**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

**x****QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE**

**SECURITIES EXCHANGE ACT OF 1934**

 

For the Quarterly Period Ended June 30, 2007

 

Commission File Number 000-25193

 

**CAPITAL CROSSING PREFERRED CORPORATION**

(Exact name of registrant as specified in its charter)

 

**Massachusetts**

(State or other jurisdiction of incorporation or organization)

 

**04-3439366**

(I.R.S. Employer Identification Number)

 

**101 Summer Street, Boston, Massachusetts**

(Address of principal executive offices)

 

**02110**

(Zip Code)

 

**(617) 880-1000**

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Large Accelerated Filer o  Accelerated Filer o  Non-Accelerated Filer x

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o  No x

 

Indicate the number of shares outstanding of the issuer’s common stock, $.01 par value per share, as of August 13, 2007: 100.

No common stock was held by non-affiliates of the issuer.

 

 

 

 

 

**Capital Crossing Preferred Corporation**

**Table of Contents**

 

**PART I – Financial Information**

 

 
|                                                                                                                                                            | Page   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| Item 1.  Financial Statements (unaudited):                                                                                                  |   |
|                                                                                                                                                            |   |
| Balance Sheets                                                                                                                                             | 1      |
|                                                                                                                                                            |   |
| Statements of Income                                                                                                                                  | 2      |
|                                                                                                                                                            |   |
| Statements of Changes in Stockholders’ Equity                                                                                     | 3      |
|                                                                                                                                                            |   |
| Statements of Cash Flows                                                                                                                         | 4      |
|                                                                                                                                                            |   |
| Notes to Financial Statements                                                                                                                    | 5      |
|                                                                                                                                                            |   |
| Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations | 6      |
|                                                                                                                                                            |   |
| Executive Level Overview                                                                                                                              | 6      |
|                                                                                                                                                            |   |
| Application of Critical Accounting Policies and Estimates                                                                         | 7      |
|                                                                                                                                                            |   |
| Results of Operations                                                                                                                                 | 9      |
|                                                                                                                                                            |   |
| Changes in Financial Conditions                                                                                                                  | 12     |
|                                                                                                                                                            |   |
| Interest Rate Risk                                                                                                                                    | 14     |
|                                                                                                                                                            |   |
| Significant Concentration of Credit Risk                                                                                                    | 14     |
|                                                                                                                                                            |   |
| Liquidity Risk Management                                                                                                                             | 15     |
|                                                                                                                                                            |   |
| Impact of Inflation and Changing Prices                                                                                                | 15     |
|                                                                                                                                                            |   |
| Item 3.  Quantitative and Qualitative Disclosures about Market Risk                                                     | 15     |
|                                                                                                                                                            |   |
| Item 4.  Controls and Procedures                                                                                                            | 16     |
|                                                                                                                                                            |   |
| **PART** **II** – **Other** **Information**                                                                                            |   |
|                                                                                                                                                            |   |
| Item 1A. Risk Factors                                                                                                                                 | 16     |
|                                                                                                                                                            |   |
| Item 6.  Exhibits                                                                                                                                     | 16     |
|                                                                                                                                                            |   |
| Signatures                                                                                                                                                      | 17     |
|                                                                                                                                                            |   |
| Exhibit Index                                                                                                                                              | 18     |

 

 

 

 

 

**PART I**

 

**Item 1. Financial Statements**

**Capital Crossing Preferred Corporation**

**Balance Sheets**

**(unaudited)**

 
|                                                                                                                 | **June 30,**                                                                                                                            |   | **December 31,**                                                                                                                            |
|----------------------------------------------------------------------------------------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                 | **2007**                                                                                                                                |   | **2006**                                                                                                                                    |
|                                                                                                                 | **(in thousands)**                                                                                                                      |
| **ASSETS**                                                                                                           |
|                                                                                                                 |
| Cash account with parent                                                                              | $                   206                  |   |  $                 203                            |
| Interest bearing deposits with parent                                                            | 63,879                                                                                                                                  |   |              83,697                                                        |
| Total cash and cash equivalents                                                                  | 64,085                                                                                                                                  |   |              83,900                                                        |
| Certificate of deposit                                                                                     | 200                                                                                                                                     |   |                   200                             |
| Loans, net of discounts and net deferred loan income                         | 79,760                                                                                                                                  |   |            90,910                                                                    |
| Less allowance for loan losses                                                                   | (1,320)                                                                                                                                 |   |             (1,519)                                                             |
| Loans, net                                                                                                 | 78,440                                                                                                                                  |   |            89,391                                                                    |
| Accrued interest receivable                                                                                | 350                                                                                                                                     |   |                   412                             |
| Other assets                                                                                                    | 2                                                                                                                                       |   | -                                                                                                                                           |
|                                                                                                                 | $            143,077                                                        |   |  $          173,903                                                                  |
|                                                                                                                 |                                                                                                                                    |   |                                                                                                                                        |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                        |
|                                                                                                                 |                                                                                                                                    |   |                                                                                                                                        |
| Accrued expenses and other liabilities                                                           | $                   929                  |   | $               1,216                                            |
| Total liabilities                                                                                               |                       929 |   | 1,216                                                                                                                                       |
| Stockholders’ equity:                                                                                      |                                                                                                                                    |   |                                                                                                                                        |
| Preferred stock, Series A, 9.75% non-cumulative,                                            |                                                                                                                                    |   |                                                                                                                                        |
| exchangeable; $.01 par value; $10 liquidation value                                    |                                                                                                                                    |   |                                                                                                                                        |
| per share; 1,449,000 shares authorized, 1,416,130 shares                          |                                                                                                                                    |   |                                                                                                                                        |
| issued and outstanding at December 31, 2006                                            | -                                                                                                                                       |   |               14                                                      |
| Preferred stock, Series B, 8% cumulative, non-convertible;                        |                                                                                                                                    |   |                                                                                                                                        |
| $.01 par value; $1,000 liquidation value per share plus                 |                                                                                                                                    |   |                                                                                                                                        |
| accrued dividends; 1,000 shares authorized, 937 shares                                 |                                                                                                                                    |   |                                                                                                                                        |
| issued and outstanding                                                                                     | -                                                                                                                                       |   | -                                                                                                                                           |
| Preferred stock, Series C, 10.25% non-cumulative, exchangeable;                   |                                                                                                                                    |   |                                                                                                                                        |
| $.01 par value; $10 liquidation value per share; 1,840,000 shares  |                                                                                                                                    |   |                                                                                                                                        |
| authorized, 1,840,000 shares issued and outstanding at December         |                                                                                                                                    |   |                                                                                                                                        |
| 31, 2006                                                                                              | -                                                                                                                                       |   |                    18                        |
| Preferred stock, Series D, 8.50% non-cumulative, exchangeable;                    |                                                                                                                                    |   |                                                                                                                                        |
| $.01 par value; $25 liquidation value per share; 1,725,000 shares       |                                                                                                                                    |   |                                                                                                                                        |
| authorized, 1,500,000 shares issued and outstanding                                         | 15                                                                                                                                      |   | 15                                                                                                                                          |
| Common stock, $.01 par value, 100 shares authorized,                              |                                                                                                                                    |   |                                                                                                                                        |
| issued and outstanding                                                                                | -                                                                                                                                       |   |                       -       |
| Additional paid-in capital                                                                            | 140,111                                                                                                                                 |   |            172,640                                                                   |
| Retained earnings                                                                                               | 2,022                                                                                                                                   |   |                 -        |
| Total stockholders’ equity                                                                            | 142,148                                                                                                                                 |   |           172,687                                                                         |
|                                                                                                                 | $            143,077                                                        |   |  $          173,903                                                                  |
|                                                                                                                 |                                                                                                                                    |   |                                                                                                                                        |
|                                                                                                                      |                                                                                                                                         |        |                                                                                                                                             |  |

See accompanying notes to financial statements.

 

1

 

 

 
| **Capital Crossing Preferred Corporation**

**Statements of Income**

**(unaudited)**  |
|----------------------------------------------------------------------------------------|
|                                                                                   |   |   |   |
|                                                                                   | **Three** **Months** **Ended** |   | **Six** **Months** **Ended** |
|                                                                                   | **June** **30,** |   | **June** **30,** |
|                                                                                   | **2007** |   | **2006** |   | **2007** |   | **2006** |
|                                                                                   | **(in** **thousands)** |
| Interest income:                                                                  |   |   |   |   |   |   |   |
| Interest and fees on loans                                         | $          1,968 |   | $        2,333 |   | $          3,917 |   | $         4,665 |
| Interest on interest-bearing deposits                              | 162 |   | 264 |   | 393 |   | 510 |
| Total interest income                                                        | 2,130 |   | 2,597 |   | 4,310 |   | 5,175 |
| Credit for loan losses                                                  | 95 |   | 54 |   | 199 |   | 67 |
| Total interest income, after credit for loan losses | 2,225 |   | 2,651 |   | 4,509 |   | 5,242 |
| Other income:                                                                     |   |   |   |   |   |   |   |
| Gain on sales of loans                                             | - |   | 286 |   | - |   | 768 |
| Guarantee fee income                                                         | 10 |   | 20 |   | 30 |   | 40 |
| Total other income                                                           | 10 |   | 306 |   | 30 |   | 808 |
|                                                                                   |   |   |   |   |   |   |   |
| Operating expenses:                                                               |   |   |   |   |   |   |   |
| Loan servicing and advisory services                               | 14 |   | 76 |   | 76 |   | 156 |
| Other general and administrative                                        | 23 |   | 46 |   | 66 |   | 82 |
| Total operating expenses                                                | 37 |   | 122 |   | 142 |   | 238 |
| Net income                                                                        | 2,198 |   | 2,835 |   | 4,397 |   | 5,812 |
|                                                                                   |   |   |   |   |   |   |   |
| Preferred stock dividends                                                    | 815 |   | 1,633 |   | 2,375 |   | 3,265 |
| Net income available to common stockholder                    | $           1,383 |   | $         1,202 |   | $          2,022 |   | $          2,547 |
|                                                                                   |   |   |   |   |   |   |   |
| See accompanying notes to financial statements.                                        |

 

 

 

 

2

 

 

 

 
| **Capital Crossing Preferred Corporation**             |
|--------------------------------------------------------|
| **Statements of Changes in Stockholders’ Equity** |

**(unaudited)**

 
|                                              | **Six Months Ended June 30, 2007** |
|---------------------------------------------------|------------------------------------|
|                                              | **Preferred Stock**                | **Preferred Stock** | **Preferred Stock** | **Preferred Stock** |   | **Additional** |   | **Total** |
|                                              | **Series** **A**              | **Series** **B** | **Series** **C** | **Series** **D** | **Common Stock** | **Paid-in** | **Retained** | **Stockholders’** |
|                                              | **Shares**                         | **Amount** | **Shares** | **Amount** | **Shares** | **Amount** | **Shares** | **Amount** | **Shares** | **Amount** | **Capital** | **Earnings** | **Equity** |
|                                              | **(in thousands)**                 |
| Balance at December 31, 2006                      | 1,416                              | $          14 | 1 | $          — | 1,840 | $          18 | 1,500 | $          15 | — | $          — | $     172,640 | $          — | $   172,687 |
| Net income                                        | —                             | — | — | — | — | — | — | — | — | — | — | 4,397 | 4,397 |
| Redemption of preferred stock, Series A and C     | (1,416)                            | (14) | — | — | (1,840) | (18) | — | — | — | — | (32,529) | — |  

(32,561) |
| Dividends on preferred stock, Series A            | —                             | — | — | — | — | — | — | — | — | — | — | (314) | (314) |
| Cumulative dividends on preferred stock, Series B | —                             | — | — | — | — | — | — | — | — | — | — | (37) | (37) |
| Dividends on preferred stock, Series C            | —                             | — | — | — | — | — | — | — | — | — | — | (430) | (430) |
| Dividends on preferred stock, Series D            | —                             | — | — | — | — | — | — | — | — | — | — | (1,594) | (1,594) |
| Balance at June 30, 2007                          | —                             | $          — | 1 | $          — | — | $          — | 1,500  | $          15 |   — | $          — | $   140,111 | $     2,022 | $   142,148 |

 

 
|                                              | **Six** **Months** **Ended** **June** **30,** **2006** |
|---------------------------------------------------|---------------------------------------------------------------------------------|
|                                              | **Preferred** **Stock**                                                    | **Preferred** **Stock** | **Preferred** **Stock** | **Preferred** **Stock** |   | **Additional** |   | **Total** |
|                                              | **Series** **A**                                                           | **Series** **B** | **Series** **C** | **Series** **D** | **Common** **Stock** | **Paid-in** | **Retained** | **Stockholders’** |
|                                              | **Shares**                                                                      | **Amount** | **Shares** | **Amount** | **Shares** | **Amount** | **Shares** | **Amount** | **Shares** | **Amount** | **Capital** | **Earnings** | **Equity** |
|                                              | **(in** **thousands)**                                                     |
| Balance at December 31, 2005                      | 1,416                                                                           | $          14 | 1 | $          — | 1,840 | $          18 | 1,500 | $          15 | — | $          — | $   202,049 | $          — | $   202,096 |
| Net income                                        | —                                                                          | — | — | — | — | — | — | — | — | — | — | 5,812 | 5,812 |
| Dividends on preferred stock, Series A            | —                                                                          | — | — | — | — | — | — | — | — | — | — | (690) | (690) |
| Cumulative dividends on preferred stock, Series B | —                                                                          | — | — | — | — | — | — | — | — | — | — | (38) | (38) |
| Dividends on preferred stock, Series C            | —                                                                          | — | — | — | — | — | — | — | — | — | — | (943) | (943) |
| Dividends on preferred stock, Series D            | —                                                                          | — | — | — | — | — | — | — | — | — | — | (1,594) | (1,594) |
| Balance at June 30, 2006                          | 1,416                                                                           | $          14 | 1 | $          — | 1,840  | $          18 | 1,500  | $          15 | — | $          — | $   202,049 | $     2,547 | $   204,643 |

 

See accompanying notes to financial statements.

 

 

3

 

 

 
| **Capital Crossing Preferred Corporation**           |
|------------------------------------------------------|
| **Statements of Cash Flows**                         |
| **(unaudited)**                                      |
|                                                 |   |   |   |
|                                                 |   |   |   |
|                                                 | **Six Months Ended June 30,** |
|                                                 | **2007** |   | **2006** |
|                                                 | **(in thousands)** |
| Cash flows provided by operating activities:         |   |   |   |
|                                                 | Net income | $               4,397 |   | $                5,812 |
|                                                 | Adjustments to reconcile net income to net cash provided by operating activities: |   |   |   |
|                                                 |   | Credit for loan losses | (199) |   | (67) |
|                                                 |   | Gain on sales of loans | - |   | (768) |
|                                                 |   | Other, net | (227) |   | (1) |
|                                                 |   |   |   |   |   |   |
|                                                 |   |   | Net cash provided by operating activities | 3,971 |   | 4,976 |
|                                                 |   |   |   |   |   |   |
| Cash flows provided by investing activities:         |   |   |   |
|                                                 | Loan repayments | 11,150 |   | 7,681 |
|                                                 | Proceeds from loan sales | - |   | 1,618 |
|                                                 | Net decrease in certificate of deposit | - |   | 96 |
|                                                 |   |   |   |   |   |   |
|                                                 |   |   | Net cash provided by investing activities | 11,150 |   | 9,395 |
|                                                 |   |   |   |   |   |   |
| Cash flows used in financing activities:             |   |   |   |
|                                                 | Redemption of preferred stock, Series A and C | (32,561) |   | - |
|                                                 | Payment of preferred stock dividends | (2,375) |   | (3,265) |
|                                                 |   |   |   |   |   |   |
|                                                 |   |   | Net cash used in financing activities | (34,936) |   | (3,265) |
|                                                 |   |   |   |   |   |   |
| Net (decrease) increase in cash and cash equivalents | (19,815) |   | 11,106 |
| Cash and cash equivalents at beginning of period     | 83,900 |   | 88,406 |
|                                                 |   |   |   |   |   |   |
| Cash and cash equivalents at end of period           | $            64,085 |   | $              99,512 |
|                                                 |   |   |   |   |   |   |
|                                                 |   |   |   |   |   |   |
|                                                 |   |   |   |   |   |   |
|                                                 |   |   |   |   |   |   |
| See accompanying notes to financial statements.      |

 

 

4

 

 

 

**Capital Crossing Preferred Corporation**

**Notes to Financial Statements**

**Three and Six Months Ended June 30, 2007 and 2006**

 

**Note 1.****Basis of Presentation**

 

Capital Crossing Preferred Corporation (“Capital Crossing Preferred”) is a Massachusetts corporation organized on March 20, 1998, to acquire and hold real estate assets. Lehman Brothers Bank, FSB (“Lehman Bank”), a subsidiary of Lehman Brothers Holdings Inc. (“LBHI” LBHI with its subsidiaries, “Lehman Brothers”), owns all of Capital Crossing Preferred’s common stock. Lehman Bank is in compliance with its regulatory capital requirements at June 30, 2007. Prior to the merger with Lehman Bank, which is further discussed below, Capital Crossing Preferred was a subsidiary of Capital Crossing Bank (“Capital Crossing”), a federally insured Massachusetts trust company, and Capital Crossing owned all of Capital Crossing Preferred’s common stock. Capital Crossing Preferred operates in a manner intended to allow it to be taxed as a real estateinvestment trust, or a “REIT”, under the Internal Revenue Coed of 1986, as amended. As a REIT, Capital Crossing Preferred generally will not be required to pay federal income tax if it distributes its earnings to its shareholders and continues to meet a number of other requirements.

 

On September 19, 2006, Capital Crossing announced that it had signed a definitive merger agreement whereby Capital Crossing would be acquired by Lehman Bank through a two step merger transaction. Under the terms of the agreement, Lehman Brothers paid $30.00 per share in cash in exchange for each outstanding share of Capital Crossing. The acquisition was subject to customary closing conditions and regulatory approvals. The final approvals were received on February 13, 2007 and on February 14, 2007, an interim thrift subsidiary of Lehman Bank was merged into Capital Crossing. Immediately following such merger, Capital Crossing was merged into Lehman Bank.

 

On January 16, 2007, Capital Crossing Preferred’s Board of Directors voted to amend Capital Crossing Preferred’s charter, subject to completion of the merger. The exchange of the Series A, Series C and Series D preferred shares into preferred shares of Capital Crossing was amended to be exchangeable into preferred shares of Lehman Bank. This amendment was approved by Capital Crossing Preferred’s common stockholder. On January 29, 2007, Capital Crossing Preferred’s Board of Directors voted to redeem the Series A preferred shares and Series C preferred shares. The redemption notice to holders of the Series A and Series C preferred shares was mailed following the completion of the merger with Lehman Bank. On March 23, 2007, Capital Crossing Preferred redeemed the Series A and C preferred shares. The Series B preferred shares and Series D preferred shares remain outstandingand remain subject to their existing terms and conditions, including their respective call features. 

 

The financial information as of June 30, 2007 and the results of operations for the three and six months ended June 30, 2007 and 2006 and, changes in stockholders’ equity and cash flows for the six months ended June 30, 2007 and 2006 are unaudited; however, in the opinion of management, the financial information reflects all adjustments (consisting solely of normal recurring accruals) necessary for a fair presentation in accordance with accounting principles generally accepted in the United States of America. The interim financial statements for the three and six months ended June 30, 2007 and 2006 are comparable as there were no changes in accounting principles as a result of the merger. Interim results are not necessarily indicative of results to be expected for the entire year. These interim financial statements are intended to be read in conjunction with the financial statementspresented in Capital Crossing Preferred’s Annual Report on Form 10-K as of, and for the year ended, December 31, 2006.

 

In preparing financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for losses on loans, the allocation of purchase discount on loans between accretable and nonaccretable portions, and the rate at which the discount is accreted into interest income.

 

**Note 2.****Recent Accounting Pronouncements**

 

In June 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation 48 (“Interpretation 48”), “Accounting for Income Tax Uncertainties.” Interpretation 48 supplements FASB Statement 109 by defining the confidence level that a tax position must meet in order to be recognized in the financial statements. The Interpretation requires that the tax effects of a position be recognized only if it is “more-likely-than-not” to be sustained based solely on its technical merits as of the reporting date. The term “more-likely-than-not” means a likelihood of more than 50 percent. Interpretation 48 is effective as of January 1, 2007. At adoption, financial statements must be adjusted to reflect only those tax positions that are more likely-than-not to be sustained as of the adoption date. Since Capital Crossing Preferred is requiredto distribute 90 percent of it net taxable income to its shareholders in order to qualify as a REIT, the adoption of Interpretation 48 did not have a material impact on Capital Crossing Preferred’s financial statements.

 

5

 

 

 

**Note 3.****Commitments, Contingencies and Guarantees**

 

*Guarantees*

 

On May 18, 2007, Lehman Bank paid off all of its outstanding Federal Home Loan Bank of Boston (“FHLBB”) advances. Prior to that, Capital Crossing Preferred had guaranteed all of the obligations of Lehman Bank under advances Lehman Bank had received from  the FHLBB. These FHLBB guarantee obligations were assumed by Lehman Bank pursuant to the merger. Capital Crossing Preferred had agreed to pledge a significant amount of its assets. This guarantee would have ranked senior to the outstanding preferred shares upon liquidation. As a result of the repayment, the guarantee was released.

 

**Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations**

 

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended. For purposes of these Acts, any statement that is not a statement of historical fact may be deemed a forward-looking statement. For example, statements containing the words “believes,” “anticipates,” “plans,” “expects,” “estimates,” “intends,” “may,” “projects,” “will,” “would,” and similar expressions may be forward-looking statements. Capital Crossing Preferred cautions investors not to place undue reliance on any forward-looking statements in this Quarterly Report on Form 10-Q. Capital Crossing Preferred undertakes no obligation to publicly update any forward-looking statements,whether as a result of new information, future events or otherwise. There are a number of factors that could cause Capital Crossing Preferred’s actual results to differ materially from those indicated by these forward-looking statements, including without limitation the factors set forth below in Part II, Item 1A. “Risk Factors”. These factors and the other cautionary statements made in this quarterly report should be read as being applicable to all related forward-looking statements wherever they appear in this quarterly report. If one or more of these factors materialize, or if any underlying assumptions prove incorrect, Capital Crossing Preferred’s actual results, performance, or achievements may vary materially from any future results, performance, or achievements expressed or implied by these forward-looking statements.

 

The following discussion of Capital Crossing Preferred’s financial condition, results of operations, capital resources and liquidity should be read in conjunction with the Financial Statements and related Notes included elsewhere herein and the audited Financial Statements and related Notes included in Capital Crossing Preferred’s Annual Report on Form 10-K for the year ended December 31, 2006 as filed with the Securities and Exchange Commission, (the “SEC”).

 

**Executive Level Overview**

 

On February 14, 2007 the merger of Capital Crossing into Lehman Bank was completed. As a result, Lehman Bank owns all of Capital Crossing Preferred’s common stock.

 

On January 29, 2007, Capital Crossing Preferred’s Board of Directors voted to redeem the Series A preferred shares and Series C preferred shares. The redemption notice to holders of the Series A and Series C preferred shares was mailed following the completion of the merger with Lehman Bank. On March 23, 2007, Capital Crossing Preferred redeemed the Series A and Series C preferred shares. The Series B preferred shares and Series D preferred shares remain outstanding and remain subject to their existing terms and conditions, including their respective call features.

 

Net income available to the common shareholder increased $181,000, or 15.1%, to $1.4 million for the three months ended June 30, 2007 compared to $1.2 million for the same period in 2006. The increase is primarily the result of a decrease in preferred stock dividends and operating expenses, partially offset by decreases in interest income and gains on sales of loans. Net income available to the common shareholder decreased $525,000, or 20.6%, to $2.0 million for the six months ended June 30, 2007 compared to $2.5 million for the same period in 2006. The decrease is primarily the result of decreases in interest and fees on loans and gains on sales of loans, partially offset by a decrease in preferred stock dividends and operating expenses. The decrease in interest income for both the three and six month periods is primarily due to a smaller loan portfolio as a result of loan amortization andrepayments. There were no sales of loans in 2007. The decrease in preferred stock dividends in both the three and six month periods is due to the redemption of the Series A and Series C preferred shares on March 23, 2007.

 

All of the mortgage assets in Capital Crossing Preferred’s loan portfolio at June 30, 2007 were acquired from Capital Crossing and it is anticipated that substantially all additional mortgage assets will be acquired from Lehman Bank. As of June 30, 2007, Capital Crossing Preferred held loans acquired from Capital Crossing with net investment balances of $79.8 million.

 

Commercial mortgage loans constituted approximately 64.5% of the net loans in Capital Crossing Preferred’s loan portfolio at June 30, 2007. Commercial mortgage loans are generally subject to greater risks than other types of loans. Capital Crossing Preferred’s commercial mortgage loans, like most commercial mortgage loans, generally lack standardized terms, tend to have shorter maturities than 

 

6

 

 

other mortgage loans and may not be fully amortizing. For these reasons, Capital Crossing Preferred may experience higher rates of default on its mortgage loans than it would if its loan portfolio was more diversified and included a greater number of owner-occupied residential or other mortgage loans.

 

Properties underlying Capital Crossing Preferred’s current mortgage assets are also concentrated primarily in California and New England. As of June 30, 2007, approximately 54.1% of the balances of its mortgage loans were secured by properties located in California and 10.2% in New England. In the instance where either region experiences adverse economic, political or business conditions, Capital Crossing Preferred would likely experience higher rates of loss and delinquency on its mortgage loans.

 

Since Capital Crossing Preferred is a subsidiary of Lehman Bank, federal bank regulatory authorities will have the right to examine it and its activities and under certain circumstances, to impose restrictions on Lehman Bank or Capital Crossing Preferred which could impact Capital Crossing Preferred’s ability to conduct its business according to its business plan. For instance, if Lehman Bank’s regulators determine that Lehman Bank’s relationship to Capital Crossing Preferred results in an unsafe and unsound banking practice, the regulators could restrict Capital Crossing Preferred’s ability to transfer assets, to make distributions to its stockholders or even require Lehman Bank to sever its relationship with or divest its ownership interest in Capital Crossing Preferred.

 

Decisions regarding the utilization of Capital Crossing Preferred’s cash are based, in large part, on its future commitments to pay preferred stock dividends. During the three months ended June 30, 2007, the loan portfolio was large enough to generate income resulting in net income, which was 2.70 times fixed charges and preferred stock dividends. Future decisions regarding mortgage asset acquisitions and returns of capital will be based on the level of preferred stock dividends at the time and the required level of income necessary to generate adequate dividend coverage.

 

**Application of Critical Accounting Policies and Estimates**

 

The SEC requires that all registrants discuss their most ‘‘critical accounting policies’’ in management’s discussion and analysis of financial condition and results of operations. The SEC indicated that a ‘‘critical accounting policy’’ is one which is both important to the portrayal of the company’s financial condition and results and requires management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. While Capital Crossing Preferred’s significant accounting policies are more fully described in Note 1 to the Financial Statements included in its Annual Report on Form 10-K for the year ended December 31, 2006, the following is a summary of the accounting policies believed by management to be most critical in their potentialeffect on Capital Crossing Preferred’s financial position or results of operations:

 

**Discounts on Acquired Loans.**In accordance with Statement of Position (“SOP”) No. 03-3 “Accounting for Certain Loans or Debt Securities Acquired in a Transfer”, Capital Crossing Preferred reviews acquired loans for differences between contractual cash flows and cash flows expected to be collected from Capital Crossing Preferred’s initial investment in the acquired loans to determine if those differences are attributable, at least in part, to credit quality. The loan’s contractually required payments receivable in excess of the amount of its cash flows expected at acquisition, or nonaccretable discount, is not accreted into income. SOP No. 03-3 requires that Capital Crossing Preferred recognize the excess of all cash flows expected at acquisition over Capital Crossing Preferred’s initial investment in the loan as interest incomeusing the interest method over the term of the loan. This excess is referred to as accretable discount.

 

Loans which, at acquisition, do not have evidence of deterioration of credit quality since origination are outside the scope of SOP No. 03-3. For such loans, the discount, representing the excess of the amount of reasonably estimable and probable discounted future cash collections over the purchase price, is accreted into interest income using the interest method over the term of the loan. Prepayments are not considered in the calculation of accretion income. Additionally, discount is not accreted on non-performing loans. 

 

No loans acquired since the adoption of SOP No. 03-3 were within the scope of the SOP.

 

There is judgment involved in estimating the amount of Capital Crossing Preferred’s future cash flows. The amount and timing of actual cash flows could differ materially from management’s estimates, which could materially affect Capital Crossing Preferred’s financial condition and results of operations. Depending on the timing of an acquisition, a preliminary allocation may be utilized until a final allocation is established. Generally, the allocation will be finalized no later than ninety days from the date of purchase.

 

If cash flows cannot be reasonably estimated for any loan, and collection is not probable, the cost recovery method of accounting is used. Under the cost recovery method, any amounts received are applied against the recorded amount of the loan. Nonaccretable discount is generally offset against the related principal balance when the amount at which a loan is resolved or restructured is determined. There is no effect on the income statement as a result of these reductions.

 

Subsequent to acquisition, if cash flow projections improve, and it is determined that the amount and timing of the cash flows related to the nonaccretable discount are reasonably estimable and collection is probable, the corresponding decrease in the nonaccretable 

 

7

 

 

discount is transferred to the accretable discount and is accreted into interest income over the remaining life of the loan on the interest method. If cash flow projections deteriorate subsequent to acquisition, the decline is accounted for through a provision for loan losses included in earnings.

 

When a loan is paid-off, the excess of any cash received over the net investment is recorded as interest income. In addition to the amount of purchase discount that is recognized at that time, income may also include interest owed by the borrower prior to Capital Crossing Preferred’s acquisition of the loan, interest collected if on non-performing status, prepayment fees and other loan fees.

 

Gains and losses on sales of loans are determined using the specific identification method. The excess (deficiency) of any cash received as compared to the net investment is recorded as gain (loss) on sales of loans. There were no loans held for sale at June 30, 2007.

 

**Allowance for Loan Losses.**Arriving at an appropriate level of allowance for loan losses requires a high degree of judgment. Capital Crossing Preferred maintains an allowance for probable loan losses that are inherent in its loan portfolio. The allowance for loan losses is increased or decreased through a provision or credit for loan losses included in earnings. 

 

In determining the adequacy of the allowance for loan losses, management makes significant judgments. Management initially reviews its loan portfolio to identify loans for which specific allocations are considered prudent. Specific allocations include the results of measuring impaired loans under Statement of Financial Accounting Standards (“SFAS”) No. 114 “Accounting by Creditors for Impairment of a Loan”. Next, management considers the level of general loan allowances deemed appropriate for loans. General risk allocations are determined by a formula whereby the portfolio is stratified by type and internal risk rating categories. Loss factors are then applied to each strata based on various considerations including collateral type, loss experience, delinquency trends, current economic conditions, industry standards, and regulatory guidelines. The allowance for loanlosses is management’s estimate of the probable loan losses incurred as of the balance sheet date. There can be no assurance that Capital Crossing Preferred’s actual losses with respect to loans will not exceed its allowance for loan losses.

 

In accordance with SOP No. 03-3, Capital Crossing Preferred does not establish allowances for loan losses in the initial accounting for loans with evidence of credit quality deterioration that are acquired in a transfer. Rather, the excess of the acquired loan’s contractually required payments receivable over the amount of cash flows Capital Crossing Preferred expects to collect at acquisition, is recorded as nonaccretable discount. For those acquired loans which do not display evidence of the deterioration of credit quality and are therefore outside the scope of SOP 03-3, general risk allocations are established through a charge to earnings. 

 

Subsequent to loan acquisition, the allowance for loan losses is increased through a provision for loan losses included in earnings when evidence indicates that there has been a decrease in estimated cash flows expected to be collected. The allowance for loan losses is decreased upon sales or payoffs of loans for which a related allowance remains unused. Reductions in connection with sales are included in the calculation of the gain or loss, and reductions related to payoffs are recorded as a credit for loan losses. Loan losses are charged against the allowance when management believes the net investment of the loan, or a portion thereof, is uncollectible. Subsequent recoveries, if any, are credited to the allowance when cash payments are received. It is anticipated that the allowance will continue to decline as credits for loan losses may continue to be recorded if loans pay off andallowance allocations related to these loans are not required or additions due to loan impairment are not required.

 

 

8

 

 

 

**Results of Operations for the Three Months Ended June 30, 2007 and 2006**

 

***Interest income***

 

The following table sets forth the yields on Capital Crossing Preferred’s earning assets for the periods indicated: 

 
|                          | **Three Months Ended June 30,**       |
|-------------------------------|---------------------------------------|
|                          | **2007**                              |   |   | **2006** |   |
|                          | **Average**                           |   | **Interest** |   |   |   |   | **Average** |   | **Interest** |   |   |   |
|                          | **Balance**                           |   | **Income** |   | **Yield** |   | **Balance** |   | **Income** |   | **Yield** |   |
|                          | **(dollars in thousands)**            |   |
|                          |                                  |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans, net (1)                | $     83,810 |   | $     1,968 |   | 9.42 | % |   | $  109,479 |   | $     2,333 |   | 8.55 | % |
| Interest-bearing deposits     | 58,816                                |   | 162 |   | 1.10 |   |   | 95,775 |   | 264 |   | 1.11 |   |
| Total interest-earning assets | $   142,626            |   | $     2,130 |   | 5.99 | % |   | $  205,254 |   | $     2,597 |   | 5.07 | % |

__________________

(1) Non-performing loans are excluded from average balance calculations.

 

The decline in interest income for the three months ended June 30, 2007 compared to the three months ended June 30, 2006 is primarily due to a decrease in the average balance of loans and interest bearing deposits offset, in part, by an increase in the yield on loans. 

 

Average loans, net for the three months ended June 30, 2007 totaled $83.8 million compared to $109.5 million for the same period in 2006. This decrease is primarily attributable to loan pay-offs and amortization of loans. No loans were acquired in 2007 or 2006. For the three months ended June 30, 2007, the yield on the loan portfolio increased to 9.42% compared to 8.55% for the same period in 2006. For the three months ended June 30, 2007, interest and fee income recognized on loan payoffs increased $121,000, or 92.4%, to $252,000 from $131,000 for the three months ended June 30, 2006. The level of interest and fee income recognized on loan payoffs varies for numerous reasons, as further discussed below. The yield from regularly scheduled interest and accretion income increased to 8.21% for the three months ended June 30, 2007 from 8.07% for the same period in 2006 primarily as a result ofincreases in market rates.

 

Income on loans includes the portion of the purchase discount that is accreted into income over the remaining lives of the related loans using the interest method. Because the carrying value of the loan portfolio is net of purchase discount, the related yield on this portfolio generally is higher than the aggregate contractual rate paid on the loans. The total yield includes the excess of a loan’s expected discounted future cash flows over its net investment, recognized using the interest method.

 

When a loan is paid off, the excess of any cash received over the net investment is recorded as interest income. In addition to the amount of purchase discount that is recognized at that time, income may also include interest owed by the borrower prior to Lehman Bank’s acquisition of the loan,interest collected if on non-performing status, prepayment fees and other loan fees (‘‘other interest and fee income’’). The following table sets forth, for the periods indicated, the components of interest and fees on loans. There can be no assurance regarding future interest income, including the yields and related level of such income, or the relative portion attributable to loan pay-offs as compared to other sources.

 

 
|                                                | **Three Months Ended June 30,**                  |
|-----------------------------------------------------|--------------------------------------------------|
|                                                | **2007**                                         |   | **2006** |
|                                                | **Interest**                                     |   |   |   |   | **Interest** |   |   |   |
|                                                | **Income**                                       |   | **Yield** |   | **Income** |   | **Yield** |
|                                                | **(dollars in thousands)**                       |
|                                                |                                             |   |   |   |   |   |   |   |   |
| Regularly scheduled interest and accretion income   | $       1,716 |   | 8.21 | % |   | $       2,202 |   | 8.07 | % |
| Interest and fee income recognized on loan payoffs: |                                             |   |   |   |   |   |   |   |   |
| Nonaccretable discount                         | 55                                               |   | 0.27 |   |   | - |   | - |   |
| Accretable discount                            | 126                                              |   | 0.60 |   |   | 131 |   | 0.48 |   |
| Other interest and fee income   | 71                                               |   | 0.34 |   |   | - |   | - |   |
|                                                |                                             |   |   |   |   |   |   |   |   |
|                                                | 252                                              |   | 1.21 |   |   | 131 |   | 0.48 |   |
|                                                | $       1,968 |   | 9.42 | % |   | $       2,333 |   | 8.55 | % |

 

 

9

 

 

 

The amount of loan payoffs and related discount income is influenced by several factors, including the interest rate environment, the real estate market in particular areas, the timing of transactions, and circumstances related to individual borrowers and loans. The amount of individual loan payoffs is often times a result of negotiations between Capital Crossing Preferred and the borrower. Based upon credit risk analysis and other factors, Capital Crossing Preferred will, in certain instances, accept less than the full amount contractually due in accordance with the loan terms.

 

The average balance of interest-bearing deposits decreased $37.0 million or 38.6% to $58.8 million for the three months ended June 30, 2007, compared to $95.8 million for the same period in 2006. The changes in the average balances of interest-bearing deposits are the result of periodic dividend payments, and returns of capital, offset by cash flows from loan repayments. Additionally, on March 23, 2007, Capital Crossing Preferred redeemed the Series A and Series C preferred shares, which caused a decrease of $32.6 million in interest-bearing deposits. 

 

***Credit for loan losses***

 

Capital Crossing Preferred recorded credits for loan losses of $95,000 and $54,000 for the three months ended June 30, 2007 and 2006, respectively, to reverse unused general reserves related to loans that have been paid off. The credit for loan losses is based on the volume and types of loan payoffs. As loans pay off, a credit for loan losses is recorded to reduce allowance allocations related to the loans that have paid off for which a related allowance remains unused. The allowance for loan losses is based on the size of the portfolio and its historical performance. The determination of this allowance requires management’s use of estimates and assumptions regarding the risks inherent in individual loans and the loan portfolio in its entirety. Should the loan portfolio continue to decline without utilization of the allowance for loan losses, future credits for loan losses may be necessary.

 

***Other income***

 

During the three months ended June 30, 2006, one loan with a carrying value of $570,000 was sold to an unaffiliated third party resulting in a gain of $286,000. There were no loan sales during the three months ended June 30, 2007. 

 

Guarantee fee income decreased $10,000 or 50.0% to $10,000 for the three months ended June 30, 2007 compared to $20,000 for the three months ended June 30, 2006 due to the fact Lehman Bank paid off its FHLBB advances in May 2007 and as a result, the guarantee was released.

 

***Operating expenses***

 

Loan servicing and advisory expenses decreased $62,000, or 81.6%, to $14,000 for the three months ended June 30, 2007 from $76,000 for the three months ended June 30, 2006 primarily as a result of an increase in loan expense reimbursements collected from borrowers previously expensed by Capital Crossing Preferred related to certain loans as well as a decrease in the average balance of the loan portfolio. 

 

Other general and administrative expenses decreased $23,000 or 50.0%, to $23,000 for the three months ended June 30, 2007 compared to $46,000 for the three months ended June 30, 2006. This decrease is primarily attributable to an increase in legal fee reimbursements collected from borrowers previously expensed by Capital Crossing Preferred related to certain loan matters, partially offset by an increase in tax preparation fees.

 

10

 

 

 

 

**Results of Operations for the Six Months Ended June 30, 2007 and 2006**

 

***Interest income***

 

The following table sets forth the yields on Capital Crossing Preferred’s earning assets for the periods indicated: 

 
|                          | **Six Months Ended June 30,**         |
|-------------------------------|---------------------------------------|
|                          | **2007**                              |   |   | **2006** |   |
|                          | **Average**                           |   | **Interest** |   |   |   |   | **Average** |   | **Interest** |   |   |   |
|                          | **Balance**                           |   | **Income** |   | **Yield** |   | **Balance** |   | **Income** |   | **Yield** |   |
|                          | **(dollars in thousands)**            |   |
|                          |                                  |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans, net (1)                | $     86,125 |   | $     3,917 |   | 9.17 | % |   | $  111,708 |   | $     4,665 |   | 8.42 | % |
| Interest-bearing deposits     | 70,634                                |   | 393 |   | 1.12 |   |   | 93,086 |   | 510 |   | 1.10 |   |
| Total interest-earning assets | $   156,759            |   | $     4,310 |   | 5.54 | % |   | $  204,794 |   | $     5,175 |   | 5.10 | % |

__________________

(1) Non-performing loans are excluded from average balance calculations.

 

The decline in interest income for the six months ended June 30, 2007 compared to the six months ended June 30, 2006 is primarily due to a decrease in the average balance of loans and interest bearing deposits offset, in part, by an increase in the yield on loans. 

 

Average loans, net for the six months ended June 30, 2007 totaled $86.1 million compared to $111.7 million for the same period in 2006. This decrease is primarily attributable to loan pay-offs and amortization of loans. No loans were acquired in 2007 or 2006. For the six months ended June 30, 2007, the yield on the loan portfolio increased to 9.17% compared to 8.42% for the same period in 2006. For the six months ended June 30, 2007, interest and fee income recognized on loan payoffs increased $256,000, or 143.8%, to $434,000 from $178,000 for the six months ended June 30, 2006. The level of interest and fee income recognized on loan payoffs varies for numerous reasons, as further discussed below. 

 

Income on loans includes the portion of the purchase discount that is accreted into income over the remaining lives of the related loans using the interest method. Because the carrying value of the loan portfolio is net of purchase discount, the related yield on this portfolio generally is higher than the aggregate contractual rate paid on the loans. The total yield includes the excess of a loan’s expected discounted future cash flows over its net investment, recognized using the interest method.

 

When a loan is paid off, the excess of any cash received over the net investment is recorded as interest income. In addition to the amount of purchase discount that is recognized at that time, income may also include interest owed by the borrower prior to Lehman Bank’s acquisition of the loan,interest collected if on non-performing status, prepayment fees and other loan fees (‘‘other interest and fee income’’). The following table sets forth, for the periods indicated, the components of interest and fees on loans. There can be no assurance regarding future interest income, including the yields and related level of such income, or the relative portion attributable to loan pay-offs as compared to other sources.

 

 
|                                                | **Six Months Ended June 30,**                    |
|-----------------------------------------------------|--------------------------------------------------|
|                                                | **2007**                                         |   | **2006** |
|                                                | **Interest**                                     |   |   |   |   | **Interest** |   |   |   |
|                                                | **Income**                                       |   | **Yield** |   | **Income** |   | **Yield** |
|                                                | **(dollars in thousands)**                       |
|                                                |                                             |   |   |   |   |   |   |   |   |
| Regularly scheduled interest and accretion income   | $       3,483 |   | 8.15 | % |   | $       4,487 |   | 8.10 | % |
| Interest and fee income recognized on loan payoffs: |                                             |   |   |   |   |   |   |   |   |
| Nonaccretable discount                         | 55                                               |   | 0.13 |   |   | 14 |   | 0.03 |   |
| Accretable discount                            | 287                                              |   | 0.67 |   |   | 152 |   | 0.27 |   |
| Other interest and fee income   | 92                                               |   | 0.22 |   |   | 12 |   | 0.02 |   |
|                                                |                                             |   |   |   |   |   |   |   |   |
|                                                | 434                                              |   | 1.02 |   |   | 178 |   | 0.32 |   |
|                                                | $       3,917 |   | 9.17 | % |   | $       4,665 |   | 8.42 | % |

 

 

11

 

 

 

The amount of loan payoffs and related discount income is influenced by several factors, including the interest rate environment, the real estate market in particular areas, the timing of transactions, and circumstances related to individual borrowers and loans. The amount of individual loan payoffs is often times a result of negotiations between Capital Crossing Preferred and the borrower. Based upon credit risk analysis and other factors, Capital Crossing Preferred will, in certain instances, accept less than the full amount contractually due in accordance with the loan terms.

 

The average balance of interest-bearing deposits decreased $22.5 million or 24.1% to $70.6 million for the six months ended June 30, 2007, compared to $93.1 million for the 2006 period. The changes in the average balances of interest-bearing deposits are the result of periodic dividend payments, and returns of capital, offset by cash flows from loan repayments. Additionally, on March 23, 2007, Capital Crossing Preferred redeemed the Series A and Series C preferred shares, which caused a decrease of $32.6 million in interest-bearing deposits. 

 

***Credit for loan losses***

 

Capital Crossing Preferred recorded credits for loan losses of $199,000 and $67,000 for the six months ended June 30, 2007 and 2006, respectively, to reverse unused general reserves related to loans that have been paid off. The credit for loan losses is based on the volume and types of loan payoffs. As loans pay off, a credit for loan losses is recorded to reduce allowance allocations related to the loans that have paid off for which a related allowance remains unused. The allowance for loan losses is based on the size of the portfolio and its historical performance. The determination of this allowance requires management’s use of estimates and assumptions regarding the risks inherent in individual loans and the loan portfolio in its entirety. Should the loan portfolio continue to decline without utilization of the allowance for loan losses, future credits for loan losses may be necessary.

 

***Other income***

 

During the six months ended June 30, 2006 there were two loan sales to unaffiliated third parties comprised of four loans, with a total carrying value of $863,000 resulting in a gain of $768,000. There were no loan sales during the six months ended June 30, 2007. 

 

Guarantee fee income decreased $10,000 or 25.0% to $30,000 for the six months ended June 30, 2007 compared to $40,000 for the six months ended June 30, 2006 due to the fact that Lehman Bank paid off its FHLBB advances in May 2007.

 

***Operating expenses***

 

Loan servicing and advisory expenses decreased $80,000, or 51.3%, to $76,000 for the six months ended June 30, 2007 from $156,000 for the six months ended June 30, 2006 primarily as a result of an increase in loan expense reimbursements collected from borrowers previously expensed by Capital Crossing Preferred related to certain loans as well as a decrease in the average balance of the loan portfolio. 

 

Other general and administrative expenses decreased $16,000 or 19.5%, to $66,000 for the six months ended June 30, 2007 compared to $82,000 for the six months ended June 30, 2006. This decrease is primarily attributable to an increase in legal fee reimbursements collected from borrowers previously expensed by Capital Crossing Preferred related to certain loan matters, partially offset by an increase in tax preparation fees.

 

**Changes in Financial Condition**

 

***Interest-bearing deposits with parent***

 

Interest-bearing deposits with parent consist entirely of money market accounts with Lehman Bank at June 30, 2007 and Capital Crossing at December 31, 2006. The balance of interest-bearing deposits decreased $19.8 million to $63.9 million at June 30, 2007 compared to $83.7 million at December 31, 2006. The decrease in the balance of interest-bearing deposits is primarily a result of the redemption of Series A and Series C preferred shares offset, in part, by cash flows from loan repayments.

 

12

 

 

 

***Loan portfolio***

 

To date, all of Capital Crossing Preferred’s loans have been acquired from Capital Crossing. The following table sets forth information regarding the composition of the loan portfolio at the dates indicated:

 
|   |   |   |   | **June 30,**

**2007** |   | **December 31, 2006** |  
 

 

**(in thousands)**

 
Mortgage loans on real estate:

 

 

 

Commercial real estate

 

 

$             51,435

 

 $           57,607

 
 

Multi-family residential

 

 

27,449

 

32,412

 
 

One-to-four family residential

 

900

 

924

 
 

Total 

 

 

79,784

 

90,943

 
 

Other 

 

 

14

 

14

 
 

Total loans, net of discounts

 

 

79,798

 

90,957

 
 

 

 

 

 

 

 
Less:

 

 

 

 

 

 
 

Allowance for loan losses

(1,320)

 

(1,519)

 
 

Net deferred loan fees

(38)

 

(47)

 
 

 

 

 

 

 

 

 
 

Loans, net

 

 

$             78,440

 

 $         89,391

 
 

 

Capital Crossing Preferred acquires primarily performing commercial real estate and multifamily residential mortgage loans. There were no loans acquired during the six months ended June 30, 2007, as the existing portfolio was large enough to generate an adequate dividend ratio. 

 

Capital Crossing Preferred intends that each loan acquired from Lehman Bank in the future will be a whole loan, and will be originated or acquired by Lehman Bank in the ordinary course of its business. Capital Crossing Preferred also intends that all loans held by it will be serviced pursuant to its master service agreement with Lehman Bank. 

 

There were no non-performing loans at June 30, 2007. Non-performing loans, net of discount, totaled $416,000 at December 31, 2006. Loans generally are placed on non-performing status and the accrual of interest and accretion of discount are generally discontinued when the collectibility of principal and interest is not probable or estimable. Unpaid interest income previously accrued on such loans is reversed in the period in which the determination is made by management. A loan is returned to accrual status in the period when it is brought current in accordance with management’s anticipated cash flows at the time of acquisition.

 

***Discounts on Acquired Loans.*******For information relating to Capital Crossing Preferred’s accounting policies related to discounts on acquired loans, see Application of Critical Accounting Policies and Estimates – Discounts on Acquired Loans.

 

The following table sets forth certain information relating to the activity in the nonaccretable discount for the periods indicated: 

 

 

 

**Three Months Ended**

 

 

**Six Months Ended**

 

**June 30,**

 

**June 30,**

 

**2007**

 

**2006**

 

**2007**

 

**2006**

 

**(in thousands)**

 

 

 

 

 

 

 

 

Balance at beginning of period

$            213

 

$            483

 

$          215

 

$          754

Accretion (1)

(57)

 

(14)

 

(59)

 

(34)

Net reductions related to loans sold

-

 

-

 

-

 

(251)

Increase related to loan restructures

-

 

126

 

-

 

126

Balance at end of period

$           156

 

$         595

 

$          156

 

$          595

 

(1)  Accretion of nonaccretable discount is recognized using the cost recovery method.

 

 

13

 

 

 

***Allowance for Loan Losses.***Capital Crossing Preferred’s allowance for loan losses at June 30, 2007 was $1.3 million. The determination of this allowance requires the use of estimates and assumptions regarding the risks inherent in individual loans and the loan portfolio in its entirety. In addition, regulatory agencies periodically review the adequacy of the allowance for loan losses and may require Capital Crossing Preferred to make additions to its allowance for loan losses. While management believes its estimates and assumptions are reasonable, there can be no assurance that they will be proven to be correct in the future. The actual amount of future provisions that may be required cannot be determined, and such provisions may exceed the amounts of past provisions. Management believes that the allowance for loan losses is adequate to absorb the knownand inherent risks in Capital Crossing Preferred’s loan portfolio at each date based on the facts known to management as of such date. Management continues to monitor and modify the allowances for general and specific loan losses as economic conditions dictate.

 

Effective January 1, 2005, and as a result of the required adoption of SOP No. 03-3, additions to the valuation allowances relating to newly acquired loans reflect only those losses incurred by****Capital Crossing Preferred subsequent to acquisition and general risk allocations for loans which no nonaccretable discount is allocated. Capital Crossing Preferred no longer increases the allowance through allocations from purchase discount and is no longer allowed to establish impairment reserves at acquisition. However, at the time of acquisition, general risk allocations are established for loans for which no nonaccretable discount is allocated through a charge to earnings. Consequently, it is anticipated that the allowance will continue to decline as credits for loan losses may continue to be recorded if loans pay off and allowance allocationsrelated to these loans are not required or additions due to impairment are not required.

 

No loans acquired since the adoption of SOP No. 03-3 were within the scope of the SOP.

 

The following table sets forth certain information relating to the activity in the allowance for loan losses for the periods indicated:

 

 

**Three Months Ended June 30,**

 

**Six Months Ended June 30,**

 

**2007**

 

**2006**

 

**2007**

 

**2006**

 

**(in thousands)**

Balance at beginning of period

$           1,415

 

$           1,963

 

$       1,519

 

$       1,981

Credit for loan losses

(95)

 

(54)

 

(199)

 

(67)

Net reduction relating to loans sold

-

 

(15)

 

-

 

(20)

Balance at end of period

$           1,320

 

$           1,894

 

$       1,320

 

$       1,894

 

**Interest Rate Risk**

 

Capital Crossing Preferred’s income consists primarily of interest income. If there is a decline in market interest rates, Capital Crossing Preferred may experience a reduction in interest income and a corresponding decrease in funds available to be distributed to its shareholders. The reduction in interest income may result from downward adjustments of the indices upon which the interest rates on loans are based and from prepayments of mortgage loans with fixed interest rates, resulting in reinvestment of the proceeds in lower yielding mortgage loans. Capital Crossing Preferred does not intend to use any derivative products to manage its interest rate risk.

 

**Significant Concentration of Credit Risk**

 

Concentration of credit risk generally arises with respect to Capital Crossing Preferred’s loan portfolio when a number of borrowers engage in similar business activities, or activities in the same geographical region. Concentration of credit risk indicates the relative sensitivity of Capital Crossing Preferred’s performance to both positive and negative developments affecting a particular industry or geographic region. Capital  Crossing Preferred’s balance sheet exposure to geographic concentrations directly affects the credit risk of the loans within its loan portfolio. 

 

At June 30, 2007, 54.1% and 10.2% of Capital Crossing Preferred’s net loan portfolio consisted of loans in California and New England, respectively. At December 31, 2006, 54.3% and 12.0% of Capital Crossing Preferred’s net real estate loan portfolio consisted of loans located in California and New England, respectively. Consequently, the portfolio may experience a higher default rate in the event of adverse economic, political or business developments or natural hazards in California or New England that may affect the ability of property owners to make payments of principal and interest on the underlying mortgages. 

 

 

 

 

14

 

 

 

**Liquidity Risk Management**

 

The objective of liquidity management is to ensure the availability of sufficient cash flows to meet all of Capital Crossing Preferred’s financial commitments and to capitalize on opportunities for Capital Crossing Preferred’s business expansion. In managing liquidity risk, Capital Crossing Preferred takes into account various legal limitations placed on a REIT. 

 

Capital Crossing Preferred’s principal liquidity needs are: 

 

 

**•**

to maintain an adequate portfolio size through the acquisition of additional mortgage assets as mortgage assets currently in the loan portfolio mature, pay down or prepay, and 

 

 

**•**

to pay dividends on the preferred shares and common shares. 

 

The acquisition of additional mortgage assets is intended to be funded primarily through repayment of principal balances of mortgage assets by individual borrowers. Capital Crossing Preferred does not have and does not anticipate having any material capital expenditures. To the extent that the Board of Directors determines that additional funding is required, Capital Crossing Preferred may raise such funds through additional equity offerings, debt financing or retention of cash flow (after consideration of provisions of the Internal Revenue Code requiring the distribution by a REIT of at least 90% of its REIT taxable income and taking into account taxes that would be imposed on undistributed income), or a combination of these methods. Capital Crossing Preferred does not currently intend to incur any indebtedness. The organizational documents of Capital Crossing Preferred limit the amount ofindebtedness which it is permitted to incur without the approval of the Series D preferred stockholders to no more than 100% of the total stockholders’ equity of Capital Crossing Preferred. Any such debt may include intercompany advances made by Lehman Bank to Capital Crossing Preferred. 

 

Capital Crossing Preferred may also issue additional series of preferred stock. However, Capital Crossing Preferred may not issue additional shares of preferred stock ranking senior to the Series D preferred shares without the consent of holders of at least two-thirds of the Series D preferred shares, each voting as a separate class, outstanding at that time. Additional shares of preferred stock ranking on a parity with the Series D preferred shares may not be issued without the approval of a majority of Capital Crossing Preferred’s independent directors.

 

**Impact of Inflation and Changing Prices**

 

Capital Crossing Preferred’s asset and liability structure is substantially different from that of an industrial company in that virtually all assets of Capital Crossing Preferred are monetary in nature. Management believes the impact of inflation on financial results depends upon Capital Crossing Preferred’s ability to react to changes in interest rates and by such reaction, reduce the inflationary impact on performance. Interest rates do not necessarily move in the same direction, or at the same magnitude, as the prices of other goods and services.

 

Various information shown elsewhere in this quarterly report will assist the reader in understanding how Capital Crossing Preferred is positioned to react to changing interest rates and inflationary trends. In particular, the discussion of market risk and other maturity and repricing information of Capital Crossing Preferred’s assets is contained in Item 3, Quantitative and Qualitative Disclosures About Market Risk, of this quarterly report.

 

**Item 3. Quantitative and Qualitative Disclosures About Market Risk**

 

Market risk is the risk of loss from adverse changes in market prices and interest rates. It is the objective of Capital Crossing Preferred to attempt to control risks associated with interest rate movements. Capital Crossing Preferred’s market risk arises primarily from interest rate risk inherent in holding loans. To that end, management actively monitors and manages the interest rate risk exposure of Capital Crossing Preferred.

 

Capital Crossing Preferred’s management reviews, among other things, the sensitivity of Capital Crossing Preferred’s assets to interest rate changes, the book and market values of assets, purchase and sale activity, and anticipated loan pay-offs. Lehman Bank’s senior management also approves and establishes pricing and funding decisions with respect to Capital Crossing Preferred’s overall asset and liability composition.

 

Capital Crossing Preferred’s methods for evaluating interest rate risk include an analysis of its interest-earning assets maturing or repricing within a given time period. Since Capital Crossing Preferred has no interest-bearing liabilities, a period of rising interest rates would tend to result in an increase in net interest income. A period of falling interest rates would tend to adversely affect net interest income.

 

 

15

 

 

 

The following table sets forth Capital Crossing Preferred’s interest-rate-sensitive assets categorized by repricing dates and weighted average yields at June 30, 2007. For fixed rate instruments, the repricing date is the maturity date. For adjustable-rate instruments, the repricing date is deemed to be the earliest possible interest rate adjustment date. Assets that are subject to immediate repricing are placed in the overnight column. 

 

 

 

**Within**

 

**Over One**

 

**Over Two**

 

**Over Three**

 

**Over Four**

 

**Over**

 

 

 

 

 

 

**One**

 

**to Two**

 

**to Three**

 

**to Four**

 

**to Five**

 

**Five**

 

 

 

 

**Overnight**

 

**Year**

 

**Years**

 

**Years**

 

**Years**

 

**Years**

 

**Years**

 

**Total**

 

 

**(dollars in thousands)**

Interest-bearing deposits

$63,879

 

$         -

 

$          -

 

$          -

 

$           -

 

$          -

 

$          -

 

$63,879

 

 

1.17%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Certificates of deposit

-

 

200

 

-

 

-

 

-

 

-

 

-

 

200

 

 

 

 

3.10%

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed-rate loans (1)

-

 

13,218

 

11,893

 

7,711

 

5,954

 

5,127

 

9,061

 

52,964

 

 

 

 

7.93%

 

7.77%

 

7.62%

 

7.44%

 

7.63%

 

6.80%

 

 

 

Adjustable-rate loans (1)

4,272

 

12,415

 

8,068

 

1,104

 

745

 

192

 

-

 

26,796

 

 

10.62%

 

8.21%

 

8.91%

 

6.73%

 

6.81%

 

7.14%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total rate-sensitive assets

$68,151

 

$25,833

 

$19,961

 

$  8,815

 

$   6,699

 

$  5,319

 

$  9,061

 

$143,839

 

 

(1) Loans are presented at net amounts before deducting the allowance for loan losses and exclude non-performing loans.

 

Based on Capital Crossing Preferred’s experience, management applies the assumption that, on average, approximately 12% of the outstanding fixed and adjustable rate loans will prepay annually.

 

**Item 4. Controls and Procedures**

 

Capital Crossing Preferred’s management, with the participation of its President and Controller, evaluated the effectiveness of Capital Crossing Preferred’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of June 30, 2007. Based on this evaluation, Capital Crossing Preferred’s President and Controller concluded that, as of June 30, 2007, Capital Crossing Preferred’s disclosure controls and procedures were (1) designed to ensure that material information relating to Capital Crossing Preferred is made known to the President and Controller by others within the entity, particularly during the period in which this report was being prepared, and (2) effective, in that they provide reasonable assurance that information required to be disclosed by Capital Crossing Preferred in the reports that it files or submits underthe Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms.

 

No change to our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the quarter ended June 30, 2007 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

**PART II**

 

**Item 1A. Risk Factors**

 

There were no material changes in Capital Crossing Preferred’s risk factors compared to those previously disclosed in its Form 10-K for the year ended December 31, 2006.

 

**Item 6. Exhibits**

31.1

Certification pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a) of the President.

31.2

Certification pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a) of the Controller.

32

Certification pursuant to 18 U.S.C. Section 1350 of the President and Controller.

 

 

16

 

 

 

**SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934, Capital Crossing Preferred Corporation has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. 

 

 

 

 

 

CAPITAL CROSSING PREFERRED CORPORATION

 

Date:     August 14, 2007

 

By:

   /s/ Richard Wayne

 

 

 

Richard Wayne

*President (Principal Executive Officer)*

 

 

 

 

CAPITAL CROSSING PREFERRED CORPORATION

 

Date:     August 14, 2007

 

By:

   /s/ Nancy E. Coyle

 

 

 

Nancy E. Coyle

*Controller (Principal Financial Officer)*

 

 

17

 

 

 

EXHIBIT INDEX

 

 

Exhibit

Item

Page Number

31.1

Certification pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a) of the President.

19

31.2

Certification pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a) of the Controller.

20

32

Certification pursuant to 18 U.S.C. Section 1350 of the President and Controller.

21

 

 

18

 

 

 

**Exhibit 31.1**

 

**CERTIFICATION**

 

I, Richard Wayne, certify that:

 

 

1.

I have reviewed this quarterly report on Form 10-Q of Capital Crossing Preferred Corporation (the “registrant”); 

 

 

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 officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) 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)

[Not applicable]

 

 

c)

Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our        conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

 

d)

Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

 

5.

The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

 

a)

All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

 

b)

Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

 

 

 

CAPITAL CROSSING PREFERRED CORPORATION

 

Date:     August 14, 2007

 

By:

   /s/ Richard Wayne

 

 

 

Richard Wayne

*President (Principal Executive Officer)*

 

 

19

 

 

 

**Exhibit 31.2**

**CERTIFICATION**

 

I, Nancy E. Coyle, certify that:

 

 

1.

I have reviewed this quarterly report on Form 10-Q of Capital Crossing Preferred Corporation (the “registrant”); 

 

 

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 officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) 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)

[Not applicable]

 

 

c)

Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

 

d)

Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

 

5.

The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

 

a)

All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

 

b)

Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

 

 

 

CAPITAL CROSSING PREFERRED CORPORATION

 

Date:     August 14, 2007

 

By:

   /s/ Nancy E. Coyle

 

 

 

Nancy E. Coyle

*Controller (Principal Financial Officer)*

 

 

20

 

 

 

**Exhibit 32**

 

**CERTIFICATION PURSUANT TO**

**18 U.S.C. SECTION 1350,**

**AS ADOPTED PURSUANT TO**

**SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002**

 

In connection with the accompanying Quarterly Report on Form 10-Q of Capital Crossing Preferred Corporation (the “Company”) for the period ended June 30, 2007 as filed with the Securities and Exchange Commission on the date hereof  (the “Report”), each of the undersigned, Richard Wayne, President of the Company and Nancy E. Coyle, Controller of the Company certify, pursuant to 18 U.S.C. 1350, as adopted pursuant to 906 of the Sarbanes-Oxley Act of 2002, to the best of his knowledge, that:

 

(1)  The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and

 

(2)  The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.

 

 

 

 

CAPITAL CROSSING PREFERRED CORPORATION

 

Date:     August 14, 2007

 

By:

   /s/ Richard Wayne

 

 

 

Richard Wayne

*President (Principal Executive Officer)*

 

 

 

 

CAPITAL CROSSING PREFERRED CORPORATION

 

Date:     August 14, 2007

 

By:

   /s/ Nancy E. Coyle

 

 

 

Nancy E. Coyle

*Controller (Principal Financial Officer)*

 

 

 

21

 

 

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