**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

**FORM 10-Q**

 

| **ý**  **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|---------------------------------------------------------------------------------------------------------------|
|                                                                                                          |
| **For the Quarterly Period Ended September 30, 2002**                                                         |
|                                                                                                          |
| **Commission File Number 000-25193**                                                                          |

 

| **CAPITAL CROSSING PREFERRED CORPORATION**                                  |
|-----------------------------------------------------------------------------|
| (Exact name of registrant as specified in its charter)                      |
|                                                                        |   |   |
| **Massachusetts**                                                           |   | **04-3439366** |
| (State or other jurisdiction of  incorporation or organization)             |   | (I.R.S. Employer Identification No.) |
|                                                                        |   |   |
| **101 Summer Street  Boston, Massachusetts**                                |   | **02110** |
| (Address of principal executive offices)                                    |   | (Zip Code) |
|                                                                        |   |   |
| Registrant’s telephone number, including area code: **(617) 880-1000** |

 

Indicateby check mark whether the registrant: (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes ý  No o

 

Thenumber of shares outstanding of the registrant’s sole class of common stock was100 shares, $.01 par value per share, as of November 5, 2002.

 

 

----

 

**Capital Crossing PreferredCorporation**

**Table of Contents**

 
| **PART I - Financial Information** |
|------------------------------------|
|                               |   |
| Item 1.                            | Financial Statements: |
|                               |   |
|                               | a) | Balance Sheets |
|                               |   |   |
|                               | b) | Statements of Income |
|                               |   |   |
|                               | c) | Statements  of Changes in Stockholders’ Equity |
|                               |   |   |
|                               | d) | Statements of Cash Flows |
|                               |   |   |
|                               | e) | Notes to Financial  Statements |
|                               |   |
| Item  2.                           | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |
|                               |   |
|                               | Risk Factors  and Other Factors Affecting Forward-Looking Statements |
|                               |   |
| Item  3.                           | Quantitative  and Qualitative Disclosures about Market Risk |
|                               |   |
| Item 4.                            | Controls and  Procedures |
|                               |   |
| **PART II - Other  Information**   |
|                               |   |
| Item 1.                            | Legal Proceedings |
|                               |   |
| Item  4.                      | Submission  of Matters to a Vote of Security Holders |
|                               |   |
| Item 6.                            | Exhibits and  Reports on Form 8-K |
|                               |   |
|                               | Signatures |
|                               |   |
|                               | Certifications |
|                               |   |
|                               | Exhibit Index |
|                               |   |
|                               |   | Exhibit 99.1 Certification signed by Richard Wayne,  President (Principal Executive Officer) pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |
|                               |   |   |
|                               |   | Exhibit 99.2 Certification signed by Edward F. Mehm,  Treasurer (Principal Financial Officer) pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |
|                                    |  |  |  |

 

----

 

**PART I**

 

##### **Item 1. Financial Statements**

 

### **Capital Crossing PreferredCorporation**

**Balance Sheets**

 
|                                                                                                                                                                                               |   | **September 30,  2002**               |    | **December 31,  2001** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------|---------|------------------------|--------|
|                                                                                                                                                                                               |   | **(unaudited)**                       |    |                   |   |
|                                                                                                                                                                                               |   | **(in thousands, except share data)** |    |
| **ASSETS**                                                                                                                                                                                         |   |                                  |    |                   |   |
|                                                                                                                                                                                               |   |                                  |    |                   |   |
| Cash account with Capital Crossing Bank                                                                                                                                                            |   | $                                     | 88      |                   | $      | 86 |   |
| Interest-bearing deposits with Capital Crossing Bank                                                                                                                                               |   | 88,142                                |    | 87,903                 |   |
| Total cash and cash equivalents                                                                                                                                                                    |   | 88,230                                |    | 87,989                 |   |
| Certificate of deposit                                                                                                                                                                             |   | 100                                   |    | 100                    |   |
|                                                                                                                                                                                               |   |                                  |    |                   |   |
| Loans                                                                                                                                                                                              |   | 301,948                               |    | 166,446                |   |
| Less discount and net deferred loan income                                                                                                                                                         |   | (34,802                               | )       | (14,411                | )      |
| Less allowance for loan losses                                                                                                                                                                     |   | (8,856                                | )       | (4,659                 | )      |
|                                                                                                                                                                                               |   |                                  |    |                   |   |
| Loans, net                                                                                                                                                                                         |   | 258,290                               |    | 147,376                |   |
|                                                                                                                                                                                               |   |                                  |    |                   |   |
| Accrued interest receivable                                                                                                                                                                        |   | 1,251                                 |    | 896                    |   |
| Other assets                                                                                                                                                                                       |   | 5                                     |    | 4                      |   |
|                                                                                                                                                                                               |   |                                  |    |                   |   |
|                                                                                                                                                                                               |   | $                                     | 347,876 |                   | $      | 236,365 |   |
|                                                                                                                                                                                               |   |                                  |    |                   |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                      |   |                                  |    |                   |   |
|                                                                                                                                                                                               |   |                                  |    |                   |   |
| Accrued expenses and other liabilities                                                                                                                                                             |   | $                                     | 446     |                   | $      | 417 |   |
|                                                                                                                                                                                               |   |                                  |    |                   |   |
| Total liabilities                                                                                                                                                                                  |   | 446                                   |    | 417                    |   |
|                                                                                                                                                                                               |   |                                  |    |                   |   |
| 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 shares issued and outstanding |   | —                                |    | —                 |   |
| Preferred stock, Series C, 10.25% non-cumulative, exchangeable; $.01  par value; $10 liquidation value per share; 1,840,000 shares authorized,  issued and outstanding                             |   | 18                                    |    | 18                     |   |
| Common stock, $.01 par value, 100 shares authorized, issued and  outstanding                                                                                                                       |   | —                                |    | —                 |   |
| Additional paid-in capital                                                                                                                                                                         |   | 329,475                               |    | 235,742                |   |
| Retained earnings                                                                                                                                                                                  |   | 17,923                                |    | 174                    |   |
|                                                                                                                                                                                               |   |                                  |    |                   |   |
| Total stockholders’ equity                                                                                                                                                                    |   | 347,430                               |    | 235,948                |   |
|                                                                                                                                                                                               |   |                                  |    |                   |   |
|                                                                                                                                                                                               |   | $                                     | 347,876 |                   | $      | 236,365 |   |

 

The accompanying notes are an integral part of these unaudited interimfinancial statements.

 

1

----

 

**Capital Crossing Preferred Corporation**

**Statements of Income**

**(unaudited)**

 
|                                       |   | **Three  Months Ended  September 30,** |   | **Nine Months Ended  September 30,** |   |
|--------------------------------------------|--------|----------------------------------------|--------|--------------------------------------|--------|
|                                       |   | **2002**                               |   | **2001**                             |   | **2002** |   | **2001** |   |
|                                       |   | **(in thousands)**                     |   |
| Interest income:                           |   |                                   |   |                                 |   |   |   |   |   |
| Interest and fees on loans                 |   | $                                      | 6,382  |                                 | $      | 5,616 |   | $ | 16,837 |   | $ | 14,975 |   |
| Interest on interest-bearing deposits      |   | 522                                    |   | 1,002                                |   | 1,469 |   | 2,832 |   |
| Total interest income                      |   | 6,904                                  |   | 6,618                                |   | 18,306 |   | 17,807 |   |
|                                       |   |                                   |   |                                 |   |   |   |   |   |
| Other income:                              |   |                                   |   |                                 |   |   |   |   |   |
| Gain on sale of loans                      |   | 1,915                                  |   | —                               |   | 2,432 |   | — |   |
| Guarantee fee income                       |   | 20                                     |   | 20                                   |   | 60 |   | 60 |   |
| Total other income                         |   | 1,935                                  |   | 20                                   |   | 2,492 |   | 60 |   |
|                                       |   |                                   |   |                                 |   |   |   |   |   |
| Operating expenses:                        |   |                                   |   |                                 |   |   |   |   |   |
| Loan servicing and advisory services       |   | 202                                    |   | 103                                  |   | 463 |   | 322 |   |
| Other general and administrative           |   | 32                                     |   | 30                                   |   | 79 |   | 67 |   |
| Total operating expenses                   |   | 234                                    |   | 133                                  |   | 542 |   | 389 |   |
|                                       |   |                                   |   |                                 |   |   |   |   |   |
| Net income                                 |   | 8,605                                  |   | 6,505                                |   | 20,256 |   | 17,478 |   |
|                                       |   |                                   |   |                                 |   |   |   |   |   |
| Preferred stock dividends                  |   | 836                                    |   | 836                                  |   | 2,507 |   | 1,727 |   |
| Net income available to common stockholder |   | $                                      | 7,769  |                                 | $      | 5,669 |   | $ | 17,749 |   | $ | 15,751 |   |

 

The accompanying notes are an integral part of these unaudited interimfinancial statements.

 

2

----

 

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

 
|                                              |   | **Nine  Months Ended September 30, 2002** |   |
|---------------------------------------------------|--------|-------------------------------------------|--------|
|                                              |   | **Preferred  Stock**                      |   | **Preferred  Stock** |   | **Preferred  Stock** |   |   |   | **Additional** |   |   |   | **Total** |   |
|                                              |   | **Series A**                              |   | **Series B** |   | **Series C** |   | **Common  Stock** |   | **Paid-in** |   | **Retained** |   | **Stockholders’** |   |
|                                              |   | **Shares**                                |   | **Amount** |   | **Shares** |   | **Amount** |   | **Shares** |   | **Amount** |   | **Shares** |   | **Amount** |   | **Capital** |   | **Earnings** |   | **Equity** |   |
|                                              |   | **(dollars  in thousands)**               |   |
|                                              |   |                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Balance at December 31, 2001                      |   | 1,416,130                                 |   | $ | 14 |   | 941 |   | $ | — |   | 1,840,000 |   | $ | 18 |   | 100 |   | $ | — |   | $ | 235,742 |   | $ | 174 |   | $ | 235,948 |   |
| Net income                                        |   | —                                    |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | 20,256 |   | 20,256 |   |
| Capital contribution from common stockholder      |   | —                                    |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | 93,733 |   | — |   | 93,733 |   |
| Dividends on preferred stock, Series A            |   | —                                    |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | (1,035 | ) | (1,035 | ) |
| Cumulative dividends on preferred stock, Series B |   | —                                    |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | (57 | ) | (57 | ) |
| Dividends on preferred stock, Series C            |   | —                                    |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | (1,415 | ) | (1,415 | ) |
| Balance at September 30, 2002                     |   | 1,416,130                                 |   | $ | 14 |   | 941 |   | $ | — |   | 1,840,000 |   | $ | 18 |   | 100 |   | $ | — |   | $ | 329,475 |   | $ | 17,923 |   | $ | 347,430 |   |
|                                              |   |                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                              |   | **Nine Months Ended September 30, 2001**  |   |
|                                              |   | **Preferred Stock**                       |   | **Preferred Stock** |   | **Preferred Stock** |   |   |   | **Additional** |   |   |   | **Total** |   |
|                                              |   | **Series A**                              |   | **Series B** |   | **Series C** |   | **Common Stock** |   | **Paid-in** |   | **Retained** |   | **Stockholders’** |   |
|                                              |   | **Shares**                                |   | **Amount** |   | **Shares** |   | **Amount** |   | **Shares** |   | **Amount** |   | **Shares** |   | **Amount** |   | **Capital** |   | **Earnings** |   | **Equity** |   |
|                                              |   | **(dollars in thousands)**                |   |
|                                              |   |                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Balance at December 31, 2000                      |   | 1,416,130                                 |   | $ | 14 |   | 946 |   | $ | — |   | — |   | $ | — |   | 100 |   | $ | — |   | $ | 218,893 |   | $ | — |   | $ | 218,907 |   |
| Net income                                        |   | —                                    |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | 17,478 |   | 17,478 |   |
| Issuance of preferred stock, Series C             |   | —                                    |   | — |   | — |   | — |   | 1,840,000 |   | 18 |   | — |   | — |   | 16,854 |   | — |   | 16,872 |   |
| Dividends on preferred stock, Series A            |   | —                                    |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | (1,036 | ) | (1,036 | ) |
| Cumulative dividends on preferred stock, Series B |   | —                                    |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | (57 | ) | (57 | ) |
| Dividends on preferred stock, Series C            |   | —                                    |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | (634 | ) | (634 | ) |
| Repurchase of preferred stock, Series B           |   | —                                    |   | — |   | (5 | ) | — |   | — |   | — |   | — |   | — |   | (5 | ) | — |   | (5 | ) |
| Balance at September 30, 2001                     |   | 1,416,130                                 |   | $ | 14 |   | 941 |   | $ | — |   | 1,840,000 |   | $ | 18 |   | 100 |   | $ | — |   | $ | 235,742 |   | $ | 15,751 |   | $ | 251,525 |   |
|                                              |   |                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                              |   |                                      |   |
|                                                   |        |                                           |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The accompanyingnotes are an integral part of these unaudited interim financial statements.

 

3

----

 

 

**Capital Crossing Preferred Corporation**

**Statements of Cash Flows**

**(unaudited)**

 
|                                                                         |   | **Nine Months Ended September 30,** |   |
|------------------------------------------------------------------------------|--------|-------------------------------------|--------|
|                                                                         |   | **2002**                            |   | **2001** |   |
|                                                                         |   | **(in thousands)**                  |   |
| Cash flows from operating activities:                                        |   |                                |   |   |   |
| Net income                                                                   |   | $                                   | 20,256 |   | $ | 17,478 |   |
| Adjustments to reconcile net income to net cash from operating  activities:  |   |                                |   |   |   |
| Gain on sale of loans                                                        |   | (2,432                              | )      | — |   |
| Other, net                                                                   |   | 525                                 |   | 164 |   |
|                                                                         |   |                                |   |   |   |
| Net cash from operating activities                                           |   | 18,349                              |   | 17,642 |   |
|                                                                         |   |                                |   |   |   |
| Cash flows used in investing activities:                                     |   |                                |   |   |   |
| Amortization and payoffs on loans                                            |   | 64,539                              |   | 34,402 |   |
| Purchase of loans from Capital Crossing Bank                                 |   | (90,341                             | )      | (34,998 | ) |
| Proceeds from sales of loans                                                 |   | 10,201                              |   | 167 |   |
|                                                                         |   |                                |   |   |   |
| Net cash used in investing activities                                        |   | (15,601                             | )      | (429 | ) |
|                                                                         |   |                                |   |   |   |
| Cash flows (used in) from financing activities:                              |   |                                |   |   |   |
| Issuance of preferred stock, Series C                                        |   | —                              |   | 16,872 |   |
| Repurchase of preferred stock, Series B                                      |   | —                              |   | (5 | ) |
| Payment of preferred stock dividends                                         |   | (2,507                              | )      | (1,571 | ) |
|                                                                         |   |                                |   |   |   |
| Net cash (used in) from financing activities                                 |   | (2,507                              | )      | 15,296 |   |
|                                                                         |   |                                |   |   |   |
| Net change in cash and cash equivalents                                      |   | 241                                 |   | 32,509 |   |
| Cash and cash equivalents at beginning of period                             |   | 87,989                              |   | 55,312 |   |
|                                                                         |   |                                |   |   |   |
| Cash and cash equivalents at end of period                                   |   | $                                   | 88,230 |   | $ | 87,821 |   |
|                                                                         |   |                                |   |   |   |
|                                                                         |   |                                |   |   |   |
| Supplemental information:                                                    |   |                                |   |   |   |
| Capital contributions from common stockholder in the form of mortgage  loans |   | $                                   | 93,733 |   | $ | — |   |

 

The accompanying notes are an integral part of these unaudited interimfinancial statements.

 

4

----

 

**Capital Crossing Preferred Corporation**

**Notesto Financial Statements**

**Three and Nine Month Periods Ended September 30, 2002 and2001**

 

Note 1.   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 federally insuredMassachusetts trust company, owns all of Capital Crossing Preferred’s commonstock. At September 30, 2002, Capital Crossing was in compliance with itsregulatory capital requirements.

 

OnMarch 31, 1998, Capital Crossing Preferred was initially capitalized with theissuance to Capital Crossing of 100 shares of Capital Crossing Preferred’scommon stock, $.01 par value, and 1,000 shares of Series B preferred stock,$.01 par value, with Capital Crossing transferring to Capital CrossingPreferred a portfolio of loans at its estimated fair value of $140,740,000.Such loans were recorded in the accompanying balance sheet at Capital Crossing’shistorical cost, which approximated their estimated fair values.

 

In1999, Capital Crossing Preferred completed the sale of 1,416,130 shares ofSeries A preferred stock.  In 2001,Capital Crossing Preferred completed the sale of 1,840,000 shares of Series Cpreferred stock.

 

The financial information as of September 30, 2002 andthe results of operations for the three and nine months ended September 30,2002 and 2001, changes in stockholders’ equity and cash flows for the ninemonths ended September 30, 2002 and 2001 are unaudited; however, in the opinionof management, the financial information reflects all adjustments (consistingsolely of normal recurring accruals) necessary for a fair presentation of suchfinancial information in accordance with accounting principles generallyaccepted in the United States of America (“GAAP”).  Interim results are not necessarily indicative of results to beexpected for the entire year.  Theseinterim statements are intended to be read in conjunction with the financialstatements presented in Capital Crossing Preferred’s Annual Report on Form 10-Kas of and for the year ended December 31, 2001.

 

In preparing financial statements in conformity withGAAP, management is required to make estimates and assumptions that affect thereported amounts of assets and liabilities as of the date of the balance sheetand reported amounts of revenues 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 whichdiscount is accreted into interest income.

 

Note 2.   Commitments andContingencies

 

Capital Crossing Preferred has guaranteed all of theobligations of Capital Crossing under advances Capital Crossing may receivefrom time to time from the Federal Home Loan Bank of Boston (“FHLBB”), and hasagreed to pledge a significant amount of its assets in connection with thoseadvances.  This guarantee would ranksenior to the preferred shares upon liquidation. Capital Crossing Preferred’sobligations under this agreement are limited by applicable laws pertaining tofraudulent conveyance and fraudulent transfer. The assets pledged to the FHLBBwill vary from time to time, however the potential exists for Capital CrossingPreferred to pledge all of its assets to the FHLBB to secure advances to CapitalCrossing. In addition, Capital Crossing has pledged to the FHLBB all of theshares of Capital Crossing Preferred’s capital stock it owns as collateral forits FHLBB borrowings.  Under the termsof the pledge, if Capital Crossing becomes undercapitalized the FHLBB mayrequire Capital Crossing to dissolve Capital Crossing Preferred such that theassets of Capital Crossing Preferred are distributed to Capital Crossing. Insuch circumstance, holders of the Series A and Series C preferred stock wouldreceive their liquidation preference only to the extent there are availableassets of Capital Crossing Preferred following satisfaction of its outstandingobligations, including its guarantee of Capital Crossing’s FHLBBborrowings.  At September 30, 2002,approximately $45.9 million, or 13.2%, of Capital Crossing Preferred’s assetshad been pledged to and accepted by the FHLBB to secure advances to CapitalCrossing.  Capital Crossing has alsoagreed with the FHLBB that it will not request or accept advances from the FHLBBin excess of Capital Crossing Preferred’s total stockholder’s equity, less thestockholder’s equity attributable to the Series A and Series C preferredshares. As of September 30, 2002, this restriction would limit CapitalCrossing’s ability to receive advances in excess of approximately $314.9million. As of September 30, 2002, Capital Crossing had $129.0 million inoutstanding FHLBB borrowings.

 

5

----

 

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

 

Statements made or incorporated in this QuarterlyReport on Form 10-Q include a number of forward-looking statements within themeaning of Section 27A of the Securities Act of 1933, as amended, and Section21E of the Securities Exchange Act of 1934, as amended.  Forward-looking statements include, withoutlimitation, statements containing the words “anticipates,” “believes,”“estimates”, “assumes”, “expects,” “intends,” “future” and words of similarimport which express management’s belief, expectations or intentions regardingthe future performance of Capital Crossing Preferred.  These forward-looking statements are made as of the date of thisreport and we do not undertake to update them at anytime after the date hereof.Capital Crossing Preferred’s actual results could differ materially from thoseset forth in the forward-looking statements as a result, among other factors,of changes in general, national or regional economic conditions, changes ininterest rates, changes in loan default and charge-off rates relating to adecline in the commercial real estate market or otherwise, the possibleexchange of the preferred shares for preferred shares of Capital Crossing atthe direction of the FDIC if Capital Crossing becomes or may in the near termbecome undercapitalized or is placed in conservatorship or receivership, risksassociated with mortgage loans generally, and particularly the geographicconcentration of Capital Crossing Preferred’s loan portfolio at September 30,2002 in California and New England, and the failure by Capital CrossingPreferred to maintain its status as a real estate investment trust (“REIT”) forfederal income tax purposes, changes in the assumptions used in making suchforward-looking statements, and the factors discussed in the section entitled“Risk Factors and Other Forward-Looking Statements” of this Form 10-Q.

 

#### **Resultsof Operations**

 

***Three Months Ended September 30, 2002 and2001***

 

Netincome available to common stockholders increased $2.1 million, or 37.0%, to$7.8 million for the three months ended September 30, 2002 compared to $5.7million for the three months ended September 30, 2001. This increase isprimarily attributable to gains on sales of loans of $1.9 million for the threemonths ended September 30, 2002, compared to none in the same period in 2001.

 

Theincrease in total interest income was primarily attributable to an increase ininterest income from loans of $766,000, or 13.6%, to $6.4 million for the threemonths ended September 30, 2002 compared to $5.6 million for the three monthsended September 30, 2001, partially offset by a decline in interest oninterest-bearing deposits of $480,000, or 47.9%, to $522,000 for the threemonths ended September 30, 2002 compared to $1.0 million for the same period in2001. The increase in interest income is due to the significant growth in theloan portfolio offset by a decline in the yield on total interest-earningassets.

 

Thefollowing table sets forth the yields on Capital Crossing Preferred’s earningassets for the periods indicated:

 
|                      |   | **Three Months Ended September 30,** |    |
|---------------------------|--------|--------------------------------------|---------|
|                      |   | **2002**                             |    | **2001** |   |
|                      |   | **Average****Balance**               |    | **Interest****Income** |   | **Yield** |   | **Average**Balance |   | **Interest****Income** |   | **Yield** |   |
|                      |   | **(dollars in thousands)**           |    |
|                      |   |                                 |    |   |   |   |   |   |   |   |   |   |   |
| Loans, net(1)             |   | $                                    | 271,789 |   | $ | 6,382 |   | 9.32 | % | $ | 151,242 |   | $ | 5,616 |   | 14.73 | % |
| Interest-bearing deposits |   | 68,959                               |    | 522 |   | 3.00 |   | 100,500 |   | 1,002 |   | 3.96 |   |
|                      |   | $                                    | 340,748 |   | $ | 6,904 |   | 8.04 | % | $ | 251,742 |   | $ | 6,618 |   | 10.43 | % |

 

----

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

 

The weighted averageyield on loans decreased to 9.32% for the three months ended September 30, 2002from 14.73% for the three months ended September 30, 2001. This decrease inyield on loans is attributable to the general decline in the rate environmentsince the 2001 period, as well as a declinein the level of interest and fee income recognized on loan payoffs. The levelof interest and fee income recognized on loan payoffs varies for numerousreasons, as further discussed below. Average loans, net, for the threemonths ended September 30, 2002 totaled $271.8 million compared to $151.2million for the three months ended September 30, 2001.  The increase in the average loan balance isprimarily attributable to the acquisition of $183.2 million of loans fromCapital Crossing during 2002, partially offset by loan amortization, payoffsand sales.

 

Income on loansincludes the portion of the purchase discount that is accreted into income overthe remaining lives of the related loans using the interest method. Because thecarrying value of the loan portfolio is net of purchase discount, the relatedyield on this portfolio generally is higher than the aggregate contractual ratepaid on the loans. The total yield includes the excess of a loan’s expecteddiscounted future cash flows over its net investment, recognized using theinterest method.

 

6

----

 

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 onnon-performing status and other loan fees (“other interest and fee income”).The following 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 payoffs as compared to other sources, willincrease or remain the same in the future.

 

|                                                |   | **Three Months Ended September 30,** |   |
|-----------------------------------------------------|--------|--------------------------------------|--------|
|                                                |   | **2002**                             |   | **2001** |   |
|                                                |   | **Interest  Income**                 |   | **Yield** |   | **Interest  Income** |   | **Yield** |   |
|                                                |   | **(dollars in thousands)**           |   |
|                                                |   |                                 |   |   |   |   |   |   |   |
| Regularly scheduled interest and accretion income   |   | $                                    | 5,372  |   | 7.84 | % | $ | 3,642 |   | 9.55 | % |
| Interest and fee income recognized on loan payoffs: |   |                                 |   |   |   |   |   |   |   |
| Non-amortizing discount                             |   | 237                                  |   | 0.35 |   | 608 |   | 1.60 |   |
| Amortizing discount                                 |   | 726                                  |   | 1.06 |   | 1,213 |   | 3.18 |   |
| Other interest and fee income                       |   | 47                                   |   | 0.07 |   | 153 |   | 0.40 |   |
|                                                |   | 1,010                                |   | 1.48 |   | 1,974 |   | 5.18 |   |
|                                                |   | $                                    | 6,382  |   | 9.32 | % | $ | 5,616 |   | 14.73 | % |

 

The amount of loanpayoffs and related 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 decision to payoff a loan rests with the borrower. The amount ofindividual loan payoffs is oftentimes a result of negotiations between CapitalCrossing Preferred and the borrower. Based upon credit risk analysis and otherfactors, Capital Crossing Preferred will, in certain instances, accept lessthan the full amount contractually due in accordance with the loan terms.

 

The average balance ofinterest-bearing deposits decreased $31.5 million to $69.0 million for thethree months ended September 30, 2002, compared to $100.5 million for 2001.This decrease is attributable to the purchase of $90.3 million of loans fromCapital Crossing partially offset by cash accumulated from loan amortization,payoffs and sales. The yield on interest-bearing deposits decreased in 2002because the rate paid by Capital Crossing on the money market account held byCapital Crossing Preferred decreased consistently with deposit interest ratesgenerally compared to 2001.

 

The gain on sales ofloans of $1.9 million is the result of the sale of nine loans to unaffiliatedthird parties. There were no loans sold to unaffiliated third parties duringthe three months ended September 30, 2001.

 

Loan servicing andadvisory services for the three months ended September 30, 2002 increased$99,000, or 96.1%, to $202,000 compared to $103,000 for the three months endedSeptember 30, 2001. This increase is due to the overall increase in the averagebalance of the loan portfolio.

 

Capital Crossing Preferred intends to pay dividends onits preferred stock and common stock in amounts necessary to continue topreserve its status as a REIT under the Internal Revenue Code.

 

***Nine Months Ended September 30, 2002 and2001***

 

Netincome available to common stockholders increased $2.0 million, or 12.7%, to$17.7 million for the nine months ended September 30, 2002 compared to $15.8million for the nine months ended September 30, 2001.  This increase is primarily attributable to gains on sales ofloans of $2.4 million for the nine months ended September 30, 2002 compared tonone in the same period in 2001, and an increase in total interest income of$499,000, or 2.8%, to $18.3 million for the nine months ended September 30,2002 compared to $17.8 million for the nine months ended September 30, 2001.These increases were partially offset by an increase in preferred stockdividends of $780,000, or 45.2%, to $2.5 million for the nine months endedSeptember 30, 2002 compared to $1.7 million during the same period in 2001 as aresult of the issuance of the Series C preferred stock on May 31, 2001.

 

Theincrease in total interest income was primarily attributable to an increase ininterest income from loans of $1.9 million, or 12.4%, to $16.8 million for thenine months ended September 30, 2002 compared to $15.0 million for the ninemonths ended September 30, 2001, partially offset by a decline in interest oninterest-bearing deposits of $1.4 million, or 48.1%, to $1.5 million for thenine months ended September 30, 2002 from $2.8 million for the same period in2001. The increase in interest income from loans is attributable to the growthin the loan portfolio partially offset by a decline in the yield oninterest-earning assets.

 

7

----

 

Thefollowing table sets forth the yields on Capital Crossing Preferred’s earningassets for the periods indicated:

 
|                      |   | **Nine Months Ended September 30,** |    |
|---------------------------|--------|-------------------------------------|---------|
|                      |   | **2002**                            |    | **2001** |   |
|                      |   | **Average  Balance**                |    | **Interest  Income** |   | **Yield** |   | **Average  Balance** |   | **Interest  Income** |   | **Yield** |   |
|                      |   | **(dollars in thousands)**          |    |
|                      |   |                                |    |   |   |   |   |   |   |   |   |   |   |
| Loans, net(1)             |   | $                                   | 215,929 |   | $ | 16,837 |   | 10.43 | % | $ | 153,512 |   | $ | 14,975 |   | 13.04 | % |
| Interest-bearing deposits |   | 70,741                              |    | 1,469 |   | 2.78 |   | 83,606 |   | 2,832 |   | 4.53 |   |
|                      |   | $                                   | 286,670 |   | $ | 18,306 |   | 8.54 | % | $ | 237,118 |   | $ | 17,807 |   | 10.04 | % |

 

----

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

 

The weighted averageyield on loans decreased to 10.43% for the nine months ended September 30, 2002from 13.04% for the nine months ended September30, 2001. This decrease in yield on loans is attributable to a decline in theinterest rate environment since the 2001 period as well as a decline, relative to the overall yield onloans, in the level of interest and fee income recognized on loan payoffs. Thelevel of interest and fee income recognized on loan payoffs varies for numerousreasons, as further discussed below. Average loans, net, for the ninemonths ended September 30, 2002 totaled $215.9 million compared to $153.5million for the nine months ended September 30, 2001. The increase in theaverage loan balance is primarily attributable to the acquisition of $183.2million of loans from Capital Crossing during 2002, partially offset by loanamortization payoffs and sales.

 

Income on loans includesthe portion of the purchase discount that is accreted into income over theremaining lives of the related loans using the interest method. Because thecarrying value of the loan portfolio is net of purchase discount, the relatedyield on this portfolio generally is higher than the aggregate contractual ratepaid on the loans. The total yield includes the excess of a loan’s expecteddiscounted future cash flows over its net investment, recognized using theinterest 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 onnon-performing status and other loan fees (“other interest and fee income”).The following table sets forth, for the periods indicated, the components ofinterest and fees on loans.  There canbe no assurance regarding future interest income, including the yields andrelated level of such income, or the relative portion attributable to loanpayoffs as compared to other sources, will increase or remain the same in thefuture.

 

|                                                |   | **Nine Months Ended September 30,** |   |
|-----------------------------------------------------|--------|-------------------------------------|--------|
|                                                |   | **2002**                            |   | **2001** |   |
|                                                |   | **Interest  Income**                |   | **Yield** |   | **Interest  Income** |   | **Yield** |   |
|                                                |   | **(dollars in thousands)**          |   |
|                                                |   |                                |   |   |   |   |   |   |   |
| Regularly scheduled interest and accretion income   |   | $                                   | 13,226 |   | 8.19 | % | $ | 11,416 |   | 9.94 | % |
| Interest and fee income recognized on loan payoffs: |   |                                |   |   |   |   |   |   |   |
| Non-amortizing discount                             |   | 1,409                               |   | 0.88 |   | 1,519 |   | 1.32 |   |
| Amortizing discount                                 |   | 2,005                               |   | 1.24 |   | 1,650 |   | 1.44 |   |
| Other interest and fee income                       |   | 197                                 |   | 0.12 |   | 390 |   | 0.34 |   |
|                                                |   | 3,611                               |   | 2.24 |   | 3,559 |   | 3.10 |   |
|                                                |   | $                                   | 16,837 |   | 10.43 | % | $ | 14,975 |   | 13.04 | % |

 

The amount of loanpayoffs and related 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 decision to payoff a loan rests with the borrower. The amount ofindividual loan payoffs is oftentimes a result of negotiations between CapitalCrossing Preferred and the borrower. Based upon credit risk analysis and otherfactors, Capital Crossing Preferred will, in certain instances, accept lessthan the full amount contractually due in accordance with the loan terms.

 

8

----

 

The average balance ofinterest-bearing deposits decreased $12.9 million to $70.7 million for the ninemonths ended September 30, 2002, compared to $83.6 million for 2001.  This decrease is primarily a result of thepurchase of $90.3 million of loans from Capital Crossing offset by cashaccumulated from loan amortization payoffs and sales. The yield oninterest-bearing deposits decreased in 2002 because the rate paid by CapitalCrossing on the money market account held by Capital Crossing Preferreddecreased consistently with deposit interest rates generally compared to 2001.

 

The gain on sales ofloans of $2.4 million is the result of the sale of ten loans to unaffiliatedthird parties. There were no loans sold to unaffiliated third parties duringthe nine months ended September 30, 2001.

 

Loan servicing andadvisory services expenses for the nine months ended September 30, 2002increased $141,000, or 43.8%, to $463,000 compared to $322,000 for the ninemonths ended September 30, 2001. This increase was due to the overall increasein the average balance of the loan portfolio.

 

General andadministrative expenses for the nine months ended September 30, 2002 increased$12,000, or 17.9%, to $79,000 compared to $67,000 for the nine months endedSeptember 30, 2001.  This increase was dueprimarily to an increase in professional services, including consulting andlegal services.

 

Preferred stock dividendsincreased $780,000, or 45.2%, to $2.5 million for the nine months endedSeptember 30, 2002 compared to $1.7 million for the nine months ended September30, 2001, as a result of dividends on Series C preferred stock issued on May31, 2001.

 

**Financial Condition**

#### ** **

#### **Interest-bearingDeposits with Capital Crossing Bank**

 

Interest-bearing deposits consist of a money marketaccount with balances of $88.1 million and $87.9 million, respectively, atSeptember 30, 2002 and December 31, 2001. The balance at period end hasremained relatively stable as proceeds from loan amortization, payoffs andsales have been utilized to purchase additional loans.

 

##### **Loan Portfolio**

 

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

 
|                           |   | **September 30,  2002** |    | **December 31,  2001** |   |
|--------------------------------|--------|-------------------------|---------|------------------------|--------|
|                           |   | **(in thousands)**      |    |
| Mortgage loans on real estate: |   |                    |    |                   |   |
| Commercial real estate         |   | $                       | 208,175 |                   | $      | 106,291 |   |
| Multi-family residential       |   | 85,117                  |    | 55,868                 |   |
| One-to-four family residential |   | 2,754                   |    | 3,073                  |   |
| Land                           |   | 5,902                   |    | 1,214                  |   |
|                           |   |                    |    |                   |   |
| Total, gross                   |   | 301,948                 |    | 166,446                |   |
|                           |   |                    |    |                   |   |
| Less:                          |   |                    |    |                   |   |
| Non-amortizing discount        |   | (9,758                  | )       | (6,062                 | )      |
| Amortizing discount            |   | (24,919                 | )       | (8,257                 | )      |
| Allowance for loan losses      |   | (8,856                  | )       | (4,659                 | )      |
| Net deferred loan fees         |   | (125                    | )       | (92                    | )      |
|                           |   |                    |    |                   |   |
| Loans, net                     |   | $                       | 258,290 |                   | $      | 147,376 |   |

 

Includedin the $258.3 million and $147.4 million of total loans, net, at September 30,2002 and December 31, 2001, are approximately $35.4 million and $22.2 million(of which $180,000 and $0 are non-performing), respectively, of net recordedinvestment in primarily commercial and multifamily real estate and securedcommercial loans. The net recorded investment represents the amortized cost ofthese loans, where at acquisition, the amounts of reasonably estimable andprobable discounted future cash collections were less than the contractualbalances owed. These loans were purchased at a price to yield a market rate ofinterest after considering the credit quality of the loans at acquisition andthe aforementioned expected future cash collections.  The excess of the contractual balances over the amount ofreasonably estimable and probable discounted future cash collections representsthe predominant portion of the $9.8 million and $6.1 million of non-amortizingdiscount at September 30, 2002 and at December 31, 2001, respectively.

 

CapitalCrossing Preferred acquires primarily performing commercial real estate andmulti-family residential mortgage loans. Total net loans acquired during the nine months ended September 30, 2002were $183.2 million consisting of $89.9 million of loans purchased from CapitalCrossing and $93.3 million of loans contributed by Capital Crossing.

 

9

----

 

CapitalCrossing Preferred intends that each loan acquired from Capital Crossing in thefuture will be a whole loan, and will be originated or acquired by CapitalCrossing in the ordinary course of its business. Capital Crossing Preferredalso intends that all loans held by it will be serviced pursuant to its masterservice agreement with Capital Crossing.

 

Non-performingloans, net of discount, totaled $439,000 and $153,000 at September 30, 2002 andDecember 31, 2001, respectively.

 

Theaccrual of interest and accretion of discount are generally discontinued whenthe collectibility of principal and interest is not probable or estimable.Unpaid interest income previously accrued on such loans is reversed againstcurrent period interest income. A loan is returned to accrual status once asatisfactory payment history has been established or the credit is restructuredat a level that conforms to the appropriate credit standards.

 

**Allowance for Loan Losses**

 

Theallowance for loan losses is based upon losses estimated to have occurred andis established through a provision for loan losses charged to earnings and byadditions in connection with loan acquisitions as deemed necessary. Loan lossesare charged against the allowance for loan losses when management believes theloan balance, or a portion thereof, is uncollectible. Subsequent recoveries, ifany, are credited to the allowance for loan losses.

 

Theallowance for loan losses is evaluated on a regular basis by management and isbased upon management’s periodic review of the collectibility of the loans inlight of known and inherent risks in the nature and volume of the loanportfolio, adverse situations that may affect the borrower’s ability to repay,the estimated value of any underlying collateral, and prevailing economicconditions. This evaluation is inherently subjective as it requires estimatesthat are susceptible to significant revision as more information becomesavailable. 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 believesthese estimates and assumptions are reasonable, there can be no assurance thatthey will 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 date. Capital Crossing Preferred continues to monitor andmodify its allowances for general and specific loan losses as economicconditions dictate.

 

CapitalCrossing Preferred performs periodic reviews of its loan portfolio to identifyloans for which specific allocations are considered prudent. Specificallocations include the results of measuring impaired loans under Statement ofFinancial Accounting Standards No. 114. General risk allocations aredetermined by a formula whereby the loan portfolio is stratified by loan typeand by internal risk rating categories. Loss factors are then applied to eachstrata based on various considerations including historic loss experience,delinquency trends, current economic conditions, industry standards andregulatory guidelines. An additional allowance is maintained based on ajudgment by management after consideration of qualitative and quantitativeassessments of certain factors including regional credit concentration,industry concentration, results of regulatory examinations, historical lossranges, portfolio composition, economic conditions such as interest rates andenergy costs and other changes in the portfolio. The allowance for loan lossesis management’s estimate of the probable loan losses as of the balance sheetdate. Any remaining unallocated portion is reviewed for adequacy in relation tothe overall loan portfolio and in recognition of estimates inherent in thecalculation methodology.

 

Inparticular, the allowance for loan losses is influenced by certainconcentrations within the portfolio, including the geographic concentration ofloans in California and New England, which represented approximately 44.6% and14.8%, respectively, of the total loan portfolio at September 30, 2002, andconcentrations of loans to individual borrowers.

 

Capital Crossing Preferred also considers historicallosses in assessing the adequacy of the allowance for loan losses.  Due to the limited operating history ofCapital Crossing Preferred, historical losses are not currently an indicator oflosses inherent in the portfolio. Management will continue to monitor historical losses to assess theadequacy of the allowance for loan losses.

 

10

----

 

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

 
|                                               |   | **Three Months Ended  September 30,** |   | **Nine Months Ended  September 30,** |   |
|----------------------------------------------------|--------|---------------------------------------|--------|--------------------------------------|--------|
|                                               |   | **2002**                              |   | **2001**                             |   | **2002** |   | **2001** |   |
|                                               |   | **(in thousands)**                    |   |
|                                               |   |                                  |   |                                 |   |   |   |   |   |
| Balance at beginning of period                     |   | $                                     | 8,896  |                                 | $      | 3,792 |   | $ | 4,659 |   | $ | 3,795 |   |
| Transfer from Capital Crossing with loans acquired |   | —                                |   | 867                                  |   | 4,250 |   | 867 |   |
| Transfer to Capital Crossing with loans sold       |   | (40                                   | )      | —                               |   | (53 | ) | (3 | ) |
| Balance at end of period                           |   | $                                     | 8,856  |                                 | $      | 4,659 |   | $ | 8,856 |   | $ | 4,659 |   |

 

***Non-AmortizingDiscount.***  At thetime of acquisition, the excess of the contractual loan balances over theamount of reasonably estimable and probable future cash collections is recordedas non-amortizing discount. The non-amortizing discount is not transferred toamortizing discount and accreted into income until it is determined that theamount and timing of the cash flows related to the non-amortizing discount arereasonably estimable and collection is probable. Non-amortizing discountgenerally is reduced and offset against the related principal balance when theamount at which a loan is resolved or restructured is determined. There is noeffect on the income statement as a result of these reductions.  If cashflow projections deteriorate subsequent to acquisition, the decline isaccounted for through the allowance for loan losses.

 

The followingtable sets forth certain information relating to the activity in thenon-amortizing discount for the periods indicated: 

 
|                                                               |   | **Three Months Ended  September 30,** |   | **Nine Months Ended  September 30,** |   |
|--------------------------------------------------------------------|--------|---------------------------------------|--------|--------------------------------------|--------|
|                                                               |   | **2002**                              |   | **2001**                             |   | **2002** |   | **2001** |   |
|                                                               |   | **(in thousands)**                    |   |
|                                                               |   |                                  |   |                                 |   |   |   |   |   |
| Balance at beginning of period                                     |   | $                                     | 9,256  |                                 | $      | 5,109 |   | $ | 6,062 |   | $ | 6,704 |   |
| Transfers to amortizing portion, net                               |   | (238                                  | )      | (610                                 | )      | (1,654 | ) | (1,623 | ) |
| Additions in connection with loans acquired from Capital Crossing  |   | 2,464                                 |   | 2,764                                |   | 8,131 |   | 2,764 |   |
| Net reductions related to resolutions and restructures             |   | (1,724                                | )      | —                               |   | (2,402 | ) | (398 | ) |
| Non-amortizing discount relating to loans sold to Capital Crossing |   | —                                |   | —                               |   | (379 | ) | (184 | ) |
| Balance at end of period                                           |   | $                                     | 9,758  |                                 | $      | 7,263 |   | $ | 9,758 |   | $ | 7,263 |   |

 

#### **InterestRate Risk**

 

CapitalCrossing Preferred’s income consists primarily of interest income on mortgageassets. Capital Crossing Preferred does not intend to use any derivativeproducts to manage its interest rate risk. If there is a decline in marketinterest rates, Capital Crossing Preferred may experience a reduction ininterest income on its mortgage loans and a corresponding decrease in fundsavailable to be distributed to its stockholders. The reduction in interestincome may result from downward adjustments of the indices upon which theinterest rates on loans are based and from prepayments of mortgage loans withfixed interest rates, resulting in reinvestment of the proceeds in loweryielding mortgage loans.

 

**Significant Concentration of CreditRisk**

 

Concentrationof credit risk generally arises with respect to Capital Crossing Preferred’sloan portfolio when a significant number of borrowers engage in similarbusiness activities, or activities in the same geographical region.Concentration of credit risk indicates the relative sensitivity of CapitalCrossing Preferred’s performance to both positive and negative developmentsaffecting a particular industry or geographical region. Capital CrossingPreferred’s balance sheet exposure to geographic concentrations directlyaffects the credit risk of the loans within its loan portfolio.

 

AtSeptember 30, 2002, 44.6% and 14.8%, respectively, of Capital CrossingPreferred’s total loan portfolio consisted of loans located in California andNew England. At December 31, 2001, 39.4% and 28.4%, respectively, of CapitalCrossing Preferred’s total loan portfolio consisted of loans located inCalifornia and New England. Consequently, the portfolio may experience a higherdefault rate, than its current default rate, in the event of adverse economic,political or business developments or natural hazards in California or NewEngland that may affect the ability of property owners to make payments ofprincipal and interest on the underlying mortgages.

#### ** **

11

----

 

#### **LiquidityRisk Management**

 

Theobjective of liquidity risk management is to ensure the availability ofsufficient cash flows to meet all of Capital Crossing Preferred’s financialcommitments and to capitalize on opportunities for Capital Crossing Preferred’sbusiness expansion. In managing liquidity risk, Capital Crossing Preferredtakes into account various legal limitations placed on a REIT.

 

CapitalCrossing Preferred’s principal liquidity needs are:

 

(1)          to maintain the currentportfolio size through the acquisition of additional mortgage assets asmortgage assets currently in the loan portfolio mature, pay down or repay, and

 

(2)          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, debtfinancing or retention of cash flow (after consideration of provisions of theInternal Revenue Code requiring the distribution by a REIT of at least 90% ofits REIT taxable 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 and the Series C preferred stockholders to no more than 100% of the totalstockholders’ equity of Capital Crossing Preferred. Any such debt may include intercompany advancesmade by Capital Crossing to Capital Crossing Preferred.

 

**RISK FACTORS AND OTHER FACTORSAFFECTING****FORWARD-LOOKING STATEMENTS**

 

ThisForm 10-Q contains statements that are “forward-looking statements.”Capital Crossing Preferred may also make forward-looking statements in otherdocuments it files with the SEC, in press releases and other written materials,and in oral statements made by its officers, directors or employees.Forward-looking statements can be identified by the use of the words “believe,”“expect,” “anticipate,” “intend,” “estimate,” “assume” and other similarexpressions which predict or indicate future events and trends and which do notrelate to historical matters. Forward-looking statements should not be relied upon,because 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 achievementsexpressed or implied by the forward–looking statements.

 

Someof the factors that might cause these differences include those set forth below.All of these factors should be carefully reviewed and there may be otherfactors that could cause these differences. These forward-looking statementswere based on information, plans and estimates at the date of this report, andCapital Crossing Preferred does not undertake to update any forward-lookingstatements to reflect changes in underlying assumptions or factors, newinformation, future events or other changes.

 

**A decline inCapital Crossing’s capital levels may result in the Series A and Series Cpreferred shares being subject to automatic exchange into preferred shares ofCapital Crossing**

 

Thereturns from an investment in the Series A or Series C preferred shareswill depend to a significant extent on the performance and capital of Capital Crossing.A significant decline in the performance and capital levels of Capital Crossingor the placement of Capital Crossing into bankruptcy, reorganization,conservatorship or receivership could result in the automatic exchange of theSeries A and Series C preferred shares for preferred shares of CapitalCrossing, which would represent an investment in Capital Crossing and not inCapital Crossing Preferred. Under these circumstances:

 

•                                          a holder of Series A or Series C preferredshares would be a preferred stockholder of Capital Crossing at a time whenCapital Crossing’s financial condition was deteriorating or when CapitalCrossing had been placed into bankruptcy, reorganization, conservatorship orreceivership and, accordingly, it is unlikely that Capital Crossing would be ina financial position to pay any dividends on the preferred shares of CapitalCrossing. An investment in Capital Crossing is also subject to risks that aredistinct from the risks associated with an investment in Capital Crossing Preferred.For example, an investment in Capital Crossing would involve risks relating tothe capital levels of, and other federal and state regulatory requirementsapplicable to, Capital Crossing, and the performance of Capital Crossing’soverall loan portfolio and other business lines. Capital Crossing also hassignificantly greater liabilities and significantly less stockholders’ equitythan does Capital Crossing Preferred;

 

12

----

 

•                                          if a liquidation of Capital Crossing occurs, theclaims of depositors and creditors of Capital Crossing and of the FDIC wouldhave priority over the claims of holders of the preferred shares of CapitalCrossing, and therefore, a holder of Series A and Series C preferredshares likely would receive substantially less than such holder would receivehad the Series A and Series C preferred shares not been exchanged forpreferred shares of Capital Crossing; and

 

•                                          the exchange of the Series A or Series Cpreferred shares for preferred shares of Capital Crossing would be a taxableevent to a holder of Series A or Series C preferred shares under theInternal Revenue Code, and such holder would incur a gain or a loss, as thecase may be, measured by the difference between such holder’s basis in theSeries A or Series C preferred shares and the fair market value of CapitalCrossing preferred shares received in the exchange.

 

**Because ofCapital Crossing Preferred’s obligations to creditors, it may not be able tomake dividend or liquidation payments to holders of the Series A andSeries C preferred shares**

 

The Series A and Series C preferred shares rank:

 

•                                          junior to borrowings of Capital CrossingPreferred, including claims of the FHLBB for amounts due or which may becomedue 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; and

 

•                                          senior to Capital Crossing Preferred’s commonstock and its Series B preferred stock with regard to payment of dividendsand amounts upon liquidation.

 

If Capital Crossing Preferred incurs significant indebtedness, it maynot have sufficient funds to make dividend or liquidation payments on theSeries A or Series C preferred shares. Upon Capital Crossing Preferred’sliquidation, its obligations to its creditors would rank senior to theSeries A and Series C preferred shares. At September 30, 2002, CapitalCrossing Preferred had approximately $95,000 in accounts payable and otherliabilities which, upon its liquidation, would be required to be paid beforeany payments could be made to holders of the Series A or Series Cpreferred shares. In addition, upon Capital Crossing Preferred’s liquidation,dissolution or winding up, if it does not have sufficient funds to pay the fullliquidation amount to the holders of the Series A and Series C preferredshares, such holders may receive less than the $10.00 per share liquidationamount.

 

The terms of the Series A and Series C preferred shares limit CapitalCrossing Preferred’s ability to incur debt in excess of 100% of itsstockholders’ equity without the approval of the holders of all of theoutstanding Series A and Series C preferred shares but do not require thatCapital Crossing Preferred obtain the approval of the holders of theSeries A and Series C preferred shares to issue additional series ofpreferred shares which rank equal to the Series A and Series C preferredshares as to payment of dividends or amount upon liquidation. As a result,subject to these limitations, Capital Crossing Preferred may incur obligationswhich may further limit its ability to make dividend or liquidation payments inthe future.

 

**Bank regulatorsmay limit the ability of Capital Crossing Preferred to implement its businessplan and may restrict its ability to pay dividends**

 

Because Capital Crossing Preferred is a subsidiary of Capital Crossing,federal and state regulatory authorities will have the right to examine it andits activities and under certain circumstances, to impose restrictions onCapital Crossing or Capital Crossing Preferred which could impact CapitalCrossing Preferred’s ability to conduct its business according to its businessplan, which could materially adversely affect the financial condition and resultsof operations of Capital Crossing Preferred:

 

•                                          if Capital Crossing’s regulators determine thatCapital Crossing’s relationship to Capital Crossing Preferred results in anunsafe and unsound banking practice, the regulators could restrict CapitalCrossing Preferred’s ability to transfer assets, to make distributions to itsstockholders, including dividends on its Series A and Series C preferredshares, or to redeem shares of Series A and Series C preferred stock oreven require Capital Crossing to sever its relationship with or divest itsownership interest in Capital Crossing Preferred. Such actions couldpotentially result in Capital Crossing Preferred’s failure to qualify as aREIT.

 

13

----

 

•                                          payment of dividends on the Series A andSeries C preferred shares could also be subject to regulatory limitations ifCapital Crossing becomes undercapitalized. Capital Crossing will be deemedundercapitalized if its total risk-based capital ratio is less than 8.0%, its Tier1 risk-based capital ratio is less than 4.0% or its Tier 1 leverage ratio isless than 4.0%. At September 30, 2002, Capital Crossing had a total risk-basedcapital ratio of 14.83%, a Tier 1 risk-based capital ratio of 13.55% and a Tier1 leverage ratio of 11.67%, which is sufficient for Capital Crossing to beconsidered well-capitalized. As part of its common stock repurchase program,Capital Crossing has also agreed with the FDIC to maintain, for so long as therepurchase program continues, its Tier 1 leverage ratio at least 8.00%. CapitalCrossing Preferred makes no assurance that Capital Crossing will bewell-capitalized under applicable regulations as of any future date. Forpurposes of calculating these capital ratios as a percentage of Capital Crossing’srisk-weighted assets, as opposed to its total assets, Capital Crossing’s assetsare assigned to risk categories based on the relative credit risk of the assetin question. These risk weights consist of 0% for assets deemed least riskysuch as cash, claims backed by the full faith and credit of the U.S.government, and balances due from Federal Reserve banks; 20% for assets deemedslightly more risky such as portions of obligations conditionally guaranteed bythe U.S. government or federal funds sold; 50% for assets deemed still morerisky such as government issued–revenue bonds, one-to-four familyresidential first mortgage loans and well-collateralized multi–familyresidential first mortgage loans; and 100% for all other assets, includingprivate sector loans such as commercial mortgage loans as well as bank-ownedreal estate.

 

•                                          while Capital Crossing Preferred believes thatdividends on the Series A and Series C preferred shares should not beconsidered distributions by Capital Crossing, the FDIC may not agree with thisposition. Under FDIC regulations on capital distributions, the ability ofCapital Crossing to make a capital distribution varies depending primarily onCapital Crossing’s earnings and regulatory capital levels. Capital distributionsare defined to include payment of dividends, stock repurchases, cash-outmergers and other distributions charged against the capital accounts of aninstitution. The FDIC could limit or prohibit the payment of dividends on theSeries A and Series C preferred shares if it determines that the paymentof those dividends is a capital distribution by Capital Crossing and thatCapital Crossing’s earnings and regulatory capital levels are below specifiedlevels.

 

**CapitalCrossing Preferred does not have insurance to cover its exposure to borrowerdefaults and bankruptcies and special hazard losses that are not covered by itsstandard hazard insurance policies**

 

Capital Crossing Preferred does not generally obtain general creditenhancements such as mortgagor bankruptcy insurance or obtain special hazardinsurance for its mortgage assets, other than standard hazard insurance, whichwill in each case only relate to individual mortgage loans. Accordingly,Capital Crossing Preferred will be subject to risks of borrower defaults andbankruptcies and special hazard losses, such as losses occurring from floodsthat are not covered by standard hazard insurance. In the event of a default onany mortgage loan held by Capital Crossing Preferred resulting from decliningproperty values or worsening economic conditions, among other factors, it wouldbear the risk of loss of principal to the extent of any deficiency between(1) the value of the related mortgaged property, plus any payments from aninsurer or guarantor in the case of commercial mortgage loans, and (2) theamount owing on the mortgage loan.

 

**CapitalCrossing Preferred’s results will be affected by factors beyond its control**

 

Capital Crossing Preferred’s mortgage loan portfolio is subject tolocal economic conditions which could affect the value of the real estateassets underlying its loans and therefore, its results of operations will beaffected by various conditions in the real estate market, all of which arebeyond its control, such as:

 

•                                          local and other economic conditions affectingreal estate values;

 

•                                          the continued financial stability of a borrowerand the borrower’s ability to make mortgage payments;

 

•                                          the ability of tenants to make lease payments;

 

•                                          the ability of a property to attract and retaintenants, which may in turn be affected by local conditions, such as oversupplyof space or a reduction in demand for rental space in the area;

 

•                                          interest rate levels and the availability ofcredit to refinance mortgage loans at or prior to maturity; and

 

•                                          increased operating costs, including energycosts, real estate taxes and costs of compliance with environmental controlsand regulations.

 

14

----

 

**CapitalCrossing Preferred’s loans are concentrated in California and New England andadverse conditions in those markets could adversely affect its operations**

 

Properties underlying Capital Crossing Preferred’s current mortgageassets are concentrated primarily in California and New England. As ofSeptember 30, 2002, approximately 44.6% of its mortgage assets were secured byproperties located in California and 14.8% in New England. Adverse economic,political or business developments or natural hazards may affect these areasand the ability of property owners in these areas to make payments of principaland interest on the underlying mortgages. If either region experienced adverseeconomic, political or business conditions, Capital Crossing Preferred wouldlikely experience higher rates of loss and delinquency on its mortgage loansthan if its loans were more geographically diverse.

 

**A substantialmajority of Capital Crossing Preferred’s loans were originated by other partieswhose level of due diligence may be different than Capital Crossing’s level ofdue diligence**

 

At September 30, 2002, approximately 93.7% of Capital CrossingPreferred’s loan portfolio consisted of loans originated by third parties thatwere purchased by Capital Crossing and subsequently acquired by CapitalCrossing Preferred from Capital Crossing. Because these loans were originatedby third parties, Capital Crossing generally is not able to conduct the samelevel of due diligence on these loans that it would have conducted had itoriginated them. Generally, while Capital Crossing conducts an acquisition review,it relies on the underwriting standards of the parties originating the loans itacquires. The standards of these loan originators may be substantiallydifferent than those of Capital Crossing. These differences may include lessrigorous appraisal requirements and debt service coverage ratios, and lessrigorous analysis of property location and environmental factors, buildingcondition and age, tenant quality, compliance with zoning regulations, any userestrictions, easements or right of ways that may impact the value and theborrower’s ability to manage the property. Other disadvantages of purchasedloans versus originated loans may include the lack of current financialinformation, incomplete legal documentation and outdated appraisals.

 

**More than halfof Capital Crossing Preferred’s loan portfolio is made up of commercialmortgage loans which are riskier than other types of loans**

 

Commercial mortgage loans constituted approximately 68.9% of the loansin Capital Crossing Preferred’s loan portfolio at September 30, 2002 andgenerally subject it to greater risks than other types of loans. CapitalCrossing Preferred’s commercial mortgage loans, like most commercial mortgageloans, generally lack standardized terms, tend to have shorter maturities thanresidential mortgage loans and may not be fully amortizing, meaning that theyhave a principal balance or “balloon” payment due on maturity. The commercialreal estate properties underlying Capital Crossing Preferred’s commercialmortgage loans also tend to be unique and are more difficult to value thanresidential real estate properties. They are also subject to relatively greaterenvironmental risks than other types of loans and to the corresponding burdensand costs of compliance with environmental laws and regulations. Because ofthese risks related to Capital Crossing Preferred’s 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 and includeda greater number of residential and other mortgage loans.

 

**CapitalCrossing Preferred may not be able to purchase loans at the same volumes orwith the same yields as it has historically purchased**

 

To date Capital Crossing Preferred has purchased all of the loans inits portfolio from Capital Crossing. Historically, Capital Crossing hasacquired such loans (1) from institutions which sought to eliminatecertain loans or categories of loans from their portfolios, (2) frominstitutions participating in securitization programs, (3) from failed orconsolidating financial institutions and (4) from government agencies.Future loan purchases will depend on the availability of pools of loans offeredfor sale and Capital Crossing’s ability to submit successful bids or negotiatesatisfactory purchase prices. The acquisition of whole loans is highlycompetitive. Consequently, Capital Crossing Preferred cannot provide assurancethat Capital Crossing will be able to purchase loans at the same volumes orwith the same yields as it has historically purchased. This may interfere withCapital Crossing Preferred’s ability to maintain the requisite level ofmortgage assets to maintain its qualification as a REIT. If volumes of loanspurchased decline or the yields on these loans decline further, CapitalCrossing Preferred would experience a material adverse effect on its business,financial condition and results of operations.

 

15

----

 

**CapitalCrossing Preferred could be held responsible for environmental liabilities ofproperties it acquires through foreclosure**

 

If Capital Crossing Preferred is forced to foreclose on a defaultedmortgage loan to recover its investment it may be subject to environmentalliabilities related to the underlying real property. Approximately 68.9% of theloans in Capital Crossing Preferred’s portfolio at September 30, 2002 werecommercial mortgage loans, which generally are subject to relatively greaterenvironmental risks than other types of loans. Hazardous substances or wastes,contaminants, pollutants or sources thereof may be discovered on propertiesduring Capital Crossing Preferred’s ownership or after a sale to a third party.The amount of environmental liability could exceed the value of the real property.There can be no assurance that Capital Crossing Preferred would not be fullyliable for the entire cost of any removal and clean-up on an acquired property,that the cost of removal and clean-up would not exceed the value of theproperty or that Capital Crossing Preferred could recoup any of the costs fromany third party. In addition, Capital Crossing Preferred may find it difficultor impossible to sell the property prior to or following any such remediation.

 

**Capital Crossing Preferred is dependent in virtually everyphase of its operations on the diligence and skill of the management of CapitalCrossing**

 

Capital Crossing, which holds all of Capital Crossing Preferred’scommon stock, is involved in virtually every aspect of Capital Crossing Preferred’sexistence.  Capital Crossing Preferredhas five officers and no other employees and does not have any independentcorporate infrastructure.  CapitalCrossing Preferred does not have any employees because it has retained CapitalCrossing to perform all necessary functions pursuant to the advisory agreementand the master service agreement.  Allof Capital Crossing Preferred’s officers are also officers of CapitalCrossing.  Under an advisory agreementbetween Capital Crossing Preferred and Capital Crossing, Capital Crossingadministers day-to-day activities, including monitoring of Capital CrossingPreferred’s credit quality and advising it with respect to the acquisition,management, financing and disposition of mortgage assets and its operations generally.  Under a master service agreement betweenCapital Crossing Preferred and Capital Crossing, Capital Crossing servicesCapital Crossing Preferred’s loan portfolio. The advisory agreement has an initial term of five years with anautomatic renewal feature and the master service agreement has a one-year termwith an automatic renewal feature.  Boththe master service agreement and the advisory agreement are subject to earliertermination upon provision of 30 days and 90 days notice, respectively.  Capital Crossing may subcontract all or aportion of its obligations under the advisory agreement to its affiliates or,with the approval of a majority of the Board of Directors as well as a majorityof the independent directors, subcontract its obligations under the advisoryagreement to unrelated third parties. Capital Crossing will not, in connection with the subcontracting of anyof its obligations under the advisory agreement, be discharged or relieved fromits obligations under the advisory agreement. The loss of the services of Capital Crossing, or the inability ofCapital 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.

 

**CapitalCrossing Preferred’s relationship with Capital Crossing may create conflicts ofinterest**

 

Capital Crossing and its affiliates may have interests which are notidentical to Capital Crossing Preferred’s and therefore conflicts of interesthave arisen and may arise in the future with respect to transactions betweenCapital Crossing 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 Crossing Preferred’sportfolio will generally reflect the nature, scope and risk of CapitalCrossing’s portfolio rather than a more diverse portfolio composed of mortgageloans also purchased from other lenders.

 

16

----

 

***Servicing of Capital CrossingPreferred mortgage 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 gross outstanding principal balances ofloans serviced. The master service agreement requires Capital Crossing toservice the loan portfolio in a manner substantially the same as for similarwork performed by Capital Crossing for transactions on its own behalf. Thiswill become especially important as Capital Crossing services any loans whichbecome classified or are placed on non-performing status, or are renegotiateddue to the financial deterioration of the borrower. While Capital CrossingPreferred believes that Capital Crossing will diligently pursue collection ofany non-performing loans, Capital Crossing Preferred cannot provide assurancethat this 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 CapitalCrossing Preferred 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 byCapital Crossing Preferred and their replacement by lesser quality loanspurchased from Capital Crossing or elsewhere which could adversely affectCapital Crossing Preferred’s business and its ability to make timely paymentsof 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, all of whom are alsoofficers of Capital Crossing, and/or its directors, three of whom are alsoofficers 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 CrossingPreferred’s guarantee of obligations of Capital Crossing.***  CapitalCrossing Preferred has guaranteed all of the obligations of Capital Crossingunder advances Capital Crossing may receive from time to time from the FHLBB,and has agreed to pledge a significant amount of it’s assets in connection withthose advances. The assets Capital Crossing Preferred pledges to the FHLBB willvary from time to time; however, the potential exists for Capital CrossingPreferred to pledge all of its assets to the FHLBB to secure advances to CapitalCrossing. In addition, Capital Crossing has pledged to the FHLBB all of theshares of Capital Crossing Preferred’s capital stock it owns as collateral forits FHLBB borrowings. Under the terms of the pledge, if Capital Crossingbecomes undercapitalized the FHLBB may require Capital Crossing to dissolveCapital Crossing Preferred such that the assets of Capital Crossing Preferredare distributed to Capital Crossing. In this circumstance the holders ofSeries A and Series C Preferred shares would receive their liquidationpreference only to the extent there are available assets of Capital CrossingPreferred following satisfaction of its outstanding obligations, including itsguarantee of Capital Crossing’s FHLBB borrowings. At September 30, 2002,approximately $45.9 million, or 13.2%, of Capital Crossing Preferredassets have been pledged to and accepted by the FHLBB to secure advances toCapital Crossing. Capital Crossing has also agreed with the FHLBB that it willnot request or accept advances from the FHLBB in excess of Capital CrossingPreferred’s total stockholders equity, less the stockholders equityattributable to the Series A and Series C preferred shares. As ofSeptember 30, 2002, this restriction would limit Capital Crossing’sability to receive advances in excess of approximately $314.9 million. Asof September 30, 2002, Capital Crossing had $129.0 million inoutstanding FHLBB borrowings. The guarantee and pledge were approved by CapitalCrossing Preferred’s independent directors, subject to certain requirements andlimitations, including the requirement that Capital Crossing pay CapitalCrossing Preferred a guarantee fee. Any default by Capital Crossing on itsobligations which would require Capital Crossing Preferred to satisfy itsguarantee could adversely affect its business and its ability to make timelypayments of dividends.

 

***The master loan purchase agreementwas not the 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 was fair to all parties and consistent with market terms, all of it’sofficers and three of its directors are also officers and/or directors ofCapital Crossing and/or affiliates of Capital Crossing. Capital Crossing, asholder of all of Capital Crossing Preferred’s outstanding common stock,controls the election of all Capital Crossing Preferred directors, includingthe independent directors. Capital Crossing Preferred cannot provide assurancethat the master mortgage loan purchase agreement was entered into on terms asfavorable to Capital Crossing Preferred as those that could have been obtainedfrom unaffiliated third parties.

 

17

----

 

**Neither CapitalCrossing Preferred nor Capital Crossing have specific policies with respect tothe purchase by Capital Crossing Preferred from Capital Crossing of particularloans or pools of loans**

 

The lack of specific policies with respect to the purchase by CapitalCrossing Preferred of loans from Capital Crossing could result in CapitalCrossing Preferred acquiring lower quality mortgage assets from CapitalCrossing than if such policies were otherwise in place. Neither CapitalCrossing Preferred nor Capital Crossing currently have specific policies withrespect to the purchase by Capital Crossing Preferred from Capital Crossing ofparticular loans or pools of loans, other than that such assets must beeligible to be held by a REIT. Capital Crossing Preferred’s Board of Directorshas adopted certain policies to guide the acquisition and disposition of assetsbut these policies may be revised from time to time at the discretion of theBoard of Directors without a vote of Capital Crossing Preferred’s stockholders.Capital Crossing Preferred intends to acquire all or substantially all of theadditional mortgage assets it may acquire in the future from Capital Crossingon terms that are comparable to those that could be obtained by CapitalCrossing Preferred if such mortgage assets were purchased from unrelated thirdparties, but Capital Crossing Preferred cannot provide assurance that this willalways be the case.

 

**Capital CrossingPreferred’s Board of Directors has broad discretion to revise Capital CrossingPreferred’s strategies**

 

Capital Crossing Preferred’s Board of Directors has established CapitalCrossing Preferred’s investment and operating strategies. These strategies maybe revised from time to time at the discretion of the Board of Directorswithout a vote of Capital Crossing Preferred’s stockholders. Changes in CapitalCrossing Preferred’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-partyvaluations as part of its loan acquisitions or dispositions and does notanticipate obtaining third-party valuations for future acquisitions anddispositions of mortgage assets. Capital Crossing Preferred does not intend toobtain third-party valuations even where it is acquiring mortgage assets from,or disposing mortgage assets to, one of its affiliates, including CapitalCrossing. Accordingly, Capital Crossing Preferred may pay its affiliates,including Capital Crossing, more than the fair market value of mortgage assetsit acquires and may receive less than the fair market value of the mortgageassets it sells based on a third-party valuation.

 

**Capital Crossing Preferred may pay more than fairmarket value for mortgages it purchases from Capital Crossing because it doesnot engage in arm’s-length negotiations with Capital Crossing**

 

Capital Crossing Preferred acquires mortgage assets from CapitalCrossing under a master mortgage loan purchase agreement between it and CapitalCrossing, at an amount equal to Capital Crossing’s net carrying value for thosemortgage assets. Because Capital Crossing is an affiliate of Capital CrossingPreferred’s, Capital Crossing Preferred does not engage in any arm’s-lengthnegotiations regarding the consideration to be paid. Accordingly, if CapitalCrossing’s net carrying value exceeds the fair market value of the mortgageassets, Capital Crossing Preferred would pay Capital Crossing more than thefair market value for those mortgaged assets.

 

**A decline ininterest rates could reduce Capital Crossing Preferred earnings and affect itsability to pay dividends**

 

Capital Crossing Preferred’s income consists primarily of interestearned on its mortgage assets and short-term investments. A significant portionof Capital Crossing Preferred’s mortgage assets bear interest at adjustablerates. If there is a decline in interest rates, then Capital Crossing Preferredwill experience a decrease in income available to be distributed to itsstockholders. If interest rates decline, Capital Crossing Preferred may alsoexperience an increase in prepayments on its mortgage assets and may find itdifficult to purchase additional mortgage assets bearing rates sufficient tosupport payment of dividends on the Series A and Series C preferredshares. Because the dividend rates on the Series A and Series C preferredshares are fixed, a significant decline in interest rates could materiallyadversely affect Capital Crossing Preferred’s ability to pay dividends on theSeries A and Series C preferred shares.

 

18

----

 

**Tax RisksRelated to REITs**

 

***If Capital Crossing Preferred failsto qualify as a REIT, it will be subject to federal income tax at regularcorporate rates.***IfCapital Crossing Preferred fails to qualify as a REIT for any taxable year, itwould be subject to federal income tax, including any applicable alternativeminimum tax, on its taxable income at regular corporate rates. As a result, theamount available for distribution to Capital Crossing Preferred’s stockholderswould be reduced for the year or years involved. In addition, unless entitledto relief under statutory provisions, Capital Crossing Preferred would bedisqualified from treatment as a REIT for the four taxable years following theyear which qualification was lost. The failure to qualify as a REIT wouldreduce Capital Crossing Preferred’s net earnings available for distribution toits stockholders 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 or Series C preferredshares, nor would it give the holders of the Series A or Series Cpreferred 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 doesnot distribute 90% of its net taxable income, it may not qualify as aREIT. ***In order to qualify as a REIT, Capital CrossingPreferred generally is required each year to distribute to its stockholders atleast 90% of its net taxable income, excluding net capital gains. CapitalCrossing Preferred may retain the remainder of REIT taxable income or all orpart of its net capital gain, but will be subject to tax at regular corporaterates on such income. In addition, Capital Crossing Preferred is subject to a4% nondeductible excise tax on the amount, if any, by which certaindistributions considered as paid by Capital Crossing Preferred with respect toany calendar year are less than the sum of (1) 85% of its ordinary incomefor the calendar year, (2) 95% of its capital gains net income for thecalendar year and (3) 100% of any undistributed income from prior periods.Under certain circumstances, federal or state regulatory authorities mayrestrict Capital Crossing Preferred’s ability, as a subsidiary of CapitalCrossing, to make distributions to its stockholders in an amount necessary toretain its REIT qualification. Such a restriction could result in CapitalCrossing Preferred failing to qualify as a REIT. To the extent Capital CrossingPreferred’s REIT taxable income may exceed the actual cash received for aparticular period, Capital Crossing Preferred may not have sufficient liquidityto make distributions necessary to retain its REIT qualification.

 

***Capital Crossing Preferred mayredeem the Series A and Series C preferred shares at any time upon the occurrence of a tax event.***At any time following the occurrence of certainchanges in the tax laws or regulations concerning REITs, Capital CrossingPreferred will have the right to redeem the Series A and Series Cpreferred shares in whole, subject to the prior written approval of the FDIC.Capital Crossing Preferred would have the right to redeem the Series A andSeries C preferred shares if it received an opinion of counsel to the effectthat, as a result of changes to the tax laws or regulations:

 

(1)                                  dividends paid by Capital Crossing Preferred withrespect to its capital stock are not fully deductible by it for income taxpurposes; or

 

(2)                                  Capital Crossing Preferred are otherwise unableto qualify as a REIT.

 

The occurrence of such changes in the tax laws or regulations will not,however, give the holders of the Series A or Series C preferred shares anyright to have their shares redeemed.

 

***Capital Crossing Preferred has imposed ownership limitationsto protect its ability to qualify as a REIT, however, if ownership of thecommon stock of Capital Crossing becomes concentrated in a small number ofindividuals Capital Crossing Preferred may fail to qualify as a REIT.***To maintain Capital Crossing Preferred’s status as a REIT, not more than 50% invalue of Capital Crossing Preferred’s outstanding shares may be owned, directlyor indirectly, by five or fewer individuals, as defined in the Internal RevenueCode, or the Code, to include certain entities, during the last half of eachtaxable year. Capital Crossing Preferred currently satisfies this requirementbecause for this purpose Capital Crossing Preferred’s common stock held byCapital Crossing is treated as held by Capital Crossing’s stockholders.However, it is possible that the ownership of Capital Crossing might becomesufficiently concentrated in the future such that five or fewer individualswould be treated as having constructive ownership of more than 50% of the valueof Capital Crossing Preferred’s stock. Capital Crossing Preferred may havedifficulty monitoring the daily ownership and constructive ownership of itsoutstanding shares and, therefore, Capital Crossing Preferred cannot provideassurance that it will continue to meet the share ownership requirement. Thisrisk may be increased in the future as Capital Crossing implements common stockrepurchase programs because repurchases may cause ownership in Capital Crossingto become more concentrated. In addition, while the fact that the Series Aand the Series C preferred shares may be redeemed or exchanged will not affectCapital Crossing Preferred’s REIT status prior to any such redemption orexchange, the redemption or exchange of all or a part of the Series A andSeries C preferred shares could adversely affect Capital Crossing Preferred’sability to satisfy the share ownership requirements in the future.

 

19

----

 

**Item 3. Quantitative and QualitativeDisclosures About Market Risk**

 

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

 

In addition to theestimated changes in interest income resulting from the repricing ofcontractual loan rates, interest income can change substantially due tofluctuations in the amount of discount income and other interest and fee incomerecognized as a result of loan payoffs. The level of loan payoffs and relatedinterest income is influenced by several factors, including the interest rateenvironment, the real estate market in particular areas, the timing oftransactions, and circumstances related to individual borrowers and loans.Refer to pages 6-8 for a further analysis and discussion of the fluctuations indiscount income.

 

Capital Crossing Preferred’s management reviews, among other things, thesensitivity of Capital Crossing Preferred’s assets to interest rate changes,the book and market values of assets, purchase and sale activity, andanticipated loan payoffs. Capital Crossing’s senior management also approvesand establishes pricing and funding decisions with respect to Capital CrossingPreferred’s overall asset and liability composition.

 

Capital Crossing Preferred’s methods for evaluating interest rate riskinclude an analysis of its interest-earning assets maturing or repricing withina given time period. Since Capital Crossing Preferred has no interest–bearingliabilities, a period of rising interest rates would tend to result in anincrease in net interest income. A period of falling interest rates would tendto adversely affect net interest income.

 

The following table sets forth Capital Crossing Preferred’sinterest-rate-sensitive assets categorized by repricing dates and weightedaverage yields at September 30, 2002. For fixed rate instruments, the repricingdate is the maturity date. For adjustable-rate instruments, the repricing dateis deemed to be the earliest possible interest rate adjustment date. Assetsthat are subject to immediate repricing are placed in 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   |   | $                           | 88,142  |                  | $      | 100                    |   | $                        | — |                      | $      | —                   |   | $                     | — |      | $      | — |   | $ | — |   | $ | 88,242 |   |
| Average interest  rate       |   | 3.30                        | %       | 2.13                  | %      |                   |   |                     |   |                      |   |                     |   |                  |   |      |   |
| Fixed-rate  loans(1)         |   | —                      |    | 59,510                |   | 29,070                 |   | 19,093                   |   | 13,557                    |   | 9,988                    |   | 27,270                |   | 158,488   |   |
| Average interest  rate       |   |                        |    | 8.57                  | %      | 8.09                   | %      | 7.79                     | %      | 7.71                      | %      | 7.65                     | %      | 7.35                  | %      |      |   |
| Adjustable-rate  loans(1)    |   | 30,416                      |    | 70,334                |   | 6,946                  |   | 523                      |   | —                    |   | —                   |   | —                |   | 108,219   |   |
| Average interest  rate       |   | 7.41                        | %       | 6.97                  | %      | 8.79                   | %      | 8.84                     | %      |                      |   |                     |   |                  |   |      |   |
|                         |   |                        |    |                  |   |                   |   |                     |   |                      |   |                     |   |                  |   |      |   |
| Total  rate-sensitive assets |   | $                           | 118,558 |                  | $      | 129,944                |   | $                        | 36,016 |                      | $      | 19,616                   |   | $                     | 13,557 |      | $      | 9,988 |   | $ | 27,270 |   | $ | 354,949 |   |

 

----

(1)                                  Loansare presented at net amounts before deducting the allowance for loan losses andexclude non-performing loans.

 

Based on CapitalCrossing Preferred’s experience, management applies the assumption that, onaverage, approximately 20% of the outstanding fixed and adjustable rate loanswill prepay annually.

 

At September 30,2002, the fair value of net loans was $261,946,000 as compared to the netcarrying value of net loans of $258,290,000. The fair value of interest-bearing deposits approximates carrying value.

 

20

----

 

**Item 4.  Controls and Procedures**

 

As required by newRules 13a-15 and 15d-15 of the Securities Exchange Act of 1934, within the90-day period prior to the filing of this report and under the supervision andwith the participation of management, including the President and Treasurer,Capital Crossing Preferred has evaluated the effectiveness of the design andoperation of its disclosure controls and procedures.  Based upon such evaluation, the President and Treasurer haveconcluded that such disclosure controls and procedures are effective inensuring that material information relating to Capital Crossing Preferred ismade known to the certifying officers by others within Capital CrossingPreferred during the period covered by this report.  There were no significant changes in Capital Crossing Preferred’sinternal controls for financial reporting or in other factors that couldsignificantly affect such internal controls subsequent to the date of suchevaluation.  In connection with the newrules, Capital Crossing Preferred currently is in the process of furtherreviewing and documenting its disclosure controls and procedures, including itsinternal accounting controls, and may from time to time make changes aimed atenhancing their effectiveness and to ensure that its systems evolve with itsbusiness.

 

21

----

 

**Part II**

 

**Item 1.  Legal Proceedings**

 

Fromtime to time, Capital Crossing Preferred may be involved in routine litigationincidental to its business, including a variety of legal proceedings withborrowers, which would contribute to Capital Crossing Preferred’s expenses,including the costs of carrying non-performing assets. Capital CrossingPreferred is not currently a party to any material proceedings.

** **

**Item 4.  Submission of Matters to a Vote of Security Holders**

 

                On August 14, 2002, Capital Crossing, as the holderof 100 shares of Capital Crossing Preferred's voting common stock comprisingall of the issued and outstanding voting common stock), executed a WrittenConsent of the Sole Common Stockholder unanimously approving the followingresolutions as of June 3, 2002,  (i)setting the number of directors of Capital Crossing Preferred at six; and (ii)electing the following persons to serve as directors of Capital CrossingPreferred until the next annual meeting of the stockholders and until theirsuccessors are elected and qualify to so serve:  Nicholas W. Lazares, Richard Wayne, Edward F. Mehm, Jeffrey P.Ross, Michael J. Fox and Douglas Shaw. Mr. Fox resigned as a director of Capital Crossing Preferred as ofAugust 1, 2002.

 

**Item6.  Exhibits and Reports on Form 8-K**

 

(a)                                  Exhibits.

 

99.1                           Certificationpursuant to Section 906 of the Sarbanes-Oxley Act of  2002 signed by Richard Wayne,President (Chief Executive Officer).

 

99.2                           Certification pursuant to Section 906 of theSarbanes-Oxley Act of  2002 signed byEdward F. Mehm, Treasurer (Principal Financial Officer).

 

(b)                                 Reports on Form 8-K.

 

No reports on Form 8-K were filed in the quarterended September 30, 2002.

 

22

----

 

**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.

 

 
| Date:  November 8, 2002 | By:  /s/ Richard Wayne  |                                          |
|-------------------------|-------------------------|-----------------------------------------------|
|                    |                    | Richard  Wayne                                |
|                    |                    | President  (Principal Executive Officer) |
|                    |                    |
|                    |                    |
| Date:  November 8, 2002 | By:  /s/ Edward F. Mehm |                                          |
|                    |                    | Edward  F. Mehm                               |
|                    |                    | Treasurer (Principal Financial  Officer)      |
|                         |                         |                                               |  |

 

23

----

 

**CERTIFICATIONS**

I, Richard Wayne, certify that:

 

1.                                       Ihave reviewed this quarterly report on Form 10-Q of Capital Crossing PreferredCorporation;

 

2.                                       Basedon my knowledge, this quarterly report does not contain any untrue statement ofa material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements weremade, not misleading with respect to the period covered by this quarterlyreport;

 

3.                                       Basedon my knowledge, the financial statements, and other financial informationincluded in this quarterly report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this quarterly report;

 

4.                                       Theregistrant’s other certifying officers and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a)                                      designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this quarterly report is being prepared;

 

b)                                     evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c)                                      presentedin this quarterly report our conclusions about the effectiveness of thedisclosure controls and procedures based on our evaluation as of the EvaluationDate;

 

5.                                       Theregistrant’s other certifying officers and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

a)                                      allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)                                     anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls; and

 

6.                                       Theregistrant’s other certifying officers and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 
| Date:  November 8, 2002 | By:  /s/ Richard Wayne |                                          |
|-------------------------|------------------------|-----------------------------------------------|
|                    |                   | Richard  Wayne                                |
|                    |                   | President  (Principal Executive Officer) |
|                         |                        |                                               |  |

 

24

----

 

I, Edward F. Mehm,certify that:

 

1.                                       Ihave reviewed this quarterly report on Form 10-Q of Capital Crossing PreferredCorporation;

 

2.                                       Basedon my knowledge, this quarterly report does not contain any untrue statement ofa material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements weremade, not misleading with respect to the period covered by this quarterlyreport;

 

3.                                       Basedon my knowledge, the financial statements, and other financial informationincluded in this quarterly report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this quarterly report;

 

4.                                       Theregistrant’s other certifying officers and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a)                                      designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this quarterly report is being prepared;

 

b)                                     evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c)                                      presentedin this quarterly report our conclusions about the effectiveness of thedisclosure controls and procedures based on our evaluation as of the EvaluationDate;

 

5.                                       Theregistrant’s other certifying officers and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

a)                                      allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)                                     anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls; and

 

6.                                       Theregistrant’s other certifying officers and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 
| Date:  November 8, 2002 | By:  /s/ Edward F. Mehm |                                     |
|-------------------------|-------------------------|------------------------------------------|
|                    |                    | Edward  F. Mehm                          |
|                    |                    | Treasurer  (Principal Financial Officer) |
|                         |                         |                                          |  |

 

25

----

 

**EXHIBIT INDEX**

 
| **Exhibit** |   | **Name**                                                                                                                                            |
|-------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------|
| 99.1        |   | Certification pursuant to Section 906 of the  Sarbanes-Oxley Act of  2002 signed by Richard Wayne, President (Chief  Executive Officer).       |
| 99.2        |   | Certification pursuant to  Section 906 of the Sarbanes-Oxley Act of   2002 signed by Edward F. Mehm, Treasurer (Principal Financial  Officer). |

 

26

----