** **

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

**x****QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934**

** **

**For the Quarterly Period Ended September 30, 2007**

** **

**Commission File Number 000-25193**

 

**CAPITAL CROSSING PREFERREDCORPORATION**

(Exact name of registrant as specified in its charter)

 

**Massachusetts**

(State or other jurisdiction of incorporation or organization)

 

**04-3439366**

(I.R.S. Employer Identification Number)

 

**101 Summer Street, Boston, Massachusetts**

(Address of principal executive offices)

 

**02110**

(Zip Code)

 

**(617) 880-1000**

(Registrant’s telephone number, including area code)

 

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 x  No o

 

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

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act). Yes o  No x

 

Indicatethe number of shares outstanding of the issuer’s common stock, $.01 par valueper share, as of November 13, 2007: 100.

Nocommon stock was held by non-affiliates of the issuer.

 

 

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**CapitalCrossing Preferred Corporation**

**Table of Contents**

 

**PART I – Financial Information**

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

 

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**PART I**

 

##### **Item1. Financial Statements**

##### ** **

## **Capital Crossing Preferred Corporation**

## **Balance Sheets**

**(unaudited)**

 
| ** **                                                                                                                                                                                                    | ** ** | **September 30,**  | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|------------------|------------|
| ** **                                                                                                                                                                                                    | ** ** | **2007**           | ** ** | **2006**         | ** ** |
| ** **                                                                                                                                                                                                    | ** ** | **(in thousands)** | ** ** |
| **ASSETS**                                                                                                                                                                                                    | ** ** | ** **         | ** ** | ** **       | ** ** |
| ** **                                                                                                                                                                                                    | ** ** | ** **         | ** ** | ** **       | ** ** |
| Cash account  with parent                                                                                                                                                                                     |       | $                  | 207        |             | $          | 203 |   |
| Interest bearing  deposits with parent                                                                                                                                                                        |       | 70,736             |       | 83,697           |       |
| Total cash and  cash equivalents                                                                                                                                                                              |       | 70,943             |       | 83,900           |       |
| Certificate of  deposit                                                                                                                                                                                       |       | 200                |       | 200              |       |
| Loans, net of  discounts and net deferred loan income                                                                                                                                                         |       | 73,727             |       | 90,910           |       |
| Less allowance  for loan losses                                                                                                                                                                               |       | (1,235             | )          | (1,519           | )          |
| Loans, net                                                                                                                                                                                                    |       | 72,492             |       | 89,391           |       |
| Accrued interest  receivable                                                                                                                                                                                  |       | 340                |       | 412              |       |
| Other assets                                                                                                                                                                                                  |       | 8                  |       | —           |       |
|                                                                                                                                                                                                          |       | $                  | 143,983    |             | $          | 173,903 |   |
|                                                                                                                                                                                                          |       |               |       |             |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                 | ** ** | ** **         | ** ** | ** **       | ** ** |
| ** **                                                                                                                                                                                                    | ** ** | ** **         | ** ** | ** **       | ** ** |
| Accrued expenses  and other liabilities                                                                                                                                                                       |       | $                  | 959        |             | $          | 1,216 |   |
| Total  liabilities                                                                                                                                                                                            |       | 959                |       | 1,216            |       |
| Stockholders’  equity:                                                                                                                                                                                   |       |               |       |             |       |
| Preferred stock,  Series A, 9.75% non-cumulative, exchangeable; $.01 par value; $10 liquidation  value per share; 1,449,000 shares authorized, 1,416,130 shares issued and  outstanding at December 31, 2006  |       | —             |       | 14               |       |
| Preferred stock,  Series B, 8% cumulative, non-convertible; $.01 par value; $1,000 liquidation  value per share plus accrued dividends; 1,000 shares authorized, 937 shares issued and outstanding            |       | —             |       | —           |       |
| Preferred stock,  Series C, 10.25% non-cumulative, exchangeable; $.01 par value; $10  liquidation value per share; 1,840,000 shares authorized, 1,840,000 shares  issued and outstanding at December 31, 2006 |       | —             |       | 18               |       |
| Preferred stock,  Series D, 8.50% non-cumulative, exchangeable; $.01 par value; $25 liquidation  value per share; 1,725,000 shares authorized, 1,500,000 shares issued and  outstanding                       |       | 15                 |       | 15               |       |
| Common stock,  $.01 par value, 100 shares authorized, issued and outstanding                                                                                                                                  |       | —             |       | —           |       |
| Additional  paid-in capital                                                                                                                                                                                   |       | 140,111            |       | 172,640          |       |
| Retained  earnings                                                                                                                                                                                            |       | 2,898              |       | —           |       |
| Total  stockholders’ equity                                                                                                                                                                              |       | 143,024            |       | 172,687          |       |
|                                                                                                                                                                                                          |       | $                  | 143,983    |             | $          | 173,903 |   |

 

See accompanyingnotes to financial statements.

 

1

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### **Capital CrossingPreferred Corporation**

**Statements of Income**

### **(unaudited)**

 
| ** **                                          | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                          | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **                                          | ** ** | **2007**               | ** ** | **2006**              | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                          | ** ** | **(in thousands)**     | ** ** |
| Interest income:                                    |       |                   |       |                  |       |   |   |   |   |
| Interest and fees on loans                          |       | $                      | 1,532      |                  | $          | 2,978 |   | $ | 5,449 |   | $ | 7,643 |   |
| Interest on interest-bearing deposits               |       | 187                    |       | 287                   |       | 580 |   | 797 |   |
| Total interest income                               |       | 1,719                  |       | 3,265                 |       | 6,029 |   | 8,440 |   |
| Credit for loan losses                              |       | 85                     |       | 171                   |       | 284 |   | 238 |   |
| Total interest income, after credit for loan losses |       | 1,804                  |       | 3,436                 |       | 6,313 |   | 8,678 |   |
| Other income:                                       |       |                   |       |                  |       |   |   |   |   |
| Gain on sales of loans                              |       | —                 |       | 272                   |       | — |   | 1,040 |   |
| Guarantee fee income                                |       | —                 |       | 20                    |       | 30 |   | 60 |   |
| Total other income                                  |       | —                 |       | 292                   |       | 30 |   | 1,100 |   |
|                                                |       |                   |       |                  |       |   |   |   |   |
| Operating expenses:                                 |       |                   |       |                  |       |   |   |   |   |
| Loan servicing and advisory services                |       | 60                     |       | 72                    |       | 136 |   | 228 |   |
| Other general and administrative                    |       | 52                     |       | 14                    |       | 118 |   | 96 |   |
| Total operating expenses                            |       | 112                    |       | 86                    |       | 254 |   | 324 |   |
| Net income                                          |       | 1,692                  |       | 3,642                 |       | 6,089 |   | 9,454 |   |
|                                                |       |                   |       |                  |       |   |   |   |   |
| Preferred stock dividends                           |       | 816                    |       | 1,633                 |       | 3,191 |   | 4,898 |   |
| Net income available to common stockholder          |       | $                      | 876        |                  | $          | 2,009 |   | $ | 2,898 |   | $ | 4,556 |   |

 

See accompanying notes to financial statements.

 

2

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### **Capital CrossingPreferred Corporation**

**Statements of Changes inStockholders’ Equity**

**(unaudited)**

 
| ** **                                              | ** ** | **Nine Months Ended September 30, 2007** | ** ** |
|---------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                              | ** ** | **Preferred Stock**                                          | ** ** | **Preferred Stock** | ** ** | **Preferred Stock** | ** ** | **Preferred Stock** | ** ** | ** ** | ** ** | ** ** | ** ** | **Additional** | ** ** | ** ** | ** ** | **Total** | ** ** |
| ** **                                              | ** ** | **Series A**                                                 | ** ** | **Series B** | ** ** | **Series C** | ** ** | **Series D** | ** ** | **Common Stock** | ** ** | **Paid-in** | ** ** | **Retained** | ** ** | **Stockholders’** | ** ** |
| ** **                                              | ** ** | **Shares**                                                        | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Capital** | ** ** | **Earnings** | ** ** | **Equity** | ** ** |
| ** **                                              | ** ** | **(in thousands)**                                           | ** ** |
| Balance at  December 31, 2006                      |       | 1,416                                                             |       | $ | 14 |   | 1 |   | $ | — |   | 1,840 |   | $ | 18 |   | 1,500 |   | $ | 15 |   | — |   | $ | — |   | $ | 172,640 |   | $ | — |   | $ | 172,687 |   |
| Net income                                              |       | —                                                            |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | 6,089 |   | 6,089 |   |
| Redemption of  preferred stock, Series A and C     |       | (1,416                                                            | )          | (14 | ) | — |   | — |   | (1,840 | ) | (18 | ) | — |   | — |   | — |   | — |   | (32,529 | ) | — |   | (32,561 | ) |
| Dividends on  preferred stock, Series A            |       | —                                                            |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | (314 | ) | (314 | ) |
| Cumulative  dividends on preferred stock, Series B |       | —                                                            |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | (56 | ) | (56 | ) |
| Dividends on  preferred stock, Series C            |       | —                                                            |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | (430 | ) | (430 | ) |
| Dividends on  preferred stock, Series D            |       | —                                                            |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | (2,391 | ) | (2,391 | ) |
| Balance at  September 30, 2007                     |       | —                                                            |       | $ | — |   | 1 |   | $ | — |   | — |   | $ | — |   | 1,500 |   | $ | 15 |   | — |   | $ | — |   | $ | 140,111 |   | $ | 2,898 |   | $ | 143,024 |   |

 
| ** **                                              | ** ** | **Nine Months Ended September 30, 2006** | ** ** |
|---------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                              | ** ** | **Preferred Stock**                                          | ** ** | **Preferred Stock** | ** ** | **Preferred Stock** | ** ** | **Preferred Stock** | ** ** | ** ** | ** ** | ** ** | ** ** | **Additional** | ** ** | ** ** | ** ** | **Total** | ** ** |
| ** **                                              | ** ** | **Series A**                                                 | ** ** | **Series B** | ** ** | **Series C** | ** ** | **Series D** | ** ** | **Common Stock** | ** ** | **Paid-in** | ** ** | **Retained** | ** ** | **Stockholders’** | ** ** |
| ** **                                              | ** ** | **Shares**                                                        | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Capital** | ** ** | **Earnings** | ** ** | **Equity** | ** ** |
| ** **                                              | ** ** | **(in thousands)**                                           | ** ** |
| Balance at  December 31, 2005                      |       | 1,416                                                             |       | $ | 14 |   | 1 |   | $ | — |   | 1,840 |   | $ | 18 |   | 1,500 |   | $ | 15 |   | — |   | $ | — |   | $ | 202,049 |   | $ | — |   | $ | 202,096 |   |
| Net income                                              |       | —                                                            |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | 9,454 |   | 9,454 |   |
| Dividends on preferred  stock, Series A            |       | —                                                            |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | (1,036 | ) | (1,036 | ) |
| Cumulative  dividends on preferred stock, Series B |       | —                                                            |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | (56 | ) | (56 | ) |
| Dividends on  preferred stock, Series C            |       | —                                                            |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | (1,415 | ) | (1,415 | ) |
| Dividends on  preferred stock, Series D            |       | —                                                            |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | (2,391 | ) | (2,391 | ) |
| Balance at  September 30, 2006                     |       | 1,416                                                             |       | $ | 14 |   | 1 |   | $ | — |   | 1,840 |   | $ | 18 |   | 1,500 |   | $ | 15 |   | — |   | $ | — |   | $ | 202,049 |   | $ | 4,556 |   | $ | 206,652 |   |

 

See accompanyingnotes to financial statements.

 

3

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**CapitalCrossing Preferred Corporation**

**Statements of Cash Flows**

**(unaudited)**

** **
| ** **                                                                         | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2007**                                                | ** ** | **2006** | ** ** |
| ** **                                                                         | ** ** | **(in thousands)**                                 | ** ** |
| Cash flows provided by operating activities:                                       |       |                                                    |       |   |   |
| Net income                                                                         |       | $                                                       | 6,089      |   | $ | 9,454 |   |
| Adjustments to reconcile net income to net cash provided by operating  activities: |       |                                                    |       |   |   |
| Credit for loan losses                                                             |       | (284                                                    | )          | (238 | ) |
| Gain on sales of loans                                                             |       | —                                                  |       | (1,040 | ) |
| Other, net                                                                         |       | (193                                                    | )          | 61 |   |
|                                                                               |       |                                                    |       |   |   |
| Net cash provided by operating activities                                          |       | 5,612                                                   |       | 8,237 |   |
|                                                                               |       |                                                    |       |   |   |
| Cash flows provided by investing activities:                                       |       |                                                    |       |   |   |
| Loan repayments                                                                    |       | 17,183                                                  |       | 15,352 |   |
| Proceeds from loan sales                                                           |       | —                                                  |       | 2,672 |   |
| Net decrease in certificate of deposit                                             |       | —                                                  |       | 96 |   |
|                                                                               |       |                                                    |       |   |   |
| Net cash provided by investing activities                                          |       | 17,183                                                  |       | 18,120 |   |
|                                                                               |       |                                                    |       |   |   |
| Cash flows used in financing activities:                                           |       |                                                    |       |   |   |
| Redemption of preferred stock, Series A and C                                      |       | (32,561                                                 | )          | — |   |
| Payment of preferred stock dividends                                               |       | (3,191                                                  | )          | (4,898 | ) |
|                                                                               |       |                                                    |       |   |   |
| Net cash used in financing activities                                              |       | (35,752                                                 | )          | (4,898 | ) |
|                                                                               |       |                                                    |       |   |   |
| Net (decrease) increase in cash and cash equivalents                               |       | (12,957                                                 | )          | 21,459 |   |
| Cash and cash equivalents at beginning of period                                   |       | 83,900                                                  |       | 88,406 |   |
|                                                                               |       |                                                    |       |   |   |
| Cash and cash equivalents at end of period                                         |       | $                                                       | 70,943     |   | $ | 109,865 |   |

 

See accompanyingnotes to financial statements.

 

4

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**CapitalCrossing Preferred Corporation**

**Notes to Financial Statements**

**Three andNine Months Ended September 30, 2007 and 2006**

 

**Note 1.   Basis ofPresentation**

 

Capital Crossing Preferred Corporation (“CapitalCrossing Preferred”) is a Massachusetts corporation organized on March 20,1998, to acquire and hold real estate assets. Lehman Brothers Bank, FSB (“LehmanBank”), a subsidiary of Lehman Brothers Holdings Inc. (“LBHI”; LBHI with itssubsidiaries, “Lehman Brothers”), owns all of Capital Crossing Preferred’scommon stock. Lehman Bank is in compliance with its regulatory capitalrequirements at September 30, 2007. Prior to the merger with Lehman Bank, whichis further discussed below, Capital Crossing Preferred was a subsidiary ofCapital Crossing Bank (“Capital Crossing”), a federally insured Massachusettstrust company, and Capital Crossing owned all of Capital Crossing Preferred’scommon stock. Capital Crossing Preferred operates in a manner intended to allowit to be taxed as a real estate investment trust, or a “REIT”, under theInternal Revenue Code of 1986, as amended. As a REIT, Capital CrossingPreferred generally will not be required to pay federal income tax if itdistributes its earnings to its shareholders and continues to meet a number ofother requirements.

 

On September 19, 2006, Capital Crossing announcedthat it had signed a definitive merger agreement whereby Capital Crossing wouldbe acquired by Lehman Bank through a two step merger transaction. Under theterms of the agreement, Lehman Brothers paid $30.00 per share in cash inexchange for each outstanding share of Capital Crossing. The acquisition wassubject to customary closing conditions and regulatory approvals. The finalapprovals were received on February 13, 2007 and on February 14, 2007, aninterim thrift subsidiary of Lehman Bank was merged into Capital Crossing. Immediatelyfollowing such merger, Capital Crossing was merged into Lehman Bank.

 

On January 16, 2007, Capital Crossing Preferred’sBoard of Directors voted to amend Capital Crossing Preferred’s charter, subjectto completion of the merger. The exchange of the Series A, Series Cand Series D preferred shares into preferred shares of Capital Crossingwas amended to be exchangeable into preferred shares of Lehman Bank. Thisamendment was approved by Capital Crossing Preferred’s common stockholder. OnJanuary 29, 2007, Capital Crossing Preferred’s Board of Directors voted toredeem the Series A preferred shares and Series C preferred shares.The redemption notice to holders of the Series A and Series Cpreferred shares was mailed following the completion of the merger with LehmanBank. On March 23, 2007, Capital Crossing Preferred redeemed the Series A and Cpreferred shares. The Series B preferred shares and Series Dpreferred shares remain outstanding and remain subject to their existing termsand conditions, including their respective call features.

 

The financial informationas of September 30, 2007 and the results of operations for the three and ninemonths ended September 30, 2007 and 2006 and, changes in stockholders’ equityand cash flows for the nine months ended September 30, 2007 and 2006 areunaudited; however, in the opinion of management, the financial informationreflects all adjustments (consisting solely of normal recurring accruals)necessary for a fair presentation in accordance with accounting principlesgenerally accepted in the United States of America. The interim financialstatements for the three and nine months ended September 30, 2007 and 2006 arecomparable as there were no changes in accounting principles as a result of themerger. Interim results are not necessarily indicative of results to beexpected for the entire year. These interim financial statements are intendedto be read in conjunction with the financial statements presented in CapitalCrossing Preferred’s Annual Report on Form 10-K as of, and for the year ended,December 31, 2006.

 

In preparing financialstatements in conformity with accounting principles generally accepted in theUnited States of America, management is required to make estimates andassumptions that affect the reported amounts of assets and liabilities as ofthe date of the balance sheet and reported amounts of revenues and expensesduring the reporting period. Actual results could differ from those estimates. Materialestimates that are particularly susceptible to significant change in the nearterm relate to the determination of the allowance for losses on loans, theallocation of purchase discount on loans between accretable and nonaccretableportions, and the rate at which the discount is accreted into interest income.

 

#### **Note2.   Recent Accounting Pronouncements**

#### ** **

In September 2006, theFinancial Accounting Standards Board issued Statement of Financial AccountingStandards No. 157, “Fair Value Measurements.”  This new standard definesfair values, establishes a framework for measuring fair value in conformitywith accounting principles generally accepted in the United State of America (“GAAP”),and expands disclosures about fair value measurements.  Prior to thisstandard, there were varying definitions of fair value and limited guidance forapplying those definitions under GAAP.  In addition, the guidance wasdispersed among many accounting pronouncements that require fair valuemeasurements.  This standard is intended to increase consistency andcomparability in fair value measurements and disclosures about fair valuemeasurements.  The provisions of this standard are effective January 1,2008.  Capital Crossing Preferred is currently evaluating the potentialimpact of the adoption of this standard on its financial positions and resultsof operations.

 

5

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#### **Note 3.  **Commitments, Contingenciesand Guarantees

#### ** **

*Guarantees*

 

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

 

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

 

This Quarterly Report on Form 10-Q containsforward-looking statements within the meaning of Section 21E of the SecuritiesExchange Act of 1934, as amended, and Section 27A of the Securities Act of1933, as amended. For purposes of these Acts, any statement that is not astatement of historical fact may be deemed a forward-looking statement. Forexample, statements containing the words “believes,” “anticipates,” “plans,” “expects,”“estimates,” “intends,” “may,” “projects,” “will,” “would,” and similarexpressions may be forward-looking statements. Capital Crossing Preferredcautions investors not to place undue reliance on any forward-lookingstatements in this Quarterly Report on Form 10-Q. Capital Crossing Preferredundertakes no obligation to publicly update any forward-looking statements,whether as a result of new information, future events or otherwise. There are anumber of factors that could cause Capital Crossing Preferred’s actual resultsto differ materially from those indicated by these forward-looking statements,including without limitation the factors set forth below in Part II, Item 1A. “RiskFactors”. These factors and the other cautionary statements made in this quarterlyreport should be read as being applicable to all related forward-lookingstatements wherever they appear in this quarterly report. If one or more ofthese factors materialize, or if any underlying assumptions prove incorrect,Capital Crossing Preferred’s actual results, performance, or achievements mayvary materially from any future results, performance, or achievements expressedor implied by these forward-looking statements.

 

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

 

**Executive Level Overview**

 

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

 

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

 

Net income available to the common shareholderdecreased $1.1 million, or 56.4%, to $876,000 for the three months ended September30, 2007 compared to $2.0 million for the same period in 2006. The decrease isprimarily the result of a decrease in interest and fees on loans and gains onsales of loans, partially offset by a decrease in preferred stock dividends. Netincome available to the common shareholder decreased $1.7 million, or 36.4%, to$2.9 million for the nine months ended September 30, 2007 compared to $4.6million for the same period in 2006. The decrease is primarily the result ofdecreases in interest and fees on loans and gains on sales of loans, partiallyoffset by a decrease in preferred stock dividends and operating expenses. Thedecrease in interest income for both the three and nine month periods isprimarily due to a smaller loan portfolio as a result of loan amortization andrepayments. There were no sales of loans in 2007. The decrease in preferredstock dividends in both the three and nine month periods is due to theredemption of the Series A and Series C preferred shares on March 23, 2007.

 

All of the mortgage assets in Capital CrossingPreferred’s loan portfolio at September 30, 2007 were acquired from CapitalCrossing and it is anticipated that substantially all additional mortgageassets will be acquired from Lehman Bank. As of September 30, 2007, CapitalCrossing Preferred held loans acquired from Capital Crossing with netinvestment balances of $73.7 million.

 

Commercial mortgage loans constituted approximately63.4% of the net loans in Capital Crossing Preferred’s loan portfolio atSeptember 30, 2007. Commercial mortgage loans are generally subject to greaterrisks than other types of loans. Capital Crossing Preferred’s commercialmortgage loans, like most commercial mortgage loans, generally lackstandardized terms, tend to have shorter

 

6

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maturities than other mortgage loans and may not befully amortizing. For these reasons, Capital Crossing Preferred may experiencehigher rates of default on its mortgage loans than it would if its loanportfolio was more diversified and included a greater number of owner-occupiedresidential or other mortgage loans.

 

Properties underlying Capital Crossing Preferred’scurrent mortgage assets are also concentrated primarily in California and NewEngland. As of September 30, 2007, approximately 56.3% of the balances of itsmortgage loans were secured by properties located in California and 6.8% in NewEngland. In the instance where either region experiences adverse economic,political or business conditions, Capital Crossing Preferred would likelyexperience higher rates of loss and delinquency on its mortgage loans.

 

Since Capital Crossing Preferred is a subsidiary ofLehman Bank, federal bank regulatory authorities will have the right to examineit and its activities and under certain circumstances, to impose restrictionson Lehman Bank or Capital Crossing Preferred which could impact CapitalCrossing Preferred’s ability to conduct its business according to its businessplan. For instance, if Lehman Bank’s regulators determine that Lehman Bank’srelationship to Capital Crossing Preferred results in an unsafe and unsoundbanking practice, the regulators could restrict Capital Crossing Preferred’sability to transfer assets, to make distributions to its stockholders or even requireLehman Bank to sever its relationship with or divest its ownership interest inCapital Crossing Preferred.

 

Decisions regarding the utilization of CapitalCrossing Preferred’s cash are based, in large part, on its future commitmentsto pay preferred stock dividends. During the three months ended September 30,2007, the loan portfolio was large enough to generate income resulting in netincome, which was 2.07 times fixed charges and preferred stock dividends.Future decisions regarding mortgage asset acquisitions and returns of capitalwill be based on the level of preferred stock dividends at the time and therequired level of income necessary to generate adequate dividend coverage.

 

**Application of Critical AccountingPolicies and Estimates**

 

The SEC requires that all registrants discuss theirmost “critical accounting policies” in management’s discussion and analysis offinancial condition and results of operations. The SEC indicated that a “criticalaccounting policy” is one which is both important to the portrayal of thecompany’s financial condition and results and requires management’s mostdifficult, subjective or complex judgments, often as a result of the need tomake estimates about the effect of matters that are inherently uncertain. WhileCapital Crossing Preferred’s significant accounting policies are more fullydescribed in Note 1 to the Financial Statements included in its Annual Reporton Form 10-K for the year ended December 31, 2006, the following is a summaryof the accounting policies believed by management to be most critical in theirpotential effect on Capital Crossing Preferred’s financial position or resultsof operations:

 

**Discountson Acquired Loans.**In accordance with Statement of Position (“SOP”)No. 03-3 “Accounting for Certain Loans or Debt Securities Acquired in aTransfer”, Capital Crossing Preferred reviews acquired loans for differencesbetween contractual cash flows and cash flows expected to be collected fromCapital Crossing Preferred’s initial investment in the acquired loans todetermine if those differences are attributable, at least in part, to creditquality. The loan’s contractually required payments receivable in excess of theamount of its cash flows expected at acquisition, or nonaccretable discount, isnot accreted into income. SOP No. 03-3 requires that Capital Crossing Preferredrecognize the excess of all cash flows expected at acquisition over CapitalCrossing Preferred’s initial investment in the loan as interest income usingthe interest method over the term of the loan. This excess is referred to asaccretable discount.

 

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

 

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

 

There is judgmentinvolved in estimating the amount of Capital Crossing Preferred’s future cashflows. The amount and timing of actual cash flows could differ materially frommanagement’s estimates, which could materially affect Capital CrossingPreferred’s financial condition and results of operations. Depending on thetiming of an acquisition, a preliminary allocation may be utilized until afinal allocation is established. Generally, the allocation will be finalized nolater than ninety days from the date of purchase.

 

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

 

Subsequent toacquisition, if cash flow projections improve, and it is determined that theamount and timing of the cash flows related to the nonaccretable discount arereasonably estimable and collection is probable, the corresponding decrease inthe nonaccretable

 

7

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discount is transferredto the accretable discount and is accreted into interest income over theremaining life of the loan on the interest method. If cash flow projectionsdeteriorate subsequent to acquisition, the decline is accounted for through aprovision for loan losses included in earnings.

 

When a loan is paid-off,the excess of any cash received over the net investment is recorded as 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 Preferred’s acquisition of the loan, interest collected if onnon-performing status, prepayment fees and other loan fees.

 

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

 

**Allowance for Loan Losses.**Arrivingat an appropriate level of allowance for loan losses requires a high degree ofjudgment. Capital Crossing Preferred maintains an allowance for probable loanlosses that are inherent in its loan portfolio. The allowance for loan lossesis increased or decreased through a provision or credit for loan losses includedin earnings.

 

In determining theadequacy of the allowance for loan losses, management makes significantjudgments. Management initially reviews its loan portfolio to identify loansfor which specific allocations are considered prudent. Specific allocationsinclude the results of measuring impaired loans under Statement of FinancialAccounting Standards (“SFAS”) No. 114 “Accounting by Creditors for Impairmentof a Loan”. Next, management considers the level of general loan allowancesdeemed appropriate for loans. General risk allocations are determined by aformula whereby the portfolio is stratified by type and internal risk ratingcategories. Loss factors are then applied to each strata based on variousconsiderations including collateral type, loss experience, delinquency trends,current economic conditions, industry standards, and regulatory guidelines. Theallowance for loan losses is management’s estimate of the probable loan lossesincurred as of the balance sheet date. There can be no assurance that CapitalCrossing Preferred’s actual losses with respect to loans will not exceed itsallowance for loan losses.

 

In accordance with SOP No. 03-3, Capital CrossingPreferred does not establish allowances for loan losses in the initialaccounting for loans with evidence of credit quality deterioration that areacquired in a transfer. Rather, the excess of the acquired loan’s contractuallyrequired payments receivable over the amount of cash flows Capital CrossingPreferred expects to collect at acquisition, is recorded as nonaccretablediscount. For those acquired loans which do not display evidence of thedeterioration of credit quality and are therefore outside the scope of SOP03-3, general risk allocations are established through a charge to earnings.

 

Subsequent to loan acquisition, the allowance for loanlosses is increased through a provision for loan losses included in earningswhen evidence indicates that there has been a decrease in estimated cash flowsexpected to be collected. The allowance for loan losses is decreased upon salesor payoffs of loans for which a related allowance remains unused. Reductions inconnection with sales are included in the calculation of the gain or loss, andreductions related to payoffs are recorded as a credit for loan losses. Loanlosses are charged against the allowance when management believes the netinvestment of the loan, or a portion thereof, is uncollectible. Subsequentrecoveries, if any, are credited to the allowance when cash payments arereceived. It is anticipated that the allowance will continue to decline ascredits for loan losses may continue to be recorded if loans pay off andallowance allocations related to these loans are not required or additions dueto loan impairment are not required.

 

8

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#### **Resultsof Operations for the Three Months Ended September 30, 2007 and 2006**

#### ** **

***Interest income***

*** ***

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

 
| ** **                    | ** ** | **Three Months Ended September 30,** | ** ** |
|-------------------------------|------------|----------------------------------------------------------|------------|
| ** **                    | ** ** | **2007**                                                 | ** ** | **2006** | ** ** |
| ** **                    | ** ** | **Average**                                              | ** ** | **Interest** | ** ** | ** ** | ** ** | **Average** | ** ** | **Interest** | ** ** | ** ** | ** ** |
| ** **                    | ** ** | **Balance**                                              | ** ** | **Income** | ** ** | **Yield** | ** ** | **Balance** | ** ** | **Income** | ** ** | **Yield** | ** ** |
| ** **                    | ** ** | **(dollars in thousands)**                     | ** ** |
|                          |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Loans, net (1)                |       | $                                                        | 76,754     |   | $ | 1,532 |   | 7.92 | % | $ | 103,329 |   | $ | 2,978 |   | 11.43 | % |
| Interest-bearing deposits     |       | 67,224                                                   |       | 187 |   | 1.10 |   | 103,355 |   | 287 |   | 1.10 |   |
| Total interest-earning assets |       | $                                                        | 143,978    |   | $ | 1,719 |   | 4.74 | % | $ | 206,684 |   | $ | 3,265 |   | 6.27 | % |

 

----

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

 

The decline in interestincome for the three months ended September 30, 2007 compared to the threemonths ended September 30, 2006 is primarily due to a decrease in the averagebalance of loans and interest bearing deposits and a decrease in the yield onloans.

 

Average loans, net forthe three months ended September 30, 2007 totaled $76.8 million comparedto $103.3 million for the same period in 2006. This decrease is primarily attributable to loan pay-offs, amortizationof loans and loan sales. No loans were acquired in 2007 or 2006. For the threemonths ended September 30, 2007, the yield on the loan portfolio decreased to7.92% compared to 11.43% for the same period in 2006. For the three monthsended September 30, 2007, interest and fee income recognized on loan payoffsdecreased $837,000, or 99.3%, to $6,000 from $843,000 for the three monthsended September 30, 2006. The level of interest and fee income recognized onloan payoffs varies for numerous reasons, as further discussed below. The yieldfrom regularly scheduled interest and accretion income decreased to 7.89% forthe three months ended September 30, 2007 from 8.20% for the same period in2006.  The decrease in the yield fromregularly scheduled interest and accretion is primarily due to the fact thatloans with higher yields have paid off during the three months ended September30, 2007.

 

Income on loans includes the portion of the purchasediscount that is accreted into income over the remaining lives of the relatedloans using the interest method. Because the carrying value of the loanportfolio is net of purchase discount, the related yield on this portfoliogenerally is higher than the aggregate contractual rate paid on the loans. Thetotal yield includes the excess of a loan’s expected discounted future cashflows over its net investment, recognized using the interest method.

 

When a loan is paid off, the excess of any cashreceived over the net investment is recorded as interest income. In addition tothe amount of purchase discount that is recognized at that time, income mayalso include interest owed by the borrower prior to Lehman Bank’s acquisitionof the loan, interestcollected if on non-performing status, prepayment fees and other loan fees (“otherinterest and fee income”). The following table sets forth, for the periodsindicated, the components of interest and fees on loans. There can be noassurance regarding future interest income, including the yields and relatedlevel of such income, or the relative portion attributable to loan pay-offs ascompared to other sources.

 
| ** **                                          | ** ** | **Three Months Ended September 30,** | ** ** |
|-----------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                          | ** ** | **2007**                                                 | ** ** | **2006** | ** ** |
| ** **                                          | ** ** | **Interest**                                             | ** ** | ** ** | ** ** | **Interest** | ** ** | ** ** | ** ** |
| ** **                                          | ** ** | **Income**                                               | ** ** | **Yield** | ** ** | **Income** | ** ** | **Yield** | ** ** |
| ** **                                          | ** ** | **(dollars in thousands)**                     | ** ** |
|                                                |       |                                                     |       |   |   |   |   |   |   |
| Regularly scheduled interest and accretion income   |       | $                                                        | 1,526      |   | 7.89 | % | $ | 2,135 |   | 8.20 | % |
| Interest and fee income recognized on loan payoffs: |       |                                                     |       |   |   |   |   |   |   |
| Nonaccretable discount                              |       | 1                                                        |       | 0.00 |   | — |   | — |   |
| Accretable discount                                 |       | 5                                                        |       | 0.03 |   | 284 |   | 1.09 |   |
| Other interest and fee income                       |       | —                                                   |       | — |   | 559 |   | 2.14 |   |
|                                                |       | 6                                                        |       | 0.03 |   | 843 |   | 3.23 |   |
|                                                |       | $                                                        | 1,532      |   | 7.92 | % | $ | 2,978 |   | 11.43 | % |

 

9

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The amount of loanpayoffs and related discount income is influenced by several factors, includingthe interest rate environment, the real estate market in particular areas, thetiming of transactions, and circumstances related to individual borrowers andloans. The amount of individual loan payoffs is often a result of negotiationsbetween Capital Crossing Preferred and the borrower. Based upon credit riskanalysis and other factors, Capital Crossing Preferred will, in certaininstances, accept less than the full amount contractually due in accordancewith the loan terms.

 

The average balance ofinterest-bearing deposits decreased $36.1 million or 35.0% to $67.2 million forthe three months ended September 30, 2007, compared to $103.4 million for thesame period in 2006. The changes in the average balances of interest-bearingdeposits are the result of periodic dividend payments, and returns of capital,offset by cash flows from loan repayments. Additionally, on March 23, 2007,Capital Crossing Preferred redeemed the Series A and Series C preferred shares,which caused a decrease of $32.6 million in interest-bearing deposits.

 

***Credit for loan losses***

 

Capital CrossingPreferred recorded credits for loan losses of $85,000 and $171,000 for thethree months ended September 30, 2007 and 2006, respectively, to reverse unusedloss reserves related to loans that have been paid off. The credit for loanlosses is based on the volume and types of loan payoffs. As loans pay off, acredit for loan losses is recorded to reduce allowance allocations related tothe loans that have paid off for which a related allowance remains unused. Theallowance for loan losses is based on the size of the portfolio and itshistorical performance. The determination of this allowance requires management’suse of estimates and assumptions regarding the risks inherent in individualloans and the loan portfolio in its entirety. Should the loan portfoliocontinue to decline without utilization of the allowance for loan losses,future credits for loan losses may be necessary.

 

***Other income***

 

During the three monthsended September 30, 2006, two loans with a carrying value of $817,000 were soldto an unaffiliated third party resulting in a gain of $272,000. There were noloan sales during the three months ended September 30, 2007.

 

Guarantee fee incometotaled $20,000 for the three months ended September 30, 2006.  There was no guarantee fee income for thethree months ended September 30, 2007 due to the fact Lehman Bank paid off itsFHLBB advances in May 2007 and as a result, the guarantee was released.

 

***Operating expenses***

 

Loan servicing andadvisory expenses decreased $12,000, or 16.7%, to $60,000 for the three monthsended September 30, 2007 from $72,000 for the three months ended September 30,2006 primarily as a result of a decrease in loan servicing expenses due to adecrease in the average balance of the loan portfolio offset by an increase inmortgage impairment insurance expense.

 

Othergeneral and administrative expenses increased $38,000 or 271.4%, to $52,000 forthe three months ended September 30, 2007 compared to $14,000 for the threemonths ended September 30, 2006. This increase is primarily attributable to anincrease in external audit expenses and a decrease in legal fee reimbursementscollected from borrowers previously expensed by Capital Crossing Preferredrelated to certain loan matters.

 

10

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#### **Resultsof Operations for the Nine Months Ended September 30, 2007 and 2006**

#### ** **

***Interest income***

*** ***

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

 
| ** **                    | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------------------|------------|---------------------------------------------------------|------------|
| ** **                    | ** ** | **2007**                                                | ** ** | **2006** | ** ** |
| ** **                    | ** ** | **Average**                                             | ** ** | **Interest** | ** ** | ** ** | ** ** | **Average** | ** ** | **Interest** | ** ** | ** ** | ** ** |
| ** **                    | ** ** | **Balance**                                             | ** ** | **Income** | ** ** | **Yield** | ** ** | **Balance** | ** ** | **Income** | ** ** | **Yield** | ** ** |
| ** **                    | ** ** | **(dollars in thousands)**                    | ** ** |
|                          |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |
| Loans, net (1)                |       | $                                                       | 82,967     |   | $ | 5,449 |   | 8.78 | % | $ | 108,885 |   | $ | 7,643 |   | 9.38 | % |
| Interest-bearing deposits     |       | 69,485                                                  |       | 580 |   | 1.12 |   | 96,547 |   | 797 |   | 1.10 |   |
| Total interest-earning assets |       | $                                                       | 152,452    |   | $ | 6,029 |   | 5.29 | % | $ | 205,432 |   | $ | 8,440 |   | 5.49 | % |
|                               |            |                                                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

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

 

The decline in interestincome for the nine months ended September 30, 2007 compared to the nine monthsended September 30, 2006 is primarily due to a decrease in the average balanceof loans and interest bearing deposits and a decrease in the yield on loans.

 

Average loans, net forthe nine months ended September 30, 2007 totaled $83.0 million compared to$108.9 million for the same period in 2006. This decrease is primarily attributable to loan pay-offs, amortizationof loans and loan sales. No loans were acquired in 2007 or 2006. For the ninemonths ended September 30, 2007, the yield on the loan portfolio decreased to8.78% compared to 9.38% for the same period in 2006. For the nine months endedSeptember 30, 2007, interest and fee income recognized on loan payoffsdecreased $581,000, or 56.9%, to $440,000 from $1.0 million for the nine monthsended September 30, 2006. The level of interest and fee income recognized onloan payoffs varies for numerous reasons, as further discussed below.

 

Income on loans includes the portion of the purchasediscount that is accreted into income over the remaining lives of the relatedloans using the interest method. Because the carrying value of the loanportfolio is net of purchase discount, the related yield on this portfoliogenerally is higher than the aggregate contractual rate paid on the loans. Thetotal yield includes the excess of a loan’s expected discounted future cashflows over its net investment, recognized using the interest method.

 

When a loan is paid off, the excess of any cashreceived over the net investment is recorded as interest income. In addition tothe amount of purchase discount that is recognized at that time, income mayalso include interest owed by the borrower prior to Lehman Bank’s acquisitionof the loan, interestcollected if on non-performing status, prepayment fees and other loan fees (“otherinterest and fee income”). The following table sets forth, for the periodsindicated, the components of interest and fees on loans. There can be noassurance regarding future interest income, including the yields and relatedlevel of such income, or the relative portion attributable to loan pay-offs ascompared to other sources.

 
| ** **                                          | ** ** | **Nine Months Ended September 30,** | ** ** |
|-----------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                          | ** ** | **2007**                                                | ** ** | **2006** | ** ** |
| ** **                                          | ** ** | **Interest**                                            | ** ** | ** ** | ** ** | **Interest** | ** ** | ** ** | ** ** |
| ** **                                          | ** ** | **Income**                                              | ** ** | **Yield** | ** ** | **Income** | ** ** | **Yield** | ** ** |
| ** **                                          | ** ** | **(dollars in thousands)**                    | ** ** |
|                                                |       |                                                    |       |   |   |   |   |   |   |
| Regularly scheduled interest and accretion income   |       | $                                                       | 5,009      |   | 8.07 | % | $ | 6,622 |   | 8.13 | % |
| Interest and fee income recognized on loan payoffs: |       |                                                    |       |   |   |   |   |   |   |
| Nonaccretable discount                              |       | 56                                                      |       | 0.09 |   | 14 |   | 0.02 |   |
| Accretable discount                                 |       | 292                                                     |       | 0.47 |   | 436 |   | 0.53 |   |
| Other interest and fee income                       |       | 92                                                      |       | 0.15 |   | 571 |   | 0.70 |   |
|                                                |       | 440                                                     |       | 0.71 |   | 1,021 |   | 1.25 |   |
|                                                |       | $                                                       | 5,449      |   | 8.78 | % | $ | 7,643 |   | 9.38 | % |

 

11

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The amount of loanpayoffs and related discount income is influenced by several factors, includingthe interest rate environment, the real estate market in particular areas, thetiming of transactions, and circumstances related to individual borrowers andloans. The amount of individual loan payoffs is often a result of negotiationsbetween Capital Crossing Preferred and the borrower. Based upon credit riskanalysis and other factors, Capital Crossing Preferred will, in certaininstances, accept less than the full amount contractually due in accordancewith the loan terms.

 

The average balance ofinterest-bearing deposits decreased $27.1 million or 28.0% to $69.5 million forthe nine months ended September 30, 2007, compared to $96.5 million for the2006 period. The changes in the average balances of interest-bearing depositsare the result of periodic dividend payments, and returns of capital, offset bycash flows from loan repayments. Additionally, on March 23, 2007, CapitalCrossing Preferred redeemed the Series A and Series C preferred shares, whichcaused a decrease of $32.6 million in interest-bearing deposits.

 

***Credit for loan losses***

 

Capital CrossingPreferred recorded credits for loan losses of $284,000 and $238,000 for thenine months ended September 30, 2007 and 2006, respectively, to reverse unusedloss reserves related to loans that have been paid off. The credit for loanlosses is based on the volume and types of loan payoffs. As loans pay off, acredit for loan losses is recorded to reduce allowance allocations related tothe loans that have paid off for which a related allowance remains unused. Theallowance for loan losses is based on the size of the portfolio and itshistorical performance. The determination of this allowance requires management’suse of estimates and assumptions regarding the risks inherent in individualloans and the loan portfolio in its entirety. Should the loan portfoliocontinue to decline without utilization of the allowance for loan losses,future credits for loan losses may be necessary.

 

***Other income***

 

During the nine monthsended September 30, 2006 there were three loan sales to unaffiliated thirdparties comprised of six loans, with a total carrying value of $1.7 millionresulting in a total gains of $1.0 million. There were no loan sales during thenine months ended September 30, 2007.

 

Guarantee fee incomedecreased $30,000 or 50.0% to $30,000 for the nine months ended September 30,2007 compared to $60,000 for the nine months ended September 30, 2006 due tothe fact that Lehman Bank paid off its FHLBB advances in May 2007 and as aresult, the guarantee was released.

 

***Operating expenses***

 

Loan servicing andadvisory expenses decreased $92,000, or 40.4%, to $136,000 for the nine monthsended September 30, 2007 from $228,000 for the nine months ended September 30,2006 primarily as a result of an increase in loan expense reimbursementscollected from borrowers previously expensed by Capital Crossing Preferredrelated to certain loans as well as a decrease in loan servicing expenses dueto a decrease in the average balance of the loan portfolio.

 

Othergeneral and administrative expenses increased $22,000 or 22.9%, to $118,000 forthe nine months ended September 30, 2007 compared to $96,000 for the ninemonths ended September 30, 2006. This increase is primarily attributable to anincrease in external audit expense.

 

**Changes in Financial Condition**

** **

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

#### *** ***

Interest-bearing deposits with parent consist entirelyof money market accounts with Lehman Bank at September 30, 2007 and CapitalCrossing at December 31, 2006. The balance of interest-bearing depositsdecreased $13.0 million to $70.7 million at September 30, 2007 compared to$83.7 million at December 31, 2006. The decrease in the balance ofinterest-bearing deposits is primarily a result of the redemption of Series Aand Series C preferred shares offset, in part, by cash flows from loanrepayments.

 

12

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#### ***Loan portfolio***

#### *** ***

Todate, all of Capital Crossing Preferred’s loans have been acquired from CapitalCrossing.  The following table sets forthinformation regarding the composition of the loan portfolio at the datesindicated: 

 
| ** **                     | ** ** | **September 30,**  | ** ** | **December 31,** | ** ** |
|--------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                     | ** ** | **2007**                | ** ** | **2006**              | ** ** |
| ** **                     | ** ** | **(in thousands)** | ** ** |
| Mortgage loans on real estate: | ** ** | ** **              | ** ** | ** **            | ** ** |
| Commercial real estate         |       | $                       | 46,799     |                  | $          | 57,607 |   |
| Multi-family residential       |       | 26,061                  |       | 32,412                |       |
| One-to-four family residential |       | 888                     |       | 924                   |       |
| Total                          |       | 73,748                  |       | 90,943                |       |
| Other                          |       | 13                      |       | 14                    |       |
| Total loans, net of discounts  |       | 73,761                  |       | 90,957                |       |
|                           |       |                    |       |                  |       |
| Less:                          |       |                    |       |                  |       |
| Allowance for loan losses      |       | (1,235                  | )          | (1,519                | )          |
| Net deferred loan fees         |       | (34                     | )          | (47                   | )          |
|                           |       |                    |       |                  |       |
| Loans, net                     |       | $                       | 72,492     |                  | $          | 89,391 |   |

 

CapitalCrossing Preferred acquires primarily performing commercial real estate andmultifamily residential mortgage loans. There were no loans acquired during thenine months ended September 30, 2007, as the existing portfolio was largeenough to generate an adequate dividend ratio.

 

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

 

Therewere no non-performing loans at September 30, 2007. Non-performing loans, netof discount, totaled $416,000 at December 31, 2006. Loans generally areplaced on non-performing status and the accrual of interest and accretion ofdiscount are generally discontinued when the collectibility of principal andinterest is not probable or estimable. Unpaid interest income previouslyaccrued on such loans is reversed in the period in which the determination ismade by management. A loan is returned to accrual status in the period when itis brought current in accordance with management’s anticipated cash flows atthe time of acquisition.

 

***Discounts on Acquired Loans.***Forinformation relating to Capital Crossing Preferred’s accounting policiesrelated to discounts on acquired loans, see Application of Critical AccountingPolicies and Estimates – Discounts on Acquired Loans.

 

The following table setsforth certain information relating to the activity in the nonaccretablediscount for the periods indicated:

 
| ** **                            | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                            | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                            | ** ** | **2007**                         | ** ** | **2006**                        | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                            | ** ** | **(in thousands)**          | ** ** |
|                                  |       |                             |       |                            |       |   |   |   |   |
| Balance at beginning of period        |       | $                                | 156        |                            | $          | 595 |   | $ | 215 |   | $ | 754 |   |
| Accretion (1)                         |       | (1                               | )          | (11                             | )          | (60 | ) | (45 | ) |
| Net reductions related to loans sold  |       | —                           |       | (239                            | )          | — |   | (490 | ) |
| Increase related to loan restructures |       | —                           |       | —                          |       | — |   | 126 |   |
| Balance at end of period              |       | $                                | 155        |                            | $          | 345 |   | $ | 155 |   | $ | 345 |   |

 

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

 

13

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***Allowance for Loan Losses.***Capital CrossingPreferred’s allowance for loan losses at September 30, 2007 was $1.2 million.The determination of this allowance requires the use of estimates andassumptions regarding the risks inherent in individual loans and the loanportfolio in its entirety. In addition, regulatory agencies periodically reviewthe adequacy of the allowance for loan losses and may require Capital CrossingPreferred to make additions to its allowance for loan losses. While managementbelieves its estimates and assumptions are reasonable, there can be noassurance that they will be proven to be correct in the future. The actualamount of future provisions that may be required cannot be determined, and suchprovisions may exceed the amounts of past provisions. Management believes thatthe allowance for loan losses is adequate to absorb the known and inherentrisks in Capital Crossing Preferred’s loan portfolio at each date based on thefacts known to management as of such date. Management continues to monitor andmodify the allowances for general and specific loan losses as economicconditions dictate.

*** ***

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

 

The following table sets forth certain informationrelating to the activity in the allowance for loan losses for the periodsindicated:

 
| ** **                                         | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                         | ** ** | **2007**                                             | ** ** | **2006**                                            | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                         | ** ** | **(in thousands)**                              | ** ** |
| Balance at beginning of period |       | $                                                    | 1,320      |                                                | $          | 1,894 |   | $ | 1,519 |   | $ | 1,981 |   |
| Credit for loan losses                             |       | (85                                                  | )          | (171                                                | )          | (284 | ) | (238 | ) |
| Net reduction relating to loans sold               |       | —                                               |       | (36                                                 | )          | — |   | (56 | ) |
| Balance at end of period                           |       | $                                                    | 1,235      |                                                | $          | 1,687 |   | $ | 1,235 |   | $ | 1,687 |   |

 

#### **InterestRate Risk**

#### ** **

Capital Crossing Preferred’s income consists primarilyof interest income. If there is a decline in market interest rates, CapitalCrossing Preferred may experience a reduction in interest income and acorresponding decrease in funds available to be distributed to itsshareholders. The reduction in interest income may result from downward adjustmentsof the indices upon which the interest rates on loans are based and fromprepayments of mortgage loans with fixed interest rates, resulting inreinvestment of the proceeds in lower yielding mortgage loans. Capital CrossingPreferred does not intend to use any derivative products to manage its interestrate risk.

 

**Significant Concentration of Credit Risk**

** **

Concentrationof credit risk generally arises with respect to Capital Crossing Preferred’sloan portfolio when a number of borrowers engage in similar businessactivities, or activities in the same geographical region. Concentration ofcredit risk indicates the relative sensitivity of Capital Crossing Preferred’sperformance to both positive and negative developments affecting a particularindustry or geographic region. Capital Crossing Preferred’s balance sheetexposure to geographic concentrations directly affects the credit risk of theloans within its loan portfolio.

 

AtSeptember 30, 2007, 56.3% and 6.8% of Capital Crossing Preferred’s net realestate loan portfolio consisted of loans in California and New England,respectively. At December 31, 2006, 54.3% and 12.0% of Capital CrossingPreferred’s net real estate loan portfolio consisted of loans located inCalifornia and New England, respectively. Consequently, the portfolio mayexperience a higher default rate in the event of adverse economic, political orbusiness developments or natural hazards in California or New England that mayaffect the ability of property owners to make payments of principal andinterest on the underlying mortgages.

 

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#### **LiquidityRisk Management**

#### ** **

Theobjective of liquidity management is to ensure the availability of sufficientcash flows to meet all of Capital Crossing Preferred’s financial commitmentsand to capitalize on opportunities for Capital Crossing Preferred’s businessexpansion. In managing liquidity risk, Capital Crossing Preferred takes intoaccount various legal limitations placed on a REIT.

 

CapitalCrossing Preferred’s principal liquidity needs are:

 

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

 

•                  to pay dividends on the preferredshares 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. Capital CrossingPreferred 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 SeriesD preferred stockholders to no more than 100% of the total stockholders’ equityof Capital Crossing Preferred. Any such debt may include intercompany advancesmade by Lehman Bank to Capital Crossing Preferred.

 

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

 

**Impactof Inflation and Changing Prices**

** **

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

 

Various information shownelsewhere in this quarterly report will assist the reader in understanding howCapital Crossing Preferred is positioned to react to changing interest ratesand inflationary trends. In particular, the discussion of market risk and othermaturity and repricing information of Capital Crossing Preferred’s assets iscontained in Item 3, Quantitative and Qualitative Disclosures About MarketRisk, of this quarterly report.

 

**Item 3.    Quantitative andQualitative Disclosures About Market Risk**

** **

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

 

Capital Crossing Preferred’s management reviews, amongother things, the sensitivity of Capital Crossing Preferred’s assets tointerest rate changes, the book and market values of assets, purchase and saleactivity, and anticipated loan pay-offs. Lehman Bank’s senior management alsoapproves and establishes pricing and funding decisions with respect to CapitalCrossing Preferred’s overall asset and liability composition.

 

Capital Crossing Preferred’s methods for evaluatinginterest rate risk include an analysis of its interest-earning assets maturingor repricing within a given time period. Since Capital Crossing Preferred hasno interest-bearing liabilities, a period of rising interest rates would tendto result in an increase in net interest income. A period of falling interestrates would tend to adversely affect net interest income.

 

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The following table sets forth Capital CrossingPreferred’s interest-rate-sensitive assets categorized by repricing dates andweighted average yields at September 30, 2007. For fixed rate instruments, therepricing date is the maturity date. For adjustable-rate instruments, therepricing date is deemed to be the earliest possible interest rate adjustmentdate. Assets that are subject to immediate repricing are placed in theovernight column. 

 
| ** **                     | ** ** | ** **                           | ** ** | **Within** | ** ** | **Over One** | ** ** | **Over Two** | ** ** | **Over Three** | ** ** | **Over Four** | ** ** | **Over**  | ** ** | ** ** | ** ** |
|--------------------------------|------------|--------------------------------------|------------|------------|------------|-------------------|------------|-------------------|------------|---------------------|------------|--------------------|------------|-----------|------------|------------|------------|
| ** **                     | ** ** | ** **                           | ** ** | **One**    | ** ** | **to Two**   | ** ** | **to Three** | ** ** | **to Four**    | ** ** | **to Five**   | ** ** | **Five**  | ** ** | ** ** | ** ** |
| ** **                     | ** ** | **Overnight**                        | ** ** | **Year**   | ** ** | **Years**         | ** ** | **Years**         | ** ** | **Years**           | ** ** | **Years**          | ** ** | **Years** | ** ** | **Total**  | ** ** |
| ** **                     | ** ** | **(dollars in thousands)** | ** ** |
| Interest-bearing deposits      |       | $                                    | 70,736     |       | $          | —            |       | $                 | —     |                | $          | —             |       | $         | —     |       | $          | — |   | $ | — |   | $ | 70,736 |   |
|                           |       | 1.10                                 | %          |       |       |              |       |              |       |                |       |               |       |      |       |       |       |
| Certificates of deposit        |       | —                               |       | 200        |       | —            |       | —            |       | —              |       | —             |       | —    |       | 200        |       |
|                           |       |                                 |       | 3.10       | %          |              |       |              |       |                |       |               |       |      |       |       |       |
| Fixed-rate loans (1)           |       | —                               |       | 17,368     |       | 8,994             |       | 6,881             |       | 5,545               |       | 4,133              |       | 9,248     |       | 52,169     |       |
|                           |       |                                 |       | 8.24       | %          | 7.50              | %          | 7.31              | %          | 7.35                | %          | 7.30               | %          | 6.81      | %          |       |       |
| Adjustable-rate loans (1) |       | 1,662                                |       | 16,430     |       | 1,927             |       | 590               |       | 413                 |       | 302                |       | 234       |       | 21,558     |       |
|                           |       | 10.61                                | %          | 8.68       | %          | 6.47              | %          | 7.30              | %          | 7.15                | %          | 7.11               | %          | 8.50      | %          |       |       |
|                           |       |                                 |       |       |       |              |       |              |       |                |       |               |       |      |       |       |       |
| Total rate-sensitive assets    |       | $                                    | 72,398     |       | $          | 33,998            |       | $                 | 10,921     |                | $          | 7,471              |       | $         | 5,958      |       | $          | 4,435 |   | $ | 9,482 |   | $ | 144,663 |   |

 

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(1) Loans are presentedat net amounts before deducting the allowance for loan losses and excludenon-performing loans.

 

Based on Capital CrossingPreferred’s experience, management applies the assumption that, on average,approximately 14% of the outstanding fixed and adjustable rate loans willprepay annually.

 

# **Item 4.    Controls andProcedures**

# ** **

Capital Crossing Preferred’s management, with theparticipation of its President and Controller, evaluated the effectiveness ofCapital Crossing Preferred’s disclosure controls and procedures (as defined inRules 13a-15(e) and 15d-15(e) under the Exchange Act) as of September 30, 2007.Based on this evaluation, Capital Crossing Preferred’s President and Controllerconcluded that, as of September 30, 2007, Capital Crossing Preferred’sdisclosure controls and procedures were (1) designed to ensure that materialinformation relating to Capital Crossing Preferred is made known to thePresident and Controller by others within the entity, particularly during theperiod in which this report was being prepared, and (2) effective, in that theyprovide reasonable assurance that information required to be disclosed byCapital Crossing Preferred in the reports that it files or submits under theExchange Act is recorded, processed, summarized, and reported within the timeperiods specified in the SEC’s rules and forms.

 

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

 

**PART II**

** **

**Item 1A. Risk Factors**

** **

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

 

**Item6.  Exhibits**

 
| 31.1   |   | Certification  pursuant to Exchange Act Rules 13a-15(e) and 15d-15(e) of the President.  |
|--------|--------|------------------------------------------------------------------------------------------|
|   |   |                                                                                     |
| 31.2   |   | Certification  pursuant to Exchange Act Rules 13a-15(e) and 15d-15(e) of the Controller. |
|   |   |                                                                                     |
| 32     |   | Certification  pursuant to 18 U.S.C. Section 1350 of the President and Controller.       |

 

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, Capital CrossingPreferred Corporation has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.

 

**CAPITALCROSSING PREFERRED CORPORATION**

** **

** **
| Date:  November 14, 2007 | By:      | /s/ Richard Wayne                           |   |
|--------------------------|----------|---------------------------------------------|--------|
|                     |     | Richard Wayne                               |
| * *                 | * * | *President (Principal Executive  Officer)*  |
| * *                 | * * | * *                                    |
| * *                 | * * | * *                                    |
| Date:  November 14, 2007 | By:      | /s/ Nancy E. Coyle                          |   |
|                     |     | Nancy E. Coyle                              |
| * *                 | * * | *Controller (Principal Financial  Officer)* |

 

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## **EXHIBIT INDEX**

## ** **

 
| **Exhibit** | ** ** | **Item**                                                                                 |
|-------------|------------|------------------------------------------------------------------------------------------|
|        |       |                                                                                     |
| 31.1        |       | Certification pursuant  to Exchange Act Rules 13a-15(e) and 15d-15(e) of the President.  |
|        |       |                                                                                     |
| 31.2        |       | Certification pursuant  to Exchange Act Rules 13a-15(e) and 15d-15(e) of the Controller. |
|        |       |                                                                                     |
| 32          |       | Certification pursuant  to 18 U.S.C. Section 1350 of the President and Controller.       |

 

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