ITEM 1. BUSINESS
This Annual Report on Form 10-K contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. For purposes of these Acts, any statement that is not a statement of historical fact may be deemed a forward-looking statement. Capital Crossing Preferred Corporation (“Capital Crossing Preferred”) may also make written or oral forward-looking statements in other documents filed with the Securities and Exchange Commission (“SEC”), in press releases and other written materials, and in oral statements made by officers or directors. Forward-looking statements can be identified by the use of the words “believe,” “expect,” “anticipate,” “intend,” “estimate,” “plan,” “assume,” “will,” “project,” “should,” and other similar expressions which predict or indicate future events and trends and which do not relate to historical matters. Forward-looking statements should not be unduly relied upon because they involve known and unknown risks, uncertainties and other factors, some of which are beyond the control of Capital Crossing Preferred. These risks, uncertainties and other factors may cause the actual results, performance or achievements of Capital Crossing Preferred to be materially different from the anticipated future results, performance or achievements that are expressed or implied by the forward-looking statements.
Capital Crossing Preferred’s actual results could differ materially from those projected in the forward-looking statements as a result, among other factors, or the factors discussed in “Item 1A Risk Factors” of this Form 10-K.
All of these factors should be carefully reviewed, and the reader of this Annual Report on Form 10-K should be aware that there may be other factors that could cause these differences. These forward-looking statements were based on information, plans and estimates at the date of this report, and Capital Crossing Preferred does not promise to update any forward-looking statements to reflect changes in underlying assumptions or factors, new information, future events or other changes.
General
Capital Crossing Preferred Corporation, formerly Atlantic Preferred Capital Corporation, is a Massachusetts corporation incorporated on March 20, 1998. Capital Crossing Bank (“Capital Crossing”), formerly Atlantic Bank and Trust Company, organized Capital Crossing Preferred to acquire and hold real estate mortgage assets in a cost-effective manner and to provide Capital Crossing with an additional means of raising capital for federal and state regulatory purposes. Capital Crossing owns all of the outstanding common stock of Capital Crossing Preferred. Capital Crossing Preferred operates in a manner intended to allow it to be taxed as a real estate investment trust, or a “REIT”, under the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”). As a REIT, Capital Crossing Preferred generally will not be required to pay federal income tax if it distributes its earnings to its stockholders and continues to meet a number of other requirements.
On September 19, 2006, Capital Crossing announced that it had signed a definitive merger agreement whereby Capital Crossing would be acquired by Lehman Brothers Bank, FSB, a subsidiary of Lehman Brothers, a global investment bank. Under the terms of the agreement, Lehman Brothers will pay $30.00 per share in cash in exchange for each outstanding share of Capital Crossing. The acquisition is subject to customary closing conditions and regulatory approvals. These approvals include the approval of the Office of Thrift Supervision (“OTS”), the Federal Deposit Insurance Corporation (“FDIC”), the Massachusetts Commissioner of Banks and the Board of Governors of the Federal Reserve System. The merger is also subject to a determination from the Board of Governors of the Federal Reserve System that the requirements under the Bank Holding Company Act of 1956, as amended, do not apply to Lehman Bank by virtue of its momentary ownership of Capital Crossing as a stand-alone bank prior to its merger into Lehman Bank.
In November 2006, the Board of Governors of the Federal Reserve System determined that the requirements under the Bank Holding Company Act do not apply to Lehman Bank in the case of this transaction. In January 2007, Lehman Bank received the necessary approvals from the OTS and the FDIC. On
January 22, 2007, a public hearing was held before the Massachusetts Board of Bank Incorporation pursuant to notice duly given. On January 23, 2007, Capital Crossing received the requisite shareholder approval to consummate the merger.
Pursuant to the merger agreement, following approval of the transaction by the Massachusetts Commissioner of Banks and the Massachusetts Board of Bank Incorporation, the acquisition is expected to be completed within two business days.
Following consummation of the merger, Capital Crossing Preferred will become a subsidiary of Lehman Bank. Lehman Bank will own all of the outstanding common stock of Capital Crossing Preferred. On January 29, 2007 Capital Crossing Preferred’s Board of Directors voted to redeem the Series A preferred shares and Series C preferred shares, subject to completion of the pending merger with Lehman Bank and regulatory approvals, if necessary. The redemption notice to holders of the Series A and Series C preferred shares will be mailed following the completion of the pending merger with Lehman Bank. The Series B preferred shares and Series D preferred shares will remain outstanding and remain subject to their existing terms and conditions, including their respective call features. Each series of preferred stock is described in greater detail below.
On January 16, 2007, Capital Crossing Preferred’s Board of Directors voted to amend Capital Crossing Preferred’s charter, subject to completion of the merger. The automatic exchange of the Series A, Series C and Series D preferred shares into preferred shares of Capital Crossing will be amended to be exchangeable into preferred shares of Lehman Bank. This amendment requires the vote of Capital Crossing Preferred’s common stockholder, which has been received and is subject to completion of the merger with Lehman Bank.
On March 31, 1998, Capital Crossing capitalized Capital Crossing Preferred by transferring mortgage loans valued at $140.7 million in exchange for 1,000 shares of Capital Crossing Preferred’s 8% Cumulative Non-Convertible Preferred Stock, Series B, valued at $1.0 million and 100 shares of Capital Crossing Preferred’s common stock valued at $139.7 million. The carrying value of these loans approximated their fair values at the date of contribution.
On February 1, 1999, Capital Crossing Preferred closed its public offering of 1,260,000 shares of its 9.75% Non-cumulative exchangeable preferred stock, Series A. On February 12, 1999, Capital Crossing Preferred sold an additional 156,130 Series A preferred shares in connection with the underwriters’ exercise of their overallotment option. The net proceeds to Capital Crossing Preferred from the sale of Series A preferred shares were $12.6 million. Series A preferred stock is redeemable at the option of Capital Crossing Preferred, with the prior consent of the Federal Deposit Insurance Corporation (the “FDIC”).
On May 31, 2001, Capital Crossing Preferred closed its public offering of 1,840,000 shares (including 240,000 shares issued upon the exercise of the underwriters’ overallotment option) of its 10.25% Non-cumulative exchangeable preferred stock, Series C. The net proceeds to Capital Crossing Preferred from the sale of Series C preferred shares were $16.9 million. Series C preferred stock is redeemable at the option of Capital Crossing Preferred, with the prior consent of the FDIC.
On May 11, 2004, Capital Crossing Preferred closed its public offering of 1,500,000 shares of its 8.50% Non-cumulative exchangeable preferred stock, Series D. The net proceeds to Capital Crossing Preferred from the sale of Series D preferred shares were $35.3 million. Series D preferred stock is redeemable at the option of Capital Crossing Preferred on or after July 15, 2009, with the prior consent of the FDIC.
Capital Crossing Preferred’s principal business objective is to acquire and hold mortgage assets that will generate net income for distribution to stockholders. All of the mortgage assets in Capital Crossing Preferred’s loan portfolio at December 31, 2006 were acquired from Capital Crossing and it is anticipated that substantially all additional mortgage assets will be acquired from Capital Crossing. As of December 31, 2006, Capital Crossing Preferred held loans acquired from Capital Crossing with net investment balances of $91.0 million. Capital Crossing Preferred’s loan portfolio at December 31, 2006 consisted primarily of mortgage assets secured by commercial and multi-family properties.
Capital Crossing administers the day-to-day activities of Capital Crossing Preferred in its roles as servicer under a master service agreement entered into between Capital Crossing and Capital Crossing Preferred and as
advisor under an advisory agreement. Capital Crossing Preferred pays Capital Crossing an annual servicing fee equal to 0.20%, payable monthly, and an annual advisory fee equal to 0.05%, also payable monthly, of the gross average outstanding principal balances of loans in the loan portfolio for the immediately preceding month. Capital Crossing and its affiliates have interests that are not identical to those of Capital Crossing Preferred. Consequently, conflicts of interest may arise with respect to transactions, including, without limitation:
| • | future acquisitions of mortgage assets from Capital Crossing or its affiliates; | |
| • | servicing of mortgage assets, particularly with respect to mortgage assets that become classified or placed on non-performing status; | |
| • | the modification of the advisory agreement and the master service agreement; and | |
| • | the terms of our guarantee of obligations of Capital Crossing. |
It is the intention of Capital Crossing Preferred that any agreements and transactions between Capital Crossing Preferred and Capital Crossing are fair to all parties and consistent with market terms, including the price paid and received for mortgage assets on their acquisition or disposition by Capital Crossing Preferred or in connection with the servicing of such mortgage assets. However, there can be no assurance that such agreements or transactions will be on terms as favorable to Capital Crossing Preferred as those that could have been obtained from unaffiliated third parties.
Following the completion of the pending merger with Lehman Bank, Capital Crossing, as a division of Lehman Bank, will continue to provide Capital Crossing Preferred servicing and advisory services under the master service agreement and advisory agreement discussed above.
Capital Crossing
Capital Crossing was organized as a Massachusetts-chartered trust company in December 1987, and commenced operations in February 1988. As noted above, on September 19, 2006, Capital Crossing announced that it had signed a definitive merger agreement whereby Capital Crossing would be acquired by Lehman Bank. Following the consummation of the merger, Capital Crossing will become a division of Lehman Bank. Capital Crossing operates as a commercial bank primarily focused on purchasing loans secured by commercial real estate, multi-family and one-to-four family residential real estate, other business assets and originating and purchasing leases that finance the business activities of small companies. Capital Crossing’s deposits are insured by the Bank Insurance Fund of the FDIC to the extent authorized by law. Capital Crossing conducts business from its executive and main office in Boston, Massachusetts, through its website at www.capitalcrossing.com and through Dolphin Capital Corp. (“Dolphin Capital”), its leasing subsidiary in Moberly, Missouri. At December 31, 2006, Capital Crossing had total assets of $1.2 billion, deposits of $853.4 million and stockholders’ equity of $83.8 million. At December 31, 2006, under the regulatory capital ratios developed and monitored by the federal bank regulatory agencies and applicable to banks, Capital Crossing’s capital was sufficient to enable it to be qualified as “well capitalized.”
Capital Crossing currently focuses on purchasing and originating loans and leases through the following principal business lines:
| • | Loan Purchasing. Capital Crossing’s loan purchasing business consists of purchasing loans primarily at a discount from their outstanding principal balances. These loans are primarily secured by commercial real estate, multi-family and one-to-four family residential real estate and other business assets and are purchased from sellers in the financial services industry or government agencies. | |
| • | Lease Financing. Capital Crossing’s lease business consists of financing business equipment to ses through its subsidiary, Dolphin Capital. The leased equipment consists principally of water purification systems and office and technology equipment such as copiers and computers. Dolphin Capital also purchases pools of leases from sellers in the financial services industry. The leased equipment in such pools includes dental equipment, laundry equipment, vehicles, restaurant equipment and various other types of business or industrial equipment. |
Capital Crossing primarily utilizes a funding strategy of wholesale sources such as brokered certificates of deposit and borrowed funds.
As a majority-owned subsidiary of Capital Crossing, the assets and liabilities and results of operations of Capital Crossing Preferred are consolidated with those of Capital Crossing for Capital Crossing’s financial reporting and regulatory capital purposes. As such, loans acquired by Capital Crossing Preferred from Capital Crossing will nevertheless be treated as assets of Capital Crossing for purposes of compliance by Capital Crossing with the FDIC’s regulatory capital requirements and in Capital Crossing’s consolidated financial statements. Interest income on those loans will be treated as interest income of Capital Crossing in Capital Crossing’s consolidated financial statements. Following consummation of the merger between Capital Crossing and Lehman Bank, Capital Crossing Preferred will become a subsidiary of Lehman Bank and the assets and liabilities and results of operations of Capital Crossing Preferred will be consolidated with those of Lehman Bank for Lehman Bank’s financial reporting and regulatory capital purposes.
Acquisition of Loan Portfolio
Pursuant to the terms of a master mortgage loan purchase agreement entered into by and between Capital Crossing Preferred and Capital Crossing, Capital Crossing assigns, from time to time, certain loans to Capital Crossing Preferred. In connection with said assignment, Capital Crossing delivers or causes to be delivered to Capital Crossing Preferred the mortgage note with respect to each mortgage endorsed to the order of Capital Crossing Preferred, the original or certified copy of the mortgage with evidence of recording indicated thereon, if available, and an original or certified copy of an assignment of the mortgage in recordable form. Such documents are initially held by Capital Crossing, acting as custodian for Capital Crossing Preferred pursuant to the terms of a master service agreement entered into by and between Capital Crossing and Capital Crossing Preferred.
Under the terms of the master mortgage loan purchase agreement, Capital Crossing makes certain representations and warranties with respect to the mortgage assets for the benefit of Capital Crossing Preferred regarding information provided with respect to mortgage assets, liens, validity of the mortgage documents, and compliance with applicable laws. Capital Crossing is obligated to repurchase any mortgage asset sold by it to Capital Crossing Preferred as to which there is a material breach of any such representation or warranty, unless Capital Crossing Preferred permits Capital Crossing to substitute other qualified mortgage assets for such mortgage asset. Capital Crossing also indemnifies Capital Crossing Preferred for damages or costs resulting from any such breach. The repurchase price for any such mortgage asset is such asset’s net carrying value plus accrued and unpaid interest on the date of repurchase.
From time to time, mortgage assets may be returned to Capital Crossing in the form of dividends or returns of capital. Capital Crossing will consider the amounts of such returns when assessing the adequacy of the size and composition of Capital Crossing Preferred’s loan portfolio and may, from time to time, contribute additional mortgage assets to Capital Crossing Preferred. Capital Crossing will seek to ensure that the mortgage assets it contributes to Capital Crossing Preferred are generally of similar quality and characteristics as those returned to it.
Future decisions regarding mortgage asset acquisitions by Capital Crossing Preferred from Capital Crossing will be based on the level of Capital Crossing Preferred’s preferred stock dividends at the time and Capital Crossing Preferred’s required level of income necessary to generate adequate dividend coverage.
Following the consummation of the pending merger with Lehman Bank, Capital Crossing, as a division of Lehman Bank, will continue to assign certain loans to Capital Crossing Preferred from time to time pursuant to the master mortgage loan purchase agreement discussed above.
Management Policies and Programs
In administering Capital Crossing Preferred’s mortgage assets, Capital Crossing has a high degree of autonomy and will retain the same high degree of autonomy following consummation of the pending merger with Lehman Bank. Capital Crossing Preferred’s Board of Directors, however, has adopted certain policies to
guide the acquisition and disposition of assets, use of capital and leverage, credit risk management and certain other activities. These policies, which are discussed below, may be amended or revised from time to time at the discretion of Capital Crossing Preferred’s Board of Directors without a vote of Capital Crossing Preferred’s stockholders, including Series A, Series C and Series D preferred shares, or without a vote of Capital Crossing Preferred’s only common stockholder, Capital Crossing.
Asset Acquisition and Disposition Policies. Capital Crossing Preferred anticipates that it will, from time to time, purchase additional mortgage assets. Capital Crossing Preferred intends to acquire all or substantially all of such mortgage assets from Capital Crossing on terms that are comparable to those that could be obtained by Capital Crossing Preferred if such mortgage assets were purchased from unrelated third parties. Capital Crossing Preferred and Capital Crossing do not currently have specific policies with respect to the purchase by Capital Crossing Preferred from Capital Crossing of particular loans or pools of loans, other than that such assets must be eligible to be held by a REIT. Capital Crossing Preferred intends generally to acquire only performing loans from Capital Crossing. Capital Crossing Preferred may also from time to time acquire mortgage assets from unrelated third parties. To date, Capital Crossing Preferred has not adopted any arrangements or procedures by which it would purchase mortgage assets from unrelated third parties, and it has not entered into any agreements with any third parties with respect to the purchase of mortgage assets. Capital Crossing Preferred anticipates that it would purchase mortgage assets from unrelated third parties only if neither Capital Crossing nor any of its affiliates had an amount or type of mortgage asset sufficient to meet the requirements of Capital Crossing Preferred. Capital Crossing Preferred currently anticipates that the mortgage assets that it purchases will primarily include commercial and multi-family mortgage loans, although if Capital Crossing develops an expertise in additional mortgage asset products, Capital Crossing Preferred may purchase such additional types of mortgage assets. In addition, Capital Crossing Preferred may also from time to time acquire limited amounts of other assets eligible to be held by REITs.
In order to preserve its status as a REIT under the Internal Revenue Code, substantially all of the assets of Capital Crossing Preferred must consist of mortgage loans and other qualified assets of the type set forth in Section 856(c)(4)(A) of the Internal Revenue Code. Such other qualifying assets include cash, cash equivalents and securities, including shares or interests in other REITs, although Capital Crossing Preferred does not currently intend to invest in shares or interests in other REITs.
Capital and Leverage Policies. To the extent that the Board of Directors determines that additional funding is required, Capital Crossing Preferred may raise such funds through additional equity offerings, debt financing or retention of cash flow (after consideration of provisions of the Internal Revenue Code requiring the distribution by a REIT of not less than 90% of its REIT taxable income and taking into account taxes that would be imposed on undistributed taxable income), or a combination of these methods.
Capital Crossing Preferred has no debt outstanding, and it currently does not intend to incur any indebtedness. The organizational documents of Capital Crossing Preferred limit the amount of indebtedness which it is permitted to incur without approval of the Series A, Series C and Series D preferred stockholders to no more than 100% of its total stockholders’ equity. Any such debt incurred may include intercompany advances made by Capital Crossing to Capital Crossing Preferred.
Capital Crossing Preferred has guaranteed all of the obligations of Capital Crossing under the advances Capital Crossing may receive from time to time from the Federal Home Loan Bank of Boston (“FHLBB”), and has agreed to pledge a significant amount of its assets in connection with these advances. The assets Capital Crossing Preferred pledges to the FHLBB will vary from time to time, however the potential exists for it to pledge all of its assets to the FHLBB to secure advances to Capital Crossing. At December 31, 2006, approximately $25.4 million, or 14.6%, of its assets have been pledged to and accepted by the FHLBB to secure FHLBB advances to Capital Crossing. The FHLBB advances are used by Capital Crossing primarily for the purchase of mortgage assets and to assist in managing Capital Crossing’s interest rate risk exposure. The assets purchased using FHLBB advances generally are available for contribution to or purchase by Capital Crossing Preferred, based upon the asset quality of the assets, and whether the assets were qualified to be held by REITs. The guarantee and pledge were approved by Capital Crossing Preferred’s independent directors, subject to certain requirements and limitations, including the requirement that Capital Crossing pay Capital
Crossing Preferred an annual guarantee fee of $80,000. Capital Crossing Preferred’s guarantee obligations under this arrangement are limited by applicable laws pertaining to fraudulent conveyance and fraudulent transfer. At December 31, 2006, Capital Crossing had borrowing capacity, subject to available qualified collateral at the FHLBB, of $300.0 million, of which $169.3 million was outstanding. Further increases in borrowings are dependent upon the qualification of additional assets as collateral and other factors as may be determined by the FHLBB.
Capital Crossing Preferred may also issue additional series of preferred stock. However, it may not issue additional shares of preferred stock ranking senior to the Series A, Series C or Series D preferred shares without consent of holders of at least two-thirds of each of the outstanding Series A, Series C and Series D preferred shares, each voting as a separate class. Although Capital Crossing Preferred’s charter does not prohibit or otherwise restrict Capital Crossing or its affiliates from holding and voting shares of Series A, Series C or Series D preferred stock, to Capital Crossing Preferred’s knowledge the amount of shares of Series A, Series C or Series D preferred stock held by Capital Crossing or its affiliates is insignificant (less than 1%). Similarly, Capital Crossing Preferred may not issue additional shares of preferred stock ranking on parity with the Series A, Series C or Series D preferred shares without the approval of a majority of its independent directors. Prior to any future issuance of additional shares of preferred stock, Capital Crossing Preferred will take into consideration Capital Crossing’s regulatory capital requirements and the cost of raising and maintaining that capital at the time.
Conflicts of Interest Policies. Because of the nature of Capital Crossing Preferred’s relationship with Capital Crossing and its affiliates, conflicts of interest have arisen and may arise with respect to certain transactions, including without limitation, Capital Crossing Preferred’s acquisition of mortgage assets from, or return of mortgage assets to Capital Crossing, or disposition of mortgage assets or foreclosed property to, Capital Crossing or its affiliates and the modification of the master service agreement. It is Capital Crossing Preferred’s policy that the terms of any financial dealings with Capital Crossing and its affiliates will be consistent with those available from unaffiliated third parties in the mortgage lending industry. In addition, Capital Crossing Preferred maintains an audit committee of its Board of Directors, which is comprised solely of three independent directors who satisfy the standards for independence promulgated by the Nasdaq Stock Market, Inc. Among other functions, the audit committee will review transactions between Capital Crossing Preferred and Capital Crossing and its affiliates. Under the terms of the advisory agreement, Capital Crossing may not subcontract its duties under the advisory agreement to an unaffiliated third party without the approval of Capital Crossing Preferred’s Board of Directors, including the approval of a majority of its independent directors. Furthermore, under the terms of the advisory agreement, Capital Crossing provides advice and recommendations with respect to all aspects of Capital Crossing Preferred’s business and operations, subject to the control and discretion of Capital Crossing Preferred’s Board of Directors.
Conflicts of interest between Capital Crossing Preferred and Capital Crossing and its affiliates may also arise in connection with decisions bearing upon the credit arrangements that Capital Crossing or one of its affiliates may have with a borrower. Conflicts could also arise in connection with actions taken by Capital Crossing as a controlling person of Capital Crossing Preferred. It is the intention of Capital Crossing Preferred and Capital Crossing that any agreements and transactions between Capital Crossing Preferred and Capital Crossing or its affiliates, including, without limitation, the master mortgage loan purchase agreement, are fair to all parties and are consistent with market terms for such types of transactions. The master service agreement provides that foreclosures and dispositions of the mortgage assets are to be performed in a manner substantially the same as for similar work performed by Capital Crossing for transactions on its own behalf. However, there can be no assurance that any such agreement or transaction will be on terms as favorable to Capital Crossing Preferred as would have been obtained from unaffiliated third parties.
There are no provisions in Capital Crossing Preferred’s charter limiting any officer, director, security holder or affiliate of Capital Crossing Preferred from having any direct or indirect pecuniary interest in any mortgage asset to be acquired or disposed of by Capital Crossing Preferred or in any transaction in which Capital Crossing Preferred has an interest or from engaging in acquiring and holding mortgage assets. As described herein, it is expected that Capital Crossing and its affiliates will have direct interests in transactions with Capital Crossing Preferred (including, without limitation, the sale of mortgage assets to Capital Crossing
Preferred). It is not currently anticipated, however, that any of the officers or directors of Capital Crossing Preferred will have any interests in such mortgage assets.
Other Policies. Capital Crossing Preferred intends to operate in a manner that will not subject it to regulation under the Investment Company Act of 1940, as amended. Capital Crossing Preferred does not intend to:
| • | invest in the securities of other issuers for the purpose of exercising control over such issuers; | |
| • | underwrite securities of other issuers; | |
| • | actively trade in loans or other investments; | |
| • | offer securities in exchange for property; or | |
| • | make loans to third parties, including without limitation officers, directors or other affiliates of Capital Crossing Preferred. |
Capital Crossing Preferred may, under certain circumstances, and subject to applicable federal and state laws and the requirements for qualifying as a REIT, purchase Series A, Series C or Series D preferred shares in the open market or otherwise, for redemption by Capital Crossing Preferred. Any such redemption may generally only be effected with the prior approval of the FDIC.
Capital Crossing Preferred currently intends to make investments and operate its business at all times in such a manner as to be consistent with the requirements of the Internal Revenue Code to qualify as a REIT. However, future economic, market, legal, tax or other considerations may cause the Board of Directors to determine that it is in the best interests of Capital Crossing Preferred and its stockholders to revoke its REIT status which would have the immediate result of subjecting Capital Crossing Preferred to federal income tax at regular corporate rates.
Under the advisory agreement, Capital Crossing monitors and reviews Capital Crossing Preferred’s compliance with the requirements of the Internal Revenue Code regarding Capital Crossing Preferred’s qualification as a REIT on a quarterly basis and has an independent public accounting firm, selected by the Board of Directors of Capital Crossing Preferred, periodically review the results of Capital Crossing’s analysis.
Servicing
The loans in Capital Crossing Preferred’s portfolio are serviced by Capital Crossing pursuant to the terms of the master service agreement. Capital Crossing in its role as servicer under the terms of the master service agreement receives an annual servicing fee equal to 0.20%, payable monthly, on the gross average outstanding principal balances of loans serviced for the immediately preceding month. For the years ended December 31, 2006, 2005 and 2004, Capital Crossing Preferred incurred $239,000, $273,000 and $302,000, respectively, in servicing fees to Capital Crossing.
The master service agreement requires Capital Crossing to service the loan portfolio in a manner substantially the same as for similar work performed by Capital Crossing for transactions on its own behalf. Capital Crossing collects and remits principal and interest payments, maintains perfected collateral positions, submits and pursues insurance claims and initiates and supervises foreclosure proceedings on the loan portfolio it services. Capital Crossing also provides accounting and reporting services required by Capital Crossing Preferred for such loans. Capital Crossing Preferred may also direct Capital Crossing to dispose of any loans which become classified, placed on non-performing status, or are renegotiated due to financial deterioration of the borrower. Capital Crossing is required to pay all expenses related to the performance of its duties under the master service agreement. Capital Crossing may institute foreclosure proceedings and foreclose, manage and protect the mortgaged premises, including exercising any power of sale contained in any mortgage or deed of trust, obtaining a deed-in-lieu-of-foreclosure or otherwise acquiring title to a mortgaged property underlying a mortgage loan by operation of law or otherwise in accordance with the terms of the master service agreement.
The master service agreement may be terminated at any time by written agreement between the parties or at any time by either party upon 30 days prior written notice to the other party and appointment of a successor
servicer. The master service agreement will automatically terminate if Capital Crossing Preferred ceases to be an affiliate of Capital Crossing.
Capital Crossing remits daily to Capital Crossing Preferred all principal and interest collected on loans serviced by Capital Crossing for Capital Crossing Preferred.
When any mortgaged property underlying a mortgage loan is conveyed by a mortgagor, Capital Crossing generally, upon notice of the conveyance, will enforce any due-on-sale clause contained in the mortgage loan, to the extent permitted under applicable law and governmental regulations. The terms of a particular mortgage loan or applicable law, however, may prohibit Capital Crossing from exercising the due-on-sale clause under certain circumstances related to the security underlying the mortgage loan and the buyer’s ability to fulfill the obligations under the related mortgage note.
Following the completion of the pending merger with Lehman Bank, Capital Crossing, as a division of Lehman Bank, will continue to provide Capital Crossing Preferred servicing under the master service agreement discussed above.
Advisory Services
Capital Crossing Preferred has entered into an advisory agreement with Capital Crossing to administer the day-to-day operations of Capital Crossing Preferred. Capital Crossing is paid an annual advisory fee equal to 0.05%, payable monthly, of the gross average outstanding principal balances of Capital Crossing Preferred’s loans for the immediately preceding month, plus reimbursement for certain expenses incurred by Capital Crossing as advisor. For the years ended December 31, 2006, 2005 and 2004, Capital Crossing Preferred incurred $60,000, $70,000, and $75,000, respectively, in advisory fees payable to Capital Crossing. As advisor, Capital Crossing is responsible for:
| • | monitoring the credit quality of the loan portfolio held by Capital Crossing Preferred; | |
| • | advising Capital Crossing Preferred with respect to the acquisition, management, financing and disposition of its loans and other assets; and | |
| • | maintaining the corporate and shareholder records of Capital Crossing Preferred. |
Capital Crossing may, from time to time, subcontract all or a portion of its obligations under the advisory agreement to one or more of its affiliates involved in the business of managing mortgage assets or, with the approval of a majority of Capital Crossing Preferred’s Board of Directors as well as a majority of its independent directors, subcontract all or a portion of its obligations under the advisory agreement to unrelated third parties. Capital Crossing will not, in connection with the subcontracting of any of its obligations under the advisory agreement, be discharged or relieved in any respect from its obligations under the advisory agreement.
The advisory agreement had an initial term of five years, and currently is renewed each year for an additional one-year period unless Capital Crossing Preferred delivers notice of nonrenewal to Capital Crossing. Capital Crossing Preferred may terminate the advisory agreement at any time upon 90 days’ prior notice. As long as any Series A preferred shares, any Series C preferred shares or any Series D preferred shares remain outstanding, any decision by Capital Crossing Preferred either not to renew the advisory agreement or to terminate the advisory agreement must be approved by a majority of its Board of Directors, as well as by a majority of its independent directors. Other than the servicing fee and the advisory fee, Capital Crossing will not be entitled to any fee for providing advisory and management services to Capital Crossing Preferred.
Following the completion of the pending merger with Lehman Bank, Capital Crossing, as a division of Lehman Bank, will continue to provide Capital Crossing Preferred advisory services under the advisory agreement discussed above.
Description of Loan Portfolio
To date, all of Capital Crossing Preferred’s loans have been acquired or were contributed from Capital Crossing. Capital Crossing Preferred’s loan portfolio may or may not have the characteristics described below at future dates.
The following table sets forth information regarding the composition of the loan portfolio at the dates indicated:
| December 31, | ||||||||||||||||||||
| 2006 | 2005 | 2004 | 2003 | 2002 | ||||||||||||||||
| (In Thousands) | ||||||||||||||||||||
|
Mortgage loans on real estate:
|
||||||||||||||||||||
|
Commercial real estate
|
$ | 57,607 | $ | 76,398 | $ | 87,247 | $ | 111,639 | $ | 172,311 | ||||||||||
|
Multi-family residential
|
32,412 | 38,392 | 35,866 | 45,101 | 70,714 | |||||||||||||||
|
Land
|
— | — | — | 191 | 255 | |||||||||||||||
|
One-to-four
family residential
|
924 | 1,305 | 858 | 1,489 | 2,151 | |||||||||||||||
|
Total
|
90,943 | 116,095 | 123,971 | 158,420 | 245,431 | |||||||||||||||
|
Other loans
|
14 | 21 | 23 | 24 | — | |||||||||||||||
|
Total loans, net of discounts
|
90,957 | 116,116 | 123,994 | 158,444 | 245,431 | |||||||||||||||
|
Less:
|
||||||||||||||||||||
|
Allowance for loan losses
|
(1,519 | ) | (1,981 | ) | (2,497 | ) | (3,281 | ) | (7,354 | ) | ||||||||||
|
Net deferred loan fees
|
(47 | ) | (55 | ) | (62 | ) | (92 | ) | (112 | ) | ||||||||||
|
Loans, net
|
$ | 89,391 | $ | 114,080 | $ | 121,435 | $ | 155,071 | $ | 237,965 | ||||||||||
The following table sets forth certain information regarding the geographic location of properties securing the mortgage loans in the loan portfolio at December 31, 2006:
|
Percentage of |
||||||||||||
|
Number of |
Net |
Total Net |
||||||||||
|
Location
|
Loans | Investment | Investment | |||||||||
| (In Thousands) | ||||||||||||
|
California
|
151 | $ | 49,339 | 54.25 | % | |||||||
|
Massachusetts
|
18 | 5,878 | 6.46 | |||||||||
|
Nevada
|
5 | 4,218 | 4.64 | |||||||||
|
Florida
|
11 | 4,096 | 4.50 | |||||||||
|
Pennsylvania
|
3 | 3,948 | 4.34 | |||||||||
|
Connecticut
|
25 | 2,883 | 3.17 | |||||||||
|
Missouri
|
7 | 2,366 | 2.60 | |||||||||
|
New York
|
7 | 2,207 | 2.43 | |||||||||
|
North Dakota
|
8 | 2,171 | 2.39 | |||||||||
|
All others
|
65 | 13,837 | 15.22 | |||||||||
| 300 | $ | 90,943 | 100.00 | % | ||||||||
The following tables set forth information regarding maturity, contractual interest rate and principal balance of all loans in the loan portfolio at December 31, 2006:
|
Percentage of |
||||||||||||
|
Number of |
Net |
Total Net |
||||||||||
|
Period Until Maturity
|
Loans | Investment | Investment | |||||||||
| (In Thousands) | ||||||||||||
|
Six months or less
|
34 | $ | 3,566 | 3.92 | % | |||||||
|
Greater than six months to one year
|
7 | 3,053 | 3.36 | |||||||||
|
Greater than one year to three
years
|
28 | 5,076 | 5.58 | |||||||||
|
Greater than three years to five
years
|
28 | 6,647 | 7.31 | |||||||||
|
Greater than five years to ten
years
|
61 | 19,503 | 21.44 | |||||||||
|
Greater than ten years
|
143 | 53,112 | 58.39 | |||||||||
| 301 | $ | 90,957 | 100.00 | % | ||||||||
|
Percentage of |
||||||||||||
|
Number of |
Net |
Total Net |
||||||||||
|
Contractual Interest Rate
|
Loans | Investment | Investment | |||||||||
| (In Thousands) | ||||||||||||
|
Less than 4.00%
|
6 | $ | 409 | 0.45 | % | |||||||
|
4.00 to 4.49
|
119 | 38,023 | 41.80 | |||||||||
|
4.50 to 4.99
|
— | — | — | |||||||||
|
5.00 to 5.49
|
4 | 372 | 0.41 | |||||||||
|
5.50 to 5.99
|
2 | 1,739 | 1.91 | |||||||||
|
6.00 to 6.49
|
11 | 2,170 | 2.39 | |||||||||
|
6.50 to 6.99
|
28 | 5,819 | 6.40 | |||||||||
|
7.00 to 7.49
|
23 | 12,280 | 13.50 | |||||||||
|
7.50 to 7.99
|
21 | 8,115 | 8.92 | |||||||||
|
8.00 to 8.49
|
17 | 4,335 | 4.77 | |||||||||
|
8.50 to 8.99
|
21 | 5,832 | 6.41 | |||||||||
|
9.00 to 9.49
|
12 | 4,598 | 5.06 | |||||||||
|
9.50 to 9.99
|
12 | 755 | 0.83 | |||||||||
|
10.00 to 10.49
|
9 | 3,305 | 3.63 | |||||||||
|
10.50 to 10.99
|
6 | 1,482 | 1.63 | |||||||||
|
11.00% and above
|
10 | 1,723 | 1.89 | |||||||||
| 301 | $ | 90,957 | 100.00 | % | ||||||||
|
Percentage of |
||||||||||||
|
Number of |
Net |
Total Net |
||||||||||
|
Principal Balance
|
Loans | Investment | Investment | |||||||||
| (In Thousands) | ||||||||||||
|
$50,000 and less
|
80 | $ | 1,732 | 1.90 | % | |||||||
|
Greater than $50,000 to $100,000
|
49 | 3,628 | 3.99 | |||||||||
|
Greater than $100,000 to $250,000
|
69 | 11,755 | 12.92 | |||||||||
|
Greater than $250,000 to $500,000
|
50 | 17,048 | 18.74 | |||||||||
|
Greater than $500,000 to $1,000,000
|
34 | 24,556 | 27.00 | |||||||||
|
Greater than $1,000,000 to
$2,000,000
|
14 | 18,297 | 20.12 | |||||||||
|
Greater than $2,000,000 to
$3,000,000
|
3 | 7,130 | 7.84 | |||||||||
|
Greater than $3,000,000 to
$4,000,000
|
2 | 6,811 | 7.49 | |||||||||
| 301 | $ | 90,957 | 100.00 | % | ||||||||
Loan Purchasing Activities. A substantial portion of Capital Crossing Preferred’s loan portfolio consists of loans which were purchased by Capital Crossing from third parties. These loans primarily are secured by commercial real estate, multi-family or one-to-four family residential real estate or land located throughout the United States. These loans generally were purchased from sellers in the financial services industry or government agencies. Capital Crossing does not utilize any specific threshold underwriting criteria in evaluating individual loans or pools of loans for purchase, but rather evaluates each individual loan, if it is purchasing an individual loan, or pool of loans, if it is purchasing a pool of loans, on a case by case basis in making a purchase decision as described in more detail below.
Prior to acquiring a loan or portfolio of loans, Capital Crossing’s loan acquisition group conducts a comprehensive review and evaluation of the loan or loans to be acquired in accordance with its credit policy for purchased loans. This review includes an analysis of information provided by the seller, including credit and collateral files, a review and valuation of the underlying collateral and a review, where applicable, of the adequacy of the income generated by the property to repay the loan. This review is conducted by Capital Crossing’s in-house loan acquisition group, which includes credit analysts, real estate appraisers, environmental specialists and legal counsel.
The estimated value of the real property collateralizing the loan is determined by Capital Crossing’s in-house appraisal group which considers, among other factors, the type of property, its condition and location and its highest and best use in its marketplace. In many cases, real estate brokers and/or appraisers with specific knowledge of the local real estate market are also consulted. For larger loans, members of Capital Crossing’s in-house loan acquisition group typically visit the real property collateralizing the loan, conduct a site inspection and conduct an internal rental analysis of similar commercial properties in the local area. Capital Crossing analyzes the current and likely future cash flows generated by the collateral to repay the loan. Capital Crossing also considers minimum debt service coverage ratios, consisting of the ratio of net operating income to total principal and interest payments. New tax and title searches may also be obtained to verify the status of any prior liens on the collateral. Capital Crossing’s in-house environmental specialists review available information with respect to each property collateralizing a loan to assess potential environmental risk.
In order to determine the amount that Capital Crossing is willing to bid to acquire individual loans or loan pools, Capital Crossing considers, among other factors:
| • | the collateral securing the loan; | |
| • | the financial resources of the borrowers or guarantors, if any; | |
| • | the recourse nature of the loan; | |
| • | the age and performance of the loan; | |
| • | the length of time during which the loan has performed in accordance with its repayment terms; | |
| • | geographic location; | |
| • | the yield expected to be earned; and | |
| • | servicing restrictions, if any. |
In addition to the factors listed above, Capital Crossing also considers the amount it may realize through collection efforts or foreclosure and sale of the collateral, net of expenses, and the length of time and costs required to complete the collection or foreclosure process in the event a loan becomes non-performing or is non-performing at the purchase date. Under Capital Crossing’s credit policy for purchased loans, all bids are subject to the approval of Capital Crossing’s Chairman or President and any individual loan relationship whose allocated purchase price exceeds $7.5 million is subject to approval by Capital Crossing’s Loan and Investment Committee which consists of Capital Crossing’s Chairman, President, three independent directors and certain other executive officers of Capital Crossing.
Loan Servicing and Asset Resolution. Capital Crossing has a number of asset managers that are divided into management teams. Loans are assigned to asset managers based on their size and performance status. Additionally, Dolphin Capital employees assist in the servicing of smaller balance loans by making collection calls when such loans become delinquent. In the event that a purchased loan becomes delinquent, or if it is delinquent at the time of purchase, Capital Crossing promptly initiates collection activities. If a delinquent loan becomes non-performing, Capital Crossing may pursue a number of alternatives with the goal of maximizing the overall return on each loan in a timely manner. During this period, Capital Crossing Preferred does not recognize interest income on such loans unless regular payments are being made. In instances when a loan is not returned to performing status, Capital Crossing may seek resolution through negotiating a discounted pay-off with borrowers, which may be accomplished through refinancing by the borrower with another lender, restructuring the loan to a level that is supported by existing collateral and debt service capabilities, or foreclosure and sale of the collateral.
Asset Quality
Payment Status of Loan Portfolio. The following table sets forth certain information relating to the payment status of loans, net in the loan portfolio at the dates indicated:
| December 31, | ||||||||||||||||||||
| 2006 | 2005 | 2004 | 2003 | 2002 | ||||||||||||||||
| (In Thousands) | ||||||||||||||||||||
|
Current
|
$ | 90,286 | $ | 115,140 | $ | 121,077 | $ | 158,314 | $ | 242,151 | ||||||||||
|
Over thirty days to eighty-nine
days past due
|
255 | 643 | 1,360 | 113 | 1,659 | |||||||||||||||
|
Ninety days or more past due
|
— | — | — | — | — | |||||||||||||||
|
Total performing loans, net
|
90,541 | 115,783 | 122,437 | 158,427 | 243,810 | |||||||||||||||
|
Non-performing loans
|
416 | 333 | 1,557 | 17 | 1,621 | |||||||||||||||
|
Total loan portfolio, net
|
$ | 90,957 | $ | 116,116 | $ | 123,994 | $ | 158,444 | $ | 245,431 | ||||||||||
Capital Crossing Preferred’s determination that a purchased loan is delinquent is made prospectively based upon the repayment schedule of the loan following the date of purchase by Capital Crossing and not from the origination date of the loan. Thus, if a borrower was previously in default under the loan (and the loan was not initially purchased as a “non-performing” loan), such default is disregarded by Capital Crossing Preferred in making a determination as to whether or not the purchased loan is delinquent. For example, if Capital Crossing acquires a loan that is past due at the time of acquisition, that loan would not be considered delinquent until it was 90 days past due from Capital Crossing’s purchase date. If Capital Crossing acquires a loan which is contractually delinquent, management evaluates the collectibility of principal and interest and interest would not be accrued when the collectibility of principal and interest is not probable or estimable. Interest income on purchased non-performing loans is accounted for using either the cash basis or the cost recovery method, whereby any amounts received are applied against the recorded amount of the loan. A determination as to which method is used is made on a case-by-case basis.
As servicing agent for Capital Crossing Preferred’s loan portfolio, Capital Crossing will continue to monitor Capital Crossing Preferred’s loans through its review procedures and updated appraisals. Additionally, in order to monitor the adequacy of cash flows on income-producing properties, Capital Crossing generally obtains financial statements and other information from the borrower and the guarantor, including, but not limited to, information relating to rental rates and income, maintenance costs and an update of real estate property tax payments.
Impaired Loans
Capital Crossing Preferred considers a purchased loan impaired when, based on current information and events, it determines that current estimated cash flows are less than the cash flows estimated by Capital Crossing at the date of purchase of the loan by Capital Crossing. A loan originated by Capital Crossing is considered impaired when, based on current information and events, it is probable that Capital Crossing
Preferred will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Impairment is measured on a loan-by-loan basis by comparing the recorded investment in the loan to the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. Substantially all of Capital Crossing Preferred’s loans which have been identified as impaired have been measured by the fair value of the existing collateral. At December 31, 2006, Capital Crossing Preferred had a net recorded investment in impaired loans of $416,000. No additional funds are committed to be advanced in connection with impaired loans. For additional information see Notes 1 and 2 to the Financial Statements.
Non-Performing Assets
The performance of Capital Crossing Preferred’s loan portfolio is evaluated regularly by management. Management generally classifies a loan as non-performing when the collectibility of principal and interest is ninety days or more past due or the collection of principal and interest is not probable or estimable.
The accrual of interest on loans and the accretion of discount is discontinued when loan payments are ninety days or more past due or the collectibility of principal and interest is not probable or estimable. Interest income previously accrued on such loans is reversed against current period interest income, and the loan is accounted for using either the cash basis or the cost recovery method whereby any amounts received are applied against the recorded amount of the loan. This determination is made on a case-by-case basis. Loans accounted for on the cost recovery method, in general, consist of non-performing loans.
Loans are returned to accrual status when the loan is brought current in accordance with management’s anticipated cash flows at the time of loan acquisition or origination.
When Capital Crossing Preferred classifies problem assets, it may establish specific allowances for loan losses or specific nonaccretable discount allocations in amounts deemed prudent by management. When Capital Crossing Preferred identifies problem loans or a portion thereof, as a loss, it will charge-off such amounts or set aside specific allowances or nonaccretable discount equal to the total loss. All of Capital Crossing Preferred’s loans are reviewed monthly to determine which loans are to be placed on non-performing status. In addition, Capital Crossing Preferred’s determination as to the classification of its assets and the amount of its valuation allowances is reviewed by the Massachusetts Commissioner of Banks and the FDIC during their examinations of Capital Crossing, which may result in the establishment of additional general or specific loss allowances.
The following table sets forth the amount of non-performing assets by category at the dates indicated:
| December 31, | ||||||||||||||||||||
| 2006 | 2005 | 2004 | 2003 | 2002 | ||||||||||||||||
| (Dollars in Thousands) | ||||||||||||||||||||
|
Non-performing loans, net:
|
||||||||||||||||||||
|
Commercial real estate
|
$ | 416 | $ | 333 | $ | 1,557 | $ | 2 | $ | 1,601 | ||||||||||
|
Multi-family real estate
|
— | — | — | 15 | 20 | |||||||||||||||
|
Non-performing loans, net
|
416 | 333 | 1,557 | 17 | 1,621 | |||||||||||||||
|
Other real estate owned
|
— | — | — | — | — | |||||||||||||||
|
Non-performing assets, net
|
$ | 416 | $ | 333 | $ | 1,557 | $ | 17 | $ | 1,621 | ||||||||||
|
Non-performing loans, net, as a
percent of loans, net of discount and deferred loan income
|
0.46 | % | 0.29 | % | 1.26 | % | 0.01 | % | 0.66 | % | ||||||||||
|
Non-performing assets, net, as a
percent of total assets
|
0.24 | 0.16 | 0.72 | 0.01 | 0.49 |
Nonaccretable Discount and Allowance for Loan Losses
Nonaccretable Discount. Effective January 1, 2005, and as a result of the required adoption of Statement of Position (“SOP”) No. 03-3, “Accounting for Certain Loans or Debt Securities Acquired in a Transfer,” Capital Crossing Preferred was required to change its discount accounting as it relates to acquired loans which, at acquisition, have evidence of deterioration of credit quality since origination and, for which it is probable that Capital Crossing Preferred will be unable to collect all contractually required payments. For such loans, the excess of the undiscounted contractual cash flows over the undiscounted cash flows estimated at the time of acquisition is not accreted into income (nonaccretable discount). The remaining amount, representing the excess of the loan’s estimated cash flows over the purchase price, is accreted into income over the life of the loan (accretable discount).
For all other loans acquired since January 1, 2005, the discount, which represents the excess of the amount of reasonably estimable and probable discounted future cash collections over the purchase price is accreted into interest income using the interest method over the term of the loan and is not accreted on non-performing loans. This is consistent with the method Capital Crossing Preferred used to account for loans purchased prior to January 1, 2005, except an allowance allocation was also made at the time of acquisition. Capital Crossing Preferred no longer increases the allowance through allocations from purchase discount.
No loans acquired since the adoption of SOP No. 03-3 were within the scope of this SOP.
Prepayments are not considered in the calculation of accretion income.
There is judgment involved in estimating the amount of Capital Crossing Preferred’s future cash flows. The amount and timing of actual cash flows could differ materially from management’s estimates, which could materially affect Capital Crossing Preferred’s financial condition and results of operations. Depending on the timing of an acquisition, a preliminary allocation may be utilized until a final allocation is established. Generally, the allocation will be finalized no later than ninety days from the date of purchase.
The nonaccretable discount is not accreted into income until it is determined that the amount and timing of the related cash flows are reasonably estimable and collection is probable. If cash flows cannot be reasonably estimated for any loan, and collection is not probable, the cost recovery method of accounting is used. Under the cost recovery method, any amounts received are applied against the recorded amount of the loan. Nonaccretable discount is generally offset against the related principal balance when the amount at which a loan is resolved or restructured is determined. There is no effect on the income statement as a result of these reductions.
Subsequent to acquisition, if cash flow projections improve, and it is determined that the amount and timing of the cash flows related to the nonaccretable discount are reasonably estimable and collection is probable, the corresponding decrease in the nonaccretable discount is transferred to the accretable portion and is accreted into interest income over the remaining life of the loan on the interest method. If cash flow projections deteriorate subsequent to acquisition, the decline is accounted for through a provision for loan losses included in earnings.
Included in net loans, at December 31, 2006 and 2005, are approximately $299,000 and $1.5 million of loans (of which none are non-performing), respectively, for which the net recorded investment represents the amortized cost of these loans, where at acquisition, the amounts of reasonably estimable and probable discounted future cash collections were less than the contractual balances owed. These loans were purchased at a price to yield a market rate of interest after considering the credit quality of the loans at acquisition and the aforementioned expected future cash collections. The excess of the contractual balances over the amount of reasonably estimable and probable discounted future cash collections represents the predominant portion of the $215,000 and $754,000 of nonaccretable discount at December 31, 2006 and 2005, respectively.
The following table sets forth certain information relating to the activity in the nonaccretable discount for the years indicated:
| Year Ended December 31, | ||||||||||||||||||||
| 2006 | 2005 | 2004 | 2003 | 2002 | ||||||||||||||||
| (In Thousands) | ||||||||||||||||||||
|
Balance at beginning of year
|
$ | 754 | $ | 883 | $ | 1,524 | $ | 8,158 | $ | 6,062 | ||||||||||
|
Accretion(1)
|
(49 | ) | (75 | ) | (94 | ) | (967 | ) | (2,007 | ) | ||||||||||
|
Transfers to accretable discount
upon improvements in cash flows
|
— | (54 | ) | (436 | ) | (2,273 | ) | (194 | ) | |||||||||||
|
Additions in connection with loans
acquired from Capital Crossing
|
— | — | — | — | 8,131 | |||||||||||||||
|
Increases related to loan
restructures
|
126 | — | — | — | — | |||||||||||||||
|
Net reductions related to
resolutions and restructures
|
(126 | ) | — | — | (35 | ) | (1,139 | ) | ||||||||||||
|
Net reductions relating to loans
sold or distributed
|
(490 | ) | — | (111 | ) | (3,359 | ) | (2,695 | ) | |||||||||||
|
Balance at end of year
|
$ | 215 | $ | 754 | $ | 883 | $ | 1,524 | $ | 8,158 | ||||||||||
(1) Accretion of nonaccretable discount is recognized using the cost recovery method.
Allowance for Loan Losses. Capital Crossing Preferred’s allowance for loan losses at December 31, 2006 was $1.5 million. The determination of this allowance requires the use of estimates and assumptions regarding the risks inherent in individual loans and the loan portfolio in its entirety. In addition, regulatory agencies periodically review the adequacy of the allowance for loan losses and may require Capital Crossing Preferred to make additions to its allowance for loan losses. While management believes its estimates and assumptions are reasonable, there can be no assurance that they will be proven to be correct in the future. The actual amount of future provisions that may be required cannot be determined, and such provisions may exceed the amounts of past provisions. Management believes that the allowance for loan losses is adequate to absorb the known and inherent risks in Capital Crossing Preferred’s loan portfolio at each date based on the facts known to management as of such date. Management continues to monitor and modify the allowances for general and specific loan losses as economic conditions dictate.
Effective January 1, 2005, and as a result of the required adoption of SOP No. 03-3, additions to the valuation allowances relating to newly acquired loans reflect only those losses incurred by Capital Crossing Preferred subsequent to acquisition and general risk allocations on loans for which no nonaccretable discount is allocated. Capital Crossing Preferred no longer increases the allowance for loan losses through allocations from purchase discount and is no longer allowed to establish impairment reserves at acquisition. However, at the time of acquisition, general risk allocations are established for loans for which no nonaccretable discount is allocated through a change to earnings. Consequently, it is anticipated that the allowance for loan losses will continue to decline as credits for loan losses may continue to be recorded if loans pay off and allowance allocations related to these loans are not required or additions due to loan impairment are not required.
No loans acquired during 2005 and 2006 were within the scope of SOP 03-3.
The following table sets forth management’s allocation of the allowance for loan losses by loan category and the percentage of the loans in each category to total loans in each category with respect to the loan portfolio at the dates indicated:
| December 31, | ||||||||||||||||||||||||||||||||||||||||
| 2006 | 2005 | 2004 | 2003 | 2002 | ||||||||||||||||||||||||||||||||||||
|
% of |
% of |
% of |
% of |
% of |
||||||||||||||||||||||||||||||||||||
|
Allowance |
Net |
Allowance |
Net |
Allowance |
Net |
Allowance |
Net |
Allowance |
Net |
|||||||||||||||||||||||||||||||
|
for Loan |
Loans |
for Loan |
Loans |
for Loan |
Loans |
for Loan |
Loans |
for Loan |
Loans |
|||||||||||||||||||||||||||||||
| Losses | to Total | Losses | to Total | Losses | to Total | Losses | to Total | Losses | to Total | |||||||||||||||||||||||||||||||
| (Dollars in Thousands) | ||||||||||||||||||||||||||||||||||||||||
|
Loan Categories:
|
||||||||||||||||||||||||||||||||||||||||
|
Commercial real estate and land
|
$ | 1,179 | 63.33 | % | $ | 1,562 | 65.80 | % | $ | 2,052 | 70.36 | % | $ | 2,691 | 70.58 | % | $ | 5,660 | 70.31 | % | ||||||||||||||||||||
|
Multi-family residential
|
337 | 35.63 | 414 | 33.06 | 437 | 28.93 | 579 | 28.46 | 1,662 | 28.81 | ||||||||||||||||||||||||||||||
|
One-to-four
family residential
|
3 | 1.02 | 5 | 1.12 | 8 | 0.69 | 11 | 0.94 | 32 | 0.88 | ||||||||||||||||||||||||||||||
|
Other
|
— | 0.02 | — | 0.02 | — | 0.02 | — | 0.02 | — | — | ||||||||||||||||||||||||||||||