** **

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**WASHINGTON, D.C.20549

 

**FORM 10-Q**

 

**ý****  QUARTERLY REPORT PURSUANT TO SECTION 13 OR15(d) OF THE**

**SECURITIES EXCHANGE ACT OF 1934**

 

**For the Quarterly Period EndedSeptember 30, 2004**

 

**Commission File Number 000-25193**

 

**CAPITAL CROSSING PREFERRED CORPORATION**

(Exact name of registrant asspecified 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 theregistrant: (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor 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 ý  No o

 

Indicate by check mark whether the registrantis an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes o  No ý

 

Indicate the number of shares outstanding ofthe issuer’s common stock, $.01 par value per share, as of November 15, 2004: 100.

No common stock was held by non-affiliates ofthe issuer.

 

 

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**Capital Crossing Preferred Corporation**

**Table of Contents**

 

**PARTI – Financial Information**

 
| Item 1. Financial  Statements:                                                                       |                                                         |   |
|------------------------------------------------------------------------------------------------------|--------------------------------------------------------------|--------|
|                                                                                                 |                                                         |   |   |
|                                                                                                 | Balance Sheets                                               |   |   |
|                                                                                                 |                                                         |   |   |
|                                                                                                 | Statements  of Income                                        |   |   |
|                                                                                                 |                                                         |   |   |
|                                                                                                 | Statements  of Changes in Stockholders’ Equity          |   |   |
|                                                                                                 |                                                         |   |   |
|                                                                                                 | Statements  of Cash Flows                                    |   |   |
|                                                                                                 |                                                         |   |   |
|                                                                                                 | Notes to  Financial Statements                               |   |   |
|                                                                                                 |                                                         |   |   |
| Item  2. Management’s Discussion and Analysis of Financial Condition and Results of  Operations |                                                         |   |
|                                                                                                 |                                                         |   |   |
|                                                                                                 | Critical Accounting  Policies                                |   |   |
|                                                                                                 |                                                         |   |   |
|                                                                                                 | Results  of Operations                                       |   |   |
|                                                                                                 |                                                         |   |   |
|                                                                                                 | Financial Condition                                          |   |   |
|                                                                                                 |                                                         |   |   |
|                                                                                                 | Interest Rate Risk                                           |   |   |
|                                                                                                 |                                                         |   |   |
|                                                                                                 | Significant  Concentration of Credit Risk                    |   |   |
|                                                                                                 |                                                         |   |   |
|                                                                                                 | Liquidity Risk Management                                    |   |   |
|                                                                                                 |                                                         |   |   |
|                                                                                                 | Risk  Factors and Factors Affecting Future Operating Results |   |   |
|                                                                                                 |                                                         |   |   |
| Item  3. Quantitative and Qualitative Disclosures about Market Risk                                  |                                                         |   |
|                                                                                                 |                                                         |   |   |
| Item 4. Controls and  Procedures                                                                     |                                                         |   |
|                                                                                                 |                                                         |   |   |
| ** **                                                                                           | **PART II – Other  Information**                        |   |   |
|                                                                                                 |                                                         |   |   |
| Item  6. Exhibits                                                                                    |                                                         |   |
|                                                                                                 |                                                         |   |   |
|                                                                                                 | Signatures                                                   |   |   |
|                                                                                                 |                                                         |   |   |
|                                                                                                 | Exhibit  Index                                               |   |   |
|                                                                                                      |                                                              |        |  |  |

 

----

 

**PART I**

**Item 1.Financial Statements**

**Capital Crossing Preferred Corporation**

**BalanceSheets**

**(unaudited)**

** **
| ** **                                                                                                                                                                                                                | ** ** | **September 30,  2004**                | ** ** | **December 31,  2003** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|------------------------|------------|
| ** **                                                                                                                                                                                                                | ** ** | **(in  thousands, except share data)** | ** ** |
| **ASSETS**                                                                                                                                                                                                                | ** ** | ** **                             | ** ** | ** **             | ** ** |
| ** **                                                                                                                                                                                                                | ** ** | ** **                             | ** ** | ** **             | ** ** |
| Cash account with Capital Crossing Bank                                                                                                                                                                                   |       | $                                      | 91         |                   | $          | 90 |   |
| Interest bearing deposits with Capital  Crossing Bank                                                                                                                                                                     |       | 143,889                                |       | 65,755                 |       |
| Total cash and cash equivalents                                                                                                                                                                                           |       | 143,980                                |       | 65,845                 |       |
|                                                                                                                                                                                                                      |       |                                   |       |                   |       |
| Certificate of deposit                                                                                                                                                                                                    |       | 200                                    |       | 200                    |       |
|                                                                                                                                                                                                                      |       |                                   |       |                   |       |
| Loans                                                                                                                                                                                                                     |       | 139,900                                |       | 177,930                |       |
| Less discount and net deferred loan income                                                                                                                                                                                |       | (15,612                                | )          | (19,578                | )          |
| Less allowance for loan losses                                                                                                                                                                                            |       | (2,367                                 | )          | (3,281                 | )          |
| Loans, net                                                                                                                                                                                                                |       | 121,921                                |       | 155,071                |       |
| Accrued interest receivable                                                                                                                                                                                               |       | 525                                    |       | 737                    |       |
| Other assets                                                                                                                                                                                                              |       | 5                                      |       | —                 |       |
|                                                                                                                                                                                                                      |       |                                   |       |                   |       |
|                                                                                                                                                                                                                      |       | $                                      | 266,631    |                   | $          | 221,853 |   |
|                                                                                                                                                                                                                      |       |                                   |       |                   |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                            | ** ** | ** **                             | ** ** | ** **             | ** ** |
| ** **                                                                                                                                                                                                                | ** ** | ** **                             | ** ** | ** **             | ** ** |
| Accrued expenses and other liabilities                                                                                                                                                                                    |       | $                                      | 1,533      |                   | $          | 423 |   |
| Total liabilities                                                                                                                                                                                                         |       | 1,533                                  |       | 423                    |       |
| Commitments and  contingencies                                                                                                                                                                                            |       |                                   |       |                   |       |
| 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                                    |       | 14                                     |       | 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, 941 and 940 shares issued and outstanding,  respectively |       | —                                 |       | —                 |       |
| Preferred stock, Series C, 10.25%  non-cumulative, exchangeable; $.01 par value; $10 liquidation value per  share; 1,840,000 shares authorized, issued and outstanding                                                    |       | 18                                     |       | 18                     |       |
| Preferred stock, Series D, 8.50%  non-cumulative, exchangeable; $.01 par value; $25 liquidation value per  share; 1,500,000 shares authorized, issued and outstanding at September 30,  2004                              |       | 15                                     |       | —                 |       |
| Common stock, $.01 par value, 100 shares  authorized, issued and outstanding                                                                                                                                              |       | —                                 |       | —                 |       |
| Additional paid-in capital                                                                                                                                                                                                |       | 246,483                                |       | 211,240                |       |
| Retained earnings                                                                                                                                                                                                         |       | 18,568                                 |       | 10,158                 |       |
| Total stockholders’ equity                                                                                                                                                                                           |       | 265,098                                |       | 221,430                |       |
|                                                                                                                                                                                                                      |       |                                   |       |                   |       |
|                                                                                                                                                                                                                      |       | $                                      | 266,631    |                   | $          | 221,853 |   |

 

See accompanying notes to unaudited interim financial statements.

 

1

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**Capital Crossing Preferred Corporation**

**Statements of Income**

**(unaudited)**

** **
| ** **                                           | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                           | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                           | ** ** | **(in thousands)**                    | ** ** |
|                                                 |       |                                  |       |                                 |       |   |   |   |   |
| Interest income:                                     |       |                                  |       |                                 |       |   |   |   |   |
| Interest and fees on loans                           |       | $                                     | 2,685      |                                 | $          | 4,544 |   | $ | 10,724 |   | $ | 15,950 |   |
| Interest on interest-bearing  deposits               |       | 391                                   |       | 103                                  |       | 909 |   | 1,165 |   |
| Total interest income                                |       | 3,076                                 |       | 4,647                                |       | 11,633 |   | 17,115 |   |
|                                                 |       |                                  |       |                                 |       |   |   |   |   |
| Credit for loan losses                               |       | 101                                   |       | 1,000                                |       | 865 |   | 3,400 |   |
| Total interest income, after  credit for loan losses |       | 3,177                                 |       | 5,647                                |       | 12,498 |   | 20,515 |   |
|                                                 |       |                                  |       |                                 |       |   |   |   |   |
| Other income:                                        |       |                                  |       |                                 |       |   |   |   |   |
| Gain on distribution of loans  to common stockholder |       | —                                |       | 3,008                                |       | — |   | 3,008 |   |
| Gain on sale of loans                                |       | —                                |       | —                               |       | 76 |   | — |   |
| Guarantee fee income                                 |       | 20                                    |       | 20                                   |       | 60 |   | 60 |   |
| Total other income                                   |       | 20                                    |       | 3,028                                |       | 136 |   | 3,068 |   |
|                                                 |       |                                  |       |                                 |       |   |   |   |   |
| Operating expenses:                                  |       |                                  |       |                                 |       |   |   |   |   |
| Loan servicing and advisory  services                |       | 89                                    |       | 133                                  |       | 290 |   | 457 |   |
| Other real estate owned income                       |       | —                                |       | (19                                  | )          | — |   | (361 | ) |
| Other general and  administrative                    |       | 46                                    |       | 126                                  |       | 179 |   | 251 |   |
| Total operating expenses                             |       | 135                                   |       | 240                                  |       | 469 |   | 347 |   |
|                                                 |       |                                  |       |                                 |       |   |   |   |   |
| Net income                                           |       | 3,062                                 |       | 8,435                                |       | 12,165 |   | 23,236 |   |
|                                                 |       |                                  |       |                                 |       |   |   |   |   |
| Preferred stock dividends                            |       | 1,633                                 |       | 835                                  |       | 3,755 |   | 2,506 |   |
| Net income available to common  stockholder          |       | $                                     | 1,429      |                                 | $          | 7,600 |   | $ | 8,410 |   | $ | 20,730 |   |
|                                                      |            |                                       |            |                                      |            |  |  |  |  |  |  |  |  |  |  |

 

See accompanying notes to unaudited interimfinancial statements.

 

2

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**CapitalCrossing Preferred Corporation**

**Statements of Changes in Stockholders' Equity**

**(unaudited)**

** **
| ** **                                               | ** ** | **Nine  Months Ended September 30, 2004** | ** ** |
|----------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                               | ** ** | **Preferred  Stock  Series A**            | ** ** | **Preferred  Stock  Series B** | ** ** | **Preferred  Stock  Series C** | ** ** | **Preferred  Stock  Series D** | ** ** | **Common  Stock** | ** ** | **Additional  Paid-in  Capital** | ** ** | **Retained  Earnings** | ** ** | **Total  Stockholders'  Equity** | ** ** |
| ** **                                               | ** ** | **Shares**                                | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** | ** ** | ** ** | ** ** |
| ** **                                               | ** ** | **(dollars  in thousands)**               | ** ** |
|                                                     |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Balance at  December 31, 2003                            |       | 1,416,130                                 |       | $ | 14 |   | 941 |   | $ | — |   | 1,840,000 |   | $ | 18 |   | — |   | $ | — |   | 100 |   | $ | — |   | $ | 211,240 |   | $ | 10,158 |   | $ | 221,430 |   |
| Net income                                               |       | —                                    |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | 12,165 |   | 12,165 |   |
| Net proceeds from  issuance of preferred stock, Series D |       | —                                    |       | — |   | — |   | — |   | — |   | — |   | 1,500,000 |   | 15 |   | — |   | — |   | 35,244 |   | — |   | 35,259 |   |
| Dividends on  preferred stock, Series A                  |       | —                                    |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | (1,036 | ) | (1,036 | ) |
| Cumulative  dividends on preferred stock, Series B       |       | —                                    |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | (56 | ) | (56 | ) |
| Dividends on  preferred stock, Series C                  |       | —                                    |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | (1,415 | ) | (1,415 | ) |
| Dividends on  preferred stock, Series D                  |       | —                                    |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | (1,248 | ) | (1,248 | ) |
| Repurchase of  preferred stock, Series B                 |       | —                                    |       | — |   | (1 | ) | — |   | — |   | — |   | — |   | — |   | — |   | — |   | (1 | ) | — |   | (1 | ) |
| Balance at  September 30, 2004                           |       | 1,416,130                                 |       | $ | 14 |   | 940 |   | $ | — |   | 1,840,000 |   | $ | 18 |   | 1,500,000 |   | $ | 15 |   | 100 |   | $ | — |   | $ | 246,483 |   | $ | 18,568 |   | $ | 265,098 |   |

 
|                                               |   | **Nine  Months Ended September 30, 2003** |   |
|----------------------------------------------------|--------|-------------------------------------------|--------|
|                                               |   | **Preferred  Stock  Series A**            |   | **Preferred  Stock  Series B** |   | **Preferred  Stock  Series C** |   | **Preferred  Stock  Series D** |   |   |   |   |   | **Additional** |   |   |   | **Total** |   |
|                                               |   |                                      |   |   |   | **Common  Stock** |   | **Paid-in** |   | **Retained** |   | **Stockholders'** |   |
|                                               |   | **Shares**                                |   | **Amount** |   | **Shares** |   | **Amount** |   | **Shares** |   | **Amount** |   | **Shares** |   | **Amount** |   | **Shares** |   | **Amount** |   | **Capital** |   | **Earnings** |   | **Equity** |   |
|                                               |   | **(dollars  in thousands)**               |   |
|                                               |   |                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Balance at  December 31, 2002                      |   | 1,416,130                                 |   | $ | 14 |   | 941 |   | $ | — |   | 1,840,000 |   | $ | 18 |   | — |   | $ | — |   | 100 |   | $ | — |   | $ | 329,475 |   | $ | 2,052 |   | $ | 331,559 |   |
| Net income                                         |   | —                                    |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | 23,236 |   | 23,236 |   |
| Dividends on  preferred stock, Series A            |   | —                                    |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | (1,035 | ) | (1,035 | ) |
| Cumulative  dividends on preferred stock, Series B |   | —                                    |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | (56 | ) | (56 | ) |
| Dividends on  preferred stock, Series C            |   | —                                    |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | (1,415 | ) | (1,415 | ) |
| Return of capital  to common stockholder           |   | —                                    |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | (118,235 | ) | — |   | (118,235 | ) |
| Common stock  dividend                             |   | —                                    |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | (16,132 | ) | (16,132 | ) |
| Balance at  September 30, 2003                     |   | 1,416,130                                 |   | $ | 14 |   | 941 |   | $ | — |   | 1,840,000 |   | $ | 18 |   | — |   | $ | — |   | 100 |   | $ | — |   | $ | 211,240 |   | $ | 6,650 |   | $ | 217,922 |   |

 

See accompanying notes to the unaudited interim financial statements.

 

3

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**Capital Crossing Preferred Corporation**

**Statements of Cash Flows**

**(unaudited)**

** **
| ** **                                                                         | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                         | ** ** | **2004**                            | ** ** | **2003** | ** ** |
| ** **                                                                         | ** ** | **(in thousands)**                  | ** ** |
| Cash flows provided by  operating activities:                                      |       |                                |       |   |   |
| Net income                                                                         |       | $                                   | 12,165     |   | $ | 23,236 |   |
| Adjustments to reconcile net  income to net cash provided by operating activities: |       |                                |       |   |   |
| Gain on sale of other real  estate owned                                           |       | —                              |       | (334 | ) |
| Gain on distribution of loans  to common stockholder                               |       | —                              |       | (3,008 | ) |
| Credit for loan losses                                                             |       | (865                                | )          | (3,400 | ) |
| Gain on sale of loans                                                              |       | (76                                 | )          | — |   |
| Other, net                                                                         |       | 1,317                               |       | 457 |   |
|                                                                               |       |                                |       |   |   |
| Net cash provided by operating  activities                                         |       | 12,541                              |       | 16,951 |   |
|                                                                               |       |                                |       |   |   |
| Cash flows provided by investing  activities:                                      |       |                                |       |   |   |
| Loan repayments                                                                    |       | 33,596                              |       | 64,522 |   |
| Proceeds from sales of other  real estate owned                                    |       | —                              |       | 1,585 |   |
| Proceeds from loan sales                                                           |       | 495                                 |       | — |   |
|                                                                               |       |                                |       |   |   |
| Net cash provided by investing  activities                                         |       | 34,091                              |       | 66,107 |   |
|                                                                               |       |                                |       |   |   |
| Cash flows provided by (used  in) financing activities:                            |       |                                |       |   |   |
| Issuance of preferred stock,  series D                                             |       | 35,259                              |       | — |   |
| Return of capital to common  stockholder                                           |       | —                              |       | (109,906 | ) |
| Repurchase of preferred stock,  Series B                                           |       | (1                                  | )          | — |   |
| Payment of preferred stock  dividend                                               |       | (3,755                              | )          | (2,506 | ) |
| Payment of common stock  dividends                                                 |       | —                              |       | (15,094 | ) |
|                                                                               |       |                                |       |   |   |
| Net cash provided by (used in)  financing activities                               |       | 31,503                              |       | (127,506 | ) |
|                                                                               |       |                                |       |   |   |
| Net change in cash and cash  equivalents                                           |       | 78,135                              |       | (44,448 | ) |
| Cash and cash equivalents at  beginning of period                                  |       | 65,845                              |       | 92,710 |   |
|                                                                               |       |                                |       |   |   |
| Cash and cash equivalents at  end of period                                        |       | $                                   | 143,980    |   | $ | 48,262 |   |
|                                                                               |       |                                |       |   |   |
| Supplemental information:                                                          |       |                                |       |   |   |
| Return of capital to common  stockholders in the form of mortgage loans            |       | $                                   | —     |   | $ | 8,329 |   |
| Dividend to common stockholder  in the form of mortgage loans                      |       | —                              |       | 1,038 |   |
| Transfers from loans to other  real estate                                         |       | —                              |       | 1,251 |   |

 

See accompanying notes to unaudited interimfinancial statements.

 

4

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**Capital Crossing Preferred CorporationNotes to Unaudited FinancialStatementsThree and Nine Month Periods Ended September 30, 2004 and 2003**

 

**Note1.   Basis of Presentation**

 

CapitalCrossing Preferred Corporation (‘‘Capital Crossing Preferred’’) is aMassachusetts corporation organized on March 20, 1998, to acquire and hold realestate assets. Capital Crossing Bank (‘‘Capital Crossing’’), a federallyinsured Massachusetts trust company, owns all of Capital Crossing Preferred’scommon stock (as defined below). Capital Crossing is in compliance with itsregulatory capital requirements at September 30, 2004.

 

On March 31,1998, Capital Crossing Preferred was initially capitalized with the issuance toCapital Crossing of 100 shares of Capital Crossing Preferred’s common stock,$.01 par value, and 1,000 shares of Series B preferred stock, $.01 par value,with Capital Crossing transferring to Capital Crossing Preferred a portfolio ofloans at its estimated fair value of $140,740,000. Such loans were recorded inthe accompanying balance sheet at Capital Crossing’s historical cost, whichapproximated their estimated fair values.

 

In 1999,Capital Crossing Preferred completed the sale of 1,416,130 shares of Series Apreferred stock. In 2001, Capital Crossing Preferred completed the sale of1,840,000 shares of Series C preferred stock. In May 2004, Capital Crossing Preferred completed the sale of 1,500,000shares of Series D preferred stock.

 

The financialinformation as of September 30, 2004 and the results of operations for thethree and nine months ended September 30, 2004 and 2003, changes instockholders’ equity and cash flows for the nine months ended September 30,2004 and 2003 are unaudited; however, in the opinion of management, thefinancial information reflects all adjustments (consisting solely of normalrecurring accruals) necessary for a fair presentation in accordance withaccounting principles generally accepted in the United States of America.  Interim results are not necessarilyindicative of results to be expected for the entire year.  These interim statements are intended to beread in conjunction with the financial statements presented in Capital CrossingPreferred’s Annual Report on Form 10-K as of and for the year ended December31, 2003.

 

In preparingfinancial statements in conformity with accounting principles generallyaccepted in the United States of America, management is required to makeestimates and assumptions that affect the reported amounts of assets andliabilities as of the date of the balance sheet and reported amounts ofrevenues and expenses during the reporting period.  Actual results could differ from thoseestimates.  Material estimates that areparticularly susceptible to significant change in the near term relate to thedetermination of the allowance for losses on loans, the allocation of purchasediscount between amortizing and non-amortizing portions, and the rate at whichthe discount is accreted into interest income.

 

*Recent Accounting Pronouncements*

 

EffectiveJanuary 1, 2005, and as a result of the required adoption of Statement ofPosition (‘‘SOP’’) No. 03-3, ‘‘Accounting for Certain Loans or Debt SecuritiesAcquired in a Transfer,’’ Capital Crossing Preferred’s allowance for loan lossmethodology will change. SOP No. 03-3 prohibits ‘‘carrying over’’ or creationof valuation allowances in the initial accounting of all loans acquired in atransfer. The prohibition of the valuation allowance carry over applies to thepurchase of an individual loan, a pool of loans, a group of loans and impairedloans acquired in a business combination. Valuation allowances should reflectonly those losses incurred by the investor after acquisition.  Effective January 1, 2005, Capital CrossingPreferred will no longer be allowed to increase the allowance throughallocations from purchase discount. Additionally, general risk allocations will no longer be applied topurchased loans.  Only specificallocations based upon the results of measuring loans that become impairedsubsequent to purchase under SFAS No. 114 will be considered in the calculationof the allowance for loan losses for purchased loans.  Consequently, it is anticipated that theallowance for loan losses will decline subsequent to the adoption of SOP No.03-3 as credits for loan losses may continue to be recorded if loans pay-offand perform above expectations.

 

#### **Note 2.  Commitmentsand Contingencies**

 

*Guarantees*

 

CapitalCrossing Preferred has guaranteed all of the obligations of Capital Crossingunder advances Capital Crossing may receive from time to time from the FederalHome Loan Bank of Boston (“FHLBB”), and Capital Crossing Preferred has agreedto pledge a significant amount of its assets in connection with those advances.This guarantee would rank senior to the preferred shares upon liquidation.Capital Crossing Preferred’s obligations under this agreement are limited byapplicable laws pertaining to fraudulent conveyance and fraudulent transfer.The assets pledged to the FHLBB will vary from time to time, however thepotential exists for

 

5

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Capital Crossing Preferred topledge all of its assets to the FHLBB to secure advances to Capital Crossing.In addition, Capital Crossing has pledged to the FHLBB all of the shares ofCapital Crossing Preferred’s capital stock it owns as collateral for its FHLBBborrowings.  Under the terms of thepledge, if Capital Crossing becomes undercapitalized, the FHLBB may requireCapital Crossing to dissolve Capital Crossing Preferred such that the assets ofCapital Crossing Preferred are distributed to Capital Crossing. In suchcircumstance, holders of the Series A, Series C and Series D preferred stockwould receive their liquidation preference only to the extent there areavailable proceeds from the liquidation of the assets of Capital CrossingPreferred following satisfaction of its outstanding obligations, including itsguarantee of Capital Crossing’s FHLBB borrowings.  At September 30, 2004, approximately $31.3million, or 11.7%, of Capital Crossing Preferred’s assets had been pledged toand accepted by the FHLBB to secure advances to Capital Crossing.  As of September 30, 2004, Capital Crossinghad $138.8 million in outstanding FHLBB borrowings.

 

#### **Note 3.  SeriesD Preferred Stock Offering**

 

On May 11,2004, Capital Crossing Preferred closed its offering of 1,500,000 shares ofSeries D non-cumulative exchangeable preferred stock at $25 per share, whichyielded net proceeds of $35.3 million after deducting the underwriting discountof 4%, or $1.5 million and additional expenses of $741,000.

 

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

 

This Form 10-Q contains “forward-lookingstatements” within the meaning of Section 27A of the Securities Act of1933 and Section 21E of the Securities Exchange Act of 1934. CapitalCrossing Preferred may also make written or oral forward-lookingstatements in other documents filed with the Securities and Exchange Commission(“SEC”), in press releases and other written materials, and in oral statementsmade by its officers or directors. Forward-looking statements can beidentified by the use of the words “believe,” “expect,” “anticipate,” “intend,”“estimate,” “assume,” “will,” “should,” and other expressions which predict orindicate future events and trends and which do not relate to historicalmatters. Forward-looking statements should not be unduly relied uponbecause they involve known and unknown risks, uncertainties and other factors,some of which are beyond the control of Capital Crossing Preferred. Theserisks, uncertainties and other factors may cause the actual results,performance or achievements of Capital Crossing Preferred to be materiallydifferent from the anticipated future results, performance or achievements thatare expressed or implied by the forward-looking statements.

 

Capital Crossing Preferred’s actual resultscould differ materially from those projected in the forward-lookingstatements as a result, among other factors, of the factors discussed in thesection entitled “Risk Factors and Factors Affecting Future Operating Results”of this Form 10-Q.

 

All of these factors should be carefully reviewed, and the reader ofthis Form 10-Q should be aware that there may be other factors thatcould cause these differences. These forward-looking statements werebased on information, plans and estimates at the date of this report, andCapital Crossing Preferred does not promise to update any forward-lookingstatements to reflect changes in underlying assumptions or factors, newinformation, future events or other changes.

 

**Executive Level Overview**

 

Net incomeavailable to the sole common stockholder, Capital Crossing, decreased $5.4million, or 63.7%, to $3.1 million for the three months ended September 30,2004 compared to $8.4 million for the same period in 2003.  Net income available to the sole commonstockholder decreased $11.1 million, or 47.6%, to $12.2 million for the ninemonths ended September 30, 2004 compared to $23.2 million for the same periodin 2003.  These decreases from the 2003to 2004 periods are primarily the result of a decline in interest and fees onloans, a decline in gain on distribution of loans to common stockholder, adecline in credit for loan losses as well as the absence of other real estateowned income.  In addition, there was anincrease in preferred stock dividends attributable to the issuance of Series Dpreferred stock on May 11, 2004.

 

During thesecond quarter of 2004, $35.3 million of additional capital was raised throughthe issuance of 1,500,000 shares of Series D preferred stock.  This capital will be utilized to purchaseadditional mortgage assets and for other corporate purposes.  During 2003 and through the third quarter of2004, Capital Crossing Preferred did not acquire any mortgage assets. Returnsof capital of $118.2 million were made during 2003. Decisions regarding theutilization of our cash are based, in large part, on our future commitments topay preferred stock dividends. During the third quarter of 2004, our loanportfolio was large enough to generate income resulting in earnings which were1.88 times fixed charges and preferred stock dividends. Future decisionsregarding mortgage asset acquisitions will be based on the level of preferredstock dividends at the time and the required level of income necessary togenerate adequate dividend coverage.

 

6

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** **

**Critical Accounting Policies**

 

The SECrequires that all registrants discuss their most ‘‘critical accounting policies’’in management’s discussion and analysis of financial condition and results ofoperations. The SEC indicated that a ‘‘critical accounting policy’’ is onewhich is both important to the portrayal of the company’s financial conditionand results and requires management’s most difficult, subjective or complexjudgments, often as a result of the need to make estimates about the effect ofmatters that are inherently uncertain. While Capital Crossing Preferred’ssignificant accounting policies are more fully described in Note 1 to theFinancial Statements included in its Annual Report on Form 10-K, the followingis a summary of the accounting policies believed by management to be mostcritical in their potential effect on Capital Crossing Preferred’s financialposition or results of operations:

 

**Allowancefor Loan Losses.**Arriving at an appropriate level ofallowance for loan losses requires a high degree of judgment. Capital CrossingPreferred maintains an allowance for probable loan losses that are inherent inits loan portfolio. The initial allowance for loan losses was transferred fromCapital Crossing at the time of the initial transfer of loans to CapitalCrossing Preferred and additional transfers are made in connection with eachtransfer of loans from Capital Crossing. Additionally, the allowance for loanlosses is increased upon allocation of purchase discount upon acquisition ofloans and decreased upon sales or pay-offs of loans for which a relatedallowance remains unused. The allocation of allowance at the time ofacquisition is generally finalized no later than ninety days from the date ofpurchase.  Reductions in connection withsales are included in the calculation of the gain or loss, and reductionsrelated to pay-offs are recorded as a credit for loan losses. Loan losses arecharged against the allowance when management believes the net investment ofthe loan, or a portion thereof, is uncollectible. Subsequent recoveries, ifany, are credited to the allowance when cash payments are received.

 

Managementmakes significant judgments in determining the adequacy of the allowance forloan losses. Management initially considers the loan loss allowancesspecifically allocated to individual impaired loans. Next, management considersthe level of general loan loss allowances deemed appropriate for the balance ofthe portfolio. Factors considered include known and inherent risks in thenature and volume of the loan portfolios, adverse situations that may affectthe borrower’s ability to repay, historical loss ranges, the estimated value ofany underlying collateral and prevailing economic conditions. An additionalallowance for loan losses is maintained based on a judgmental process wherebymanagement considers qualitative and quantitative assessments of other factorsincluding regional credit concentration, industry concentration, results ofregulatory examinations, historical loss ranges, portfolio composition,economic conditions such as interest rates and energy costs and other changesin the portfolio. The allowance for loan losses is management’s estimate of theprobable loan losses incurred as of the balance sheet date. There can be noassurance that Capital Crossing Preferred’s actual losses with respect to loanswill not exceed its allowance for loan losses.

 

EffectiveJanuary 1, 2005, and as a result of the required adoption of SOP No. 03-3, ‘‘Accountingfor Certain Loans or Debt Securities Acquired in a Transfer,’’ Capital CrossingPreferred’s allowance for loan loss methodology will change. SOP No. 03-3prohibits ‘‘carrying over’’ or creation of valuation allowances in the initialaccounting of all loans acquired in a transfer. The prohibition of thevaluation allowance carry over applies to the purchase of an individual loan, apool of loans, a group of loans and impaired loans acquired in a businesscombination. Valuation allowances should reflect only those losses incurred bythe investor after acquisition. Effective January 1, 2005, Capital Crossing Preferred will no longer beallowed to increase the allowance through allocations from purchasediscount.  Additionally, general riskallocations will no longer be applied to purchased loans.  Only specific allocations based upon theresults of measuring loans that become impaired subsequent to purchase underSFAS No. 114 will be considered in the calculation of the allowance for loanlosses for purchased loans. Consequently, it is anticipated that the allowance for loan losses willdecline subsequent to the adoption of SOP No. 03-3 as credits for loan lossesmay continue to be recorded as loans pay-off and perform above expectations.

 

**Discountson Acquired Loans.**At the time of acquisition ofpurchased pools of loans, the excess of the contractual balances over theamount of reasonably estimable and probable discounted future cash collectionsfor each loan is allocated between non-amortizing discount and the allowancefor loan losses. Depending on the timing of an acquisition, a preliminaryallocation may be utilized until a final allocation is established. Generally,the allocation will be finalized no later than ninety days from the date ofpurchase. The remaining discount, which represents the excess of the amount ofreasonably estimable and probable discounted future cash collections over theacquisition amount is accreted into interest income using the interest methodover the term of the loans and is not accreted on non-performing loans. Thereis judgment involved in estimating the amount of future cash flows. The amountand timing of actual cash flows could differ materially from management’sestimates, which could materially affect Capital Crossing Preferred’s financialcondition and results of operations.

 

Thenon-amortizing discount is not accreted into income until it is determined thatthe amount and timing of the related cash flows are reasonably estimable andcollection is probable. If cash flows cannot be reasonably estimated for anyloan, and collection is not probable, the cost recovery method of accounting isused. Under the cost recovery method, any amounts received are applied againstthe recorded amount of the loan. Non-amortizing discount is generally offsetagainst the related principal balance when the amount at which a loan isresolved or restructured is determined. There is no effect on the incomestatement as a result of these reductions.

 

7

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Subsequent toacquisition, if cash flow projections improve, and it is determined that theamount and timing of the cash flows related to the non-amortizing discount arereasonably estimable and collection is probable, the corresponding decrease inthe non-amortizing discount is transferred to the amortizing portion and isaccreted into interest income over the remaining life of the loan on theinterest method. If cash flow projections deteriorate subsequent toacquisition, the decline is accounted for through the allowance for loanlosses.

 

When a loan ispaid-off, the excess of any cash received over the net investment is recordedas interest income. In addition to the amount of purchase discount that isrecognized at that time, income may also include interest owed by the borrowerprior to Capital Crossing’s acquisition of the loan, interest collected if onnon-performing status, prepayment fees and other loan fees.

 

Gains and losseson sales of loans are determined using the specific identification method. Theexcess (deficiency) of any cash received as compared to the net investment isrecorded as gain (loss) on sales of loans. There are no loans held for sale atSeptember 30, 2004.

 

Changes ininterest rates also can affect the value of Capital Crossing Preferred’s loansand its ability to realize gains on the resolution of assets. A significantportion of Capital Crossing Preferred’s earnings results from acceleratedinterest income resulting from loan pay-offs. This type of income can varysignificantly from quarter to quarter and year to year based on a number ofdifferent factors, includingthe interest rate environment. An increase in interest rates that adverselyaffects the ability of borrowers to pay the principal or interest on CapitalCrossing Preferred’s loans may lead to a reduction of discount accreted intoincome, which could have a material adverse effect on its results ofoperations.

 

#### **Resultsof Operations**

 

***Three Months Ended September30, 2004 and 2003***

 

The yields on Capital Crossing Preferred’searning assets are summarized as follows:

 
| ** **                | ** ** | **Three Months Ended September 30,** | ** ** |
|---------------------------|------------|--------------------------------------|------------|
| ** **                | ** ** | **2004**                             | ** ** | **2003** | ** ** |
|                      |       | **Average  Balance**                 | ** ** | **Interest  Income** | ** ** | **Yield** | ** ** | **Average  Balance** | ** ** | **Interest  Income** | ** ** | **Yield** | ** ** |
|                      |       | **(dollars in thousands)**           | ** ** |
|                      |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Loans, net (1)            |       | $                                    | 125,957    |   | $ | 2,685 |   | 8.48 | % | $ | 185,191 |   | $ | 4,544 |   | 9.73 | % |
| Interest-bearing deposits |       | 141,281                              |       | 391 |   | 1.10 |   | 37,536 |   | 103 |   | 1.09 |   |
|                      |       | $                                    | 267,238    |   | $ | 3,076 |   | 4.58 | % | $ | 222,727 |   | $ | 4,647 |   | 8.28 | % |

 

----

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

 

The decline in interest income for the threemonths ended September 30, 2004 compared to the three months ended September30, 2003 is primarily due to the decline in interest income on loans due toboth a decline in the average balance and the yield.  The yield on interest-earning assetsalso decreased primarily due to a shift in the composition of averageinterest-earning assets such that average loans represents a smaller percentageof total average interest-earning assets for the three months ended September30, 2004 as compared to the same period in 2003.  Average loans, net for the three months endedSeptember 30, 2004 totaled $126.0 million compared to $185.2 millionfor the same period in 2003.  Thisdecrease is primarily attributable to loan pay-offs and amortization.  During 2003 and through September 30, 2004,Capital Crossing Preferred did not acquire any loans.  The yield on the loan portfolio decreasedprimarily as a result of a decrease in interest income recognized at the timeof individual loan pay-offs.

 

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

 

8

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When a loan is paid-off, the excess of anycash received over the net investment is recorded as interest income. Inaddition 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’sacquisition of the loan, interest collected if on non-performing status and other loanfees (collectively, ‘‘other interest income’’). The following table sets forth,for the periods indicated, the components of interest and fees on loans. Therecan be no assurance regarding future interest income, including the yields andrelated level of such income, or the relative portion attributable to loanpay-offs as compared to other sources.

 
| ** **                                           | ** ** | **Three Months Ended September 30,** | ** ** |
|------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                           | ** ** | **2004**                             | ** ** | **2003** | ** ** |
| ** **                                           | ** ** | **Interest  Income**                 | ** ** | **Yield** | ** ** | **Interest  Income** | ** ** | **Yield** | ** ** |
| ** **                                           | ** ** | **(dollars in thousands)**           |       |
|                                                 |       |                                 |       |   |   |   |   |   |   |
| Regularly scheduled interest  and accretion income   |       | $                                    | 2,368      |   | 7.48 | % | $ | 3,585 |   | 7.68 | % |
| Interest and fee income  recognized on loan payoffs: |       |                                 |       |   |   |   |   |   |   |
| Non-amortizing discount                              |       | —                               |       | — |   | 107 |   | 0.23 |   |
| Amortizing discount                                  |       | 126                                  |       | 0.40 |   | 507 |   | 1.08 |   |
| Other interest and fee income                        |       | 191                                  |       | 0.60 |   | 345 |   | 0.74 |   |
|                                                 |       | 317                                  |       | 1.00 |   | 959 |   | 2.05 |   |
|                                                 |       | $                                    | 2,685      |   | 8.48 | % | $ | 4,544 |   | 9.73 | % |

 

The amount of loan pay-offsand related discount income is influenced by several factors, including theinterest rate environment, the real estate market in particular areas, thetiming of transactions, and circumstances related to individual borrowers andloans.

 

The average balance ofinterest-bearing deposits increased $103.7 million or 276.4% to $141.3 millionfor the three months ended September 30, 2004, compared to $37.5 million forthe 2003 period, as a result of cash flows from loan repayments and theproceeds from the Series D preferred stock offering on May 11, 2004 offset byperiodic dividend payments, returns of capital and proceeds from loans sold.

 

A credit forloan losses of $101,000 was recorded for the three months ended September 30,2004 compared to a credit for loan losses of $1.0 million recorded for thethree months ended September 30, 2003. The credit for loan losses is based on the volume of loan pay-offs.  As loans pay off, a credit for loan losses isrecorded to reduce allowance allocations related to the loans that havepaid-off and loans which have performed above original expectations. Theallowance for loan losses is based on the size of the portfolio and itshistorical performance. The determination of this allowance requires the use ofestimates and assumptions regarding the risks inherent in individual loans andthe loan portfolio in its entirety. Should the loan portfolio continue todecline without utilization of the allowance for loan losses, future creditsfor loans losses may be necessary.

 

Loan servicingand advisory services expenses for the three months ended September 30, 2004decreased $44,000, or 33.1%, to $89,000 compared to $133,000 for the threemonths ended September 30, 2003. This decrease was due to the decrease in theaverage balance of the loan portfolio.

 

There was no other real estate owned income during the three monthsended September 30, 2004.  Other realestate owned income for the three months ended September 30, 2003 was comprisedof rental income of $19,000.

 

Other general and administrative expenses decreased $80,000, or 63.5%,to $46,000 for the three months ended September 30, 2004 compared to $126,000for the three months ended September 30, 2003. This decrease is primarilyattributable to a decrease in legal fees related to loan collection matters.

 

Preferredstock dividends increased as a result of the issuance of 1,500,000 shares ofSeries D preferred shares on May 11, 2004. These shares have a liquidation value of $25 per share and a dividendrate of 8.5%.  Capital Crossing Preferredintends to pay dividends on its preferred stock and common stock in amountsnecessary to continue to preserve its status as a REIT under the InternalRevenue Code.

 

9

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***Nine Months Ended September 30,2004 and 2003***

 

The yields on Capital Crossing Preferred’searning assets are summarized as follows:

 
| ** **                | ** ** | **Nine Months Ended September 30,** | ** ** |
|---------------------------|------------|-------------------------------------|------------|
| ** **                | ** ** | **2004**                            | ** ** | **2003** | ** ** |
| ** **                | ** ** | **Average  Balance**                | ** ** | **Interest  Income** | ** ** | **Yield** | ** ** | **Average  Balance** | ** ** | **Interest  Income** | ** ** | **Yield** | ** ** |
| ** **                | ** ** | **(dollars in thousands)**          |       |
| ** **                | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |   |
| Loans, net (1)            |       | $                                   | 137,065    |   | $ | 10,724 |   | 10.45 | % | $ | 208,498 |   | $ | 15,950 |   | 10.23 | % |
| Interest-bearing deposits |       | 110,335                             |       | 909 |   | 1.10 |   | 92,696 |   | 1,165 |   | 1.68 |   |
|                      |       | $                                   | 247,400    |   | $ | 11,633 |   | 6.28 | % | $ | 301,194 |   | $ | 17,115 |   | 7.60 | % |
|                           |            |                                     |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

 

The decline in interest incomefrom the nine months ended September 30, 2003 to the 2004 period is primarily aresult of a decrease in the average balance of loans, in addition to a declinein the yield on interest-bearing deposits. The decline in yield on interest-earning assets is due to a shift in thecomposition of average interest-bearing assets such that average loansrepresents a smaller percentage of total average interest-bearing assets forthe nine months ended September 30, 2004 as compared to the same period in2003.  Average loans, net for the ninemonths ended September 30, 2004 totaled $137.1 million compared to$208.5 million for the same period in 2003.  This decrease is primarily attributable toloan pay-offs, sales, and amortization since the third quarter of 2003.  During 2003 and through September 30, 2004,Capital Crossing Preferred did not acquire any loans.  The yield on the loan portfolio increased asa result of an increase in interest income recognized at the time of individualloan pay-offs, relative to the overall yield, mainly attributable to anincrease in the amount of amortizing discount recognized as income.

 

Income on loans includes the portion of thepurchase discount that is accreted into income over the remaining lives of therelated loans using the interest method. Because the carrying value of the loanportfolio is net of purchase discount, the related yield on this portfoliogenerally is higher than the aggregate contractual rate paid on the loans. Thetotal yield includes the excess of a loan’s expected discounted future cashflows 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 interestincome. In addition to the amount of purchase discount that is recognized atthat time, income may also include interest owed by the borrower prior toCapital Crossing’s acquisition of the loan, interest collected if on non-performingstatus and other loan fees (collectively, “other interest income”). Thefollowing table sets forth, for the periods indicated, the components ofinterest and fees on loans. There can be no assurance regarding future interestincome, including the yields and related level of such income, or the relativeportion attributable to loan pay-offs as compared to other sources.

 
| ** **                                            | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                            | ** ** | **2004**                            | ** ** | **2003** | ** ** |
| ** **                                            | ** ** | **Interest  Income**                | ** ** | **Yield** | ** ** | **Interest  Income** | ** ** | **Yield** | ** ** |
| ** **                                            | ** ** | ** **                          | ** ** | **(dollars in thousands)** | ** ** | ** ** |   |
| ** **                                            | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |   |
| Regularly scheduled interest  and accretion income    |       | $                                   | 7,902      |   | 7.70 | % | $ | 12,046 |   | 7.73 | % |
| Interest and fee income  recognized on loan pay-offs: |       |                                |       |   |   |   |   |   |   |
| Non-amortizing discount                               |       | 91                                  |       | 0.09 |   | 968 |   | 0.62 |   |
| Amortizing discount                                   |       | 2,237                               |       | 2.18 |   | 2,481 |   | 1.59 |   |
| Other interest and fee income                         |       | 494                                 |       | 0.48 |   | 455 |   | 0.29 |   |
|                                                  |       | 2,822                               |       | 2.75 |   | 3,904 |   | 2.50 |   |
|                                                  |       | $                                   | 10,724     |   | 10.45 | % | $ | 15,950 |   | 10.23 | % |

 

10

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The amount of loan pay-offsand related discount income is influenced by several factors, including theinterest rate environment, the real estate market in particular areas, thetiming of transactions, and circumstances related to individual borrowers andloans.

 

The average balance of interest-bearingdeposits increased $17.6 million to $110.3 million for the nine months endedSeptember 30, 2004, compared to $92.7 million for the same period in 2003, as aresult of cash flows from loan repayments, the proceeds from the Series D stockoffering on May 11, 2004 and proceeds from loans sold offset by periodicdividend payments and returns of capital.  The yield on interest-bearing deposits for thenine months ended September 30, 2004 decreased compared to the 2003 period as aresult of a decline in the interest rate environment.

 

Capital Crossing Preferred recorded a creditfor loan losses of $865,000 for the nine months ended September 30, 2004,compared to a credit for loan losses of $3.4 million for the nine months endedSeptember 30, 2003.  The credit for loanlosses is based on the volume of loan payoffs. As loans pay off, a credit for loan losses is recorded to reduceallowance allocations related to the loans that have paid-off and loans whichhave performed above original expectations. The allowance for loan losses isbased on the size of the portfolio and its historical performance. The determinationof this allowance requires the use of estimates and assumptions regarding therisks inherent in individual loans and the loan portfolio in its entirety.  Should the loan portfolio continue to declinewithout utilization of the allowance for loan losses, future credits for loanslosses may be necessary.

 

During thenine months ended September 30, 2004 there was one loan sale to an unaffiliatedthird party resulting in a gain of $76,000. There were no loan sales during the nine months ended September 30,2003.

 

Loan servicing and advisory services expensesfor the nine months ended September 30, 2004 decreased $167,000, or 36.5%, to$290,000 compared to $457,000 for the nine months ended September 30, 2003.This decrease was due to the decrease in the average balance of the loanportfolio.

 

There was no other real estate owned incomeduring the nine months ended September 30, 2004.  Other real estate owned income for the ninemonths ended September 30, 2003 was comprised of a gain of $334,000 on the saleof one property to an unaffiliated third party and rental income of $27,000.

 

Other general and administrative expenses for the nine months endedSeptember 30, 2004 decreased $72,000, or 28.7%, to $179,000 compared to$251,000 for the nine months ended September 30, 2003.  This decrease was due primarily to a decreasein legal fees related to loan collection matters.

 

Preferredstock dividends increased as a result of the issuance of 1,500,000 shares ofSeries D preferred shares on May 11, 2004. These shares have a liquidation value of $25 per share and a dividendrate of 8.5%.  Capital Crossing Preferredintends to pay dividends on its preferred stock and common stock in amountsnecessary to continue to preserve its status as a REIT under the Internal RevenueCode.

 

11

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**Financial Condition**

 

**Interest-bearingDeposits with Capital Crossing Bank**

 

Interest-bearingdeposits with Capital Crossing Bank consists of money market accounts atSeptember 30, 2004 and December 31, 2003. The balance of interest-bearing deposits increased $78.1 million to$143.9 million at September 30, 2004 compared to $65.8 million at December 31,2003. The increase in the balance of interest-bearing deposits is the result ofcash flows from loan repayments and proceeds from the Series D preferred stockoffering, offset by periodic dividend payments and returns of capital.

 

##### **Loan Portfolio**

 

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

 
| ** **                     | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|--------------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                     |       | **(in thousands )**     |       |
| Mortgage loans on real estate: |       |                    |       |                   |       |
| Commercial real estate         |       | $                       | 92,747     |                   | $          | 120,317 |   |
| Multi-family residential       |       | 41,434                  |       | 50,390                 |       |
| One-to-four family residential |       | 1,208                   |       | 1,714                  |       |
| Land                           |       | 4,485                   |       | 5,481                  |       |
|                           |       | 139,874                 |       | 177,902                |       |
| Other loans                    |       | 26                      |       | 28                     |       |
| Total loans, gross             |       | 139,900                 |       | 177,930                |       |
|                           |       |                    |       |                   |       |
| Less:                          |       |                    |       |                   |       |
| Non-amortizing discount        |       | (1,041                  | )          | (1,524                 | )          |
| Amortizing discount            |       | (14,510                 | )          | (17,962                | )          |
| Net deferred loan fees         |       | (61                     | )          | (92                    | )          |
| Allowance for loan losses      |       | (2,367                  | )          | (3,281                 | )          |
|                           |       |                    |       |                   |       |
| Loans, net                     |       | $                       | 121,921    |                   | $          | 155,071 |   |

 

Capital Crossing Preferred acquires primarilyperforming commercial real estate and multifamily residential mortgageloans.  No loans were acquired in 2003 orin the first nine months of 2004, as the existing portfolio was large enough togenerate an adequate dividend coverage ratio.

 

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

 

From time to time, returns of capital may be made to Capital Crossing.This would have the effect of reducing the asset size of Capital CrossingPreferred.

 

There were no non-performing loans as of September 30, 2004.  Non-performing loans, net of discount,totaled $17,000 at December 31, 2003.

 

Loans generally are placed on non-performing status and theaccrual of interest and accretion of discount are generally discontinued whenthe collectibility of principal and interest is not probable or estimable. Unpaidinterest income previously accrued on such loans is reversed against currentperiod interest income. A loan is returned to accrual status when it is broughtcurrent in accordance with management’s anticipated cash flows at the time ofacquisition.

 

12

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***Non-Amortizing Discount.***Atthe time of acquisition of purchased pools of loans, the excess of thecontractual balances over the amount of reasonably estimable and probablediscounted future cash collections for each loan is allocated betweennon-amortizing discount and the allowance for loan losses. Depending on thetiming of an acquisition, a preliminary allocation may be utilized until afinal allocation is established. Generally, the allocation will be finalized nolater than ninety days from the date of purchase. The remaining discount, whichrepresents the excess of the amount of reasonably estimable and probablediscounted future cash collections over the acquisition amount is accreted intointerest income using the interest method over the term of the loans and is notaccreted on non-performing loans. There is judgment involved in estimating theamount of future cash flows. The amount and timing of actual cash flows coulddiffer materially from management’s estimates, which could materially affectCapital Crossing Preferred’s financial condition and results of operations.

 

Thenon-amortizing discount is not accreted into income until it is determined thatthe amount and timing of the related cash flows are reasonably estimable andcollection is probable. If cash flows cannot be reasonably estimated for anyloan, and collection is not probable, the cost recovery method of accounting isused. Under the cost recovery method, any amounts received are applied againstthe recorded amount of the loan. Non-amortizing discount is generally offsetagainst the related principal balance when the amount at which a loan isresolved or restructured is determined. There is no effect on the incomestatement as a result of these reductions.

 

Subsequent toacquisition, if cash flow projections improve, and it is determined that theamount and timing of the cash flows related to the non-amortizing discount arereasonably estimable and collection is probable, the corresponding decrease inthe non-amortizing discount is transferred to the amortizing portion and isaccreted into interest income over the remaining life of the loan on theinterest method. If cash flow projections deteriorate subsequent toacquisition, the decline is accounted for through the allowance for loanlosses.

 

Included in net loans, at September 30, 2004and December 31, 2003, are approximately $2.3 million and $6.7 million (ofwhich none are non-performing), respectively, for which the net recorded investmentrepresents the amortized cost of these loans, where at acquisition, the amountsof reasonably estimable and probable discounted future cash collections wereless than the contractual balances owed. These loans were purchased at a priceto yield a market rate of interest after considering the credit quality of theloans at acquisition and the aforementioned expected future cash collections.The excess of the contractual balances over the amount of reasonably estimableand probable discounted future cash collections represents the predominantportion of the $1.0 million and $1.5 million of non-amortizing discount atSeptember 30, 2004 and December 31, 2003, respectively.

 

The following table sets forth certaininformation relating to the activity in the non-amortizing discount forthe periods indicated:

 
| ** **                                                                         | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                         | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                         | ** ** | **(in thousands )**                   | ** ** |
|                                                                               |       |                                  |       |                                 |       |   |   |   |   |
| Balance at beginning of period                                                     |       | $                                     | 1,167      |                                 | $          | 6,614 |   | $ | 1,524 |   | $ | 8,158 |   |
| Accretion                                                                          |       | —                                |       | (107                                 | )          | (91 | ) | (967 | ) |
| Transfers to amortizing portion  upon improvements in cash flows                   |       | (126                                  | )          | (1,619                               | )          | (281 | ) | (2,268 | ) |
| Net reductions related to  resolutions and restructures                            |       | —                                |       | —                               |       | — |   | (35 | ) |
| Non-amortizing discount  relating to loans sold or distributed to Capital Crossing |       | —                                |       | (3,359                               | )          | (111 | ) | (3,359 | ) |
| Balance at end of period                                                           |       | $                                     | 1,041      |                                 | $          | 1,529 |   | $ | 1,041 |   | $ | 1,529 |   |

 

***Allowance for Loan Losses.***CapitalCrossing Preferred maintains an allowance for loan losses that are known andinherent in its loan portfolio. The allowance for loan losses is increased ordecreased through a provision or credit for loan losses included in earnings.Additionally, the allowance for loan losses is increased upon allocation ofpurchase discount upon acquisition of loans and decreased upon sales andpay-offs of loans for which a related allowance remains unused. The allocationof allowance at the time of acquisition is generally finalized no later thanninety days from the date of purchase. Loans are charged-off when they aredeemed to be uncollectible, or partially charged-off when a portion of a loanis deemed uncollectible. Subsequent recoveries, if any, are credited to theallowance when cash payments are received.

 

CapitalCrossing Preferred performs reviews of its loan portfolio to identify loans forwhich specific allocations are considered prudent. Specific allocations includethe results of measuring impaired loans under Statement of Financial AccountingStandards No. 114. General risk allocations are determined by a formula wherebythe loan portfolio is stratified by type and by

 

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internal risk ratingcategories. Loss factors are then applied to each strata based on variousconsiderations including historic loss experience, delinquency trends, currenteconomic conditions, industry standards and regulatory guidelines. This amountis adjusted from time to time based upon actual experience. An additionalallowance is maintained based on a judgment by management after considerationof qualitative and quantitative assessments of certain factors includingregional credit concentration, industry concentration, results of regulatoryexaminations, historical loss ranges, portfolio composition, economic conditionssuch as interest rates and energy costs and other changes in the portfolio. Theallowance for loan losses is management’s estimate of the probable loan lossesincurred as of the balance sheet date.

 

Additionalfactors influencing the calculation of the allowance for loan losses areparticular concentrations within the portfolio, including the geographicconcentration of loans in California, which accounted for approximately 48.6%of the portfolio at September 30, 2004, and concentrations of loans to individualborrowers.

 

CapitalCrossing Preferred’s allowance for loan losses at September 30, 2004 was $2.4million. The determination of this allowance requires the use of estimates andassumptions regarding the risks inherent in individual loans and the loanportfolio in its entirety. In addition, regulatory agencies periodically review the adequacy ofthe allowance for loan losses and may require Capital Crossing Preferred tomake additions to its allowance for loan losses. While management believes itsestimates and assumptions are reasonable, there can be no assurance that theywill be proven to be correct in the future. The actual amount of futureprovisions that may be required cannot be determined, and such provisions mayexceed the amounts of past provisions. Management believes that the allowancefor loan losses is adequate to absorb the known and inherent risks in CapitalCrossing Preferred’s loan portfolio at each date based on the facts known tomanagement as of such dates. Management continues to monitor and modify theallowances for general and specific loan losses as economic conditions dictate.

 

EffectiveJanuary 1, 2005, and as a result of the required adoption of SOP No. 03-3, ‘‘Accountingfor Certain Loans or Debt Securities Acquired in a Transfer,’’ Capital CrossingPreferred’s allowance for loan loss methodology will change. SOP No. 03-3prohibits ‘‘carrying over’’ or creation of valuation allowances in the initialaccounting of all loans acquired in a transfer. The prohibition of the valuationallowance carry over applies to the purchase of an individual loan, a pool ofloans, a group of loans and impaired loans acquired in a business combination.Valuation allowances should reflect only those losses incurred by the investorafter acquisition.  Effective January 1,2005, Capital Crossing Preferred will no longer be allowed to increase theallowance through allocations from purchase discount.  Additionally, general risk allocations willno longer be applied to purchased loans. Only specific allocations based upon the results of measuring loans thatbecome impaired subsequent to purchase under SFAS No. 114 will be considered inthe calculation of the allowance for loan losses for purchased loans.  Consequently, it is anticipated that theallowance for loan losses will decline subsequent to the adoption of SOP No.03-3 as credits for loan losses may continue to be recorded as loans pay-offand perform above expectations.

 

The followingtable sets forth certain information relating to the activity in the allowancefor loan losses for the periods indicated:

 
| ** **                                           | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                           | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                 |       | **(in thousands)**                    |       |
|                                                 |       | ** **                            |       |
| Balance at beginning of period                       |       | $                                     | 2,468      |                                 | $          | 4,954 |   | $ | 3,281 |   | $ | 7,354 |   |
| Credit for loan losses                               |       | (101                                  | )          | (1,000                               | )          | (865 | ) | (3,400 | ) |
| Net reduction relating to loans  sold or distributed |       | —                                |       | (164                                 | )          | (49 | ) | (164 | ) |
| Balance at end of period                             |       | $                                     | 2,367      |                                 | $          | 3,790 |   | $ | 2,367 |   | $ | 3,790 |   |

 

#### **InterestRate Risk**

 

CapitalCrossing Preferred’s income consists primarily of interest income. If there isa decline in market interest rates, Capital Crossing Preferred may experience areduction in interest income and a corresponding decrease in funds available tobe distributed to its shareholders. The reduction in interest income may resultfrom downward adjustments of the indices upon which the interest rates on loansare 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 tomanage its interest rate risk.

 

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**Significant Concentration of Credit Risk**

 

Concentration of credit risk generally ariseswith respect to Capital Crossing Preferred’s loan portfolio when a number ofborrowers engage in similar business activities, or activities in the samegeographical region. Concentration of credit risk indicates the relativesensitivity of Capital Crossing Preferred’s performance to both positive andnegative developments affecting a particular industry. Capital CrossingPreferred’s balance sheet exposure to geographic concentrations directlyaffects the credit risk of the loans within its loan portfolio.

 

At September30, 2004, 48.6% and 14.2% of Capital Crossing Preferred’s total loan portfolioconsisted of loans in California  and NewEngland, respectively. At December 31, 2003, 44.5% and 14.5% of CapitalCrossing Preferred’s total real estate loan portfolio consisted of loanslocated in California and New England, respectively. Consequently, theportfolio may experience a higher default rate in the event of adverseeconomic, political or business developments or natural hazards in Californiaor New England that may affect the ability of property owners to make paymentsof principal and interest on the underlying mortgages.

 

#### **LiquidityRisk Management**

 

The objectiveof liquidity management is to ensure the availability of sufficient cash flowsto meet all of Capital Crossing Preferred’s financial commitments and tocapitalize on opportunities for Capital Crossing Preferred’s businessexpansion. In managing liquidity risk, Capital Crossing Preferred takes intoaccount various legal limitations placed on a REIT.  Capital Crossing Preferred’s principalliquidity need is to maintain an adequate loan portfolio size through theacquisition of additional mortgage assets as mortgage assets currently in theloan portfolio mature, pay down or prepay, in order to pay dividends on thepreferred shares and common shares.

 

Theacquisition of additional mortgage assets is intended to be funded primarilythrough repayment of principal balances of mortgage assets by individualborrowers. Capital Crossing Preferred does not have and does not anticipatehaving any material capital expenditures. To the extent that the Board ofDirectors determines that additional funding is required, Capital CrossingPreferred may raise such funds through additional equity offerings, debt financingor retention of cash flow (after consideration of provisions of the InternalRevenue Code requiring the distribution by a REIT of at least 90% of its REITtaxable income and taking into account taxes that would be imposed onundistributed income), or a combination of these methods. Except for itsobligation to guarantee certain borrowings of Capital Crossing, CapitalCrossing Preferred does not currently intend to incur any indebtedness. Theorganizational documents of Capital Crossing Preferred limit the amount ofindebtedness which it is permitted to incur without the approval of the SeriesA, Series C and Series D preferred stockholders to no more than 100% of thetotal stockholders’ equity of Capital Crossing Preferred. Any such debt mayinclude intercompany advances made by Capital Crossing to Capital CrossingPreferred.

 

CapitalCrossing Preferred may also issue additional series of preferred stock.However, Capital Crossing Preferred may not issue additional shares ofpreferred stock ranking senior to the Series A, Series C or Series D preferredshares without the consent of holders of at least two-thirds of the Series A,Series C and Series D preferred shares outstanding at that time. AlthoughCapital Crossing Preferred’s charter does not prohibit or otherwise restrictCapital Crossing or its affiliates from holding and voting shares of Series A,Series C or Series D preferred stock, to Capital Crossing Preferred’s knowledgethe amount of shares of Series A, Series C and Series D preferred shares heldby Capital Crossing or its affiliates is insignificant (less than 1%).Additional shares of preferred stock ranking on a parity with the Series A,Series C and Series D preferred shares may not be issued without the approvalof a majority of Capital Crossing Preferred’s independent directors.

 

# **RISK FACTORS AND FACTORS AFFECTING FUTURE OPERATING RESULTS**

 

*Set forth below are a number of risk factors that may cause CapitalCrossing Preferred’s actual results to differ materially from anticipatedfuture results, performance or achievements expressed or implied by theforward-looking statement. All of these factors should be carefully reviewed,and the reader of this Form 10-Q should be aware that there may be otherfactors that could cause these differences.*

 

**A decline in Capital Crossing’s capitallevels may result in the Series A, Series C and Series D preferred shares beingsubject to automatic exchange into preferred shares of Capital Crossing**

 

The returnsfrom an investment in the Series A, Series C or Series D preferred shares willdepend to a significant extent on the performance and capital of CapitalCrossing. A significant decline in the performance and capital levels ofCapital Crossing or the placement of Capital Crossing into bankruptcy, reorganization,conservatorship or receivership could result in the automatic exchange of theSeries A, Series C and Series D preferred shares for preferred shares ofCapital Crossing, which would represent an investment in Capital Crossing andnot in Capital Crossing Preferred. Under these circumstances:

 

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• a holder of Series A, Series C orSeries D preferred shares would be a preferred stockholder of Capital Crossingat a time when Capital Crossing’s financial condition was deteriorating or whenCapital Crossing had been placed into bankruptcy, reorganization,conservatorship or receivership and, accordingly, it is unlikely that CapitalCrossing would be in a financial position to pay any****dividends on the preferred shares ofCapital Crossing. An investment in Capital Crossing is also subject to risksthat are distinct from the risks associated with an investment in CapitalCrossing Preferred. For example, an investment in Capital Crossing wouldinvolve risks relating to the capital levels of, and other federal and stateregulatory requirements applicable to, Capital Crossing, and the performance ofCapital Crossing’s overall loan portfolio and other business lines. CapitalCrossing also has significantly greater liabilities and significantly lessstockholders’ equity than does Capital Crossing Preferred;

 

• if a liquidation of Capital Crossingoccurs, the claims of depositors and creditors of Capital Crossing and of theFDIC would have priority over the claims of holders of the preferred shares ofCapital Crossing, and therefore, a holder of Series A, Series C and Series Dpreferred shares likely would receive substantially less than such holder wouldreceive had the Series A, Series C and Series D preferred shares not beenexchanged for preferred shares of Capital Crossing; and

 

• the exchange of the Series A, Series Cor Series D preferred shares for preferred shares of Capital Crossing would bea taxable event to a holder of Series A, Series C or Series D preferred sharesunder the Internal Revenue Code, and such holder would incur a gain or a loss,as the case may be, measured by the difference between such holder’s basis inthe Series A, Series C or Series D preferred shares and the fair market valueof Capital Crossing preferred shares received in the exchange.

 

**Because of Capital Crossing Preferred’sobligations to creditors, it may not be able to make dividend or liquidationpayments to holders of the Series A, Series C and Series D preferred shares**

 

The Series A, Series C and Series D preferredshares rank:

 

• junior to borrowings of CapitalCrossing Preferred, including claims of the FHLBB for amounts due or which maybecome due under Capital Crossing Preferred’s guarantee of Capital Crossing’sobligations to the FHLBB, and any other obligations to Capital CrossingPreferred’s creditors upon its liquidation. As of September 30, 2004, Capital Crossing had $138.8 million inoutstanding FHLBB borrowings;

 

• senior to Capital Crossing Preferred’scommon stock and its Series B preferred stock with regard to payment ofdividends and amounts upon liquidation.

 

If CapitalCrossing Preferred incurs significant indebtedness, it may not have sufficientfunds to make dividend or liquidation payments on the Series A, Series C orSeries D preferred shares. Upon Capital Crossing Preferred’s liquidation, itsobligations to its creditors would rank senior to the Series A, Series C andSeries D preferred shares. At September 30, 2004, Capital Crossing Preferredhad approximately $85,000 in accounts payable and other liabilities which, uponits liquidation, would be required to be paid before any payments could be madeto holders of the Series A, Series C or Series D preferred shares. In addition,upon Capital Crossing Preferred’s liquidation, dissolution or winding up, if itdoes not have sufficient funds to pay the full liquidation amount to theholders of the Series A, Series C and Series D preferred shares, such holdersmay receive less than the per share liquidation amount.

 

The terms ofthe Series A, Series C and Series D preferred shares limit Capital CrossingPreferred’s ability to incur debt in excess of 100% of its stockholders’ equitywithout the approval of the holders of all of the outstanding Series A, SeriesC and Series D preferred shares but do not require that Capital CrossingPreferred obtain the approval of the holders of the Series A, Series C andSeries D preferred shares to issue additional series of preferred shares whichrank equal to the Series A, Series C and Series D preferred shares as topayment of dividends or amount upon liquidation. As a result, subject to theselimitations, Capital Crossing Preferred may incur obligations which may furtherlimit its ability to make dividend or liquidation payments in the future.

 

**Bank regulators may limit the ability ofCapital Crossing Preferred to implement its business plan and may restrict itsability to pay dividends**

 

BecauseCapital Crossing Preferred is a subsidiary of Capital Crossing, federal andstate regulatory authorities will have the right to examine it and itsactivities and under certain circumstances, to impose restrictions on CapitalCrossing or Capital Crossing Preferred which could impact Capital CrossingPreferred’s ability to conduct its business according to its business plan,which could materially adversely affect the financial condition and results ofoperations of Capital Crossing Preferred:

 

• if Capital Crossing’s regulatorsdetermine that Capital Crossing’s relationship to Capital Crossing Preferredresults in an unsafe and unsound banking practice, the regulators couldrestrict Capital Crossing Preferred’s ability to transfer assets, to makedistributions to its stockholders, including dividends on its Series A, SeriesC and Series D preferred shares, or to redeem shares of Series A, Series C andSeries D preferred stock or even require Capital Crossing to sever itsrelationship

 

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with or divestits ownership interest in Capital Crossing Preferred. Such actions couldpotentially result in Capital Crossing Preferred’s failure to qualify as aREIT.

 

• payment of dividends on the Series A,Series C and Series D preferred shares could also be subject to regulatorylimitations if Capital Crossing becomes undercapitalized. Capital Crossing willbe deemed undercapitalized if its total risk-based capital ratio is less than8.0%, its Tier 1 risk-based capital ratio is less than 4.0% or its Tier 1leverage ratio is less than 4.0%. At September 30, 2004, Capital Crossing had atotal risk-based capital ratio of 20.00%, a Tier 1 risk-based capital ratio of14.62% and a Tier 1 leverage ratio of 10.73%, which is sufficient for CapitalCrossing to be considered well-capitalized. As part of its common stock repurchaseprogram, Capital Crossing has also agreed with the FDIC to maintain, for solong as the repurchase program continues, its Tier 1 leverage ratio at least7.00%, as well as remaining well capitalized. Capital Crossing Preferred makesno assurance that Capital Crossing will be well-capitalized under applicableregulations as of any future date, which is required in order to continue torepurchase common stock, but which is not a condition to the payment ofdividends on the preferred shares. For purposes of calculating these capitalratios as a percentage of Capital Crossing’s risk-weighted assets, as opposedto its total assets, Capital Crossing’s assets are assigned to risk categoriesbased on the relative credit risk of the asset in question. These risk weightsconsist of 0% for assets deemed least risky such as cash, claims backed by thefull faith and credit of the U.S. government, and balances due from FederalReserve banks; 20% for assets deemed slightly more risky such as portions ofobligations conditionally guaranteed by the U.S. government or federal fundssold; 50% for assets deemed still more risky such as government issued-revenuebonds, one-to-four family residential first mortgage loans andwell-collateralized multi-family residential first mortgage loans; and 100% forall other assets, including private sector loans such as commercial mortgageloans as well as bank-owned real estate.

 

• while Capital Crossing Preferredbelieves that dividends on the Series A, Series C and Series D preferred sharesshould not be considered distributions by Capital Crossing, the FDIC may notagree with this position. Under FDIC regulations on capital distributions, theability of Capital Crossing to make a capital distribution varies dependingprimarily on Capital Crossing’s earnings and regulatory capital levels. Capitaldistributions are defined to include payment of dividends, stock repurchases,cash-out mergers and other distributions charged against the capital accountsof an institution. The FDIC could limit or prohibit the payment of dividends onthe Series A, Series C and Series D preferred shares if it determines that thepayment of those dividends is a capital distribution by Capital Crossing andthat Capital Crossing’s earnings and regulatory capital levels are belowspecified levels.

 

**Capital Crossing Preferred does not haveinsurance to cover its exposure to borrower defaults and bankruptcies andspecial hazard losses that are not covered by its standard hazard insurancepolicies**

 

CapitalCrossing Preferred does not normally obtain general credit enhancements such asmortgagor bankruptcy insurance or obtain special hazard insurance for itsmortgage assets, other than standard hazard insurance, which will in each caseonly relate to individual mortgage loans. Accordingly, Capital CrossingPreferred will be subject to risks of borrower defaults and bankruptcies andspecial hazard losses, such as losses occurring from floods or earthquakes thatare not covered by standard hazard insurance. A significant number of loansacquired in recent years are loans that were originated under the SmallBusiness Administration’s disaster relief program. These loans are typicallyloans made to small businesses and individuals for the purpose of assistingthose who have been the victim of a disaster and may be located in an areaprone to such disasters. In the event of a default on any mortgage loan held byCapital Crossing Preferred resulting from declining property values orworsening economic conditions, among other factors, it would bear the risk ofloss of principal to the extent of any deficiency between (1) the value of therelated mortgaged property, plus any payments from an insurer or guarantor inthe case of commercial mortgage loans, and (2) the amount owing on the mortgageloan.

 

**Capital Crossing Preferred’s results will beaffected by factors beyond its control**

 

CapitalCrossing Preferred’s mortgage loan portfolio is subject to local economicconditions which could affect the value of the real estate assets underlyingits loans and therefore, its results of operations will be affected by variousconditions in the real estate market, all of which are beyond its control, suchas:

 

• local and other economic conditionsaffecting real estate values;

 

• the continued financial stability of aborrower and the borrower’s ability to make mortgage payments;

 

• the ability of tenants to make leasepayments;

 

• the ability of a property to attractand retain tenants, which may in turn be affected by local conditions, such asoversupply of space or a reduction in demand for rental space in the area;

 

• interest rate levels and theavailability of credit to refinance mortgage loans at or prior to maturity; and

 

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• increased operating costs, includingenergy costs, real estate taxes and costs of compliance with environmentalcontrols and regulations.

 

**Capital Crossing Preferred’s loans areconcentrated in California and New England and adverse conditions in thosemarkets could adversely affect its operations**

 

Propertiesunderlying Capital Crossing Preferred’s current mortgage assets areconcentrated primarily in California, particularly Southern California, and NewEngland. As of September 30, 2004, approximately 48.6% of the balances of itsmortgage loans were secured by properties located in California and 14.2% inNew England. Adverse economic, political or business developments or naturalhazards may affect these areas and the ability of property owners in theseareas to make payments of principal and interest on the underlying mortgages.If either region experienced adverse economic, political or business conditionsor natural hazards, Capital Crossing Preferred would likely experience higherrates of loss and delinquency on its mortgage loans than if its loans were moregeographically diverse.

 

**A substantial majority of Capital CrossingPreferred’s loans were originated by other parties whose level of due diligencemay be different than Capital Crossing’s level of due diligence**

 

At September30, 2004, substantially all of Capital Crossing Preferred’s loans consisted ofloans originated by third parties that were purchased by Capital Crossing andsubsequently acquired by Capital Crossing Preferred from Capital Crossing.Because these loans were originated by third parties, Capital Crossinggenerally is not able to conduct the same level of due diligence on these loansthat it would have conducted had it originated them. Generally, while CapitalCrossing conducts an acquisition review, it relies on the underwritingstandards of the parties originating the loans it acquires. The standards ofthese loan originators may be substantially different than those of CapitalCrossing. These differences may include less rigorous appraisal requirementsand debt service coverage ratios, and less rigorous analysis of propertylocation and environmental factors, building condition and age, tenant quality,compliance with zoning regulations, any use restrictions, easements or right ofways that may impact the value and the borrower’s ability to manage theproperty. Other disadvantages of purchased loans versus originated loans mayinclude the lack of current financial information, incomplete legaldocumentation and outdated appraisals.

 

**More than half of Capital Crossing Preferred’sloan portfolio is made up of commercial mortgage loans which are generallyriskier than other types of loans**

 

Commercialmortgage loans constituted approximately 66.3% of the total gross loans inCapital Crossing Preferred’s loan portfolio at September 30, 2004 andcommercial mortgage loans are generally subject to greater risks than othertypes of loans. Capital Crossing Preferred’s commercial mortgage loans, likemost commercial mortgage loans, generally lack standardized terms, tend to haveshorter maturities than residential mortgage loans and may not be fullyamortizing, meaning that they have a principal balance or ‘‘balloon’’ paymentdue on maturity. The commercial real estate properties underlying CapitalCrossing Preferred’s commercial mortgage loans also tend to be unique and aremore difficult to value than residential real estate properties. They are alsosubject to relatively greater environmental risks than other types of loans andto the corresponding burdens and costs of compliance with environmental lawsand regulations. Because of these risks related to commercial mortgage loans,Capital Crossing Preferred may experience higher rates of default on itsmortgage loans than it would if its loan portfolio was more diversified andincluded a greater number of owner-occupied residential or other mortgageloans. Higher rates of default would cause Capital Crossing Preferred toincrease its provision for loan losses, which may have a material adverseaffect on its business, financial condition and results of operation.

 

**Capital Crossing Preferred may not be able topurchase loans at the same volumes or with the same yields as it hashistorically purchased**

 

To dateCapital Crossing Preferred has purchased all of the loans in its portfolio fromCapital Crossing. Historically, Capital Crossing has acquired such loans (1)from institutions which sought to eliminate certain loans or categories ofloans from their portfolios, (2) from institutions participating in securitizationprograms, (3) from failed or consolidating financial institutions and (4) fromgovernment agencies, specifically the Small Business Administration. Futureloan purchases will depend on the availability of pools of loans offered forsale and Capital Crossing’s ability to submit successful bids or negotiatesatisfactory purchase prices. The acquisition of loans is highly competitive.In fact, the Small Business Administration has recently announced that allfuture assets sales are on hold, pending the outcome of an internal review ofits loan sale program. Consequently, Capital Crossing Preferred cannot provideassurance that Capital Crossing will be able to purchase loans at the samevolumes or with the same yields as it has historically purchased. This mayinterfere with Capital Crossing Preferred’s ability to maintain the requisitelevel of mortgage assets to maintain its qualification as a REIT. If volumes ofloans purchased or the yields on these loans decline, Capital****CrossingPreferred would experience a material adverse effect on its business, financialcondition and results of operations.

 

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**Capital Crossing Preferred could be heldresponsible for environmental liabilities of properties it acquires throughforeclosure**

 

If CapitalCrossing Preferred chooses to foreclose on a defaulted mortgage loan to recoverits investment it may be subject to environmental liabilities related to theunderlying real property. Approximately 66.3% of the loans in Capital CrossingPreferred’s portfolio at September 30, 2004 were commercial mortgage loans,which generally are subject to relatively greater environmental risks thanother types of loans. Hazardous substances or wastes, contaminants, pollutantsor sources thereof may be discovered on properties during Capital CrossingPreferred’s ownership or after a sale to a third party. The amount ofenvironmental liability could exceed the value of the real property. There canbe no assurance that Capital Crossing Preferred would not be fully liable forthe entire cost of any removal and clean-up on an acquired property, that thecost of removal and clean-up would not exceed the value of the property or thatCapital Crossing Preferred could recoup any of the costs from any third party.In addition, Capital Crossing Preferred may find it difficult or impossible tosell the property prior to or following any such remediation.  The incurrence of any significantenvironmental liabilities with respect to a property securing a mortgage loancould have a material adverse effect on Capital Crossing Preferred’s business,financial condition and results of operations.

 

**Capital Crossing Preferred is dependent invirtually every phase of its operations on the diligence and skill of the managementof Capital Crossing**

 

CapitalCrossing, which holds all of Capital Crossing Preferred’s common stock, isinvolved in virtually every aspect of Capital Crossing Preferred’s existence.Capital Crossing Preferred has six officers, including three executiveofficers, and no other employees and does not have any independent corporateinfrastructure. Capital Crossing Preferred does not have any employees becauseit has retained Capital Crossing to perform all necessary functions pursuant tothe advisory agreement and the master service agreement. All of CapitalCrossing Preferred’s officers are also officers of Capital Crossing. Under anadvisory agreement between Capital Crossing Preferred and Capital Crossing,Capital Crossing administers day-to-day activities, including monitoring ofCapital Crossing Preferred’s credit quality and advising it with respect to theacquisition, management, financing and disposition of mortgage assets and itsoperations generally. Under a master service agreement between Capital CrossingPreferred and Capital Crossing, Capital Crossing services Capital CrossingPreferred’s loan portfolio. The advisory agreement has an initial term of fiveyears with an automatic renewal feature and the master service agreement has aone-year term with an automatic renewal feature. Both the master serviceagreement and the advisory agreement are subject to earlier termination uponprovision of 30 days and 90 days notice, respectively. Capital Crossing maysubcontract all or a portion of its obligations under the advisory agreement toits affiliates or, with the approval of a majority of the Board of Directors aswell as a majority of the independent directors, subcontract its obligationsunder the advisory agreement to unrelated third parties. Capital Crossing willnot, in connection with the subcontracting of any of its obligations under theadvisory agreement, be discharged or relieved from its obligations under theadvisory agreement. The loss of the services of Capital Crossing, or the inabilityof Capital Crossing to effectively provide such services whether as a result ofthe loss of key members of Capital Crossing’s management, early termination ofthe agreements or otherwise, and Capital Crossing Preferred’s inability toreplace such services on favorable terms, or at all, could adversely affectCapital Crossing Preferred’s ability to conduct its operations.

 

**Capital Crossing Preferred’s relationshipwith Capital Crossing may create conflicts of interest**

 

CapitalCrossing and its affiliates may have interests which are not identical toCapital Crossing Preferred’s and therefore conflicts of interest have arisenand may arise in the future with respect to transactions between CapitalCrossing Preferred and Capital Crossing such as:

 

***Acquisition of mortgage assets.***CapitalCrossing Preferred anticipates that it will from time to time continue topurchase additional mortgage assets. Capital Crossing Preferred intends toacquire all or substantially all of such mortgage assets from Capital Crossing,on terms that are comparable to those that could be obtained by CapitalCrossing Preferred if such mortgage assets were purchased from unrelated thirdparties. Neither Capital Crossing Preferred nor Capital Crossing currently havespecific policies with respect to the purchase by Capital Crossing Preferredfrom Capital Crossing of particular loans or pools of loans, other than thatsuch assets must be eligible to be held by a REIT. Although these purchases arestructured to take advantage of the underwriting procedures of CapitalCrossing, and while Capital Crossing Preferred believes that any agreements andtransactions between it, on the one hand, and Capital Crossing and/or itsaffiliates on the other hand, are fair to all parties and consistent withmarket terms, neither Capital Crossing Preferred nor Capital Crossing haveobtained any third-party valuation to confirm whether Capital CrossingPreferred will be paying fair market value for these loans, nor does CapitalCrossing Preferred anticipate doing so in the future. Additionally, throughlimiting Capital Crossing Preferred’s source of purchased mortgage assetssolely to those originated or purchased by Capital Crossing, Capital CrossingPreferred’s portfolio will generally reflect the nature, scope and risk ofCapital Crossing’s portfolio rather than a more diverse portfolio composed ofmortgage loans also purchased from other lenders.

 

***Servicing of Capital Crossing Preferredmortgage assets by Capital Crossing.***CapitalCrossing Preferred’s loans are serviced by Capital Crossing pursuant to theterms of the master service agreement. Capital Crossing in its role as servicerunder the terms of the master service agreement receives a fee equal to 0.20%per annum, payable monthly, on the average gross outstanding 

 

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principal balances of loansserviced. The master service agreement requires Capital Crossing to service theloan portfolio in a manner substantially the same as for similar work performedby Capital Crossing for transactions on its own behalf. This will becomeespecially important as Capital Crossing services any loans which becomeclassified or are placed on non-performing status, or are renegotiated due tothe financial deterioration of the borrower. While Capital Crossing Preferredbelieves that Capital Crossing will diligently pursue collection of anynon-performing loans, Capital Crossing Preferred cannot provide assurance thatthis will be the case. Capital Crossing Preferred’s ability to make timelypayments of dividends will depend in part upon Capital Crossing’s promptcollection efforts on behalf of Capital Crossing Preferred.

 

***Future dispositions by Capital CrossingPreferred of mortgage assets to Capital Crossing or its affiliates.***Themaster service agreement provides that foreclosures and dispositions of themortgage assets are to be performed with a view toward maximizing CapitalCrossing Preferred’s recovery as owner of the mortgage assets, and CapitalCrossing shall service the mortgage assets solely with a view toward CapitalCrossing Preferred’s interests, and without regard to the interests of CapitalCrossing or any of its affiliates. However, Capital Crossing Preferred cannotprovide assurance that any such agreement or transaction will be on terms asfavorable to it as would have been obtained from unaffiliated third parties.Capital Crossing may seek to exercise its influence over Capital CrossingPreferred’s affairs so as to cause the sale of the mortgage assets owned by CapitalCrossing Preferred and their replacement by lesser quality loans purchased fromCapital Crossing or elsewhere which could adversely affect Capital CrossingPreferred’s business and its ability to make timely payments of dividends.

 

***Future modifications of the advisoryagreement or master service agreement.***ShouldCapital Crossing Preferred seek to modify either the advisory agreement or themaster service agreement, it would rely upon its officers who are also officersand directors of Capital Crossing. Specifically, (i) all of Capital Crossing Preferred’s officers are alsoofficers of Capital Crossing, (ii) two of Capital Crossing Preferred’sexecutive, or “inside”, directors are also directors of Capital Crossing and(iii) one of Capital Crossing Preferred’s non-executive, or “outside”,directors is also a director of Capital Crossing.  Thus, Capital Crossing Preferred’s officersand/or directors would be responsible for taking positions with respect to suchagreements that, while in Capital Crossing Preferred’s best interests, wouldnot be in the best interests of Capital Crossing. Although the termination,modification or decision not to renew the advisory agreement and/or the masterservice agreement requires the approval of a majority of Capital CrossingPreferred’s independent directors, Capital Crossing, as holder of all ofCapital Crossing Preferred’s outstanding common stock, controls the election ofall Capital Crossing Preferred directors, including the independent directors.Capital Crossing Preferred cannot provide assurance that such modificationswill be on terms as favorable to it as those that could have been obtained fromunaffiliated third parties.

 

***The terms of Capital Crossing Preferred’sguarantee of obligations of Capital Crossing.***Capital Crossing Preferred hasguaranteed all of the obligations of Capital Crossing under advances CapitalCrossing may receive from time to time from the FHLBB, and has agreed to pledgea significant amount of its assets in connection with those advances. Theassets Capital Crossing Preferred pledges to the FHLBB will vary from time totime; however, the potential exists for Capital Crossing Preferred to pledgeall of its assets to the FHLBB to secure advances to Capital Crossing. Inaddition, Capital Crossing has pledged to the FHLBB all of the shares ofCapital Crossing Preferred’s capital stock it owns as collateral for its FHLBBborrowings. Under the terms of the pledge, if Capital Crossing becomesundercapitalized the FHLBB may require Capital Crossing to dissolve CapitalCrossing Preferred such that the assets of Capital Crossing Preferred aredistributed to Capital Crossing. In this circumstance the holders of Series A,Series C and Series D preferred shares would receive their liquidation preferenceonly to the extent there are available proceeds from the liquidation of theassets of Capital Crossing Preferred following satisfaction of its outstandingobligations, including its guarantee of Capital Crossing’s FHLBB borrowings. AtSeptember 30, 2004, approximately $31.3 million, or 11.7%, of Capital CrossingPreferred assets have been pledged to and accepted by the FHLBB to secureadvances to Capital Crossing.  As ofSeptember 30, 2004, Capital Crossing had $138.8 million in outstanding FHLBBborrowings.  The guarantee and pledgewere approved by Capital Crossing Preferred’s independent directors, subject tocertain requirements and limitations, including the requirement that CapitalCrossing pay Capital Crossing Preferred a guarantee fee. Any default by CapitalCrossing on its obligations which would require Capital Crossing Preferred tosatisfy its guarantee could adversely affect its business and its ability tomake timely payments of dividends.

 

***The master loan purchase agreement was notthe result of arm’s-length negotiations.***CapitalCrossing Preferred acquires loans pursuant to the master mortgage loan purchaseagreement between Capital Crossing Preferred and Capital Crossing, at an amountequal to Capital Crossing’s net carrying value for those mortgage assets. WhileCapital Crossing Preferred believes that the master mortgage loan purchaseagreement, when entered into, was fair to all parties and consistent withmarket terms, its officers who are also officers and directors of CapitalCrossing.  Specifically, (i) all ofCapital Crossing Preferred’s officers are also officers of Capital Crossing,(ii) two of Capital Crossing Preferred’s executive, or “inside”, directors arealso directors of Capital Crossing and (iii) one of Capital Crossing Preferred’snon-executive, or “outside”, directors is also a director of CapitalCrossing.  Capital Crossing, as holder ofall of Capital Crossing Preferred’s outstanding common stock, controls theelection of all Capital Crossing Preferred directors, including the independentdirectors. Capital Crossing Preferred cannot provide assurance that the mastermortgage loan purchase agreement was entered into on terms as favorable toCapital Crossing Preferred as those that could have been obtained fromunaffiliated third parties.

 

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**Neither Capital Crossing Preferred norCapital Crossing have specific policies with respect to the purchase by CapitalCrossing Preferred from Capital Crossing of particular loans or pools of loans**

 

The lack ofspecific policies with respect to the purchase by Capital Crossing Preferred ofloans from Capital Crossing could result in Capital Crossing Preferredacquiring lower quality mortgage assets from Capital Crossing than if suchpolicies were otherwise in place. Neither Capital Crossing Preferred norCapital Crossing currently have specific policies with respect to the purchaseby Capital Crossing Preferred from Capital Crossing of particular loans orpools of loans, other than such assets must be eligible to be held by a REIT.Capital Crossing Preferred’s Board of Directors has adopted certain policies toguide the acquisition and disposition of assets but these policies may berevised from time to time at the discretion of the Board of Directors without avote of Capital Crossing Preferred’s stockholders. Capital Crossing Preferredintends to acquire all or substantially all of the additional mortgage assetsit may acquire in the future from Capital Crossing on terms that are comparableto those that could be obtained by Capital Crossing Preferred if such mortgageassets were purchased from unrelated third parties, but Capital CrossingPreferred cannot provide assurance that this will always be the case.

 

**Capital Crossing Preferred’s Board ofDirectors has broad discretion to revise Capital Crossing Preferred’sstrategies**

 

CapitalCrossing Preferred’s Board of Directors has established Capital CrossingPreferred’s investment and operating strategies. These strategies may berevised from time to time at the discretion of the Board of Directors without avote of Capital Crossing Preferred’s stockholders. Changes in Capital CrossingPreferred’s strategies could have a negative effect on shareholders.

 

**Capital Crossing Preferred does not obtain third-partyvaluations and therefore it may pay more or receive less than fair market valuefor its mortgage assets**

 

To date,Capital Crossing Preferred has not obtained third-party valuations as part ofits loan acquisitions or dispositions and does not anticipate obtainingthird-party valuations for future acquisitions and dispositions of mortgageassets. Capital Crossing Preferred does not intend to obtain third-partyvaluations even where it is acquiring mortgage assets from, or disposingmortgage assets to, one of its affiliates, including Capital Crossing.Accordingly, Capital Crossing Preferred may pay its affiliates, includingCapital Crossing, more than the fair market value of mortgage assets itacquires and may receive less than the fair market value of the mortgage assetsit sells based on a third-party valuation.

 

**Capital Crossing Preferred may pay more thanfair market value for mortgages it purchases from Capital Crossing because itdoes not engage in arm’s-length negotiations with Capital Crossing**

 

CapitalCrossing Preferred acquires mortgage assets from Capital Crossing under amaster mortgage loan purchase agreement between it and Capital Crossing, at anamount equal to Capital Crossing’s net carrying value for those mortgageassets. Because Capital Crossing is an affiliate of Capital Crossing Preferred,Capital Crossing Preferred does not engage in any arm’s-length negotiationsregarding the consideration to be paid. Accordingly, if Capital Crossing’s netcarrying value exceeds the fair market value of the mortgage assets, CapitalCrossing Preferred would pay Capital Crossing more than the fair market valuefor those mortgaged assets.

 

**Fluctuations in interest rates could reduceCapital Crossing Preferred earnings and affect its ability to pay dividends**

 

Capital Crossing Preferred’s income consists primarilyof interest earned on mortgage assets and short-term investments.  A significant portion of Capital CrossingPreferred’s mortgage assets bear interest at adjustable rates. Interest ratesare currently in a period of historically low levels. If there is a furtherdecline in interest rates, then Capital Crossing Preferred will experience adecrease in income available to be distributed to its stockholders. If interestrates decline, Capital Crossing Preferred may also experience an increase inprepayments on its mortgage assets and may find it difficult to purchaseadditional mortgage assets bearing rates sufficient to support payment ofdividends on the Series A preferred shares, the Series C preferred shares, andthe Series D preferred shares. Conversely, an increase in mortgage rates couldresult in increased borrower defaults, which in turn could result in decreasedinterest income and increased non-interest expense related to workouts and othercollection efforts. An increase in interest rates that adversely affects theability of borrowers to pay the principal or interest on Capital CrossingPreferred’s loans may lead to an increase in non-performing assets and areduction of discount accreted into income, which could have a material adverseeffect on Capital Crossing Preferred’s results of operations. Because thedividend rates on the Series A preferred shares, the Series C preferred shares,and the Series D preferred shares are fixed, a significant decline or increasein interest rates, either of which results in lower net income, couldmaterially adversely affect Capital Crossing Preferred’s ability to paydividends on the Series A preferred shares, the Series C preferred shares, andthe Series D preferred shares.

 

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**Tax Risks Related to REITs**

 

***If Capital Crossing Preferred fails toqualify as a REIT, it will be subject to federal income tax at regularcorporate rates.***If Capital Crossing Preferredfails to qualify as a REIT for any taxable year, it would be subject to federalincome tax, including any applicable alternative minimum tax, on its taxableincome at regular corporate rates. As a result, the amount available fordistribution to Capital Crossing Preferred’s stockholders would be reduced forthe year or years involved. In addition, unless entitled to relief understatutory provisions, Capital Crossing Preferred would be disqualified fromtreatment as a REIT for the four taxable years following the year whichqualification was lost. The failure to qualify as a REIT would reduce CapitalCrossing Preferred’s net earnings available for distribution to itsstockholders because of the additional tax liability for the year or yearsinvolved. Capital Crossing Preferred’s failure to qualify as a REIT would notby itself give it the right to redeem the Series A, Series C or Series Dpreferred shares, nor would it give the holders of the Series A, Series C orSeries D preferred shares the right to have their shares redeemed.

 

AlthoughCapital Crossing Preferred currently intends to operate in a manner designed toqualify as a REIT, future economic, market, legal, tax or other considerationsmay cause it to determine that it is in its best interest and in the bestinterest of holders of its common stock and preferred stock to revoke its REITelection. The tax law prohibits Capital Crossing Preferred from electingtreatment as a REIT for the four taxable years following the year of any suchrevocation.

 

***If Capital Crossing Preferred does notdistribute 90% of its net taxable income, it may not qualify as a REIT.***Inorder to qualify as a REIT, Capital Crossing Preferred generally is requiredeach year to distribute to its stockholders at least 90% of its net taxableincome, excluding net capital gains. Capital Crossing Preferred may retain theremainder of REIT taxable income or all or part of its net capital gain, butwill be subject to tax at regular corporate rates on such income. In addition,Capital Crossing Preferred is subject to a 4% nondeductible excise tax on theamount, if any, by which certain distributions considered as paid by CapitalCrossing Preferred with respect to any calendar year are less than the sum of(1) 85% of its ordinary income for the calendar year, (2) 95% of its capitalgains net income for the calendar year and (3) 100% of any undistributed incomefrom prior periods. Under certain circumstances, federal or state regulatoryauthorities may restrict Capital Crossing Preferred’s ability, as a subsidiaryof Capital Crossing, to make distributions to its stockholders in an amountnecessary to retain its REIT qualification. Such a restriction could result inCapital Crossing Preferred failing to qualify as a REIT. To the extent CapitalCrossing Preferred’s REIT taxable income may exceed the actual cash receivedfor a particular period, Capital Crossing Preferred may not have sufficientliquidity to make distributions necessary to retain its REIT qualification.

 

***Capital Crossing Preferred may redeem theSeries A, Series C and Series D preferred shares at any time upon theoccurrence of a tax event.***At any time followingthe occurrence of certain changes in the tax laws or regulations concerningREITs, Capital Crossing Preferred will have the right to redeem the Series A,Series C and Series D preferred shares in whole, subject to the prior writtenapproval of the FDIC. Capital Crossing Preferred would have the right to redeemthe Series A, Series C and Series D preferred shares if it received an opinionof counsel to the effect that, as a result of changes to the tax laws orregulations:

 

(1) dividendspaid by Capital Crossing Preferred with respect to its capital stock are notfully deductible by it for income tax

purposes; or

 

(2) CapitalCrossing Preferred are otherwise unable to qualify as a REIT.

 

The occurrenceof such changes in the tax laws or regulations will not, however, give theholders of the Series A, Series C or Series D preferred shares any right tohave their shares redeemed.

 

***Capital Crossing Preferred has imposedownership limitations to protect its ability to qualify as a REIT, however, ifownership of the common stock of Capital Crossing becomes concentrated in asmall number of individuals Capital Crossing Preferred may fail to qualify as aREIT.***To maintain Capital Crossing Preferred’sstatus as a REIT, not more than 50% in value of Capital Crossing Preferred’soutstanding shares may be owned, directly or indirectly, by five or fewerindividuals, as defined in the Internal Revenue Code, or the Code, to includecertain entities, during the last half of each taxable year. Capital CrossingPreferred currently satisfies this requirement because for this purpose CapitalCrossing Preferred’s common stock held by Capital Crossing is treated as heldby Capital Crossing’s stockholders. However, it is possible that the ownershipof Capital Crossing might become sufficiently concentrated in the future suchthat five or fewer individuals would be treated as having constructive ownershipof more than 50% of the value of Capital Crossing Preferred’s stock. CapitalCrossing Preferred may have difficulty monitoring the daily ownership andconstructive ownership of its outstanding shares and, therefore, CapitalCrossing Preferred cannot provide assurance that it will continue to meet theshare ownership requirement. This risk may be increased in the future asCapital Crossing continues its common stock repurchase programs becauserepurchases may cause ownership in Capital Crossing to become moreconcentrated. In addition, while the fact that the Series A, Series C and theSeries D preferred shares may be redeemed or exchanged will not affect CapitalCrossing Preferred’s REIT status prior to any such redemption or exchange, theredemption or exchange of all or a part of the

 

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Series A, Series C and Series Dpreferred shares could adversely affect Capital Crossing Preferred’s ability tosatisfy the share ownership requirements in the future.

 

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

 

Market risk is the risk of loss from adversechanges in market prices and interest rates. It is the objective of CapitalCrossing Preferred to attempt to control risks associated with interest ratemovements. Capital Crossing Preferred’s market risk arises primarily frominterest rate risk inherent in holding loans. To that end, management activelymonitors and manages the interest rate risk exposure of Capital CrossingPreferred.

 

Capital Crossing Preferred’s managementreviews, among other things, the sensitivity of Capital Crossing Preferred’sassets to interest rate changes, the book and market values of assets, purchaseand sale activity, and anticipated loan pay-offs. Capital Crossing’s seniormanagement also approves and establishes pricing and funding decisions withrespect to Capital Crossing Preferred’s overall asset and liabilitycomposition.

 

Capital Crossing Preferred’s methods forevaluating interest rate risk include an analysis of its interest-earningassets maturing or repricing within a given time period. Since Capital CrossingPreferred has no interest-bearing liabilities, a period of risinginterest rates would tend to result in an increase in interest income. A periodof falling interest rates would tend to adversely affect interest income.

 

The following table sets forth CapitalCrossing Preferred’s interest-rate-sensitive assets categorized by repricingdates and weighted average yields at September 30, 2004. For fixed rateinstruments, the repricing date is the maturity date. For adjustable-rateinstruments, the repricing date is deemed to be the earliest possible interestrate adjustment date. Assets that are subject to immediate repricing are placedin the overnight column.

 
| ** **                   | ** ** | **Overnight** | ** ** | **Within  One  Year** | ** ** | **One to  Two  Years** | ** **                  | **Two to  Three  Years** | ** ** | **Three to  Four  Years** | ** ** | **Four to  Five  Years** | ** ** | **Over  Five  Years** | ** ** | **Total** | ** ** |
|------------------------------|------------|---------------|------------|-----------------------|------------|------------------------|-----------------------------|--------------------------|------------|---------------------------|------------|--------------------------|------------|-----------------------|------------|-----------|------------|
| ** **                   | ** ** | ** **    | ** ** | ** **            | ** ** | ** **             | **(dollars  in thousands)** | ** **               | ** ** | ** **                | ** ** | ** **               | ** ** |
| ** **                   | ** ** | ** **    | ** ** |
| Interest-bearing  deposits   |       | $             | 143,889    |                  | $          | —                 |                        | $                        | —     |                      | $          | —                   |       | $                     | —     |      | $          | — |   | $ | — |   | $ | 143,889 |   |
| Average interest  rate       |       | 1.10          | %          |                  |       |                   |                        |                     |       |                      |       |                     |       |                  |       |      |       |
| Certificate of  deposit      |       | —        |       | 200                   |       | —                 |                        | —                   |       | —                    |       | —                   |       | —                |       | 200       |       |
| Average interest  rate       |       |          |       | 1.32                  | %          |                   |                        |                     |       |                      |       |                     |       |                  |       |      |       |
| Fixed-rate loans  (1)        |       | —        |       | 20,860                |       | 14,110                 |                        | 10,945                   |       | 8,250                     |       | 6,144                    |       | 20,416                |       | 80,725    |       |
| Average interest  rate       |       |          |       | 8.60                  | %          | 8.16                   | %                           | 8.04                     | %          | 7.91                      | %          | 7.77                     | %          | 7.41                  | %          |      |       |
| Adjustable-rate  loans(1)    |       | 14,459        |       | 24,868                |       | 1,935                  |                        | 937                      |       | 576                       |       | 308                      |       | 480                   |       | 43,563    |       |
| Average interest  rate       |       | 7.74          | %          | 6.49                  | %          | 7.54                   | %                           | 6.74                     | %          | 5.79                      | %          | 5.52                     | %          | 6.65                  | %          |      |       |
|                         |       |          |       |                  |       |                   |                        |                     |       |                      |       |                     |       |                  |       |      |       |
| Total  rate-sensitive assets |       | $             | 158,348    |                  | $          | 45,928                 |                        | $                        | 16,045     |                      | $          | 11,882                   |       | $                     | 8,826      |      | $          | 6,452 |   | $ | 20,896 |   | $ | 268,377 |   |
|                              |            |               |            |                       |            |                        |                             |                          |            |                           |            |                          |            |                       |            |           |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1) Loans are presented at net amounts before deducting the allowance forloan losses.

 

Based on Capital Crossing Preferred’sexperience, management applies the assumption that, on average, approximately16% of the outstanding fixed and adjustable rate loans will prepay annually.

 

At September 30, 2004, the fair value of netloans was $126.3 million as compared to the net carrying value of net loans of$121.9 million. The fair value of interest-bearing deposits in banksapproximates carrying value.

*** ***

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*** ***

**Item 4.  Controls and Procedures**

 

(a)           Evaluationof Disclosure Controls and Procedures.

 

As required by Rule 13a-15 under the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”), as of September 30,2004, Capital Crossing Preferred carried out an evaluation under thesupervision and with the participation of its management, including itsPrincipal Executive Officer and Principal Financial Officer, of theeffectiveness of the design and operation of Capital Crossing Preferred’sdisclosure controls and procedures. In designing and evaluating CapitalCrossing Preferred’s disclosure controls and procedures, Capital CrossingPreferred and its management recognize that any controls and procedures, nomatter how well designed and operated, can provide only a reasonable assuranceof achieving the desired control objectives, and management necessarily wasrequired to apply its judgment in evaluating and implementing possible controlsand procedures. Based upon that evaluation, the Principal Executive Officer andPrincipal Financial Officer concluded that they believe Capital CrossingPreferred’s disclosure controls and procedures are reasonably effective toensure that information required to be disclosed by Capital Crossing Preferredin the reports it files or submits under the Exchange Act is recorded,processed, summarized and reported within the time periods specified in theSecurities and Exchange Commission’s rules and forms. In connection with therules regarding disclosure controls and procedures, we intend to continue toreview and document our disclosure controls and procedures, including ourinternal controls and procedures for financial reporting, and may from time totime make changes aimed at enhancing their effectiveness and to ensure that oursystems evolve with our business.

 

(b)           Changesin Internal Controls.

 

None.

 

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**PART II**

 

**Item5.  Other Information**

 

(a) EffectiveAugust 4, 2004, Douglas Shaw resigned as a director and member of the AuditCommittee of Capital Crossing Preferred. On April 22, 2004, Mr. Shaw had been elected to the board of directorsof Capital Crossing Preferred’s parent, Capital Crossing, and he had indicatedhis intention at that time to resign as a director of Capital CrossingPreferred.  On August 4, 2004, theNominating Committee of Capital Crossing Preferred met with Kirk Sykes toconsider him for election to the board. The Committee recommended to the board that Mr. Sykes be elected as adirector of Capital Crossing Preferred and on the same date, the board electedMr. Sykes to serve as a director and member of the Audit Committee of CapitalCrossing Preferred.

 

 

**Item6.  Exhibits**

 
| 31.1   |   | Rule 13a-14(a) Certification signed by Richard Wayne, President (Principal Executive  Officer). FILED HEREWITH.                                                               |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                          |
| 31.2   |   | Rule 13a-14(a) Certification signed by Edward F. Mehm, Treasurer (Principal Financial  Officer). FILED HEREWITH.                                                              |
|   |   |                                                                                                                                                                          |
| 32     |   | Rule 13a-14(b) Certification signed by Richard Wayne, President (Principal Executive  Officer), and Edward F. Mehm, Treasurer (Principal Financial  Officer). FILED HEREWITH. |

 

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**SIGNATURES**

 

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

 

**CAPITAL CROSSING PREFERRED CORPORATION**

 

 
| Date: November 15, 2004 | By:    | /s/ Richard Wayne                          |   |
|-------------------------|--------|--------------------------------------------|--------|
|                    |   | Richard Wayne                              |
|                    |   | *President  (Principal Executive Officer)* |
|                         |        |                                            |        |  |

 

 
| Date: November 15, 2004 | By:    | /s/ Edward F. Mehm                         |   |
|-------------------------|--------|--------------------------------------------|--------|
|                    |   | Edward F. Mehm                             |
|                    |   | *Treasurer  (Principal Financial Officer)* |
|                         |        |                                            |        |  |

 

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**EXHIBITINDEX**

 

 
| **Exhibit** | ** ** | **Item**                                                                                                                                                      |
|-------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.1        |       | Rule 13a-14(a) Certification signed by Richard Wayne, President (Principal Executive  Officer).                                                               |
|        |       |                                                                                                                                                          |
| 31.2        |       | Rule 13a-14(a) Certification signed by Edward F. Mehm, Treasurer (Principal Financial  Officer).                                                              |
|        |       |                                                                                                                                                          |
| 32          |       | Rule 13a-14(b) Certification signed by Richard Wayne, President (Principal Executive  Officer), and Edward F. Mehm, Treasurer (Principal Financial  Officer). |

 

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