UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
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þ
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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For the Quarterly Period Ended June 30, 2009
Commission File Number 000-25193
CAPITAL CROSSING PREFERRED CORPORATION
(Exact name of registrant as specified in its charter)
Massachusetts
(State or other jurisdiction of incorporation or organization)
04-3439366
(I.R.S. Employer Identification Number)
1271
Avenue of the Americas, 46
th
Floor, New York, New York
(Address of principal executive offices)
(646) 333-8809
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes
þ
No
o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12
months (or for such shorter period that the registrant was required to submit and post such files).
Yes
o
No
o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated
filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
(Check one):
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Large accelerated filer
o
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Accelerated filer
o
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Non-accelerated filer
þ
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Smaller reporting company
o
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(Do not check if a smaller reporting company)
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act). Yes
o
No
þ
The number of shares outstanding of the registrants sole class of common stock was 100 shares,
$.01 par value per share, as of August 13, 2009. No common stock was held by non-affiliates of the
issuer.
Capital Crossing Preferred Corporation
Table of Contents
PART I
Item 1. Financial Statements
Capital Crossing Preferred Corporation
Balance Sheets
(unaudited)
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June 30,
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December 31,
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2009
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2008
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(in thousands)
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ASSETS
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Cash account with parent
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$
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208
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$
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208
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Interest-bearing deposits with parent
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46,989
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43,549
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Total cash and cash equivalents
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47,197
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43,757
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Loans held for sale
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33,164
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Loans held for investment, net of discounts and net deferred loan income
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52,998
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Less allowance for loan losses
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(915
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Loans held for investment, net
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52,083
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Accrued interest receivable
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191
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224
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Other assets
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18
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3
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$
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80,570
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$
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96,067
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LIABILITIES AND STOCKHOLDERS EQUITY
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Accrued expenses and other liabilities
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$
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302
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$
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931
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Total liabilities
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302
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931
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Stockholders equity:
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Preferred stock, Series B, 8% cumulative,
non-convertible; $.01 par value; $1,000 liquidation
value per share plus
accrued dividends; 1,000 shares authorized, 937 shares
issued and outstanding
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Preferred stock, Series D, 8.50% non-cumulative,
exchangeable; $.01 par value; $25 liquidation value
per share; 1,725,000 shares
authorized, 1,500,000 shares issued and outstanding
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15
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15
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Common stock, $.01 par value, 100 shares authorized,
issued and outstanding
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Additional paid-in capital
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95,121
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95,121
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Accumulated deficit
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(14,868
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)
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Total stockholders equity
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80,268
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95,136
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$
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80,570
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$
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96,067
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See accompanying notes to financial statements.
1
Capital Crossing Preferred Corporation
Statements of Income
(unaudited)
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Three Months Ended
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Six Months Ended
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June 30,
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June 30,
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2009
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2008
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2009
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2008
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(in thousands)
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Interest income:
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Interest and fees on loans
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$
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679
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$
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1,252
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$
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1,508
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$
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2,547
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Interest on interest-bearing deposits
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202
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243
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393
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470
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Total interest income
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881
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1,495
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1,901
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3,017
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Provision for loan losses
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40
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915
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155
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Valuation allowance on loans held for sale
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(1,029
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(16,210
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Net revenue
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(148
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1,535
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(13,394
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3,172
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Operating expenses:
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Loan servicing and advisory services
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44
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51
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88
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99
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Other general and administrative
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284
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58
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570
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101
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Total operating expenses
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328
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109
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658
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200
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Net income (loss)
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(476
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1,426
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(14,052
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2,972
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Preferred stock dividends
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815
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816
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1,631
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Net income (loss) available to common stockholder
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$
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(476
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$
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611
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$
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(14,868
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$
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1,341
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See accompanying notes to financial statements.
2
Capital Crossing Preferred Corporation
Statements of Changes in Stockholders Equity
(unaudited)
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Six Months ended June 30, 2009
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Preferred Stock
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Preferred Stock
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Additional
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Retained
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Total
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Series B
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Series D
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Common Stock
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Paid-in
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Earnings/
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Stockholders
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Shares
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Amount
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Shares
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Amount
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Shares
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Amount
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Capital
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Accumulated Deficit
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Equity
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(in thousands)
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Balance at December 31, 2008
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1
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$
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1,500
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$
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15
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$
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$
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95,121
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$
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$
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95,136
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Net loss
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(14,052
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(14,052
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Cumulative dividends on preferred stock, Series B
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(19
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(19
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Dividends on preferred stock, Series D
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(797
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(797
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Balance at June 30, 2009
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1
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$
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1,500
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$
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15
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$
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$
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95,121
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$
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(14,868
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$
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80,268
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Six Months ended June 30, 2008
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Preferred Stock
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Preferred Stock
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Additional
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Total
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Series B
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Series D
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Common Stock
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Paid-in
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Retained
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Stockholders
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Shares
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Amount
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Shares
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Amount
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Shares
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Amount
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Capital
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Earnings
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Equity
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(in thousands)
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Balance at December 31, 2007
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1
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$
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1,500
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$
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15
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$
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$
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115,354
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$
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$
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115,369
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Net income
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2,972
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2,972
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Cumulative dividends on preferred stock, Series B
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(37
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(37
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Dividends on preferred stock, Series D
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(1,594
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)
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(1,594
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Balance at June 30, 2008
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1
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$
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1,500
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$
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15
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$
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$
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115,354
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$
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1,341
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$
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116,710
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See accompanying notes to financial statements.
3
Capital Crossing Preferred Corporation
Statements of Cash Flows
(unaudited)
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Six Months Ended June 30,
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2009
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2008
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(in thousands)
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Cash flows provided by operating activities:
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Net (loss) income
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$
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(14,052
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$
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2,972
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Adjustments to reconcile net income to net cash provided by operating activities:
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Valuation allowance on loans held for sale
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16,210
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Provision for loan losses
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(915
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)
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(155
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)
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Decrease in accrued interest receivable
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33
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47
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Increase (decrease) in accrued expenses and other liabilities
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186
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(56
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)
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Other, net
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(15
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)
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(13
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)
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Net cash provided by operating activities
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1,447
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2,795
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Cash flows provided by investing activities:
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Loan repayments
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3,624
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7,113
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Net cash provided by investing activities
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3,624
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7,113
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Cash flows used in financing activities:
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Payment of preferred stock dividends
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(1,631
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)
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(1,631
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)
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Net cash used in financing activities
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(1,631
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)
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(1,631
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Net change in cash and cash equivalents
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3,440
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8,277
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Cash and cash equivalents at beginning of period
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43,757
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50,581
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Cash and cash equivalents at end of period
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$
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47,197
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$
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58,858
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See accompanying notes to financial statements.
4
Capital Crossing Preferred Corporation
Notes to Financial Statements
Three and Six Months Ended June 30, 2009 and 2008
Note 1.
Basis of Presentation
Capital Crossing Preferred Corporation (the Company) is a Massachusetts corporation
organized on March 20, 1998, to acquire and hold real estate assets. The Companys current
principal business objective is to hold mortgage assets that will generate net income for
distribution to stockholders. The Company may acquire additional mortgage assets in the future.
However, management currently has no intention of acquiring additional assets other than any assets
that may be acquired in a potential alternative transaction to the terminated asset exchange
described below. Effective as of April 27, 2009, Lehman Brothers Bank, FSB, the owner of all of the
Companys common stock, formally changed its name to Aurora Bank FSB (prior to and after the name
change, Aurora Bank). Aurora Bank is a subsidiary of Lehman Brothers Holdings Inc. (LBHI; LBHI
with its subsidiaries, Lehman Brothers). Prior to the merger with Aurora Bank, which is further
discussed below, the Company was a subsidiary of Capital Crossing Bank (Capital Crossing), a
federally insured Massachusetts trust company, and Capital Crossing owned all of the Companys
common stock. The Company 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. As a REIT, the
Company 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 March 31, 1998, Capital Crossing capitalized the Company by transferring mortgage loans
valued at $140.7 million in exchange for 1,000 shares of the Companys 8% Cumulative
Non-Convertible Preferred Stock, Series B, valued at $1.0 million and 100 shares of the Companys
common stock valued at $139.7 million.
On May 11, 2004, the Company closed its public offering of 1,500,000 shares of its 8.50%
Non-Cumulative Exchangeable Preferred Stock, Series D. The net proceeds to the Company from the
sale of Series D preferred stock was $35.3 million. The Series D preferred stock is redeemable at
the option of the Company on or after July 15, 2009, with the prior consent of the Office of Thrift
Supervision (the OTS).
On February 14, 2007, Capital Crossing was acquired by Aurora Bank through a two step merger
transaction. An interim thrift subsidiary of Aurora Bank was merged into Capital Crossing.
Immediately following such merger, Capital Crossing was merged into Aurora Bank. Under the terms of
the agreement, Lehman Brothers paid $30.00 per share in cash in exchange for each outstanding share
of Capital Crossing.
All shares of the Companys 9.75% Non-Cumulative Exchangeable Preferred Stock, Series A and
10.25% Non-Cumulative Exchangeable Preferred Stock, Series C were redeemed on March 23, 2007. The
Companys Series B preferred stock and Series D preferred stock remain outstanding and remain
subject to their existing terms and conditions, including the call feature with respect to the
Series D preferred stock.
The financial information as of June 30, 2009 and the results of operations for the three and
six months ended June 30, 2009 and 2008 and changes in stockholders equity and cash flows for the
six months ended June 30, 2009 and 2008 are unaudited; however, in the opinion of management, the
financial information reflects all adjustments necessary for a fair presentation in accordance with
accounting principles generally accepted in the United States of America (GAAP). On February 5,
2009, as discussed below, the Company agreed to transfer 207 loans secured primarily by commercial
real estate and multifamily residential real estate to Aurora Bank in exchange for 205 loans
secured primarily by residential real estate. As a result, during the first quarter of 2009 the
Company reclassified all of its loan assets as held for sale and recorded a valuation allowance to
reflect these loan assets at the lower of their cost or fair value in accordance with
Statement of Financial Accounting Standards (SFAS) No. 65, Accounting for Certain Mortgage Banking
Activities. Notwithstanding the termination of the asset exchange prior to its consummation, as
discussed below, the Company continues to record these loan assets at the lower of their cost or fair value in accordance with SFAS No. 65 as the Company continues to explore potential alternative transactions. Prior to February 5, 2009, the Companys loan
assets were recorded at historical cost adjusted for the amortization of any purchase discount and
deferred fees less an allowance for loan losses. Interim results are not necessarily indicative of
results to be expected for the entire year. These interim financial statements are intended to be
read in conjunction with the financial statements presented in the Companys Annual Report on Form
10-K as of, and for the year ended December 31, 2008.
In preparing financial statements in conformity with GAAP, management is required to make
estimates and assumptions that affect the reported amounts of assets and liabilities as of the date
of the balance sheet and reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates. Material estimates that are particularly
susceptible to significant change in the near term relate to the determination of the fair value of
loans held for sale. The fair value of the Companys loan portfolio is estimated based upon an
internal analysis by management which considers, among other factors, information, to the extent
available, about then current sale prices, bids, credit quality, liquidity and other available
information for loans with similar characteristics as the Companys loan portfolio. For a more
detailed discussion of the basis for the estimates of the fair value of the Companys loan
5
portfolio, please see Note 5, Fair Market Value of Loans Held for Sale below. Prior to
February 5, 2009, material estimates also included the determination of the allowance for losses on
loans, the allocation of purchase discount on loans between accretable and nonaccretable portions,
and the rate at which the discount is accreted into interest income.
Note 2.
Recent Developments
Bankruptcy of Lehman Brothers Holdings Inc.
On September 15, 2008, LBHI, the parent company of Aurora Bank, filed a voluntary petition
under Chapter 11 of the U.S. Bankruptcy Code. The bankruptcy filing of LBHI has materially and
adversely affected the capital and liquidity of Aurora Bank, the parent of the Company. This has
led to increased regulatory constraints being placed on Aurora Bank by its bank regulatory
authorities, primarily the OTS. Certain of these constraints apply to Aurora Banks subsidiaries,
including the Company. As more fully discussed below, both the bankruptcy filing of LBHI and the
increased regulatory constraints placed on Aurora Bank have negatively impacted the Companys
ability to conduct its business according to its business objectives.
Abandoned Liquidation of the Company.
On October 27, 2008, the Board of Directors of the Company (the Board of Directors)
unanimously approved, subject to obtaining the approval of the OTS, the voluntary complete
liquidation and dissolution of the Company. The liquidation and dissolution was approved by Aurora
Bank, in its capacity as the holder of all of the outstanding common stock of the Company. In
connection with the anticipated liquidation and dissolution, the Board of Directors also approved
the voluntary delisting of the Series D preferred stock from The NASDAQ Stock Market, which was
expected to occur concurrently with the consummation of the liquidation and dissolution.
On October 28, 2008, Aurora Bank made a formal request to the OTS for a letter of
non-objection with respect to the liquidation and dissolution of the Company. Following requests
for additional information by the OTS, a second non-objection request was submitted by Aurora Bank
on November 12, 2008. The OTS did not approve or grant a non-objection letter with respect to the
liquidation and dissolution of the Company. On November 26, 2008, however, the OTS notified Aurora
Bank that the outstanding Series D preferred stock of the Company would be afforded Tier 1 capital
treatment at Aurora Bank at a time while Aurora Banks capital levels were continuing to decrease.
Accordingly, given the refusal of the OTS to approve or grant a non-objection letter with respect
to the proposed liquidation and dissolution, the Board of Directors approved the abandonment of the
proposed liquidation and dissolution of the Company and the delisting of the Series D preferred
stock.
Terminated Asset Exchange
On February 5, 2009, the Company and Aurora Bank entered into an Asset Exchange Agreement (the
Agreement) pursuant to which the Company agreed to transfer 207 loans secured primarily by
commercial real estate and multifamily residential real estate (together, the Loans) to Aurora
Bank in exchange for 205 loans secured primarily by residential real estate (the Exchange). The
Loans represented substantially all of the Companys assets, excluding cash and interest-bearing
deposits as of December 31, 2008. The Exchange was subject to certain conditions to closing as well
as the receipt of a non-objection letter from the OTS. On July 20, 2009, the Company and Aurora
Bank mutually agreed to terminate the Agreement. The Agreement was terminated following receipt of
a letter from the OTS failing to grant Aurora Banks requests for non-objection with respect to the
Exchange. As a result of the termination of the Agreement, which termination was without liability
to either party, the Exchange will not be consummated and the Company will continue to own the
portfolio of loans secured by commercial real estate and multifamily real estate that the Company
owned prior to entering into the Agreement. The Company continues to consider potential alternative
transactions involving its loan portfolio, however there can be no assurances that any such
alternative transaction will occur. As a result of entering into the Agreement and continuing to
consider potential alternative transactions, the Company reclassified all of its loan assets as
held for sale and now records these loan assets at the lower of their cost or fair value
in accordance with SFAS No. 65, Accounting for Certain Mortgage Banking Activities.
Aurora Bank Regulatory Actions and Capital Levels
On January 26, 2009, the OTS entered a cease and desist order against Aurora Bank (the
Order). The Order, among other things, required Aurora Bank to file various privileged
prospective operating plans with the OTS to manage the liquidity and operations of Aurora Bank
going forward, including a strategic plan to be activated whenever Aurora Banks capital ratios are
less than specified levels. This strategic plan will remain operative until the OTS confirms that
the Order has been lifted based, among other things, on Aurora Banks capital ratios. The Order
requires Aurora Bank to ensure that each of its subsidiaries, including the Company, complies with
the Order, including the operating restrictions contained in the Order. These operating
restrictions, among other things, restrict transactions with affiliates, contracts outside the
ordinary course of business and changes in senior executive officers, board members or their
employment arrangements without prior written notice to the OTS. More detailed information can be
found in the Order itself, which was entered against Aurora Bank under its former name, Lehman
Brothers Bank, FSB, a copy of which is available on the OTS website. In addition, on February 4,
2009, the OTS issued a prompt corrective action directive to Aurora Bank (the PCA Directive). The
PCA Directive requires Aurora Bank to, among other things, raise its capital ratios such that it
will be deemed to be adequately capitalized and places additional constraints on Aurora Bank and
its subsidiaries, including the Company. More detailed information can be found in
6
PCA Directive itself, which was entered against Aurora Bank under its former name, Lehman
Brothers Bank, FSB, a copy of which is available on the OTS website.
On June 26, 2009, the OTS notified Aurora Bank that the prior approval of the OTS is currently
required before payment by the Company of dividends on the Series D preferred stock as a result of
the Order and the PCA Directive. As a result of the notice from the OTS, the Board of Directors
voted not to declare or pay the Series D preferred stock dividend that would have been payable on
July 15, 2009. Aurora Bank has made a formal request to the OTS to approve the payment of future
dividends on the Series D preferred stock, however, there can be no assurance that such approval
will be received from the OTS or when or if such OTS approval requirement will be removed.
Furthermore, if approval is received from the OTS, any future dividends on the Series D preferred stock will be payable only when, as and
if declared by the Board of Directors. The terms of the Series D preferred stock provide that
dividends on the Series D preferred stock are not cumulative and if no dividend is declared for a
quarterly dividend period, the holders of the Series D preferred stock will have no right to
receive a dividend for that period, and the Company will have no obligation to pay a dividend for
that period, whether or not dividends are declared and paid for any future period.
In order to continue to qualify as a real REIT, the Company generally is required each year to
distribute to its stockholders at least 90% of its net taxable income, excluding net capital gains.
As a REIT, the Company generally is not required to pay federal income tax if it continues to meet
this and a number of other requirements. If the OTS does not grant approval to the Company to pay
dividends to its stockholders in an amount necessary to retain the Companys REIT qualification,
including at least 90% of its net taxable income (if any), the Company will fail to qualify as a
REIT and, as a result, will be subject to federal income tax. These
financial statements do not include any adjustments that might result
from this uncertainty.
As of June 30, 2009, Aurora Bank maintained its status as adequately capitalized under
applicable regulatory guidelines according to a recent public filing by Aurora Bank with the OTS
and taking into account the Order and PCA Directive. The classification of Aurora Banks
capitalization level, however, is subject to review and acceptance by the OTS. On August 5, 2009,
the bankruptcy court issued an order permitting LBHI to take certain actions intended to strengthen
the capital position of Aurora Bank, including: (1) the increase of the maximum amount available to
Aurora Bank under its repurchase facility with LBHI from $325 million to $450 million, (2) the
increase of the advance rate available under the repurchase facility from 50% to 75% of the value
of the assets that serve as collateral for the repurchase facility and (3) the approval of a
servicing advancement bridge facility for Aurora Bank from LBHI in the amount of $500 million.
Note 3.
Recent Accounting Pronouncements
In September 2006, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 157,
Fair Value Measurements. This standard defines fair values, establishes a framework for measuring
fair value in conformity with GAAP, and expands disclosures about fair value measurements. Prior to
this standard, there were varying definitions of fair value and limited guidance for applying those
definitions under GAAP. In addition, the guidance was dispersed among many accounting
pronouncements that require fair value measurements. This standard was intended to increase
consistency and comparability in fair value measurements and disclosures about fair value
measurements. The provisions of this standard became effective January 1, 2008. The Company applies
the provisions of SFAS No. 157 in the determination of the fair value of the loan assets for
purposes of the determination of the lower of cost or fair value of the loans classified
as held for sale.
In April 2009, the FASB issued Staff Position (FSP) No. FAS 157-4, Determining Fair Value
When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and
Identifying Transactions That Are Not Orderly. FSP 157-4 emphasizes that the objective of fair
value measurement described in SFAS No. 157 remains unchanged and provides additional guidance for
determining whether market activity for a financial asset or liability has significantly decreased
and for identifying circumstances that indicate that transactions are not orderly. FSP 157-4
indicates that if a market is determined to be inactive and the related market price is deemed to
be reflective of a distressed sale price, then management judgment may be required to estimate
fair value. Further, FSP 157-4 identifies factors to be considered when determining whether or not
a market is inactive. FSP 157-4 is effective for interim and annual reporting periods ending after
June 15, 2009, and is applied prospectively. The Company believes its valuation methodologies
already considered the concepts discussed in FSP 157-4. Therefore, its application did not have an
impact on the consolidated earnings or financial position of the Company.
In April 2009, the FASB issued Staff Position No. FAS 107-1 and APB 28-1, Interim Disclosures
about Fair Value of Financial Instruments. FSP 107-1 and APB 28-1 amend SFAS No. 107, Disclosures
About Fair Value of Financial Instruments
, and Accounting Principles Board Opinion No. 28,
Interim Financial Reporting
to require disclosures about fair values of financial instruments in
all interim financial statements. Upon adoption by the Company on June 30, 2009, the disclosures
required by FSP 107-1 and APB 28-1 are to be provided prospectively. The required disclosures are
provided in Note 5 below.
In May 2009, the FASB issued SFAS No. 165, Subsequent Events. This standard establishes
general accounting and disclosure with respect to events that occur after the balance sheet date
but before financial statements are issued or otherwise available. The standard sets forth guidance
with respect to (a) the period after the balance sheet date during which management of a reporting
entity should evaluate events or transactions that may occur for potential recognition or
disclosure in its financial statements; (b) the circumstances under which an entity should
recognize events or transactions occurring after the balance sheet date in its financial
statements; and (c) the disclosures that an entity should provide about events or transactions that
occur after the balance sheet date. The Company adopted SFAS 165 effective June 30, 2009.
Accordingly, the Company evaluated events occurring subsequent to the date of the balance sheet for
potential recognition or disclosure in the financial statements. Events occurring through August
14, 2009, the date this Quarterly Report on Form 10-Q was filed with the Securities and Exchange
Commission (the SEC), were evaluated.
Note 4.
Loans
As a result of entering into the Asset Exchange Agreement and in accordance with SFAS No. 65,
Accounting for Certain Mortgage Banking Activities, effective February 5, 2009 all of the
Companys loan assets were considered held for sale and valued at the lower of their cost
or fair value. As discussed in more detail in Note 5 below, the fair value of the Companys loan
portfolio
7
was estimated based upon an internal analysis by management which considered, among other factors,
information, to the extent available, about then current sale prices, bids, credit quality,
liquidity and other available information for loans with similar characteristics as the Companys
loan portfolio.
The amount by which the cost of the Companys loan assets exceeded the fair value at
the date the loans were reclassified as held for sale was recognized as a valuation allowance.
Subsequent changes to the valuation allowance will be included in the determination of net income
in the period in which the change occurs. Increases in the fair value of the loan assets will be
recognized only up to the cost of the loans on the date they were classified as held for
sale.
Any remaining discount relating to the purchase of the loans by the Company is not amortized
as interest revenue during the period the loans are classified as held for sale. Deferred revenue
associated with loans held for sale is deferred until the related loan is sold.
Commercial mortgage loans constituted approximately 59.9% of the fair value of the Companys
total loan portfolio at June 30, 2009. Commercial mortgage loans are generally subject to greater
risks than other types of loans. The Companys commercial mortgage loans, like most commercial
mortgage loans, generally lack standardized terms, tend to have shorter maturities than other
mortgage loans and may not be fully amortizing.
A summary of the fair value of the Companys loans, which were considered held for sale as of
June 30, 2009, follows:
|
|
|
|
|
|
|
June 30, 2009
|
|
|
|
(in thousands)
|
|
Mortgage loans on real estate:
|
|
|
|
|
Commercial real estate
|
|
$
|
19,888
|
|
Multi-family residential
|
|
|
12,713
|
|
One-to-four family residential
|
|
|
575
|
|
|
|
|
|
Total
|
|
|
33,176
|
|
Other
|
|
|
9
|
|
|
|
|
|
Total loans
|
|
|
33,185
|
|
|
|
|
|
|
Less:
|
|
|
|
|
Net deferred loan fees
|
|
|
(21
|
)
|
|
|
|
|
|
|
|
|
|
Loans, net of valuation
allowance of $16,210
|
|
$
|
33,164
|
|
|
|
|
|
A summary of the balances of the Companys loans, which were considered held for investment as
of December 31, 2008, follows:
|
|
|
|
|
|
|
December 31,
|
|
|
|
2008
|
|
|
|
(in thousands)
|
|
Mortgage loans on real estate:
|
|
|
|
|
Commercial real estate
|
|
$
|
31,647
|
|
Multi-family residential
|
|
|
20,384
|
|
One-to-four family residential
|
|
|
981
|
|
|
|
|
|
Total
|
|
|
53,012
|
|
Other
|
|
|
13
|
|
|
|
|
|
Total loans, net of discounts
|
|
|
53,025
|
|
|
|
|
|
|
Less:
|
|
|
|
|
Allowance for loan losses
|
|
|
(915
|
)
|
Net deferred loan fees
|
|
|
(27
|
)
|
|
|
|
|
|
|
|
|
|
Loans, net
|
|
$
|
52,083
|
|
|
|
|
|
8
During the six months ended June 30, 2009, the Company reversed a $915,000 allowance for loan
losses and recorded a valuation allowance of $16.2 million because the Companys loan portfolio is
recorded at its fair value in accordance with SFAS No. 65, Accounting for Certain Mortgage Banking
Activities. The determination of fair value includes, among other factors, consideration of the
creditworthiness of borrowers, and therefore no allowance for loan losses existed at June 30, 2009,
compared to an allowance for loan losses of approximately $1.0 million at June 30, 2008 and
$915,000 at December 31, 2008.
Activity in the allowance for loan losses follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30,
|
|
|
Six Months Ended June 30,
|
|
|
|
2009
|
|
|
2008
|
|
|
2009
|
|
|
2008
|
|
|
|
(in thousands)
|
|
Balance at beginning of period
|
|
$
|
|
|
|
$
|
1,065
|
|
|
$
|
915
|
|
|
$
|
1,180
|
|
Provision for loan losses
|
|
|
|
|
|
|
(40
|
)
|
|
|
(915
|
)
|
|
|
(155
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at end of period
|
|
$
|
|
|
|
$
|
1,025
|
|
|
$
|
|
|
|
$
|
1,025
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Since the Companys loan portfolio is now classified as held for sale and recorded at its
fair value in accordance with SFAS No. 65, Accounting for Certain Mortgage Banking Activities,
there was no nonaccretable discount at June 30, 2009. At June 30, 2008, there was a nonaccretable
discount of $155,000 related to two loans (neither of which were non-performing) with an aggregate
net investment balance of $193,000. No loans were acquired in 2009 or 2008.
The estimated fair value of non-performing loans totaled $2.0 million as of June 30,
2009. Non-performing loans, net of discount, totaled $589,000 as of June 30, 2008. The
increase in non-performing assets is due to the fact that 12 loans, representing 9
borrowers, were not performing as of June 30, 2009.
Note 5.
Fair Value
Fair Value Measurements
As a result of entering into the Asset Exchange Agreement and in accordance with SFAS No. 65,
Accounting for Certain Mortgage Banking Activities, effective February 5, 2009 the Companys
loans were reclassified as held for sale and the Company recorded a valuation allowance in the
first quarter. Notwithstanding the termination of the Exchange prior to consummation, the
Companys loan assets continue to be recorded at the lower of cost or fair value in the
balance sheet in accordance with SFAS No. 65 as the Company continues to explore potential
alternative transactions. SFAS No. 157, Fair Value Measurements, defines fair value and
establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to
measure fair value. SFAS No. 157 defines fair value as the price at which an asset or liability
could be exchanged in a current transaction between knowledgeable, willing parties. Where
available, fair value is based on observable market prices or inputs or derived from such prices or
inputs. Where observable prices or inputs are not available, other valuation methodologies are
applied. At June 30, 2009, the fair value of the Companys loan portfolio was estimated based upon
an internal analysis by management which considered, among other factors, information, to the
extent available, about then current sale prices, bids, credit quality, liquidity and other
available information for loans with similar characteristics as the Companys loan portfolio. The
valuation of the loan portfolio involves some level of management estimation and judgment, the
degree of which is dependent on the terms of the loans and the availability of market prices and
inputs.
SFAS No. 157 requires the categorization of financial assets and liabilities based on a
hierarchy of the inputs to the valuation techniques used to measure fair value. The hierarchy gives
the highest priority to quoted prices in active markets for identical assets or liabilities (Level
I) and the lowest priority to valuation methods using unobservable inputs (Level III). The three
levels are described below:
Level
I Inputs are unadjusted, quoted prices in active markets for identical assets
or liabilities at the measurement date.
Level
II Inputs are either directly or indirectly observable for the asset or
liability through correlation with market data at the measurement date and for the
duration of the instruments anticipated life.
Level
III Inputs reflect managements best estimate of what market participants would
use in pricing the asset or liability at the measurement date. Consideration is given
to the risk inherent in the valuation technique and the risk inherent in the inputs to
the model.
9
The loans categorization within the fair value hierarchy is based on the lowest level of
significant input to its valuation.
The categorization of the level of judgment in the fair value determination of the Companys
loans at June 30, 2009 was:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Level I
|
|
Level II
|
|
Level III
|
|
Total
|
|
|
(in thousands)
|
Loans Held for Sale:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial real estate
|
|
|
|
|
|
|
|
|
|
$
|
19,867
|
|
|
$
|
19,867
|
|
Multi-family residential
|
|
|
|
|
|
|
|
|
|
|
12,713
|
|
|
|
12,713
|
|
One-to-four family residential
|
|
|
|
|
|
|
|
|
|
|
575
|
|
|
|
575
|
|
Other
|
|
|
|
|
|
|
|
|
|
|
9
|
|
|
|
9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
33,164
|
|
|
$
|
33,164
|
|
|
|
|
The table presented below summarizes the change in balance sheet carrying value associated
with Level III loans during the three months ended June 30, 2009. Caution should be utilized when
evaluating reported net revenues for Level III loans.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
|
|
Payments,
|
|
Net
|
|
|
|
|
|
|
|
|
|
Balance
|
|
|
March 31,
|
|
Purchases
|
|
Transfers
|
|
Gains / (Losses)
(1)
|
|
June 30,
|
|
|
2009
|
|
and Sales
|
|
In/(Out)
|
|
Realized
|
|
Unrealized
|
|
2009
|
|
|
(in thousands)
|
Loans Held for Sale:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial real estate
|
|
$
|
21,436
|
|
|
$
|
(1,007
|
)
|
|
|
|
|
|
|
|
|
|
$
|
(562
|
)
|
|
$
|
19,867
|
|
Multi-family residential
|
|
|
13,484
|
|
|
|
(321
|
)
|
|
|
|
|
|
|
|
|
|
|
(450
|
)
|
|
|
12,713
|
|
One-to-four family
residential
|
|
|
617
|
|
|
|
(25
|
)
|
|
|
|
|
|
|
|
|
|
|
(17
|
)
|
|
|
575
|
|
Other
|
|
|
9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
9
|
|
|
Total
|
|
$
|
35,546
|
|
|
$
|
(1,353
|
)
|
|
$
|
0
|
|
|
$
|
0
|
|
|
$
|
(1,029
|
)
|
|
$
|
33,164
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
The current period gains/(losses) from changes in values of Level
III loans represent gains/(losses) from changes in values of those loans only for the
period(s) in which the loans were classified as Level III.
|
The table presented below summarizes the change in balance sheet carrying value
associated with Level III loans during the six months ended June 30, 2009. Caution should be
utilized when evaluating reported net revenues for Level III loans.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
|
|
Payments,
|
|
Net
|
|
|
|
|
|
|
|
|
|
Balance
|
|
|
December 31,
|
|
Purchases
|
|
Transfers
|
|
Gains / (Losses)
(1)
|
|
June 30,
|
|
|
2008
|
|
and Sales
|
|
In/(Out)
|
|
Realized
|
|
Unrealized
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
|
|
|
|
|
|
|
Loans Held for Sale:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial real estate
|
|
$
|
0
|
|
|
$
|
(1,007
|
)
|
|
$
|
29,762
|
|
|
|
|
|
|
$
|
(8,888
|
)
|
|
$
|
19,867
|
|
Multi-family residential
|
|
|
0
|
|
|
|
(321
|
)
|
|
|
19,982
|
|
|
|
|
|
|
|
(6,948
|
)
|
|
|
12,713
|
|
One-to-four family
residential
|
|
|
0
|
|
|
|
(25
|
)
|
|
|
970
|
|
|
|
|
|
|
|
(370
|
)
|
|
|
575
|
|
Other
|
|
|
0
|
|
|
|
|
|
|
|
13
|
|
|
|
|
|
|
|
(4
|
)
|
|
|
9
|
|
|
Total
|
|
$
|
0
|
|
|
$
|
(1,353
|
)
|
|
$
|
50,727
|
|
|
$
|
0
|
|
|
$
|
(16,210
|
)
|
|
$
|
33,164
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
The current period gains/(losses) from changes in values of Level
III loans represent gains/(losses) from changes in values of those loans only for the
period(s) in which the loans were classified as Level III.
|
Fair Value of Financial Instruments
SFAS No. 107, Disclosures about Fair Value of Financial Instruments, requires disclosure of
estimated fair values of all financial instruments where it is practicable to estimate such values.
In determining the fair value measurements for financial assets and liabilities, the Company
utilizes quoted prices, when available. If quoted prices are not available, the Company estimates
fair value using present value or other valuation techniques that utilize inputs that are
observable for the asset or liability, either directly or indirectly, when available. When
observable inputs are not available, inputs may be used that are unobservable and, therefore,
reflect the Companys own assumptions about the assumptions market participants would use in
pricing the asset or liability based on the best information available in the circumstances.
10
SFAS No. 107 excludes certain financial instruments and all nonfinancial instruments from
its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not
represent the underlying value of the Company.
The following methods and assumptions were used by the Company in estimating fair value
disclosures for financial instruments:
Cash and cash equivalents:
The carrying amounts of cash and interest-bearing deposits
approximate fair value because of the short-term maturity of these instruments.
Loans:
The fair value of the loan portfolio was estimated based upon an internal analysis by
management which considered, among other things, information, to the extent available, about then
current sale prices, bids and other available information for loans with similar characteristics as
the Companys loan portfolio. The incremental credit risk for non-performing loans was considered
in the determination of the fair value of loans.
Accrued interest receivable:
The carrying amount of accrued interest receivable
approximates fair value because of the short-term nature of these financial instruments.
The estimated fair values, and related carrying amounts, of the Companys financial
instruments are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2009
|
|
December 31, 2008
|
|
|
Carrying
|
|
|
|
|
|
Carrying
|
|
|
|
|
Amount
|
|
Fair Value
|
|
Amount
|
|
Fair Value
|
|
|
(in thousands)
|
Cash and cash equivalents
|
|
$
|
47,197
|
|
|
$
|
47,197
|
|
|
$
|
43,757
|
|
|
$
|
43,757
|
|
Loans held for sale, net
|
|
|
33,164
|
|
|
|
33,164
|
|
|
|
|
|
|
|
|
|
Loans, net
|
|
|
|
|
|
|
|
|
|
|
52,083
|
|
|
|
37,046
|
|
Accrued interest receivable
|
|
|
191
|
|
|
|
191
|
|
|
|
224
|
|
|
|
224
|
|
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
This report contains certain statements that constitute forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of 1995. Words such as expects,
anticipates, believes, estimates and other similar expressions or future or conditional verbs
such as will, should, would, and could are intended to identify such forward-looking
statements. These statements are not historical facts, but instead represent the Companys current
expectations, plans or forecasts of its future results, growth opportunities, business outlook,
loan growth, credit losses, liquidity position and other similar matters, including, but not
limited to, the ability to pay dividends with respect to the Series D preferred stock, the ability
to consummate any alterative transaction to the terminated asset exchange, future bank regulatory
actions that may impact the Company and the effect of the bankruptcy of LBHI on the Company. These
statements are not guarantees of future results or performance and involve certain risks,
uncertainties and assumptions that are difficult to predict and often are beyond the Companys
control. Actual outcomes and results may differ materially from those expressed in, or implied by,
the Companys forward-looking statements. You should not place undue reliance on any
forward-looking statement and should consider all uncertainties and risks, including, among other
things, the risks set forth herein and in our Annual Report on Form 10-K for the year ended
December 31, 2008, as well as those discussed in any of the Companys other subsequent Securities
and Exchange Commission filings. Forward-looking statements speak only as of the date they are
made, and the Company undertakes no obligation to update any forward-looking statement to reflect
the impact of circumstances or events that arise after the date the forward-looking statement was
made.
Possible events or factors could cause results or performance to differ materially from
what is expressed in our forward-looking statements. These possible events or factors include, but
are not limited to, those risk factors discussed under Item 1A Risk Factors in our Annual Report
on Form 10-K for the year ended December 31, 2008 or in Item 1A of this Quarterly Report on Form
10-Q, and the following: limitations by regulatory authorities on the Companys ability to
implement its business plan and restrictions on its ability to pay dividends; further regulatory
limitations on the business of Aurora Bank that are applicable to the Company; negative economic
conditions that adversely affect the general economy, housing prices, the job market, consumer
confidence and spending habits which may affect, among other things, the credit quality of our loan
portfolios (the degree of the impact of which is dependent upon the duration and severity of these
conditions); the level and volatility of interest rates; changes in consumer, investor and
counterparty confidence in, and the related impact on, financial markets and institutions;
legislative and regulatory actions which may adversely affect the Companys business and economic
conditions as a whole; the impact of litigation and regulatory investigations; various monetary and
fiscal policies and regulations; changes in accounting standards, rules and interpretations and the
impact on the Companys financial statements; the
11
ability to
consummate any alternative transaction to the terminated asset exchange; and changes
in the nature and quality of the types of loans held by the Company.
The following discussion of the Companys financial condition, results of operations, capital
resources and liquidity should be read in conjunction with the financial statements and related
notes included elsewhere in this report and the audited financial statements and related notes
included in the Companys Annual Report on Form 10-K for the year ended December 31, 2008 as filed
with the SEC.
Executive Level Overview
Aurora Bank owns all of the Companys common stock. The Companys Series B preferred stock and
Series D preferred stock remain outstanding and remain subject to their existing terms and
conditions, including the call feature with respect to the Series D preferred stock.
All of the mortgage assets in the Companys loan portfolio at June 30, 2009 were acquired from
Capital Crossing, previously the sole common stockholder, and it is anticipated that substantially
all additional mortgage assets, if any assets are acquired in the future, will be acquired from
Aurora Bank, currently the sole common stockholder. As of June 30, 2009, the Company held loans
acquired from Capital Crossing with an aggregate fair value of approximately $33.2 million.
Commercial mortgage loans constituted approximately 59.9% of the fair value of the Companys
total loan portfolio at June 30, 2009. Commercial mortgage loans are generally subject to greater
risks than other types of loans. The Companys commercial mortgage loans, like most commercial
mortgage loans, generally lack standardized terms, tend to have shorter maturities than other
mortgage loans and may not be fully amortizing. For these reasons, the Company may experience
higher rates of default on its mortgage loans than it would if its loan portfolio was more
diversified and included a greater number of owner-occupied residential or other mortgage loans.
Properties underlying the Companys current mortgage assets are also concentrated primarily in
California, New England and Nevada. As of June 30, 2009, approximately 63.1% of the fair value of
the Companys mortgage loans were secured by properties located in California, 6.8% in New England
and 5.3% in Nevada. Beginning in 2007 and continuing through June 2009, the housing and real estate
sectors in California and Nevada were hit particularly hard by the recession with higher overall
foreclosure rates than the national average. If these regions experience further adverse economic,
political or business conditions, or natural hazards, the Company will likely experience higher
rates of loss and delinquency on its mortgage loans than if its loans were more geographically
diverse.
Net income available to the common stockholder decreased $1.1 million to a net loss of
$476,000 for the three months ended June 30, 2009, compared to net income of $611,000 for the same
period in 2008. The decrease in net income available to the common stockholder is primarily the
result of a $614,000 reduction in interest, a net reduction in the fair value of loans of $1.1 million during the
quarter, and an increase in general and administrative expenses of $226,000, offset by an $815,000
reduction in dividends as no dividends were declared in the second quarter of 2009.
Decisions regarding the utilization of the Companys cash are based, in large part, on its
current and future commitments to pay preferred stock dividends and its ability to pay dividends on
its preferred stock and common stock in amounts necessary to continue to preserve its status as a
REIT under the Internal Revenue Code. Future decisions regarding mortgage asset acquisitions and
returns of capital will be based on the levels of the Companys cash and cash equivalents at the
time, the preferred stock dividends at the time and the required income necessary to generate
adequate dividend coverage in the future, the dividends on its preferred stock and common stock
necessary to continue to preserve the Companys status as a REIT and other factors determined to be
relevant at the time.
Impact of Economic Recession
Dramatic declines in the housing market over the past year, with falling home prices and
increasing foreclosures, unemployment and underemployment, have negatively impacted the credit
performance of mortgage loans and resulted in significant write-downs of asset values by financial
institutions, including government-sponsored entities as well as major commercial and investment
banks. Reflecting concern about the stability of the financial markets generally and the strength
of counterparties, many lenders and institutional investors have reduced or ceased providing
funding to borrowers, including to other financial institutions. This market turmoil and tightening
of credit have led to an increased level of delinquencies, decreased consumer spending, lack of
confidence, increased market volatility and widespread reduction of business activity generally.
The resulting economic pressure on borrowers, and lack of confidence in the financial markets have
negatively impacted, and may further negatively impact, the credit quality of our commercial loan
portfolio and may impact the credit quality of our residential loan
portfolio and, in turn, the value the Company could realize upon the
sale or exchange of all or a portion of the loans. The depth and
breadth of the downturn as well as the resulting impacts on the credit quality of both our
commercial and residential loan portfolios remain unclear. Continued market turbulence and economic
uncertainty may result in further reductions in the fair value of the loans held for sale in future
periods.
12
Bankruptcy of LBHI
On September 15, 2008, LBHI filed a voluntary petition for relief under Chapter 11 of the
U.S. Bankruptcy Code. Aurora Bank is a subsidiary of LBHI. Aurora Bank has not been placed into
bankruptcy, reorganization, conservatorship or receivership and the Company has not filed for
bankruptcy protection. We expect, however, that the bankruptcy of LBHI may limit the ability of
LBHI to contribute capital to Aurora Bank now or in the future. In addition, the timing and amount
of any payments received by Aurora Bank with respect to debts owned to Aurora Bank by LBHI may be
limited by the bankruptcy of LBHI, which could in turn negatively impact the assets, capital levels
and regulatory capital ratios of Aurora Bank. On August 5, 2009, the bankruptcy court issued an
order permitting LBHI to take certain actions intended to strengthen the capital position of Aurora
Bank, including: (1) the increase of the maximum amount available to Aurora Bank under its
repurchase facility with LBHI from $325 million to $450 million, (2) the increase of the advance
rate available under the repurchase facility from 50% to 75% of the value of the assets that serve
as collateral for the repurchase facility and (3) the approval of a servicing advancement bridge
facility for Aurora Bank from LBHI in the amount of $500 million. The Company is dependent in
virtually every phase of its operations on the management of Aurora Bank and as a subsidiary of
Aurora Bank is subject to regulation by federal banking authorities. The bankruptcy of LBHI and its
potential negative effects on Aurora Bank has resulted in increased oversight, and we expect will
continue to result in increased oversight, of the Company by the OTS and may result in further
restrictions on the Companys ability to conduct its business.
Abandoned Liquidation of the Company
On October 27, 2008, the Board of Directors unanimously approved, subject to obtaining
the approval of the OTS, the voluntary complete liquidation and dissolution of the Company. The
liquidation and dissolution was approved by Aurora Bank, in its capacity as the holder of all of
the outstanding common stock of the Company. In connection with the anticipated liquidation and
dissolution, the Board of Directors also approved the voluntarily delisting of the Series D
preferred stock from The NASDAQ Stock Market, which was expected to occur concurrently with the
consummation of the liquidation and dissolution.
On October 28, 2008, Aurora Bank made a formal request to the OTS for a letter of
non-objection with respect to the liquidation and dissolution of the Company. Following requests
for additional information by the OTS, a second formal non-objection request was submitted by
Aurora Bank on November 12, 2008. The OTS did not approve or grant a non-objection letter with
respect to the liquidation and dissolution of the Company. On November 26, 2008, however, the OTS
notified Aurora Bank that the outstanding Series D preferred stock of the Company would be afforded
Tier 1 capital treatment at Aurora Bank at a time while Aurora Banks capital levels were
continuing to decrease. Accordingly, given the refusal of the OTS to approve or grant a
non-objection letter with respect to the proposed liquidation and dissolution, the Board of
Directors approved the abandonment of the proposed liquidation and dissolution of the Company and
the delisting of the Series D preferred stock.
Terminated Asset Exchange
On February 5, 2009, the Company and Aurora Bank entered into an Asset Exchange Agreement
pursuant to which the Company agreed to transfer 207 loans secured primarily by commercial real
estate and multifamily residential real estate to Aurora Bank in exchange for 205 loans secured
primarily by residential real estate. The Loans represented substantially all of the Companys
assets, excluding cash and interest-bearing deposits as of December 31, 2008. The Exchange was
subject to certain conditions to closing as well as the receipt of a non-objection letter from the
OTS. On July 20, 2009, the Company and Aurora Bank mutually agreed to terminate the Agreement. The
Agreement was terminated following receipt of a letter from the OTS failing to grant Aurora Banks
requests for non-objection with respect to the Exchange. As a result of the termination of the
Agreement, which termination was without liability to either party, the Exchange will not be
consummated and the Company will continue to own the portfolio of loans secured by commercial real
estate and multifamily real estate that the Company owned prior to entering into the Agreement. The
Company continues to consider potential alternative transactions involving its loan portfolio,
however there can be no assurances that any such alternative transaction will occur. As a result of
entering into the Agreement and continuing to consider potential alternative transactions, the
Company reclassified all of its loan assets as held for sale and now records these loan assets at
the lower of their cost or fair value in accordance with SFAS No. 65, Accounting for
Certain Mortgage Banking Activities.
Regulatory Actions Involving Aurora Bank
On January 26, 2009, the OTS entered a cease and desist order against Aurora Bank. The
Order, among other things, required Aurora Bank to file various privileged prospective operating
plans with the OTS to manage the liquidity and operations of Aurora Bank going forward, including a
strategic plan to be activated whenever Aurora Banks capital ratios are less than specified
levels. This strategic plan will remain operative until the OTS confirms that the Order has been lifted based,
among other things, on Aurora Banks capital ratios. The Order requires Aurora Bank to ensure that
each of its subsidiaries, including the Company, complies with the Order, including the operating
restrictions contained in the Order. These operating restrictions, among other things, restrict
transactions with affiliates, contracts outside the ordinary course of business and changes in
senior executive officers, board members or their employment arrangements without prior written
notice to the OTS. In addition, on February 4, 2009, the OTS issued a prompt corrective action
13
directive to Aurora Bank. The PCA Directive requires Aurora Bank to, among other things, raise its
capital ratios such that it will be deemed to be adequately capitalized and places additional
constraints on Aurora Bank and its subsidiaries, including the Company. More detailed information
can be found in the Order and the PCA Directive themselves, which were entered against Aurora Bank
under its former name, Lehman Brothers Bank, FSB, copies of which are available on the OTS
website.
On June 26, 2009, the OTS notified Aurora Bank that the prior approval of the OTS is
currently required before payment by the Company of dividends on the Series D preferred stock, as a
result of the Order and the PCA Directive. As a result of the notice from the OTS, the Board of
Directors voted not to declare or pay the Series D preferred stock dividend that would have been
payable on July 15, 2009. Aurora Bank has made a formal request to the OTS to approve the payment
of future dividends on the Series D preferred stock, however, there can be no assurance that such
approval will be received from the OTS or when or if such OTS approval requirement will be removed.
Furthermore, if approval is received from the OTS, any future dividends on the Series D preferred stock will be payable only when, as and
if declared by the Board of Directors. The terms of the Series D preferred stock provide that
dividends on the Series D preferred stock are not cumulative and if no dividend is declared for a
quarterly dividend period, the holders of the Series D preferred stock will have no right to
receive a dividend for that period, and the Company will have no obligation to pay a dividend for
that period, whether or not dividends are declared and paid for any future period.
As of June 30, 2009, Aurora Bank maintained its status as adequately capitalized under
applicable regulatory guidelines according to a recent public filing by Aurora Bank with the OTS
and taking into account the Order and PCA Directive. The classification of Aurora Banks
capitalization level, however, is subject to review and acceptance by the OTS.
The bankruptcy of LBHI and its potential negative effects on Aurora Bank has resulted in
increased oversight, and we expect will continue to result in increased oversight, of the Company
by the OTS and may result in further restrictions on the Companys ability to conduct its business.
Application of Critical Accounting Policies and Estimates
Our discussion and analysis of financial condition and results of operations are based upon
our consolidated financial statements, which have been prepared in accordance with U.S. generally
accepted accounting principles, or GAAP. The preparation of these financial statements in
conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts
of assets and liabilities at the date of the financial statements and the reported amount of
revenues and expenses in the reporting period. Our actual results may differ from these estimates.
We describe below those accounting policies that require material subjective or complex judgments
and that have the most significant impact on our financial condition and results of operations. Our
management evaluates these estimates on an ongoing basis, based upon information currently
available and on various assumptions management believes are reasonable as of the date on the front
cover of this report. Although a number of our significant accounting policies have changed since
all of the Companys loan assets are now considered held for sale and, as discussed further below,
valued at the lower of their cost or fair value in accordance with SFAS No. 65,
Accounting for Certain Mortgage Banking Activities, the remainder of the Companys significant
accounting policies summarized in Note 1 to our financial statements included in our Annual Report
on Form 10-K for the year ended December 31, 2008 remain in effect.
Loans Held for Sale.
On February 5, 2009, the Company agreed to transfer 207 loans secured
primarily by commercial real estate and multifamily residential real estate to Aurora Bank in
exchange for 205 loans secured primarily by residential real estate. As a result, during the first
quarter of 2009 the Company reclassified all of its loan assets as held for sale and recorded a
valuation allowance to reflect these loan assets at the lower of their cost or fair value
in accordance with Statement of Financial Accounting Standards (SFAS) No. 65, Accounting for
Certain Mortgage Banking Activities. Despite the termination of the asset exchange prior to its
consummation, the Company continues to account for the loan portfolio as held for sale as it
considers other potential alternative transactions. Prior to February 5, 2009, the Companys loan
assets were recorded at historical cost less an allowance for loan losses. The fair value of the
Companys loan portfolio as of June 30, 2009 was estimated based upon an internal analysis by
management which considered, among other factors, information, to the extent available, about then
current sale prices, bids, credit quality, liquidity and other available information for loans with
similar characteristics as the Companys loan portfolio.
The amount by which the cost of the Companys loan assets exceeded the fair value at
the date the loans were reclassified as held for sale was recognized as a valuation allowance.
Subsequent changes to the valuation allowance will be included in the determination of net income
in the period in which the change occurs. Increases in the fair value of the loan assets will be
recognized only up to the cost of the loans on the date they were classified as held for
sale.
Any remaining discount relating to the purchase of the loans by the Company are not amortized
as interest revenue during the period the loans are classified as held for sale. Deferred revenue
associated with loans held for sale is deferred until the related loan is sold.
14
Discounts on Acquired Loans.
Prior to entering into the Asset Exchange Agreement on February
5, 2009 and reclassifying the loans as held for sale, in accordance with Statement of Position (SOP) No. 03-3 Accounting for Certain Loans or
Debt Securities Acquired in a Transfer, the Company reviewed acquired loans for differences
between contractual cash flows and cash flows expected to be collected from the Companys initial
investment in the acquired loans to determine if those differences were attributable, at least in
part, to credit quality. If those differences were attributable to credit quality, the loans
contractually required payments receivable in excess of the amount of its cash flows expected at
acquisition, or nonaccretable discount, was not accreted into income. Prior to February 5, 2009,
SOP No. 03-3 required that the Company recognize the excess of all cash flows expected at
acquisition over the Companys initial investment in the loan as interest income using the interest
method over the term of the loan. This excess is referred to as accretable discount.
No loans acquired since the adoption of SOP No. 03-3 were within the scope of the SOP.
Loans which, at acquisition, do not have evidence of deterioration of credit quality since
origination are outside the scope of SOP No. 03-3. For such loans, the discount, representing the
excess of the amount of reasonably estimable and probable discounted future cash collections over
the purchase price, was accreted into interest income using the interest method over the term of
the loan. Prepayments were not considered in the calculation of accretion income. Additionally,
discount was not accreted on non-performing loans.
There was judgment involved in estimating the amount of the Companys future cash flows on
acquired loans. The amount and timing of actual cash flows could differ materially from
managements estimates. If cash flows could not be reasonably estimated for any loan, and
collection was not probable, the cost recovery method of accounting was used. Under the cost
recovery method, any amounts received were applied against the recorded amount of the loan.
Nonaccretable discount was generally offset against the related principal balance when the amount
at which a loan was resolved or restructured was determined. There was no effect on the income
statement as a result of these reductions.
Subsequent to acquisition, if cash flow projections improved, and it was determined that the
amount and timing of the cash flows related to the nonaccretable discount were reasonably estimable
and collection was probable, the corresponding decrease in the nonaccretable discount was
transferred to the accretable discount and was accreted into interest income over the remaining
life of the loan on the interest method. If cash flow projections deteriorated subsequent to
acquisition, the decline was accounted for through a provision for loan losses included in
earnings.
Allowance for Loan Losses.
Prior to entering into the Asset Exchange Agreement on February 5,
2009 and reclassifying the loans as held for sale, the Company maintained an allowance for probable
loan losses that were inherent in its loan portfolio. Since the loan portfolio is now classified as
held for sale and recorded at the lower of its cost or fair value, the Company no longer
maintains an allowance for loan losses. In prior periods, arriving at an appropriate level of
allowance for loan losses required a high degree of judgment. The allowance for loan losses was
increased or decreased through a provision for loan losses.
In determining the adequacy of the allowance for loan losses, management made significant
judgments. Aurora Bank initially reviewed the Companys loan portfolio to identify loans for which
specific allocations were considered prudent. Specific allocations included the results of
measuring impaired loans under Statement of Financial Accounting Standards (SFAS) No. 114
Accounting by Creditors for Impairment of a Loan. Next, management considered the level of loan
allowances deemed appropriate for loans determined not to be impaired under SFAS No. 114. The
allowance for these loans was determined by a formula whereby the portfolio was stratified by type
and internal risk rating categories. Loss factors were then applied to each strata based on various
considerations including collateral type, loss experience, delinquency trends, current economic
conditions and industry standards. The allowance for loan losses was managements estimate of the
probable loan losses incurred as of the balance sheet date.
The determination of the allowance for loan losses required managements use of significant
estimates and judgments. In making this determination, management considered known information
relative to specific loans, as well as collateral type, loss experience, delinquency trends,
current economic conditions and industry trends, generally. Based on these factors, management
estimated the probable loan losses incurred as of the reporting date and increased or decreased the
allowance through a change in the provision for loan losses. Loan losses were charged against the
allowance when management believed the net investment of the loan, or a portion thereof, was
uncollectible. Subsequent recoveries, if any, were credited to the allowance when cash payments
were received.
Gains and losses on sales of loans are determined using the specific identification method.
The excess (deficiency) of any cash received as compared to the net investment is recorded as gain
(loss) on sales of loans. There were no loans sold during the six months ended June 30, 2009.
15
Results of Operations for the Three Months Ended June 30, 2009 and 2008
Interest income
The following table sets forth the yields on the Companys interest-earning assets for the
periods indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30,
|
|
|
|
2009
|
|
|
2008
|
|
|
|
Average
|
|
|
Interest
|
|
|
|
|
|
|
Average
|
|
|
Interest
|
|
|
|
|
|
|
Balance
|
|
|
Income
|
|
|
Yield
|
|
|
Balance
|
|
|
Income
|
|
|
Yield
|
|
|
|
(dollars in thousands)
|
|
Loans, net (1)
|
|
$
|
47,229
|
|
|
$
|
679
|
|
|
|
5.77
|
%
|
|
$
|
61,148
|
|
|
$
|
1,252
|
|
|
|
8.23
|
%
|
Interest-bearing deposits
|
|
|
46,124
|
|
|
|
202
|
|
|
|
1.76
|
|
|
|
55,914
|
|
|
|
243
|
|
|
|
1.75
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest-earning assets
|
|
$
|
93,353
|
|
|
$
|
881
|
|
|
|
3.79
|
%
|
|
$
|
117,062
|
|
|
$
|
1,495
|
|
|
|
5.14
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
For purposes of providing a meaningful yield comparison, the forgoing table reflects the
average accreted cost of the loans, net of discounts, and not the fair value of the loan portfolio.
Non-performing loans are excluded from average balance calculations.
|
The decline in interest income for the three months ended June 30, 2009 compared to the three
months ended June 30, 2008 is primarily due to a decrease in the average balance of loans and
interest bearing deposits and a decrease in the yield on loans.
The average cost of the loans, net of discounts, for the three months ended June 30,
2009 totaled $47.2 million compared to $61.1 million for the same period in 2008. This decrease is
primarily attributable to loan payoffs, amortization and sales of loans. No loans have been
acquired by the Company since 2005 and management currently has no intention of acquiring
additional loans other than in connection with a potential alternative transaction to the asset
exchange. For the three months ended June 30, 2009, the yield on the loan portfolio decreased to
5.77% compared to 8.23% for the same period in 2008. For the three months ended June 30, 2009,
interest and fee income recognized on loan payoffs decreased $126,000, or 88.7%, to $16,000 from
$142,000 for the three months ended June 30, 2008. The level of interest and fee income recognized
on loan payoffs varies for numerous reasons, as further discussed below. The yield from regularly
scheduled interest and accretion income decreased to 5.63% for the three months ended June 30, 2009
from 7.30% for the same period in 2008 due to a $201,000 reduction in interest income resulting
from the discontinuance of the amortization of purchase discount and fees on loans as a result of
the loans being reclassified to held for sale during the first quarter of 2009, a reduction in average balances and decreases in market interest rates.
The average balance of interest-bearing deposits decreased $9.8 million or 17.5% to $46.1
million for the three months ended June 30, 2009, compared to $55.9 million for the same period in
2008. The changes in the average balances of interest-bearing deposits are the result of periodic
dividend payments and returns of capital partially offset by cash flows from loan repayments. The
interest rate on interest-bearing deposits remained static for the three months ended June 30, 2009
as compared to the same period in 2008.
The table above presents the average cost balance of the Companys loans, net of
discounts, and does not present the loans at their fair value. Therefore, for periods prior to
February 5, 2009, income on loans includes the portion of the purchase discount that is accreted
into income over the remaining lives of the related loans using the interest method. Because the
carrying value of the loan portfolio is net of purchase discount, the related yield on this
portfolio generally is higher than the aggregate contractual rate paid on the loans. The total
yield includes the excess of a loans expected discounted future cash flows over its net
investment, recognized using the interest method. For periods after February 5, 2009, the yields
shown in the above table are representative of actual yields.
Prior to February 5, 2009, when a loan was paid off, the excess of any cash received over the
net investment was recorded as interest income. In addition to the amount of purchase discount that
was recognized at that time, income may also have included interest owed by the borrower prior to
the Companys acquisition of the loan, interest collected if on non-performing status,
prepayment fees and other loan fees (other interest and fee income). For periods after February
5, 2009, when a loan is paid off, the excess of any cash received over the net investment is
considered in the change in the valuation allowance. The following table sets forth, for the periods indicated, the
components of interest and fees on loans. There can be no assurance regarding future interest
income, including the yields and related level of such income, or the relative portion attributable
to loan payoffs as compared to other sources.
16
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30,
|
|
|
|
2009
|
|
|
2008
|
|
|
|
Interest
|
|
|
|
|
|
|
Interest
|
|
|
|
|
|
|
Income
|
|
|
Yield
|
|
|
Income
|
|
|
Yield
|
|
|
|
(dollars in thousands)
|
|
Regularly scheduled interest and accretion income
|
|
$
|
663
|
|
|
|
5.63
|
%
|
|
$
|
1,110
|
|
|
|
7.30
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest and fee income recognized on loan payoffs:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nonaccretable discount
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accretable discount
|
|
|
|
|
|
|
|
|
|
|
129
|
|
|
|
0.85
|
|
Other interest and fee income
|
|
|
16
|
|
|
|
0.14
|
|
|
|
13
|
|
|
|
0.08
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
16
|
|
|
|
0.14
|
|
|
|
142
|
|
|
|
0.93
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
679
|
|
|
|
5.77
|
%
|
|
$
|
1,252
|
|
|
|
8.23
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The amount of loan payoffs and related discount income is influenced by several factors,
including the interest rate environment, the real estate market in particular areas, the timing of
transactions, and circumstances related to individual borrowers and loans. The amount of individual
loan payoffs is often times a result of negotiations between the Company and the borrower. Based
upon credit risk analysis and other factors, the Company will, in certain instances, accept less
than the full amount contractually due in accordance with the loan terms.
Provision for loan losses
Prior to entering into the Asset Exchange Agreement on February 5, 2009 and reclassifying the
loans as held for sale, the Company maintained an allowance for probable loan losses that were
inherent in its loan portfolio. Since the loan portfolio is now classified as held for sale and
recorded at the lower of its cost or fair value, the Company no longer maintains an
allowance for loan losses as the determination of fair value includes consideration of, among other
factors, the creditworthiness of borrowers. Prior to the reclassification of the loan portfolio on
February 5, 2009, the determination of the allowance for loan losses required managements use of
significant estimates and judgments. In making this determination, management considered known
information relative to specific loans, as well as collateral type, loss experience, delinquency
trends, current economic conditions and industry trends, generally. Based on these factors,
management estimated the probable loan losses incurred as of the reporting date and increased or
decreased the allowance through a change in the provision for loan losses. The Company recorded a
reduction of the allowance for loan losses of $40,000 for the three months ended June 30, 2008 due
to the decrease in the balance of loans due to payoffs without a significant change in the credit
profile of the remaining portfolio during the period.
Operating expenses
Loan servicing and advisory expenses decreased $7,000, or 13.7%, to $44,000 for the three
months ended June 30, 2009 from $51,000 for the three months ended June 30, 2008. The decrease is
primarily the result of a decrease in loan servicing expenses due to the decrease in the average
balance of the loan portfolio.
Other general and administrative expenses increased $226,000 or 389.7%, to $284,000 for the
three months ended June 30, 2009 compared to $58,000 for the three months ended June 30, 2008. This
increase is primarily attributable to an increase in legal fees, an increase in external audit
expenses and an increase in printing fees. This increase was partially offset by a decrease in
directors fees.
Preferred stock dividends
Preferred stock dividends decreased $815,000 to $0 for the three months ended June 30, 2009 as
compared to $815,000 for the three months ended June 30, 2008. On June 26, 2009, the OTS notified
Aurora Bank that the prior approval of the OTS is currently required before payment by the Company
of dividends on the Series D and Series B preferred stock, as a result of the Order and the PCA
Directive. As a result of the notice from the OTS, the Board of Directors voted not to declare or
pay the preferred stock dividend that would have been payable on July 15, 2009. Aurora Bank has
made a formal request to the OTS to approve the payment of future dividends on the preferred stock,
however, there can be no assurance that such approval will be received from the OTS or when or if
such OTS approval requirement will be removed. Furthermore, if approval is received from the OTS, any future dividends on the preferred
stock will be payable only when, as and if declared by the Board of Directors. The terms of the
Series D preferred stock provide that dividends on the Series D preferred stock are not cumulative
and if no dividend is declared for a quarterly dividend period, the holders of the Series D
preferred stock will have no right to receive a dividend for that period, and the Company will have
no obligation to pay a dividend for that period, whether or not dividends are declared and paid for
any future period. The Company, subject to receipt of approval from the OTS, intends to pay
dividends on its preferred stock and common stock in amounts necessary to continue to preserve its
status as a REIT under the Internal Revenue Code.
17
Results of Operations for the Six Months Ended June 30, 2009 and 2008
Interest income
The following table sets forth the yields on the Companys interest-earning assets for the
periods indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30,
|
|
|
|
2009
|
|
|
2008
|
|
|
|
Average
|
|
|
Interest
|
|
|
|
|
|
|
Average
|
|
|
Interest
|
|
|
|
|
|
|
Balance
|
|
|
Income
|
|
|
Yield
|
|
|
Balance
|
|
|
Income
|
|
|
Yield
|
|
|
|
(dollars in thousands)
|
|
Loans, net (1)
|
|
$
|
48,060
|
|
|
$
|
1,508
|
|
|
|
6.33
|
%
|
|
$
|
62,939
|
|
|
$
|
2,547
|
|
|
|
8.14
|
%
|
Interest-bearing deposits
|
|
|
45,265
|
|
|
|
393
|
|
|
|
1.75
|
|
|
|
54,030
|
|
|
|
470
|
|
|
|
1.75
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest-earning assets
|
|
$
|
93,325
|
|
|
$
|
1,901
|
|
|
|
4.11
|
%
|
|
$
|
116,969
|
|
|
$
|
3,017
|
|
|
|
5.19
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
For purposes of providing a meaningful yield comparison, the forgoing table reflects the
average accreted cost of the loans, net of discounts, and not the fair value of the loan portfolio.
Non-performing loans are excluded from average balance calculations.
|
The decline in interest income for the six months ended June 30, 2009 compared to the six
months ended June 30, 2008 is primarily due to a decrease in the average balance of loans and
interest bearing deposits and a decrease in the yield on loans.
The average cost of the loans, net of discounts, for the six months ended June 30,
2009 totaled $48.1 million compared to $62.9 million for the same period in 2008. This decrease is
primarily attributable to loan payoffs, amortization and sales of loans. No loans have been
acquired by the Company since 2005 and management currently has no intention of acquiring
additional loans other than in connection with a potential alternative transaction to the asset
exchange. For the six months ended June 30, 2009, the yield on the loan portfolio decreased to
6.33% compared to 8.14% for the same period in 2008. For the six months ended June 30, 2009,
interest and fee income recognized on loan payoffs decreased $139,000, or 56.7%, to $106,000 from
$245,000 for the six months ended June 30, 2008. The level of interest and fee income recognized on
loan payoffs varies for numerous reasons, as further discussed below. The yield from regularly
scheduled interest and accretion income decreased to 5.89% for the six months ended June 30, 2009
from 7.36% for the same period in 2008 due to a $421,000 reduction in interest income resulting
from the discontinuance of the amortization of purchase discount and fees on loans as a result of
the loans being reclassified to held for sale during the first quarter of 2009, a reduction in average
balances and decreases in market interest rates.
The average balance of interest-bearing deposits decreased $8.7 million or 16.2% to $45.3
million for the six months ended June 30, 2009, compared to $54.0 million for the same period in
2008. The changes in the average balances of interest-bearing deposits are the result of periodic
dividend payments and returns of capital partially offset by cash flows from loan repayments. The
interest rate on interest-bearing deposits remained static for the six months ended June 30, 2009
as compared to the same period in 2008.
The table above presents the average cost balance of the Companys loans, net of
discounts, and does not present the loans at their fair value. Therefore, for periods prior to
February 5, 2009, income on loans includes the portion of the purchase discount that is accreted
into income over the remaining lives of the related loans using the interest method. Because the
carrying value of the loan portfolio is net of purchase discount, the related yield on this
portfolio generally is higher than the aggregate contractual rate paid on the loans. The total
yield includes the excess of a loans expected discounted future cash flows over its net
investment, recognized using the interest method. For periods after February 5, 2009, the yields
shown in the above table are representative of actual yields.
Prior to February 5, 2009, when a loan was paid off, the excess of any cash received over the
net investment was recorded as interest income. In addition to the amount of purchase discount that
was recognized at that time, income may also have included interest owed by the borrower prior to
the Companys acquisition of the loan, interest collected if on non-performing status,
prepayment fees and other loan fees (other interest and fee income). For periods after February
5, 2009, when a loan is paid off, the excess of any cash received over the net investment is
considered in the change in the valuation allowance. The following table sets forth, for the periods indicated, the
components of interest and fees on loans. There can be no assurance regarding future interest
income, including the yields and related level of such income, or the relative portion attributable
to loan payoffs as compared to other sources.
18
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30,
|
|
|
|
2009
|
|
|
2008
|
|
|
|
Interest
|
|
|
|
|
|
|
Interest
|
|
|
|
|
|
|
Income
|
|
|
Yield
|
|
|
Income
|
|
|
Yield
|
|
|
|
|
|
|
|
(dollars in thousands)
|
|
|
|
|
|
Regularly scheduled interest and accretion income
|
|
$
|
1,402
|
|
|
|
5.89
|
%
|
|
$
|
2,302
|
|
|
|
7.36
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest and fee income recognized on loan payoffs:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nonaccretable discount
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accretable discount
|
|
|
86
|
|
|
|
0.36
|
|
|
|
187
|
|
|
|
0.60
|
|
Other interest and fee income
|
|
|
20
|
|
|
|
0.08
|
|
|
|
58
|
|
|
|
0.18
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
106
|
|
|
|
0.44
|
|
|
|
245
|
|
|
|
0.78
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
1,508
|
|
|
|
6.33
|
%
|
|
$
|
2,547
|
|
|
|
8.14
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The amount of loan payoffs and related discount income is influenced by several factors,
including the interest rate environment, the real estate market in particular areas, the timing of
transactions, and circumstances related to individual borrowers and loans. The amount of individual
loan payoffs is often times a result of negotiations between the Company and the borrower. Based
upon credit risk analysis and other factors, the Company will, in certain instances, accept less
than the full amount contractually due in accordance with the loan terms.
Provision for loan losses
Prior to entering into the Asset Exchange Agreement on February 5, 2009 and reclassifying the
loans as held for sale, the Company maintained an allowance for probable loan losses that were
inherent in its loan portfolio. Since the loan portfolio is now classified as held for sale and
recorded at the lower of its cost or fair value, the Company no longer maintains an
allowance for loan losses as the determination of fair value includes consideration of, among other
factors, the creditworthiness of borrowers. During the six months ended June 30, 2009, the Company
recorded a $915,000 reversal of the allowance for loan losses and recorded a valuation allowance of
$16.2 million to reflect the change to record the Companys loan portfolio at fair value. Prior to
the reclassification of the loan portfolio, the determination of the allowance for loan losses
required managements use of significant estimates and judgments. In making this determination,
management considered known information relative to specific loans, as well as collateral type,
loss experience, delinquency trends, current economic conditions and industry trends, generally.
Based on these factors, management estimated the probable loan losses incurred as of the reporting
date and increased or decreased the allowance through a change in the provision for loan losses.
The Company recorded a reduction of the allowance for loan losses of $155,000 for the six months
ended June 30, 2008 due to the decrease in the balance of loans due to payoffs without a
significant change in the credit profile of the remaining portfolio during the period.
Operating expenses
Loan servicing and advisory expenses decreased $11,000, or 11.1%, to $88,000 for the six
months ended June 30, 2009 from $99,000 for the six months ended June 30, 2008. The decrease is
primarily the result of a decrease in loan servicing expenses due to the decrease in the average
balance of the loan portfolio. This decrease was partially offset by a increase in environmental
fees.
Other general and administrative expenses increased $469,000 or 464.4%, to $570,000 for the
six months ended June 30, 2009 compared to $101,000 for the six months ended June 30, 2008. This
increase is primarily attributable to an increase in legal fees and an increase in external audit
expenses. This increase was partially offset by a decrease in directors fees.
Preferred stock dividends
Preferred stock dividends decreased $815,000, or 50.0%, to $816,000, for the six months ended
June 30, 2009 compared to $1.6 million for the same period in 2008. As discussed above, the OTS
notified Aurora Bank that the prior approval of the OTS is currently required before payment by the
Company of dividends on the Series D and Series B preferred stock, as a result of the Order and the
PCA Directive, and therefore the Board of Directors voted not to declare or pay the preferred stock
dividend that would have been payable on July 15, 2009.
19
Changes in Financial Condition
Interest-bearing deposits with parent
Interest-bearing deposits with parent consist entirely of money market accounts with Aurora
Bank. The balance of interest-bearing deposits increased $3.5 million to $47.0 million at June 30,
2009 compared to $43.5 million at December 31, 2008. The increase in the balance of
interest-bearing deposits is primarily a result of cash flows from loan repayments.
Loan portfolio
To date, all of the Companys loans have been acquired from Aurora Bank. A summary of the fair
value of the Companys loans, which were considered held for sale as of June 30, 2009, follows:
|
|
|
|
|
|
|
June 30, 2009
|
|
|
|
(in thousands)
|
|
Mortgage loans on real estate:
|
|
|
|
|
Commercial real estate
|
|
$
|
19,888
|
|
Multi-family residential
|
|
|
12,713
|
|
One-to-four family residential
|
|
|
575
|
|
|
|
|
|
Total
|
|
|
33,176
|
|
Other
|
|
|
9
|
|
|
|
|
|
Total loans
|
|
|
33,185
|
|
|
|
|
|
|
Less:
|
|
|
|
|
Net deferred loan fees
|
|
|
(21
|
)
|
|
|
|
|
|
|
|
|
|
Loans, net of valuation allowance
of $16,210
|
|
$
|
33,164
|
|
|
|
|
|
A summary of the balances of the Companys loans, which were considered held for investment as
of December 31, 2008, follows:
|
|
|
|
|
|
|
December 31,
|
|
|
|
2008
|
|
|
|
(in thousands)
|
|
Mortgage loans on real estate:
|
|
|
|
|
Commercial real estate
|
|
$
|
31,647
|
|
Multi-family residential
|
|
|
20,384
|
|
One-to-four family residential
|
|
|
981
|
|
|
|
|
|
Total
|
|
|
53,012
|
|
Other
|
|
|
13
|
|
|
|
|
|
Total loans, net of discounts
|
|
|
53,025
|
|
|
|
|
|
|
Less:
|
|
|
|
|
Allowance for loan losses
|
|
|
(915
|
)
|
Net deferred loan fees
|
|
|
(27
|
)
|
|
|
|
|
|
|
|
|
|
Loans, net
|
|
$
|
52,083
|
|
|
|
|
|
The decrease in the total amount of loans is primarily attributable to the reclassification of
the Companys loans to held for sale in connection with entering into the Asset Exchange Agreement
and the related valuation allowance recorded to reflect the loans at the lower of their cost or fair value. The Company has historically acquired primarily performing commercial real
estate and multifamily residential mortgage loans. During the six month periods ended June 30, 2009
and June 30, 2008, the Company did not acquire any loans from Aurora Bank.
20
The Company intends that each loan acquired from Aurora Bank in the future, if any are
acquired in the future, will be a whole loan, and will be originated or acquired by Aurora Bank in
the ordinary course of its business. The Company also intends that all loans held by it will be
serviced pursuant to its master service agreement with Aurora Bank.
The estimated fair value of non-performing loans totaled $2.0 million as of June 30, 2009.
Non-performing loans, net of discount, totaled $589,000 as of June 30, 2008. The increase in
non-performing assets is due to the fact that 12 loans, representing 9 borrowers, were not
performing as of June 30, 2009. Loans generally are placed on non-performing status and the accrual
of interest is generally discontinued when the collectability of principal and interest is not
probable or estimable. Unpaid interest income previously accrued on such loans is reversed against
current period interest income. A loan is returned to accrual status when it is brought current in
accordance with managements anticipated cash flows at the time of acquisition and collection of
future principal and interest is probable and estimable.
Allowance for Loan Losses
Prior to entering into the Asset Exchange Agreement on February 5, 2009 and reclassifying the
loans as held for sale, the Company maintained an allowance for probable loan losses that were
inherent in its loan portfolio. Since the loan portfolio is now classified as held for sale and
recorded at the lower of its cost or fair value, the Company will no longer maintain an
allowance for loan losses as the determination of fair value includes consideration of, among other
factors, the creditworthiness of borrowers. During the six months ended June 30, 2009, the Company
recorded a $915,000 reversal of the allowance for loan losses and recorded a valuation allowance of
$16.2 million to reflect the change to record the Companys loan portfolio at fair value. Prior to
the reclassification of the loan portfolio, the determination of the allowance for loan losses
required managements use of significant estimates and judgments. In making this determination,
management considered known information relative to specific loans, as well as collateral type,
loss experience, delinquency trends, current economic conditions and industry trends, generally.
Based on these factors, management estimated the probable loan losses incurred as of the reporting
date and increased or decreased the allowance through a change in the provision for loan losses.
The following table sets forth certain information relating to the activity in the allowance
for loan losses for the periods indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30,
|
|
|
Six Months Ended June 30,
|
|
|
|
2009
|
|
|
2008
|
|
|
2009
|
|
|
2008
|
|
|
|
|
|
|
|
(in thousands)
|
|
|
|
|
|
Balance at beginning of period
|
|
$
|
|
|
|
$
|
1,065
|
|
|
$
|
915
|
|
|
$
|
1,180
|
|
Provision for loan losses
|
|
|
|
|
|
|
(40
|
)
|
|
|
(915
|
)
|
|
|
(155
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at end of period
|
|
$
|
|
|
|
$
|
1,025
|
|
|
$
|
|
|
|
$
|
1,025
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Rate Risk
The Companys income consists primarily of interest income. If there is a decline in market
interest rates, the Company may experience a reduction in interest income and a corresponding
decrease in funds available to be distributed to its stockholders. The reduction in interest income
may result from downward adjustments of the indices upon which the interest rates on floating-rate
loans and interest-bearing deposits are based and from prepayments of mortgage loans with fixed
interest rates, resulting in reinvestment of the proceeds in lower yielding assets. The Company
does not intend to use any derivative products to manage its interest rate risk. The majority of
the Companys loan portfolio consists of fixed rate loans with contractual interest rates that are
not affected by changes in market interest rates. Approximately 27% of the average cost
balance of the Companys loan portfolio, however, is comprised of floating-rate loans with
contractual interest rates that may fluctuate based on changes in market interest rates. In
addition, negative fluctuations in interest rates could reduce the amount of interest paid on
interest-bearing cash deposits of the Company, which could negatively impact the amount of cash
available to pay dividends on the Series D preferred stock. The Company is not able to precisely
quantify the potential impact on its operating results or funds available for distribution to
stockholders from material changes in interest rates.
Significant Concentration of Credit Risk
Concentration of credit risk generally arises with respect to the Companys loan portfolio
when a number of borrowers engage in similar business activities, or activities in the same
geographical region. Concentration of credit risk indicates the relative sensitivity of Companys
performance to both positive and negative developments affecting a particular industry or
geographic region. The Companys balance sheet exposure to geographic concentrations directly
affects the credit risk of the loans within its loan portfolio.
21
At June 30, 2009, 63.1%, 6.8% and 5.3% of the fair value of the Companys real estate loan
portfolio consisted of loans in California, New England and Nevada respectively. At December 31,
2008, 64.5%, 7.4% and 5.1% of the Companys net real estate loan portfolio consisted of loans
located in California, New England and Nevada, respectively. Consequently, the portfolio may
experience a higher default rate in the event of adverse economic, political or business
developments or natural hazards in California, New England or Nevada that may affect the ability of
property owners to make payments of principal and interest on the underlying mortgages. Beginning
in 2007 and continuing through June 2009, the housing and real estate sectors in California and
Nevada were hit particularly hard by the recession with higher overall foreclosure rates than the
national average. If these regions experience further adverse economic, political or business conditions, or natural hazards, the Company will likely experience higher rates of loss
and delinquency on its mortgage loans than if its loans were more geographically diverse.
Liquidity Risk Management
The objective of liquidity management is to ensure the availability of sufficient
cash flows to meet all of the Companys financial commitments. In managing liquidity risk, the
Company takes into account various legal limitations placed on a REIT. The Companys principal
liquidity need is to pay dividends on its preferred shares and common shares.
If and to the extent that any additional assets are acquired in the future, such acquisitions
are intended to be funded primarily with available cash balances or through repayment of principal
balances of mortgage assets by individual borrowers. The Company does not have and does not
anticipate having any material capital expenditures. To the extent that the Board of Directors
determines that additional funding is required, the Company 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 at least 90% of its REIT taxable
income and taking into account taxes that would be imposed on undistributed income), or a
combination of these methods. The Company does not currently intend to incur any indebtedness. The
organizational documents of the Company limit the amount of indebtedness which it is permitted to
incur without the approval of the Series D preferred stockholders to no more than 100% of the total
stockholders equity of the Company. Any such debt may include intercompany advances made by Aurora
Bank to the Company.
The Company may also issue additional series of preferred stock, subject to OTS approval.
However, the Company may not issue additional shares of preferred stock ranking senior to the
Series D preferred shares without the consent of holders of at least two-thirds of the Series D
preferred shares outstanding at that time. Although the Companys charter does not prohibit or
otherwise restrict Aurora Bank or its affiliates from holding and voting shares of Series D
preferred stock, to the Companys knowledge the amount of shares of Series D preferred stock held
by Aurora Bank or its affiliates is insignificant (less than 1%). Additional shares of preferred
stock ranking on a parity with the Series D preferred shares may not be issued without the approval
of a majority of the Companys independent directors.
Impact of Inflation and Changing Prices
The Companys asset and liability structure is substantially different from that of an
industrial company in that virtually all of the Companys assets are monetary in nature. Management
believes the impact of inflation on financial results depends upon the Companys ability to react
to changes in interest rates and by such reaction, reduce the inflationary impact on performance.
Interest rates do not necessarily move in the same direction, or at the same magnitude, as the
prices of other goods and services.
Various information disclosed elsewhere in this quarterly report will assist the reader in
understanding how the Company is positioned to react to changing interest rates and inflationary
trends. In particular, the discussion of market risk and other maturity and repricing information
of the Companys assets is contained in Item 3. Quantitative and Qualitative Disclosures About
Market Risk below.
|
|
|
Item 3.
|
|
Quantitative and Qualitative Disclosures About Market Risk
|
Market risk is the risk of loss from adverse changes in market prices and interest rates.
Currently, approximately 27% of the average cost balance of the Companys loan portfolio
is comprised of floating-rate loans with contractual interest rates that may fluctuate based on
changes in market interest rates. In addition, negative fluctuations in interest rates could reduce
the amount of interest paid on interest-bearing cash deposits of the Company. The Companys market
risk arises primarily from interest rate risk inherent in holding loans. To that end, Aurora Bank
actively monitors the interest rate risk exposure of the Company pursuant to an advisory agreement.
Aurora Bank reviews, among other things, the sensitivity of the Companys assets to interest
rate changes, the book and market values of assets, purchase and sale activity, and anticipated
loan payoffs. Aurora Banks senior management also approves and establishes pricing and funding
decisions with respect to the Companys overall asset and liability composition.
22
The Companys methods for evaluating interest rate risk include an analysis of its
interest-earning assets maturing or repricing within a given time period. Since the Company has no
interest-bearing liabilities, a period of rising interest rates would tend to result in an increase
in net interest income. A period of falling interest rates would tend to adversely affect net
interest income.
The following table sets forth the Companys interest-rate-sensitive assets categorized by
repricing dates and weighted average yields at June 30, 2009. For fixed rate instruments, the
repricing date is the maturity date. For adjustable-rate instruments, the repricing date is deemed
to be the earliest possible interest rate adjustment date. Assets that are subject to immediate
repricing are placed in the overnight column.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Within
|
|
|
Over One
|
|
|
Over Two
|
|
|
Over Three
|
|
|
Over Four
|
|
|
Over
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One
|
|
|
to Two
|
|
|
to Three
|
|
|
to Four
|
|
|
to Five
|
|
|
Five
|
|
|
|
|
|
|
Fair
|
|
|
|
Overnight
|
|
|
Year
|
|
|
Years
|
|
|
Years
|
|
|
Years
|
|
|
Years
|
|
|
Years
|
|
|
Total
|
|
|
Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing deposits
|
|
$
|
46,989
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
46,989
|
|
|
$
|
46,989
|
|
|
|
|
1.75
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed-rate loans (1)
|
|
|
255
|
|
|
|
1,817
|
|
|
|
2,957
|
|
|
|
3,641
|
|
|
|
2,361
|
|
|
|
1,232
|
|
|
|
21,661
|
|
|
|
33,924
|
|
|
|
23,700
|
|
|
|
|
14.50
|
%
|
|
|
5.11
|
%
|
|
|
6.41
|
%
|
|
|
6.28
|
%
|
|
|
5.92
|
%
|
|
|
4.75
|
%
|
|
|
4.43
|
%
|
|
|
|
|
|
|
|
|
Adjustable-rate loans (1)
|
|
|
287
|
|
|
|
11,844
|
|
|
|
34
|
|
|
|
101
|
|
|
|
90
|
|
|
|
155
|
|
|
|
|
|
|
|
12,511
|
|
|
|
7,437
|
|
|
|
|
6.47
|
%
|
|
|
5.14
|
%
|
|
|
7.16
|
%
|
|
|
7.72
|
%
|
|
|
6.48
|
%
|
|
|
6.87
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total rate-sensitive assets
|
|
$
|
47,531
|
|
|
$
|
13,661
|
|
|
$
|
2,991
|
|
|
$
|
3,742
|
|
|
$
|
2,451
|
|
|
$
|
1,387
|
|
|
$
|
21,661
|
|
|
$
|
93,424
|
|
|
$
|
78,126
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
Loans are presented at the average accreted costs of the loans, net of discount, and
exclude non-performing loans.
|
Based on the Companys experience, management applies the assumption that, on average,
approximately 5% of the outstanding fixed and adjustable-rate loans will prepay annually.
The Companys loan portfolio is subject to general market risk, including, without limitation,
negative economic conditions that adversely affect the general economy, housing prices, the job
market, consumer confidence and spending habits which may affect, among other things, the credit
quality of our loan portfolios (the degree of the impact of which is dependent upon the duration
and severity of these conditions); the level and volatility of interest rates; changes in consumer,
investor and counterparty confidence in, and the related impact on, financial markets and
institutions; and various monetary and fiscal policies and regulations. The fair value of the
Companys loan portfolio and the amount of the Companys loans that are non-performing may be
negatively affected by these factors.
|
|
|
Item 4T.
|
|
Controls and Procedures
|
The Companys management, with the participation of its President and Chief Financial Officer,
evaluated the effectiveness of the Companys disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange
Act), as of June 30, 2009. Based on this evaluation, the Companys President and Chief Financial
Officer concluded that, as of June 30, 2009, the Companys disclosure controls and procedures were
(1) designed to ensure that material information relating to the Company is made known to the
President and Chief Financial Officer by others within the entity, particularly during the period
in which this report was being prepared, and (2) effective, in that they provide reasonable
assurance that information required to be disclosed by the Company in the reports that it files or
submits under the Exchange Act is recorded, processed, summarized, and reported within the time
periods specified in the SECs rules and forms.
No change to our internal control over financial reporting (as defined in Rules 13a-15(f) and
15d-15(f) under the Exchange Act) occurred during the quarter ended June 30, 2009 that has
materially affected, or is reasonably likely to materially affect, our internal control over
financial reporting.
23
PART II
|
|
|
Item 1.
|
|
Legal Proceedings
|
From time to time, the Company may be involved in routine litigation incidental to its
business, including a variety of legal proceedings with borrowers, which would contribute to the
Companys expenses, including the costs of carrying non-performing assets.
In addition, the Company has received letters from two holders of the Series D preferred
stock threatening litigation in connection with the abandoning of the liquidation of the Company
and the approval of the Exchange. One of these holders brought suit against the Company in the
Superior Court of Massachusetts to compel the Company to produce certain books and records for the
benefit of the stockholder and to reimburse the stockholder for related attorneys fees. On June 5,
2009, the Court denied the stockholders motions to compel production of these books and records
and to reimburse the stockholder for related attorneys fees and dismissed the case, without
prejudice.
A number of risk factors, including, without limitation, the risk factor set forth below and
the risk factors found in Item 1A of the Companys Annual Report on Form 10-K for the annual period
ended December 31, 2008, may cause the Companys actual results to differ materially from
anticipated future results, performance or achievements expressed or implied in any forward-looking
statements contained in this Quarterly Report on Form 10-Q or any other report filed by the Company
with the SEC. All of these factors should be carefully reviewed, and the reader of this Quarterly
Report on Form 10-Q should be aware that there may be other factors that could cause difference in
future results, performance or achievements.
If the OTS does not approve Aurora Banks request to permit the payment of future dividends, the
Company will be prohibited from paying dividends in the future and therefore may fail to qualify as
a REIT
On June 26, 2009, the OTS notified Aurora Bank that the prior approval of the OTS is currently
required before payment by the Company of dividends on the Series D preferred stock as a result of
the Order and the PCA Directive. As a result of the notice from the OTS, the Board of Directors
voted not to declare or pay the Series D preferred stock dividend that would have been payable on
July 15, 2009. Aurora Bank has made a formal request to the OTS to approve the payment of future
dividends on the Series D preferred stock. If the OTS does not approve this request, the Company
will be prohibited from paying future dividends, which could result in the Company failing to
qualify as a REIT. In order to qualify as a REIT, the Company generally is required each year to
distribute to its stockholders at least 90% of its net taxable income, excluding net capital gains.
The Company may retain the remainder of REIT taxable income or all or part of its net capital gain,
but will be subject to tax at regular corporate rates on such income. In addition, the Company is
subject to a 4% nondeductible excise tax on the amount, if any, by which certain distributions
considered as paid by the Company with respect to any calendar year are less than the sum of (1)
85% of its ordinary income for the calendar year, (2) 95% of its capital gains net income for the
calendar year and (3) 100% of any undistributed income from prior periods.
|
|
|
Item 4.
|
|
Submission of Matters to a Vote of Security Holders
|
During the three months ended June 30, 2009, no matters were submitted for approval to Aurora
Bank, the sole common stockholder of the Company. No matters were submitted to a vote of the
holders of the Series D preferred stock during this period.
|
|
|
Item 5.
|
|
Other Information
|
None
|
|
|
31.1
|
|
Certification pursuant to Exchange Act Rules 13a-15(e) and 15d-15(e) of the President.
|
|
|
|
31.2
|
|
Certification pursuant to Exchange Act Rules 13a-15(e) and 15d-15(e) of the Chief Financial Officer.
|
|
|
|
32
|
|
Certification pursuant to 18 U.S.C. Section 1350 of the President and Chief Financial Officer.
|
24
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, Capital Crossing
Preferred Corporation has duly caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
CAPITAL CROSSING PREFERRED CORPORATION
|
|
|
|
|
|
|
|
Date: August 14, 2009
|
By:
|
/s/ Lana Franks
|
|
|
|
Lana Franks
|
|
|
|
President (Principal Executive Officer)
|
|
|
|
|
|
Date: August 14, 2009
|
By:
|
/s/ Thomas OSullivan
|
|
|
|
Thomas OSullivan
|
|
|
|
Chief Financial Officer (Principal Financial Officer)
|
|
25
EXHIBIT INDEX
|
|
|
|
|
|
|
Exhibit
|
|
Item
|
|
Page Number
|
31.1
|
|
Certification pursuant to Exchange Act Rules
13a-15(e) and 15d-15(e) of the President.
|
|
|
|
27
|
|
|
|
|
|
|
|
31.2
|
|
Certification pursuant to Exchange Act Rules
13a-15(e) and 15d-15(e) of the Chief
Financial Officer.
|
|
|
|
28
|
|
|
|
|
|
|
|
32
|
|
Certification pursuant to 18 U.S.C. Section
1350 of the President and Chief Financial
Officer.
|
|
|
|
29
|
26
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