-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, GCKY/OUZTxyq1ax6RH+WxEZ/ESXryumswhQXfA8Sw4v+9HlUnnoODnDAs0AyObQz /MRFp5lufNC452BEi+EraQ== 0000950172-05-000808.txt : 20050316 0000950172-05-000808.hdr.sgml : 20050316 20050316170342 ACCESSION NUMBER: 0000950172-05-000808 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 20041231 FILED AS OF DATE: 20050316 DATE AS OF CHANGE: 20050316 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ANTHRACITE CAPITAL INC CENTRAL INDEX KEY: 0001050112 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE INVESTMENT TRUSTS [6798] IRS NUMBER: 133978906 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-13937 FILM NUMBER: 05686313 BUSINESS ADDRESS: STREET 1: 40 EAST 52ND STREET CITY: NEW YORK STATE: NY ZIP: 10022 BUSINESS PHONE: 2127545560 MAIL ADDRESS: STREET 1: 40 EAST 52ND STREET CITY: NEW YORK STATE: NY ZIP: 10022 FORMER COMPANY: FORMER CONFORMED NAME: ANTHRACITE MORTGAGE CAPITAL INC DATE OF NAME CHANGE: 19971121 10-K 1 ny492629.txt FORM 10-K =============================================================================== UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark one) |X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2004 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from: ________ to ________ Commission File No. 001-13937 ANTHRACITE CAPITAL, INC. (Exact name of registrant as specified in its charter) MARYLAND 13-3978906 ------------------------------- --------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 40 East 52nd Street New York, New York 10022 - --------------------------------------- --------------------- (Address of principal executive office) (Zip Code) (212) 810-3333 ------------------------------------------------------------------ (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: COMMON STOCK, $.001 PAR VALUE NEW YORK STOCK EXCHANGE 9.375% SERIES C CUMULATIVE REDEEMABLE NEW YORK STOCK EXCHANGE PREFERRED STOCK, $.001 PAR VALUE (Title of each class) (Name of each exchange on which registered) Securities registered pursuant to Section 12(g) of the Act: Not Applicable Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No /_/ Indicate by check mark if disclosure of delinquent filers pursuant to item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. /_/ Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes |X| No /_/ The aggregate market value of the registrant's Common Stock, $.001 par value, held by non-affiliates of the registrant, computed by reference to the closing sale price of $11.98 as reported on the New York Stock Exchange on June 30, 2004, was $630,821,384 (for purposes of this calculation, affiliates include only directors and executive officers of the registrant). The number of shares of the registrant's Common Stock, $.001 par value, outstanding as of March 16, 2005 was 53,296,678 shares. Documents Incorporated by Reference: The registrant's Definitive Proxy Statement for the 2005 Annual Meeting of Stockholders is incorporated by reference into Part III. =============================================================================== ANTHRACITE CAPITAL, INC. AND SUBSIDIARIES 2004 FORM 10-K ANNUAL REPORT TABLE OF CONTENTS ----------------- PAGE PART I Item 1. Business...........................................................4 Item 2. Properties ......................................................26 Item 3. Legal Proceedings ................................................26 Item 4. Submission of Matters to a Vote of Security Holders .................................................26 PART II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters ..................................27 Item 6. Selected Financial Data ..........................................28 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations ....................29 Item 7A. Quantitative and Qualitative Disclosures About Market Risk ......................................................53 Item 8. Financial Statements and Supplementary Data ......................57 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ..........................106 Item 9A. Controls and Procedures..........................................106 PART III Item 10. Directors and Executive Officers of the Registrant ..............107 Item 11. Executive Compensation ..........................................107 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters ...........107 Item 13. Certain Relationships and Related Transactions ..................107 Item 14. Principal Accountant Fees and Services...........................107 PART IV Item 15. Exhibits and Financial Statement Schedules ......................108 Signatures ..............................................................110 CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS Certain statements contained herein constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 with respect to future financial or business performance, strategies or expectations. Forward-looking statements are typically identified by words or phrases such as "trend," "opportunity," "pipeline," "believe," "comfortable," "expect," "anticipate," "current," "intention," "estimate," "position," "assume," "potential," "outlook," "continue," "remain," "maintain," "sustain," "seek," "achieve" and similar expressions, or future or conditional verbs such as "will," "would," "should," "could," "may" or similar expressions. Anthracite Capital, Inc. (the "Company") cautions that forward-looking statements are subject to numerous assumptions, risks and uncertainties, which change over time. Forward-looking statements speak only as of the date they are made, and the Company assumes no duty to and does not undertake to update forward-looking statements. Actual results could differ materially from those anticipated in forward-looking statements and future results could differ materially from historical performance. In addition to factors previously disclosed in the Company's Securities and Exchange Commission (the "SEC") reports and those identified elsewhere in this report, the following factors, among others, could cause actual results to differ materially from forward-looking statements or historical performance: (1) the introduction, withdrawal, success and timing of business initiatives and strategies; (2) changes in political, economic or industry conditions, the interest rate environment or financial and capital markets, which could result in changes in the value of the Company's assets; (3) the relative and absolute investment performance and operations of the Company's manager, BlackRock Financial Management, Inc. (the "Manager"); (4) the impact of increased competition; (5) the impact of capital improvement projects; (6) the impact of future acquisitions and divestitures; (7) the unfavorable resolution of legal proceedings; (8) the extent and timing of any share repurchases; (9) the impact, extent and timing of technological changes and the adequacy of intellectual property protection; (10) the impact of legislative and regulatory actions and reforms and regulatory, supervisory or enforcement actions of government agencies relating to the Company, the Manager or The PNC Financial Services Group, Inc. ("PNC Bank"); (11) terrorist activities, which may adversely affect the general economy, real estate, financial and capital markets, specific industries, and the Company and the Manager; (12) the ability of the Manager to attract and retain highly talented professionals. (13) fluctuations in foreign currency exchange rates; and (14) the impact of changes to tax legislation and, generally, the tax position of the Company. Forward-looking statements speak only as of the date they are made. The Company does not undertake, and specifically disclaims any obligation, to publicly release the result of any revisions which may be made to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements. PART I ITEM 1. BUSINESS All dollar figures expressed herein are expressed in thousands, except share or per share amounts. General The Company, a Maryland corporation, is a real estate finance company that generates income based on the spread between the interest income on its mortgage loans and securities investments and the interest expense from borrowings to finance its investments. The Company's primary activity is investing in high yielding commercial real estate debt. The Company combines traditional real estate underwriting and capital markets expertise to exploit the opportunities arising from the continuing integration of these two disciplines. The Company focuses on acquiring pools of performing loans in the form of commercial mortgage-backed securities ("CMBS"), issuing secured debt backed by CMBS and providing strategic capital for the commercial real estate industry in the form of mezzanine loan financing. The Company commenced operations on March 24, 1998. The Company's common stock is traded on the New York Stock Exchange under the symbol "AHR". The Company's primary long-term objective is to distribute consistent dividends supported by earnings. The Company establishes its dividend by analyzing the long-term sustainability of earnings given existing market conditions and the current composition of its portfolio. This includes an analysis of the Company's credit loss assumptions, general level of interest rates and projected hedging costs. The Company is managed by BlackRock Financial Management, Inc. (the "Manager"), a subsidiary of BlackRock, Inc., a publicly traded (NYSE: BLK) asset management company with over $341,800,000 of assets under management as of December 31, 2004. The Manager provides an operating platform that incorporates significant asset origination, risk management, and operational capabilities. The Company's ongoing investment activities encompass two core investment activities: 1) Commercial Real Estate Securities 2) Commercial Real Estate Loans The commercial real estate securities portfolio provides diversification and high yields that are adjusted for anticipated losses over a period of time (typically, a ten-year weighted average life) and can be financed through the issuance of secured debt that matches the life of the investment. Commercial real estate loans provide attractive risk adjusted returns over shorter periods of time through strategic investments in specific property types or regions. The Company believes these portfolios can serve to provide stable earnings over time. During the third quarter of 2004, the Company completed its repositioning into commercial real estate assets. As of December 31, 2004, CMBS and commercial real estate loans represented 90% of portfolio assets while residential mortgage-backed securities ("RMBS") represented 10%. Commercial Real Estate Securities The Company's principal activity is to underwrite and acquire high yielding CMBS that are rated below investment grade. The Company's CMBS are securities backed by pools of loans secured by first mortgages on commercial real estate throughout the United States. The commercial real estate securing the first mortgages consist of income producing properties including office buildings, shopping centers, apartment buildings, industrial properties, healthcare properties, and hotels, among others. The terms of a typical loan include a fixed rate of interest, thirty-year amortization, some form of prepayment protection, and a large interest rate increase if not paid off at maturity. The loans are originated by various lenders and pooled together in trusts which issue securities in the form of various classes of fixed rate debt secured by the cash flows from the underlying loans. The securities issued by the trusts are rated by one or more nationally recognized credit rating organizations and are rated AAA down to CCC. The security that is affected first by loan losses is not rated. The principal amount of the pools of loans securing the CMBS securities varies. Each trust has a designated special servicer. Special servicers are responsible for carrying out loan loss mitigation strategies. A servicer will also advance funds to a trust to maintain principal and interest cash flows on the trust's securities provided it believes there is a significant probability of recovering those advances from the underlying borrowers. The servicer is paid interest on advanced funds and a fee for its efforts in carrying out loss mitigation strategies. The Company focuses on acquiring the securities rated below investment grade (BB+ or lower). The most subordinated CMBS classes are the first to absorb realized losses in the loan pools. To the extent there are losses in excess of the most subordinated class' stated entitlement to principal and interest, then the remaining CMBS classes will bear such losses in order of their relative subordination. If a loss of face value, or par, is experienced in the underlying loans, a corresponding reduction in the par of the lowest rated security occurs, reducing the cash flow entitlement. The majority owner of the first loss position has the right to control the workout process and therefore designate the trust's special servicer. The Company will generally seek to control the workout process in each of its CMBS transactions by purchasing the majority of the trust's non-rated securities and sequentially rated securities as high as BB+. Typically, the par amount of all securities that are rated below investment grade represents 2.75% - 6.0% of the par of the underlying loans of newly issued CMBS transactions. This is known as the subordination level because 2.75% - 6.0% of the loan balance is subordinated to the senior, investment grade rated securities. The Company does not typically purchase a BB- rated security unless the Company is involved in the new issue due diligence process and has a clear pari-passu alignment of interest with the special servicer, or we can appoint the special servicer. The Company purchases BB+ and BB rated securities at their original issue or in the secondary market without necessarily having control of the workout process. BB+ and BB rated CMBS do not absorb losses until the BB- and lower rated securities have experienced losses of their entire principal amounts. The Company believes the 2.5% - 4.0% subordination levels of these securities provide additional credit protection and diversification with an attractive risk return profile. As of December 31, 2004, the Company owns 16 different trusts ("Controlling Class") where the Company through its investment in subordinated CMBS of such trusts is in the first loss position. As a result of this investment position, the Company controls the workout process on $18,580,729 of underlying loans. The total par amount owned of these subordinated Controlling Class securities is $631,649. The Company does not own the senior securities that represent the remaining par amount of the underlying mortgage loans. The special servicer on 11 of the 16 trusts is Midland Loan Services, Inc., the special servicer on two trusts is GMAC Commercial Mortgage Management, Inc., and the special servicer on the remaining three trusts is Lennar Partners, Inc. The Company also purchases investment grade commercial real estate related securities in the form of CMBS and unsecured debt of commercial real estate companies. The addition of these higher rated securities is intended to add greater stability to the long-term performance of the Company's portfolios as a whole and to provide greater diversification to optimize secured financing alternatives. The Company generally seeks to assemble a portfolio of high quality issues that will maintain consistent performance over the life of the security. The Company also acquires CMBS interest only securities ("IOs"). These securities represent a portion of the interest coupons paid by the underlying loans. The Company views this portfolio as an attractive relative value versus other alternatives. These securities do not have significant prepayment risk because the underlying loans generally have prepayment restrictions. Furthermore, the credit risk is also mitigated because the IO represents a portion of all underlying loans, not solely the first loss. Owning commercial real estate loans in these forms allows the Company to earn its loss-adjusted returns over a period of time while achieving significant diversification across geographic areas and property types. On November 9, 2004, the Company closed its fourth collateralized debt obligation ("CDO") secured by a portfolio of below investment grade CMBS ("CDO HY1"). The transaction was accounted for as a sale in accordance with Statement of Financial Accounting Standard ("SFAS") No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." The Company received cash proceeds of $140,425 as well as all of the CDO HY1 preferred shares that had a fair market value of $15,885 as of December 31, 2004 in exchange for the collateral. The collateral was carried at a fair market value of $109,933 on the Company's September 30, 2004 consolidated statement of financial condition based on price quotes received from third parties. The transaction raised reinvestable proceeds of $95,799. The following table summarizes the impact of this transaction on fourth quarter 2004 results and per share amounts: Realized gain at closing of CDO HY1 $14,769 $0.28 Realized gain from subsequent sale of A- tranche 1,825 0.03 Increase in accumulated other comprehensive income 29,782 0.56 ------------------------- Total book value impact $46,376 $0.87 ========================= The following table indicates the amounts of each category of commercial real estate securities the Company owns as of December 31, 2004. The dollar price ("Dollar Price") represents the estimated fair value or adjusted purchase price of a security, respectively, relative to its par value.
Estimated Adjusted Loss Fair Dollar Purchase Dollar Adjusted Assets Par Value Price Price* Price Yield - ------------------------------------------------------------------------------------------------------------ Investment Grade Commercial Real Estate Related Securities $ 668,101 $692,054 103.59 $674,167 100.91 5.83% CMBS IOs 3,712,604 125,246 3.37 122,379 3.30 7.31% Other Below Investment Grade CMBS 332,225 313,282 94.30 290,771 87.52 8.51% Controlling Class CMBS 661,483 473,521 71.58 452,086 68.34 9.48% CDO Investments 203,182 19,836 9.76 19,450 9.57 56.65% ------------------------------------------------------------------------------ Total $5,577,595 $1,623,939 29.12 $1,558,854 27.95 8.14% ============================================================================== * The adjusted purchase price represents the amortized cost of the Company's investments.
The Company finances the majority of these portfolios with match funded, secured term debt through CDO offerings. To accomplish this, the Company forms a special purpose entity ("SPE") and contributes a portfolio of mostly below investment grade CMBS, investment grade CMBS, and unsecured debt of commercial real estate companies in exchange for the preferred equity interest in the SPE. With the exception of CDO HY1, these transactions are considered financings and the SPEs are fully consolidated on the Company's consolidated financial statements. The SPE will then issue fixed and floating rate debt secured by the cash flows of the securities in its portfolio. The SPE will enter into an interest rate swap agreement to convert the floating rate debt issued to a fixed interest rate, thus matching the cash flow profile of the underlying portfolio. The structure of the CDO debt also eliminates the mark to market requirement of other types of financing, thus eliminating the need to provide additional collateral if the value of the underlying portfolio declines. The debt issued by the SPE is generally rated AAA down to BB; due to its preferred equity interest, the Company continues to manage the credit risk of the underlying portfolio as it did prior to the assets being contributed to the CDO. The CDO provides an optimal capital structure to maximize returns on these types of portfolios on a non-recourse basis. Other forms of financing used for these types of assets include multi-year committed financing facilities and 30-day reverse repurchase agreements. The following table indicates the market values of each category of commercial real estate securities collateralizing different types of borrowings as of December 31, 2004:
Market Value Securing -------------------------------------------------------------------------- Reverse Committed Not CDO Debt Repo Facilities Financed Total -------------------------------------------------------------------------- Investment Grade Commercial Real Estate Related Securities $478,645 $182,165 $ - $31,243 $692,053 CMBS IOs - 115,214 - 10,032 125,246 Other Below Investment Grade CMBS 286,748 1,483 - 25,051 313,282 Controlling Class CMBS 412,064 30,979 9,217 21,261 473,521 CDO Investments - - - 19,837 19,837 -------------------------------------------------------------------------- Total $1,177,457 $329,841 $9,217 $107,424 $1,623,939 ==========================================================================
Prior to acquiring Controlling Class securities, the Company performs a significant amount of due diligence on the underlying loans to ensure their risk profiles fit the Company's criteria. Loans that do not fit the Company's criteria are either removed from the pool or price adjustments occur. The debt service coverage ratios are evaluated to determine if they are appropriate for each asset class. The average loan to value ratio ("LTV") of the underlying loans is generally 70% at origination. Due to its greater levels of credit protection, other below investment grade CMBS are subject to less comprehensive due diligence than Controlling Class securities. As part of the underwriting process, the Company assumes a certain amount of loans will incur losses over time. In performing continuing credit reviews on the 16 Controlling Class trusts, the Company estimates that $418,995 of principal of the underlying loans will not be recoverable. This amount represents 2.02% of the underlying loan pools and 66.3% of the par amount of the subordinated Controlling Class securities owned by the Company. This loss assumption is used to compute a loss adjusted yield, which is then used to report income on the Company's consolidated financial statements. The weighted average loss adjusted yield for all subordinated Controlling Class securities is 9.56%. For all Controlling Class securities with a rating of BB- and below, the weighted average loss adjusted yield is 10.3%. If the loss assumptions prove to be consistent with actual loss experience, the Company will maintain that level of income for the life of the security. As actual losses differ from the original loss assumptions, yields are adjusted to reflect the updated assumptions. A write down of the adjusted purchase price or write up of loss adjusted yields of the security may also be required (See Item 7A - -"Quantitative and Qualitative Disclosures About Market Risk" for more information on the sensitivity of the Company's income and adjusted purchase price to changes in credit experience). Once acquired, the Company uses a performance monitoring system to track the credit experience of the mortgages in the pools securing both the Controlling Class and the other below investment grade CMBS. The Company receives remittance reports monthly from the trustees and closely monitors any delinquent loans or other issues that may affect the performance of the loans. The special servicer of a loan pool also assists in this process. The Company reviews its loss assumptions every quarter using updated payment and debt service coverage information on each loan in the context of economic trends on both a national and regional level. The Company's anticipated yields on its investments are based upon a number of assumptions that are subject to certain business and economic uncertainties and contingencies. Examples of such contingencies include, among other things, the timing and severity of expected credit losses, the rate and timing of principal payments (including prepayments, repurchases, defaults, liquidations, special servicer fees, and other related expenses), the pass-through or coupon rate, and interest rate fluctuations. Additional factors that may affect the Company's anticipated yields on its Controlling Class CMBS include interest payment shortfalls due to delinquencies on the underlying mortgage loans, the timing and magnitude of credit losses on the mortgage loans underlying the Controlling Class CMBS that are a result of the general condition of the real estate market (including competition for tenants and their related credit quality), and changes in market rental rates. As these uncertainties and contingencies are difficult to predict and are subject to future events, which may alter these assumptions, no assurance can be given that the Company's anticipated yields to maturity will be maintained. Commercial Real Estate Loans The Company's loan activity is focused on providing mezzanine capital to the commercial real estate industry. The Company targets well capitalized real estate operators with strong track records and compelling business plans designed to enhance the value of their real estate. These loans are generally subordinated to a senior lender or first mortgage and are priced to reflect a higher return. The Company has significant experience in closing large, complex loan transactions and can deliver a timely and competitive financing package. The types of investments in this class include subordinated participations in first mortgages, loans secured by partnership interests, preferred equity interests in real estate limited partnerships and loans secured by second mortgages. The weighted average life of these investments is generally two to three years and average leverage is 1:1 debt to equity generally funded with committed financing facilities. These investments have fixed or floating rate coupons and some provide additional earnings through an internal rate of return ("IRR") look back or gross revenue participation. The Company performs significant due diligence before making investments to evaluate risks and opportunities in this sector. The Company generally focuses on strong sponsorship, attractive real estate fundamentals, and pricing and structural characteristics that provide significant control over the underlying asset. Since 2001, the Company's activity in this sector has generally been conducted through Carbon Capital, Inc. ("Carbon I") and Carbon Capital II, Inc. ("Carbon II"and collectively with Carbon I, the "Carbon Capital Funds"), private commercial real estate income opportunity funds. As of December 31, 2004, the Company owned approximately 20% of Carbon I as well as approximately 20% of Carbon II. Various institutional investors, an affiliate of the Manager and PNC Bank own the remainder. The Manager also manages the Carbon Capital Funds. The Company does not incur any additional management or incentive fees to the Manager as a result of its investment in the Carbon Capital Funds. In certain cases the Manager may be paid up to 1.0% of an investment's par as an origination fee. The Company believes the use of the Carbon Capital Funds allows it to invest in larger institutional quality assets with greater diversification. The Company's consolidated financial statements include its share of the net assets and income of the Carbon Capital Funds. During 2001, the Company entered into a $50,000 commitment to acquire shares in Carbon I, a private commercial real estate income opportunity fund managed by the Manager. The Carbon I investment period ended on July 12, 2004. No additional capital will be called. The Company's investment in Carbon I as of December 31, 2004 was $39,563. On October 6, 2004, the Company entered into a $30,000 commitment to acquire shares in Carbon Capital II. On November 19, 2004 the Company entered into an additional $32,067 commitment to acquire shares in Carbon II. During 2004, the Company received capital call notices of $16,953. The proceeds were used by Carbon II to purchase nine commercial mortgage loans. As of December 31, 2004, the Company's investment in Carbon II was $17,249 and the Company's remaining commitment to Carbon II is $45,114. On December 31, 2004, the Company owned commercial real estate loans with a carrying value of $375,811. The average yield of this portfolio at December 31, 2004 was 9.1%. The majority of these loans pay interest based on the one-month London Interbank Offered Rate ("LIBOR"). Commercial real estate loans with a carrying value of $102,694 were held in the Carbon Capital Funds and $273,117 were held directly. The Company and the Carbon Capital Funds each have committed financing facilities used to finance these assets. During the year ended December 31, 2004, the Company invested $226,997 in new loans and received par payoffs of $23,285. In addition, during 2004, the Company invested $29,453 in the Carbon Capital Funds and received a return of capital of $6,719. Hedging Activities The Company enters into hedging transactions to protect its investment portfolio and related borrowings from interest rate fluctuations and other changes in market conditions. These transactions may include interest rate swaps, the purchase or sale of interest rate collars, caps or floors, options, and other hedging instruments. These instruments may be used to hedge as much of the interest rate risk as the Manager determines is in the best interest of the Company's stockholders, given the cost of such hedges. The Manager may elect to have the Company bear a level of interest rate risk that could otherwise be hedged when the Manager believes, based on all relevant facts, that bearing such risk is advisable. The Manager has extensive experience in hedging mortgages, mortgage-related assets and related borrowings with these types of instruments. Hedging instruments often are not traded on regulated exchanges, guaranteed by an exchange or its clearinghouse, or regulated by any U.S. or foreign governmental authorities. The Company will enter into these transactions only with counter parties with long-term debt rated A or better by at least one nationally recognized credit rating organization. The business failure of a counter party with which the Company has entered into a hedging transaction will most likely result in a default, which may result in the loss of unrealized profits. Although the Company generally will seek to reserve for itself the right to terminate its hedging positions, it may not always be possible to dispose of or close out a hedging position without the consent of the counter party, and the Company may not be able to enter into an offsetting contract in order to cover its risk. There can be no assurance that a liquid secondary market will exist for hedging instruments purchased or sold, and the Company may be required to maintain a position until exercise or expiration, which could result in losses. The Company's hedging activities are intended to address both income and capital preservation. Income preservation refers to maintaining a stable spread between yields from mortgage assets and the Company's borrowing costs across a reasonable range of adverse interest rate environments. Capital preservation refers to maintaining a relatively steady level in the market value of the Company's capital across a reasonable range of adverse interest rate scenarios. However, no strategy can insulate the Company completely from changes in interest rates. From time to time, the Company may modify its exposure to market interest rates by entering into various financial instruments that adjust portfolio duration and short-term rate exposure. These financial instruments are intended to mitigate the effect of changes in interest rates on the value of the Company's assets and the cost of borrowing. At December 31, 2004, the Company had no outstanding futures contracts. At December 31, 2003, the Company had outstanding short positions of 30 five-year and 73 ten-year U.S. Treasury Note future contracts. At December 31, 2004 and 2003, the Company had a forward LIBOR cap with a notional amount of $85,000 and a fair value of $694 and $1,114, respectively. Swap agreements as of December 31, 2004 and 2003 consisted of the following:
As of December 31, 2004 ------------------------------------------------------------------------- Estimated Fair Unamortized Average Remaining Notional Value Value Cost Term (years) ------------------------------------------------------------------------- Cash flow hedges $452,600 $253 - 5.44 Trading swaps 16,000 (5) - 1.94 CDO cash flow hedges 718,120 (11,262) - 8.50 CDO timing swaps 223,445 145 - 8.08 As of December 31, 2003 ------------------------------------------------------------------------- Estimated Fair Unamortized Average Remaining Notional Value Value Cost Term (years) ------------------------------------------------------------------------- Cash flow hedges $611,300 $(4,442) - 6.53 Trading swaps 308,000 1,513 - 3.34 CDO cash flow hedges 454,778 (23,651) - 8.51 CDO timing swaps 171,545 29 - 8.61
The counterparties for the Company's swaps are Deutsche Bank, AG, Merrill Lynch Capital Services, Inc., Goldman Sachs Capital Markets, L.P., Lehman Special Financing Inc., and Societe Generale with ratings of AA-, A+, A+, A, and AA-, respectively. The Company continually monitors the rating and overall credit quality of its swap counterparties. Financing and Leverage The Company has financed its assets with the net proceeds of its stock offerings, the issuance of common stock under the Company's Dividend Reinvestment and Stock Purchase Plan (the "Dividend Reinvestment Plan"), the issuance of preferred stock, long-term secured borrowings, short-term borrowings under repurchase agreements, and the lines of credit discussed below. In the future, operations may be financed by future offerings of equity securities, as well as unsecured and secured borrowings. The Company expects that, in general, it will employ leverage consistent with the type of assets acquired and the desired level of risk in various investment environments. The Company's governing documents do not explicitly limit the amount of leverage that the Company may employ. Instead, the Board of Directors has adopted an indebtedness policy for the Company that limits total leverage to a maximum 6.0 to 1 debt to equity ratio. Subsequent to December 31, 2004, the Board of Directors adopted a new indebtedness policy for the Company that limits recourse debt to a maximum of 3.0 to 1. The Company's recourse debt-to-equity ratio of 1.6 to 1 was in compliance with the revised policy as of December 31, 2004. The Company anticipates that it will maintain recourse debt-to-equity ratios between 1.0 to 1 and 3.0 to 1 in the foreseeable future, although this ratio may be higher or lower at any time. The Board of Directors may change the Company's indebtedness policy at any time in the future. On May 29, 2002, the Company issued ten tranches of secured debt through a collateralized debt obligation ("CDO I"). In this transaction, a wholly owned subsidiary of the Company issued secured debt in the par amount of $419,185 secured by the subsidiary's assets. The adjusted issue price of the CDO I debt, as of December 31, 2004, was $405,377. Five tranches were issued at a fixed rate coupon and five tranches were issued at a floating rate coupon with a combined weighted average remaining maturity of 7.29 years as of December 31, 2004. All floating rate coupons were swapped to fixed rate coupons resulting in a total fixed rate cost of funds for CDO I of approximately 7.21%. On December 10, 2002, the Company issued seven tranches of secured debt through a second collateralized debt obligation ("CDO II"). In this transaction, a wholly owned subsidiary of the Company issued secured debt in the par amount of $280,783 secured by the subsidiary's assets. In July 2004, the Company issued a bond with a par of $12,850 from CDO II that it had previously retained. Before issuing this security, the Company amended the indenture to reduce the coupon from 9.0% to 7.6%. The adjusted issue price of the CDO II debt as of December 31, 2004 was $293,167. Five tranches were issued at a fixed rate coupon and three tranches were issued at a floating rate coupon with a combined weighted average remaining maturity of 7.72 years as of December 31, 2004. All floating rate coupons were swapped to fixed rate coupons, resulting in a total fixed rate cost of funds for CDO II of approximately 5.79%. Included in CDO II was a ramp facility that was utilized to fund the purchase of an additional $50,000 of par of below investment grade CMBS. The Company utilized the ramp in February 2003 and July 2003, to contribute $30,000 of par of CSFB 03-CPN1 and $20,000 of par of GECMC 03-C2, respectively. On March 30, 2004 the Company issued its third collateralized debt obligation ("CDO III") through Anthracite CDO 2004-1. The total par value of bonds sold was $372,456. The adjusted issue price of the CDO III debt as of December 31, 2004 was $369,422. Five tranches were issued at a fixed rate coupon and six tranches were issued at a floating rate coupon with a combined weighted average remaining maturity of 8.39 years as of December 31, 2004. All floating rate coupons were swapped to fixed rate coupons resulting in a total fixed rate cost of funds for CDO I of approximately 5.03%. Included in CDO III was a $50,000 ramp facility that was fully utilized as of December 31, 2004. The Company has a $200,000 committed credit facility with Deutsche Bank, AG (the "Deutsche Bank Facility"), which matures on December 20, 2007. The Deutsche Bank Facility can be used to replace existing reverse repurchase agreement borrowings and to finance the acquisition of mortgage-backed securities, loan investments, and investments in real estate joint ventures. As of December 31, 2004 and 2003, the outstanding borrowings under this facility were $126,349 and $82,406, respectively. Outstanding borrowings under the Deutsche Bank Facility bear interest at a LIBOR based variable rate. On July 18, 2002, the Company entered into a $75,000 committed credit facility with Greenwich Capital, Inc. Outstanding borrowings under this credit facility bear interest at a LIBOR based variable rate. As of December 31, 2004, outstanding borrowings under this facility were $24,527. As of December 31, 2003, outstanding borrowings under this facility were $7,530. At December 31, 2004, the Company had outstanding borrowings of $12,800 under a $13,000 committed credit facility with Morgan Stanley Mortgage Capital, Inc. The Morgan Stanley Mortgage Capital, Inc. facility matures May 11, 2006. The Company is subject to various covenants in its lines of credit, including maintaining a minimum net worth of $305,000 as determined under generally accepted accounting principles in the United States of America ("GAAP"), a debt-to-equity ratio not to exceed 5.5 to 1, a recourse debt-to-equity of 3.0 to 1, a minimum cash requirement based upon certain debt-to-equity ratios, a minimum debt service coverage ratio of 1.5 and a minimum liquidity reserve of $10,000. The Company received authorization from its lenders to permit debt to equity ratios in excess of existing covenants and a debt service coverage ratio less than 1.5. As of December 31, 2004 and 2003, the Company was in compliance with all other covenants. As part of the CORE Cap Inc. merger ("CORE Cap"), the Company authorized and issued 2,261,000 shares of Series B Preferred Stock, $0.001 par value per share ("Series B Preferred Stock"), to CORE Cap stockholders. The Series B Preferred Stock was perpetual, carried a 10% coupon, had a preference in liquidation as of December 31, 2003 of $43,942, and was convertible into the Company's Common Stock at a price of $17.09 per share, subject to adjustment. At the end of the first quarter of 2004, the Board of Directors approved the Company's decision to redeem its Series B Preferred Stock, $0.001 par value per share ("Series B Preferred Stock"). The second quarter of 2004 earnings includes a charge of $0.21 per share for the redemption of the Company's Series B Preferred. All the Series B Preferred Stock was redeemed on May 6, 2004. On May 29, 2003, the Company authorized and issued 2,300,000 shares of 9.375% Series C Cumulative Redeemable Preferred Stock ("Series C Preferred Stock"), par value $0.001 per share. The Series C Preferred Stock is perpetual, carries a 9.375% coupon, and has a preference in liquidation of $57,500. The aggregate net proceeds to the Company (after deducting underwriting fees and expenses) were approximately $55,435. For the year ended December 31, 2004, the Company issued 1,084,619 shares of Common Stock under its Dividend Reinvestment Plan. Net proceeds to the Company were approximately $12,691. For the year ended December 31, 2003, the Company issued 1,955,919 shares of Common Stock under its Dividend Reinvestment Plan. Net proceeds to the Company were approximately $21,134. For the years ended December 31, 2004 and 2003, the Company issued 294,400 and 45,000 shares of Common Stock under a sale agency agreement with Brinson Patrick Securities Corporation. Net proceeds to the Company were approximately $3,210 and $497, respectively. The Company has entered into reverse repurchase agreements to finance its securities that are not financed under its lines of credit or CDOs. The reverse repurchase agreements collateralized by most of these securities bear interest at rates that have historically moved in close relationship to LIBOR. Further information with respect to the Company's collateralized borrowings at December 31, 2004 is summarized as follows:
Commercial Total Lines of Reverse Repurchase Mortgage Collateralized Collateralized Credit Agreements Loan Pools Debt Obligations Borrowings -------------- ------------------- -------------- ----------------- ---------------- Commercial Real Estate Securities Outstanding Borrowings $5,798 $284,224 $- $1,083,471* $1,373,493 Weighted average borrowing rate 3.76% 2.62% - 6.04% 5.32% Weighted average remaining maturity days 192 30 - 2,942 2,328 Estimated fair value of assets pledged $9,217 $339,073 $- $1,202,760 $1,551,050 Residential Mortgage-Backed Securities Outstanding Borrowings - $356,451 $- - $356,451 Weighted average borrowing rate - 2.36% - - 2.36% Weighted average remaining - maturity days - 23 - 23 Estimated fair value of assets - pledged - $372,071 $- $372,071 Commercial Mortgage Loan Pools Outstanding Borrowings $773 - $1,294,058 - $1,294,830 Weighted average borrowing rate 3.61% - 3.76% - 3.76% Weighted average remaining - maturity days 189 - 2,587 2,585 Estimated fair value of assets - pledged $1,339 - $1,312,045 $1,313,384 Commercial Real Estate Loans Outstanding Borrowings $141,601 - - - $141,601 Weighted average borrowing rate 3.47% - - - 3.47% Weighted average remaining - - - maturity days 222 222 Estimated fair value of assets - - - pledged $211,566 $211,566 * $15.054 of the Company's CDO debt is the financing of CDO bonds that the Company has chosen not to sell and financed under its lines of credit.
At December 31, 2004, the Company's collateralized borrowings had the following remaining maturities: Reverse Commercial Total Lines of Repurchase Mortgage Loan Collateralized Collateralized Credit Agreements Pools Debt Obligations Borrowings ---------------- ------------------- ------------------- ------------------- ------------------ Within 30 days $ - $605,944 $- $ - $605,944 31 to 59 days - 7,925 - - 7,925 Over 60 days 163,676 26,806 1,294,058 1,067,967 2,552,507 ---------------- ------------------- ------------------- ------------------- ------------------ $163,676 $640,675 $1,294,058 $1,067,967 $3,166,376 ================ =================== =================== =================== ==================
As of December 31, 2004, $73,651 of the Company's $200,000 Deutsche Bank Facility was available for future borrowings and $50,473 of the Company's $75,000 committed credit facility with Greenwich Capital, Inc. was available. Certain information with respect to the Company's collateralized borrowings at December 31, 2003 is summarized as follows:
Reverse Total Lines of Repurchase Collateralized Collateralized Credit Agreements Debt Obligations Borrowings ------------ ---------------- ----------------- ---------------- Commercial Real Estate Securities Outstanding Borrowings $67,226 $360,629 $684,970 $1,112,825 Weighted average borrowing rate 2.26% 1.46% 6.60% 4.68% Weighted average remaining maturity days 562 17 3,033 1,906 Estimated fair value of assets pledged $110,652 $423,244 $770,575 $1,304,471 Residential Mortgage-Backed Securities Outstanding Borrowings - $688,006 - $688,006 Weighted average borrowing rate - 1.12% - 1.12% Weighted average remaining maturity days - 24 - 24 Estimated fair value of assets pledged - $714,296 - $714,296 Real Estate Joint Ventures Outstanding Borrowings $513 - - $513 Weighted average borrowing rate 3.12% - - 3.12% Weighted average remaining maturity days 212 - - 212 Estimated fair value of assets pledged $2,750 - - $2,750 Commercial Real Estate Loans Outstanding Borrowings $22,197 - - $22,197 Weighted average borrowing rate 2.79% - - 2.79% Weighted average remaining maturity days 254 - - 254 Estimated fair value of assets pledged $33,206 - - $33,206
At December 31, 2003, the Company's collateralized borrowings had the following remaining maturities: Total Lines of Reverse Repurchase Collateralized Collateralized Credit Agreements Debt Obligations Borrowings -------------- --------------------- ------------------- ---------------- Within 30 days $ - $1,048,635 $ - $1,048,635 31 to 59 days - - - - Over 60 days 89,936 - 684,970 774,906 -------------- --------------------- ------------------- ---------------- $89,936 $1,048,635 $684,970 $1,823,541 ============== ===================== =================== ================
As of December 31, 2003, $102,594 of the Company's $185,000 Deutsche Bank Facility was available for future borrowings and $67,470 of the Company's $75,000 committed credit facility with Greenwich Capital, Inc. was available. Under the lines of credit and the reverse repurchase agreements, the respective lender retains the right to mark the underlying collateral to estimated market value. A reduction in the value of pledged assets would require the Company to provide additional collateral or fund cash margin calls. From time to time, the Company may be required to provide additional collateral or fund margin calls. The Company maintains adequate liquidity to meet such calls. Risks Risk is an inherent part of investing in high yielding commercial real estate debt. Risk management is considered to be of paramount importance to the Company's day-to-day operations. Consequently, the Company devotes significant resources across all its operations to the identification, measurement, monitoring, management and analysis of risk. Risks related to our manager Conflicts of interest of the Manager may result in decisions that do not fully reflect stockholders' best interests. The Company and the Manager have common officers and directors, which may present conflicts of interest in the Company's dealings with the Manager and its affiliates, including the Company's purchase of assets originated by such affiliates. For example, the Company may purchase certain mortgage assets from PNC Bank, an affiliate of PNC Bancorp, Inc. which owns approximately 71% of the outstanding capital stock of the Manager's parent company, BlackRock, Inc as of December 31, 2004. The Manager and its employees may engage in other business activities that could reduce the time and effort spent on the management of the Company. The Manager also provides services to real estate investment trusts ("REITs") not affiliated with us. As a result, there may be a conflict of interest between the operations of the Manager and its affiliates in the acquisition and disposition of mortgage assets. In addition, the Manager and its affiliates may from time to time purchase mortgage assets for their own account and may purchase or sell assets from or to the Company. For example, BlackRock Realty Advisors, Inc., a subsidiary of the Manager, provides real estate equity and other real estate related products and services in a variety of strategies to its institutional investor client base. In doing so, it purchases real estate that may underlie the real estate loans and securities the Company acquires, and consequently depending on the factual circumstances involved, there may be conflicts between the Company and those investors. Such conflicts may result in decisions and allocations of mortgage assets by the Manager, or decisions by the Manager's affiliates, that are not in the Company's best interests. Although the Company has adopted investment guidelines, these guidelines give the Manager significant discretion in investing. The Company's investment and operating policies and the strategies that the Manager uses to implement those policies may be changed at any time without the consent of stockholders. The Company is dependent on the Manager, and the termination by the Company of its management agreement with the Manager could result in a termination fee. The Company's success is dependent on the Manager's ability to attract and retain quality personnel. The market for portfolio managers, investment analysts, financial advisers and other professionals is extremely competitive. There can be no assurance the Manager will be successful in its efforts to recruit and retain the required personnel. The management agreement between the Company and the Manager provides for base management fees payable to the Manager without consideration of the performance of the Company's portfolio and also provides for incentive fees based on certain performance criteria, which could result in the Manager recommending riskier or more speculative investments. Termination of the management agreement between the Company and the Manager by the Company would result in the payment of a substantial termination fee, which could adversely affect the Company's financial condition. Termination of the management agreement by the Company could also adversely affect the Company if the Company were unable to find a suitable replacement. There is a limitation on the liability of the Manager. Pursuant to the management agreement, the Manager will not assume any responsibility other than to render the services called for under the management agreement and will not be responsible for any action of the Company's board of directors in following or declining to follow its advice or recommendations. The Manager and its directors and officers will not be liable to the Company, any of its subsidiaries, its unaffiliated directors, its stockholders or any subsidiary's stockholders for acts performed in accordance with and pursuant to the management agreement, except by reason of acts constituting bad faith, willful misconduct, gross negligence or reckless disregard of their duties under the management agreement. The Company has agreed to indemnify the Manager and its directors and officers with respect to all expenses, losses, damages, liabilities, demands, charges and claims arising from acts of the Manager not constituting bad faith, willful misconduct, gross negligence or reckless disregard of duties, performed in good faith in accordance with and pursuant to the management agreement. Risks related to our business Interest rate fluctuations will affect the value of the Company's mortgage assets, net income and common stock. Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond the Company's control. Interest rate fluctuations can adversely affect the income and value of the Company's common stock in many ways and present a variety of risks, including the risk of a mismatch between asset yields and borrowing rates, variances in the yield curve and changing prepayment rates. The Company's operating results depend in large part on differences between the income from its assets (net of credit losses) and borrowing costs. The Company funds a substantial portion of its assets with borrowings that have interest rates that reset relatively rapidly, such as monthly or quarterly. The Company anticipates that, in most cases, the income from its assets will respond more slowly to interest rate fluctuations than the cost of borrowings, creating a potential mismatch between asset yields and borrowing rates. Consequently, changes in interest rates, particularly short-term interest rates, may significantly influence the Company's net income. Increases in these rates tend to decrease the Company's net income and market value of the Company's net assets. Interest rate fluctuations that result in the Company's interest expense exceeding interest income would result in the Company incurring operating losses. The Company also invests in fixed-rate mortgage-backed securities. In a period of rising interest rates, the Company's interest payments could increase while the interest the Company earns on its fixed-rate mortgage-backed securities would not change. This would adversely affect the Company's profitability. The relationship between short-term and long-term interest rates is often referred to as the "yield curve." Ordinarily, short-term interest rates are lower than long-term interest rates. If short-term interest rates rise disproportionately relative to long-term interest rates (a flattening of the yield curve), the Company's borrowing costs may increase more rapidly than the interest income earned on the Company's assets. Because the Company's borrowings will primarily bear interest at short-term rates and the Company's assets will primarily bear interest at medium-term to long-term rates, a flattening of the yield curve tends to decrease the Company's net income and market value of the Company's net assets. Additionally, to the extent cash flows from long-term assets that return scheduled and unscheduled principal are reinvested, the spread between the yields of the new assets and available borrowing rates may decline and also may tend to decrease the net income and market value of the Company's net assets. It is also possible that short-term interest rates may adjust relative to long-term interest rates such that the level of short-term rates exceeds the level of long-term rates (a yield curve inversion). In this case, the Company's borrowing costs may exceed the Company's interest income and operating losses could be incurred. Interest rate caps on the Company's mortgage-backed securities may adversely affect the Company's profitability. The Company's adjustable-rate mortgage-backed securities are typically subject to periodic and lifetime interest rate caps. Periodic interest rate caps limit the amount an interest rate can increase during any given period. Lifetime interest rate caps limit the amount an interest rate can increase through maturity of a mortgage-backed security. The Company's borrowings are not subject to similar restrictions. Accordingly, in a period of rapidly increasing interest rates, the Company could experience a decrease in net income or a net loss because the interest rates on its borrowings could increase without limitation while the interest rates on its adjustable-rate mortgage-backed securities would be limited by caps. The Company's assets include subordinated CMBS which are subordinate in right of payment to more senior securities. The Company's assets include a significant amount of subordinated CMBS, which are the most subordinate class of securities in a structure of securities secured by a pool of loans and accordingly are the first to bear the loss upon a restructuring or liquidation of the underlying collateral and the last to receive payment of interest and principal. The Company may not recover the full amount or, in extreme cases, any of its initial investment in such subordinated interests. Additionally, market values of these subordinated interests tend to be more sensitive to changes in economic conditions than more senior interests. As a result, such subordinated interests generally are not actively traded and may not provide holders thereof with liquidity of investment. The Company's assets include mezzanine loans which have greater risks of loss than more senior loans. The Company's assets include a significant amount of mezzanine loans that involve a higher degree of risk than long-term senior mortgage loans. In particular, a foreclosure by the holder of the senior loan could result in the mezzanine loan becoming unsecured. Accordingly, the Company may not recover some or all of its investment in such a mezzanine loan. Additionally, the Company may permit higher loan to value ratios on mezzanine loans than it would on conventional mortgage loans when the Company is entitled to share in the appreciation in value of the property securing the loan. Prepayment rates can increase which would adversely affect yields on the Company's investments. The yield on investments in mortgage loans and mortgage-backed securities and thus the value of the Company's common stock is sensitive to changes in prevailing interest rates and changes in prepayment rates, which results in a divergence between the Company's borrowing rates and asset yields, consequently reducing income derived from the Company's investments. The Company's ownership of non-investment grade mortgage assets subjects the Company to an increased risk of loss. The Company acquires mortgage loans and non-investment grade mortgage-backed securities, which are subject to greater risk of credit loss on principal and non-payment of interest in contrast to investments in senior investment grade securities. The Company's mortgage loans are subject to certain risks. The Company acquires, accumulates and securitizes mortgage loans as part of its investment strategy. While holding mortgage loans, the Company is subject to risks of borrower defaults, bankruptcies, fraud and special hazard losses that are not covered by standard hazard insurance. Also, the costs of financing and hedging the mortgage loans can exceed the interest income on the mortgage loans. In the event of any default under mortgage loans held by the Company, the Company will bear the risk of loss of principal to the extent of any deficiency between the value of the mortgage collateral and the principal amount of the mortgage loan. In addition, delinquency and loss ratios on the Company's mortgage loans are affected by the performance of third-party servicers and special servicers. The Company invests in multifamily and commercial loans which involve a greater risk of loss than single family loans. The Company's investments include multifamily and commercial real estate loans which are considered to involve a higher degree of risk than single family residential lending because of a variety of factors, including generally larger loan balances, dependency for repayment on successful operation of the mortgaged property and tenant businesses operating therein, and loan terms that include amortization schedules longer than the stated maturity which provide for balloon payments at stated maturity rather than periodic principal payments. In addition, the value of multifamily and commercial real estate can be affected significantly by the supply and demand in the market for that type of property. Limited recourse loans limit the Company's recovery to the value of the mortgaged property. A substantial portion of the mortgage loans the Company acquires may contain limitations on the mortgagee's recourse against the borrower. In other cases, the mortgagee's recourse against the borrower is limited by applicable provisions of the laws of the jurisdictions in which the mortgaged properties are located or by the mortgagee's selection of remedies and the impact of those laws on that selection. In those cases, in the event of a borrower default, recourse may be limited to only the specific mortgaged property and other assets, if any, pledged to secure the relevant mortgage loan. As to those mortgage loans that provide for recourse against the borrower and their assets generally, there can be no assurance that such recourse will provide a recovery in respect of a defaulted mortgage loan greater than the liquidation value of the mortgaged property securing that mortgage loan. The volatility of certain mortgaged property values may adversely affect the Company's mortgage loans. Commercial and multifamily property values and net operating income derived from are subject to volatility and may be affected adversely by a number of factors, including, but not limited to, national, regional and local economic conditions (which may be adversely affected by plant closings, industry slowdowns and other factors); local real estate conditions (such as an oversupply of housing, retail, industrial, office or other commercial space); changes or continued weakness in specific industry segments; perceptions by prospective tenants, retailers and shoppers of the safety, convenience, services and attractiveness of the property; the willingness and ability of the property's owner to provide capable management and adequate maintenance; construction quality, age and design; demographic factors; retroactive changes to building or similar codes; and increases in operating expenses (such as energy costs). Leveraging the Company's investments may increase the Company's exposure to loss. The Company leverages its investments and thereby increases the volatility of its income and net asset value that may result in operating or capital losses. If borrowing costs increase, or if the cash flow generated by the Company's assets decreases, the Company's use of leverage will increase the likelihood that the Company will experience reduced or negative cash flow and reduced liquidity. The Company's investments may be illiquid and their value may decrease. Many of the Company's assets are relatively illiquid. In addition, certain of the mortgage-backed securities that the Company has acquired or will acquire will include interests that have not been registered under the relevant securities laws, resulting in a prohibition against transfer, sale, pledge or other disposition of those mortgage-backed securities except in a transaction that is exempt from the registration requirements of, or otherwise in accordance with, those laws. The Company's ability to vary its portfolio in response to changes in economic and other conditions may be relatively limited. No assurances can be given that the fair market value of any of the Company's assets will not decrease in the future. The Company's hedging transactions can limit the Company's gains and increase the Company's exposure to losses. The Company uses hedging strategies that involve risk and that may not be successful in insulating the Company from exposure to changing interest and prepayment rates. There can be no assurance that a liquid secondary market will exist for hedging instruments purchased or sold, and the Company may be required to maintain a position until exercise or expiration, which could result in losses. Failure to maintain REIT status would have adverse tax consequences. To continue to qualify as a REIT, the Company must comply with requirements regarding the nature of its assets and its sources of income. If the Company is compelled to liquidate its mortgage-backed securities, the Company may be unable to comply with these requirements, ultimately jeopardizing its status as a REIT. If in any taxable year the Company fails to qualify as a REIT: o the Company would be subject to federal and state income tax on its taxable income at regular corporate rates; o the Company would not be allowed to deduct distributions to stockholders in computing its taxable income; and o unless the Company were entitled to relief under the United States Internal Revenue Code of 1986, as amended (the "Code"), the Company would also be disqualified from treatment as a REIT for the four taxable years following the year during which the Company lost qualification. If the Company fails to qualify as a REIT, the Company might need to borrow funds or liquidate some investments in order to pay the additional tax liability. Accordingly, funds available for investment or distribution to the Company's stockholders would be reduced for each of the years involved. Qualification as a REIT involves the application of highly technical and complex provisions of the Code to the Company's operations and the determination of various factual matters and circumstances not entirely within the Company's control. There are only limited judicial or administrative interpretations of these provisions. Although the Company operates in a manner consistent with the REIT qualification rules, there cannot be any assurance that the Company is or will remain so qualified. In addition, the rules dealing with federal income taxation are constantly under review by persons involved in the legislative process and by the Internal Revenue Service and the United States Department of the Treasury. Changes to the tax law could adversely affect the Company's stockholders. The Company cannot predict with certainty whether, when, in what forms, or with what effective dates, the tax laws applicable to the Company or its stockholders may be changed. Competition may adversely affect the Company's ability to acquire assets. Because of competition, the Company may not be able to acquire mortgage-backed securities at favorable yields. Failure to maintain an exemption from the Investment Company Act of 1940 would restrict the Company's operating flexibility. The Company conducts its business so as not to become regulated as an investment company under the Investment Company Act of 1940, as amended (the "Investment Company Act"). Accordingly, the Company does not expect to be subject to the restrictive provisions of the Investment Company Act. Failure to maintain an exemption from the Investment Company Act would adversely affect the Company's ability to operate. The Company may become subject to environmental liabilities. The Company may become subject to environmental risks when it acquires interests in properties with material environmental problems. Such environmental risks include the risk that operating costs and values of these assets may be adversely affected by the obligation to pay for the cost of complying with existing environmental laws, ordinances and regulations, as well as the cost of complying with future legislation. Such laws often impose liability regardless of whether the owner or operator knows of, or was responsible for, the presence of such hazardous or toxic substances. The costs of investigation, remediation or removal of hazardous substances could exceed the value of the property. The Company's income and ability to make distributions to stockholders could be affected adversely by the existence of an environmental liability with respect to the Company's properties. Operating Policies The Company has adopted compliance guidelines, including restrictions on acquiring, holding, and selling assets, to ensure that the Company meets the requirements for qualification as a REIT under the Code and is excluded from regulation as an investment company. Before acquiring any asset, the Manager determines whether such asset would constitute a "Real Estate Asset" under the REIT provisions of the Code, as amended. The Company regularly monitors purchases of mortgage assets and the income generated from such assets, including income from its hedging activities, in an effort to ensure that at all times the Company's assets and income meet the requirements for qualification as a REIT and exclusion under the Investment Company Act. In order to maintain the Company's REIT status, the Company generally intends to distribute to its stockholders aggregate dividends equaling at least 90% of its taxable income each year. The Code permits the Company to fulfill this distribution requirement by the end of the year following the year in which the taxable income was earned. The Company's unaffiliated directors review all transactions on a quarterly basis to ensure compliance with the Company's operating policies and to ratify all transactions with PNC Bank (an affiliate of the Manager) and its affiliates, except that the purchase of securities from PNC Bank and its affiliates require prior approval. The unaffiliated directors rely substantially on information and analysis provided by the Manager to evaluate the Company's operating policies, compliance therewith, and other matters relating to the Company's investments. Regulation The Company intends to continue to conduct its business so as not to become regulated as an investment company under the Investment Company Act. Under the Investment Company Act, a non-exempt entity that is an investment company is required to register with the SEC and is subject to extensive, restrictive, and potentially adverse regulation relating to, among other things, operating methods, management, capital structure, dividends, and transactions with affiliates. The Investment Company Act exempts entities that are "primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate" ("Qualifying Interests"). Under current interpretation by the staff of the SEC, to qualify for this exemption, the Company, among other things, must maintain at least 55% of its assets in Qualifying Interests. Substantially all of the Company's interests in RMBS are Qualifying Interests. A portion of the CMBS acquired by the Company are collateralized by pools of first mortgage loans where the Company can monitor the performance of the underlying mortgage loans through loan management and servicing rights and when the Company has appropriate workout/foreclosure rights with respect to the underlying mortgage loans. When such arrangements exist, the Company believes that the related Controlling Class CMBS constitute Qualifying Interests for purposes of the Investment Company Act. Therefore, the Company believes that it should not be required to register as an "investment company" under the Investment Company Act as long as it continues to invest in a sufficient amount of such Controlling Class CMBS and/or in other Qualifying Interests. If the SEC or its staff were to take a different position with respect to whether the Company's Controlling Class CMBS constitute Qualifying Interests, the Company could be required to modify its business plan so that either (i) it would not be required to register as an investment company or (ii) it would comply with the Investment Company Act and be able to register as an investment company. In such event, modification of (i) the Company's business plan so that it would not be required to register as an investment company would likely entail a disposition of a significant portion of the Company's Controlling Class CMBS or the acquisition of significant additional assets, such as agency pass-through and mortgage-backed securities, which are Qualifying Interests or (ii) the Company's business plan to register as an investment company would result in significantly increased operating expenses and would likely entail significantly reducing the Company's indebtedness (including the possible prepayment of the Company's short-term borrowings), which could also require it to sell a significant portion of its assets. No assurances can be given that any such dispositions or acquisitions of assets, or de-leveraging, could be accomplished on favorable terms. Consequently, any such modification of the Company's business plan could have a material adverse effect on the Company. Further, if it were established that the Company were an unregistered investment company, there would be a risk that the Company would be subject to monetary penalties and injunctive relief in an action brought by the SEC, that the Company would be unable to enforce contracts with third parties, and that third parties could seek to obtain recession of transactions undertaken during the period it was established that the Company was an unregistered investment company. Any such results would be likely to have a material adverse effect on the Company. Competition The Company's net income depends, in large part, on the Company's ability to acquire mortgage assets at favorable spreads over the Company's borrowing costs. In acquiring mortgage assets, the Company competes with other mortgage REITs, specialty finance companies, savings and loan associations, banks, mortgage bankers, insurance companies, mutual funds, institutional investors, investment banking firms, other lenders, governmental bodies, and other entities. In addition, there are numerous mortgage REITs with asset acquisition objectives similar to the Company's, and others may be organized in the future. The effect of the existence of additional REITs may be to increase competition for the available supply of mortgage assets suitable for purchase by the Company. Some of the Company's anticipated competitors are significantly larger than the Company, have access to greater capital and other resources, and may have other advantages over the Company. In addition to existing companies, other companies may be organized for purposes similar to that of the Company, including companies organized as REITs focused on purchasing mortgage assets. A proliferation of such companies may increase the competition for equity capital and thereby adversely affect the market price of the Company's Common Stock. Employees The Company does not have any employees. The Company's officers, each of whom is a full-time employee of the Manager, perform the duties required pursuant to the Management Agreement (as defined below) with the Manager and the Company's bylaws. Management Agreement The Company is managed pursuant to a management agreement, dated March 27, 1998, between the Company and the Manager (the "Management Agreement"), and pursuant to which the Manager is responsible for the day-to-day operations of the Company and performs such services and activities relating to the assets and operations of the Company as may be appropriate. On March 25, 2002, the Management Agreement was extended for one year through March 27, 2003, with the approval of the unaffiliated directors, on terms similar to the prior agreement with the following changes: (i) the incentive fee calculation would be based upon GAAP earnings instead of funds from operations, (ii) the removal of the four-year period to value the Management Agreement in the event of termination and (iii) subsequent renewal periods of the Management Agreement would be for one year instead of two years. Houlihan Lokey Howard & Zukin Financial Advisors, Inc., a national investment banking and financial advisory firm, advised the Board of Directors in the 2002 renewal process. On March 6, 2003, the unaffiliated directors approved an extension of the Management Agreement from its expiration of March 27, 2003 for one year through March 31, 2004. The terms of the renewed agreement were similar to the prior agreement except for the incentive fee calculation that would provide for a rolling four-quarter high watermark rather than a quarterly calculation. In determining the rolling four-quarter high watermark, the Company would calculate the incentive fee based upon the current and prior three quarters' net income. The Manager would be paid an incentive fee in the current quarter if the Yearly Incentive Fee, as defined, was greater than what was paid to the Manager in the prior three quarters cumulatively. The Company phased in the rolling four-quarter high watermark commencing with the second quarter of 2003. Calculation of the incentive fee was based on GAAP earnings and adjusted to exclude special one-time events pursuant to changes in GAAP accounting pronouncements after discussion between the Manager and the unaffiliated directors. The incentive fee threshold did not change. The high watermark provided for the Manager to be paid 25% of the amount of earnings (calculated in accordance with GAAP) per share that exceeds the product of the adjusted issue price of the Company's Common Stock per share and the greater of 9.5% or 350 basis points over the ten-year Treasury note. The Management Agreement was further extended for one year from March 31, 2004 through March 31, 2005. The base management fee was revised to equal 2% of the quarterly average total stockholders' equity for the applicable quarter. The incentive fee was revised to be 25% of the amount of earnings (calculated in accordance with GAAP) per share that exceeds the product of the adjusted issue price of the Company's common stock per share ($11.37 as of December 31, 2004) and the greater of 8.5% or 400 basis points over the ten-year Treasury note. On March 10, 2004, the members of the Company's Board of Directors who are not affiliated with the Manager approved an extension of the Company's management agreement with the Manager for one additional year through March 31, 2006. The terms of the extended agreement did not change. During the third quarter of 2003, the Manager agreed to reduce its management fees by 20% from its calculated amount for the third and fourth quarter of 2003 and the first quarter of 2004. This revision resulted in $1,046 in savings to the Company during 2003 and $532 during 2004, respectively. The Manager primarily engages in four activities on behalf of the Company: (i) acquiring and originating mortgage loans and other real estate related assets; (ii) asset/liability and risk management, hedging of floating rate liabilities, and financing, management and disposition of assets, including credit and prepayment risk management; (iii) surveillance and restructuring of real estate loans and (iv) capital management, structuring, analysis, capital raising, and investor relations activities. In conducting these activities, the Manager formulates operating strategies for the Company, arranges for the acquisition of assets by the Company, arranges for various types of financing and hedging strategies for the Company, monitors the performance of the Company's assets, and provides certain administrative and managerial services in connection with the operation of the Company. At all times, the Manager is subject to the direction and oversight of the Company's Board of Directors. The Company may terminate, or decline to renew the term of, the Management Agreement without cause at any time upon 60 days' written notice by a majority vote of the unaffiliated directors. Although no termination fee is payable in connection with a termination for cause, in connection with a termination without cause, the Company must pay the Manager a termination fee, which could be substantial. The amount of the termination fee will be determined by independent appraisal of the value of the Management Agreement. Such appraisal is to be conducted by a nationally-recognized appraisal firm mutually agreed upon by the Company and the Manager. During 2000, the Company completed the acquisition of CORE Cap, Inc. The merger was a stock for stock acquisition where the Company issued 4,180,552 shares of its Common Stock and 2,261,000 shares of its Series B Preferred Stock. At the time of the CORE Cap acquisition, the Manager agreed to pay GMAC (CORE Cap, Inc.'s external advisor) $12,500 over a ten-year period ("Installment Payment") to purchase the right to manage the assets under the existing management contract ("GMAC Contract"). The GMAC Contract had to be terminated in order to allow for the Company to complete the merger, as the Company's management agreement with the Manager did not provide for multiple managers. As a result, the Manager offered to buy-out the GMAC Contract as the Manager estimated it would receive incremental fees above and beyond the Installment Payment, and thus was willing to pay for, and separately negotiate, the termination of the GMAC Contract. Accordingly, the value of the Installment Payment was not considered in the Company's allocation of its purchase price to the net assets acquired in the acquisition of CORE Cap, Inc. The Company agreed that should the Management Agreement with the Manager be terminated, not renewed or not extended for any reason other than for cause, the Company would pay to the Manager an amount equal to the Installment Payment less the sum of all payments made by the Manager to GMAC. As of December 31, 2004, the Installment Payment would be $6,500 payable over six years. The Company does not accrue for this contingent liability. In addition, the Company has the right at any time during the term of the Management Agreement to terminate the Management Agreement without the payment of any termination fee upon, among other things, a material breach by the Manager of any provision contained in the Management Agreement that remains uncured at the end of the applicable cure period. Taxation of the Company The Company has elected to be taxed as a REIT under the Code, commencing with its taxable year ended December 31, 1998, and the Company intends to continue to operate in a manner consistent with the REIT provisions of the Code. The Company's qualification as a REIT depends on its ability to meet the various requirements imposed by the Code, through actual operating results, asset holdings, distribution levels, and diversity of stock ownership. Provided the Company continues to qualify for taxation as a REIT, it generally will not be subject to Federal corporate income tax on its net income that is currently distributed to stockholders. This treatment substantially eliminates the "double taxation" (at the corporate and stockholder levels) that generally results from an investment in a corporation. If the Company fails to qualify as a REIT in any taxable year, its taxable income would be subject to Federal income tax at regular corporate rates (including any applicable alternative minimum tax). Even if the Company qualifies as a REIT, it will be subject to Federal income and excise taxes on its undistributed income. If in any taxable year the Company fails to qualify as a REIT and, as a result, incurs additional tax liability, the Company may need to borrow funds or liquidate certain investments in order to pay the applicable tax, and the Company would not be compelled to make distributions under the Code. Unless entitled to relief under certain statutory provisions, the Company would also be disqualified from treatment as a REIT for the four taxable years following the year during which qualification is lost. Although the Company currently intends to operate in a manner designated to qualify as a REIT, it is possible that future economic, market, legal, tax, or other considerations may cause the Company to fail to qualify as a REIT or may cause the Board of Directors to revoke the Company's REIT election. The Company and its stockholders may be subject to foreign, state, and local taxation in various foreign, state, and local jurisdictions, including those in which it or they transact business or reside. The state and local tax treatment of the Company and its stockholders may not conform to the Company's Federal income tax treatment. Website The Company's website address is www.anthracitecapital.com. The Company makes available free of charge through its website its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC, and also makes available on its website the charters for the Audit, Nominating and Corporate Governance Committees of the Board of Directors and its Codes of Ethics, as well as its corporate governance guidelines. Copies in print of these documents are available upon request to the Secretary of the Company at the address indicated on the cover of this report. To communicate with the Board of Directors electronically, the Company has established an e-mail address, anthracitebod@blackrock.com, to which stockholders may send correspondence to the Board of Directors or any such individual directors or group or committee of directors. ITEM 2. PROPERTIES The Company does not maintain an office and owns no real property. It does not pay rent and utilizes the offices of the Manager, located at 40 East 52nd Street, New York, New York 10022. ITEM 3. LEGAL PROCEEDINGS At December 31, 2004 there were no pending legal proceedings of which the Company was a defendant or of which any of its property was subject. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of the Company's security holders during the fourth quarter of 2004 through the solicitation of proxies or otherwise. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock has been listed and traded on the New York Stock Exchange under the symbol "AHR" since the initial public offering in March 1998. The following table sets forth, for the periods indicated, the high, low and last sale prices in dollars on the New York Stock Exchange for the Company's Common Stock and the dividends declared by the Company with respect to the periods indicated as were traded during these respective time periods. Dividends 2003 High Low Last Sale Declared First Quarter................... 12.04 10.27 11.44 .35 Second Quarter.................. 12.89 11.00 12.06 .35 Third Quarter................... 12.55 9.26 9.65 .28 Fourth Quarter.................. 11.30 9.50 11.07 .28 2004 First Quarter................... 13.01 10.52 12.73 .28 Second Quarter.................. 13.00 10.51 11.98 .28 Third Quarter................... 12.14 10.50 11.12 .28 Fourth Quarter.................. 12.69 11.05 12.36 .28 On March 4, 2005, the closing sale price for the Company's Common Stock, as reported on the New York Stock Exchange, was $11.95. As of March 4, 2005, there were approximately 1,114 record holders of the Common Stock. This figure does not reflect beneficial ownership of shares held in nominee name. The following table summarizes information about options outstanding under the 1998 Stock Option Plan: Weighted Average Shares Exercise Price -------------- --------------- Outstanding at January 1, 2004 1,468,351 $14.75 Granted 5,000 11.81 Exercised (30,000) 8.44 Cancelled (25,500) 15.00 -------------- Outstanding at December 31, 2004 1,417,851 $14.87 ============== Options exercisable at December 31, 2004 1,417,851 $14.87 ============== Weighted-average fair value of options granted during the year ended December 31, 2004 (per option) $ 0.36 ============== Shares of Common Stock available for future grant under the 1998 Stock Option Plan at December 31, 2004 were 774,502. ITEM 6. SELECTED FINANCIAL DATA The selected financial data set forth below as of and for the years ended December 31, 2004, 2003, 2002, 2001, and 2000 has been derived from the Company's audited financial statements. This information should be read in conjunction with "Item 1. Business" and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations", as well as the audited financial statements and notes thereto included in "Item 8. Financial Statements and Supplementary Data".
For the Year For the Year For the Year For the Year For the Year Ended Ended Ended Ended Ended December 31, December 31, December 31, December 31, December 31, 2004 2003 2002 2001 2000 - --------------------------------------------------------------------------------------------------------------------- (In thousands, except per share data) Operating Data: Total income $203,866 $163,778 $162,445 $131,220 $97,642 Interest expense 128,166 83,249 65,018 59,400 51,112 Other operating expenses 12,383 11,707 14,850 12,736 9,727 Other gains (losses) (1) (20,125) (77,464) (28,949) (910) 2,523 Cumulative transition adjustment (2) - - 6,327 (1,903) - Net income (loss) 43,192 (8,642) 59,955 56,271 39,326 Net income (loss) available to common stockholders 25,768 (16,386) 54,793 47,307 32,261 Per Share Data: Net income (loss): Basic 0.50 (0.34) 1.18 1.41 1.37 Diluted 0.50 (0.34) 1.18 1.35 1.28 Dividends declared per common share 1.12 1.26 1.40 1.29 1.17 Balance Sheet Data: Total assets 3,729,134 2,398,846 2,640,558 2,627,203 1,033,651 Long-term obligations 3,215,396 1,981,416 2,234,342 2,244,088 791,397 Total stockholders' equity 513,738 417,430 406,216 383,115 242,254
(1) Other gains (losses) for the year ended December 31, 2004 of $(20,125) consist primarily of $(26,018) related to impairments on assets and a loss of $(11,464) related to securities held-for-trading. Other gains (losses) for the year ended December 31, 2003 of $(77,464) consist primarily of a loss of $(32,426) related to impairments on assets and a loss of $(38,206) related to securities held-for-trading. Other gains (losses) for the year ended December 31, 2002 of $(28,949) consist primarily of a loss of $(10,273) related to impairments on assets, a loss of $(29,255) related to securities held-for-trading, and a gain of $11,391 related to the sale of securities available-for-sale. Other gains (losses) for the year ended December 31, 2001 of $(910) consist primarily of a loss of $(5,702) related to impairments on assets, a loss of $(2,604) related to securities held-for-trading, and a gain of $7,401 related to the sale of securities available-for-sale. (2) The cumulative transition adjustment represents the Company's adoption of SFAS No. 142 and SFAS 133 for the years ended December 31, 2002 and 2001, respectively. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS All dollar figures expressed herein are expressed in thousands, except share and per share amounts. General Anthracite Capital, Inc. (the "Company"), a Maryland corporation, is a real estate finance company that invests in high yielding commercial real estate debt. The Company commenced operations on March 24, 1998. The Company's primary focus is to invest in a diverse portfolio of commercial real estate loans and commercial mortgage-backed securities ("CMBS"). The CMBS that the Company purchases are fixed income instruments similar to bonds that carry an interest coupon and stated principal. The cash flow used to pay the interest and principal on the CMBS comes from a designated pool of first mortgage loans on commercial real estate (the "Underlying Loans"). Underlying Loans are usually originated by commercial banks or investment banks and are secured by a first mortgage on office buildings, retail centers, apartment buildings, hotels and other types of commercial real estate. A typical loan pool may contain several hundred loans with principal amounts of as little as $1,000 to over $100,000. The pooling concept also permits significant geographic diversification. Converting loans into CMBS in this fashion allows investors to purchase these securities in global capital markets and to participate in the commercial real estate sector with significant diversification among property types, sizes and locations in one fixed income investment. The type of CMBS issued from a typical loan pool is generally broken down by credit rating. The highest rated CMBS will receive payments of principal first and is therefore least exposed to the credit performance of the Underlying Loan. These securities will carry a credit rating of AAA and will be issued with a principal amount that represents some portion of the total principal amount of the Underlying Loan pool. The CMBS that receive principal payments last are generally rated below investment grade (BB+ or lower.) As the last to receive principal these CMBS are also the first to absorb any credit losses incurred in the Underlying Loan pool. The principal amount of these below investment grade classes generally represents 3.0-5.0% of the principal of the Underlying Loan pools. The investor that owns the lowest rated, or non-rated, CMBS class is designated as the controlling class representative for the underlying loan pool. This designation allows the holder to assert a significant degree of control over any workouts or foreclosures of defaulted Underlying Loans. These securities are generally issued with a high yield to compensate for the credit risk inherent in owning the CMBS class which is the first to absorb losses. The Company's high yield commercial real estate loan strategy is based on a similar concept of investing in a portion of the principal and interest of a specific loan instead of a pool of loans as in CMBS. In this case the principal amount of a single loan is separated into a senior interest ("A note") and a junior interest ("B note"). Prior to a borrower default, the A note and the B note receive principal and interest pari passu; however after a borrower default, the A note would receive its principal and interest first and the B note would absorb the credit losses that occur, if any, up to the full amount of its principal. The B note holder generally has certain rights to control workouts or foreclosures. The Company invests in B notes as they provide higher yields with a degree of control over dispositions. The Company also invests in mezzanine loans on commercial real estate. The ownership interests in an entity that owns real estate secure mezzanine loans. These loans are generally subordinated to a first mortgage and would absorb a credit loss prior to the senior mortgage holder. The Company is managed by BlackRock Financial Management, Inc. (the "Manager"), a subsidiary of BlackRock, Inc., a publicly traded (NYSE: BLK) asset management company with approximately $341,800,000 of assets under management as of December 31, 2004. The Company believes that the trend toward highly structured investment products requires significant expertise in traditional real estate underwriting as well as in the capital markets. Through its external management contract with the Manager, the Company can source and manage more opportunities by taking advantage of a unique platform that combines these two disciplines. The Company's common stock is traded on the New York Stock Exchange under the symbol "AHR." The Company's primary long-term objective is to distribute consistent dividends supported by earnings. The Company establishes its dividend by analyzing the long-term sustainability of earnings given existing market conditions and the current composition of its portfolio. This includes an analysis of the Company's credit loss assumptions, general level of interest rates and projected hedging costs. During the third quarter of 2004, the Company completed its repositioning into commercial real estate assets. As of December 31, 2004, CMBS and commercial real estate loans represent 90% of portfolio assets while residential mortgage-backed securities ("RMBS") represent 10%. During 2004, exclusive of its investment in the Carbon Capital, Inc. ("Carbon I") and Carbon Capital II, Inc. ("Carbon II"and collectively with Carbon I, the "Carbon Capital Funds") and the commercial mortgage loan pools, the Company acquired commercial real estate assets with a market value of $638,632, comprised primarily of $151,094 of below investment grade CMBS, $120,423 of investment grade CMBS, $67,507 of investment grade REIT debt, and $227,773 of high yield commercial real estate loans. The table below is a summary of the Company's investments by asset class for the last five years:
Carrying Value as of December 31, 2004 2003 2002 2001 2000 Amount % Amount % Amount % Amount % Amount % ------------------------------------------------------------------------------------------------------------- Commercial real estate securities $ 1,623,939 44.6% $1,393,010 62.8% $ 894,345 35.9% $453,953 20.8% $412,435 42.6% Commercial mortgage loan pools 1,312,045 36.1 - - - - - - - - Commercial real estate loans(1) 329,930 9.1 97,984 4.4 88,926 3.6 159,738 7.3 163,541 16.9 RMBS 372,071 10.2 726,717 32.8 1,506,450 60.5 1,570,009 71.9 337,222 34.9 U.S. Treasury securities - - - - - - - - 54,043 5.6 ------------------------------------------------------------------------------------------------------------- Total $ 3,637,985 100.0% $2,217,711 100.0% $2,489,721 100.0% $2,183,700 100.0% $967,241 100.0% =============================================================================================================
(1) Includes real estate joint ventures and an equity investment. As of December 31, 2004, the Company owns 16 different trusts where it is in the first loss position and is designated as the controlling class representative by owning the lowest rate or non-rated CMBS class. The Company considers the CMBS securities where it maintains the right to control the foreclosure/workout process on the underlying loans its controlling class CMBS ("Controlling Class"). The Company divides its below investment grade CMBS investment activity into two portfolios: Controlling Class CMBS and other below investment grade CMBS. Commercial Mortgage Loan Pools and Commercial Real Estate Securities Portfolio Activity The Company continues to increase its investments in commercial real estate securities. Commercial real estate securities include CMBS, investment grade real estate investment trusts ("REIT") debt and collateralized debt obligation ("CDO") investments. During the year ended December 31, 2004, the Company increased its commercial real estate securities portfolio by 19% from $1,366,508 to $1,623,939. This increase was primarily attributable to the purchase of subordinated CMBS and investment grade CMBS that have a market value as of December 31, 2004 of $133,760 and $84,702, respectively. During the second quarter of 2004, the Company acquired subordinated CMBS in a trust establishing a Controlling Class interest. As the Controlling Class holder, the Company has the ability to control dispositions or workouts of any defaulted loans in this trust. The Company negotiated for and obtained a greater degree of discretion over the disposition of the commercial mortgage loans than is typically granted to the special servicer. As a result of this expanded discretion, Financial Accounting Standards Board ("FASB") interpretation No. 46, "Consolidation of Variable Interest Entities" (revised December 2003) ("FIN 46R") requires the Company to consolidate the net assets and results of operations of the trust. The CMBS securities acquired by the Company had a par value of $41,495 with $13,890 not rated and the balance rated BBB- to B-. During the third quarter of 2004 the Company sold the BBB- rated security, which had the impact of increasing the borrowings for the commercial loan pool by $5,848. As of December 31, 2004, the CMBS securities owned by the Company have a par value of $35,495. The debt associated with the real estate mortgage investment conduit ("REMIC") trust is non-recourse to the Company, and is secured only by the commercial mortgage loan pools. As of December 31, 2004, the consolidation of the REMIC trust results in an increase in the Company's total debt to capital ratio from 3.7:1 to 6.2:1, but has no effect on the Company's recourse debt to capital ratio. The Company received authorization from its lenders to permit debt to capital ratios in excess of existing covenants. Approximately 45% of the par amount of the commercial mortgage loan pool is comprised of loans that are shadow rated A2 or better by Moody's Investors Service, Inc. and AA by Standard & Poor's Rating Group, a division of The McGraw-Hill Companies, Inc. The Company has taken into account the credit quality of the underlying loans in formulating its loss assumptions. Credit losses assumed on the entire pool are 1.40% of the principal balance, or 2.53% of the unrated principal balance. For income recognition purposes, the Company accounts for the unrated commercial mortgage loans in the pool as a single asset based on common credit risk characteristics. Over the life of the commercial mortgage loan pools, the Company reviews and updates its loss assumptions to determine the impact on expected cash flows to be collected. A decrease in estimated cash flows will reduce the amount of interest income recognized in future periods and may result in a loan loss reserve depending upon the severity of the cash flow reductions. An increase in estimated cash flows will first reduce the loan loss reserve and any additional cash will increase the amount of interest income recorded in future periods. The Company's CDO offerings allow the Company to match fund its commercial real estate portfolio by issuing long-term debt to finance long-term assets. The CDO debt is non-recourse to the Company; therefore, the Company's losses are limited to its equity investment in the CDO. The CDO debt is also fully hedged to protect the Company from an increase in short-term interest rates. As of December 31, 2004, over 86% of the market value of the Company's subordinated CMBS assets are match funded in the Company's CDOs in this manner. The Company's first CDO transaction ("CDO I") was issued as Anthracite CDO 2002 CIBC-1 and closed on May 15, 2002. The Company issued $403,633 of debt secured by a portfolio of commercial real estate securities with a total par of $515,880 and an adjusted purchase price of $431,995. On December 10, 2002, the Company issued another $280,607 of debt through Anthracite CDO 2002-2 secured by a separate portfolio of commercial real estate securities with a par of $313,444 and an average adjusted purchase price of $289,197. Included in the Company's second collateralized debt obligation ("CDO II") was a ramp facility that was utilized to fund the purchase of an additional $50,000 of par of below investment grade CMBS. The Company utilized the ramp in February 2003 and July 2003, to contribute $30,000 of par of CSFB 03-CPN1 and $20,000 of par of GECMC 03-C2, respectively. In July 2004, the Company issued a bond with a par of $12,850 from CDO II. Before issuing this security, the Company amended the indenture to reduce the coupon from 9.0% to 7.6%. On March 30, 2004 the Company issued its third collateralized debt obligation ("CDO III") through Anthracite CDO 2004-1. The total par value of bonds sold was $372,456. The total cost of funds on a fully hedged basis was 5.0%. Included in CDO III was a $50,000 ramp facility that was fully utilized as of December 31, 2004. The Company retained 100% of the equity of CDOs I, II and III and recorded the transactions on its consolidated financial statements as secured financing.
Collateral as of December 31, 2004 Debt as of December 31, 2004 -------------------------------------------------------------------------------- Adjusted Purchase Adjusted Issue Weighted Average Price Loss Adjusted Yield Price Cost of Funds * Net Spread ----------------------------------------------------------------------------------------------- CDO I $434,661 8.89% $405,377 7.21% 1.68% CDO II 324,324 7.80% 293,167** 5.79% 2.01% CDO III 377,154 7.09% 369,422** 5.03% 2.06% - ----------------------------------------------------------------------------------------------------------- Total ** $1,136,139 7.98% $1,067,967 6.06% 1.91%
* Weighted Average Cost of Funds is the current cost of funds plus hedging expenses. ** The Company chose not to sell $10,000 of par of CDO II debt rated BB and $13,069 of par of CDO III debt rated BB. The following table details the par, fair market value, adjusted purchase price, and loss adjusted yield of the Company's commercial real estate securities outside of the CDOs as of December 31, 2004:
Adjusted Fair Market Dollar Purchase Dollar Loss Adjusted Par Value Price Price Price Yield -------------------------------------------------------------------------------- Investment grade CMBS $145,420 $146,467 100.72 $150,612 103.57 4.59% Investment grade REIT debt 43,885 43,291 98.65 44,274 100.89 5.34% CMBS rated BB+ to B 93,455 73,158 78.28 71,329 76.32 8.22% CMBS rated B- or lower 74,740 14,833 19.85 16,120 21.57 11.00% CDO Investments 203,182 19,837 9.76 19,450 9.57 56.65% CMBS Interest Only securities ("IOs") 3,712,604 125,246 3.37 122,379 3.30 7.31% Project Loans 23,082 23,649 102.46 24,092 104.38 5.65% -------------------------------------------------------------------------------- Total $4,296,368 $446,481 10.39 $448,257 10.43 8.53%
The following table details the par, fair market value, adjusted purchase price and loss adjusted yield of the Company's commercial real estate securities outside of the CDOs as of December 31, 2003:
Adjusted Fair Market Dollar Purchase Dollar Loss Adjusted Par Value Price Price Price Yield ---------------------------------------------------------------------------------- Investment grade CMBS $277,276 $268,593 96.87 $272,853 98.40 4.9% Investment grade REIT debt 29,000 29,567 101.95 30,210 104.17 5.0% CMBS rated BB+ to B 186,217 133,868 71.89 150,775 80.97 8.9% CMBS rated B- or lower 304,358 80,680 26.51 107,653 35.37 12.6% CMBS IOs 2,623,456 84,493 3.22 83,704 3.19 7.5% Other CMBS 20,266 20,142 99.39 20,264 99.99 5.7% ---------------------------------------------------------------------------------- Total $3,440,573 $617,343 17.94 $665,459 19.34 7.4%
On November 9, 2004, the Company closed its fourth collateralized debt obligation ("CDO HY1") secured by a portfolio of below investment grade CMBS with an average rating of CCC. The CMBS portfolio was carried at fair market value of $109,933 on the Company's consolidated statement of financial condition based on price quotes received from third parties. The transaction was accounted for as a sale under relevant accounting guidelines. The Company received cash proceeds of $140,425 as well as all of the CDO HY1 preferred shares that had a fair market value of $15,885 as of December 31, 2004. The transaction raised re-investable proceeds of $95,799. The following table summarizes the impact of this transaction on fourth quarter 2004 results and per share amounts: Realized gain at closing of CDO HY1 $14,769 $0.28 Realized gain from subsequent sale of A- tranche 1,825 0.03 Increase in accumulated other comprehensive income 29,782 0.56 ----------- ---------- Total book value impact $46,376 $0.87 =========== ========== Below Investment Grade CMBS and Underlying Loan Performance The Company divides its below investment grade CMBS investment activity into two portfolios; Controlling Class CMBS and other below investment grade CMBS. The distinction between the two is in the rights the Company obtains with its investment in Controlling Class CMBS. Controlling Class rights allow the Company to control the workout and/or disposition of defaults that occur in the underlying loans. These securities absorb the first losses realized in the underlying loan pools. The Company's other below investment grade CMBS have no rights associated with its ownership to control the workout and/or disposition of underlying loan defaults; however, these investments are not the first to absorb losses in the underlying pools. The coupon payment on the non-rated security can also be reduced for special servicer fees charged to the trust. The next highest rated security in the structure will then generally be downgraded to non-rated and become the first to absorb losses and expenses from that point on. During 2004, the Company acquired $39,597 of par of other below investment grade CMBS and $239,290 of par of new Controlling Class CMBS. The total par of the Company's other below investment grade CMBS at December 31, 2004 was $332,225; the average credit protection, or subordination level, of this portfolio is 5.91%. The total par of the Company's subordinated Controlling Class CMBS securities at December 31, 2004 was $631,649 and the total par of the loans underlying these securities was $18,580,729. The Company's investment in its subordinated Controlling Class CMBS securities by credit rating category at December 31, 2004 is as follows: Adjusted Fair Market Dollar Purchase Dollar Subordination Par Value Price Price Price Level ------------------------------------------------------------------------- BB+ $129,493 $ 122,294 $94.44 $112,754 $ 87.07 6.50% BB 76,575 65,610 85.68 61,602 80.45 4.73% BB- 118,144 91,919 77.80 90,307 76.44 4.16% B+ 61,604 40,409 65.59 40,951 66.48 2.88% B 171,093 106,455 62.22 102,893 60.14 2.64% B- 7,809 4,478 57.35 4,552 58.29 1.41% CCC 19,326 4,360 22.56 6,573 34.01 1.38% NR 47,605 5,984 12.57 4,996 10.49 n/a ------------------------------------------------------------------------- Total $631,649 $ 441,509 $69.90 $424,628 $ 67.23 During 2004, one of the Company's Controlling Class securities was upgraded from BB+ to BBB and is not included in the chart above. The Company's investment in its subordinated Controlling Class CMBS by credit rating category at December 31, 2003 is as follows:
Adjusted Fair Market Dollar Purchase Dollar Subordination Par Value Price Price Price Level ------------------------------------------------------------------------------------ BB+ $ 84,503 $ 73,766 $ 87.29 $ 72,680 $ 86.01 7.54% BB 89,945 75,349 83.77 76,842 85.43 6.04% BB- 101,393 71,285 70.31 81,036 79.92 5.12% B+ 44,314 28,904 65.22 31,179 70.36 3.43% B 182,119 105,061 57.69 133,718 73.42 3.06% B- 83,296 34,160 41.01 51,935 62.35 1.54% CCC+ 11,924 5,595 46.92 7,129 59.78 1.53% CCC 70,273 13,375 19.03 22,844 32.51 1.23% C 8,940 2,531 28.31 2,734 30.58 0.62% NR 129,925 25,003 19.24 23,011 17.71 n/a ------------------------------------------------------------------------------------ Total $806,632 $ 435,029 $ 53.93 $503,108 $ 62.37 ------------------------------------------------------------------------------------
During 2004, servicers reduced the par amount of the Company's Controlling Class CMBS in the amount of $32,157. Further delinquencies and losses may cause the par reductions to continue and cause the Company to conclude that a change in loss adjusted yield is required along with a write down of the adjusted purchase price through the income statement according to Emerging Issue Task Force ("EITF") 99-20. Also during 2004, the loan pools were paid down by $451,662. Pay down proceeds are distributed to the highest rated CMBS class first and reduce the percent of total underlying collateral represented by each rating category. For all of the Company's Controlling Class securities, the Company assumes that a total of 2.02% of the original loan balance will not be recoverable. This estimate was developed based on an analysis of individual loan characteristics and prevailing market conditions at the time of origination. This loss estimate equates to cumulative expected defaults of approximately 6% over the life of the portfolio and an average assumed loss severity of 35% of the defaulted loan balance. All estimated workout expenses including special servicer fees are included in these assumptions. Actual results could differ materially from these estimated results. See Item 7A -"Quantitative and Qualitative Disclosures About Market Risk" for a discussion of how differences between estimated and actual losses could affect Company earnings. The Company monitors credit performance on a monthly basis and debt service coverage ratios on a quarterly basis. Using these and other statistics, the Company maintains watch lists for loans that are delinquent thirty days or more and for loans that are not delinquent but have issues that the Company's management believes require close monitoring. During 2004, the Company completed a detailed re-underwriting of its 1998 vintage Controlling Class CMBS. Upon completion, the Company determined that the Company's portfolio contained six 1998 vintage CMBS securities in four separate CMBS transactions that required impairment charges at December 31, 2004 following the application of EITF 99-20. As a result, the Company recorded a loss on impairment of assets of $26,018 in the fourth quarter of 2004. A variety of factors influence updated yields for these securities, including magnitude of credit loss, timing of credit loss, prepayments and servicer advances. The magnitude of credit losses did not significantly change as a result of this process, as total loss expectations on the underlying loans moved from 2.06% to 2.04%. Changes in the timing of credit losses and prepayments caused updated yields on these securities to decline by a weighted average of 66 basis points. Market dislocations in 1998 caused disproportionate unrealized losses in market value on these securities based on price quotes received from third parties. The Company had recorded these unrealized losses as other comprehensive loss on its consolidated statement of financial condition since that time. Based on current economic conditions and updated credit assumptions, the Company believes these 1998 vintage CMBS securities will be repaid in full and that the impairment charge of $25,355 with respect to five of the six securities will be reflected in income over the remaining life of the bonds. In addition, the Company increased underlying loan loss expectations on one non-rated security resulting in an impairment charge of $663. The Company considers delinquency information from the Lehman Brothers Conduit Guide to be the most relevant benchmark to measure credit performance and market conditions applicable to its Controlling Class CMBS holdings. The year of issuance, or vintage year, is important, as older loan pools will tend to have more delinquencies than newly underwritten loans. The Company owns Controlling Class CMBS issued in 1998, 1999, 2001, 2002, 2003, and 2004. Comparable delinquency statistics referenced by vintage year as a percentage of par outstanding as of December 31, 2004 are shown in the table below: Vintage Year Underlying Delinquencies Lehman Brothers Collateral Outstanding Conduit Guide ---------------------------------------------------------------------- 1998 $6,872,404 2.31% 1.85% 1999 691,576 1.80% 2.46% 2001 907,293 1.02% 1.62% 2002 1,179,256 0.52% 0.64% 2003 2,153,409 - 0.24% 2004 6,776,791 - 0.04% ---------------------------------------------------------- Total $18,580,729 1.01%* 0.94%* * Weighted average based on current principal balance. Morgan Stanley also tracks CMBS loan delinquencies for the specific CMBS transactions with more than $200,000 of collateral and that have been seasoned for at least one year. This seasoning criteria will generally adjust for the lower delinquencies that occur in newly originated collateral. As of December 31, 2003, the Morgan Stanley index indicated that delinquencies on 243 securitizations were 2.47%, and as of December 31, 2004, this same index indicated that delinquencies on 286 securitizations were 1.74%. See Item 7A - "Quantitative and Qualitative Disclosures About Market Risks" for a detailed discussion of how delinquencies and loan losses affect the Company. Delinquencies on the Company's CMBS collateral as a percent of principal increased in line with expectations. The Company's aggregate delinquency experience is consistent with comparable data provided in the Lehman Brothers Conduit Guide. Of the 41 delinquent loans shown on the chart in Note 2 of the consolidated financial statements, 2 loans were real estate owned and being marketed for sale, no loans were in foreclosure, and the remaining 39 loans were in some form of workout negotiations. Aggregate realized losses of $22,911 were realized during year ended December 31, 2004. This brings cumulative realized losses to $74,976, which is 17.9% of total estimated losses. These losses include special servicer and other workout expenses. This experience to date is in line with the Company's loss expectations. Realized losses and special servicer expenses are expected to increase on the underlying loans as the portfolio matures. Special servicer expenses are also expected to increase as portfolios mature. The Company manages its credit risk through disciplined underwriting, diversification, active monitoring of loan performance and exercise of its right to control the workout process for delinquent loans as early as possible. The Company maintains diversification of credit exposures through its underwriting process and can shift its focus in future investments by adjusting the mix of loans in subsequent acquisitions. The comparative profiles of the loans underlying the Company's CMBS by property type as of December 31, 2004 and for the two prior years are as follows:
12/31/04 Exposure 12/31/03 Exposure 12/31/02 Exposure ---------------------------------------------------------------------------------------------------- Property Type Loan Balance % of % of % of Total Loan Balance Total Loan Balance Total ---------------------------------------------------------------------------------------------------- Multifamily $5,305,129 28.6% $3,770,944 33.2% $3,302,387 34.4% Retail 6,026,472 32.4 3,446,371 30.4 2,704,952 28.1 Office 4,617,616 24.9 2,266,160 20.0 1,809,519 18.8 Lodging 915,369 4.9 786,920 6.9 834,854 8.7 Industrial 1,272,583 6.8 713,942 6.3 589,044 6.1 Healthcare 327,832 1.8 337,333 3.0 346,298 3.6 Other 115,728 0.6 25,611 0.2 29,743 0.3 ---------------------------------------------------------------------------------- Total $18,580,729 100% $11,347,281 100% $9,616,797 100% ==================================================================================
As of December 31, 2004, the fair market value of the Company's holdings of Controlling Class CMBS is $16,881 higher than the adjusted cost for these securities which consists of a gross unrealized gain of $26,921 and a gross unrealized loss of $10,040. The adjusted purchase price of the Company's Controlling Class CMBS portfolio as of December 31, 2004 represents approximately 67.2% of its par amount. The market value of the Company's Controlling Class CMBS portfolio as of December 31, 2004 represents approximately 69.9% of its par amount. As the portfolio matures, the Company expects to recoup the $10,040 of unrealized loss, provided that the credit losses experienced are not greater than the credit losses assumed in the projected cash flow analysis. As of December 31, 2004, the Company believes there has been no material deterioration in the credit quality of its portfolio below current expectations. As the portfolio matures and expected losses occur, subordination levels of the lower rated classes of a CMBS investment will be reduced. This may cause the lower rated classes to be downgraded, which would negatively affect their market value and therefore the Company's net asset value. Reduced market value will negatively affect the Company's ability to finance any such securities that are not financed through a CDO or similar matched funding vehicle. In some cases, securities held by the Company may be upgraded to reflect seasoning of the underlying collateral and thus would increase the market value of the securities. During 2004 the Company experienced nine rating upgrades and four rating downgrades on its CMBS. The Company's income calculated in accordance with generally accepted accounting principles in the United States of America ("GAAP") for its CMBS securities is computed based upon a yield, which assumes credit losses would occur. The yield to compute the Company's taxable income does not assume there would be credit losses, as a loss can only be deducted for tax purposes when it has occurred. As a result, for the years 1998 through December 31, 2004, the Company's GAAP income accrued on its CMBS assets was approximately $36,625 lower than the taxable income accrued on the CMBS assets. Commercial Real Estate Loan Activity The Company's commercial real estate loan portfolio generally emphasizes larger transactions located in metropolitan markets, as compared to the typical loan in the CMBS portfolio. In June 2003, the borrower submitted payment in an attempt to fully repay the loan on a Los Angeles office building in connection with the borrower's sale of the property. Upon the sale of the property securing this loan, and pursuant to the loan documents, the Company was entitled to a supplemental exit fee that was to be paid upon repayment of the loan. The borrower has refused to pay the supplemental exit fee. The Company filed suit on July 15, 2003 against the co-borrowers, MP-555 West Fifth Mezzanine, LLC and MP-808 South Olive Mezzanine, LLC, which are both affiliates of Maguire Properties, Inc. (NYSE: MPG). The suit also names the Guarantor, Robert F. Maguire, III. The following table summarizes the Company's commercial real estate loan portfolio by property type as of December 31, 2004, 2003, and 2002:
Loan Outstanding ----------------------------------------------------------------------- Weighted Average December 31, 2004 December 31, 2003 December 31, 2002 Coupon Property ----------------------- ----------------------- ----------------------- -------------------------- Type Amount % Amount % Amount % 2004 2003 2002 - ----------------- ------------ ---------- ------------ ---------- ------------ ---------- -------- -------- -------- Office $ 100,344 35.5% $ 57,381 76.4% $ 69,431 91.4% 9.3% 9.4% 9.5% Residential 15,959 5.7 2,794 3.7 3,013 4.0 10.7 3.8 3.6 Retail 61,316 21.7 - - 3,500 4.6 6.6 - 4.6 Hotel 104,678 37.1 14,951 19.9 - - 7.2 6.6 - ------------ ---------- ------------ ---------- ------------ ---------- -------- -------- -------- Total $ 282,297 100.0% $ 75,126 100.0% $ 75,944 100.0% 8.0% 8.6% 9.2% ------------ ---------- ------------ ---------- ------------ ---------- -------- -------- --------
Critical Accounting Estimates Management's discussion and analysis of financial condition and results of operations are based on the amounts reported in the Company's consolidated financial statements. These financial statements are prepared in accordance with GAAP. In preparing the financial statements, management is required to make various judgments, estimates and assumptions that affect the reported amounts. Changes in these estimates and assumptions could have a material effect on the Company's consolidated financial statements. The following is a summary of the Company's accounting policies that are the most affected by management judgments, estimates and assumptions: Securities Available-for-sale The Company has designated certain investments in mortgage-backed securities, mortgage-related securities and certain other securities as available-for-sale. Securities available-for-sale are carried at estimated fair value with the net unrealized gains or losses reported as a component of accumulated other comprehensive income (loss) in stockholders' equity. Many of these investments are relatively illiquid, and management must estimate their values. In making these estimates, management generally utilizes market prices provided by dealers who make markets in these securities, but may, under certain circumstances, adjust these valuations based on management's judgment. Changes in the valuations do not affect the Company's reported net income or cash flows, but impact stockholders' equity and, accordingly, book value per share. Management must also assess whether unrealized losses on securities reflect a decline in value that is other than temporary, and, accordingly, write the impaired security down to its fair value, through earnings. Significant judgment by management is required in this analysis, which includes, but is not limited to, making assumptions regarding the collectability of the principal and interest, net of related expenses, on the underlying loans. Income on these securities is recognized based upon a number of assumptions that are subject to uncertainties and contingencies. Examples include, among other things, the rate and timing of principal payments (including prepayments, repurchases, defaults and liquidations), the pass-through or coupon rate and interest rate fluctuations. Additional factors that may affect the Company's reported interest income on its mortgage securities include interest payment shortfalls due to delinquencies on the underlying mortgage loans, the timing and magnitude of credit losses on the mortgage loans underlying the securities that are a result of the general condition of the real estate market (including competition for tenants and their related credit quality) and changes in market rental rates. These uncertainties and contingencies are difficult to predict and are subject to future events that may alter the assumptions. The Company recognizes interest income from its purchased beneficial interests in securitized financial interests ("beneficial interests") (other than beneficial interests of high credit quality, sufficiently collateralized to ensure that the possibility of credit loss is remote, or that cannot contractually be prepaid or otherwise settled in such a way that the Company would not recover substantially all of its recorded investment) in accordance with EITF 99-20. Accordingly, on a quarterly basis, when changes in estimated cash flows from the cash flows previously estimated occur due to actual prepayment and credit loss experience, the Company calculates a revised yield based on the current amortized cost of the investment (including any other-than-temporary impairments recognized to date) and the revised cash flows. The revised yield is then applied prospectively to recognize interest income. For other mortgage-backed and related mortgage securities, the Company accounts for interest income under SFAS No. 91, using the effective yield method which includes the amortization of discount or premium arising at the time of purchase and the stated or coupon interest payments. As a result of the closing of CDO I at the end of the first quarter 2002, the Company reclassified all of its subordinated CMBS on its consolidated statement of financial condition from available-for-sale to held-to-maturity. The effect of this reclassification changed the accounting basis for these securities, prospectively, from fair market value to adjusted cost. However, in accordance with the Statement of Financial Accounting Standard ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities," ("SFAS No. 133"), the interest rate swap agreements entered into by the Company to hedge the variable rate exposure of the debt of CDO I are required to be presented on the balance sheet at their fair market value. Accordingly, the Company determined that at December 31, 2002, and going forward, it would classify all of its subordinated CMBS as available-for-sale securities and record them at fair market value. This is consistent with the mark to market requirement for the CDO's interest rate swap agreements. The reclassification of these securities to available-for-sale from held-to-maturity increased the recorded value of these securities from $558,522 to $610,713 at December 31, 2002 with the difference being recorded in other comprehensive income. Under the various CDO indentures, the collateral administrator to the CDO has an ongoing fiduciary obligation to monitor the credit risk of the collateral securities contributed to the CDO. The collateral administrator may sell collateral securities that have suffered a credit event (such as a rating downgrade) or, in the collateral administrator's reasonable business judgment, have a significant risk of declining in credit quality over time. The Company has concluded there are circumstances under the various CDO indentures that permit, and the reasonable exercise of business judgment would warrant, the sale of one or more securities outside the boundaries of paragraph 8(a) of SFAS No. 115. The circumstance causing the Company to change this classification was not considered a permitted circumstance as stated in SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS No. 115"), and is therefore inconsistent with the Company's intent regarding its held-to-maturity classification. Accordingly, the Company's held-to-maturity classification has been tainted and the Company was prohibited from classifying any securities as held-to-maturity for a period of two years commencing December 31, 2002. Securities Held-for-trading The Company has designated certain other securities as held-for-trading. Securities held-for-trading are also carried at estimated fair value, with changes in fair value included in income. The valuations of these securities and the interest income recognized are subject to the same uncertainties as those discussed above. Mortgage Loans The Company purchases and originates commercial mortgage loans to be held as long-term investments. The Company also has investments in private opportunity funds that invest in commercial mortgage loans and are managed by the Manager. Management must periodically evaluate each loan for possible impairment. Impairment is indicated when it is deemed probable that the Company will not be able to collect all amounts due according to the contractual terms of the loan. If a loan were determined to be impaired, the Company would establish a reserve for probable losses and a corresponding charge to earnings. Given the nature of the Company's loan portfolio and the underlying commercial real estate collateral, significant judgment of management is required in determining impairment and the resulting loan loss allowance, which includes but is not limited to making assumptions regarding the value of the real estate that secures the mortgage loan. To date, the Company has determined that no loan loss allowances have been necessary on the loans in its portfolio or held by the opportunity funds. Real Estate Joint Ventures The Company makes investments in real estate entities over which the Company exercises significant influence, but not control. The real estate held by such entities must be regularly reviewed for impairment, and would be written down to its estimated fair value, through earnings, if impairment were determined to exist. This review involves assumptions about the future operating results of the real estate and market factors, all of which are subjective and difficult to predict. To date, the Company has determined that none of the real estate held by its joint ventures is impaired. Derivative Instruments The Company utilizes various hedging instruments (derivatives) to hedge interest rate and foreign currency exposures or to modify the interest rate or foreign currency characteristics of related Company investments. All derivatives are carried at fair value, generally estimated by management based on valuations provided by the counterparty to the derivative contract. For accounting purposes, the Company's management must decide whether to designate these derivatives as either a hedge of an asset or liability, securities available-for-sale, securities held-for-trading, or foreign currency exposure. This designation decision affects the manner in which the changes in the fair value of the derivatives are reported. Impairment - Securities In accordance with SFAS No. 115, when the estimated fair value of the security classified as available-for-sale has been below amortized cost for a significant period of time and the Company concludes that it no longer has the ability or intent to hold the security for the period of time over which the Company expects the values to recover to amortized cost, the investment is written down to its fair value. The resulting charge is included in income, and a new cost basis is established. Additionally, under EITF 99-20, when changes in estimated cash flows from the cash flows previously estimated occur due to actual prepayment and credit loss experience, and the present value of the revised cash flows using the current expected yield is less than the present value of the previously estimated remaining cash flows (adjusted for cash receipts during the intervening period), an other-than-temporary impairment is deemed to have occurred. Accordingly, the security is written down to fair value with the resulting change being included in income, and a new cost basis established. In both instances, the original discount or premium is written off when the new cost basis is established. After taking into account the effect of an impairment charge, income is recognized under EITF 99-20 or SFAS No. 91, as applicable, using the market yield for the security used in establishing the write-down. Recent Accounting Pronouncements In December 2004, FASB issued SFAS No. 123R, "Share-Based Payment." This statement is a revision to SFAS No. 123, "Accounting for Stock-Based Compensation" and supercedes APB Opinion No. 25, "Accounting for Stock Issued to Employees." This statement establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services, primarily focusing on the accounting for transactions in which an entity obtains employee services in share-based payment transactions. Entities will be required to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exceptions). That cost will be recognized over the period during which an employee is required to provide service, the requisite service period (usually the vesting period), in exchange for the award. The grant-date fair value of employee share options and similar instruments will be estimated using option-pricing models. If an equity award is modified after the grant date, incremental compensation cost will be recognized in an amount equal to the excess of the fair value of the modified award over the fair value of the original award immediately before the modification. This statement is effective as of the beginning of the first interim or annual reporting period that begins after June 15, 2005. In accordance with the standard, the Company will adopt SFAS No. 123R during the year ended December 31, 2005. The Company has determined that this statement will not impact the Company's consolidated financial statements, as there are no unvested options as of December 31, 2004 and the Company already applies the fair value method to all newly-issued options. In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary Assets--An Amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions". SFAS No. 153 eliminates the exception from fair value measurement for nonmonetary exchanges of similar productive assets in paragraph 21(b) of APB Opinion No. 29, "Accounting for Nonmonetary Transactions," and replaces it with an exception for exchanges that do not have commercial substance. SFAS No. 153 specifies that a nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS No. 153 is effective for the fiscal periods beginning after June 15, 2005 and is required to be adopted by the Company for the year ended December 31, 2006. The adoption of SFAS No. 153 is not expected to have a significant impact on the Company's financial statements. In March 2004, the Emerging Issues Task Force ("EITF") reached a consensus on the "recognition" provisions of Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments" ("EITF No. 03-1"). EITF No. 03-1 requires that a loss be recognized for an impairment that is other-than-temporary. A three-step impairment model should be applied to debt securities subject to SFAS No. 115, including those debt securities subject to EITF No. 99-20, "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets." On September 30, 2004, the FASB issued FASB Staff Position (FSP) EITF No. 03-1-1, "Effective Date of Paragraphs 10-20 of EITF Issue No. 03-1," which delayed the effective date of the recognition provisions of EITF No. 03-1 until the issuance of the final FSP EITF Issue 03-1-a, "Implementation Guidance for the Application of Paragraph 16 of EITF Issue No. 03-1." Until the final FSP is issued, management is not able to evaluate whether the adoption of the "recognition" provisions under such guidance will have a material effect on our results of operations or financial position. In December 2003, the FASB issued FASB Interpretation No. 46 (revised 2003), "Consolidation of Variable Interest Entities" ("FIN 46R"). FIN 46R addresses the application of Accounting Research Bulletin No. 51, "Consolidated Financial Statements," to variable interest entities ("VIE") and generally would require that the assets, liabilities and results of operations of a VIE be consolidated into the financial statements of the enterprise that has a controlling financial interest in it. The interpretation provides a framework for determining whether an entity should be evaluated for consolidation based on voting interests or significant financial support provided to the entity ("variable interests"). An entity is classified as a VIE if total equity is not sufficient to permit the entity to finance its activities without additional subordinated financial support or its equity investors lack the direct or indirect ability to make decisions about an entity's activities through voting rights, absorb the expected losses of the entity if they occur or receive the expected residual returns of the entity if they occur. Once an entity is determined to be a VIE, its assets, liabilities and results of operations should be consolidated with those of its primary beneficiary. The primary beneficiary of a VIE is the entity that either will absorb a majority of the VIE's expected losses or has the right to receive a majority of the VIE's expected residual returns. The expected losses and residual returns of a VIE include expected variability in its net income or loss, fees to decision makers and fees to guarantors of substantially all VIE assets or liabilities and are calculated in accordance with Statement of Financial Accounting Concept No. 7, "Using Cash Flow Information and Present Value in Accounting Measurements." A public enterprise with a variable interest in a VIE must apply FIN 46R to that VIE no later than the end of the first reporting period that ends after March 15, 2004, with the exception of special purpose entities ("SPEs"), as defined. A public enterprise with a variable interest in an SPE which has been deemed a VIE must apply FIN 46R to that VIE no later than the end of the first reporting period that ends after December 15, 2003. Additionally, if it is reasonably possible that an enterprise will consolidate or disclose information about a VIE when the guidance becomes effective, there are several disclosure requirements effective for all financial statements issued after January 31, 2003. The Company's ownership of the subordinated classes of CMBS from a single issuer where it maintains the right to control the foreclosure/workout process on the underlying loans ("Controlling Class CMBS") are variable interests in SPEs which have been deemed VIEs and therefore subject to the FIN 46R consolidation criteria. Provided in Paragraph 4(d) of FIN 46R, are exceptions to the consolidation of VIE's specifically, that an enterprise that holds variable interests in a qualifying special-purpose entity ("QSPE") shall not consolidate that entity unless that enterprise has the unilateral ability to cause the entity to liquidate or change the entity so that it not longer meets the conditions in paragraph 25 or 35 of SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. Pursuant to FIN 46R, the Company's management has concluded that the trusts holding its Controlling Class CMBS (except for LBUBS 2004-C2) are QSPEs and accordingly, the Company did not consolidate these trusts. The Controlling Class CMBS that have been deemed VIEs are detailed below. The Company's actual loss from its Controlling Class CMBS investments is limited to the amounts invested in such securities and further limited to such amounts not financed in its non-recourse CDOs. The fair value of the subordinated Controlling Class securities financed in the CDOs is $380,063; the total fair value of the Company's subordinated Controlling Class CMBS is $441,509 (See Note 3 of the consolidated financial statements for further discussion of LBUBS 2004-C2). The table below details the purchase date, par of the Company's Controlling Class securities and the entire par of each Controlling Class issuance owned by the Company as of December 31, 2004.
Controlling Class Purchase Date Par Held by the Total CMBS Issued Securities Company ------------------------------------------------------------------------------------------ Unconsolidated CMAC 1998-C1 July 1998 $47,786 $1,192,239 CMAC 1998-C2 September 1998 88,140 2,891,309 DLJCM 1998-CG1 June 1998 65,747 1,564,253 GMAC 1998-C1 April 1998 24,737 1,438,000 LBCMT 1998-C1 May 1998 100,000 1,727,818 PNCMA 1999-CM1 November 1999 18,059 760,414 LBUBS 2002-C2 October 2004 30,060 1,210,453 CSFB 2001-CK6 December 2001 48,115 939,182 CSFB 2003-CPN1 February 2003 39,759 1,006,389 GECMC 2003-C2 July 2003 38,450 1,183,080 BACM 2004-1 March 2004 24,705 1,327,183 JPMCC 2004-PNC1 June 2004 21,949 1,097,416 BACM 2004-3 July 2004 23,103 1,253,168 GMACC 2004-C2 August 2004 22,177 933,735 BACM 2004-6 December 2004 38,862 956,589 ---------------------------------------- Total Unconsolidated $ 631,649 $ 19,481,228 ======================================== Consolidated LBUBS 2004-C2 April 2004 35,495 1,237,113 ---------------------------------------- Total Consolidated $ 35,495 $ 1,237,113 ======================================== Total Controlling Class CMBS $ 667,144 $ 20,718,341 ========================================
Results of Operations Net income for the year ended December 31, 2004 was $43,192, or $0.50 per share (basic and diluted). Net loss for the year ended December 31, 2003 was $(8,642), or $(0.34) per share (basic and diluted). Net income for the year ended December 31, 2002 was $59,995, or $1.18 per share (basic and diluted). Interest Income: The following table sets forth information regarding the total amount of income from certain of the Company's interest-earning assets and the resulting average yields. Information is based on monthly average adjusted cost basis during the period.
For the Year Ended December 31, 2004 -------------------------------------------------------- Interest Average Annualized Income Balance Yield ----------------- ------------------ ------------------- Commercial real estate securities $123,860 $1,660,425 7.46% Commercial mortgage loan pools 39,672 987,481 4.02% Commercial real estate loans 11,896 105,305 11.30% Residential mortgage-backed securities 18,901 543,257 3.48% ("RMBS") Cash and cash equivalents 638 48,428 1.32% ----------------- ------------------ ------------------- Total $194,967 $3,344,896 5.83% ================= ================== ===================
For the Year Ended December 31, 2003 -------------------------------------------------------- Interest Average Annualized Income Balance Yield ----------------- ------------------ ------------------- Commercial real estate securities $98,113 $1,128,689 8.69% Commercial real estate loans 5,875 56,344 10.43% RMBS 54,504 1,312,641 4.15% Cash and cash equivalents 964 73,326 1.13% ----------------- ------------------ ------------------- Total $159,456 $2,571,000 6.20% ================= ================== ===================
For the Year Ended December 31, 2002 ------------------------------------------------------------ Interest Average Annualized Income Balance Yield ------------------------------------------------------------ Commercial real estate securities $72,205 $730,391 9.89% Commercial real estate loans 13,997 128,385 10.90% RMBS 72,524 1,392,389 5.21% Cash and cash equivalents 1,473 95,996 1.53% ------------------------------------------------------------ Total $160,199 $2,347,161 6.83% ============================================================
The following chart reconciles interest income and total income for the years ended December 31, 2004, 2003 and 2002.
For the Years Ended December 31, 2004 2003 2002 ------------------------------------------------- Interest Income $194,967 $159,456 $160,199 Earnings from real estate joint ventures 1,097 955 1,044 Earnings from equity investments 7,060 3,367 1,202 Other income 742 - - ------------------------------------------------- Total Income $203,866 $163,778 $162,445 =================================================
At the end of the third quarter of 2003, the Company decided to accelerate its strategic reduction of RMBS due to the volatility of interest rates and structural changes in the RMBS market. As a result, the source of a significant portion of the Company's income has shifted from RMBS to commercial real estate assets. The Company completed its repositioning into commercial real estate assets during the third quarter of 2004. Interest Expense: The following table sets forth information regarding the total amount of interest expense from certain of the Company's collateralized borrowings. Information is based on daily average balances during the period; the collateralized debt obligations for the year ended December 31, 2004 and 2003 includes the cost of hedging those transactions. For the Year Ended December 31, 2004 --------------------------------------------- Interest Average Annualized Expense Balance Rate ------------ ------------- ------------- Collateralized debt obligations $58,986 $969,586 6.08% Commercial mortgage loan pools 37,527 1,297,057 2.89% Reverse repurchase agreements 12,111 813,742 1.49% Lines of credit and term loan 4,093 105,588 3.88% ------------ ------------- ------------- Total $112,717 $3,185,973 3.54% ============ ============= ============= For the Year Ended December 31, 2003 --------------------------------------------- Interest Average Annualized Expense Balance Rate ------------ ------------- ------------- Collateralized debt obligations $ 44,226 $ 684,797 6.46% Reverse repurchase agreements 18,614 1,460,049 1.27% Lines of credit and term loan 2,325 45,199 5.14% ------------ ------------- ------------- Total $ 65,165 $ 2,190,045 2.98% ============ ============= ============= For the Year Ended December 31, 2002 --------------------------------------------- Interest Average Annualized Expense Balance Rate ------------ ------------- ------------- Collateralized debt obligations $ 17,374 $ 263,242 6.60% Reverse repurchase agreements 31,651 1,607,376 1.97% Lines of credit and term loan 2,451 65,741 3.73% ------------ ------------- ------------- Total $ 51,476 $ 1,936,359 2.66% ============ ============= ============= The foregoing interest expense amounts for the year ended December 31, 2004 do not include $1,015 of hedge ineffectiveness expense, as well as $14,434 of interest expense related to interest rate hedges outside of the CDOs. The foregoing interest expense amounts for the year ended December 31, 2003 do not include $706 of hedge ineffectiveness income, as well as $18,790 of interest expense related to interest rate hedges outside of the CDOs. The foregoing interest expense amounts for the year ended December 31, 2002 do not include hedge ineffectiveness income of $236, as well as $13,778 of interest expense related to interest rate hedges outside of the CDOs. See Note 15 of the consolidated financial statements, Derivative Instruments, for further description of the Company's hedge ineffectiveness. The Company issued the first of its three consolidated CDOs in the second quarter of 2002. As the Company issued additional match funded liabilities, the source of the Company's interest expense shifted from reverse repurchase agreements and lines of credit to collateralized debt obligations. Additionally, during 2004 the Company acquired subordinated CMBS in a trust that, in accordance with FIN 46R, was required to be consolidated on the Company's financial statements, resulting in interest expense from commercial mortgage loan pools. Net Interest Margin and Net Interest Spread from the Portfolio: The Company considers its portfolio to consist of its securities available-for-sale, securities held-for-trading, commercial mortgage loans, and cash and cash equivalents because these assets relate to its core strategy of acquiring and originating high yield loans and securities backed by commercial real estate, while at the same time maintaining a portfolio of investment grade securities to enhance the Company's liquidity. Net interest margin from the portfolio is annualized net interest income divided by the average market value of interest-earning assets. Net interest income is total interest income less interest expense relating to collateralized borrowings. Net interest spread equals the yield on average assets for the period less the average cost of funds for the period. The yield on average assets is interest income divided by average amortized cost of interest earning assets. The average cost of funds is interest expense from the portfolio divided by average outstanding collateralized borrowings. The following chart describes the interest income, interest expense, net interest margin and net interest spread for the Company's portfolio. The following interest income and interest expense amounts exclude income and expense related to real estate joint ventures, equity investments, hedge ineffectiveness, and the effect of the consolidation of the commercial mortgage loan pools. For the Year Ended December 31, 2004 2003 2002 ------------- -------------- -------------- Interest income $159,036 $159,456 $160,200 Interest expense $88,942 $83,930 $65,207 Net interest margin 3.16% 3.08% 4.40% Net interest spread 2.45% 2.68% 4.05% Other Expenses: Expenses other than interest expense consist primarily of management fees and general and administrative expenses. Management fees paid to the Manager of $8,956 for the year ended December 31, 2004 were comprised entirely of base management fees. During the third quarter of 2003, the Manager agreed to reduce the management fees by 20% from its calculated amount for the third and fourth quarter of 2003 and the first quarter of 2004. This revision resulted in $1,046 in savings to the Company during 2003 and $532 during 2004. Management fees paid to the Manager of $9,411 for the year ended December 31, 2003 were comprised entirely of base management fees. Management fees paid to the Manager of $12,527 for the year ended December 31, 2002 were comprised of base management fees of $9,332 and incentive fees of $3,195. General and administrative expense of $3,427 for the year ended December 31, 2004, $2,296 for the year ended December 31, 2003, and $2,323 for the year ended December 31, 2002 were comprised of accounting agent fees, custodial agent fees, directors' fees, fees for professional services, insurance premiums, broken deal expenses, and due diligence costs. General and administrative fees for the year ended December 31, 2004 rose primarily due to an increase in professional fees related to Sarbanes-Oxley Act compliance and legal fees in connection with the Company's claim for a supplemental fee on a repaid commercial mortgage loan. Other Gains (Losses): During the year ended December 31, 2004, the Company sold a portion of its securities available-for-sale for total proceeds of $503,898 resulting in a realized gain of $17,544. During the year ended December 31, 2003, the Company sold a portion of its securities available-for-sale for total proceeds of $1,466,552, resulting in a realized loss of $6,832. During the year ended December 31, 2002, the Company sold a portion of its securities available-for-sale for total proceeds of $1,017,534, resulting in a realized gain of $11,391. The loss on securities held-for-trading of $11,464, $38,206, and $29,255 for the years ended December 31, 2004, 2003, and 2002, respectively, consisted primarily of realized and unrealized gains and losses on U.S. Treasury and Agency securities, forward commitments to purchase or sell agency RMBS and hedges. The foreign currency loss of $187 and $812 for the years ended December 31, 2004 and 2002, respectively, relates to the Company's net investment in a commercial mortgage loan denominated in pounds sterling, a commercial mortgage loan denominated in euros, and associated hedging. The loss on impairment of assets of $26,018, $32,426, and $10,273, for the years ended December 31, 2004, 2003, and 2002, respectively, were related to the Company's write downs of Controlling Class CMBS and franchise loan backed securities. Dividends Declared: During the year ended December 31, 2004, the Company declared dividends to stockholders totaling $58,208, or $1.12 per share, of which $43,287 was paid during the year and $14,921 was paid on February 1, 2005. During the year ended December 31, 2003, the Company declared dividends to common stockholders totaling $61,088, or $1.26 per share, of which $47,238 was paid during the year and $13,850 was paid on February 2, 2004. For U.S. Federal income tax purposes, the dividends are ordinary income to the Company's stockholders. Changes in Financial Condition Securities Available-for-sale: The Company's securities available-for-sale, which are carried at estimated fair value, included the following at December 31, 2004 and December 31, 2003:
December December 31, 2004 31, 2003 Estimated Estimated Fair Fair Security Description Value Percentage Value Percentage ------------------------------------------------------------------------------------------------------------ Commercial mortgage-backed securities: CMBS IOs $ 125,246 7.1% $84,493 4.7% Investment grade CMBS 389,813 22.1 333,454 18.5 Non-investment grade rated subordinated securities 748,807 42.6 678,424 37.6 Non-rated subordinated securities 5,994 0.3 25,019 1.4 Credit tenant lease 25,251 1.4 25,696 1.4 Investment grade REIT debt 285,341 16.2 219,422 12.1 Project loans 23,650 1.3 26,502 1.4 CDO investments 19,837 1.1 - - -------------------------------------------------------- Total CMBS 1,623,939 92.1 $1,393,010 77.1 -------------------------------------------------------- Single-family residential mortgage-backed securities: Agency adjustable rate securities 112,139 6.4 180,381 10.0 Agency fixed rate securities - - 222,500 12.3 Residential CMOs 1,407 0.1 3,464 0.2 Hybrid arms 25,606 1.5 6,645 0.4 -------------------------------------------------------- Total RMBS 139,153 7.9 412,990 22.9 -------------------------------------------------------- --------------------------------------------------------- Total securities available-for-sale $1,763,092 100.0% $1,806,000 100.0% =========================================================
The decrease in RMBS is attributable to the Company's strategic reduction of the RMBS portfolio. Borrowings: As of December 31, 2004 and 2003, the Company's debt consisted of line-of-credit borrowings, CDO debt, term loans and reverse repurchase agreements, collateralized by a pledge of most of the Company's securities available-for-sale, securities held-for-trading, and its commercial mortgage loans. The Company's financial flexibility is affected by its ability to renew or replace on a continuous basis its maturing short-term borrowings. As of December 31, 2004 and 2003, the Company obtained financing in amounts and at interest rates consistent with the Company's short-term financing objectives. Under the lines of credit, term loans, and the reverse repurchase agreements, the lender retains the right to mark the underlying collateral to market value. A reduction in the value of its pledged assets would require the Company to provide additional collateral or fund margin calls. The following table sets forth information regarding the Company's collateralized borrowings:
For the Year Ended December 31, 2004 -------------------------------------------------------------------- December 31, 2004 Maximum Range of Balance Balance Maturities -------------------------------------------------------------------- CDO debt* $1,067,967 $1,068,210 6.9 to 9.1 years Commercial mortgage loan pools 1,294,058 $1,298,984 3.1 to 9.8 years Reverse repurchase agreements 640,675 1,148,306 4 to 143 days Line of credit and term loan borrowings 163,676 391,511 188 to 496 days --------------------------------------------------------------------
For the Year Ended December 31, 2003 -------------------------------------------------------------------- December 31, 2003 Maximum Range of Balance Balance Maturities -------------------------------------------------------------------- CDO debt* $684,970 $685,239 7.9 to 9.7 years Reverse repurchase agreements 1,048,635 1,858,434 2 to 29 days Line of credit and term loan borrowings 89,936 89,936 100 to 562 days --------------------------------------------------------------------
* Disclosed as adjusted issue price. Total par of the Company's CDO debt as of December 31, 2004 and 2003 was $1,081,418 and $699,553, respectively. Hedging Instruments: From time to time, the Company may modify its exposure to market interest rates by entering into various financial instruments that adjust portfolio duration and short-term rate exposure. These financial instruments are intended to mitigate the effect of changes in interest rates on the value of the Company's assets and the cost of borrowing. At December 31, 2004, the Company had no outstanding future contracts. At December 31, 2003, the Company had outstanding short positions of 30 five-year and 73 ten-year U.S. Treasury Note future contracts. At December 31, 2004 and 2003, the Company had a forward London Interbank Offered Rate ("LIBOR") cap with a notional amount of $85,000 and a fair value of $694 and $1,114, respectively. Swap agreements as of December 31, 2004 and 2003 consisted of the following:
As of December 31, 2004 ----------------------------------------------------------------------------------- Notional Estimated Fair Unamortized Average Remaining Value Value Cost Term (years) ----------------------------------------------------------------------------------- Cash flow hedges $452,600 $253 - 5.44 Trading swaps 16,000 (5) - 1.94 CDO cash flow hedges 718,120 (11,262) - 8.50 CDO timing swaps 223,445 145 - 8.08 As of December 31, 2003 ----------------------------------------------------------------------------------- Notional Estimated Fair Unamortized Average Remaining Value Value Cost Term (years) ----------------------------------------------------------------------------------- Cash flow hedges $611,300 $(4,442) - 6.53 Trading swaps 308,000 1,513 - 3.34 CDO cash flow hedges 454,778 (23,651) - 8.51 CDO timing swaps 171,545 29 - 8.61
The counterparties for the Company's swaps are Deutsche Bank, AG, Merrill Lynch Capital Services, Inc., Goldman Sachs Capital Markets, L.P., Lehman Special Financing Inc., and Societe Generale with ratings of AA-, A+, A+, A, and AA-, respectively. The Company continually monitors the rating and overall credit quality of its swap counterparties. Capital Resources and Liquidity Liquidity is a measurement of the Company's ability to meet cash requirements, including ongoing commitments to repay borrowings, fund investments, loan acquisition and lending activities, and for other general business purposes. The primary sources of funds for liquidity consist of collateralized borrowings, principal and interest payments on and maturities of securities available-for-sale, securities held-for-trading, commercial mortgage loans, and proceeds from the maturity or sales thereof. The Company finances itself with its common equity, follow-on common equity offerings, preferred stock offerings, secured term debt, committed financing facilities, and reverse repurchase agreements. An important part of the Company's risk analysis includes a thorough assessment of the financing alternatives in the context of the assets being financed. Reverse repurchase agreements are secured loans generally with a term of 30 days. The interest rate is based on 30-day LIBOR plus a spread that is determined based on the asset pledged as security. The terms include a daily mark to market provision that requires the posting of additional collateral if the value of the pledged asset declines. After the 30-day period expires, there is no obligation for the lender to extend credit for an additional period. This type of financing is generally available only for more liquid securities. The interest rate charged on reverse repurchase agreements is usually the lowest relative to the alternatives due to the lower risk inherent in these transactions. Committed financing facilities represent multi-year agreements to provide secured financing for a specific asset class. These facilities include a daily mark to market provision requiring posting of additional collateral if the value of the pledged asset declines in excess of a threshold amount. A significant difference between committed financing facilities and reverse repurchase agreements is the term of the financing. A committed facility provider is generally required to provide financing for the full term of the agreement, usually two to three years, rather than thirty days as generally used in the reserve repurchase market. This longer term makes the financing of less liquid assets viable. Issuance of secured term debt is generally done through a CDO offering. This entails creating a special purpose entity that holds assets used to secure the payments required of the debt issued. With the exception of CDO HY1, these transactions are considered financings and the special purpose entities ("SPE") are fully consolidated on the Company's consolidated financial statements. Asset cash flows are generally matched with the debt service requirements over their respective lives and an interest rate swap is used to match the fixed or floating rate nature of the coupon payments where necessary. This type of transaction is usually referred to as "match funding" or "term financing" the assets. There is no mark to market requirement in this structure and the debt cannot be called or terminated by the bondholders. Furthermore, the debt issued is non-recourse to the issuer therefore permanent reductions in value do not affect the liquidity of the Company. However, since the Company expects to earn a positive spread between the income generated by the assets and the expense of the debt issued, a permanent impairment of any of the assets would negatively affect the spread over time. The Company may issue preferred stock from time to time as a source of long-term or permanent capital. Preferred stock generally has a fixed coupon and may have a fixed term in the form of a maturity date or other redemption or conversion feature. The preferred stockholder typically has the right to a preferential distribution for dividends and any liquidity proceeds. Another source of permanent capital is the issuance of common stock through a follow-on offering. This allows investors to purchase a large block of common stock in one transaction. A common stock issuance can be accretive to the Company's book value per share if the issue price per share exceeds the Company's book value per share. It can also be accretive to earnings per share if the Company deploys the new capital into assets that generate a risk adjusted return that exceeds the return of the Company's existing assets. Furthermore, earnings accretion can also be achieved at reinvestment rates that are lower than the return on existing assets if common stock is issued at a premium to book value. The Company continuously evaluates the market for follow-on common stock offerings as well as the available opportunities to deploy new capital on an accretive basis. In 2004, the Company issued 2,415,000 shares of common stock in a follow-on offering at $11.50 per share. During 2003, the Company did not issue any common stock in follow-on equity offerings. Additionally, for the years ended December 31, 2004 and 2003, respectively, the Company issued 1,084,619 and 1,955,919 shares of Common Stock under its Dividend Reinvestment Plan. Net proceeds to the Company were approximately $12,691 and $21,134, respectively. At December 31, 2004, the Company's collateralized borrowings had the following remaining maturities:
Reverse Commercial Collateralized Total Lines of Repurchase Mortgage Loan Debt Collateralized Credit Agreements Pools Obligations* Borrowings ------------------------------------------------------------------------------------- Within 30 days $- $605,944 $- $- $605,944 31 to 59 days - 7,925 - - 7,925 60 days to less than 1 year 150,876 26,806 - - 177,682 1 year to 3 years 12,800 - - - 12,800 3 years to 5 years - - - - - Over 5 years - - 1,294,058 1,067,967 2,362,025 ---------------------------------------------------------------------------------- $163,676 $640,675 $1,294,058 $1,067,967 $3,166,376 ==================================================================================
* Comprised of $405,377 of CDO debt with a weighted average remaining maturity of 7.29 years as of December 31, 2004 and $293,167 of CDO debt with a weighted average remaining maturity of 7.72 years as of December 31, 2004, and $369,422 of CDO debt with a weighted average remaining maturity of 8.39 years as of December 31, 2004. In addition, the Company has no off-balance sheet financing arrangements. Cash provided by (used in) the Company's operating activities totaled $135,948, $563,525 and $(787,464) for the years ended December 31, 2004, 2003 and 2002, respectively, primarily through net income, offset by purchases of trading securities in 2002. Net cash flow (used in) provided by investing activities was $(110,901), $(232,268) and $516,542 for the years ended December 31, 2004, 2003 and 2002, respectively, primarily to purchase securities available for sale and to fund commercial mortgage loans, offset by significant sales of securities during 2002. Net cash flow (used in) provided by financing activities was $(22,097), $(335,150) and $252,549 for the years ended December 31, 2004, 2003 and 2002, respectively, primarily to decrease short-term borrowings and pay dividends, offset by increases in collateralized debt obligations, and stock issuance. In addition, at the end of the first quarter of 2004, the Board of Directors approved the Company's decision to redeem its Series B Preferred Stock, $0.001 par value per share ("Series B Preferred Stock") for $43,930. The Series B Preferred Stock was redeemed on May 6, 2004. Contingent Liability During 2000, the Company completed the acquisition of CORE Cap, Inc. The merger was a stock for stock acquisition where the Company issued 4,180,552 shares of its Common Stock and 2,261,000 shares of its Series B Preferred Stock. At the time of the CORE Cap acquisition, BlackRock Financial Management, Inc. (the "Manager") agreed to pay GMAC (CORE Cap, Inc.'s external advisor) $12,500 over a ten-year period ("Installment Payment") to purchase the right to manage the assets under the existing management contract ("GMAC Contract"). The GMAC Contract had to be terminated in order to allow for the Company to complete the merger, as the Company's management agreement with the Manager did not provide for multiple managers. As a result the Manager offered to buy-out the GMAC Contract as the Manager estimated it would receive incremental fees above and beyond the Installment Payment, and thus was willing to pay for, and separately negotiate, the termination of the GMAC Contract. Accordingly, the value of the Installment Payment was not considered in the Company's allocation of its purchase price to the net assets acquired in the acquisition of CORE Cap, Inc. The Company agreed that should the Management Agreement with the Manager be terminated, not renewed or not extended for any reason other than for cause, the Company would pay to the Manager an amount equal to the Installment Payment less the sum of all payments made by the Manager to GMAC. As of December 31, 2004, the Installment Payment would be $6,500 payable over six years. The Company does not accrue for this contingent liability. Transactions with Affiliates The Company has a Management Agreement with the Manager, a majority owned indirect subsidiary of The PNC Financial Services Group, Inc. ("PNC Bank") and the employer of certain directors and officers of the Company, under which the Manager manages the Company's day-to-day operations, subject to the direction and oversight of the Company's Board of Directors. On March 25, 2002, the Management Agreement was extended for one year through March 27, 2003, with the approval of the unaffiliated directors, on terms similar to the prior agreement with the following changes: (i) the incentive fee calculation would be based on GAAP earnings instead of funds from operations, (ii) the removal of the four-year period to value the Management Agreement in the event of termination and (iii) subsequent renewal periods of the Management Agreement would be for one year instead of two years. Houlihan Lokey Howard & Zukin Financial Advisors, Inc., a national investment banking and financial advisory firm, advised the Board in the 2002 renewal process. On March 6, 2003, the unaffiliated directors approved an extension of the Management Agreement from its expiration of March 27, 2003 for one year through March 31, 2004. The terms of the renewed agreement were similar to the prior agreement except for the incentive fee calculation that would provide for a rolling four-quarter high watermark rather than a quarterly calculation. In determining the rolling four-quarter high watermark, the Company would calculate the incentive fee based upon the current and prior three quarters' net income. The Manager would be paid an incentive fee in the current quarter if the Yearly Incentive Fee, as defined, were greater than what was paid to the Manager in the prior three quarters cumulatively. The Company phased in the rolling four-quarter high watermark commencing with the second quarter of 2003. Calculation of the incentive fee was based on GAAP earnings and adjusted to exclude special one-time events pursuant to changes in GAAP accounting pronouncements after discussion between the Manager and the unaffiliated directors. The incentive fee threshold did not change. The high watermark provided for the Manager to be paid 25% of the amount of earnings (calculated in accordance with GAAP) per share that exceeds the product of the adjusted issue price of the Company's Common Stock per share and the greater of 9.5% or 350 basis points over the ten-year Treasury note. The Management Agreement was further extended for one year from March 31, 2004 through March 31, 2005. The base management fee was revised to equal 2% of the quarterly average total stockholders' equity for the applicable quarter. The incentive fee was revised to be 25% of the amount of earnings (calculated in accordance with GAAP) per share that exceeds the product of the adjusted issue price of the Company's Common Stock per share ($11.37 as of December 31, 2004) and the greater of 8.5% or 400 basis points over the ten-year Treasury note. On March 10, 2004, the members of the Company's Board of Directors who are not affiliated with the Manager approved an extension of the Company's management agreement with the Manager for one additional year through March 31, 2006. The terms of the extended agreement did not change. During the third quarter of 2003, the Manager agreed to reduce the management fees by 20% from its calculated amount for the third and fourth quarter of 2003 and the first quarter of 2004. This revision resulted in $1,046 in savings to the Company during 2003 and $532 during 2004, respectively. The Company incurred $8,956, $9,411, and $9,332 in base management fees in accordance with the terms of the Management Agreement for the years ended December 31, 2004, 2003, and 2002, respectively. In accordance with the provisions of the Management Agreement, the Company recorded reimbursements to the Manager of $120, $66, and $14 for certain expenses incurred on behalf of the Company during 2004, 2003, and 2002, respectively. The Company has an administration agreement with the Manager. Under the terms of the administration agreement, the Manager provides financial reporting, audit coordination and accounting oversight services to the Company. Either party can cancel the agreement upon 60-day written notice. The Company pays the Manager a monthly administrative fee at an annual rate of 0.06% of the first $125 million of average net assets, 0.04% of the next $125 million of average net assets and 0.03% of average net assets in excess of $250 million subject to a minimum annual fee of $120. For the years ended December 31, 2004, 2003, and 2002, the Company paid administration fees of $174, $173, and $168, respectively. The special servicer on 11 of the Company's 16 Controlling Class trusts is Midland Loan Services, Inc. ("Midland"), a wholly owned indirect subsidiary of PNC Bank. The Company's fees for Midland's services are at market rates. During 2001, the Company entered into a $50,000 commitment to acquire shares in Carbon I, a private commercial real estate income opportunity fund managed by the Manager. The Carbon I investment period ended on July 12, 2004 and the Company's investment in Carbon I as of December 31, 2004 was $39,563. The Company does not incur any additional management or incentive fees to the Manager as a result of its investment in Carbon I. On December 31, 2004, the Company owned approximately 20% of the outstanding shares in Carbon I. On October 13, 2004, the Company entered into a commitment of up to $30,000 to acquire shares in Carbon Capital II, Inc. ("Carbon II"), a private commercial real estate income opportunity fund managed by the Manager. On November 19, 2004 the Company entered into an additional $32,067 commitment to acquire shares in Carbon II. During 2004, the Company received capital call notices of $16,953. As of December 31, 2004, the Company's investment in Carbon II was $17,249 and the Company's remaining commitment to Carbon II is $45,114. The Company may commit up to the lower of 20% of the total of Carbon II's capital commitments or $100,000. The Company does not incur any additional management or incentive fees to the Manager as a result of its investment in Carbon II. The Company's unaffiliated directors approved this transaction in September 2004. REIT Status: The Company has elected to be taxed as a REIT and therefore must comply with the provisions of the Code with respect thereto. Accordingly, the Company generally will not be subject to Federal income tax to the extent of its distributions to stockholders and as long as certain asset, income, and stock ownership tests are met. The Company may, however, be subject to tax at corporate rates or at excise tax rates on net income or capital gains not distributed. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market Risk: Market risk includes the exposure to loss resulting from changes in interest rates, credit curve spreads, foreign currency exchange rates, commodity prices and equity prices. The primary market risks to which the Company is exposed are interest rate risk and credit curve risk. Interest rate risk is highly sensitive to many factors, including governmental, monetary and tax policies, domestic and international economic and political considerations and other factors beyond the control of the Company. Credit curve risk is highly sensitive to the dynamics of the markets for commercial mortgage securities and other loans and securities held by the Company. Excessive supply of these assets combined with reduced demand will cause the market to require a higher yield. This demand for higher yield will cause the market to use a higher spread over the U.S. Treasury securities yield curve, or other benchmark interest rates, to value these assets. Changes in the general level of the U.S. Treasury yield curve can have significant effects on the market value of the Company's portfolio. The majority of the Company's assets are fixed rate securities valued based on a market credit spread to U.S. Treasuries. As U.S. Treasury securities are priced to a higher yield and/or the spread to U.S. Treasuries used to price the Company's assets is increased, the market value of the Company's portfolio may decline. Conversely, as U.S. Treasury securities are priced to a lower yield and/or the spread to U.S. Treasuries used to price the Company's assets is decreased, the market value of the Company's portfolio may increase. Changes in the market value of the Company's portfolio may affect the Company's net income or cash flow directly through their impact on unrealized gains or losses on securities held-for-trading or indirectly through their impact on the Company's ability to borrow. Changes in the level of the U.S. Treasury yield curve can also affect, among other things, the prepayment assumptions used to value certain of the Company's securities and the Company's ability to realize gains from the sale of such assets. In addition, changes in the general level of the LIBOR money market rates can affect the Company's net interest income. As of December 31, 2004, all of the Company's liabilities outside of the CDOs are floating rate based on a market spread to LIBOR. As the level of LIBOR increases or decreases, the Company's interest expense will move in the same direction. The Company may utilize a variety of financial instruments, including interest rate swaps, caps, floors and other interest rate exchange contracts, in order to limit the effects of fluctuations in interest rates on its operations. The use of these types of derivatives to hedge interest-earning assets and/or interest-bearing liabilities carries certain risks, including the risk that losses on a hedge position will reduce the funds available for payments to holders of securities and that such losses may exceed the amount invested in such instruments. A hedge may not perform its intended purpose of offsetting losses or increased costs. Moreover, with respect to certain of the instruments used as hedges, the Company is exposed to the risk that the counterparties with which the Company trades may cease making markets and quoting prices in such instruments, which may render the Company unable to enter into an offsetting transaction with respect to an open position. If the Company anticipates that the income from any such hedging transaction will not be qualifying income for REIT income purposes, the Company may conduct part or all of its hedging activities through a to-be-formed corporate subsidiary that is fully subject to federal corporate income taxation. The profitability of the Company may be adversely affected during any period as a result of changing interest rates. The Company monitors and manages interest rate risk based on a method that takes into consideration the interest rate sensitivity of the Company's assets and liabilities, including its preferred stock. The Company's objective is to acquire assets and match fund the purchase so that interest rate risk associated with financing these assets is reduced or eliminated. The primary risks associated with acquiring and financing these assets are mark to market risk and short-term rate risk. Examples of these financing types include 30-day repurchase agreements and committed borrowing facilities. Certain secured financing arrangements provide for an advance rate based upon a percentage of the market value of the asset being financed. Market movements that cause asset values to decline would require a margin call or a cash payment to maintain the relationship between asset value and amount borrowed. A cash flow based CDO is an example of a secured financing vehicle that does not require a mark to market to establish or maintain a level of financing. When financed assets are subject to a mark to market margin call, the Company carefully monitors the interest rate sensitivity of those assets. The duration of the assets financed which are subject to a mark to market margin call was 2.21 years based on reported GAAP book value as of December 31, 2004. The Company's reported book value incorporates the market value of the Company's interest bearing assets but it does not incorporate the market value of the Company's interest bearing liabilities. The fixed rate interest bearing liabilities and preferred stock will generally reduce the actual interest rate risk of the Company from a pure economic perspective even though changes in the value of these liabilities are not reflected in the Company's book value. The fixed rate liabilities issued in CDO I, CDO II and CDO III reduce the Company's economic duration by approximately 4.74 years. The Series C Preferred Stock reduces the Company's economic duration by approximately 0.48 year. The Company's reported book value is not reduced by these liabilities and therefore is approximately 5.22 years longer than the economic duration. The Company's duration management strategy focuses on the economic risk and maintains economic duration within a band of 3.0 to 5.0 years. At December 31, 2004, economic duration was 3.56 years. Earnings per share is analyzed using the assumptions that interest rates, as defined by the LIBOR curve, increase or decrease and that the yield curves of the LIBOR rate shocks will be parallel to each other. Market value in this scenario is calculated using the assumption that the U.S. Treasury yield curve remains constant even though changes in both long- and short-term interest rates can occur simultaneously. Regarding the table below, all changes in income and value are measured as percentage changes from the respective values calculated in the scenario labeled as "Base Case." The base interest rate scenario assumes interest rates as of December 31, 2004. Actual results could differ significantly from these estimates. Projected Percentage Change In Earnings Per Share Given LIBOR Movements Change in LIBOR, Projected Change in +/- Basis Points Earnings per Share -------------------------------------------------- -200 $0.074 -100 $0.037 -50 $0.018 Base Case +50 $(0.018) +100 $(0.037) +200 $(0.074) Credit Risk: The Company's portfolios of commercial real estate assets are subject to a high degree of credit risk. Credit risk is the exposure to loss from loan defaults. Default rates are subject to a wide variety of factors, including, but not limited to, property performance, property management, supply/demand factors, construction trends, consumer behavior, regional economics, interest rates, the strength of the U.S. economy, and other factors beyond the control of the Company. All loans are subject to a certain probability of default. Before acquiring a Controlling Class security, the Company will perform an analysis of the quality of all of the loans proposed. As a result of this analysis, loans with unacceptable risk profiles are either removed from the proposed pool or the Company receives a price adjustment. The Company underwrites its Controlling Class CMBS investments assuming the underlying loans will suffer a certain dollar amount of defaults and these defaults will lead to some level of realized losses. Loss adjusted yields are computed based on these assumptions and applied to each class of security supported by the cash flow on the underlying loans. The most significant variables affecting loss adjusted yields include, but are not limited to, the number of defaults, the severity of loss that occurs subsequent to a default and the timing of the actual loss. The different rating levels of CMBS will react differently to changes in these assumptions. The lowest rated securities (B- or lower) are generally more sensitive to changes in timing of actual losses. The higher rated securities (B or higher) are more sensitive to the severity of losses and timing of cashflows. The Company generally assumes that all of the principal of a non-rated security and a significant portion, if not all, of CCC and a portion of B- rated securities will not be recoverable over time. The loss adjusted yields of these classes reflect that assumption; therefore, the timing of when the total loss of principal occurs is the most important assumption in determining value. The interest coupon generated by a security will cease when there is a total loss of its principal regardless of whether that principal is paid. Therefore, timing is of paramount importance because the longer the principal balance remains outstanding, the more interest coupon the holder receives; which results in a larger economic return. Alternatively, if principal is lost faster than originally assumed, there is less opportunity to receive interest coupon; which results in a lower or possibly negative return. Additional losses, which occur due to greater severity, will not have a significant effect as all principal is already assumed to be non-recoverable. If actual principal losses on the underlying loans exceed assumptions, the higher rated securities will be affected more significantly as a loss of principal may not have been assumed. The Company generally assumes that all principal will be recovered by classes rated B or higher. The Company manages credit risk through the underwriting process, establishing loss assumptions and careful monitoring of loan performance. After the securities have been acquired, the Company monitors the performance of the loans, as well as external factors that may affect their value. Factors that indicate a higher loss severity or acceleration of the timing of an expected loss will cause a reduction in the expected yield and therefore reduce the earnings of the Company. Furthermore, the Company may be required to write down a portion of the adjusted purchase price of the affected assets through its consolidated statements of financial condition. For purposes of illustration, a doubling of the losses in the Company's Controlling Class CMBS, without a significant acceleration of those losses, would reduce GAAP income going forward by approximately $0.18 per share of Common Stock per year and cause a significant write down at the time the loss assumption is changed. The amount of the write down depends on several factors, including which securities are most affected at the time of the write down, but is estimated to be in the range of $1.15 to $1.40 per share based on a doubling of expected losses. A significant acceleration of the timing of these losses would cause the Company's net income to decrease. The Company's exposure to a write down is mitigated by the fact that most of these assets are financed on a non-recourse basis in the Company's CDOs, where a significant portion of the risk of loss is transferred to the CDO bondholders. As of December 31, 2004, securities with a total market value of $1,192,337 are collateralizing the CDO borrowings of $1,083,471; therefore, the Company's preferred equity interest in the three CDOs is $108,866 ($2.04 per share). The CDO borrowings are not marked to market in accordance with GAAP even though their economic value will change in response to changes in interest rates and/or credit spreads. Asset and Liability Management: Asset and liability management is concerned with the timing and magnitude of the re-pricing and/or maturing of assets and liabilities. It is the Company's objective to attempt to control risks associated with interest rate movements. In general, management's strategy is to match the term of the Company's liabilities as closely as possible with the expected holding period of the Company's assets. This is less important for those assets in the Company's portfolio considered liquid, as there is a very stable market for the financing of these securities. Other methods for evaluating interest rate risk, such as interest rate sensitivity "gap" (defined as the difference between interest-earning assets and interest-bearing liabilities maturing or re-pricing within a given time period), are used but are considered of lesser significance in the daily management of the Company's portfolio. Management considers this relationship when reviewing the Company's hedging strategies. Because different types of assets and liabilities with the same or similar maturities react differently to changes in overall market rates or conditions, changes in interest rates may affect the Company's net interest income positively or negatively even if the Company were to be perfectly matched in each maturity category.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA PAGE Management's Responsibility for Financial Reporting ......................................58 Management's Report on Internal Control Over Financial Reporting..........................59 Report of Independent Registered Public Accounting Firm...................................60 Consolidated Financial Statements: Consolidated Statements of Financial Condition at December 31, 2004 and 2003..............63 Consolidated Statements of Operations For the Years Ended December 31, 2004, 2003 and 2002......................................64 Consolidated Statements of Changes in Stockholders' Equity For the Years Ended December 31 2004, 2003 and 2002.......................................65 Consolidated Statements of Cash Flows For the Years Ended December 31, 2004, 2003 and 2002......................................67 Notes to Consolidated Financial Statements................................................68
All schedules have been omitted because either the required information is not applicable or the information is shown in the financial statements or notes thereto. MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL REPORTING Anthracite Capital, Inc. is responsible for the preparation, quality and fair presentation of its published financial statements. The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States and, as such, include judgments and estimates of management. Anthracite Capital, Inc. also prepared the other information included in the Annual Report and is responsible for its accuracy and consistency with the consolidated financial statements. Management is responsible for establishing and maintaining effective internal control over financial reporting. The internal control system is augmented by written policies and procedures and by audits performed by the Manager's internal audit staff. The internal audit staff reports to the Manager's Audit Committee, and, for Anthracite Capital-related matters, to the Company's Audit Committee. Internal auditors test the operation of the internal control system and report findings to the Manager, management and as well as the Manager's and the Company's Audit Committees, and corrective actions are taken to address identified control deficiencies and other opportunities for improving the internal control system. The Audit Committees, composed solely of outside directors, provide oversight to the financial reporting process. MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING Management of Anthracite Capital, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rule 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended, as a process designed by, or under the supervision of, the company's principal executive and principal financial officers and effected by the Company's board of directors, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that: o pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the company; o provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the company; and o provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting can provide only reasonable assurance with respect to financial statement preparation and presentation. Projections of any evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Management assessed the effectiveness of the Company's internal control over financial reporting as of December 31, 2004. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on our assessment, management concluded that, as of December 31, 2004, the Company's internal control over financial reporting is effective. The Company's independent registered public accounting firm has issued a report on our assessment of the Company's internal control over financial reporting. This report begins on the following page. REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of Anthracite Capital, Inc. New York, New York We have audited the accompanying consolidated statements of financial condition of Anthracite Capital, Inc. and subsidiaries (the "Company") at December 31, 2004 and 2003, and the related consolidated statements of operations, changes in stockholders' equity and cash flows for each of the three years in the period ended December 31, 2004. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Anthracite Capital, Inc. and subsidiaries at December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004, in conformity with accounting principles generally accepted in the United States of America. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company's internal control over financial reporting as of December 31, 2004, based on the criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 14, 2005 expressed an unqualified opinion on management's assessment of the effectiveness of the Company's internal control over financial reporting and an unqualified opinion on the effectiveness of the Company's internal control over financial reporting. /s/ Deloitte & Touche LLP New York, New York March 14, 2005 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of Anthracite Capital, Inc. New York, New York We have audited management's accompanying assessment, included in the December 31, 2004 Form 10-K of Anthracite Capital, Inc. and subsidiaries (the "Company") under the heading Management's Report on Internal Control over Financial Reporting, that the Company maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the Company's internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions. A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, management's assessment that the Company maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on the criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on the criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statement of financial condition of at December 31, 2004, and the related consolidated statements of operations, changes in stockholders' equity and cash flows for the year ended December 31, 2004 of the Company and our report dated March 14, 2005 expressed an unqualified opinion on those financial statements. /s/ Deloitte & Touche LLP New York, New York March 14, 2005
ANTHRACITE CAPITAL, INC. CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (in thousands, except per share data) - ---------------------------------------------------------------------------------------------------------------------------------- December 31, 2004 December 31, 2003 ----------------- ----------------- ASSETS Cash and cash equivalents $ 23,755 $ 20,805 Restricted cash equivalents 19,680 12,845 Securities available-for-sale, at fair value Subordinated commercial mortgage-backed securities ("CMBS") $ 774,638 $ 703,443 Residential mortgage-backed securities ("RMBS") 139,153 412,990 Investment grade securities 849,302 689,567 ------------- ----------------- Total securities available-for-sale 1,763,093 1,806,000 Commercial mortgage loan pools, at amortized cost 1,312,045 - Securities held-for-trading, at fair value 232,918 313,727 Commercial mortgage loans, net 268,086 61,668 Equity investment in the Carbon Capital Funds 56,812 28,493 Investments in real estate joint ventures 5,031 7,823 Receivable for investments sold - 99,056 Other assets 47,714 48,429 --------------- ----------------- Total Assets $3,729,134 $2,398,846 =============== ================= LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Borrowings: Collateralized debt obligations ("CDOs") $1,067,967 $684,970 Secured by pledge of subordinated CMBS 29,358 100,892 Secured by pledge of other securities available-for-sale and cash equivalents 408,832 710,968 Secured by pledge of commercial mortgage loan pools 1,294,830 - Secured by pledge of securities held-for-trading 223,788 304,001 Secured by pledge of investments in real estate joint ventures - 513 Secured by pledge of commercial mortgage loans 141,601 22,197 ------------- ----------------- Total borrowings $3,166,376 $1,823,541 Securities sold, not yet settled - 99,551 Distributions payable 15,819 14,749 Other liabilities 33,201 43,575 --------------- ----------------- Total Liabilities $3,215,396 $1,981,416 --------------- ----------------- Commitments and Contingencies Stockholders' Equity: Common Stock, par value $0.001 per share; 400,000 shares authorized; 53,289 shares issued and outstanding in 2004; 49,464 shares issued and outstanding in 2003 53 49 10% Series B Preferred Stock, liquidation preference $43,942 in 2003 - 33,431 9.375% Series C Preferred stock, liquidation preference $57,500 in 2004 and 2003 55,435 55,435 Additional paid-in capital 578,919 536,333 Distributions in excess of earnings (134,075) (101,635) Accumulated other comprehensive income (loss) 13,406 (106,183) --------------- ----------------- Total Stockholders' Equity 513,738 417,430 --------------- ----------------- Total Liabilities and Stockholders' Equity $3,729,134 $2,398,846 =============== ================= THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
ANTHRACITE CAPITAL, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share data) For the year ended For the year ended For the year ended December 31, 2004 December 31, 2003 December 31, 2002 ------------------ ------------------ ------------------ Income: Interest from securities available-for-sale $ 131,342 $ 120,430 $99,308 Interest from commercial mortgage loans 11,896 5,875 13,997 Interest from commercial mortgage loan pools 39,672 - - Interest from securities held-for-trading 11,419 32,187 45,421 Earnings from real estate joint ventures 1,097 955 1,044 Earnings from equity investments 7,060 3,367 1,202 Interest from cash and cash equivalents 638 964 1,473 Other income 742 - - ------------ ------------ ------------ Total income 203,866 163,778 162,445 ------------ ------------ ------------ Expenses: Interest 124,289 76,093 50,987 Interest - securities held-for-trading 3,877 7,156 14,031 Management and incentive fee 8,956 9,411 12,527 General and administrative expense 3,427 2,296 2,323 ------------ ------------ ------------ Total expenses 140,549 94,956 79,868 ------------ ------------ ------------ Other gains (losses): Sale of securities available-for-sale 17,544 (6,832) 11,391 Securities held-for-trading (11,464) (38,206) (29,255) Foreign currency loss (187) - (812) Loss on impairment of assets (26,018) (32,426) (10,273) ------------ ------------ ------------ Total other losses (20,125) (77,464) (28,949) ------------ ------------ ------------ Income (Loss) before cumulative transition adjustments 43,192 (8,642) 53,628 Cumulative transition adjustment-SFAS No. 142 - - 6,327 Net income (loss) 43,192 (8,642) 59, 955 ------------ ------------ ------------ Dividends and accretion on Preferred Stock 6,916 7,744 5,162 Cost to retire preferred stock in excess of carrying value 10,508 - - ------------ ------------ ------------ Net income (loss) available to Common Stockholders $25,768 $(16,386) $54,793 ============ ============ ============ Net income (loss) per common share, basic: Income (Loss) before cumulative transition adjustment $0.50 $(0.34) $ 1.04 Cumulative transition adjustment - SFAS No. 142 - - 0.14 Net income (loss) $0.50 $(0.34) $1.18 ============ ============ ============ Net income (loss) per common share, diluted: Income (Loss) before cumulative transition $0.50 $(0.34) $ 1.04 adjustment Cumulative transition adjustment - SFAS No. 142 - - 0.14 Net income (loss) $0.50 $(0.34) $1.18 ============ ============ ============ Weighted average number of shares outstanding: Basic 51,767 48,246 46,411 Diluted 51,776 48,246 46,452 THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
ANTHRACITE CAPITAL, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002 (in thousands) - ------------------------------------------------------------------------------------------------------------------------------------ Series Series Accumulated Common B C Additional Distributions Other Total Stock, Preferred Preferred Paid-In In Excess Comprehensive Comprehensive Stockholders' Par Value Stock Stock Capital Of Earnings Income (Loss) Income Equity Balance at January 1, 2002 $45 $42,086 $492,531 $(13,588) $ (137,959) $383,115 Net Income 59,955 $59,955 59,955 Unrealized loss on cash flow hedges (56,769) (56,769) (56,769) Reclassification adjustments from cash flow hedges included in net income 5,619 5,619 5,619 Change in net unrealized loss on securities available-for-sale, net of reclassification adjustment 67,880 67,880 67,880 ------- Other comprehensive income 16,730 ------- Comprehensive income $76,685 ======= Dividends declared-common stock (65,366) (65,366) Dividends declared-preferred stock (5,162) (5,162) Issuance of common stock 1 16,685 16,686 Conversion of Series B preferred stock to common stock 1 (5,707) 5,706 Conversion of Series A preferred stock to common stock 258 258 ---------------------------------------------------------------------------------------------------- Balance at December 31, 2002 47 36,379 515,180 (24,161) (121,229) 406,216 Net Income (8,642) $(8,642) (8,642) Unrealized gain on cash flow hedges 12,474 12,474 12,474 Reclassification adjustments from cash flow hedges included in net loss 7,704 7,704 7,704 Change in net unrealized loss on securities available-for-sale, net of reclassification adjustment (5,132) (5,132) (5,132) ------- Other comprehensive income 15,046 ------- Comprehensive income $6,404 ======= Dividends declared-common stock (61,088) (61,088) Dividends on preferred stock (7,744) (7,744) Issuance of common stock 2 22,079 22,081 Issuance of Series C preferred stock 55,435 55,435 Redemption of Series B preferred stock (2,948) (926) (3,874) ---------------------------------------------------------------------------------------------------- Balance at December 31, 2003 49 33,431 55,435 536,333 (101,635) (106,183) 417,430 Net Income 43,192 43,192 43,192 Unrealized gain on cash flow hedges 1,078 1,078 1,078 Reclassification adjustments from cash flow hedges included in net income 6,133 6,133 6,133 Change in net unrealized loss on securities available-for-sale, net of reclassification adjustment 112,378 112,378 112,378 ------- Other comprehensive income 119,589 ------- Comprehensive income 162,781 ------- Dividends declared-common stock (58,208) (58,208) Dividends on preferred stock (6,916) (6,916) Issuance of common stock 4 42,577 42,581 Conversion of Series B preferred stock to common stock (9) 9 - Redemption of Series B preferred stock (33,422) (10,508) (43,930) ---------------------------------------------------------------------------------------------------- Balance at December 31, 2004 $53 $- $55,435 $578,919 $(134,075) $13,406 $513,738 ==================================================================================================== DISCLOSURE OF RECLASSIFICATION ADJUSTMENT: Years ended December 31, -------------------------------------- 2004 2003 2002 -------------------------------------- Unrealized holding gain (loss) on securities available-for-sale $94,834 $ 1,700 $ 56,489 Reclassification for realized gains previously recorded as unrealized 17,544 (6,832) 11,391 -------------------------------------- $112,378 $(5,132) $ 67,880 ====================================== THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
ANTHRACITE CAPITAL, INC. CONSOLIDATED STATEMENTS OF CASH FLOW (in thousands) Years Ended December 31, ------------------------ 2004 2003 2002 -------------------------------------- Cash flows from operating activities: Net income (loss) $ 43,192 $ (8,642) $ 59,955 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Net sale (purchase) of trading securities 69,345 502,577 (878,980) Net (gain) loss on sale of securities (6,080) 45,038 17,864 Amortization of CDO issuance costs 2,083 1,607 624 Cumulative transition adjustment - - (6,327) Discount accretion, net (4,060) (2,313) (9,295) Loss on impairment of assets 26,018 32,426 10,273 Unrealized net foreign currency loss 6 - 276 Decrease in other assets 16,286 9,083 1,079 (Decrease) increase in other liabilities (10,842) (16,251) 17,067 -------------------------------------- Net cash provided by (used in) operating activities 135,948 563,525 (787,464) -------------------------------------- Cash flows from investing activities: Purchase of securities available-for-sale (428,876) (2,043,765) (686,710) Purchase of commercial mortgage loan pools (22,669) - - Sale of commercial mortgage loan pools 5,847 - - Principal payments received on securities available-for-sale 79,157 299,858 167,570 Funding of commercial mortgage loans (226,997) (18,520) (3,370) Repayments received from commercial mortgage loans 23,285 13,851 82,865 Increase (decrease) in restricted cash equivalents (6,835) 71,640 (47,109) Distributions (earnings) from equity investments and joint ventures in excess of earnings 3,925 (973) (61) Investment in Carbon Capital Funds (29,453) (12,081) (6,100) Proceeds from sale of securities available-for-sale 503,898 1,466,552 1,017,534 Net payments under hedging securities (12,183) (8,830) (8,077) -------------------------------------- Net cash (used in) provided by investing activities (110,901) (232,268) 516,542 -------------------------------------- Cash flows from financing activities: Net decrease in borrowings (334,219) (338,500) (361,625) Net increase in collateralized debt obligations 382,997 380 684,590 CDO issuance costs (5,472) - (15,918) Proceeds from issuance of Series C preferred stock, net of offering costs - 55,435 - Proceeds from issuance of common stock, net of offering costs 42,581 22,081 16,686 Redemption of Series B preferred stock (43,930) (3,874) - Dividends paid on common stock (57,138) (63,826) (64,633) Dividends paid on preferred stock (6,916) (6,846) (6,551) -------------------------------------- Net cash (used in) provided by financing activities (22,097) (335,150) 252,549 -------------------------------------- Net (decrease) increase in cash and cash equivalents 2,950 (3,893) (18,373) Cash and cash equivalents, beginning of year 20,805 24,698 43,071 -------------------------------------- Cash and cash equivalents, end of year $ 23,755 $ 20,805 $ 24,698 ====================================== Supplemental disclosure of cash flow information: Interest paid $ 89,733 $ 83,159 $ 71,746 Investments purchased not settled $ - $ - $ 524 Investments sold not settled $ - $ 99,056 $ - Supplemental disclosure of non-cash investing and financing activities: The Company purchased the controlling class securities of a REMIC trust During the year ended December 31, 2004: Carrying value of assets acquired $1,329,777 Liabilities assumed $1,306,724 THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
ANTHRACITE CAPITAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share data) ----------------------------------------------------------------------------- Note 1 ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES The Company was incorporated in Maryland in November 1997 and commenced operations on March 24, 1998. The Company's principal business activity is to invest in a diversified portfolio of CMBS, multifamily and commercial mortgage loans, and other real estate related assets in the U.S. and non-U.S. markets. The Company is organized and managed as a single business segment. A summary of the Company's significant accounting policies follows: Use of Estimates In preparing the consolidated financial statements in accordance with accounting principles generally accepted in the United States of America ("GAAP"), management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the statements of financial condition and revenues and expenses for the periods covered. Actual results could differ from those estimates and assumptions. Significant estimates in the consolidated financial statements include the valuation of the Company's investments and an estimate of credit performance on CMBS investments. Principles of Consolidation The consolidated financial statements include the financial statements of the Company and its subsidiaries, which are wholly-owned or controlled by the Company or entities which are VIEs in which the Company is the primary beneficiary under FIN 46R. FIN 46R requires a VIE to be consolidated by its primary beneficiary. The primary beneficiary is the party that absorbs the majority of the VIE's anticipated losses and/or the majority of the expected returns. The Company has evaluated its investments for potential variable interests by evaluating the sufficiency of the entities equity investment at risk to absorb losses. All significant inter-company balances and transactions have been eliminated in consolidation. Cash and Cash Equivalents All highly liquid investments with original maturities of three months or less are considered to be cash equivalents. Deferred Financing Costs Deferred financing costs, which are included in other assets on the Company's consolidated statements of financial condition, includes issuance costs related to the Company's debt and is amortized using the effective interest method. Securities Available-for-Sale The Company has designated certain investments in mortgage-backed securities, mortgage-related securities and certain other securities as assets available-for-sale because the Company may dispose of them prior to maturity and does not hold them principally for the purpose of selling them in the near term. Securities available-for-sale are carried at estimated fair value with the net unrealized gains or losses reported as a component of accumulated other comprehensive income (loss) in stockholders' equity. Unrealized losses on securities that reflect a decline in value that is judged by management to be other than temporary, if any, are charged to earnings. At disposition, the realized net gain or loss is included in income on a specific identification basis. As a result of the closing of the Company's CDO I, at the end of the first quarter 2002, the Company reclassified all of its subordinated CMBS on the balance sheet from available-for-sale to held-to-maturity. The effect of this reclassification changed the accounting basis of these securities, prospectively, from fair market value to adjusted cost. However, in accordance with SFAS No. 133, as amended and interpreted, the interest rate swap agreements entered into by the Company to hedge the variable rate exposure of the debt of CDO I are required to be presented on the balance sheet at their fair market value. This difference in treatment caused fluctuations in the book value of the Company. Accordingly, the Company determined that at December 31, 2002, and going forward, it will classify all of its subordinated CMBS as available-for-sale securities and record them at fair market value. This treatment is consistent with the mark to market requirement for CDO I's interest rate swap agreements. The reclassification of these securities to available-for-sale from held-to-maturity increased the recorded value of these securities from $558,522 to $610,713 at December 31, 2002 with the difference being recorded in other comprehensive income. Under the various CDO indentures, the collateral administrator to the CDO has an ongoing fiduciary obligation to monitor the credit risk of the collateral securities contributed to the CDO. The collateral administrator may sell collateral securities that have suffered a credit event (such as a rating downgrade) or, in the collateral administrator's reasonable business judgment, have a significant risk of declining in credit quality over time. The Company has concluded there are circumstances under the various CDO indentures that permit, and the reasonable exercise of business judgment would warrant, the sale of one or more securities outside the boundaries of paragraph 8(a) of SFAS No. 115. The circumstance that caused the Company to change this classification was not considered a permitted circumstance as stated in SFAS No. 115, and is therefore inconsistent with the Company's intent regarding its held-to-maturity classification. Accordingly, the Company's held-to-maturity classification has been tainted and the Company was prohibited from classifying any securities as held-to-maturity for a period of two years commencing December 31, 2002. The Company recognizes interest income from its purchased beneficial interests in securitized financial interests ("beneficial interests") (other than beneficial interests of high credit quality, sufficiently collateralized to ensure that the possibility of credit loss is remote, or that cannot contractually be prepaid or otherwise settled in such a way that the Company would not recover substantially all of its recorded investment) in accordance with EITF 99-20. Accordingly, on a quarterly basis, when changes in estimated cash flows from the cash flows previously estimated occur due to actual prepayment and credit loss experience, the Company calculates a revised yield based on the current amortized cost of the investment (including any other-than-temporary impairments recognized to date) and the revised cash flows. The revised yield is then applied prospectively to recognize interest income. For other mortgage-backed and related mortgage securities, the Company accounts for interest income under SFAS No. 91, using the effective yield method which includes the amortization of discount or premium arising at the time of purchase and the stated or coupon interest payments. Actual prepayment and credit loss experience is reviewed quarterly and effective yields are recalculated when differences arise between prepayments and credit losses originally anticipated and amounts actually received plus anticipated future prepayments and credit losses. In accordance with SFAS No. 115, when the estimated fair value of the security classified as available-for-sale has been below amortized cost for a significant period of time and the Company concludes that it no longer has the ability or intent to hold the security for the period of time over which the Company expects the values to recover to amortized cost, the investment is written down to its fair value. The resulting charge is included in income, and a new cost basis established. Additionally, under EITF 99-20, when changes in estimated cash flows from the cash flows previously estimated occur due to actual prepayment and credit loss experience, and the present value of the revised cash flows using the current expected yield is less than the present value of the previously estimated remaining cash flows (adjusted for cash receipts during the intervening period), an other-than-temporary impairment is deemed to have occurred. Accordingly, the security is written down to fair value with the resulting change being included in income, and a new cost basis established. In both instances, the original discount or premium is written off when the new cost basis is established. After taking into account the effect of the impairment charge, income is recognized under EITF 99-20 or SFAS No. 91, as applicable, using the market yield for the security used in establishing the write-down. Securities Held-for-Trading The Company has designated certain securities as assets held-for-trading because the Company intends to sell them in the near term. Securities held-for-trading are carried at estimated fair value with net unrealized gains or losses included in the consolidated statements of operations. Commercial Mortgage Loans and Loan Pools The Company purchases and originates certain commercial mortgage loans to be held as long-term investments. In accordance with SFAS No. 65 "Accounting for Certain Mortgage Banking Activities", commercial mortgage loans and loan pools are classified as long term investments because the Company has the ability and the intent to hold these loans to maturity. Loans are recorded at cost at the date of purchase. Premiums and discounts related to these loans are amortized over their estimated lives using the effective interest method. Any origination fee income and application fee income, net of direct costs, associated with originating or purchasing commercial mortgage loans are deferred and included in the basis of the loans on the consolidated statements of financial condition. The net fees are amortized over the life of the loans using the effective interest method. The Company recognizes impairment on the loans when it is probable that the Company will not be able to collect all amounts due according to the contractual terms of the loan agreement. The Company measures impairment (both interest and principle) based on the present value of expected future cash flows discounted at the loan's effective interest rate or the fair value of the collateral if the loan is collateral dependent. Equity Investments and Real Estate Joint Ventures Investments in real estate entities over which the Company exercises significant influence, but not control, are accounted for under the equity method. The Company recognizes its share of each venture's income or loss, and reduces its investment balance by distributions received. Real estate held by such entities is regularly reviewed for impairment, and would be written down to its estimated fair value if impairment were determined to exist. Short Sales As part of its short-term trading strategies, the Company may sell securities that it does not own ("short sales"). To complete a short sale, the Company may arrange through a broker to borrow the securities to be delivered to the buyer. The broker retains the proceeds received by the Company from the short sale until the Company replaces the borrowed securities, generally within a period of less than one month. In borrowing the securities to be delivered to the buyer, the Company becomes obligated to replace the securities borrowed at their market price at the time of the replacement, whatever that price may be. A gain, limited to the price at which the Company sold the security short, or a loss, unlimited as to dollar amount, will be recognized upon the termination of a short sale if the market price is less than or greater than the proceeds originally received. The Company's liability under the short sales is recorded at fair value, with unrealized gains or losses included in net gain or loss on securities held-for-trading in the consolidated statement of operations. Any broker that holds a deposit as collateral for securities borrowed exposes the Company to credit loss in the event of nonperformance. However, the Company does not anticipate nonperformance by any broker. Forward Commitments - Trading As part of its short-term trading strategies, the Company may enter into forward commitments to purchase or sell U.S. Treasury securities or securities issued by Federal Home Loan Mortgage Corporation ("FHLMC"), Federal National Mortgage Association ("FNMA") or Government National Mortgage Association ("GNMA") (collectively "Agency Securities"), which obligate the Company to purchase or sell such securities at a specified date at a specified price. When the Company enters into such a forward commitment, it will, generally within sixty days or less, enter into a matching forward commitment with the same or a different counterparty which entitles the Company to sell (in instances where the original transaction was a commitment to purchase) or purchase (in instances where the original transaction was a commitment to sell) the same or similar securities on or about the same specified date as the original forward commitment. Any difference between the specified price of the original and matching forward commitments will result in a gain or loss to the Company. Changes in the fair value of open commitments are recognized on the consolidated statement of financial condition and included among assets (if there is an unrealized gain) or among liabilities (if there is an unrealized loss). A corresponding amount is included as a component of net gain or loss on securities held-for-trading in the consolidated statement of operations. The Company is exposed to interest rate risk on these commitments, as well as to credit loss in the event of nonperformance by any other party to the Company's forward commitments. However, the Company does not anticipate nonperformance by any counterparty. Financial Futures Contracts - Trading As part of its short-term trading strategies, the Company may enter into financial futures contracts, which are agreements between two parties to buy or sell a financial instrument for a set price on a future date. Initial margin deposits are made upon entering into futures contracts and can be either cash or securities. During the period that the futures contract is open, changes in the value of the contract are recognized as gains or losses on securities held-for-trading by "marking-to-market" on a daily basis to reflect the market value of the contract at the end of each day's trading. Variation margin payments are received or made, depending upon whether gains or losses are incurred. The Company is exposed to interest rate risk on the contracts, as well as to credit loss in the event of nonperformance by any other party to the contract. However, the Company does not anticipate nonperformance by any counterparty. Derivative Instruments As part of its asset/liability risk management activities, the Company may enter into interest rate swap agreements, forward currency exchange contracts and other financial instruments in order to hedge interest rate and foreign currency exposures or to modify the interest rate or foreign currency characteristics of related items in its consolidated statement of financial condition. Income and expense from interest rate swap agreements that are, for accounting purposes, designated as cash flow hedges are recognized as a net adjustment to the interest expense of the hedged item and changes in fair value are recognized as a component of accumulated other comprehensive income (loss) in stockholder's equity. The fair market value of all swaps is included among assets (if there is an unrealized gain) or among liabilities (if there is an unrealized loss). Changes in fair value are collateralized with cash or cash equivalents and are recorded in the consolidated statements of financial condition as restricted cash. A corresponding amount is included as a component of accumulated other comprehensive income (loss) in stockholders' equity. Ineffective portions of changes in the fair value of cash flow hedges are recognized in earnings. The Company accounts for revenue and expense from the interest rate swap agreements designated as cash flow hedges under the accrual basis over the period to which the payment relates. Amounts paid to acquire these instruments are capitalized and amortized over the life of the instrument. Amortization of capitalized fees paid as well as payments received under these agreements is recorded as an adjustment to interest expense. If the underlying hedged securities are sold, the amount of unrealized gain or loss in accumulated other comprehensive income (loss) relating to the corresponding interest rate swap agreement is included in the determination of gain or loss on the sale of the securities. If interest rate swap agreements are terminated, the associated gain or loss is deferred over the shorter of the remaining term of the swap agreement, or the underlying hedged item, provided that the underlying hedged item has not been sold. Income and expense from interest rate swap agreements that are, for accounting purposes, designated as trading derivatives are recognized as a net adjustment to total other gain (loss). During the term of the interest rate swap agreement, changes in fair value are recognized in the consolidated statements of operations and included among assets (if there is an unrealized gain) or among liabilities (if there is an unrealized loss). Changes in fair value are collateralized with cash or cash equivalents and are recorded in the consolidated statements of financial condition as restricted cash. A corresponding amount is included as loss on securities held for trading in the consolidated statement of operations. The Company accounts for revenue and expense from the interest rate swap agreements classified as trading derivatives under the accrual basis over the period to which the payment relates. Amounts paid to acquire these instruments are capitalized and amortized over the life of the instrument. Amortization of capitalized fees paid as well as payments received under these agreements is recorded as an adjustment to loss on securities held for trading in the consolidated statement of operations. Revenue and expense from forward currency exchange contracts are recognized as a net adjustment to foreign currency gain or loss. During the term of the forward currency exchange contracts, changes in fair value are recognized in the consolidated statement of financial condition and included among assets (if there is an unrealized gain) or among liabilities (if there is an unrealized loss). A corresponding amount is included as a component of net foreign currency gain or loss in the consolidated statement of operations. Financial futures contracts that are, for accounting purposes, designated as hedging securities held-for-trading, are carried at fair value, with changes in fair value included in the consolidated statement of operations. The Company monitors its hedging instruments throughout their terms to ensure that they remain effective for their intended purpose. The Company is exposed to interest rate and/or currency risk on these hedging instruments, as well as to credit loss in the event of nonperformance by any other party to the Company's hedging instruments. The Company's policy is to enter into hedging agreements with counterparties rated A or better. Stock Options The options issued under the 1998 Stock Option Plan, options covering 979,426 shares of the Company's Common Stock, were granted prior to December 15, 1998 to individuals deemed to be employees. The Company adopted the disclosure-only provisions of SFAS No. 123 for such options. No compensation cost for these options has been recorded in the consolidated statement of operations because all options granted had an exercise price equal to or above the market value of the underlying Common Stock on the date of grant. Had compensation cost for these options been determined based on the fair value of the options at the grant date consistent with the provisions of SFAS No. 123, the Company's net income per share would not have changed in any period preceded. For the options to purchase 786,915 shares of the Company's Common Stock, granted to non-employees under the 1998 Stock Option Plan, compensation cost is accrued based on the estimated fair value of the options issued and amortized over the vesting period. Because vesting of the options is contingent upon the recipient continuing to provide services to the Company to the vesting date, the Company estimates the fair value of the non-employee options at each period end, up to the vesting date, and adjusts expensed amounts accordingly. The value of these non-employee options at each period end was negligible and all options were fully vested by March 2002. Negative Goodwill Negative goodwill reflected the excess of the estimated fair value of the net assets acquired in the CORE Cap Inc. merger over the purchase price for such assets. Negative goodwill was being amortized using the straight-line method from the date of acquisition over the weighted average lives of the assets acquired in the merger that the Company intended to retain. Negative goodwill, net, was $6,327 at December 31, 2001. Pursuant to the implementation of SFAS No. 142 (See Recently Adopted Accounting Pronouncements), the Company recognized the unamortized negative goodwill balance in income during the first quarter of 2002 as a transition adjustment. Income Taxes The Company has elected to be taxed as a REIT and to comply with the provisions of the Code with respect thereto. Accordingly, the Company generally will not be subject to Federal income tax to the extent of its distributions to stockholders and as long as certain asset, income and stock ownership tests are met. As of December 31, 2004, the Company had a Federal capital loss carryover of approximately $62,430 available to offset future capital gains. Recent Accounting Pronouncements In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment." This statement is a revision to SFAS No. 123, "Accounting for Stock-Based Compensation" and supercedes APB Opinion No. 25, "Accounting for Stock Issued to Employees." This statement establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services, primarily focusing on the accounting for transactions in which an entity obtains employee services in share-based payment transactions. Entities will be required to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exceptions). That cost will be recognized over the period during which an employee is required to provide service, the requisite service period (usually the vesting period), in exchange for the award. The grant-date fair value of employee share options and similar instruments will be estimated using option-pricing models. If an equity award is modified after the grant date, incremental compensation cost will be recognized in an amount equal to the excess of the fair value of the modified award over the fair value of the original award immediately before the modification. This statement is effective as of the beginning of the first interim or annual reporting period that begins after June 15, 2005. In accordance with the standard, the Company will adopt SFAS No. 123R during the year ended December 31, 2005. The Company has determined that this statement will not impact the Company's consolidated financial statements, as there are no unvested options as of December 31, 2004 and the Company already applies the fair value method to all newly-issued options. In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary Assets--An Amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions". SFAS No. 153 eliminates the exception from fair value measurement for nonmonetary exchanges of similar productive assets in paragraph 21(b) of APB Opinion No. 29, "Accounting for Nonmonetary Transactions," and replaces it with an exception for exchanges that do not have commercial substance. SFAS No. 153 specifies that a nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS No. 153 is effective for the fiscal periods beginning after June 15, 2005 and is required to be adopted by the Company for the year ended December 31, 2006. The adoption of SFAS No. 153 is not expected to have a significant impact on the Company's financial statements. In March 2004, the Emerging Issues Task Force ("EITF") reached a consensus on the "recognition" provisions of Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments" ("EITF No. 03-1"). EITF No. 03-1 requires that a loss be recognized for an impairment that is other-than-temporary. A three-step impairment model should be applied to debt securities subject to SFAS No. 115, including those debt securities subject to EITF No. 99-20, "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets." On September 30, 2004, the FASB issued FASB Staff Position (FSP) EITF No. 03-1-1, "Effective Date of Paragraphs 10-20 of EITF Issue No. 03-1," which delayed the effective date of the recognition provisions of EITF No. 03-1 until the issuance of the final FSP EITF Issue 03-1-a, "Implementation Guidance for the Application of Paragraph 16 of EITF Issue No. 03-1." Until the final FSP is issued, management is not able to evaluate whether the adoption of the "recognition" provisions under such guidance will have a material effect on our results of operations or financial position. In December 2003, the FASB issued FASB Interpretation No. 46 (revised 2003), "Consolidation of Variable Interest Entities" ("FIN 46R"). FIN 46R addresses the application of Accounting Research Bulletin No. 51, "Consolidated Financial Statements," to variable interest entities ("VIE") and generally would require that the assets, liabilities and results of operations of a VIE be consolidated into the financial statements of the enterprise that has a controlling financial interest in it. The interpretation provides a framework for determining whether an entity should be evaluated for consolidation based on voting interests or significant financial support provided to the entity ("variable interests"). An entity is classified as a VIE if total equity is not sufficient to permit the entity to finance its activities without additional subordinated financial support or its equity investors lack the direct or indirect ability to make decisions about an entity's activities through voting rights, absorb the expected losses of the entity if they occur or receive the expected residual returns of the entity if they occur. Once an entity is determined to be a VIE, its assets, liabilities and results of operations should be consolidated with those of its primary beneficiary. The primary beneficiary of a VIE is the entity that either will absorb a majority of the VIE's expected losses or has the right to receive a majority of the VIE's expected residual returns. The expected losses and residual returns of a VIE include expected variability in its net income or loss, fees to decision makers and fees to guarantors of substantially all VIE assets or liabilities and are calculated in accordance with Statement of Financial Accounting Concept No. 7, "Using Cash Flow Information and Present Value in Accounting Measurements." A public enterprise with a variable interest in a VIE must apply FIN 46R to that VIE no later than the end of the first reporting period that ends after March 15, 2004, with the exception of special purpose entities ("SPEs"), as defined. A public enterprise with a variable interest in an SPE which has been deemed a VIE must apply FIN 46R to that VIE no later than the end of the first reporting period that ends after December 15, 2003. Additionally, if it is reasonably possible that an enterprise will consolidate or disclose information about a VIE when the guidance becomes effective, there are several disclosure requirements effective for all financial statements issued after January 31, 2003. The Company's ownership of the subordinated classes of CMBS from a single issuer where it maintains the right to control the foreclosure/workout process on the underlying loans ("Controlling Class CMBS") are variable interests in SPEs which have been deemed VIEs and therefore subject to the FIN 46R consolidation criteria. Provided in Paragraph 4(d) of FIN 46R, are exceptions to the consolidation of VIE's specifically, that an enterprise that holds variable interests in a qualifying special-purpose entity ("QSPE") shall not consolidate that entity unless that enterprise has the unilateral ability to cause the entity to liquidate or change the entity so that it not longer meets the conditions in paragraph 25 or 35 of SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. Pursuant to FIN 46R, the Company's management has concluded that the trusts holding its Controlling Class CMBS (except for LBUBS 2004-C2) are QSPEs and accordingly, the Company did not consolidate these trusts. The Controlling Class CMBS that have been deemed VIEs are detailed below. The Company's actual loss from its Controlling Class CMBS investments is limited to the amounts invested in such securities and further limited to such amounts not financed in its non-recourse CDOs. The fair value of the subordinated Controlling Class securities financed in the CDOs is $380,063; the total fair value of the Company's subordinated Controlling Class CMBS is $441,509 (See Note 3 of the consolidated financial statements for further discussion of LBUBS 2004-C2). The table below details the purchase date, par of the Company's Controlling Class securities and the entire par of each Controlling Class issuance owned by the Company as of December 31, 2004. Controlling Class Purchase Par Held by Total Securities Date the Company CMBS Issued ----------------------------------------------------------------------------- Unconsolidated ---------------- CMAC 1998-C1 July 1998 $47,786 $1,192,239 CMAC 1998-C2 September 1998 88,140 2,891,309 DLJCM 1998-CG1 June 1998 65,747 1,564,253 GMAC 1998-C1 April 1998 24,737 1,438,000 LBCMT 1998-C1 May 1998 100,000 1,727,818 PNCMA 1999-CM1 November 1999 18,059 760,414 LBUBS 2002-C2 October 2004 30,060 1,210,453 CSFB 2001-CK6 December 2001 48,115 939,182 CSFB 2003-CPN1 February 2003 39,759 1,006,389 GECMC 2003-C2 July 2003 38,450 1,183,080 BACM 2004-1 March 2004 24,705 1,327,183 JPMCC 2004-PNC1 June 2004 21,949 1,097,416 BACM 2004-3 July 2004 23,103 1,253,168 GMACC 2004-C2 August 2004 22,177 933,735 BACM 2004-6 December 2004 38,862 956,589 ----------------------------------- Total Unconsolidated $ 631,649 $ 19,481,228 ----------------------------------- Consolidated ------------- LBUBS 2004-C2 April 2004 35,495 1,237,113 ------------------------------------- Total Consolidated $ 35,495 $ 1,237,113 ------------------------------------- Total Controlling Class CMBS $ 667,144 $ 20,718,341 ===================================== Reclassifications Certain items previously reported have been reclassified to conform to the current year's presentation. Note 2 SECURITIES AVAILABLE-FOR-SALE The Company's securities available-for-sale are carried at estimated fair value. The amortized cost and estimated fair value of securities available-for-sale as of December 31, 2004 are summarized as follows:
Gross Gross Estimated Amortized Unrealized Unrealized Fair Security Description Cost Gain Loss Value ------------------------------------------------------------------------------------------------------------------------------- CMBS: CMBS IOs $ 122,379 $ 4,304 $ (1,437) $ 125,246 Investment grade CMBS 380,673 14,302 (5,162) 389,813 Non-investment grade rated subordinated securities 710,403 48,578 (10,174) 748,807 Non-rated subordinated securities 4,996 998 - 5,994 Credit tenant lease 25,517 448 (714) 25,251 Investment grade REIT debt 271,344 15,456 (1,458) 285,342 Project loans 24,092 - (442) 23,650 CDO investments 19,450 387 - 19,837 ---------------------------------------------------------------------- Total CMBS 1,558,854 84,473 (19,387) 1,623,940 ---------------------------------------------------------------------- RMBS: Agency adjustable rate securities 112,010 318 (189) 112,139 Residential CMOs 1,342 66 - 1,408 Hybrid adjustable rate mortgages ("ARMs") 25,934 - (328) 25,606 ---------------------------------------------------------------------- Total RMBS 139,286 384 (517) 139,153 ---------------------------------------------------------------------- Total securities available-for-sale $ 1,698,140 $84,857 $ (19,904) $ 1,763,093 ======================================================================
As of December 31, 2004, an aggregate of $1,695,097 in estimated fair value of the Company's securities available-for-sale was pledged to secure its collateralized borrowings. The amortized cost and estimated fair value of securities available-for-sale as of December 31, 2003 are summarized as follows:
Security Description Amortized Gross Gross Estimated Fair Cost Unrealized Gain Unrealized Loss Value ------------------------------------------------------------------------------------------------------------------------- CMBS: CMBS IOs $ 83,704 $ 1,566 $ (777) $ 84,493 Investment grade CMBS 332,342 7,353 (6,241) 333,454 Non-investment grade rated subordinated securities 742,923 19,322 (83,821) 678,424 Non-rated subordinated securities 23,011 4,840 (2,832) 25,019 Credit tenant lease 25,861 - (165) 25,696 Investment grade REIT debt 204,382 15,736 (696) 219,422 Project Loans 25,969 543 (10) 26,502 -------------------------------------------------------------------- Total CMBS 1,438,192 49,360 (94,542) 1,393,010 -------------------------------------------------------------------- RMBS: Agency adjustable rate securities 179,917 464 - 180,381 Agency fixed rate securities 226,842 47 (4,389) 222,500 Residential CMOs 3,404 89 (29) 3,464 ARMs 6,682 - (37) 6,645 -------------------------------------------------------------------- Total RMBS 416,845 600 (4,455) 412,990 -------------------------------------------------------------------- -------------------------------------------------------------------- Total Available-For-Sale $ 1,855,037 $ 49,960 $ (98,997) $ 1,806,000 ====================================================================
As of December 31, 2003, an aggregate of $1,683,952 in estimated fair value of the Company's securities available-for-sale was pledged to secure its collateralized borrowings. As of December 31, 2004 and 2003, the aggregate estimated fair values by underlying credit rating of the Company's securities available-for-sale are as follows:
December 31, 2004 December 31, 2003 Estimated Estimated Security Rating Fair Value Percentage Fair Value Percentage -------------------------------------------------------------------------------------------------------------------- Agency and agency insured securities $159,892 9% $426,915 24% AAA 222,203 13 238,382 13 AA- 1,886 - - - A+ 9,155 1 - - A 22,283 1 15,643 1 A- 23,354 1 23,126 1 BBB+ 119,214 7 106,752 6 BBB 217,968 12 146,072 8 BBB- 195,050 11 126,313 7 BB+ 372,347 21 284,081 16 BB 119,559 7 129,401 7 BB- 100,831 6 75,316 4 B+ 40,660 2 28,904 2 B 106,571 6 105,061 6 B- 4,478 1 34,160 2 CCC+ - - 5,595 - CCC 4,360 - 13,375 1 C - - 2,531 - Not rated 43,281 2 44,373 2 --------------------------------------------------------------------- Total securities available-for-sale $1,763,092 100% $1,806,000 100% =====================================================================
The following table shows the Company's fair value and gross unrealized losses, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2004.
Less than 12 Months 12 Months or More Total ------------------------------------------------------------------------------------------- Gross Gross Gross Fair Unrealized Fair Unrealized Fair Unrealized Value (Losses) Value Losses Value Losses ------------------------------------------------------------------------------------------- CMBS IOs $ 19,120 $ (1,117) $ 2,061 $ (320) $ 21,181 $ (1,437) Investment grade CMBS 52,754 (654) 98,952 (4,508) 151,706 (5,162) Non-investment grade rated subordinated securities 37,098 (604) 60,548 (9,570) 97,646 (10,174) Credit tenant lease - - 16,168 (714) 16,168 (714) Investment grade REIT debt 35,290 (311) 37,794 (1,147) 73,084 (1,458) Project loans 22,367 (340) 1,282 (102) 23,649 (442) Agency adjustable rate securities 11,692 (189) - - 11,692 (189) ARMs 25,606 (328) - - 25,606 (328) ------------------------------------------------------------------------------------------- Total temporarily impaired securities $203,927 $(3,543) $216,805 $(16,361) $420,732 $(19,904) ===========================================================================================
The temporary impairment of the available-for-sale securities results from the fair value of the securities falling below the amortized cost basis. Management possesses both the intent and the ability to hold the securities until the Company has recovered amortized cost. As such, management does not believe any of the securities held are impaired other than those for which the Company recorded an impairment charge in 2003 and 2004 (see Note 9 of the consolidated financial statements). As of December 31, 2004 and 2003, the mortgage loans underlying the Controlling Class CMBS held by the Company were secured by properties of the types and at the locations identified below: Percentage (1) Percentage (1) ------------------------------------------------------------------------------- Geographic Property Type 2004 2003 Location 2004 2003 ------------------------------------------------------------------------------- Multifamily 28.6% 33.2% California 13.7% 11.7% Retail 32.4 30.4 Texas 10.1 10.9 Office 24.9 20.0 New York 11.7 9.8 Lodging 4.9 6.9 Florida 8.4 6.0 Other (2) 9.2 9.5 Other (2) 56.1 61.6 -------------------- --------------------- Total 100.0% 100.0% Total 100.0% 100.0% ==================== ===================== (1) Based on a percentage of the total unpaid principal balance of the underlying loans. (2) No other individual category comprises more than 5% of the total. The following table sets forth certain information relating to the aggregate principal balance and payment status of delinquent mortgage loans underlying the Controlling Class CMBS held by the Company as of December 31, 2004 and 2003:
2004 2003 --------------------------------------------------------------------------------------------- Number of % of Number of % of Principal Loans Collateral Principal Loans Collateral --------------------------------------------------------------------------------------------- Past due 30 days to 60 days $20,288 10 0.11% $13,773 3 0.12% Past due 60 days to 90 days 67,902 12 0.37 12,162 3 0.11 Past due 90 days or more 93,453 17 0.50 123,242 16 1.08 Resolved loans - - - - - - Real Estate owned 5,310 2 0.03 18,354 4 0.17 --------------------------------------------------------------------------------------------- Total Delinquent $186,953 41 1.01% $167,531 26 1.48% ============================================================================================= Total Principal Balance $18,580,729 2,864 $11,347,281 2,163
Of the 41 delinquent loans as of December 31, 2004, 2 loans were real estate owned and being marketed for sale, no loans were in foreclosure and the remaining 39 loans were in some form of workout negotiations. The Controlling Class CMBS owned by the Company have a delinquency rate of 1.01%, which is consistent with industry averages. During 2004, the Company experienced early payoffs of $451,662 that represents 2.43% of the year-end pool balance. These loans were paid-off at par with no loss. To the extent that realized losses, if any, or such resolutions differ from the Company's original loss estimates, it may be necessary to reduce or increase the projected yield on the applicable CMBS investment to better reflect such investment's expected earnings net of expected losses, from the date of purchase. While realized losses on individual assets may be higher or lower than original estimates, the Company currently believes its aggregate loss estimates and yields remain appropriate. The CMBS held by the Company consist of subordinated securities collateralized by adjustable and fixed rate commercial and multifamily mortgage loans. The RMBS held by the Company consist of adjustable rate and fixed rate residential pass-through or mortgage-backed securities collateralized by adjustable and fixed rate single-family residential mortgage loans. Agency RMBS were issued by FHLMC, FNMA or GNMA. Privately issued RMBS were issued by entities other than FHLMC, FNMA or GNMA. The Company's securities available-for-sale are subject to credit, interest rate, and/or prepayment risks. The CMBS owned by the Company provide credit support to the more senior classes of the related commercial securitization. The Company generally does not own the senior classes of its below investment grade CMBS. Cash flow from the mortgages underlying the CMBS generally is allocated first to the senior classes, with the most senior class having a priority entitlement to cash flow. Then, any remaining cash flow is allocated generally among the other CMBS classes in order of their relative seniority. To the extent there are defaults and unrecoverable losses on the underlying mortgages, resulting in reduced cash flows, the most subordinated CMBS class will bear this loss first. To the extent there are losses in excess of the most subordinated class' stated entitlement to principal and interest, then the remaining CMBS classes will bear such losses in order of their relative subordination. As of December 31, 2004 and 2003, the anticipated weighted average unleveraged based upon adjusted cost of the Company's entire subordinated CMBS portfolio was 10.4% and 9.7% per annum, respectively, and of the Company's other securities available-for-sale was 5.8% and 5.1% per annum, respectively. The Company's anticipated yields to maturity on its subordinated CMBS and other securities available-for-sale are based upon a number of assumptions that are subject to certain business and economic uncertainties and contingencies. Examples of these include, among other things, the rate and timing of principal payments (including prepayments, repurchases, defaults, liquidations, and related expenses), the pass-through or coupon rate, and interest rate fluctuations. Additional factors that may affect the Company's anticipated yields to maturity on its Controlling Class CMBS include interest payment shortfalls due to delinquencies on the underlying mortgage loans, and the timing and magnitude of credit losses on the mortgage loans underlying the Controlling Class CMBS that are a result of the general condition of the real estate market (including competition for tenants and their related credit quality), and changes in market rental rates. As these uncertainties and contingencies are difficult to predict and are subject to future events that may alter these assumptions, no assurance can be given that the anticipated yields to maturity, discussed above and elsewhere, will be achieved. The agency adjustable rate RMBS held by the Company is subject to periodic and lifetime caps that limit the amount the interest rates of such securities can change during any given period and over the life of the loan. As of December 31, 2004 and 2003, adjustable rate RMBS with a market value of $139,513 and $27,419, respectively, is included in securities available-for-sale on the consolidated statement of financial condition. As of December 31, 2004, the unamortized net discount on all securities available-for-sale was $425,982, which represented 21.3% of the then remaining face amount of such securities. During 2004, the Company sold securities available-for-sale for total proceeds of $503,898, resulting in a realized gain of $17,544. During 2003, the Company sold securities available-for-sale for total proceeds of $1,466,552, resulting in a realized loss of $(6,832). During 2002, the Company sold securities available-for-sale for total proceeds of $1,017,534, resulting in a realized gain of $11,391. Note 3 COMMERCIAL MORTGAGE LOAN POOLS During the second quarter of 2004, the Company acquired subordinated CMBS in a trust establishing a Controlling Class interest. As the Controlling Class holder, the Company has the ability to control dispositions or workouts of any defaulted loans in this trust. The Company negotiated for and obtained a greater degree of discretion over the disposition of the commercial mortgage loans than is typically granted to the special servicer. As a result of this expanded discretion, FASB FIN 46R requires the Company to consolidate the net assets and results of operations of the trust. The CMBS securities acquired by the Company had a par value of $41,495 with $13,890 not rated and the balance rated BBB- to B-. During the third quarter the Company sold the BBB- rated security, which had the impact of increasing the borrowings for the commercial loan pool by $5,848. As of December 31, 2004, the CMBS securities owned by the Company have a par value of $35,495. The debt associated with the REMIC trust is non-recourse to the Company, and is secured only by the commercial mortgage loan pools. As of December 31, 2004, the consolidation of the REMIC trust results in an increase in the Company's total debt to capital ratio from 3.7:1 to 6.2:1, but has no effect on the Company's recourse debt to capital ratio. The Company received authorization from its lenders to permit debt to capital ratios in excess of existing covenants. Approximately 45% of the par amount of the commercial mortgage loan pool is comprised of loans that are shadow rated A2 or better by Moody's Investors Service, Inc. and AA by Standard & Poor's Rating Group, a division of the McGraw-Hill Companies, Inc. The Company has taken into account the credit quality of the underlying loans in formulating its loss assumptions. Credit losses assumed on the entire pool are 1.40% of the principal balance, or 2.53% of the unrated principal balance. For income recognition purposes, the Company accounts for the unrated commercial mortgage loans in the pool as a single asset based on common credit risk characteristics. Over the life of the commercial mortgage loan pools, the Company reviews and updates its loss assumptions to determine the impact on expected cash flows to be collected. A decrease in estimated cash flows will reduce the amount of interest income recognized in future periods and may result in a loan loss reserve depending upon the severity of the cash flow reductions. An increase in estimated cash flows will first reduce the loan loss reserve and any additional cash will increase the amount of interest income recorded in future periods. Note 4 SECURITIZATION TRANSACTION During 2004, the Company sold non-investment grade CMBS with a fair market value of $109,933 to a qualifying special purpose entity (the "CDO HY1"). These CMBS were securitized into various classes of non-recourse bonds and preferred equity. CDO HY1 sold the investment grade rated bonds to unrelated third parties for net proceeds of $121,547. In accordance with SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," a gain of $14,769 was recognized on the sale of the CMBS collateral to CDO HY1. At closing, the Company retained the A- rated bond and the preferred equity in CDO HY1. Subsequently, the A- rated bond was sold at a gain of $1,825 during the fourth quarter of 2004. The table below summarizes the cash flows received from CDO HY1 during the year ended December 31, 2004. 2004 ------------ Proceeds from CDO HY1 $ 121,547 Subsequent sale of A- bond $18,879 Cash flow on preferred equity (1) $0 (1) The preferred equity pays interest quarterly and its first scheduled quarterly payment was in January 2005. Key economic assumptions used in measuring the fair value of the preferred equity at the date of the securitization was as follows: 2004 ------------ Weighted average life 11.5 years Preferred equity pre-loss cash flows discount rate 67.4% When subsequently measuring the fair value of the preferred equity, the Company applies certain key assumptions to loss adjusted cash flows. The Company estimated credit losses and the timing of losses for each loan underlying the CMBS collateral, and accordingly does not apply a constant default rate to the portfolio. At December 31, 2004, the amortized cost of the preferred equity was $14,513, with an estimated fair value of $15,884, based on key economic assumptions. The sensitivity of the preferred equity to immediate adverse changes in those assumptions follows: 2004 --------- Reduction of income per share: 50% adverse change in credit losses $0.02 100% adverse change in credit losses $0.04 Writedown per share: 50% adverse change in credit losses $0.04 100% adverse change in credit losses $0.07 These sensitivities are hypothetical and should be used with caution. As the figures indicate, changes in fair value based on a variation in key assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. This non-linear relationship exists because we apply our key assumptions on a loan-by-loan basis to the assets underlying the CMBS collateral. Also, in this table, the effect of a variation in a particular assumption on the fair value of the preferred equity was calculated without changing any other assumption; in reality, changes in one factor may result in changes to another, which might magnify or counteract the sensitivities. The Company reviews all major assumptions periodically using the most recent empirical and market data available, and makes adjustments where warranted. Note 5 SECURITIES HELD-FOR-TRADING Securities classified as held-for-trading include investments that the Company intends to hold for a short period of time, usually less than one year. This classification generally includes highly liquid securities that the Company acquires to earn net interest income until the Company redeploys that capital into credit sensitive commercial real estate opportunities. The Company's securities held-for-trading are carried at estimated fair value. At December 31, 2004, the Company's securities held-for-trading consisted of FNMA and FHLMC mortgage pools with an estimated fair value of $232,918. At December 31, 2003, the Company's securities held-for-trading consisted of FNMA and FHLMC mortgage pools with an estimated fair value of $313,727 and short positions of 30 five-year and 73 ten-year U.S. Treasury Note future contracts, which represented $3,000 and $7,300 in face amount of U.S. Treasury Notes, respectively. The estimated fair value of the contracts was approximately $(11,436) at December 31, 2003. As of December 31, 2004, securities held-for-trading consisted entirely of hybrid adjustable rate mortgages and adjustable rate securities. As of December 31, 2003, adjustable rate RMBS with a market value of $255,557 are included in securities held-for-trading on the consolidated statements of financial condition. The Company's trading strategies are subject to the risk of unanticipated changes in the relative prices of long and short positions in trading securities, but are designed to be relatively unaffected by changes in the overall level of interest rates. Note 6 COMMERCIAL MORTGAGE LOANS The following table summarizes the Company's loan investments at December 31, 2004 and 2003:
Date of Initial Scheduled Property Property Par Book Value Interest Rate Yield Investment Maturity Name/ Location Type 2004 2003 2004 2003 2004 2003 2004 2003 - ----------------------------------------------------------------------------------------------------------------------------------- 11/7/01 11/11/07 Landmark Bldg. Office $10,724 $10,820 $10,434 $11,355 7.2% 7.2% F 7.2% 7.2% San Francisco, CA (2) 11/7/01 11/11/07 Landmark Bldg. Office 9,651 9,737 9,694 10,055 6.7 6.7 F 6.7 6.7 San Francisco, CA (2) 12/17/01 4/9/04 Greensboro Center Office - 22,000 - 22,000 - 8.2 L - 8.9 Tyson's Corner, VA 5/17/02 12/11/05 Alliance I/O Residential 2,479 2,795 - 52 2.6 3.8 L - - Southwest (3) 6/30/03 6/1/10 Windsor Hotel(1)(4) Hotel 14,678 14,916 12,645 11,206 6.6 6.6 L 11.8 11.8 10/28/03 03/09/05 Woolworth Building Office 7,000 7,000 7,000 7,000 16.8 16.8 L 16.8 16.8 New York, NY (5) 03/31/04 01/01/11 PPG Place Office 19,814 - 19,992 - 11.8 - F 11.8 - Pittsburgh, PA (1)(6) 04/07/04 12/11/18 Cumberland Place Retail 192 - 192 - 11.0 - F 11.0 - Smyma, GA 04/20/04 08/05/18 GGP Portfolio(1)(7) Retail 17,124 - 14,878 - 6.3 - F 6.3 - 06/02/04 11/15/10 Eiger Trust Various 4,580 - 4,580 - 8.6 - F 8.6 - Switzerland(8) 07/14/04 04/01/14 17 State Street(1) Office 22,425 - 20,072 - 7.3 - F 7.5 - New York, NY 08/03/04 06/30/06 Fordgate Office Office 21,119 - 21,119 - 8.1 - L 8.1 - Portfolio(9) 8/26/04 8/9/06 Windsor Hotel II Hotel 25,000 - 25,000 - 8.7 - L 8.7 - (1)(10)(11) 09/15/04 07/09/06 Strategic Hotel Hotel 30,000 - 30,000 - 6.4 - L 6.4 - Portfolio - (1)(11)(12) 09/29/04 05/11/08 Lembi Apartments(1) Residential 9,980 - 9,980 - 10.5 - F 10.5 - 09/29/04 03/11/09 Lembi Nob Hill Residential 3,500 - 3,500 - 17.0 - F 17.0 - Apartments, San Francisco, CA 09/30/04 10/09/05 Palladium at City Retail 10,000 - 10,000 - 11.8 - L 11.8 - Place West Palm Beach, FL(1)(13) 10/19/04 07/12/06 Lake Las Vegas Hotel 10,000 - 10,000 5.4 - L 5.4 - Hyatt, Henderson, NV(1)(14) 10/28/04 12/09/05 Hotel Del Coronado, Hotel 25,000 - 25,000 - 7.7 - L 7.7 - San Diego, CA(1) 10/28/04 11/09/05 The Maine Mall, Retail 34,000 - 34,000 5.2 - L 5.2 - Portland, ME (1)(11)(15) -------------------------------------------------------------------------------------- Totals $277,266 $67,268 $268,086 $61,668
F - Fixed Rate; L - LIBOR based floating rate (1)The entire principal balance of the Company's investment is pledged to secure line of credit borrowing agreements. (2) Two subordinate interests in a $125,000 note secured by one 11-story office building. The entire principal balance of the Company's investment is pledged to secure collateralized debt obligations. (3) Represents a 1.46% interest only strip off of a B Note secured by a portfolio of apartments (5,389 units). Payments received are the greater of 1.5% or 9.5% less LIBOR+450, based upon a notional par value. (4) Represents a subordinate position in a $125,000 first mortgage, secured by six hotels in California and one hotel in Michigan. (5) Represents a subordinate interest in a $26,000 mezzanine loan, secured by partnership interests in a 54 story, landmark office building. (6) PPG is a junior participation in a $59.00MM Mezzanine Note. The Mezzanine Note is secured by 100% of the partnership interests in the entity that owns a 1.5 million square foot office complex, known as PPG Place. (7) GGP is a junior participation in an $115,000 first mortgage loan secured by three regional malls. The Properties are located in Bowling Green, Kentucky, Springfield, Oregon, and Jefferson City, Missouri. (8) Eiger is a 50% interest in the most subordinate tranche of a loan, indirectly secured by 112 office and light industrial buildings. Since origination over 30 properties have been disposed with approximately 75 properties remaining. The collateral is primarily occupied by SwissCom (majority-owned by the Swiss Government) and the Swiss Postal Service, and is located throughout Switzerland with the largest concentrations in Bern and Zurich. (9) Fordgate is a subordinate interest in a first mortgage on a Portfolio of seven office buildings located in London and Edinburgh and Aberdeen, Scotland. The loan may be extended at the borrower's options for an additional three-year term. (10) Represents a junior mezzanine loan, secured by the borrower's pledge of its ownership interests in a portfolio of nine Embassy Suites hotels consisting of 2,150 rooms, located in six states and seven metropolitan areas. (11) May be extended at the borrower's option for three additional twelve-month periods, subject to certain performance hurdles. (12) Represents a pari-passu participation in a $100,000 senior mezzanine loan, secured by the pledge of the equity in seven luxury, business, and group oriented hotel properties located in New York (2), Northern California (3), and Southern California (2). The portfolio totals 3,451 rooms. (13) Palladium at City Place is a mezzanine loan secured by a pledge of 100% of the equity interests in the owner of the Palladium at CityPlace , a 626 square foot open-air entertainment/retail center with 110 residential/commercial units in the downtown area of West Palm Beach, Florida. The loan is also collateralized by two additional parcels it the CityPlace development. (14) May be extended at the borrower's option for three additional twelve-month periods, subject to certain performance hurdles and an extension fee for the second and third extension. (15) Represents a $34,000 mezzanine loan secured by a pledge in the ownership interests in the owners of The Maine Mall, a four-anchor super-regional mall located in South Portland, Maine. The total mall size is approximately 1.,005 square feet, of which 759 square feet is collateral for the loan. Reconciliation of commercial mortgage loans: Par Book Value ------------- --------------- Balance at January 1, 2003 $67,679 $ 65,664 Discount accretion - 264 Proceeds from repayment of mortgage loans (22,195) (22,780) Reduction in notional par value (218) - Investments in commercial mortgage loans 22,002 18,520 ------------- -------------- Balance at December 31, 2003 $67,268 $ 61,668 Discount accretion - 2,706 Proceeds from repayment of mortgage loans (23,285) (23,285) Reduction in notional par value (316) - Investments in commercial mortgage loans 233,599 226,997 ------------- -------------- Balance at December 31, 2004 $277,266 $268,086 ============= ============== Note 7 EQUITY INVESTMENTS AND REAL ESTATE JOINT VENTURES On July 20, 2000, the Company made an investment aggregating $5,121 in two limited partnerships for the purpose of purchasing a ninety-nine thousand square foot office building and a one hundred twenty thousand square foot office building, both of which are located in suburban Philadelphia. The Company exercised significant influence, but not control, and accounted for its investment under the equity method. The Company's ownership interest was 64.81% in each partnership. The Company received a preferred return of 12% compounded on its unreturned capital, paid monthly. On June 30, 2004, the Company received the return of its capital and an additional 3% return representing its share of the proceeds from refinancing. The book value of the investment in the partnerships at December 31, 2003 was $2,750. On December 14, 2000, the Company made an investment aggregating approximately $5,149 in a limited liability company for the purpose of acquiring a five hundred thousand square foot office and retail complex in Tallahassee, Florida. The Company exercises significant influence, but not control, and accounts for its investment under the equity method. The Company's ownership interest is 36.4% of the limited liability company. The Company receives a preferred return of 13.25% and a return of capital of $3, which is payable monthly. The book value of the investment at December 31, 2004 and 2003 was $5,031 and $5,073, respectively. On January 13, 2005, the Company received the return of its remaining capital. As of December 31, 2004 and 2003, the Company owns approximately 20% of Carbon I. As of December 31, 2004, the Company also owns approximately 20% of Carbon II. Collectively, the Carbon Capital Funds are private commercial real estate income opportunity funds managed by the Manager (see Note 12 of the consolidated financial statements). The Company entered into a $50,000 commitment on July 20, 2001 to acquire shares in Carbon I. On July 12, 2004, the investment period expired. No additional capital will be called. Shares purchased by the Company are as follows: Number of Date Stock issued Shares Issued Amount ---- ------------ ------------- ------ November 19, 2001 Series K Common 8,784 $8,784 October 30, 2002 Series K Common 6,100 6,100 February 6, 2003 Series K Common 2,680 2,680 September 15, 2003 Series K Common 5,265 5,265 October 9, 2003 Series K Common 4,137 4,137 March 17, 2004 Series K Common 4,349 4,349 April 20, 2004 Series K Common 4,784 4,784 May 17, 2004 Series K Common 2,968 2,968 June 24, 2004 Series K Common 7,117 7,117 The Company's investment in Carbon I as of December 31, 2004 and 2003 was $39,563 and $28,493, respectively. On October 6, 2004, the Company entered into a $30,000 commitment to acquire shares in Carbon II. On November 19, 2004 the Company entered into an additional $32,067 commitment. Shares purchased by the Company are as follows: Number of Date Stock issued Shares Issued Amount ---- ------------ ------------- ------ December 6, 2004 Series K Common 4,986 $4,986 December 28, 2004 Series K Common 11,967 11,967 The Company's investment in Carbon II as of December 31, 2004 was $17,249. The Company's remaining commitment as of December 31, 2004 was $45,114. The following table summarizes the loan investments held by the Carbon Capital Funds at December 31, 2004 and 2003.
Date of Initial Scheduled Property Property Par Book Value Interest Rate Yield Investment Maturity Name/ Location Type 2004 2003 2004 2003 2004 2003 2004 2003 - ----------------------------------------------------------------------------------------------------------------------------------- 11/19/01 6/15/04 230 Park Avenue Office $ - $10,000 $ - $9,938 -% 7.7% L 9.2% 8.8% New York, NY 11/20/01 12/11/07 Landmark Building Office - 11,953 - 9,889 - 10.0 F 19.0 16.6 San Francisco, CA 12/17/01 4/9/04 Greensboro Center Office - 10,000 - 8,759 - 9.0 L 27.3 19.5 Tyson's Corner, VA 5/17/02 12/11/05 Alliance I/O (1) Residential 10,070 11,278 67 138 2.6 3.8 L - - 10/16/02 11/1/07 311 S. Wacker Dr. Office 31,418 31,710 31,128 31,181 8.00 9.3 L 11.5 9.8 Mez. Chicago, IL (3)(22) 11/1/02 11/9/05 Westin St. Francis Hotel 35,000 35,000 34,973 34,964 11.9 10.7 L 11.9 10.7 Mez. San Francisco, CA (3)(4) 2/10/03 3/11/08 Pennmark (3)(5)(22) Mixed-use 35,000 35,000 34,739 34,388 8.8 8.8 L 8.9 9.8 New York, NY 5/7/03 11/1/04 The Edge Condominium Residential - 12,000 - 11,912 - 22.0 F 22.1 22.4 Chicago, IL (6) 5/9/03 1/09/06 Alliance FQ B Note Residential 7,850 8,450 7,701 8,130 7.5 7.5 L 10 9.6 Texas (2)(3)(7)(22) 5/9/03 1/09/06 Alliance FQ Residential 6,000 6,000 5,879 5,755 15.1 17.9 L 17.9 17.7 Mezzanine Texas (2)(3)(7)(22) 8/19/03 1/14/04 880 Mandalay Residential - 6,885 - 6,853 - 7.8 L 19.7 8.1 Clearwater Beach, FL 9/16/03 3/09/06 Ocean's Resort Hotel 24,421 26,375 23,276 24,890 10.7 10.7 L 12.6 12.8 Portfolio Daytona Beach, FL (2)(3)(8)(22) 11/10/03 4/2/04 Pointe @ Park Center Residential - 9,546 - 9,546 - 7.6 L 34.5 7.5 Alexandria, VA 11/25/03 11/24/05 Mary Brickell Village Retail 13,640 13,640 13,511 13,442 18.0 18.0 F 18.1 18.4 Miami, FL(9) 12/15/03 12/1/06 Independent Office 13,836 14,000 13,752 13,864 10.2 10.0 L 10.5 10.5 Square(3)(22) Jacksonville, FL 2/6/04 2/9/06 Hyatt Regency Hotel 15,000 - 15,000 - 9.7 - L 8.7 - Mezzanine Washington, D.C.(3)(10) 3/10/04 2/28/06 Highpointe Condo Residential 14,500 - 14,500 - 20.0 - F 20.7 - Hunt Valley, MD (11) 3/18/04 1/9/06 Prime Retail 26,000 - 25,985 - 13.1 - L 13.1 - Outlets(3)(12)(22) 4/26/04 2/9/06 Town Mall Retail 10,000 - 9,906 - 7.7 - L 8.1 - (3)(10)(13)(22) Westminster, MD 4/30/04 4/30/07 Leasco(2)(14) Storage 10,171 - 10,171 - 16.0 - F 16.0 - 5/19/04 4/30/07 Park Crest at Residential 3,990 - 3,990 - 8.8 - L 14.6 - Innisbrook II Palm Harbor, FL(15) 5/21/04 5/9/06 River East - Retail 14,000 - 13,964 - 16.5 - L 18.1 - Mez(3)(16) Chicago, IL 5/21/04 5/9/06 River East - Retail 17,800 - 17,800 - 7.4 - L 7.4 - Loan(3)(16) Chicago, IL 5/28/04 11/12/06 Parkway Office 12,838 - 12,796 - 7.9 - L 8.0 - Center(2)(17)(22) Roseville, CA 6/25/04 6/17/07 Island Club Residential 7,224 - 7,224 - 8.8 - L 15.4 - Apartments Miami, FL(18) 7/01/04 6/17/07 Marquis at Vienna Residential 4,343 - 4,343 - 8.8 - L 18.4 - (19) Vienna, VA 6/30/04 7/9/07 Market Tower #1 Office 7,500 - 7,432 - 11.0 - F 11.0 - (2)(20) Indianapolis, IN 6/30/04 7/9/07 Market Tower #2 Office 7,500 - 7,500 - 11.0 - F 11.0 - (2)(20) Indianapolis, IN 8/20/04 8/9/06 Penncomm(10)(21) Office 8,914 - 8,914 - 11.1 - L 11.1 - New York, NY 12/29/04 12/31/09 10/Ten Post Office Office 17,000 - 16,980 - 8.1 - L 8.1 - (23) Boston, MA 11/24/04 8/1/05 Westbrook Office 23,285 - 23,285 - 8.1 - L 8.1 - Portfolio(24)(25) 12/07/04 1/9/05 L Enfant Plaza Office 13,700 - 13,700 - 7.7 - L 7.7 - (2)(26) Washington D.C. 11/23/04 10/9/06 Fifteen Group Mezz Residential 24,692 - 24,692 - 7.6 - L 7.6 - (3)(27) 12/20/04 11/9/06 Alliance Eaton Residential 52,500 - 52,500 - 8.1 - L 8.1 - Vance Portfolio, (10) (28) 11/4/04 10/4/06 Desert Passage Jr. Retail 20,000 - 20,000 - 17.0 - L 17.0 - Mezz Las Vegas, NV (3)(29)(30) 10/13/04 8/10/07 Oceanview Residential 26,400 - 26,400 - 8.2 - L 8.2 - Sunny Isles Beach, FL(31) 11/18/04 11/1/07 Palazzo at Park Residential 16,800 - 16,800 - 8.2 - L 8.2 - Center Alexandria, VA(32) ---------------------------------------------------------------------------------- Totals $531,392 $241,837 $436,194 $223,649
F - Fixed Rate; L - LIBOR based floating rate (1) The Concordia Portfolio was secured by the partnership interests in three super regional malls. In conjunction with the purchase of the Portfolio, the Company purchased a 1.46% interest only strip (the "Alliance I/O") off of a B Note secured by a portfolio of apartments (5,389 units) located in Dallas/Fort Worth and Phoenix. Payments received are the greater of 1.5% or 9.5% less LIBOR+450, based upon a notional par. (2) May be extended at the borrower's option for two additional twelve-month periods, subject to certain performance hurdles and an extension fee. (3) The entire principal balance of the Company's investment is pledged to secure line of credit borrowing agreements. (4) Represents a $35,000 mezzanine loan, secured by the borrower's interest in a full service hotel. May be extended at the borrower's option for two additional twelve-month periods for a 0.125% extension fee. On March 20, 2003, the Company sold at par, a $30,000 subordinate interest in a $160,000 note secured by the same hotel property. (5) Represents a $35,000 mezzanine loan secured by 100% of the ownership interests in the entity, which owns the Pennmark, a 24-story apartment and retail development. This property is encumbered with an $111,000 first mortgage. (6) Represents a $12,000 mezzanine construction loan, secured by a second mortgage and 100% pledge of partnership interests. Borrower paid a current interest rate of 12% with the remaining 10% paid at maturity. The Company's remaining commitment of $545 was paid on July 18, 2003. (7) Represents a subordinate interest in a $43,000 note secured by three apartment properties located in Corpus Christi and Houston, Texas and a $6,000 mezzanine loan, secured by the borrower's interest in the same properties. (8) Interest payments on the loan are based upon a spread to 30-day LIBOR, subject to a floor of 2.5% on the first $20,250 of original par. (9) Represents a $13,640 mezzanine construction loan, secured by a 100% pledge of partnership interests. The loan may be extended at the borrower's option for one additional twelve-month period for a fee of 1%. Borrower pays a current interest rate of 12% with the remaining 6% plus $354 payable at maturity. (10) May be extended at the borrower's option for three additional twelve-month periods, subject to certain compliance hurdles. (11) Represents a $14,500 mezzanine loan for the acquisition and condominium conversion of a 389-unit rental apartment community in suburban Baltimore, secured by a 100% pledge of partnership interests in the property. The loan may be extended at the borrower's option for one additional twelve-month period and one additional six-month period for a fee of .50%. Borrower pays a current interest rate of 12% with the remaining 8% payable at maturity. (12) Prime Outlets is a $26,000 junior participation in a $336,000 first mortgage, secured by nine retail outlet properties with 3.1 million square feet, located in seven states. The loan may be extended at the borrower's option for three additional twelve-month periods. An extension fee of .125% is due for the second and third extensions. (13) Represents a $10,000 B-Note secured by a subordinate interest in a first mortgage on a 629,000 square foot regional mall located in suburban Baltimore. (14) Represents a $10,171 mezzanine loan for borrower's acquisition of a 14-property self-storage portfolio located in California (10 properties), Phoenix (3 properties), and Las Vegas (1 property). Borrower pays a current interest of 12% with the remaining 4% payable at maturity. The Borrower invested 10% of project costs and has arranged first mortgage and mezzanine loans totaling 90% of total acquisition cost. (15) Represents a subordinate participation in a $40,450 first mortgage loan, secured by a 396-unit condominium conversion project located in Palm Harbor, Florida. In addition to interest, borrower is required to pay a release fee of approximately $1 per unit. Release fees are included in interest income. (16) Represents a $17,800 subordinate interest in a first mortgage note secured by retail and parking components of River East Center, a large mixed-use development in downtown Chicago and a $14,000 mezzanine loan, secured by the borrower's interest in the same property. May be extended at the borrower's option for three additional twelve-month periods, subject to certain performance hurdles, and an extension fee on second and third extension of the mezzanine loan. (17) Represents a subordinate interest in a $45,000 note, secured by a first mortgage on the 286,775 square foot office complex in Roseville, California. (18) Represents a subordinate participation in a $57,300 first mortgage loan, secured by a 300-unit condominium conversion project located in Miami, Florida. In addition to interest, borrower is required to pay a release fee of approximately $3 per unit. If the loan is prepaid prior to the sale of all of the units or if the property is not converted, borrower is required to pay an exit fee of $476. Release fees are included in interest income. (19) Represents a subordinate participation in a $74,000 note, secured by a 327-unit rental apartment community in Vienna, Virginia. In addition to interest, borrower is required to pay a release fee of $6 at the time of sale of each unit until 2.75% of the first mortgage has been paid. The total release fee will be adjusted until it equals 2.25% of the first mortgage if the Loan is repaid 20 months prior to the Maturity and reduced to 2.50% if the Loan is repaid 1 year prior to the Maturity. (20) Represents a $15,000 mezzanine loan, secured by the borrower's interest in a 30-story office tower in Indianapolis, Indiana. (21) Represents a junior participation interest in an $82,000 first mortgage, secured by a 17-story class B office building in the Penn Plaza/Garment district of New York, NY. (22) The LIBOR floor component of these loans has been bifurcated from the loans, classified as prepaid and other assets on the balance sheet, with subsequent changes in fair value included in the statement of operations. The bifurcation causes an additional discount on the loan, which is then amortized over the loan's expected maturity using the effective interest method. The loss on LIBOR floors for all the Company's loans was $1,892 for the year ended December 31, 2004. (23) Represents a mezzanine loan secured by a 100% pledge of partnership interests in the entity that owns 10/Ten Post Office Square, a 437 square foot, multi-tenant office building, located in the Boston financial district. (24) The Westbrook Portfolio represents a senior mezzanine loan secured by a pledge of partnership interests in the entity that owns a portfolio of 18 office properties primarily concentrated in and around Kansas City, Orlando and Denver. (25) May be extended at the borrower's option for two additional twelve-month periods, subject to certain performance hurdles. (26) Represents a subordinate interest in a $43,500 first mortgage note, secured by a 264 square foot office building leased primarily to the General Services Administration (GSA). (27) Represents mezzanine loans secured by 100% pledge of partnership interests in the entity that owns a portfolio of ten apartment complexes located primarily in Los Angeles, California, Birmingham, Alabama, and Dallas, Texas. May be extended at the borrower's option for two additional twelve-month periods and one additional eleven-month term, subject to certain performance hurdles and fees for the second and third extensions. (28) Represents a junior participation in an $802,500 first mortgage note secured by an 80-property, 24,165-unit apartment portfolio located primarily in the Southeastern and Southwestern United States. (29) Represents a junior participation interest in a 75.000 mezzanine loan secured by a pledge of equity interests in the owner of the Desert Passage, a themed retail and entertainment complex and parking garage, adjacent to the Aladdin Hotel and Casino on Las Vegas Boulevard ("The Strip") in Las Vegas, Nevada. (30) May be extended for three additional twelve-month periods, subject to certain performance hurdles and a fee for each extension. (31) Represents a subordinate interest in a $146,200 note secured by a 1,198-unit apartment property expected to be converted to condominiums. In addition to interest, the borrower is required to pay a release fee of approximately $2 per unit. If the conversion does not occur, an additional 3% fee will be due at maturity. (32) Represents a subordinate interest in a $79,200 note secured by a 392-unit apartment complex expected to be converted to condominiums. In addition to interest, the borrower is required to pay an exit fee to be paid at the earlier of maturity or $3 per unit upon sale. Combined summarized financial information of the unconsolidated equity investments and real estate joint ventures of the Company is as follows:
December 31, ------------------------------------------- 2004 2003 ------------------ --------------------- Combined Balance Sheets: Real estate property $31,163 $46,547 Commercial mortgage loans, net 518,908 225,636 Other assets 21,235 18,709 ------------------ --------------------- Total Assets $571,306 $290,892 ================== ===================== Mortgage debt $15,977 $30,536 Other liabilities 259,313 102,438 Partners', members' and stockholders' equity 296,016 157,918 ------------------ --------------------- Total liabilities, partners', members', and stockholders' equity $571,306 $290,892 ================== ===================== Anthracite Capital, Inc.'s share of equity $61,843 $36,316 ================== ===================== For the years ended December 31, ------------------------------------------- 2004 2003 2002 ----------- ------------ ------------ Combined Statements of Operations: Revenues $49,107 $30,767 $19,901 ----------- ------------ ------------ Expenses Interest expense 7,731 7,043 4,877 Depreciation and amortization 1,274 1,824 2,203 Operating expenses 6,752 5,711 5,611 ----------- ------------ ------------ Total expenses 15,757 14,578 12,691 ----------- ------------ ------------ Net Income $33,350 $16,189 7,210 =========== ============ ============ The Company's share of net income $8,157 $4,322 $2,246 =========== ============ ============
Note 8 FAIR VALUE OF FINANCIAL INSTRUMENTS SFAS No. 107, "Disclosures about Fair Value of Financial Instruments" ("SFAS No. 107"), requires the disclosure of the estimated fair value of financial instruments. The following table presents the notional amount, carrying value and estimated fair value of financial instruments as of December 31, 2004 and 2003:
2004 2003 ---------------------------------------------- --------------------------------------------- Notional Carrying Estimated Notional Carrying Estimated Amount Value Fair Value Amount Value Fair Value ---------------------------------------------- --------------------------------------------- Securities available-for-sale $ - $1,763,093 $1,763,093 $ - $1,806,000 $1,806,000 Securities held-for-trading - 232,918 232,918 - 313,727 313,727 Commercial mortgage loans - 268,086 268,086 - 61,668 61,668 Secured borrowings - 804,351 804,351 - 1,138,571 1,138,571 CDO borrowings - 1,067,967 1,079,243 - 684,970 696,195 Commercial mortgage loan pool borrowings - 1,294,058 1,294,058 - - - Currency forward contracts - (25,807) (25,807) - - - Interest rate swap agreements 1,410,165 (10,869) (10,869) 1,545,623 (26,352) (26,352) Futures - - - 103 (11,436) (11,436)
Notional amounts are a unit of measure specified in a derivative instrument. The fair values of the Company's securities available-for-sale, securities held-for-trading, currency forward contracts and interest rate swap agreements are based on market prices provided by certain dealers who make markets in these financial instruments. The fair values reported reflect estimates and may not necessarily be indicative of the amounts the Company could realize in a current market exchange. Commercial mortgage loans and secured borrowings are floating rate instruments, and based on these terms their carrying value approximates fair value. Note 9 IMPAIRMENTS - CMBS In 2001, the Company adopted the rules contained in EITF 99-20, These rules require the Company to update its estimated cash flows for its non-investment grade securities and compare the net present value of these cash flows to the adjusted purchase price. The Company complies with EITF 99-20 by comparing the yields resulting from the updated cash flows to the current accrual yields. An impairment charge is required under EITF 99-20 if the updated yield is lower than the current accrual yield and the security has a market value less than its adjusted purchase price. The Company carries all these securities at their market value on its consolidated statement of financial condition. The Company's portfolio has six 1998 vintage CMBS securities in four separate CMBS transactions that required impairment charges at December 31, 2004 following the application of EITF 99-20. As a result, the Company recorded a loss on impairment of assets of $26,018 in the fourth quarter of 2004. A variety of factors influence updated yields for these securities including magnitude of credit loss, timing of credit loss, prepayments and servicer advances. The Company completed a re-evaluation of credit assumptions of its 1998 vintage CMBS portfolio in the fourth quarter of 2004. The magnitude of credit losses did not significantly change as a result of this process, as total loss expectations on the underlying loans moved from 2.06% to 2.04%. Changes in the timing of credit losses and prepayments caused updated yields on these securities to decline by a weighted average of 66 basis points. Market dislocations in 1998 caused disproportionate unrealized losses in market value on these securities based on price quotes received from third parties. The Company had recorded these unrealized losses as other comprehensive loss on its consolidated statement of financial condition since that time. Based on current economic conditions and updated credit assumptions, the Company believes these 1998 vintage CMBS securities will be repaid in full and that the impairment charge of $25,355 with respect to five of the six securities will be reflected in income over the remaining life of the bonds. In addition, the Company increased underlying loan loss expectations on one non-rated security resulting in an impairment charge of $663. During 2003, the Company performed an analysis of its current underlying loan loss expectations and credit performance of its 1998 vintage Controlling Class CMBS. The Company increased underlying loan loss expectations on four securities from three 1998 vintage CMBS transactions. As a result of the increase in loss expectations, the Company recorded an impairment charge of $27,014 during the second quarter of 2003, to reduce the amortized cost of these securities to their fair value. The $27,014 impairment charge is comprised of $19,217 related to the non-rated and CCC rated classes of CMAC 98-C2, $5,573 related to LBCMT 98-C1, and $2,224 related to GMAC 98-C1. Three of the four impaired securities are not rated and the fourth security is rated CCC by Fitch Ratings. Securities that are not rated are highly sensitive to changes in the timing of losses recognized on the underlying loans. Based on the delinquencies and defaults in the underlying pools, and missed payments during the fourth quarter of 2002, the Company revised its estimated future cash flows from its investment in FMACT 1998-BA class B security. Accordingly, as of December 31, 2002, the Company determined that its investment was impaired and wrote down the adjusted purchase price of this security by $10,273 to its estimated fair value and increased the security's yield from 7.69% to a market yield for a security of this credit quality, estimated to be 20%. These figures incorporate the assumption that the underlying loan pools and an estimate of another 1.0% of losses per year will experience an additional $31,203 of losses over the remaining life of the trust. This security was part of the CORE Cap acquisition in May of 2000 and was rated AA at that time. The most recent rating of this security was CC by Fitch Ratings was in December 2002. During the third quarter of 2003, the Company determined it is unlikely that further payments will be received from the FMACT 1998-BA class B security and wrote this security down to zero, despite the servicer reporting a par balance of $16,366 as of September 30, 2003. As a result, the Company recorded an impairment charge during the quarter of $5,412. Note 10 COMMON STOCK For the year ended December 31, 2004, the Company issued 1,084,619 shares of Common Stock under its Dividend Reinvestment Plan. Net proceeds to the Company were approximately $12,691. For the year ended December 31, 2003, the Company issued 1,955,919 shares of Common Stock under its Dividend Reinvestment Plan. Net proceeds to the Company were approximately $21,134. For the year ended December 31, 2002, the Company issued 1,455,725 shares of Common Stock under its Dividend Reinvestment Plan. Net proceeds to the Company were approximately $15,920. During the year ended December 31, 2004, the Company declared dividends to stockholders totaling $58,208 or $1.12 per share, of which $43,287 was paid during the year and $14,921 was paid on February 1, 2005. During the year ended December 31, 2003, the Company declared dividends to stockholders totaling $61,088 or $1.26 per share, of which $47,238 was paid during the year and $13,850 was paid on February 2, 2004. During the year ended December 31, 2002, the Company declared dividends to stockholders totaling $65,366 or $1.40 per share, of which $48,777 was paid during the year and $16,589 was paid on January 31, 2003. For the year ended December 31, 2004 and 2003, respectively, the Company issued 294,400 and 45,000 shares of Common Stock under a sale agency agreement with Brinson Patrick Securities Corporation. Net proceeds to the Company were approximately $3,210 and $497, respectively. For the year ended December 31, 2003, the Company issued 45,000 shares of Common Stock under a sale agency agreement with Brinson Patrick Securities Corporation. Net proceeds to the Company were approximately $497. All Common Stock dividends paid by the Company during 2004 are 100% ordinary income. The following chart details the estimated tax characterization of the Company's Common Stock dividends with March 31, 2003, June 30, 2003, and September 30, 2003 record dates. Cash Taxable Non-taxable Record Payable Distribution Ordinary Return of Date Date Per Share Dividend Capital - -------------------------------------------------------------------------- 3/31/03 4/30/03 $0.3500 $0.3344 $0.0156 6/30/03 7/31/03 $0.3500 $0.3344 $0.0156 9/30/03 10/31/03 $0.2800 $0.2675 $0.0125 ------------------------------------------------ Total $0.9800 $0.9363 $0.0437 During the first quarter of 2004, the Company suspended its Dividend Reinvestment Plan for all investments after March 26, 2004, and for all future investment dates. During the second quarter of 2004, the dividend reinvestment portion of the Dividend Reinvestment Plan was reinstated for all dividend payments made after August 2, 2004, and for all future dividend payment dates with a discount of 2%. The optional cash purchase portion of the Dividend Reinvestment Plan remains suspended; however, it may be resumed at any time. On June 30, 2004, the Company completed a follow-on offering of 2,100,000 shares of its Common Stock in an underwritten public offering. The net proceeds to the Company (after deducting underwriting fees and expenses) were approximately $23,184. The Company had granted the underwriters an option, exercisable for 30 days, to purchase up to 315,000 additional shares of Common Stock to cover over-allotments. This option was exercised on July 6, 2004 and resulted in net proceeds to the Company of approximately $3,478. Note 11 PREFERRED STOCK At the end of the first quarter of 2004, the Board of Directors approved the Company's decision to redeem its Series B Preferred Stock, $0.001 par value per share ("Series B Preferred Stock"). The second quarter of 2004 earnings includes a charge of $0.21 per share for the redemption of the Company's Series B Preferred Stock. The Series B Preferred Stock was redeemed on May 6, 2004. On May 29, 2003, the Company authorized and issued 2,300,000 shares of Series C Preferred Stock, including 300,000 shares of Series C Preferred Stock issued pursuant to an option granted to the underwriters to cover over-allotments. The Series C Preferred Stock is perpetual, carries a 9.375% coupon and has a preference in liquidation of $57,500. The aggregate net proceeds to the Company (after deducting underwriting fees and expenses) were approximately $55,435. As part of the CORE Cap merger, the Company authorized and issued 2,261,000 shares of Series B Preferred Stock, $0.001 par value per share, to CORE Cap stockholders. The Series B Preferred Stock was perpetual, carries a 10% coupon, has a preference in liquidation as of December 31, 2003 of $43,942, and is convertible into the Company's Common Stock at a price of $17.09 per share, subject to adjustment. If converted, the Series B Preferred Stock would convert into approximately 2,571,423 shares of the Company's Common Stock. On May 29, 2003, the Company redeemed 155,000 shares at its liquidation value of $25 per share. In 2002, 300,000 shares of 10% Series B Preferred Stock with a liquidation preference of $7,500 were converted at the stockholder's option into 438,885 shares of the Company's Common stock. As of December 31, 2004, the Company has authorized and un-issued 94,394,003 shares of preferred stock. All Series B Preferred Stock dividends paid by the Company during 2004 are 100% ordinary income. The following chart details the estimated tax characterization of the Company's Series B Preferred Stock dividends with March 15, 2003, June 15, 2003, September 15, 2003, and December 15, 2003 record dates. Cash Taxable Non-taxable Record Payable Distribution Ordinary Return of Date Date Per Share Dividend Capital - -------------------------------------------------------------------------- 3/15/03 3/31/03 $0.6250 $0.5963 $0.0287 6/15/03 6/30/03 0.6250 0.5963 0.0287 9/15/03 9/30/03 0.6250 0.5963 0.0287 12/15/03 12/31/03 0.6250 0.5963 0.0287 ------------------------------------------------- Total $2.5000 $2.3853 $0.1147 The following chart details the estimated tax characterization of the Company's Series C Preferred Stock dividends with July 15, 2003 and October 10, 2003 record dates. All other Series C Preferred Stock dividends that have been paid by the Company are 100% ordinary income. Cash Taxable Non-taxable Record Payable Distribution Ordinary Return of Date Date Per Share Dividend Capital - -------------------------------------------------------------------------- 7/15/03 7/31/03 $0.4100 $0.3556 $0.0544 10/10/03 10/31/03 0.5860 0.5083 0.0777 ------------------------------------------------- Total $0.9960 $0.8639 $0.1321 Note 12 TRANSACTIONS WITH AFFILIATES The Company has a Management Agreement with the Manager, a majority owned indirect subsidiary of The PNC Financial Services Group, Inc. and the employer of certain directors and officers of the Company, under which the Manager manages the Company's day-to-day operations, subject to the direction and oversight of the Company's Board of Directors. On March 25, 2002, the Management Agreement was extended for one year through March 27, 2003, with the approval of the unaffiliated directors, on terms similar to the prior agreement with the following changes: (i) the incentive fee calculation would be based on GAAP earnings instead of funds from operations, (ii) the removal of the four-year period to value the Management Agreement in the event of termination and (iii) subsequent renewal periods of the Management Agreement would be for one year instead of two years. Houlihan Lokey Howard & Zukin Financial Advisors, Inc., a national investment banking and financial advisory firm, advised the Board in the 2002 renewal process. On March 6, 2003, the unaffiliated directors approved an extension of the Management Agreement from its expiration of March 27, 2003 for one year through March 31, 2004. The terms of the renewed agreement were similar to the prior agreement except for the incentive fee calculation that would provide for a rolling four-quarter high watermark rather than a quarterly calculation. In determining the rolling four-quarter high watermark, the Company would calculate the incentive fee based upon the current and prior three quarters' net income. The Manager would be paid an incentive fee in the current quarter if the Yearly Incentive Fee, as defined, were greater than what was paid to the Manager in the prior three quarters cumulatively. The Company phased in the rolling four-quarter high watermark commencing with the second quarter of 2003. Calculation of the incentive fee was based on GAAP earnings and adjusted to exclude special one-time events pursuant to changes in GAAP accounting pronouncements after discussion between the Manager and the unaffiliated directors. The incentive fee threshold did not change. The high watermark provided for the Manager to be paid 25% of the amount of earnings (calculated in accordance with GAAP) per share that exceeds the product of the adjusted issue price of the Company's Common Stock per share and the greater of 9.5% or 350 basis points over the ten-year Treasury note. The Management Agreement was further extended for one year from March 31, 2004 through March 31, 2005. The base management fee was revised to equal 2% of the quarterly average total stockholders' equity for the applicable quarter. The incentive fee was revised to be 25% of the amount of earnings (calculated in accordance with GAAP) per share that exceeds the product of the adjusted issue price of the Company's Common Stock per share ($11.37 as of December 31, 2004) and the greater of 8.5% or 400 basis points over the ten-year Treasury note. On March 10, 2004, the members of the Company's Board of Directors who are not affiliated with the Manager approved an extension of the Company's management agreement with the Manager for one additional year through March 31, 2006. The terms of the extended agreement did not change. During the third quarter of 2003, the Manager agreed to reduce its management fees by 20% from its calculated amount for the third and fourth quarter of 2003 and the first quarter of 2004. This revision resulted in $1,046 in savings to the Company during 2003 and $532 during 2004, respectively. The Company incurred $8,956, $9,411, and $9,332 in base management fees in accordance with the terms of the Management Agreement for the years ended December 31, 2004, 2003 and 2002, respectively. In accordance with the provisions of the Management Agreement, the Company recorded reimbursements to the Manager of $120, $66, and $14 for certain expenses incurred on behalf of the Company during 2004, 2003 and 2002, respectively. The Company has an administration agreement with the Manager. Under the terms of the administration agreement, the Manager provides financial reporting, audit coordination and accounting oversight services to the Company. Either party can cancel the agreement upon 60-day written notice. The Company pays the Manager a monthly administrative fee at an annual rate of 0.06% of the first $125,000 of average net assets, 0.04% of the next $125,000 of average net assets and 0.03% of average net assets in excess of $250,000 subject to a minimum annual fee of $120. For the years ended December 31, 2004, 2003 and 2002, the Company paid administration fees of $174, $173, and $168, respectively. The special servicer on 11 of the Company's 16 Controlling Class trusts is Midland Loan Services, Inc. ("Midland"), a wholly owned indirect subsidiary of PNC Bank. The Company's fees for Midland's services are at market rates. In March 2001, the Company purchased twelve certificates each representing a 1% interest in different classes of Owner Trust NS I Trust ("Owner Trusts") for an aggregate investment of $37,868. These certificates were purchased from PNC Bank. The assets of the Owner Trusts consist of commercial mortgage loans originated or acquired by an affiliate of PNC Bank. The Company entered into a $50,000 committed line of credit from PNC Funding Corp. to borrow up to 95% of the fair market value of the Company's interest in the Owner Trusts. Outstanding borrowings against this line of credit bear interest at a LIBOR based variable rate. As of December 31, 2001, there was $13,885 borrowed under this line of credit. The Company earned $1,468 from the Owner Trusts and paid interest of approximately $849 to PNC Funding Corp. as interest on borrowings under a related line of credit for year ended December 31, 2001. During 2001, the Company sold four Owner Trusts. The gain on the sale of those Owner Trusts was $35. The outstanding borrowings were repaid prior to the expiration on March 13, 2002, at which time the remaining Owner Trusts were sold at a gain of $90. During 2001, the Company entered into a $50,000 commitment to acquire shares in Carbon I, a private commercial real estate income opportunity fund managed by the Manager. The Carbon I investment period ended on July 12, 2004 and the Company's investment in Carbon I as of December 31, 2004 was $39,563. The Company does not incur any additional management or incentive fees to the Manager as a result of its investment in Carbon I. On December 31, 2004, the Company owned approximately 20% of the outstanding shares in Carbon I. On October 13, 2004, the Company entered into a commitment of up to $30,000 to acquire shares in Carbon II, a private commercial real estate income opportunity fund managed by the Manager. On November 19, 2004 the Company entered into an additional $32,067 commitment to acquire shares in Carbon II. During 2004, the Company received capital call notices of $16,953. As of December 31, 2004, the Company's investment in Carbon II was $17,249 and the Company's remaining commitment to Carbon II is $45,114. The Company may commit up to the lower of 20% of the total of Carbon II's capital commitments or $100,000. The Company may commit up to the lower of 20% of the total of Carbon II's capital commitments or $100,000. The Company does not incur any additional management or incentive fees to the Manager as a result of its investment in Carbon II. The Company's unaffiliated directors approved this transaction in September of 2004. During 2000, the Company completed the acquisition of CORE Cap, Inc. The merger was a stock for stock acquisition where the Company issued 4,180,552 shares of its common stock and 2,261,000 shares of its Series B preferred stock. At the time of the CORE Cap acquisition, the Manager agreed to pay GMAC (CORE Cap, Inc.'s external advisor) $12,500 over a ten-year period ("Installment Payment") to purchase the right to manage the assets under the existing management contract ("GMAC Contract"). The GMAC Contract had to be terminated in order to allow for the Company to complete the merger, as the Company's management agreement with the Manager did not provide for multiple managers. As a result the Manager offered to buy-out the GMAC Contract as the Manager estimated it would receive incremental fees above and beyond the Installment Payment, and thus was willing to pay for, and separately negotiate, the termination of the GMAC Contract. Accordingly, the value of the Installment Payment was not considered in the Company's allocation of its purchase price to the net assets acquired in the acquisition of CORE Cap, Inc. The Company agreed that should the Management Agreement with its Manager be terminated, not renewed or not extended for any reason other than for cause, the Company would pay to the Manager an amount equal to the Installment Payment less the sum of all payments made by the Manager to GMAC. As of December 31, 2004, the Installment Payment would be $6,500 payable over six years. The Company does not accrue for this contingent liability. Note 13 STOCK OPTIONS The Company has adopted a stock option plan (the "1998 Stock Option Plan") that provides for the grant of both qualified incentive stock options that meet the requirements of Section 422 of the Code and non-qualified stock options, stock appreciation rights and dividend equivalent rights. Stock options may be granted to the Manager, directors, officers and any key employees of the Company, directors, officers and key employees of the Manager and to any other individual or entity performing services for the Company. The exercise price for any stock option granted under the 1998 Stock Option Plan may not be less than 100% of the fair market value of the shares of Common Stock at the time the option is granted. Each option must terminate no more than ten years from the date it is granted and have vested over either a two or three-year period. Subject to anti-dilution provisions for stock splits, stock dividends and similar events, the 1998 Stock Option Plan authorizes the grant of options to purchase up to an aggregate of 2,470,453 shares of Common Stock. On May 25, 2004, the Company granted stock options to each of its unaffiliated directors with an exercise price equal to the closing price of the Common Stock on the New York Stock Exchange on such date (or $11.81). The options vested immediately upon grant. The fair value of the options granted is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions. May 25, 2004 ------------------ Estimated volatility 22.6% Expected life 7 years Risk-free interest rate 1.2% Expected dividend yield 9.5% The fair value of the options granted on May 25, 2004 was negligible. There were no options granted in 2003. The following table summarizes information about options outstanding under the 1998 Stock Option Plan:
2004 2003 2002 ------------------------ ------------------------- --------------------------- Weighted- Weighted- Weighted- Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price ------------ ----------- ------------ ------------ -------------- ------------ Outstanding at January 1 1,468,351 $ 14.75 1,560,542 $ 14.49 1,766,341 $ 11.87 Granted 5,000 11.81 - - - - Exercised (30,000) 8.44 (65,400) 8.45 (182,700) 8.33 Cancelled (25,500) 15.00 (26,791) 15.00 (23,099) 15.63 Outstanding at December 31 1,417,851 $ 14.87 1,468,351 $ 14.75 1,560,542 $ 14.49 ============ ============ ============== Options exercisable at December 31 1,417,851 $ 14.87 1,468,351 $ 14.75 1,560,542 $ 14.49 ============ ============ ==============
The following table summarizes information about options outstanding under the 1998 Stock Option Plan at December 31, 2004: Options Remaining Options Outstanding at Contractual Life Exercisable at Exercise Price December 31, 2004 (Years) December 31, 2004 - ------------------------------------------------------------------------------- $ 7.82 3,850 5.1 3,850 8.44 25,000 4.2 25,000 9.11 3,850 4.2 3,850 11.81 5,000 9.4 5,000 15.00 1,310,851 3.2 1,310,851 15.58 57,750 2.7 57,750 15.83 11,550 3.2 11,550 - ------------------------------------------------------------------------------- $7.82-$15.83 1,417,851 3.3 1,417,851 =============================================================================== Shares of Common Stock available for future grant under the 1998 Stock Option Plan at December 31, 2004 were 774,502. Note 14 BORROWINGS The Company's borrowings consist of lines of credit, CDOs, commercial mortgage loan pools and reverse repurchase borrowings. The Company has a $200,000 committed credit facility with Deutsche Bank, AG (the "Deutsche Bank Facility") that matures December 20, 2007. The Deutsche Bank Facility can be used to replace existing reverse repurchase agreement borrowings and to finance the acquisition of mortgage-backed securities, loan investments and investments in real estate joint ventures. As of December 31, 2004 and 2003, the outstanding borrowings under this facility were $126,349 and $82,406, respectively. Outstanding borrowings under the Deutsche Bank Facility bear interest at a LIBOR based variable rate. On July 18, 2002, the Company entered into a $75,000 committed credit facility with Greenwich Capital, Inc. The facility provides the Company with the ability to borrow only through July 17, 2004 with the repayment of principal not due until July 7, 2005. Outstanding borrowings under this credit facility bear interest at a LIBOR based variable rate. As of December 31, 2004, outstanding borrowings under this facility were $24,527. As of December 31, 2003, outstanding borrowings under this facility were $7,530. At December 31, 2004, the Company had outstanding borrowings of $12,800 under a $13,000 committed credit facility with Morgan Stanley Mortgage Capital, Inc. The Morgan Stanley Mortgage Capital, Inc. facility matures May 11, 2006. The Company is subject to various covenants in its lines of credit, including maintaining a minimum net worth measured on GAAP of $305,000, a debt-to-equity ratio not to exceed 5.5 to 1, a recourse debt-to-equity of 3.0 to 1, a minimum cash requirement based upon certain debt-to-equity ratios, a minimum debt service coverage ratio of 1.5 and a minimum liquidity reserve of $10,000. The Company received authorization from its lenders to permit debt to equity ratios in excess of existing covenants and a debt service coverage ratio less than 1.5. As of December 31, 2004 and 2003, the Company was in compliance with all other covenants. On May 29, 2002, the Company issued ten tranches of secured debt through CDO I. In this transaction, a wholly owned subsidiary of the Company issued secured debt in the par amount of $419,185 secured by the subsidiary's assets. The adjusted issue price of the CDO I debt, as of December 31, 2004, is $405,377. Five tranches were issued at a fixed rate coupon and five tranches were issued at a floating rate coupon with a combined weighted average remaining maturity of 7.29 years as of December 31, 2004. All floating rate coupons were swapped to fixed rate coupons resulting in a total fixed rate cost of funds for CDO I of approximately 7.21%. The Company incurred $9,890 of issuance costs that will be amortized over the weighted average life of the CDO. The CDO was structured to match fund the cash flows from a significant portion of the Company's CMBS and unsecured real estate investment trust debt portfolio (REIT debt). The par amount as of December 31, 2004 of the collateral securing CDO I consists of 78% CMBS rated B or higher and 22% REIT debt rated BBB or higher. As of December 31, 2004, the collateral securing CDO I has a fair value of $475,157. On December 10, 2002, the Company issued seven tranches of secured debt through CDO II. In this transaction, a wholly owned subsidiary of the Company issued secured debt in the par amount of $280,783 secured by the subsidiary's assets. In July 2004, the Company issued a bond with a par of $12,850 from its CDO II. Before issuing this security, the Company amended the indenture to reduce the coupon from 9.0% to 7.6%. The adjusted issue price of the CDO II debt as of December 31, 2004 is $293,167. Five tranches were issued at a fixed rate coupon and three tranches were issued at a floating rate coupon with a combined weighted average remaining maturity of 7.72 years as of December 31, 2004. All floating rate coupons were swapped to fixed rate coupons resulting in a total fixed rate cost of funds for CDO II of approximately 5.79%. The Company incurred $6,004 of issuance costs that will be amortized over the weighted average life of the CDO. The CDO was structured to match fund the cash flows from a significant portion of the Company's CMBS and unsecured real estate investment trust debt portfolio (REIT debt). The par amount as of December 31, 2004 of the collateral securing CDO II consists of 84% CMBS rated B or higher and 16% REIT debt rated BBB or higher. As of December 31, 2004, the collateral securing CDO II has a fair value of $340,686. On March 30, 2004 the Company issued its third collateralized debt obligation ("CDO III") through Anthracite CDO 2004-1. The total par value of bonds sold was $372,456. The adjusted issue price of the CDO III debt, as of December 31, 2004, is $369,422. Five tranches were issued at a fixed rate coupon and six tranches were issued at a floating rate coupon with a combined weighted average remaining maturity of 8.39 years as of December 31, 2004. All floating rate coupons were swapped to fixed rate coupons resulting in a total fixed rate cost of funds for CDO I of approximately 5.03%. The Company incurred $2,006 of issuance costs that will be amortized over the weighted average life of the CDO. The CDO was structured to match fund the cash flows from a significant portion of the Company's CMBS and unsecured real estate investment trust debt portfolio (REIT debt). The par amount as of December 31, 2004 of the collateral securing CDO III consists of 88% CMBS rated B or higher and 12% REIT debt rated BBB or higher. As of December 31, 2004, the collateral securing CDO II has a fair value of $386,916. Proceeds from the CDOs were used to pay off all of the financing of the Company's CMBS below investment grade portfolio, BBB portfolio and its REIT debt. Prior to the CDOs, these portfolios were financed with thirty-day repurchase agreements with various counterparties that marked the assets to market on a daily basis at interest rates based on 30-day LIBOR. For accounting purposes, these transactions were treated as a secured financing, and the debt is non-recourse to the Company. The Company has entered into reverse repurchase agreements to finance most of its securities available-for-sale that are not financed under its lines of credit or from the issuance of its collateralized debt obligations. The reverse repurchase agreements are collateralized by most of the Company's securities available-for-sale and bear interest at a LIBOR based variable rate. Certain information with respect to the Company's collateralized borrowings as of December 31, 2004 is summarized as follows:
Lines of Reverse Commercial Collateralized Total Credit and Repurchase Mortgage Loan Debt Collateralized Term Loans Agreements Pools Obligations Borrowings ------------------------------------------------------------------------------------------ Outstanding borrowings $163,676 $640,675 $1,294,058 $1,067,967 $3,166,376 Weighted average borrowing rate 3.52% 2.47% 3.76% 6.07% 4.27% Weighted average remaining maturity 218 days 26 days 2,587 days 2,936 days 2,064 days Estimated fair value of assets pledged $222,122 $701,913 $1,312,045 $1,202,760 $3,438,839
As of December 31, 2004, the Company's collateralized borrowings had the following remaining maturities:
Reverse Commercial Collateralized Total Lines of Repurchase Mortgage Debt Collateralized Credit Agreements Loan Pools Obligations* Borrowings -------------------------------------------------------------------------------------- Within 30 days $- $605,944 $- $- $605,944 31 to 59 days - 7,925 - - 7,925 60 days to less than 1 year 150,876 26,806 - - 177,682 1 year to 3 years 12,800 - - - 12,800 3 years to 5 years - - - - - Over 5 years - - 1,294,058 1,067,967 2,362,025 -------------------------------------------------------------------------------------- $163,676 $640,675 $1,294,058 $1,067,967 $3,166,376 ======================================================================================
* Comprised of $405,377 of CDO debt with a weighted average remaining maturity of 7.29 years as of December 31, 2004 and $293,167 of CDO debt with a weighted average remaining maturity of 7.72 years as of December 31, 2004, and $369,422 of CDO debt with a weighted average remaining maturity of 8.39 years as of December 31, 2004. Certain information with respect to the Company's collateralized borrowings as of December 31, 2003 is summarized as follows:
Lines of Reverse Collateralized Total Credit and Repurchase Debt Collateralized Term Loans Agreements Obligations Borrowings ----------------------------------------------------------------------------- Outstanding borrowings $89,936 $1,048,635 $684,970 $1,823,541 Weighted average borrowing rate 2.40% 1.24% 6.60% 3.31% Weighted average remaining maturity 484 days 21 days 3,033 days 1,175 days Estimated fair value of assets pledged $146,608 $1,137,539 $770,575 $2,054,722
As of December 31, 2003, the Company's collateralized borrowings had the following remaining maturities:
Total Lines of Reverse Repurchase Collateralized Collateralized Credit Agreements Debt Obligations Borrowings ----------------------------------------------------------------------------- Within 30 days $ - $1,048,635 $ - $1,048,635 31 to 59 days - - - - 60 days to less than 1 year 15,180 - - 15,180 1 year to 2 years 74,756 - - 74,756 3 years to 5 years - - - - Over 5 years - - 684,970* 684,970 ----------------------------------------------------------------------------- $89,936 $1,048,635 $684,970 $1,823,541 =============================================================================
* Comprised of $404,637 of CDO debt with a weighted average remaining maturity of 8.29 years as of December 31, 2003 and $280,333 of CDO debt with a weighted average remaining maturity of 8.34 years as of December 31, 2003. Under the lines of credit and the reverse repurchase agreements, the respective lender retains the right to mark the underlying collateral to estimated market value. A reduction in the value of pledged assets would require the Company to provide additional collateral or fund margin calls. From time to time, the Company may be required to provide additional collateral or fund margin calls. Note 15 DERIVATIVE INSTRUMENTS Effective January 1, 2001, the Company adopted SFAS No. 133, as amended and interpreted, which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities. All derivatives, whether designated in hedging relationships or not, are required to be recorded on the balance sheet at fair value. If the derivative is designated as a fair value hedge, the changes in the fair value of the derivative and of the hedged item attributable to the hedged risk are recognized in earnings. If the derivative is designated as a cash flow hedge, the effective portions of change in the fair value of the derivative are recorded in other comprehensive income ("OCI") and are recognized in the income statement when the hedged item affects earnings. Ineffective portions of changes in the fair value of cash flow hedges are recognized in earnings. For those swaps designated as cash flow hedges, the Company will maintain variable rate debt equal to or greater than the notional of the outstanding cash flow hedges. Ineffective portions of charges in the fair value of cash flow hedges are recognized in earnings. The Company uses interest rate swaps to manage exposure to variable cash flows on portions of its borrowings under reverse repurchase agreements and as trading derivatives intended to offset changes in fair value related to securities held as trading assets. On the date in which the derivative contract is entered, the Company designates the derivative as either a cash flow hedge or a trading derivative. The reverse repurchase agreements bear interest at a LIBOR based variable rate. Increases in the LIBOR rate could negatively impact earnings. The interest rate swap agreements allow the Company to receive a variable rate cash flow based on LIBOR and pay a fixed rate cash flow, mitigating the impact of this exposure. Interest rate swap agreements contain an element of risk in the event that the counterparties to the agreements do not perform their obligations under the agreements. The Company minimizes its risk exposure by entering into agreements with parties rated at least A or better by Standard & Poor's Rating Services. Furthermore, the Company has interest rate swap agreements established with several different counterparties in order to reduce the risk of credit exposure to any one counterparty. Management does not expect any counterparty to default on their obligations. As of December 31, 2004, the counterparties for the Company's swaps are Deutsche Bank, AG, Merrill Lynch Capital Services, Inc., Goldman Sachs Capital Markets, L.P., Lehman Special Financing Inc., and Societe Generale with ratings of AA-, A+, A+, A, and AA-, respectively. The Company continually monitors the rating and overall credit quality of its swap counterparties. On July 6, 2004, interest rate swaps with a notional of $264,000 classified as trading derivatives were re-designated as cash flow hedges of borrowings under reverse repurchase agreements. The reclassification was based on the Company's intent with respect to these derivatives with the principle objective of generating returns from other than short-term pricing differences. As of December 31, 2004, the Company had interest rate swaps that were designated as cash flow hedges of borrowings under reverse repurchase agreements. Cash flow hedges with a fair value of $10,252 are included in other assets on the consolidated statement of financial condition and cash flow hedges with a fair value of $(21,261) are included in other liabilities on the consolidated statement of financial condition. This liability was collateralized with the restricted cash equivalents recorded on the Company's consolidated statement of financial condition. For the year ended December 31, 2004, the fair value of the interest rate swaps decreased by $2,793 of which $1,015 was deemed ineffective and is included as an addition of interest expense, $1,078 was recorded as an increase of OCI and $2,856 was included as an addition to loss on trading securities due to a period of ineffectiveness. The Company expects that $1,038 currently recorded as a component of OCI will be recognized in earnings in the next twelve months as the hedged forecasted transactions occur. As of December 31, 2004, the $1,170,720 notional of swaps that were designated as cash flow hedges had a weighted average remaining term of 7.32 years. During the year ended December 31, 2004, the Company terminated fifteen of its interest rate swaps with a notional amount of $623,000 that were designated as cash flow hedges of borrowings under reverse repurchase agreements. The Company will reclassify from OCI as an increase to interest expense the $18,978 loss in value incurred, over 5.54 years, which was the weighted average remaining term of the swaps at the time they were closed out. For the year ended December 31, 2004, $2,016 was reclassified as an increase to interest expense and $2,471 will be reclassified as an increase to interest expense for the next 12 months. As of December 31, 2004, the Company had interest rate swaps with notional amounts aggregating $239,445 designated as trading derivatives. Trading derivatives with a fair value of $145 are included in other assets on the consolidated statement of financial condition and trading derivatives with a fair value of $(5) are included in other liabilities on the consolidated statement of financial condition. For the year ended December 31, 2004, the change in fair value for these trading derivatives was $(54) and is included as an addition to loss on securities held-for-trading in the consolidated statement of operations. As of December 31, 2004, the $239,445 notional of swaps, which were designated as trading derivatives, had a weighted average remaining term of 7.67 years. As of December 31, 2003, the Company had interest rate swaps that were designated as cash flow hedges of borrowings under reverse repurchase agreements. Cash flow hedges with a fair value of $2,759 are included in other assets on the consolidated statement of financial condition and cash flow hedges with a fair value of $(30,653) are included in other liabilities on the consolidated statement of financial condition. This liability was collateralized with the restricted cash equivalents recorded on the Company's consolidated statement of financial condition. For the year ended December 31, 2003, the fair value of the interest rate swaps increased by $13,180 of which $706 was deemed ineffective and is included as a reduction of interest expense. The remaining increase in fair value of $12,474 was recorded as a decrease to other comprehensive loss. As of December 31, 2003, the $1,066,078 notional of swaps, which were designated as cash flow hedges, had a weighted average remaining term of 7.4 years. During the year ended December 31, 2003, the Company terminated one of its interest rate swaps with a notional amount of $200,000 that was designated as a cash flow hedge of borrowings under reverse repurchase agreements. The Company will reclassify from OCI as an increase to interest expense the $1,593 loss in value incurred, over 1.9 years, which was the remaining term of the swap at the time it was closed out. For the year ended December 31, 2003, $476 was reclassified as an increase to interest expense and $212 was reclassified as an increase to interest expense each quarter for the next 12 months. As of December 31, 2003, the Company had interest rate swaps with notional amounts aggregating $479,545 designated as trading derivatives. Trading derivatives with a fair value of $1,591 are included in other assets on the consolidated statement of financial condition and trading derivatives with a fair value of $(49) are included in other liabilities on the consolidated statement of financial condition. For the year ended December 31, 2003, the change in fair value for these trading derivatives was $(714) and is included as an addition to loss on securities held-for-trading in the consolidated statement of operations. As of December 31, 2003, the $479,545 notional of swaps, which were designated as trading derivatives, had a weighted average remaining term of 5.2 years. The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk-management objectives and strategies for undertaking various hedge transactions. The Company assesses, both at the inception of the hedge and on an on-going basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items. When it is determined that a derivative is not highly effective as a hedge, the Company discontinues hedge accounting prospectively. Occasionally, counterparties will require the Company or the Company will require counterparties to provide collateral for the interest rate swap agreements in the form of margin deposits. Net deposits are recorded as a component of other assets or other liabilities. Should the counterparty fail to return deposits paid, the Company would be at risk for the fair market value of that asset. At December 31, 2004 and 2003, the balance of such net margin deposits owed to counterparties as collateral under these agreements totaled $4,680 and $10,445, respectively. The implementation of SFAS No. 133 did not change the manner in which the Company accounts for its forward currency exchange contracts. Hedge accounting is not applied for these contracts and they are carried at fair value, with changes in fair value included as a component of net foreign currency gain or loss in the consolidated statement of operations. The Company's foreign currency exchange contracts were intended to economically hedge currency risk in connection with the Company's investment in the London Loan, which was denominated in pounds sterling. The estimated fair value of the forward currency exchange contracts was a liability of $365 at December 31, 2002, which change was recognized as a reduction of foreign currency losses. As of December 31, 2003, the Company did not have economic exposure to its forward currency exchange contract. The contracts identified in the remaining portion of this footnote have been entered into to limit the Company's mark to market exposure to long-term interest rates. The Company had a forward LIBOR cap with a notional amount of $85,000 and a fair value at December 31, 2004 of $694 that is included in other assets. At December 31, 2003, the Company had outstanding short positions of 30 five-year and 73 ten-year U.S. Treasury Note future contracts, which represented $3,000 and $7,300 in face amounts of U.S. Treasury Notes, respectively. The estimated fair value of the contracts was approximately $(11,436), and the change in fair value related to these contracts is included as a component of loss on securities held-for-trading. Additionally, the Company had a forward LIBOR cap with a notional amount of $85,000 and a fair value at December 31, 2003 of $1,114 that is included in other assets. Note 16 NET INCOME PER SHARE Net income per share is computed in accordance with SFAS No. 128, "Earnings Per Share" ("SFAS No. 128"). Basic income per share is calculated by dividing net income available to common stockholders by the weighted average number of shares of Common Stock outstanding during the period. Diluted income per share is calculated using the weighted average number of shares of Common stock outstanding during the period plus the additional dilutive effect of common stock equivalents. The dilutive effect of outstanding stock options is calculated using the treasury stock method, and the dilutive effect of preferred stock is calculated using the "if converted" method.
For the year ended December 31, 2004 2003 2002 ----------------------------------------------- Numerator: Net income (loss) available to common stockholders before cumulative transition adjustment $25,768 $(16,386) $48,466 Cumulative transition adjustment - SFAS No. 142 - - 6,327 Numerator for basic and diluted earnings (loss) per share $25,768 $(16,386) $54,793 Denominator: Denominator for basic earnings per share--weighted average common shares outstanding 51,766,877 48,245,927 46,411,324 Effect of 10.5% Series A senior cumulative redeemable preferred stock - - 7,283 Dilutive effect of stock options 8,903 - 33,663 ----------- ----------- ----------- Denominator for diluted earnings per share--weighted average common shares outstanding and common stock equivalents outstanding 51,775,780 48,245,927 46,452,270 =========== =========== =========== Basic net income (loss) per weighted average common share: Income (loss) before cumulative transition adjustment $0.50 $(0.34) $1.04 Cumulative transition adjustment - SFAS No. 142 - - 0.14 ----------------------------------------------- Net income (loss) $0.50 $(0.34) $1.18 =============================================== Diluted net income (loss) per weighted average common stock and common stock equivalents: Income (loss) before cumulative transition adjustment $0.50 $(0.34) $1.04 Cumulative transition adjustment - SFAS No. 142 - - 0.14 ----------------------------------------------- Net income (loss) $0.50 $(0.34) $1.18 ===============================================
Total anti-dilutive stock options and warrants excluded from the calculation of net income (loss) per share were 1,385,151, 1,468,351 and 1,432,442 for the years ended December 31, 2004, 2003, and 2002, respectively. Note 17 SUMMARIZED QUARTERLY RESULTS (UNAUDITED) The following is a presentation of quarterly results of operations:
Quarters Ending March 31 June 30 September 30 December 31 2004 2003 2004 2003 2004 2003 2004 2003 --------------------------------------------------------------------------------------------------- Interest Income $ 39,064 $ 42,823 $ 52,146 $ 42,410 $ 56,094 $ 40,329 $ 56,560 $38,216 --------------------------------------------------------------------------------------------------- Expenses: Interest 20,873 19,705 33,150 21,737 37,359 21,614 36,784 20,193 Management fee and Other 2,732 3,159 2,796 3,240 3,098 2,666 3,757 2,642 --------------------------------------------------------------------------------------------------- Total Expenses 23,605 22,864 35,946 24,977 40,457 24,280 40,541 22,835 --------------------------------------------------------------------------------------------------- Gain (loss) on sale of securities available-for-sale 2,813 142 (4,036) 3,294 2,081 (4,704) 16,687 (5,564) Gain (loss) on securities held-for-trading (5,983) (10,404) (4,046) (4,716) (1,103) (28,154) (331) 5,068 Foreign currency (loss) - - (12) - (114) - (61) - Loss on impairment of assets - - - (27,014) - (5,412) (26,018) - --------------------------------------------------------------------------------------------------- Net income (loss) $ 12,289 $ 9,697 $ 8,106 $(11,003) $ 16,501 $(22,221) $ 6,295 $14,885 --------------------------------------------------------------------------------------------------- Cost to retire preferred stock in excess of carrying value - - 10,508 - - - - - Dividends and accretion on redeemable convertible preferred stock 2,446 $ 1,195 1,775 1,611 1,348 2,491 1,348 2,446 --------------------------------------------------------------------------------------------------- Net income (loss) available to common stockholders $ 9,843 $ 8,502 $ (4,177) $ (12,614) $ 15,153 $ (24,712) $ 4,948 $12,439 =================================================================================================== Net income (loss) per share, basic: $ 0.20 $ 0.18 $ (0.08) $ (0.26) $ 0.28 $ (0.51) $ 0.09 $ 0.25 =================================================================================================== Net income (loss) per share, diluted: $ 0.20 $ 0.18 $ (0.08) $ (0.26) $ 0.28 $ (0.51) $ 0.09 $ $0.25 ===================================================================================================
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. ITEM 9A. CONTROLS AND PROCEDURES Under the direction of the Company's Chief Executive Officer and Chief Financial Officer, the Company evaluated its disclosure controls and procedures and concluded that its disclosure controls and procedures were effective as of December 31, 2004. No change in internal control over financial reporting occurred during the quarter ended December 31, 2004 that has materially affected, or is reasonably likely to materially affect, such internal control over financial reporting. ITEM 9B. OTHER INFORMATION (a) None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Incorporated by reference to the Company's Definitive Proxy Statement for the 2005 Annual Meeting of Stockholders. ITEM 11. EXECUTIVE COMPENSATION Incorporated by reference to the Company's Definitive Proxy Statement for the 2005 Annual Meeting of Stockholders. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS Incorporated by reference to the Company's Definitive Proxy Statement for the 2005 Annual Meeting of Stockholders. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Incorporated by reference to the Company's Definitive Proxy Statement for the 2005 Annual Meeting of Stockholders. ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES Incorporated by reference to the Company's Definitive Proxy Statement for the 2005 Annual Meeting of Stockholders. PART IV ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES. (a)(1) Financial statements See index to Financial statements at item 8 of this report. (a)(3) Exhibit Index *3.1 Articles of Amendment and Restatement of the Registrant *3.2 Bylaws of the Registrant *3.3 Form of Articles Supplementary of the Registrant establishing 10% Cumulative Convertible Series B Preferred Stock. *3.4 Articles Supplementary of the Registrant establishing 9.375% Series C Cumulative Redeemable Preferred Stock. *10.1 Investment Advisory Agreement between the Registrant and BlackRock Financial Management, Inc. *10.2 Amendment No. 1 to the Investment Advisory Agreement between the Registrant and BlackRock Financial Management, Inc. *10.3 Amendment No. 2 to the Investment Advisory Agreement between the Registrant and BlackRock Financial Management, Inc. *10.4 Amendment No. 3 to the Investment Advisory Agreement between the Registrant and BlackRock Financial Management, Inc. 10.5 Amended and Restated Investment Advisory Agreement between the Registrant and BlackRock Financial Management, Inc. *10.6 Form of 1998 Stock Option Incentive Plan 10.7 Annex I to Master Repurchase Agreement between Anthracite Funding LLC and Deutsche Bank AG, Cayman Islands 21.1 Subsidiaries of the Registrant 23.1 Consent of Deloitte & Touche LLP 24.1 Power of Attorney (included on signature page hereto) 31.1 Certification of Chief Executive Officer 31.2 Certification of Chief Financial Officer 32.1 Section 1350 Certification of Chief Executive Officer and Chief Financial Officer - ------------------------------------------------------------------------------- * Previously filed. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. ANTHRACITE CAPITAL, INC. Date: March 16, 2005 By: /s/ Christopher A. Milner -------------------------------- Christopher A. Milner Chief Executive Officer (duly authorized representative) KNOW ALL MEN BY THESE PRESENTS, that each individual whose signature appears below constitutes and appoints Richard M. Shea his true and lawful attorney-in-fact and agents with full power of substitution and re-substitution, for his name, place and stead, in any and all capacities, to sign any and all amendments (including post-effective amendments) to this Form 10-K and to file the same with all exhibits thereto, and all documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. This power of attorney may be executed in counterparties. Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Date: March 16, 2005 By: /s/ Christopher A. Milner -------------------------------- Christopher A. Milner Chief Executive Officer Date: March 16, 2005 By: /s/ James J. Lillis --------------------------------- James J. Lillis Chief Financial Officer Date: March 16, 2005 By: /s/ Laurence D. Fink --------------------------------- Laurence D. Fink Chairman of the Board of Directors Date: March 16, 2005 By: /s/ Hugh R. Frater --------------------------------- Hugh R. Frater Director Date: March 16, 2005 By: /s/ Donald G. Drapkin --------------------------------- Donald G. Drapkin Director Date: March 16, 2005 By: /s/ Carl F. Geuther --------------------------------- Carl F. Geuther Director Date: March 16, 2005 By: /s/ Jeffrey C. Keil --------------------------------- Jeffrey C. Keil Director Date: March 16, 2005 By: /s/ Ralph L. Schlosstein --------------------------------- Ralph L. Schlosstein Director Date: March 16, 2005 By: /s/ Leon T. Kendall --------------------------------- Leon T. Kendall Director Date: March 16, 2005 By: /s/ Clay G. Lebhar --------------------------------- Clay G. Lebhar Director EX-10 2 anthra_ex10-5.txt EX 10.5 Exhibit 10.5 ------------ AMENDED AND RESTATED INVESTMENT ADVISORY AGREEMENT ----------------------------- AGREEMENT, dated as of March 11, 2004, between Anthracite Capital, Inc. (the "Company"), a Maryland corporation, and BlackRock Financial Management, Inc. (the "Manager"), a Delaware corporation. WHEREAS, the Company is a real estate finance company that generates income based on the spread between the interest income on its mortgage loans and securities investments and the interest expense from borrowings used to finance its investments. The Company seeks to earn high returns on a risk-adjusted basis to support a consistent quarterly dividend. The Company expects to qualify for the tax benefits accorded by Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the "Code"); WHEREAS, the Company desires to retain the Manager to acquire, sell and otherwise manage the investments of the Company and to perform certain supervisory services for the Company in the manner and on the terms set forth herein; WHEREAS, the Company and the Manager entered into that certain Amended and Restated Investment Advisory Agreement, dated as of March 27, 2003 (the "Prior Agreement"); WHEREAS, the Manager and the Company desire to amend and restate the Prior Agreement in its entirety as set forth below; and WHEREAS, this Agreement amends and restates the Prior Agreement in all respects. NOW THEREFORE, in consideration of the mutual promises and agreements herein contained and other good and valuable consideration, the receipt of which is hereby acknowledged, it is agreed by and between the parties hereto as follows: 1. Certain Definitions (a) "Affiliate" means, when used with reference to a specified person, (i) any person that directly or indirectly controls or is controlled by or is under common control with the specified person, (ii) any person that is an officer of, partner in or trustee of, or serves in a similar capacity with respect to, the specified person or of which the specified person is an officer, partner or trustee, or with respect to which the specified person serves in a similar capacity and (iii) any person that, directly or indirectly, is the beneficial owner of 5% or more of any class of equity securities of the specified person or of which the specified person is directly or indirectly the owner of 5% or more of any class of equity securities; provided, however, that neither the Company nor any of its controlled Affiliates will be treated as an Affiliate of the Manager or any of its Affiliates. (b) "Agreement" means this Amended and Restated Investment Advisory Agreement, as amended from time to time. (c) "Board of Directors" means the Board of Directors of the Company. (d) "GAAP" means accounting principles generally accepted in the United States of America. (e) "Mortgage-Backed Securities" means debt obligations (bonds) that are secured by Mortgage Loans or mortgage certificates. (r) "Mortgage Loans" means multifamily, residential and commercial term loans secured by real property. (g) "Quarterly Average Total Stockholders' Equity" means the average of (i) the Total Stockholders' Equity at the end of the quarter preceding the applicable quarter and (ii) the Total Stockholders' Equity at the end of the applicable quarter, as reported in the Company's publicly filed financial statements. (h) "REIT Provisions of the Code" means Sections 856 through 860 of the Code. (i) "Ten-Year U.S. Treasury Rate" means the arithmetic average of the weekly average yield to maturity for actively traded current coupon U.S. Treasury fixed interest rate securities (adjusted to constant maturities of ten years) published by the Federal Reserve Board during a quarter, or if such rate is not published by the Federal Reserve Board, any Federal Reserve Bank or agency or department of the federal government selected by the Company. If the Company determines in good faith that the Ten-Year U.S. Treasury Rate cannot be calculated as provided above, then the rate shall be the arithmetic average of the per annum average yields to maturities, based upon closing asked prices on each business day during a quarter, for each actively traded marketable U.S. Treasury fixed interest rate security with a final maturity date not less than eight nor more than twelve years from the date of the closing asked prices as chosen and quoted for each business day in each such quarter in New York City by at least three recognized dealers in U.S. government securities selected by the Company. (j) "Unaffiliated Directors" shall mean those directors serving on the Board of Directors who (a) do not own greater than a de minimis interest in the Manager or any of its Affiliates or (b) within the last two years, have not directly or indirectly (i) been an officer of or employed by the Company or the Manager or any of their respective Affiliates, (ii) been a director of the Manager or any of its Affiliates, (iii) performed more than a de minimis amount of services for the Manager or any of its Affiliates or (iv) had any material business or professional relationship with the Manager or any of its Affiliates. 2. In General The Manager agrees, as more fully set forth herein, to act as investment adviser to the Company with respect to the investment of the Company's assets and to supervise and arrange the purchase of securities and loans for and the sale of securities and loans held in the investment portfolio of the Company. The Manager shall manage the business affairs of the Company in conformity with the policies that are approved and monitored by the Board of Directors. The Manager shall prepare regular reports for the Board of Directors that will review the Company's acquisitions of assets, portfolio composition and characteristics, credit quality, performance and compliance with the policies approved by the Board of Directors. The Manager shall allocate investment and disposition opportunities in accordance with policies and procedures the Manager considers fair and equitable, including, without limitation, such considerations as investment objectives, restrictions and time horizons, availability of cash and the amount of existing holdings. 3. Duties and Obligations of the Manager with Respect to Investment of Assets of the Company (a) Subject to the succeeding provisions of this Section and subject to the direction and control of the Board of Directors, the Manager will be responsible for the day-to-day operations of the Company and will perform (or cause to be performed) such services and activities relating to the assets and operations of the Company as may be appropriate, including, but not limited to: (i) providing a complete program of investing and reinvesting the capital and assets of the Company in pursuit of the Company's investment objectives and in accordance with the policies adopted by the Board of Directors from time to time; (ii) serving as the Company's consultant with respect to formulation of investment criteria and preparation of policy guidelines by the Board of Directors; (iii) assisting the Company in developing criteria for mortgage asset purchase commitments that are specifically tailored to the Company's investment objectives and making available to the Company the Company's knowledge and experience with respect to mortgage assets and other real estate related assets; (iv) counseling the Company in connection with policy decisions made by the Board of Directors; (v) evaluating and recommending hedging strategies to the Board of Directors in accordance with hedging guidelines and policies adopted by the Board of Directors, and engaging in hedging activities on behalf of the Company, consistent with the Company's status as a REIT; (vi) maintaining the Company's exemption from regulation as an investment company under the Investment Company Act of 1940, as amended (the "Investment Company Act"); (vii) representing the Company in connection with the purchase and commitment to purchase or sell mortgage assets, including the accumulation of Mortgage Loans for securitization and the incurrence of debt; (viii) arranging for the issuance of Mortgage-Backed Securities from pools of Mortgage Loans owned by the Company; (ix) furnishing reports and statistical and economic research to the Company regarding the Company's activities and the services performed for the Company by the Manager; (x) monitoring and providing to the Board of Directors on an ongoing basis price information and other data, obtained from certain nationally recognized dealers that maintain markets in mortgage assets identified by the Board of Directors from time to time, and providing data and advice to the Board of Directors in connection with the identification of such dealers; (xi) administering the day-to-day operations of the Company and performing and supervising the performance of such other administrative functions necessary in the management of the Company as may be agreed upon by the Manager and the Board of Directors; (xii) contracting, as necessary, with third parties for master servicing and special servicing of assets acquired by the Company; (xiii) communicating on behalf of the Company with the holders of the equity and debt securities of the Company as required to satisfy the reporting and other requirements of any governmental bodies or agencies and to maintain effective relations with such holders; (xiv) causing the Company to qualify to do business in all applicable jurisdictions; (xv) causing the Company to retain qualified accountants and legal counsel to assist in developing appropriate accounting procedures, compliance procedures and testing systems and to conduct quarterly compliance reviews; (xvi) assisting the Company in complying with all regulatory requirements applicable to the Company in respect of its business activities, including preparing or causing to be prepared all financial statements required under applicable regulations and contractual undertakings and all reports and documents, if any, required under the Securities Exchange Act of 1934, as amended (the "Exchange Act"); (xvii) assisting the Company in making all required tax filings and reports and maintaining its status as a REIT, including soliciting stockholders for required information to the extent provided in the REIT Provisions of the Code; (xviii) performing such other services as may be required from time to time for management and other activities relating to the assets of the Company as the Board of Directors shall reasonably request or the Manager shall deem appropriate under the particular circumstances; and (xix) using all reasonable efforts to cause the Company to comply with all applicable laws. (b) In the performance of its duties under this Agreement, the Manager shall at all times use all reasonable efforts to conform to and act in accordance with any requirements imposed by (i) the status of the Company as a REIT as defined in the REIT Provisions of the Code; (ii) the Company's status as an entity exempt from regulation under the Investment Company Act; (iii) any other applicable provision of law; (iv) the provisions of the Articles of Incorporation and By-Laws of the Company, as such documents are amended from time to time; (v) the investment objectives and policies of the Company as set forth in its Registration Statement on Form S-11; and (vi) any policies and determinations of the Board of Directors. (c) The Manager will bear all costs and expenses of the Manager's officers and employees and any overhead incurred in connection with the Manager's duties hereunder, the cost of office space and equipment required for performance of the Manager's duties and shall bear the costs of any salaries or directors' fees of any officers or directors of the Company who are Affiliates of the Manager, except that the Board of Directors may approve reimbursement to the Manager of the Company's pro rata portion of the salaries, bonuses, health insurance, retirement benefits and all similar employment costs for the time spent on Company operations and administration (other than the provision of services covered by Section 3(a) above) of all personnel employed by the Manager who devote substantial time to Company operations and administration or the operations and administration of other companies advised by the Manager; provided that the Manager shall not be expected to bear the following expenses: issuance and transaction costs incident to the acquisition, disposition and financing of investments, legal, accounting and auditing fees and expenses, the compensation and expenses of the Company's Unaffiliated Directors, the costs of printing and mailing proxies and reports to stockholders, costs incurred by employees of the Manager for travel on behalf of the Company, costs associated with any computer software or hardware that is used solely for the Company, costs to obtain liability insurance to indemnify the Company's directors and officers, the Manager and its employees and directors and any underwriters, and the compensation and expenses of the Company's custodian and transfer agent, if any. The Company will also be required to pay all expenses incurred in connection with due diligence, the accumulation of Mortgage Loans, the master and special servicing of Mortgage Loans, the issuance and administration of Mortgage-Backed Securities from pools of Mortgage Loans or otherwise, the raising of capital, the incurrence of debt, the acquisition of assets, interest expenses, taxes and license fees, non-cash costs, litigation, the base and incentive management fee and extraordinary or non-recurring expenses. (d) The Manager shall give the Company the benefit of its best judgment and effort in rendering services hereunder. (e) Nothing in this Agreement shall prevent the Manager or any partner, officer, employee or other Affiliate of the Manager from acting as investment adviser for any other person, firm or corporation, or from engaging in any other lawful activity, and shall not in any way limit or restrict the Manager or any of its shareholders, officers, employees or agents from buying, selling or trading any securities for its or their own accounts or for the accounts of others for whom it or they may be acting; provided, however that the Manager will not undertake activities which, in its judgment, will substantially and adversely affect the performance of its obligations under this Agreement. (f) The Manager shall maintain an appropriate books of accounts and records relating to services performed under this Agreement, and such books of accounts and records shall be accessible for inspection by representatives of the Company or any of its subsidiaries at any time during normal business hours. The Manager shall keep confidential any and all information obtained in connection with the services rendered under this Agreement and shall not disclose any such information to nonaffiliated third parties except with the prior written consent of the Board of Directors or as may be required by law or order of a court or other tribunal having requisite jurisdiction. (g) The Manager shall require each seller or transferor of assets to be acquired by the Company to make such representations and warranties regarding such assets as may be directed by the Board of Directors, or, if no such directions are given, as may, in the judgment of the Manager, be necessary and appropriate. In addition, the Manager shall take such other action as may be directed by the Board of Directors, or, if no such directions are given, as it deems necessary or appropriate with regard to the protection of the Company's assets. 4. Portfolio Transactions and Brokerage The Manager is authorized, for the purchase and sale of the Company's assets, to employ such securities dealers as may, in the judgment of the Manager, implement the policy of the Company to obtain the best net results taking into account such factors as price, including dealer spread, the size, type and difficulty of the transaction involved, the firm's general execution and operational facilities and the firm's risk in positioning the securities involved. Consistent with this policy, the Manager is authorized to direct the execution of the Company's portfolio transactions to dealers and brokers furnishing statistical information or research deemed by the Manager to be useful or valuable to the performance of the Manager's investment advisory functions for the Company. 5. Compensation of the Manager (a) The Company agrees to pay to the Manager and the Manager agrees to accept as full compensation for all services rendered by the Manager as such, (i) a quarterly base management fee calculated as 2% of the Quarterly Average Total Stockholders' Equity for the applicable quarter and (ii) incentive compensation in an amount equal to the product of 25% of the dollar amount by which: (1) net income of the Company (before incentive fee) determined in accordance with GAAP, plus $534,623.47 (the "Fixed Amount") for each fiscal quarter for which a calculation is made under this Section (provided, that, if this Agreement is not renewed pursuant to Section 7 hereof or, in the event this Agreement is so renewed, if the terms of this Section 5(a)(ii)(1) are amended to modify the Fixed Amount, then the Fixed Amounts which would have been payable through and including the quarter ended December 31, 2005 shall be included in the final calculation made pursuant to this Section 5(a)(ii)(1) prior to giving effect to any such non-renewal or modification; provided, further, that the Fixed Amount for the quarter ended December 31, 2005 shall be deemed to be $446,141.80) exceeds (2) an amount equal to (A) the weighted average of the price per share of the Common Stock in the initial public offering and the prices per share of Common Stock in any secondary offerings of Common Stock by the Company, including, without limitation, issuances of Common Stock pursuant to the Company's Dividend Reinvestment and Stock Purchase Plan, private placements, public offerings and exercises of options granted under the Company's 1998 Stock Option Plan, multiplied by (B) the greater of: (i) 8.5% or (ii) the Ten-Year U.S. Treasury Rate plus 4.0% per annum (expressed as a quarterly percentage) multiplied by (C) the weighted average number of shares of Common Stock outstanding during such quarter. Calculation of the incentive fee payable to the Manager shall be calculated using a rolling four-quarter high watermark (the "Watermark"). In determining the Watermark, the Manager shall calculate the incentive fee based upon the current and prior three quarters' net income (the "Yearly Incentive Fee"). The Company shall pay the Manager an incentive fee in the current quarter if the Yearly Incentive Fee is greater than the amount the Company paid to the Manager in the prior three quarters cumulatively. Calculation of the incentive fee shall be based on GAAP and adjusted to exclude special one-time events pursuant to changes in GAAP accounting pronouncements, or other one-time events, after discussion between the Manager and the Unaffiliated Directors. For any period less than a fiscal quarter during which this Agreement is in effect, the fee shall be prorated according to the proportion which such period bears to a full quarter of 90, 91 or 92 days, as the case may be. (c) The management fees earned under Section 5(a)(i) will be payable in arrears. The Manager shall compute the compensation payable under Section 5(a) of this Agreement within 45 days after the end of each calendar quarter. A copy of the computations made by the Manager to calculate its compensation shall thereafter promptly be delivered to the Board of Directors and, upon such delivery, payment of the compensation earned under Section 5(a) of this Agreement shown therein shall be due and payable within 60 days after the end of such fiscal quarter. If requested by the Manager, the Company will make advance payments of the base management fee in Section 5(a)(i) above as often as semi-monthly at the rate of 75% of such fee estimated by the Manager. (d) The base management fee is intended to compensate the Manager for its costs in providing management services to the Company. The Board of Directors may adjust the base management fee with the consent of the Manager in the future if necessary to align the fee more closely with the costs of such services. 6. Indemnity (a) The Company hereby agrees to indemnify the Manager and each of the Manager's shareholders, officers, employees, agents, associates and controlling persons and the shareholders, officers, employees and agents thereof (including any individual who serves at the Manager's request as director, officer, partner, trustee or the like of another corporation) (each such person being an "indemnitee") against any liabilities and expenses, including amounts paid in satisfaction of judgments, in compromise or as fines and penalties, and counsel fees (all as provided in accordance with applicable corporate law) reasonably incurred by such indemnitee in connection with the defense or disposition of any action, suit or other proceeding, whether civil or criminal, before any court or administrative or investigative body in which he may be or may have been involved as a party or otherwise or with which he may be or may have been threatened, while acting in any capacity set forth above in this Section 6 or thereafter by reason of his having acted in any such capacity, except with respect to any matter as to which he shall have been adjudicated not to have acted in good faith in the reasonable belief that his action was in the best interests of the Company and furthermore, in the case of any criminal proceeding, so long as he had no reasonable cause to believe that the conduct was unlawful; provided, however, that (1) no indemnitee shall be indemnified hereunder against any liability to the Company or its stockholders or any expense of such indemnitee arising by reason of (i) willful misfeasance, (ii) bad faith, (iii) gross negligence or (iv) reckless disregard of the duties involved in the conduct of his position (the conduct referred to in such clauses (i) through (iv) being sometimes referred to herein as "disabling conduct"), (2) as to any matter disposed of by settlement or a compromise payment by such indemnitee, pursuant to a consent decree or otherwise, no indemnification either for such payment or for any other expenses shall be provided unless there has been a determination that such settlement or compromise is in the best interests of the Company and that such indemnitee appears to have acted in good faith in the reasonable belief that his action was in the best interests of the Company and did not involve disabling conduct by such indemnitee and (3) with respect to any action, suit or other proceeding voluntarily prosecuted by any indemnitee as plaintiff, indemnification shall be mandatory only if the prosecution of such action, suit or other proceeding by such indemnitee was authorized by a majority of the Board of Directors. (b) The Company shall make advance payments in connection with the expenses of defending any action with respect to which indemnification might be sought hereunder if the Company receives a written affirmation of the indemnitee's good faith belief that the standard of conduct necessary for indemnification has been met and a written undertaking to reimburse the Company unless it is subsequently determined that he is entitled to such indemnification and if a majority of the Board of Directors determine that the facts then known to them would not preclude indemnification. In addition, at least one of the following conditions must be met: (A) the indemnitee shall provide a security for his undertaking, (B) the Company shall be insured against losses arising by reason of any lawful advances or (C) a majority of a quorum consisting of directors of the Company who are neither affiliated persons of the Company nor parties to the proceeding ("Disinterested Non-Party Directors") or an independent legal counsel in a written opinion, shall determine, based on a review of readily available facts (as opposed to a full trial-type inquiry), that there is reason to believe that the indemnitee ultimately will be found entitled to indemnification. (c) All determinations with respect to indemnification hereunder shall be made (1) by a final decision on the merits by a court or other body before whom the proceeding was brought that such indemnitee is not liable by reason of disabling conduct or (2) in the absence of such a decision, by (i) a majority vote of a quorum of the Disinterested Non-Party Directors of the Company or (ii) if a majority vote of such quorum so directs, independent legal counsel in a written opinion. All determinations that advance payments in connection with the expense of defending any proceeding shall be authorized shall be made in accordance with the immediately preceding clause (2). (d) The rights accruing to any indemnitee under these provisions shall not exclude any other right to which he may be lawfully entitled. 7. Duration and Termination This Agreement shall commence on the date hereof for an initial term expiring on March 31, 2005. Thereafter, successive extensions, each for a period not to exceed one year, may be made by agreement between the Company and the Manager, with the approval of a majority of the Unaffiliated Directors until terminated or assigned under the provisions of this Section 7 or Section 9, as the case may be, of this Agreement. Upon termination of this Agreement by the Company, the Company is obligated to pay the Manager a termination fee that will be determined by independent appraisal other than in the case of termination by the Company for cause (as described below). The Company may terminate, or decline to renew the term of, this Agreement without cause at any time upon 60 days' written notice by a majority vote of the Unaffiliated Directors; provided that the Company shall pay the Manager a termination fee determined by independent appraisal of the value of this Agreement. Such appraisal is to be conducted by a nationally recognized appraisal firm mutually agreed upon by the Company and the Manager. If the Company and the Manager are unable to agree upon an appraisal firm, then each of the Company and the Manager is to choose an independent appraisal firm to conduct an appraisal. In such event, (i) if the appraisals prepared by the two appraisers so selected are the same or differ by an amount that does not exceed 20% of the higher of the two appraisals, the termination fee is to be deemed to be the average of the appraisals as prepared by each party's chosen appraiser and (ii) if these two appraisals differ by more than 20% of such higher amount, the two appraisers together are to select a third appraisal firm to conduct an appraisal. If the two appraisers are unable to agree as to the identity of such third appraiser, either of the Manager and the Company may request that the American Arbitration Association ("AAA") select the third appraiser. The termination fee then is to be the amount determined by such third appraiser, but in no event shall the termination fee be less than the lower of the two initial appraisals or more than the higher of such two initial appraisals. Each party shall pay the costs of the appraisers chosen by it, and each party shall pay one half of the costs of the third appraiser. Any appraisal hereunder shall be performed no later than 45 days following selection of the appraiser or appraisers. At the option of the Company, this Agreement, or any extension hereof, shall be and become terminated with cause upon 60 days' prior written notice of termination from the Board of Directors to the Manager, without payment of any termination fee, if any of the following events occur: (i) if the Manager commits a material breach of any provision of this Agreement (including any material breach of the provisions contained in Section 3(a) and (b) herein) and, after notice of such violation, shall not cure such violation within 30 days; or (ii) there is entered an order for relief or similar decree or order with respect to the Manager by a court having competent jurisdiction in an involuntary case under the federal bankruptcy laws as now or hereafter constituted or under any applicable federal or state bankruptcy, insolvency or other similar laws; or the Manager (A) ceases, or admits in writing its inability, to pay its debts as they become due and payable, or makes a general assignment for the benefit of, or enters into any composition or arrangement with, creditors; (B) applies for, or consents (by admission of material allegations of a petition or otherwise) to the appointment of a receiver, trustee, assignee, custodian, liquidator or sequestrator (or other similar official) of the Manager or of any substantial part of its properties or assets, or authorizes such an application or consent, or proceedings seeking such appointment are commenced without such authorization, consent or application against the Manager and continue undismissed for 30 days; or (C) authorizes or files a voluntary petition in bankruptcy, or applies for or consents (by admission of material allegations of a petition or otherwise) to the application of any bankruptcy, reorganization, arrangement, readjustment of debt, insolvency, dissolution, liquidation or other similar law of any jurisdiction, or authorizes such application or consent, of proceedings to such end are instituted against application or consent, or proceedings to such end are instituted against the Manager without such authorization, application or consent and are approved as properly instituted and remain undismissed for 30 days or result in adjudication of bankruptcy or insolvency; or (D) permits or suffers all or any substantial part of its properties or assets to be sequestered or attached by court order and the order remains undismissed for 30 days. The Manager agrees that if any of the events specified above occur, it will give prompt written notice thereof to the Board of Directors after the occurrence of such event. Upon written request from the Company, the Manager shall prepare, execute and deliver to a successor manager any and all documents and other instruments, place in such successor manager's possession all files and do or cause to be done all other acts or things necessary or appropriate to effect the purposes of such notice of termination, to the successor manager at the Manager's sole expense; provided, however, that the Manager shall be entitled to retain copies of all such documents and other instruments as it may be required by federal or state law. The Manager agrees to cooperate with Company and such successor manager in effecting the termination of the Manager's responsibilities and rights under this Agreement. 8. Action Upon Termination. From and after the effective date of termination of this Agreement pursuant to Section 7 hereof, the Manager shall not be entitled to compensation for further services under this Agreement, but shall be paid all compensation accruing to the date of termination and, if such termination is not for cause, the termination fee determined pursuant to Section 7. The Manager shall forthwith upon such termination deliver to the Board of Directors all funds and property, documents, corporate records, reports and software of the Company or any subsidiary of the Company then in the custody of Manager; provided, however, that the Manager shall be entitled to retain copies of all such documents and other instruments as it may be required by federal or state law. 9. Assignment This Agreement may not be assigned without the prior written consent of all the parties to this Agreement. For the foregoing purposes, "assigned" shall have the meaning ascribed to it under the Investment Advisers Act of 1940, as amended and the rules promulgated thereunder. 10. Notices Any notice under this Agreement shall be in writing to the other party at such address as the other party may designate from time to time for the receipt of such notice and shall be deemed to be received on the earlier of the date actually received or on the fourth day after the postmark if such notice is mailed first class postage prepaid. 11. Governing Law This Agreement shall be construed in accordance with the laws of the State of New York for contracts to be performed entirely therein without reference to choice of law principles thereof. 12. Amendments This Agreement shall not be amended, changed, modified, terminated or discharged in whole or in part except by an instrument in writing signed by all parties hereto, or their respective successors or assigns, or otherwise as provided herein. 13. Severability The invalidity or unenforceability of any provision of this Agreement shall not affect the validity of any other provision, and all other provisions shall remain in full force and effect. 14. Entire Agreement This instrument contains the entire agreement between the parties as to the rights granted and the obligations assumed in this instrument. 15. Counterparts This Agreement may be signed by the parties in counterparts which together shall constitute one and the same agreement among the parties. 16. Manager Brochure The Company hereby acknowledges that it has received from the Manager a copy of the Manager's Form ADV, Part II, at least forty-eight hours prior to entering into this Agreement. IN WITNESS WHEREOF, the parties hereto have caused the foregoing instrument to be executed by their duly authorized officers, all as of the date and the year first above written. ANTHRACITE CAPITAL, INC. By: /s/Chris A. Milner ------------------------------------------ Name: Chris A. Milner Title: President and Chief Executive Officer BLACKROCK FINANCIAL MANAGEMENT, INC. By: /s/Laurence D. Fink ------------------------------------------ Name: Laurence D. Fink Title: Chairman and Chief Executive Officer EX-10 3 aciex10-7.txt EXHIBIT 10.7 Exhibit 10.7 ------------ ANNEX I TO MASTER REPURCHASE AGREEMENT SUPPLEMENTAL TERMS AND CONDITIONS DATED AS OF DECEMBER 21, 2004 BETWEEN ANTHRACITE FUNDING, LLC, AS SELLER AND DEUTSCHE BANK, AG, CAYMAN ISLANDS BRANCH, AS BUYER TABLE OF CONTENTS Page ---- 1 OTHER APPLICABLE ANNEXES.............................................1 2 ADDITIONAL AND SUBSTITUTE DEFINITIONS................................1 3 INITIATION; CONFIRMATION; TERMINATION; FEES.........................21 4 MARGIN MAINTENANCE..................................................30 5 INCOME PAYMENTS AND PRINCIPAL PAYMENTS..............................32 6 SECURITY INTEREST...................................................34 7 PAYMENT, TRANSFER AND CUSTODY.......................................35 8 SALE, TRANSFER, HYPOTHECATION OR PLEDGE OF PURCHASED SECURITIES.....42 9 SUBSTITUTION........................................................43 10 REPRESENTATIONS.....................................................44 11 NEGATIVE COVENANTS OF SELLER........................................48 12 AFFIRMATIVE COVENANTS OF SELLER.....................................49 13 SINGLE-PURPOSE ENTITY...............................................52 14 EVENTS OF DEFAULT; REMEDIES.........................................54 15 RECORDING OF COMMUNICATIONS.........................................60 16 NOTICES AND OTHER COMMUNICATIONS....................................60 17 NON-ASSIGNABILITY...................................................60 18 CONSENT TO JURISDICTION; WAIVER OF JURY TRIAL.......................61 19 NO RELIANCE.........................................................62 20 INDEMNITY...........................................................62 21 DUE DILIGENCE.......................................................63 22 SERVICING...........................................................64 23 MISCELLANEOUS.......................................................65 EXHIBITS AND SCHEDULES SCHEDULE I-A Original Purchase Percentages, CF Sweep Purchase Percentages, Buyer's Margin Percentages and Applicable Spreads EXHIBIT I Form of Confirmation EXHIBIT II Authorized Representatives of Seller EXHIBIT III Monthly Reporting Package EXHIBIT IV Form of Custodial Delivery EXHIBIT V Form of Power of Attorney EXHIBIT VI Representations and Warranties Regarding Individual Purchased Loans and Purchased Securities EXHIBIT VII Collateral Information EXHIBIT VIII Advance Procedure EXHIBIT IX Form of Re-Direction Letter ANNEX I TO MASTER REPURCHASE AGREEMENT Supplemental Terms and Conditions --------------------------------- This Annex I forms a part of the Master Repurchase Agreement dated as of December 21, 2004, between Anthracite Funding, LLC, as seller, and Deutsche Bank AG, Cayman Islands Branch, as buyer (the "Agreement"). Capitalized terms used in this Annex I without definition shall have the respective meanings assigned to such terms in the Agreement. This Annex I is intended to supplement the Agreement and shall, wherever possible, be interpreted so as to be consistent with the Agreement; however, in the event of any conflict or inconsistency between the provisions of this Annex I, on the one hand, and the provisions of the Agreement, on the other, the provisions of this Annex I shall govern and control. All references in the Agreement to "the Agreement" shall be deemed to mean and refer to the Agreement, as supplemented and modified by this Annex I or as otherwise modified after the date hereof. 1 OTHER APPLICABLE ANNEXES In addition to this Annex I, the following Annexes and any Schedules thereto shall form a part of the Agreement and shall be applicable thereunder: Annex II - Names and Addresses for Communications Between Parties. 2 ADDITIONAL AND SUBSTITUTE DEFINITIONS (a) In addition to the terms defined in the Agreement, the following terms shall have the respective meanings set forth below: "Accepted Servicing Practices" shall mean with respect to any Purchased Loan, those mortgage servicing practices of prudent mortgage loan servicers which service mortgage or other commercial loans of the same type as such Purchased Loan in the jurisdiction where the related Mortgaged Property is located. "Accelerated Repurchase Date" shall have the meaning specified in Section 14(b)(i) of this Annex I. "Affiliate" shall mean, when used with respect to any specified Person, any other Person directly or indirectly controlling, controlled by, or under common control with, such Person. Control shall mean the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a Person, whether through the ownership of voting securities, by contract or otherwise and "controlling" and "controlled" shall have meanings correlative thereto; provided, however, with respect to Seller, no Person shall be deemed an Affiliate of Seller due to such Person's having Blackrock Financial Management as such Person's manager. "Agreement" shall have the meaning specified in the introductory paragraph of this Annex I. "Alternative Rate" shall have the meaning specified in Section 3(g) of this Annex I. "Alternative Rate Transaction" shall mean, with respect to any Pricing Rate Period, any Transaction with respect to which the Pricing Rate for such Pricing Rate Period is determined with reference to the Alternative Rate. "Applicable Spread" shall mean, with respect to a Transaction involving Purchased Securities in any Rating Category and/or Purchased Loans in any Collateral Type Grouping, (i) so long as no Event of Default shall have occurred and be continuing, the incremental per annum rate (expressed as a number of "basis points", each basis point being equivalent to 1/100 of 1%) specified in Schedule I-A attached to this Annex I as being the "Applicable Spread" for Purchased Securities in such Rating Category or Purchased Loans, in such Collateral Type Grouping, and (ii) after the occurrence and during the continuance of an Event of Default, the applicable incremental per annum rate described in clause (i) of this definition, plus 400 basis points (4.0%). "Assignment of Leases" shall mean with respect to any Purchased Loan, any assignment of leases, rents and profits or equivalent instrument, whether contained in the related Mortgage or executed separately, assigning to the holder or holders of such Mortgage all of the related Mortgagor's interest in the leases, rents and profits derived from the ownership, operation, leasing or disposition of all or a portion of the related Mortgaged Property as security for repayment of such Purchased Loan. "Assignment of Mortgage" shall mean, with respect to any Mortgage, an assignment of the mortgage, notice of transfer or equivalent instrument in recordable form, sufficient under the laws of the jurisdiction wherein the related property is located to reflect the assignment and pledge of the Mortgage. "Business Day" shall mean a day other than (i) a Saturday or Sunday, or (ii) either (a) with respect to a US Loan, a day in which the New York Stock Exchange or banks in the State of New York or Illinois are authorized or obligated by law or executive order to be closed or (b) with respect to an English Loan, a day on which banks in London, England are closed for interbank or foreign exchange transactions. When used with respect to a Reset Date, a "Business Day" shall mean a day on which banks in London, England are closed for interbank or foreign exchange transactions. "Buyer" shall mean Deutsche Bank AG, Cayman Islands Branch, or any successor. "Cash Management Account" shall mean a segregated interest bearing account, in the name of Buyer, established at the Depository. "CF Sweep Event" shall mean, with respect to any Purchased Security or Purchased Loan as of any date, a determination by Buyer in the exercise of its good faith business judgment that (i) the Repurchase Price of such Purchased Security or such Purchased Loan as of such date exceeds (ii) the product obtained by multiplying the Market Value of such Purchased Security or Purchased Loan as of such date by the "CF Sweep Purchase Percentage" for such Purchased Security or Purchased Loan, as set forth in Schedule I-A attached to this Annex I. "CF Sweep Purchase Percentage" shall mean, with respect to any Transaction as of any day, the "CF Sweep Purchase Percentage" specified for the applicable Rating Category or Collateral Type Grouping in Schedule I-A attached to this Annex I. "Change of Control" shall mean any of the following events have occurred: (i) BlackRock Financial Management shall cease to act as the external manager of the Sponsor with exclusive responsibility for the Sponsor's investment decision-making; (ii) any two of Messrs. Chris Milner, Richard Shea or Laurence Fink shall cease to occupy the senior managerial position each such Person occupies as of the date of the Agreement at BlackRock Financial Management (or a comparable senior managerial position at BlackRock Financial Management acceptable to the Buyer); or (iii) a merger, reorganization or consolidation of the Sponsor where the successor entity is not the Sponsor as of the Closing Date. "Collateral" has the meaning given to that term in Section 6 of this Annex I. "Collateral Information" shall mean, with respect to each Purchased Loan, the information set forth in Exhibit VII attached hereto. "Collateral Type Grouping" shall mean, with respect to the Eligible Loans, any of the types of Eligible Loans listed in Schedule I-A attached to this Annex I. "Collection Period" shall mean (i) with respect to the first Remittance Date in any month, the period beginning on but excluding the last Cut-off Date in the month preceding the month in which such Remittance Date occurs and continuing to and including the Cut-off Date immediately preceding such Remittance Date and (ii) with respect to the second Remittance Date in any month, the period beginning on but excluding the first Cut-off Date in the month in which such Remittance Date occurs and continuing to and including the Cut-off Date immediately preceding such Remittance Date. "Credit Gain" shall mean, with respect to the Purchased Securities in any Rating Category, any gain in value of such Purchased Securities as determined by Buyer in the exercise of its good faith business judgment (including, without limitation, as a result of any bond rating upgrade affecting such Purchased Securities). "Credit Loss" shall mean, with respect to the Purchased Securities in any Rating Category, (i) any loss in value of such Purchased Securities as determined by Buyer in the exercise of its good faith business judgment (including, without limitation, as a result of any realized loss (as such term or any comparable term is defined or otherwise used in the Securitization Document for such Purchased Securities)), (ii) any appraisal reduction (as such term or any comparable term is defined in the Securitization Document for such Purchased Securities), or (iii) any Purchased Security experiences a rating downgrade or is placed on credit watch for possible downgrade or with negative implications or other similar status and, with respect to any Purchased Loans, any loss in value of such Purchased Loans as determined by Buyer in the exercise of its good faith business judgment (including, without limitation, as a result of any losses in connection with a foreclosure). "Custodial Agreement" shall mean the Custodial Agreement, dated as of December 21, 2004, by and among the Custodian, the Seller and the Buyer. "Custodial Delivery" shall mean the form executed by Seller in order to deliver the Purchased Loan Schedule and the Purchased Loan File to Buyer or its designee (including the Custodian) pursuant to Section 7, a form of which is attached hereto as Exhibit IV. "Custodian" shall mean LaSalle Bank National Association or any successor Custodian appointed by Buyer with the prior written consent of Seller (which consent shall not be unreasonably withheld or delayed). "Cut-off Date" shall mean the second Business Day preceding each Remittance Date. "DB Securitization" shall mean a securitization (including, but not limited to, a real estate mortgage investment conduit (or REMIC), re-REMIC, re-securitization or collateralized debt obligation (or CDO) transaction) where Deutsche Bank Securities Inc. or its Affiliate is acting as lead manager and book runner where the Seller or an Affiliate of the Seller contributes Purchased Securities or Purchased Loans that were previously subject to Transactions. "Default" shall mean any event which, with the giving of notice, the passage of time, or both, would constitute an Event of Default. "Deficit Cure Amount" shall mean, with respect to any Purchased Security or any Purchased Loan as of any date, the amount (expressed in United States Dollars) obtained by dividing (i) the Repurchase Price of such Purchased Security or Purchased Loan as of such date by (ii) the "Original Purchase Percentage" for the Rating Category for such Purchased Security or Collateral Type Grouping for such Purchased Loan, as set forth in Schedule I-A attached to this Annex I. "Depository" shall mean LaSalle Bank National Association or any successor Depository appointed by Buyer with the prior written consent of Seller (which consent shall not be unreasonably withheld or delayed). "Diligence Materials" shall mean the Preliminary Due Diligence Package together with the Supplemental Due Diligence List. "Draft Appraisal" shall mean a short form appraisal, "letter opinion of value," or any other form of draft appraisal reasonably acceptable to Buyer. "Early Repurchase Date" shall have the meaning specified in Section 3(d) of this Annex I. "Eligible Loans" shall mean any of the following types of performing loans, which performing loans are acceptable to Buyer in the exercise of its good faith business judgment and are secured directly or indirectly by or the payments on which are derived from a property that may include, but not be limited to, multifamily, retail, office, warehouse, or hospitality property (or any other property type acceptable to Buyer in the exercise of its good faith business judgment, but excluding in all cases undeveloped land) that is located in the United States of America, its territories or possessions, or England, Wales, Northern Ireland or Scotland or another jurisdiction (provided, that with respect to (1) any performing loans located in a jurisdiction other than the United States of America, its territories or possessions, or England, Wales, Northern Ireland or Scotland or (2) any performing loans described in clauses (iii)(y) or (iv)(y) below which are located in England, Wales, Northern Ireland or Scotland, such loans must be approved by Buyer in its sole discretion as contemplated in Section 3(a) hereto): (i) subject to the following proviso, performing commercial mortgage loans secured by first liens on multifamily or commercial properties which satisfy the following criteria (referred to on Schedule 1-A as the "1st Lien--Low Leverage" Collateral Type Grouping): (a) LTV determined by Buyer for the Mortgaged Property securing directly such loan (including for purposes of this calculation, such loan but excluding any loan junior to such loan and secured directly or indirectly by the related Mortgaged Property) does not exceed 70%; and (b) the underwritten debt service coverage ratio at the related Purchase Date as determined by Buyer in the exercise of its good faith business judgment (giving effect to any cash reserves and letters of credit acceptable to Buyer which are substituted for such cash reserves) for the Mortgaged Property securing directly such loan (including for purposes of this calculation, such loan but excluding any loan junior to such loan and secured directly or indirectly by the related Mortgaged Property) is not less than 1.35x, (ii) subject to the following proviso, performing commercial mortgage loans secured by first liens on multifamily or commercial properties which satisfy the following criteria (referred to on Schedule 1-A as the "1st Lien--Other" Collateral Type Grouping): (a) LTV determined by Buyer for the Mortgaged Property securing directly such loan (including for purposes of this calculation, such loan but excluding any loan junior to such loan and secured directly or indirectly by the related Mortgaged Property) does not exceed 75%; (b) the underwritten debt service coverage ratio at the related Purchase Date as determined by Buyer in the exercise of its good faith business judgment (giving effect to any cash reserves and letters of credit acceptable to Buyer which are substituted for such cash reserves) for the Mortgaged Property securing directly such loan (including for purposes of this calculation, such loan but excluding any loan junior to such loan and secured directly or indirectly by the related Mortgaged Property) is not less than 1.25x; and such loan is not of the type which satisfies the criteria set forth in clause (i)(a) and (i)(b) above, provided, that with respect to any Eligible Loan of the type described in this clause (ii) which has an LTV in excess of 75% and which Buyer accepts for inclusion in a Transaction, Buyer shall in good faith consider administering such Eligible Loan as two Eligible Loans with the portion of such Eligible Loan equal to 75% LTV treated as an Eligible Loan of the type described in this clause (ii) and the balance of such Eligible Loan up to a LTV of 85% (or 90% in the determination of the Buyer in its sole and absolute discretion) treated as an Eligible Loan of the type described in clause (iv) below), (iii) (x) loans secured by second liens in, junior participation interests in or junior notes in performing commercial mortgage loans secured by first liens in multifamily or commercial properties or (y) performing mezzanine loans secured by pledges of the entire equity ownership interests (or the applicable lesser ownership interest approved by Buyer in its sole discretion) in entities that directly or indirectly own multifamily or commercial properties (or participation interests in such performing mezzanine loans), each of which satisfy the following criteria (referred to on Schedule 1-A as the "2nd Lien/B-Note/Mezzanine Loan/Participation--Low Leverage" Collateral Type Grouping): (a) LTV determined by Buyer for the Mortgaged Property from which payments on such loan, participation, junior note or mezzanine loan are derived (including for purposes of this calculation, such loan, participation, junior note or mezzanine loan and any loan senior to such loan, participation, junior note or mezzanine loan and secured directly or indirectly by the related Mortgaged Property and excluding any more junior loan or participation) does not exceed 75%; and (b) the underwritten debt service coverage ratio at the related Purchase Date as determined by Buyer in the exercise of its good faith business judgment (giving effect to any reserves and letters of credit acceptable to Buyer which are substituted for such cash reserves) for the Mortgaged Property from which payments on such loan, participation, junior note or mezzanine loan are derived (including for purposes of this calculation, such loan, participation, junior note or mezzanine loan and any loan senior to such loan, participation, junior note or mezzanine loan and secured directly or indirectly by the related Mortgaged Property and excluding any more junior loan or participation) is not less than 1.30x, (iv) (x) loans secured by second liens in, junior participation interests in or junior notes in performing commercial mortgage loans secured by first liens in multifamily or commercial properties or (y) performing mezzanine loans secured by pledges of the entire equity ownership interests (or the applicable lesser ownership interest approved by Buyer in its sole discretion) in, or preferred equity ownership interests in, entities that directly or indirectly own multifamily or commercial properties (or participation interests in such performing mezzanine loans), each of which satisfy the following criteria (referred to on Schedule 1-A as the "2nd Lien/B-Notes/Mezzanine Loan/Participation/Preferred Equity--Other" Collateral Type Grouping): (a) LTV determined by Buyer for the Mortgaged Property from which payments on such loan, participation interest, junior note, mezzanine loan or ownership are derived or securing indirectly such loan, participation interest, junior note, mezzanine loan or ownership (including for purposes of this calculation, such loan, participation interest, junior note, mezzanine loan or ownership and any loan senior to such loan, participation interest, junior note, mezzanine loan or ownership and secured directly or indirectly by the related Mortgaged Property and excluding any more junior loan or participation) exceeds 75% but does not exceed 85% (or 90%, in the determination of the Buyer in its sole and absolute discretion); (b) the underwritten debt service coverage ratio at the related Purchase Date as determined by Buyer (giving effect to any reserves and letters of credit acceptable to Buyer which are substituted for such cash reserves) for the property securing indirectly such loan, participation interest, junior note, mezzanine loan or ownership (including for purposes of this calculation, such loan, participation interest, junior note, mezzanine loan or ownership and any loan senior to such loan, participation interest, junior note, mezzanine loan or ownership and secured directly or indirectly by the related Mortgaged Property and excluding any more junior loan or participation) is not less than 1.15x; and (c) such loan, participation interest, junior note, mezzanine loan or ownership is not of the type which satisfies the criteria set forth in clause (iii)(a) and (iii)(b) above. "Eligible Securities" shall mean performing commercial mortgage-backed securities that (A) (i) either (a) have a rating of "CCC" (or its equivalent) or higher from any Rating Agency or (b) are unrated securities, in each case with respect to this clause (b) issued in a conduit commercial mortgage-backed securities offering, which securities are acceptable to Buyer in the exercise of its good faith business judgment provided, that "Eligible Securities" shall exclude securities derived from the re-securitization (including for this purpose "re-REMIC") of Eligible Securities and (ii) are denominated in United States Dollars or (B) (i) have a rating of "B-" (or its equivalent) or higher from any Rating Agency and (ii) are denominated in United Kingdom Sterling or another currency, approved by Buyer in its sole discretion as contemplated in Section 3(a). "English Loan" shall mean any Eligible Loan governed by English law and secured (inter alia) by Mortgaged Property located in England, Wales, Northern Ireland or Scotland. "English Loan Supplement" shall mean the Master Repurchase Agreement English Loan Supplement dated hereof and made between the (1) the Seller and (2) the Buyer. "Environmental Report" shall have the meaning specified in paragraph 12 of Exhibit VI. "Equity" shall mean, with respect to each Purchased Loan or Purchased Security, the amount (not less than zero) equal to the Market Value of such Purchased Loan or Purchased Security minus the related Repurchase Price. "Equity Deficit" shall mean the amount (not less than zero) equal to the Minimum Seller's Equity Requirement minus the Seller's Equity. "ERISA" means the Employee Retirement Income Security Act of 1974, as amended from time to time, and the regulations promulgated thereunder. Section references to ERISA are to ERISA, as in effect at the date of this Agreement and, as of the relevant date, any subsequent provisions of ERISA, amendatory thereof, supplemental thereto or substituted therefor. "ERISA Affiliate" means any corporation or trade or business that is a member of any group of organizations (i) described in Section 414(b) or (c) of the Code of which Seller is a member and (ii) solely for purposes of potential liability under Section 302(c)(11) of ERISA and Section 412(c)(l1) of the Code and the lien created under Section 302(f) of ERISA and Section 412(n) of the Code, described in Section 414(m) or (o) of the Code of which Seller is a member. "Exit Fee" shall mean the fee payable by the Seller either: (x) pursuant to Section 3(d) of this Annex I in the event Seller terminates a Transaction on demand and repurchases any Purchased Loan or any Purchased Security, or (y) pursuant to Section 14(a)(iii) of this Annex I if an Event of Default on the part of Seller occurs and Buyer disposes of any Purchased Loan or any Purchased Security, in each case of (x) or (y), in an amount equal to 0.50% of the related Market Value times the applicable Original Purchase Price; provided, that no Exit Fee shall be due and payable: (1) if the reason for the termination of a Transaction is the related Purchased Loan of the type described in clause (i) of the definition of Eligible Loan or Purchased Security is simultaneous with such termination being included in a securitization (including, but not limited to, a real estate mortgage investment conduit (or REMIC), re-REMIC, re-securitization or collateralized debt obligation (or CDO) transaction where Deutsche Bank Securities Inc. or its Affiliate is acting as lead manager and book runner), or (2) if in connection with the termination of the Transaction, Buyer has accepted a substitution pursuant to Section 9(a) of this Annex I, or (3) in connection with the repurchase by Seller of any Purchased Loans or Purchased Securities on any Business Day 90 or fewer days prior to the Repurchase Date; provided, however, that if within 180 days of such early repurchase, the Purchased Loans and Purchased Securities that were the subject of such early repurchase are included in a securitization (including, but not limited to, a real estate mortgage investment conduit (or REMIC), re-REMIC, re-securitization or collateralized debt obligation (or CDO) transaction) where neither Deutsche Bank Securities Inc. nor its Affiliate is acting as lead manager and book runner, then the Exit Fee that would otherwise apply in the absence of this clause (3) shall apply, and the obligation of Seller to pay such Exit Fee shall survive any termination of this Agreement. "Extension Conditions" and "Extension Date Repurchase Price" shall have the respective meanings specified in Section 3(e) of this Annex I. "Facility Amount" shall mean $200,000,000. "Filings" shall have the meaning specified in Section 6 of this Annex I. "GAAP" shall mean United States generally accepted accounting principles consistently applied as in effect from time to time. "Governmental Authority" shall mean any national or federal government, any state, regional, local or other political subdivision thereof with jurisdiction and any Person with jurisdiction exercising executive, legislative, judicial, regulatory or administrative functions of or pertaining to government. "Guaranty" shall mean the Guaranty, dated as of the date hereof, from the Sponsor to the Buyer, of full and timely payment of all amounts due under this Agreement to the Buyer. "Hedging Transactions" shall mean, with respect to any or all of the Purchased Securities and/or Purchased Loans, any short sale of U.S. Treasury Securities or mortgage-related securities, futures contract (including Eurodollar futures) or options contract or any interest rate swap, cap or collar agreement or similar arrangements providing for protection against fluctuations in interest rates or the exchange of nominal interest obligations, either generally or under specific contingencies, entered into by Sponsor or Seller or an Affiliate of either such Person (or following an Event of Default, by Buyer), with one or more counterparties reasonably acceptable to the Buyer. "Indemnified Amounts" and "Indemnified Parties" shall have the meaning specified in Section 20 of this Annex I. "Insured Closing Letter and Escrow Instructions" shall mean a letter addressed to Seller and Buyer from the Settlement Agent for each Table Funded Purchased Loan and related escrow instructions, which letter and instructions shall be in form and substance reasonably acceptable to Buyer and Seller. "LIBOR" shall mean the rate per annum calculated as set forth below: (i) On each Pricing Rate Determination Date, LIBOR for the next Pricing Rate Period will be the rate for deposits in United States dollars for a one-month period which appears on Telerate Page 3750 as of 11:00 a.m., London time, on such date; or (ii) On any Pricing Rate Determination Date on which no such rate appears on Telerate Page 3750 as described above, LIBOR for the next Pricing Rate Period will be determined on the basis of the arithmetic mean of the rates at which deposits in United States dollars are offered by the Reference Banks at approximately 11:00 a.m., London time, on such date to prime banks in the London interbank market for a one-month period. All percentages resulting from any calculations or determinations referred to in this definition will be rounded upwards, if necessary, to the nearest multiple of 1/100th of 1% and all U.S. dollar amounts used in or resulting from such calculations will be rounded to the nearest cent (with one-half cent or more being rounding upwards). "LIBO Rate" shall mean, with respect to any Pricing Rate Period pertaining to a Transaction, a rate per annum determined for such Pricing Rate Period in accordance with the following formula (rounded upward to the nearest 1/100th of 1%): LIBOR ----------------------------------- 1 - Reserve Requirement "LIBOR Transaction" shall mean, with respect to any Pricing Rate Period, any Transaction with respect to which the Pricing Rate for such Pricing Rate Period is determined with reference to the LIBO Rate. "LTV" shall mean the ratio of total loan to appraised value for the Mortgaged Property securing directly or indirectly an Eligible Loan or from which the payments on such Eligible Loan are derived. If Seller has not received an appraisal (or Draft Appraisal) approved by Buyer from an MAI Appraiser or (in relation to an English Loan) a valuation by a suitably qualified valuer on the basis of the then current Statements of Asset Valuation Practice and Guidance Notes issued by the Royal Institution of Chartered Surveyors, "LTV" shall mean the ratio of total loan to market value for the Mortgaged Property securing directly or indirectly an Eligible Loan or from which the payments on such Eligible Loan are derived, as determined by the Buyer in the exercise of its good faith business judgment. "Mezzanine Note" shall mean a note or other evidence of indebtedness of the owner or owners of all equity or ownership interests in an underlying real property owner secured by a pledge of such ownership interests. "Midland" shall mean Midland Loan Services, Inc., a Delaware corporation. "Minimum CMBS Diversification" means, at any time, ten (10) or more issues of Purchased Securities are then subject to Transactions. "Minimum Seller's Equity Requirement" means an amount equal to $45,000,000. "Moody's" shall mean Moody's Investor Service, Inc. "Mortgage" shall mean a mortgage, deed of trust, deed to secure debt or other instrument, creating a valid and enforceable first lien on or a first priority ownership interest in an estate in fee simple or leasehold estate in real property and the improvements thereon, securing a mortgage note or similar evidence of indebtedness. "Mortgage Note" shall mean (in relation to a US Loan) a note or other evidence of indebtedness of a Mortgagor secured by a Mortgage or (in relation to an English Loan) the credit agreement or other loan instrument pursuant to which the related loan has been advanced. "Mortgaged Property" shall mean the real property securing repayment of the debt evidenced by a Mortgage Note. "Mortgagor" shall mean (in relation to a US Loan) the obligor on a Mortgage Note and the grantor of the related Mortgage or (in relation to an English Loan) the grantor(s) of the Mortgage(s) securing repayment of the related Mortgage Note. "Multiemployer Plan" shall mean a multiemployer plan defined as such in Section 3(37) of ERISA to which contributions have been, or were required to have been, made by Seller or any ERISA Affiliate and which is covered by Title IV of ERISA. "New Collateral" shall mean an Eligible Loan or Eligible Security that Seller proposes to be included as Collateral. "Original Purchase Percentage" shall mean, with respect to any Transaction as of any day, the "Original Purchase Percentage" specified for the applicable Rating Category or Collateral Type Grouping in Schedule I-A attached to this Annex I. "Originated Collateral" shall mean any Collateral that is an Eligible Loan and whose Purchased Loan Documents were prepared by Seller, Sponsor or an Affiliate controlled by the Sponsor. "Permitted Purchased Loan Modification" shall mean any modification of a Purchased Loan, other than a modification which (1) amends or modifies the interest rate, principal amount, maturity date or any other financial or economic term (including, but not limited to, the amortization schedule) of a Purchased Loan, (2) extends any payment date for the payment of such principal or interest, (3) amends, modifies or waives any cash management or reserve account requirements of a Purchased Loan, (4) releases or subordinates any portion of the collateral securing such Purchased Loan, (5) waives any foreclosure rights with respect to any portion of the collateral securing such Purchased Loan or (6) is reasonably likely to materially and adversely affect the rights or interests of the Buyer hereunder. "Person" shall mean an individual, corporation, limited liability company, business trust, partnership, joint tenant or tenant-in-common, trust, unincorporated organization, or other entity, or a federal, state or local government or any agency or political subdivision thereof. "Plan" means an employee benefit or other plan established or maintained by Seller or any ERISA Affiliate during the five year period ended prior to the date of this Agreement or to which Seller or any ERISA Affiliate makes, is obligated to make or has, within the five year period ended prior to the date of this Agreement, been required to make contributions and that is covered by Title IV of ERISA or Section 302 of ERISA or Section 412 of the Code, other than a Multiemployer Plan. "Portfolio Collateral" shall mean, collectively, the Portfolio Securities and the Purchased Loans. "Portfolio Securities" shall mean, collectively, the Purchased Securities and, to the extent transferred to the Buyer, the Related Securities. "Pre-Existing Collateral" shall mean any Collateral that is an Eligible Loan and is not Originated Collateral. "Preliminary Due Diligence Package" shall mean with respect to any New Collateral, a summary memorandum outlining the proposed transaction, including potential transaction benefits and all material underwriting risks, all Underwriting Issues and all other characteristics of the proposed transaction that a reasonable buyer would consider material, together with the following due diligence information relating to the New Collateral to be provided by Seller to Buyer pursuant to this Agreement: With respect to each Eligible Loan: (i) the Collateral Information; (ii) current rent roll, if applicable; (iii) cash flow pro-forma, plus historical information, if available; (iv) description of the Mortgaged Property and the ownership structure of the borrower and the sponsor (including, without limitation, the board of directors, if applicable) and financial statements of the borrower and the sponsor; (v) indicative debt service coverage ratios; (vi) indicative loan-to-value ratio; (vii) term sheet outlining the transaction generally; (viii) Seller's relationship with the Mortgagor, if any; and (ix) with respect to any New Collateral that is Pre-Existing Collateral, a list that specifically and expressly identifies any Purchased Loan Documents that relate to such New Collateral but are not in Seller's possession; and (x) any exceptions to the representations and warranties set forth in Exhibit VI to the Agreement or (in so far as those representations and warranties relate to English Loans) the representations and warranties set forth in the English Loan Supplement. With respect to each Eligible Security: (i) collateral summary books which include, to the extent provided to the Seller, the following: (A) loan detail and asset description (B) map, photo (C) rent roll (D) operating information (E) appraisal, environmental, engineering summary; (ii) the Seller's underwriting materials and analysis, which includes the executive summary, all loss scenarios and the asset summaries for the twenty (20) largest loans used in the Seller's roll-up meetings; (iii) loan data disk; (iv) materials furnished to the Rating Agencies in connection with the issuance of the Eligible Securities, to the extent provided to Seller; (v) Securitization Documents; (vi) remittance report for most recent period in Seller's possession; (vii) quarterly remittance reports in Seller's possession; (viii) accounting reports delivered with respect to the Eligible Security in Seller's possession; (ix) legal opinions delivered with respect to the Eligible Security in Seller's possession; and (x) a copy of the executed trade ticket (including evidence of the dollar price paid and purchase spread over Treasuries or other relevant benchmark for such Eligible Security) and any adjustments to the purchase price not reflected in such trade ticket. "Pricing Rate Determination Date" shall mean (a) in the case of the first Pricing Rate Period with respect to any Transaction, the second (2nd) Business Day preceding the first day of such Pricing Rate Period and (b) with respect to any subsequent Pricing Rate Period, the second (2nd) Business Day preceding the first day of the Pricing Rate Period commencing on and including the first Remittance Date in a calendar month. Each Pricing Rate Determination Date after the first Pricing Rate Period with respect to any Transaction, shall be applicable to the immediately following two Pricing Rate Periods. "Pricing Rate Period" shall mean, (a) in the case of the first Pricing Rate Period with respect to any Transaction, the period commencing on and including the Purchase Date for such Transaction and ending on and excluding the following Remittance Date, and (b) in the case of any subsequent Pricing Rate Period, the period commencing on and including such Remittance Date and ending on and excluding the following Remittance Date; provided, however, that in no event shall any Pricing Rate Period end subsequent to the Repurchase Date. "Principal Payment" shall mean, with respect to any Purchased Loans or Purchased Securities, any payment or prepayment of principal received by the Depository in respect thereof. "Purchased Loan Documents" shall mean, with respect to a Purchased Loan, the documents comprising the Purchased Loan File for such Purchased Loan. "Purchased Loan File" shall mean the documents specified as the "Purchased Loan File" in Section 7(e), or (in relation to an English Loan) the documents specified as the "Purchased Loan File" in the English Loan Supplement together (in each case) with any additional documents and information required to be delivered to Buyer or its designee (including the Custodian) pursuant to this Agreement. "Purchased Loan Schedule" shall mean a schedule of Purchased Loans attached to each Trust Receipt and Custodial Delivery containing information substantially similar to the Collateral Information. "Purchased Loans" shall mean (i) with respect to any Transaction, the Eligible Loans sold by Seller to Buyer in such Transaction until such Eligible Loans are repurchased pursuant to this Agreement and (ii) with respect to the Transactions in general, all Eligible Loans sold by Seller to Buyer and any additional collateral delivered by Seller to Buyer pursuant to Section 4(a) of this Annex I until such Eligible Loans are repurchased pursuant to this Agreement. "Rating Agency" shall mean any of Fitch Inc., Moody's and Standard & Poor's. "Rating Category" shall mean any of the rating categories listed in Schedule I-A attached to this Annex I. "Reference Banks" shall mean banks each of which shall (i) be a leading bank engaged in transactions in Eurodollar deposits in the international Eurocurrency market and (ii) have an established place of business in London. Initially, the Reference Banks shall be JP Morgan Chase Bank, Barclays Bank, Plc and Deutsche Bank AG. If any such Reference Bank should be unwilling or unable to act as such or if the Buyer shall terminate the appointment of any such Reference Bank or if any of the Reference Banks should be removed from the Reuters Monitor Money Rates Service or in any other way fail to meet the qualifications of a Reference Bank, the Buyer in the exercise of its good faith business judgment may designate alternative banks meeting the criteria specified in clauses (i) and (ii) above. "Related Securities" shall mean commercial mortgage backed securities (other than the Purchased Securities) issued as part of the same transaction as the transaction in which the Purchased Securities are issued and having a lower rating than such Purchased Securities or having no rating. "Relevant System" shall mean (a) The Depository Trust Company in New York, New York, or (b) such other clearing organization or book-entry system as is designated in writing by the Buyer. "Remittance Date" shall mean each of the twelfth (12th) and the twentieth (20th) calendar day of each month, or the next succeeding Business Day, if either such calendar day shall not be a Business Day; provided however, that with respect to any Purchased Loan or Purchased Security denominated in a currency other than United States Dollars, there shall be only one (1) Remittance Date per month which Remittance Date shall be a day of month agreed upon by Buyer and Seller as of the related Purchase Date. "Requirement of Law" shall mean any law, treaty, rule, regulation, code, directive, policy, order or requirement or determination of an arbitrator or a court or other Governmental Authority whether now or hereafter enacted or in effect. "Reserve Requirement" shall mean, with respect to any Pricing Rate Period, the aggregate (without duplication) of the rates (expressed as a decimal fraction) of reserve requirements in effect during such Pricing Rate Period (including, without limitation, basic, supplemental, marginal and emergency reserves under any regulations of the Board of Governors of the Federal Reserve System or other governmental authority having jurisdiction with respect thereto) dealing with reserve requirements prescribed for eurocurrency funding (currently referred to as "Eurocurrency Liabilities" in Regulation D of such Board of Governors) maintained by the Buyer. "Reset Date" shall mean, with respect to any Transaction, the day prior to the first day of the Pricing Rate Period commencing on and including the first Remittance Date in a calendar month with respect to such Transaction. "Securitization Document" shall mean, with respect to any Eligible Securities, any pooling and servicing agreement or other agreement governing the issuance and administration of such Eligible Securities and any offering document used in the distribution and sale of such Eligible Securities (including, without limitation, the preliminary and final private placement memorandum, prospectus and/or offering memorandum). "Seller" shall mean Anthracite Funding LLC, a Delaware limited liability company. "Seller's Equity" means an aggregate amount equal to the sum of the Equity with respect to each Purchased Loan and Purchased Security, which amount and its relationship to the Minimum Seller's Equity Requirement (i.e. lower than on the one hand or equal to or greater than on the other hand) shall determine the applicable "Original Purchase Percentage," "CF Sweep Purchase Percentage" and "Buyer's Margin Percentage" as set forth on Schedule I-A to this Annex I for each Transaction. Upon request of Seller made from time to time, Buyer shall provide to Seller information with respect to the Equity with respect to each Purchased Loan and Purchased Security. In addition, Seller's Equity shall include any cash and the value as determined by Buyer of other collateral (including, without limitation, Eligible Loans or Eligible Securities) which the Seller pledges and/or delivers to the Buyer and the Seller and the Buyer agree in writing shall be included in the determination of Seller's Equity. "Servicing Agreement" has the meaning specified in Section 22(b) of this Annex I. "Servicing Records" has the meaning specified in Section 22(b) of this Annex I. "Settlement Agent" shall mean, with respect to any Transaction involving Table Funded Purchased Loans, an entity satisfactory to the Buyer in its reasonable discretion (which may be a title company, escrow company or attorney in accordance with local law and practice in the jurisdiction where the related Table Funded Purchased Loan is being originated), to which the Purchase Price is to be wired by Buyer at the request of Seller. "Single-Purpose Entity" shall mean a Person, other than an individual, which is formed or organized solely for the purpose of holding, directly and subject to this Agreement, the Portfolio Collateral, does not engage in any business unrelated to the Portfolio Collateral and the financing thereof, does not have any assets other than the Portfolio Collateral and the financing thereof, or any indebtedness other than as permitted by the Agreement, has its own separate books and records and its own accounts, in each case which are separate and apart from the books and records and accounts of any other Person, holds itself out as being a Person and separate and apart from any other Person. If the foregoing entity is a limited partnership or limited liability company, (i) its partnership agreement or limited liability company agreement (as applicable) shall provide that the partnership or limited liability company shall dissolve upon the withdrawal or dissolution of the last remaining general partner or managing member, but the partnership or limited liability company will not be dissolved if the remaining partners or members, within ninety (90) days, by majority vote elect to continue the partnership or limited liability company and appoint a new general partner or new managing member, and (ii) the partnership agreement or limited liability company agreement (as applicable) must provide that the dissolution and winding up or bankruptcy or insolvency filing of such partnership or limited liability company shall require the unanimous consent of all members (including the board of directors of such members). "Sovereign Repurchase Event" shall mean as a result of sovereign action or inaction (directly or indirectly), Buyer becomes unable to perform any absolute or contingent obligation to make a payment or transfer or to receive a payment or transfer in respect of any Transaction hereunder or to comply with any other material provision of the Agreement relating to such Transaction. "Sponsor" shall mean Anthracite Capital Inc., a Maryland corporation. "Standard & Poor's" shall mean Standard & Poor's Ratings Services, a division of The McGraw-Hill Companies, Inc. "Supplemental Due Diligence List" shall mean, with respect to any New Collateral, information or deliveries concerning the New Collateral that Buyer shall reasonably request in addition to the Preliminary Due Diligence Package. "Survey" shall mean a certified ALTA/ACSM (or applicable state standards for the state in which the Collateral is located) survey of a Mortgaged Property prepared by a registered independent surveyor and in form and content satisfactory to the Buyer and the company issuing the Title Policy for such Property. "Table Funded Purchased Loan" shall mean a Purchased Loan which is sold to the Buyer simultaneously with the origination or acquisition thereof, which origination or acquisition is financed with the Purchase Price, pursuant to Seller's request, paid directly to the Settlement Agent for disbursement in connection with such origination or acquisition. A Purchased Loan shall cease to be a Table Funded Purchased Loan after the Custodian has delivered a Trust Receipt to Buyer certifying its receipt of the Purchased Loan File therefor. "Table Funded Trust Receipt" shall have the meaning given to such term in the Custodial Agreement. "Target Price" shall mean, with respect to any Purchased Securities or Purchased Loans as of any date, the amount (expressed in United States Dollars) obtained by multiplying (i) the Market Value of such Purchased Securities or Purchased Loans as of such date by (ii) the "Original Purchase Percentage" for the Rating Category applicable to such Purchased Securities or the Collateral Type Grouping applicable to such Purchased Loans, as set forth in Schedule I-A attached to this Annex I. "Telerate Page 3750" shall mean the display page currently so designated on the Dow Jones Service (or such other page as may replace that page on that service for the purpose of displaying comparable rates or prices). "Title Policy" shall have the meaning specified in paragraph 8 of the first paragraph of Exhibit VI. "Transaction Conditions Precedent" shall have the meaning specified in Section 3(b) of this Annex I. "Transaction Documents" shall mean, collectively, the Agreement, this Annex I, any other applicable Annexes to the Agreement, the Guaranty, the Custodial Agreement and all Confirmations executed pursuant to the Agreement and this Annex I in connection with specific Transactions. "Transition Down Date" shall have the meaning specified in Section 4(a) of this Annex I. "Transition Up Date" shall have the meaning specified in Section 3(l) of this Annex I. "Trustee" shall mean, with respect to any Eligible Securities, the trustee under the Securitization Document applicable to such Eligible Securities. "Trust Receipt" shall mean a trust receipt issued by Custodian to Buyer confirming the Custodian's possession of certain Purchased Loan Files which are the property of and held by Custodian for the benefit of the Buyer (or any other holder of such trust receipt). "UCC" shall have the meaning specified in Section 6 of this Annex I. "Underwriting Issues" shall mean, with respect to any Collateral as to which Seller intends to request a Transaction, all material information that has come to Seller's attention that, based on the making of reasonable inquiries and the exercise of reasonable care and diligence under the circumstances, would be considered a materially "negative" factor (either separately or in the aggregate with other information) including but not limited to, to the extent of the Seller's knowledge, whether any of the Purchased Securities or Purchased Loans were rejected for inclusion in, or repurchased from, any securitization transaction, warehouse loan facility or a repurchase transaction due to the breach of a representation and warranty), or a material defect in loan documentation or closing deliveries (such as any absence of any material Purchased Loan Document(s)), to a reasonable institutional mortgage Buyer in determining whether to originate or acquire the Collateral in question. "US Loan" shall mean any Eligible Loan governed by the law of a state forming part of the United States of America and secured (inter alia) by Mortgaged Property located in the United States of America. (b) The following capitalized terms shall have the respective meanings set forth below, in lieu of the meanings for such terms set forth in the Agreement: "Buyer's Margin Percentage" shall mean, with respect to the Purchased Loans or Purchased Securities, as of any date, the "Buyer's Margin Percentage" specified for the applicable Rating Category or Collateral Type Grouping in Schedule I-A attached to this Annex I. "Confirmation" shall have the meaning specified in Section 3(b) of this Annex I. "Event of Default" shall have the meaning specified in Section 14 of this Annex I. "Margin Notice Deadline" shall mean 11:00 a.m. (New York City time). "Market Value" shall mean, with respect to any Purchased Securities as of any relevant date, the market value for such Purchased Securities on such date, as determined by Buyer in the exercise of its good faith business judgment or, with respect to any Purchased Loans as of any relevant date, the lesser of (x) the market value for such Purchased Loans on such date, as determined in good faith by Buyer in the exercise of its good faith business judgment and (y) the par amount of such Purchased Loan (and including the value of any Hedging Transactions assigned with such Purchased Securities or Purchased Loans for which the Buyer or an Affiliate of the Buyer is the counterparty). The Market Value of all Purchased Securities and Purchased Loans shall be determined by Buyer, in the exercise of its good faith business judgment, on each Business Day during the term of the Agreement. "Price Differential" shall mean, with respect to any Transaction as of any date, the aggregate amount obtained by daily application of the Pricing Rate for such Transaction to the Repurchase Price for such Transaction on a 360-day-per-year basis for the actual number of days during the period commencing on (and including) the Purchase Date for such Transaction and ending on (but excluding) the date of determination (reduced by any amount of such Price Differential previously paid by Seller to Buyer with respect to such Transaction). "Pricing Rate" shall mean, for any Pricing Rate Period, with respect to a Transaction involving Purchased Securities in any Rating Category and/or Purchased Loans in any Collateral Type Grouping on Schedule I-A of this Annex I, an annual rate equal to the LIBO Rate for the Pricing Rate Period commencing on and including the first Remittance Date in a calendar month plus the relevant Applicable Spread for such Transaction, subject to adjustment and/or conversion as provided in Sections 3(g) and 3(h); provided, that with respect to a Transaction involving Purchased Securities in any Rating Category and/or Purchased Loans in any Collateral Type Grouping on Schedule I-A of this Annex in each case denominated in a currency other than United States Dollars and for which the interest accrues at a rate other than the LIBOR Rate (e.g., EURIBOR), the Pricing Rate shall equal such other interest rate for the Pricing Rate Period commencing on and including the first Remittance Date in a calendar month plus the relevant Applicable Spread for such Transaction, subject to adjustment and/or conversion as provided in Section 3(g) and 3(h). "Purchase Price" shall mean, with respect to any Purchased Securities or Purchased Loans, (i) initially the price at which such Purchased Securities or Purchased Loans are transferred by Seller to Buyer on the applicable Purchase Date and (ii) thereafter, such price increased by the amount of any cash transferred by Buyer to Seller pursuant to Section 3(l) or 4(b) hereof. The Purchase Price as of any Purchase Date for any Purchased Securities in a particular Rating Category or any Purchased Loans in a particular Collateral Type Grouping shall be an amount equal to the product obtained by multiplying (i) the Market Value of such Purchased Securities (or, if the Securities proposed to be included in a Transaction are being or were acquired by the Seller from the Sponsor, the acquisition cost of the Sponsor in such Securities, if lower than the Market Value) or such Purchased Loans by (ii) the "Original Purchase Percentage" for such Rating Category or such Collateral Type Grouping, as set forth in Schedule I-A attached to this Annex I; and (2) the Seller may request that the Purchase Price set forth in a Confirmation be determined applying a percentage lower than the Original Purchase Percentage set forth in Schedule I-A attached to this Annex I and, in such event, such lower percentage shall be deemed the "Original Purchase Percentage" for purposes of the calculation of the Target Price but not for any other purpose under the Agreement. The Purchase Price shall be expressed in United States Dollars with respect to any Purchased Securities or Purchased Loans denominated in United States Dollars. Any Purchased Loans or Purchased Securities denominated in a currency other than United States Dollars shall be purchased in such other currency. "Purchased Securities" shall mean, (i) with respect to any Transaction, the Eligible Securities sold by Seller to Buyer in such Transaction until such Eligible Securities are repurchased pursuant to this Agreement, and (ii) with respect to the Transactions in general, all Eligible Securities sold by Seller to Buyer and any additional collateral delivered by Seller to Buyer pursuant to Section 4(a) of this Annex I until such Eligible Securities are repurchased pursuant to this Agreement. Whenever Purchased Securities are rated by more than one Rating Agency and a split rating applies to such Purchased Securities (i.e., one Rating Agency rates such Purchased Securities at a lower rating level than the other of such Rating Agencies), then for all purposes of this Agreement where a rating is to be selected (including, without limitation, in the determination of any percentages pursuant to Schedule I-A of this Annex I), the lower of the ratings shall apply. "Replacement Collateral" shall have the meaning specified in Section 14(b)(ii) of this Annex I. "Repurchase Date" shall mean the Business Day immediately preceding the third anniversary of the date of the Agreement; provided, however, that if all of the Extension Conditions described in Section 3(e) of this Annex I shall be timely satisfied, the Repurchase Date shall be extended to the Business Day immediately preceding the fourth anniversary of the date of the Agreement. "Repurchase Price" shall mean, with respect to any Purchased Securities or Purchased Loans as of any date, the price at which such Purchased Securities or Purchased Loans are to be transferred from Buyer to Seller upon termination of the related Transaction in whole or in part; such price shall be an amount determined in each case as the sum of the Purchase Price of such Purchased Securities or Purchased Loans and the Price Differential with respect to such Purchased Securities or Purchased Loans as of the date of such determination, minus all Income and cash actually received by Buyer in respect of such Transaction pursuant to Sections 4(a), 5(b), 5(c), 5(d) and 5(e) of this Annex I. The Repurchase Price shall be expressed in United States Dollars with respect to any Purchased Securities or Purchased Loans denominated in United States Dollars. Any Purchased Loans or Purchased Securities denominated in a currency other than United States Dollars shall be repurchased in such other currency. 3 INITIATION; CONFIRMATION; TERMINATION; FEES The provisions of Paragraph 3 of the Agreement are hereby modified and superseded in their respective entireties by the following provisions of this Section 3: (a) Subject to the terms and conditions set forth in the Agreement (including, without limitation, the "Transaction Conditions Precedent" specified in Section 3(b) of this Annex I) the Buyer shall from time to time enter into Transactions with the Seller on any Business Day from and including the date of the Agreement to but excluding the three year anniversary date of the date of the Agreement and pursuant to any such Transaction, Seller shall be entitled to sell, repurchase and re-sell any assets in accordance with this Agreement. An agreement to enter into a Transaction shall be made in writing at the initiation of Seller as provided below; provided, however, that the aggregate Repurchase Price (excluding the Price Differential with respect to the Purchased Securities and Purchased Loans as of the date of determination) for all Transactions shall not exceed the Facility Amount. Seller shall give Buyer written notice of each proposed Transaction and Buyer shall inform Seller of its determination with respect to any assets proposed to be sold to Buyer by Seller solely in accordance with Exhibit VIII attached hereto. Buyer shall have the right to review all Eligible Loans and Eligible Securities proposed to be sold to Buyer in any Transaction and to conduct its own due diligence investigation of such Eligible Loans and Eligible Securities as Buyer reasonably determines. Buyer shall be entitled to make a determination, in the exercise of its good faith business judgment, that it shall not purchase any or all of the assets proposed to be sold to Buyer by Seller. On the Purchase Date for the Transaction which shall be not less than three (3) Business Days following the approval of an Eligible Loan or an Eligible Security by the Buyer in accordance with Exhibit VIII hereto, the Purchased Securities or Purchased Loans shall be transferred to Buyer or its agent against the transfer of the Purchase Price to an account of Seller. With respect to a Transaction involving an Eligible Loan or Eligible Security to be purchased by Buyer in a currency other than United States Dollars, Seller shall give Buyer irrevocable notice of sale of such Eligible Loan or Eligible Security at least one (1) Business Day in advance of the related Purchase Date; provided further, that, if Seller does not complete such Transaction on the Purchase Date set forth in such irrevocable notice, Seller shall pay Buyer any amounts, if any, as may be required pursuant to Section 3(i) hereof. Any proposal by Seller for Transactions relating to Eligible Loans or Eligible Securities denominated in United Kingdom Sterling or for which the related Mortgaged Property is located in England, Wales, Northern Ireland or Scotland shall be governed by the English Loan Supplement which supersedes this Annex I; provided, that any Eligible Loans for which the related Mortgaged Property is located in England, Wales, Northern Ireland or Scotland and which are described in clauses (iii)(y) and (iv)(y) of the definition of Eligible Loans to be entered into by Seller and Buyer must be approved by Buyer in its sole discretion and consent and subject to applicable terms and conditions set forth at such time. From time to time, Seller may propose to Buyer that Buyer and Seller enter into Transactions involving Eligible Loans or Eligible Securities denominated in a currency other than United States Dollars or United Kingdom Sterling or for which the related Mortgaged Property is located outside of the United States or England, Wales, Scotland or Northern Ireland. Any proposal by Seller for Transactions relating to Eligible Loans or Eligible Securities denominated in a currency other than United States Dollars or United Kingdom Sterling or for which the related Mortgaged Property is located outside of the United States or England, Wales, Northern Ireland or Scotland may be entered into by Seller and Buyer at Buyer's sole discretion and consent and subject to applicable terms and conditions set forth at such time. All outstanding and/or proposed Transactions denominated in a currency other than United States Dollars shall be converted to United States Dollars on each Purchase Date (or, on the relevant Purchase Date with respect to proposed Transactions) or on any other date in relation to which a determination is required to give effect to the Repurchase Agreement, in each case on the basis of the spot rate for the sale of such other currency against the purchase of United States Dollars in the [London foreign exchange market] quoted by any leading international bank selected by the Buyer on the first date immediately preceding the date of calculation on which commercial banks and foreign exchange markets are open for business in London. (b) Upon agreeing to enter into a Transaction hereunder, provided each of the Transaction Conditions Precedent (as hereinafter defined) shall have been satisfied (or waived by Buyer), Buyer shall promptly (and in any event within five (5) Business Days) deliver to Seller a written confirmation in the form of Exhibit I attached hereto of each Transaction (a "Confirmation"). Unless otherwise agreed by the parties, Buyer shall deliver a separate Confirmation with respect to each Purchased Loan or Purchased Security which is the subject of a Transaction. Such Confirmation shall describe the Purchased Securities (including CUSIP number, if any) and/or Purchased Loans, shall identify Buyer and Seller, and shall set forth: (i) the Purchase Date, (ii) the Purchase Price for such Purchased Securities and/or Purchased Loans, (iii) the Repurchase Date, (iv) the Pricing Rate applicable to the Transaction (including the Applicable Spread) (v) the acquisition cost; and (vi) and any additional terms or conditions not inconsistent with the Agreement. With respect to any Transaction, the Pricing Rate shall be determined initially on the Pricing Rate Determination Date applicable to the first Pricing Rate Period for such Transaction, and shall be reset on each Reset Date for the next two succeeding Pricing Rate Periods for such Transaction. Buyer or its agent shall determine in accordance with the terms of this Agreement the Pricing Rate on each Pricing Rate Determination Date for the next succeeding two Pricing Rate Periods and notify Seller of such rate for such periods on the Reset Date. For purposes of this Section 3(b), the "Transaction Conditions Precedent" shall be deemed to have been satisfied with respect to any proposed Transaction if: (1) no Default or Event of Default under the Agreement shall have occurred and be continuing as of the Purchase Date for such proposed Transaction; (2) Seller shall have certified to Buyer in writing the acquisition cost of such Securities (including therein reasonable supporting documentation required by the Buyer, if any); (3) the representations and warranties made by Seller in any of the Transaction Documents shall be true and correct in all material respects as of the Purchase Date for such Transaction; (4) Buyer shall have (A) determined, in accordance with the applicable provisions of Section 3(a) of this Annex I, that the assets proposed to be sold to Buyer by Seller in such Transaction are Eligible Securities and/or Eligible Loans and (B) with respect to any Eligible Loan only, obtained internal credit approval for the inclusion of such Eligible Loan as a Purchased Loan in a Transaction; (5) [reserved]; (6) Buyer shall have received the Guaranty executed by the Sponsor; (7) following the consummation of such Transaction, the total Repurchase Price of Transactions with respect to Purchased Loans of the types described in clauses (iii) and (iv) of the definition of Eligible Loan shall not exceed $100,000,000; (8) with respect to any proposed Transaction for Securities in the event the Seller or an Affiliate of the Seller owns the Related Securities, the Seller shall have (x) caused ownership of the Related Securities to be transferred to the Seller simultaneous with or prior to the purchase of the Purchased Securities by Buyer and (y) delivered to the Buyer a power of attorney and any other documentation reasonably required by the Buyer sufficient to permit the Buyer upon the occurrence and during the continuance of an Event of Default to register the transfer of the Related Securities from Seller to Buyer or its designee; (9) Buyer shall have determined that, with respect to the Purchased Securities then subject to Transactions, following the consummation of the proposed Transaction: (i) the aggregate Market Value with respect to all Purchased Securities then subject to Transactions in each Rating Category set forth below does not exceed the applicable percentage set forth below as a percentage of the Market Value of all Purchased Securities then subject to Transactions: Rating Category (or the Maximum Market Value (%) equivalent) BB- 45 B+ 35 B 35 B- 35 NR&CCC 30 (ii) if the number of separate issues of Purchased Securities then subject to Transactions with a minimum $20,000,000 outstanding face or notional principal amount per issue is less than or equal to ten (10), then the aggregate outstanding face or notional principal amount of all Purchased Securities then subject to Transactions issued by a single issuer does not exceed $100,000,000; provided, however, if the number of issues is greater than ten (10), than the aggregate outstanding face or notional principal amount of all Purchased Securities then subject to Transactions issued by a single issuer may exceed $100,000,000; (10) Buyer shall have determined that, with respect to any Purchased Securities which are the subject of a proposed Transaction and are rated "B+"(or the equivalent) or lower or are not rated, such Purchased Securities, together with any Purchased Securities issued by the same trust, entitle the holder thereof to control the selection of the special servicer for the mortgage loans underlying such Purchased Securities; and (11) with respect to any proposed Transaction for Purchased Securities in a "real estate mortgage investment conduit" (or REMIC), in the event the Seller or an Affiliate of the Seller owns the Related Securities (it being understood that for purposes of this provision, Related Securities shall include (a) the securities issued in such "real estate mortgage investment conduit" (or REMIC) transaction which have no rating and (b) if such unrated securities do not entitle the holder thereof to control the selection of the special servicer for the mortgage loans underlying such Purchased Securities (i.e. serve as the controlling class), the securities which have a rating and entitle the holder thereof to control the selection of the special servicer for the mortgage loans underlying such Purchased Securities (i.e. serve as the controlling class)), the Seller shall have either (x) (i) caused ownership of the Related Securities to be transferred to the Seller simultaneous with or prior to the purchase of the Purchased Securities by Buyer and (ii) delivered to the Buyer a power of attorney and any other documentation reasonably required by the Buyer sufficient to permit the Buyer upon the occurrence and during the continuance of an Event of Default to register the transfer of the Related Securities from Seller to Buyer or its designee, or (y) delivered to the Buyer an agreement satisfactory to Buyer irrevocably conveying and transferring to Buyer the right to control the selection of the special servicer for the related mortgage loans if an Event of Default occurs under the Agreement. (c) Each Confirmation, together with the Agreement, including this Annex I, shall be conclusive evidence of the terms of the Transaction(s) covered thereby unless objected to in writing by Seller no more than two (2) Business Days after the date such Confirmation is received by Seller. An objection sent by Seller with respect to any Confirmation must state specifically that the writing is an objection, must specify the provision(s) of such Confirmation being objected to by Seller, must set forth such provision(s) in the manner that Seller believes such provisions should be stated, and must be received by Buyer no more than two (2) Business Days after such Confirmation is received by Seller. (d) No Transaction shall be terminable on demand by Buyer (other than upon the occurrence and during the continuance of an Event of Default by Seller or if a Sovereign Repurchase Event occurs). Seller shall be entitled to terminate a Transaction in whole or in part on demand and repurchase all or a portion of Purchased Securities and/or Purchased Loans subject to a Transaction on any Business Day prior to the Repurchase Date (an "Early Repurchase Date"); provided, however, that: (i) Seller repurchases on such Early Repurchase Date, all or the portion of the Purchased Securities and/or Purchased Loans subject to such Transaction which Seller has elected to repurchase, (ii) Seller notifies Buyer in writing of its intent to terminate such Transaction and repurchase such Purchased Securities and/or Purchased Loans no later than five (5) Business Days prior to such Early Repurchase Date, (iii) on such Early Repurchase Date, Seller pays to Buyer an amount equal to the sum of the Repurchase Price for such Transaction (or, in the case of a termination of a Transaction in part an amount acceptable to the Buyer in the exercise of its good faith business judgment but not more than such Repurchase Price), the Exit Fee, if any, and any other amounts payable under this Agreement (including, without limitation, Section 3(i) of this Annex I) with respect to such Transaction against transfer to the Seller or its agent of such Purchased Securities and/or Purchased Loans; (iv) on such Early Repurchase Date, if the Minimum Seller's Equity Requirement has not been achieved and if a CF Sweep Event has occurred and is continuing with respect to any Purchased Security or Purchased Loan, Seller shall, if the Purchased Security or Purchased Loan in question is not being redeemed or satisfied by the underlying obligor, only be permitted to repurchase a Purchased Security or Purchased Loan (other than the Purchased Security or Purchase Loan that triggered a CF Sweep Event) if Seller pays to Buyer an amount, in addition to the amount referred to in clause (iii) above, on account of and to reduce the Repurchase Price of the Purchased Securities or Purchased Loans in respect of which such CF Sweep Event occurred, until the Repurchase Price for such Purchased Securities or Purchased Loans has been reduced to the amount (expressed in United States Dollars) obtained by multiplying (i) the Market Value of such Purchased Securities or Purchased Loans as of such date by (ii) the "CF Sweep Purchase Percentage" applicable to such Purchased Securities or Purchased Loans, as set forth in Schedule I-A attached to this Annex I, respectively as of the date of such payment (as determined by Buyer after giving effect to such Principal Payment); and (v) if the reason for the termination of a Transaction is the related Purchased Security or Purchased Loan is simultaneous with such termination being included in a collateralized debt obligation (or CDO) transaction, then the proceeds of the transfer of such Purchased Security or Purchased Loan shall be applied as follows: (1) first, to pay to Buyer the amount referred to in clause (iii) above; (2) second, if a Transition Down Date has occurred, to reduce the Repurchase Price of any Purchased Securities or Purchased Loans then subject to Transactions in respect of which the Market Value is less than the Buyer's Margin Amount (using the higher Original Purchase Percentages and CF Sweep Purchase Percentages and lower Margin Maintenance Percentages then in effect as described in Section 4 of this Annex I) until the Repurchase Price of all such Purchased Securities and Purchased Loans then subject to Transactions equals the Target Price (for this purpose, making such payment in the order of those Purchased Securities or Purchased Loans with the largest to smallest excess of Repurchase Price over Target Price); and (3) third, to pay any excess to the Seller. Such notice shall set forth the Early Repurchase Date and shall identify with particularity the Purchased Securities and/or Purchased Loans to be repurchased on such Early Repurchase Date. (e) On the Repurchase Date, termination of the applicable Transactions will be effected by transfer to Seller or its agent of the Purchased Securities and Purchased Loans and any Income in respect thereof received by Buyer (and not previously credited or transferred to, or applied to the obligations of, Seller pursuant to Section 5 of this Annex I) against the simultaneous transfer of the Repurchase Price to an account of Buyer. Notwithstanding the foregoing, provided all of the Extension Conditions (as hereinafter defined) shall have been satisfied, the Repurchase Date shall be extended with respect to all of the Transactions until the first (1st) anniversary of the originally scheduled Repurchase Date (all of the other terms and conditions of such Transactions remaining the same). For purposes of the preceding sentence, the "Extension Conditions" shall be deemed to have been satisfied if: (i) Seller shall have given Buyer written notice, not less than thirty (30) days prior to the originally scheduled Repurchase Date, of Seller's desire to extend the Repurchase Date, (ii) no Default or Event of Default under the Agreement shall have occurred and be continuing as of the originally scheduled Repurchase Date, (iii) Seller shall have paid Buyer an extension fee in an amount equal to one-quarter of one percent (0.25%) of the aggregate outstanding Repurchase Price of all Transactions as of the Business Day prior to the third anniversary of the date of the Agreement (such Repurchase Price, the "Extension Date Repurchase Price"); and (iv) Seller shall have reduced the Repurchase Price of any Purchased Securities or Purchased Loans then subject to Transactions to the extent necessary to cause the Repurchase Price of all Purchased Securities and Purchased Loans then subject to Transactions to equal the Target Price. In the event the Repurchase Date is extended pursuant to this Section 3(e) of Annex I, then Seller shall be required to terminate all Transactions in part by paying 50% of the Extension Date Repurchase Price by not later than the initial Remittance Date occurring in March 2008, by paying 75% of the Extension Date Repurchase Price by not later than the initial Remittance Date occurring in June 2008 and by paying any unpaid portion of the Repurchase Price of all Transactions on the Repurchase Date, as extended. Each such payment of the Repurchase Price of all Transactions shall reduce the Repurchase Price of individual Transactions on a pro rata basis. (f) Reserved. (g) If prior to the first day of any Pricing Rate Period with respect to any Transaction, (i) Buyer shall have determined (which determination shall be conclusive and binding upon Seller) that, by reason of circumstances affecting the relevant market, adequate and reasonable means do not exist for ascertaining the LIBO Rate for such Pricing Rate Period, or (ii) the LIBO Rate determined or to be determined for such Pricing Rate Period will not adequately and fairly reflect the cost to Buyer (as determined and certified by Buyer) of making or maintaining Transactions during such Pricing Rate Period, Buyer shall give telecopy or telephonic notice thereof to Seller as soon as practicable thereafter. If such notice is given, the Pricing Rate with respect to such Transaction for such Pricing Rate Period, and for any subsequent Pricing Rate Periods until such notice has been withdrawn by Buyer, shall be a per annum rate (the "Alternative Rate") equal to a rate determined based on an index approximating the behavior of LIBOR as reasonably determined by Buyer (which may be the Prime Rate). (h) Notwithstanding any other provision herein, if the adoption of or any change in any Requirement of Law or in the interpretation or application thereof shall make it unlawful for Buyer to effect Transactions as contemplated by the Transaction Documents, (a) the commitment of Buyer hereunder to enter into new Transactions and to continue Transactions as such shall forthwith be canceled, and (b) the Transactions then outstanding shall be converted automatically to Alternative Rate Transactions on the last day of the then current Pricing Rate Period or within such earlier period as may be required by law. If any such conversion of a Transaction occurs on a day which is not the last day of the then current Pricing Rate Period with respect to such Transaction, Seller shall pay to Buyer such amounts, if any, as may be required pursuant to Section 3(i) of this Annex I. (i) Upon demand by Buyer, Seller shall indemnify Buyer and hold Buyer harmless from any net loss or expense (not to include any lost profit or opportunity) (including, without limitation, reasonable attorneys' fees actually incurred and disbursements) which Buyer may sustain or incur as a consequence of (i) default by Seller in selling Eligible Securities or Eligible Loans after Seller has notified Buyer of a proposed Transaction and Buyer has agreed to purchase such Eligible Securities or Eligible Loans in accordance with the provisions of this Agreement (including also, but not limited to, a default by Seller in selling Eligible Securities and Eligible Loans on the Purchase Date as set forth in an irrevocable notice in accordance with Section 3(a) hereto), (ii) any payment of the Repurchase Price on any day other than a Remittance Date, (iii) with respect to any Purchased Securities or Purchased Loans denominated in a currency other than United States Dollars, any unscheduled payment of the Repurchase Price (excluding Price Differential) on a Remittance Date without at least four (4) Business Day's prior notice by Seller to Buyer, or (iv) default by the Seller in terminating any Transaction after the Seller has given a notice in accordance with Section 3(d) of a termination of a Transaction (in each case of (i)-(iv) above, including, without limitation, any such loss or expense in the nature of a breakage cost attributable thereto arising from the reemployment of funds obtained by Buyer to maintain Transactions hereunder or from fees payable to terminate the deposits from which such funds were obtained). As a condition to Seller's liability under this paragraph, Buyer shall promptly deliver to Seller a certificate as to such costs, losses, damages and expenses, setting forth the calculations therefor and including any available supporting documentation, which certificate shall be conclusive and binding on Seller in the absence of manifest error. (j) If the adoption of or any change in any Requirement of Law or in the interpretation or application thereof by any Governmental Authority or compliance by Buyer with any directive from any central bank or other Governmental Authority having jurisdiction over Buyer made subsequent to the date hereof: (i) shall subject Buyer to any tax of any kind whatsoever with respect to the Transaction Documents, any Purchased Security or Purchased Loan or any Transaction, or change the basis of taxation of payments to Buyer in respect thereof (except for changes in the rate of tax on Buyer's overall net income); (ii) shall impose, modify or hold applicable any reserve, special deposit, compulsory loan or similar requirement against assets held by, deposits or other liabilities in or for the account of, advances, loans or other extensions of credit by, or any other acquisition of funds by, any office of Buyer which is not otherwise included in the determination of the LIBO Rate hereunder; or (iii) shall impose on Buyer any other condition; and the result of any of the foregoing is to increase the cost to Buyer, by an amount which Buyer deems to be material, of entering into, continuing or maintaining Transactions or to reduce any amount receivable under the Transaction Documents in respect thereof; then, in any such case, Seller shall promptly pay Buyer, upon its demand, any additional amounts necessary to compensate Buyer for such increased cost or reduced amount receivable. If Buyer becomes entitled to claim any additional amounts pursuant to this Section 3(j), it shall promptly notify Seller of the event by reason of which it has become so entitled. As a condition to Seller's liability under this paragraph, Buyer shall promptly deliver to Seller a certificate as to the calculation of any additional amounts payable pursuant to this subsection and including any available supporting documentation, which certificate shall be conclusive and binding upon Seller in the absence of manifest error. This covenant shall survive the termination of the Agreement and this Annex I and the repurchase by Seller of any or all of the Purchased Securities and Purchased Loans. (k) If Buyer shall have determined that the adoption of or any change in any Requirement of Law regarding capital adequacy or in the interpretation or application thereof or compliance by Buyer or any corporation controlling Buyer with any directive regarding capital adequacy from any Governmental Authority made subsequent to the date hereof does or shall have the effect of reducing the rate of return on Buyer's or such corporation's capital as a consequence of its obligations hereunder to a level below that which Buyer or such corporation could have achieved but for such adoption, change or compliance by an amount which is deemed by Buyer to be material, then from time to time, after submission by Buyer to Seller of a written request therefore, Seller shall pay to Buyer such additional amount or amounts as will compensate Buyer for such reduction. As a condition to Seller's liability under this paragraph, Buyer shall promptly deliver to Seller a certificate as to the calculation of any additional amounts payable pursuant to this subsection and including any available supporting documentation, which certificate shall be conclusive and binding upon Seller in the absence of manifest error. This covenant shall survive the termination of the Agreement and this Annex I and the repurchase by Seller of any or all of the Purchased Securities and Purchased Loans. (l) If (x) the Seller's Equity at any time equals or exceeds the Minimum Sellers' Equity Requirement and with respect to the Purchased Securities only, the number of issues of Purchased Securities which are then subject to Transactions at any time equals or exceeds the Minimum CMBS Diversification or (y) the rating of any Purchased Security then subject to a Transaction is upgraded (such date, the "Transition Up Date"), then, so long as an Event of Default shall not have occurred, (i) the Original Purchase Percentage, CF Sweep Purchase Percentage and Buyer's Margin Percentage shall, without further action of the parties, immediately be deemed increased as set forth in Schedule I-A attached hereto (1) in the case of clause (x), with respect to all Purchased Securities and Purchased Loans then subject to Transactions (i.e. the percentages that apply shall shift horizontally to the right one column under each such heading), or (2) in the case of clause (y), with respect to the affected Purchased Security (i.e. the percentages that apply shall shift vertically upward to the applicable Rating Category), and (ii) on the Purchase Date for the initial Transaction following the Transition Up Date or on any Business Day not less than five (5) Business Days after the Transition Up Date, as determined by Seller, the Buyer shall transfer to an account of Seller the corresponding increase in the Purchase Price which reflects the new higher Original Purchase Percentage for the applicable Purchased Loans and Purchased Securities referred to in the preceding clause (i) and Buyer and Seller shall enter into an amended and restated Confirmation reflecting such change in Purchase Price for each prior Transaction; provided, that such increase in Purchase Price reflecting the higher Original Purchase Percentage for each Purchased Security or Purchased Loan which was included in a Transaction prior to such Purchase Date shall in no event reduce the Seller's Equity below the Minimum Seller's Equity Requirement. 4 MARGIN MAINTENANCE (a) Paragraphs 4(a) and 4(b) of the Agreement are hereby modified in their entirety to read as follows: "(a) If at any time, either (i) the Market Value of any of the Purchased Securities or any of the Purchased Loans shall be less than the Buyer's Margin Amount for such Purchased Securities or Purchased Loans, respectively (a "Margin Deficit"), or (ii) a Credit Loss shall occur with respect to the Purchased Securities in any Rating Category subject to the last sentence of this Paragraph 4(a) or a Credit Loss shall occur with respect to the Purchased Loans in any Collateral Type Grouping, then Buyer may by notice to Seller require Seller to transfer to Buyer (A) cash or (B) additional collateral or a letter of credit acceptable to Buyer in its sole and absolute discretion, so that the sum obtained by adding the Market Value of such Purchased Securities or Purchased Loans plus such cash and additional collateral or letter of credit shall equal or exceed the Deficit Cure Amount for such Purchased Securities or Purchased Loans, respectively, as of the same date. Seller's failure to cure any Margin Deficit as required by the preceding sentence shall constitute an Event of Default under the Transaction Documents and shall entitle Buyer to exercise its remedies under Section 14 of Annex I (including, without limitation, the liquidation remedy provided for in Section 14(c)(iv) of Annex I). For purposes of this Paragraph 4(a), a Credit Loss shall only be deemed to have occurred with respect to the Purchased Securities in any Rating Category if and to the extent such Credit Loss shall not have been offset by Credit Gains with respect to Purchased Securities in the same Rating Category." In connection with the foregoing, if the Margin Deficit is caused at any time by the Seller's Equity (which previously exceeded the Minimum Seller's Equity Requirement) falling below the Minimum Seller's Equity Requirement or by the Minimum CMBS Diversification (which previously was in effect) no longer being in effect (such date, the "Transition Down Date"), then (1) except as described in clause (2) below, the Original Purchase Percentages and CF Sweep Purchase Percentages shall automatically be reduced to the lower Original Purchase Percentages and CF Sweep Purchase Percentages and the Buyer's Margin Percentages shall automatically be increased to the higher Buyer's Margin Percentages, in each case for the Purchased Securities and/or Purchased Loans subject to Transactions as of such Transition Down Date, and (2) in the event the Transition Down Date was caused by a collateralized debt obligation (or CDO) transaction, (x) during the (9) months following the closing of such transaction the Original Purchase Percentages, CF Sweep Purchase Percentage and Buyer's Margin Percentages shall not be reduced or increased as described in (1) above and shall remain at the Original Purchase Percentages, CF Sweep Purchase Percentages and Buyer's Margin Percentages that applied immediately before the collateralized debt obligation (or CDO) transaction (i.e. during such nine (9) month period Buyer shall apply Income deposited in the Cash Management Account pursuant to Section 5 utilizing such higher or lower percentages, as the case may be) and (y) at the end of such nine (9) month period, the Original Purchase Percentages, CF Sweep Purchase Percentages and Buyer's Margin Percentages shall be determined by whether the Minimum Seller's Equity Requirement and the Minimum CMBS Diversification is achieved at such time." "(b) If any time the aggregate Market Value of any Purchased Security in any Rating Category or Purchased Loan in any Collateral Type Grouping multiplied by the "Original Purchase Percentage" for such Rating Category or such Collateral Type Grouping as such Original Purchase Percentage may be adjusted in accordance with this Agreement shall be greater than the aggregate Repurchase Price for the Transaction relating to such Purchased Security or Purchased Loan, respectively (a "Margin Excess") then Seller may by notice to Buyer require Buyer to transfer to Seller cash in an amount (expressed in United States Dollars) up to the Margin Excess; provided, that any such transfer of cash (1) shall be subject to the restrictions set forth in the parenthetical in and the proviso to the definition of "Purchase Price", (2) shall not be in an amount less than $1,000,000 and (3) shall be evidenced by amended and restated Confirmations. (b) If any notice is given by Buyer under Paragraph 4(a) of the Agreement at or before the Margin Notice Deadline on any Business Day, the Seller shall transfer cash or additional collateral or letter of credit as provided in Paragraph 4(a) no later than the close of business in the relevant market on the next Business Day. If any such notice is given after the Margin Notice Deadline, the Seller shall transfer such cash or additional collateral or letter of credit no later than the close of business in the relevant market on the second Business Day following such notice. If any notice is given by Seller under Paragraph 4(b) of the Agreement prior to the close of business on any Business Day, the Buyer shall transfer cash as provided in Paragraph 4(b) no later than the close of business in the relevant market on the second following Business Day. Notice required pursuant to Paragraph 4(a) or 4(b) of the Agreement may be given by any means of telecopier or telegraphic transmission and shall be delivered in accordance with the terms of the Agreement. The failure of Buyer or Seller, on any one or more occasions, to exercise its rights under Paragraph 4(a) or 4(b) of the Agreement shall not change or alter the terms and conditions to which the Agreement is subject or limit the right of Buyer or Seller to do so at a later date. Buyer and Seller agree that any failure or delay by either party to exercise its rights under Paragraph 4(a) or 4(b) of the Agreement shall not limit such party's rights under the Agreement or otherwise existing by law or in any way create additional rights for such party. (c) Paragraph 4(d) of the Agreement is hereby modified in its entirety to read as follows: "(d) Any cash transferred to Buyer or Seller pursuant to Paragraph 4(a) or 4(b) of the Agreement with respect to any Purchased Securities or any Purchased Loans shall be attributed to the relevant Transaction." (d) Paragraphs 4(e) and 4(f) of the Agreement are hereby deleted in their respective entireties. 5 INCOME PAYMENTS AND PRINCIPAL PAYMENTS The provisions of Paragraph 5 of the Agreement are hereby modified and superseded in their respective entireties by the following provisions of this Section 5: (a) The Cash Management Account shall be established at the Depository concurrently with the execution and delivery of the Agreement and this Annex I by Seller and Buyer. Buyer shall have sole dominion and control over the Cash Management Account. The Seller shall cause all Income in respect of the Purchased Securities and the Purchased Loans and the associated Hedging Transactions to be deposited directly into the Cash Management Account. Such Income shall be remitted by the Depository in accordance with the applicable provisions of Sections 5(b), 5(c), 5(d), 5(e), 5(f) and 14(a)(iii) of this Annex I. (b) With respect to Purchased Loans, Seller shall deliver to each Mortgagor, issuer of a participation or borrower under a Purchased Loan an irrevocable direction letter in the form attached as Exhibit IX to this Agreement instructing the Mortgagor, issuer of a participation or borrower to pay all Income under the related Purchased Loan to the Cash Management Account and shall provide to Buyer proof of such delivery. If a Mortgagor, issuer of a participation or borrower forwards any Income with respect to a Purchased Loan to Seller rather than directly to the Cash Management Account, Seller shall (i) deliver an additional irrevocable direction letter to the applicable Mortgagor, issuer of a participation or borrower and make other commercially reasonable efforts to cause such Mortgagor, issuer of a participation or borrower to forward such amounts directly to the Cash Management Account and (ii) within one Business Day deposit in the Cash Management Account any such amounts. (c) So long as no Event of Default or CF Sweep Event with respect to any Purchased Security and Purchased Loan shall have occurred and be continuing, all Income received by the Depository in respect of the Purchased Securities and the Purchased Loans and the associated Hedging Transactions (other than Principal Payments) during each Collection Period shall be applied by the Depository on the related Remittance Date as follows: (i) first, to remit to Buyer an amount equal to the Price Differential which has accrued and is outstanding as of such Remittance Date; and (ii) second, to remit to Seller the remainder, if any. (d) So long as no Event of Default or CF Sweep Event with respect to any Purchased Security and Purchased Loan shall have occurred and be continuing, any Principal Payment received by the Depository in respect of any of the Purchased Securities and the Purchased Loans during each Collection Period shall be applied by the Depository on the related Remittance Date in the following order of priority: (i) first, to make a payment to Buyer on account of the Repurchase Price of the Purchased Securities or Purchased Loans in respect of which such Principal Payment has been received, until the Repurchase Price for such Purchased Securities or Purchased Loans has been reduced to the Target Price for such Purchased Securities or Purchased Loans, respectively as of the date of such payment (as determined by Buyer after giving effect to such Principal Payment); (ii) second, to make a payment to Buyer on account of the Repurchase Price of any other Purchased Securities or Purchased Loans as to which the Repurchase Price exceeds the Target Price (for this purpose, making such payment in the order of those Purchased Securities or Purchased Loans with the largest to smallest excess of Repurchase Price over Target Price), until the aggregate Repurchase Price for all of such Purchased Securities or Purchased Loans has been reduced to the aggregate Target Price for all of the Purchased Securities or Purchased Loans, respectively as of the date of such payment (as determined by Buyer after giving effect to such Principal Payment); and (iii) third, to remit to Seller the remainder of such Principal Payment. (e) If a CF Sweep Event with respect to any Purchased Security and Purchased Loan shall have occurred and be continuing, all Income received by the Depository in respect of the Purchased Securities and the Purchased Loans and the associated Hedging Transactions shall be applied by the Depository on the Business Day next following the Business Day on which such funds are deposited in the Cash Management Account as follows: (i) first, to remit to Buyer an amount equal to the Price Differential which has accrued and is outstanding in respect of all of the Purchased Securities and Purchased Loans as of such Business Day; (ii) second, to make a payment to Buyer pro rata on account of the Repurchase Price of the Purchased Securities or the Purchased Loans in respect of which the CF Sweep Event occurred, until the Repurchase Price for such Purchased Securities or such Purchased Loans has been reduced to the Target Price for such Purchased Securities or such Purchased Loans as of the date of such payment (as determined by Buyer after giving effect to such remittance); (iii) third, to make a payment to Buyer pro rata on account of the Repurchase Price of any other Purchased Securities or Purchased Loans for which a CF Sweep Event shall not have occurred and as to which the Repurchase Price exceeds the Target Price, until the aggregate Repurchase Price for all of the Purchased Securities and all of the Purchased Loans has been reduced to the aggregate Target Price for all of the Purchased Securities and Purchased Loans as of the date of such payment (as determined by Buyer after giving effect to such remittance); and (iv) fourth, to remit to Seller the remainder. (f) If an Event of Default shall have occurred and be continuing, all Income received by the Depository in respect of the Purchased Securities and the Purchased Loans and the associated Hedging Transactions shall be applied by the Depository on the Business Day next following the Business Day on which such funds are deposited in the Cash Management Account as follows: (i) first, to remit to Buyer an amount equal to the Price Differential which has accrued and is outstanding in respect of all of the Purchased Securities and Purchased Loans as of such Business Day; (ii) second, to make a payment to Buyer pro rata on account of the Repurchase Price of the Purchased Securities and Purchased Loans until the Repurchase Price for all of the Purchased Securities in all Rating Categories and all of the Purchased Loans in all Collateral Type Groupings has been reduced to zero; and (iii) third, to remit to Seller the remainder. 6 SECURITY INTEREST Paragraph 6 of the Agreement is hereby modified in its entirety to read as follows: The Buyer and Seller intend that all Transactions hereunder be sales to the Buyer of the Purchased Securities and Purchased Loans and not loans from the Buyer to Seller secured by the Purchased Securities and Purchased Loans. However, in the event any such Transaction is deemed to be a loan, Seller hereby pledges all of its right, title, and interest in, to and under and grants a first priority lien on, and security interest in, all of the following property, whether now owned or hereafter acquired, now existing or hereafter created and wherever located (collectively, the "Collateral") to the Buyer to secure the payment and performance of all other amounts or obligations owing to the Buyer pursuant to this Agreement and the related documents described herein: (a) the Purchased Securities purchased pursuant to this Agreement and all "securities accounts" created in connection therewith (as defined in Section 8-501(a) of the UCC) to which any or all of such Purchased Securities are credited; (b) the Purchased Loans purchased pursuant to this Agreement, Servicing Agreements in connection with this Agreement, Servicing Records in connection with this Agreement, insurance relating to such Purchased Loans, and collection and escrow accounts relating to such Purchased Loans; (c) the Cash Management Account created in connection with this Agreement and all monies from time to time on deposit in such Cash Management Account; (d) all "general intangibles", "accounts" and "chattel paper" as defined in the UCC relating to or constituting any and all of the foregoing; and (e) all replacements, substitutions or distributions on or proceeds, payments, Income and profits of, and records (but excluding any financial models or other proprietary information) and files relating to any and all of any of the foregoing. The Buyer's security interest in the Collateral shall terminate only upon termination of the Seller's obligations under this Agreement and the documents delivered in connection herewith and therewith. For purposes of the grant of the security interest pursuant to Paragraph 6 of the Agreement, the Agreement shall be deemed to constitute a security agreement under the New York Uniform Commercial Code (the "UCC"). Buyer shall have all of the rights and may exercise all of the remedies of a secured creditor under the UCC and the other laws of the State of New York. In furtherance of the foregoing, (a) Seller, at its sole cost and expense, shall cause to be filed in such locations as may be necessary to perfect and maintain perfection and priority of the security interest granted hereby, UCC-1 financing statements and continuation statements (collectively, the "Filings"), and shall forward copies of such Filings to Buyer upon completion thereof, and (b) Seller shall from time to time take such further actions as may be reasonably requested by Buyer to maintain and continue the perfection and priority of the security interest granted hereby (including marking its records and files to evidence the interests granted to Buyer hereunder). 7 PAYMENT, TRANSFER AND CUSTODY The provisions of Paragraph 7 of the Agreement are hereby modified and superseded in their respective entireties by the following provisions of this Section 7; provided that, with respect to any Purchased Loans that are English Loans, this Section 7 of Annex I shall be superseded by the English Loan Supplement: (a) On the Purchase Date for each Transaction, ownership of the Portfolio Securities and/or Purchased Loans shall be transferred to Buyer or its designee (including the Custodian) against the simultaneous transfer of the Purchase Price to an account of Seller specified in the Confirmation relating to such Transaction. (b) On or prior to the applicable Purchase Date, the Seller shall deliver the related Portfolio Securities re-registered in the name of the Buyer or other designee of the Buyer in accordance with the Custodial Agreement (or, subject to the approval of Buyer, together with documentation sufficient to permit the re-registration of the Purchased Securities by the Buyer in the name of the Buyer or other designee of the Buyer) and the Buyer or its other designee shall have all rights of conversions, exchange, subscription and any other rights, privileges and options pertaining to such Portfolio Securities as the owner thereof, and in connection therewith, the right to deposit and deliver any and all of such Portfolio Securities with any committee, depositary transfer, agent, register or other designated agency upon such terms and conditions as the Buyer may determine. The Portfolio Securities shall be held by the Buyer or its designee, as exclusive bailee and agent for the Buyer, either directly or through the facilities of a Relevant System, as "securities intermediary" (as defined in Section 8-102(a)(14) of the UCC and 31 C.F.R. Section 357.2) and credited to the "securities account" (as defined in Section 8-501(a) of the UCC) of the Buyer. The Buyer, as "entitlement holder" (as defined in Section 8-102(a)(7) of the UCC) with respect to such Portfolio Securities, shall be entitled to receive all cash dividends and distributions paid in respect thereof. Any such dividends or distributions with respect to such Portfolio Securities received by the Seller shall be promptly remitted to the Cash Management Account. (c) With respect to the Portfolio Securities that shall be delivered or held in uncertificated form and the ownership of which is registered on books maintained by the issuer thereof or its transfer agent, the Seller shall cause the registration of such security or other item of investment property in the name of Buyer or its designee and at the request of the Buyer, shall take such other and further steps, and shall execute and deliver such documents or instruments necessary in the reasonable opinion of the Buyer, to effect a legally valid transfer to Buyer hereunder. With respect to such Portfolio Securities that shall be delivered or held in definitive, certificated form, the Seller shall deliver to the Buyer or its designee (which shall be the Custodian initially) the original of the relevant certificate registered in the name of the Buyer or its designee (or, subject to the approval of Buyer, together with documentation sufficient to permit the re-registration of the Purchased Securities by the Buyer in the name of the Buyer or other designee of the Buyer). Unless otherwise instructed by Buyer, any delivery of a security or other item of investment property in definitive, certificated form shall be made to the Custodian. With respect to such Portfolio Securities that shall be delivered through a Relevant System in book entry form and credited to or otherwise held in a securities account, the Seller shall take such actions necessary to provide instruction to the relevant financial institution or other entity, which instruction shall be sufficient if complied with to register the transfer of such Portfolio Securities from Seller to Buyer or its designee. In connection with any account to which such Portfolio Securities are credited or otherwise held, the Seller shall execute and deliver such other and further documents or instruments necessary, in the reasonable opinion of the Buyer, to effect a legally valid transfer to Buyer hereunder. Any account to which such Portfolio Securities are credited or otherwise held shall be designated in accordance with the Custodial Agreement or such variation thereon as the Buyer may direct. Any delivery of such Portfolio Security in accordance with this paragraph, or any other method acceptable to the Buyer, shall be sufficient to cause the Buyer to be the "entitlement holder" (as defined in Section 8-102(a)(7) of the UCC) with respect to such Portfolio Securities and, if the Transaction is recharacterized as a secured financing, to have a perfected first priority security interest therein. No Portfolio Securities, whether certificated or uncertificated, shall remain in the name, or possession, of Seller or any of its agents or in any securities account in the name of Seller or any of its agents. (d) As a condition to Buyer's purchase of any Securities, Seller shall deliver to Buyer on or prior to the Purchase Date with respect to such Securities: (A) copies of the executed Securitization Document governing such Securities, and the offering documents related to such Securities, each certified by the Seller as a true, correct and complete copy of the original document delivered to the Seller, and any ancillary documents required to be delivered to holders of the Securities under such Securitization Document; (B) one or more officer's certificates with respect to the completeness of the documents delivered as may be reasonably requested by Buyer, (C) an instruction letter from the Seller to the Trustee under such Securitization Document, instructing the Trustee to remit all sums required to be remitted to the holder of such Securities under such Securitization Document to the Depository or as otherwise directed in a written notice signed by Seller and Buyer, (D) copies of all distribution statements, if any, delivered to the Seller pursuant to such Securitization Document during the three-month period immediately preceding such Purchase Date, and (E) any other documents or instruments necessary in the reasonable opinion of the Buyer to consummate the sale of such Securities to the Buyer or, if such Transaction is recharacterized as a secured financing, to create and perfect in favor of Buyer a valid perfected first priority security interest in such Securities. (e) On or before each Purchase Date with respect to each Purchased Loan, Seller shall deliver or cause to be delivered to Buyer or its designee the Custodial Delivery in the form attached hereto as Exhibit IV. On or before each Purchase Date, with respect to each Table Funded Purchased Loan, the Seller shall cause the Settlement Agent to deliver to the Custodian by facsimile the related Mortgage Note, the Insured Closing Letter and Escrow Instructions, and a Settlement Agent trust receipt issued thereunder. In connection with each sale, transfer, conveyance and assignment of a Purchased Loan, on or prior to each Purchase Date with respect to such Purchased Loan (other than a Table Funded Purchased Loan) or by not later than 12:00 p.m. (New York time) on the third Business Day following the applicable Purchase Date with respect to each Table Funded Purchased Loan, the Seller shall deliver or cause to be delivered and released to the Custodian the following original documents (collectively, the "Purchased Loan File"), pertaining to each of the Purchased Loans identified in the Custodial Delivery delivered therewith: With respect to each Purchased Loan secured by a Mortgage: (i) The original Mortgage Note bearing all intervening endorsements, endorsed "Pay to the order of _________ without recourse" and signed in the name of the last endorsee (the "Last Endorsee") by an authorized Person (in the event that the Mortgage Loan was acquired by the Last Endorsee in a merger, the signature must be in the following form: "[Last Endorsee], successor by merger to [name of predecessor]"; in the event that the Purchased Loan was acquired or originated by the Last Endorsee while doing business under another name, the signature must be in the following form: "[Last Endorsee], formerly known as [previous name]"). (ii) The original of any guarantee executed in connection with the Mortgage Note (if any). (iii) The original Mortgage with evidence of recording thereon, or a copy thereof together with an officer's certificate of Seller certifying that such represents a true and correct copy of the original and that such original has been submitted for recordation in the appropriate governmental recording office of the jurisdiction where the Mortgaged Property is located. (iv) The originals of all assumption, modification, consolidation or extension agreements with evidence of recording thereon, or copies thereof together with an officer's certificate of Seller certifying that such represent true and correct copies of the originals and that such originals have each been submitted for recordation in the appropriate governmental recording office of the jurisdiction where the Mortgaged Property is located. (v) The original Assignment of Mortgage in blank for each Purchased Loan, in form and substance acceptable for recording and signed in the name of the Last Endorsee (in the event that the Purchased Loan was acquired by the Last Endorsee in a merger, the signature must be in the following form: "[Last Endorsee], successor by merger to [name of predecessor]"; in the event that the Purchased Loan was acquired or originated while doing business under another name, the signature must be in the following form: "[Last Endorsee], formerly known as [previous name]"). (vi) The originals of all intervening assignments of mortgage with evidence of recording thereon, or copies thereof together with an officer's certificate of Seller certifying that such represent true and correct copies of the originals and that such originals have each been submitted for recordation in the appropriate governmental recording office of the jurisdiction where the Mortgaged Property is located. (vii) The original attorney's opinion of title and abstract of title or the original mortgagee title insurance policy, or if the original mortgagee title insurance policy has not been issued, the irrevocable marked commitment to issue the same. (viii) The original of any security agreement, chattel mortgage or equivalent document executed in connection with the Purchased Loan. (ix) The original assignment of leases and rents, if any, with evidence of recording thereon, or a copy thereof together with an officer's certificate of Seller, certifying that such copy represents a true and correct copy of the original that has been submitted for recordation in the appropriate governmental recording office of the jurisdiction where the Mortgaged Property is located. (x) The originals of all intervening assignments of assignment of leases and rents, if any, or copies thereof, with evidence of recording thereon. (xi) A copy of the UCC-1 financing statements, certified as true and correct by Seller, and all necessary UCC-3 continuation statements with evidence of filing thereon or copies thereof certified by Seller to have been sent for filing, and UCC-3 assignments executed by Seller in blank, which UCC-3 assignments shall be in form and substance acceptable for filing. (xii) An environmental indemnity agreement (if any). (xiii) An omnibus assignment in blank (if any). (xiv) A disbursement letter from the Mortgagor to the original mortgagee (if any). (xv) Mortgagor's certificate or title affidavit (if any). (xvi) A survey of the Mortgaged Property (if any) as accepted by the title company for issuance of the Title Policy. (xvii) A copy of the Mortgagor's opinion of counsel (if any). (xviii) An assignment of permits, contracts and agreements (if any). With respect to each Purchased Loan which is a mezzanine loan secured by a pledge of the entire equity ownership interest in an entity that owns a multifamily or commercial property: (i) The original Mezzanine Note signed in connection with the Purchased Loan bearing all intervening endorsements, endorsed "Pay to the order of __________ without recourse" and signed in the name of the Last Endorsee by an authorized Person (in the event that the Mezzanine Note was acquired by the Last Endorsee in a merger, the signature must be in the following form: "[Last Endorsee], successor by merger to [name of predecessor]"; in the event that the Purchased Loan was acquired or originated by the Last Endorsee while doing business under another name, the signature must be in the following form: "[Last Endorsee], formerly known as [previous name]"). (ii) The original of the loan agreement and the guarantee, if any, executed in connection with the Purchased Loan. (iii) The original intercreditor or loan coordination agreement, if any, executed in connection with the Purchased Loan. (iv) The original security agreement executed in connection with the Purchased Loan. (v) Copies of all documents relating to the formation and organization of the borrower of such Purchased Loan, together with all consents and resolutions delivered in connection with such borrower's obtaining the Purchased Loan. (vi) All other documents and instruments evidencing, guaranteeing, insuring or otherwise constituting or modifying or otherwise affecting such Purchased Loan, or otherwise executed or delivered in connection with, or otherwise relating to, such Purchased Loan, including all documents establishing or implementing any lockbox pursuant to which Seller is entitled to receive any payments from cash flow of the underlying real property. (vii) The assignment of Purchased Loan sufficient to transfer to Buyer all of Seller's rights, title and interest in and to the Purchased Loan. (viii) A copy of the borrower's opinion of counsel (if any). (ix) A copy of the UCC-1 financing statements, certified as true and correct by the Seller, and all necessary UCC-3 continuation statements with evidence of filing thereon or copies thereof certified by the Seller to have been sent for filing, and UCC-3 assignments executed by the Seller in blank, which UCC-3 assignments shall be in form and substance acceptable for filing. (x) The original certificates representing the pledged equity interests (if any). (xi) Stock powers relating to each pledged equity interest, executed in blank, if an original stock certificate is provided. (xii) Assignment of any management agreements, agreements among equity interest holders or other material contracts. (xiii) If no original stock certificate is provided, evidence (which may be an officer's certificate confirming such circumstances) that the pledged ownership interests have been transferred to, or otherwise made subject to a first priority security interest in favor of, the Seller. With respect to each Purchased Loan which consists of a preferred equity interest in an entity that owns a multifamily or commercial property (the "Property Owner"): (i) An fully executed counterpart of the organizational agreement of the Property Owner, together with all amendments thereof; (ii) Copies of all other documents relating to the formation and organization of the Property Owner; (iii) The original of any agreement entered into between the holder of such preferred equity interest and any creditor of the Property Owner; (iv) Copies of all consents and resolutions, if any, delivered in connection with the origination of such Purchased Loan; (v) All other documents and instruments evidencing, guaranteeing, insuring or otherwise constituting or modifying or otherwise affecting such Purchased Loan, or otherwise executed or delivered in connection with, or otherwise relating to, such Purchased Loan, including all documents establishing or implementing any lockbox pursuant to which Seller is entitled to receive any payments from cash flow of the underlying real property or setting forth any representations and warranties to induce the funding of the Purchased Loan or providing the holder of the Purchased Loan with any option or other pre-emptive rights; (vi) The assignment of Purchased Loan sufficient to transfer to Buyer all of Seller's rights, title and interest in and to the Purchased Loan, together with any necessary consents for such assignment and transfer (if not already provided for in the organizational agreement of Property Owner); (vii) A copy of any opinion of counsel delivered in connection with the origination of such Purchased Loan; (viii) The original certificates representing the pledged equity interests (if any); (ix) Stock powers relating to each pledged equity interest, executed in blank, if an original stock certificate is provided; (x) Assignment of any management agreements, agreements among equity interest holders, or other material contracts; (xi) If no original stock certificate is provided, evidence (which may be an officer's certificate confirming such circumstances) that the preferred equity interests have been transferred to, or otherwise made subject to a first priority security interest in favor of, the Seller; (xii) For any mortgage, deed of trust, or other real property security instrument to which Property Owner is a party or its assets are subject, copies of the documents that this agreement would require Seller to deliver to Buyer for a purchased Mortgage Loan, but excluding any assignment documents in favor of Buyer; and (xiii) If obtained for the Purchased Loan and not already included in "xii," then a copy of a mezzanine lender endorsement relating to Property Owner's policy of title insurance, identifying the holder of the Purchased Loan as the beneficiary of such endorsement. With respect to each Purchased Loan which is a junior participation interest (including a junior or "B" note) in a commercial mortgage loan secured by a first lien on a multifamily or commercial property; (i) Originals or copies of all of the applicable documents described above with respect to a Purchased Loan secured by a Mortgage. (ii) The original of any participation agreement, intercreditor agreement and/or servicing agreement executed in connection with the Purchased Loan. (iii) The assignment of Purchased Loan sufficient to transfer to Buyer all of Seller's Preferred Equity rights, title and interest in and to the Purchased Loan. From time to time, Seller shall forward to the Custodian additional original documents or additional documents evidencing any assumption, modification, consolidation or extension of a Purchased Loan approved in accordance with the terms of the Agreement, and upon receipt of any such other documents, the Custodian shall hold such other documents as Buyer shall request from time to time. With respect to any documents which have been delivered or are being delivered to recording offices for recording and have not been returned to Seller in time to permit their delivery hereunder at the time required, in lieu of delivering such original documents, Seller shall deliver to Buyer a true copy thereof with an officer's certificate certifying that such copy is a true, correct and complete copy of the original, which has been transmitted for recordation. Seller shall deliver such original documents to the Custodian promptly when they are received. With respect to all of the Purchased Loans delivered by Seller to Buyer or its designee (including the Custodian), Seller shall execute an omnibus power of attorney substantially in the form of Exhibit V attached hereto irrevocably appointing Buyer its attorney-in-fact with full power upon the occurrence and during the continuance of an Event of Default to (i) complete and record the Assignment of Mortgage, (ii) complete the endorsement of the Mortgage Note or Mezzanine Note and (iii) take such other steps as may be necessary or desirable to enforce Buyer's rights against such Purchased Loans and the related Purchased Loan Files and the Servicing Records. Buyer shall deposit the Purchased Loan Files representing the Purchased Loans, or direct that the Purchased Loan Files be deposited directly, with the Custodian. The Purchased Loan Files shall be maintained in accordance with the Custodial Agreement. Any Purchased Loan Files not delivered to Buyer or its designee (including the Custodian) are and shall be held in trust by Seller or its designee for the benefit of Buyer as the owner thereof. Seller or its designee shall maintain a copy of the Purchased Loan File and the originals of the Purchased Loan File not delivered to Buyer or its designee. The possession of the Purchased Loan File by Seller or its designee is at the will of the Buyer for the sole purpose of servicing the related Purchased Loan, and such retention and possession by the Seller or its designee is in a custodial capacity only. The books and records (including, without limitation, any computer records or tapes) of Seller or its designee shall be marked appropriately to reflect clearly the sale of the related Purchased Loan to Buyer. Seller or its designee (including the Custodian) shall release its custody of the Purchased Loan File only in accordance with written instructions from Buyer, unless such release is required as incidental to the servicing of the Purchased Loans or is in connection with a repurchase of any Purchased Loan by Seller. (f) Unless an Event of Default on the part of Seller shall have occurred and be continuing, Buyer shall exercise all voting and corporate rights with respect to the Portfolio Securities in accordance with Seller's written instructions; provided, however, that Buyer shall not be required to follow Seller's instructions concerning any vote or corporate right if doing so would, in Buyer's good faith reasonable business judgment, impair the Purchased Securities or be inconsistent with or result in any violation of any provision of the Transaction Documents. Upon the occurrence and during the continuation of an Event of Default on the part of Seller, Buyer shall be entitled to exercise all voting and corporate rights with respect to the Portfolio Securities without regard to Seller's instructions (including, but not limited to, if an Act of Insolvency shall occur with respect to Seller or the Sponsor, to the extent Seller controls or is entitled to control selection of the special servicer, Buyer may transfer such special servicing to an entity satisfactory to Buyer). 8 SALE, TRANSFER, HYPOTHECATION OR PLEDGE OF PURCHASED SECURITIES The provisions of Paragraph 8 of the Agreement are hereby modified and superseded in their respective entireties by the following provisions of this Section 8: (a) Title to all Purchased Securities and Purchased Loans shall pass to Buyer on the applicable Purchase Date, and Buyer shall have free and unrestricted use of all Purchased Securities and Purchased Loans. Nothing in the Agreement or any other Transaction Document shall preclude Buyer from engaging in repurchase transactions with the Purchased Securities and Purchased Loans or otherwise selling, transferring, pledging, repledging, hypothecating, or rehypothecating the Purchased Securities and Purchased Loans, but no such transaction shall relieve Buyer of its obligations under Section 17 or Buyer's obligations to transfer the Purchased Securities and/or Purchased Loans to Seller pursuant to Sections 3 or 14 of this Annex I or of Buyer's obligation to credit or pay Income to, or apply Income to the obligations of, Seller pursuant to Section 5 hereof. (b) Nothing contained in the Agreement or any other Transaction Document shall obligate Buyer to segregate any Purchased Security or Purchased Loan delivered to Buyer by Seller. Notwithstanding anything to the contrary in this Agreement or any other Transaction Document, no Purchased Security or Purchased Loan shall remain in the custody of the Seller or an Affiliate of the Seller. 9 SUBSTITUTION Paragraph 9 of the Agreement ("Substitution") is hereby deleted in its entirety and replaced by the following: (a) In the case of any Transaction for which the Repurchase Date is other than the Business Day immediately following the Purchase Date and with respect to which Seller does not have any existing right to substitute substantially the same Eligible Loans or Eligible Securities for the Purchased Loans or Purchased Securities, respectively, Seller shall have the right, subject to the proviso to this sentence, upon notice to Buyer, which notice shall be given at or prior to 10:00 a.m. (New York time) on such Business Day, to substitute substantially the same Eligible Loans or Eligible Securities for any Purchased Loans or Purchased Securities, respectively, provided, however, that Buyer may elect, in the exercise of its good faith business judgment, by the close of business on the Business Day notice is received, or by the close of the next Business Day if notice is given after 10:00 a.m. (New York time) on such day, not to accept such substitution. In the event such substitution is accepted by Buyer, such substitution shall be made by Seller's transfer to Buyer of such other Eligible Loans or Eligible Securities and Buyer's transfer to Seller of such Purchased Loans or Purchased Securities, respectively, and after substitution, the substituted Eligible Loans or Eligible Securities shall be deemed to be Purchased Loans or Purchased Securities, respectively. In the event Buyer elects not to accept such substitution, Buyer shall offer Seller the right to terminate the Transaction. (b) In the event Seller exercises its right to substitute or terminate under sub-paragraph (a), Seller shall be obligated to pay to Buyer, by the close of the Business Day of such substitution or termination, as the case may be, an amount equal to (A) Buyer's actual out-of-pocket cost (including all fees, expenses and commissions) of (i) entering into replacement transactions; (ii) entering into or terminating hedge transactions; and/or (iii) terminating transactions or substituting mortgage loans in like transactions with third parties in connection with or as a result of such substitution or termination, and (B) to the extent Buyer determines not to enter replacement transactions, the loss incurred by Buyer directly arising or resulting from such substitution or termination. The foregoing amounts shall be solely determined and calculated by Buyer in good faith, with such calculations provided to Seller in writing prior to the closing of such substitution or termination. 10 REPRESENTATIONS (a) In addition to the representations and warranties appearing in Paragraph 10 of the Agreement, Seller represents and warrants to Buyer that as of the Purchase Date for the purchase of any Purchased Securities or Purchased Loans by Buyer from Seller and any Transaction thereunder and as of the date of the Agreement and at all times while the Agreement and any Transaction thereunder is in full force and effect: (i) Organization. Seller is duly organized, validly existing and in good standing under the laws and regulations of the state of Seller's organization and is duly licensed, qualified, and in good standing in every state where such licensing or qualification is necessary for the transaction of Seller's business. Seller has the power to own and hold the assets it purports to own and hold, and to carry on its business as now being conducted and proposed to be conducted, and has the power to execute, deliver, and perform its obligations under the Agreement and the other Transaction Documents. (ii) Due Execution; Enforceability. The Transaction Documents have been duly executed and delivered by Seller, for good and valuable consideration. The Transaction Documents constitute the legal, valid and binding obligations of Seller, enforceable against Seller in accordance with their respective terms subject to bankruptcy, insolvency, and other limitations on creditors' rights generally and to equitable principles. (iii) Non-Contravention. Neither the execution and delivery of the Transaction Documents, nor consummation by Seller of the transactions contemplated by the Transaction Documents (or any of them), nor compliance by Seller with the terms, conditions and provisions of the Transaction Documents (or any of them) will conflict with or result in a breach of any of the terms, conditions or provisions of (i) the limited liability company agreement of Seller, (ii) any contractual obligation to which Seller is now a party or the rights under which have been assigned to Seller or the obligations under which have been assumed by Seller or to which the assets of Seller are subject or constitute a default thereunder, or result thereunder in the creation or imposition of any lien upon any of the assets of Seller, other than pursuant to the Transaction Documents, (iii) any judgment or order, writ, injunction, decree or demand of any court applicable to Seller, or (iv) any applicable Requirement of Law. Seller has all necessary licenses, permits and other consents from Governmental Authorities necessary to acquire, own and sell the Portfolio Collateral and for the performance of its obligations under the Transaction Documents. (iv) Litigation; Requirements of Law. There is no action, suit, proceeding, investigation, or arbitration pending or, to the best knowledge of Seller, threatened against Seller, the Sponsor or any of their respective assets, which may result in any material adverse change in the business, operations, financial condition, properties, or assets of Seller or the Sponsor, or which may have an adverse effect on the validity of the Transaction Documents or the Purchased Securities or any action taken or to be taken in connection with the obligations of Seller under any of the Transaction Documents. Seller is in compliance in all material respects with all Requirements of Law. Neither Seller nor the Sponsor is in default in any material respect with respect to any judgment, order, writ, injunction, decree, rule or regulation of any arbitrator or Governmental Authority. (v) No Broker. Seller has not dealt with any broker, investment banker, agent, or other Person (other than Buyer or an Affiliate of Buyer) who may be entitled to any commission or compensation in connection with the sale of Purchased Securities pursuant to any of the Transaction Documents. (vi) Good Title to Purchased Securities and Purchased Loans. Immediately prior to the purchase of any Purchased Securities or Purchased Loans by Buyer from Seller, such Purchased Securities and Purchased Loans are free and clear of any lien, encumbrance or impediment to transfer (including any "adverse claim" as defined in Section 8-102(a)(1) of the UCC), and Seller is the record and beneficial owner of and has good and marketable title to and the right to sell and transfer such Purchased Securities and Purchased Loans to Buyer and, upon transfer of such Purchased Securities or Purchased Loans to Buyer, Buyer shall be the owner of such Purchased Securities and Purchased Loans free of any adverse claim. In the event the related Transaction is recharacterized as a secured financing of the Purchased Securities or Purchased Loans, the provisions of the Agreement are effective to create in favor of the Buyer a valid security interest in all rights, title and interest of the Seller in, to and under the Collateral and the Buyer shall have a valid, perfected first priority security interest in the Purchased Securities or Purchased Loans (and without limitation on the foregoing, the Buyer, as entitlement holder, shall have a "security entitlement" to the Purchased Securities). (vii) No Default. No Default or Event of Default exists under or with respect to the Transaction Documents. (viii) Representations in Securitization Documents. All of the Purchased Securities have been validly issued and are fully paid and non-assessable and not subject to preemptive rights and have been offered, issued and sold in compliance with all Requirements of Law. To the extent that an Affiliate of the Seller is a party thereto, the Securitization Documents are genuine, in full force and effect and the legal, valid and binding obligation of such Affiliate enforceable in accordance with their terms. The Securitization Documents have not been altered or modified in any material respect, except as disclosed to the Buyer in writing. The Seller has not waived the performance of any action or any default, breach or violation resulting from action or inaction under a Securitization Document and has not been made aware of any such waiver. Except as disclosed to the Buyer in writing, there is no default, breach, violation or event of acceleration existing under a Securitization Document and no event has occurred which, with the passage of time or giving of notice or both and the expiration of any grace or cure period, would constitute a default, breach, violation or event of acceleration thereunder. Each Purchased Security is freely assignable and the related Securitization Document permits the Seller to sell, assign or pledge such Purchased Security. (ix) Representations and Warranties Regarding Purchased Loans; Delivery of Purchased Loan File. Seller represents and warrants to the Buyer that each Purchased Loan sold hereunder and each pool of Purchased Loans sold in a Transaction hereunder, as of each Purchase Date for a Transaction conform to the applicable representations and warranties set forth in Exhibit VI attached hereto (or, in relation to an English Loan, Exhibit 1 to the English Loan Supplement), except as disclosed to the Buyer in writing. It is understood and agreed that the representations and warranties set forth in Exhibit VI (or, in relation to an English Loan, in Exhibit 1 of the English Loan Supplement) hereto, if any, shall survive delivery of the respective Purchased Loan File to Buyer or its designee (including the Custodian). With respect to each Purchased Loan, the Mortgage Note or Mezzanine Note, the Mortgage (if any), the Assignment of Mortgage (if any) and any other documents required to be delivered under this Agreement and the Custodial Agreement for such Purchased Loan have been delivered to the Buyer or the Custodian on its behalf. Seller or its designee is in possession of a complete, true and accurate Purchased Loan File with respect to each Purchased Loan, except for such documents the originals of which have been delivered to the Custodian. (x) Adequate Capitalization; No Fraudulent Transfer. Seller has, as of such Purchase Date, adequate capital for the normal obligations reasonably foreseeable in a business of its size and character and in light of its contemplated business operations. Seller is generally able to pay, and as of the date hereof is paying, its debts as they come due. Seller has not become, or is presently, financially insolvent nor will Seller be made insolvent by virtue of Seller's execution of or performance under any of the Transaction Documents within the meaning of the bankruptcy laws or the insolvency laws of any jurisdiction. Seller has not entered into any Transaction Document or any Transaction pursuant thereto in contemplation of insolvency or with intent to hinder, delay or defraud any creditor. (xi) Consents. No consent, approval or other action of, or filing by Seller with, any Governmental Authority or any other Person is required to authorize, or is otherwise required in connection with, the execution, delivery and performance of any of the Transaction Documents (other than consents, approvals and filings that have been obtained or made, as applicable). (xii) Members. Seller does not have any members other than the Sponsor. (xiii) Organizational Documents. Seller has delivered to Buyer certified copies of its certificate of formation and limited liability company agreement, together with all amendments thereto and certified copies of its sole member's organizational document, together with all amendments thereto. (xiv) No Encumbrances. There are (i) no outstanding rights, options, warrants or agreements on the part of Seller for a purchase, sale or issuance, in connection with the Purchased Securities or Purchased Loans, (ii) no agreements on the part of the Seller to issue, sell or distribute the Purchased Securities or Purchased Loans, and (iii) no obligations on the part of the Seller (contingent or otherwise) to purchase, redeem or otherwise acquire any securities or any interest therein or to pay any dividend or make any distribution in respect of the Purchased Securities. (xv) Federal Regulations. Seller is not (A) an "investment company," or a company "controlled by an investment company," within the meaning of the Investment Company Act of 1940, as amended, or (B) a "holding company," or a "subsidiary company of a holding company," or an "affiliate" of either a "holding company" or a "subsidiary company of a holding company," as such terms are defined in the Public Utility Holding Company Act of 1935, as amended. (xvi) Taxes. Seller has filed or caused to be filed all tax returns which to the knowledge of Seller would be delinquent if they had not been filed on or before the date hereof and has paid all taxes shown to be due and payable on or before the date hereof on such returns or on any assessments made against it or any of its property and all other taxes, fees or other charges imposed on it and any of its assets by any Governmental Authority; no tax liens have been filed against any of Seller's assets and, to Seller's knowledge, no claims are being asserted with respect to any such taxes, fees or other charges. (xvii) ERISA. Seller does not have any Plans or any ERISA Affiliates and makes no contributions to any Plans or any Multiemployer Plans. (xviii) Judgments/Bankruptcy. Except as disclosed in writing to Buyer, there are no judgments against Seller or the Managing Member unsatisfied of record or docketed in any court located in the United States of America and no Act of Insolvency has ever occurred with respect to Seller or the Managing Member. (xix) Full and Accurate Disclosure. No information contained in the Transaction Documents, or any written statement furnished by or on behalf of Seller pursuant to the terms of the Transaction Documents, contains any untrue statement of a material fact or omits to state a material fact necessary to make the statements contained herein or therein not misleading in light of the circumstances under which they were made. (xx) Financial Information. All financial data concerning Seller and the Purchased Securities and Purchased Loans that has been delivered by or on behalf of Seller to Buyer is true, complete and correct in all material respects and has been prepared in accordance with GAAP. Since the delivery of such data, except as otherwise disclosed in writing to Buyer, there has been no change in the financial position of Seller or the Purchased Securities and Purchased Loans, or in the results of operations of Seller, which change is reasonably likely to have in a material adverse effect on Seller. (xxi) Chief Executive Office. On the date of the Agreement, the Seller's chief executive office and principal place of business is located at 40 East 52nd Street, New York, New York. The location where the Seller keeps its books and records, including all computer tapes and records relating to the Collateral is its chief executive office. (b) On the Purchase Date for any Transaction, Seller shall be deemed to have made all of the representations set forth in Section 10(a) of this Annex I as of such Purchase Date. 11 NEGATIVE COVENANTS OF SELLER On and as of the date hereof and each Purchase Date and until the Agreement and this Annex I are no longer in force with respect to any Transaction, Seller shall not without the prior written consent of the Buyer: (a) take any action which would directly or indirectly impair or adversely affect Buyer's title to the Purchased Securities or the Purchased Loans; (b) transfer, assign, convey, grant, bargain, sell, set over, deliver or otherwise dispose of, or pledge or hypothecate, directly or indirectly, any interest in the Purchased Securities or the Purchased Loans (or any of them) to any Person other than Buyer, or engage in repurchase transactions or similar transactions with respect to the Purchased Securities or Purchased Loans (or any of them) with any Person other than Buyer; (c) with respect to any Purchased Securities purchased by Buyer where the Related Securities are owned by the Seller or an Affiliate of the Seller, transfer, assign, convey, grant, bargain, sell, set over, deliver or otherwise dispose of or pledge or hypothecate, directly or indirectly, any interest in the Related Securities (it being understood that for purposes of this provision Related Securities shall include (a) the securities issued in a "real estate mortgage investment conduit" transaction which have no rating and (b) if such unrated securities do not entitle the holder thereof to control the selection of the special servicer for the mortgage loans underlying such Purchased Securities, the securities which have a rating and entitle the holder thereof to control the selection of the special servicer for the mortgage loans underlying such Purchased Securities); provided however, that this subsection (c) shall not apply or be operative as to any Purchased Securities as to which Seller has delivered an agreement reasonably satisfactory to Buyer irrevocably conveying and transferring to Buyer the right to control the selection of the special servicer for the related mortgage loans; (d) create, incur or permit to exist any lien, encumbrance or security interest in or on the Portfolio Securities or the Purchased Loans, except as described in Paragraph 6 of the Agreement; (e) create, incur or permit to exist any lien, encumbrance or security interest in or on any of the other Collateral subject to the security interest granted by Seller pursuant to Paragraph 6 of the Agreement; (f) modify or terminate any of the organizational documents of Seller; (g) consent or assent to any amendment or supplement to, or termination of, any Securitization Document, any note, loan agreement, mortgage or guaranty relating to the Purchased Loans or other material agreement or instrument relating to the Portfolio Securities or the Purchased Loans other than in accordance with Section 7(f) or a Permitted Purchased Loan Modification; provided, that for purposes of this Section 11(g) only, the Buyer agrees to not unreasonably withhold, delay or condition a written request from the Seller to consent to an amendment to a Purchased Loan and to respond to any such written request within ten (10) Business Days; (h) subject to Section 12(r), admit any additional members in Seller, or permit the sole member in Seller to assign or transfer all or any portion of its member interest in Seller; (i) at any time after an Event of Default on the part of Seller, has occurred and is continuing, vote or take any action to permit any rights afforded to a holder of the Portfolio Securities under the related Securitization Documents; or (j) after the occurrence and during the continuation of any Default or Event of Default, make any distribution, payment on account of, or set apart assets for, a sinking or other analogous fund for the purchase, redemption, defeasance, retirement or other acquisition of any equity or ownership interest of Seller, whether now or hereafter outstanding, or make any other distribution in respect thereof, either directly or indirectly, whether in cash or property or in obligations of Seller. 12 AFFIRMATIVE COVENANTS OF SELLER (a) Seller shall promptly notify Buyer of any material adverse change in its business operations and/or financial condition; provided, however, that nothing in this Section 12 shall relieve Seller of its obligations under the Agreement. (b) Seller shall provide Buyer with copies of such documents as Buyer may reasonably request evidencing the truthfulness of the representations set forth in Section 10. (c) Seller (1) shall defend the right, title and interest of the Buyer in and to the Collateral against, and take such other action as is necessary to remove, the Liens, security interests, claims and demands of all Persons (other than security interests by or through Buyer) and (2) shall, at Buyer's reasonable request, take all action necessary to ensure that Buyer will have a first priority security interest in the Portfolio Securities and Purchased Loans subject to any of the Transactions in the event such Transactions are recharacterized as secured financings. (d) Seller shall notify Buyer and the Depository of the occurrence of any Default or Event of Default with respect to Seller as soon as possible but in no event later than the second (2nd) Business Day after obtaining actual knowledge of such event. (e) Seller shall, at all times with respect to Purchased Securities then subject to Transactions, cause the special servicer rating of the special servicer with respect to all mortgage loans underlying such Purchased Security to be no lower than "above-average" by Standard & Poor's Ratings Group. If an Act of Insolvency occurs with respect to Seller or Sponsor, Seller shall permit Buyer to transfer special servicing with respect to all mortgage loans underlying the Portfolio Securities to an entity satisfactory to Buyer at Seller's expense, to the extent the Seller controls or is entitled to control the selection of the special servicer. If the Purchased Securities at any time do not entitle the holder of such Purchased Securities to control the selection of the special servicer for the related mortgage loans (i.e. such securities are not the controlling class) and the Seller shall not have (i) caused ownership of the Related Securities to be transferred to the Seller simultaneous with or prior to the purchase of the Purchased Securities by Buyer and (ii) delivered to the Buyer a power of attorney and any other documentation reasonably required by the Buyer sufficient to permit the Buyer upon the occurrence and during the continuance of an Event of Default to register the transfer of the Related Securities from Seller to Buyer or its designee, then Seller shall either (x) deliver an agreement reasonably satisfactory to Buyer irrevocably conveying and transferring to Buyer the right to control the selection of the special servicer for the related mortgage loans or (y) upon request of Buyer, terminate the related Transaction on demand pursuant to and in accordance with Section 3(d) of this Annex I. (f) Seller shall maintain a hedging strategy acceptable to Buyer. At any time Transactions are outstanding between Buyer and Seller hereunder, Seller shall deliver to Buyer on a monthly basis by not later than the fifteenth (15th) day of each month and upon written request of Buyer more frequently within two (2) Business Days of request a written report describing in reasonable detail the hedging strategy maintained by the Sponsor for the Sponsor and its Affiliates (including the Seller) and the Hedging Transactions with hedge counterparties entered into or proposed to be entered into in furtherance of such strategy. Seller acknowledges and agrees that upon the occurrence and during the continuance of an Event of Default under this Agreement, Buyer may enter into Hedging Transactions at the reasonable expense of the Seller designed to hedge against interest rate risk and achieve interest rate protection with respect to the Purchased Loans and the Purchased Securities. (g) Seller shall promptly (and in any event not later than two (2) Business Days following receipt) deliver to Buyer (i) any notice of the occurrence of an event of default under or report received by or required to be delivered by Seller pursuant to the Securitization Documents; (ii) any notice of transfer of servicing under the Securitization Documents and (iii) any other information with respect to the Portfolio Collateral as may be reasonably requested by Buyer from time to time to the extent such information is in Seller's possession or can be obtained by Seller at a reasonable cost. (h) Seller will permit Buyer or its designated representative to inspect Seller's records with respect to the Collateral and the conduct and operation of its business related thereto upon reasonable prior written notice from Buyer or its designated representative, at such reasonable times and with reasonable frequency, and to make copies of extracts of any and all thereof, subject to the terms of any confidentiality agreement between the Buyer and the Seller. Buyer shall act in a commercially reasonable manner in requesting and conducting any inspection relating to the conduct and operation of Seller's business. (i) If the Seller shall at any time become entitled to receive or shall receive any rights, whether in addition to, in substitution of, as a conversion of, or in exchange for the Portfolio Securities, or otherwise in respect thereof, the Seller shall accept the same as the Buyer's agent, hold the same in trust for the Buyer and deliver the same forthwith to the Buyer in the exact form received, duly endorsed by the Seller to the Buyer, if required, together with an undated bond or other securities power covering such certificate duly executed in blank to be held by the Buyer hereunder as additional collateral security for the Transactions. If any sums of money or property so paid or distributed in respect of the Portfolio Securities shall be received by the Seller, the Seller shall, until such money or property is paid or delivered to the Buyer, hold such money or property in trust for the Buyer, segregated from other funds of the Seller, as additional collateral security for the Transactions. (j) At any time from time to time upon reasonable prior written request of Buyer, at the sole expense of Seller, Seller will promptly and duly execute and deliver such further instruments and documents and take such further actions as Buyer may reasonably request for the purposes of obtaining or preserving the full benefits of this Agreement including the first priority security interest granted hereunder and of the rights and powers herein granted (including, among other things, filing such UCC financing statements as Buyer may reasonably request). If any amount payable under or in connection with any of the Collateral shall be or become evidenced by any promissory note, other instrument or chattel paper, such note, instrument or chattel paper shall be immediately delivered to the Buyer, duly endorsed in a manner satisfactory to the Buyer, to be held as Collateral pursuant to this Agreement, and the documents delivered in connection herewith. (k) Seller shall provide Buyer with the following financial and reporting information: (i) Within 45 days after the last day of the first three fiscal quarters in any fiscal year, Sponsor's unaudited consolidated statement of income and statements of changes in cash flow for such quarter and balance sheet as of the end of such quarter (which statement and balance sheet shall separately break out the statement of income and changes in cash flow and balance sheet of the Seller), in each case presented fairly in accordance with GAAP and certified as being true and correct by an officer's certificate; (ii) Within 90 days after the last day of its fiscal year, Sponsor's audited consolidated statement of income and statement of changes in cash flow for such year and balance sheet as of the end of such year (which statements and balance sheets shall separately break out the statement of income and changes in cash flow and balance sheet of the Seller), in each case presented fairly in accordance with GAAP, and accompanied, in all cases, by an unqualified report of Deloitte & Touche or another nationally recognized independent certified public accounting firm consented to by Buyer; (iii) Within 45 days after the last day of each calendar quarter in any fiscal year, an officer's certificate from the Seller addressed to Buyer certifying that, as of such calendar month, (x) Seller is in compliance with all of the terms, conditions and requirements of this Agreement, and (y) no Event of Default exists; and (iv) Within 15 days after each month end, a monthly reporting package containing all information set forth on Exhibit III attached hereto. (l) Seller shall at all times comply in all material respects with all laws, ordinances, rules and regulations of any federal, state, municipal or other public authority having jurisdiction over Seller or any of its assets and Seller shall do or cause to be done all things reasonably necessary to preserve and maintain in full force and effect its legal existence, and all licenses material to its business. (m) Seller shall at all times keep proper books of records and accounts in which full, true and correct entries shall be made of its transactions in accordance with GAAP and set aside on its books from its earnings for each fiscal year all such proper reserves in accordance with GAAP. (n) Seller shall observe, perform and satisfy all the terms, provisions, covenants and conditions required to be observed, performed or satisfied by it, and shall pay when due all costs, fees and expenses required to be paid by it, under the Transaction Documents. Seller shall pay and discharge all taxes, levies, liens and other charges on its assets and on the Collateral that, in each case, in any manner would create any lien or charge upon the Collateral, except for any such taxes as are being appropriately contested in good faith by appropriate proceedings diligently conducted and with respect to which adequate reserves have been provided in accordance with GAAP. (o) Seller shall advise Buyer in writing of the opening of any new chief executive office or the closing of any such office and of any change in Seller's name or the places where the books and records pertaining to the Purchased Securities are held not less than fifteen (15) Business Days prior to taking any such action. (p) Seller will maintain records with respect to the Collateral and the conduct and operation of its business with no less a degree of prudence than if the Collateral were held by Seller for its own account and will furnish Buyer, upon reasonable request by Buyer or its designated representative, with reasonable information reasonably obtainable by Seller with respect to the Collateral and the conduct and operation of its business. (q) Seller shall provide Buyer with access to operating statements, the occupancy status and other property level information, with respect to the Mortgaged Properties, plus any such additional reports as Buyer may reasonably request. (r) In the event the Sponsor proposes to sell or transfer equity ownership interests in the Seller or equity in a collateralized debt obligation transaction which securitizes Purchased Securities or Purchased Loans subject to Transactions, the Seller shall notify the Buyer in writing of such sale or transfer and provide to Buyer or an Affiliate of Buyer designated by Buyer the opportunity to co-invest on the same terms and not be subject to any preferred distributions or equity returns of third party investors. Buyer shall notify the Seller in writing within ten (10) Business Days of its decision to co-invest or not to co-invest on such terms; provided, that if Buyer does not deliver written notice by the end of such ten (10) Business Day period of any decision, then Buyer shall be deemed to have decided not to co-invest. 13 SINGLE-PURPOSE ENTITY Seller hereby represents and warrants to Buyer, and covenants with Buyer, that as of the date hereof and so long as any of the Transaction Documents shall remain in effect: (a) It is and intends to remain solvent and it has paid and will pay its debts and liabilities (including employment and overhead expenses) from its own assets as the same shall become due. (b) It has complied and will comply with the provisions of its certificate of formation and its limited liability company agreement. (c) It has done or caused to be done and will do all things necessary to observe limited liability company formalities and to preserve its existence. (d) It has maintained and will maintain all of its books, records, financial statements and bank accounts separate from those of its Affiliates, its members and any other Person, and it will file its own tax returns (except to the extent consolidation is required under GAAP or as a matter of law). (e) It has been, is and will be, and at all times will hold itself out to the public as, a legal entity separate and distinct from any other entity (including any Affiliate), shall correct any known misunderstanding regarding its status as a separate entity, shall conduct business in its own name, shall not identify itself or any of its Affiliates as a division or part of the other, shall maintain and utilize separate stationery, invoices and checks, and shall pay to any Affiliate that incurs costs for office space and administrative services that it uses, the amount of such costs allocable to its use of such office space and administrative services. (f) It has not owned and will not own any property or any other assets other than Portfolio Collateral and cash. (g) It has not engaged and will not engage in any business other than the acquisition, ownership, financing and disposition of Portfolio Collateral in accordance with the applicable provisions of the Transaction Documents. (h) It has not entered into, and will not enter into, any contract or agreement with any of its Affiliates, except upon terms and conditions that are intrinsically fair and substantially similar to those that would be available on an arm's-length basis with Persons other than such Affiliate. (i) It has not incurred and will not incur any indebtedness or obligation, secured or unsecured, direct or indirect, absolute or contingent (including guaranteeing any obligation), other than (A) obligations under the Transaction Documents and (B) unsecured trade payables, in an aggregate amount not to exceed $1,000,000 at any one time outstanding, incurred in the ordinary course of acquiring, owning, financing and disposing of Portfolio Collateral; provided, however, that any such trade payables incurred by Seller shall be paid within 30 days of the date incurred. (j) It has not made and will not make any loans or advances to any other Person, and shall not acquire obligations or securities of any member or any Affiliate of any member (other than in connection with the acquisition of the Portfolio Securities and Purchased Loans) or any other Person. (k) It will maintain adequate capital for the normal obligations reasonably foreseeable in a business of its size and character and in light of its contemplated business operations. (l) Neither it nor its sole member will seek its dissolution, liquidation or winding up, in whole or in part, or suffer any Change of Control, consolidation or merger with respect to Seller or the Sponsor. (m) It will not commingle its funds and other assets with those of any of its Affiliates or any other Person. (n) It has maintained and will maintain its assets in such a manner that it will not be costly or difficult to segregate, ascertain or identify its individual assets from those of any of its Affiliates or any other Person. (o) It has not held and will not hold itself out to be responsible for the debts or obligations of any other Person. (p) The Seller shall not permit its sole member to take any of the following actions: (i) dissolve or liquidate, in whole or in part; (ii) consolidate or merge with or into any other entity or convey or transfer all or substantially all of its properties and assets to any entity; (iii) institute any proceeding to be adjudicated as bankrupt or insolvent, or consent to the institution of bankruptcy or insolvency proceedings against it, or file a petition or answer or consent seeking reorganization or relief under the Bankruptcy Code or consent to the filing of any such petition or to the appointment of a receiver, rehabilitator, conservator, liquidator, assignee, trustee or sequestrator (or other similar official) of the such member or Seller or of any substantial part of its property, or ordering the winding up or liquidation of its affairs, or make an assignment for the benefit of creditors, or admit in writing its inability to pay its debts generally as they become due, or take any action in furtherance of any of the foregoing; (v) amend the certificate of formation or limited liability company agreement of Seller; (vi) enter into any transaction with an Affiliate not in the ordinary course of Seller's business; or (vii) withdraw as the sole member of Seller. (q) It has no liabilities, contingent or otherwise, other than those normal and incidental to the acquisition, ownership, financing and disposition of Portfolio Collateral. (r) It has conducted and shall conduct its business consistent with the requirements of being a Single-Purpose Entity. (s) It shall not maintain any employees. 14 EVENTS OF DEFAULT; REMEDIES After the occurrence and during the continuance of an Event of Default on the part of Seller, Seller hereby appoints Buyer as attorney-in-fact of Seller for the purpose of carrying out the provisions of this Agreement and taking any action and executing or endorsing any instruments that Buyer may deem necessary or advisable to accomplish the purposes hereof, which appointment as attorney-in-fact is irrevocable and coupled with an interest. Furthermore, Paragraph 11 of the Agreement is amended by the deletion of clauses (i) and (vi) in the first paragraph, by the addition of "or Purchased Loans" in clause (ii) of the first paragraph after the term Purchased Securities and by the addition of the following at the end of the first paragraph before the phrase, "(each an `Event of Default')": (i) either (A) the Transaction Documents shall for any reason not cause, or shall cease to cause, Buyer to be the owner free of any adverse claim of any of the Purchased Securities or Purchased Loans, or (B) if a Transaction is recharacterized as a secured financing, the Transaction Documents with respect to any Transaction shall for any reason cease to create a valid first priority security interest in favor of Buyer in any of the Purchased Securities or Purchased Loans; (ii) in the event that the Buyer or any of its Affiliates is a party to an ISDA Master Agreement with Seller and an event occurs which would constitute an Event of Default or an Additional Termination Event under any Transaction between Seller and the Buyer or any of its Affiliates (capitalized terms used in this paragraph (ix) shall have the respective meanings ascribed to them in the ISDA Master Agreement (including respective Schedules and Confirmations) between Seller and the Buyer and/or any of its Affiliates); (iii) failure of the Buyer to receive on any Remittance Date the accreted value of the Price Differential (less any amount of such Price Differential previously paid by Seller to Buyer) (including, without limitation, in the event the Income paid or distributed on or in respect of the Purchased Securities and Purchased Loans is insufficient to make such payment and the Seller does not make such payment or cause such payment to be made) (except that such failure shall not be an Event of Default by Seller if sufficient Income, other than Principal Payments, is on deposit in the Cash Management Account and the Depository fails to remit such funds to Buyer); (iv) failure of the Seller to make any other payment owing to the Buyer which has become due, whether by acceleration or otherwise under the terms of this Agreement which failure is not remedied within the applicable period (in the case of a failure pursuant to Paragraph 4) or five Business Days (in the case of any other such failure); (v) any governmental, regulatory, or self-regulatory authority shall have taken any action to remove, limit, restrict, suspend or terminate the rights, privileges, or operations of Seller, which suspension has a material adverse effect on the financial condition or business operations of Seller; (vi) Buyer shall have determined, in the exercise of its good faith business judgment, (A) that there has been a material adverse change in the business, operations, corporate structure or financial condition, creditworthiness or prospects of Seller or the Sponsor; (B) that Seller or the Sponsor will not meet or has breached any of its obligations under any Transaction pursuant to any of the Transaction Documents; or (C) that a material adverse change in the financial or legal condition of Seller or the Sponsor may occur due to the pendency or threatened pendency of a material legal action against Seller or the Sponsor; (vii) a Change of Control or an Act of Insolvency shall have occurred with respect to the Sponsor; (viii) any representation made by Seller or Buyer shall have been incorrect or untrue in any material respect when made or repeated or deemed to have been made or repeated (other than the representations and warranties set forth in Section 10(a)(viii) or (ix) or (xix) (in the case of (xix), with respect to the affected Purchased Securities or Purchased Loans only) made by the Seller, which shall not be considered an Event of Default if incorrect or untrue in any material respect, provided the Buyer terminates the related Transaction in whole or in part, as applicable, and repurchases the related Purchased Securities or Purchased Loans on an Early Repurchase Date no later than three (3) Business Days after receiving notice of such incorrect or untrue representation; unless the Seller shall have made any such representation with knowledge that it was materially incorrect or untrue at the time made); (ix) the Sponsor shall fail to observe any of the financial covenants set forth in Section 5 of the Guaranty or shall have defaulted or failed to perform under the Guaranty; (x) a final judgment by any competent court in the United States of America for the payment of money in an amount greater than $250,000 (in the case of the Seller) or $1,000,000 (in the case of the Sponsor) shall have been rendered against Seller or the Sponsor, and remained undischarged or unpaid for a period of thirty (30) days, during which period execution of such judgment is not effectively stayed; (xi) Sponsor shall have defaulted or failed to perform under any note, indenture, loan agreement, guaranty, swap agreement or any other contract, agreement or transaction to which it is a party, which default (A) involves the failure to pay a matured obligation in excess of $1,000,000, or (B) permits the acceleration of the maturity of obligations by any other party to or beneficiary of such note, indenture, loan agreement, guaranty, swap agreement or other contract agreement or transaction, or Sponsor shall breach any covenant or condition, shall fail to perform, admits its inability to perform or state its intention not to perform its obligations under any Transaction or in respect of any repurchase agreement, reverse repurchase agreement, securities contract or derivative transaction with any party; provided, however, that any such default, failure to perform or breach shall not constitute an Event of Default if Sponsor cures such default, failure to perform or breach, as the case may be, within the grace period, if any, provided under the applicable agreement; or (xii) if Seller or Buyer shall breach or fail to perform any of the terms, covenants, obligations or conditions of this Agreement, other than as specifically otherwise referred to in this definition of "Event of Default", and such breach or failure to perform is not remedied within five (5) Business Days after notice thereof to Seller or Buyer from the applicable party or its successors or assigns; provided, that if such breach or failure to perform is a default other than a default which can be cured by the payment of a sum of money and is susceptible of cure but cannot reasonably be cured within such five (5) Business Days period, such five (5) Business Days period shall be extended to a period of ten (10) calendar days in total. (b) Paragraph 11(a)-(i) of the Agreement is hereby deleted and replaced with the following and with Section 14(b) below: If an Event of Default shall occur and be continuing with respect to Seller, the following rights and remedies shall be available to Buyer: (i) At the option of Buyer, exercised by written notice to Seller (which option shall be deemed to have been exercised, even if no notice is given, immediately upon the occurrence of an Act of Insolvency), the Repurchase Date for each Transaction hereunder shall, if it has not already occurred, be deemed immediately to occur (the date on which such option is exercised or deemed to have been exercised being referred to hereinafter as the "Accelerated Repurchase Date") (ii) If Buyer exercises or is deemed to have exercised the option referred to in Section 14(a)(i) of this Annex I: (A) Seller's obligations hereunder to repurchase all Purchased Securities and Purchased Loans shall become immediately due and payable on and as of the Accelerated Repurchase Date; and (B) to the extent permitted by applicable law, the Repurchase Price with respect to each Transaction (determined as of the Accelerated Repurchase Date) shall be increased by the aggregate amount obtained by daily application of, on a 360 day per year basis for the actual number of days during the period from and including the Accelerated Repurchase Date to but excluding the date of payment of the Repurchase Price (as so increased), (x) the Pricing Rate for such Transaction multiplied by (y) the Repurchase Price for such Transaction (decreased by (I) any amounts actually remitted to Buyer by the Depository Seller or Sponsor from time to time pursuant to Section 5 of this Annex I and applied to such Repurchase Price, and (II) any amounts applied to the Repurchase Price pursuant to Section 14(a)(iii) of this Annex I); and (C) the Custodian shall, upon the request of Buyer, deliver to Buyer all instruments, certificates and other documents then held by the Custodian relating to the Purchased Securities and Purchased Loans. (C) In addition to any rights and remedies of the Buyer provided by this Agreement and by law, the Buyer shall have the right, without prior notice to the Seller, any such notice being expressly waived by the Seller to the extent permitted by applicable law, upon any amount becoming due and payable by the Seller hereunder (whether at the stated maturity, by acceleration or otherwise) to set-off and appropriate and apply against such amount any and all deposits (general or special, time or demand, provisional or final), in any currency, and any other credits, indebtedness or claims, in any currency, in each case whether direct or indirect, absolute or contingent, matured or unmatured, at any time held or owing by the Buyer or any Affiliate thereof to or for the credit or the account of the Seller. The Buyer agrees promptly to notify the Seller after any such set-off and application made by the Buyer; provided that the failure to give such notice shall not affect the validity of such set-off and application. (iii) After five (5) Business Days' notice to Seller (which notice need not be given if an Act of Insolvency shall have occurred with respect to the Seller or the Sponsor, and which may be the notice given under Section 14(a)(i) above), Buyer may (A) immediately sell, at a public or private sale in a commercially reasonable manner and at such price or prices as Buyer may reasonably deem satisfactory any or all of the Purchased Securities and Purchased Loans or (B) in its sole discretion elect, in lieu of selling all or a portion of such Purchased Securities and Purchased Loans, to give Seller credit for such Purchased Securities and Purchased Loans in an amount equal to the Market Value of such Purchased Securities and Purchased Loans against the aggregate unpaid Repurchase Price for such Purchased Securities and Purchased Loans and any other amounts owing by Seller under the Transaction Documents. The proceeds of any disposition of Purchased Securities and Purchased Loans effected pursuant to this Section 14(a)(iii) shall be applied, (v) first, to the costs and expenses incurred by Buyer in connection with Seller's default; (w) second, to consequential damages, including, but not limited to, costs of cover and/or Hedging Transactions, if any; (x) third, to the Repurchase Price; (y) fourth, to the Exit Fee, if any; and (z) fifth, to any other outstanding obligation of Seller to Buyer or its Affiliates. (iv) The parties recognize that it may not be possible to purchase or sell all of the Purchased Securities and Purchased Loans on a particular Business Day, or in a transaction with the same purchaser, or in the same manner because the market for such Purchased Securities and Purchased Loans may not be liquid. In view of the nature of the Purchased Securities and Purchased Loans, the parties agree that liquidation of a Transaction or the Purchased Securities and Purchased Loans does not require a public purchase or sale and that a good faith private purchase or sale shall be deemed to have been made in a commercially reasonable manner. Accordingly, Buyer may elect, in its sole discretion, the time and manner of liquidating any Purchased Securities and Purchased Loans, and nothing contained herein shall (A) obligate Buyer to liquidate any Purchased Securities and Purchased Loans on the occurrence and during the continuance of an Event of Default or to liquidate all of the Purchased Securities and Purchased Loans in the same manner or on the same Business Day or (B) constitute a waiver of any right or remedy of Buyer. (v) Seller shall be liable to Buyer for (A) the amount of all expenses, including reasonable legal fees and expenses, actually incurred by Buyer in connection with or as a consequence of an Event of Default with respect to Seller, (B) consequential damages, including, without limitation, all costs incurred in connection with covering transactions or Hedging Transactions, and (C) any other loss, damage, cost or expense directly arising or resulting from the occurrence of an Event of Default with respect to Seller. (vi) Buyer shall have, in addition to its rights and remedies under the Transaction Documents, all of the rights and remedies provided by applicable federal, state, foreign, and local laws (including, without limitation, if the Transactions are recharacterized as secured financings, the rights and remedies of a secured party under the UCC of the State of New York, to the extent that the UCC is applicable, and the right to offset any mutual debt and claim), in equity, and under any other agreement between Buyer and Seller. Without limiting the generality of the foregoing, Buyer shall be entitled to set off the proceeds of the liquidation of the Purchased Securities and Purchased Loans against all of Seller's obligations to Buyer, whether or not such obligations are then due, without prejudice to Buyer's right to recover any deficiency. (vii) Buyer may exercise any or all of the remedies available to Buyer immediately upon the occurrence of an Event of Default and at any time during the continuance thereof. All rights and remedies arising under the Transaction Documents, as amended from time to time, are cumulative and not exclusive of any other rights or remedies which Buyer may have. (viii) Buyer may enforce its rights and remedies hereunder without prior judicial process or hearing, and Seller hereby expressly waives any defenses Seller might otherwise have to require Buyer to enforce its rights by judicial process. Seller also waives any defense Seller might otherwise have arising from the use of nonjudicial process, disposition of any or all of the Purchased Securities and Purchased Loans, or from any other election of remedies. Seller recognizes that nonjudicial remedies are consistent with the usages of the trade, are responsive to commercial necessity and are the result of a bargain at arm's length. (c) If an Event of Default occurs and is continuing with respect to Buyer, the following rights and remedies shall be available to Seller: (i) Upon tender by Seller of payment of the aggregate Repurchase Price for all Purchased Securities and Purchased Loans, Buyer's right, title and interest in such Purchased Securities and Purchased Loans shall be deemed transferred to Seller, and Buyer shall deliver such Purchased Securities and Purchased Loans to Seller. (ii) If Seller exercises the option referred to in Section 14(b)(i) hereof and Buyer fails to deliver any Purchased Securities or Purchased Loans to Seller, after three (3) Business Days' notice to Buyer, Seller may (A) purchase securities or loans, as applicable ("Replacement Collateral"), that are in as similar an amount and interest rate as is reasonably practicable and in the same Rating Category as such Purchased Securities or the same Collateral Type Grouping as such Purchased Loans or (B) in its sole discretion elect, in lieu of purchasing Replacement Collateral, to be deemed to have purchased Replacement Collateral at a price therefor equal to the Market Value of such Purchased Securities or Purchased Loans as of such date. (iii) Buyer shall be liable to Seller for any excess of the price paid (or deemed paid) by Seller for Replacement Collateral therefor over the Repurchase Price for the Purchased Securities and Purchased Loans replaced thereby. In addition, Buyer shall be liable to Seller for interest at the related Pricing Rate on such remaining liability with respect to each such purchase (or deemed purchase) of Replacement Collateral calculated on a 360-day year basis for the actual number of days during the period from and including the date of such purchase (or deemed purchase) until paid in full by Buyer. 15 RECORDING OF COMMUNICATIONS EACH OF BUYER AND SELLER SHALL HAVE THE RIGHT (BUT NOT THE OBLIGATION) FROM TIME TO TIME TO MAKE OR CAUSE TO BE MADE TAPE RECORDINGS OF COMMUNICATIONS BETWEEN ITS EMPLOYEES AND THOSE OF THE OTHER PARTY WITH RESPECT TO TRANSACTIONS; PROVIDED, HOWEVER, THAT SUCH RIGHT TO RECORD COMMUNICATIONS SHALL BE LIMITED TO COMMUNICATIONS OF EMPLOYEES TAKING PLACE ON THE TRADING FLOOR OF THE APPLICABLE PARTY. EACH OF BUYER AND SELLER HEREBY CONSENTS TO THE ADMISSIBILITY OF SUCH TAPE RECORDINGS IN ANY COURT, ARBITRATION, OR OTHER PROCEEDINGS, AND AGREES THAT A DULY AUTHENTICATED TRANSCRIPT OF SUCH A TAPE RECORDING SHALL BE DEEMED TO BE A WRITING CONCLUSIVELY EVIDENCING THE PARTIES' AGREEMENT. 16 NOTICES AND OTHER COMMUNICATIONS The provisions of Paragraph 13 of the Agreement are hereby modified and superseded in their respective entireties by the following provisions of this Section 16: All notices, consents, approvals and requests required or permitted hereunder shall be given in writing and shall be effective for all purposes if hand delivered or sent by (a) hand delivery, with proof of attempted delivery, (b) certified or registered United States mail, postage prepaid, (c) expedited prepaid delivery service, either commercial or United States Postal Service, with proof of attempted delivery, or (d) by telecopier (with answerback acknowledged) provided that such telecopied notice must also be delivered by one of the means set forth in (a), (b) or (c) above, to the address specified in Annex II hereto or at such other address and person as shall be designated from time to time by any party hereto, as the case may be, in a written notice to the other parties hereto in the manner provided for in this Section. A copy of all notices, consents, approvals and requests directed to Seller (other than Confirmations) shall be delivered concurrently to the following: Dechert LLP, 4000 Bell Atlantic Tower, 1717 Arch Street, Philadelphia, PA 19103, Attention: Richard Jones, Esquire, Telefax Number: 215.994.2222. A notice shall be deemed to have been given: (a) in the case of hand delivery, at the time of delivery, (b) in the case of registered or certified mail, when delivered or the first attempted delivery on a Business Day, (c) in the case of expedited prepaid delivery upon the first attempted delivery on a Business Day, or (d) in the case telecopier, upon receipt of answerback confirmation, provided that such telecopied notice was also delivered as required in this Section. A party receiving a notice which does not comply with the technical requirements for notice under this Section may elect to waive any deficiencies and treat the notice as having been properly given. 17 NON-ASSIGNABILITY The provisions of Paragraph 15 of the Agreement are hereby modified and superseded in their respective entireties by the following provisions of this Section 17: (a) The rights and obligations of the parties under the Transaction Documents and under any Transaction shall not be assigned by either party without the prior written consent of the other party; provided, however, that Buyer may assign its rights and obligations under the Transaction Documents and/or under any Transaction to any Affiliate whose long term unsecured debt rating is (either directly or indirectly through its being part of a holding company or other form of corporate organization) investment grade by a nationally recognized statistical rating organization, without the prior written consent of Seller. (b) Buyer shall be entitled to issue one or more participation interests with respect to any or all of the Transactions; provided, however, that (i) Buyer shall act as exclusive agent for all participants in any dealings with Seller in connection with such Transactions and (ii) Seller shall not be obligated to deal directly with any party other than Buyer in connection with such Transactions, or to pay or reimburse Buyer for any costs that would not have been incurred by Buyer had no participation interests in such Transactions been issued. (c) Subject to the foregoing, the Transaction Documents and any Transactions shall be binding upon and shall inure to the benefit of the parties and their respective successors and assigns. Nothing in the Transaction Documents, express or implied, shall give to any Person, other than the parties to the Transaction Documents and their respective successors, any benefit or any legal or equitable right, power, remedy or claim under the Transaction Documents. 18 CONSENT TO JURISDICTION; WAIVER OF JURY TRIAL (a) Each party irrevocably and unconditionally (i) submits to the non-exclusive jurisdiction of any United States Federal or New York State court sitting in Manhattan, and any appellate court from any such court, solely for the purpose of any suit, action or proceeding brought to enforce its obligations under the Agreement or relating in any way to the Agreement or any Transaction under the Agreement and (ii) waives, to the fullest extent it may effectively do so, any defense of an inconvenient forum to the maintenance of such action or proceeding in any such court and any right of jurisdiction on account of its place of residence or domicile. (b) To the extent that either party has or hereafter may acquire any immunity (sovereign or otherwise) from any legal action, suit or proceeding, from jurisdiction of any court or from set off or any legal process (whether service or notice, attachment prior to judgment, attachment in aid of execution of judgment, execution of judgment or otherwise) with respect to itself or any of its property, such party hereby irrevocably waives and agrees not to plead or claim such immunity in respect of any action brought to enforce its obligations under the Agreement or relating in any way to the Agreement or any Transaction under the Agreement. (c) The parties hereby irrevocably waive, to the fullest extent it may effectively do so, the defense of an inconvenient forum to the maintenance of such action or proceeding and irrevocably consent to the service of any summons and complaint and any other process by the mailing of copies of such process to them at their respective address specified herein. The parties hereby agree that a final judgment in any such action or proceeding shall be conclusive and may be enforced in other jurisdictions by suit on the judgment or in any other manner provided by law. Nothing in this Section 18 shall affect the right of the Buyer to serve legal process in any other manner permitted by law or affect the right of the Buyer to bring any action or proceeding against the Seller or its property in the courts of other jurisdictions. (d) EACH OF THE PARTIES HEREBY IRREVOCABLY WAIVES ALL RIGHT TO A TRIAL BY JURY IN ANY ACTION, PROCEEDING OR COUNTERCLAIM ARISING OUT OF OR RELATING TO THIS AGREEMENT, ANY OTHER TRANSACTION DOCUMENT OR ANY INSTRUMENT OR DOCUMENT DELIVERED HEREUNDER OR THEREUNDER. 19 NO RELIANCE Each of Buyer and Seller hereby acknowledges, represents and warrants to the other that, in connection with the negotiation of, the entering into, and the performance under, the Transaction Documents and each Transaction thereunder: (a) It is not relying (for purposes of making any investment decision or otherwise) upon any advice, counsel or representations (whether written or oral) of the other party to the Transaction Documents, other than the representations expressly set forth in the Transaction Documents. (b) It has consulted with its own legal, regulatory, tax, business, investment, financial and accounting advisors to the extent that it has deemed necessary, and it has made its own investment, hedging and trading decisions (including decisions regarding the suitability of any Transaction) based upon its own judgment and upon any advice from such advisors as it has deemed necessary and not upon any view expressed by the other party. (c) It is a sophisticated and informed Person that has a full understanding of all the terms, conditions and risks (economic and otherwise) of the Transaction Documents and each Transaction thereunder and is capable of assuming and willing to assume (financially and otherwise) those risks; (d) It is entering into the Transaction Documents and each Transaction thereunder for the purposes of managing its borrowings or investments or hedging its underlying assets or liabilities and not for purposes of speculation; and (e) It is not acting as a fiduciary or financial, investment or commodity trading advisor for the other party and has not given the other party (directly or indirectly through any other Person) any assurance, guaranty or representation whatsoever as to the merits (either legal, regulatory, tax, business, investment, financial accounting or otherwise) of the Transaction Documents or any Transaction thereunder. 20 INDEMNITY The Seller hereby agrees to indemnify the Buyer, the Buyer's designee and each of its officers, directors, employees and agents ("Indemnified Parties") from and against any and all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, taxes (including stamp, excise, sales or other taxes which may be payable or determined to be payable with respect to any of the Collateral or in connection with any of the transactions contemplated by this Agreement and the documents delivered in connection herewith, other than income taxes of the Buyer), fees, costs, expenses (including reasonable attorneys fees and disbursements actually incurred) or disbursements (all of the foregoing, collectively "Indemnified Amounts") which may at any time (including, without limitation, such time as this Agreement shall no longer be in effect and the Transactions shall have been repaid in full) be imposed on or asserted against any Indemnified Party in any way whatsoever arising out of or in connection with, or relating to, this Agreement or any Transactions thereunder or any action taken or omitted to be taken by any Indemnified Party under or in connection with any of the foregoing; provided, that Seller shall not be liable for Indemnified Amounts resulting (A) from the gross negligence or willful misconduct of any Indemnified Party or (B) attributable to Buyer's ownership of any Purchased Loan following enforcement of its rights under this Agreement with respect thereto (unless and to the extent such liability relates to an event, circumstance or condition which occurred prior to the enforcement of such rights). Without limiting the generality of the foregoing, Seller agrees to hold Buyer harmless from and indemnify Buyer against all Indemnified Amounts with respect to all Purchased Loans relating to or arising out of any violation or alleged violation of any environmental law, rule or regulation or any consumer credit laws, including without limitation ERISA, the Truth in Lending Act and/or the Real Estate Settlement Procedures Act, that, in each case, results from anything other than Buyer's gross negligence or willful misconduct. In any suit, proceeding or action brought by Buyer in connection with any Purchased Loan for any sum owing thereunder, or to enforce any provisions of any Purchased Loan, Seller will save, indemnify and hold Buyer harmless from and against all expense, loss or damage suffered by reason of any defense, set-off, counterclaim, recoupment or reduction or liability whatsoever of the account debtor or obligor thereunder, arising out of a breach by Seller of any obligation thereunder or arising out of any other agreement, indebtedness or liability at any time owing to or in favor of such account debtor or obligor or its successors from Seller. Seller also agrees to reimburse Buyer as and when billed by Buyer for all Buyer's costs and expenses incurred in connection with Buyer's due diligence reviews with respect to the Purchased Loans and Purchased Securities (including, without limitation, those incurred pursuant to Section 21) and the enforcement or the preservation of Buyer's rights under this Agreement or any Transaction contemplated hereby, including without limitation the reasonable fees and disbursements of its counsel. Seller hereby acknowledges that, the obligation of Seller hereunder is a recourse obligation of Seller. 21 DUE DILIGENCE Seller acknowledges that Buyer has the right to perform continuing due diligence reviews with respect to the Purchased Securities and the Purchased Loans, for purposes of verifying compliance with the representations, warranties and specifications made hereunder, or otherwise, and Seller agrees that upon reasonable prior written notice to Seller, Buyer or its authorized representatives will be permitted during normal business hours to examine, inspect, and make copies and extracts of, the Purchased Loan Files, Servicing Records and any and all documents, records, agreements, instruments or information relating to such Purchased Securities and Purchased Loans in the possession or under the control of Seller, any other servicer or subservicer and/or the Custodian. Seller also shall make available to Buyer a knowledgeable financial or accounting officer for the purpose of answering questions respecting the Purchased Loan Files and the Purchased Securities and Purchased Loans. Without limiting the generality of the foregoing, Seller acknowledges that Buyer may enter into Transactions with the Seller based solely upon the information provided by Seller to Buyer and the representations, warranties and covenants contained herein, and that Buyer, at its option, has the right at any time to conduct a partial or complete due diligence review on some or all of the Purchased Securities and Purchased Loans. Buyer may underwrite such Purchased Loans itself or engage a third party underwriter to perform such underwriting. Seller agrees to reasonably cooperate with Buyer and any third party underwriter in connection with such underwriting, including, but not limited to, providing Buyer and any third party underwriter with access to any and all documents, records, agreements, instruments or information relating to such Purchased Securities and Purchased Loans in the possession, or under the control, of Seller. Seller further agrees that Seller shall reimburse Buyer for any and all out-of-pocket costs and expenses reasonably incurred by Buyer in connection with Buyer's activities pursuant to this Section 21. 22 SERVICING (a) Notwithstanding the purchase and sale of the Purchased Loans hereby, Seller, Midland, PNC Bank NA or Sponsor shall continue to service the Purchased Loans for the benefit of Buyer and, if Buyer shall exercise its rights to pledge or hypothecate the Purchased Loans prior to the Repurchase Date pursuant to Section 8, Buyer's assigns; provided, however, that the obligations of Seller, Midland, PNC Bank NA or Sponsor to service any of the Purchased Loans shall cease, at Seller's option, upon the payment by Seller to Buyer of the Repurchase Price therefor. Seller shall service or cause the servicer to service the Purchased Mortgage Loans in accordance with Accepted Servicing Practices. (b) Seller agrees that Buyer is the owner of all servicing records, including but not limited to any and all servicing agreements (the "Servicing Agreements"), files, documents, records, data bases, computer tapes, copies of computer tapes, proof of insurance coverage, insurance policies, appraisals, other closing documentation, payment history records, and any other records relating to or evidencing the servicing of Purchased Loans (the "Servicing Records") so long as the Purchased Loans are subject to this Agreement. Seller grants Buyer a security interest in all servicing fees and rights relating to the Purchased Loans and all Servicing Records to secure the obligation of the Seller or its designee to service in conformity with this Section and any other obligation of Seller to Buyer. Seller covenants to safeguard such Servicing Records and to deliver them promptly to Buyer or its designee (including the Custodian) at Buyer's request. (c) Upon the occurrence and continuance of an Event of Default, Buyer may, in its sole discretion, (i) sell its right to the Purchased Loans on a servicing released basis or (ii) terminate the Seller or any sub-servicer of the Purchased Loans with or without cause, in each case without payment of any termination fee. (d) Seller shall not employ sub-servicers (other than Midland, PNC Bank NA or the Sponsor) to service the Purchased Loans without the prior written approval of Buyer. If the Purchased Loans are serviced by a sub-servicer, Seller shall irrevocably assign all rights, title and interest in the Servicing Agreements in the Purchased Loans to Buyer. (e) Seller shall cause any sub-servicers engaged by Seller to execute a letter agreement with Buyer acknowledging Buyer's security interest and agreeing that it shall deposit all Income with respect to the Purchased Loans in the Cash Management Account. (f) The payment of servicing fees shall be subordinate to payment of amounts outstanding under any Transaction and this Agreement. 23 MISCELLANEOUS (a) Time is of the essence under the Transaction Documents and all Transactions thereunder and all references to a time shall mean New York time in effect on the date of the action unless otherwise expressly stated in the Transaction Documents. (b) All rights, remedies and powers of Buyer hereunder and in connection herewith are irrevocable and cumulative, and not alternative or exclusive, and shall be in addition to all other rights, remedies and powers of Buyer whether under law, equity or agreement. In addition to the rights and remedies granted to it in this Agreement, Buyer shall have all rights and remedies of a secured party under the UCC. (c) The Transaction Documents may be executed in counterparts, each of which so executed shall be deemed to be an original, but all of such counterparts shall together constitute but one and the same instrument. (d) The headings in the Transaction Documents are for convenience of reference only and shall not affect the interpretation or construction of the Transaction Documents. (e) Without limiting the rights and remedies of Buyer under the Transaction Documents, Seller shall pay Buyer's reasonable out-of-pocket costs and expenses, including reasonable fees actually incurred and expenses of accountants, attorneys and advisors, incurred in connection with the preparation, negotiation, execution and consummation of, and any amendment, supplement or modification to, the Transaction Documents and the Transactions thereunder. Seller agrees to pay Buyer on demand all costs and expenses (including reasonable expenses actually incurred for legal services of every kind) of any subsequent enforcement of any of the provisions hereof, or of the performance by Buyer of any obligations of Seller in respect of the Purchased Securities, or any actual or attempted sale, or any exchange, enforcement, collection, compromise or settlement in respect of any of the Collateral and for the custody, care or preservation of the Collateral (including insurance costs) and defending or asserting rights and claims of Buyer in respect thereof, by litigation or otherwise. In addition, Seller agrees to pay Buyer on demand all reasonable costs and expenses (including reasonable expenses for legal services actually incurred) incurred in connection with the maintenance of the Cash Management Account and registering the Collateral in the name of Buyer or its nominee. All such expenses shall be recourse obligations of Seller to Buyer under this Agreement. (f) Each provision of this Agreement shall be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Agreement shall be prohibited by or be invalid under such law, such provision shall be ineffective to the extent of such prohibition or invalidity, without invalidating the remainder of such provision or the remaining provisions of this Agreement. (g) The parties acknowledge and agree that although they intend to treat each Transaction as a sale of the Purchased Securities and Purchased Loans, in the event that such sale shall be recharacterized as a secured financing, this Annex I shall also serve as a security agreement with respect to Buyer's rights in the Collateral. In order to secure and to provide for the prompt and unconditional repayment of the Repurchase Price and the performance of its obligations under the Agreement, Seller hereby pledges to Buyer and hereby grants to Buyer a first priority security interest in all of its rights in the Purchased Securities and Purchased Loans. Seller hereby covenants to duly execute any Form UCC-1 financing statements as reasonably required by Buyer in order to perfect its security interest created hereby in such rights and obligations granted above, it being agreed that Seller shall pay any and all fees required to file such financing statements. (h) This Agreement contains a final and complete integration of all prior expressions by the parties with respect to the subject matter hereof and thereof and shall constitute the entire agreement among the parties with respect to such subject matter, superseding all prior oral or written understandings. (i) The parties understand that this Agreement is a legally binding agreement that may affect such party's rights. Each party represents to the other that it has received legal advice from counsel of its choice regarding the meaning and legal significance of this Agreement and that it is satisfied with its legal counsel and the advice received from it. (j) Should any provision of this Agreement require judicial interpretation, it is agreed that a court interpreting or construing the same shall not apply a presumption that the terms hereof shall be more strictly construed against any Person by reason of the rule of construction that a document is to be construed more strictly against the Person who itself or through its agent prepared the same, it being agreed that all parties have participated in the preparation of this Agreement. (k) The parties recognize that each Transaction is a "securities contract" as that term is defined in Section 741 of Title 11 of the United States Code, as amended. IN WITNESS WHEREOF, the parties have executed this Annex I as of the 3rd day of December, 2004. BUYER: ------ DEUTSCHE BANK AG, CAYMAN ISLANDS BRANCH By: /s/Christopher Tognola ---------------------------------------- Name: Christopher Tognola Title: Vice President By: /s/Christine Belbusti ---------------------------------------- Name: Christine Belbusti Title: Vice President SELLER: ------- ANTHRACITE FUNDING, LLC, a Delaware limited liability company By: Anthracite Capital, Inc., a Maryland corporation, its sole member By: /s/Robert Friedberg --------------------------------- Name: Robert Friedberg Title: Vice President EXHIBITS AND SCHEDULES SCHEDULE I-A Original Purchase Percentages, CF Sweep Purchase Percentages, Buyer's Margin Percentages and Applicable Spreads EXHIBIT I Form of Confirmation EXHIBIT II Authorized Representatives of Seller EXHIBIT III Monthly Reporting Package EXHIBIT IV Form of Custodial Agreement EXHIBIT V Form of Power of Attorney EXHIBIT VI Representations and Warranties Regarding Individual Purchased Loans EXHIBIT VII Collateral Information EXHIBIT VIII Transaction Procedure EXHIBIT IX Redirection Letter
SCHEDULE I-A Original Purchase Percentages, CF Sweep Purchase Percentages Buyer's Margin Percentages and Applicable Spreads ------------------------------------------------- ELIGIBLE LOANS: - ----------------- ------------------------- -------------------------- ---------------------------- --------- ----------- Collateral Original CF Sweep Purchase Buyer's Margin Percentage Spread Limits Type Purchase Percentage Percentage in Grouping Basis Points - ----------------- ------------ ------------ ------------- ------------ -------------- ------------- --------- ----------- MSER(1)<$45mm MSER>$45mm MSER<$45mm MSER>$45mm MSER<$45mm MSER>$45mm > or = > or = > or = - ----------------- ------------ ------------ ------------- ------------ -------------- ------------- --------- ----------- 1st Lien - Low 75% 90% 85% 92% 111.11% 105.26% 80 N/A Leverage2 - ----------------- ------------ ------------ ------------- ------------ -------------- ------------- --------- ----------- 1st Lien - 70% 85% 85% 90% 111.11% 105.26% 100 N/A Other3 - ----------------- ------------ ------------ ------------- ------------ -------------- ------------- --------- ----------- 2nd 65% 75% 70% 80% 133.33% 117.65% 150 N/A Lien/B-Note/ Mezzanine Loans/ Participation - Low Leverage4 - ----------------- ------------ ------------ ------------- ------------ -------------- ------------- --------- ----------- 2nd 55% 60% 65% 70% 133.33% 125.00% 200 $40mm-$75mm6 Lien/B-Note/ Mezzanine Loans/ Participation/ Preferred Equity - Other5 - ----------------- ------------ ------------ ------------- ------------ -------------- ------------- --------- -----------
ELIGIBLE SECURITIES: - --------------------- ---------------------------- ---------------------------- ----------------------------- ----------- Rating Category Original CF Sweep Buyer's Margin Percentage Spread Purchase Percentage Purchase Percentage in Basis Points,7 - --------------------- -------------- ------------- ------------- -------------- -------------- -------------- ----------- MSER<$45mm MSER>or=$45mm MSER<$45mm MSER>or=$45mm MSER<$45mm MSER>or=$45mm Initial /Div 8<10 /Div>10 /Div<10 /Div>10 /Div<10 /Div>10 90 days /after 90 days - --------------------- -------------- ------------- ------------- -------------- -------------- -------------- ----------- BBB- & higher 75% 85% 82.5% 90% 117.65% 108.11% 50/155 - --------------------- -------------- ------------- ------------- -------------- -------------- -------------- ----------- BB+ & BB 65% 75% 80% 82.5% 121.21% 117.65% 100/155 - --------------------- -------------- ------------- ------------- -------------- -------------- -------------- ----------- BB- 60% 70% 75% 80% 125.00% 117.65% 125/155 - --------------------- -------------- ------------- ------------- -------------- -------------- -------------- ----------- B+ & B 55% 65% 70% 75% 133.33% 125.00% 125/155 - --------------------- -------------- ------------- ------------- -------------- -------------- -------------- ----------- B- 45% 55% 60% 65% 142.86% 133.33% 125/155 - --------------------- -------------- ------------- ------------- -------------- -------------- -------------- ----------- NR/CCC 25% 30% 30% 35% 285.71% 250.00% 155/155 - --------------------- -------------- ------------- ------------- -------------- -------------- -------------- -----------
__________________ 1 "MSER" means Minimum Seller's Equity Requirement. 2 Loan-to-Value not to exceed 70% and Debt Service Coverage Ratio of at least 1.35x. 3 Loan-to-Value not to exceed 75% (or, 90% in Buyer's sole and absolute discretion) and Debt Service Coverage Ratio of at least 1.25x. 4 Loan-to-Value not to exceed 75% and Debt Service Coverage Ratio of at least 1.30x. 5 Loan-to-Value not to exceed 85% (or, 90% in Buyer's sole and absolute discretion) and Debt Service Coverage Ratio of at least 1.15x. 6 If at any time the aggregate Repurchase Price (excluding accrued Price Differential) is equal to or less than $80,000,000, the aggregate Repurchase Price (excluding accrued Price Differential) with respect to all Transactions involving Purchased Loans of the Category Type Group "2nd Lien/B-Note/Mezzanine Loans/Participation/Preferred Equity -- Other" may not exceed $40,000,000; if at any time the aggregate Repurchase Price (excluding accrued Price Differential) is greater than $80,000,000 but less than $150,000,000, then the aggregate Repurchase Price with respect to all Transactions involving Purchased Loans of the Category Type Group "2nd Lien/B-Note/Mezzanine Loans/Participation/Preferred Equity -- Other" may not exceed 50% of such aggregate Repurchase Price (excluding accrued Price Differential); if at any time the aggregate Repurchase Price (excluding accrued Price Differential) is equal to or greater than $150,000,000, the aggregate Repurchase Price (excluding accrued Price Differential) with respect to all Transactions involving Purchased Loans of the Category Type Group "2nd Lien/B-Note/Mezzanine Loans/Participation/Preferred Equity -- Other" may not exceed $75,000,000. 7 For any Rating Category, the spread in basis points during the initial 90 days commencing the date of the Agreement is the lesser of the two provided spread in basis points (if the provided spread in basis points are different); the spread in basis points during any period after the initial 90 days commencing the date of the Agreement is the greater of the two provided spread in basis points (if the provides spread in basis points are different). 8 "DIV" means Minimum CMBS Diversification. EXHIBIT I CONFIRMATION STATEMENT DEUTSCHE BANK AG, Cayman Islands Branch Ladies and Gentlemen: Deutsche Bank AG, Cayman Islands Branch, is pleased to deliver our written CONFIRMATION of our agreement to enter into the Transaction pursuant to which Deutsche Bank AG, Cayman Islands Branch shall purchase from you the Purchased Securities and/or Purchased Loans identified in Annex I, pursuant to the Master Repurchase Agreement between Deutsche Bank AG, Cayman Islands Branch (the "Buyer") and Anthracite Funding, LLC ("Seller"), dated as of December 21, 2004 (the "Agreement"; capitalized terms used herein without definition have the meanings given in the Agreement), as follows below and on the attached Schedule 1: Purchase Date: __________, 20__ Purchased Securities/ Purchased Loans: Aggregate Principal Amount of Purchased Securities/Purchased Loans (Original/Current): Percentage Class Purchased: _________% Repurchase Date: Buyer's Purchase Price: $ Original Purchase Percentage: Pricing Rate: one-month LIBOR plus ______% Margin Maintenance Percentage: Seller's Acquisition Cost/ Acquisition Price: $ / % Dollar Price Paid or Benchmark/Spread to Benchmark: Buyer's Margin Percentage: Margin Notice Deadline: 11:00 a.m. Governing Agreements/Trustee: As identified on attached Schedule 1 Name and address for communications: Buyer: Deutsche Bank AG, Cayman Islands Branch 60 Wall Street New York, New York 10005 Attention: Stephen Choe Telephone: (212) 250-6911 Telecopy: (212) 797-4461 Seller: Anthracite Funding, LLC 40 East 52nd Street New York, New York 10022 Attention: Richard Shea Telephone: (212) 754-5519 Telecopy: (212) 754-8758 DEUTSCHE BANK AG, CAYMAN ISLANDS BRANCH By: __________________________________ Name: ________________________________ Title: _______________________________ By: __________________________________ Name: ________________________________ Title: _______________________________ AGREED AND ACKNOWLEDGED: ANTHRACITE FUNDING, LLC, a Delaware limited liability company By: Anthracite Capital, Inc., a Maryland corporation, its sole member By: __________________________________ Name: ________________________________ Title: _______________________________ Schedule 1 to Confirmation Statement Purchased Securities: Aggregate Principal Amount (Original/Current): CUSIP NO.: Securitization Document (including Master Servicer, Special Servicer and Trustee): - ------------------------------------------------------------------------------- Purchased Loans: Aggregate Principal Amount (Original/Current): Purchased Loan Documents:
Summary of Purchased Securities/Purchased Loans Purchased Security/Purchased Loan: ______ Spread over Seller Seller's Buyer's Original Buyer's one Outstanding Owned Acquisition Market Rating, Purchase Purchase month Class, if any Balance Face Cost Value if any Percentage Price LIBOR ------------- ----------- ------ ----------- ------ ------ ---------- ------- -----
EXHIBIT II AUTHORIZED REPRESENTATIVES OF SELLER ------------------------------------ Name Specimen Signature - ---- ------------------ Richard Shea CFO/COO/Treasurer __________________ Robert Friedberg Vice President/Secretary __________________ Chris Milner CEO/President __________________ EXHIBIT III MONTHLY REPORTING PACKAGE ------------------------- FORM OF AGGREGATE COLLATERAL REPORT AGGREGATE COLLATERAL REPORT INFORMATION FOR EACH PORTFOLIO SECURITY Portfolio Security Information (By Rating Category): Issuer, Series and Class Beginning Balance Pass-Through Rate Principal Distribution Amount Interest Distribution Amount Total Distribution Principal Losses Interest Shortfalls/Recoveries Ending Certificate Balance Available credit support, in %, available to Portfolio Security* Additional Underlying Trust Expenses Rating CUSIP No. Deal Name Description Payment Date Trustee, Master Servicer, Special Servicer Special Servicing Report Details Mortgage Loan Information: Aggregate Outstanding Balance Realized Losses per Asset for Underlying Trust for the Prior Month Cumulative Realized Losses per Asset Dollar Amount and Percentage of Aggregate Pool Balance of: Purchased Loans 30-59 days delinquent Purchased Loans 60-89 days delinquent Purchased Loans 90 or more days delinquent Purchased Loans in Foreclosure REO - Listing of Assets Number of loans at start and end of the month Outstanding principal balance at start and end of the month Repayments - Listing of Assets Foreclosures - Listing of Assets Bankruptcies - Listing of Assets Current weighted average maturity Current weighted average coupon (Based on Pay Rate) ______________________ * Only to the extent provided in Portfolio Security distribution date statements. EXHIBIT IV FORM OF CUSTODIAL DELIVERY -------------------------- On this ______ of ________, 20__, Anthracite Funding, LLC ("Seller"), as the Seller under that certain Master Repurchase Agreement, dated as of December 21, 2004 (the "Repurchase Agreement") between the Seller and Deutsche Bank AG, Cayman Islands Branch ("Buyer"), does hereby deliver to LaSalle Bank National Association ("Custodian"), as custodian under that certain Custodial Agreement, dated as of December 21, 2004, among Buyer, Seller and Custodian, the Purchased Loan Files with respect to the Purchased Loans to be purchased by Buyer pursuant to the Repurchase Agreement, which Purchased Loans are listed on the Purchased Loan Schedule attached hereto and which Purchased Loans shall be subject to the terms of the Custodial Agreement on the date hereof. With respect to the Purchased Loan Files delivered hereby, for the purposes of issuing the Trust Receipt, the Custodian shall review the Purchased Loan Files to ascertain delivery of the documents listed in Section 3(g) to the Custodial Agreement. Capitalized terms used herein and not otherwise defined shall have the meanings set forth in the Custodial Agreement. IN WITNESS WHEREOF, the Seller has caused its name to be signed hereto by its officer thereunto duly authorized as of the day and year first above written. ANTHRACITE FUNDING, LLC, a Delaware limited liability company By: Anthracite Capital, Inc., a Maryland corporation, its sole member By: _____________________________ Name: ___________________________ Title: __________________________ EXHIBIT V FORM OF POWER OF ATTORNEY ------------------------- "Know All Men by These Presents, that Anthracite Funding, LLC ("Seller"), does hereby appoint Deutsche Bank AG, Cayman Islands Branch ("Buyer"), its attorney-in-fact to act in Seller's name, place and stead in any way which Seller could do with respect to (i) the completion of the endorsements of the Mortgage Notes and the Assignments of Mortgages and the Mezzanine Notes, (ii) the recordation of the Assignments of Mortgages and (iii) the enforcement of the Seller's rights under the Purchased Loans purchased by Buyer pursuant to the Master Repurchase Agreement dated as of December 21, 2004 between Seller and Buyer and to take such other steps as may be necessary or desirable to enforce Buyer's rights against such Purchased Loans, the related Purchased Loan Files and the Servicing Records to the extent that Seller is permitted by law to act through an agent. TO INDUCE ANY THIRD PARTY TO ACT HEREUNDER, SELLER HEREBY AGREES THAT ANY THIRD PARTY RECEIVING A DULY EXECUTED COPY OF FACSIMILE OF THIS INSTRUMENT MAY ACT HEREUNDER, AND THAT REVOCATION OR TERMINATION HEREOF SHALL BE INEFFECTIVE AS TO SUCH THIRD PARTY UNLESS AND UNTIL ACTUAL NOTICE OR KNOWLEDGE OR SUCH REVOCATION OR TERMINATION SHALL HAVE BEEN RECEIVED BY SUCH THIRD PARTY, AND SELLER ON ITS OWN BEHALF AND ON BEHALF OF SELLER'S ASSIGNS, HEREBY AGREES TO INDEMNIFY AND HOLD HARMLESS ANY SUCH THIRD PARTY FROM AND AGAINST ANY AND ALL CLAIMS THAT MAY ARISE AGAINST SUCH THIRD PARTY BY REASON OF SUCH THIRD PARTY HAVING RELIED ON THE PROVISIONS OF THIS INSTRUMENT. IN WITNESS WHEREOF Seller has caused this Power of Attorney to be executed and the Seller's seal to be affixed this _____ day of __________, 20__. ANTHRACITE FUNDING, LLC, a Delaware limited liability company By: Anthracite Capital, Inc., a Maryland corporation, its sole member By: _____________________________ Name: ___________________________ Title: __________________________ (Seal) EXHIBIT VI REPRESENTATIONS AND WARRANTIES REGARDING EACH INDIVIDUAL PURCHASED LOAN SECURED BY A MORTGAGE --------------------- With respect to each Purchased Loan of the type described in clauses (i) or (ii) of the definition of Eligible Loan (or which is a loan secured by a second lien on multifamily or commercial property as set forth in clauses (iii)(a) or (iv)(a) of the definition of Eligible Loan), the Seller represents and warrants on each Purchase Date as follows, other than as set forth on the exception report provided to Buyer in accordance with the Agreement. 1. Purchased Loan Schedule and Collateral Information. The information set forth in the Purchased Loan Schedule and the Collateral Information is complete, true and correct in all material respects. 2. Whole Loan; Ownership of Purchased Loans. Each Purchased Loan is a whole loan and not a participation interest in a whole loan. Immediately prior to the transfer to the Buyer of the Purchased Loans, the Seller had good title to, and was the sole owner of, each Purchased Loan. The Seller has full right, power and authority to transfer and assign each of the Purchased Loans to or at the direction of the Buyer and has validly and effectively conveyed (or caused to be conveyed) to the Buyer or its designee all of the Seller's legal and beneficial interest in and to the Purchased Loans free and clear of any and all pledges, liens, charges, security interests and/or other encumbrances. The sale of the Purchased Loans to the Buyer or its designee does not require the Seller to obtain any governmental or regulatory approval or consent that has not been obtained. 3. Payment Record. No scheduled payment of principal and interest under any Purchased Loan was 30 days or more past due as of the Purchase Date without giving effect to any applicable grace period, and no Purchased Loan was 30 days or more delinquent in the twelve-month period immediately preceding the Purchase Date. 4. Lien; Valid Assignment. The Mortgage related to and delivered in connection with each Purchased Loan constitutes a valid and, subject to the exceptions set forth in paragraph 13 below, enforceable first priority lien (or with respect to loans secured by second liens as set forth in clauses (iii)(a) or (iv)(a) of the definition of Eligible Loan, enforceable second priority lien) upon the related Mortgaged Property, prior to all other liens and encumbrances, except for (a) the lien for current real estate taxes and assessments not yet due and payable, (b) covenants, conditions and restrictions, rights of way, easements and other matters that are of public record and/or are referred to in the related lender's title insurance policy, (c) exceptions and exclusions specifically referred to in such lender's title insurance policy, and (d) other matters to which like properties are commonly subject, none of which matters referred to in clauses (b), (c) or (d) materially interferes with the security intended to be provided by such Mortgage or the marketability or current use of the Mortgaged Property or the current ability of the Mortgaged Property to generate operating income sufficient to service the Purchased Loan debt (the foregoing items (a) through (d) being herein referred to as the "Permitted Encumbrances"). The related assignment of such Mortgage executed and delivered in favor of the Buyer is in recordable form and constitutes a legal, valid and binding assignment, sufficient to convey to the assignee named therein all of the assignor's right, title and interest in, to and under such Mortgage. Such Mortgage, together with any separate security agreements, chattel mortgages or equivalent instruments, establishes and creates a valid and, subject to the exceptions set forth in paragraph 13 below, enforceable security interest in favor of the holder thereof in all of the related Mortgagor's personal property used in, and reasonably necessary to operate the related Mortgaged Property. A Uniform Commercial Code financing statement has been filed and/or recorded in all places necessary to perfect a valid security interest in such personal property, and such security interest is a first or second priority security interest, subject to any prior purchase money security interest in such personal property and any personal property leases applicable to such personal property. Notwithstanding the foregoing, no representation is made as to the perfection of any security interest in rents or other personal property to the extent that possession or control of such items or actions other than the filing of Uniform Commercial Code financing statements are required in order to effect such perfection. 5. Assignment of Leases and Rents. The Assignment of Leases set forth in the Mortgage (or in a separate instrument) and related to and delivered in connection with each Purchased Loan establishes and creates a valid, subsisting and, subject to the exceptions set forth in paragraph 13 below, enforceable first or second priority perfected lien and first or second priority perfected security interest in the related Mortgagor's interest in all leases, sub-leases, licenses or other agreements pursuant to which any person is entitled to occupy, use or possess all or any portion of the real property subject to the related Mortgage, and each assignor thereunder has the full right to assign the same. The related assignment of any Assignment of Leases, not included in a Mortgage, executed and delivered in favor of the Buyer is in recordable form and constitutes a legal, valid and binding assignment, sufficient to convey to the assignee named therein all of the assignor's right, title and interest in, to and under such Assignment of Leases. 6. Mortgage Status; Waivers and Modifications. No Mortgage has been satisfied, canceled, rescinded or subordinated in whole or in material part, and the related Mortgaged Property has not been released from the lien of such Mortgage, in whole or in material part, nor has any instrument been executed that would effect any such satisfaction, cancellation, subordination, rescission or release except for any partial reconveyances of portions of the real property that do not materially adversely affect the value of the property. None of the terms of any Mortgage Note, Mortgage or Assignment of Leases have been impaired, waived, altered or modified in any respect, except by written instruments, all of which are included in the related Mortgage File. 7. Condition of Property; Condemnation. Except as set forth in an engineering report prepared in connection with the origination or acquisition of the related Purchased Loan, each Mortgaged Property is, to the Seller's knowledge, free and clear of any damage that would materially and adversely affect its value as security for the related Purchased Loan (normal wear and tear excepted). The Seller has received no notice of any pending or threatened proceeding for the condemnation of all or any material portion of any Mortgaged Property. To the Seller's knowledge (based on surveys and/or title insurance obtained in connection with the origination or acquisition of the Purchased Loans) as of the date of the origination or acquisition of each Purchased Loan, all of the material improvements on the related Mortgaged Property which were considered in determining the appraised value of the Mortgaged Property lay wholly within the boundaries and building restriction lines of such property, except for encroachments that are insured against by the lender's title insurance policy referred to herein or that do not materially and adversely affect the value or marketability of such Mortgaged Property, and no improvements on adjoining properties materially encroached upon such Mortgaged Property so as to materially and adversely affect the value or marketability of such Mortgaged Property, except those encroachments that are insured against by the Title Policy referred to herein. 8. Title Insurance. Each Mortgaged Property is covered by an American Land Title Association (or an equivalent form thereof as adopted in the applicable jurisdiction) lender's title insurance policy (the "Title Policy") in the original principal amount of the related Purchased Loan after all advances of principal. Each Title Policy insures that the related Mortgage is a valid first or second priority lien on such Mortgaged Property, subject only to the exceptions stated therein (or an escrow letter or a marked up title insurance commitment on which the required premium has been paid exists which evidences that such Title Policy will be issued). Each Title Policy (or, if it has yet to be issued, the coverage to be provided thereby) is in full force and effect, all premiums thereon have been paid and, to the Seller's knowledge, no material claims have been made thereunder and no claims have been paid thereunder. No holder of the related Mortgage has done, by act or omission, anything that would materially impair the coverage under such Title Policy. Immediately following the transfer and assignment of the related Purchased Loan to the Buyer, such Title Policy (or, if it has yet to be issued, the coverage to be provided thereby) will inure to the benefit of the Buyer without the consent of or notice to the insurer. 9. No Holdbacks. The proceeds of each Purchased Loan have been fully disbursed and there is no obligation for future advances with respect thereto. With respect to each Purchased Loan, any and all requirements as to completion of any on-site or off-site improvement and as to disbursements of any funds escrowed for such purpose that were to have been complied with on or before the Purchase Date have been complied with, or any such funds so escrowed have not been released. 10. Mortgage Provisions. The Mortgage Note or Mortgage for each Purchased Loan, together with applicable state law, contains customary and enforceable provisions for comparable mortgaged properties similarly situated (subject to the exceptions set forth in paragraph 13) such as to render the rights and remedies of the holder thereof adequate for the practical realization against the related Mortgaged Property of the principal benefits of the security intended to be provided thereby. 11. Buyer under Deed of Trust. If any Mortgage is a deed of trust, (1) a trustee, duly qualified under applicable law to serve as such, is properly designated and serving under such Mortgage, and (2) no fees or expenses are payable to such trustee by the Seller, the Buyer or any transferee thereof except in connection with a trustee's sale after default by the related Mortgagor or in connection with any full or partial release of the related Mortgaged Property or related security for the related Purchased Loan. 12. Environmental Conditions. An environmental site assessment (or an update of a previous assessment) was performed with respect to each Mortgaged Property in connection with the origination or acquisition of the related Purchased Loan, a report of each such assessment (an "Environmental Report") has been delivered to the Buyer, and to Seller's knowledge there is no material and adverse environmental condition or circumstance affecting any Mortgaged Property that was not disclosed in such report. Each Mortgage requires the related Mortgagor to comply with all applicable federal, state and local environmental laws and regulations. Where such Environmental Report disclosed the existence of a material and adverse environmental condition or circumstance affecting any Mortgaged Property, (i) a party not related to the Mortgagor was identified as the responsible party for such condition or circumstance, (ii) the related Mortgagor was required either to provide additional security and/or to obtain an operations and maintenance plan or (iii) the related Mortgagor provided evidence that applicable federal, state or local governmental authorities would not take any action, or require the taking of any action, in respect of such condition or circumstance. The related Purchased Loan Documents contain provisions pursuant to which the related borrower or a principal of such borrower has agreed to indemnify the mortgagee for damages resulting from violations of any applicable Environmental Laws. 13. Loan Document Status. Each Mortgage Note, Mortgage and other agreement that evidences or secures a Purchased Loan and that was executed by or on behalf of the related Mortgagor is the legal, valid and binding obligation of the maker thereof (subject to any non-recourse provisions contained in any of the foregoing agreements and any applicable state anti-deficiency or market value limit deficiency legislation), enforceable in accordance with its terms, except as such enforcement may be limited by bankruptcy, insolvency, reorganization or other similar laws affecting the enforcement of creditors' rights generally, and by general principles of equity (regardless of whether such enforcement is considered in a proceeding in equity or at law) and there is no valid defense, counterclaim or right of offset or rescission available to the related Mortgagor with respect to such Mortgage Note, Mortgage or other agreements. 14. Insurance. Each Mortgaged Property is, and is required pursuant to the related Mortgage to be, insured by (a) a fire and extended perils insurance policy issued by an insurer meeting the requirements of such Purchased Loan providing coverage against loss or damage sustained by reason of fire, lightning, windstorm, hail, explosion, riot, riot attending a strike, civil commotion, aircraft, vehicles and smoke, and, to the extent required as of the date of origination by the originator of such Purchased Loan consistent with its normal commercial mortgage lending practices, against other risks insured against by persons operating like properties in the locality of the Mortgaged Property in an amount not less than the lesser of the principal balance of the related Purchased Loan and the replacement cost (not allowing for depreciation) of the Mortgaged Property, and not less than the amount necessary to avoid the operation of any co-insurance provisions with respect to the Mortgaged Property; (b) a business interruption or rental loss insurance policy, in an amount at least equal to six months of operations of the Mortgaged Property (other than Manufactured Housing Communities); (c) a flood insurance policy (if any portion of the Mortgaged Property is located in an area identified by the Federal Emergency Management Agency as having special flood hazards) and (d) a comprehensive general liability insurance policy in amounts as are generally required by commercial mortgage lenders, and in any event not less than $1 million per occurrence. Such insurance policy contains a standard mortgagee clause that names the Mortgagee as an additional insured and that requires at least thirty days' (in the case of termination or cancellation other than for nonpayment of premiums) and at least ten days' (in the case of termination or cancellation for nonpayment of premiums) prior notice to the holder of the Mortgage, and no such notice has been received, including any notice of nonpayment of premiums, that has not been cured. Each Mortgage obligates the related Mortgagor to maintain all such insurance and, upon such Mortgagor's failure to do so, authorizes the holder of the Mortgage to maintain such insurance at the Mortgagor's cost and expense and to seek reimbursement therefor from such Mortgagor. Other than as set forth in paragraph 17(h) hereof, each Mortgage provides that casualty insurance proceeds will be applied either to the restoration or repair of the related Mortgaged Property or to the reduction or defeasance of the principal amount of the Purchased Loan. 15. Taxes and Assessments. There are no delinquent or unpaid taxes or assessments (including assessments payable in future installments), or other outstanding charges affecting any Mortgaged Property which are or may become a lien of priority equal to or higher than the lien of the related Mortgage. For purposes of this representation and warranty, real property taxes and assessments shall not be considered unpaid until the date on which interest and/or penalties would be first payable thereon. 16. Mortgagor Bankruptcy. To Seller's actual knowledge, no Mortgagor is a debtor in any state or federal bankruptcy or insolvency proceeding. 17. Leasehold Estate. Each Mortgaged Property consists of the related Mortgagor's fee simple estate in real estate or, if the related Purchased Loan is secured in whole or in part by the interest of a Mortgagor as a lessee under a ground lease of a Mortgaged Property (a "Ground Lease"), by the related Mortgagor's interest in the Ground Lease but not by the related fee interest in such Mortgaged Property (the "Fee Interest"). With respect to any Purchased Loan secured by a Ground Lease but not by the related Fee Interest: a. Such Ground Lease or a memorandum thereof has been duly recorded; such Ground Lease (or the related estoppel letter or lender protection agreement between the Seller and related lessor) permits the current use of the Mortgaged Property and permits the interest of the lessee thereunder to be encumbered by the related Mortgage and does not restrict the use of the related Mortgaged Property by such lessee, its successors or assigns in a manner that would adversely effect the security provided by the related Mortgage by limiting in any way its current use; and there has been no material change in the payment terms of such Ground Lease since the origination or acquisition of the related Purchased Loan, with the exception of material changes reflected in written instruments that are a part of the related Mortgage File; b. The lessee's interest in such Ground Lease is not subject to any liens or encumbrances superior to, or of equal priority with, the related Mortgage, other than Permitted Encumbrances; c. The Mortgagor's interest in such Ground Lease is assignable to the Buyer and its successors and assigns upon notice to, but without the consent of, the lessor thereunder (or, if such consent is required, it has been obtained prior to the Purchase Date) and, in the event that it is so assigned, is further assignable by the Buyer and its successors and assigns upon notice to, but without the need to obtain the consent of, such lessor; d. Such Ground Lease is in full force and effect, and the Seller has received no notice that an event of default has occurred thereunder, and, to the Seller's knowledge, there exists no condition that, but for the passage of time or the giving of notice, or both, would result in an event of default under the terms of such Ground Lease; e. Such Ground Lease, or an estoppel letter or other agreement, (A) requires the lessor under such Ground Lease to give notice of any default by the lessee to the mortgagee, provided that the mortgagee has provided the lessor with notice of its lien in accordance with the provisions of such Ground Lease to the extent such Ground Lease requires such notice, (B) further provides that no notice of termination given under such Ground Lease (including rejection of such Ground Lease in a bankruptcy proceeding) is effective against the holder of the Mortgage unless a copy of such notice has been delivered to such holder and the lessor has offered to enter into a new lease with such holder on terms that do not materially vary from the economic terms of the Ground Lease; f. A mortgagee is permitted a reasonable opportunity (including, where necessary, sufficient time to gain possession of the interest of the lessee under such Ground Lease) to cure any default under such Ground Lease, which is curable after the receipt of notice of any such default, before the lessor thereunder may terminate such Ground Lease; g. Such Ground Lease has an original term (including any extension options set forth therein) which extends not less than twenty years beyond the stated maturity date of the related Purchased Loan; h. Under the terms of such Ground Lease and the related Mortgage, taken together, any related insurance proceeds or condemnation award other than in respect of a total loss will be applied either to the repair or restoration of all or part of the related Mortgaged Property, with the mortgagee or a Buyer appointed by it having the right to hold and disburse such proceeds as the repair or restoration progresses (except in such cases where a provision entitling another party to hold and disburse such proceeds would not be viewed as commercially unreasonable by a prudent commercial mortgage lender for conduit programs), or to the payment or defeasance of the outstanding principal balance of the Purchased Loan together with any accrued interest thereon; i. Such Ground Lease does not impose any restrictions on subletting which would be viewed as commercially unreasonable by prudent commercial mortgage lenders in the lending area where the Mortgaged Property is located; and j. Such Ground Lease provides, or the lessor has otherwise agreed, that such Ground Lease may not be amended or modified without the prior written consent of the mortgagee under such Purchased Loan. 18. Escrow Deposits. All escrow deposits and payments relating to each Purchased Loan that are, as of the Purchase Date required to be deposited or paid have been so deposited or paid. 19. LTV Ratio. The gross proceeds of each Purchased Loan to the related Mortgagor at origination did not exceed the non-contingent principal amount of the Purchased Loan and either: (a) such Purchased Loan is secured by an interest in real property having a fair market value (i) at the date the Purchased Loan was originated at least equal to 80 percent of the original principal balance of the Purchased Loan or (ii) at the Purchase Date at least equal to 80 percent of the principal balance of the Purchased Loan on such date; provided that for purposes hereof, the fair market value of the real property interest must first be reduced by (x) the amount of any lien on the real property interest that is senior to the Purchased Loan and (y) a proportionate amount of any lien that is in parity with the Purchased Loan (unless such other lien secures a Purchased Loan that is cross-collateralized with such Purchased Loan, in which event the computation described in clauses (a)(i) and (a)(ii) of this paragraph 19 shall be made on a pro rata basis in accordance with the fair market values of the Mortgaged Properties securing such cross-collateralized Purchased Loans; or (b) substantially all the proceeds of such Purchased Loan were used to acquire, improve or protect the real property which served as the only security for such Purchased Loan (other than a recourse feature or other third party credit enhancement within the meaning of Treasury Regulations Section 1.860G-2(a)(1)(ii)). 20. Advancement of Funds by the Seller. The Seller has not and, to the Seller's actual knowledge, no other holder of a Purchased Loan has advanced funds or induced, solicited or knowingly received any advance of funds from a party other than the owner of the related Mortgaged Property, directly or indirectly, for the payment of any amount required by such Purchased Loan. 21. No Mechanics' Liens. As of the date of the Mortgage, and to the actual knowledge of the Seller as of the Purchase Date, each Mortgaged Property is free and clear of any and all mechanics' and materialmen's liens that are prior or equal to the lien of the related Mortgage, and no rights are outstanding that under law could give rise to any such lien that would be prior or equal to the lien of the related Mortgage except, in each case, for liens insured against by the Title Policy referred to herein or otherwise bonded. 22. Compliance with Usury Laws. Each Purchased Loan complied with, or is exempt from, all applicable usury laws in effect at its date of origination. 23. Cross-collateralization; Cross-default. No Purchased Loan is cross-collateralized or cross-defaulted with any loan other than one or more other Purchased Loans. 24. Releases of Mortgaged Property. Except as described in the next sentence, no Mortgage Note or Mortgage requires the mortgagee to release all or any material portion of the related Mortgaged Property from the lien of the related Mortgage except upon payment in full or defeasance of all amounts due under the related Purchased Loan. The Mortgages relating to those Purchased Loans identified on the Purchased Loan Schedule require the mortgagee to grant releases of portions of the related Mortgaged Properties upon (a) the satisfaction of certain legal and underwriting requirements and (b) except where the portion of the Mortgaged Property permitted to be released was not considered by the Seller to be material in the underwriting of the Purchased Loan, either (1) the payment of a release price set forth therein and prepayment consideration in connection therewith or (2) the partial defeasance of such Purchased Loan. No Purchased Loan permits the release or substitution of collateral if such release or substitution (a) would create a "significant modification" of such Purchased Loan within the meaning of Treas. Reg. ss.1.1001 3 or (b) would cause such Purchased Loan not to be a "qualified mortgage" within the meaning of Section 860G(a)(3) of the Code (without regard to clauses (A)(i) or (A)(ii) thereof). 25. No Equity Participation or Contingent Interest. No Purchased Loan contains any equity participation by the lender or provides for negative amortization or for any contingent or additional interest in the form of participation in the cash flow of the related Mortgaged Property. 26. No Material Default. To the Seller's knowledge, there exists no material default, breach, violation or event of acceleration (and no event which, with the passage of time or the giving of notice, or both, would constitute any of the foregoing) under the documents evidencing or securing the Purchased Loan, in any such case to the extent the same materially and adversely affects the value of the Purchased Loan and the related Mortgaged Property; provided, however, that this representation and warranty does not address or otherwise cover any default, breach, violation or event of acceleration that specifically pertains to any matter otherwise covered by any other representation and warranty made by the Seller in any of paragraphs 3, 7, 12, 14, 15 and 17 of this Exhibit VI. 27. Local Law Compliance. Based on due diligence considered reasonable by prudent commercial mortgage lenders in the lending area where each Mortgaged Property is located, the improvements located on or forming part of each Mortgaged Property complies with applicable zoning laws and ordinances, or constitutes a legal non-conforming use or structure or, if any such improvement does not so comply, such non-compliance does not materially and adversely affect the value of the related Mortgaged Property as determined by the appraisal performed at origination. 28. Junior Liens. None of the Purchased Loans permits the related Mortgaged Property to be encumbered by any lien junior to or of equal priority with the lien of the related Mortgage without the prior written consent of the holder thereof or the satisfaction of debt service coverage or similar criteria specified therein. To Seller's knowledge, none of the Mortgaged Properties is encumbered by any lien junior to the lien of the related Mortgage. Each Purchased Loan contains a "due on sale" clause that provides for the acceleration of the payment of the unpaid principal balance of the Purchased Loan if, without the prior written consent of the holder of the Purchased Loan, the related Mortgaged Property is transferred or sold. 29. Actions Concerning Purchased Loans. To the knowledge of the Seller, there are no actions, suits or proceedings pending or threatened before any court, administrative agency or arbitrator concerning any Purchased Loan or related Mortgagor or Mortgaged Property that might adversely affect title to the Purchased Loan or the validity or enforceability of the related Mortgage or that might materially and adversely affect the value of the Mortgaged Property as security for the Purchased Loan or the use for which the premises were intended. 30. Servicing. The servicing and collection practices used by the Seller have been in all material respects legal, proper and prudent and have met customary industry standards for servicing of commercial Purchased Loans similar to the Purchased Loans in question. 31. Licenses and Permits. To the Seller's knowledge, as of the date of origination of each Purchased Loan, the related Mortgagor was in possession of all material licenses, permits and franchises required by applicable law for the ownership and operation of the related Mortgaged Property as it was then operated. 32. Assisted Living Facility Regulation. If any Mortgaged Property is operated as an assisted living facility, to the Seller's knowledge, (a) the related Mortgagor and operator, if different, is in compliance in all material respects with all federal and state laws applicable to the use and operation of the related Mortgaged Property and (b) if the operator of the Mortgaged Property participates in Medicare or Medicaid programs, the facility is in compliance in all material respects with the requirements for participation in such programs. 33. Non-Recourse Exceptions. The Purchased Loan Documents for each Purchased Loan provide that such Purchased Loan constitutes the non-recourse obligations of the related obligor thereon except that either (i) such provision does not apply in the case of fraud by the Mortgagor or (ii) such documents provide that the Mortgagor shall be liable to the holder of the Purchased Loan for losses incurred as a result of fraud by the Mortgagor. 34. Single Purpose Entity. The Mortgagor on each Purchased Loan with an outstanding principal balance in excess of $5,000,000, was, as of the origination of the Purchased Loan, a Single Purpose Entity. For this purpose, a "Single Purpose Entity" shall mean an entity, other than an individual, whose organizational documents provide substantially to the effect that it was formed or organized solely for the purpose of owning and operating one or more Mortgaged Properties securing the Purchased Loans and prohibit it from engaging in any business unrelated to such Mortgaged Property or Properties, and whose organizational documents further provide, or which entity represented in the related Purchased Loan documents, substantially to the effect that it does not have any assets other than those related to its interest in and operation of such Mortgaged Property or Properties, or any indebtedness other than as permitted by the related Mortgage or the other related Purchased Loan documents, that it has its own books and records and accounts separate and apart from any other person, and that it holds itself out as a legal entity, separate and apart from any other person. Each borrower of a Purchased Loan in excess of $10,000,000 is an entity which has represented in connection with the origination of the Purchased Loan, or whose organizational documents as of the date of origination of the Purchased Loan, provided that so long as the Purchased Loan is outstanding it will have at least one independent director, manager or executive committee member. 35. Separate Tax Parcels. To Seller's actual knowledge, each Mortgaged Property constitutes one or more complete separate tax lots or is subject to an endorsement under the related title insurance policy. 36. Operating or Financial Statement. The related Purchased Loan Documents require the related borrower to furnish to the mortgagee at least annually an operating statement with respect to the related Mortgaged Property. 37. Purchased Loan Modifications. Any Purchased Loan that was "significantly modified" prior to the Purchase Date so as to result in a taxable exchange under Section 1001 of the Code either (a) was modified as a result of the default or reasonably foreseeable default of such Purchased Loan or (b) satisfies the provisions of either clause (a)(i) of paragraph 19 (substituting the date of the last such modification for the date the Purchased Loan was originated) or clause (a)(ii) of paragraph 19, including the proviso thereto. 38. Inspections. The Seller (or if the Seller is not the originator, the originator of the Purchased Loan) has inspected or caused to be inspected each Mortgaged Property in connection with the origination of the related Purchased Loan. 39. Defeasance. Each Purchased Loan containing provisions for defeasance of mortgage collateral either (i) requires the prior written consent of, and compliance with the conditions set by, the holder of the Purchased Loan, or (ii) requires that (A) defeasance may not occur prior to the time permitted by applicable "real estate mortgage investment conduit" rules and regulations (if applicable), (B) the replacement collateral consist of U.S. governmental securities in an amount sufficient to make all scheduled payments under the Mortgage Note when due, (C) independent public accountants certify that the collateral is sufficient to make such payments, (D) counsel provide an opinion that the Buyer has a perfected security interest in such collateral prior to any other claim or interest, and (E) all costs and expenses arising from the defeasance of the mortgage collateral shall be borne by the borrower. REPRESENTATIONS AND WARRANTIES REGARDING EACH INDIVIDUAL PURCHASED LOAN NOT SECURED BY A MORTGAGE WHICH IS A MEZZANINE LOAN SECURED BY A PLEDGE OF THE ENTIRE EQUITY OWNERSHIP INTEREST OR A PREFERRED EQUITY OWNERSHIP INTEREST, IN EACH CASE, IN AN ENTITY THAT OWNS A MULTIFAMILY OR COMMERCIAL PROPERTY With respect to each Purchased Loan of the type described in clauses (iii)(b) and (iv)(b) of the definition of Eligible Loan (except a loan secured by a second lien on multifamily or commercial property, which is described in Representations and Warranties Regarding Each Individual Purchased Loan Secured by a Mortgage set forth in this Exhibit VI), the Seller represents and warrants on each Purchase Date as follows, other than as set forth on the exception report provided to Buyer in accordance with the Agreement: (1) Purchased Loan Information. The information set forth in the Purchased Loan Schedule is complete, true and correct in all material respects. (2) No Default or Dispute Under Purchased Loan Documents. To the Seller's knowledge, there exists no material default, breach, violation or event of acceleration (and no event which, with the passage of time or the giving of notice, or both, would constitute any of the foregoing) under the documents evidencing or securing the Purchased Loan, in any such case to the extent the same materially and adversely affects the value of the Purchased Loan and the related underlying real property. (3) No Offsets, Defenses or Counterclaims. There is no valid offset, defense or counterclaim to such Purchased Loan. (4) Equity Pledges. With respect to each Purchased Loan which is a Mezzanine Loan only, the pledge of ownership interests securing such Purchased Loan relates to all direct or indirect equity or ownership interests in the underlying real property owner (so that, except for the equity interests pledged to Seller, there are no direct or indirect equity or ownership interests in underlying real property owner or in any constituent entity) and has been fully perfected in favor of Seller as mezzanine lender. (5) Lockbox. The lockbox administrator, if any, is not an Affiliate of Seller. (6) Enforceability. The Purchased Loan Documents have been duly and properly executed by the parties thereto, and each is the legal, valid and binding obligation of the parties thereto, enforceable in accordance with its terms, except as such enforcement may be limited by bankruptcy, insolvency, reorganization, receivership, moratorium or other laws relating to or affecting the rights of creditors generally and by general principles of equity (regardless of whether such enforcement is considered in a proceeding in equity or at law). The Purchased Loan is not usurious. Seller has fully and validly perfected all security interests created or intended to be created pursuant to the Purchased Loan Documents. (7) Waivers and Modifications. The terms of the related Purchased Loan Documents have not been impaired, waived, altered or modified in any material respect (other than by a written instrument which is included in the related Purchased Loan File). (8) Valid Assignment. The assignment of Purchased Loan constitutes the legal, valid and binding assignment of such Purchased Loan from Seller to or for the benefit of Buyer. No consent or approval by any third party is required for any such assignment of such Purchased Loan, for Buyer's exercise of any rights or remedies under the assignment of Purchased Loan, or for Buyer's sale or other disposition of such Purchased Loan if Buyer acquires title thereto, other than consents and approvals which have been obtained. No third party (including underlying real property owner and underlying real property mortgagee) holds any "right of first refusal," "right of first negotiation," "right of first offer," purchase option, or other similar rights of any kind on account of the occurrence of any of the foregoing. No other impediment exists to any such transfer. (9) Certain Representations and Warranties. To the Seller's actual knowledge, all representations and warranties in the Purchased Loan Documents and in the underlying real property mortgage documents are true and correct in all material respects. (10) Parties Authorized. To the extent required under applicable law as of the Purchase Date, each party to the Purchased Loan Documents was authorized to do business in the jurisdiction in which the related underlying real property is located at all times when it held the Purchased Loan to the extent necessary to ensure the validity and enforceability of such Purchased Loan. (11) No Advances of Funds. No party to the Purchased Loan Documents has advanced funds on account of any default under the Purchased Loan or under the underlying real property mortgage documents. (12) Servicing. The servicing and collection practices used by Seller for the Purchased Loan have complied with applicable law in all material respects and are consistent with those employed by prudent servicers of comparable Purchased Loans. (13) No Assignment. Seller has not effectuated any transfer, sale, assignment, hypothecation, or other conveyance of any of its rights and obligations under any Purchased Loan Document, except in connection with the Agreement. (14) No Bankruptcy. To Seller's actual knowledge, none of the following parties is a debtor in any state or federal bankruptcy or insolvency proceeding: Seller; underlying real property owner; or underlying real property mortgagee. REPRESENTATIONS AND WARRANTIES REGARDING EACH INDIVIDUAL PURCHASED LOAN WHICH IS A JUNIOR PARTICIPATION INTEREST (OR JUNIOR OR "B" NOTE) IN A PERFORMING COMMERCIAL MORTGAGE LOAN SECURED BY A FIRST LIEN ON A MULTIFAMILY OR COMMERCIAL PROPERTY ------------------------------------ With respect to each Purchased Loan of the type described in clauses (iii)(a) or (iv)(a) of the definition of Eligible Loan, the Seller represents and warrants on each Purchase Date as follows, other than as set forth on the exception report provided to Buyer in accordance with the Agreement. (1) Purchased Loan Information. The information set forth in the Purchased Loan Schedule is complete, true and correct in all material respects. (2) No Default or Dispute Under Purchased Loan Documents. There exists no material default, breach, violation or event of acceleration (and no event which, with the passage of time or the giving of notice, or both, would constitute any of the foregoing) under the documents evidencing or securing the Purchased Loan, in any such case to the extent the same materially and adversely affects the value of the Purchased Loan and the related underlying real property. (3) No Offsets, Defenses or Counterclaims. There is no valid offset, defense or counterclaim to such Purchased Loan. (4) Lockbox. The lockbox administrator, if any, is not an Affiliate of Seller. (5) Enforceability. The Purchased Loan Documents have been duly and properly executed by the parties thereto, and each is the legal, valid and binding obligation of the parties thereto, enforceable in accordance with its terms, except as such enforcement may be limited by bankruptcy, insolvency, reorganization, receivership, moratorium or other laws relating to or affecting the rights of creditors generally and by general principles of equity (regardless of whether such enforcement is considered in a proceeding in equity or at law). The Purchased Loan is not usurious. Seller has fully and validly perfected all security interests created or intended to be created pursuant to the Purchased Loan Documents. (6) Waivers and Modifications. The terms of the related Purchased Loan Documents have not been impaired, waived, altered or modified in any material respect (other than by a written instrument which is included in the related Purchased Loan File). (7) Valid Assignment. The assignment of Purchased Loan constitutes the legal, valid and binding assignment of such Purchased Loan from Seller to or for the benefit of Buyer. No consent or approval by any third party is required for any such assignment of such Purchased Loan, for Buyer's exercise of any rights or remedies under the assignment of Purchased Loan, or for Buyer's sale or other disposition of such Purchased Loan if Buyer acquires title thereto, other than consents and approvals which have been obtained. No third party (including underlying real property owner and underlying real property mortgagee) holds any "right of first refusal," "right of first negotiation," "right of first offer," purchase option, or other similar rights of any kind on account of the occurrence of any of the foregoing. No other material impediment exists to any such transfer. (8) Certain Representations and Warranties. To the Seller's knowledge, all representations and warranties in the Purchased Loan Documents and in the underlying documents for the performing commercial mortgage loan secured by a first lien on a multifamily or commercial property to which such Purchased Loan relates are true and correct in all material respects. (9) Parties Authorized. To the extent required under applicable law as of the Purchase Date, each party to the Purchased Loan Documents was authorized to do business in the jurisdiction in which the related underlying real property is located at all times when it held the Purchased Loan to the extent necessary to ensure the validity and enforceability of such Purchased Loan. (10) No Advances of Funds. No party to the Purchased Loan Documents has advanced funds on account of any default under the Purchased Loan or under the underlying real property mortgage documents. (11) Servicing. The servicing and collection practices used by Seller for the Purchased Loan have complied with applicable law in all material respects and are consistent with those employed by prudent servicers of comparable Purchased Loans. (12) No Assignment. Seller has not effectuated any transfer, sale, assignment, hypothecation, or other conveyance of any of its rights and obligations under any Purchased Loan Document, except in connection with the Agreement. (13) No Bankruptcy. To Seller's actual knowledge, none of the following parties is a debtor in any state or federal bankruptcy or insolvency proceeding: Seller; underlying real property owner; or underlying real property mortgagee. EXHIBIT VII COLLATERAL INFORMATION ---------------------- Loan ID #: Borrower Name: Borrower Address: Borrower City: Borrower State: Borrower Zip Code: Recourse? Guaranteed? Related Borrower Name(s): Original Principal Balance: Note Date: Loan Date: Loan Type (e.g. fixed/arm): Current Principal Balance: Current Interest Rate (per annum): Paid to date: Annual P&I: Next Payment due date: Index (complete whether fixed or arm): Gross Spread/Margin (complete whether fixed or arm): Life Cap: Life Floor: Periodic Cap: Periodic Floor: Rounding Factor: Lookback (in days): Interest Calculation Method (e.g., Actual/360): Interest rate adjustment frequency: P&I payment frequency: First P&I payment due: First interest rate adjustment date: First payment adjustment date: Next interest rate adjustment date: Next payment adjustment date: Conversion Date: Converted Interest Rate Index: Converted Interest Rate Spread: Maturity date: Loan term: Amortization term: Hyper-Amortization Flag: Hyper-Amortization Term: Hyper-Amortization Rate Increase: Balloon Amount: Balloon LTV: Prepayment Penalty Flag: Prepayment Penalty Text: Lockout Period: Lien Position: Fee/Leasehold: Ground Lease Expiration Date: Property Name: Property Address: Property City: Property Zip Code: Property Type (General): Property Type (Specific): Cross-collateralized (Yes/No)*: Property Size: Year built: Year renovated: Actual Average Occupancy: Occupancy Rent Roll Date: Underwritten Average Occupancy: Largest Tenant: Largest Tenant SF: Largest Tenant Lease Expiration: 2nd Largest Tenant: 2nd Largest Tenant SF: 2nd Largest Tenant Lease Expiration: 3rd Largest Tenant: 3rd Largest Tenant SF: 3rd Largest Tenant Lease Expiration: Underwritten Average Rental Rate/ADR: Underwritten Vacancy/Credit Loss: Underwritten Other Income: Underwritten Total Revenues: Underwritten Replacement Reserves: Underwritten Management Fees: Underwritten Franchise Fees: Underwritten Total Expenses: Underwritten Leasing Commissions: Underwritten Tenant Improvement Costs: Underwritten NOI: Underwritten NCF: Underwritten Debt Service Constant: Underwritten DSCR at NOI: Underwritten DSCR at NCF: Underwritten NOI Period End Date: Hotel Franchise: Hotel Franchise Expiration Date: Appraiser Name: (if Applicable) Appraised Value: (if Applicable) Appraisal Date: (if Applicable) Appraisal Cap Rate: (if Applicable) Appraisal Discount Rate: (if Applicable) Underwritten LTV: Environmental Report Preparer: Environmental Report Date: Environmental Report Issues: Architectural and Engineering Report Preparer: Architectural and Engineering Report Date: Deferred Maintenance Amount: Ongoing Replacement Reserve Requirement per A&E Report: Immediate Repairs Escrow % (e.g. 125%): Replacement Reserve Annual Deposit: Replacement Reserve Balance: Tenant Improvement/Leasing Commission Annual Deposits: Tenant Improvement/Leasing Commission Balance: Taxes paid through date: Monthly Tax Escrow: Tax Escrow Balance: Insurance paid through date: Monthly Insurance Escrow: Insurance Escrow Balance: Reserve/Escrow Balance as of Date: Probable Maximum Loss %: Covered by Earthquake Insurance (Yes/No): Number of times 30 days late in last 12 months: Number of times 60 days late in last 12 months: Number of times 90 days late in last 12 months: Servicing Fee: Notes: _____________________ * If yes, give property information on each property covered and in aggregate as appropriate. Loan ID' EXHIBIT VIII ADVANCE PROCEDURE ----------------- Final Approval of New Collateral Which is an Eligible Security/Preliminary Approval of New Collateral Which is an Eligible Loan. (a) Seller may, from time to time, submit to Buyer a Preliminary Due Diligence Package for Buyer's review and approval in order to enter into a Transaction with respect to any New Collateral that Seller proposes to be included as Collateral under the Agreement. (b) Upon Buyer's receipt of a complete Preliminary Due Diligence Package, Buyer, within two (2) Business Days, shall have the right to request, in Buyer's good faith business judgment, additional diligence materials and deliveries that Buyer shall specify on a Supplemental Due Diligence List. Upon Buyer's receipt of all of the Diligence Materials or Buyer's waiver thereof, Buyer, within two (2) Business Days (in the case of an Eligible Security) or five (5) Business Days and following receipt of internal credit approval (in the case of an Eligible Loan), shall either (i) notify Seller of the Purchase Price and the Market Value for the New Collateral or (ii) deny, in Buyer's sole and absolute discretion, Seller's request for a Transaction. Buyer's failure to respond to Seller within two (2) or five (5) Business Days, as applicable, shall be deemed to be a denial of Seller's request for an Advance, unless Buyer and Seller have agreed otherwise in writing. With respect to a Transaction involving an Eligible Loan or Eligible Security to be purchased by Buyer in a currency other than United States Dollars, Seller shall give Buyer irrevocable notice of sale of such Eligible Loan or Eligible Security at least one (1) Business Day in advance of the related Purchase Date as set forth in Section 3(a) of Annex I. Final Approval of New Collateral which is an Eligible Loan. Upon Buyer's notification to Seller of the Purchase Price and the Market Value for any New Collateral which is an Eligible Loan, Seller shall, if Seller desires to enter into a Transaction with respect to such New Collateral, satisfy the conditions set forth below (in addition to satisfying the Transaction Conditions Precedent to obtaining each advance) as a condition precedent to Buyer's approval of such New Collateral as Collateral, all in a manner reasonably satisfactory to Buyer and pursuant to documentation reasonably satisfactory to Buyer: (a) Delivery of Purchased Loan Documents. Seller shall deliver to Buyer: (i) with respect to New Collateral that is Pre-Existing Collateral, each of the Purchased Loan Documents, except Purchased Loan Documents that Seller expressly and specifically disclosed in Seller's Preliminary Due Diligence Package were not in Seller's possession; and (ii) with respect to New Collateral that is Originated Collateral, each of the Purchased Loan Documents. (b) Environmental and Engineering. Buyer shall have received a "Phase 1" (and, if necessary, "Phase 2") environmental report, an asbestos survey, if applicable, and an engineering report, each in form reasonably satisfactory to Buyer, by an engineer or environmental consultant reasonably approved by Buyer. (c) Appraisal. Buyer shall have received either an appraisal approved by Buyer (or a Draft Appraisal), each by an MAI appraiser or (in relation to an English Loan) a valuation by a suitably qualified valuer on the basis of the then current Statements of Asset Valuation Practice and Guidance Notes issued by the Royal Institution of Chartered Surveyors. If Buyer receives only a Draft Appraisal prior to entering into a Transaction, Seller shall deliver an appraisal approved by Buyer by an MAI appraiser or (in relation to an English Loan) a valuation by a suitably qualified valuer on the basis of the then current Statements of Asset Valuation Practice and Guidance Notes issued by the Royal Institution of Chartered Surveyors on or before thirty (30) days after the Purchase Date. (d) Insurance. Buyer shall have received certificates or other evidence of insurance demonstrating insurance coverage in respect of the Mortgaged Property of types, in amounts, with insurers and otherwise in compliance with the terms, provisions and conditions set forth in the Purchased Loan Documents. Such certificates or other evidence shall indicate that Seller will be named as an additional insured as its interest may appear and shall contain a loss payee endorsement in favor of such additional insured with respect to the policies required to be maintained under the Purchased Loan Documents. (e) Survey. Buyer shall have received all surveys of the Mortgaged Property that are in Seller's possession. (f) Lien Search Reports. Buyer or Buyer's counsel shall have received, as reasonably requested by Buyer, satisfactory reports of UCC, tax lien, judgment and litigation searches and title updates conducted by search firms and/or title companies acceptable to Buyer with respect to the Eligible Loan, Mortgaged Property, Seller and Mortgagor, such searches to be conducted in each location Buyer shall reasonably designate or (in relation to an English Loan) office copy entries of each title to a Mortgaged Property which are not less than 6 months old (where the relevant property is registered at HM Land Registry) or relevant Land Charges Searches (where the relevant property is not registered at HM Land Registry). (g) Opinions of Counsel. Buyer shall have received copies of all legal opinions in the Seller's possession with respect to the Eligible Loan which shall be in form and substance reasonably satisfactory to Buyer. (h) Additional Real Estate Matters. Seller shall have delivered to Buyer to the extent in Seller's possession such other real estate related certificates and documentation as may have been requested by Buyer, such as: (i) certificates of occupancy issued by the appropriate Governmental Authority and either letters certifying that the Mortgaged Property is in compliance with all applicable zoning laws issued by the appropriate Governmental Authority or evidence that the related Title Policy includes a zoning endorsement and (ii) abstracts of all leases in effect at the Mortgaged Property and estoppel certificates, in form and substance acceptable to Buyer, from any ground lessor and from any tenant that occupies 7.5% or more of the rentable space at the Mortgaged Property, and in any event from tenants whose occupancies aggregate not less than 70% of the occupied rentable square footage at the Mortgaged Property. (i) Other Documents. Buyer shall have received such other documents as Buyer or its counsel shall reasonably deem necessary. Within two (2) Business Days of Seller's satisfaction of all of the conditions enumerated in clauses (a) through (i) above, Buyer shall either (i) if the Purchased Loan Documents with respect to the New Collateral are not reasonably satisfactory in form and substance to Buyer, notify Seller that Buyer has not approved the New Collateral as Collateral or (ii) notify Seller that Buyer has approved the New Collateral as Collateral. Buyer's failure to respond to Seller within two (2) Business Days shall be deemed to be a denial of Seller's request that Buyer approve the New Collateral, unless Buyer and Seller have agreed otherwise in writing. EXHIBIT IX FORM OF REDIRECTION LETTER -------------------------- [Letterhead of Seller] [__________], 2004 [Borrower Name] [Address] Re: [__________] To Whom It May Concern: [__________] has transferred all of its interest in the Loan to Anthracite Funding, LLC, ("Anthracite"), and, accordingly, Anthracite is now your lender with regard to the Loan. All notices, demands and requests to be given to the lender under the documents evidencing, securing and/or governing the Loan shall be sent to the following address (until such address for notice is changed in accordance with the Loan documents): Anthracite Funding, LLC 40 East 52nd Street New York, New York 10022 Attn: Richard Shea with a copy to: [ ] All payments to be made to Anthracite under the Loan shall be made by wire transfer in accordance with the following instructions: [__________] ABA No. [__________] Account No. [__________] Account Name: Anthracite Funding, LLC subject to the security interest of Deutsche Bank AG, Cayman Islands Branch Reference: [__________] Please feel free to call [_________] at (___) [___-____] should you have any questions or concerns. Thank you. [__________], a [__________] corporation By: Its: ANTHRACITE FUNDING, LLC, a Delaware limited liability company By: Anthracite Capital, Inc., a Maryland corporation, its sole member By: _________________________ Name: _______________________ Title: ______________________ EX-21 4 anthra_ex21-1.txt EX 21.1 Exhibit 21.1 ------------ List of Subsidiaries Subsidiary Jurisdiction of Organization Newpa/AHR Equity, LP Delaware Newpa/AHR GP, LLC Delaware Newpa/AHA Equity GP LLC Delaware Newpa/AHA Equity GP LLC Delaware 1940 Monroe Street LLC Delaware Anthracite Funding ML LLC Delaware Anthracite Funding, LLC Delaware Anthracite CDO Depositor, LLC Delaware Anthracite CDO I Ltd. Cayman Anthracite CDO I Corp. Delaware Anthracite CDO II Depositor, LLC Delaware Anthracite CDO II Ltd. Cayman Anthracite CDO II Corp. Delaware Anthracite CDO III Depositor, LLC Delaware Anthracite CDO III Ltd. Cayman Anthracite CDO III Corp. Delaware LB-UBS Commercial Mortgage Trust 2004-C2 Delaware Anthracite 2004-HY1 Depositor, LLC Delaware Anthracite 2004-HY1 Ltd. Cayman Anthracite 2004-HY1 Corp. Delaware AHR Capital Limited Ireland EX-23 5 anthra_ex23-1.txt EX 23.1 Exhibit 23.1 ------------ CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We consent to the incorporation by reference in Registration Statements No. 333-32166, 333-69848, and 333-69400 of Anthracite Capital, Inc. on Form S-3, of our reports dated March 14, 2005, appearing in this Annual Report on Form 10-K of Anthracite Capital, Inc. for the year ended December 31, 2004. /s/ Deloitte & Touche LLP New York, New York March 14, 2005 EX-31 6 anthra_ex31-1.txt EX 31.1 Exhibit 31.1 ------------ CERTIFICATION OF CHIEF EXECUTIVE OFFICER I, Christopher A. Milner, certify that: 1. I have reviewed this annual report on Form 10-K of Anthracite Capital, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: March 16, 2005 /s/ Christopher A. Milner ---------------------------------------- Name: Christopher A. Milner Title: Chief Executive Officer EX-31 7 anthra_ex31-2.txt EX 31.2 Exhibit 31.2 ------------ CERTIFICATION OF CHIEF FINANCIAL OFFICER I, James J. Lillis, certify that: 1. I have reviewed this annual report on Form 10-K of Anthracite Capital, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: March 16, 2005 /s/ James J. Lillis ------------------------------------------- Name: James J. Lillis Title: Chief Financial Officer EX-32 8 anthra_ex32.txt EX 32 Exhibit 32 ---------- Certification of CEO and CFO Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 In connection with the Annual Report on Form 10-K of Anthracite Capital, Inc. (the "Company") for the year ending December 31, 2004 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), Christopher A. Milner, as Chief Executive Officer of the Company, and James J. Lillis, as Chief Financial Officer of the Company, each hereby certifies, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that, to the best of his knowledge: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Christopher A. Milner - -------------------------------- Name: Christopher A. Milner Title: Chief Executive Officer Date: March 16, 2005 /s/ James J. Lillis - --------------------------------- Name: James J. Lillis Title: Chief Financial Officer Date: March 16, 2005 -----END PRIVACY-ENHANCED MESSAGE-----