings and distribution benchmarks.
CREDIT INTERMEDIATION
---------------------
We conduct our credit intermediation activities primarily through our
Centerbrook Holdings LLC ("Centerbrook") subsidiary which commenced operations
in June 2006 and through our Charter Mac Corporation ("CM Corp.") subsidiary. We
own 90% of Centerbrook and IXIS Capital Markets North America Inc. ("IXIS"), an
unrelated party, owns the remainder. IXIS has been issued warrants which,
generally, may be exercised beginning June 2009 and if exercised, would increase
IXIS' ownership percentage to 19%.
8
What we refer to as "credit intermediation" falls into several categories:
o using credit default swaps to support the credit of the mortgage
revenue bonds in our securitization programs;
o using credit default swaps to provide a specified rate of return
during the life of an LIHTC fund we sponsor. These transactions may be
for the construction period or the operation period of a pool of
properties, or for the combined periods. These transactions
historically have involved supporting obligations of a primary credit
support provider;
o supporting a developer's credit during the construction and/or
lease-up phase of a property; and
o supporting a developer's credit following the stabilization of a
property for the operational period.
While historically CM Corp. has supported the commitments of a third-party
primary intermediator, we expect that Centerbrook may fulfill the primary
intermediator role in future transactions.
Centerbrook's total volume of credit intermediation activity since its inception
in June 2006 totals approximately $1.1 billion, predominantly in connection with
securitizations in the Portfolio Investing segment. While Centerbrook will
initially be involved in credit intermediation for transactions in which our
subsidiaries are involved, it will also seek to provide these services to third
party customers.
Upon its launch, Centerbrook was capitalized with equity by us and IXIS and
entered into a senior debt facility and a mezzanine debt facility to provide
capital to support its business lines.
This segment generates income and cash flows from credit intermediation fees and
from interest income on cash invested. Credit intermediation fees are generally
recognized over the applicable risk-weighted periods.
3. MORTGAGE BANKING
Our Mortgage Banking activities include the following:
o originating mortgage loans; and
o servicing mortgage loans we originate and loans for third parties.
ORIGINATIONS
------------
We conduct our mortgage origination activity primarily through our subsidiary
CharterMac Mortgage Capital Corp. ("CMC"), a full-service, direct mortgage
banking firm specializing in originating, underwriting, and servicing mortgage
loans for multifamily and commercial properties nationwide. CMC also manages the
operations of another subsidiary, CharterMac Mortgage Partners Corporation,
which originates and services certain Freddie Mac loans. Throughout this
document, we will refer to "CMC" as encompassing our entire mortgage origination
operations.
Our mortgage originations operations include:
o closing and delivering multifamily mortgages to Fannie Mae under its
Delegated Underwriter and Servicer ("DUS") program. Fannie Mae
delegates the responsibility for originating, underwriting, closing
and delivering multifamily mortgage loans to the DUS lenders. In most
cases, the DUS lenders share the risk of loss on the mortgage loans
with Fannie Mae. Under the DUS program, upon obtaining a commitment
from Fannie Mae with regard to a particular loan, Fannie Mae commits
to acquire or credit enhance the mortgage loan based upon CMC's
underwriting, and (in the case of loss sharing loans) CMC agrees to
bear a portion of the risk of potential losses in the event of a
default. Fannie Mae commitments may be made to acquire and/or credit
enhance the mortgage loan from CMC for cash or in exchange for a
mortgage-backed security backed by the mortgage loan;
o closing and delivering multifamily mortgages to Freddie Mac under the
Freddie Mac Program Plus ("Program Plus") and Delegated Underwriting
Initiative ("DUI") programs. These programs are similar to the DUS
program, although Program Plus does not involve loss sharing;
o originating mortgages for AMAC and ARESS;
o acting as an approved seller for Ginnie Mae;
9
o originating loans as a leading commercial loan correspondent for Wall
Street conduits and life insurance companies; and
o acting as an approved loan processor for the FHA.
Mortgage loans we originate for Fannie Mae, Freddie Mac or Ginnie Mae are
generally closed in CMC's name, using cash borrowed from a warehouse lender.
Following closing of a loan, the loan documentation and an assignment are
delivered to the mortgagor, or a document custodian on its behalf, and the cash
purchase price or mortgage-backed security is delivered to us. This may occur
from one week to three months following the closing of the loan. We use the cash
received to repay the warehouse loans or we sell the mortgage-backed securities
for cash pursuant to prior agreements and use that cash to repay the warehouse
loans. We do not retain any interest in any of the mortgage loans except for
mortgage servicing rights ("MSRs") and certain contingent liabilities under the
loss-sharing arrangements with Fannie Mae and Freddie Mac.
SERVICING
---------
We service many of the loans we originate and sub-service loans originated by
other firms. We also provide primary and interim loan servicing to third parties
and serve as the named special servicer on CMBS securitizations in which either
ARCap, or the funds ARCap manages, invest.
Our mortgage banking activities generate income and cash flow predominantly
from:
o origination fees;
o assumption and modification fees;
o ongoing fees for servicing a majority of the loans we originate as
well as other loans that we sub-service. Servicing fees include a loss
sharing premium for loans originated for Fannie Mae (and in certain
cases, Freddie Mac);
o liquidation fees;
o prepayment penalties, generally associated with refinancing; and
o interest earned on amounts held in escrow.
4. CONSOLIDATED PARTNERSHIPS
In accordance with accounting rules regarding consolidation, we consolidate the
balance sheets and operations of numerous funds that we sponsor and other
partnerships that we manage.
Consolidated Partnerships consist of four 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");
o CMBS Partnerships we sponsor, which we initially consolidated upon the
ARCap acquisition in August 2006; and
o a Direct Loan Partnership we manage and consolidate (ARESS), which we
initially consolidated following our acquisition of ARCap.
While we have little or no equity interest in the LIHTC and Property
Partnerships, we control them for reasons associated with our role in managing
them and the nominal equity interests of our executive officers. With respect to
the CMBS and Direct Loan Partnerships, we do own minority interest of varying
degrees, but all less than 25%. While our Fund Management and Portfolio
Investing segments earn fees or interest from certain of these consolidated
partnerships, we consider the partnerships as a separate business for management
purposes.
The high yield CMBS funds finance their investments through equity contributions
from their investors, and from proceeds from repurchase facility agreements.
Once the high yield CMBS funds accumulate investments of appropriate number,
size and diversity, the repurchase agreement financing is replaced with CDO
financing, which provides long-term nonrecourse, matched term funding secured by
the CMBS investments.
ARESS finances its investments through equity contributions from its members,
and from proceeds under repurchase facility agreements. ARESS also maintains a
subscription line credit facility, which is collateralized by the remaining
10
uncalled capital commitments of its members and may be used to acquire
investments or for general working capital purposes.
For a more detailed discussion, see Note 1 to the consolidated financial
statements.
Competition
-----------
We face increasing levels of competition both in terms of new competitors and
new competing products. From time to time, we may be in competition with private
investors, investment banks, mortgage banking companies, lending institutions,
Government Sponsored Enterprises ("GSEs") such as Fannie Mae and Freddie Mac,
mutual funds, domestic and foreign credit intermediators, bond insurers,
investment partnerships and other entities with objectives similar to ours.
Although we operate in a competitive environment, competitors focused on
providing all of our custom-designed programs are relatively few. Specifically:
o our Portfolio Investing business competes directly with commercial
banks, GSEs, real estate finance companies and others seeking to
invest in tax-exempt mortgage revenue bonds;
o our Fund Management business competes directly with others seeking to
raise capital for tax advantaged funds, some of which offer credit
intermediation for their funds. We also compete with regional and
national banks that directly acquire LIHTC investments, high yield
CMBS debt instruments and joint venture equity as well as with other
real estate fund management companies;
o our Mortgage Banking business is in competition with 24 other licensed
DUS lenders which originate multifamily mortgages on behalf of Fannie
Mae, 30 other Freddie Mac Program Plus lenders, four other companies
that participate in the DUI program as well as numerous banks, finance
companies and others that originate mortgages for investment or
resale; and
o our credit intermediation business is in competition with investment
banks, insurance companies and other credit intermediation companies.
Some of these competitors have substantially greater financial and operational
resources than we do. In addition, affiliates of some of our managing trustees
have formed, and may continue to form, various entities to engage in businesses
that may be competitive with us, but, at this time, there is no other such
business that has all of our real estate financing and investing products (see
RISKS RELATED TO INVESTING IN OUR COMPANY in Item 1A below). However, we feel we
can effectively compete due to:
o our on-going relationships with developers and other users of capital;
o our unified product platform; and
o our efforts to continually develop new products that will complement
our existing diversified real estate finance and investment product
offerings.
Financing and Equity
--------------------
As noted in the segment descriptions above, we typically fund the expansion of
our business through a combination of operating cash flows, short-term
borrowings, securitizations, repurchase agreements, long-term borrowings and
equity issuances. These funding vehicles are described in detail in MANAGEMENT'S
DISCUSSION AND ANALYSIS - LIQUIDITY AND CAPITAL RESOURCES and in Notes 8, 9, 13
and 14 to our consolidated financial statements.
Tax Matters
-----------
We are a Delaware statutory trust and a significant portion of our revenue is
non-taxable. Further, for federal income tax purposes, the parent trust and many
of our subsidiaries (including all that constitute our Portfolio Investing
segment) are treated as partnerships that are not subject to income taxes. We
pass through our income, including federally tax-exempt income, to our
shareholders for inclusion in their tax returns. We derive a substantial portion
of our income from ownership of first mortgage multifamily housing "Private
Activity Bonds." The interest from these bonds is generally exempt from regular
federal income tax. However, the Tax Reform Act of 1986 classified this type of
interest for bonds issued after August 7, 1986, as a tax preference item for
individual and corporate alternative minimum tax ("AMT") purposes. The
percentage of our tax-exempt interest income subject to AMT was approximately
94% for the year ended December 31, 2006, compared to 93% in 2005 and 2004. We
expect the percentage to increase over time as older pre-AMT mortgage revenue
bonds are repaid. As a result of AMT, the percentage of our income that is
exempt from federal income tax may be different for each shareholder.
11
Through CM Corp. and its subsidiaries, which collectively operate much of our
Fund Management and all of our Mortgage Banking businesses, we also conduct
businesses that generate income for which we pay income taxes. In addition,
through ARCap and its subsidiaries we generate income that is taxable to our
shareholders, since such income is included in income of the parent trust. That
income is passed through to our shareholders, as noted above.
Governance
----------
We are governed by a board of trustees comprised of thirteen managing trustees,
seven of whom are independent. Our board of trustees has five committees:
(1) Audit;
(2) Compensation;
(3) Nominating/Governance;
(4) Capital Markets; and
(5) Investment.
In accordance with New York Stock Exchange guidelines, the Audit, Compensation
and Nominating/Governance committees consist entirely of independent trustees.
Employees
---------
Our subsidiaries had approximately 500 employees at December 31, 2006, none of
whom were parties to any collective bargaining agreement.
Regulatory Matters
------------------
Our Mortgage Banking business is subject to various governmental and
quasi-governmental regulations. As noted above, CMC is licensed or approved to
service and/or originate and sell mortgage loans under Fannie Mae, Freddie Mac,
Ginnie Mae and FHA programs. FHA and Ginnie Mae are agencies of the Federal
government and Fannie Mae and Freddie Mac are federally-chartered public
corporations. These agencies require CMC to meet minimum net worth and capital
requirements and to comply with other reporting requirements. Mortgage loans
made under these programs are also required to meet the requirements of these
programs. In addition, under Fannie Mae's DUS program, CMC has the authority to
originate loans without a prior review by Fannie Mae and is required to share in
the losses on loans originated under this program. If CMC fails to comply with
the requirements of these programs, the agency can terminate its license or
approval. In addition, Fannie Mae and Freddie Mac have the authority under their
guidelines to terminate a lender's authority to originate and service their
loans for any reason. If CMC's authority is terminated under any of these
programs, it would prevent CMC from originating or servicing loans under that
program. As a condition for receiving Fannie Mae and Freddie Mac's approval of
our acquisitions of the businesses comprising the Mortgage Banking segment we
are required to guarantee such business' obligations under these programs.
ITEM 1A. RISK FACTORS.
As with any business, we face a number of risks. If any of the following risks
occur, our business, prospects, results of operations and financial condition
would likely suffer. We have grouped these risk factors into several categories,
as follows:
1. General Risks Related to Our Business
2. Risks Related to Our Portfolio Investing Business
3. Risks Related to Our Fund Management Business
4. Risks Related to Our Mortgage Banking Business
5. Risks Related to Application of Tax Laws
6. Risks Related to Investing in Our Company
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1. GENERAL RISKS RELATED TO OUR BUSINESS
THERE ARE RISKS ASSOCIATED WITH THE PROPERTIES UNDERLYING OUR FINANCING PRODUCTS
AND INVESTMENTS THAT COULD ADVERSELY AFFECT OUR NET INCOME AND CASH FLOWS
Through our subsidiaries, we derive a large portion of our earnings by:
o investing in mortgage revenue bonds;
o sponsoring funds that provide equity to LIHTC properties;
o sponsoring funds that originate or acquire direct mortgage loans and
high yield CMBS or joint venture equity; and
o originating and servicing mortgages.
With respect to affordable housing properties, in many cases we are both the
sponsor of the fund and the holder of the debt secured by the property which is
indirectly owned by the fund. In addition, we also support credit on behalf of
developers, provide specified investment returns to the investors in certain
equity funds we sponsor and issue other credit support associated with the
performance of a property.
Our success depends in large part on the performance of the properties
underlying our financing and investing products and, therefore, subjects us to
various types and degrees of risk, including the following:
o the property securing our debt might not generate sufficient income to
meet its operating expenses and payments on its related debt;
o local, regional or national economic conditions may limit the amount
of rent that can be charged for rental units at the properties and may
result in a reduction in rent payments or the timeliness of rent
payments or a reduction in occupancy levels;
o federal LIHTCs and local, state and federal housing subsidy or similar
programs which apply to many of the properties impose rent limitations
that could adversely affect the ability to increase rents to generate
the funds necessary to maintain the properties in proper condition,
which is particularly important during periods of rapid inflation or
declining market value of such properties;
o if a bond or other investment defaults, the value of the property
securing such investment (plus, for properties that have availed
themselves of the federal LIHTC, the remaining value of such LIHTC)
may be less than the unamortized principal amount of the investment;
o there are certain types of losses (generally of a catastrophic nature,
such as earthquakes, floods, terrorism, wars and toxic mold or other
environmental conditions) which are either uninsurable or not
economically insurable;
o under various laws, ordinances and regulations, an owner or operator
of real estate is liable for damages caused by or the costs of removal
or remediation of certain hazardous or toxic substances released on,
above, under or in such real estate. These laws often impose liability
whether or not the owner knew of, or was responsible for, the presence
of such hazardous or toxic substances. As a result, the entities we
sponsor which own real estate, and the owners of the real estate
securing our investments, could be required to pay for such damages or
removal or remediation costs; and
o a guarantor may be unable to fulfill its obligations.
All of these conditions and events may increase the possibility that, among
other things:
o a property owner may be unable to meet its obligations to us as holder
of its debt;
o a property owner may default on a mortgage for which we have a
loss-sharing obligation;
o a fund may not be able to pay our fees;
o a fund may not generate the return that we have committed to provide
and we may be called upon to satisfy the promised return;
o our promotes from fund management may be subject to recapture if the
funds do not reach overall investment hurdles; and
o we could lose our invested capital and/or anticipated future revenue.
This could decrease the fair value of our investments, lower the fair value of
assets we pledge as collateral, impair our ability to generate new business and
affect our net income and cash flows.
13
WE MAY SUFFER ADVERSE CONSEQUENCES FROM CHANGING INTEREST RATES
Because a large portion of the debt we owe is variable rate, an increase in
interest rates could negatively affect our net income and cash flows.
Additionally, increasing interest rates may:
o reduce the fair value of our investments or the investments of funds
we manage, including our fixed-rate mortgage revenue bonds and
residual interests in securitization transactions;
o decrease the amount we could realize on the sale or financing of those
investments;
o reduce the income and promotes from funds that we manage;
o result in a reduction in the number of properties which are
economically feasible to finance;
o reduce the demand for financing, which could limit our ability to
invest in mortgage revenue bonds or to structure transactions, thereby
reducing fees and interest we receive;
o increase our borrowing costs;
o restrict our access to capital;
o cause investors to find alternative investments that are more
attractive than the equity funds we sponsor; and
o adversely affect the amount of cash available for distribution to
shareholders.
Since a significant portion of our investments are residual interests in
mortgage revenue bonds or other securities whose cash flow is first used to pay
senior securities with short-term floating interest rates, any increase in
short-term interest rates will increase the amount of interest paid on the
senior securities and reduce the net cash flow in our Portfolio Investing
business.
Conversely, a decrease in interest rates may lead to the refinancing of some of
the debt we own if lockout periods have ended. We may not be able to reinvest
the proceeds of any such refinancing at the same interest rates as the debt
refinanced. Additionally, falling interest rates may prompt historical renters
to become homebuyers, in turn potentially reducing the demand for multifamily
rental housing. Further, a portion of our net income is generated by interest
income we earn on mortgage escrow deposits. If interest rates were to decrease,
our net income in the Mortgage Banking segment would decrease as well.
Furthermore, strategies we may follow to address these risks carry risks of
their own, including, but not limited to:
o the potential inability to refinance variable-rate debt at terms that
we find acceptable;
o alternate sources of fixed rate or lower cost financing may not be
available to us;
o the risk that interest rate swap counterparties may default on their
obligations to us;
o we may not be able to match the duration or reset periods of assets
and liabilities that we want to alleviate the effect of changing
rates; and
o other efforts to manage risks related to changes in interest rates may
not be successful.
If a change in interest rates causes the consequences described above, or
otherwise negatively affects us, the result could adversely affect our ability
to generate net income or cash flows to make distributions and other payments in
respect of our shares.
THE INABILITY TO MAINTAIN OUR RECURRING FEE ARRANGEMENTS AND TO GENERATE NEW
TRANSACTION FEES COULD HAVE A NEGATIVE IMPACT ON OUR NET INCOME AND CASH FLOWS
Two revenue sources in our Fund Management segment are the transaction fees
generated by our sponsorship of new investment programs and recurring fees
payable by existing and future programs. Transaction fees are generally
"up-front" fees that are generated:
o by the sponsorship of new investment programs; and
o upon investment of the capital raised in an investment program.
Recurring fees are generated by the ongoing operation of investment programs we
sponsor, some of which have finite lives. The termination of one or more of
these recurring fee arrangements, or the inability to sponsor new programs which
will generate new recurring and transaction fees, would reduce net income and
cash flows. There can be no assurance that existing recurring fee arrangements
will not be reduced or terminated or that we will be able to realize revenues
from new investment programs.
14
Likewise, the two principal revenue streams in our Mortgage Banking business are
fees we earn for originating loans and ongoing fees we earn for servicing loans.
A decline in origination volume or the loss or termination of a servicing
arrangement could adversely affect our results of operations and reduce net
income and cash flows. There can be no assurance that existing recurring fee
arrangements will not be reduced or terminated or that we will be able to
realize revenues from new business.
WE RELY UPON RELATIONSHIPS WITH KEY INVESTORS AND DEVELOPERS WHICH MAY NOT
CONTINUE
We rely upon relationships with key investors and developers. If these
relationships do not continue, or if we are unable to form new relationships,
our ability to generate revenue will be adversely affected. In 2006, five key
investors provided approximately 76.6% of the equity capital raised by tax
credit syndication programs we sponsored, with Fannie Mae and Freddie Mac
together providing approximately 32.4% of the equity capital. In addition, ten
key developers provided approximately 45.5% of the LIHTC properties for which we
arranged equity financing in 2006. Further, Fannie Mae and Freddie Mac were the
purchasers of 58.5% of the loans originated by our Mortgage Banking business in
2006, while AMAC was the purchaser of 34.7% of the loans it originated.
There can be no assurance that we will be able to continue to do business with
these key investors and developers or that new relationships will be formed.
Developers may also experience financial difficulties that would, in turn,
reduce the amount of business we transact with them. If developers were to fail,
it could also lead to some of the adverse consequences listed under the "THERE
ARE RISKS ASSOCIATED WITH THE PROPERTIES UNDERLYING OUR FINANCING PRODUCTS AND
INVESTMENTS THAT COULD ADVERSELY AFFECT OUR NET INCOME AND CASH FLOWS" section
above.
We also rely upon relationships with providers of products in which we invest
(e.g. CMBS) and investors who invest in the funds which we manage. If our
relationships with CMBS issuers, Wall Street firms, banks and insurance
companies who create and sell high yield debt products were to terminate, we
might not be able to obtain product for our own balance sheet or funds which we
manage.
By reason of their regulated status, certain of our investors have regulatory
incentives to invest in our sponsored investment programs in addition to the
economic return from such investments. A change in such regulations could result
in determinations by such investors to seek other investment opportunities.
REVENUES FROM OUR FEE-GENERATING ACTIVITIES AND OTHER INCOME FROM CERTAIN OF OUR
FINANCING AND INVESTING PRODUCTS ARE LESS PREDICTABLE THAN THOSE FROM OUR
MORTGAGE REVENUE BOND INVESTMENTS AND COULD RESULT IN A DECREASE IN NET INCOME
AND CASH FLOWS, FLUCTUATIONS IN OUR SHARE PRICE AND A REDUCTION IN THE PORTION
OF OUR INCOME THAT IS TAX-EXEMPT
In 2006, approximately 21.7% of the revenue we recognized in our statement of
income was derived from fee-generating service activities through our taxable
subsidiaries. Fee-generating businesses are inherently less predictable than the
ownership of mortgage revenue bonds, and there can be no assurance that the
fee-generating activities will be profitable. Additionally, in 2006, 32.0% of
our income before income taxes was generated by equity income we earned from
funds we sponsor through ARCap. A significant portion of equity income we expect
to generate from these funds is based on "promotes" that we earn, and the
occurrence of events that would trigger such earnings is not in our control. In
addition, the net income and cash flows generated by our Fund Management
business has historically fluctuated between quarters due to the typical
variability in the timing of fund sponsorships and investments made by those
funds as well as promotes we earn from certain of those investments. These
fluctuations could be perceived negatively and, therefore, adversely affect our
share price. Refer to Note 19 to our consolidated financial statements for
quarterly financial information.
In addition, the portion of our distributions that is excludable from gross
income for federal income tax purposes could decrease based on the size of our
future taxable business. Our taxable subsidiaries do not currently distribute
dividend income to the parent trust but rather reinvest it in their businesses.
If we invest in a larger percentage of taxable investments, or if our taxable
subsidiaries were to distribute dividend income to the parent trust, the result
would likely be that the taxable portion of our overall income would increase.
Also, the CMBS fund sponsorship portion of our Fund Management business
generates income, most of which is taxable, and that income is passed through to
the parent trust. As that business continues to grow, the percentage of our net
income distributed to shareholders that is federally tax-exempt will likely
decrease.
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HEIGHTENED COMPETITION MAY ERODE OUR EARNINGS
We are subject to competition in all of our business lines, as described in Item
1. - BUSINESS - COMPETITION. As competition increases, we may experience
compression in the level of profits we earn on our various investments and
financing products due to, among other things:
o Reductions in the rate of interest we earn on mortgage revenue bonds;
o Reductions in the rates of origination and servicing fees for
mortgages;
o Reductions in the rate of fees we earn from originating and managing
funds; and
o Lower levels of discounts at which high-yield investments may be
purchased.
As we often borrow funds to make investments, rising interest rates may compound
this issue. Absent cost reductions, such compression may not permit us to enjoy
the margins we have achieved historically, thereby lowering our revenues and net
income.
THE ATTRACTIVENESS OF REAL ESTATE AS AN INVESTMENT MAY DECLINE
Real estate underlies all of our business lines, whether by direct investment or
by virtue of sponsoring funds that are associated with real estate. While often
viewed as an attractive investment sector, there is no guarantee that the
investors in the funds we sponsor will continue to allocate capital to
investments associated with real estate. Should there be a general decline in
capital invested in the sector, our ability to sponsor funds would be diminished
and the income we earn from these activities would decline.
2. RISKS RELATED TO OUR PORTFOLIO INVESTING BUSINESS
WE HAVE NO RECOURSE AGAINST STATE OR LOCAL GOVERNMENTS OR PROPERTY OWNERS UPON
DEFAULT OF OUR MORTGAGE REVENUE BONDS OR UPON THE BANKRUPTCY OF AN OWNER OF
PROPERTIES SECURING OUR MORTGAGE REVENUE BONDS
Although state or local governments or their agencies or authorities issue the
mortgage revenue bonds we purchase, the mortgage revenue bonds are not general
obligations of any state or local government. No government, as an issuer of
these bonds, is liable to make payments on the mortgage revenue bonds, nor is
the taxing power of any government pledged for the payment of principal or
interest on the mortgage revenue bonds. An assignment by the issuing government
agency or authority of the mortgage loan in favor of a bond trustee on behalf of
us, or in some cases, an assignment directly to the bondholder, secures each
mortgage revenue bond we own. The mortgage loan is also secured by an assignment
of rents. Following the time that the properties securing the mortgage loans are
placed into service and achieve stabilized occupancy, the underlying mortgage
loans are non-recourse to the property owner, other than customary recourse
carve-outs for bad acts, such as fraud and breach of environmental
representations and covenants. Accordingly, the revenue derived from the
operation of the properties securing the mortgage revenue bonds that we own and
amounts derived from the sale, refinancing or other disposition of the
properties are the sole sources of funds for payment of principal and interest
on the mortgage revenue bonds.
Our revenue may be adversely affected by the bankruptcy of an owner of
properties securing the mortgage revenue bonds that we directly or indirectly
own. An owner of properties under bankruptcy protection may be able forcibly to
restructure its debt service payments and stop making debt service payments to
us, temporarily or otherwise. Our rights in this event would be defined by
applicable law.
WE ARE SUBJECT TO CONSTRUCTION COMPLETION AND REHABILITATION RISKS THAT COULD
ADVERSELY AFFECT OUR EARNINGS
As of December 31, 2006, mortgage revenue bonds with an aggregate fair value of
approximately $277.5 million were secured by affordable multifamily housing
properties which are still in various stages of construction and mortgage
revenue bonds with an aggregate fair value of approximately $488.6 million were
secured by affordable multifamily housing properties which are undergoing
substantial rehabilitation. Construction and/or substantial rehabilitation of
such properties generally lasts approximately 12 to 24 months. The principal
risk associated with this type of lending is the risk of non-completion of
construction or rehabilitation which may arise as a result of:
o underestimated construction or rehabilitation costs;
o delays;
o failure to obtain governmental approvals; and
16
o adverse weather and other unpredictable contingencies beyond the
control of the developer.
If construction and/or rehabilitation of a property is not timely completed as
required in the mortgage loan documents, we, as the holder of the mortgage
revenue bonds secured by such mortgage, may incur certain costs and be required
to invest additional capital in order to preserve our investment.
THE PROPERTIES SECURING CERTAIN OF OUR MORTGAGE REVENUE BONDS, WHICH ARE
CURRENTLY IN CONSTRUCTION, LEASE-UP OR REHABILITATION STAGES, MAY EXPERIENCE
FINANCIAL DISTRESS IF THEY DO NOT MEET OCCUPANCY AND DEBT SERVICE COVERAGE
LEVELS SUFFICIENT TO STABILIZE SUCH PROPERTIES, NEGATIVELY AFFECTING OUR ASSETS
AND EARNINGS
As of December 31, 2006, mortgage revenue bonds in our portfolio with a fair
value of approximately $1.6 billion were secured by mortgages on properties in
construction, lease-up or rehabilitation stages. The lease-up of these
underlying properties may not be completed on schedule or at anticipated rent
levels, resulting in a greater risk that they may go into default than bonds
secured by mortgages on properties that are fully leased-up. Should a bond go
into default, we may not receive interest income, which would reduce our net
income and cash flows. Moreover, there can be no assurance that the underlying
property will achieve expected occupancy or debt service coverage levels.
CERTAIN OF OUR MORTGAGE REVENUE BONDS WE AND OUR SUBSIDIARIES HOLD HAVE BEEN
PLEDGED
A significant portion of our mortgage revenue bond portfolio has been pledged as
collateral in connection with our securitizations and credit intermediation
activities and we may not have full access to them until we exit the related
programs. The fair value of the pledged bonds varies from time to time. As of
December 31, 2006, the fair value of all pledged bonds was approximately $2.3
billion.
RISK ASSOCIATED WITH SECURITIZATION COULD ADVERSELY AFFECT OUR NET INCOME AND
CASH FLOWS
Through securitizations, we seek to enhance our overall return on our
investments and to generate proceeds that, along with operating cash flows and
equity offering proceeds, facilitate the acquisition of additional investments.
In our variable rate securitizations, a bank or another type of financial
institution provides liquidity to the purchasers of senior interests in our
mortgage revenue bonds. They also provide certain credit intermediation with
respect to the underlying revenue bond, which enables the senior interests to be
sold to investors seeking investments with credit ratings of at least "A" short
term and "AA" long term. The liquidity facilities are generally for one-year
terms and are renewable annually. If the credit strength of either the liquidity
or credit intermediation providers deteriorates, we anticipate that the return
on the residual interests would decrease, negatively affecting our net income
and subsequent executions. In addition, if we are unable to renew the liquidity
or credit intermediation facilities, we would be forced to find alternative
(possibly more expensive) facilities, to repurchase the underlying bonds or to
liquidate the underlying bonds and our investment in the residual interests. If
we were forced to liquidate an investment, we would recognize gains or losses on
the liquidation, which might be significant depending on market conditions. As
of December 31, 2006:
o Merrill Lynch provided liquidity for senior interests with an
aggregate amount of $403.4 million in the P-FLOATs/RITES program.
There is a risk that the program may not be renewed at the end of its
current term;
o Goldman Sachs provided liquidity for senior interests with an
aggregate amount of $944.8 million in the Goldman Sachs
Floats/Residuals program. There is a risk that the program may not be
renewed at the end of its current term; and
o Primary credit intermediation on the P-FLOATs/RITES and
Floaters/Residuals programs is generally provided by Centerbrook, with
IXIS serving as the secondary credit intermediator. In certain
circumstances Merrill Lynch or IXIS are the primary or secondary
credit intermediator.
OTHER PARTIES HAVE THE FIRST RIGHT TO CASH FLOW FROM OUR SECURITIZED REVENUE
BOND INVESTMENTS
Because of our utilization of securitizations, our interests in a significant
portion of our mortgage revenue bond investments are subordinated or may be
junior in right of payment to other senior securities. There are risks in owning
"junior residual interests" that could adversely affect our net income and cash
flows, including:
17
o the risk that borrowers may not be able to make payments, resulting in
us, as the holder of the junior residual interests, receiving
principal and interest payments that are less than expected or no
payment at all;
o the risk that short-term interest rates may rise significantly,
increasing the amounts payable to the holders of the floating-rate
senior interests created through our securitizations and reducing the
amounts payable to us as holder of the junior residual interests; and
o the risk that the holders of the senior mortgage revenue bonds or
senior interests may control the ability to enforce remedies, limiting
our ability to take actions that might protect our interests.
OUR MORTGAGE REVENUE BONDS MAY BE CONSIDERED USURIOUS
State usury laws establish restrictions, in certain circumstances, on the
maximum rate of interest that may be charged by a lender and impose penalties on
parties making usurious loans, including monetary penalties, forfeiture of
interest and unenforceability of the debt. There is a risk that our mortgage
revenue bonds could be found to be usurious as a result of uncertainties in
determining the maximum legal rate of interest in certain jurisdictions,
especially with respect to mortgage revenue bonds that bear participating or
otherwise contingent interest. Therefore, the amount of interest to be charged
and the return on our mortgage revenue bonds would be limited by state usury
laws and we may have to agree to defer or reduce the amount of interest that can
be paid in any particular year (potentially to zero). Some states may prohibit
the compounding of interest, in which case we may have to agree to forego the
compounding feature of our mortgage revenue bonds originated in those states.
OUR INVESTMENTS IN MORTGAGE REVENUE BONDS LACK LIQUIDITY
Our investments in mortgage revenue bonds lack a regular trading market. There
is no limitation in our trust agreement or otherwise as to the percentage of our
investments that may be illiquid and we expect to continue to invest in assets,
substantially all of which will be illiquid securities. If a situation arises
where we require additional cash, we could be forced to liquidate some or all of
our investments on unfavorable terms (if any sale is possible) that could
substantially reduce the amount of distributions available and payments made in
respect of our shares.
MORTGAGE REVENUE BONDS MAY GO INTO DEFAULT FROM TIME TO TIME AND NEGATIVELY
AFFECT OUR NET INCOME AND CASH FLOWS
Properties underlying our mortgage revenue bonds may experience financial
difficulties from time to time, which could cause certain of our mortgage
revenue bonds to go into default. Were that to occur, we might take remedial
action such as, among other things, entering into a work-out or forbearance
agreement with the owner of the property or exercising our rights with respect
to the collateral securing such mortgage revenue bond, including the
commencement of mortgage foreclosure proceedings. In addition, in the event that
we were to successfully foreclose the mortgage on the underlying property, it is
likely that, during the period that we or an affiliate owned both the property
and the defaulted bond, we, as holder of the defaulted bond, would be deemed to
be a related party to a "substantial user" of the property underlying such bond.
As a result, during such period, the interest we receive on the bond would be
taxable. See "SUBSTANTIAL USER" LIMITATION within "RISKS ASSOCIATED TO
APPLICATION OF TAX LAWS" below.
3. RISKS RELATED TO OUR FUND MANAGEMENT BUSINESS
THERE ARE RISKS ASSOCIATED WITH CREDIT INTERMEDIATION AND COMMITMENTS TO PROVIDE
SPECIFIED RATES OF RETURN THAT EXPOSE US TO LOSSES
Through our taxable subsidiaries, we provide credit intermediation to third
parties for a fee. If such third parties default on their obligations for which
we provided credit intermediation, our loss would likely be in an amount far in
excess of the fee paid to us for providing the service. We also provide
specified internal rates of return to investors in partnerships designed to pass
through tax benefits, including LIHTCs, to investors. In connection with such
transactions we might be required to advance funds to ensure that the investors
do not lose their expected tax benefits and, if the internal rate of return to
investors falls below the specified level, we would be required to make a
payment so that the specified rate of return will be achieved. Our maximum
potential liability pursuant to those transactions is detailed in MANAGEMENT'S
DISCUSSION AND ANALYSIS - OFF BALANCE SHEET ARRANGEMENTS and Note 21 to the
consolidated financial statements.
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THERE IS A RISK OF ELIMINATION OF, OR CHANGES TO, GOVERNMENTAL PROGRAMS THAT
COULD LIMIT OUR PRODUCT OFFERINGS
A significant portion of our Fund Management revenues is derived from the
syndication of partnership interests in partnerships that invest in properties
eligible for LIHTCs which are a provision of the Internal Revenue Code of 1986,
as amended (the "Code").
Section 42 of the Code authorizes federal LIHTCs for affordable multifamily
rental housing. Under this program, a project either receives an allocation of
federal LIHTCs from an agency designated by the government of the state in which
the project is located or the project is entitled to the LIHTCs by reason of its
being financed by volume cap mortgage revenue bonds. There are two types of
credits:
o 4% credits - for new buildings and existing buildings financed with
mortgage revenue bonds that receive an allocation of the volume cap,
or for new and existing buildings financed with below-market federal
financing that receive an allocation of federal LIHTCs from state
agencies; and
o 9% credits - for new buildings that receive an allocation of federal
LIHTCs from state agencies.
The credits are taken over a period of 10 years, which can span over an 11-year
operating period. The credit amount is based on the qualified basis of each
building, which is based upon the adjusted basis of the building multiplied by
the percentage of units in the building leased to low-income tenants.
In order to qualify for the federal LIHTC, the property must comply with either
of the 20/50 or 40/60 tests that apply to tax-exempt bonds. However, in
addition, the amount of rent that may be charged to qualifying low-income
tenants cannot exceed 30% of the "imputed income" for each unit, i.e., 30% of
the imputed income of a family earning 50% or 60% of area median income, as
adjusted for family size. Failure to comply continuously with these requirements
throughout the 15 year recapture period could result in a recapture of the
federal LIHTCs. In addition, if the rents from the property are not sufficient
to pay debt service on the mortgage revenue bonds or other financing secured by
the property and a default ensues, the initial borrower could lose ownership of
the project as the result of foreclosure of the mortgage. In such event, the
initial equity investors would no longer be entitled to claim the federal
LIHTCs, but the foreclosing lender could claim the remaining LIHTCs provided the
project continues to be operated in accordance with the requirements of Section
42. As a result, there is a strong incentive for the federal LIHTC investor to
ensure that the development is current on debt service payments by making
additional capital contributions or otherwise.
With respect to most of the properties, substantially all the multifamily units
are rented to individuals or families earning no greater than 60% of area median
income and, thus, substantially all of the qualified basis may be used to
determine the amount of the federal LIHTC. This maximizes the amount of equity
raised from the purchasers of the federal LIHTCs for each development and
provides for the maximum amount of rent that can be obtained from tenants where
there is currently strong occupancy demand.
Investors in CharterMac Capital LIHTC sponsored funds are usually Fortune 500
corporations that have projected long-term positive tax positions. These
investors generally become limited partners in the CharterMac Capital sponsored
fund which, in turn, invests as a limited partner in the developer/owner of the
affordable housing property. The CharterMac Capital sponsored fund contributes
to the developer/owner the negotiated equity paid over time. In the case of
properties utilizing 4% credits, this contribution will usually provide between
25% and 35% of the costs of the development. For properties utilizing 9%
credits, this contribution will usually provide between 45% and 55% of the cost
of the development.
Although LIHTCs are a part of the Code, Congress could repeal or modify this
legislation at any time or modify the tax laws so that the value of LIHTC
benefits is reduced. If such legislation is repealed or adversely modified, we
would no longer be able to pursue this portion of our business strategy.
CERTAIN AGREEMENTS PURSUANT TO WHICH WE EARN FEES HAVE FINITE TERMS AND MAY NOT
BE RENEWED WHICH COULD NEGATIVELY AFFECT OUR NET INCOME AND CASH FLOWS
We receive fees pursuant to an advisory agreement with AMAC, an affiliated
company. This advisory agreement is subject to annual renewal and approval by
the independent trustees of AMAC and there is no guarantee that the agreement
will be renewed.
19
We also receive fees from investment funds we sponsor. These funds generally do
not require or authorize their investors to approve the funds' management
arrangements with us; instead, we will generally acquire controlling interests
in the entities which control these funds. However, these interests are subject
to the fiduciary duty of the controlling entity to the investors in those
programs, which may affect our ability to continue to collect fees from those
funds. Furthermore, the organizational documents of certain of these funds allow
for the investors, at their option, to remove the entity controlled by us as
general partner or managing member without cause. Although the funds will
generally be required to pay fair market value if they exercise this right, our
right to receive future fees would terminate and there can be no assurance that
the payment will fully compensate us for this loss. Finally, many of these funds
typically have finite periods in which they are scheduled to exist, after which
they are liquidated. The termination of a fund will result in a termination of
the fees we receive from it.
OUR ROLE AS A SPONSOR OF INVESTMENT FUNDS AND CO-DEVELOPER OF LIHTC PROPERTIES
EXPOSES US TO RISKS OF LOSS
In connection with the sponsorship of investment funds and joint venture
activities for co-development of LIHTC properties, we act as a fiduciary to the
investors in our syndication programs and are often also required to provide
performance guarantees. We advance funds to acquire interests in property-owning
partnerships for inclusion in investment programs and, at any point in time, the
amount of funds advanced can be material. Recovery of these amounts is subject
to our ability to attract investors to new investment funds or, if investors are
not found, the sale of the partnership interests in the underlying properties.
We could also be liable to investors in investment programs and third parties as
a result of serving as general partner or special limited partner in various
investment funds. In addition, even when we are not required to do so, we may
advance funds to allow investment funds to meet their expenses and/or generate
the expected tax benefits to investors.
FUNDS MAY NOT GENERATE SUFFICIENT CASH TO PAY FEES DUE TO US, WHICH MAY
NEGATIVELY IMPACT OUR NET INCOME AND CASH FLOWS
Much of the revenue in our Fund Management business is earned from fees that
upper-tier funds we sponsor pay to our subsidiaries for services rendered. These
funds are dependent upon the cash flows of lower-tier partnerships in which they
invest to generate their own cash flows that are used to pay such fees for
services, such as asset management and advisory services. As the lower-tier
partnerships are susceptible to numerous operational risks (see "THERE ARE RISKS
ASSOCIATED WITH THE PROPERTIES UNDERLYING OUR FINANCING PRODUCTS AND INVESTMENTS
THAT COULD ADVERSELY AFFECT OUR NET INCOME AND CASH FLOWS" above), the
upper-tier funds may not collect sufficient cash to pay the fees they owe to us.
If we do not receive these fees, the negative impact on our cash flows, and our
net income if we determine the fees are not collectible, could negatively impact
our business.
4. RISKS RELATED TO OUR MORTGAGE BANKING BUSINESS
THERE ARE RISKS OF LOSS ASSOCIATED WITH OUR MORTGAGE ORIGINATIONS WHICH MAY
NEGATIVELY IMPACT OUR NET INCOME AND CASH FLOWS
In our DUS program, we originate loans through one of our subsidiaries which are
thereafter purchased or credit enhanced by Fannie Mae. For most of these loans,
we retain a first loss position with respect to loans that we originate and sell
under this program. For these loss sharing loans, we assume responsibility for a
portion of any loss that may result from borrower defaults, based on the Fannie
Mae loss sharing formulas, and risk Levels I, II, or III. Of the 865 loss
sharing loans in this program as of December 31, 2006, all but one were Level I
loans. For such loans, if a default occurs, we are responsible for the first 5%
of the unpaid principal balance and a portion of any additional losses to a
maximum of 20% of the original principal balance; any remaining loss is borne by
Fannie Mae. In Level II and Level III loans we carry a higher loss sharing
percentage.
Under the terms of our master loss sharing agreement with Fannie Mae, we are
responsible for funding 100% of mortgagor delinquency (principal and interest)
and servicing (taxes, insurance and foreclosure costs) advances until the
amounts advanced exceed 5% of the unpaid principal balance at the date of
default. Thereafter, for Level I loans, we may request interim loss sharing
adjustments which allow us to fund 25% of such advances until final settlement
under the master loss sharing agreement. No interim sharing adjustments are
available for Level II and Level III loans.
We also participate in loss sharing transactions under Freddie Mac's DUI program
whereby we originate loans that are purchased by Freddie Mac.
20
Under the terms of our master agreement with Freddie Mac, we are obligated to
reimburse Freddie Mac for a portion of any loss that may result from borrower
defaults on DUI transactions. For such loans, if a default occurs, our share of
the loss will be the first 5% of the unpaid principal balance and 25% of the
next 20% of the remaining unpaid principal balance to a maximum of 10% of the
unpaid principal balance. The loss on a defaulted loan is calculated as the
unpaid principal amount due, unpaid interest due and default resolutions costs
(taxes, insurance, operation and foreclosure costs) less recoveries.
Our maximum "first loss" exposure under the DUS and DUI programs is detailed in
MANAGEMENT'S DISCUSSION AND ANALYSIS - OFF BALANCE SHEET ARRANGEMENTS and Note
21 to the consolidated financial statements.
CHANGES IN EXISTING GOVERNMENT SPONSORED AND FEDERAL MORTGAGE PROGRAMS COULD
NEGATIVELY AFFECT OUR MORTGAGE BANKING BUSINESS
Our ability to generate revenue through mortgage sales to institutional
investors largely depends on programs sponsored by Fannie Mae and Freddie Mac,
which facilitate the issuance of mortgage-backed securities in the secondary
market. Any discontinuation of, or significant reduction in, the operation of
those programs could have a material adverse effect on our mortgage banking
business and results of operations. Also, any significant adverse change in the
level of activity in the secondary market or the underwriting criteria of these
entities would reduce our revenues.
THE LOSS OF OUR RELATIONSHIPS WITH GSES AND RELATED ENTITIES COULD ADVERSELY
AFFECT OUR BUSINESS
Our agreements with Fannie Mae and Freddie Mac afford us a number of advantages
and may be canceled by the counterparty for cause. Cancellation of one or more
of these agreements would have a material adverse affect on our operating
results and could result in further disqualification with other counterparties,
loss of technology and other materially adverse consequences.
AS A MORTGAGE LENDER, WE MUST COMPLY WITH NUMEROUS LICENSING REQUIREMENTS, AND
OUR INABILITY TO REMAIN IN COMPLIANCE WITH SUCH REQUIREMENTS COULD ADVERSELY
AFFECT OUR OPERATIONS AND OUR REPUTATION GENERALLY
Like other mortgage banking companies, we must comply with the applicable
licensing and other regulatory requirements of each jurisdiction in which we are
authorized to lend. These requirements are complex and vary from jurisdiction to
jurisdiction. From time to time we are subject to examination by regulators and,
if it is determined that we are not in compliance with the applicable
requirements, we may be fined, and our license to lend in one or more
jurisdictions may be suspended or revoked.
IF OUR LOAN SERVICING PORTFOLIO DECREASES, OUR NET INCOME AND CASH FLOWS WOULD
BE NEGATIVELY AFFECTED
A large portion of our revenues in the Mortgage Banking business relate to
recurring fees for servicing mortgages we originate or those for which we have
sub-servicing agreements. Loans in our portfolio are subject to maturity,
prepayments, defaults and refinancing after which we may not recapture the loan.
Upon these events, our portfolio would decline, depriving us of the associated
revenue stream. This, in turn, would negatively affect our net income and cash
flows.
PROPOSED CHANGES TO ACCOUNTING RULES COULD ADVERSELY AFFECT OUR REPORTED NET
INCOME
During 2005, the Financial Accounting Standards Board issued proposed revisions
to its Standard No. 140, ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL
ASSETS AND EXTINGUISHMENTS OF LIABILITIES, which governs the accounting for,
among other things, the origination and sale of mortgage loans. One
interpretation of the proposed changes may call into question whether the
mortgages we originate and sell under the DUS and DUI programs may be recognized
as sales for accounting purposes. Should that interpretation become a part of
any final accounting standard issued, it is possible that we may have to
continue to carry such loans on our balance sheet as assets, account for the
proceeds received as debt and not recognize certain mortgage banking fees as
revenues upon the sale as we do currently. Such accounting changes would
decrease our reported net income, which may negatively affect our share price.
In addition, the potential decline in net income and the likely increase in our
level of reported debt may cause non-compliance with debt covenants.
21
Additionally, other changes contemplated could eliminate the designation of
"Qualified Special Purpose Entities" ("QSPEs") which are a standard element of
securitization transactions, particularly within the CMBS industry. Should such
a change be effected, there could be a negative impact on our Fund Management
business.
5. RISKS RELATED TO APPLICATION OF TAX LAWS
OUR CLASSIFICATION AS A PUBLICLY TRADED PARTNERSHIP NOT TAXABLE AS A CORPORATION
IS NOT FREE FROM DOUBT AND COULD BE CHALLENGED
We, and all of our Portfolio Investing subsidiaries, operate as partnerships or
are disregarded for federal income tax purposes. This allows us to pass through
our income, including our federally tax-exempt income, and deductions to our
shareholders. The listing of our common shares on the New York Stock Exchange
causes us to be treated as a "publicly traded partnership" for federal income
tax purposes. We and our counsel, Paul, Hastings, Janofsky & Walker LLP ("Paul
Hastings"), believe that we have been and are properly treated as a partnership
for federal income tax purposes. However, the Internal Revenue Service ("IRS")
could challenge our partnership status and we could fail to qualify as a
partnership in years that are subject to audit or in future years. Qualification
as a partnership involves the application of numerous technical legal
provisions. For example, a publicly traded partnership is generally taxable as a
corporation unless 90% or more of its gross income is "qualifying" income (which
includes interest, dividends, real property rents, gains from the sale or other
disposition of real property, gain from the sale or other disposition of capital
assets held for the production of interest or dividends, and certain other
items). We have represented that in all prior years of our existence at least
90% of our gross income was qualifying income and we intend to conduct our
operations in a manner such that at least 90% of our gross income will
constitute qualifying income in the current year and in the future. In the
opinion of Paul Hastings, although the issue is not free from doubt, we have
been and are properly treated as a partnership for federal income tax purposes.
In determining whether interest is treated as qualifying income under these
rules, interest income derived from a "financial business" and income and gains
derived by a "dealer" in securities are not treated as qualifying income. We
have represented that we are acting as an investor with respect to our mortgage
revenue bond investments and that we have not engaged in, and will not engage
in, a financial business, although there is no clear guidance on what
constitutes a financial business under the tax law. We have taken the position
that for purposes of determining whether we are in a financial business,
portfolio investing activities that we are engaged in now and that we
contemplate engaging in prospectively would not cause us to be engaged in a
financial business or to be considered a "dealer" in securities. The IRS could
assert that our activities constitute a financial business. If our activities
constitute (or as a result of increased volume constitute) a financial business
or cause us to be treated as a dealer, there is a substantial risk that more
than 10% of our gross income would not constitute qualifying income. We could
also be treated as if we were engaged in a financial business if the activities
of CM Corp. and its subsidiaries were attributed to us and were determined to
constitute a financial business. CM Corp., including its principal subsidiaries
CharterMac Capital and CMC, is subject to income tax on its income. Accordingly,
we believe the activities and income of CM Corp. and its subsidiaries will not
be attributed to CharterMac for purposes of determining CharterMac's tax status.
In addition, in determining whether interest is treated as qualifying income,
interest income that is determined based upon the income or profits of any
person is not treated as qualifying income. A portion of the interest payable on
participating interest bonds owned by us is determined based upon the income or
profits of the properties securing our investments. Accordingly, if we were to
receive more than 10% of our gross income in any given year from such
"contingent interest," the IRS could take the position that we should be treated
as a publicly traded partnership taxable as a corporation. There can be no
assurance that such monitoring would be effective in all events to avoid the
receipt of contingent interest and any other non-qualifying income in any given
year that exceeds 10% of our gross income because circumstances outside of our
(or our subsidiaries) control could cause such a result.
If, for any reason, less than 90% of our gross income constitutes qualifying
income, items of income and deduction would not pass through to our shareholders
and our shareholders would be treated for federal income tax purposes as
stockholders in a corporation. We would be required to pay income tax at
corporate rates on any portion of our net income that did not constitute
tax-exempt income. In addition, a portion of our federally tax-exempt income may
be included in determining our alternative minimum tax liability. Distributions
by us to our shareholders would constitute dividend income taxable to such
holders to the extent of our earnings and profits, which would include
tax-exempt income, as well as any taxable income we might have, and the payment
of these distributions would not be deductible by us. These consequences would
have a material adverse effect on us, our shareholders and the price of our
shares.
22
OUR TREATMENT OF INCOME FROM OUR RESIDUAL INTERESTS AS FEDERALLY TAX-EXEMPT
COULD BE CHALLENGED
We hold, indirectly, residual interests in certain federally tax-exempt mortgage
revenue bonds through securitization programs, such as the P-FLOATs/RITES
program, which entitle us to a share of the federally tax-exempt interest of
such mortgage revenue bonds. Special tax counsel have each rendered an opinion
to the effect that the issuer of the RITES and similar instruments will each be
classified as a partnership for federal income tax purposes and the holders of
the RITES and similar instruments will be treated as partners of each
partnership. Consequently, as the holder of the RITES and similar instruments,
we treat our share of the federally tax-exempt income allocated and distributed
to us as federally tax-exempt income. However, it is possible that the IRS could
disagree with those conclusions and an alternative characterization could cause
income from the RITES and similar instruments to be treated as ordinary taxable
income. If such an assertion of an alternative characterization prevailed, it
would materially adversely affect us and our shareholders.
THERE IS A RISK THAT THE IRS WILL DISAGREE WITH OUR JUDGMENT WITH RESPECT TO
ALLOCATIONS
We use various accounting and reporting conventions to determine each
shareholder's allocable share of income, including any market discount taxable
as ordinary income, gain, loss and deductions. Our allocation provisions will be
respected for federal income tax purposes only if they are considered to have
"substantial economic effect" or are in accordance with the partners' "interest
in the partnership." There is no assurance that the IRS will agree with our
various accounting methods, conventions and allocation provisions, particularly
our allocation of adjustments to shareholders attributable to the differences
between the shareholders' purchase price of common shares and their shares of
our tax basis in our assets, pursuant to an election we made.
THE STRUCTURE OF OUR ACQUISITIONS COULD BE CHALLENGED
Our acquisitions of CharterMac Capital and other subsidiaries were structured to
prevent us from realizing active income from these businesses and effectively to
receive a tax deduction (via the allocation of subsidiary income) for payments
made to its selling principals. It is possible that the IRS could challenge this
structure, with material adverse consequences to us. First, the IRS could assert
that we, as the parent trust, are the owner of these businesses, in which case
the parent trust would realize an amount of active income from them that would
require it to be treated as a corporation instead of a publicly traded
partnership for income tax purposes. If the IRS prevailed, we would be required
to pay taxes on that income, thereby reducing the amount available for us to
make distributions. As a result, it is likely that the value of our shares would
decline. Second, the IRS might assert that the Special Common Units ("SCUs"),
Special Membership Units ("SMUs") and Special Common Interests ("SCIs") held by
the selling principals of the businesses and others are actually shares of our
Company. If this position prevailed, the distributions payable on the units
would not reduce the taxable income of CM Corp. In such event, CM Corp. would be
subject to increased tax, which could reduce our net income, our cash flows and
our distributions, which could also result in a decrease in the portion of our
distributions that is excluded from gross income for federal income tax
purposes.
THE TAXABILITY OF OUR INCOME DEPENDS UPON THE APPLICATION OF TAX LAWS THAT COULD
BE CHALLENGED
The following discussion relates only to the portion of our investments which
generate federally tax-exempt income.
TAX-EXEMPTION OF OUR MORTGAGE REVENUE BONDS
On the date of original issuance or re-issuance of each mortgage revenue
bond, nationally recognized bond counsel or special tax counsel rendered
its opinion to the effect that, based on the law in effect on that date,
interest on such mortgage revenue bonds is excludable from
federally-taxable gross income, except with respect to any revenue bond
(other than a revenue bond, the proceeds of which are loaned to a
charitable organization described in Section 501(c)(3) of the Code) during
any period in which it is held by a "substantial user" of the property
financed with the proceeds of such mortgage revenue bonds or a "related
person" of such a "substantial user." Each opinion speaks only as of the
date it was delivered. In addition, in the case of mortgage revenue bonds
which, subsequent to their original issuance, have been reissued for
federal tax purposes, nationally recognized bond counsel or special tax
counsel has delivered opinions that interest on the reissued bond is
excludable from federally-taxable gross income of the holder from the date
of re-issuance or, in some cases, to the effect that the re-issuance did
not adversely affect the excludability of interest on the mortgage revenue
23
bonds from the gross income of the holders thereof. However, an opinion of
counsel has no binding effect and there is no assurance that the IRS will
not contest these conclusions or, if contested, that they will be sustained
by a court.
The Code establishes certain requirements which must be met subsequent to
the issuance and delivery of tax-exempt mortgage revenue bonds for interest
on such mortgage revenue bonds to remain excludable from federally-taxable
gross income. Among these continuing requirements are restrictions on the
investment and use of the revenue bond proceeds and, for mortgage revenue
bonds the proceeds of which are loaned to a charitable organization
described in Section 501(c)(3) of the Code, the continued exempt status of
such borrower. In addition, there is a requirement that the property be
operated as a rental property and that during the Qualified Project Period
(defined below) at least either:
o 20% of the units must be rented to individuals or families whose
income is less than 50% of the area median gross income (the "20/50
test"); or
o 40% of the units must be rented to individuals or families whose
income is less than 60% of the area median gross income (the "40/60
test");
in each case with adjustments for family size. The Qualified Project Period
begins when 10% of the units in the property are first occupied and ends on
the latest of the date:
(i) which is 15 years after 50% of the units are occupied;
(ii) on which all the bonds have been retired; or
(iii) on which any assistance provided under Section 8 of the U.S. Housing
Act of 1937 terminates.
Continuing requirements also include regulatory agreement compliance and
compliance with rules pertaining to arbitrage. Each issuer of the mortgage
revenue bonds, as well as each of the underlying borrowers, has covenanted
to comply with certain procedures and guidelines designed to ensure
satisfaction of the continuing requirements of the Code. Failure to comply
with these continuing requirements of the Code may cause the interest on
such bonds to be includable in federally-taxable gross income retroactively
to the date of issuance, regardless of when such noncompliance occurs.
Greenberg Traurig, LLP (also referred to as "Greenberg Traurig") as our
bond counsel, and Paul Hastings, as our securities counsel (Greenberg
Traurig and Paul Hastings are collectively referred to herein as our
"Counsel"), have not, in connection with this filing, passed upon and do
not assume any responsibility for, but rather have assumed the continuing
correctness of, the opinions of bond counsel or special tax counsel
(including opinions rendered by Greenberg Traurig) relating to the
exclusion from federally-taxable gross income of interest on the mortgage
revenue bonds and have not independently verified whether any events or
circumstances have occurred since the date such opinions were rendered that
would adversely affect the conclusions set forth herein.
"SUBSTANTIAL USER" LIMITATION
Interest on a mortgage revenue bond we own, other than a bond the proceeds
of which are loaned to a charitable organization described in Section
501(c)(3) of the Code, will not be excluded from gross income during any
period in which we are a "substantial user" of the properties financed with
the proceeds of such mortgage revenue bond or a "related person" to a
"substantial user."
A "substantial user" generally includes any underlying borrower and any
person or entity that uses the financed properties on other than a de
minimis basis. We would be a "related person" to a "substantial user" for
this purpose if, among other things,
o the same person or entity owned more than a 50% interest in both us
and in the properties financed with the proceeds of a bond owned by us
or one of our subsidiaries; or
o we owned a partnership or similar equity interest in the owner of a
property financed with the proceeds of a bond owned by us or one of
our subsidiaries.
Greenberg Traurig has reviewed the mortgage revenue bonds we own, the
ownership of the obligors of our mortgage revenue bonds and the ownership
of our shares and our subsidiaries' shares, and concurs in the conclusion
that we are not "substantial users" of the properties financed with the
proceeds of the mortgage revenue bonds or related parties thereto. There
can be no assurance, however, that the IRS would not challenge such
24
conclusion. If such challenge were successful, the interest received on any
bond for which we were treated as a "substantial user" or a "related party"
thereto would be includable in federally taxable gross income.
SECURITIZATION PROGRAMS AND REVENUE PROCEDURE 2003-84
Many of the senior interests in our securitization programs are held by
tax-exempt money-market funds. For various reasons, money market funds will
only acquire and hold interests in securitization programs that comply with
Revenue Procedure 2003-84, which provides for exemption from Schedule K-1
reporting requirements for certain partnerships. Our counsel, Greenberg
Traurig, has advised us that the partnerships we use in our securitizations
currently meet the requirements of Revenue Procedure 2003-84. It is our
intention to continue to meet those requirements, which include an income
test and an expense test, on an ongoing basis. There can be no assurance,
however, that unforeseen circumstances might cause one or more of our
securitization partnerships to fail either the income test or the expense
test, which would cause our securitization partnerships to have to comply
with all of the requirements of subchapter K of the Code. In the event one
or more of our securitization partnerships was forced to comply with the
provisions of subchapter K of the Code, it is likely that all of the
tax-exempt money market funds that hold the senior interests in those
securitizations would tender their positions. This would require our
remarketing agent to locate new purchasers, which were not tax-exempt money
market funds, for those tendered senior interests. This would probably
result in an increase in the distributions to the holders of the senior
interests, which would reduce, dollar for dollar, the distributions on the
residual interests in the securitizations, which are owned by us through
our subsidiaries.
TAXABLE INCOME
In our Portfolio Investing business, we primarily invest in investments
that produce only tax-exempt income. However, the IRS may seek to
re-characterize a portion of our tax-exempt income as taxable income as
described above. If the IRS were successful, a shareholder's distributive
share of such income would be taxable to the shareholder, regardless of
whether an amount of cash equal to such distributive share is actually
distributed. Any taxable income would be allocated pro rata among our CRA
Preferred Shares, our CRA Shares and our common shares. We may also have
taxable income in the form of market discount or gain on the sale or other
disposition of our investments, and we expect to own investments and engage
in certain fee generating activities (through our subsidiaries) that will
generate taxable income.
The following discussion relates only to our REIT subsidiary:
ADVERSE CONSEQUENCES OF FAILURE TO MAINTAIN REIT STATUS MAY INCLUDE
TAXATION OF A PORTION OF OUR EARNINGS NOT OTHERWISE TAXABLE
ARCap REIT, Inc. ("ARCap REIT"), a subsidiary of ARCap, intends to continue
to operate in a manner so as to qualify as a REIT for federal income tax
purposes. If ARCap REIT were to fail to qualify as a REIT in any taxable
year, it would be subject to federal income tax (including any applicable
alternative minimum tax) on its taxable income at regular corporate rates,
and distributions to its stockholders would not be deductible in computing
its taxable income. Any such corporate tax liability could be substantial
and would reduce the amount of cash available for distribution to our
shareholders. Unless entitled to relief under certain provisions of the
Code, ARCap REIT also would be disqualified from taxation as a REIT for the
four taxable years following the year during which it ceased to qualify as
a REIT.
ARCap REIT must distribute annually at least 90% of its taxable income
(excluding any net capital gain) in order to be exempt from corporate
income taxation of the earnings that it distributes. In addition, ARCap
REIT is subject to a 4% nondeductible excise tax on the amount, if any, by
which certain distributions it pays with respect to any calendar year are
less than the sum of:
1. 85% of its ordinary income for that year,
2. 95% of its capital gain net income for that year; and
3. 100% of its undistributed ordinary income and capital gain net
income from prior years.
While ARCap REIT intends to make distributions to its stockholders to
comply with the 90% distribution requirement and to be exempt from the
nondeductible excise tax, differences in timing between the recognition of
taxable income and the actual receipt of cash may require it to borrow
funds to meet this distribution requirement and to avoid the excise tax. In
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addition, the requirement to distribute a substantial portion of its
taxable income could cause ARCap REIT to:
1. distribute amounts that represent a return of capital;
2. distribute amounts that would otherwise be spent on capital
expenditures or repayment of debt; or
3. distribute amounts that may be treated as excess inclusion income
and accordingly, unrelated business taxable income in the hands
of certain not-for-profit stockholders.
To qualify as a REIT, ARCap REIT must satisfy certain requirements
concerning the nature of its assets and income, which may restrict its
ability to invest in various types of assets. Specifically:
1. at least 75% of ARCap's assets must consist of real estate
assets, cash and cash items, and certain government securities,
to ensure that the bulk of ARCap REIT's investments are either
equity or mortgage interests in real property; and
2. ARCap REIT will not be able to acquire securities (other than
securities that are treated as an interest in real property or
interests in a taxable REIT subsidiary) of any single issuer that
would represent either more than 5% of the total value of its
assets or 10% of the voting securities of such issuer, to ensure
a diversification of ARCap REIT's non-real-property investments.
In addition, to satisfy the income requirements of a REIT, ARCap REIT
generally will be restricted to acquiring assets that generate qualifying
income for purposes of certain income tests. These restrictions could
affect adversely ARCap REIT's ability to optimize its portfolio of assets.
CHANGES IN TAX LAWS REGARDING REITS COULD ADVERSELY AFFECT OUR NET INCOME
Congress, and to some extent the United States Department of Treasury, as
well as state legislatures and regulatory authorities, could at any time
adversely change the way in which a REIT and its stockholders are taxed, by
imposing additional entity-level taxes, further restricting the permissible
beneficial ownership and types of assets and income of a REIT, requiring
additional distributions, or changing the law in any other respect.
Moreover, such changes could apply retroactively. Should any such changes
be implemented, they would likely cause our net income to decline.
6. RISKS RELATED TO INVESTING IN OUR COMPANY
BECAUSE WE HOLD MOST OF OUR INVESTMENTS THROUGH OUR SUBSIDIARIES, OUR
SHAREHOLDERS ARE EFFECTIVELY SUBORDINATED TO THE LIABILITIES AND EQUITY OF OUR
SUBSIDIARIES
We hold most of our investments through our subsidiaries. Because we own only
common equity of our subsidiaries, we, and therefore holders of our shares, are
effectively subordinated to the debt obligations, preferred equity, SCUs, SMUs
and SCIs of our subsidiaries, which at December 31, 2006, aggregated
approximately $3.1 billion. In particular, the holders of the preferred shares
of one of our Equity Issuer subsidiaries are entitled to receive preferential
distributions with respect to revenues generated by mortgage revenue bonds held
directly or indirectly by it, which constitute a substantial portion of our
assets. Similarly, holders of senior interests created through our
securitization programs have a superior claim to the cash flow from the mortgage
revenue bonds deposited in such programs. Accordingly, a portion of the cash
flow from our investments will not be available for distribution on our common
shares. Likewise if we pay a common dividend:
o holders of SCUs issued by our CharterMac Capital Company LLC ("CCC")
subsidiary are entitled to receive preferential distributions with
respect to the earnings of CharterMac Capital;
o holders of SMUs issued by our CM Investor LLC ("CM Investor")
subsidiary are entitled to receive preferential distributions with
respect to the earnings of CM Investor; and
o holders of SCIs issued by our ARCap subsidiary are entitled to receive
preferential distributions with respect to the earnings of ARCap.
Those earnings, therefore, may not be available for distribution to our common
shareholders.
26
WE DEPEND UPON THE SERVICES OF OUR EXECUTIVE OFFICERS
We and our subsidiaries depend upon the services of our executive officers and
other individuals who comprise our executive management team. All decisions with
respect to the management and control of our Company and our subsidiaries,
subject to the supervision of our board of trustees (or the applicable
subsidiary's board), are currently made by these key officers. The departure or
the loss of the services of any of these key officers or a large number of
senior management personnel and other employees could have a material adverse
effect on our ability to operate our business effectively and our future results
of operations.
OUR BOARD OF TRUSTEES CAN CHANGE OUR BUSINESS POLICIES UNILATERALLY
Our board of trustees may amend or revise our business plan and certain other
policies without shareholder approval. Therefore, our shareholders have no
control over changes in our policies, including our business policies with
respect to acquisitions, financing, growth, debt, capitalization and
distributions, which are determined by our board of trustees.
THERE ARE POSSIBLE ADVERSE EFFECTS ARISING FROM SHARES AVAILABLE FOR FUTURE SALE
Our board of trustees is permitted to offer additional equity or debt securities
of our Company and our subsidiaries in exchange for money, property or other
consideration. Our ability to sell or exchange such securities will depend on
conditions then prevailing in the relevant capital markets and our results of
operations, financial condition, investment portfolio and business prospects.
Subject to New York Stock Exchange rules which require shareholder approval for
certain issuances of securities and as long as the issuance is made in
accordance with our trust agreement, the issuance of such additional securities
will not be subject to the approval of our shareholders and may negatively
affect the resale price of our shares. Shareholders will not have any preemptive
rights in connection with the issuance of any additional securities we or our
subsidiaries may offer and any of our equity offerings would cause dilution of a
shareholder's investment in us.
THE FORMER OWNERS OF CHARTERMAC CAPITAL AND MEMBERS OF OUR MANAGEMENT TEAM HAVE
SIGNIFICANT VOTING POWER ON MATTERS SUBMITTED TO A VOTE OF OUR SHAREHOLDERS, AND
THEIR INTERESTS MAY BE IN CONFLICT WITH THE INTERESTS OF OUR OTHER SHAREHOLDERS
In connection with our acquisition of CharterMac Capital, we issued to each of
its selling principals one special preferred voting share for each SCU they
received. Our special preferred voting shares have no economic interest, but
entitle each holder to one vote per special preferred voting share on all
matters subject to a vote of the holders of our common shares. The selling
principals of CharterMac Capital who received special preferred voting shares
include members of our executive management team (Mr. Hirmes and Mr. Schnitzer)
and a subsidiary of The Related Companies, L.P. ("TRCLP"), which is controlled
by Mr. Ross, the chairman of our board of trustees.
Mr. Schnitzer and Mr. Hirmes have also received share grants from the Company
that are entitled to vote during the vesting periods, as have other members of
our executive management team. As a result of the special preferred voting share
issuance, additional common shares directly or indirectly owned by them and
share grants we have made, members of our executive management team and Mr. Ross
in the aggregate directly or indirectly owned voting shares representing
approximately 20.7% of our voting power as of December 31, 2006. As such, if
they vote as a block, such shareholders will have significant voting power on
all matters submitted to a vote of our common shareholders.
Also, because three of the selling principals of CharterMac Capital serve as our
managing trustees, there are ongoing conflicts of interest when we are required
to determine whether or not to take actions to enforce our rights under the
various agreements entered into in connection with the CharterMac Capital
acquisition. While any material decisions involving these persons are subject to
the vote of a majority of our independent trustees, such decisions may create
conflicts between us and these persons.
In addition, we have some obligations to these former owners which will require
us to make choices as to how we operate our business which may affect those
obligations. For example, we have guaranteed the payment to all holders of the
SCUs of all but $5.0 million of the distributions they would otherwise be
entitled to receive under the operating agreement of CCC. In addition, we have
agreed to share cash flow from investment programs so that we and certain of
these former owners can receive payment of deferred fees. Further, TRCLP and its
27
affiliates currently engage in businesses which compete with us. The
non-competition covenants contained in a future relations agreement entered into
by TRCLP and its affiliates in connection with our acquisition of CharterMac
Capital prohibit TRCLP and its affiliates from competing with any business
currently engaged in by us other than in specified areas, including:
o providing credit intermediation on debt products secured by "80/20"
multifamily housing properties; and
o providing mezzanine financing to multifamily housing properties other
than so-called "tax credit properties."
There can be no assurance that we and TRCLP and its affiliates will not compete
for similar products and opportunities in these areas in the future.
NO ASSURANCE CAN BE GIVEN THAT OUR SHAREHOLDERS WILL BE ENTITLED TO THE SAME
LIMITATION ON PERSONAL LIABILITY AS STOCKHOLDERS OF PRIVATE CORPORATIONS FOR
PROFIT
We are governed by the laws of the State of Delaware. Under our trust agreement
and the Delaware Statutory Trust Act, as amended ("Delaware Act"), our
shareholders will be entitled to the same limitation of personal liability
extended to stockholders of private corporations for profit organized under the
General Corporation Law of the State of Delaware. In general, stockholders of
Delaware corporations are not personally liable for the payment of corporate
debts and obligations, and are liable only to the extent of their investment in
the Delaware corporation. However, a shareholder may be obligated to make
certain payments provided for in our trust agreement and bylaws. The properties
securing our investments are dispersed in numerous states and the District of
Columbia. In jurisdictions which have not adopted legislative provisions
regarding statutory trusts similar to those of the Delaware Act, questions exist
as to whether such jurisdictions would recognize a statutory trust, absent a
state statute, and whether a court in such jurisdiction would recognize the
Delaware Act as controlling. If not, a court in such jurisdiction could hold
that our shareholders are not entitled to the limitation of liability set forth
in our trust agreement and the Delaware Act and, as a result, are personally
liable for our debts and obligations.
OUR ANTI-TAKEOVER PROVISIONS MAY DISCOURAGE THIRD-PARTY PROPOSALS
Certain provisions of our trust agreement may have the effect of discouraging a
third party from making an acquisition proposal for our Company. This could
inhibit a change in control of our Company under circumstances that could give
our shareholders the opportunity to realize a premium over then-prevailing
market prices. Such provisions include the following:
ADDITIONAL CLASSES AND SERIES OF SHARES
Our trust agreement permits our board of trustees to issue additional
classes or series of beneficial interests and to establish the preferences
and rights of any such securities. Thus, our board of trustees could
authorize the issuance of beneficial interests with terms and conditions
which could have the effect of discouraging a takeover or other
transaction.
STAGGERED BOARD
Our board of trustees is divided into three classes of managing trustees.
The terms of the first, second and third classes will expire in 2008, 2009
and 2007, respectively. Managing trustees for each class will be chosen for
a three-year term upon the expiration of the current class' term. The use
of a staggered board makes it more difficult for a third-party to acquire
control over us.
SALES IN THE PUBLIC MARKET OF OUR COMMON SHARES ISSUABLE IN EXCHANGE FOR OUR
SCUS, SMUS AND SCIS COULD ADVERSELY AFFECT THE MARKET PRICE OF OUR SHARES
Future sales of substantial amounts of our common shares in the public market
could adversely affect prevailing market prices of our shares. As of December
31, 2006, approximately 14.8 million common shares remained issuable in exchange
for the SCUs we issued, approximately 278,000 common shares remained issuable in
exchange for the SMUs we issued, approximately 268,000 common shares remained
issuable in exchange for the SCIs we issued and we have granted restricted
common shares of which approximately 2.1 million were unvested at December 31,
2006. When these shares vest and/or convert, their sale in the public market
could, and depending upon the number of involved, likely would, adversely affect
28
prevailing market prices of our shares and our ability to raise additional
capital through the equity markets. As of December 31, 2006, TRCLP and its
owners indirectly held approximately 10.2 million SCUs and approximately 543,000
common shares which, subject to some exceptions, are not subject to a lock-up
agreement. In addition, former executives of our Company held approximately 2.0
million SCUs as of December 31, 2006. These SCUs are not subject to lock-up
agreements and may be converted to common shares at any time.
IF WE HAD TO REGISTER UNDER THE INVESTMENT COMPANY ACT, THERE COULD BE NEGATIVE
CONSEQUENCES TO OUR INVESTMENT STRATEGY
Neither we nor our subsidiaries are registered under the Investment Company Act
of 1940, as amended (the "Investment Company Act") and we may not be able to
conduct our activities as we currently do if we were required to so register.
At all times, we intend to conduct our activities, and those of our
subsidiaries, so as not to become regulated as an "investment company" under the
Investment Company Act. Even if we are not an investment company under the
Investment Company Act, we could be subject to regulation under the Investment
Company Act if a subsidiary of ours were deemed to be an investment company.
There are a number of possible exemptions from registration under the Investment
Company Act that we believe apply to us and our subsidiaries and which we
believe make it possible for us not to be subject to registration under the
Investment Company Act.
For example, the Investment Company Act exempts entities that are "primarily
engaged in the business of purchasing or otherwise acquiring mortgages and other
liens on and interests in real estate," which we refer to as "qualifying
interests." Under current interpretations by the SEC staff, one of the ways in
which our subsidiaries can qualify for this exemption is to maintain at least
55% of their assets directly in qualifying interests and the balance in real
estate-type interests. We believe our subsidiaries can rely on this exemption or
another exemption from registration.
The requirement that our subsidiaries maintain 55% of their assets in qualifying
interests (or satisfy another exemption from registration) may inhibit our
ability to acquire certain kinds of assets or to securitize additional interests
in the future. If any of our subsidiaries fail to qualify for exemption from
registration as an investment company and we, in turn, are required to register
as an investment company, our ability to maintain our financing strategies would
be substantially reduced, and we would be unable to conduct our business as
described herein. Such a failure to qualify could have a material adverse effect
upon our ability to make distributions to our shareholders.
AN INABILITY TO RAISE CAPITAL OR ACCESS FINANCING ON FAVORABLE TERMS, OR AT ALL,
COULD ADVERSELY AFFECT OUR GROWTH
A major aspect of our business plan includes the acquisition of additional
mortgage revenue bonds, which requires capital. We typically fund the expansion
of our business through a combination of operating cash flows, short-term
borrowings, securitizations, repurchase agreements and long-term borrowings. A
failure to renew our existing facilities, to increase our capacity under our
existing facilities or to add or new or replacement debt facilities could have a
material adverse effect on our business, financial condition and results of
operations. See the description of our existing facilities under "MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -
LIQUIDITY AND CAPITAL RESOURCES."
We also raise capital by periodically offering securities issued by us or one or
more of our subsidiaries. Our ability to raise capital through securities
offerings is subject to risks, including:
o conditions then prevailing in the relevant capital markets;
o our results of operations, financial condition, investment portfolio
and business prospects;
o the timing and amount of distributions to the holders of our shares
which could negatively affect the price of a common share; and
o the amount of securities that are structurally senior to the
securities being sold.
29
ITEM 1B. UNRESOLVED STAFF COMMENTS.
None
ITEM 2. PROPERTIES.
We lease the office space in which our headquarters are located at 625 Madison
Avenue, New York, NY. The leases expire in 2017.
We also lease office space in other locations as follows:
o Jersey City, NJ - An office facility; the lease expires in 2010.
o Morristown, NJ - An office facility; the lease expires in 2007.
o Bethesda, MD - An office facility; the lease expires in 2009.
o Irvine, CA - An office facility; the lease expires in 2011.
o San Francisco, CA - An office facility; the lease expires in 2012.
o Boston, MA - An office facility; the lease expires in 2011.
o Irving, TX - An office facility; the leases expires in 2016.
o Chicago, IL - An office facility; the lease expires in 2009.
o San Rafael, CA - An office facility; the lease expires in 2008.
We believe that these facilities are suitable for current requirements and
contemplated future operations.
ITEM 3. LEGAL PROCEEDINGS.
We are subject to routine litigation and administrative proceedings arising in
the ordinary course of business. Management does not believe that such matters
will have a material adverse impact on our financial position, results of
operations or cash flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
There were no matters submitted to shareholders for voting during the fourth
quarter of 2006.
30
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES.
Market Information
------------------
Our common shares have been listed on the New York Stock Exchange since January
10, 2006, under the symbol "CHC". From October 1, 1997, until January 9, 2006,
they were traded on the American Stock Exchange under the same symbol. Prior to
October 1, 1997, there was no established public trading market for our common
shares.
The high and low prices for each quarterly period of the last two years during
which our common shares were traded were as follows:
2006 2005
----------------------- -----------------------
Quarter Ended Low High Low High
------------- --------- --------- --------- ---------
March 31 $ 19.52 $ 22.65 $ 20.65 $ 24.50
June 30 $ 16.86 $ 20.13 $ 20.30 $ 22.49
September 30 $ 18.10 $ 21.05 $ 20.43 $ 23.37
December 31 $ 19.52 $ 21.76 $ 18.50 $ 23.02
The last reported sale price of our common shares on the New York Stock Exchange
on February 23, 2007, was $20.70.
Holders
-------
As of February 23, 2007, there were 2,798 registered shareholders owning
51,404,234 common shares.
Distributions
-------------
After providing for distributions to our 4.4% Convertible Preferred Shares, our
net income is allocated pro rata among the common shares and the Convertible CRA
Shares (see Note 14 to the consolidated financial statements). The Convertible
CRA Shares rank on par with the common shares with respect to rights upon
liquidation, dissolution or winding up of our Company, although both are
subordinate to our 4.4% Convertible CRA Preferred shares. Quarterly cash
distributions during the years ended December 31, 2006 and 2005 were as follows:
Total Amount
Date Per Distributed
Cash Distribution for Quarter Ended Paid Share (In thousands)
----------------------------------- -------- -------- --------------
March 31, 2006 5/15/06 $ 0.42 $24,764
June 30, 2006 8/14/06 0.42 24,806
September 30, 2006 11/14/06 0.42 25,175
December 31, 2006 2/14/07 0.42 25,201
-------- -------
Total for 2006 $ 1.68 $99,946
======== =======
March 31, 2005 5/13/05 $ 0.41 $23,729
June 30, 2005 8/12/05 0.41 23,766
September 30, 2005 11/14/05 0.41 23,843
December 31, 2005 2/14/06 0.42 24,587
-------- -------
Total for 2005 $ 1.65 $95,925
======== =======
31
There are no material legal restrictions upon our present or future ability to
make distributions in accordance with the provisions of our Second Amended and
Restated Trust Agreement. We do not believe that the financial covenants
contained in our and our subsidiaries' secured indebtedness or in the terms of
the preferred shares issued by Equity Issuer will have any adverse impact on our
ability to make distributions in the normal course of business to our common and
Convertible CRA shareholders. Future distributions will be at the discretion of
the trustees based upon evaluation of our actual cash flows, our financial
condition, capital requirements and such other factors as our trustees deem
relevant.
Securities authorized for issuance under equity compensation plans
------------------------------------------------------------------
The following table provides information related to our share incentive plans as
of December 31, 2006:
(a) (b) (c)
Number of securities
Number of remaining available for
securities to be future issuance under
issued upon exercise Weighted-average equity compensation
of outstanding exercise price of plans (excluding
options, warrants outstanding options, securities reflected in
and rights warrants and rights column a) (1)
-------------------- -------------------- -----------------------
Equity compensation plans
approved by security holders 2,018,741 $ 20.77 3,794,017
Equity compensation plans not
approved by security holders -- -- --
--------- --------- ---------
Totals 2,018,741 $ 20.77 3,794,017
========= ========= =========
(1) Our Incentive Share Plan (see Note 15 to the consolidated financial
statements) authorizes us to issue options or other share-based
compensation equal to 10% of the total shares outstanding (as defined in
the plan) as of December 31 of the year preceding the issuance of new
grants or options.
Securities purchased by us
--------------------------
The following table presents information related to our repurchases of our
equity securities during the fourth quarter of 2006 and other information
related to our repurchase program:
Purchases of Equity Securities
(a) (b) (c) (d)
Total number
Total of shares Maximum number
number of Average purchased as part of shares that may yet
shares price paid of publicly be purchased under the
Period purchased (1) per share announced program plans or program
--------------------------------- --------------- ---------------- ----------------- ----------------------
October 1 - 31, 2006 -- $ -- --
November 1 - 30, 2006 77,080 21.35 --
December 1 - 31, 2006 18,507 21.35 --
-------- -------- --------
Total 95,587 $ 21.35 -- 570,540
======== ======== ======== ==========
(1) These repurchases were in connection with tax withholding obligations
incurred by holders of newly vested restricted shares and were outside of
our share repurchase program.
32
Other information required by this item, as well as information regarding our
share repurchase program and share compensation paid to our independent
trustees, is included in Notes 14 and 15 to our consolidated financial
statements.
ITEM 6. SELECTED FINANCIAL DATA.
The information set forth below presents our selected financial data. Additional
financial information is set forth in the consolidated financial statements and
notes thereto.
For the Years Ended December 31 (in thousands, except per share amounts):
Operations 2006 (1) 2005 (2) 2004 (3) 2003 (4) 2002
--------------------------------- ----------- ----------- ----------- ----------- -----------
Total revenues $ 387,259 $ 295,097 $ 232,432 $ 152,240 $ 116,614
Income before income taxes $ 47,786 $ 30,437 $ 48,120 $ 60,514 $ 62,117
Net income $ 41,294 $ 59,014 $ 65,363 $ 66,586 $ 60,833
Net income applicable to
shareholders (5) $ 36,542 $ 56,994 $ 65,363 $ 61,248 $ 55,905
Net cash provided by (used in):
Operating activities $ 86,716 $ 685 $ 106,405 $ 97,902 $ 80,977
Investing activities $ (523,896) $ (373,018) $ (366,647) $ (365,419) $ (418,379)
Financing activities $ 454,792 $ 462,341 $ 279,295 $ 306,052 $ 245,737
Net income per share (5)
Basic $ 0.63 $ 0.98 $ 1.19 $ 1.31 $ 1.31
Diluted $ 0.62 $ 0.98 $ 1.19 $ 1.31 $ 1.31
Financial position
---------------------------------
Total assets $ 9,688,516 $ 6,968,757 $ 5,737,221 $ 2,581,169 $ 1,852,868
Financing arrangements $ 1,801,170 $ 1,429,692 $ 1,068,428 $ 900,008 $ 671,659
Notes payable $ 591,165 $ 304,888 $ 174,454 $ 153,350 $ 68,556
Preferred shares of subsidiary:
Subject to mandatory repurchase $ 273,500 $ 273,500 $ 273,500 $ 273,500 $ 273,500
Not subject to mandatory
repurchase $ 104,000 $ 104,000 $ 104,000 $ -- $ --
Dividends
---------------------------------
Dividends declared per share (6) $ 1.68 $ 1.65 $ 1.57 $ 1.37 $ 1.26
(1) Includes ARCap beginning in August 2006, and includes $29.2 million of
expense (or $0.50 per basic and diluted share) related to a valuation
allowance recorded against deferred tax assets (see Note 12 to the
consolidated financial statements).
(2) Includes a $22.6 million non-cash pre-tax charge ($12.3 million after tax,
or $0.21 per basic and diluted share) related to the write-off of the
"Related Capital Company" trade-name intangible asset (see Note 5 to the
consolidated financial statements).
(3) Reflects adoption of Interpretation 46(R), CONSOLIDATION OF VARIABLE
INTEREST ENTITIES ("FIN 46(R)"), as of March 31, 2004 (See Note 1 to the
consolidated financial statements).
(4) Includes CharterMac Capital beginning in November 2003.
(5) Includes common shareholders and Convertible CRA shareholders.
(6) Distributions per share are the same for both common shares and Convertible
CRA shares.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following Management's Discussion and Analysis ("MD&A") is intended to help
the reader understand the results of operations and financial condition of
CharterMac. MD&A is provided as a supplement to, and should be read in
conjunction with, our consolidated financial statements and the accompanying
notes.
Forward-Looking Statements
--------------------------
This MD&A contains forward-looking statements. These forward-looking statements
are not historical facts, but rather our beliefs and expectations and are based
on our current expectations, estimates, projections, beliefs and assumptions
about our Company and industry. Words such as "anticipates," "expects,"
"intends," "plans," "believes," "seeks," "estimates" and similar expressions are
intended to identify forward-looking statements. These statements are not
33
guarantees of future performance and are subject to risks, uncertainties and
other factors, some of which are beyond our control, are difficult to predict
and could cause actual results to differ materially from those expressed or
forecasted in the forward-looking statements. Some of these risks (described
more fully in Item 1A. of this filing on Form 10-K) include, among other things:
o adverse changes in real estate markets;
o competition with other companies;
o interest rate fluctuations;
o general economic and business conditions;
o environmental/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.
We caution you not to place undue reliance on these forward-looking statements,
which reflect our view only as of the date of this annual report on Form 10-K.
Factors Affecting Comparability
-------------------------------
ACQUISITIONS
In August 2006, we acquired ARCap. Prior to the acquisition date, we recorded
equity earnings on our 10.7% equity investment in ARCap in our Portfolio
Investing segment. 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.
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.
ACCOUNTING CHANGES
The adoption of several accounting pronouncements has affected our consolidated
financial statements.
Primarily due to our adoption of FIN 46(R) as of March 31, 2004, we consolidate
more than 149 partnerships (predominantly investment funds we sponsor) in our
consolidated financial statements. The operating results for 2006 and 2005
include a full period of operations for these entities, as well as the
elimination of transactions between the entities and our subsidiaries. In 2004,
the operating results include only nine months' operating results as we adopted
this accounting standard as of March 31 of that year (see Notes 1 and 7 to the
consolidated financial statements).
The adoption of FIN 46(R) led to a significant increase in the amount of assets
and liabilities we record and also results in the recognition of the operating
results of partnerships in which we have virtually no equity interest, the
elimination of transactions between our businesses and those partnerships and
the allocation of their results to their investor partners.
OTHER ITEMS
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
34
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.
In September 2006, we terminated a loan investment and recognized a one-time
gain totaling approximately $6.9 million. We also closed a subsidiary and
recorded goodwill and intangible asset impairment charges of approximately $2.6
million in the third and fourth quarters of 2006.
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.
In 2005 and 2004, an income tax benefit was recognized.
At the end of 2005, management elected to discontinue the use of the "Related
Capital Company" trade name, effective January 1, 2006. The decision resulted in
the non-cash write-off of an intangible asset recorded at the time we acquired
Related Capital (now known as CharterMac Capital). The write-off amounted to
$22.6 million and reduced net income by $12.3 million, net of tax benefit, or
$0.21 per basic and diluted share.
Results of Operations
----------------------
OVERVIEW
The following is a summary of our operations:
% %
Change Change
% of % of % of 2006 vs. 2005 vs.
(In thousands) 2006 Revenues 2005 Revenues 2004 Revenues 2005 2004
------------------ --------- -------- --------- -------- --------- -------- -------- --------
Total revenues $ 387,259 100.0% $ 295,097 100.0% $ 232,432 100.0% 31.2 % 27.0 %
Income before
income taxes:
Income (loss)
subject to tax (31,555) (8.1) (48,872) (16.6) (31,965) (13.8) (35.4) 52.9
Income not subject
to tax 79,341 20.5 79,309 26.9 80,085 34.5 -- (1.0)
--------- ------ --------- ------ --------- ------ ------ ------
47,786 12.3 30,437 10.3 48,120 20.7 57.0 (36.7)
Income tax
(provision)
benefit (6,492) (1.7) 28,577 9.7 17,243 7.4 (122.7) 65.7
Net income 41,294 10.7 59,014 20.0 65,363 28.1 (30.0) (9.7)
Our consolidated results over the three-year period reflect our changing
business focus from direct investing, primarily generating recurring, revenues
towards growing the business through fund and asset management with a large
proportion of fee-based transaction income. This transition included:
o rapid growth of our taxable, fee-based business through the
sponsorship of increasingly larger and greater number of funds in
2004, 2005 and 2006;
o approximately doubling our Mortgage Banking business through the
acquisition of CCLP in 2005;
o commencement of Centerbrook in June 2006; and
o our acquisition of ARCap in August 2006 positively impacting our Fund
Management and Mortgage Banking segments.
Our reported revenues do not fully reflect the growth of the individual
businesses due to the impact of consolidating sponsored investment partnerships,
as described more fully below. The underlying revenue growth stems from the
35
introduction of new products such as variable-rate bond financing and
loss-sharing mortgage loan originations for Freddie Mac.
Beyond the growth of our businesses, costs have also increased due to (among
other factors):
o increasing financing costs due to higher borrowing levels attendant to
expansion and general increases in interest rates;
o the requirement for infrastructure to support growth, primarily in
2004 and 2005, and the costs to operate acquired businesses;
o the costs associated with the creation of tax credit equity funds that
vary with the level of fund sponsorship activity, although the
majority of such costs are reimbursed and the reimbursements are
recognized as revenue;
o start-up costs as well as termination and other costs associated with
the restructuring of securitization programs in connection with the
launch of Centerbrook; and
o restructuring costs relating to integration actions with respect to
the ARCap acquisition in 2006.
Along with the compositional changes in the business, we are now also
increasingly subject to taxation, although tax benefits may result based upon
the annual taxable income or loss from these businesses. The tax benefits
recognized in 2004 and 2005 reflect the increasing proportion of these taxable
businesses and increased book losses of those businesses. 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 assets as noted above. See also
INCOME TAXES below.
REVENUES
Our revenues for the years ended December 31 were as follows:
% Change % Change
2006 vs. 2005 vs.
(In thousands) 2006 2005 2005 2004 2004
------------------------------------- -------- -------- -------- -------- --------
Mortgage revenue bond interest income $156,500 $146,024 7.2 % $132,075 10.6 %
Other interest income 34,159 16,162 111.4 9,346 72.9
Fee income
Fund sponsorship 44,739 50,982 (12.2) 45,564 11.9
Mortgage banking 34,247 27,104 26.4 15,026 80.4
Credit intermediation 5,215 6,694 (22.1) 8,476 (21.0)
-------- -------- ------- -------- -------
Total fee income 84,201 84,780 (0.7) 69,066 22.8
Other revenues
Prepayment penalties 6,856 6,326 8.4 1,877 237.0
Construction service fees 4,801 4,583 4.8 1,445 217.1
Rental income of real estate owned 5,918 3,860 53.3 -- --
Administration fees 2,371 1,832 29.4 1,381 32.7
Expense reimbursements 3,658 4,923 (25.7) 2,785 76.8
Other 5,057 2,511 101.4 2,244 11.9
-------- -------- ------- -------- -------
Total other revenues 28,661 24,035 19.2 9,732 147.0
Revenues of consolidated partnerships 83,738 24,096 247.5 12,213 97.3
-------- -------- ------- -------- -------
Total revenues $387,259 $295,097 31.2 % $232,432 27.0 %
======== ======== ======= ======== =======
The ARCap acquisition in 2006 and the CCLP acquisition in 2005 drove a
significant amount of our annual revenue increase in 2006 and 2005,
respectively. Adjusting to include ARCap revenues and CCLP revenues for all
periods, our total revenues would have increased approximately 11.9% in 2006 and
8.6% in 2005.
As we transition to increase our position as an asset and fund manager, the
revenue fluctuations above are not necessarily representative of the growth of
our businesses as we consolidate many partnerships from which we earn revenues,
and as a result many transactions are eliminated in consolidation. For example,
we eliminate revenues earned by our subsidiaries in transactions with LIHTC and
Property Partnerships we have consolidated but in which we have virtually no
36
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. The consolidation also results in
the elimination of revenues earned by our Portfolio Investing and Fund
Management subsidiaries for transactions with the partnerships. The revenues
eliminated were as follows:
% Change % Change
2006 vs. 2005 vs.
(In thounsands) 2006 2005 2005 2004 2004
------------------------------------- -------- -------- -------- -------- --------
Mortgage revenue bond interest income $11,198 $ 3,555 215.0 % $ 581 511.9 %
Other interest income 210 321 (34.6) 159 101.9
Fund sponsorship fees 47,152 39,708 18.7 25,531 55.5
Credit intermediation fees 3,789 3,152 20.2 1,609 95.9
Other revenues 5,372 2,783 93.0 3,320 (16.2)
------- ------- ------ ------- ------
Total $67,721 $49,519 36.8 % $31,200 58.7 %
======= ======= ====== ======= =====
These amounts, along with revenues of consolidated partnerships, increased
significantly over the three year period due to additional partnerships
consolidated during the periods.
For discussion of individual revenue streams, see RESULTS BY SEGMENT below.
EXPENSES
Our expenses for the three years ended December 31 were as follows:
% Change % Change
2006 vs. 2005 vs.
(In thounsands) 2006 2005 2005 2004 2004
------------------------------------- -------- -------- -------- -------- --------
Interest expense $ 97,055 $ 56,698 71.2 % $ 30,932 83.3 %
-------- -------- ------ -------- ------
Interest expense - preferred shares
of subsidiary 18,898 18,898 -- 18,898 --
-------- -------- ------ -------- ------
Salaries and benefits 94,916 68,983 37.6 56,044 23.1
Fund origination and property
acquisition expenses 12,338 15,704 (21.4) 15,980 (1.7)
Operating costs of real estate owned 4,861 3,218 51.1 -- --
Restructuring costs 1,446 -- -- -- --
Other general and administrative 52,087 40,708 28.0 29,282 39.0
-------- -------- ------ -------- ------
Subtotal 165,648 128,613 28.8 101,306 27.0
-------- -------- ------ -------- ------
Depreciation and amortization 47,527 44,195 7.5 30,407 45.3
Write off of intangible assets 2,644 22,567 (88.3) -- --
Loss on impairment of assets 5,003 4,555 9.8 757 501.7
-------- -------- ------ -------- ------
Subtotal 336,775 275,526 22.2 182,300 51.1
-------- -------- ------ -------- ------
Interest expense of consolidated
LIHTC and Property partnerships 25,989 26,322 (1.3) 21,395 23.0
Interest expense of consolidated CMBS
and Direct Loan partnerships 21,937 -- -- -- --
-------- -------- ------ -------- ------
47,926 26,322 82.1 21,395 23.0
-------- -------- ------ -------- ------
Other expenses of consolidated LIHTC
and Property partnerships 75,479 49,810 51.5 30,519 63.2
Other expenses of consolidated CMBS
and Direct Loan partnerships 467 -- -- -- --
-------- -------- ------ -------- ------
75,946 49,810 52.5 30,519 63.2
-------- -------- ------ -------- ------
Subtotal 123,872 76,132 62.7 51,914 46.7
-------- -------- ------ -------- ------
Total expenses $460,647 $351,658 31.0 % $234,214 50.1 %
======== ======== ====== ======== ======
The total amount of operating costs we recognize increased significantly over
the three-year period due to increased investment activity and general expansion
of our businesses, the CCLP acquisition in 2005, the ARCap acquisition in 2006
and the amortization of intangible assets acquired.
37
The increase in interest expense reflects the higher borrowing levels as we
expand our various business lines. Significant borrowings during 2006 and 2005
included those related to:
o our acquisition of ARCap in 2006, for which the cash portion of the
purchase price was approximately $263.3 million;
o acquisitions and fundings of mortgage revenue bonds totaling
approximately $419.9 million in 2006 and $443.5 million in 2005; and
o short-term lending for mortgage loans prior to their sale to agencies
and conduits, which increased markedly in 2006 and 2005 as the
business grew.
In addition to higher borrowings, interest expense over the three year period
reflects an increase in the average borrowing rate, resulting primarily from
gradual increases in the Bond Market Association Municipal Swap Index ("BMA")
and LIBOR rates over the three year period, following sharp declines in prior
years. Interest expense also includes amounts paid and received pursuant to swap
agreements as part of our risk management strategy.
(Dollars in thousands) 2006 2005 2004
------------------------------------ ---------- ---------- ----------
Average borrowing rate 4.6 % 3.8 % 2.6 %
Average BMA rate 3.45 % 2.45 % 1.22 %
Average LIBOR rate 5.13 % 3.46 % 1.54 %
Swap agreements - notional amount at
December 31 $ 725,000 $ 500,000 $ 50,000
The amount reported as "interest expense - preferred shares of subsidiary"
represents dividends on the Equity Issuer preferred shares that are subject to
mandatory repurchase (see also OTHER ITEMS below regarding dividends on shares
that are not subject to mandatory repurchase).
The increase in salaries and benefits expense in 2006 as compared to 2005
primarily relates to:
o approximately 100 employees added upon the ARCap acquisition;
o incremental non-cash compensation cost of approximately $8.0 million
related to shares issued in connection with the ARCap acquisition (of
the incremental amount, approximately $1.1 million related to shares
that vested immediately);
o deferred participation compensation of approximately $4.7 million
related to CMBS funds we sponsor;
o severance related costs of approximately $2.5 million associated with
the elimination of certain executive positions during 2006; and
o continued growth of our component businesses.
The increase in salaries and benefits expense in 2005 as compared to 2004 is
primarily related to the acquisition of CCLP in 2005 and the addition of
approximately 100 employees at that time. In addition, 2005 also includes
approximately $3.2 million of costs related to the departure of our Chief
Executive Officer and an executive of one of our subsidiaries.
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 (see FUND MANAGEMENT section below for
related revenue discussion).
Restructuring costs relate to integration initiatives in connection with the
ARCap acquisition.
Other general and administrative expenses in many categories increased in 2006
and 2005 due to the expansion of our businesses, increased occupancy needs and:
o the acquisitions of ARCap in 2006 and CCLP in 2005 which increased
infrastructure costs;
o start-up costs and termination and other fees associated with
restructuring of our securitization programs in connection with the
launch of Centerbrook in 2006; and
o growth in professional fees due, in part, to auditing and compliance
costs related to Sarbanes-Oxley implementation and legal costs related
to protecting our interests in properties whose developers/contractors
experienced financial problems (see Note 21 to the consolidated
38
financial statements) and other properties on which we foreclosed (see
Note 6 to the consolidated financial statements).
Depreciation and amortization expenses were higher in the 2006 and 2005 periods,
primarily due to:
o higher amortization of mortgage servicing rights following the CCLP
and ARCap acquisitions and the expansion of the Mortgage Banking
business;
o a write-off of previously deferred fees in 2006 in connection with the
restructuring of certain securitization programs upon the launch of
Centerbrook; and
o recognizing a retroactive depreciation charge in 2006 for real estate
owned which was reclassified from held for sale to held and used (see
Note 6 to the consolidated financial statements).
The write-off of intangible assets in 2006 represents a goodwill impairment
charge of approximately $1.0 million to account for the portion of our total
investment in a subsidiary that we did not recover upon discontinuance of the
business and the write-off of $1.6 million in unamortized other intangible
assets recognized at the time of its acquisition. The 2005 write-off pertains to
management's decision at the end of 2005 to discontinue the use of the "Related
Capital Company" trade name when we renamed the subsidiary CharterMac Capital.
The absence of amortization during 2006 related to this write-off partially
offset the depreciation and amortization increases above.
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 year worth of operating costs compared to approximately eight
months during 2005.
Loss on impairment of assets is discussed in PORTFOLIO INVESTING below.
The increases in the LIHTC and Property partnerships expense categories over the
three year period are due to the increase in the number of such partnerships
consolidated due to the incremental fund sponsorship activity as well as an
increase in the number of Property Partnerships which we have taken control of
over the past two years to protect our investments (see also Note 21 to the
consolidated financial statements). 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 and Direct Loan partnerships represent funds we
sponsor to syndicate investments in CMBS and associated resecuritization trusts,
along with a Direct Loan partnership we manage and consolidate. These items were
incorporated into our financial results following our acquisition of ARCap in
August 2006.
OTHER ITEMS
% Change % Change
2006 vs. 2005 vs.
(In thousands) 2006 2005 2005 2004 2004
------------------------------------- --------- --------- ---------- --------- ---------
Equity and other income $ 1,978 $ 7,037 (71.9)% $ 3,442 104.4 %
Gain on termination of CCA loan $ 6,916 $ -- -- % $ -- -- %
Gain on sale or repayment of mortgage
revenue bonds and other assets 1,120 1,561 (28.3) 217 619.4
Gain on sale or repayment of loans 10,334 6,501 59.0 7,651 (15.0)
--------- --------- ------ --------- ------
Gain on sale or repayment of loans $ 18,370 $ 8,062 127.9 % $ 7,868 2.5 %
and mortgage revenue bonds
Income allocated to preferred
shareholders of subsidiary $ (6,225) $ (6,225) -- % $ (3,942) 57.9 %
Income allocated to SCUs $ (16,131) $ (23,091) (30.1)% $ (28,174) (18.0)%
Income allocated to SMUs (102) (330) (69.1) -- --
Income allocated to SCI's (80) -- -- -- --
Other 219 -- -- (194) --
--------- --------- ------ --------- ------
Total income allocated to minority $ (16,094) $ (23,421) (31.3)% $ (28,368) (17.4)%
interests
Loss allocated to partners of
consolidated partnerships $ 401,377 $ 349,531 14.8 % $ 219,950 58.9 %
39
Equity and other income decreased in the 2006 period as we no longer recognize
equity income from our investment in ARCap after completing our acquisition in
August. Subsequent to the ARCap acquisition, equity and other income is
comprised of income earned from property development joint ventures, offset by
losses from tax advantaged investment vehicles similar to those we sponsor. The
sharp increase in 2005 relates to the level of joint venture investment activity
as several ventures approached completion, allowing us to realize our share of
development income and gains on sale. The 2005 increase also includes
incremental dividends from converting a portion of our ARCap investment from
preferred to common units. Equity income from our investment in CMBS funds is
eliminated in consolidation, but positively impacts our net income. From the
date of acquisition through December 31, 2006, this amount was approximately
$15.3 million. There is no comparable amount in 2005 or 2004 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 a participating loan and the estimated
value of the manager interest in CUC that was assigned to us (see Note 4 to the
consolidated financial statements).
The variance in gain on repayment of mortgage revenue bonds relates to the level
of repayments in the Portfolio Investing segment. Similarly, the year-to-year
variations in gains on sales or repayment of loans are attributable to the
fluctuations in the volume of mortgage originations. See RESULTS BY SEGMENT
below.
The total of "income allocated to preferred shareholders of subsidiary,"
increased in 2005 as compared to the 2004 period due to an additional preferred
offering consummated in April 2004.
The income allocation to SCUs and 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 and therefore fluctuates
along with net income. There was no income allocated to SMUs in 2004 as the
units were first issued in May 2005; likewise, the SCIs were issued in August
2006 in connection with our ARCap acquisition. "Other" minority interest in 2006
principally represents the portion of Centerbrook owned by IXIS. The amount for
2004 pertains to the portion of CMC that we did not acquire until the first
quarter of 2005.
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 $10,000) and the majority ownership in
CMBS funds we sponsor.
Income Taxes
------------
A large majority of our pre-tax income is derived from our Portfolio Investing
businesses, which are structured as flow-through entities. Likewise, the CMBS
and Direct Loan Fund Sponsorship businesses which are included in our Fund
Management segment are similarly structured. As such, the income from those
businesses does not subject us to income taxes.
The Fund Management businesses (other than those noted above) and the 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. In
2005, the other factors include the $22.6 million write-off of an intangible
asset (see EXPENSES above and Note 5 to the consolidated financial statements).
We provide for income taxes for these corporate subsidiaries in accordance with
SFAS No. 109, ACCOUNTING FOR INCOME TAXES ("SFAS No. 109") which requires the
recognition of deferred tax assets and liabilities for the expected future tax
consequences of temporary differences between the financial statement carrying
amounts and the tax bases of assets and liabilities.
The tax benefit disclosed in years prior to 2006 relates to the book losses of
the taxable businesses and the tax deductible distributions on their subsidiary
equity. As the proportion of our pre-tax income contributed by the businesses
generating taxable income and losses changes, the resulting tax benefit or
provision may appear incongruous with our consolidated income before income
taxes, as illustrated in Note 12 to the consolidated financial statements. 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
40
subsidiaries for the foreseeable future, all of the deferred tax assets will
likely not be realized and hence a valuation allowance was provided.
As noted above, we recognized an income tax provision in 2006 compared to an
income tax benefit for the comparable periods in 2005 and 2004. The effective
tax rate on a consolidated basis was 13.6% in 2006, (93.9)% in 2005 and (35.8)%
in 2004, due to the factors noted above. The effective rate for our corporate
subsidiaries that were subject to taxes was (20.6)% in 2006, 58.5% in 2005 and
54.4% in 2004. See Note 12 to the consolidated financial statements for further
information regarding the effective tax rate.
Results by Segment
------------------
PORTFOLIO INVESTING
The table below shows selected information regarding our Portfolio Investing
activities:
% Change % Change
2006 vs. 2005 vs.
(In thousands) 2006 2005 2005 2004 2004
----------------------------------------- ---------- ---------- --------- ---------- ---------
New mortgage revenue bond acquisitions $ 298,875 $ 378,746 (21.1)% $ 290,967 30.2 %
Funding of mortgage revenue bonds
acquired in prior years 24,700 1,800 -- 17,735 (89.9)
Acquisitions related to prior
period forward commitments 96,365 62,971 53.0 16,395 284.1
---------- ---------- --------- ---------- ---------
Total acquisition and funding activity $ 419,940 $ 443,517 (5.3)% $ 325,097 36.4 %
Forward commitments issued but not funded $ -- $ 8,000 -- % $ 88,676 (91.0)%
Mortgage revenue bonds repaid $ 83,746 $ 104,279 (19.7)% $ 26,870 288.1 %
Average portfolio balance (fair
value) $2,560,548 $2,229,654 14.8 % $1,946,433 14.6 %
Weighted average permanent interest
rate of bonds acquired 5.99% 6.19% 6.26%
Weighted average yield of portfolio 6.72% 6.77% 6.79%
Average borrowing rate (1) 4.17% 3.65% 2.51%
Average BMA rate 3.45% 2.45% 1.22%
Mortgage revenue bond interest income (2) $ 170,273 $ 150,222 13.3 % $ 132,815 13.1 %
Other interest income (2) 19,894 10,602 87.6 7,100 49.3
Prepayment penalties 1,662 1,176 41.3 30 --
Rental income of real estate owned 5,918 3,860 53.3 -- --
Other revenues (2) 5,885 3,495 68.4 2,966 17.8
---------- ---------- --------- ---------- ---------
$ 203,632 $ 169,355 20.2 % $ 142,911 18.5 %
========== ========== ========= ========== =========
Interest expense and securitization
fees (2) $ 97,233 $ 53,617 81.3 % $ 32,373 65.6 %
Loss on impairment of assets $ 5,003 $ 4,555 9.8 % $ 757 501.7 %
Gain on termination of CCA loan $ 6,916 $ -- -- % $ -- -- %
Gain on repayments of mortgage
revenue bonds $ 1,048 $ 1,523 (31.2)% $ 217 601.8 %
---------- ---------- --------- ---------- ---------
CAD $ 101,022 $ 102,927 (1.9)% $ 106,317 (3.2)%
---------- ---------- --------- ---------- ---------
(1) Includes effect of swaps and in 2006, incremental costs related to
restructuring of our securitization programs.
(2) Prior to intersegment eliminations.
The increase in mortgage revenue bond interest income is primarily due to
expanding our revenue bond portfolio in 2005 and 2006, although the rate of
investment has slowed due to challenging market conditions we have experienced
since 2004. Also included in mortgage revenue bond interest income is contingent
interest of approximately $5.2 million in 2006, $2.6 million in 2005 and
$230,000 in 2004, related to bonds prepaid during those years.
Other interest income in this segment is predominantly interest income on
investments other than mortgage revenue bonds and intercompany interest
eliminated in consolidation. The higher level of income in the 2006 and 2005
periods relates primarily to increased intercompany lending to utilize this
segment's cash flow, offset by a lower level of outside investments following
41
the conversion of loans to equity in relation to the CCLP and ARCap acquisitions
in 2005 and 2006 and the CCA loan termination in 2006.
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. In 2006, one borrower prepaid a
bond resulting in a $1.0 million gain on repayment.
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 year of operations while the 2005 results represent only a partial
period.
While the decline in interest rates for new investments has gradually lowered
the average yield of our portfolio, from an income perspective, the low interest
rate environment has been favorable for us. Although the BMA rate, the
short-term tax-exempt index, increased markedly in 2006 and 2005, our weighted
average cost of debt associated with these investments, taking our hedging into
effect, continues to allow us to recognize spreads of several percentage points
between our cost of borrowing and the interest rates earned. 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 securitizations in 2006 resulted in incremental interest
costs of approximately $2.6 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. Also, the fixed rate securitization we entered into in
2006 should serve to temper our exposure to interest rate increases.
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 eight mortgage revenue bonds in the
2006 period with seven underlying properties, four in the 2005 period with three
underlying properties and one in the 2004 period with one underlying property.
While the number of impairments increased in the 2006 period, the losses have
declined in comparison with the growth rate of the portfolio.
CAD in this segment declined in 2006 from the 2005 period level due to higher
borrowing costs from steadily increasing interest rates and charges recorded in
2006 associated with restructuring of our securitization programs. These factors
were partially offset by a $6.0 million cash termination fee received upon the
termination of the loan to CCA and a sharply higher level of prepayment penalty
income. CAD declined in 2005 as compared to 2004 due primarily to higher
borrowing costs from increasing interest rates, partially offset by increased
interest income from revenue bond portfolio expansion from 2004 to 2005.
42
FUND MANAGEMENT
The table below shows selected information regarding our Fund Management
activities for the years ended December 31:
% Change % Change
2006 vs. 2005 vs.
(In thousands) 2006 2005 2005 2004 2004
------------------------------------------- ---------- ---------- --------- ---------- ---------
Equity raised by LIHTC funds $1,184,321 $1,131,274 4.7 % $1,143,379 (1.1)%
Equity invested by LIHTC funds (1) $1,113,289 $1,074,457 3.6 % $ 972,477 10.5 %
Fees based on equity raised (2) $ 14,739 $ 16,211 (9.1)% $ 11,003 47.3 %
Fees based on equity invested (2) $ 46,737 $ 45,733 2.2 % $ 41,970 9.0 %
Fees based on management of other entities:
Asset management and partnership fees (2) $ 29,53 $ 28,888 2.2 % $ 18,632 55.0 %
Investment origination fees (2) 377 592 (36.3) 590 0.3
Other (2) 101 60 68.3 1 --
---------- ---------- --------- ---------- ---------
Subtotal 30,011 29,540 1.6 19,223 53.7
---------- ---------- --------- ---------- ---------
Total fund sponsorship fees (2) 91,487 91,484 -- 72,196 26.7
Credit intermediation fees (2) 11,475 9,845 16.6 10,085 (2.4)
Expense reimbursement (2) 12,816 9,409 36.2 7,142 31.7
Construction fees (2) 4,801 4,583 4.8 1,445 217.2
Other interest income (2) 7,013 236 -- 110 114.5
Other revenues (2) 3,773 2,195 71.9 1,685 30.3
---------- ---------- --------- ---------- ---------
Total $ 131,365 $ 117,752 11.6 % $ 92,663 27.1 %
---------- ---------- --------- ---------- ---------
Equity income from CMBS and Direct
Loan funds (2) $ 15,284 $ -- -- % $ -- -- %
---------- ---------- --------- ---------- ---------
CAD $ 59,550 $ 58,010 2.7 % $ 52,215 11.1 %
---------- ---------- --------- ---------- ---------
(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 and 2005
increases relate to the funds closed in 2004 and 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
service fees are realized immediately while we earn the partnership management
fees over five-year periods.
Fees earned for O&O services decreased approximately 20.2% to $7.8 million
compared to $9.8 million in the 2005 period primarily due a decrease in the fee
rate realized stemming from heightened competition relating to certain types of
funds, offset by an increase in equity raised. These same revenues increased
approximately 3.5% compared to $9.5 million in the 2004 period primarily due to
the increase in the fee rate realized, offset by a marginal decrease in equity
raised.
Partnership management fees revenues increased approximately 30.2% in 2006 to
$6.9 million compared to $5.3 million for the same period in 2005. These same
revenues increased approximately 245.6% in 2005 compared to $1.5 million for the
same period in 2004. This increase is primarily the result of fund sponsorships
completed during the three year period increasing the amount of deferred revenue
being amortized over that period.
43
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 we recognize
in a given period.
These fees increased to approximately $46.7 million in 2006, representing an
approximate 2.2% increase compared to the 2005 results. The increase in fees is
comparable to the increase in funds originated.
These fees increased to approximately $45.7 million in 2005, representing an
approximate 9.0% increase compared to the 2004 results. The increase in fees is
lower than the increase of equity invested because of a decrease in the fee rate
realized, stemming from changes in the mix of funds originated.
FEES BASED ON MANAGEMENT OF OTHER ENTITIES
The increase in asset management and partnership fees is attributable to:
o the higher level of assets under management as we add to the
population of funds sponsored (with 10 added in 2006 and nine added in
2005); and
o the improvement of the cash position of certain investment funds
allowing us to collect management fees in 2005 which we did not
previously recognize until collectability was reasonably assured.
The 2006 increase was partially offset due 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 collectability is
not reasonably assured.
Fees earned from AMAC helped to increase our partnership and asset management
fees in 2005 as we earned $1.9 million in incentive fees. We earned no incentive
management fees in 2006 or 2004.
OTHER INTEREST INCOME
Other interest income in 2006 includes interest on resecuritization certificates
held by ARCap and other temporary investments. The increase in 2006 relates
entirely to the ARCap acquisition.
OTHER REVENUES
Credit intermediation, expense reimbursement, construction fees 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 increased over the three year period due to
additional credit intermediated funds being closed over the same period and the
launch of Centerbrook in 2006.
We anticipate that the market for tax credit equity investing will continue to
be strong in the near term but that heightened competition in the marketplace
will lead to margin compression. We expect, however, that the launching of our
in-house credit intermediation business will offset the impact of that margin
compression from a net income perspective as we are likely to retain amounts
previously paid or shared for credit intermediation and for providing specified
rates of return to fund investors.
EQUITY INCOME
We are general partner of the CMBS and Direct Loan 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.
44
Segment CAD increased over the three year period due predominantly to higher
fund sponsorship activity and the up-front fees received in the transactions.
For 2006, the addition of equity income from the CMBS and Direct Loan funds to
this segment with the acquisition of ARCap also benefited the CAD results as a
portion of the income recognized is cash based. These gains were partially
offset each year by higher infrastructure costs in expanding the business and
for 2006, by initial start-up costs associated with the Centerbrook business.
MORTGAGE BANKING
The table below shows selected information regarding our Mortgage Banking
activities for the years ended December 31:
% Change % Change
2006 vs. 2005 vs.
(In thousands) 2006 2005 2005 2004 2004
------------------------------------ ----------- ----------- -------- ----------- --------
Originations $ 1,541,797 $ 1,278,448 20.6 % $ 838,162 52.5 %
Mortgage portfolio at December 31:
Primary servicing $ 9,624,571 $ 9,050,576 6.3 % $ 3,852,529 134.9 %
Interim servicing 11,707,108 -- -- -- --
Special servicing 201,207 -- -- -- --
Carrying value of mortgage servicing
rights at December 31 $ 68,875 $ 62,190 10.7 % $ 32,366 92.1 %
----------- ----------- -------- ----------- --------
Mortgage origination fees (1) $ 9,136 $ 7,454 22.6 % $ 5,455 36.6 %
Servicing fees (1) 21,985 18,928 16.2 9,571 97.8
Assumption fees (1) 3,383 887 281.4 220 303.2
----------- ----------- -------- ----------- --------
Total fee income 34,504 27,269 26.5 15,246 78.9
Other interest income (1) 20,893 10,150 105.8 3,217 215.5
Prepayment penalties (1) 5,194 5,150 0.9 1,846 179.0
Other revenues (1) 2,206 1,003 119.9 719 39.5
----------- ----------- -------- ----------- --------
$ 62,797 $ 43,572 44.1 % $ 21,028 107.2 %
=========== =========== ======== =========== ========
Gain on sale of mortgages $ 10,334 $ 6,501 59.0 % $ 7,651 (15.0)%
----------- ----------- -------- ----------- --------
CAD $ 20,199 $ 14,871 35.8 % $ 4,388 238.9 %
----------- ----------- -------- ----------- --------
(1) Prior to intersegment eliminations.
Revenues in 2006 and 2005 increased in this segment largely due to the
acquisitions of ARCap in August 2006 and of CCLP in March 2005. Including all
businesses for all periods, the 2006 increase would have been approximately
12.0% over 2005, and the 2005 increase would have been approximately 12.6% over
2004.
Originations for the three-years ended December 31 are broken down as follows:
% of % of % of
(In thousands) 2006 Total 2005 Total 2004 Total
----------------- ---------- ------- ---------- ------- ---------- -------
Fannie Mae $ 620,583 40.3% $ 705,024 55.1% $ 284,479 33.9%
Freddie Mac 280,093 18.2 160,835 12.6 326,391 38.9
CharterMac Direct 535,554 34.7 -- -- -- --
Conduit and other 105,567 6.8 412,589 32.3 227,292 27.2
---------- ------- ---------- ------- ---------- -------
Total $1,541,797 100.0% $1,278,448 100.0% $ 838,162 100.0%
========== ======= ========== ======= ========== =======
Origination fees increased primarily due to the increase in originations. Fannie
Mae and conduit originations decreased and CharterMac Direct increased from the
2005 period because the loan production staff focused its efforts on originating
loans for CharterMac Direct, which was launched in late 2005 and through which
we originate loans for AMAC and ARESS. Freddie Mac originations increased
sharply due to three large portfolio transactions totaling $123 million in the
2006 period and our participation in the Freddie Mac DUI program.
With the ARCap acquisition, our servicing portfolio has expanded to include both
special servicing and interim servicing, which entails short-term servicing
conduits prior to the issuance of their securitizations.
The activity gains in 2005 stemmed from a significant increase in Fannie Mae
originations, as CCLP had traditionally conducted a large portion of its
business through Fannie Mae, and pricing changes that allowed us to garner
45
greater market share. Conduit originations also increased sharply as we
continued to pursue business not involving agency execution in response to
market demand. These increases were partially offset by a sharp decline in
Freddie Mac business, as the 2004 period reflects a large single-borrower pool
transaction, with no comparable transaction in the 2005 period.
A significantly higher level of assumption fees were earned over the course of
the three year period for when a new borrower assumes the obligation for a loan
in the servicing portfolio. The higher volume of assumptions stemmed from
increasing sales of underlying properties for which the existing borrowers did
not wish to pay prepayment penalties.
Despite the high volume of originations in 2005 and 2006, our primary servicing
portfolio at December 31, 2006 declined from the 2005 level due to a high volume
of loans paid off each year coupled with a high percentage of originations for
loans without associated servicing.
Adjusting for the impact of the CCLP and ARCap acquisitions, servicing fee
income in 2006 declined approximately 14.8% as compared to the same period in
2005, while 2005 servicing fee income increased approximately 20.9% as compared
to the same period in 2004. The 2006 decline is due to the erosion of the
primary servicing rate due to the higher proportion of non-agency loans in the
portfolio. This trend has also affected the level of mortgage service rights, as
write-offs in connection with the prepayment of mortgages at higher servicing
rights are replaced with new assets generating lower fee streams. Generally, as
our prepayments have increased, our mortgage servicing rights have decreased.
This decrease is partially offset by an increase in the average loan balances
serviced by ARCap in 2006 over 2005. The 2005 increase is due to a significant
increase in the average loan balances serviced by ARCap over 2004.
Interest income relates primarily to that earned on escrow balances. The
increases in 2006 and 2005 resulted from higher account balances and increased
market rates earned. Interest income also increased due to the CCLP and ARCap
acquisitions.
Gain on sale of mortgages relates directly to the value of mortgage service
rights recorded when loans are sold. The mortgage service rights, in turn, are
valued based on projected servicing revenues, which, excluding the mortgage
service rights of $15.2 million acquired as part of the ARCap acquisition,
decreased in 2006 as compared to 2005 due to erosion of servicing fee rates for
new originations as discussed above. An increase in 2005 as compared to 2004 due
to the increased origination volume was offset by a higher reserve for loan
losses, due to the increased volume and the underlying debt service statistics
in the portfolio.
Segment CAD increased over the three year 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 in 2006 and CCLP in 2005, and the higher interest income was also due in
part to increasing interest rates in 2005 and 2006. The increases were partially
offset each year by a higher level of ongoing infrastructure costs as we
continue to grow the business and, in 2006, by restructuring costs recorded in
connection with the ARCap acquisition. 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.
We anticipate that the continued growth of the securitized loan market will
result in an increase in the proportion of our conduit executions to the total
in coming years. We expect that our affiliations with pension fund advisors and
AMAC will aid this growth. In addition, the increased customer base that comes
with CharterMac's overall expansion through acquisitions and organic growth
should increase our origination volume as we further develop our integrated
infrastructure. The availability of the significant level of debt capital in the
market and general compression of fees industry-wide, however, are likely to put
pressure on our fee revenue and margins for the foreseeable future and may
offset some of the profits expected from volume gains.
46
CONSOLIDATED PARTNERSHIPS
The results of consolidated partnerships reflected in our consolidated financial
statements are for entities we control according to the definitions of FIN 46(R)
and similar accounting pronouncements. With respect to the more than 130 LIHTC
and Property partnerships, we have no equity interest or, in the case of 38 of
the partnerships, an insignificant equity interest. With respect to CMBS and
Direct Loan partnerships, we have ownership of varying degrees, but all less
than 25%.
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 10 funds in the past year and the
assumption of the general partner interests in 20 property level
partnerships during 2006.
The increased revenue, expense, equity loss and allocation amounts in 2005
are due to the origination of nine funds and the assumption of the general
partner interests in 12 property level partnerships during 2005, all of
which are included in the population.
As third party investors hold virtually all of the equity partnership
interests in these entities, we allocate all results of operations to those
partners except for approximately $10,000, representing our nominal
ownership. As a result, the consolidation of these partnerships has an
insignificant impact on our net income.
CMBS AND DIRECT LOAN PARTNERSHIPS
CMBS and Direct Loan Partnerships were incorporated upon our acquisition of
ARCap in August 2006 and as such, there is no comparable information for
2005 and 2004.
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, repurchase
agreements 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 a $100.0 million warehouse line, used for mortgage banking needs,
which matures in May 2007, and we expect to enter into a new facility
or a further extension of this line upon maturity;
o a $250.0 million revolving credit facility, 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;
47
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.
As of December 31, 2006, we had approximately $145.6 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.
In addition to the credit lines detailed above, we have a $453.0 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 December 31, 2006.
The securitization certificates have a weighted average term of eight years and
the term loan matures in 2012.
We continue to actively manage our balance sheet and our lending relationships
and to continue to diversify our sources of capital. Although the mortgage
banking warehouse line matures in 2007, 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 terms favorable to us. Also, while we intend to optimize our
securitization borrowing, our continued ability to do so is dependent on:
o the availability of bonds to be used in securitizations or as excess
collateral;
o the depth of the market of buyers for tax-exempt floating rate
investments; and
o our ability to maintain and expand our relationships with credit
intermediators and liquidity providers.
Our debt financing facilities are more fully described in Notes 8 and 9 to our
consolidated financial statements.
EQUITY
------
Other than our common shares, we have several classes of equity outstanding,
with varying claims upon our income and cash flows:
o Convertible Community Reinvestment Act Preferred Shares ("Convertible
CRA Shares");
o 4.4% Perpetual Convertible Community Reinvestment Act Preferred Shares
("4.4% Convertible CRA Shares");
o Preferred shares of Equity Issuer (some of which are subject to
mandatory repurchase);
o SCUs of our subsidiary, CharterMac Capital Company LLC ("CCC");
o SMUs of our subsidiary CM Investor, LLC; and
o SCIs of our subsidiary ARCap.
The Convertible CRA Shares are economically equivalent to our common shares,
receiving the same dividend. Unlike the common shares, however, these shares are
not publicly traded and do not have voting rights but entitle the holders to
"credit" under the US government's Community Reinvestment Act. These shares are
convertible into common shares at the holders' option, mostly on a one-for-one
basis. We first issued Convertible CRA Shares during 2000 and the program became
popular with a broad range of banks that invest in our shares to both make an
investment in us and to make qualifying Community Reinvestment Act investments.
The 4.4% Convertible CRA Shares are similar to the Convertible CRA Shares in
that they entitle the holder to CRA "credit" and are convertible into common
shares without having voting rights prior to conversion. Unlike the Convertible
CRA Shares, however, these shares carry a fixed dividend and each will be
convertible into common shares at a rate of approximately 1.81:1 beginning in
July 2008.
The preferred shares of Equity Issuer entitle their holders to a claim on the
income and cash flows of most of our Portfolio Investing business. They have no
voting rights with respect to CharterMac and are not convertible into CharterMac
common shares.
The SCUs entitle their holders to a claim on the income and cash flows of
certain of our subsidiaries through which we operate our LIHTC fund sponsorship
business. The SCUs have no direct voting rights with respect to CharterMac, but
48
all of the holders also have special preferred voting shares of CharterMac,
which have voting rights equivalent to our common shares. The SCUs are
convertible into common shares on a one-for-one basis and are entitled to
tax-adjusted dividends based on the common dividend rate.
SMU holders are entitled to distributions at the same time as, and only if, we
pay distributions on our common shares. SMU distributions are currently $1.73
per year, subject to adjustment in the amount of 95% of the percentage increases
or decreases in the dividends paid by us on the common shares. The SMUs are
convertible into common shares on a one-for-one basis.
SCI holders are entitled to distributions at the same time as, and only if, we
pay distributions on our common shares. SCI distributions are currently $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. The
SCIs are convertible into common shares on a one-for-one basis.
In October 2004, we filed a shelf registration with the SEC providing for the
issuance of up to $400.0 million in common shares, preferred shares and debt
securities. The shelf registration was declared effective on March 1, 2005 and
was available for use beginning April 1, 2006. We have no current plans to draw
upon this shelf registration but may as opportunities present themselves or
business requirements dictate.
Further information about our equity instruments is included in Notes 13 and 14
to our consolidated financial statements.
SUMMARY OF CASH FLOWS
2006 vs. 2005
-------------
For the year ended December 31, 2006, cash and cash equivalents increased by a
smaller amount than in the comparable 2005 period. A sharp increase in 2006
operating cash flows was more than offset by increased investing cash outflows
and less cash provided by financing activities.
Operating cash flows in 2006 were $86.0 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 that 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.
These increases were partially offset by increased collateral deposits in
connection with Centerbrook and higher receivable balances, particularly with
respect to advances to partnerships.
Cash used in investing activities was higher in 2006 as compared to 2005 by a
margin of $150.9 million primarily due to the ARCap acquisition, offset in part
by an investment sold to AMAC in April 2006, a decrease in restricted cash due
to reduced restricted cash requirements when we restructured our securitization
programs and returns of capital from ARCap prior to our acquisition.
Financing inflows in the 2006 period were lower than in 2005 by $7.5 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. Also
contributing to the overall decrease in financing activities were treasury stock
purchases made during the year.
2005 vs. 2004
-------------
The larger increase in cash and cash equivalents in 2005 as compared to 2004
resulted principally from increased financing cash flows that offset a decline
in cash provided by operating activities.
Operating cash flows decreased by $105.7 million in 2005 as compared to the 2004
level, due primarily to the high level of mortgage originations at the end of
2005. While the assets were sold in the first quarter of 2006, the increase in
49
the level of mortgage assets held at the end of the year served to offset the
increase in net income exclusive of non-cash expenses and charges.
Investing outflows in 2005 were approximately the same as in 2004 despite
increased mortgage revenue bond acquisitions (net of repayments) and restricted
cash requirements as we expanded the Mortgage Banking segment. Investing
activities in 2004 included a higher level of investing outside of our normal
business lines, most notably the loan to Capri, while 2005 included a $26.0
million co-investment with AMAC in a first mortgage loan, and other investments
that aggregated less than $10.0 million.
Financing inflows in 2005 were $183.0 million higher than in 2004. This was
primarily a result of optimizing our securitization capabilities and taking
advantage of these facilities to monetize our mortgage revenue bond investment
portfolio, the expansion of our Mortgage Banking borrowing capacity and the
issuance of our 4.4% Convertible CRA Shares. These factors collectively exceeded
the higher level of equity issuances (including subsidiary equity) in 2004.
LIQUIDITY REQUIREMENTS AFTER DECEMBER 31, 2006
----------------------------------------------
During February 2007, equity distributions were paid as follows:
(In thousands)
--------------
Common/CRA shareholders $25,201
SCU/SMU/SCI holders 8,884
4.4% CRA Preferred shareholders 1,188
Equity Issuer Preferred shareholders 6,281
-------
Total $41,554
=======
Subsequent to December 31, 2006, we paid down the CMC warehouse line as the
temporary expansion of the facility expired February 1, 2007 (see Note 9 to the
consolidated financial statements).
Management is not aware of any trends or events, commitments or uncertainties,
which have not otherwise been disclosed that will or are likely to impact
liquidity in a material way (see also CONTINGENT LIABILITIES below).
Contractual Obligations
-----------------------
The following table provides our commitments as of December 31, 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) $ 591,165 $ 166,165 $ 182,500 $ 5,000 $ 237,500
Notes payable of consolidated
partnerships (3) 594,477 66,679 155,250 29,032 343,516
Repurchase agreements of
consolidated partnerships (1) 942,224 255,823 7,135 149,009 530,257
Operating lease obligations 79,205 8,717 17,093 15,445 37,950
Subleases (7,984) (1,174) (2,581) (2,610) (1,619)
Unfunded investment commitments (4) 231,518 144,180 87,338 -- --
Financing arrangements (1)(2) 1,801,780 1,801,780 -- -- --
Preferred shares of subsidiary
(subject to mandatory repurchase) 273,500 -- -- -- 273,500
----------- ----------- ----------- ----------- -----------
Total $ 4,505,885 $ 2,442,170 $ 446,735 $ 195,876 $ 1,421,104
=========== =========== =========== =========== ===========
(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 as described in LIQUIDITY AND CAPITAL RESOURCES.
(2) Recourse debt represents principal amount only and therefore does not
include accrued interest of $5.8 million. The weighted average interest rate at
December 31, 2006, including the impact of our swaps, was 5.32%.
50
(3) Of the notes payable of consolidated partnerships, $444.3 million are
collateralized by equity subscriptions of 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 $150.2 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, $181.8 million represents mortgage loan origination
commitments with corresponding sale commitments.
Off Balance Sheet Arrangements
------------------------------
The following table reflects our maximum exposure and the carrying amounts as of
December 31, 2006:
Maximum Carrying
(In thousands) Exposure Amount
-------------------------------------------- ---------- ----------
Completion guarantees (1) $ 23,902 $ --
Development deficit guarantees (1) 44,198 578
Operating deficit guarantees (1) 7,524 169
ACC transition guarantees (1) 3,245 --
Recapture guarantees (1) 114,703 169
Replacement reserve (1) 3,120 48
Guarantee of payment (1) 14,720 --
LIHTC credit intermediation (2) 1,098,475 30,211
Mortgage banking loss sharing agreements (3) 816,321 13,116
---------- ----------
$2,126,208 $ 44,291
========== ==========
(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.
(3) The loss sharing agreements with Fannie Mae and Freddie Mac are a normal
part of the DUS and DUI lender programs and afford a higher level of fees than
we earn for other comparable funding sources. The carrying value disclosed above
is our estimate of potential exposure under the guarantees, although any funding
requirements for such exposure is based on the contractual requirements of the
underlying loans we sell to Fannie Mae and Freddie Mac, which vary as to amount
and duration, up to a maximum of 30 years. See also RISK RELATED TO OUR MORTGAGE
BANKING BUSINESS in Item 1A, RISK FACTORS.
The maximum exposure amount is not indicative of our expected losses under the
guarantees. For details of these transactions, see Note 21 to the consolidated
financial statements.
Application of Critical Accounting Estimates
--------------------------------------------
Our consolidated financial statements are based on the selection and application
of accounting principles generally accepted in the United States of America
("GAAP"), which require us to make estimates and assumptions that affect the
reported amounts of assets, liabilities, revenues and expenses. These estimates
and assumptions sometimes involve future events that cannot be determined with
absolute certainty. Therefore, our determination of estimates requires that we
exercise our judgment. While we have used our best estimates based on the facts
and circumstances available to us at the time, different results may actually
occur and any such differences could be material to our consolidated financial
statements.
51
We believe the following policies may involve a higher degree of judgment and
complexity and represent the critical accounting policies used in the
preparation of our consolidated financial statements:
o valuation of investments in mortgage revenue bonds;
o valuation of mortgage servicing rights;
o valuation of derivatives;
o impairment of goodwill and intangible assets; and
o accounting for income taxes.
VALUATION OF INVESTMENTS IN MORTGAGE REVENUE BONDS
SFAS No. 115, ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES,
provides guidance on determining the valuation of investments owned. The initial
classification of our investments in the "available for sale" category rather
than as "held to maturity" is due to a provision in most of the mortgage revenue
bonds under which we have a right to require redemption prior to maturity,
although we can and may elect to hold them up to their maturity dates unless
otherwise modified, and the ability of the borrower to prepay the bond after a
lockout period. Because of this classification, we must carry our investments at
fair value. Since there is no ready market for these investments, we must
exercise judgment in determining what constitutes "fair value". We estimate the
fair value by calculating the present value of expected future cash flows under
the bonds. For bonds secured by non-stabilized properties, the discount rate is
based upon the average rate of new originations for the quarter leading up to
the valuation date. For bonds secured by stabilized properties, the discount
rate is reflective of the lower inherent risk. If the property underlying the
bond has substandard performance, a factor is added to the discount rate to
allow for the additional risk. Conversely, if the underlying property is
performing much better than expected, the discount rate may be reduced to allow
for the reduced risk.
In making these determinations, we evaluate, among other factors:
Bonds Secured by Properties in Construction Phase
-------------------------------------------------
o Assets where there are issues outstanding regarding timely completion
of the construction, even if there is no apparent risk of financial
loss.
Bonds Secured by Properties that are in Lease-Up or Stabilized Phases
---------------------------------------------------------------------
o Stabilization requirements (i.e., minimum occupancy level and debt
service coverage for specified periods) not yet met but all completion
requirements (i.e., timely submission of documentation regarding
certificates of occupancy, deal waivers, etc., as well as completing
construction within the budgeted cost) are met;
o Established material variation from anticipated operating performance,
ability to meet stabilization test within the allotted time period is
in question or material deficiencies at the collateral level, or other
weaknesses exist calling into question the viability of the project in
the near to intermediate term; or
o Project viability is in question and defaults exist and notification
of such has been delivered. Enhanced possibility of loss may exist or
has been specified.
We use these criteria to assess all of our mortgage revenue bonds. In our
valuation review, any bonds meeting these criteria are monitored and assessed
for risk of other-than-temporary impairment. If our analysis indicates that no
other-than-temporary impairment has occurred, the fair value of a bond is
considered to be the lower of outstanding face amount or the present value of
expected future cash flows, with the discount rate adjusted to provide for the
applicable risk factors. If however, our analysis indicates that
other-than-temporary impairment has occurred, the bond is considered impaired,
is written down to fair value as determined by the present value of expected
future cash flows, and a corresponding charge to earnings is recorded in the
statement of income.
VALUATION OF MORTGAGE SERVICING RIGHTS
SFAS No. 140, ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND
EXTINGUISHMENTS OF LIABILITIES, requires that servicing rights retained when
mortgage loans are sold be recorded as assets at fair value and amortized in
proportion to, and over the period of, estimated net servicing income.
Significant judgment is required in accounting for these assets, including:
52
o Determining the fair value of the asset retained when the associated
mortgage is sold and in subsequent reporting periods, including such
factors as costs to service the loans, the estimated rate of
prepayments, the estimated rate of default and an appropriate discount
rate to calculate the present value of cash flows; and
o Estimating the appropriate proportion and period for amortizing the
asset.
Changes in these estimates and assumptions could materially affect the
determination of fair value.
We assess our mortgage servicing rights for impairment based on the fair value
of the assets as compared to carrying values. We estimate the fair value by
obtaining market information from one of the primary mortgage servicing rights
brokers. To determine impairment, the mortgage servicing portfolio is stratified
by the risk characteristics of the underlying mortgage loans and we compare the
estimated fair value of each stratum to its carrying value. With respect to our
primary servicing portfolio, we have determined that the predominant risk
characteristic is the absence or presence of loss sharing provisions associated
with the underlying loans. For our other servicing portfolios we have determined
that the predominant risk characteristic is the ability to generate a consistent
income stream per loan due to the short-term nature of the loans being serviced
or due to the fact that certain servicing revenues are not recurring.
When the carrying value of capitalized servicing assets exceeds fair value, we
recognize temporary impairment through a valuation allowance; fair value in
excess of the amount capitalized is not recognized. In addition, we periodically
evaluate our mortgage servicing rights for other-than-temporary impairment to
determine whether the carrying value before the application of the valuation
allowance is recoverable. When we determine that a portion of the balance is not
recoverable, the asset and the valuation allowance are reduced to reflect
permanent impairment.
VALUATION OF DERIVATIVES
We utilize derivative financial instruments as a means to help manage our
interest rate risk exposure on a portion of our variable rate debt obligations,
through the use of cash flow hedges. The instruments utilized are generally
pay-fixed swaps which are widely used in the industry and typically entered into
with major financial institutions. Our accounting policies generally reflect
these instruments at their fair value with unrealized changes in fair value
reflected in "accumulated other comprehensive income" on our consolidated
balance sheets. Realized effects on cash flows as well as amounts considered
ineffective are generally recognized currently in income.
IMPAIRMENT OF GOODWILL AND INTANGIBLE ASSETS
SFAS No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS, requires that goodwill be
tested for impairment at the reporting unit level (operating segment or one
level below an operating segment) on an annual basis and between annual tests if
an event occurs or circumstances change that would more likely than not reduce
the fair value of a reporting unit below its carrying value. These events or
circumstances could include a significant change in the business climate, legal
factors, operating performance indicators, competition, sale or disposition of a
significant portion of a reporting unit. Application of the goodwill impairment
test requires judgment regarding the fair value of each reporting unit which is
estimated using a discounted cash flow methodology. This, in turn, requires
significant judgments including estimation of future cash flows, which is
dependent on internal forecasts, estimation of the long-term rate of growth for
our business and the life over which cash flows will occur. Changes in these
estimates and assumptions could materially affect the determination of fair
value and/or goodwill impairment.
In addition, should we determine that goodwill is impaired, we would also review
intangible assets for the same business to determine if they were impaired also.
As with goodwill, any indicators of impairment of a specific intangible asset
would also lead to a review. As the methods for determining fair values of
intangible assets are similar to those for determining the fair value of
goodwill, the same judgments and uncertainties apply to these determinations as
well.
ACCOUNTING FOR INCOME TAXES
SFAS No. 109 establishes financial accounting and reporting standards for the
effect of income taxes. The objectives of accounting for income taxes are to
recognize the amount of taxes payable or refundable for the current year and
deferred tax liabilities and assets for the future tax consequences of events
that have been recognized in an entity's financial statements or tax returns.
Judgment is required in assessing the future tax consequences of events that
53
have been recognized in our consolidated financial statements or tax returns as
well as the recoverability of amounts we record, including deferred tax assets.
Furthermore, these projected future tax consequences include our assumption as
to the continuing tax-free nature of a significant portion of our earnings.
Variations in the actual outcome of these future tax consequences could
materially impact our financial position or our results of operations.
Recently Issued Accounting Standards
------------------------------------
In 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 15 to the consolidated financial statements.
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 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 consolidated financial statements as we intend to continue
amortization of our MSRs.
In June 2006, the FASB issued Interpretation No. 48 ("FIN 48"), ACCOUNTING FOR
UNCERTAINTY IN INCOME TAXES, an interpretation of SFAS No. 109. FIN 48
prescribes a comprehensive model for how companies should recognize, measure,
present and disclose uncertain tax positions taken or expected to be taken on a
tax return. Under FIN 48, we shall initially recognize tax positions in the
financial statements when it is more likely than not the position will be
sustained upon examination by the tax authorities. We shall initially and
subsequently measure such tax positions as the largest amount of tax benefit
that is greater than 50% likely of being realized upon ultimate settlement with
the tax authority assuming full knowledge of the position and all relevant
facts. FIN 48 also revises disclosure requirements to include an annual tabular
rollforward of unrecognized tax benefits. We will adopt this interpretation as
required in 2007 and will apply its provisions to all tax positions upon initial
adoption with any cumulative effect adjustment recognized as an adjustment to
retained earnings. We are still evaluating the impact of adoption on our
consolidated 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 consolidated financial statements.
In September 2006, the SEC issued Staff Accounting Bulletin No. 108, CONSIDERING
THE EFFECTS OF PRIOR YEAR MISSTATEMENTS WHEN QUANTIFYING MISSTATEMENTS IN
CURRENT YEAR FINANCIAL STATEMENTS ("SAB 108"). SAB 108 provides interpretive
guidance on how the effects of the carryover or reversal of prior year
misstatements should be considered in quantifying a current year misstatement.
The SEC staff believes that registrant should quantify errors using both a
balance sheet and an income statement approach and evaluate whether either
approach results in quantifying a misstatement that, when all relevant
quantitative and qualitative factors are considered, is material. SAB 108 was
effective for 2006 and adoption of the SAB did not have a material effect on the
consolidated financial statements.
54
In February 2007, the FASB issued Statement of Financial Accounting Standards
No. 159, THE FAIR VALUE OPTION FOR FINANCIAL ASSETS AND FINANCIAL LIABILITIES.
This Statement permits entities to choose to measure many financial instruments
and certain other items at fair value that are not currently required to be
measured at fair value under existing GAAP. This Statement also establishes
presentation and disclosure requirements designed to facilitate comparisons
between entities that choose different measurement attributes for similar types
of assets and liabilities. This Statement does not affect any existing
accounting literature that requires certain assets and liabilities to be carried
at fair value. We will adopt the provision of this Statement, as required, in
the first quarter of 2008. We are currently evaluating the impact of adoption,
if any, on our consolidated financial statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS.
We invest in certain financial instruments, primarily mortgage revenue bonds and
other investments that are subject to various forms of market risk, including
interest rate risk. We seek to prudently and actively manage such risks to earn
sufficient compensation to justify the undertaking of such risks and to maintain
capital levels which are commensurate with the risks we undertake.
The assumptions related to the following discussion of market risk involve
judgments involving future economic market conditions, future corporate
decisions and other interrelating factors, many of which are beyond our control
and all of which are difficult or impossible to predict with precise accuracy.
Although we believe that the assumptions underlying the forward-looking
information are reasonable, any of the assumptions could be inaccurate and,
therefore, there can be no assurance that the forward-looking information
included herein will prove to be accurate. Due to the significant uncertainties
inherent in forward-looking information, the inclusion of such information
should not be regarded as our representation that our objectives and plans would
be achieved.
INTEREST RATE RISK
------------------
The nature of our investments and the instruments used to raise capital for
their acquisition expose us to income and expense volatility due to fluctuations
in market interest rates. Market interest rates are highly sensitive to many
factors, including governmental policies, domestic and international economic
and political considerations and other factors beyond our control. A rising
interest rate environment could reduce the demand for multifamily tax-exempt and
taxable financing, which could limit our ability to invest in mortgage revenue
bonds or to structure transactions. Conversely, falling interest rates may
prompt historical renters to become homebuyers, in turn potentially reducing the
demand for multifamily housing.
Our exposure to interest rate is twofold:
o the potential increase in interest expense on our variable rate debt;
and
o the impact of interest rates on the fair value of our assets.
IMPACT ON EARNINGS
Our investments in mortgage revenue bonds generally bear interest at fixed
rates, or pay interest according to the cash flows of the underlying properties,
which do not fluctuate with changes in market interest rates.
In contrast, payments required under our variable rate securitization programs
fluctuate with market interest rates based on the BMA index and are re-set
weekly or every 35 days. In addition, we have variable rate debt related to our
corporate term loan, and revolving credit and 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, and a $453.0 fixed rate securitization facility, the full amount of
our liabilities labeled on our consolidated balance sheet as Financing
Arrangements and Notes Payable are variable rate debts. We estimate that an
increase of 1.0% in interest rates would decrease our annual net income by
approximately $12.1 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 net income by
approximately $1.8 million.
55
We manage this risk through the use of interest rate swaps, interest rate caps
and forward bond origination commitments, as described in Notes 11 and 21 to our
consolidated financial statements. In addition, we manage our exposure by
striving for diversification in our businesses to include those less susceptible
to interest rate changes and by managing our leverage.
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
mortgage revenue bond as the present value of its expected future 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 $162.3 million and a 1%
decrease would result in an increase of approximately $182.1 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.
56
MANAGEMENT'S REPORT ON THE EFFECTIVENESS OF
INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of CharterMac and subsidiaries (the "Company") is responsible for
establishing and maintaining adequate internal control over financial reporting.
Our internal control system was designed to provide reasonable assurance to our
management and Board of Trustees regarding the preparation and fair presentation
of published financial statements.
All internal control systems, no matter how well designed, have inherent
limitations. Therefore, even those systems determined to be effective can
provide only reasonable assurance with respect to financial statement
preparation and presentation.
CharterMac management assessed the effectiveness of the Company's internal
control over financial reporting as of December 31, 2006. In making this
assessment, management used the criteria set forth by the Committee of
Sponsoring Organizations of the Treadway Commission ("COSO") in Internal Control
- Integrated Framework. Based upon our assessment we believe that, as of
December 31, 2006, our internal control over financial reporting is effective in
accordance with those criteria. Management excluded from its assessment the
internal controls over financial reporting at ARCap Investors, LLC, which was
acquired on August 15, 2006, and whose financial statements constitute 19
percent and 18 percent of net and total assets, respectively, 14 percent of
revenues and 10 percent of net income of the consolidated financial statement
amounts as of and for the year ended December 31, 2006.
Deloitte & Touche LLP, our independent auditors, have issued an audit report on
our assessment of the Company's internal control over financial reporting, which
appears on page 58.
/s/ Marc D. Schnitzer /s/ Robert L. Levy
--------------------- ------------------
Marc D. Schnitzer Robert L. Levy
Chief Executive Officer Chief Financial Officer
March 9, 2007 March 9, 2007
57
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Trustees
and Shareholders of
CharterMac
New York, New York
We have audited management's assessment, included in the accompanying
"Management's Report on the Effectiveness of Internal Controls over Financial
Reporting", that CharterMac and subsidiaries (the "Company") maintained
effective internal control over financial reporting as of December 31, 2006,
based on the criteria established in INTERNAL CONTROL--INTEGRATED FRAMEWORK
issued by the Committee of Sponsoring Organizations of the Treadway Commission.
As described in "Management's Report on the Effectiveness of Internal Control
Over Financial Reporting", management excluded from its assessment the internal
control over financial reporting at ARCap Investors, LLC and subsidiaries, which
was acquired on August 15, 2006 and whose financial statements constitute 19
percent and 18 percent of net and total assets, respectively, 14 percent of
revenues, and 10 percent of net income of the consolidated financial statement
amounts as of and for the year ended December 31, 2006. Accordingly, our audit
did not include the internal control over financial reporting at ARCap
Investors, LLC and subsidiaries. The Company's management is responsible for
maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial reporting.
Our responsibility is to express an opinion on management's assessment and an
opinion on the effectiveness of the Company's internal control over financial
reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed by,
or under the supervision of, the company's principal executive and principal
financial officers, or persons performing similar functions, and effected by the
company's board of directors, management, and other personnel to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial
reporting, including the possibility of collusion or improper management
override of controls, material misstatements due to error or fraud may not be
prevented or detected on a timely basis. Also, projections of any evaluation of
the effectiveness of the internal control over financial reporting to future
periods are subject to the risk that the controls may become inadequate because
of changes in conditions, or that the degree of compliance with the policies or
procedures may deteriorate.
In our opinion, management's assessment that the Company maintained effective
internal control over financial reporting as of December 31, 2006, is fairly
stated, in all material respects, based on the criteria established in INTERNAL
CONTROL--INTEGRATED FRAMEWORK issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Also in our opinion, the Company
maintained, in all material respects, effective internal control over financial
reporting as of December 31, 2006, based on the criteria established in INTERNAL
CONTROL--INTEGRATED FRAMEWORK issued by the Committee of Sponsoring
Organizations of the Treadway Commission.
58
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated financial
statements and financial statement schedules as of and for the year ended
December 31, 2006 of the Company and our report dated March 9, 2007 expressed an
unqualified opinion on those consolidated financial statements and financial
statement schedules.
/s/ DELOITTE & TOUCHE LLP
New York, New York
March 9, 2007
59
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Page
----
(a) 1. Financial Statements
--------------------
Report of Independent Registered Public Accounting Firm 61
Consolidated Balance Sheets as of December 31, 2006 and 2005 62
Consolidated Statements of Income for the years ended December 31,
2006, 2005 and 2004 63
Consolidated Statements of Shareholders' Equity for the
years ended December 31, 2006, 2005 and 2004 64
Consolidated Statements of Cash Flows for the years ended December 31,
2006, 2005 and 2004 67
Notes to Consolidated Financial Statements 69
60
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Trustees
and Shareholders of
CharterMac
New York, New York
We have audited the accompanying consolidated balance sheets of CharterMac and
subsidiaries (the "Company") as of December 31, 2006 and 2005, and the related
consolidated statements of income, shareholders' equity, and cash flows for each
of the three years in the period ended December 31, 2006. Our audits also
included the financial statement schedules listed in the Index at Item 15(a)2.
These financial statements and financial statement schedules are the
responsibility of the Company's management. Our responsibility is to express an
opinion on the financial statements and financial statement schedules based on
our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of CharterMac and subsidiaries as of
December 31, 2006 and 2005, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 2006, in
conformity with accounting principles generally accepted in the United States of
America. Also, in our opinion, such financial statement schedules, when
considered in relation to the basic consolidated financial statements taken as a
whole, present fairly, in all material respects, the information set forth
therein.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of the Company's
internal control over financial reporting as of December 31, 2006, based on the
criteria established in INTERNAL CONTROL--INTEGRATED FRAMEWORK issued by the
Committee of Sponsoring Organizations of the Treadway Commission and our report
dated March 9, 2007 expressed an unqualified opinion on management's assessment
of the effectiveness of the Company's internal control over financial reporting
and an unqualified opinion on the effectiveness of the Company's internal
control over financial reporting.
/s/DELOITTE & TOUCHE LLP
New York, New York
March 9, 2007
61
CHARTERMAC AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands)
December 31,
--------------------------
2006 2005
----------- -----------
ASSETS
Cash and cash equivalents $ 178,907 $ 161,295
Restricted cash 14,843 34,025
Mortgage revenue bonds-at fair value (Note 3) 2,397,738 2,294,787
Other investments (Note 4) 338,920 298,590
Goodwill and intangible assets, net (Note 5) 542,277 439,175
Deferred costs and other assets, net (Note 6) 196,145 135,509
Loan to affiliate (Note 18) 15,000 --
Investments held by consolidated partnerships (Note 7) 4,965,907 3,025,762
Other assets of consolidated partnerships (Note 7) 1,038,779 579,614
----------- -----------
Total assets $ 9,688,516 $ 6,968,757
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Financing arrangements (Note 8) $ 1,801,170 $ 1,429,692
Notes payable (Note 9) 591,165 304,888
Preferred shares of subsidiary (subject to mandatory repurchase)
(Note 13) 273,500 273,500
Accounts payable, accrued expenses and other liabilities (Note 10) 214,344 178,365
Notes payable and other liabilities of consolidated partnerships
(Note 7) 2,700,154 1,618,395
----------- -----------
Total liabilities 5,580,333 3,804,840
----------- -----------
Minority interests in consolidated subsidiaries (Note 13) 247,390 262,274
----------- -----------
Preferred shares of subsidiary (not subject to mandatory repurchase)
(Note 13) 104,000 104,000
----------- -----------
Limited partners' interests in consolidated partnerships 2,806,661 1,747,808
----------- -----------
Commitments and contingencies (Note 21)
Shareholders' equity (Note 14):
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 97,499 104,369
Special preferred voting shares; no par value (14,825 shares issued
and outstanding in 2006 and 14,885 shares issued and outstanding
in 2005) 148 150
Common shares; no par value (160,000 shares authorized; 52,746 issued
and 51,343 outstanding in 2006 and 52,309 issued and 51,988
outstanding in 2005) 709,142 752,042
Restricted shares granted -- (4,193)
Treasury shares of beneficial interest - common, at cost (1,403
shares in 2006 and 321 shares in 2005) (28,018) (7,135)
Accumulated other comprehensive income 66,863 100,104
----------- -----------
Total shareholders' equity 950,132 1,049,835
----------- -----------
Total liabilities and shareholders' equity $ 9,688,516 $ 6,968,757
=========== ===========
See accompanying notes to consolidated financial statements
62
CHARTERMAC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands except per share amounts)
Year Ended December 31,
-----------------------------------
2006 2005 2004
--------- --------- ---------
Revenues:
Mortgage revenue bond interest income $ 156,500 $ 146,024 $ 132,075
Other interest income 34,159 16,162 9,346
Fee income 84,201 84,780 69,066
Other revenues 28,661 24,035 9,732
Revenues of consolidated partnerships (Note 7) 83,738 24,096 12,213
--------- --------- ---------
Total revenues 387,259 295,097 232,432
--------- --------- ---------
Expenses:
Interest expense 97,055 56,698 30,932
Interest expense of consolidated partnerships 47,926 26,322 21,395
Interest expense - distributions to preferred shareholders
of subsidiary 18,898 18,898 18,898
General and administrative (Note 16) 165,648 128,613 101,306
Depreciation and amortization 47,527 44,195 30,407
Write-off of goodwill and intangible assets 2,644 22,567 --
Loss on impairment of mortgage revenue bonds and other assets 5,003 4,555 757
Expenses of consolidated partnerships (Note 7) 75,946 49,810 30,519
--------- --------- ---------
Total expenses 460,647 351,658 234,214
--------- --------- ---------
Loss before other income (73,388) (56,561) (1,782)
Equity and other income 1,978 7,037 3,442
Gain on sale or repayment of mortgage revenue bonds and
other assets 18,370 8,062 7,868
Loss on investments held by consolidated partnerships (278,232) (247,986) (149,048)
--------- --------- ---------
Loss before allocations and income taxes (331,272) (289,448) (139,520)
Income allocated to preferred shareholders of subsidiary (6,225) (6,225) (3,942)
Minority interests in consolidated subsidiaries, net of tax
(Note 13) (16,094) (23,421) (28,368)
Loss allocated to partners of consolidated partnerships 401,377 349,531 219,950
--------- --------- ---------
Income before income taxes 47,786 30,437 48,120
Income tax (provision) benefit (Note 12) (6,492) 28,577 17,243
--------- --------- ---------
Net income $ 41,294 $ 59,014 $ 65,363
========= ========= =========
Allocation of net income to:
4.4% Convertible CRA preferred shareholders $ 4,752 $ 2,020 $ --
Common shareholders 32,405 50,558 56,786
Convertible CRA shareholders 4,137 6,436 8,577
--------- --------- ---------
Total $ 41,294 $ 59,014 $ 65,363
========= ========= =========
Net income per share (Note 17):
Basic $ 0.63 $ 0.98 $ 1.19
========= ========= =========
Diluted $ 0.62 $ 0.98 $ 1.19
========= ========= =========
Weighted average shares outstanding (Note 17):
Basic 58,154 58,018 54,786
========= ========= =========
Diluted 58,711 58,291 55,147
========= ========= =========
Dividends declared per share $ 1.68 $ 1.65 $ 1.57
========= ========= =========
See accompanying notes to consolidated financial statements
63
CHARTERMAC AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(In thousands)
Beneficial Owners Equity
---------------------------------------------------------
4.4%
Convertible Special Treasury
CRA Preferred Convertible Preferred Common Shares -
Shares CRA Shares Voting Shares Shares Common
------------- ------------ ------------- -------- ---------
Balance at January 1, 2004 $ -- $138,748 $ 161 $644,641 $ (378)
Comprehensive income:
Net income 8,577 56,786
Other comprehensive loss:
Net unrealized loss on derivatives
Unrealized holding loss on mortgage revenue bonds
Less: reclassification to net income
Other comprehensive loss
Comprehensive income
Options exercised and other share based compensation,
net of forfeitures (564)
Amortization of share awards
Conversion of Special Common Units and redemption of
Special Preferred Voting Shares (9) 17,789
Conversion of Convertible CRA shares (27,585) 27,585
Issuance costs of Convertible CRA shares (148)
Issuance of common shares 105,541
Repurchase of treasury shares (2,592)
Distributions (10,847) (78,613)
------------- ------------ ------------- -------- ---------
Balance at December 31, 2004 $ -- $108,745 $ 152 $773,165 $ (2,970)
------------- ------------ ------------- -------- ---------
Accumulated
Restricted Other
Shares Comprehensive Comprehensive
Granted Income Income Total
---------- ------------- ------------- ---------
Balance at January 1, 2004 $(19,385) $ 28,436 $792,223
Comprehensive income:
Net income $ 65,363 65,363
-------------
Other comprehensive loss:
Net unrealized loss on derivatives (1,078)
Unrealized holding loss on mortgage revenue bonds (16,023)
Less: reclassification to net income 217
-------------
Other comprehensive loss (16,884) (16,884) (16,884)
-------------
Comprehensive income $ 48,479
-------------
Options exercised and other share based compensation,
net of forfeitures (169) (733)
Amortization of share awards 11,632 11,632
Conversion of Special Common Units and redemption of
Special Preferred Voting Shares 17,780
Conversion of Convertible CRA shares --
Issuance costs of Convertible CRA shares (148)
Issuance of common shares 105,541
Repurchase of treasury shares (2,592)
Distributions (89,460)
---------- ------------- ---------
Balance at December 31, 2004 $ (7,922) $ 11,552 $882,722
---------- ------------- ---------
(continued)
See accompanying notes to consolidated financial statements
64
CHARTERMAC AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(In thousands)
(continued)
Beneficial Owners Equity
---------------------------------------------------------
4.4%
Convertible Special Treasury
CRA Preferred Convertible Preferred Common Shares -
Shares CRA Shares Voting Shares Shares Common
------------- ------------ ------------- -------- ---------
Balance at December 31, 2004 $ -- $108,745 $ 152 $773,165 $ (2,970)
Comprehensive income:
Net income 2,020 6,436 50,558
Other comprehensive income:
Net unrealized gain on derivatives
Unrealized gain on marketable securities
Unrealized holding gain on mortgage revenue bonds
Less: reclassification to net income
Other comprehensive income
Comprehensive income
Options exercised and other share based compensation,
net of forfeitures 8,325
Amortization of share awards 895
Conversion of Special Common Units and redemption of
Special Preferred Voting Shares (2) 4,818
Issuance of 4.4% Convertible CRA Preferred shares 104,498
Repurchase of treasury shares (4,165)
Distributions (2,020) (10,812) (85,719)
------------- ------------ ------------- -------- ---------
Balance at December 31, 2005 $104,498 $104,369 $ 150 $752,042 $ (7,135)
------------- ------------ ------------- -------- ---------
Accumulated
Restricted Other
Shares Comprehensive Comprehensive
Granted Income Income Total
---------- ------------- ------------- ----------
Balance at December 31, 2004 $ (7,922) $ 11,552 $ 882,722
Comprehensive income:
Net income $ 59,014 59,014
-------------
Other comprehensive income:
Net unrealized gain on derivatives 5,848
Unrealized gain on marketable securities 35
Unrealized holding gain on mortgage revenue bonds 84,230
Less: reclassification to net income (1,561)
-------------
Other comprehensive income 88,552 88,552 88,552
-------------
Comprehensive income $147,566
-------------
Options exercised and other share based compensation,
net of forfeitures (2,936) 5,389
Amortization of share awards 6,665 7,560
Conversion of Special Common Units and redemption of
Special Preferred Voting Shares 4,816
Issuance of 4.4% Convertible CRA Preferred shares 104,498
Repurchase of treasury shares (4,165)
Distributions (98,551)
---------- ------------- ----------
Balance at December 31, 2005 $ (4,193) $100,104 $1,049,835
---------- ------------- ----------
(continued)
See accompanying notes to consolidated financial statements
65
CHARTERMAC AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(In thousands)
(continued)
Beneficial Owners Equity
---------------------------------------------------------
4.4%
Convertible Special Treasury
CRA Preferred Convertible Preferred Common Shares -
Shares CRA Shares Voting Shares Shares Common
------------- ------------ ------------- -------- ---------
Balance at December 31, 2005 $104,498 $104,369 $ 150 $752,042 $ (7,135)
Comprehensive income:
Net income 4,752 4,137 32,405
Other comprehensive loss:
Net unrealized loss on derivatives
Unrealized gain on marketable securities
Unrealized holding loss on mortgage revenue bonds
and other assets
Less: reclassification to net income
Other comprehensive loss
Comprehensive income
Reclassification of unamortized restricted shares
upon adoption of FAS 123(R) (4,193)
Options exercised and other share based
compensation, net of forfeitures 743
Amortization of share awards 15,105
Conversion of Special Common Units and
redemption of Special Preferred Voting Shares (2) 1,954
Repurchase of treasury shares (20,883)
Distributions (4,752) (11,007) (88,914)
------------- ------------ ------------- -------- ---------
Balance at December 31, 2006 $104,498 $ 97,499 $ 148 $709,142 $(28,018)
============= ============ ============= ======== =========
Accumulated
Restricted Other
Shares Comprehensive Comprehensive
Granted Income Income Total
---------- ------------- ------------- ----------
Balance at December 31, 2005 $ (4,193) $100,104 $1,049,835
Comprehensive income:
Net income $ 41,294 41,294
-------------
Other comprehensive loss:
Net unrealized loss on derivatives (2,267)
Unrealized gain on marketable securities 1,561
Unrealized holding loss on mortgage revenue bonds
and other assets (31,991)
Less: reclassification to net income (544)
-------------
Other comprehensive loss (33,241) (33,241) (33,241)
-------------
Comprehensive income $ 8,053
-------------
Reclassification of unamortized restricted shares upon
adoption of FAS 123(R) 4,193
Options exercised and other share based
compensation, net of forfeitures 743
Amortization of share awards 15,105
Conversion of Special Common Units and
redemption of Special Preferred Voting Shares 1,952
Repurchase of treasury shares (20,883)
Distributions (104,673)
---------- ------------- ----------
Balance at December 31, 2006 $ -- $ 66,863 $ 950,132
========== ============= ==========
See accompanying notes to consolidated financial statements
66
CHARTERMAC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Year Ended December 31,
-----------------------------------
2006 2005 2004
--------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 41,294 $ 59,014 $ 65,363
Adjustments to reconcile net income to net cash provided
by operating activities:
Gain on sale or repayment of mortgage revenue bonds
and other assets (1,055) (1,561) (217)
Loss on impairment of mortgage revenue bonds and other
assets 5,003 4,555 757
Depreciation and amortization 47,527 44,195 30,407
Equity in income of unconsolidated entities (1,979) (7,037) (3,442)
Write-off of goodwill and intangible assets 2,644 22,567 --
Gain on CUC contract (916) -- --
Income allocated to preferred shareholders of subsidiary 6,225 6,225 3,942
Income allocated to minority interests in consolidated
subsidiaries 16,087 23,421 28,368
Non-cash compensation expense 18,467 8,924 11,632
Other non-cash (income) expense (531) 2,737 3,303
Deferred taxes 2,156 (28,178) (20,545)
Distributions received from equity investees 4,469 3,702 2,219
Reserves for bad debt 25,898 24,238 13,631
Changes in operating assets and liabilities:
Mortgage servicing rights (8,648) (7,520) (6,854)
Mortgage loans receivable 31,288 (125,797) (5,610)
Loan to affiliate (15,000) 4,600 (4,600)
Deferred revenues 24,167 10,210 35,122
Restructuring costs payable 1,128 -- --
Receivables (88,742) (65,172) --
Other assets (23,417) (337) (46,259)
Accounts payable, accrued expenses and other liabilities 651 21,899 (812)
--------- --------- ---------
Net cash provided by operating activities 86,716 685 106,405
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Repayments of mortgage revenue bonds 115,600 133,611 39,067
Mortgage revenue bond acquisitions and fundings (419,940) (443,517) (325,037)
Investments in notes receivable (6,594) (34,401) (3,900)
Repayments of notes receivable 48,930 3,039 1,958
Acquisitions, net of cash acquired (262,659) (290) (1,579)
Loans to Capri Capital -- (8,011) (84,000)
Advances to partnerships (195,044) (146,977) (173,526)
Collection of advances to partnerships 188,711 138,981 156,875
Deferred investment acquisition costs (1,478) (2,579) (1,342)
Decrease in cash and cash equivalents - restricted 19,338 317 6,781
Return of capital from equity investees 16,667 -- --
Purchases of marketable securities (109) -- --
Other investing activities (27,318) (13,191) 18,056
--------- --------- ---------
Net cash used in investing activities (523,896) (373,018) (366,647)
--------- --------- ---------
See accompanying notes to consolidated financial statements
continued
67
CHARTERMAC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(continued)
Year Ended December 31,
-----------------------------------------
2006 2005 2004
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Distributions to shareholders (104,168) (96,556) (84,395)
Distributions to preferred shareholders of subsidiary (6,225) (6,225) (2,386)
Distributions to Special Common Unit, Special Membership
Unit and Special Common Interest holders (35,589) (34,677) (28,411)
Proceeds from financing arrangements 1,409,098 546,632 281,060
Repayments of financing arrangements (1,028,533) (185,369) (112,639)
Increase in notes payable 244,679 130,434 21,105
Minority interest contribution 5,250 -- --
Proceeds from stock options exercised 756 3,804 308
Retirement of Special Common Units and special preferred voting shares (724) (2) (10)
Treasury stock purchases (20,447) -- --
Issuance of preferred shares -- 108,000 --
Issuance of common or Convertible CRA shares -- -- 110,803
Issuance of preferred subsidiary shares -- -- 104,000
Deferred financing costs (9,305) (3,700) (10,140)
----------- ----------- -----------
Net cash provided by financing activities 454,792 462,341 279,295
----------- ----------- -----------
Net increase in cash and cash equivalents 17,612 90,008 19,053
Cash and cash equivalents at the beginning of the year 161,295 71,287 52,234
----------- ----------- -----------
Cash and cash equivalents at the end of the year $ 178,907 $ 161,295 $ 71,287
----------- ----------- -----------
SUPPLEMENTAL INFORMATION:
Interest paid $ 94,713 $ 55,771 $ 31,057
Taxes paid $ 1,204 $ 768 $ 8,040
Acquisition activity:
Conversion of existing assets $ 14,221 $ 70,000
Issuance of subsidiary equity 4,859 7,500
Decrease in minority interest -- (4,200) $ (1,579)
Assets acquired (341,248) (90,530)
Liabilities assumed 59,509 16,940
----------- ----------- -----------
Net cash paid for acquisitions $ (262,659) $ (290) $ (1,579)
=========== =========== ===========
Non-cash activities relating to adoption of FIN 46(R):
Decrease in mortgage revenue bonds $ 33,821
Increase in other assets 4,731
Increase in investments held by consolidated partnerships (2,173,621)
Increase in other assets of consolidated partnerships (210,494)
Increase in notes payable and other liabilities of
consolidated partnerships 1,047,976
Increase in partners' interests of consolidated partnerships 1,297,587
-----------
$ --
===========
Non-cash investing and financing activities:
Share grants and SCUs issued $ 41,767 $ 3,706 $ 1,875
Issuance of SMUs in exchange for investment or acquisition $ -- $ 11,576 $ --
Conversion of SCUs to common shares $ 1,954 $ 4,818 $ 17,789
Conversion of CRA shares to common shares $ -- $ -- $ 27,585
Treasury stock purchases via employee withholding $ 436 $ 4,165 $ 2,592
Cancellation of acquisition - related SMUs $ (4,076) $ -- $ --
See accompanying notes to consolidated financial statements
68
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A. CONSOLIDATION AND BASIS OF PRESENTATION
The consolidated financial statements include the accounts of CharterMac, our
wholly owned and majority owned subsidiary statutory trusts, corporations and
limited liability companies which it controls and entities consolidated pursuant
to the adoption of FASB Interpretation No. 46(R) or similar accounting
pronouncements (see 1.O. CONSOLIDATED PARTNERSHIPS below). 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 our consolidated subsidiaries.
Our consolidated financial statements are prepared on the accrual basis of
accounting in accordance with accounting principles generally accepted in the
United States of America ("GAAP"). The preparation of financial statements in
conformity with GAAP requires us to make estimates and assumptions that affect
the reported amounts of assets and liabilities and the disclosure of contingent
assets and liabilities at the date of the financial statements as well as the
reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
B. REVENUE RECOGNITION
We derive our revenues from a variety of investments and services, summarized as
follows:
o MORTGAGE REVENUE BOND INTEREST INCOME
We recognize income as it accrues, provided collectability of future
amounts is reasonably assured. We recognize contingent interest when
received. For bonds with modified terms, or when collectability is
uncertain, we recognize revenue based upon expected cash receipts. For
bonds which carry a different interest rate during the construction
period than during the balance of the term, we calculate the effective
yield on the bond and use that rate to recognize income over the life
of the bond. Acquisition fees received upon acquisition of mortgage
revenue bonds are deferred and amortized through the call dates of the
bonds.
We place loans on a non-accrual status when any portion of the
principal or interest is 90 days past due or earlier when concern
exists as to the ultimate collectability of principal or interest.
Loans return to accrual status when principal and interest become
current. There were seven bonds with a fair value of $35.1 million on
non-accrual status at December 31, 2006 and eight bonds with a fair
value of $49.9 million on non-accrual status at December 31, 2005.
o OTHER INTEREST INCOME
We recognize income on temporary investments (such as cash in banks
and short-term instruments) as well as longer term investments (from
promissory notes, mortgages receivable, etc.) and escrow accounts we
manage, on the accrual basis as earned.
We recognize income on resecuritization certificates as it accrues,
provided collectability of future amounts is reasonably assured. 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.
o FEE INCOME
o FUND SPONSORSHIP FEES
o ORGANIZATION, OFFERING AND ACQUISITION ALLOWANCE FEES are
for reimbursement of costs we incur for organizing
Low-Income Housing Tax Credit ("LIHTC") investment funds and
for providing assistance in acquiring the properties to be
included in the funds. We recognize the organization and
offering allowance fee when the investor equity is raised
and recognize the acquisition allowance fee when the
69
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
investment funds acquire properties. The related expenses
are included in general and administrative expenses.
o PARTNERSHIP MANAGEMENT FEES are for maintaining the books
and records of LIHTC investment funds, including requisite
investor reporting. We recognize these fees over the five
year contractual service period following the initial
closing of the fund.
o PROPERTY ACQUISITION AND ACQUISITION ALLOWANCE FEES are for
services we perform in acquiring interests in
property-owning partnerships which comprise the assets of
LIHTC funds we sponsor. We recognize these fees when the
investor equity is invested and as the properties limited
partnership interest are acquired by the investment fund.
o ASSET MANAGEMENT FEES from:
o LIHTC investment funds, based on a percentage of each
investment fund's invested assets are earned for
monitoring the acquired property interests to ensure
that their development, leasing and operations comply
with LIHTC or other tax credit requirements;
o American Mortgage Acceptance Company ("AMAC"), an
affiliated, publicly traded real estate investment
trust we manage (see Note 18), based upon AMAC's equity
as well as incentive management fees if certain
profitability levels are attained; and
o CharterMac Urban Capital LLC ("CUC"), an investment
fund in which we also have a membership interest (see
Note 4), based on a percentage of the fund's invested
assets.
Asset management fees are recorded monthly as earned,
provided that collection is reasonably assured.
o MORTGAGE BANKING FEES
o MORTGAGE ORIGINATION FEES for originating loans are recorded
upon settlement of sale to the purchaser of the loans.
o MORTGAGE SERVICING FEES are recognized on an accrual basis
as the services are performed over the servicing period.
o CREDIT INTERMEDIATION FEES
o Fees for credit intermediation transactions to provide
specified rates of return for an LIHTC fund, received in
advance, are deferred and amortized over the applicable
risk-weighted periods on a straight-line basis. For those
pertaining to the construction and lease-up phase of a pool
of properties, the periods are generally one to three years.
For those pertaining to the operational phase of a pool of
properties, the period is approximately 20 years.
o Fees for other credit intermediation transactions are
received monthly and recognized as income when earned.
o OTHER REVENUES
o PREPAYMENT PENALTIES from early payments of mortgage revenue
bonds or serviced mortgage loans are recognized at the time
of prepayment.
o CONSTRUCTION SERVICE FEEs from borrowers for servicing
mortgage revenue bonds during the construction period are
deferred and amortized into other income over the estimated
construction period.
70
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
o ADMINISTRATION FEES charged to the property partnerships or
to other entities we manage are recorded as the payments are
received due to the uncertainty of collectability.
o EXPENSE REIMBURSEMENTS include amounts billed to investment
funds and other affiliated entities ("affiliates") for the
reimbursement of salaries and certain other ongoing
operating expenditures incurred by CharterMac Capital on
behalf of these affiliates. We recognize these amounts as
incurred.
o REVENUES OF CONSOLIDATED PARTNERSHIPS
Rental income for property partnerships is accrued as earned
based on underlying lease agreements. Interest income for all
consolidated partnerships is accrued as earned. For our funds
which invest in commercial mortgage-backed securities ("CMBS"),
we recognize interest income as earned. We compute accretion of
purchase discounts 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.
C. INVESTMENT IN MORTGAGE REVENUE BONDS
We account for our investments in mortgage revenue bonds as available-for-sale
debt securities under the provisions of SFAS No. 115, ACCOUNTING FOR CERTAIN
INVESTMENTS IN DEBT AND EQUITY SECURITIES ("SFAS No. 115"). This classification
is due to a provision in most of the bonds whereby we have a right to require
redemption prior to maturity, although we can and may elect to hold them up to
their maturity dates unless otherwise modified, and the ability of the borrower
to prepay the bond after a lockout period. Accordingly, we carry investments in
mortgage revenue bonds at their estimated fair values, and report unrealized
gains and losses in accumulated other comprehensive income.
Because mortgage revenue bonds have a limited market, we estimate fair value for
each bond as the present value of its expected future cash flows using a
discount rate for comparable tax-exempt investments. This process is based upon
projections of future economic events affecting the real estate collateralizing
the bonds, such as property occupancy rates, rental rates, operating cost
inflation, market capitalization rates and an appropriate market rate of
interest.
Direct costs relating to unsuccessful acquisitions and all indirect costs
relating to the mortgage revenue bonds are charged to operations.
We consider a mortgage revenue bond as impaired when we determine it is probable
that not all required contractual payments will be made when due, from property
operations or other sources of collection (such as sale under foreclosure and
syndication of associated tax credits) would not cover any shortfall. If we
determine a bond is impaired, we write it down to its estimated fair value and
record a realized loss in the statement of income. Our primary tool to determine
which loans are likely to incur a loss is to evaluate the debt service coverage
ratio based on our historical experience with similar properties and the
frequency of such losses.
When a mortgage revenue bond is underperforming with respect to certain of our
standards (for example, expectations of timely construction completion, actual
occupancy levels or actual debt service coverage) but we still expect to recover
all contractual payments (either through debt service or collateral), we value
it based on our estimate of the fair value as described above, although such
fair value will not exceed the outstanding face amount.
D. OTHER INVESTMENTS
Equity Method Investments
-------------------------
o We invest in partnership interests related to the real estate equity
investment funds we sponsor. Typically, we hold these investments for
a short period until we establish a new fund.
o We account for investments in entities in which we have significant
influence but do not control (such as CharterMac Urban Capital LLC
("CUC") and our pre-acquisition investment in ARCap Investors, LLC
("ARCap") under the equity method of accounting. We recognize income
71
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
based on our respective ownership percentages. For the preferred
portion of the pre-acquisition ARCap investment, we accrued our equity
earnings at the applicable cumulative dividend rate.
Available-for-Sale
------------------
o We hold investments in resecuritization certificates, and funds that
we consolidate hold 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 accumulated other comprehensive income. We
evaluate any unrealized losses to determine if the declines in fair
value are other-than-temporary; if so, we record the decline in fair
value as an impairment to the security and record a realized loss in
the statement of income. 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 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.
o We value marketable securities based on quoted market prices.
Other
-----
o Mortgage loans held for sale represent amounts we are due for mortgage
loans that were sold under purchase agreements to permanent investors,
but for which we are awaiting settlement of funds, and the balance
includes net origination costs. We do not retain any interest in these
loans except for mortgage servicing rights and certain contingent
liabilities pursuant to loss sharing agreements. We record loan
commitment fees as deferred revenue net of direct costs associated
with closing the related loan and recognize them as income when the
loans are sold in accordance with SFAS No. 91, ACCOUNTING FOR
NONREFUNDABLE FEES AND COSTS ASSOCIATED WITH ORIGINATING OR ACQUIRING
LOAN AND INITIAL DIRECT COSTS OF LEASES.
o Notes receivable are carried at their net realizable value. When we
believe that we will not collect all amounts due under the terms of
the loan, we record a valuation allowance.
o We invest in affiliated entities that co-develop properties.
Development investments include amounts invested to fund
pre-development and development costs. Investment funds we sponsor
acquire the limited partnership interest in these properties. We
expect to recapture these amounts from various sources attributable to
the properties, including capital contributions of investments funds,
cash flow from operations, and/or from co-development partners, who in
turn have cash flow notes from the properties. In connection with our
co-development agreements, affiliates of CharterMac issue construction
completion, development deficit guarantees and operating deficit
guarantees to the lender and investment funds (for the underlying
financing of the properties) on behalf of our subsidiary (see Note
21).
E. CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash in banks and investments in short-term
instruments with an original maturity of three months or less. Restricted cash
includes collateral for borrowings within our securitization programs and in
accordance with Fannie Mae and Freddie Mac requirements.
72
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
F. DEFERRED COSTS
We capitalize costs incurred in connection with our debt and securitization
programs (see Note 8) and amortize them on a straight-line basis over the terms
of the debt facilities, or 10 years, which approximates the average remaining
term to maturity of the mortgage revenue bonds in the securitization programs.
We capitalize costs incurred in connection with the issuance of preferred shares
of our Equity Issuer subsidiary and amortize them on a straight-line basis over
the period to the mandatory repurchase date of the shares. We record costs we
incur in connection with the issuance of equity as a reduction of the applicable
beneficial owners' equity.
G. GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill
--------
We test goodwill for impairment (via third party appraisals) annually or if
circumstances indicate there may be reason to believe impairment has occurred.
Any such impairment would be charged to expense in the period in which it is
determined.
Other Intangible Assets
-----------------------
We amortize other intangible assets on a straight-line basis over their
estimated useful lives. Should goodwill be deemed impaired, the useful lives of
identified intangible assets may need to be reassessed and amortization
accelerated, or such intangible assets could be deemed impaired as well.
Mortgage Servicing Rights ("MSRs")
----------------------------------
In accordance with SFAS No. 140, ACCOUNTING FOR TRANFERS AND SERVICING OF
FINANCIAL ASSETS AND EXTINGUISHMENT OF LIABILITIES, we recognize as assets the
rights to service mortgage loans for others, whether the MSRs are acquired
through a separate purchase or through loans originated and sold. We record
purchased MSRs at cost. For originated loans, we allocate total costs incurred
to the loan originated and the MSR retained based on the relative fair values.
In subsequent periods, we carry the assets at the amortized initial basis. All
MSRs are amortized in proportion to, and over the period of, estimated net
servicing income.
We assess MSRs for impairment based on the fair value of the assets as compared
to carrying values. We estimate the fair value by obtaining market information
from one of the primary mortgage servicing rights brokers. To determine
impairment, the mortgage servicing portfolio is stratified by the risk
characteristics of the underlying mortgage loans and we compare the estimated
fair value of each stratum to its carrying value. When the carrying value of
capitalized servicing assets exceeds fair value, we recognize temporary
impairment through a valuation allowance; fair value in excess of the amount
capitalized is not recognized. In addition, we periodically evaluate our MSRs
for other-than-temporary impairment to determine whether the carrying value
before the application of the valuation allowance is recoverable. When we
determine that a portion of the balance is not recoverable, the asset and the
valuation allowance are reduced to reflect permanent impairment. For the
servicing portfolio associated with our mortgage originating activities, we have
determined that the predominant risk characteristic is the existence or absence
of loss sharing provisions associated with the underlying loans. For our other
servicing portfolios we have determined that the predominant risk characteristic
is the ability to generate a consistent income stream per loan due to the
short-term nature of the loans being serviced or due to the fact that certain
servicing revenues are not recurring.
We account for exposure to loss under our servicing contracts with Fannie Mae
and Freddie Mac through a provision for loan losses and record the reserve as a
contra-asset applied to the MSR balance. The exposure to loss results from
guarantees made to Fannie Mae and Freddie Mac under the "DUS" and "DUI" programs
to share the risk of loan losses (See Note 21 for more details). The provision
recorded is considered the fair value of the guarantees. Our determination of
the adequacy of the reserve for losses on loans serviced is based on an
evaluation of the risk characteristics and exposure to loss associated with
those loans. Our assessment is based on a number of factors, including but not
limited to general economic conditions, inability of the borrower to meet debt
service requirements, or a substantial decline in the value of the collateral.
For performing loans, we maintain a general reserve, which is based on the
73
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
stratification of the loan servicing portfolio by debt service coverage ratio
(DSCR). The probability of default and loss is higher for loans with lower DSCRs
and therefore a higher reserve is maintained for such loans. For defaulted
loans, we maintain a loan specific reserve based on an estimate of our share of
the loss.
H. FINANCIAL RISK MANAGEMENT AND DERIVATIVES
We account for derivative financial instruments pursuant to SFAS No. 133,
ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING Activities ("SFAS No. 133"),
as amended and interpreted. We record derivatives at fair value, with changes in
fair value of those that we classify as cash flow hedges recorded in accumulated
other comprehensive income, to the extent they are effective. If deemed
ineffective, we record the amount considered ineffective in the consolidated
statement of income.
We have determined that we will not apply hedge accounting to fair value hedges.
Any change in the fair value of these hedges is therefore included in current
period net income. As of December 31, 2006, we did not have any fair value
hedges.
I. 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.
J. FAIR VALUE OF FINANCIAL INSTRUMENTS
As described above, our investments in mortgage revenue bonds, our MSRs and our
derivatives are carried at estimated fair values. We have determined that the
fair value of our remaining financial instruments, including temporary
investments, cash and cash equivalents, promissory notes receivable, mortgage
notes receivable and borrowings approximate their carrying values at December
31, 2006 and 2005, due primarily to their short term nature or variable rates of
interest.
K. INCOME TAXES
We provide for income taxes 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 basis
of assets and liabilities. We assess the recoverability of deferred tax assets
through evaluation of carryback availability, projected taxable income and other
factors as applicable. If we determine that deferred tax assets may not be
recoverable, we record a valuation allowance as appropriate.
L. NET INCOME PER SHARE
Basic net income per share represents net income allocated to Common and
Convertible CRA shareholders (see Note 17) by the weighted average number of
Common and Convertible CRA shares outstanding during the period. Diluted net
income per share includes the weighted average number of shares outstanding
during the period and the dilutive effect of common share equivalents,
calculated using the treasury stock method.
The Convertible CRA shareholders are included in the calculation of shares
outstanding as they share the same economic benefits as common shareholders.
SCUs, SMUs, SCIs and 4.4% Convertible CRA preferred shares (see Notes 13 and 14)
are not included in the calculation as they are antidilutive.
74
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
M. CREDIT INTERMEDIATION TRANSACTIONS
For guarantees and other credit intermediation transactions issued since January
1, 2003, we record liabilities (included in deferred revenues) equal to the fair
values of the obligations undertaken. For transactions for which we receive
fees, we consider the fees received to be fair value, in accordance with FASB
Interpretation No. 45, GUARANTOR'S ACCOUNTING AND DISCLOSURE REQUIREMENTS FOR
GUARANTEES, INCLUDING INDIRECT GUARANTEES OF INDEBTEDNESS OF OTHERS ("FIN 45").
For completion and other guarantees issued to lenders for the underlying
financing of properties, as required by an investment fund, we generally
recognize no liability upon inception of the guarantee as the exposure is
considered minimal and no fee is received. We monitor our exposure under these
agreements and, should we determine a loss is probable, accrue a liability in
accordance with SFAS No. 5, ACCOUNTING FOR CONTINGENCIES.
N. SHARE BASED COMPENSATION
We record restricted share grants as a reduction of beneficial owners' equity
within shareholders' equity. The balance recorded equals the number of shares
issued (and that we expect to vest) multiplied by the closing price of our
common shares on the grant date. We recognize the value of the awards as expense
in our consolidated statement of income on a straight-line basis over the
applicable service periods. For each separately vesting portion of an award, we
record the expense as if the award was, in substance, multiple awards. We
expense any shares granted with immediate vesting when granted.
Because share-based compensation is based on awards that we ultimately expect to
vest, share-based compensation expense has been reduced to account for estimated
forfeitures. Statement of Financial Accounting Standards No. 123(R), SHARE-BASED
PAYMENT ("SFAS No. 123(R)") requires forfeitures to be estimated at the time of
grant and revised, if necessary, in subsequent periods if actual forfeitures
differ from those estimates. In periods prior to 2006, we accounted for
forfeitures as they occurred.
Under SFAS No. 123(R), we are required to select a valuation technique or option
pricing model that meets the criteria as stated in the standard. At present, we
use the Black-Scholes model, which requires the input of subjective assumptions.
These assumptions include estimating the length of time employees will retain
their vested stock options before exercising them ("expected term"), the
estimated volatility of the Company's common stock price over the expected term
("volatility"), the risk free interest rate and the dividend yield.
O. CONSOLIDATED PARTNERSHIPS
"Consolidated Partnerships" consist of four groups:
o Certain 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");
o CMBS Partnerships we sponsor, which we initially consolidated upon the
ARCap Investors LLC ("ARCap") acquisition in August 2006 (see Note 2);
and
o a Direct Loan Partnership we manage and consolidate, which we also
consolidated following the ARCap acquisition.
LIHTC Partnerships
------------------
Through our acquisition of CharterMac Capital, and in subsequent fund
originations, we became the general partner or equivalent in more than 130
entities in which we have little or no financial investment. Typically,
outside investors acquire all partnership interest in an upper-tier, or
investment partnership, or 100% of the membership interest if structured as
a limited liability company. The investment partnership, in turn, invests
as a limited partner in one or more lower-tier (operating) partnerships
that own and operate the multifamily housing complexes. Partners in the
investment partnerships are most often corporations who are able to utilize
the tax benefits, which are comprised of operating losses and LIHTCs.
75
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Investment partnerships in which the limited partners or limited members do
not have the right to remove us as the general partner or managing member
are variable interest entities ("VIEs") as defined by FASB Interpretation
No. 46(R), CONSOLIDATION OF VARIABLE INTEREST ENTITIES ("FIN 46(R)"). We
have concluded that, as the general partner or managing member for these
type of investments, we are the primary beneficiary as defined by FIN 46(R)
because we absorb the majority of the expected income and loss variability
(as we are entitled to fees and are the "decision maker" of the funds), and
such variability is disproportionate to our actual ownership interest,
which in most cases is none although some of our executive officers have
nominal, indirect equity interests in many of the funds. We have
consolidated the assets and liabilities of these entities in our balance
sheets and have recorded their results of operations in our statements of
income beginning April 1, 2004.
For the LIHTC Partnerships, the balance sheets and statements of operations
included in our 2006 consolidated financial statements are as of and for
the year ended September 30, 2006, the latest date available. Likewise, the
amounts included in the 2005 consolidated financial statements are as of
and for the year ended September 30, 2005. Upon receipt of full-year
audited results, we include any adjustments to amounts we previously
recorded in the next quarterly reporting period.
Property Partnerships
---------------------
We have the general partner interest in 55 lower-tier property-level
operating partnerships in which we have little or no ownership interest. We
assumed the general partner interest in these partnerships in order to
protect our interests in the underlying properties. As with the investment
funds described above, the limited partners or limited members do not have
the right to remove us as the general partner or managing member. Although
these entities are not VIEs, we are deemed to control them and consolidate
them pursuant to ARB No. 51, CONSOLIDATED FINANCIAL STATEMENTS or SOP 78-9
ACCOUNTING FOR INVESTMENTS IN REAL ESTATE VENTURES ("SOP 78-9).
For the Property Partnerships, the balance sheets and statements of
operations consolidated in our 2006 consolidated financial statements are
as of and for the year ended September 30, 2006, the latest date available.
Likewise, the amounts included in the 2005 consolidated financial
statements are as of and for the year ended September 30, 2005.
CMBS Partnerships
-----------------
CMBS partnerships are funds we sponsor in which we have minority interests
but for which our subsidiaries are general partners. Although these
entities are not VIEs, we control them and consolidate them.
Direct Loan Partnership
-----------------------
ARCap Real Estate Special Situations Mortgage Fund, LLC ("ARESS") is a
direct loan fund we sponsor, in which we have a 5% interest and for which
one of our subsidiaries is the general partner. Although this entity is not
a VIE, we control it and consolidate it pursuant to EITF 04-5, DETERMINING
WHETHER A GENERAL PARTNER, OR THE GENERAL PARTNERS AS A GROUP, CONTROLS A
LIMITED PARTNERSHIP OR SIMILAR ENTITY WHEN THE LIMITED PARTNERS HAVE
CERTAIN RIGHTS ("EITF 04-5"). ARESS invests in bridge loans, subordinate
interests in first mortgages ("B-notes") and subordinate loans secured by
interests in the borrowing entity ("mezzanine loans").
For the CMBS and Direct Loan Partnerships, the balance sheets and
statements of operations consolidated in our 2006 consolidated financial
statements are as of and for the period ended December 31, 2006.
P. NEW ACCOUNTING PRONOUNCEMENTS
Effective March 31, 2004, we adopted FIN 46(R) which clarified the application
of existing accounting pronouncements to certain entities in which equity
investors do not have the characteristics of a controlling financial interest or
do not have sufficient equity at risk for the entity to finance its activities
without additional subordinated financial support from other parties. See
CONSOLIDATED PARTNERSHIPS, above, regarding the impact of our adopting this
standard.
76
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
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 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.
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 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 consolidated financial statements as we intend to continue
amortization of our MSRs.
In June 2006, the FASB issued Interpretation No. 48 ("FIN 48"), ACCOUNTING FOR
UNCERTAINTY IN INCOME TAXES, an interpretation of SFAS No. 109. FIN 48
prescribes a comprehensive model for how companies should recognize, measure,
present and disclose uncertain tax positions taken or expected to be taken on a
tax return. Under FIN 48, we shall initially recognize tax positions in the
consolidated financial statements when it is more likely than not the position
will be sustained upon examination by the tax authorities. We shall initially
and subsequently measure such tax positions as the largest amount of tax benefit
that is greater than 50% likely of being realized upon ultimate settlement with
the tax authority assuming full knowledge of the position and all relevant
facts. FIN 48 also revises disclosure requirements to include an annual tabular
rollforward of unrecognized tax benefits. We will adopt this interpretation as
required in 2007 and will apply its provisions to all tax positions upon initial
adoption with any cumulative effect adjustment recognized as an adjustment to
retained earnings. We are still evaluating the impact of adoption on our
consolidated 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 consolidated financial statements.
In September 2006, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin No. 108, CONSIDERING THE EFFECTS OF PRIOR YEAR MISSTATEMENTS
WHEN QUANTIFYING MISSTATEMENTS IN CURRENT YEAR FINANCIAL STATEMENTS ("SAB 108").
SAB 108 provides interpretive guidance on how the effects of the carryover or
reversal of prior year misstatements should be considered in quantifying a
current year misstatement. The SEC staff believes that registrant should
quantify errors using both a balance sheet and an income statement approach and
evaluate whether either approach results in quantifying a misstatement that,
when all relevant quantitative and qualitative factors are considered, is
material. SAB 108 was effective for 2006 and adoption of the SAB did not have a
material effect on the consolidated financial statements.
In February 2007, the FASB issued Statement of Financial Accounting Standards
No. 159, THE FAIR VALUE OPTION FOR FINANCIAL ASSETS AND FINANCIAL LIABILITIES.
This Statement permits entities to choose to measure many financial instruments
and certain other items at fair value that are not currently required to be
measured at fair value under existing GAAP. This Statement also establishes
presentation and disclosure requirements designed to facilitate comparisons
between entities that choose different measurement attributes for similar types
of assets and liabilities. This Statement does not affect any existing
accounting literature that requires certain assets and liabilities to be carried
77
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
at fair value. We will adopt the provision of this Statement, as required, in
the first quarter of 2008. We are currently evaluating the impact of adoption,
if any, on our consolidated financial statements.
Q. RECLASSIFICATIONS
Certain amounts from prior years have been reclassified to conform to the 2006
presentation, including the reclassification of real estate owned from a "Held
for Sale" classification to "Held and Used", and associated reclassifications in
the income statement pertaining to operations of these properties.
NOTE 2 - ACQUISITIONS
A. ARCAP
In August 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 $275.3 million included:
o cash of approximately $263.3 million, including transaction costs;
o approximately 268,000 Special Common Interests ("SCIs") of a
subsidiary (see Note 13) with a value of approximately $4.9 million;
and
o the remaining basis of our prior investment in ARCap (approximately
$7.1 million) which had been reduced by distributions accounted for as
returns of capital (see Note 4).
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 in 2007 and 2008.
The cash portion of the acquisition and associated acquisition costs were funded
by a new credit facility (see Note 9). In connection with the acquisition, we
also issued approximately 1.7 million restricted common shares to ARCap
employees (see Note 15).
We accounted for the acquisition as a purchase, and accordingly, we included the
results of operations in the consolidated financial statements from the
acquisition date. We allocated our cost of the acquisition on the basis of the
estimated fair values of the assets acquired and liabilities assumed. 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.
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
Goodwill 110,504
Other intangible assets 18,998
Deferred costs and other assets 13,283
Investments in consolidated partnerships 45,504
Financing arrangements (32,513)
Accounts payable, accrued expenses and other liabilities (14,141)
---------
Total purchase price $ 275,257
=========
78
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Pro Forma results of operations assuming we had consummated the acquisition on
January 1, 2005, are as follows:
Year Ended December 31,
-----------------------
(Unaudited)
-----------------------
(In thousands, except per share amounts) 2006 2005
---------------------------------------- ---------- ----------
Total revenues $474,543 $420,836
Net income $ 56,927 $ 78,565
Net income per share:
Basic $ 0.90 $ 1.32
Diluted $ 0.87 $ 1.30
B. CHARTERMAC REAL ESTATE SECURITIES
In March 2006, we acquired Capri Real Estate Services from Capri Capital
Advisors LLC ("CCA"), and renamed it CharterMac Real Estate Securities ("CRES").
CRES was a manager of hedge funds and other funds concentrating on investing in
securities of publicly traded real estate 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 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 subsidiary equity units that we had issued (see Note
13) were returned and others held in escrow were cancelled. In addition, the
founder assumed CRES' line of credit. In connection with this agreement, we
reduced goodwill by $5.1 million for the cancellation of the subsidiary equity
units held in escrow as well as the subsidiary equity units returned to us and
the assumption of the line of credit. We also recognized a goodwill impairment
charge of approximately $1.0 million to account for the portion of our total
investment in, and advances to, CRES that we did not recover and wrote-off the
$1.6 million unamortized balance of other intangible assets recognized at the
time of the acquisition.
Pro forma information is not presented for the acquisition or discontinuance as
this business is not material to our revenues, net income or assets.
C. CAPRI CAPITAL LIMITED PARTNERSHIP
Effective March 1, 2005, we purchased 100% of the ownership interests of Capri
Capital Limited Partnership ("CCLP"). The initial purchase price was $70.0
million plus $1.8 million of acquisition costs. Subsequently, the sellers earned
$15.0 million of additional consideration based on the 2004 financial results of
CCLP's mortgage banking business. The initial purchase price of $70.0 million
was paid via conversion into equity of our existing loan to CCLP and its
affiliates (collectively "Capri") (see Note 4). Of the additional $15.0 million
contingent consideration, we issued subsidiary equity units for half of the
amount (see Note 13), and paid the balance in cash. Pro forma financial results
for CCLP are not presented as the acquisition was not material to our assets,
revenues or net income.
79
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
D. CHARTERMAC MORTGAGE CAPITAL CORP.
Prior to 2005, we acquired 87% of the common shares of CharterMac Mortgage
Capital Corp. ("CMC"). In 2005, we purchased the remaining shares and made the
final payments under the terms of the original purchase agreement. The total
purchase price of the 2005 transactions was $7.9 million, $7.5 million of which
we paid in cash and the balance was paid in stock. The 2005 transaction resulted
in $3.6 million of additional goodwill.
NOTE 3 - MORTGAGE REVENUE BONDS
A. GENERAL
All of our mortgage revenue bonds bear fixed base interest rates and, to the
extent permitted by existing regulations, may also provide for contingent
interest and other features. Terms generally are five to 35 years, although we
may have the right to cause repayment prior to maturity through a mandatory
redemption feature (five to seven years with up to six month's notice). In some
cases, the bonds call for amortization or "sinking fund" payments, generally at
the completion of rehabilitation or construction, of principal based on 30 to 40
year level debt service amortization schedules.
The principal and interest payments on each mortgage revenue bond are payable
primarily from the cash flows of the underlying properties, including proceeds
from a sale of a property or the refinancing of the mortgage loan securing a
bond. None of the mortgage revenue bonds constitute a general obligation of any
state or local government, agency or authority. The structure of each mortgage
loan mirrors the structure of the corresponding revenue bond that it secures. In
order to protect the tax-exempt status of the mortgage revenue bonds, the owners
of the underlying properties are required to enter into agreements to own,
manage and operate the properties in accordance with requirements of the
Internal Revenue Code of 1986, as amended. If they do not comply, the interest
income we receive could be subject to taxes.
Certain mortgage revenue bonds provide for "participating interest" which is
equal to a percentage of net property cash flow of the net sale or refinancing
proceeds. Bonds that contain these provisions are referred to as "participating"
while the rest are "non-participating". Both the stated and participating
interest on the mortgage revenue bonds are exempt from federal income tax. As of
December 31, 2006, we had two participating bonds with a fair value of $20.2
million. Participating interest included in mortgage revenue bond interest
income was approximately $5.2 million in 2006, $2.6 million in 2005 and $230,000
in 2004.
No single mortgage revenue bond provided interest income that exceeded 10% of
our total revenue for the years ended December 31, 2006, 2005, or 2004.
Mortgage revenue bonds are generally not subject to optional prepayment during
the first five to ten years of our ownership and may carry various prepayment
penalty structures. Certain mortgage revenue bonds may be purchased at a
discount from their face value.
In selected circumstances, and generally only in connection with the acquisition
of tax-exempt mortgage revenue bonds, we may acquire a small amount of taxable
bonds:
o which we may be required to acquire in order to satisfy state
regulations with respect to the issuance of tax-exempt bonds; and
o to fund certain costs associated with the issuance of the tax-exempt
bonds, that under current law cannot be funded by the proceeds of the
tax-exempt bond itself.
80
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
B. SUMMARY
The following tables summarize our mortgage revenue bond portfolio at December
31, 2006:
(Dollars in Thousands)
Units Face Amount of Bond (1) Fair Value at 12/31/06
--------------------- ----------------------- -----------------------
Current
Stated
Number % of % of % of Interest
of Bonds Number Total $ Amount Total $ Amount Total Rate
-------- -------- --------- ---------- --------- ---------- --------- --------
BY STATE: (2)
----------------
Texas 81 14,675 26.20% $ 781,803 27.70% $ 784,940 28.08% 6.83%
Georgia 34 7,600 13.60% 406,336 14.40% 395,120 14.14% 6.50%
California 62 6,135 10.90% 356,717 12.70% 354,482 12.68% 6.53%
Missouri 35 3,026 5.40% 166,543 5.90% 163,887 5.86% 6.27%
Florida 23 3,768 6.70% 154,800 5.50% 147,559 5.28% 7.01%
All others 142 20,844 37.20% 952,248 33.80% 949,078 33.96% 6.60%
----------------------------------------------------------------------------------------------------------------------------
Subtotal 377 56,048 100.00% 2,818,447 100.00% 2,795,066 100.00% 6.64%
========
Eliminations (3) (44) (7,614) -- (401,032) -- (397,328)
--------------------------------------------------------------------------------------------------
Total 333 48,434 -- $2,417,415 -- $2,397,738
==================================================================================================
2005 Total 295 47,513 -- $2,237,699 -- $2,294,787
==================================================================================================
BY PROPERTY
STATUS:
---------------
Stabilized 156 26,449 47.20% $1,164,075 41.30% $1,187,925 42.50% 7.03%
Lease-up 114 15,659 27.90% 866,298 30.70% 841,043 30.09% 6.75%
Construction 29 4,811 8.60% 283,207 10.10% 277,503 9.93% 6.07%
Rehab 78 9,129 16.30% 504,867 17.90% 488,595 17.48% 5.90%
----------------------------------------------------------------------------------------------------------------------------
Subtotal 377 56,048 100.00% 2,818,447 100.00% 2,795,066 100.00% 6.64%
========
Eliminations (3) (44) (7,614) -- (401,032) -- (397,328)
--------------------------------------------------------------------------------------------------
Total 333 48,434 -- $2,417,415 -- $2,397,738
==================================================================================================
2005 Total 295 47,513 -- $2,237,699 -- $2,294,787
==================================================================================================
Pertinent Weighted Average Dates Annualized Base Interest
--------------------------------------- ------------------------
Debt
Service
Occupancy Coverage
Optional on Ratio on
Redemption % of Stabilized Stabilized
Put Date Date Maturity Date $ Amount Total Properties Properties
-------- ---------- ------------- -------- --------- ---------- ----------
BY STATE: (2)
----------------
Texas May-20 Nov-19 Nov-41 $ 53,404 30.00% 89.9% 0.94x
Georgia Apr-21 Jun-20 Feb-44 23,698 13.30% 91.3% 0.90x
California Apr-20 Mar-19 Feb-40 20,294 11.40% 96.3% 1.34x
Missouri Nov-21 Aug-21 Jun-37 10,410 5.80% 93.0% 1.12x
Florida Aug-20 Jan-18 Jun-41 10,855 6.10% 96.1% 1.26x
All others Aug-20 Apr-19 Jun-39 59,617 33.40% 94.1% 1.19x
----------------------------------------------------------------------------------------------------------------
Subtotal Sep-20 Sep-19 Nov-40 178,278 100.00% 93.6% 1.10x
=================================================
Eliminations (3)
--------------------
Total
====================
2005 Total $167,415 100.00% 94.1% 1.12x
==================== =================================================
BY PROPERTY
STATUS:
---------------
Stabilized Mar-19 Oct-17 May-39 $ 81,782 45.90% 93.6% 1.10x
Lease-up Oct-20 Jul-19 Mar-41 58,504 32.80% N/A N/A
Construction Jul-22 Jul-22 Nov-43 16,244 9.10% N/A N/A
Rehab Jan-23 Dec-22 Feb-42 21,748 12.20% N/A N/A
----------------------------------------------------------------------------------------------------------------
Subtotal Sep-20 Sep-19 Nov-40 178,278 100.00% 93.6% 1.10x
=================================================
Eliminations (3)
--------------------
Total
====================
2005 Total $167,415 100.00% 94.1% 1.12x
==================== =================================================
(1) Original principal amount at issuance.
(2) Other than those detailed, based on face amount, no state comprises more
than 10% of the total at December 31, 2006 or 2005.
(3) These bonds are either recorded as liabilities on the balance sheets of
certain consolidated partnerships or are recorded as liabilities of real estate
owned and are therefore eliminated in consolidation.
81
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Units Face Amount of Bond (1) Fair Value at 12/31/06
------------------- ----------------------- ----------------------
Number of % of % of % of Current Stated
Bonds Number Total $ Amount Total $ Amount Total Interest Rate
--------- -------- ------- ----------- ------- ----------- ------- --------------
BY PUT DATE:
----------------
No put date 83 972 1.70% $ 168,748 6.00% $ 151,168 5.41% 6.66%
6 months notice 2 546 1.00% 20,200 0.80% 20,200 0.72% 8.06%
2007-2010 3 298 0.50% 17,523 0.60% 17,518 0.63% 6.74%
2011-2015 6 1,286 2.30% 56,163 2.00% 57,729 2.07% 6.94%
2016-2020 159 30,507 54.40% 1,412,566 50.00% 1,407,713 50.37% 6.97%
2021-2025 107 19,320 34.50% 985,764 35.00% 977,561 34.97% 6.15%
2026-2030 15 2,943 5.30% 149,198 5.30% 154,667 5.53% 6.53%
2031-2035 2 176 0.30% 8,285 0.30% 8,510 0.30% 6.63%
-----------------------------------------------------------------------------------------------------------------------
Subtotal 377 56,048 100.00% 2,818,447 100.00% 2,795,066 100.00% 6.64%
=======================
Eliminations (2) (44) (7,614) -- (401,032) -- (397,328)
--------------------------------------------------------------------------------------------
Total 333 48,434 $2,417,415 $2,397,738
============================================================================================
2005 Total 295 47,513 -- $2,237,699 -- $2,294,787 100.00% 6.63%
=======================================================================================================================
BY MATURITY
DATE:
-----------------
2007-2010 28 368 0.70% $ 85,019 3.00% $ 77,766 2.78% 6.50%
2011-2015 30 133 0.20% 31,045 1.10% 24,790 0.89% 6.24%
2016-2020 25 460 0.80% 52,249 1.90% 47,925 1.71% 7.23%
2021-2025 19 336 0.60% 49,869 1.80% 48,380 1.73% 7.63%
2026-2030 9 779 1.40% 32,782 1.20% 28,960 1.04% 7.08%
2031-2035 12 2,597 4.60% 98,924 3.50% 102,663 3.67% 6.89%
2036-2040 59 11,419 20.40% 490,532 17.40% 500,305 17.90% 7.03%
2041-2045 141 30,147 53.80% 1,455,244 51.60% 1,449,468 51.86% 6.68%
2046 and after 54 9,809 17.50% 522,783 18.50% 514,809 18.42% 6.02%
-----------------------------------------------------------------------------------------------------------------------
Subtotal 377 56,048 100.00% 2,818,447 100.00% 2,795,066 100.00% 6.64%
=======================
Eliminations (2) (44) (7,614) -- (401,032) -- (397,328)
--------------------------------------------------------------------------------------------
Total 333 48,434 $2,417,415 $2,397,738
============================================================================================
2005 Total 295 47,513 -- $2,237,699 -- $2,294,787 100.00% 6.63%
=======================================================================================================================
(1) Original principal amount at issuance.
(2) These bonds are either recorded as liabilities on the balance sheets of
certain consolidated partnerships or are recorded as liabilities of real estate
owned and are therefore eliminated in consolidation.
82
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The following table summarizes the maturity dates of mortgage revenue bonds we
held as of December 31, 2006:
Outstanding Weighted
Number of Bond Average
(Dollars in thousands) Bonds Amount Fair Value Interest Rate
------------------------------ --------- ----------- ---------- -------------
Due in less than one year 5 $ 10,766 $ 10,156 6.36%
Due between one and five years 26 75,486 68,765 6.54%
Due after five years 346 2,732,195 2,716,145 6.65%
------- ---------- ---------- -------
Total/weighted average 377 2,818,447 2,795,066 6.64%
=======
Less: eliminations (1) (44) (401,032) (397,328)
------- ---------- ----------
Total 333 $2,417,415 $2,397,738
======= ========== ==========
(1) These bonds are either recorded as liabilities on the balance sheets of
certain consolidated partnerships or are recorded as liabilities of real estate
owned and are therefore eliminated in consolidation.
C. PORTFOLIO ACTIVITY
Reconciliation of mortgage revenue bonds (In thousands): 2006 2005
-------------------------------------------------------- ----------- -----------
Balance at beginning of period $ 2,294,787 $ 2,100,720
Acquisitions and additional fundings 419,940 443,517
Repayment proceeds (83,746) (104,279)
Principal payments (31,854) (22,466)
Realized gain 544 1,541
Advance returned by Trustee -- (6,866)
Impairment losses (4,676) (4,555)
Net change in fair value (37,178) 86,323
Accretion/amortization of yield adjustments (3,690) (5,384)
Reclassification to other assets (629) (34,238)
----------- -----------
Subtotal 2,553,498 2,454,313
Less: change in eliminations (1) (155,760) (159,526)
----------- -----------
Balance at close of period $ 2,397,738 $ 2,294,787
=========== ===========
(1) Certain bonds are either recorded as liabilities on the balance sheets of
certain consolidated partnerships or are recorded as liabilities of real estate
owned and are therefore eliminated in consolidation.
83
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Mortgage revenue bonds acquired and/or additional fundings made during 2006 and
2005 are summarized below:
Weighted Weighted
Average Average
Number of Face Construction Permanent
(Dollars in thousands) Bonds (1) Amount (2) Rate Interest Rate
-------------------------------------- --------- ---------- ------------ -------------
2006
Construction/rehabilitation properties 68 $395,240 6.37% 6.04%
Additional funding of existing bonds -- 24,700 5.28% 5.31%
-------- -------- ------- -------
Total 2006 acquisitions 68 $419,940 6.31% 5.99%
======== ======== ======= =======
2005
Construction/rehabilitation properties 59 $429,966 5.81% 6.17%
Additional funding of existing bonds -- 13,551 5.36% 6.60%
-------- -------- ------- -------
Total 2005 acquisitions 59 $443,517 5.80% 6.19%
======== ======== ======= =======
(1) Number of additional fundings not included as they are not additive to the
number of bonds in the portfolio.
(2) Original principal amount at issuance.
Mortgage revenue bonds and notes repaid during 2006 and 2005 are summarized
below:
Number of Net Book Realized
(Dollars in thousands) Bonds Value Proceeds Gains (Losses)
--------------------------------- --------- --------- -------- --------------
2006
Participating, stabilized 3 $ 30,756 $ 31,725 $ 969
Non-participating, stabilized 4 21,754 21,585 (169)
Non-participating, not stabilized 7 30,692 30,436 (256)
-------- -------- -------- --------
Total 14 $ 83,202 $ 83,746 $ 544
======== ======== ======== ========
2005
Participating, stabilized 4 $ 29,471 $ 30,402 $ 931
Non-participating, stabilized 3 31,233 32,450 1,217
Non-participating, not stabilized 8 42,034 41,427 (607)
-------- -------- -------- --------
Total 15 $102,738 $104,279 $ 1,541
======== ======== ======== ========
D. UNREALIZED GAINS AND LOSSES
The amortized cost basis of our portfolio of mortgage revenue bonds and the
related unrealized gains and losses were as follows at December 31:
(In thousands) 2006 2005
---------------------------------- ----------- -----------
Amortized cost basis $ 2,727,372 $ 2,417,185
Gross unrealized gains 101,364 116,541
Gross unrealized losses (33,670) (11,424)
----------- -----------
Subtotal/fair value 2,795,066 2,522,302
Less: eliminations (1) (397,328) (227,515)
----------- -----------
Total fair value per balance sheet $ 2,397,738 $ 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.
84
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
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
------------------------------------ --------- --------- --------
DECEMBER 31, 2006
Number 76 60 136
Fair value $502,758 $356,543 $859,301
Gross unrealized loss $ 22,355 $ 11,315 $ 33,670
DECEMBER 31, 2005
Number 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 expected cash flows from the bonds and discount these cash flows at
current rates; as rates rise, the fair value of our portfolio decreases. We have
the intent and ability to hold these bonds until recovery and have therefore
concluded that these declines in fair value are temporary. For discussion of
other-than temporary impairments, see IMPAIRMENT below.
E. SECURITIZED AND PLEDGED ASSETS
As of December 31, 2006, mortgage revenue bonds with an aggregate fair value of
approximately $2.3 billion were securitized or pledged as collateral in relation
to financing arrangements (see Note 8).
F. IMPAIRMENT
During 2006, we recognized approximately $4.7 million of mortgage revenue bond
impairment charges in light of substandard performance at seven 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.
During 2005, we determined that construction should be halted on a property for
which we had assumed the general partner interest (see Note 21), agreed in
principle to revise the terms of another mortgage revenue bond and also
determined that two bonds secured by a property would likely require term
revisions to reduce the rate of interest. As a result, we recognized impairment
losses of approximately $4.6 million.
In 2004, in light of the underperformance of one of our investments, which
necessitated the temporary revision of payment terms, we recognized an
impairment loss of approximately $610,000.
G. FORECLOSURE
In May 2005, an affiliate of ours foreclosed upon the properties underlying
three of our mortgage revenue bonds. 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 Foreclosed properties are
included in "Real Estate Owned" within Deferred Costs and Other Assets on the
consolidated balance sheets (see Note 6).
85
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
See also Note 21 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.
NOTE 4 - OTHER INVESTMENTS
Investments other than mortgage revenue bonds consisted of:
(In thousands) 2006 2005
----------------------------------------------------- -------- --------
Equity Method Investments
Investment in equity interests in LIHTC properties $ 53,492 $ 46,985
CCA loans and preferred stock -- 26,884
Investment in CUC 3,066 --
Investment in ARCap -- 19,874
Available for Sale
Resecuritization certificates 102,357 --
Marketable securities 1,465 1,249
Other
Mortgage loans held for sale 122,459 153,277
Notes receivable 46,477 32,670
Other investments 9,604 17,651
-------- --------
Total other investments $338,920 $298,590
======== ========
A. INVESTMENTS IN EQUITY INTERESTS IN LIHTC PROPERTIES
Through a subsidiary, we acquire equity interests in property ownership entities
on a short-term basis for inclusion in Fund Management offerings to investors.
We expect to recapture such amounts from the proceeds of the equity and debt
financing when the investment fund has closed. The developer also guarantees
repayment of these investments.
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
interest in Capri Urban Capital LLC, which we renamed CharterMac Urban Capital
LLC ("CUC"). CUC is an investment fund with the California Public Employees
Retirement System ("CalPERS") as majority investor, focusing on investments in
multifamily properties in major urban markets. We recognized the value of the
membership interest in CUC (approximately $900,000) as an intangible asset (see
Note 5). Our membership interest includes a co-investment obligation amounting
to 2.5% of capital invested (see Note 21). 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" at December 31, 2005, also
included $4.1 million of preferred stock that was redeemed and $3.2 million of
advances that were forgiven as part of the purchase price of CRES (see Note 2).
86
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
C. RESECURITIZATION CERTIFICATES
Resecuritization certificates we hold (not including the certificates held at
the fund level detailed in Note 7) were comprised of the following as of
December 31, 2006:
Percentage of
(Dollars in thousands) Face Amount Accreted Cost Fair Value Fair Value
--------------------------- ----------- ------------- ---------- -------------
Security rating:
AAA interest only $ -- $ 16,685 $ 21,441 $ 20.94%
AAA 26,150 13,475 25,319 24.73
BBB+ 12,536 5,013 9,085 8.88
BBB 9,402 3,422 6,181 6.04
BBB- 9,402 2,689 5,629 5.50
BB+ 24,454 8,140 12,585 12.30
BB 8,501 2,067 3,509 3.43
BB- 11,635 2,158 4,103 4.01
B+ 13,273 2,165 2,891 2.82
B 11,486 1,120 1,791 1.75
B- 11,635 974 1,659 1.62
Non-rated 65,880 3,894 7,453 7.28
Non-rated interest only -- 450 711 0.70
-------- -------- -------- -------
$204,354 $ 62,252 $102,357 $100.00%
======== ======== ======== =======
At December 31, 2006, the AAA interest only certificate had a notional amount of
$539.7 million and the non-rated interest only certificates had a combined
notional amount of $197.0 million.
Fair value of the resecuritization certificates is determined assuming no
defaults on the underlying collateral loans and according to the payment terms
of the underlying loans, which generally do not allow prepayment without yield
maintenance except during the last three months of a loan. The remaining key
assumptions used in measuring fair value at the resecuritization date were as
follows:
Fair Value at Weighted Discount Rate
Resecuritization Average applied to Cash
(Dollars in thousands) Face Amount Date Life (yrs) Flows
----------------------------- ----------- ---------------- ---------- ---------------
Security rating:
AAA interest only $ -- $ 29,827 -- 8.19%
AAA 26,150 26,180 8.73 6.14
BBB+ 12,536 9,900 11.27 9.76
BBB 9,402 6,830 11.78 11.01
BBB- 9,402 6,291 12.16 12.26
BB+ 24,454 13,202 11.87 13.78
BB 8,501 3,765 12.36 17.21
BB- 11,635 4,283 12.65 19.86
B+ 13,273 2,878 12.34 29.72
B 11,486 1,832 12.83 40.55
B- 11,635 1,708 13.03 43.51
Non-rated 65,880 15,139 14.79 53.94
Non-rated interest only -- 839 -- 36.36
-------- --------
Total $204,354 $122,674
======== ========
87
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
At the resecuritization date, the AAA interest only certificate had a notional
amount of $545.4 million and the non-rated interest only certificates had a
combined notional amount of $197.5 million.
At December 31, 2006, the sensitivity of the current fair value of the
resecuritization certificates to potential adverse changes is as follows:
Expected Discount Rate Applied to
Credit Loss Cash Flows
---------------------- ------------------------
Weighted
Average 1.0% 2.0%
Life 1% 2% Adverse Adverse
(Dollars in thousands) Fair Value (yrs) CDR (1) CDR (1) Change Change
---------------------- ---------- -------- --------- --------- --------- ---------
Security rating:
AAA interest only $ 21,441 6.10 1.49 % (4.57)% (2.80)% (5.41)%
AAA 25,319 9.19 (0.56) (0.70) (6.66) (12.78)
BBB+ 9,085 11.71 (1.18) (37.51) (7.23) (13.76)
BBB 6,181 11.88 (2.09) (60.13) (7.03) (13.41)
BBB- 5,629 11.94 (3.36) (64.13) (6.81) (12.99)
BB+ 12,585 11.28 (5.84) (68.23) (6.46) (12.36)
BB 3,509 11.72 (8.78) (66.20) (5.92) (11.35)
BB- 4,103 11.88 (18.16) (64.56) (5.50) (10.51)
B+ 2,891 11.66 (9.37) (55.51) (4.84) (9.27)
B 1,791 12.50 (15.57) (46.81) (3.39) (6.53)
B- 1,659 12.78 (22.10) (47.35) (2.95) (5.70)
Non-rated 7,453 -- (46.69) (57.26) (1.97) (3.89)
Non-rated interest
only 711 8.17 (56.12) (63.06) (2.91) (4.40)
----------
Total $ 102,357
==========
(1) Constant Default Rate
The interest rates on the principal classes range from 4.0% to 5.7% and range
from 0.1% to 1.1% on the interest only classes. During the year ended December
31, 2006, we received approximately $7.3 million from retained resecuritization
certificates.
Delinquencies on the collateral loans underlying the resecuritization
certificates totaled 0.4% at December 31, 2006. At December 31, 2006, actual
losses to date were 7.3% of the original pool balances, and projected remaining
losses are estimated at 13.3% of the original pool balances.
D. MORTGAGE LOANS HELD FOR SALE
The balance of mortgage loans held for sale fluctuates based on origination
volume and the timing of corresponding sales. These loans are typically sold
within three months of origination.
E. NOTES RECEIVABLE
Notes receivable at December 31, 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.
At December 31, 2005, this balance included a $26.0 million investment in a
mortgage loan in which we had co-invested with AMAC (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 11).
88
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
F. INVESTMENT IN ARCAP
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. Prior to the acquisition, we received special distributions from
ARCap and reduced the basis of our investment by approximately $11.7 million for
the portion which represented a return of capital.
NOTE 5 - GOODWILL AND INTANGIBLE ASSETS
Goodwill and intangible assets consisted of the following at December 31:
(In thousands) 2006 2005
------------------------------ -------- --------
Goodwill $345,806 $235,684
Other intangible assets, net 127,686 141,301
Mortgage servicing rights, net 68,785 62,190
-------- --------
Total $542,277 $439,175
======== ========
A. GOODWILL
The following table provides information regarding goodwill by segment:
Fund Mortgage
(In thousands) Management Banking Total
---------------------------- ---------- --------- ---------
Balance at December 31, 2004 $ 200,153 $ 6,244 $ 206,397
Additions -- 31,503 31,503
Reductions (2,216) -- (2,216)
--------- --------- ---------
Balance at December 31, 2005 197,937 37,747 235,684
Additions 106,472 10,302 116,774
Reductions (6,652) -- (6,652)
--------- --------- ---------
Balance at December 31, 2006 $ 297,757 $ 48,049 $ 345,806
========= ========= =========
The additions in 2005 pertain to our purchase of CMC shares we did not
previously own and the final payments under the terms of the original purchase
agreement, as well as the acquisition of CCLP (see Note 2).
The 2006 additions relate 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 in 2006 and 2005 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 in 2006 by approximately $6.1 million in connection with the
closure of CRES. Of the $6.1 million reduction, $4.1 million related to the
cancellation of the subsidiary equity units included in the purchase price (see
Note 13), $1.0 million represented the assumption of CRES' line of credit by its
founder and the remaining $1.0 million was charged to expense.
Although partially contingent upon subsidiary equity conversions, all of our
goodwill is tax-deductible.
89
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
B. OTHER INTANGIBLE ASSETS
The components of other identified intangible assets are as follows:
Estimated
Useful
Life Gross Accumulated
(Dollars in thousands) (in Years) Carrying Amount Amortization Net
----------------------------------------- ---------- ------------------- ------------------- -------------------
2006 2005 2006 2005 2006 2005
-------- -------- -------- -------- -------- --------
Amortized identified intangible assets:
Transactional relationships 16.7 $103,000 $103,000 $ 25,590 $ 17,864 $ 77,410 $ 85,136
Partnership service contracts 9.4 47,300 47,300 16,604 10,718 30,696 36,582
General partner interests 8.5 6,016 5,100 1,774 1,201 4,242 3,899
Joint venture developer relationships 5.0 4,800 4,800 2,915 2,035 1,885 2,765
Internally developed software 3.0 1,390 -- 163 -- 1,227 --
Mortgage banking broker relationships 5.0 1,080 1,080 396 180 684 900
Other identified intangibles 9.3 4,427 4,427 3,658 3,181 769 1,246
------- -------- -------- -------- -------- -------- --------
Weighted average life/subtotal 13.6 168,013 165,707 51,100 35,179 116,913 130,528
=======
Unamortized identified intangible assets:
Mortgage banking licenses and approvals
with no expiration 10,773 10,773 -- -- 10,773 10,773
-------- -------- -------- -------- -------- --------
Total identified intangible assets $178,786 $176,480 $ 51,100 $ 35,179 $127,686 $141,301
======== ======== ======== ======== ======== ========
(In thousands) 2006 2005 2004
-------------------- ------- ------- -------
Amortization expense $15,921 $14,332 $16,684
======= ======= =======
In 2006, we wrote off approximately $1.6 million of unamortized transactional
relationship assets associated with the closure of CRES (see Note 2).
At the end of 2005, management decided to change the name of the subsidiary that
conducts our fund sponsorship business from "Related Capital Company" to
"CharterMac Capital," effective January 1, 2006. Accordingly, we wrote off the
unamortized balance attributed to the prior name, resulting in a pre-tax charge
of approximately $22.6 million in 2005.
The estimated amortization expense for other intangible assets for the next five
years is as follows:
(In thousands)
--------------
2007 $ 16,244
2008 $ 15,871
2009 $ 14,263
2010 $ 9,428
2011 $ 9,278
The amortization of "other identified intangibles" (approximately $477,000 per
year) is included as a reduction to mortgage revenue bond interest income as
they pertain to the acquisition of such bond investments.
90
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
C. MORTGAGE SERVICING RIGHTS
The components of the change in MSRs and related reserves were as follows:
(In thousands)
------------------------------------------------------------- --------------
Balance at December 31, 2004 $ 32,366
MSRs acquired 45,400
MSRs capitalized 9,581
Amortization (18,670)
Increase in reserves (6,487)
--------
Balance at December 31, 2005 62,190
MSRs and other servicing assets acquired in ARCap acquisition 17,607
MSRs capitalized 8,798
Amortization (19,660)
Increase in reserves (150)
--------
Balance at December 31, 2006 $ 68,785
========
Reserve for Loan Losses
Balance at December 31, 2004 $ 6,479
Net additions 6,487
--------
Balance at December 31, 2005 12,966
Net additions 150
--------
Balance at December 31, 2006 $ 13,116
========
The estimated amortization expense for the MSRs for the next five years is as
follows:
(In thousands)
--------------
2007 $ 15,210
2008 $ 12,622
2009 $ 10,058
2010 $ 7,204
2011 $ 6,333
The estimated fair values of the MSRs, based upon third-party and internal
valuations, were $99.0 million at December 31, 2006 and $79.8 million at
December 31, 2005. The significant assumptions used in estimating the fair
values at December 31, were as follows:
2006 2005
---------- ----------
Weighted average discount rate 16.04% 17.50%
Weighted average pre-pay speed 10.94% 10.88%
Weighted average lockout period 4.7 years 4.3 years
Weighted average default rate .27% .50%
Cost to service loans $ 2,286 $ 2,305
Acquisition cost (per loan) $ 1,457 $ 1,456
91
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The table below illustrates hypothetical fair values of MSRs at December 31,
2006, caused by assumed immediate changes to key assumptions which are used to
determine fair value.
(In thousands)
--------------
Fair value of MSRs at December 31, 2006 $ 98,956
Prepayment speed:
Fair value after impact of +10% change 98,095
Fair value after impact of -10% change 99,917
Fair value after impact of +20% change 97,335
Fair value after impact of -20% change 100,831
Discount rate:
Fair value after impact of +10% change 94,381
Fair value after impact of -10% change 104,090
Fair value after impact of +20% change 90,219
Fair value after impact of -20% change 109,801
Default rate:
Fair value after impact of +10% change 98,813
Fair value after impact of -10% change 99,084
Fair value after impact of +20% change 98,709
Fair value after impact of -20% change 99,205
D. IMPAIRMENT
The initial gross carrying amounts for identified intangible assets were based
on third party valuations. We review goodwill and intangible assets annually for
impairment. Through December 31, 2006, we have concluded that these assets have
not been impaired, although we have written off assets due to discontinuation of
use.
NOTE 6 - DEFERRED COSTS AND OTHER ASSETS
The components of deferred costs and other assets at December 31 were as
follows:
(In thousands) 2006 2005
-------------------------------------------------------------------------- --------- ---------
Deferred financing and other costs $ 32,472 $ 38,059
Less: Accumulated amortization (6,718) (14,031)
--------- ---------
Net deferred costs 25,754 24,028
Real estate owned, net of accumulated depreciation of $1.3 million in 2006 41,743 35,608
Interest receivable 23,606 16,964
Fees receivable, net 23,313 29,386
Deposits receivable 18,863 98
Due from unconsolidated partnerships, net 31,466 5,080
PRS/CRG/ERC advances 13,780 9,070
Income taxes receivable 714 4,276
Interest rate swaps at fair value (see Note 11) 2,236 4,857
Deferred taxes (see Note 12) -- 1,849
Other 14,670 4,293
--------- ---------
Total $ 196,145 $ 135,509
========= =========
92
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
A. DEFERRED FINANCING AND OTHER COSTS
In connection with the restructuring of our securitization programs (see Note 8)
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 2006. In connection with refinancing our lines of
credit at the time of the ARCap acquisition (see Notes 2 and 9) 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 Sale" upon foreclosure of
the properties securing mortgage revenue bonds in 2005 (see Note 3). 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 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 9).
D. PRS/CRG/ERC ADVANCES
The advances due from PRS/CRG/ERC related to the financial difficulties of two
developers and our subsequent actions to protect our investments in the
properties that were under development (see Note 21). The above balances are net
of eliminations with liabilities of consolidated partnerships of $24.3 million
at December 31, 2006 and $4.8 million at December 31, 2005. Of the $38.1 million
total amount receivable at December 31, 2006, we received $12.1 million in
January 2007 through capital released by an equity partner.
NOTE 7 - CONSOLIDATED PARTNERSHIPS
Consolidated Partnerships consist of four 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");
o Funds we sponsor to syndicate investments in CMBS and associated
resecuritization trusts ("CMBS Partnerships"); and
o a Direct Loan investing partnership.
The CMBS and Direct Loan Partnerships were consolidated following the ARCap
acquisition in August 2006.
Financial information for the LIHTC and Property Partnerships are as of and for
the year ended September 30 of each year, the latest practical date (except for
2004, which represents nine months of operations following our consolidation as
of March 31 of that year). Information with respect to the CMBS and Direct Loan
partnerships is as of and for the period ended December 31, 2006.
93
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Assets and liabilities of consolidated partnerships consisted of the following
at December 31:
2006 2005
------------------------------------- ------------
LIHTC and CMBS and LIHTC and
Property Direct Loan Property
(In thousands) Partnerships Partnerships Total Partnerships
--------------------------------------------- ------------ ------------ ---------- ------------
Investments in property partnerships $3,546,208 $ -- $3,546,208 $3,025,762
Investments in CMBS - available for sale -- 719,645 719,645 --
Investments in resecuritization
certificates - available for sale -- 597,491 597,491 --
Notes receivable -- 101,156 101,156 --
Other investments -- 1,407 1,407 --
---------- ---------- ---------- ----------
Investments held by consolidated partnerships 3,546,208 1,419,699 4,965,907 3,025,762
---------- ---------- ---------- ----------
Land, buildings and improvements, net of
accumulated depreciation 576,171 -- 576,171 329,869
Cash 277,860 27,213 305,073 172,622
Other assets 123,890 33,645 157,535 77,123
---------- ---------- ---------- ----------
Other assets of consolidated partnerships 977,921 60,858 1,038,779 579,614
---------- ---------- ---------- ----------
Total assets $4,524,129 $1,480,557 $6,004,686 $3,605,376
========== ========== ========== ==========
Financing arrangements $ -- $ 709,219 $ 709,219 $ --
Notes payable 594,477 -- 594,477 565,877
Due to property partnerships 925,301 -- 925,301 896,031
Repurchase agreements -- 243,955 243,955 --
Other liabilities 215,628 11,574 227,202 156,487
---------- ---------- ---------- ----------
Total liabilities $1,735,406 $ 964,748 $2,700,154 $1,618,395
========== ========== ========== ==========
A. INVESTMENTS IN PROPERTY PARTNERSHIPS AND DUE TO PROPERTY PARTNERSHIPS
"Investments in property partnerships" represent the equity investments held by
LIHTC partnerships in property level partnerships that neither we nor the LIHTC
partnerships control. "Due to property partnerships" represents the capital
commitments of the LIHTC partnerships in those property partnerships that have
not yet been spent.
B. INVESTMENTS IN CMBS
Investments in CMBS included within consolidated partnerships were comprised of
the following as of December 31, 2006:
Percentage
of
(Dollars in thousands) Face Accreted Cost Fair Value Fair Value
---------------------- ---------- ------------- ---------- ----------
Security rating:
BBB- $ 106,723 $ 100,531 $ 101,899 14.16%
BB+ 124,600 106,195 106,611 14.81
BB 146,235 121,019 120,906 16.79
BB- 160,537 113,483 116,059 16.13
B+ 79,324 49,922 50,916 7.09
B 81,237 46,801 48,708 6.77
B- 104,509 47,308 52,378 7.28
Non-rated 377,943 110,927 122,168 16.97
---------- ---------- ---------- ---------
$1,181,108 $ 696,186 $ 719,645 100.00%
========== ========== ========== =========
94
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
C. INVESTMENTS IN RESECURITIZATION CERTIFICATES
Investments in resecuritization certificates included within consolidated
partnerships were comprised of the following as of December 31, 2006:
Percentage
of
(Dollars in thousands) Face Accreted Cost Fair Value Fair Value
-------------------------------- -------- ------------- ---------- ----------
Security rating:
AAA $111,900 $106,259 $109,198 18.28%
AA 66,600 64,170 65,699 11.00
A 47,000 45,105 46,913 7.85
A- 23,900 24,054 24,355 4.08
BBB+ 66,800 67,266 69,013 11.55
BBB 61,138 56,018 57,490 9.62
BBB- 109,781 106,846 110,769 18.54
BB+ 88,114 52,608 62,702 10.49
BB 12,158 4,868 6,990 1.17
BB- 12,157 4,379 6,284 1.05
B+ 21,073 6,734 9,670 1.62
B 11,348 2,574 3,711 0.62
B- 12,158 2,079 3,006 0.50
Non-rated 183,741 10,367 16,515 2.76
Non-rated interest only -- 5,148 5,176 0.87
-------- -------- -------- --------
$827,868 $558,475 $597,491 100.00%
======== ======== ======== ========
At December 31 2006, the non-rated interest only certificate had a combined
notional amount of $1.4 billion.
Fair value of the resecuritization certificates is determined assuming no
defaults on the underlying collateral loans and according to the payment terms
of the underlying loans, which generally do not allow prepayment without yield
maintenance except during the last three months of a loan. The remaining key
assumptions used in measuring fair value at the resecuritization date were as
follows:
Fair Value at Weighted Discount Rate
Face Amount Resecuritization Average applied to Cash
(Dollars in thousands) Held by Fund Date Life (yrs) Flows
----------------------------- ------------ ---------------- ---------- ---------------
Security rating:
BB+ $ 47,820 $ 29,599 10.92 9.80%
BB 12,158 6,671 11.33 11.20
BB- 12,157 5,991 11.42 12.50
B+ 21,073 9,210 11.75 13.90
B 11,348 3,520 12.02 18.70
B- 12,158 2,853 12.17 23.20
Non-rated 186,416 16,493 13.81 49.40
Non-rated interest only -- 2,080 10.05 63.20
-------- --------
Total $303,130 $ 76,417
======== ========
At the resecuritization date, the non-rated interest only certificates had a
combined notional amount of $648.4 million.
95
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
At December 31, 2006, the sensitivity of the current fair value of the
resecuritization certificates to potential adverse changes is as follows:
Expected Discount Rate Applied to
Credit Loss Cash Flows
----------------------- ------------------------
Weighted 100 bps 200 bps
Average 1% 2% Adverse Adverse
(Dollars in thousands) Fair Value Life(yrs) CDR (1) CDR (1) Change Change
---------------------- ---------- --------- ------- ------- ------- -------
Security rating:
BB+ $30,908 10.19 (4.40)% (75.60)% (7.20)% (13.70)%
BB 6,990 10.59 (5.90) (75.20) (7.20) (13.70)
BB- 6,284 10.73 (7.80) (73.90) (7.00) (13.40)
B+ 9,670 11.07 (9.30) (72.40) (6.90) (13.20)
B 3,710 11.32 (12.10) (66.40) (6.20) (11.80)
B- 3,006 11.43 (13.80) (60.30) (5.40) (10.40)
Non-rated 16,515 13.08 (24.40) (40.40) (2.10) (4.20)
Non-rated interest
only 2,092 9.29 (65.60) (65.60) (3.10) (3.10)
-------
Total $79,175
=======
(1) Constant Default Rate
The interest rate on the principal classes is 4.0% and 0.2% on the interest only
class. During the year ended December 31, 2006, consolidated partnerships
received approximately $4.7 million from retained resecuritization certificates.
Delinquencies on the collateral loans underlying the resecuritization
certificates totaled 0.4% at December 31, 2006. At December 31, 2006, actual
losses to date were 0.4% of the original pool balance, and projected remaining
losses are estimated at 25.4% of the original pool balance.
D. NOTES RECEIVABLE
The aggregate carrying values, allocated by product type and weighted average
coupons, of notes receivable as of December 31, 2006 were as follows:
Allocation Fixed
by Rate
Total Carrying Product (Average Average
(Dollars in thousands) Commitment Value Type Yield) Yield
------------------------------- ---------- -------- ---------- --------- ---------
Product Type:
Bridge loans, floating rate $ 15,000 $ 1,178 9.30% -- 8.35%
Bridge loans, fixed rate 22,496 22,496 13.94 7.29 --
B-notes, floating rate 40,000 34,157 24.79 -- 9.64
B-notes, fixed rate 17,125 12,781 10.61 8.17 --
Mezzanine loans, floating rate 36,500 27,982 22.62 -- 9.22
Mezzanine loans, fixed rate 30,246 2,562 18.74 15.00 --
-------- -------- -------- -------- -------
Total / Average $161,367 $101,156 100.00% 10.15% 9.07%
======== ======== ======== ======== =======
96
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Notes receivable had the following scheduled maturities as of December 31, 2006:
Current Carrying
Number of Loans Value
Year of Maturity Maturing (in thousands)
---------------- --------------- ----------------
2007 1 $ 29,901
2008 2 10,756
2009 9 40,740
2010 1 6,482
2011 2 10,121
Thereafter 1 3,156
------- ---------
Total 16 $ 101,156
======= =========
E. FINANCING ARRANGEMENTS
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 recourse to the specific collateral and
non-recourse to the CMBS funds.
F. NOTES PAYABLE
Of the LIHTC Partnerships notes payable balance, at December 31, 2006, $444.3
million are collateralized by equity subscriptions of 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 $150.2 million is collateralized with the underlying properties of
the consolidated operating partnerships. All of this debt is non-recourse to us.
G. REPURCHASE AGREEMENTS
At December 31, 2006, eight repurchase agreements with three counterparties
provided total commitments of $495.0 million. As of December 31, 2006, the CMBS
Partnerships had borrowed $214.2 million under these repurchase agreements with
average maturity of 32 days and had the ability to borrow an additional $3.4
million without pledging additional collateral. As of December 31, 2006, the
fair value of collateral pledged was $298.7 million. Interest rates range from
5.3% to 6.1%.
The Direct Loan fund finances its investments through three separate repurchase
agreement facilities, as well as a subscription line collateralized by the
remaining capital commitments from the ARESS members. As of December 31, 2006,
the Direct Loan fund had borrowed $29.7 million under these repurchase
agreements and had the ability to borrow an additional $21.9 million without
pledging additional collateral. The repurchase agreements have weighted average
interest rates ranging from 6.1% to 6.6% and weighted average remaining
maturities of 31 days.
At December 31, 2006, the Direct Loan fund had borrowed $21.5 million under a
subscription line facility and had the ability to borrow an additional $28.5
million. The subscription line facility, which was amended in January 2007,
expires in 2010 and has an interest rate of 6.05% at December 31, 2006.
97
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
H. FINANCIAL RISK MANAGEMENT AND DERIVATIVES
The CMBS partnerships have entered into amortizing forward-starting swap
agreements with Bear Stearns Capital Markets Inc. and Morgan Stanley Capital
Services Inc. 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 SFAS No. 133, while
others are not. The Direct Loan fund has entered into spot-starting swap
agreements with Bear Stearns Capital Markets, Inc. to mitigate its risk of
changes in the interest-related cash outflows on its financing of its fixed rate
investments. These swaps are designated as hedges under SFAS No. 133.
At December 31, 2006, those swaps not designated as hedges, had a combined
notional balance of $180.7 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 $2.6
million.
At December 31, 2006, those swaps designated as hedges had a combined notional
balance of $175.8 million, maturity dates ranging from December 2009 to January
2017, and interest rates ranging from 4.89% to 5.75%, and were in a net
liability position, in the aggregate, of approximately $2.5 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 and Direct Loan
partnerships.
I. REVENUES AND EXPENSES
Revenues and expenses of consolidated partnerships consisted of the following:
Year Ended December 31,
----------------------------------
(In thousands) 2006 2005 2004
----------------------------------- -------- -------- --------
Rental income $ 30,701 $ 18,824 $ 11,235
Interest and other income 53,037 5,272 978
-------- -------- --------
Total revenues $ 83,738 $ 24,096 $ 12,213
======== ======== ========
Interest expense $ 47,926 $ 26,322 $ 21,395
Asset management fees 20,960 21,600 14,547
Property operating expenses 15,964 9,089 5,978
General and administrative expenses 17,841 8,705 4,672
Depreciation and amortization 21,181 10,416 5,322
-------- -------- --------
Other expenses 75,946 49,810 30,519
Total expenses $123,872 $ 76,132 $ 51,914
======== ======== ========
NOTE 8 - FINANCING ARRANGEMENTS
Our financing arrangements are securitization programs that effectively allow us
to borrow against the fair value of our mortgage revenue bond portfolio. They
involve the sales of senior certificates to third party investors while we
retain subordinated residual certificated interests. The net effect of these
programs is that a portion of the interest we receive from mortgage revenue
bonds is distributed to holders of the senior certificates while we receive any
remaining interest via the residual certificate after related expenses are
deducted.
98
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Following are the components of financing arrangements at December 31:
(In thousands) 2006 2005
-------------------------------------------- ---------- ----------
P-FLOATs/RITES $ 403,381 $ 760,084
Floats/Residuals (formerly known as TIC/TOC) 944,799 187,108
Fixed-Rate Securitization 452,990 --
MBIA:
Floater Certificates -- 382,500
Auction Certificates -- 100,000
---------- ----------
Total $1,801,170 $1,429,692
========== ==========
In June 2006, we restructured several of our securitization programs whereby our
Centerbrook subsidiary is now the provider of credit intermediation, as
supported by IXIS Financial Products, Inc. ("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, as detailed
below. 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 $2.6 million of other costs (recorded in interest
expense) in the second quarter of 2006.
A. P-FLOATS/RITES AND FLOATS/RESIDUALS PROGRAMS
We have securitized certain mortgage revenue bonds through the Merrill Lynch
Pierce Fenner & Smith Incorporated ("Merrill Lynch") P-FLOATs/RITES program and
through the Goldman, Sachs & Co ("Goldman Sachs") Floats/Residuals program,
formerly known as the TIC/TOC program. There is no limit to the number or amount
of bonds we can securitize through these programs. Under these programs, we
transfer certain mortgage revenue bonds, or trust certificates that represent
senior interests in the mortgage revenue bonds, to Merrill Lynch or Goldman
Sachs and they deposit each revenue bond into an individual special purpose
trust. That trust, in turn, issues two types of securities:
o Puttable Floating Option Tax-Exempt Receipts ("P-FLOATs") or "Floats",
short-term senior securities which bear interest at a floating rate
reset weekly at the lowest rate that will clear the market at par; and
o Residual Interest Tax Exempt Securities ("RITES") or "Residuals",
subordinate securities which receive the residual interest payment
after payment of P-FLOAT or Float interest and ongoing transaction
fees.
The P-FLOATs or Floats are sold to third party investors and the RITES or
Residuals are generally sold back to us. We have the right, depending on the
program, with at least 5 to 14 days notice to the trustee, to purchase the
outstanding P-FLOATs or Floats and withdraw the underlying mortgage revenue
bonds or trust certificates from the trust. When the mortgage revenue bonds or
trust certificates are deposited into the P-FLOAT or Float Trust, we receive the
proceeds from the sale of the P-FLOATs or Floats less certain transaction costs.
In certain other cases, Merrill Lynch or Goldman Sachs may directly buy the
mortgage revenue bonds from local issuers, deposit them in the trust, sell the
P-FLOAT or Float security to investors and then the RITES or Residuals to us.
Due to the repurchase right, we account for the net proceeds received upon
transfer as secured borrowings and, accordingly, continue to account for the
mortgage revenue bonds as assets.
Credit intermediation under these programs is provided by Merrill Lynch or IXIS
or by Centerbrook, as supported by either Merrill Lynch or IXIS. To facilitate
the securitization, we have pledged certain additional mortgage revenue bonds
(or trust certificates representing senior interests in mortgage revenue bonds)
as collateral for the benefit of the credit intermediator or liquidity provider.
At December 31, 2006, the total fair value of such collateral was approximately
$98.6 million for the P-FLOATs/RITES program and approximately $174.0 million
for the Floats/Residuals program.
99
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
B. FIXED-RATE SECURITIZATIONS
In August 2006, we closed a $455.0 million securitization whereby we sold fixed
rate certificates secured by a pool of our mortgage revenue bonds. These
certificates have a weighted average life of eight 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
========
As of December 31, 2006, approximately $453.0 million remains outstanding.
In March 2005, we terminated a prior $100.0 million fixed-rate securitization
and remarketed the borrowings under the P-FLOATs/RITES program.
C. MBIA SECURITIZATION PROGRAM
Through June 2006, we securitized bonds through a program structured with MBIA
where we contributed mortgage revenue bonds to Series Trusts which then issued
senior and residual certificates similar to the P-FLOATs/RITES and
Floaters/Residuals programs. This program was terminated in connection with the
restructuring of our programs as discussed above.
D. RESTRICTED ASSETS
Certain of our subsidiaries hold mortgage revenue bonds which at December 31,
2006, had an aggregate fair value of approximately $2.3 billion that serve as
collateral for securitized borrowings or are securitized. The subsidiaries
holding these bonds had net assets at December 31, 2006, of approximately $710.8
million.
E. COVENANTS
We are subject to customary covenants with respect to our financing
arrangements. As of December 31, 2006, we were in compliance with all such
covenants.
100
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
F. COST OF FUNDS
Our annualized cost of funds relating to financing arrangements and the related
amount of interest expense were as follows:
2006 2005 2004
--------- --------- ---------
Cost of funds (1) 4.17% 3.65% 2.51%
Interest expense (in millions) (1) $ 68.7 $ 44.8 $ 24.6
Rate at December 31, excluding fees:
4.02% 3.33%
P-FLOATs/RITES
Floaters/Residuals (formerly known as TIC/TOC) 4.03 3.29%
Fixed rate 4.61 --
MBIA -- 3.21%
(1) Includes effect of our swaps and, in 2006, incremental costs related to
restructuring of our securitization programs.
NOTE 9 - NOTES PAYABLE
Notes payable included the following at December 31:
(In thousands) 2006 2005
--------------------------------- -------- --------
Term loan $249,375 $ --
Revolving credit facility 177,500 --
CMC warehouse line 122,459 179,277
CMBS repurchase lines 41,598 --
CMC acquisition loan -- 19,765
CharterMac Capital warehouse line -- 45,613
Capri acquisition lines -- 60,000
Other 233 233
-------- --------
Total notes payable $591,165 $304,888
======== ========
A. TERM LOAN AND REVOLVING CREDIT FACILITY
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.
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 as discussed below. Stock
of certain of our subsidiaries is pledged as collateral under the Term Loan and
the Credit Facility. The weighted average net rate was 7.47% as of December 31,
2006.
101
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
B. CMC WAREHOUSE LINE
CMC has a $100.0 million secured, revolving mortgage warehouse facility with
Bank of America. The term of this facility has been extended to May 31, 2007.
The facility bears interest at LIBOR plus 0.75%. The balance at December 31,
2006, includes additional borrowings pursuant to a temporary expansion of the
facility that expired in February 2007.
C. CMBS REPURCHASE LINES
At December 31, 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 December 31, 2006, we borrowed $41.6 million
under these agreements and had the ability to borrow $44.9 million without
pledging additional collateral. As of December 31, 2006, the fair value of
collateral pledged was $115.1 million. Interest rates range from 5.7% to 6.1%.
Of the amounts outstanding, $11.8 million matures in 23 months, and $29.8
million has no specified maturity date, although it may be called upon six
months' notice by the counterparty. As of December 31, 2006, no such notice had
been received from the counterparty.
D. CMC ACQUISITION LINE, CHARTERMAC CAPITAL WAREHOUSE LINE AND CAPRI ACQUISITION
LINES
In connection with the acquisition of CMC, we entered into a loan with Bank of
America which was due to expire in December 2006 and bore interest at six-month
LIBOR plus 2.25%. The rate was 6.83% at December 31, 2005.
CharterMac Capital had entered into a warehouse facility in the amount of $90.0
million with Bank of America, Merrill Lynch, C.D.C., Citicorp, USA, HSBC Bank
USA, N.A. and Comerica Bank. This facility was due to mature in October 2006 and
bore interest, at our option, at either 30-day LIBOR plus 1.70% or the prime
rate plus .125%. The weighted average net rate was 6.84% December 31, 2005. This
facility was collateralized by a lien on certain limited partnership interests
(See Note 4).
The Capri acquisition lines with Bank of America bore interest at 60-day LIBOR
plus 1.65% and were due to mature in August 2006. The weighted average interest
rate on the loans was 5.81% at December 31, 2005.
These facilities were repaid and terminated in connection with our new Term Loan
and Revolving Credit Facility as discussed above.
E. 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., IXIS 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%.
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%.
102
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
As of December 31, 2006, no amounts were outstanding under these facilities.
F. COVENANTS
We are subject to customary covenants with respect to our various notes payable.
As of December 31, 2006, we were in compliance with all such covenants.
NOTE 10 - ACCOUNTS PAYABLE, ACCRUED EXPENSES AND OTHER LIABILITIES
Accounts payable, accrued expenses and other liabilities consisted of the
following at December 31:
(In thousands) 2006 2005
----------------------------------------------- -------- --------
Deferred revenues $ 92,564 $ 70,025
Distributions payable 41,554 41,080
Accounts payable 18,626 22,314
Salaries and benefits 29,551 15,816
Accrued fund organization and offering expenses 11,860 9,562
Escrow/deposits payable 5,570 6,128
Accrued interest payable 5,825 4,879
Interest rate swaps at fair value (Note 11) 1,997 208
Restructuring accrual 1,128 --
Other 5,669 8,353
-------- --------
Total $214,344 $178,365
======== ========
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 January 1, 2006 $ -- $ -- $ --
Additions 580 1,251 1,831
Payments (174) (144) (318)
Adjustments (171) (378) (549)
------- ------- -------
Balance at December 31, 2006 235 729 964
------- ------- -------
Lease termination costs
Balance at January 1, 2006 -- -- --
Additions -- 164 164
------- ------- -------
Balance at December 31, 2006 -- 164 164
------- ------- -------
Total $ 235 $ 893 $ 1,128
======= ======= =======
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 substantially completed by the end of
the first quarter of 2007 and do not anticipate increases to the amounts
detailed above.
103
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 11 - FINANCIAL RISK MANAGEMENT AND DERIVATIVES
Our financing arrangements and notes payable (see Notes 8 and 9) incur interest
expense at variable rates, exposing us to interest rate risk. We have
established a policy for risk management and our objectives and strategies for
the use of derivative instruments to potentially mitigate such risk. We
currently manage a portion of our interest rate risk resulting from the exposure
to variable rates on our financing agreements through the use of interest rate
swaps indexed to the BMA rate, the most widely used tax-exempt floating rate
index, or to LIBOR. Under each swap agreement, for a specified period of time we
are required to pay a fixed rate of interest on a specified notional amount to
the transaction counterparty and we receive a floating rate of interest
equivalent to the BMA or LIBOR index. The average BMA rate was 3.45% in 2006,
2.45% in 2005 and 1.22% in 2004. The average LIBOR rate was 5.13% in 2006, 3.46%
in 2005 and 1.54% in 2004.
At inception, we designate these swaps as hedging instruments in cash flow
hedges with the hedging relationships item being the variable interest payments
on our floating rate debt. We assess both at the inception of the hedge and on
an ongoing basis whether the swap agreements are effective in offsetting changes
in the cash flows of the hedged financing. Amounts in accumulated other
comprehensive income will be reclassified into earnings in the same period
during which the hedged forecasted transaction affects earnings. Since we are
hedging the variable interest payments in our floating rate debt, the forecasted
transactions are the interest payments. An inherent risk of these swap
agreements is the credit risk related to the counterparty's ability to meet
terms of the contracts with us.
We have entered into swap agreements as follows:
Notional
Amount at December 31,
Counterparty (in millions) Inception Date Expiration Date Rate
------------------------------- ---------------------- -------------- --------------- -----------------
2006 2005
-------- --------
CASH FLOW HEDGES:
Merrill Lynch Capital Services, Inc. $ -- $ 50.0 January 2001 January 2006 3.98%
Bank of America 100.0 100.0 January 2005 December 2007 2.56%
Bank of America 50.0 50.0 January 2005 January 2008 2.00% in 2005,
2.78% in 2006
and 3.27% in 2007
Bank of America 50.0 50.0 January 2005 January 2008 2.86%
Bank of America 50.0 50.0 January 2005 January 2009 3.08%
RBC Capital Markets 100.0 100.0 January 2005 January 2009 3.075%
Wachovia (1) 275.0 -- August 2006 August 2009 5.25%
Bank of America 100.0 100.0 January 2005 January 2010 3.265%
------ ------
Subtotal cash flow hedges 725.0 500.0
------ ------
FAIR VALUE SWAP:
Bank of America -- 26.0 November 2005 November 2014 4.92%
------ ------
Total $725.0 $526.0
====== ======
(1) We entered into a new $275.0 million interest rate swap during 2006 in
connection with our new term loan and revolving credit facility (see Note
9).
We evaluate our interest rate risk on an ongoing basis to determine whether it
would be advantageous to engage in any further hedging transactions.
104
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
For the cash flow hedge swaps in place and others that have expired, there was
ineffectiveness for certain of our swaps in the hedging relationships during the
three years ended December 31, 2006. We recorded ineffectiveness of
approximately $1.5 million.
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 Note 4). 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.
For discussion of derivatives related to consolidated partnerships, see Note 7.
Interest rate swaps for which we are in a net settlement liability position are
recorded in accounts payable, accrued expenses and other liabilities and those
for which we are in a net settlement asset position are recorded in other
assets. The amounts recorded at December 31 were as follows:
(In thousands) 2006 2005
--------------------------------------- -------- --------
Net liability position $1,997 $ 208
Net asset position $2,236 $4,857
Interest expense included the following expense (income) related to our swaps
for the years ended December 31:
(In thousands) 2006 2005 2004
------------------------------------------ -------- ------- -------
Interest expense $ 448 $ 2,963 $ 1,807
Interest income (2,299) (219) (82)
Change in fair value of free standing swap
assigned to AMAC (203) 203 --
------- ------- -------
Total $(2,054) $ 2,947 $ 1,725
======= ======= =======
We estimate that approximately $2.9 million of net unrealized gain included in
accumulated other comprehensive income will be reclassified into interest
expense within the next twelve months, due to the fact our swaps have been and
we expect they will continue to be effective.
NOTE 12 - INCOME TAXES
A large majority of our pre-tax income is derived from our Portfolio Investing
businesses and the Fund Management businesses we acquired with ARCap, which are
structured as flow-through entities; as such, the income from those investments
does not subject us to income taxes. The remainder of the Fund Management
business and the entire Mortgage Banking business are conducted in corporations
and are subject to income taxes.
The components of our pre-tax income were as follows:
(In thousands) 2006 2005 2004
-------------------------------- -------- -------- --------
Not subject to tax $ 79,341 $ 79,309 $ 80,085
Subject to tax (31,555) (48,872) (31,965)
-------- -------- --------
Total income before income taxes $ 47,786 $ 30,437 $ 48,120
======== ======== ========
105
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The income tax (benefit) provision consisted of the following components:
(In thousands) 2006 2005 2004
--------------------------------- -------- -------- --------
Current:
Federal $ 1,107 $ (1,783) $ 2,279
State and local 3,230 1,384 1,022
-------- -------- --------
Total current 4,337 (399) 3,301
Deferred:
Federal (17,560) (18,012) (13,286)
State and local (9,436) (10,166) (7,258)
-------- -------- --------
Total deferred (26,996) (28,178) (20,544)
Valuation allowance 29,151 -- --
-------- -------- --------
Total tax provision (benefit) $ 6,492 $(28,577) $(17,243)
======== ======== ========
The tax provision (benefit) does not include:
(1) the current tax benefit related to additional tax deductions for share
based compensation which was credited to beneficial owners' equity; or
(2) the deferred tax benefit and related valuation allowance resulting
from unrealized losses on derivative contracts which was credited to
other comprehensive income.
Deferred income tax assets and liabilities are computed based on temporary
differences between the financial statement and income tax bases of assets and
liabilities that existed at the balance sheet date.
A reconciliation of the statutory federal tax rate to our effective tax rate is
as follows:
2006 2005 2004
------ ------ ------
Statutory tax rate 35.0 % 35.0 % 35.0 %
Partnership income not subject to tax (54.2) (89.6) (56.4)
State and local taxes, net of federal benefit (8.6) (19.0) (8.2)
SCUs / SMUs (see Note 13) (13.0) (13.2) (3.4)
Valuation allowance 61.1 -- --
Tax-exempt interest (5.3) (6.1) --
Share based compensation (0.5) (0.7) (1.4)
Other (0.9) (0.3) (1.4)
------ ------ ------
Effective tax rate 13.6 % (93.9)% (35.8)%
====== ====== ======
106
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The components of the deferred tax assets and (liabilities) are as follows:
(In thousands) 2006 2005
---------------------------------------------------- -------- --------
DEFERRED TAX ASSETS:
Deferred revenue $ 42,720 $ 31,142
Share based compensation 4,599 3,216
Unrealized loss on derivatives 5,273 1,331
Purchased servicing rights 1,632 --
Bad debt reserves 3,518 1,885
Partnerships and depreciation 2,996 --
Tax credits and state operating loss carry forwards 2,654 1,026
Other, net 396 415
-------- --------
Total deferred tax assets 63,788 39,015
-------- --------
DEFERRED TAX LIABILITIES:
Intangible assets (20,250) (26,575)
Deferred costs (1,119) (1,562)
Originated mortgage service rights (9,329) (9,029)
-------- --------
Total deferred tax liabilities (30,698) (37,166)
-------- --------
Valuation allowance (33,090) --
-------- --------
Net deferred tax asset $ -- $ 1,849
======== ========
At December 31, 2006, our corporate subsidiaries had the following carry
forwards:
(In thousands)
Low income housing credits (expiring starting in 2024) $ 1,234
Alternative minimum tax credits (do not expire) $ 1,420
In 2006, we determined that, in light of projected taxable losses in the
corporate subsidiaries for the foreseeable future, all of our deferred tax
assets will likely not be realized and therefore we have provided a full
valuation allowance.
The Internal Revenue Service is examining the consolidated corporate federal
income tax return for our subsidiaries subject to taxes for the tax periods
ended June 30, 2003, December 31, 2003 and December 31, 2004. The New York City
taxing authority is examining the partnership tax returns of one of our
subsidiaries for the years ended December 31, 2003 and December 31, 2004. These
examinations are in a preliminary stage and no significant issues have yet been
raised.
107
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 13 - SUBSIDIARY EQUITY
A. PREFERRED SHARES OF A SUBSIDIARY - SUBJECT TO MANDATORY REPURCHASE
Since June 1999, we have issued multiple series of Cumulative Preferred Shares,
which are subject to mandatory repurchase, through our Equity Issuer Trust I
("Equity Issuer") subsidiary.
Liquidation
Preferred Date of Mandatory Mandatory Number of Preference per Total Face Dividend
Series Issuance Tender Repurchase Shares Share Amount Rate
--------------------------------------------------------------------------------------------------------------------
(In thousands)
Series A June 1999 June 2009 June 2049 45 $2,000 $ 90,000 6.625%
Series A-1 July 2000 June 2009 June 2049 48 500 24,000 7.100%
Series A-2 October 2001 June 2009 June 2049 62 500 31,000 6.300%
Series A-3 June 2002 October 2014 October 2052 60 500 30,000 6.800%
Series B July 2000 November 2010 November 2050 110 500 55,000 7.600%
Series B-1 October 2001 November 2010 November 2050 37 500 18,500 6.800%
Series B-2 June 2002 October 2014 October 2052 50 500 25,000 7.200%
---------
Total $ 273,500
=========
We collectively refer to the Series A Cumulative Preferred Shares, Series A-1
Cumulative Preferred Shares, Series A-2 Cumulative Preferred Shares and Series
A-3 Cumulative Preferred Shares as the "Series A Shares." We collectively refer
to the Series B Subordinate Cumulative Preferred Shares, Series B-1 Subordinate
Cumulative Preferred Shares and Series B-2 Subordinate Cumulative Preferred
Shares as the "Series B Shares." We also collectively refer to the Series A
Shares and the Series B Shares as the "Preferred Shares."
The Series A Shares all have identical terms except as to the distribution
commencement date and other terms listed in the table above. Likewise, the
Series B Shares all have identical terms, except as to the distribution
commencement date and other terms listed in the table above. Equity Issuer may
not redeem the Preferred Shares before their mandatory repurchase dates. The
Preferred Shares are subject to mandatory tender for remarketing and purchase on
such dates and each remarketing date thereafter at their respective liquidation
amounts plus all distributions accrued but unpaid. Each holder of the Preferred
Shares will be required to tender its shares on the dates listed above, unless
Equity Issuer decides to remarket them. Holders of the Preferred Shares may
elect to retain their shares upon remarketing, with a new distribution rate to
be determined at that time by the remarketing agent. After the initial
remarketing dates, Equity Issuer may repurchase some or all of the Preferred
Shares, subject to certain conditions. The Preferred Shares are not convertible
into our common shares.
The Preferred Shares have annual preferred dividends payable quarterly in
arrears upon declaration by our Board of Trustees, but only to the extent of
tax-exempt net income for the particular quarter. With respect to payment of
distributions and amounts upon liquidation, dissolution or winding-up of our
Company, the Series A Shares rank, senior to:
o all classes or series of Convertible CRA Shares (see Note 14);
o all Series B shares; and
o our common shares.
With respect to payment of distributions and amounts upon liquidation,
dissolution or winding-up of our Company, the Series B Shares rank senior to our
Convertible CRA Shares and common shares.
Equity Issuer may not pay any distributions to the parent trust until it has
either paid all Preferred Share distributions, or in the case of the next
following distribution payment date, set aside funds sufficient for payment.
108
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Since issuance of the Preferred Shares, all quarterly distributions have been
declared at each stated annualized dividend rate for each respective series and
all distributions due have been paid.
Equity Issuer is subject to, among others, the following covenants with respect
to the Preferred Shares:
TAX-EXEMPT INTEREST AND DISTRIBUTION
Equity Issuer may only acquire new investments that it reasonably believes
will generate interest and distributions excludable from gross income for
federal income tax purposes. As soon as commercially practicable, Equity
Issuer will dispose of any investment if its interest becomes includable in
gross income for federal income tax purposes, for any reason.
LEVERAGE
Equity Issuer will not, and will not permit any of its subsidiaries to,
directly or indirectly, incur any obligation unless:
o Equity Issuer is not in default under its trust agreement;
o Equity Issuer has paid or declared and set aside for payment all
accrued and unpaid distributions on the Preferred Shares; and
o the leverage ratio on the portfolio is less than 0.6 to 1 after giving
effect to the incurrence of the obligation.
FAILURE TO PAY DISTRIBUTIONS
If Equity Issuer has not paid, in full, six consecutive quarterly
distributions on the Preferred Shares, it is required to reconstitute its
board of trustees so that a majority of the board of trustees consists of
trustees who are independent with respect to Equity Issuer, CharterMac and
CharterMac Capital.
ALLOCATION OF TAXABLE INTEREST INCOME AND MARKET DISCOUNT
Equity Issuer will specially allocate taxable interest income and market
discount that is taxable as ordinary income to us. Market discount, if any,
may arise where Equity Issuer acquires a bond other than upon its original
issuance for less than its stated redemption price at maturity and the
difference is greater than a minor amount (generally 1/4 of 1% of a bond's
stated redemption price at maturity multiplied by the number of complete
years to maturity).
In accordance with SFAS No. 150, ACCOUNTING FOR CERTAIN FINANCIAL INSTRUMENTS
WITH CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY ("SFAS No. 150") we classify
the Preferred Shares as liabilities in our balance sheet and include the
dividends paid for those share as interest expense in our consolidated
statements of income.
109
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
B. PREFERRED SHARES OF A SUBSIDIARY - NOT SUBJECT TO MANDATORY REPURCHASE
In May 2004, Equity Issuer issued the following Cumulative Preferred Shares,
which are not subject to mandatory repurchase:
Liquidation
Preferred Date of Number of Preference Total Face Dividend
Series Issuance Shares per Share Amount Rate
--------------------------------------------------------------------------------------
(In thousands)
Series A-4-1 May 2004 60 $500 $ 30,000 5.75%
Series A-4-2 May 2004 58 500 29,000 6.00%
Series B-3-1 May 2004 50 500 25,000 6.00%
Series B-3-2 May 2004 40 500 20,000 6.30%
---------
Total $ 104,000
=========
Except for the absence of a mandatory repurchase feature (and for specific terms
enumerated in the table above),
o the Series A-4-1and Series A-4-2 shares have the same characteristics
as the Series A Shares described above; and
o the Series B-3-1 and Series B-3-2 shares have the same characteristics
as the Series B shares described above.
In accordance with SFAS No. 150, as these shares are not subject to mandatory
repurchase, we classify them as mezzanine equity and the associated dividends
are classified outside of interest expense in the consolidated statements of
income.
C. MINORITY INTERESTS
Minority interests in consolidated subsidiaries consisted of the following at
December 31:
(In thousands) 2006 2005
-------------------------------- -------- --------
Convertible SCUs of a subsidiary $231,262 $250,866
Convertible SMUs of a subsidiary 5,110 11,408
Convertible SCIs of a subsidiary 4,758 --
Other 6,260 --
-------- --------
Total $247,390 $262,274
======== ========
Income (loss) allocated to minority interests was as follows for the years ended
December 31:
(In thousands) 2006 2005 2004
-------------------------- -------- -------- --------
SCUs $ 16,131 $ 23,091 $ 28,174
SMUs 102 330 --
SCIs 80 -- --
Other (219) -- 194
-------- -------- --------
Total $ 16,094 $ 23,421 $ 28,368
======== ======== ========
110
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
SCUS
In connection with our acquisition of CharterMac Capital, our subsidiary issued
membership interests in the form of 16.1 million special common units ("SCUs").
SCU holders are entitled to distributions at the same time as, and only if, we
pay distributions on our common shares. SCU distributions are calculated as the
amount of common share distributions divided by 0.72, to adjust for the taxable
nature of the income comprising the SCU distributions. SCU distributions are
payable only to the extent of the subsidiary's cash flow, supplemented by a loan
of all but $5.0 million from the parent trust in the event of a shortfall. Any
remaining shortfall will accrue interest at a market rate and will only be
payable at the time the subsidiary has sufficient cash flow.
Each holder of SCUs has the right to:
o exchange all or a portion of their SCUs for cash; and
o receive cash for any accrued but unpaid distributions with respect to
SCUs exchanged (not including accrued and unpaid distributions for the
quarterly period in which the exchange occurs).
Instead of cash, we may, at our discretion, exchange the SCUs (and any accrued
but unpaid distributions) for common shares on a one-for-one basis, subject to
anti-dilution adjustments. We would issue the common shares at a price equal to
the average closing market price of our common shares for the five consecutive
trading days prior to the date when we receive notice of intent to convert. Our
subsidiary may not pay any distributions to the parent trust until it has paid
all SCU distributions. Through December 31, 2006, all SCU distributions have
been paid.
As of December 31, 2006, there were approximately 14.8 million SCUs outstanding
and approximately 14.9 million were outstanding at December 31, 2005.
SMUS
The Special Membership Units ("SMUs") outstanding were issued in connection with
the CCLP acquisition (See Note 2). Additional SMUs which were issued in
connection with a preferred investment in CCA (see Note 4) were returned and/or
cancelled in connection with the closure of CRES (see Note 2).
SMU holders are entitled to distributions at the same time as, and only if, we
pay distributions on our common shares. SMU distributions were initially $1.69
per year, subject to adjustment in the amount of 95% of the percentage increases
or decreases in the dividends paid by us on the common shares. Distributions
paid to SMU holders consist of taxable income.
Each holder of SMUs has the right to:
o exchange all or a portion of their SMUs for cash; and
o receive cash for any accrued but unpaid distributions with respect to
SMUs exchanged (not including accrued and unpaid distributions for the
quarterly period in which the exchange occurs).
Instead of cash, we may, at our discretion, exchange the SMUs (and any accrued
but unpaid distributions) for common shares on a one-for-one basis, subject to
anti-dilution adjustments. We would issue the common shares at a price equal to
the average closing market price of our common shares for the five consecutive
trading days prior to the date when we receive notice of intent to convert.
Our subsidiary may not pay any distributions to the parent trust until it has
paid all SMU distributions. Through December 31, 2006, all SMU distributions
have been paid.
As of December 31, 2006, there were approximately 278,000 SMUs outstanding and
approximately 539,000 were outstanding at December 31, 2005.
111
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
SCIS
In connection with our acquisition of ARCap (see Note 2), our subsidiary issued
membership interests in the form of approximately 268,000 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.
Each holder of SCIs 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
SCIs 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 for the five consecutive
trading days prior to the date when we receive notice of intent to convert.
As of December 31, 2006, there were approximately 268,000 SCIs outstanding.
OTHER
"Other" minority interests at December 31, 2006, primarily represent the 10%
interest in Centerbrook owned by IXIS. IXIS has been issued warrants which,
generally, may be exercised beginning June 2009, and if exercised, would
increase IXIS' ownership percentage to 19%. We purchased the outstanding
minority interest in CMC during the first quarter of 2005 (see Note 2).
NOTE 14 - SHAREHOLDERS' EQUITY
A. SPECIAL PREFERRED VOTING SHARES
Each holder of SCUs (see Note 13) also holds one special preferred voting share
(at a par value of $.01 per share) for each SCU. The special preferred voting
shares have no economic interest, but entitle the holder to vote, on a
one-for-one basis, on all matters subject to a vote of our common shareholders.
We have the right to require that each special preferred voting share be
redeemed at par and cancelled simultaneously upon the exchange of an SCU by its
holder into cash or a common share. Other than the payment of $.01 per share
upon redemption of the special preferred voting shares or the liquidation of our
Company, the special preferred voting shares are not entitled to any
distributions or other economic rights.
The selling principals of CharterMac Capital entered into a voting agreement
which governs the voting of all of their:
o special preferred voting shares,
o common shares issuable upon exchange of their SCUs, and
o any other common shares currently owned or which may be acquired by
them in the future.
The voting agreement provides that the selling principals of CharterMac Capital
will:
o vote their common shares or special preferred voting shares in favor
of the election of any independent trustee approved by our board of
trustees or in the same proportion as the unaffiliated holders of our
common shares vote in such election; and
112
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
o not exercise any right as shareholder of our Company to nominate any
independent trustee.
With the exception of Stephen M. Ross (see Note 18), the voting agreement will
terminate for each of the remaining selling principals at the time he or she is
no longer an employee, officer, or trustee of our Company. The voting agreement
with respect to Mr. Ross will remain in effect as long as he owns any of our
special preferred voting shares or common shares.
B. CONVERTIBLE CRA SHARES
Our Convertible Community Reinvestment Act Preferred Shares ("Convertible CRA
Shares") enable financial institutions to receive certain regulatory benefits in
connection with their investment. We have developed a proprietary method for
allocating these regulatory benefits to specific financial institutions that
invest in the Convertible CRA Shares. Other than the preferred allocation of
regulatory benefits, the preferred investors receive the same economic benefits
as our common shareholders including:
o receipt of the same dividends per share;
o pro rata allocation of earnings between the two classes of shares; and
o equal ranking with the common shares with respect to rights upon
liquidation, dissolution or winding up of our Company.
The Convertible CRA Shares have no voting rights, except on matters relating to
the terms of the Convertible CRA Shares or to amendments to our Trust Agreement
which would adversely affect the Convertible CRA Shares.
For Convertible CRA shares issued prior to 2002, the investors have the option
to convert their shares into common shares at a predetermined conversion price,
calculated as the greater of:
o our book value per common share as set forth in our most recently
issued annual or quarterly report filed with the SEC prior to the
respective Convertible CRA Share issuance date; or
o 110% of the closing price of a common share on the respective
Convertible CRA Share's pricing date.
For Convertible CRA Shares issued in 2002 and later, conversion into common
shares is on a one-for-one basis.
Upon conversion, the investors would no longer be entitled to a special
allocation of the regulatory benefit.
At December 31, 2006 and 2005, we had the following Convertible CRA Shares
outstanding:
(In thousands)
--------------
Convertible CRA Shares issued prior to 2002 998
Convertible CRA Shares issued 2002 and later 5,554
--------
Total outstanding 6,552
========
Common shares issuable upon conversion 6,487
========
C. 4.4% CONVERTIBLE CRA PREFERRED SHARES
Our 4.4% Cumulative Perpetual Convertible Community Reinvestment Act Preferred
Shares ("4.4% Convertible CRA Preferred Shares") have the same CRA related
benefits of the Convertible CRA Shares and likewise have no voting rights except
on certain matters relating to the terms of the 4.4% Convertible CRA Preferred
Shares or to amendments to our Trust Agreement which would adversely affect the
4.4% Convertible CRA Preferred Shares.
The shares rank senior to our common shares and the Convertible CRA Shares with
respect to rights upon liquidation, dissolution or winding up of our Company.
They rank senior to our common shares and the Convertible CRA Shares with
113
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
respect to distributions, which are cumulative and fixed at 4.4% of the
liquidation amount of $50 per share. The shares have no stated maturity.
Beginning July 2008, the 4.4% Convertible CRA Preferred Shares will be
convertible into our common shares at the option of the holders thereof at any
time at a conversion rate of approximately 1.81 common shares each (a total of
approximately 3.9 million common shares), subject to stipulated conversion
adjustment conditions. Also beginning July 2008, we may redeem the shares at a
price equal to their liquidation amount plus any accrued and unpaid
distributions. The shares are also subject to remarketing provisions beginning
in July 2015. All distributions have been paid through December 2006.
D. ISSUANCES AND CONVERSIONS
In June 2004, we sold 5.75 million common shares to the public for net proceeds
of approximately $105.5 million after deducting underwriting discounts and
commissions. The underwriters for this offering were Wachovia Securities, UBS
Securities LLC, RBC Capital Markets Corporation and Legg Mason Wood Walker.
As noted above, we issued approximately 2.2 million of our 4.4% Convertible CRA
Preferred Shares in July 2005 for gross proceeds of $108.0 million. Net of
underwriters fees and expenses, our net proceeds were approximately $104.5
million. Meridian Investments acted as placement agent for this offering.
Holders of Convertible CRA shares and subsidiary equity units converted holdings
as follows:
Number Common shares
Year converted issued Cash paid
------ --------- ------------- ---------
2004 Convertible CRA shares 1,627,691 1,600,028 --
SCUs 933,000 933,000 --
2005 SCUs 287,000 287,000 --
2006 SCUs 60,000 20,000 $723,000
SMUs 75,000 75,000 --
Additionally, in connection with the closure of CRES (see Note 2), we cancelled
approximately 114,000 SMUs and 72,000 others were returned to us. We reversed
the aggregate amount of approximately $4.1 million from minority interests to
goodwill.
E. DIVIDEND REINVESTMENT PLAN
In May 2000, we implemented a dividend reinvestment and common share purchase
plan. Under this plan, common shareholders may elect to have their distributions
automatically reinvested in additional common shares at a price equal to the
average of the high and low market price from the previous day's trading, and
make cash payments for further investment. As of December 31, 2006, there were
approximately 153,000 shares participating in the plan, which represented 354
investors.
F. REPURCHASES
The board of trustees has authorized the implementation of a common share
repurchase plan, enabling us to repurchase, from time to time, up to 1.5 million
common shares. This plan has no expiration date. The repurchases will be made in
the open market and the timing is dependent on the availability of common shares
and other market conditions. During 2006, we entered into a 10b5-1 trading plan
to facilitate the purchases of shares under this program.
114
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
In addition to the repurchase plan, we may repurchase shares from employees in
connection with tax withholding requirements upon vesting of restricted share
grants. We account for repurchased common shares as treasury shares of
beneficial interest.
During the years ended December 31, we repurchased shares as follows, including
shares we purchased through the 10b5-1 plan, shares purchased in 2006 prior to
implementing that plan, and via employee withholdings:
(in thousands) 2006 2005 2004
----------------------------------------------- ------- ------- ------
Number of shares 1,082 187 111
Cost, including commissions and service charges $20,883 $ 4,165 $2,592
All repurchases during 2005 or 2004 were in connection with employee
withholdings and there were no repurchases made under the repurchase plan during
those years.
Although additional shares may be repurchased in 2007, we are unable to estimate
how many.
G. ACCUMULATED OTHER COMPREHENSIVE INCOME
Changes in accumulated other comprehensive income were as follows:
Net Unrealized
Gain/(Loss) on Net Unrealized
Mortgage Gain/(Loss) on Accumulated Other
Revenue Bonds, Derivatives, Comprehensive
(In thousands) Net of Tax Net of Tax Other Income (Loss)
---------------------------- -------------- -------------- ------------ -----------------
Balance at January 1, 2004 $ 31,395 $ (2,959) $ 28,436
Period change (15,806) (1,078) (16,884)
--------- --------- ---------
Balance at December 31, 2004 15,589 (4,037) 11,552
Period change 82,669 5,848 $ 35 88,552
--------- --------- --------- ---------
Balance at December 31, 2005 98,258 1,811 35 100,104
Period change (32,535) (2,267) 1,561 (33,241)
--------- --------- --------- ---------
Balance at December 31, 2006 $ 65,723 $ (456) $ 1,596 $ 66,863
========= ========= ========= =========
NOTE 15 - SHARE BASED COMPENSATION
A. THE PLAN
As approved by shareholders in 1997 and amended and restated in 2003, we have an
Amended and Restated Incentive Share Plan (the "Plan"), the purpose of which is
to:
o attract and retain qualified persons as trustees and officers; and
o provide incentive and more closely align the financial interests of
our employees, officers and trustees with the interests of our
shareholders by providing them with a financial interest in our
success.
The compensation committee of our board of trustees administers the Plan.
Pursuant to the Plan, the maximum number of common shares that may be awarded is
the lesser of:
o 10% of the number of total shares outstanding (as defined in the Plan)
as of December 31 preceding issuances of such awards; and
115
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
o the limits prescribed by the national security exchange or national
quotation system on which the shares may then be listed.
The Plan allows for the issuance of share options, restricted share grants,
share appreciation rights, restricted and deferred shares, performance units and
performance shares.
B. SHARE OPTIONS
All options granted have an exercise price equal to or greater than the market
price of our common shares on the grant date. The maximum option term is ten
years from the date of grant and options granted pursuant to the Plan may vest
immediately upon issuance or over a period determined by our compensation
committee.
We granted the following options pursuant to the Plan (none were granted in
2004):
Weighted Weighted
Average Weighted Average
Year Number Exercise Price Average Term Vesting Period
---- ---------- -------------- ------------- ----------------
2005 656,515 $24.35 10.0 years 3.0 years
2006 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:
2006 2005
------ ------
Risk free interest rate 4.42% 3.01%
Expected years until exercise 1.71 2.00
Expected stock volatility 23.14% 20.38%
Dividend yield 8.11% 6.71%
The following table summarizes share option activity in our share option plans
as of the year ended December 31:
2006 2005 2004
------------------------- ----------------------- ------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
--------- -------- --------- -------- --------- --------
Outstanding at beginning
of year 1,510,341 $20.42 1,075,313 $17.36 1,119,914 $17.33
Granted 544,000 21.78 656,515 24.35 -- --
Forfeited -- -- -- -- (22,167) 17.56
Exercised (35,600) 21.18 (221,487) 17.18 (22,434) 15.73
--------- ------ --------- ------ --------- ------
Outstanding at end of year 2,018,741 $20.77 1,510,341 $20.42 1,075,313 $17.36
========= ====== ========= ====== ========= ======
(In thousands) 2006 2005 2004
--------------------------------------------- ------ ------ ------
Fair value of options granted during the year $ 852 $1,196 $ --
====== ====== ======
Compensation cost recorded $ 937 $ 895 $ 597
====== ====== ======
116
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
As of December 31, 2006
--------------------------------------------------
Weighted
Average
Weighted Remaining Aggregate
Average Contractual Intrinsic
Exercise Term Value
Options Price (in years) (in thousands)
--------- --------- ----------- --------------
Vested and expected to vest at
end of period 2,018,741 $ 20.77 7.2 $ 3,508
========= ========= ====== =========
Exercisable at end of year 943,751 $ 17.48 6.2 $ 2,032
========= ======== ====== =========
The aggregate intrinsic value in the table above represents the difference
between our closing common share price on December 31, 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.
The following table summarizes information about share options outstanding and
exercisable at December 31, 2006:
Weighted
Average
Remaining
Number Contractual Number
Exercise Price Outstanding Life (in Years) Exercisable
-------------- ----------- --------------- -----------
$11.56 51,576 3.3 51,576
$17.56 2,250 5.7 2,250
$17.78 800,000 6.9 400,000
$21.18 123,910 0.2 123,910
$21.61 20,000 8.4 6,667
$22.03 384,490 9.0 --
$24.44 636,515 8.0 359,348
--------- ------ ---------
2,018,741 7.2 943,751
========= ====== =========
C. NON-VESTED SHARES AND SCUS
We issue restricted share grants primarily in connection with acquisitions or
employee bonuses. In conjunction with the CharterMac Capital acquisition in
2003, we issued restricted common shares to various individuals who are either
employees of CharterMac Capital or are one of the selling principals, most of
which vested over periods ranging from three months to four years. During 2006,
in connection with the ARCap acquisition, we issued approximately 1.7 million
restricted common shares to ARCap employees (see Note 2), of which approximately
56,000 shares vested immediately, with the remaining vesting over a period of
one to four years.
Also, in conjunction with the CharterMac Capital acquisition, our subsidiary
issued SCUs to employees other than the selling principals. These SCUs vest over
periods ranging from three to four years.
117
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Activity with respect to non-vested shares and SCUs was as follows for the years
ended December 31:
Weighted Weighted
Average Average
Non-vested Grant Date Non-vested Grant Date
shares Fair Value SCUs Fair Value
---------- ---------- ---------- ----------
Non-vested at January 1, 2004 725,557 $ 19.33 217,300 $ 17.92
Granted 109,932 20.27 93,100 17.92
Vested (312,776) 19.40 -- --
Forfeited (28,022) 19.33 -- --
--------- --------- -------- ---------
Non-vested at December 31, 2004 494,691 19.37 310,400 17.92
--------- --------- -------- ---------
Granted 119,592 22.37 -- --
Vested (365,022) 19.78 -- --
Forfeited (8,067) 19.46 -- --
--------- --------- -------- ---------
Non-vested at December 31, 2005 241,194 20.25 310,400 17.92
--------- --------- -------- ---------
Granted 2,170,371 19.73 -- --
Vested (300,483) 20.06 (148,087) 17.92
Forfeited (22,511) 20.56 -- --
--------- --------- -------- ---------
Non-vested at December 31, 2006 2,088,571 $ 19.74 162,313 $ 17.92
========= ========= ======== =========
(In thousands) 2006 2005 2004
---------------------------------------------- ------- ------- -------
Compensation cost recorded, net of forfeitures $14,209 $ 7,543 $11,035
D. UNAMORTIZED COSTS AND SHARES AVAILABLE FOR GRANT
As of December 31, 2006, there was $35.3 million of total unrecognized
compensation cost related to share options and non-vested share-based
compensation grants. We expect to recognize this compensation cost over a
weighted-average period of 2.9 years.
As of December 31, 2006, there were approximately 3.8 million options or share
grants available for issuance under the Plan.
E. TRUSTEE GRANTS
Our independent trustees receive a portion of their annual compensation in
common shares. In 2006, we issued 5,862 shares for trustee compensation as
compared to 7,518 in 2005. An additional 5,047 were issued in January 2007 in
connection with 2006 services. Expense we recognized related to the 2005 grants
was approximately $150,000. Expense related to those shares issued in 2006 and
2007 was approximately $218,000.
118
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 16 - GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses consisted of the following for the years
ending December 31:
(In thousands) 2006 2005 2004
--------------------------------------------- -------- -------- --------
Salaries and benefits $ 94,916 $ 68,983 $ 56,044
Fund origination and property acquisition
expenses 12,338 15,704 15,980
Operating costs of real estate owned (Note 6) 4,861 3,218 --
Restructuring costs (Note 10) 1,446 -- --
Other general and administrative 52,087 40,708 29,282
-------- -------- --------
Total $165,648 $128,613 $101,306
======== ======== ========
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.
NOTE 17 - EARNINGS PER SHARE, PROFIT AND LOSS ALLOCATIONS AND DISTRIBUTIONS
We allocate the income of CCC (the subsidiary we created as CharterMac Capital's
direct parent) first to the holders of the SCUs for an amount based on a
proportionate share of net income. Beginning in 2005, we made a similar
allocation for SMU holders of our CM Investor subsidiary and also a similar
allocation beginning in 2006 for SCI holders of our ARCap subsidiary. We then
allocate the remaining profits to shareholders in accordance with their
percentage interests.
(In thousands, except per share amounts) Income Shares* Per Share
------------------------------------------------ -------- ------- ---------
2006:
----
Net income $41,294
Preferred dividends 4,752
-------
Net income allocable to shareholders (Basic EPS) 36,542 58,154 $ 0.63
========
Effect of dilutive securities -- 557
------- -------
Diluted EPS $36,542 58,711 $ 0.62
======= ======= ========
2005:
----
Net income $59,014
Preferred dividends 2,020
-------
Net income allocable to shareholders (Basic EPS) 56,994 58,018 $ 0.98
========
Effect of dilutive securities -- 273
------- -------
Diluted EPS $56,994 58,291 $ 0.98
======= ======= ========
2004:
----
Net income allocable to shareholders (Basic EPS) $65,363 54,786 $ 1.19
========
Effect of dilutive securities -- 361
------- -------
Diluted EPS $65,363 55,147 $ 1.19
======= ======= ========
* Includes common and Convertible CRA Shares (see Note 14).
119
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 18 - RELATED PARTIES
A. TRCLP
General and administrative expenses include shared service fees paid or payable
to The Related Companies, L.P. ("TRCLP"), a company owned by our chairman.
In addition, a subsidiary of TRCLP 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 fees, incentive management fees and expense
reimbursements from AMAC. These fees are included in "Fee income" or "Other
revenues" in the consolidated statements of 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 11). 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
December 31, there were advances to AMAC of $15.0 million outstanding under this
facility. Income we earn from this facility is included in "Other interest
income" in the consolidated statements of 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 $535.5 million in
loans on behalf of AMAC and received approximately $2.8 million of mortgage
banking fees from the borrowers. We also received approximately $739,000 in
referral and equity fees in connection with loans originated for TRCLP entities.
We record all of these fees in "Fee income" in the 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.
We serve as the collateral manager for AMAC's collateralized debt obligation
("CDO") offering of approximately $362.0 million in November 2006. We also
service all of the loans in AMAC's CDO, as well as other loans currently held by
AMAC outside of the CDO. In this capacity, we perform all primary servicing
functions as well as special servicing of any loans in default. We receive fees
from AMAC based on the dollar amount of loans we service and record these fees
in "Fee income" in the consolidated statements of income.
120
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
C. INCOME STATEMENT IMPACT
Fees paid to TRCLP and income earned from AMAC was as follows as of December 31:
(In thousands) 2006 2005 2004
---------------------------------------------- ------ ------ ------
Shared service fee expense $ 620 $ 507 $4,252
TRCLP property management services expense $4,277 $3,158 $1,751
AMAC asset management and incentive management
fee income and expense reimbursements $3,630 $4,926 $2,248
AMAC credit facility interest income $1,461 $ 87 $ 195
AMAC servicing fees $ 66 $ -- $ --
NOTE 19 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
(In thousands, except per share amounts) 2006 Quarter Ended (1)
----------------------------------------------
March 31 June 30 September 30 December 31
-------- -------- ------------ -----------
Total revenues $ 72,139 $ 79,231 $107,947 $127,942
Income before income taxes $ 11,738 $ 3,843 $ 21,804 $ 10,401
Net income $ 14,657 $ 4,248 $ 14,571 $ 7,818
Net income per share (4)
Basic $ 0.23 $ 0.05 $ 0.23 $ 0.11
Diluted $ 0.23 $ 0.05 $ 0.23 $ 0.11
Weighted average shares outstanding
Basic 58,578 58,639 58,015 57,878
Diluted 58,895 58,919 58,396 58,458
2005 Quarter Ended
--------------------------------------------------
March 31 June 30 September 30 December 31 (2)
-------- -------- ------------ ---------------
Total revenues (3) $ 57,946 $ 78,480 $ 78,844 $ 79,828
Income (loss) before income taxes $ 6,420 $ 19,109 $ 13,662 $ (8,754)
Net income $ 14,785 $ 19,444 $ 18,678 $ 6,107
Net income per share (4)
Basic $ 0.26 $ 0.34 $ 0.31 $ 0.08
Diluted $ 0.25 $ 0.33 $ 0.31 $ 0.08
Weighted average shares outstanding
Basic 57,821 57,890 58,059 58,294
Diluted 58,236 58,274 58,366 58,532
(1) Includes expense related to valuation allowances recorded against deferred
tax assets (see Note 12) of $1.2 million during March 31 quarter, $8.1
million during June 30 quarter, $10.2 million during September 30 quarter
and $9.7 million during December 31 quarter.
(2) Includes a $22.6 million non-cash pre-tax charge (equal to $12.3 million
after tax, or $0.21 per basic and diluted share) related to the write-off
of the "Related Capital Company" trade-name intangible asset (see Note 5).
(3) Includes reclassification adjustments related to real estate owned from a
"Held for Sale" classification to "Held and Used" (see Note 6).
(4) The total for the year may differ from the sum of the quarters as a result
of weighting.
121
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 20 - BUSINESS SEGMENTS
We operate in four business segments:
1. Portfolio Investing, which includes subsidiaries that invest primarily in
tax-exempt first mortgage revenue bonds issued by various state or local
governments, agencies or authorities and other investments. 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
pre-liquidation investment in a fund that CRES sponsored.
2. Fund Management, which includes:
o Tax Credit Fund Sponsorship - 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 High Yield CMBS Fund Sponsorship - subsidiaries that sponsor and
manage funds that invest in high yield real estate instruments
including B-Notes, bridge loans, mezzanine loans and subordinated
interests associated with CMBS, commercial real estate mortgages and
similar investments. These subsidiaries also hold, for investment,
investments like the ones held by sponsored funds. These subsidiaries
earn income and promotes from equity investments in the sponsored
funds and interest income from their investments;
o Advisory Services - subsidiaries that provides advisory services to
the parent trust, other subsidiaries of ours and to AMAC;
o Direct Loan Fund Sponsorship - our equity interest in ARESS;
o Equity Fund Sponsorship - our membership interest in CUC; and
o Credit Intermediation - subsidiaries that participate in credit
intermediation transactions, including those for pools of mortgage
loans and provide specified returns to investors in LIHTC equity funds
and credit intermediation to our portfolio investing businesses, in
exchange for fees.
3. Mortgage Banking, which includes subsidiaries that originate and underwrite
predominantly multifamily mortgage loans on behalf of third parties,
including:
o Fannie Mae;
o Freddie Mac;
o the FHA;
o GNMA;
o AMAC and ARESS; and
o Insurance companies and conduits.
In exchange for these activities, we receive origination fees.
This segment also includes subsidiaries that provide multifamily and
commercial loan servicing for third parties and special servicing on the
CMBS securitizations 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.
This segment also earns interest income on escrow and reserve balances held
on loans we service.
122
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
4. Consolidated Partnerships, which primarily include the LIHTC equity funds
and debt 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 and Direct
Loan Investing 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.
123
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The following table provides more information regarding our segments:
(In thousands) 2006 2005 2004
--------------- --------------- -------------
REVENUES
Portfolio Investing $ 203,632 $ 169,355 $ 142,911
Fund Management (1) 131,365 117,752 92,663
Mortgage Banking (1) 62,797 43,572 21,028
Consolidated partnerships (2)(3) 83,738 24,096 12,213
Elimination of intersegment transactions (94,273) (59,678) (36,383)
----------- ----------- -----------
Consolidated $ 387,259 $ 295,097 $ 232,432
=========== =========== ===========
CAD
Portfolio Investing $ 101,022 $ 102,927 $ 106,317
Fund Management (1) 59,550 58,010 52,215
Mortgage Banking (1) 20,199 14,871 4,388
----------- ----------- -----------
Total Segment CAD 180,771 175,808 162,920
Preferred dividends (4,752) (2,020) --
Subsidiary equity distributions (35,553) (34,666) (33,036)
Dividends on subsidiary preferred stock (25,123) (25,123) (22,840)
Current tax benefit (expense) (4,313) 711 (3,413)
----------- ----------- -----------
Consolidated CAD 111,030 114,710 103,631
Fees deferred for GAAP (4) (30,426) (23,930) (27,096)
Depreciation and amortization expense
(including write off of intangible assets) (50,171) (66,762) (30,407)
Interest income yield adjustments (5) (4,137) 596 85
Gain on sale of loans (6) 10,855 11,140 6,805
Loss on impairment of assets (5,003) (4,555) (757)
Tax adjustment (7) (2,180) 27,866 20,655
Non-cash compensation (8) (19,348) (8,541) (11,753)
Non-cash equity income 6,253 (358) (281)
Difference between subsidiary equity
distributions and income allocated to
subsidiary equity holders(9) 19,243 11,245 4,862
Preferred dividends 4,752 2,020 --
Other, net 426 (4,417) (381)
----------- ----------- -----------
Consolidated Net Income $ 41,294 $ 59,014 $ 65,363
=========== =========== ===========
DEPRECIATION AND AMORTIZATION (10)
Portfolio Investing $ 9,097 $ 5,250 $ 3,357
Fund Management (1) (10) 20,735 41,734 18,974
Mortgage Banking (1) 20,339 19,778 8,076
----------- ----------- -----------
Consolidated $ 50,171 $ 66,762 $ 30,407
=========== =========== ===========
IDENTIFIABLE ASSETS AT DECEMBER 31
Portfolio Investing $ 5,047,923 $ 5,481,974
Fund Management (1) 1,388,811 800,684
Mortgage Banking (1) 301,532 353,996
Consolidated partnerships (2)(3) 6,064,476 3,610,031
Elimination of intersegment balances (3,114,226) (3,274,518)
----------- -----------
Consolidated $ 9,688,516 $ 6,972,167
=========== ===========
(1) Includes ARCap as of August 2006.
(2) Consolidated beginning April 2004 pursuant to FIN 46(R). See Notes 1 and 7.
(3) Includes funds sponsored by ARCap as of August 2006.
(4) 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).
124
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(5) Represents the adjustment for amortization of bond discounts or premiums
that are recognized immediately for CAD but are deferred and recognized over
time for GAAP accounting, as well as the difference between actual interest
income received and income recognized under the effective yield method.
(6) Represents non-cash gain recognized on sale of mortgage loans when servicing
rights are retained and gains on sales of mortgage revenue bonds.
(7) Represents the difference between the tax benefit or provision recorded and
the net cash amount we expect to pay or receive in relation to the current
period.
(8) Represents the add-back of amortization of costs recognized for share-based
compensation, share-based trustee fees and employee sharing in fund profits.
(9) 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.
(10) 2006 and 2005 include write-offs of goodwill and intangible assets.
NOTE 21 - COMMITMENTS AND CONTINGENCIES
PRS/CRG/ ERC, INC.
PRS/ CRG
PRS Companies ("PRS") and Capital 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. A construction affiliate of
PRS served as general contractor for most of these partnerships. Due to
financial difficulties experienced by PRS and its construction affiliate, we
ceased our business dealings with PRS and acquired the general partner interest
in certain partnerships sponsored by PRS as part of agreements reached in April
of 2005 (the "PRS Partnerships"). There were two additional projects for which
the PRS construction affiliate was general contractor (the "GCG Partnerships")
for which the general partner interest owned by PRS or an affiliate were
transferred at the same time.
Likewise, we entered into agreements with CRG with respect to certain
partnerships in which CRG served as sponsor in April of 2005 (the "CRG
Partnerships"). The PRS financial difficulties created construction finance
shortfalls that have created liquidity problems for these partnerships as well.
In December of 2006, we entered into an additional agreement with CRG to
transfer the general partner interests held by CRG in four additional
properties. This agreement included the termination of certain rights retained
by CRG with respect to the CRG Partnerships in the 2005 Agreements and we have
ceased our business dealings with CRG.
The PRS Partnerships, GCG Partnerships, and CRG Partnerships are set out in the
table on page 126.
In addition to the PRS Partnerships, CRG Partnerships and GCG Partnerships
described above, we own bonds that finance other partnerships associated with
PRS and CRG. In these partnerships our funds are not the equity sponsor, and 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 2005, we halted construction on one property, and foreclosed upon and sold
the property in 2006 for our carrying basis. In 2006, we halted construction on
another property and sold our general partner and limited partner interest and
have recovered our fund's investment in the project.
ERC
To protect our interests in properties for which we had provided debt or equity
financing, in October 2006 we reached an agreement with ERC, Inc. (a developer)
to acquire its general partner interests in partnerships it had sponsored. Those
partnerships are also summarized in the table below.
125
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Two of the properties are under construction, and we expect that the equity of
the applicable property partnerships is sufficient to cover the estimated costs
to complete these two properties. 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 the future equity payments due these partnerships will be sufficient
to repay the advances.
The partnerships in question are summarized as follows:
(In thousands)
---------------------------
Fair Value of
CharterMac CharterMac Mortgage
Holds or Capital Loan Revenues
Will Hold Sponsored Included in CharterMac Third Amounts Bonds
Mortgage Fund is Credit Capital Parties Upon Full Outstanding at
Revenue Equity Intermediated Holds GP Provided Draw December 31,
Number Bond Partner Funds Interest Equity Down 2006
------- ---------- ---------- ------------- ---------- -------- --------- --------------
PRS PARTNERSHIPS
Lease-Up 10 9 5 3 5 5 $103,846 $101,361
Rehab 1 1 1 1 1 -- 19,300 20,126
Stabilized 2 2 -- -- -- 2 18,407 18,921
------------------------------------------------------------------------------------------------------------------
Subtotal 13 12 6 4 6 7 141,553 140,408
------------------------------------------------------------------------------------------------------------------
CRG PARTNERSHIPS
Lease-Up 4 2 4 3 2 -- 19,975 20,086
Rehab 2 2 2 2 2 -- 61,912 62,892
------------------------------------------------------------------------------------------------------------------
Subtotal 6 4 6 5 4 -- 81,887 82,978
------------------------------------------------------------------------------------------------------------------
GCG PARTNERSHIPS
Construction 1 1 1 1 -- -- 16,600 16,600
Lease-Up 1 1 1 -- -- -- 13,170 13,471
------------------------------------------------------------------------------------------------------------------
Subtotal 2 2 2 1 -- -- 29,770 30,071
------------------------------------------------------------------------------------------------------------------
ERC PARTNERSHIPS
Construction 2 2 2 2 2 -- 16,950 17,463
Lease-Up 14 13 14 13 14 -- 111,842 112,799
Stabilized 2 2 2 1 2 -- 9,408 9,755
------------------------------------------------------------------------------------------------------------------
Subtotal 18 17 18 16 18 -- 138,200 140,017
------------------------------------------------------------------------------------------------------------------
Total 39 35 32 26 28 7 $391,410 $393,474
==================================================================================================================
Total eliminated in consolidation $286,338 $290,408
===========================
Our potential exposure falls into three categories as follows:
Cash required to bring the properties to break-even operation - As of
December 31, 2006, advances outstanding totaled approximately
$37.8 million, although we recovered approximately $12.1 million
in January 2007. These advances, and additional loans, are
assessed periodically for collectability and the impact on the
potential impairment of existing mortgage revenue bonds. At
present, we do not anticipate that any such advances would require
a charge to expense. Based on lease-up estimates and projected
costs to complete construction, we currently estimate that we will
not need to advance funds materially in excess of advances made to
date.
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.
126
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Potential cost to provide specified yields - As noted in the table
on page 126, 26 of the partnerships 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.
There can be no assurance that a bankruptcy by or against PRS or its affiliates
or against ERC may not give rise to additional claims concerning these
partnerships.
FORWARD TRANSACTIONS
At December 31, 2006, our Mortgage Banking subsidiaries had forward commitments
of approximately $181.8 million for mortgages to be funded in 2007 and later and
each lending commitment has an associated sale commitment. In addition, those
subsidiaries had commitments to sell mortgages totaling $143.3 million.
Approximately $122.5 million of this amount was funded as of December 31, 2006,
and is included in "Other Investments" as "Mortgage Loans Held for Sale" (see
Note 4). The balance of approximately $20.8 million is to be funded in 2007.
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 $24.8 million by the end of 2007.
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 $8.3
million at December 31, 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 December 31, 2006, substantially all 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.
127
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Our maximum exposure at December 31, 2006, pursuant to these agreements, was
approximately $816.3 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 December 31, 2006, that reserve was
approximately $13.1 million, which, we believe, represents our actual potential
losses at that time.
As of December 31, 2006, our Mortgage Banking subsidiaries maintained,
collateral consisting of treasury notes, and Fannie Mae and Freddie Mac
securities of approximately $900,000 and a money market account of approximately
$12.4 million, which is included in "Restricted cash" in the consolidated
balance sheet, to satisfy the Fannie Mae collateral requirements of $11.3
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 December 31, 2006, commitments under this reimbursement
agreement totaled $2.9 million.
YIELD TRANSACTIONS
We have entered into several credit intermediation agreements with either 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 15 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 $1.1
billion, 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 $30.2 million as of December 31, 2006. This amount is
included in "Deferred revenues" within "Accounts payable, accrued expenses and
other liabilities" on our consolidated balance sheet (see Note 10). Refer also
to PRS / CRG / ERC 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 8). 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
128
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
maximum aggregate exposure relating to these transactions is approximately
$211.4 million as of December 31, 2006. The fair value of these obligations,
representing the deferral of the fee income over the obligation periods, was
approximately $1.0 million as of December 31, 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 December 31, 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 asseted against subsidiaries of the Company in two 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. One of the lawsuits claims unspecified
damages while the other lawsuit claims damages of $10.0 - 15.0 million. One suit
(with unspecified damages claimed) is scheduled for trial in May 2008. The
parties are engaged in discovery and have entered into 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.
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 membership 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 December 31, 2006, was approximately
$147,000 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 December 31,
2006, our remaining unfunded capital commitments were $14.8 million to ARESS
(see Note 1) and $1.8 million to CMBS Partnerships.
129
CHARTERMAC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
LEASE OBLIGATIONS
The future minimum payments and income from subleases for operating leases as of
December 31, 2006, were as follows:
Minimum Net minimum
lease Sublease lease
(in thousands) payments income payments
------------------------ -------- -------- -----------
Year Ending December 31,
2007 $ 8,717 $(1,174) $ 7,543
2008 8,817 (1,359) 7,458
2009 8,276 (1,222) 7,054
2010 8,384 (1,293) 7,091
2011 7,061 (1,317) 5,744
Thereafter 37,950 (1,619) 36,331
------- ------- -------
Total $79,205 $(7,984) $71,221
======= ======= =======
We recorded rent expense of approximately $8.9 million in 2006, $8.4 million in
2005 and $3.3 million in 2004 (including amounts paid to TRCLP in 2004).
NOTE 22 - SUBSEQUENT EVENTS
In March 2007, we entered into a 10b5-1 plan whereby we plan to purchase up to
9.8% of the outstanding shares of AMAC in open-market purchases based on
pre-determined parameters. We can not estimate how many shares we will purchase
in 2007.
130
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
ITEM 9A. CONTROLS AND PROCEDURES.
(a) Evaluation of Disclosure Controls and Procedures. Our Chief
Executive Officer and Chief Financial Officer have evaluated the
effectiveness of our disclosure controls and procedures (as
defined in Rule 13a-15(e) or Rule 15a-15(e) under the Securities
Exchange Act of 1934, as amended (the "Exchange Act")) as of the
end of the period covered by this annual report. Based on such
evaluation, such officers have concluded that our disclosure
controls and procedures as of the end of the period covered by
this annual report were 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 period to which this report relates that
have materially affected, or are reasonably likely to materially
affect, our internal control over financial reporting. Refer to
MANAGEMENT'S REPORT ON THE EFFECTIVENESS OF INTERNAL CONTROL OVER
FINANCIAL REPORTING on page 57.
ITEM 9B. OTHER INFORMATION.
None.
131
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
The information required by this item is incorporated herein by
reference to our definitive proxy statement to be filed pursuant to
Regulation 14A under the Exchange Act.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this item is incorporated herein by
reference to our definitive proxy statement to be filed pursuant to
Regulation 14A under the Exchange Act.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.
The information required by this item is incorporated herein by
reference to our definitive proxy statement to be filed pursuant to
Regulation 14A under the Exchange Act.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE.
The information required by this item is incorporated herein by
reference to our definitive proxy statement to be filed pursuant to
Regulation 14A under the Exchange Act.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.
The information required by this item is incorporated herein by
reference to our definitive proxy statement to be filed pursuant to
Regulation 14A under the Exchange Act.
132
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
Sequential
Page
----------
(a)1. Financial Statements
Report of Independent Registered Public Accounting Firm 61
Consolidated Balance Sheets as of December 31, 2006 and 2005 62
Consolidated Statements of Income for the years ended December 31,
2006, 2005 and 2004 63
Consolidated Statements of Shareholders' Equity for the years ended
December 31, 2006, 2005 and 2004 64
Consolidated Statements of Cash Flows for the years ended December 31,
2006, 2005 and 2004 67
Notes to Consolidated Financial Statements 69
(a)2. Financial Statement Schedules
Schedule I - Condensed Financial Information of Registrant 147
Schedule II - Valuation and Qualifying Accounts 151
All other schedules have been omitted because they are not applicable
or the required information is included in the consolidated financial
statements and the notes thereto.
(a)3. Exhibits
--------
3.1(a) Certificate of Business Trust dated as of August 12, 1996
(incorporated by reference to our Registration Statement on Form 10,
filed with the Commission on August 1, 1997).
3.1(b) Certificate of Amendment of the Restated Certificate of Business Trust
(incorporated by reference to our Registration Statement on Form S-8,
filed with the Commission on November 24, 2003).
3.1(c) Second Amended and Restated Trust Agreement dated as of November 17,
2003. (incorporated by reference to Exhibit 3.1(c) in our December 31,
2005 Annual Report on Form 10-K).
3.1(d) Amendment No. 1 to Second Amended and Restated Trust Agreement dated
as of September 20, 2005 (incorporated by referenced to our Current
Report on Form 8-K, filed with the Commission on September 22, 2005).
3.1(e) Amendment No. 2 to Second Amended and Restated Trust Agreement dated
as of November 30, 2005 (incorporated by referenced to our
Registration Statement on Form 8-A filed with the Commission on
January 3, 2006).
133
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----------
3.1(f) Amendment No. 3 to Second Amended and Restated Trust Agreement
(incorporated by reference to Exhibit 3.1(a) in our June 30, 2006
Quarterly Report on Form 10-Q).
3.2(a) Fourth Amended and Restated Bylaws (incorporated by referenced to
our Current Report on Form 8-K, filed with the Commission on September
22, 2005).
3.2(b) Amendment No. 1 to Fourth Amended and Restated Bylaws (incorporated
by reference to Exhibit 3.2(b) in our December 31, 2005 Annual Report
on Form 10-K).
4.1 Specimen Copy of Share Certificate for shares of our beneficial
interest (incorporated by reference to our Registration Statement on
Form S-8, filed with the Commission on November 24, 2003).
4.2 Certificate of Designation of Special Preferred Voting Shares, dated
November 17, 2003 (incorporated by reference to our Current Report on
Form 8-K, filed with the Commission on December 1, 2003).
10(a) Management Agreement dated as of November 17, 2003, between us and
Related Capital Company LLC (incorporated by reference to Exhibit
10(a) in our December 31, 2003 Annual Report on Form 10-K).
10(b) Contribution Agreement dated as of December 17, 2002 (incorporated by
reference to our Preliminary Proxy Statement on Schedule 14A filed on
February 2, 2003).
10(c) Amended and Restated Operating Agreement of CharterMac Capital
Company LLC, dated as of November 17, 2003 (incorporated by reference
to our Current Report on Form 8-K, filed with the Commission on
December 1, 2003).
10(d) Special Preferred Voting Shares Purchase Agreement, dated as of
November 17, 2003, by and among the Company and APH Associates L.P.,
DLK Associates L.P., Marc Associates, L.P., Related General II, L.P.
and SJB Associates L.P. (incorporated by reference to our Current
Report on Form 8-K, filed with the Commission on December 1, 2003).
10(e) Standstill Agreement, dated as of November 17, 2003, by and among the
Company and APH Associates L.P., DLK Associates L.P., Marc Associates,
L.P., Related General II, L.P. and SJB Associates L.P. (incorporated
by reference to our Current Report on Form 8-K, filed with the
Commission on December 1, 2003).
10(f) Voting Agreement, dated as of November 17, 2003, by and among the
Company and APH Associates L.P., DLK Associates L.P., Marc Associates,
L.P., Related General II, L.P. and SJB Associates L.P. (incorporated
by reference to our Current Report on Form 8-K, filed with the
Commission on December 1, 2003).
10(g) Exchange Rights Agreement, dated as of November 17, 2003, by and
among CharterMac Capital Company, LLC, CharterMac Corporation, APH
Associates L.P., DLK Associates L.P, Marc Associates, L.P., Related
General II, L.P. and SJB Associates L.P. (incorporated by reference to
our Current Report on Form 8-K, filed with the Commission on December
1, 2003).
10(h) Lock-up Agreement of Alan P. Hirmes, dated November 17, 2003
(incorporated by reference to our Current Report on Form 8-K, filed
with the Commission on December 1, 2003).
134
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----------
10(i) Lock-up Agreement of Marc D. Schnitzer, dated November 17, 2003
(incorporated by reference to our Current Report on Form 8-K, filed
with the Commission on December 1, 2003).
10(j) Lock-Up Agreement of Stephen M. Ross, dated November 17, 2003
(incorporated by reference to our Current Report on Form 8-K, filed
with the Commission on December 1, 2003).
10(k) Future Relations Agreement, dated as of November 17, 2003, by and
among Stephen Ross, Related General II L.P., RCMP Management Inc., the
Related Companies, L.P., and CharterMac Capital Company, LLC
(incorporated by reference to our Current Report on Form 8-K, filed
with the Commission on December 1, 2003).
10(l) Ross Non-Qualified Share Option Agreement (incorporated by reference
to our Registration Statement on Form S-8, filed on November 24,
2003).
10(m) Registration Rights Agreement, dated as of November 17, 2003, by and
among our Company and APH Associates L.P., DLK Associates L.P., Marc
Associates, L.P., Related General II, L.P. and SJB Associates L.P.
(incorporated by reference to our Registration Statement on Form S-8,
filed on November 24, 2003).
10(n) Shared Services Agreement, dated as of November 17, 2003, by and
among The Related Companies, L.P., Related Management Company, and
CharterMac Capital Company (incorporated by reference to our Current
Report on Form 8-K, filed with the Commission on December 1, 2003).
10(o) Other Services Agreement, dated November 17, 2003, by and between
Relcap Holding Company LLC and CharterMac Capital Company, LLC
(incorporated by reference to our Current Report on Form 8-K, filed
with the Commission on December 1, 2003).
10(p) CharterMac Guaranty, dated December 17, 2002 (incorporated by
reference to our Current Report on Form 8-K, filed with the Commission
on December 1, 2003).
10(q) Restricted Share Plan (incorporated by reference to our Registration
Statement on Form S-8, filed with the Commission on November 24,
2003).
10(r) Amended and Restated Incentive Share Plan (incorporated by reference
to our Form S-8/A, filed with the Commission on March 2, 2004).
10(s) Amendment to Amended and Restated Incentive Share Plan.*
10(t) Form of Non-Qualified Share Option Award Agreement. (incorporated by
reference to Exhibit 10(af) in our December 31, 2004 Annual Report on
Form 10-K).
10(u) Form of Restricted Share Award Agreement. (incorporated by reference
to Exhibit 10(ag) in our December 31, 2004 Annual Report on Form
10-K).
10(v) Separation and consulting agreement with Stuart J. Boesky
(incorporated by reference to our current report on Form 8-K, filed
with the Commission on November 9, 2005).
135
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----------
10(w) Amended and Restated Mortgage Warehousing Credit and Security
Agreement, dated as of March 18, 2005, by and between CharterMac
Mortgage Capital Corporation, Fleet National Bank, a Bank of America
Company, as Agent and Lenders, as amended. (incorporated by reference
to Exhibit 10(ag) in our December 31, 2005 Annual Report on Form
10-K).
10(x) Second Amended and Restated Advisory Services Agreement between
American Mortgage Acceptance Company and CharterMac AMI Associates,
Inc. (incorporated by reference to Exhibit 10(ak) in our December 31,
2005 Annual Report on Form 10-K).
10(y) First Amendment to Second Amended and Restated Advisory Services
Agreement between American Mortgage Acceptance Company and CharterMac
AMI Associates, Inc. dated July 26, 2006. *
10(z) First Amendment to the Loan Agreement between CharterMac and American
Mortgage Acceptance Company (incorporated by reference to our current
report on Form 8-K, filed with the Commission on April 26, 2006).
10(aa) Second Amendment to the Loan Agreement between Chartermac and
American Mortgage Acceptance Company (incorporated by reference to our
current report on Form 8-K, filed with the Commission on April 26,
2006).
10(ab) Amended and Restated Credit Note of American Mortgage Acceptance
Company (incorporated by reference to our current report on Form 8-K,
filed with the Commission on April 26, 2006).
10(ac) Limited Liability Company Agreement of Centerbrook Holdings LLC and
IXIS Financial Products Inc. and Charter Mac Corporation dated June
28, 2006 (incorporated by reference to Exhibit 10.1 in our June 30,
2006 Quarterly Report on Form 10-Q).
10(ad) Unitholder and Warrant Agreement among Centerbrook Holdings LLC,
IXIS Financial Products Inc. and Charter Mac Corporation, dated as of
June 28, 2006 (incorporated by reference to Exhibit 10.2 in our June
30, 2006 Quarterly Report on Form 10-Q).
10(ae) Limited Liability Company Agreement of Centerbrook Financial LLC,
dated as of June 28, 2006 (incorporated by reference to Exhibit 10.3
in our June 30, 2006 Quarterly Report on Form 10-Q).
10(af) Senior Loan Agreement among Centerbrook Financial LLC, the lenders
that are party thereto and Citibank, N.A., as senior agent, dated as
of June 28, 2006 (incorporated by reference to Exhibit 10.4 in our
June 30, 2006 Quarterly Report on Form 10-Q).
10(ag) Mezzanine Loan Agreement among Centerbrook Financial LLC, the
lenders that are party thereto and Citibank, N.A., as mezzanine agent,
dated as of June 28, 2006 (incorporated by reference to Exhibit 10.5
in our June 30, 2006 Quarterly Report on Form 10-Q).
10(ah) Subordination and Security Agreement among Centerbrook Financial
LLC, Deutsche Bank Trust Company Americas, and Citibank, N.A., as
senior agent and mezzanine agent, dated as of June 28, 2006
(incorporated by reference to Exhibit 10.6 in our June 30, 2006
Quarterly Report on Form 10-Q).
10(ai) Guarantee Agreement between CharterMac and IXIS Financial Products
Inc., dated as of June 28, 2006 (incorporated by reference to Exhibit
10.7 in our June 30, 2006 Quarterly Report on Form 10-Q).
136
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----------
10(aj) Right of First Refusal Letter Agreement among CharterMac and
Centerbrook Financial LLC, dated as of June 28, 2006 (incorporated by
reference to Exhibit 10.8 in our June 30, 2006 Quarterly Report on Form
10-Q).
10(ak) Fee Letter between IXIS Capital Markets North America Inc. and
Centerbrook Holdings LLC, dated as of June 28, 2006 (incorporated by
reference to Exhibit 10.9 in our June 30, 2006 Quarterly Report on Form
10-Q).
10(al) Credit Support Swap between Charter Mac Origination Trust 1 and
Centerbrook Financial LLC (incorporated by reference to Exhibit 10.10
in our June 30, 2006 Quarterly Report on Form 10-Q).
10(am) Securities Purchase Agreement, dated as of August 15, 2006, by and
among the Company, ARCap Investors, the Selling Members, ARCap REIT,
AISR, CM Corp and CM ARCap Investors (incorporated by reference to our
current report on Form 8-K, filed with the Commission on August 21,
2006).
10(an) Second Amended and Restated Limited Liability Company Agreement of
ARCap Investors, dated as of August 15, 2006, by and among CM ARCap
Investors, Leonard W. Cotton and James L. Duggins (incorporated by
reference to our current report on Form 8-K, filed with the Commission
on August 21, 2006).
10(ao) Exchange Rights Agreement, dated as of August 15, 2006, by and among
the Company, ARCap Investors, CM ARCap Investors, Leonard W. Cotton and
James L. Duggins (incorporated by reference to our current report on
Form 8-K, filed with the Commission on August 21, 2006).
10(ap) Registration Rights Agreement, dated as of August 15, 2006, by and
among the Company, CM ARCap Investors, Leonard W. Cotton and James L.
Duggins (incorporated by reference to our current report on Form 8-K,
filed with the Commission on August 21, 2006).
10(aq) Executive Employment Agreement, dated as of August 15, 2006, by and
between Leonard W. Cotton and ARCap REIT (incorporated by reference to
our current report on Form 8-K, filed with the Commission on August 21,
2006).
10(ar) Executive Employment Agreement, dated as of August 15, 2006, by and
between James L. Duggins and ARCap REIT (incorporated by reference to
our current report on Form 8-K, filed with the Commission on August 21,
2006).
10(as) Revolving Credit and Term Loan Agreement, dated as of August 15, 2006,
by and among the Company, CM Corp., the Guarantors listed on Schedule 1
thereto, the Lenders named therein, Bank of America, N.A. and UBS
Securities LLC, as agents, Bank of America, N.A., as issuing bank and
swingline lender and as administrative agent, and Banc of America
Securities, LLC and UBS Securities LLC, as joint lead arrangers and
joint book managers (incorporated by reference to our current report on
Form 8-K, filed with the Commission on August 21, 2006).
10(at) Restructuring Agreement, dated August 31, 2006, among Capri Realty
Holdings, LLC, Quintin Primo, Brian Fargo and Daryl Carter et al. and
CM Investor LLC (incorporated by reference to our current report on
Form 8-K, filed with the Commission on September 6, 2006).
137
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10(au) Employment Agreement, dated as of November 28, 2006, by and between
Alan Hirmes and CharterMac Capital LLC (incorporated by reference to
our current report on Form 8-K, filed with the Commission on December
4, 2006).
10(av) Executive Employment Agreement, dated as of November 28, 2006, by
and between Robert Levy and CharterMac Capital LLC (incorporated by
reference to our current report on Form 8-K, filed with the Commission
on December 4, 2006).
10(aw) Executive Employment Agreement, dated as of January 1, 2007, by and
between Marc D. Schnitzer and CharterMac Capital LLC (incorporated by
reference to our current report on Form 8-K, filed with the Commission
on February 7, 2007).
12 Ratio of earnings to fixed charges and preferred dividends.* 141
21 Subsidiaries of our Company.* 142
23 Consent of Independent Registered Public Accounting Firm* 143
31.1 Chief Executive Officer certification pursuant to Section 302 of the
Sarbanes- Oxley Act of 2002.* 144
31.2 Chief Financial Officer certification pursuant to Section 302 of the
Sarbanes- Oxley Act of 2002.* 145
32 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.* 146
* Filed herewith.
138
SIGNATURES
----------
Pursuant to the requirements of Section 13 or 15(d) 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
(COMPANY)
Date: March 9, 2007 By: /s/ Marc D Schnitzer
--------------------
Marc D. Schnitzer
Managing Trustee, Chief Executive Officer
and President
Date: March 9, 2007 By: /s/ Robert L. Levy
------------------
Robert L. Levy
Chief Financial Officer
139
POWER OF ATTORNEY
Each person whose signature appears below hereby constitutes and appoints Marc
D. Schnitzer and Robert L. Levy, and each or either of them, his true and lawful
attorney-in-fact with full power of substitution and resubstitution, for him and
in his name, place and stead, in any and all capacities, to sign any and all
amendments to this Annual Report, and to cause the same to be filed, with all
exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, hereby granting to said attorneys-in-fact
and agents, and each of them, full power and authority to do and perform each
and every act and thing whatsoever requisite or desirable to be done in and
about the premises, as fully to all intents and purposes as the undersigned
might or could do in person, hereby ratifying and confirming all acts and things
that said attorneys-in-fact and agents, or either of them, or their substitutes
or substitute, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended,
this report has been signed by the following persons on behalf of us and in the
capacities and on the dates indicated:
Signature Title Date
------------------------ ---------------------------- --------------
/s/ Stephen M. Ross Managing Trustee,
-------------------
Stephen M. Ross Chairman of the Board March 9, 2007
/s/ Leonard W. Cotton Managing Trustee,
---------------------
Leonard W. Cotton Vice-Chairman March 9, 2007
/s/ Marc D. Schnitzer Managing Trustee,
---------------------
Marc D. Schnitzer Chief Executive Officer and
President March 9, 2007
/s/ Alan P. Hirmes Managing Trustee,
------------------
Alan P. Hirmes Chief Operating Officer March 9, 2007
/s/ Peter T. Allen
------------------
Peter T. Allen Managing Trustee March 9, 2007
/s/ Jeff T. Blau
----------------
Jeff T. Blau Managing Trustee March 9, 2007
/s/ Janice Cook Roberts
-----------------------
Janice Cook Roberts Managing Trustee March 9, 2007
/s/ Robert J. Dolan
-------------------
Robert J. Dolan Managing Trustee March 9, 2007
/s/ Nathan Gantcher
-------------------
Nathan Gantcher Managing Trustee March 9, 2007
/s/ Jerome Y. Halperin
----------------------
Jerome Y. Halperin Managing Trustee March 9, 2007
/s/ Robert L. Loverd
--------------------
Robert L. Loverd Managing Trustee March 9, 2007
/s/ Robert A. Meister
---------------------
Robert A. Meister Managing Trustee March 9, 2007
/s/ Thomas W. White
-------------------
Thomas W. White Managing Trustee March 9, 2007
140
Exhibit 12
Ratio of Earnings to Combined Fixed Charges and Preference Dividends
(Dollars in thousands)
December 31,
-----------------------------------------------------------------
2006 2005 2004 2003 2002
--------- --------- --------- --------- ---------
Interest expense $ 144,981 $ 83,020 $ 52,327 $ 23,919 $ 19,004
Amortized capitalized costs related to
indebtedness 5,431 2,642 3,310 2,163 940
Preference security dividend requirements
of consolidated subsidiaries 25,123 25,123 22,840 18,897 17,266
--------- --------- --------- --------- ---------
Total fixed charges $ 175,535 $ 110,785 $ 78,477 $ 44,979 $ 37,210
========= ========= ========= ========= =========
Net income before minority interests $(337,497) $(295,673) $(143,462) $ 64,498 $ 62,613
Add: Total fixed charges 175,535 110,785 78,477 44,979 37,210
Less: Preference security dividend
requirements of consolidated subsidiaries (25,123) (25,123) (22,840) (18,897) (17,266)
--------- --------- --------- --------- ---------
Earnings $(187,085) $(210,011) $ (87,825) $ 90,580 $ 82,557
========= ========= ========= ========= =========
Ratio of Earnings to Combined Fixed
Charges and Preference Dividends See NOTE See NOTE See NOTE 2.0:1 2.2:1
For the purposes of computing the ratio of earnings to fixed charges and
preference dividends, earnings were calculated using income before minority
interest adding back total fixed charges less preference security dividend
requirements of consolidated subsidiaries. Fixed charges consist of interest
expense, recurring fees and amortization of capitalized costs related to
indebtedness and preference security dividend requirements of consolidated
subsidiaries.
NOTE: Earnings (as defined in Regulation S-K) were insufficient to cover
Combined Fixed Charges and Preference Dividends (also as defined in Regulation
S-K) by $362.6 million for the year ended December 31, 2006, by $320.8 million
for the year ended December 31, 2005 and by $166.3 million for the year ending
December 31, 2004, yielding a ratio of earnings to combined fixed charges and
preference dividends of -1.1:1 in 2006, -1.9:1 in 2005 and -1.1:1 in 2004. These
shortfalls are due to the consolidation of partnerships deemed to be variable
interest entities ("consolidated partnerships") pursuant to Financial
Interpretation 46(R) ("FIN 46(R)") or consolidated pursuant to similar
accounting pronouncements. Pursuant to Regulation S-K, the definition of
Earnings does not permit the subtraction of amounts allocated to minority
interests in consolidated subsidiaries if those subsidiaries incur fixed
charges. The inclusion of the consolidated partnerships in the consolidated
financial statements affected this ratio as follows:
o Combined Fixed Charges and Preference Dividends (which, as defined,
totaled $175.5 million in 2006, $110.8 million in 2005 and $78.5
million in 2004) includes consolidated partnership interest expense of
$47.9 million in 2006, $26.3 million in 2005 and $21.4 million in
2004, although these expenses are paid directly by the consolidated
partnerships; and
o Earnings (which, as defined, was a loss of $187.1 million in 2006,
$210.0 million in 2005 and $87.9 million in 2004) includes
consolidated partnership operating losses totaling $401.4 million in
2006, $349.5 million in 2005 and $220.0 million in 2004, although
virtually all such operating losses are absorbed by the limited
partners of the consolidated partnerships.
141
Exhibit 21
Subsidiaries of the Company as of December 31, 2006
---------------------------------------------------
CM Holding Trust, a Delaware statutory trust
CM Holding Trust II, a Delaware statutory trust
CharterMac Corporation, a Delaware corporation
CM ARCap Investor LLC, a Delaware limited liability company
Subsidiaries of CM Holding Trust
--------------------------------
CharterMac Equity Issuer Trust, a Delaware statutory trust
Subsidiaries of CM Holding Trust II
-----------------------------------
CharterMac Equity Issuer Trust II, a Delaware statutory trust
Subsidiary of CharterMac Equity Issuer Trust
--------------------------------------------
CharterMac Origination Trust I, a Delaware statutory trust
Subsidiaries of CharterMac Corporation
--------------------------------------
CharterMac Mortgage Capital Corp., Inc. a Delaware corporation
CharterMac Capital Company, LLC, a Delaware limited liability company
CM Investor LLC, a Delaware limited liability company
Centerbrook Holdings LLC, a Delaware limited liability company
Subsidiary of CharterMac Capital Company LLC
--------------------------------------------
CharterMac Capital LLC, a Delaware limited liability company (formerly known as
Related Capital Company LLC)
Subsidiary of CharterMac Capital LLC
------------------------------------
RCC Manager LLC, a Delaware limited liability company
Subsidiary of Centerbrook Holdings LLC
--------------------------------------
Centerbrook Financial LLC, a Delaware limited liability company
Subsidiary of CM ARCap Investors LLC
------------------------------------
ARCap Investors LLC, a Delaware limited liability company
Subsidiary of ARCap Investors LLC
---------------------------------
ARCap REIT, Inc., a Delaware corporation
142
Exhibit 23
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We consent to the incorporation by reference
o in the Registration Statement (Form S-3ASR No. 333-138706) of
CharterMac,
o in the Registration Statement (Form S-3ASR No. 333-133118) of
CharterMac,
o in the Registration Statement (Form S-11 No. 333-126044) of
CharterMac,
o in the Registration Statement (Form S-3MEF No. 333-117650) of
CharterMac,
o in the Registration Statement (Form S-3/A No. 333-120077) of
CharterMac, in the Registration Statement (Form S-8 and its post
effective amendment on Form S-8/A No. 333-55957) pertaining to the
CharterMac (formerly known as "Charter Municipal Mortgage Acceptance
Company") Incentive Share Option Plan,
o in the Registration Statement (Form S-3 No. 333-54802) of CharterMac,
o in the Registration Statement (Form S-3 No. 333-109078) of CharterMac,
o in the Registration Statement (Form S-3/A No. 333-74988) of
CharterMac,
o in the Registration Statement (Form S-3/A No. 333-57384) of
CharterMac,
o in the Registration Statement (Form S-8 No. 333-110722) of CharterMac,
o in the Registration Statement (Form S-3/A and its post effective
amendment on Form POS AM 1 No. 333-111919) of CharterMac.
of our reports dated March 9, 2007, relating to the consolidated financial
statements and financial statement schedules of CharterMac and subsidiaries, and
management's report on the effectiveness of internal control over financial
reporting appearing in the Annual Report on Form 10-K of CharterMac and
subsidiaries for the year ended December 31, 2006.
/s/ DELOITTE & TOUCHE LLP
New York, New York
March 9, 2007
143
Exhibit 31.1
CERTIFICATION
I, Marc D. Schnitzer, hereby certify that:
1. I have reviewed this annual report on Form 10-K of CharterMac;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
in order to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal
control over financial reporting (as defined in Exchange Act Rules
13a-15(f) and 15d-15(f)) for the registrant and we have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure the material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this annual report is being prepared;
b) designed such internal control over financial reporting, or caused
such internal control over financial reporting to be designed under our
supervision, to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting
principals;
c) evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
d) disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors or persons performing the equivalent
functions:
a) all significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: March 9, 2007 By: /s/ Marc D. Schnitzer
------------- ---------------------
Marc D. Schnitzer
Chief Executive Officer
144
Exhibit 31.2
CERTIFICATION
I, Robert L. Levy, hereby certify that:
1. I have reviewed this annual report on Form 10-K of CharterMac;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
in order to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal
control over financial reporting (as defined in Exchange Act Rules
13a-15(f) and 15d-15(f)) for the registrant and we have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure the material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this annual report is being prepared;
b) designed such internal control over financial reporting, or caused
such internal control over financial reporting to be designed under our
supervision, to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting
principals;
c) evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
d) disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors or persons performing the equivalent
functions:
a) all significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: March 9, 2007 By: /s/ Robert L. Levy
------------- ------------------
Robert L. Levy
Chief Financial Officer
145
Exhibit 32
CERTIFICATION PURSUANT TO
18.U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of CharterMac (the "Company") on Form 10-K
for the year ending December 31, 2006, as filed with the Securities and Exchange
Commission on the date hereof (the "Report"), I, Marc D. Schnitzer, Chief
Executive Officer of the Company and I, Robert L. Levy, Chief Financial Officer
of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
By: /s/ Marc D. Schnitzer By: /s/ Robert L. Levy
--------------------- ------------------
Marc D. Schnitzer Robert L. Levy
Chief Executive Officer Chief Financial Officer
March 9, 2007 March 9, 2007
A signed original of this written statement required by Section 906 has been
provided to the Company and will be retained by the Company and furnished to the
Securities and Exchange Commission or its staff upon request.
146
CHARTERMAC
SCHEDULE I
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
Summarized condensed financial information of registrant
(not including its consolidated subsidiaries)
CONDENSED BALANCE SHEETS
(In thousands)
December 31,
-------------------------
2006 2005
---------- ----------
ASSETS
Mortgage revenue bonds-at fair value $ 89,054 $ 81,539
Cash and cash equivalents 25,638 52,791
Deferred costs - net of amortization of $90 and $7,485 1,360 5,095
Due from subsidiaries 101,645 133,162
Intangible assets - net of amortization of $2,849 and $2,503 258 603
Investment in subsidiaries 831,290 740,289
Other investments 9,031 57,086
Other assets 15,273 9,955
Loan to affiliate 15,000 --
---------- ----------
Total Assets $1,088,549 $1,080,520
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Notes payable $ 104,375 $ --
Accounts payable, accrued expenses and other
liabilities 7,653 4,802
Distributions payable 26,389 25,883
---------- ----------
Total liabilities 138,417 30,685
---------- ----------
Commitments and contingencies
Shareholders' equity:
Beneficial owners equity:
4.4% Convertible CRA preferred shares; no par value
(2,160 issued and outstanding in 2006 and 2005) 104,498 104,498
Convertible CRA Shares (6,552 shares issued and
outstanding in 2006 and 2005) 97,499 104,369
Special preferred voting shares; no par value
(14,825 shares issued and outstanding in 2006 and
14,885 shares issued and outstanding in 2005) 148 150
Common shares; no par value (160,000 shares
authorized; 52,746 issued and 51,343 outstanding
in 2006 and 52,309 issued and 51,988 outstanding
in 2005) 709,142 752,042
Restricted shares granted -- (4,193)
Treasury shares of beneficial interest - common, at
cost (1,403 shares in 2006 and 321 shares in 2005) (28,018) (7,135)
Accumulated other comprehensive income 66,863 100,104
---------- ----------
Total shareholders' equity 950,132 1,049,835
---------- ----------
Total liabilities and shareholders' equity $1,088,549 $1,080,520
========== ==========
See accompanying notes to financial statements
147
CHARTERMAC
SCHEDULE I
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED STATEMENTS OF OPERATIONS
(In thousands)
Years Ended December 31,
----------------------------------
2006 2005 2004
-------- -------- --------
Revenues:
Mortgage revenue bond interest income $ 8,025 $ 7,267 $ 7,948
Other revenues 16,211 8,591 4,212
-------- -------- --------
Total revenues 24,236 15,858 12,160
-------- -------- --------
Expenses:
Interest expense 2,595 4 35
General and administrative 8,206 8,503 6,958
Depreciation and amortization 4,333 1,895 1,630
Loss on impairment of assets 428 296 147
-------- -------- --------
Total expenses 15,562 10,698 8,770
-------- -------- --------
Income before equity in earnings of subsidiaries
and investments and loss on repayment of mortgage revenue bonds 8,674 5,160 3,390
Equity in earnings of subsidiaries 32,058 50,874 59,792
Equity in earnings of investments 568 3,038 2,219
Loss on repayment of mortgage revenue bonds (6) (58) (38)
-------- -------- --------
Net income $ 41,294 $ 59,014 $ 65,363
======== ======== ========
Allocation of net income to:
4.4% Convertible CRA preferred shareholders $ 4,752 $ 2,020 $ --
Common shareholders $ 32,405 $ 50,558 $ 56,786
Convertible CRA shareholders $ 4,137 $ 6,436 8,577
-------- -------- --------
Total $ 41,294 $ 59,014 $ 65,363
-------- -------- --------
See accompanying notes to financial statements
148
CHARTERMAC
SCHEDULE I
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED STATEMENTS OF CASH FLOWS
(In thousands)
Years Ended December 31,
-------------------------------------
2006 2005 2004
--------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 41,294 $ 59,014 $ 65,363
Adjustments to reconcile net income to net cash used in
operating activities:
Loss on repayment of mortgage revenue bonds 101 58 38
Loss on impairment of assets -- 296 147
Depreciation and amortization 4,333 1,895 1,630
Equity in earnings of subsidiaries and unconsolidated
entities (44,293) (50,874) (59,792)
Distributions received from subsidiaries and unconsolidated
entities 349,553 -- --
Non-cash compensation expense 7,036 8,661 597
Other non-cash expense 1,014 1,107 525
Changes in operating assets and liabilities:
Other assets (4,629) (4,595) 180
Accounts payable, accrued expenses and other liabilities 2,285 (3,300) (5,752)
Loans to affiliates (15,000) 4,600 (4,600)
Due to / from subsidiaries 97,400 (6,616) (25,275)
--------- --------- ---------
Net cash provided by (used in) operating activities 439,094 10,246 (26,939)
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Repayments of mortgage revenue bonds and notes 1,679 17,518 2,935
Mortgage revenue bond acquisitions and fundings (7,683) (3,405) (2,390)
Deferred investment acquisition costs 226 (47) --
Investment in subsidiaries (459,897) 38,398 3,108
Return of capital from equity investees 16,667 -- --
Other investments 21,806 (34,494) (742)
--------- --------- ---------
Net cash provided by investing activities (427,202) 17,970 2,911
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Distributions to shareholders (104,168) (96,582) (84,395)
Increase in notes payable 84,375 -- --
Issuance of preferred shares -- 108,000 --
Issuance of common shares and convertible CRA shares -- -- 110,803
Proceeds from stock options exercised 756 3,804 308
Retirement of special preferred voting shares 1,889 (2) (10)
Treasury stock purchases (20,447) -- --
Deferred financing costs (1,450) (3,602) (6,484)
--------- --------- ---------
Net cash provided by financing activities (39,045) 11,618 20,222
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents (27,153) 39,834 (3,806)
Cash and cash equivalents at the beginning of the period 52,791 12,957 16,763
--------- --------- ---------
Cash and cash equivalents at the end of the period $ 25,638 $ 52,791 $ 12,957
========= ========= =========
Supplemental information
Supplemental disclosure of non-cash activities:
Contribution of mortgage revenue bonds to subsidiaries $ 35,413 $ 15,715 $ --
======== ========= =========
Distribution of mortgage revenue bonds from subsidiaries $ 37,155 $ -- $ 12,664
======== ========= =========
See accompanying notes to financial statements
149
CHARTERMAC
SCHEDULE I
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
NOTES TO CONDENSED FINANCIAL STATEMENTS
1. Introduction and Basis of Presentation
Basis of Financial Information
The accompanying condensed financial statements (the "Parent Company Financial
Statements") are for CharterMac (not including its subsidiaries).
The Parent Company Financial Statements, including the notes thereto, should be
read in conjunction with our consolidated financial statements and the notes
thereto which are included in this Form 10-K.
2. Cash Dividends received from subsidiaries
The table below reflects the cash dividends received for each of the last three
fiscal years from subsidiaries and 50% or less owned persons accounted for under
the equity method.
(In thousands) 2006 2005 2004
----------------------------- ---------- --------- ---------
Consolidated subsidiaries CMC $ -- $ -- $ 2,200
Equity method ARCap 15,957 2,219 2,219
3. Guarantees
In connection with the CMC warehouse line, both we and our subsidiary, CM Corp.,
have entered into guarantees for the benefit of Bank of America, guaranteeing
the total advances drawn under the line, up to the maximum of $100 million,
together with interest, fees, costs, and charges related to the CMC warehouse
line.
150
Schedule II
Valuation and Qualifying Accounts
December 31, 2006
ALLOWANCE FOR DOUBTFUL ACCOUNTS
Additions
-------------------------
Charged to
Balance at Charged to Other Balance at
beginning of costs and Accounts - Deductions - end of
(IN THOUSANDS) period expenses Describe Describe period
--------------------- ------------ ---------- ---------- ------------- ----------
2006 $ 15,083 $ 4,953 $ (373)(3) $ 9,255(2) $ 10,408
2005 13,328 5,123 -- 3,368(1) 15,083
2004 10,856 2,472 -- -- 13,328
(1) Reversal of reserves for investment funds and for repayment of mortgage
revenue bonds.
(2) Reversal of reserves for repayment of mortgage revenue bonds.
(3) Receipt of previously reserved interest amounts,net of additonal reserves.
151