**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

**ý****QUARTERLY REPORT PURSUANT TO SECTION13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

 

**For theQuarterly Period Ended June 30, 2003**

 

**Commission FileNumber 000-25193**

 

**CAPITAL CROSSING PREFERRED CORPORATION**

(Exact name of registrant asspecified in its charter)

 

**Massachusetts**

(State or other jurisdiction ofincorporation or organization)

 

**04-3439366**

(I.R.S. Employer IdentificationNumber)

 

**101 SummerStreet, Boston, Massachusetts**

(Address of principal executiveoffices)

 

**02110**

(Zip Code)

 

**(617) 880-1000**

(Registrant’s telephone number,including area code)

 

Indicate by check mark whether theregistrant: (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past 90 days. Yes  ý    No  o

 

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

 

Indicate the number of shares outstanding ofthe issuer’s common stock, $.01 par value per share, as of August 8, 2003: 100.

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

 

 

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**CapitalCrossing Preferred Corporation**

**Tableof Contents**

 
| **PART I – Financial Information** |
|-----------------------------------------|
|                                    |   |
| Item 1.                                 | Financial Statements: |
|                                    |   |
|                                    | Balance Sheets |
|                                    |   |
|                                    | Statements of Income |
|                                    |   |
|                                    | Statements of Changes in Stockholders’  Equity |
|                                    |   |
|                                    | Statements of Cash Flows |
|                                    |   |
|                                    | Notes to Financial Statements |
|                                    |   |
| Item 2.                                 | Management’s Discussion and Analysis of  Financial Condition and Results of Operations |
|                                    |   |
|                                    | Critical Accounting Policies |
|                                    |   |
|                                    | Results of Operations |
|                                    |   |
|                                    | Financial Condition |
|                                    |   |
|                                    | Interest Rate Risk |
|                                    |   |
|                                    | Significant Concentration of Credit Risk |
|                                    |   |
|                                    | Liquidity Risk Management |
|                                    |   |
|                                    | Risk Factors and Factors Affecting Future  Operating Results |
|                                    |   |
| Item 3                                  | Quantitative  and Qualitative Disclosures about Market Risk |
|                                    |   |
| Item 4.                                 | Disclosure Controls and Procedures |
|                                    |   |
| **PART II – Other Information**    |
|                                    |   |
| Item 1.                                 | Legal Proceedings |
|                                    |   |
| Item 4.                                 | Submission of Matters to a Vote of Security  Holders |
|                                    |   |
| Item 6.                                 | Exhibits and Reports on Form 8-K |
|                                    |   |
|                                    | Signatures |
|                                    |   |
|                                    | Exhibit Index |
|                                    |   |

 

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**PART I**

 

##### **Item 1. FinancialStatements**

 

### **Capital Crossing Preferred Corporation**

**Balance Sheets**

 
|                                                                                                                    |   | **June 30,  2003**                    |       | **December 31,  2002** |   |
|-------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------|------------|------------------------|--------|
|                                                                                                                    |   | **(in thousands, except share data)** | ** ** |
| **ASSETS**                                                                                                              |   |                                  |       |                   |   |
|                                                                                                                    |   |                                  |       |                   |   |
| Cash account  with Capital Crossing Bank                                                                                |   | $                                     | 89         |                   | $      | 88 |   |
| Interest-bearing  deposits with Capital Crossing Bank                                                                   |   | 26,077                                |       | 92,622                 |   |
|                                                                                                                    |   |                                  |       |                   |   |
| Total cash and  cash equivalents                                                                                        |   | 26,166                                |       | 92,710                 |   |
| Certificate of  deposit                                                                                                 |   | 100                                   |       | 100                    |   |
|                                                                                                                    |   |                                  |       |                   |   |
| Loans                                                                                                                   |   | 226,159                               |       | 277,515                |   |
| Less discount  and net deferred loan income                                                                             |   | (28,410                               | )          | (32,196                | )      |
| Less allowance  for loan losses                                                                                         |   | (4,954                                | )          | (7,354                 | )      |
|                                                                                                                    |   |                                  |       |                   |   |
| Loans, net                                                                                                              |   | 192,795                               |       | 237,965                |   |
|                                                                                                                    |   |                                  |       |                   |   |
| Accrued  interest receivable                                                                                            |   | 890                                   |       | 1,219                  |   |
| Other assets                                                                                                            |   | 22                                    |       | —                 |   |
|                                                                                                                    |   |                                  |       |                   |   |
|                                                                                                                    |   | $                                     | 219,973    |                   | $      | 331,994 |   |
|                                                                                                                    |   |                                  |       |                   |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                           |   |                                  |       |                   |   |
|                                                                                                                    |   |                                  |       |                   |   |
| Accrued  expenses and other liabilities                                                                                 |   | $                                     | 372        |                   | $      | 435 |   |
|                                                                                                                    |   |                                  |       |                   |   |   |   |
| Total  liabilities                                                                                                      |   | 372                                   |       | 435                    |   |
|                                                                                                                    |   |                                  |       |                   |   |
| Stockholders’  equity:                                                                                             |   |                                  |       |                   |   |
| Preferred  stock, Series A, 9.75% non-cumulative, exchangeable; $.01 par value;                                         |   |                                  |       |                   |   |
| $10  liquidation value per share; 1,449,000 shares authorized, 1,416,130 shares  issued and outstanding                 |   | 14                                    |       | 14                     |   |
| Preferred  stock, Series B, 8% cumulative, non convertible; $.01 par value;                                             |   |                                  |       |                   |   |
| $1,000  liquidation value per share plus accrued dividends; 1,000 shares authorized,  941 shares issued and outstanding |   | —                                |       | —                 |   |
| Preferred  stock, Series C, 10.25% non-cumulative, exchangeable; $.01 par value;                                        |   |                                  |       |                   |   |
| $10  liquidation value per share; 1,840,000 shares authorized, issued and  outstanding                                  |   | 18                                    |       | 18                     |   |
| Common stock,  $.01 par value, 100 shares authorized, issued and outstanding                                            |   | —                                |       | —                 |   |
| Additional  paid-in capital                                                                                             |   | 219,569                               |       | 329,475                |   |
| Retained  earnings                                                                                                      |   | —                                |       | 2,052                  |   |
|                                                                                                                    |   |                                  |       |                   |   |
| Total  stockholders’ equity                                                                                        |   | 219,601                               |       | 331,559                |   |
|                                                                                                                    |   |                                  |       |                   |   |
|                                                                                                                    |   | $                                     | 219,973    |                   | $      | 331,994 |   |

 

See accompanying notes tounaudited interim financial statements.

 

1

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**Capital Crossing Preferred Corporation**

**Statements of Income**

 
|                                               |   | **Three  Months Ended  June 30,** |       | **Six Months Ended  June 30,** |       |
|----------------------------------------------------|--------|----------------------------------------|------------|-------------------------------------|------------|
|                                               |   | **2003**                               |       | **2002**                            | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                               |   | **(in thousands)**                     | ** ** |
| Interest  income:                                  |   |                                   |       |                                |       |   |   |   |   |
| Interest and  fees on loans                        |   | $                                      | 5,735      |                                | $          | 5,485 |   | $ | 11,406 |   | $ | 10,455 |   |
| Interest on  interest-bearing deposits             |   | 343                                    |       | 366                                 |       | 1,062 |   | 947 |   |
| Total interest  income                             |   | 6,078                                  |       | 5,851                               |       | 12,468 |   | 11,402 |   |
|                                               |   |                                   |       |                                |       |   |   |   |   |
| Credit for  loan losses                            |   | 2,400                                  |       | —                              |       | 2,400 |   | — |   |
| Net interest  income, after credit for loan losses |   | 8,478                                  |       | 5,851                               |       | 14,868 |   | 11,402 |   |
|                                               |   |                                   |       |                                |       |   |   |   |   |
| Other income:                                      |   |                                   |       |                                |       |   |   |   |   |
| Gain on sale  of loans                             |   | —                                 |       | —                              |       | — |   | 517 |   |
| Guarantee fee  income                              |   | 20                                     |       | 20                                  |       | 40 |   | 40 |   |
| Total other  income                                |   | 20                                     |       | 20                                  |       | 40 |   | 557 |   |
|                                               |   |                                   |       |                                |       |   |   |   |   |
| Operating  expenses:                               |   |                                   |       |                                |       |   |   |   |   |
| Loan servicing  and advisory services              |   | 152                                    |       | 157                                 |       | 324 |   | 261 |   |
| Other real  estate owned income                    |   | (342                                   | )          | —                              |       | (342 | ) | — |   |
| Other general  and administrative                  |   | 66                                     |       | 30                                  |       | 125 |   | 47 |   |
| Total  operating expenses                          |   | (124                                   | )          | 187                                 |       | 107 |   | 308 |   |
|                                               |   |                                   |       |                                |       |   |   |   |   |
| Net income                                         |   | 8,622                                  |       | 5,684                               |       | 14,801 |   | 11,651 |   |
|                                               |   |                                   |       |                                |       |   |   |   |   |
| Preferred  stock dividends                         |   | 836                                    |       | 836                                 |       | 1,671 |   | 1,671 |   |
| Net income  available to common stockholder        |   | $                                      | 7,786      |                                | $          | 4,848 |   | $ | 13,130 |   | $ | 9,980 |   |

 

 

See accompanying notes tounaudited interim financial statements.

 

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**Capital Crossing Preferred Corporation**

**Statements of Changes in Stockholders’ Equity**

 
|                                              |   | **Six Months Ended June 30, 2003** |       |
|---------------------------------------------------|--------|------------------------------------|------------|
|                                              |   | **Preferred Stock  Series A**      | ** ** | **Preferred Stock  Series B** | ** ** | **Preferred Stock  Series C** | ** ** | **Common Stock** | ** ** | **Additional  Paid-in  Capital** | ** ** | **Retained********Earnings** | ** ** | **Total  Stockholders’********Equity** | ** ** |
|                                              |   | **Shares**                         |       | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** | ** ** | ** ** | ** ** |
|                                              |   | **(dollars in thousands)**         | ** ** |
|                                              |   |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Balance at December 31, 2002                      |   | 1,416,130                          |       | $ | 14 |   | 941 |   | $ | — |   | 1,840,000 |   | $ | 18 |   | 100 |   | $ | — |   | $ | 329,475 |   | $ | 2,052 |   | $ | 331,559 |   |
| Net income                                        |   | —                             |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | 14,801 |   | 14,801 |   |
| Dividends on preferred stock, Series A            |   | —                             |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | (690 | ) | (690 | ) |
| Cumulative dividends on preferred stock, Series B |   | —                             |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | (38 | ) | (38 | ) |
| Dividends on preferred stock, Series C            |   | —                             |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | (943 | ) | (943 | ) |
| Return of capital to common stockholder           |   | —                             |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   | (109,906 | ) | — |   | (109,906 | ) |
| Common stock dividend                             |   | —                             |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | (15,182 | ) | (15,182 | ) |
| Balance at June 30, 2003                          |   | 1,416,130                          |       | $ | 14 |   | 941 |   | $ | — |   | 1,840,000 |   | $ | 18 |   | 100 |   | $ | — |   | $ | 219,569 |   | $ | — |   | $ | 219,601 |   |

 
|                                              |   | **Six Months Ended June 30, 2002** |       |
|---------------------------------------------------|--------|------------------------------------|------------|
|                                              |   | **Preferred Stock  Series A**      | ** ** | **Preferred Stock  Series B** | ** ** | **Preferred Stock  Series C** | ** ** | **Common Stock** | ** ** | **Additional  Paid-in  Capital** | ** ** | **Retained********Earnings** | ** ** | **Total  Stockholders’********Equity** | ** ** |
|                                              |   | **Shares**                         |       | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** | ** ** | ** ** | ** ** |
|                                              |   | **(dollars in thousands)**         | ** ** |
|                                              |   |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Balance at December 31, 2001                      |   | 1,416,130                          |       | $ | 14 |   | 941 |   | $ | — |   | 1,840,000 |   | $ | 18 |   | 100 |   | $ | — |   | $ | 235,742 |   | $ | 174 |   | $ | 235,948 |   |
| Net income                                        |   | —                             |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | 11,651 |   | 11,651 |   |
| Capital contribution from common stockholder      |   | —                             |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   | 83,222 |   | — |   | 83,222 |   |
| Dividends on preferred stock, Series A            |   | —                             |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | (690 | ) | (690 | ) |
| Cumulative dividends on preferred stock, Series B |   | —                             |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | (38 | ) | (38 | ) |
| Dividends on preferred stock, Series C            |   | —                             |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | (943 | ) | (943 | ) |
| Balance at June 30, 2002                          |   | 1,416,130                          |       | $ | 14 |   | 941 |   | $ | — |   | 1,840,000 |   | $ | 18 |   | 100 |   | $ | — |   | $ | 318,964 |   | $ | 10,154 |   | $ | 329,150 |   |

 

Seeaccompanying notes to unaudited interim financial statements.

 

3

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**Capital Crossing Preferred CorporationStatements of Cash Flows**

 
|                                                                         |   | **Six Months Ended June 30,** |       |
|------------------------------------------------------------------------------|--------|------------------------------------|------------|
|                                                                         |   | **2003**                           |       | **2002** |   |
|                                                                         |   | **(in thousands)**                 | ** ** |
| Cash flows  from operating activities:                                       |   |                               |       |   |   |
| Net income                                                                   |   | $                                  | 14,801     |   | $ | 11,651 |   |
| Adjustments to  reconcile net income to net cash from operating activities:  |   |                               |       |   |   |
| Gain on sale  of other real estate owned                                     |   | (334                               | )          | — |   |
| Gain on sale  of loans                                                       |   | —                             |       | (517 | ) |
| Credit for  loan losses                                                      |   | (2,400                             | )          | — |   |
| Other, net                                                                   |   | 244                                |       | 241 |   |
|                                                                         |   |                               |       |   |   |
| Net cash from  operating activities                                          |   | 12,311                             |       | 11,375 |   |
|                                                                         |   |                               |       |   |   |
| Cash flows  from (used in) investing activities:                             |   |                               |       |   |   |
| Amortization  and pay-offs on loans                                          |   | 46,231                             |       | 39,094 |   |
| Proceeds from  sale of other real estate owned                               |   | 1,585                              |       | — |   |
| Proceeds from  sales of loans                                                |   | —                             |       | 2,686 |   |
| Purchase of  loans from Capital Crossing Bank                                |   | —                             |       | (75,637 | ) |
|                                                                         |   |                               |       |   |   |
| Net cash from  (used in) investing activities                                |   | 47,816                             |       | (33,857 | ) |
|                                                                         |   |                               |       |   |   |
| Cash flows  used in financing activities:                                    |   |                               |       |   |   |
| Return of  capital to common stockholder                                     |   | (109,906                           | )          | — |   |
| Payment of  preferred stock dividends                                        |   | (1,671                             | )          | (1,671 | ) |
| Payment of  common stock dividend                                            |   | (15,094                            | )          | — |   |
|                                                                         |   |                               |       |   |   |
| Net cash used  in financing activities                                       |   | (126,671                           | )          | (1,671 | ) |
|                                                                         |   |                               |       |   |   |
| Net change in  cash and cash equivalents                                     |   | (66,544                            | )          | (24,153 | ) |
| Cash and cash  equivalents at beginning of period                            |   | 92,710                             |       | 87,989 |   |
|                                                                         |   |                               |       |   |   |
| Cash and cash  equivalents at end of period                                  |   | $                                  | 26,166     |   | $ | 63,836 |   |
|                                                                         |   |                               |       |   |   |
| Supplemental  information:                                                   |   |                               |       |   |   |
| Dividend to  common stockholder in the form of mortgage loans                |   | $                                  | 88         |   | $ | — |   |
| Transfers from  loans to other real estate owned                             |   | 1,251                              |       | — |   |
| Capital  contributions from common stockholder in the form of mortgage loans |   | —                             |       | 83,222 |   |

 

See accompanying notes tounaudited interim financial statements.

 

4

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**CapitalCrossing Preferred CorporationNotes to Financial StatementsThree and Six Month Periods Ended June 30, 2003 and 2002**

 

**Note 1. Basis of Presentation**

 

CapitalCrossing Preferred Corporation (“Capital Crossing Preferred), is aMassachusetts corporation organized on March 20, 1998, to acquire and holdreal estate assets.  Capital CrossingBank (“Capital Crossing”), a federally insured Massachusetts trust company,owns all of Capital Crossing Preferred’s outstanding common stock.  Capital Crossing is in compliance with itsregulatory capital requirements at June 30, 2003.

 

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

 

In 1999, Capital Crossing Preferred completed the sale of 1,416,130shares of Series A preferred stock.  In2001, Capital Crossing Preferred completed the sale 1,840,000 shares of SeriesC preferred stock.

 

The financial information as of June 30, 2003 and the results ofoperations for the three and six months ended June 30, 2003 and 2002,changes in stockholders’ equity and cash flows for the six months endedJune 30, 2003 and 2002 are unaudited; however, in the opinion ofmanagement, the financial information reflects all adjustments (consistingsolely of normal recurring accruals) necessary for a fair presentation inaccordance with accounting principles generally accepted in the United Statesof America.  Interim results are notnecessarily indicative of results to be expected for the entire year.  These interim statements are intended to beread in conjunction with the financial statements presented in Capital CrossingPreferred’s Annual Report on Form 10-K as of and for the year endedDecember 31, 2002.

 

In preparing financial statements in conformity with accountingprinciples generally accepted in the United States of America, management isrequired to make estimates and assumptions that affect the reported amounts ofassets and liabilities as of the date of the balance sheet and reported amountsof revenues and expenses during the reporting period.  Actual results could differ from those estimates.  Material estimates that are particularlysusceptible to significant change in the near term relate to the determinationof the allowance for losses on loans, the allocation of purchase discountbetween amortizing and non-amortizing portions, and the rate at which thediscount is accreted into interest income.

 

#### **Note 2. Commitments and Contingencies**

#### ** **

*Guarantees*

 

Capital Crossing Preferred has guaranteed all of the obligations ofCapital Crossing under advances Capital Crossing may receive from time to timefrom the Federal Home Loan Bank of Boston (“FHLBB”), and Capital CrossingPreferred has agreed to pledge a significant amount of its assets in connectionwith those advances. This guarantee would rank senior to the preferred sharesupon liquidation. Capital Crossing Preferred’s obligations under this agreementare limited by applicable laws pertaining to fraudulent conveyance andfraudulent transfer. The assets pledged to the FHLBB will vary from time totime, however the potential exists for Capital Crossing Preferred to pledge allof its assets to the FHLBB to secure advances to Capital Crossing. In addition,Capital Crossing has pledged to the FHLBB all of the shares of Capital CrossingPreferred’s capital stock it owns as collateral for its FHLBB borrowings.  Under the terms of the pledge, if CapitalCrossing becomes undercapitalized, the FHLBB may require Capital Crossing todissolve Capital Crossing Preferred such that the assets of Capital CrossingPreferred are distributed to Capital Crossing. In such circumstance, holders ofthe Series A and Series C preferred stock would receive their liquidationpreference only to the extent there are available assets of Capital CrossingPreferred following satisfaction of its outstanding obligations, including itsguarantee of Capital Crossing’s FHLBB borrowings.  At June 30, 2003, approximately $38.3 million, or 17.4%, ofCapital Crossing Preferred’s assets had been pledged to and accepted by theFHLBB to secure advances to Capital Crossing. Capital Crossing has also agreed that it will not request or acceptadvances from the FHLBB in excess of Capital Crossing Preferred’s totalstockholder’s equity, less the stockholder’s equity attributable to the SeriesA and Series C preferred shares. As of June 30, 2003, this restrictionwould limit Capital Crossing’s ability to receive advances in excess ofapproximately $187.0 million. As of June 30, 2003, Capital Crossing had$129.0 million in outstanding FHLBB borrowings.

 

5

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*Tax assessment*

 

The Massachusetts Department of Revenue(“DOR”) had issued tax assessments to Capital Crossing and numerous otherfinancial institutions in Massachusetts that reported a deduction for dividendsreceived from a REIT on their Massachusetts financial institution excise tax returns.

 

On March 5, 2003, the Governor ofMassachusetts signed a bill that amends Massachusetts law to expressly disallowthe deduction for dividends from a REIT. This amendment applies retroactivelyto tax years ending on or after December 31, 1999.

 

Capital Crossing Preferred had also receiveda Notice of Assessment for additional taxes from the DOR. However, onJune 23, 2003, Capital Crossing announced that it had entered into asettlement with the DOR to pay approximately 50% of the disputed tax liabilityfor the years 1998 through 2002. As a result of this settlement, the DOR hasagreed not to seek further actions to disallow Capital Crossing Preferred’sdividend paid deductions taken during the disputed tax years.

 

6

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**Item2. Management’s Discussion andAnalysis of Financial Condition and Results of Operations**

 

This Form 10-Q contains “forward-lookingstatements” within the meaning of Section 27A of the Securities Act of1933 and Section 21E of the Securities Exchange Act of 1934. CapitalCrossing Preferred may also make written or oral forward-looking statements inother documents filed with the Securities and Exchange Commission (“SEC”), inpress releases and other written materials, and in oral statements made by itsofficers or directors. Forward-looking statements can be identified by the useof the words “believe,” “expect,” “anticipate,” “intend,” “estimate,” “assume,”“will,” “should,” and other expressions which predict or indicate future eventsand trends and which do not relate to historical matters. Forward-lookingstatements should not be unduly relied upon because they involve known andunknown risks, uncertainties and other factors, some of which are beyond thecontrol of Capital Crossing Preferred. These risks, uncertainties and otherfactors may cause the actual results, performance or achievements of CapitalCrossing Preferred to be materially different from the anticipated futureresults, performance or achievements that are expressed or implied by theforward-looking statements.

 

Capital Crossing Preferred’s actual resultscould differ materially from those projected in the forward-looking statementsas a result, among other factors, of the factors discussed in the sectionentitled “Risk Factors and Factors Affecting Future Operating Results” of thisForm 10-Q.

 

All of these factors should be carefully reviewed, and the reader ofthis Form 10-Q should be aware that there may be other factors that couldcause these differences. These forward-looking statements were based oninformation, plans and estimates at the date of this report, and CapitalCrossing Preferred does not promise to update any forward-looking statements toreflect changes in underlying assumptions or factors, new information, futureevents or other changes.

 

#### **Critical Accounting Policies**

#### ** **

In December 2001, the SEC requested thatall registrants discuss their most “critical accounting policies” inmanagement’s discussion and analysis of financial condition and results ofoperations. The SEC indicated that a “critical accounting policy” is one whichis both important to the portrayal of the company’s financial condition andresults and requires management’s most difficult, subjective or complexjudgments, often as a result of the need to make estimates about the effect ofmatters that are inherently uncertain. While Capital Crossing Preferred’ssignificant accounting policies are more fully described in Note 1 to theFinancial Statements included in its Annual Report on Form 10-K, managementbelieves the following accounting policies to be most critical in theirpotential effect on Capital Crossing Preferred’s financial position or resultsof operations:

 

**Allowance for LoanLosses.** Arriving at an appropriate level of allowance for loan losses requires ahigh degree of judgment. Capital Crossing Preferred maintains an allowance forprobable loan losses that are inherent in its loan portfolio. The initialallowance for loan losses was transferred from Capital Crossing at the time of theinitial transfer of loans to Capital Crossing Preferred and additionaltransfers are made in connection with each transfer of loans from CapitalCrossing. Subsequent to the date of transfer, the allowance for loan losseswill be increased or decreased through a provision or credit for loan lossesincluded in earnings. Additionally, the allowance for loan losses may beincreased upon allocation of purchase discount upon acquisition of loans. Loanlosses are charged against the allowance when management believes the loanbalance, or a portion thereof, is uncollectible. Subsequent recoveries, if any,are credited to the allowance when cash payments are received.

 

Management makes significant judgments indetermining the adequacy of the allowance for loan losses. Management initiallyconsiders the loan loss allowances specifically allocated to individualimpaired loans. Next, management considers the level of general loan lossallowances deemed appropriate for the balance of the portfolio. Factorsconsidered include known and inherent risks in the nature and volume of theloan portfolio, adverse situations that may affect the borrower’s ability torepay, historical loss ranges, the estimated value of any underlying collateraland prevailing economic conditions. An additional allowance for loan losses ismaintained based on a judgmental process whereby management considersqualitative and quantitative assessments of other factors including regionalcredit concentration, industry concentration, results of regulatoryexaminations, historical loss ranges, portfolio composition, economicconditions such as interest rates and energy costs and other changes in theportfolio. The allowance for loan losses is management’s estimate of theprobable loan losses incurred as of the balance sheet date. There can be noassurance regarding the future levels of Capital Crossing’s actual losses withrespect to loans and leases.

 

7

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**Discounts on AcquiredLoans.**  At thetime of acquisition of purchased pools of loans, the excess of the contractualbalances over the amount of reasonably estimable and probable discounted futurecash collections for each loan is recorded as non-amortizing discount. Theremaining discount, which represented the excess of the amount of reasonablyestimable and probable discounted future cash collections over the acquisitionamount is accreted into interest income using the interest method over the termof the loans and is not accreted on non-performing loans. There is a highdegree of judgment involved in estimating the amount of future cash flows. Theamount and timing of actual cash flows could differ materially frommanagement’s estimates, which could materially affect financial condition andresults of operations.

 

The non-amortizing discount is not accretedinto income until it is determined that the amount and timing of the relatedcash flows are reasonably estimable and collection is probable. If cash flowscannot be reasonably estimated for any loan, and collection is not probable,the cost recovery method of accounting is used. Under the cost recovery method,any amounts received are applied against the recorded amount of the loan.Non-amortizing discount is generally offset against the related principal balancewhen the amount at which a loan is resolved or restructured is determined.

 

Subsequent to acquisition, if cash flowprojections improve, and it is determined that the amount and timing of thecash flows related to the non-amortizing discount are reasonably estimable andcollection is probable, the corresponding decrease in the non-amortizingdiscount is transferred to the amortizing portion and is accreted into interestincome over the remaining life of the loan on the interest method. If cash flowprojections deteriorate subsequent to acquisition, the decline is accounted forthrough the allowance for loan losses.

 

When a loan is paid-off, the excess of anycash received over the net investment is recorded as interest income. Inaddition to the amount of purchase discount that is recognized at that time,income may also include interest owed by the borrower prior to CapitalCrossing’s acquisition of the loan, interest collected if on non-performingstatus, prepayment fees and other loan fees.

 

Changes in interest rates also can affect the value of Capital CrossingPreferred’s loans (and other interest-earning assets) and its ability torealize gains on the resolution of assets. A significant portion of CapitalCrossing Preferred’s earnings results from accelerated interest incomeresulting from loan prepayments. This type of income can vary significantlyfrom quarter to quarter and year to year based on a number of differentfactors, including the interest rate environment. An increase in interest ratesthat adversely affects the ability of borrowers to pay the principal orinterest on Capital Crossing Preferred’s loans may lead to a reduction ofdiscount accreted into income, which could have a material adverse effect onits results of operations.

 

#### **Resultsof Operations**

#### ** **

***ThreeMonths Ended June 30, 2003 and 2002***

 

Net income available to common stockholderincreased $2.9 million, or 60.6%, to $7.8 million for the three months endedJune 30, 2003 compared to $4.9 million for the three months endedJune 30, 2002.  This increase isprimarily attributable to a credit for loan losses, an increase in interest andfees on loans and an increase in other real estate owned income. Total interestincome for the three months ended June 30, 2003 increased $227,000, or3.9%, to $6.1 million, compared to $5.9 million for the three months endedJune 30, 2002.

 

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

 

 
|                       |   | **Three Months Ended June 30,** |       |
|----------------------------|--------|--------------------------------------|------------|
|                       |   | **2003**                             |       | **2002** |   |
|                       |   | **Average  Balance**                 |       | **Interest  Income** | ** ** | **Yield** | ** ** | **Average  Balance** | ** ** | **Interest  Income** | ** ** | **Yield** | ** ** |
|                       |   | **(dollars in thousands)**           | ** ** |
|                       |   |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Loans, net (1)             |   | $                                    | 205,714    |   | $ | 5,735 |   | 11.18 | % | $ | 223,462 |   | $ | 5,485 |   | 9.85 | % |
| Interest-bearing  deposits |   | 137,459                              |       | 343 |   | 1.00 |   | 53,025 |   | 366 |   | 2.77 |   |
|                       |   | $                                    | 343,173    |   | $ | 6,078 |   | 7.10 | % | $ | 276,487 |   | $ | 5,851 |   | 8.49 | % |

 

----

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

 

8

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The yield on the loan portfolio increased as a result of an increase inincome recognized at the time of individual loan pay-offs, partially offset bya decline in regularly scheduled interest income. The decline in regularlyscheduled interest income is a result of: (1) a declining interest rateenvironment, (2) the purchase or contribution in 2002 of loans from CapitalCrossing that were acquired from the Small Business Administration whichgenerate lower regularly scheduled interest and accretion and (3) a decline inthe average balance of the loan portfolio. Average loans, net for the threemonths ended June 30, 2003 totaled $205.7 million compared to$223.5 million for the same period in 2002. This decrease is primarilyattributable to pay-offs and amortization of loans, partially offset bypurchases of loans from or contributions of loans by Capital Crossing totaling$108.5 million since the second quarter of 2002.

 

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

 

When a loan is paid-off, the excess of any cash received over the netinvestment is recorded as interest income. In addition to the amount ofpurchase discount that is recognized at that time, income may also includeinterest owed by the borrower prior to Capital Crossing’s acquisition of theloan, interest collected if on non-performing status and other loan fees(“other interest and fee income”). The following table sets forth, for theyears indicated, 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 June 30,** |       |
|-------------------------------------------------------|--------|--------------------------------------|------------|
|                                                  |   | **2003**                             |       | **2002** |   |
|                                                  |   | **Interest  Income**                 |       | **Yield** | ** ** | **Interest  Income** | ** ** | **Yield** | ** ** |
|                                                  |   | **(dollars in thousands)**           | ** ** |
|                                                  |   |                                 |       |   |   |   |   |   |   |
| Regularly  scheduled interest and accretion income    |   | $                                    | 3,989      |   | 7.78 | % | $ | 4,555 |   | 8.18 | % |
| Interest and  fee income recognized on loan pay-offs: |   |                                 |       |   |   |   |   |   |   |
| Non-amortizing  discount                              |   | 301                                  |       | 0.59 |   | 519 |   | 0.93 |   |
| Amortizing  discount                                  |   | 1,340                                |       | 2.61 |   | 295 |   | 0.53 |   |
| Other interest  and fee income                        |   | 105                                  |       | 0.20 |   | 116 |   | 0.21 |   |
|                                                  |   | 1,746                                |       | 3.40 |   | 930 |   | 1.67 |   |
|                                                  |   | $                                    | 5,735      |   | 11.18 | % | $ | 5,485 |   | 9.85 | % |

 

The amount of loan pay-offs and related discount income is influencedby several factors, including the interest rate environment, the real estatemarket in particular areas, the timing of transactions, and circumstancesrelated to individual borrowers and loans.

 

The average balance of interest-bearing deposits increased $84.4million to $137.5 million for the three months ended June 30, 2003,compared to $53.0 million for the same period in 2002, as a result of cashflows from loan repayments; offset by loan purchases and periodic dividendpayments. The yield on interest-bearing deposits decreased in 2003 because therate paid by Capital Crossing on the money market account held by CapitalCrossing Preferred decreased consistently with deposit interest rates generallycompared to 2002.

 

Capital Crossing Preferred recorded a credit for loan losses of $2.4million for the three months ended June 30, 2003. No provision or creditwas recorded for the three months ended June 30, 2002. Capital CrossingPreferred has experienced a high rate of loan pay-offs and thus recorded acredit for loan losses to reduce allowance allocations related to the loansthat have paid off. The allowance for loan losses is based on the size of theportfolio and its historical performance. The determination of this allowancerequires the use of estimates and assumptions regarding the risks inherent inindividual loans and the loan portfolio in its entirety.  Should the loan portfolio continue todecline without utilization of the allowance for loan losses, future creditsfor loans losses may be necessary.

 

Loan servicing and advisory services for the three months endedJune 30, 2003 decreased $5,000, or 3.2%, to $152,000 compared to $157,000for the three months ended June 30, 2002. This decrease is due to theoverall decrease in the average balance of the loan portfolio.

 

Other real estate owned income for the three months ended June 30,2003 is comprised of a gain of $334,000 on the sale of one property to anunaffiliated third party and rental income of $8,000. There was no other realestate owned income during the three

 

9

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months ended June 30,2002.

 

Other general and administrative expenses for the three months endedJune 30, 2003 increased $36,000, or 120.0%, to $66,000 compared to $30,000for the three months ended June 30, 2002. This increase is due primarilyto an increase in legal fees in connection with loan-related matters.

 

Capital Crossing Preferred intends to pay dividends on its preferredstock and common stock in amounts necessary to continue to preserve its statusas REIT under the Internal Revenue Code.

 

***SixMonths Ended June 30, 2003 and 2002***

 

Net income available to common stockholderincreased $3.2 million, or 31.6%, to $13.1 million for the six months endedJune 30, 2003 compared to $10.0 million for the six months endedJune 30, 2002. This increase is primarily attributable to a credit forloan losses, an increase in interest income and an increase in other realestate owned income. Total interest income for the six months endedJune 30, 2003 increased $1.1 million, or 9.3%, to $12.5 million, comparedto $11.4 million for the six months ended June 30, 2002.

 

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

 
|                       |   | **Six Months Ended June 30,** |       |
|----------------------------|--------|------------------------------------|------------|
|                       |   | **2003**                           |       | **2002** |   |
|                       |   | **Average  Balance**               |       | **Interest  Income** | ** ** | **Yield** | ** ** | **Average  Balance** | ** ** | **Interest  Income** | ** ** | **Yield** | ** ** |
|                       |   | **(dollars in thousands)**         | ** ** |
|                       |   |                               |       |   |   |   |   |   |   |   |   |   |   |
| Loans, net (1)             |   | $                                  | 220,343    |   | $ | 11,406 |   | 10.44 | % | $ | 187,537 |   | $ | 10,455 |   | 11.24 | % |
| Interest-bearing  deposits |   | 120,732                            |       | 1,062 |   | 1.77 |   | 71,648 |   | 947 |   | 2.67 |   |
|                       |   | $                                  | 341,075    |   | $ | 12,468 |   | 7.37 | % | $ | 259,185 |   | $ | 11,402 |   | 8.87 | % |

 

----

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

 

The yield on the loan portfolio declined as a result of: (1) adecrease in yield attributable to regularly scheduled interest income as aresult of the declining interest rate environment, (2) a decline, relativeto the overall yield on loans, in interest income recognized at the time ofindividual loan pay-offs and (3) the purchase or contribution in 2002 ofloans from Capital Crossing that were acquired from the Small Business Administrationwhich generate lower regularly scheduled interest and accretion. Average loans,net for the six months ended June 30, 2003 totaled $220.3 millioncompared to $187.5 million for the same period in 2002. This increase isprimarily attributable to purchases of loans from or contribution of loans byCapital Crossing totaling $108.5 million, which was partially offset bypay-offs, sales, and amortization related to loans, since the second quarter of2002.

 

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

 

When a loan is paid-off, the excess of any cash received over the netinvestment is recorded as interest income. In addition to the amount ofpurchase discount that is recognized at that time, income may also includeinterest owed by the borrower prior to Capital Crossing’s acquisition of theloan, interest collected if on non-performing status and other loan fees(“other interest and fee income”). The following table sets forth, for theyears indicated, 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.

 

10

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|                                                  |   | **Six Months Ended June 30,** |       |
|-------------------------------------------------------|--------|------------------------------------|------------|
|                                                  |   | **2003**                           |       | **2002** |   |
|                                                  |   | **Interest  Income**               |       | **Yield** | ** ** | **Interest  Income** | ** ** | **Yield** | ** ** |
|                                                  |   | **(dollars in thousands)**         | ** ** |
|                                                  |   |                               |       |   |   |   |   |   |   |
| Regularly  scheduled interest and accretion income    |   | $                                  | 8,461      |   | 7.74 | % | $ | 7,854 |   | 8.44 | % |
| Interest and  fee income recognized on loan pay-offs: |   |                               |       |   |   |   |   |   |   |
| Non-amortizing  discount                              |   | 861                                |       | 0.79 |   | 1,172 |   | 1.26 |   |
| Amortizing  discount                                  |   | 1,974                              |       | 1.81 |   | 1,279 |   | 1.38 |   |
| Other interest  and fee income                        |   | 110                                |       | 0.10 |   | 150 |   | 0.16 |   |
|                                                  |   | 2,945                              |       | 2.70 |   | 2,601 |   | 2.80 |   |
|                                                  |   | $                                  | 11,406     |   | 10.44 | % | $ | 10,455 |   | 11.24 | % |

 

The amount of loan pay-offs and related discount income is influencedby several factors, including the interest rate environment, the real estatemarket in particular areas, the timing of transactions, and circumstancesrelated to individual borrowers and loans.

 

The average balance of interest-bearing deposits increased $49.1million to $120.7 million for the six months ended June 30, 2003, comparedto $71.6 million for the same period in 2002, as a result of cash flows fromloan repayments; offset by loan purchases and periodic dividend payments. The yieldon interest-bearing deposits decreased in 2003 because the rate paid by CapitalCrossing on the money market account held by Capital Crossing Preferreddecreased consistently with deposit interest rates generally compared to 2002.

 

Capital Crossing Preferred recorded a credit for loan losses of $2.4million for the six months ended June 30, 2003. No provision or credit wasrecorded for the six months ended June 30, 2002. Capital CrossingPreferred has experienced a high rate of loan pay-offs and thus recorded acredit for loan losses to reduce allowance allocations related to the loansthat have paid off. The allowance for loan losses is based on the size of theportfolio and its historical performance. The determination of this allowancerequires the use of estimates and assumptions regarding the risks inherent inindividual loans and the loan portfolio in its entirety.  Should the loan portfolio continue todecline without utilization of the allowance for loan losses, future creditsfor loans losses may be necessary.

 

The gain on sales of loans of $517,000 is the result of the sale of oneloan to an unaffiliated third party during the six months ended June 30,2002. There were no loans sold to unaffiliated third parties during the sixmonths ended June 30, 2003.

 

Loan servicing and advisory services expenses for the six months endedJune 30, 2003 increased $63,000, or 24.1%, to $324,000 compared to$261,000 for the six months ended June 30, 2002. This increase was due tothe overall increase in the average balance of the loan portfolio.

 

Other real estate owned income for the six months ended June 30,2003 is comprised of a gain of $334,000 on the sale of one property to anunaffiliated third party and rental income of $8,000. There was no other realestate owned income during the six months ended June 30, 2002.

 

Other general and administrative expenses for the six months endedJune 30, 2003 increased $78,000, or 166.0%, to $125,000 compared to$47,000 for the six months ended June 30, 2002.  This increase was due primarily to an increase in legal fees inconnection with loan-related matters.

 

Capital Crossing Preferred intends to pay dividends on its preferredstock and common stock in amounts necessary to continue to preserve its statusas a REIT under the Internal Revenue Code.

 

**Financial Condition**

 

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

 

Interest-bearing deposits with Capital Crossing Bank consist entirelyof a money market account at June 30, 2003.

 

11

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##### **Loan Portfolio**

##### ** **

To date, all of Capital Crossing Preferred’sloans have been purchased from or contributed by Capital Crossing. Thefollowing table sets forth information regarding the composition of the loanportfolio at the dates indicated:

 
|                            |   | **June 30,****2003** |       | **December 31,  2002** |   |
|---------------------------------|--------|---------------------------|------------|-----------------------------|--------|
|                            |   | **(in thousands)**        | ** ** |
| Mortgage loans  on real estate: |   |                      |       |                        |   |
| Commercial  real estate         |   | $                         | 156,757    |                        | $      | 191,567 |   |
| Multi-family  residential       |   | 61,693                    |       | 77,598                      |   |
| One-to-four  family residential |   | 2,057                     |       | 2,529                       |   |
| Land                            |   | 5,652                     |       | 5,821                       |   |
| Total, gross                    |   | 226,159                   |       | 277,515                     |   |
|                            |   |                      |       |                        |   |
| Less:                           |   |                      |       |                        |   |
| Non-amortizing  discount        |   | (6,614                    | )          | (8,158                      | )      |
| Amortizing  discount            |   | (21,570                   | )          | (23,926                     | )      |
| Net deferred  loan fees         |   | (226                      | )          | (112                        | )      |
| Allowance for  loan losses      |   | (4,954                    | )          | (7,354                      | )      |
| Loans, net                      |   | $                         | 192,795    |                        | $      | 237,965 |   |

 

Included in net loans, at June 30, 2003 and December 31,2002, are approximately $23.0 million and $32.9 million (of which $180,000 atDecember 31, 2002 are non-performing), respectively, for which the netrecorded investment represents the amortized cost of these loans, where atacquisition, the amounts of reasonably estimable and probable discounted futurecash collections were less than the contractual balances owed. These loans werepurchased at a price to yield a market rate of interest after considering thecredit quality of the loans at acquisition and the aforementioned expectedfuture cash collections. The excess of the contractual balances over the amountof reasonably estimable and probable discounted future cash collections representsthe predominant portion of the $6.6 million and $8.2 million of non-amortizingdiscount at June 30, 2003 and December 31, 2002, respectively.

 

Capital Crossing Preferred intends that eachloan acquired from Capital Crossing in the future will be a whole loan, andwill be originated or acquired by Capital Crossing in the ordinary course ofits business. Capital Crossing Preferred also intends that all loans held by itwill be serviced pursuant to its master service agreement with CapitalCrossing.

 

From time to time, returns of capital may bemade to Capital Crossing. This would have the effect of reducing the asset sizeof Capital Crossing Preferred.  Suchreturns were made during the three months ended June 30, 2003, as furtherdescribed under “Stockholders’ Equity” below.

 

Non-performing loans, net of discount,totaled $20,000 and $1.8 million at June 30, 2003 and December 31,2002, respectively.

 

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

 

***Non-AmortizingDiscount.*** At the time of acquisition, the excess of the contractual loan balancesover the amount of reasonably estimable and probable future cash collections isrecorded as non-amortizing discount. The non-amortizing discount is nottransferred to amortizing discount and accreted into income until it isdetermined that the amount and timing of the cash flows related to thenon-amortizing discount are reasonably estimable and collection is probable.Non-amortizing discount generally is reduced and offset against the relatedprincipal balance when the amount at which a loan is resolved or restructuredis determined. There is no effect on the income statement as a result of thesereductions.  If cash flow projectionsdeteriorate subsequent to acquisition, the decline is accounted for through theallowance for loan losses.

 

12

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The following table sets forth certain information relating to theactivity in the non-amortizing discount for the periods indicated:

 
|                                                                |   | **Three Months Ended  June30,** |       | **Six Months Ended  June 30,** |       |
|---------------------------------------------------------------------|--------|---------------------------------|------------|-------------------------------------|------------|
|                                                                |   | **2003**                        |       | **2002**                            | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                                                |   | **(in thousands)**              | ** ** |
|                                                                |   |                            |       |                                |       |   |   |   |   |
| Balance at  beginning of period                                     |   | $                               | 7,267      |                                | $          | 4,388 |   | $ | 8,158 |   | $ | 6,062 |   |
| Additions in  connection with loans acquired from Capital Crossing  |   | —                          |       | 5,459                               |       | — |   | 5,667 |   |
| Accretion                                                           |   | (295                            | )          | (519                                | )          | (855 | ) | (1,172 | ) |
| Transfers to  amortizing portion upon improvements in cash flows    |   | (328                            | )          | —                              |       | (649 | ) | (244 | ) |
| Net reductions  related to resolutions and restructures             |   | (30                             | )          | —                              |       | (40 | ) | (678 | ) |
| Non-amortizing  discount relating to loans sold to Capital Crossing |   | —                          |       | (72                                 | )          | — |   | (379 | ) |
| Balance at end  of period                                           |   | $                               | 6,614      |                                | $          | 9,256 |   | $ | 6,614 |   | $ | 9,256 |   |

 

 

***Allowancefor Loan Losses.***  Capital Crossing Preferred maintains an allowance for probableloan losses that are inherent in its loan portfolio. The allowance for probableloan losses is increased or decreased by provisions or credits for loan lossesincluded in earnings. Additionally, the allowance for loan losses is increasedupon allocations of discounts on purchased loans and reduced by net loancharge-offs. Loans are charged-off when they are deemed to be uncollectible, orpartially charged-off when a portion of a loan is deemed uncollectible.Recoveries are generally recorded only when cash payments are received. Theloan loss allowance policy requires the maintenance of allowances sufficient tosatisfy estimated probable losses arising from impaired real estate or othersecured commercial loans.

 

Capital Crossing Preferred performs periodicreviews of its loan portfolio to identify loans for which specific allocationsare considered prudent. Specific allocations include the results of measuring impairedloans under Statement of Financial Accounting Standards No. 114. Generalrisk allocations are determined by a formula whereby the loan portfolio isstratified by loan type and by internal risk rating categories. Loss factorsare then applied to each strata based on various considerations includinghistoric loss experience, delinquency trends, current economic conditions,industry standards and regulatory guidelines. An additional allowance ismaintained based on a judgment by management after consideration of qualitativeand quantitative assessments of certain factors including regional creditconcentration, industry concentration, results of regulatory examinations,historical loss ranges, portfolio composition, economic conditions such asinterest rates and energy costs and other changes in the portfolio. Theallowance for loan losses is management’s estimate of the probable loan lossesincurred as of the balance sheet date.

 

Additional factors influencing thecalculation of the allowance for loan losses are particular concentrationswithin the portfolio, including the geographic concentration of loans inCalifornia, which accounted for approximately 42.7% of the portfolio atJune 30, 2003, and concentrations of loans to individual borrowers.

 

CapitalCrossing Preferred’s allowance for loan losses at June 30, 2003 was$5.0 million. The determination of this allowance requires the use ofestimates and assumptions regarding the risks inherent in individual loans andthe loan portfolio in its entirety. In addition, regulatory agenciesperiodically review the adequacy of the allowance for loan losses and mayrequire Capital Crossing Preferred to make additions to its allowance for loanlosses. While management believes its estimates and assumptions are reasonable,there can be no assurance that they will be proven to be correct in the future.The actual amount of future provisions that may be required cannot bedetermined, and such provisions may exceed the amounts of past provisions.Management believes that the allowance for loan losses is adequate to absorbthe known and inherent risks in Capital Crossing Preferred’s loan portfolio ateach date based on the facts known to management as of such date. Managementcontinues to monitor and modify the allowances for general and specific loanlosses as economic conditions dictate.

 

13

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The following table sets forth an analysis of the allowance for loanlosses for the periods indicated:

 
|                                                 |   | **Three Months Ended June 30,** |       | **Six Months Ended June 30,** |       |
|------------------------------------------------------|--------|--------------------------------------|------------|------------------------------------|------------|
|                                                 |   | **2003**                             |       | **2002**                           | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                                 |   | **(in thousands)**                   | ** ** |
| Balance at  beginning of period                      |   | $                                    | 7,354      |                               | $          | 5,140 |   | $ | 7,354 |   | $ | 4,659 |   |
| Credit for  loan losses                              |   | (2,400                               | )          | —                             |       | (2,400 | ) | — |   |
| Transfer from  Capital Crossing with loans purchased |   | —                               |       | 3,763                              |       | — |   | 4,250 |   |
| Transfer to  Capital Crossing with loans sold        |   | —                               |       | (7                                 | )          | — |   | (13 | ) |
| Balance at end  of period                            |   | $                                    | 4,954      |                               | $          | 8,896 |   | $ | 4,954 |   | $ | 8,896 |   |

 

#### ***Stockholders’ Equity.***  Total stockholders’ equity decreased $112.0million, or 33.8%, to $219.6 million at June 30, 2003 from $331.6 millionat December 31, 2002. The decrease in stockholders’ equity was a result ofdistributions to the common stockholder of $125.1 million, in the form commonstock dividends and a return of capital, and preferred dividends of $1.7million, offset by net income of $14.8 million.

#### ** **

The return of capital to the common stockholder was a result of excesscash which had accumulated as a result of loan repayments. In the future, cashcollections may be used to purchase additional loans or for additional returnsof capital depending on various factors such as the level of loans held at thetime.

 

#### **InterestRate Risk**

#### ** **

Capital Crossing Preferred’s income consistsprimarily of interest income. If there is a decline in market interest rates,Capital Crossing 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 downwardadjustments of the indices upon which the interest rates on loans are based andfrom prepayments 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.

 

**SignificantConcentration of Credit Risk**

 

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

 

At June 30, 2003, 42.7% and 13.8%,respectively, of Capital Crossing Preferred’s total loan portfolio consisted ofloans located in California and New England. At December 31,2002, 43.7% and 14.1% of Capital Crossing Preferred’s total real estate loanportfolio consisted of loans located in California and New England,respectively. Consequently, theportfolio may experience a higher default rate in the event of adverseeconomic, political or business developments or natural hazards in Californiaor New England that may affect the ability of property owners to make paymentsof principal and interest on the underlying mortgages.

 

#### **Liquidity Risk Management**

#### ** **

The objective of liquidity management is toensure the availability of sufficient cash flows to meet all of CapitalCrossing Preferred’s financial commitments. In managing liquidity risk, CapitalCrossing Preferred takes into account various legal limitations placed on aREIT. Capital Crossing Preferred’s principal liquidity need is to pay dividendson the preferred shares and common shares.

 

14

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The acquisition of additional mortgage assetsis intended to be funded primarily through repayment of principal balances ofmortgage assets by individual borrowers. Capital Crossing Preferred does nothave and does not anticipate having any material capital expenditures. To theextent that the Board of Directors determines that additional funding isrequired, Capital Crossing Preferred may raise such funds through additionalequity offerings, debt financing or retention of cash flow (after considerationof provisions of the Internal Revenue Code requiring the distribution by a REITof at least 90% of its REIT taxable income and taking into account taxes thatwould be imposed on undistributed income), or a combination of these methods.Except for its obligation to guarantee certain borrowings of Capital Crossing,Capital Crossing Preferred does not currently intend to incur any indebtedness.The organizational documents of Capital Crossing Preferred limit the amount ofindebtedness which it is permitted to incur without the approval of the Series Aand the Series C preferred stockholders to no more than 100% of the totalstockholders’ equity of Capital Crossing Preferred. Any such debt may includeintercompany advances made by Capital Crossing to Capital Crossing Preferred.

 

15

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# **RISK FACTORS AND FACTORS AFFECTING FUTUR**E OPERATING RESULTS

# ** **

Set forth below are a number of risk factors that investors shouldcarefully consider in making an investment in Capital Crossing Preferred’spreferred stock. These factors may cause Capital Crossing Preferred’s actualresults to differ materially from anticipated future results, performance orachievements expressed or implied by the forward-looking statements.

 

All of these factors should be carefully reviewed, and the reader ofthis Form 10-Q should be aware that there might be other factors that couldcause these differences.

 

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

 

The returns from an investment in the Series A or Series Cpreferred shares will depend to a significant extent on the performance andcapital of Capital Crossing. A significant decline in the performance andcapital levels of Capital Crossing or the placement of Capital Crossing intobankruptcy, reorganization, conservatorship or receivership could result in theautomatic exchange of the Series A and Series C preferred shares forpreferred shares of Capital Crossing, which would represent an investment inCapital Crossing and not in Capital Crossing Preferred. Under thesecircumstances:

 

•                  aholder of Series A or Series C preferred shares would be a preferredstockholder of Capital Crossing at a time when Capital Crossing’s financialcondition was deteriorating or when Capital Crossing had been placed intobankruptcy, reorganization, conservatorship or receivership and, accordingly,it is unlikely that Capital Crossing would be in a financial position to pay anydividends on the preferred shares of Capital Crossing. An investment in CapitalCrossing is also subject to risks that are distinct from the risks associatedwith an investment in Capital Crossing Preferred. For example, an investment inCapital Crossing would involve risks relating to the capital levels of, andother federal and state regulatory requirements applicable to, CapitalCrossing, and the performance of Capital Crossing’s overall loan portfolio andother business lines. Capital Crossing also has significantly greaterliabilities and significantly less stockholders’ equity than does CapitalCrossing Preferred;

 

•                  ifa liquidation of Capital Crossing occurs, the claims of depositors andcreditors of Capital Crossing and of the FDIC would have priority over theclaims of holders of the preferred shares of Capital Crossing, and therefore, aholder of Series A and Series C preferred shares likely would receivesubstantially less than such holder would receive had the Series A andSeries C preferred shares not been exchanged for preferred shares ofCapital Crossing; and

 

•                  theexchange of the Series A or Series C preferred shares for preferredshares of Capital Crossing would be a taxable event to a holder ofSeries A or Series C preferred shares under the Internal RevenueCode, and such holder would incur a gain or a loss, as the case may be,measured by the difference between such holder’s basis in the Series A orSeries C preferred shares and the fair market value of Capital Crossingpreferred shares received in the exchange.

 

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

 

The Series A and Series C preferred shares rank:

 

•                  juniorto borrowings of Capital Crossing Preferred, including claims of the FHLBB foramounts due or which may become due under Capital Crossing Preferred’sguarantee of Capital Crossing’s obligations to the FHLBB, and any otherobligations to Capital Crossing Preferred’s creditors upon its liquidation; and

 

•                  seniorto Capital Crossing Preferred’s common stock and its Series B preferredstock with regard to payment of dividends and amounts upon liquidation.

 

If Capital Crossing Preferred incurs significantindebtedness, it may not have sufficient funds to make dividend or liquidationpayments on the Series A or Series C preferred shares. Upon CapitalCrossing Preferred’s liquidation, its obligations to its creditors would ranksenior to the Series A and Series C preferred shares. AtJune 30, 2003, Capital Crossing Preferred had approximately $81,000 inaccounts payable and other liabilities which, upon its liquidation, would berequired to be paid before any payments could be made to holders of the Series Aor Series C preferred shares. In addition, upon Capital CrossingPreferred’s liquidation, dissolution or winding up, if it does not havesufficient funds to pay the full liquidation amount to the holders of theSeries A and Series C preferred shares, such holders may receive lessthan the $10.00 per share liquidation amount.

 

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The terms of the Series A andSeries C preferred shares limit Capital Crossing Preferred’s ability toincur debt in excess of 100% of its stockholders’ equity without the approvalof the holders of all of the outstanding Series A and Series Cpreferred shares but do not require that Capital Crossing Preferred obtain theapproval of the holders of the Series A and Series C preferred sharesto issue additional series of preferred shares which rank equal to theSeries A and Series C preferred shares as to payment of dividends oramount upon liquidation. As a result, subject to these limitations, CapitalCrossing Preferred may incur obligations which may further limit its ability tomake dividend or liquidation payments in the future.

 

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

 

Because Capital Crossing Preferred is asubsidiary of Capital Crossing, federal and state regulatory authorities willhave the right to examine it and its activities and under certaincircumstances, to impose restrictions on Capital Crossing or Capital CrossingPreferred which could impact Capital Crossing Preferred’s ability to conductits business according to its business plan, which could materially adverselyaffect the financial condition and results of operations of Capital CrossingPreferred:

 

•                  ifCapital Crossing’s regulators determine that Capital Crossing’s relationship toCapital Crossing Preferred results in an unsafe and unsound banking practice,the regulators could restrict Capital Crossing Preferred’s ability to transferassets, to make distributions to its stockholders, including dividends on itsSeries A and Series C preferred shares, or to redeem shares ofSeries A and Series C preferred stock or even require CapitalCrossing to sever its relationship with or divest its ownership interest in CapitalCrossing Preferred. Such actions could potentially result in Capital CrossingPreferred’s failure to qualify as a REIT.

 

•                  paymentof dividends on the Series A and Series C preferred shares could alsobe subject to regulatory limitations if Capital Crossing becomesundercapitalized. Capital Crossing will be deemed undercapitalized if its totalrisk-based capital ratio is less than 8.0%, its Tier 1 risk-based capital ratiois less than 4.0% or its Tier 1 leverage ratio is less than 4.0%. At June 30,2003, Capital Crossing had a total risk-based capital ratio of 13.92%, a Tier 1risk-based capital ratio of 12.65% and a Tier 1 leverage ratio of 10.63%, whichis sufficient for Capital Crossing to be considered well-capitalized. As partof its common stock repurchase program, Capital Crossing has also agreed withthe FDIC to maintain, for so long as the repurchase program continues, its Tier1 leverage ratio at least 8.00%. Capital Crossing Preferred makes no assurancethat Capital Crossing will be well-capitalized under applicable regulations asof any future date. For purposes of calculating these capital ratios as apercentage of Capital Crossing’s risk-weighted assets, as opposed to its totalassets, Capital Crossing’s assets are assigned to risk categories based on therelative credit risk of the asset in question. These risk weights consist of 0%for assets deemed least risky such as cash, claims backed by the full faith andcredit of the U.S. government, and balances due from Federal Reserve banks; 20%for assets deemed slightly more risky such as portions of obligationsconditionally guaranteed by the U.S. government or federal funds sold; 50% forassets deemed still more risky such as government issued-revenue bonds,one-to-four family residential first mortgage loans and well-collateralizedmulti-family residential first mortgage loans; and 100% for all other assets,including private sector loans such as commercial mortgage loans as well asbank-owned real estate.

 

•                  whileCapital Crossing Preferred believes that dividends on the Series A andSeries C preferred shares should not be considered distributions byCapital Crossing, the FDIC may not agree with this position. Under FDICregulations on capital distributions, the ability of Capital Crossing to make acapital distribution varies depending primarily on Capital Crossing’s earningsand regulatory capital levels. Capital distributions are defined to includepayment of dividends, stock repurchases, cash-out mergers and otherdistributions charged against the capital accounts of an institution. The FDICcould limit or prohibit the payment of dividends on the Series A andSeries C preferred shares if it determines that the payment of thosedividends is a capital distribution by Capital Crossing and that CapitalCrossing’s earnings and regulatory capital levels are below specified levels.

 

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

 

Capital Crossing Preferred does not normallyobtain general credit enhancements such as mortgagor bankruptcy insurance orobtain special hazard insurance for its mortgage assets, other than standardhazard insurance, which will in each case only relate to individual mortgageloans. Accordingly, Capital Crossing Preferred will be subject to risks ofborrower defaults and bankruptcies and special hazard losses, such as lossesoccurring from floods that are not covered by standard hazard insurance. Asignificant number of loans acquired in recent years are loans that wereoriginated under the Small Business Administration’s disaster relief program.These loans are typically loans made to small businesses and individuals forthe purpose of assisting those who have been the victim of a disaster and maybe located in an area prone to such disasters. In the event of a default on anymortgage loan held by Capital Crossing Preferred resulting from decliningproperty values or worsening economic conditions, among other factors, it wouldbear the risk of loss of principal to the extent of any deficiency between(1) the value of the related mortgaged property, plus any payments from aninsurer or guarantor in the case of commercial mortgage loans, and (2) theamount owing on the mortgage loan.

 

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

 

Capital Crossing Preferred’s mortgage loanportfolio is subject to local economic conditions which could affect the valueof the real estate assets underlying its loans and therefore, its results ofoperations will be affected by various conditions in the real estate market,all of which are beyond its control, such as:

 

•                  localand other economic conditions affecting real estate values;

 

•                  thecontinued financial stability of a borrower and the borrower’s ability to makemortgage payments;

 

•                  theability of tenants to make lease payments;

 

•                  theability of a property to attract and retain tenants, which may in turn beaffected by local conditions, such as oversupply of space or a reduction indemand for rental space in the area;

 

•                  interestrate levels and the availability of credit to refinance mortgage loans at or priorto maturity; and

 

•                  increasedoperating costs, including energy costs, real estate taxes and costs ofcompliance with environmental controls and regulations.

 

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

 

Properties underlying Capital CrossingPreferred’s current mortgage assets are concentrated primarily in California,particularly Southern California, and New England. As of June 30, 2003,approximately 42.7% of its mortgage assets were secured by properties locatedin California and 13.8% in New England. Adverse economic, political or businessdevelopments or natural hazards may affect these areas and the ability ofproperty owners in these areas to make payments of principal and interest onthe underlying mortgages. If either region experienced adverse economic,political or business conditions, Capital Crossing Preferred would likelyexperience higher rates of loss and delinquency on its mortgage loans than ifits loans were more geographically diverse.

 

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

 

At June 30, 2003, approximately 93.4% ofCapital Crossing Preferred’s loan portfolio consisted of loans originated bythird parties that were purchased by Capital Crossing and subsequently acquiredby Capital Crossing Preferred from Capital Crossing. Because these loans wereoriginated by third parties, Capital Crossing generally is not able to conductthe same level of due diligence on these loans that it would have conducted hadit originated them. Generally, while Capital Crossing conducts an acquisitionreview, it relies on the underwriting standards of the parties originating theloans it acquires. The standards of these loan originators may be substantiallydifferent than those of Capital Crossing. These differences may include lessrigorous appraisal requirements and debt service coverage ratios, and lessrigorous analysis of property location and environmental factors, buildingcondition and age, tenant quality, compliance with zoning regulations, any userestrictions, easements or right of ways that may impact the value and theborrower’s ability to manage the property. Other disadvantages of purchasedloans versus originated loans may include the lack of current financialinformation, incomplete legal documentation and outdated appraisals.

 

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**More than half of Capital CrossingPreferred’s loan portfolio is made up of commercial mortgage loans which aregenerally riskier than other types of loans**

 

Commercial mortgage loans constitutedapproximately 69.3% of the total gross loans in Capital Crossing Preferred’sloan portfolio at June 30, 2003 and commercial mortgage loans aregenerally subject it to greater risks than other types of loans. CapitalCrossing Preferred’s commercial mortgage loans, like most commercial mortgageloans, generally lack standardized terms, tend to have shorter maturities thanresidential mortgage loans and may not be fully amortizing, meaning that theyhave a principal balance or “balloon” payment due on maturity. The commercialreal estate properties underlying Capital Crossing Preferred’s commercialmortgage loans also tend to be unique and are more difficult to value thanresidential real estate properties. They are also subject to relatively greaterenvironmental risks than other types of loans and to the corresponding burdensand costs of compliance with environmental laws and regulations. Because ofthese risks related to commercial mortgage loans, Capital Crossing Preferredmay experience higher rates of default on its mortgage loans than it would ifits loan portfolio was more diversified and included a greater number ofresidential and other mortgage loans.

 

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

 

To date Capital Crossing Preferred haspurchased all of the loans in its portfolio from Capital Crossing.Historically, Capital Crossing has acquired such loans (1) frominstitutions which sought to eliminate certain loans or categories of loansfrom their portfolios, (2) from institutions participating insecuritization programs, (3) from failed or consolidating financialinstitutions and (4) from government agencies, specifically the SmallBusiness Administration. Future loan purchases will depend on the availabilityof pools of loans offered for sale and Capital Crossing’s ability to submitsuccessful bids or negotiate satisfactory purchase prices. The acquisition ofwhole loans is highly competitive. In fact, the Small Business Administrationhas recently announced that all future assets sales are on hold, pending theoutcome of an internal review of its loan sale program. Consequently, CapitalCrossing Preferred cannot provide assurance that Capital Crossing will be ableto purchase loans at the same volumes or with the same yields as it hashistorically purchased. This may interfere with Capital Crossing Preferred’sability to maintain the requisite level of mortgage assets to maintain itsqualification as a REIT. If volumes of loans purchased decline or the yields onthese loans decline further, Capital Crossing Preferred would experience amaterial adverse effect on its business, financial condition and results ofoperations.

 

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

 

If Capital Crossing Preferred chooses toforeclose on a defaulted mortgage loan to recover its investment it may besubject to environmental liabilities related to the underlying real property.Approximately 69.3% of the loans in Capital Crossing Preferred’s portfolio atJune 30, 2003 were commercial mortgage loans, which generally are subjectto relatively greater environmental risks than other types of loans. Hazardoussubstances or wastes, contaminants, pollutants or sources thereof may bediscovered on properties during Capital Crossing Preferred’s ownership or aftera sale to a third party. The amount of environmental liability could exceed thevalue of the real property. There can be no assurance that Capital CrossingPreferred would not be fully liable for the entire cost of any removal andclean-up on an acquired property, that the cost of removal and clean-up wouldnot exceed the value of the property or that Capital Crossing Preferred couldrecoup any of the costs from any third party. In addition, Capital CrossingPreferred may find it difficult or impossible to sell the property prior to orfollowing any such remediation.

 

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

 

Capital Crossing, which holds all of CapitalCrossing Preferred’s common stock, is involved in virtually every aspect ofCapital Crossing Preferred’s existence. Capital Crossing Preferred has fiveofficers and no other employees and does not have any independent corporateinfrastructure. Capital Crossing Preferred does not have any employees becauseit has retained Capital Crossing to perform all necessary functions pursuant tothe advisory agreement and the master service agreement. All of CapitalCrossing Preferred’s officers are also officers of Capital Crossing. Under anadvisory agreement between Capital Crossing Preferred and Capital Crossing,Capital Crossing administers day-to-day activities, including monitoring ofCapital Crossing Preferred’s credit quality and advising it with respect to theacquisition, management, financing and disposition of mortgage assets and itsoperations generally. Under a master service agreement between Capital CrossingPreferred and Capital Crossing, Capital Crossing services Capital CrossingPreferred’s loan portfolio. The advisory agreement has an initial term of five yearswith an automatic renewal feature and the master service agreement has anone-year term with an automatic renewal feature. Both the master serviceagreement and the advisory agreement are subject to earlier termination uponprovision of 30 days and 90 days notice, respectively. CapitalCrossing may subcontract all or a portion of its obligations under the advisoryagreement to its affiliates or, with the approval of a majority of the Board ofDirectors as well as a majority of the independent directors, subcontract itsobligations under the advisory agreement to unrelated third parties. CapitalCrossing will not, in connection with the subcontracting of any of itsobligations under the advisory agreement, be discharged or relieved from itsobligations under the advisory agreement. The loss of the services of CapitalCrossing, or the inability of Capital Crossing to effectively provide suchservices whether as a result of the loss of key members of Capital Crossing’smanagement, early termination of the agreements or otherwise, and CapitalCrossing Preferred’s inability to replace such services on favorable terms, orat all, could adversely affect Capital Crossing Preferred’s ability to conductits operations.

 

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

 

Capital Crossing and its affiliates may haveinterests which are not identical to Capital Crossing Preferred’s and thereforeconflicts of interest have arisen and may arise in the future with respect to transactionsbetween Capital Crossing Preferred and Capital Crossing such as

 

***Acquisitionof mortgage assets.***  Capital Crossing Preferred anticipates that it will from time totime continue to purchase additional mortgage assets. Capital CrossingPreferred intends to acquire all or substantially all of such mortgage assetsfrom Capital Crossing, on terms that are comparable to those that could beobtained by Capital Crossing Preferred if such mortgage assets were purchasedfrom unrelated third parties. Neither Capital Crossing Preferred nor CapitalCrossing currently have specific policies with respect to the purchase byCapital Crossing Preferred from Capital Crossing of particular loans or poolsof loans, other than that such assets must be eligible to be held by a REIT.Although these purchases are structured to take advantage of the underwritingprocedures of Capital Crossing, and while Capital Crossing Preferred believesthat any agreements and transactions between it, on the one hand, and CapitalCrossing and/or its affiliates on the other hand, are fair to all parties andconsistent with market terms, neither Capital Crossing Preferred nor CapitalCrossing have obtained any third-party valuation to confirm whether CapitalCrossing Preferred will be paying fair market value for these loans, nor doesCapital Crossing Preferred anticipate doing so in the future. Additionally,through limiting Capital Crossing Preferred’s source of purchased mortgageassets solely to those originated or purchased by Capital Crossing, CapitalCrossing Preferred’s portfolio will generally reflect the nature, scope andrisk of Capital Crossing’s portfolio rather than a more diverse portfoliocomposed of mortgage loans also purchased from other lenders.

 

***Servicingof Capital Crossing Preferred mortgage assets by Capital Crossing.***  Capital Crossing Preferred’s loans areserviced by Capital Crossing pursuant to the terms of the master serviceagreement. Capital Crossing in its role as servicer under the terms of themaster service agreement receives a fee equal to 0.20% per annum, payablemonthly, on the gross outstanding principal balances of loans serviced. Themaster service agreement requires Capital Crossing to service the loanportfolio in a manner substantially the same as for similar work performed byCapital Crossing for transactions on its own behalf. This will becomeespecially important as Capital Crossing services any loans which becomeclassified or are placed on non-performing status, or are renegotiated due tothe financial deterioration of the borrower. While Capital Crossing Preferredbelieves that Capital Crossing will diligently pursue collection of anynon-performing loans, Capital Crossing Preferred cannot provide assurance thatthis will be the case. Capital Crossing Preferred’s ability to make timelypayments of dividends will depend in part upon Capital Crossing’s promptcollection efforts on behalf of Capital Crossing Preferred.

 

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***Future dispositionsby Capital Crossing Preferred of mortgage assets to Capital Crossing or itsaffiliates.*** The master service agreement provides that foreclosures and dispositionsof the mortgage assets are to be performed with a view toward maximizingCapital Crossing Preferred’s recovery as owner of the mortgage assets, andCapital Crossing shall service the mortgage assets solely with a view towardCapital Crossing Preferred’s interests, and without regard to the interests ofCapital Crossing or any of its affiliates. However, Capital Crossing Preferredcannot provide assurance that any such agreement or transaction will be onterms as favorable to it as would have been obtained from unaffiliated thirdparties. Capital Crossing may seek to exercise its influence over Capital CrossingPreferred’s affairs so as to cause the sale of the mortgage assets owned byCapital Crossing Preferred and their replacement by lesser quality loanspurchased from Capital Crossing or elsewhere which could adversely affectCapital Crossing Preferred’s business and its ability to make timely paymentsof dividends.

 

***Futuremodifications of the advisory agreement or master service agreement.***  Should Capital Crossing Preferred seek tomodify either the advisory agreement or the master service agreement, it wouldrely upon its officers, all of whom are also officers of Capital Crossing,and/or its directors, three of whom are also officers of Capital Crossing.Thus, Capital Crossing Preferred’s officers and/or directors would beresponsible for taking positions with respect to such agreements that, while inCapital Crossing Preferred’s best interests, would not be in the best interestsof Capital Crossing. Although the termination, modification or decision not torenew the advisory agreement and/or the master service agreement requires theapproval of a majority of Capital Crossing Preferred’s independent directors,Capital Crossing, as holder of all of Capital Crossing Preferred’s outstandingcommon stock, controls the election of all Capital Crossing Preferred directors,including the independent directors. Capital Crossing Preferred cannot provideassurance that such modifications will be on terms as favorable to it as thosethat could have been obtained from unaffiliated third parties.

 

***Theterms of Capital Crossing Preferred’s guarantee of obligations of CapitalCrossing.*** Capital Crossing Preferred has guaranteed all of the obligations ofCapital Crossing under advances Capital Crossing may receive from time to timefrom the FHLBB, and has agreed to pledge a significant amount of it’s assets inconnection with those advances. The assets Capital Crossing Preferred pledgesto the FHLBB will vary from time to time; however, the potential exists forCapital Crossing Preferred to pledge all of its assets to the FHLBB to secureadvances to Capital Crossing. In addition, Capital Crossing has pledged to theFHLBB all of the shares of Capital Crossing Preferred’s capital stock it ownsas collateral for its FHLBB borrowings. Under the terms of the pledge, ifCapital Crossing becomes undercapitalized the FHLBB may require CapitalCrossing to dissolve Capital Crossing Preferred such that the assets of CapitalCrossing Preferred are distributed to Capital Crossing. In this circumstancethe holders of Series A and Series C Preferred shares would receivetheir liquidation preference only to the extent there are available assets ofCapital Crossing Preferred following satisfaction of its outstandingobligations, including its guarantee of Capital Crossing’s FHLBB borrowings. AtJune 30, 2003, approximately $38.3 million, or 17.4%, of CapitalCrossing Preferred assets have been pledged to and accepted by the FHLBB tosecure advances to Capital Crossing. Capital Crossing has also agreed with theFHLBB that it will not request or accept advances from the FHLBB in excess ofCapital Crossing Preferred’s total stockholders equity, less the stockholdersequity attributable to the Series A and Series C preferred shares. Asof June 30, 2003, this restriction would limit Capital Crossing’s abilityto receive advances in excess of approximately $187.0 million. As ofJune 30, 2003, Capital Crossing had $129.0 million in outstandingFHLBB borrowings. The guarantee and pledge were approved by Capital CrossingPreferred’s independent directors, subject to certain requirements andlimitations, including the requirement that Capital Crossing pay CapitalCrossing Preferred a guarantee fee. Any default by Capital Crossing on itsobligations which would require Capital Crossing Preferred to satisfy itsguarantee could adversely affect its business and its ability to make timelypayments of dividends.

 

***Themaster loan purchase agreement was not the result of arm’s-length negotiations.***  Capital Crossing Preferred acquires loanspursuant to the master mortgage loan purchase agreement between CapitalCrossing Preferred and Capital Crossing, at an amount equal to CapitalCrossing’s net carrying value for those mortgage assets. While Capital CrossingPreferred believes that the master mortgage loan purchase agreement was fair toall parties and consistent with market terms, all of it’s officers and three ofits directors are also officers and/or directors of Capital Crossing and/oraffiliates of Capital Crossing. Capital Crossing, as holder of all of Capital CrossingPreferred’s outstanding common stock, controls the election of all CapitalCrossing Preferred directors, including the independent directors. CapitalCrossing Preferred cannot provide assurance that the master mortgage loanpurchase agreement was entered into on terms as favorable to Capital CrossingPreferred as those that could have been obtained from unaffiliated thirdparties.

 

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

 

The lack of specific policies with respect tothe purchase by Capital Crossing Preferred of loans from Capital Crossing couldresult in Capital Crossing Preferred acquiring lower quality mortgage assetsfrom Capital Crossing than if such policies were otherwise in place. NeitherCapital Crossing Preferred nor Capital Crossing currently have specificpolicies with respect to the purchase by Capital Crossing Preferred fromCapital Crossing of particular loans or pools of loans, other than that suchassets must be eligible to be held by a REIT. Capital Crossing Preferred’sBoard of Directors has adopted certain policies to guide the acquisition anddisposition of assets but these policies may be revised from time to time atthe discretion of the Board of Directors without a vote of Capital CrossingPreferred’s stockholders. Capital Crossing Preferred intends to acquire all orsubstantially all of the additional mortgage assets it may acquire in thefuture from Capital Crossing on terms that are comparable to those that couldbe obtained by Capital Crossing Preferred if such mortgage assets werepurchased from unrelated third parties, but Capital Crossing Preferred cannotprovide assurance that this will always be the case.

 

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

 

Capital Crossing Preferred’s Board of Directorshas established Capital Crossing Preferred’s investment and operatingstrategies. These strategies may be revised from time to time at the discretionof the Board of Directors without a vote of Capital Crossing Preferred’sstockholders. Changes in Capital Crossing Preferred’s strategies could have anegative effect on shareholders.

 

**Capital Crossing Preferred does not obtainthird-party valuations and therefore it may pay more or receive less than fairmarket value for its mortgage assets**

 

To date, Capital Crossing Preferred has notobtained third-party valuations as part of its loan acquisitions ordispositions and does not anticipate obtaining third-party valuations forfuture acquisitions and dispositions of mortgage assets. Capital CrossingPreferred does not intend to obtain third-party valuations even where it isacquiring mortgage assets from, or disposing mortgage assets to, one of itsaffiliates, including Capital Crossing. Accordingly, Capital Crossing Preferredmay pay its affiliates, including Capital Crossing, more than the fair marketvalue of mortgage assets it acquires and may receive less than the fair marketvalue of the mortgage assets it sells based on a third-party valuation.

 

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

 

Capital Crossing Preferred acquires mortgageassets from Capital Crossing under a master mortgage loan purchase agreement betweenit and Capital Crossing, at an amount equal to Capital Crossing’s net carryingvalue for those mortgage assets. Because Capital Crossing is an affiliate ofCapital Crossing Preferred’s, Capital Crossing Preferred does not engage in anyarm’s-length negotiations regarding the consideration to be paid. Accordingly,if Capital Crossing’s net carrying value exceeds the fair market value of themortgage assets, Capital Crossing Preferred would pay Capital Crossing morethan the fair market value for those mortgaged assets.

 

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

 

Capital Crossing Preferred’s income consistsprimarily of interest earned on its mortgage assets and short-term investments.A significant portion of Capital Crossing Preferred’s mortgage assets bearinterest at adjustable rates. If there is a decline in interest rates, thenCapital Crossing Preferred will experience a decrease in income available to bedistributed to its stockholders. If interest rates decline, Capital CrossingPreferred may also experience an increase in prepayments on its mortgage assetsand may find it difficult to purchase additional mortgage assets bearing ratessufficient to support payment of dividends on the Series A andSeries C preferred shares. Because the dividend rates on the Series Aand Series C preferred shares are fixed, a significant decline in interestrates could materially adversely affect Capital Crossing Preferred’s ability topay dividends on the Series A and Series C preferred shares.

 

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**Tax Risks Related to REITs**

 

***IfCapital Crossing Preferred fails to qualify as a REIT, it will be subject tofederal income tax at regular corporate rates.***  If Capital Crossing Preferred fails toqualify as a REIT for any taxable year, it would be subject to federal incometax, including any applicable alternative minimum tax, on its taxable income atregular corporate rates. As a result, the amount available for distribution toCapital Crossing Preferred’s stockholders would be reduced for the year oryears involved. In addition, unless entitled to relief under statutoryprovisions, Capital Crossing Preferred would be disqualified from treatment asa REIT for the four taxable years following the year which qualification waslost. The failure to qualify as a REIT would reduce Capital CrossingPreferred’s net earnings available for distribution to its stockholders becauseof the additional tax liability for the year or years involved. CapitalCrossing Preferred’s failure to qualify as a REIT would not by itself give itthe right to redeem the Series A or Series C preferred shares, norwould it give the holders of the Series A or Series C preferredshares the right to have their shares redeemed.

 

Although Capital Crossing Preferred currentlyintends to operate in a manner designed to qualify as a REIT, future economic,market, legal, tax or other considerations may cause it to determine that it isin its best interest and in the best interest of holders of its common stockand preferred stock to revoke its REIT election. The tax law prohibits CapitalCrossing Preferred from electing treatment as a REIT for the four taxable yearsfollowing the year of any such revocation.

 

***IfCapital Crossing Preferred does not distribute 90% of its net taxable income,it may not qualify as a REIT.***  In order to qualify as a REIT, CapitalCrossing Preferred generally is required each year to distribute to itsstockholders at least 90% of its net taxable income, excluding net capitalgains. Capital Crossing Preferred may retain the remainder of REIT taxableincome or all or part of its net capital gain, but will be subject to tax atregular corporate rates on such income. In addition, Capital Crossing Preferredis subject to a 4% nondeductible excise tax on the amount, if any, by whichcertain distributions considered as paid by Capital Crossing Preferred withrespect to any calendar year are less than the sum of (1) 85% of its ordinaryincome for the calendar year, (2) 95% of its capital gains net income forthe calendar year and (3) 100% of any undistributed income from priorperiods. Under certain circumstances, federal or state regulatory authoritiesmay restrict Capital Crossing Preferred’s ability, as a subsidiary of CapitalCrossing, to make distributions to its stockholders in an amount necessary toretain its REIT qualification. Such a restriction could result in CapitalCrossing Preferred failing to qualify as a REIT. To the extent Capital CrossingPreferred’s REIT taxable income may exceed the actual cash received for aparticular period, Capital Crossing Preferred may not have sufficient liquidityto make distributions necessary to retain its REIT qualification.

 

***CapitalCrossing Preferred may redeem the Series A and Series C preferredshares at any time upon the occurrence of a tax event.***  At any time following the occurrence ofcertain changes in the tax laws or regulations concerning REITs, CapitalCrossing Preferred will have the right to redeem the Series A andSeries C preferred shares in whole, subject to the prior written approvalof the FDIC. Capital Crossing Preferred would have the right to redeem theSeries A and Series C preferred shares if it received an opinion ofcounsel to the effect that, as a result of changes to the tax laws orregulations:

 

(1)          dividends paid byCapital Crossing Preferred with respect to its capital stock are not fullydeductible by it for income tax purposes; or

 

(2)          Capital Crossing Preferredare otherwise unable to qualify as a REIT.

 

The occurrence of such changes in the taxlaws or regulations will not, however, give the holders of the Series A orSeries C preferred shares any right to have their shares redeemed.

 

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

 

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

 

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

 

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

 

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

 

The following table sets forth CapitalCrossing Preferred’s interest-rate-sensitive assets categorized by repricingdates and weighted average yields at June 30, 2003. For fixed rateinstruments, the repricing date is the maturity date. For adjustable-rateinstruments, the repricing date is deemed to be the earliest possible interestrate adjustment date. Assets that are subject to immediate repricing are placedin the overnight column.

 
|                        |   | **Overnight**               |   | **Within  One  Year** |   | **One to  Two  Years** |   | **Two to  Three  Years** |   | **Three to  Four  Years** |   | **Four to  Five  Years** |   | **Over  Five  Years** |   | **Total** |   |
|-----------------------------|--------|-----------------------------|--------|-----------------------|--------|------------------------|--------|--------------------------|--------|---------------------------|--------|--------------------------|--------|-----------------------|--------|-----------|--------|
|                        |   | **(dollars  in thousands)** |   |
|                        |   |                        |   |                  |   |                   |   |                     |   |                      |   |                     |   |                  |   |      |   |
| Interest-bearing deposits   |   | $                           | 26,077 |                  | $      | 100                    |   | $                        | — |                      | $      | —                   |   | $                     | — |      | $      | — |   | $ | — |   | $ | 26,177 |   |
| Average interest rate       |   | 1.00                        | %      | 2.00                  | %      |                   |   |                     |   |                      |   |                     |   |                  |   |      |   |
| Fixed-rate loans (1)        |   | —                      |   | 43,123                |   | 25,027                 |   | 16,758                   |   | 11,665                    |   | 8,434                    |   | 18,719                |   | 123,726   |   |
| Average interest rate       |   |                        |   | 8.47                  | %      | 8.36                   | %      | 8.18                     | %      | 8.02                      | %      | 7.86                     | %      | 7.51                  | %      |      |   |
| Adjustable-rate loans(1)    |   | 23,119                      |   | 45,366                |   | 5,307                  |   | 211                      |   | —                    |   | —                   |   | —                |   | 74,003    |   |
| Average interest rate       |   | 7.15                        | %      | 6.93                  | %      | 8.54                   | %      | 8.56                     | %      |                      |   |                     |   |                  |   |      |   |
| Total rate-sensitive assets |   | $                           | 49,196 |                  | $      | 88,589                 |   | $                        | 30,334 |                      | $      | 16,969                   |   | $                     | 11,665 |      | $      | 8,434 |   | $ | 18,719 |   | $ | 223,906 |   |

 

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

 

Based on Capital Crossing Preferred’s experience, management appliesthe assumption that, on average, approximately 23% of the outstanding fixed andadjustable rate loans will prepay annually.

 

At June 30, 2003, the fair value of net loans was $202.7 millionas compared to the net carrying value of net loans of $192.8 million. The fairvalue of interest-bearing deposits in banks approximates carrying value.

 

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**Item 4. Disclosure Controls and Procedures**

 

(a)                                  Evaluation of disclosure controls andprocedures.

 

As required by Rule 13a-15(b) under theExchange Act, Capital Crossing Preferred’s management carried out anevaluation, with the participation of its Principal Executive Officer andPrincipal Financial Officer, of the effectiveness of its disclosure controlsand procedures as of the end of the most recent fiscal quarter. In designingand evaluating Capital Crossing Preferred’s disclosure controls and procedures,Capital Crossing Preferred and its management recognize that any controls andprocedures, no matter how well designed and operated, can provide only areasonable assurance of achieving the desired control objectives, and managementnecessarily was required to apply its judgment in evaluating and implementingpossible controls and procedures. Based upon that evaluation, the PrincipalExecutive Officer and Principal Financial Officer concluded that they believeCapital Crossing Preferred’s disclosure controls and procedures are reasonablyeffective to ensure that information required to be disclosed by CapitalCrossing Preferred in the reports it files or submits under the Exchange Act isrecorded, processed, summarized and reported, within the time periods specifiedin the Securities and Exchange Commission’s rules and forms. In connection withthe rules regarding disclosure controls and procedures, we intend to continueto review and document our disclosure controls and procedures, including ourinternal controls and procedures for financial reporting, and may from time totime make changes aimed at enhancing their effectiveness and to ensure that oursystems evolve with our business.

 

(b)                                 Changes in internal controls.

 

None.

 

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**Part II**

 

**Item 1.  Legal Proceedings**

 

From time to time, Capital Crossing Preferredmay be involved in routine litigation incidental to its business, including avariety of legal proceedings with borrowers, which would contribute to CapitalCrossing Preferred’s expenses, including the costs of carrying non-performingassets. Capital Crossing Preferred is not currently a party to any materialproceedings.

 

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

 

Capital Crossing executed a Written Consentof the Sole Common Stockholder as of June 19, 2003, which was in lieu ofthe annual meeting of stockholders of Capital Crossing Preferred, for thepurpose of setting the number of directors and electing directors to serveuntil the next annual meeting of stockholders. Capital Crossing holds 100 shares of the Common Stock and is the solestockholder of the Common Stock. Capital Crossing voted all of its shares in favor of setting the numberof directors at six and the election of the following directors:  Nicholas W. Lazares, Richard Wayne, EdwardF. Mehm, Jeffrey P. Ross, Douglas Shaw and John Lapidus.

 

**Item 6.  Exhibitsand Reports on Form 8-K**

 

(a)                                  Exhibits.

 

31                                    Rule 13a-14(a) Certifications signed by Richard Wayne,President (Principal Executive Officer); and Edward F. Mehm, Treasurer(Principal Financial Officer).

 

32                                    Rule 13a-14(b) Certification signed by RichardWayne, President (Principal Executive Officer); and Edward F. Mehm, Treasurer(Principal Financial Officer).

 

(b)                                 Reports on Form 8-K.

 

No reports onForm 8-K were filed in the quarter ended June 30, 2003.

 

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**SIGNATURES**

 

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

 

**CAPITALCROSSING PREFERRED CORPORATION**

 
| Date:   August 13, 2003 | By:    | /s/ Richard Wayne                         |   |
|-----------------------------------|--------|-------------------------------------------|--------|
|                              |   | Richard Wayne                             |
|                              |   | *President (Principal Executive Officer)* |
|                              |   |                                      |
|                              |   |                                      |
| Date:   August 13, 2003 | By:    | /s/ Edward F. Mehm                        |   |
|                              |   | Edward F. Mehm                            |
|                              |   | *Treasurer (Principal Financial Officer)* |
|                                   |        |                                           |        |  |

 

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**EXHIBIT INDEX**

 
| **Exhibit** |   | **Name**                                                                                                                                                                     |
|-------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31          |   | Rule 13a-14(a) Certifications signed by Richard Wayne, President  (Principal Executive Officer); and Edward F. Mehm, Treasurer  (Principal Financial Officer) |
|        |   |                                                                                                                                                                         |
| 32          |   | Rule 13a-14(b) Certification signed by Richard Wayne, President  (Principal Executive Officer); and Edward F. Mehm, Treasurer  (Principal Financial Officer)  |

 

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