** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

**ý****QUARTERLY REPORT PURSUANT TO SECTION 13 OR15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

 

**For the Quarterly Period Ended June 30, 2004**

 

**Commission File Number 000-25193**

 

**CAPITALCROSSING PREFERRED CORPORATION**

(Exactname of registrant as specified in its charter)

 

| **Massachusetts**                                              |
|----------------------------------------------------------------|
| (State or other jurisdiction of incorporation or organization) |
|                                                           |
| **04-3439366**                                                 |
| (I.R.S. Employer Identification Number)                        |
|                                                           |
| **101 Summer Street, Boston, Massachusetts**                   |
| (Address of principal executive offices)                       |
|                                                           |
| **02110**                                                      |
| (Zip Code)                                                     |
|                                                           |
| **(617) 880-1000**                                             |
| (Registrant’s telephone number, including area code)      |

 

Indicate by check mark whether theregistrant: (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months(or for such shorter period that the registrant was required to file suchreports), and (2) has been subject to such filing requirements for the past 90days. 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 13,2004: 100.

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

 

 

----

 

**CapitalCrossing Preferred Corporation**

 

**Table ofContents**

 
| **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  Unaudited Financial Statements |   |
|                                     |   |   |
| Item 2.                                  | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |   |
|                                     |   |   |
|                                     | Executive Level Overview |   |
|                                     |   |   |
|                                     | Critical Accounting  Policies |   |
|                                     |   |   |
|                                     | Results  of Operations |   |
|                                     |   |   |
|                                     | Changes in Financial  Condition |   |
|                                     |   |   |
|                                     | Interest  Rate Risk |   |
|                                     |   |   |
|                                     | Significant  Concentration of Credit Risk |   |
|                                     |   |   |
|                                     | Liquidity Risk Management |   |
|                                     |   |   |
|                                     | Risk  Factors and Factors Affecting Future Operating Results |   |
|                                     |   |   |
| Item 3.                                  | Quantitative  and Qualitative Disclosures about Market Risk |   |
|                                     |   |   |
| Item 4.                                  | Controls and Procedures |   |
|                                     |   |   |
| **PART  II – Other Information**    |
|                                     |   |   |
| Item 6.                                  | Exhibits and Reports  on Form 8-K |   |
|                                     |   |   |
|                                     | Signatures |   |
|                                     |   |   |
|                                     | Exhibit Index |   |

 

----

 

**PART I**

 

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

 

## **Capital Crossing Preferred Corporation**

## **Balance Sheets**

**(unaudited)**

 
| ** **                                                                                                                                                                                                                | ** ** | **June 30,  2004**                | ** ** | **December 31,  2003** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                                | ** ** | **(in thousands, except share  data)** | ** ** |
| **ASSETS**                                                                                                                                                                                                                |       |                                   |       |                        |       |
|                                                                                                                                                                                                                      |       |                                   |       |                        |       |
| Cash account  with Capital Crossing Bank                                                                                                                                                                                  |       | $                                      | 91         |                        | $          | 90 |   |
| Interest  bearing deposits with Capital Crossing Bank                                                                                                                                                                     |       | 137,898                                |       | 65,755                      |       |
| Total cash  and cash equivalents                                                                                                                                                                                          |       | 137,989                                |       | 65,845                      |       |
|                                                                                                                                                                                                                      |       |                                   |       |                        |       |
| Certificate  of deposit                                                                                                                                                                                                   |       | 200                                    |       | 200                         |       |
|                                                                                                                                                                                                                      |       |                                   |       |                        |       |
| Loans                                                                                                                                                                                                                     |       | 144,640                                |       | 177,930                     |       |
| Less  discount and net deferred loan income                                                                                                                                                                               |       | (16,102                                | )          | (19,578                     | )          |
| Less  allowance for loan losses                                                                                                                                                                                           |       | (2,468                                 | )          | (3,281                      | )          |
| Loans, net                                                                                                                                                                                                                |       | 126,070                                |       | 155,071                     |       |
| Accrued  interest receivable                                                                                                                                                                                              |       | 606                                    |       | 737                         |       |
| Other assets                                                                                                                                                                                                              |       | 4                                      |       | —                      |       |
|                                                                                                                                                                                                                      |       |                                   |       |                        |       |
|                                                                                                                                                                                                                      |       | $                                      | 264,869    |                        | $          | 221,853 |   |
|                                                                                                                                                                                                                      |       |                                   |       |                        |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                             |       |                                   |       |                        |       |
|                                                                                                                                                                                                                      |       |                                   |       |                        |       |
| Accrued expenses  and other liabilities                                                                                                                                                                                   |       | $                                      | 1,200      |                        | $          | 423 |   |
| Total  liabilities                                                                                                                                                                                                        |       | 1,200                                  |       | 423                         |       |
| Commitments and contingencies                                                                                                                                                                                             |       |                                   |       |                        |       |
| Stockholders’  equity:                                                                                                                                                                                               |       |                                   |       |                        |       |
| Preferred  stock, Series A, 9.75% non-cumulative, exchangeable; $.01 par value; $10  liquidation value per share; 1,449,000 shares authorized, 1,416,130 shares  issued and outstanding                                   |       | 14                                     |       | 14                          |       |
| Preferred  stock, Series B, 8% cumulative, non-convertible; $.01 par value; $1,000  liquidation value per share plus accrued dividends; 1,000 shares authorized,  941 and 940 shares issued and outstanding, respectively |       | —                                 |       | —                      |       |
| Preferred  stock, Series C, 10.25% non-cumulative, exchangeable; $.01 par value; $10  liquidation value per share; 1,840,000 shares authorized, issued and  outstanding                                                   |       | 18                                     |       | 18                          |       |
| Preferred  stock, Series D, 8.50% non-cumulative, exchangeable; $.01 par value; $25  liquidation value per share; 1,500,000 shares authorized, issued and  outstanding at June 30, 2004                              |       | 15                                     |       | —                      |       |
| Common  stock, $.01 par value, 100 shares authorized, issued and outstanding                                                                                                                                              |       | —                                 |       | —                      |       |
| Additional  paid-in capital                                                                                                                                                                                               |       | 246,483                                |       | 211,240                     |       |
| Retained  earnings                                                                                                                                                                                                        |       | 17,139                                 |       | 10,158                      |       |
| Total  stockholders’ equity                                                                                                                                                                                          |       | 263,669                                |       | 221,430                     |       |
|                                                                                                                                                                                                                      |       |                                   |       |                        |       |
|                                                                                                                                                                                                                      |       | $                                      | 264,869    |                        | $          | 221,853 |   |

 

See accompanying notes tounaudited interim financial statements.

 

1

----

 

### **Capital Crossing Preferred Corporation**

**Statements of Income**

**(unaudited)**

 
| ** **                                          | ** ** | **Three Months Ended  June 30,** | ** ** | **Six  Months Ended  June 30,** | ** ** |
|-----------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                          | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                          | ** ** | **(in  thousands)**                   | ** ** |
| Interest income:                                    |       |                                  |       |                                 |       |   |   |   |   |
| Interest and fees on loans                          |       | $                                     | 4,195      |                                 | $          | 5,735 |   | $ | 8,039 |   | $ | 11,406 |   |
| Interest on interest-bearing deposits               |       | 314                                   |       | 343                                  |       | 518 |   | 1,062 |   |
| Total interest income                               |       | 4,509                                 |       | 6,078                                |       | 8,557 |   | 12,468 |   |
|                                                |       |                                  |       |                                 |       |   |   |   |   |
| Credit for loan losses                              |       | 353                                   |       | 2,400                                |       | 764 |   | 2,400 |   |
| Total interest income, after credit for loan losses |       | 4,862                                 |       | 8,478                                |       | 9,321 |   | 14,868 |   |
|                                                |       |                                  |       |                                 |       |   |   |   |   |
| Other income:                                       |       |                                  |       |                                 |       |   |   |   |   |
| Gain on sale of loans                               |       | —                                |       | —                               |       | 76 |   | — |   |
| Guarantee fee income                                |       | 20                                    |       | 20                                   |       | 40 |   | 40 |   |
| Total other income                                  |       | 20                                    |       | 20                                   |       | 116 |   | 40 |   |
|                                                |       |                                  |       |                                 |       |   |   |   |   |
| Operating expenses:                                 |       |                                  |       |                                 |       |   |   |   |   |
| Loan servicing and advisory services                |       | 95                                    |       | 152                                  |       | 201 |   | 324 |   |
| Other real estate owned income                      |       | —                                |       | (342                                 | )          | — |   | (342 | ) |
| Other general and administrative                    |       | 54                                    |       | 66                                   |       | 133 |   | 125 |   |
| Total operating expenses                            |       | 149                                   |       | (124                                 | )          | 334 |   | 107 |   |
|                                                |       |                                  |       |                                 |       |   |   |   |   |
| Net income                                          |       | 4,733                                 |       | 8,622                                |       | 9,103 |   | 14,801 |   |
|                                                |       |                                  |       |                                 |       |   |   |   |   |
| Preferred stock dividends                           |       | 1,287                                 |       | 836                                  |       | 2,122 |   | 1,671 |   |
| Net income available to common stockholder          |       | $                                     | 3,446      |                                 | $          | 7,786 |   | $ | 6,981 |   | $ | 13,130 |   |

 

See accompanying notes to unaudited interim financial statements.

 

2

----

 

**Capital Crossing Preferred Corporation**

**Statementsof Changes in Stockholders’ E****quity**

**(unaudited)**

 
| ** **                                               | ** ** | **Six Months Ended June 30,  2004** | ** ** |
|----------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                               | ** ** | **Preferred Stock**                      | ** ** | **Preferred Stock** | ** ** | **Preferred Stock** | ** ** | **Preferred Stock** | ** ** | ** ** | ** ** | ** ** | ** ** | **Additional** | ** ** | ** ** | ** ** | **Total** | ** ** |
| ** **                                               | ** ** | **Series A**                             | ** ** | **Series B** | ** ** | **Series C** | ** ** | **Series D** | ** ** | **Common Stock** | ** ** | **Paid-in** | ** ** | **Retained** | ** ** | **Stockholders’** | ** ** |
| ** **                                               | ** ** | **Shares**                               | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Capital** | ** ** | **Earnings** | ** ** | **Equity** | ** ** |
| ** **                                               | ** ** | **(dollars in thousands)**               | ** ** |
|                                                     |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Balance at  December 31, 2003                       |       | 1,416,130                                |       | $ | 14 |   | 941 |   | $ | — |   | 1,840,000 |   | $ | 18 |   | — |   | $ | — |   | 100 |   | $ | — |   | $ | 211,240 |   | $ | 10,158 |   | $ | 221,430 |   |
| Net income                                               |       | —                                   |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | 9,103 |   | 9,103 |   |
| Net proceeds from issuance  of preferred stock, Series D |       | —                                   |       | — |   | — |   | — |   | — |   | — |   | 1,500,000 |   | 15 |   | — |   | — |   | 35,244 |   | — |   | 35,259 |   |
| Dividends on preferred  stock, Series A                  |       | —                                   |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | (690 | ) | (690 | ) |
| Cumulative dividends on  preferred stock, Series B       |       | —                                   |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | (38 | ) | (38 | ) |
| Dividends on preferred  stock, Series C                  |       | —                                   |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | (943 | ) | (943 | ) |
| Dividends on preferred  stock, Series D                  |       | —                                   |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | (451 | ) | (451 | ) |
| Repurchase of preferred  stock, Series B                 |       | —                                   |       | — |   | (1 | ) | — |   | — |   | — |   | — |   | — |   | — |   | — |   | (1 | ) | — |   | (1 | ) |
| Balance at June 30,  2004                           |       | 1,416,130                                |       | $ | 14 |   | 940 |   | $ | — |   | 1,840,000 |   | $ | 18 |   | 1,500,000 |   | $ | 15 |   | 100 |   | $ | — |   | $ | 246,483 |   | $ | 17,139 |   | $ | 263,669 |   |

 
| ** **                                         | ** ** | **Six Months Ended June 30,  2003** | ** ** |
|----------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                         | ** ** | **Preferred Stock**                      | ** ** | **Preferred Stock** | ** ** | **Preferred Stock** | ** ** | **Preferred Stock** | ** ** | ** ** | ** ** | ** ** | ** ** | **Additional** | ** ** | ** ** | ** ** | **Total** | ** ** |
| ** **                                         | ** ** | **Series A**                             | ** ** | **Series B** | ** ** | **Series C** | ** ** | **Series D** | ** ** | **Common Stock** | ** ** | **Paid-in** | ** ** | **Retained** | ** ** | **Stockholders’** | ** ** |
| ** **                                         | ** ** | **Shares**                               | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Capital** | ** ** | **Earnings** | ** ** | **Equity** | ** ** |
| ** **                                         | ** ** | **(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 |   |

 

See accompanying notes to theunaudited interim financial statements.

 

3

----

 

**Capital Crossing Preferred Corporation**

**Statements of Cash Flows**

**(unaudited)**

 
| ** **                                                                  | ** ** | **Six  Months Ended June 30,** | ** ** |
|-----------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                  | ** ** | **2004**                            | ** ** | **2003** | ** ** |
| ** **                                                                  | ** ** | **(in  thousands)**                 | ** ** |
| Cash flows provided by operating activities:                                |       |                                |       |   |   |
| Net income                                                                  |       | $                                   | 9,103      |   | $ | 14,801 |   |
| Adjustments to reconcile net income to net cash from operating  activities: |       |                                |       |   |   |
| Gain on sale of other real estate owned                                     |       | —                              |       | (334 | ) |
| Credit for loan losses                                                      |       | (764                                | )          | (2,400 | ) |
| Gain on sale of loans                                                       |       | (76                                 | )          | — |   |
| Other, net                                                                  |       | 904                                 |       | 244 |   |
|                                                                        |       |                                |       |   |   |
| Net cash provided by operating activities                                   |       | 9,167                               |       | 12,311 |   |
|                                                                        |       |                                |       |   |   |
| Cash flows provided by investing activities:                                |       |                                |       |   |   |
| Loan repayments                                                             |       | 29,346                              |       | 46,231 |   |
| Proceeds from sale of other real estate owned                               |       | —                              |       | 1,585 |   |
| Proceeds from loan sales                                                    |       | 495                                 |       | — |   |
|                                                                        |       |                                |       |   |   |
| Net cash provided by investing activities                                   |       | 29,841                              |       | 47,816 |   |
|                                                                        |       |                                |       |   |   |
| Cash flows provided by (used in) financing activities:                      |       |                                |       |   |   |
| Issuance of preferred stock, series D                                       |       | 35,259                              |       | — |   |
| Return of capital to common stockholder                                     |       | —                              |       | (109,906 | ) |
| Repurchase of preferred stock, Series B                                     |       | (1                                  | )          | — |   |
| Payment of preferred stock dividends                                        |       | (2,122                              | )          | (1,671 | ) |
| Payment of common stock dividend                                            |       | —                              |       | (15,094 | ) |
|                                                                        |       |                                |       |   |   |
| Net cash provided by (used in) financing activities                         |       | 33,136                              |       | (126,671 | ) |
|                                                                        |       |                                |       |   |   |
| Net change in cash and cash equivalents                                     |       | 72,144                              |       | (66,544 | ) |
| Cash and cash equivalents at beginning of period                            |       | 65,845                              |       | 92,710 |   |
|                                                                        |       |                                |       |   |   |
| Cash and cash equivalents at end of period                                  |       | $                                   | 137,989    |   | $ | 26,166 |   |
|                                                                        |       |                                |       |   |   |
| Supplemental information:                                                   |       |                                |       |   |   |
| Dividend to common stockholder in the form of mortgage loans                |       | $                                   | —     |   | $ | 88 |   |
| Transfers from loans to other real estate owned                             |       | —                              |       | 1,251 |   |

 

See accompanying notes to unaudited interim financial statements.

 

4

----

 

**CapitalCrossing Preferred Corporation**

**Notes to Unaudited Financial Statements**

**Three andSix Month Periods Ended June 30, 2004 and 2003**

 

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

 

Capital Crossing Preferred Corporation (‘‘Capital Crossing Preferred’’)is a Massachusetts corporation organized on March 20, 1998, to acquire andhold real estate assets. Capital Crossing Bank (‘‘Capital Crossing’’), afederally insured Massachusetts trust company, owns all of Capital CrossingPreferred’s common stock (as defined below). Capital Crossing is in compliancewith its regulatory capital requirements at June 30, 2004.

 

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 recorded in the accompanying balance sheet atCapital Crossing’s historical cost, which approximated their estimated fairvalues.

 

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

 

The financial information as of June 30,2004 and the results of operations for the three and six months endedJune 30, 2004 and 2003, changes in stockholders’ equity and cash flows forthe six months ended June 30, 2004 and 2003 are unaudited; however, in theopinion of management, the financial information reflects all adjustments(consisting solely of normal recurring accruals) necessary for a fairpresentation in accordance with accounting principles generally accepted in theUnited States of America.  Interim resultsare not necessarily indicative of results to be expected for the entireyear.  These interim statements areintended to be read in conjunction with the financial statements presented inCapital Crossing Preferred’s Annual Report on Form 10-K as of and for the yearended December 31, 2003.

 

In preparing financial statements inconformity with accounting principles generally accepted in the United Statesof America, management is required to make estimates and assumptions thataffect the reported amounts of assets and liabilities as of the date of thebalance sheet and reported amounts of revenues and expenses during thereporting period.  Actual results coulddiffer from those estimates.  Materialestimates that are particularly susceptible to significant change in the nearterm relate to the determination of the allowance for losses on loans, theallocation of purchase discount between amortizing and non-amortizing portions,and the rate at which the discount is accreted into interest income.

 

*Recent Accounting Pronouncements*

 

Effective January 1, 2005, as a result of therequired adoption of Statement of Position (‘‘SOP’’) No. 03-3, ‘‘Accounting forCertain Loans or Debt Securities Acquired in a Transfer,’’ Capital CrossingPreferred expects its allowance for loan loss methodology to change. SOP No.03-3 prohibits ‘‘carrying over’’ or creation of valuation allowances in theinitial accounting of all loans acquired in a transfer. The prohibition of thevaluation allowance carry over applies to the purchase of an individual loan, apool of loans, a group of loans and impaired loans acquired in a businesscombination. Valuation allowances should reflect only those losses incurred bythe investor after acquisition.  EffectiveJanuary 1, 2005 Capital Crossing Preferred will no longer be allowed toincrease the allowance through allocations from purchase discount.  Additionally, general risk allocations willno longer be applied to purchased loans. Only specific allocations based upon the results of measuring loans thatbecome impaired subsequent to purchase under SFAS No. 114 will be considered inthe calculation of the allowance for loan losses for purchased loans.  Consequently, it is anticipated that theallowance for loan losses will decline subsequent to the adoption of SOP No.03-3 as credits for loan losses may continue to be recorded if loans pay-offand perform above expectations.  For moreinformation related to SOP No. 03-3, see Note 1-Recent Accounting Pronouncementsto the Financial Statements included in Capital Crossing Preferred’s AnnualReport on Form 10-K.

 

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

#### ** **

*Guarantees*

 

CapitalCrossing Preferred has guaranteed all of the obligations of Capital Crossingunder advances Capital Crossing may receive from time to time from the FederalHome Loan Bank of Boston (“FHLBB”), and Capital Crossing Preferred has agreedto pledge a significant amount of its assets in connection with those advances.This guarantee would rank senior to the preferred shares

 

5

----

 

uponliquidation. Capital Crossing Preferred’s obligations under this agreement arelimited by applicable laws pertaining to fraudulent conveyance and fraudulenttransfer. The assets pledged to the FHLBB will vary from time to time, howeverthe potential exists for Capital Crossing Preferred to pledge all of its assetsto the FHLBB to secure advances to Capital Crossing. In addition, CapitalCrossing has pledged to the FHLBB all of the shares of Capital Crossing Preferred’scapital 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, Series C and Series D preferred stock would receive theirliquidation preference only to the extent there are available proceeds from theliquidation of the assets of Capital Crossing Preferred following satisfactionof its outstanding obligations, including its guarantee of Capital Crossing’sFHLBB borrowings.  At June 30, 2004,approximately $27.5 million, or 10.4%, of Capital Crossing Preferred’s assetshad been pledged to and accepted by the FHLBB to secure advances to CapitalCrossing.  Capital Crossing has alsoagreed that it will not request or accept advances from the FHLBB in excess ofCapital Crossing Preferred’s total stockholder’s equity, less the stockholder’sequity attributable to the Series A, Series C and Series D preferredshares.  As of June 30, 2004, thisrestriction would limit Capital Crossing’s ability to receive advances inexcess of approximately $193.6 million. As of June 30, 2004, Capital Crossing had $129.0 million inoutstanding FHLBB borrowings.

 

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

#### ** **

On May 11, 2004, Capital Crossing Preferredclosed its offering of 1,500,000 shares of Series D non-cumulative exchangeablepreferred stock at $25 per share, which yielded net proceeds of $35.3 millionafter deducting the underwriting discount of 4%, or $1.5 million and additionalexpenses of $741,000.

 

**Item 2.****  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 thesection entitled “Risk Factors and Factors Affecting Future OperatingResults” of this Form 10-Q.

 

All of these factors should be carefullyreviewed, and the reader of this Form 10-Q should be aware that there maybe other factors that could cause these differences. These forward-lookingstatements were based on information, plans and estimates at the date of thisreport, and Capital Crossing Preferred does not promise to update anyforward-looking statements to reflect changes in underlying assumptions orfactors, new information, future events or other changes.

 

**Executive Level Overview**

 

Net income available to the sole common stockholder, Capital Crossing,decreased $4.3 million, or 55.7%, to $3.4 million for the three months endedJune 30, 2004 compared to $7.8 million for the same period in 2003.  Net income available to the sole common stockholderdecreased $6.1 million, or 46.8%, to $7.0 million for the six months endedJune 30, 2004 compared to $13.1 million for the same period in 2003.  These decreases from the 2003 to 2004 periodsare primarily the result of a decline in interest and fees on loans, a declinein credit for loan losses as well as the absence of other real estate ownedincome.  In addition, there was anincrease in preferred stock dividends attributable to the issuance of Series Dpreferred stock on May 11, 2004.

 

During the second quarter of 2004, $35.3 million of additional capitalwas raised through the issuance of 1,500,000 shares of Series D preferredstock.  This capital will be utilized topurchase additional mortgage assets and for other corporate purposes.  During 2003 and through the second quarter of2004, Capital Crossing Preferred did not acquire any mortgage assets. Returnsof capital of $118.2 million were made during 2003. Decisions regarding theutilization of our cash are based, in large part, on our future commitments topay preferred stock dividends. During the second quarter of 2004, our loanportfolio was large enough to generate income resulting in earnings which were3.68 times fixed charges and preferred stock dividends. Future decisionsregarding mortgage

 

6

----

 

assetacquisitions will be based on the level of preferred stock dividends at thetime and the required level of income necessary to generate adequate dividendcoverage.

 

**Critical Accounting Policies**

 

The SEC requires that all registrants discuss their most ‘‘criticalaccounting policies’’ in management’s discussion and analysis of financialcondition and results of operations. The SEC indicated that a ‘‘criticalaccounting policy’’ is one which is both important to the portrayal of the company’sfinancial condition and results and requires management’s most difficult,subjective or complex judgments, often as a result of the need to makeestimates about the effect of matters that are inherently uncertain. WhileCapital Crossing Preferred’s significant accounting policies are more fullydescribed in Note 1 to the Financial Statements included in its Annual Reporton Form 10-K, the following is a summary of the accounting policies believed bymanagement to be most critical in their potential effect on Capital CrossingPreferred’s financial position or results of operations:

 

**Allowance for Loan Losses.**Arrivingat an appropriate level of allowance for loan losses requires a high degree ofjudgment. Capital Crossing Preferred maintains an allowance for probable loanlosses that are inherent in its loan portfolio. The initial allowance for loanlosses was transferred from Capital Crossing at the time of the initialtransfer of loans to Capital Crossing Preferred and additional transfers aremade in connection with each transfer of loans from Capital Crossing.Additionally, the allowance for loan losses is increased upon allocation ofpurchase discount upon acquisition of loans and decreased upon sales orpay-offs of loans for which a related allowance remains unused. Reductions inconnection with sales are included in the calculation of the gain or loss, andreductions related to pay-offs are recorded as a credit for loan losses. Loanlosses are charged against the allowance when management believes the netinvestment of the loan, or a portion thereof, is uncollectible. Subsequentrecoveries, if any, are credited to the allowance when cash payments arereceived.

 

Management makes significant judgments in determining the adequacy ofthe allowance for loan losses. Management initially considers the loan lossallowances specifically allocated to individual impaired loans. Next,management considers the level of general loan loss allowances deemedappropriate for the balance of the portfolio. Factors considered include knownand inherent risks in the nature and volume of the loan portfolios, adversesituations that may affect the borrower’s ability to repay, historical lossranges, the estimated value of any underlying collateral and prevailingeconomic conditions. An additional allowance for loan losses is maintainedbased on a judgmental process whereby management considers qualitative andquantitative assessments of other 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. There can be no assurance that CapitalCrossing Preferred’s actual losses with respect to loans will not exceed itsallowance for loan losses.

 

Effective January 1, 2005, as a result of the required adoption ofStatement of Position (‘‘SOP’’) No. 03-3, ‘‘Accounting for Certain Loans orDebt Securities Acquired in a Transfer,’’ Capital Crossing Preferred expectsits allowance for loan loss methodology to change. SOP No. 03-3 prohibits‘‘carrying over’’ or creation of valuation allowances in the initial accountingof all loans acquired in a transfer. The prohibition of the valuation allowancecarry over applies to the purchase of an individual loan, a pool of loans, agroup of loans and impaired loans acquired in a business combination. Valuationallowances should reflect only those losses incurred by the investor afteracquisition.  Effective January 1,2005 Capital Crossing Preferred will no longer be allowed to increase theallowance through allocations from purchase discount.  Additionally, general risk allocations willno longer be applied to purchased loans. Only specific allocations based upon the results of measuring loans thatbecome impaired subsequent to purchase under SFAS No. 114 will be considered inthe calculation of the allowance for loan losses for purchased loans.  Consequently, it is anticipated that theallowance for loan losses will decline subsequent to the adoption of SOP No.03-3 as credits for loan losses may continue to be recorded as loans pay-offand perform above expectations.  For moreinformation related to SOP No. 03-3, see Note 1-Recent AccountingPronouncements to the Financial Statements included in Capital CrossingPreferred’s Annual Report on Form 10-K.

 

**Discounts on Acquired Loans.**Atthe time of acquisition of purchased pools of loans, the excess of thecontractual balances over the amount of reasonably estimable and probablediscounted future cash collections for each loan is recorded as non-amortizingdiscount. Depending on the timing of an acquisition, a preliminary allocationmay be utilized until a final allocation is established. Generally, theallocation will be finalized no later than ninety days from the date ofpurchase. The remaining discount, which represents the excess of the amount ofreasonably estimable and probable discounted future cash collections over theacquisition amount is accreted into interest income using the interest methodover the term of the loans and is not accreted on non-performing loans. Thereis judgment involved in estimating the amount of future cash flows. The amountand timing of actual cash flows could differ materially from management’sestimates, which could materially affect Capital Crossing Preferred’s financialcondition and results of operations.

 

The non-amortizing discount is not accreted into income until it isdetermined that the amount and timing of the related cash flows are reasonablyestimable and collection is probable. If cash flows cannot be reasonablyestimated for any loan, and collection is not probable, the cost recoverymethod of accounting is used. Under the cost recovery method, any amountsreceived are applied

 

7

----

 

against therecorded amount of the loan. Non-amortizing discount is generally offsetagainst the related principal balance when the amount at which a loan isresolved or restructured is determined. There is no effect on the incomestatement as a result of these reductions.

 

Subsequent to acquisition, if cash flow projections improve, and it isdetermined that the amount and timing of the cash flows related to thenon-amortizing discount are reasonably estimable and collection is probable,the corresponding decrease in the non-amortizing discount is transferred to theamortizing portion and is accreted into interest income over the remaining lifeof the loan on the interest method. If cash flow projections deterioratesubsequent to acquisition, the decline is accounted for through the allowancefor loan losses.

 

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, prepayment fees and otherloan fees.

 

Gains and losses on sales of loans are determined using the specificidentification method. The excess (deficiency) of any cash received as comparedto the net investment is recorded as gain (loss) on sales of loans. There areno loans held for sale at June 30, 2004.

 

Changes in interest rates also can affect the value of Capital CrossingPreferred’s loans and its ability to realize gains on the resolution of assets.A significant portion of Capital Crossing Preferred’s earnings results fromaccelerated interest income resulting from loan pay-offs. This type of incomecan vary significantly from quarter to quarter and year to year based on a numberof different factors,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.

 

#### **Results of Operations**

 

***Three Months EndedJune 30, 2004 and 2003***

 

The yields onCapital Crossing Preferred’s earning assets are summarized as follows:

 
| ** **                | ** ** | **Three  Months Ended June 30,** | ** ** |
|---------------------------|------------|---------------------------------------|------------|
| ** **                | ** ** | **2004**                              | ** ** | **2003** | ** ** |
| ** **                | ** ** | **Average  Balance**                  | ** ** | **Interest  Income** | ** ** | **Yield** | ** ** | **Average  Balance** | ** ** | **Interest  Income** | ** ** | **Yield** | ** ** |
| ** **                | ** ** | **(dollars  in thousands)**           | ** ** |
|                      |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Loans, net (1)            |       | $                                     | 134,358    |   | $ | 4,195 |   | 12.56 | % | $ | 205,714 |   | $ | 5,735 |   | 11.18 | % |
| Interest-bearing deposits |       | 114,765                               |       | 314 |   | 1.10 |   | 137,459 |   | 343 |   | 1.00 |   |
|                      |       | $                                     | 249,123    |   | $ | 4,509 |   | 7.28 | % | $ | 343,173 |   | $ | 6,078 |   | 7.10 | % |

 

----

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

 

The yield on interest-earning assets increasedprimarily as a result of an increase in the yield on loans, offset by a shiftin the composition of average interest-earning assets such that average loansrepresents a smaller percentage of total average interest-earning assets forthe three months ended June 30, 2004 as compared to the same period in2003.  The yield on the loan portfolioincreased primarily as a result of an increase, relative to the overall yieldon loans, in interest income recognized at the time of individual loanpay-offs.   Average loans, net for thethree months ended June 30, 2004 totaled $134.4 million compared to$205.7 million for the same period in 2003.   This decrease is primarily attributable toloan pay-offs and amortization.  During2003 and through June 30, 2004, Capital Crossing Preferred did not acquireany loans.

 

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

 

8

----

 

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-performing status and other loanfees (collectively, ‘‘other interest income’’). The following table sets forth,for the periods indicated, the components of interest and fees on loans. Therecan be no assurance regarding future interest income, including the yields andrelated level of such income, or the relative portion attributable to loanpay-offs as compared to other sources.

 
| ** **                                           | ** ** | **Three  Months Ended June 30,** | ** ** |
|------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                           | ** ** | **2004**                              | ** ** | **2003** | ** ** |
| ** **                                           | ** ** | **Interest  Income**                  | ** ** | **Yield** | ** ** | **Interest  Income** | ** ** | **Yield** | ** ** |
| ** **                                           | ** ** | **(dollars  in thousands)**           | ** ** |
|                                                 |       |                                  |       |   |   |   |   |   |   |
| Regularly scheduled interest and accretion income    |       | $                                     | 2,618      |   | 7.84 | % | $ | 3,989 |   | 7.78 | % |
| Interest and fee income recognized on loan pay-offs: |       |                                  |       |   |   |   |   |   |   |
| Non-amortizing discount                              |       | —                                |       | — |   | 301 |   | 0.59 |   |
| Amortizing discount                                  |       | 1,392                                 |       | 4.17 |   | 1,340 |   | 2.61 |   |
| Other interest income                                |       | 185                                   |       | 0.55 |   | 105 |   | 0.20 |   |
|                                                 |       | 1,577                                 |       | 4.72 |   | 1,746 |   | 3.40 |   |
|                                                 |       | $                                     | 4,195      |   | 12.56 | % | $ | 5,735 |   | 11.18 | % |

 

The amount of loan pay-offs and relateddiscount income is influenced by several factors, including the interest rateenvironment, the real estate market in particular areas, the timing oftransactions, and circumstances related to individual borrowers and loans.

 

The average balance of interest-bearingdeposits decreased $22.7 million or 16.5% to $114.8 million for the threemonths ended June 30, 2004, compared to $137.5 million for the 2003period, as a result of periodic dividend payments, returns of capital andproceeds from loans sold offset by cash flows from loan repayments and theproceeds from the Series D preferred stock offering on May 11, 2004.  The yield on interest-bearing depositsincreased because the rate paid by Capital Crossing on the money market accountheld by Capital Crossing Preferred increased in 2004 compared to 2003.

 

A credit for loan losses of $353,000 wasrecorded for the three months ended June 30, 2004 compared to a credit forloan losses of $2.4 million recorded for the three months ended June 30,2003.  The credit for loan losses isbased on the volume of loan pay-offs. Capital Crossing Preferred has experienced a high rate of loan pay-offsand thus recorded a credit for loan losses to reduce allowance allocationsrelated to the loans that have paid-off and loans which have performed aboveoriginal expectations. The allowance for loan losses is based on the size ofthe portfolio and its historical performance. The determination of thisallowance requires the use of estimates and assumptions regarding the risksinherent in individual loans and the loan portfolio in its entirety. Should theloan portfolio continue to decline without utilization of the allowance forloan losses, future credits for loans losses will be necessary.

 

Loan servicing and advisory services expensesfor the three months ended June 30, 2004 decreased $57,000, or 37.5%, to$95,000 compared to $152,000 for the three months ended June 30, 2003.This decrease was due to the decrease in the average balance of the loanportfolio.

 

There was no other real estate owned incomeduring the three months ended June 30, 2004.  Other real estate owned income for the threemonths ended June 30, 2003 was comprised of a gain of $334,000 on the saleof one property to an unaffiliated third party and rental income of $8,000.

 

Other generaland administrative expenses decreased $12,000, or 18.2%, to $54,000 for thethree months ended June 30, 2004 compared to $66,000 for the three monthsended June 30, 2003. This decrease is primarily attributable to a decreasein legal fees related to loan collection matters.

 

Preferred stock dividends increased as aresult of the issuance of 1,500,000 shares of Series D preferred shares on May11, 2004.  These shares have aliquidation value of $25 per share and a dividend rate of 8.5%.  Capital Crossing Preferred intends to paydividends on its preferred stock and common stock in amounts necessary tocontinue to preserve its status as a REIT under the Internal Revenue Code.

 

9

----

 

***Six Months Ended June 30,2004 and 2003***

 

The yields onCapital Crossing Preferred’s earning assets are summarized as follows:

 
| ** **                | ** ** | **Six  Months Ended June 30,** | ** ** |
|---------------------------|------------|-------------------------------------|------------|
| ** **                | ** ** | **2004**                            | ** ** | **2003** | ** ** |
| ** **                | ** ** | **Average  Balance**                | ** ** | **Interest  Income** | ** ** | **Yield** | ** ** | **Average  Balance** | ** ** | **Interest  Income** | ** ** | **Yield** | ** ** |
| ** **                | ** ** | **(dollars  in thousands)**         | ** ** |
|                      |       |                                |       |   |   |   |   |   |   |   |   |   |   |
| Loans, net (1)            |       | $                                   | 142,680    |   | $ | 8,039 |   | 11.33 | % | $ | 220,343 |   | $ | 11,406 |   | 10.44 | % |
| Interest-bearing deposits |       | 94,692                              |       | 518 |   | 1.10 |   | 120,732 |   | 1,062 |   | 1.77 |   |
|                      |       | $                                   | 237,372    |   | $ | 8,557 |   | 7.25 | % | $ | 341,075 |   | $ | 12,468 |   | 7.37 | % |

 

----

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

 

The decline in yield on interest-earningassets from the six months ended June 30, 2003 to the 2004 period is aresult of a decrease in the yield on interest-bearing deposits, partiallyoffset by an increase in the yield on the loan portfolio.  The yield on the loan portfolio increased asa result of an increase in interest income recognized at the time of individualloan pay-offs mainly attributable to an increase in amortizing discount.  Average loans, net for the six months endedJune 30, 2004 totaled $142.7 million compared to $220.3 millionfor the same period in 2003. This decrease is primarily attributable to loanpay-offs, sales, and amortization since the second quarter of 2003.  During 2003 and through June 30, 2004,Capital Crossing Preferred did not acquire any loans.

 

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 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 and other loan fees (collectively, “other interest income”). Thefollowing table sets forth, for the periods indicated, the components ofinterest and fees on loans. There can be no assurance regarding future interestincome, including the yields and related level of such income, or the relativeportion attributable to loan pay-offs as compared to other sources.

 
| ** **                                           | ** ** | **Six  Months Ended June 30,** | ** ** |
|------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                           | ** ** | **2004**                            | ** ** | **2003** | ** ** |
| ** **                                           | ** ** | **Interest  Income**                | ** ** | **Yield** | ** ** | **Interest  Income** | ** ** | **Yield** | ** ** |
| ** **                                           | ** ** | **(dollars  in thousands)**         | ** ** |
|                                                 |       |                                |       |   |   |   |   |   |   |
| Regularly scheduled interest and accretion income    |       | $                                   | 5,534      |   | 7.80 | % | $ | 8,461 |   | 7.74 | % |
| Interest and fee income recognized on loan pay-offs: |       |                                |       |   |   |   |   |   |   |
| Non-amortizing discount                              |       | 91                                  |       | 0.13 |   | 861 |   | 0.79 |   |
| Amortizing discount                                  |       | 2,111                               |       | 2.97 |   | 1,974 |   | 1.81 |   |
| Other interest income                                |       | 303                                 |       | 0.43 |   | 110 |   | 0.10 |   |
|                                                 |       | 2,505                               |       | 3.53 |   | 2,945 |   | 2.70 |   |
|                                                 |       | $                                   | 8,039      |   | 11.33 | % | $ | 11,406 |   | 10.44 | % |

 

The amount of loan pay-offs and relateddiscount income is influenced by several factors, including the interest rateenvironment, the real estate market in particular areas, the timing oftransactions, and circumstances related to individual borrowers and loans.

 

10

----

 

The average balance of interest-bearingdeposits decreased $26.0 million to $94.7 million for the six months endedJune 30, 2004, compared to $120.7 million for the same period in 2003, asa result of periodic dividend payments, returns of capital and proceeds fromloans sold, offset by cash flows from loan repayments and the proceeds from theSeries D stock offering on May 11, 2004. The yield on interest-bearing deposits for the six months endedJune 30, 2004 decreased compared to the 2003 period as a result of adecline in the interest rate environment.

 

Capital Crossing Preferred recorded a creditfor loan losses of $764,000 for the six months ended June 30, 2004,compared to a credit for loan losses of $2.4 million for the six months endedJune 30, 2003.  The credit for loanlosses is based on the volume of loan payoffs. Capital Crossing Preferred has experienced a high rate of loan pay-offsand thus recorded a credit for loan losses to reduce allowance allocationsrelated to the loans that have paid-off and loans which have performed aboveoriginal expectations. The allowance for loan losses is based on the size ofthe portfolio and its historical performance. The determination of thisallowance requires the use of estimates and assumptions regarding the risksinherent in individual loans and the loan portfolio in its entirety.  Should the loan portfolio continue to declinewithout utilization of the allowance for loan losses, future credits for loanslosses may be necessary.

 

During the six months ended June 30,2004 there was one loan sale to an unaffiliated third party resulting in a gainof $76,000.  There were no loan salesduring the six months ended June 30, 2003.

 

Loan servicing and advisory services expensesfor the six months ended June 30, 2004 decreased $123,000, or 38.0%, to$201,000 compared to $324,000 for the six months ended June 30, 2003. Thisdecrease was primarily due to the decrease in the average balance of the loanportfolio.

 

There was no other real estate owned incomeduring the six months ended June 30, 2004. Other real estate owned income for the six months ended June 30,2003 was comprised of a gain of $334,000 on the sale of one property to anunaffiliated third party and rental income of $8,000.

 

Other general and administrative expenses forthe six months ended June 30, 2004 increased $8,000, or 6.4%, to $133,000compared to $125,000 for the six months ended June 30, 2003.  This increase was due primarily to anincrease in legal fees related to loan collection matters.

 

Preferred stock dividends increased as aresult of the issuance of 1,500,000 shares of Series D preferred shares on May11, 2004.  These shares have aliquidation value of $25 per share and a dividend rate of 8.5%.  Capital Crossing Preferred intends to paydividends on its preferred stock and common stock in amounts necessary tocontinue to preserve its status as a REIT under the Internal Revenue Code.

 

11

----

 

**Changes in****Financial Condition**

 

#### **Interest-bearing Deposits with Capital Crossing Bank**

 

Interest-bearing deposits with Capital Crossing Bank consists of moneymarket accounts at June 30, 2004 and December 31, 2003.  The balance of interest-bearing depositsincreased $72.1 million to $137.9 million at June 30, 2004 compared to$65.8 million at December 31, 2003. The change in the balance ofinterest-bearing deposits is the result of cash flows from loan repayments andproceeds from the Series D preferred stock offering, offset by periodicdividend payments and returns of capital.

 

#### **Loan Portfolio**

 

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

 

| ** **                     | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|--------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                     | ** ** | **(in  thousands)**     | ** ** |
| Mortgage loans on real estate: |       |                    |       |                        |       |
| Commercial real estate         |       | $                       | 96,226     |                        | $          | 120,317 |   |
| Multi-family residential       |       | 42,424                  |       | 50,390                      |       |
| One-to-four family residential |       | 1,324                   |       | 1,714                       |       |
| Land                           |       | 4,639                   |       | 5,481                       |       |
|                           |       | 144,613                 |       | 177,902                     |       |
| Other                          |       | 27                      |       | 28                          |       |
| Total loans, gross             |       | 144,640                 |       | 177,930                     |       |
|                           |       |                    |       |                        |       |
| Less:                          |       |                    |       |                        |       |
| Non-amortizing discount        |       | (1,167                  | )          | (1,524                      | )          |
| Amortizing discount            |       | (14,863                 | )          | (17,962                     | )          |
| Net deferred loan fees         |       | (72                     | )          | (92                         | )          |
| Allowance for loan losses      |       | (2,468                  | )          | (3,281                      | )          |
|                           |       |                    |       |                        |       |
| Loans, net                     |       | $                       | 126,070    |                        | $          | 155,071 |   |

 

Capital CrossingPreferred acquires primarily performing commercial real estate and multifamilyresidential mortgage loans.  No loanswere acquired in 2003 or in the first six months of 2004, as the existingportfolio was large enough to generate an adequate dividend coverage ratio.

 

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

 

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

 

There were nonon-performing loans as of June 30, 2004. Non-performing loans, net of discount, totaled $17,000 atDecember 31, 2003.

 

Loans generally are placed on non-performingstatus and the accrual of interest and accretion of discount are generallydiscontinued when the collectibility of principal and interest is not probableor estimable. Unpaid interest income previously accrued on such loans isreversed against current period interest income. A loan is returned to accrualstatus when it is brought current in accordance with management’s anticipatedcash flows at the time of acquisition.

 

12

----

 

***Non-AmortizingDiscount.***At the time of acquisition of purchasedpools of loans, the excess of the contractual balances over the amount ofreasonably estimable and probable discounted future cash collections for eachloan is recorded as non-amortizing discount. Depending on the timing of anacquisition, a preliminary allocation may be utilized until a final allocationis established. Generally, the allocation will be finalized no later thanninety days from the date of purchase. The remaining discount, which representsthe excess of the amount of reasonably estimable and probable discounted futurecash collections over the acquisition amount is accreted into interest incomeusing the interest method over the term of the loans and is not accreted onnon-performing loans. There is judgment involved in estimating the amount offuture cash flows. The amount and timing of actual cash flows could differmaterially from management’s estimates, which could materially affect CapitalCrossing Preferred’s financial condition and results of operations.

 

The non-amortizing discount is not accreted into income until it isdetermined that the amount and timing of the related cash flows are reasonablyestimable and collection is probable. If cash flows cannot be reasonablyestimated for any loan, and collection is not probable, the cost recovery methodof accounting is used. Under the cost recovery method, any amounts received areapplied against the recorded amount of the loan. Non-amortizing discount isgenerally offset against the related principal balance when the amount at whicha loan is resolved or restructured is determined. There is no effect on theincome statement as a result of these reductions.

 

Subsequent to acquisition, if cash flow projections improve, and it isdetermined that the amount and timing of the cash flows related to the non-amortizingdiscount are reasonably estimable and collection is probable, the correspondingdecrease in the non-amortizing discount is transferred to the amortizingportion and is accreted into interest income over the remaining life of theloan on the interest method. If cash flow projections deteriorate subsequent toacquisition, the decline is accounted for through the allowance for loanlosses.

 

Included innet loans, at June 30, 2004 and December 31, 2003, are approximately$4.8 million and $6.7 million (of which none are non-performing), respectively,for which the net recorded investment represents the amortized cost of theseloans, where at acquisition, the amounts of reasonably estimable and probablediscounted future cash collections were less than the contractual balancesowed. These loans were purchased at a price to yield a market rate of interestafter considering the credit quality of the loans at acquisition and theaforementioned expected future cash collections. The excess of the contractualbalances over the amount of reasonably estimable and probable discounted futurecash collections represents the predominant portion of the $1.2 million and$1.5 million of non-amortizing discount at June 30, 2004 andDecember 31, 2003, respectively.

 

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

 
| ** **                                                      | ** ** | **Three  Months Ended  June 30,** | ** ** | **Six  Months Ended  June 30,** | ** ** |
|-----------------------------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|
| ** **                                                      | ** ** | **2004**                               | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                      | ** ** | **(in  thousands)**                    | ** ** |
|                                                            |       |                                   |       |                                 |       |   |   |   |   |
| Balance at beginning of period                                  |       | $                                      | 1,192      |                                 | $          | 7,267 |   | $ | 1,524 |   | $ | 8,158 |   |
| Accretion                                                       |       | —                                 |       | (295                                 | )          | (91 | ) | (855 | ) |
| Transfers to amortizing portion upon improvements in cash flows |       | (25                                    | )          | (328                                 | )          | (155 | ) | (649 | ) |
| Net reductions related to resolutions and restructures          |       | —                                 |       | (30                                  | )          | — |   | (40 | ) |
| Net reductions related to loans sold                            |       | —                                 |       | —                               |       | (111 | ) | — |   |
| Balance at end of period                                        |       | $                                      | 1,167      |                                 | $          | 6,614 |   | $ | 1,167 |   | $ | 6,614 |   |

 

***Allowance for LoanLosses.***Capital Crossing Preferred maintains anallowance for loan losses that are known and inherent in its loan portfolio.The allowance for loan losses is increased or decreased through a provision orcredit for loan losses included in earnings. Additionally, the allowance forloan losses is increased upon allocation of purchase discount upon acquisitionof loans and decreased upon sales and pay-offs of loans for which a relatedallowance remains unused. Loans are charged-off when they are deemed to beuncollectible, or partially charged-off when a portion of a loan is deemeduncollectible. Subsequent recoveries, if any, are credited to the allowancewhen cash payments are received.

 

Capital Crossing Preferred performs reviews of its loan portfolio toidentify loans for which specific allocations are considered prudent. Specificallocations include the results of measuring impaired loans under Statement ofFinancial Accounting Standards No. 114. General risk allocations are determinedby a formula whereby the loan portfolio is stratified by type and by

 

13

----

 

internal riskrating categories. Loss factors are then applied to each strata based onvarious considerations including historic loss experience, delinquency trends,current economic conditions, industry standards and regulatory guidelines. Thisamount is adjusted from time to time based upon actual experience. Anadditional allowance is maintained based on a judgment by management afterconsideration of qualitative and quantitative assessments of certain factorsincluding regional credit concentration, industry concentration, results ofregulatory examinations, historical loss ranges, portfolio composition,economic conditions such as interest rates and energy costs and other changesin the portfolio. The allowance for loan losses is management’s estimate of theprobable loan losses incurred as of the balance sheet date.

 

Additional factors influencing the calculation of the allowance forloan losses are particular concentrations within the portfolio, including thegeographic concentration of loans in California, which accounted forapproximately 47.9% of the portfolio at June 30, 2004, and concentrationsof loans to individual borrowers.

 

Capital Crossing Preferred’s allowance for loan losses at June 30,2004 was $2.5 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 agencies periodically review the adequacy ofthe allowance for loan losses and may require Capital Crossing Preferred tomake additions to its allowance for loan losses. While management believes itsestimates and assumptions are reasonable, there can be no assurance that theywill be proven to be correct in the future. The actual amount of futureprovisions that may be required cannot be determined, and such provisions mayexceed the amounts of past provisions. Management believes that the allowancefor loan losses is adequate to absorb the known and inherent risks in CapitalCrossing Preferred’s loan portfolio at each date based on the facts known tomanagement as of such dates. Management continues to monitor and modify theallowances for general and specific loan losses as economic conditions dictate.

 

Effective January 1, 2005, as a result of the required adoption ofStatement of Position (‘‘SOP’’) No. 03-3, ‘‘Accounting for Certain Loans orDebt Securities Acquired in a Transfer,’’ Capital Crossing Preferred expectsits allowance for loan loss methodology to change. SOP No. 03-3 prohibits‘‘carrying over’’ or creation of valuation allowances in the initial accountingof all loans acquired in a transfer. The prohibition of the valuation allowancecarry over applies to the purchase of an individual loan, a pool of loans, agroup of loans and impaired loans acquired in a business combination. Valuationallowances should reflect only those losses incurred by the investor afteracquisition.  Effective January 1,2005 Capital Crossing Preferred will no longer be allowed to increase the allowancethrough allocations from purchase discount. Additionally, general risk allocations will no longer be applied topurchased loans.  Only specificallocations based upon the results of measuring loans that become impairedsubsequent to purchase under SFAS No. 114 will be considered in the calculationof the allowance for loan losses for purchased loans.  Consequently, it is anticipated that theallowance for loan losses will decline subsequent to the adoption of SOP No.03-3 as credits for loan losses may continue to be recorded as loans pay-offand perform above expectations.  For moreinformation related to SOP No. 03-3, see Note 1-Recent AccountingPronouncements to the Financial Statements included in Capital CrossingPreferred’s Annual Report on Form 10-K.

 

Thefollowing table sets forth certain information relating to the activity in theallowance for loan losses for the periods indicated:

 
| ** **                           | ** ** | **Three  Months Ended June 30,** | ** ** | **Six  Months Ended June 30,** | ** ** |
|--------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                           | ** ** | **2004**                              | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                           | ** ** | **(in  thousands)**                   | ** ** |
| Balance at beginning of period       |       | $                                     | 2,821      |                                | $          | 7,354 |   | $ | 3,281 |   | $ | 7,354 |   |
| Credit for loan losses               |       | (353                                  | )          | (2,400                              | )          | (764 | ) | (2,400 | ) |
| Net reduction relating to loans sold |       | —                                |       | —                              |       | (49 | ) | — |   |
| Balance at end of period             |       | $                                     | 2,468      |                                | $          | 4,954 |   | $ | 2,468 |   | $ | 4,954 |   |

 

#### **InterestRate Risk**

 

Capital Crossing Preferred’s income consists primarily of interestincome. If there is a decline in market interest rates, Capital CrossingPreferred may experience a reduction in interest income and a correspondingdecrease in funds available to be distributed to its shareholders. Thereduction in interest income may result from downward adjustments of theindices upon which the interest rates on loans are based and from prepaymentsof mortgage loans with fixed interest rates, resulting in reinvestment of theproceeds in lower yielding mortgage loans. Capital Crossing Preferred does notintend to use any derivative products to manage its interest rate risk.

 

14

----

 

**Significant Concentration of Credit Risk**

 

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

 

#### **At June 30, 2004, 47.9% and14.6% of Capital Crossing Preferred’s total loan portfolio consisted of loansin California and New England, respectively. At December 31, 2003, 44.5%and 14.5% of Capital Crossing Preferred’s total real estate loan portfolioconsisted of loans located in California and New England, respectively.Consequently, the portfolio may experience a higher default rate in the eventof adverse economic, political or business developments or natural hazards inCalifornia or New England that may affect the ability of property owners tomake payments of principal and interest on the underlying mortgages.**

#### ** **

#### **Liquidity Risk Management**

#### ** **

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

 

Capital Crossing Preferred’s principal liquidity needs are:

 

(1) to maintain the current portfolio sizethrough the acquisition of additional mortgage assets as mortgage assetscurrently in the loan portfolio mature, pay down or prepay, and

 

(2) to pay dividends on the preferred sharesand common shares.

 

The acquisition of additional mortgage assets is intended to be fundedprimarily through repayment of principal balances of mortgage assets byindividual borrowers. Capital Crossing Preferred does not have and does notanticipate having any material capital expenditures. To the extent that theBoard of Directors determines that additional funding is required, CapitalCrossing Preferred may raise such funds through additional equity offerings,debt financing or retention of cash flow (after consideration of provisions ofthe Internal Revenue Code requiring the distribution by a REIT of at least 90%of its REIT taxable income and taking into account taxes that would be imposedon undistributed income), or a combination of these methods. Except for itsobligation to guarantee certain borrowings of Capital Crossing, CapitalCrossing Preferred does not currently intend to incur any indebtedness. Theorganizational documents of Capital Crossing Preferred limit the amount ofindebtedness which it is permitted to incur without the approval of the SeriesA, Series C and Series D preferred stockholders to no more than 100% of thetotal stockholders’ equity of Capital Crossing Preferred. Any such debt mayinclude intercompany advances made by Capital Crossing to Capital CrossingPreferred.

 

Capital Crossing Preferred may also issue additional series ofpreferred stock. However, Capital Crossing Preferred may not issue additionalshares of preferred stock ranking senior to the Series A, Series C or Series Dpreferred shares without the consent of holders of at least two-thirds of theSeries A, Series C and Series D preferred shares outstanding at that time.Although Capital Crossing Preferred’s charter does not prohibit or otherwiserestrict Capital Crossing or its affiliates from holding and voting shares ofSeries A, Series C or Series D preferred stock, to Capital Crossing Preferred’sknowledge the amount of shares of Series A, Series C and Series D preferredshares held by Capital Crossing or its affiliates is insignificant (less than1%). Additional shares of preferred stock ranking on a parity with the SeriesA, Series C and Series D preferred shares may not be issued without theapproval of a majority of Capital Crossing Preferred’s independent directors.

 

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

# ** **

*Set forth below are a number of risk factorsthat may cause Capital Crossing Preferred’s actual results to differ materiallyfrom anticipated future results, performance or achievements expressed orimplied by the forward-looking statement. All of these factors should becarefully reviewed, and the reader of this Form 10-Q should be aware that theremay be other factors that could cause these differences.*

 

**Adecline in Capital Crossing’s capital levels may result in the Series A, SeriesC and Series D preferred shares being subject to automatic exchange intopreferred shares of Capital Crossing**

 

The returns from an investment in the Series A, Series C or Series Dpreferred 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

 

15

----

 

placement ofCapital Crossing into bankruptcy, reorganization, conservatorship orreceivership could result in the automatic exchange of the Series A, Series Cand Series D preferred shares for preferred shares of Capital Crossing, whichwould represent an investment in Capital Crossing and not in Capital CrossingPreferred. Under these circumstances:

 

• a holderof Series A, Series C or Series D 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 payany****dividendson the preferred shares of Capital Crossing. An investment in Capital Crossingis also subject to risks that are distinct from the risks associated with aninvestment in Capital Crossing Preferred. For example, an investment in CapitalCrossing would involve risks relating to the capital levels of, and otherfederal and state regulatory requirements applicable to, Capital Crossing, andthe performance of Capital Crossing’s overall loan portfolio and other businesslines. Capital Crossing also has significantly greater liabilities andsignificantly less stockholders’ equity than does Capital Crossing Preferred;

 

• if aliquidation of Capital Crossing occurs, the claims of depositors and creditorsof Capital Crossing and of the FDIC would have priority over the claims ofholders of the preferred shares of Capital Crossing, and therefore, a holder ofSeries A, Series C and Series D preferred shares likely would receivesubstantially less than such holder would receive had the Series A, Series Cand Series D preferred shares not been exchanged for preferred shares ofCapital Crossing; and

 

• theexchange of the Series A, Series C or Series D preferred shares for preferredshares of Capital Crossing would be a taxable event to a holder of Series A,Series C or Series D preferred shares under the Internal Revenue Code, and suchholder would incur a gain or a loss, as the case may be, measured by thedifference between such holder’s basis in the Series A, Series C or Series Dpreferred shares and the fair market value of Capital Crossing preferred sharesreceived in the exchange.

 

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

 

The Series A,Series C and Series D preferred shares rank:

 

• junior toborrowings 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 itsliquidation.  As of June 30, 2004,Capital Crossing had $129.0 million in outstanding FHLBB borrowings;

 

• senior toCapital Crossing Preferred’s common stock and its Series B preferred stock withregard to payment of dividends and amounts upon liquidation.

 

If Capital Crossing Preferred incurs significant indebtedness, it maynot have sufficient funds to make dividend or liquidation payments on theSeries A, Series C or Series D preferred shares. Upon Capital CrossingPreferred’s liquidation, its obligations to its creditors would rank senior tothe Series A, Series C and Series D preferred shares. At June 30, 2004, CapitalCrossing Preferred had approximately $193,000 in accounts payable and otherliabilities which, upon its liquidation, would be required to be paid beforeany payments could be made to holders of the Series A, Series C or Series Dpreferred shares. In addition, upon Capital Crossing Preferred’s liquidation,dissolution or winding up, if it does not have sufficient funds to pay the fullliquidation amount to the holders of the Series A, Series C and Series Dpreferred shares, such holders may receive less than the per share liquidationamount.

 

The terms of the Series A, Series C and Series D preferred shares limitCapital Crossing Preferred’s ability to incur debt in excess of 100% of itsstockholders’ equity without the approval of the holders of all of the outstandingSeries A, Series C and Series D preferred shares but do not require thatCapital Crossing Preferred obtain the approval of the holders of the Series A,Series C and Series D preferred shares to issue additional series of preferredshares which rank equal to the Series A, Series C and Series D preferred sharesas to payment of dividends or amount upon liquidation. As a result, subject tothese limitations, Capital Crossing Preferred may incur obligations which mayfurther limit its ability to make dividend or liquidation payments in thefuture.

 

**Bankregulators may limit the ability of Capital Crossing Preferred to implement itsbusiness plan and may restrict its ability to pay dividends**

 

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

 

16

----

 

• 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, Series C and Series D preferred shares, or to redeem shares of SeriesA, Series C and Series D preferred stock or even require Capital Crossing tosever 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, Series C and Series D 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%. AtJune 30, 2004, Capital Crossing had a total risk-based capital ratio of18.00%, a Tier 1 risk-based capital ratio of 13.19% and a Tier 1 leverage ratioof 12.79%, which is sufficient for Capital Crossing to be considered well-capitalized.As part of its common stock repurchase program, Capital Crossing has alsoagreed with the FDIC to maintain, for so long as the repurchase programcontinues, its Tier 1 leverage ratio at least 7.00%, as well as remaining wellcapitalized. Capital Crossing Preferred makes no assurance that CapitalCrossing will be well-capitalized under applicable regulations as of any futuredate, which is required in order to continue to repurchase common stock, butwhich is not a condition to the payment of dividends on the preferred shares.For purposes of calculating these capital ratios as a percentage of CapitalCrossing’s risk-weighted assets, as opposed to its total assets, CapitalCrossing’s assets are assigned to risk categories based on the relative creditrisk of the asset in question. These risk weights consist of 0% for assetsdeemed least risky such as cash, claims backed by the full faith and credit ofthe U.S. government, and balances due from Federal Reserve banks; 20% forassets deemed slightly more risky such as portions of obligations conditionallyguaranteed by the U.S. government or federal funds sold; 50% for assets deemedstill more risky such as government issued-revenue bonds, one-to-four familyresidential first mortgage loans and well-collateralized multi-familyresidential first mortgage loans; and 100% for all other assets, includingprivate sector loans such as commercial mortgage loans as well as bank-ownedreal estate.

 

• whileCapital Crossing Preferred believes that dividends on the Series A, Series Cand Series D preferred shares should not be considered distributions by CapitalCrossing, the FDIC may not agree with this position. Under FDIC regulations oncapital distributions, the ability of Capital Crossing to make a capitaldistribution varies depending primarily on Capital Crossing’s earnings andregulatory capital levels. Capital distributions are defined to include paymentof dividends, stock repurchases, cash-out mergers and other distributionscharged against the capital accounts of an institution. The FDIC could limit orprohibit the payment of dividends on the Series A, Series C and Series Dpreferred shares if it determines that the payment of those dividends is acapital distribution by Capital Crossing and that Capital Crossing’s earningsand regulatory capital levels are below specified levels.

 

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

 

Capital Crossing Preferred does not normally obtain general creditenhancements such as mortgagor bankruptcy insurance or obtain special hazardinsurance for its mortgage assets, other than standard hazard insurance, whichwill in each case only relate to individual mortgage loans. Accordingly,Capital Crossing Preferred will be subject to risks of borrower defaults andbankruptcies and special hazard losses, such as losses occurring from floods orearthquakes that are not covered by standard hazard insurance. A significantnumber of loans acquired in recent years are loans that were originated underthe Small Business Administration’s disaster relief program. These loans aretypically loans made to small businesses and individuals for the purpose ofassisting those who have been the victim of a disaster and may be located in anarea prone to such disasters. In the event of a default on any mortgage loanheld by Capital Crossing Preferred resulting from declining property values orworsening economic conditions, among other factors, it would bear the risk ofloss of principal to the extent of any deficiency between (1) the value of therelated mortgaged property, plus any payments from an insurer or guarantor inthe case of commercial mortgage loans, and (2) the amount owing on the mortgageloan.

 

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

 

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

 

• local andother 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;

 

17

----

 

•the ability 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 orprior to maturity; and

 

•increased operating costs, including energy costs, real estate taxes and costsof compliance with environmental controls and regulations.

 

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

 

Properties underlying Capital Crossing Preferred’s current mortgageassets are concentrated primarily in California, particularly SouthernCalifornia, and New England. As of June 30, 2004, approximately 47.9% ofthe balances of its mortgage loans were secured by properties located inCalifornia and 14.6% 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 or natural hazards, Capital Crossing Preferredwould likely experience higher rates of loss and delinquency on its mortgageloans than if its loans were more geographically diverse.

 

**Asubstantial majority of Capital Crossing Preferred’s loans were originated byother parties whose level of due diligence may be different than Capital Crossing’slevel of due diligence**

 

At June 30, 2004, substantially all of Capital CrossingPreferred’s loans consisted of loans originated by third parties that werepurchased by Capital Crossing and subsequently acquired by Capital CrossingPreferred from Capital Crossing. Because these loans were originated by thirdparties, Capital Crossing generally is not able to conduct the same level ofdue diligence on these loans that it would have conducted had it originatedthem. Generally, while Capital Crossing conducts an acquisition review, itrelies on the underwriting standards of the parties originating the loans itacquires. The standards of these loan originators may be substantiallydifferent than those of Capital Crossing. These differences may include lessrigorous appraisal requirements and debt service coverage ratios, and lessrigorous analysis of property location and environmental factors, buildingcondition and age, tenant quality, compliance with zoning regulations, any userestrictions, easements or right of ways that may impact the value and theborrower’s ability to manage the property. Other disadvantages of purchasedloans versus originated loans may include the lack of current financialinformation, incomplete legal documentation and outdated appraisals.

 

**Morethan half of Capital Crossing Preferred’s loan portfolio is made up ofcommercial mortgage loans which are generally riskier than other types of loans**

 

Commercial mortgage loans constituted approximately 66.5% of the totalgross loans in Capital Crossing Preferred’s loan portfolio at June 30,2004 and commercial mortgage loans are generally subject to greater risks thanother types of loans. Capital Crossing Preferred’s commercial mortgage loans,like most commercial mortgage loans, generally lack standardized terms, tend tohave shorter maturities than residential mortgage loans and may not be fullyamortizing, meaning that they have a principal balance or ‘‘balloon’’ paymentdue on maturity. The commercial real estate properties underlying CapitalCrossing Preferred’s commercial mortgage loans also tend to be unique and aremore difficult to value than residential real estate properties. They are alsosubject to relatively greater environmental risks than other types of loans andto the corresponding burdens and costs of compliance with environmental lawsand regulations. Because of these risks related to commercial mortgage loans,Capital Crossing Preferred may experience higher rates of default on itsmortgage loans than it would if its loan portfolio was more diversified andincluded a greater number of owner-occupied residential or other mortgageloans. Higher rates of default would cause Capital Crossing Preferred toincrease its provision for loan losses, which may have a material adverseaffect on its business, financial condition and results of operation.

 

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

 

To date Capital Crossing Preferred has purchased all of the loans inits portfolio from Capital Crossing. Historically, Capital Crossing hasacquired such loans (1) from institutions which sought to eliminate certainloans or categories of loans from their portfolios, (2) from institutionsparticipating in securitization programs, (3) from failed or consolidatingfinancial institutions 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 ofloans is highly competitive. In fact, the Small Business Administration hasrecently 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 has

 

18

----

 

historicallypurchased. This may interfere with Capital Crossing Preferred’s ability tomaintain the requisite level of mortgage assets to maintain its qualificationas a REIT. If volumes of loans purchased or the yields on these loans decline,Capital****Crossing Preferred would experience a materialadverse effect on its business, financial condition and results of operations.

 

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

 

If Capital Crossing Preferred chooses to foreclose on a defaultedmortgage loan to recover its investment it may be subject to environmentalliabilities related to the underlying real property. Approximately 66.5% of theloans in Capital Crossing Preferred’s portfolio at June 30, 2004 werecommercial mortgage loans, which generally are subject to relatively greaterenvironmental risks than other types of loans. Hazardous substances or wastes,contaminants, pollutants or sources thereof may be discovered on propertiesduring Capital Crossing Preferred’s ownership or after a sale to a third party.The amount of environmental liability could exceed the value of the realproperty. There can be no assurance that Capital Crossing Preferred would notbe fully liable for the entire cost of any removal and clean-up on an acquiredproperty, that the cost of removal and clean-up would not exceed the value ofthe property or that Capital Crossing Preferred could recoup any of the costsfrom any third party. In addition, Capital Crossing Preferred may find itdifficult or impossible to sell the property prior to or following any suchremediation.  The incurrence of anysignificant environmental liabilities with respect to a property securing amortgage loan could have a material adverse effect on Capital CrossingPreferred’s business, financial condition and results of operations.

 

**CapitalCrossing Preferred is dependent in virtually every phase of its operations onthe diligence and skill of the management of Capital Crossing**

 

Capital Crossing, which holds all of Capital Crossing Preferred’scommon stock, is involved in virtually every aspect of Capital CrossingPreferred’s existence. Capital Crossing Preferred has six officers, includingthree executive officers, and no other employees and does not have anyindependent corporate infrastructure. Capital Crossing Preferred does not haveany employees because it has retained Capital Crossing to perform all necessaryfunctions pursuant to the advisory agreement and the master service agreement.All of Capital Crossing Preferred’s officers are also officers of CapitalCrossing. Under an advisory agreement between Capital Crossing Preferred andCapital Crossing, Capital Crossing administers day-to-day activities, includingmonitoring of Capital Crossing Preferred’s credit quality and advising it withrespect to the acquisition, management, financing and disposition of mortgageassets and its operations generally. Under a master service agreement betweenCapital Crossing Preferred and Capital Crossing, Capital Crossing servicesCapital Crossing Preferred’s loan portfolio. The advisory agreement has aninitial term of five years with an automatic renewal feature and the masterservice agreement has a one-year term with an automatic renewal feature. Boththe master service agreement and the advisory agreement are subject to earliertermination upon provision of 30 days and 90 days notice, respectively. 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.

 

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

 

Capital Crossing and its affiliates may have interests which are notidentical to Capital Crossing Preferred’s and therefore conflicts of interesthave arisen and may arise in the future with respect to transactions betweenCapital Crossing Preferred and Capital Crossing such as:

 

***Acquisition ofmortgage assets.***Capital Crossing Preferredanticipates that it will from time to time continue to purchase additionalmortgage assets. Capital Crossing Preferred intends to acquire all orsubstantially all of such mortgage assets from Capital Crossing, on terms thatare comparable to those that could be obtained by Capital Crossing Preferred ifsuch mortgage assets were purchased from unrelated third parties. 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. Although these purchases arestructured to take advantage of the underwriting procedures of CapitalCrossing, and while Capital Crossing Preferred believes that any agreements andtransactions between it, on the one hand, and Capital Crossing and/or itsaffiliates on the other hand, are fair to all parties and consistent withmarket terms, neither Capital Crossing Preferred nor Capital Crossing haveobtained any third-party valuation to confirm whether Capital CrossingPreferred will be paying fair market value for these loans, nor does CapitalCrossing Preferred anticipate doing so in the future. Additionally, throughlimiting Capital Crossing Preferred’s source of purchased mortgage assetssolely to those originated or purchased by Capital Crossing, Capital CrossingPreferred’s portfolio will generally reflect the nature, scope and risk ofCapital Crossing’s portfolio rather than a more diverse portfolio composed ofmortgage loans also purchased from other lenders.

 

19

----

 

***Servicing of CapitalCrossing Preferred mortgage assets by Capital Crossing.***CapitalCrossing Preferred’s loans are serviced by Capital Crossing pursuant to theterms of the master service agreement. Capital Crossing in its role as servicerunder the terms of the master service agreement receives a fee equal to 0.20%per annum, payable monthly, on the average gross outstanding principal balancesof loans serviced. The master service agreement requires Capital Crossing toservice the loan portfolio in a manner substantially the same as for similar workperformed by Capital Crossing for transactions on its own behalf. This willbecome especially important as Capital Crossing services any loans which becomeclassified or are placed on non-performing status, or are renegotiated due tothe financial deterioration of the borrower. While Capital Crossing Preferredbelieves that Capital Crossing will diligently pursue collection of anynon-performing loans, Capital Crossing Preferred cannot provide assurance thatthis will be the case. Capital Crossing Preferred’s ability to make timelypayments of dividends will depend in part upon Capital Crossing’s promptcollection efforts on behalf of Capital Crossing Preferred.

 

***Future dispositionsby Capital Crossing Preferred of mortgage assets to Capital Crossing or itsaffiliates.***The master service agreement providesthat foreclosures and dispositions of the mortgage assets are to be performedwith a view toward maximizing Capital Crossing Preferred’s recovery as owner ofthe mortgage assets, and Capital Crossing shall service the mortgage assetssolely with a view toward Capital Crossing Preferred’s interests, and withoutregard to the interests of Capital Crossing or any of its affiliates. However,Capital Crossing Preferred cannot provide assurance that any such agreement ortransaction will be on terms as favorable to it as would have been obtainedfrom unaffiliated third parties. Capital Crossing may seek to exercise itsinfluence over Capital Crossing Preferred’s affairs so as to cause the sale ofthe mortgage assets owned by Capital Crossing Preferred and their replacementby lesser quality loans purchased from Capital Crossing or elsewhere whichcould adversely affect Capital Crossing Preferred’s business and its ability tomake timely payments of dividends.

 

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

 

***The terms of CapitalCrossing Preferred’s guarantee of obligations of Capital Crossing.***Capital Crossing Preferred hasguaranteed all of the obligations of Capital Crossing under advances CapitalCrossing may receive from time to time from the FHLBB, and has agreed to pledgea significant amount of its assets in connection with those advances. Theassets Capital Crossing Preferred pledges to the FHLBB will vary from time totime; however, the potential exists for Capital Crossing Preferred to pledgeall of its assets to the FHLBB to secure advances to Capital Crossing. 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. Underthe terms of the pledge, if Capital Crossing becomes undercapitalized the FHLBBmay require Capital Crossing to dissolve Capital Crossing Preferred such thatthe assets of Capital Crossing Preferred are distributed to Capital Crossing.In this circumstance the holders of Series A, Series C and Series D preferredshares would receive their liquidation preference only to the extent there areavailable proceeds from the liquidation of the assets of Capital CrossingPreferred following satisfaction of its outstanding obligations, including itsguarantee of Capital Crossing’s FHLBB borrowings. At June 30, 2004,approximately $27.5 million, or 10.4%, of Capital Crossing Preferred assetshave been pledged to and accepted by the FHLBB to secure advances to CapitalCrossing.  Capital Crossing has alsoagreed with the FHLBB that it will not request or accept advances from theFHLBB in excess of Capital Crossing Preferred’s total stockholder’s equity,less the stockholder’s equity attributable to the Series A, Series C and SeriesD preferred shares.  As of June 30,2004, this restriction would limit Capital Crossing’s ability to receiveadvances in excess of approximately $193.6 million.  As of June 30, 2004, Capital Crossinghad $129.0 million in outstanding FHLBB borrowings.  The guarantee and pledge were approved byCapital Crossing Preferred’s independent directors, subject to certainrequirements and limitations, including the requirement that Capital Crossingpay Capital Crossing Preferred a guarantee fee. Any default by Capital Crossingon its obligations which would require Capital Crossing Preferred to satisfyits guarantee could adversely affect its business and its ability to maketimely payments of dividends.

 

***The master loanpurchase agreement was not the result of arm’s-length negotiations.***CapitalCrossing Preferred acquires loans pursuant to the master mortgage loan purchaseagreement between Capital Crossing Preferred and Capital Crossing, at an amountequal to Capital Crossing’s net carrying value for those mortgage assets. WhileCapital Crossing Preferred believes that the master mortgage loan purchaseagreement, when entered into, was fair to all parties and consistent withmarket terms, its officers who

 

20

----

 

are alsoofficers and directors of Capital Crossing. Specifically, (i) all of Capital Crossing Preferred’s officers are alsoofficers of Capital Crossing, (ii) two of Capital Crossing Preferred’sexecutive, or “inside”, directors are also directors of Capital Crossing and(iii) one of Capital Crossing Preferred’s non-executive, or “outside”,directors is also a director of Capital Crossing.  Capital Crossing, as holder of all of CapitalCrossing Preferred’s outstanding common stock, controls the election of allCapital Crossing Preferred directors, including the independent directors.Capital Crossing Preferred cannot provide assurance that the master mortgageloan purchase agreement was entered into on terms as favorable to CapitalCrossing Preferred as those that could have been obtained from unaffiliatedthird parties.

 

**NeitherCapital Crossing Preferred nor Capital Crossing have specific policies withrespect to the purchase by Capital Crossing Preferred from Capital Crossing ofparticular loans or pools of loans**

 

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

 

**CapitalCrossing Preferred’s Board of Directors has broad discretion to revise CapitalCrossing Preferred’s strategies**

 

Capital Crossing Preferred’s Board of Directors has established CapitalCrossing Preferred’s investment and operating strategies. These strategies maybe revised from time to time at the discretion of the Board of Directorswithout a vote of Capital Crossing Preferred’s stockholders. Changes in CapitalCrossing Preferred’s strategies could have a negative effect on shareholders.

 

**CapitalCrossing Preferred does not obtain third-party valuations and therefore it maypay more or receive less than fair market value for its mortgage assets**

 

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

 

**CapitalCrossing Preferred may pay more than fair market value for mortgages itpurchases from Capital Crossing because it does not engage in arm’s-lengthnegotiations with Capital Crossing**

 

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

 

**Fluctuationsin interest rates could reduce Capital Crossing Preferred earnings and affectits ability to pay dividends**

 

CapitalCrossing Preferred’s income consists primarily of interest earned on mortgageassets and short-term investments.  Asignificant portion of Capital Crossing Preferred’s mortgage assets bearinterest at adjustable rates. Interest rates are currently in a period ofhistorically low levels. If there is a further decline in interest rates, thenCapital Crossing Preferred will experience a decrease in income available to bedistributed to our 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 preferred shares,the Series C preferred shares, and the Series D preferred shares. Conversely,an increase in mortgage rates could result in increased borrower defaults,which in turn could result in decreased interest income and increasednon-interest expense related to workouts and other collection efforts. Anincrease in interest rates that adversely affects the ability of borrowers topay the principal or interest on Capital Crossing Preferred’s loans may lead toan increase in non-performing assets and a reduction of discount accreted intoincome, which could have a material adverse effect on

 

21

----

 

Capital Crossing Preferred’s results of operations. Because thedividend rates on the Series A preferred shares, the Series C preferred shares,and the Series D preferred shares are fixed, a significant decline or increasein interest rates, either of which results in lower net income, couldmaterially adversely affect Capital Crossing Preferred’s ability to paydividends on the Series A preferred shares, the Series C preferred shares, andthe Series D preferred shares.

 

**TaxRisks Related to REITs**

 

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

 

Although Capital Crossing Preferred currently intends to operate in amanner designed to qualify as a REIT, future economic, market, legal, tax orother considerations may cause it to determine that it is in its best interestand in the best interest of holders of its common stock and preferred stock torevoke its REIT election. The tax law prohibits Capital Crossing Preferred fromelecting treatment as a REIT for the four taxable years following the year ofany such revocation.

 

***If Capital CrossingPreferred does not distribute 90% of its net taxable income, it may not qualifyas 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 for thecalendar year and (3) 100% of any undistributed income from prior periods.Under certain circumstances, federal or state regulatory authorities mayrestrict Capital Crossing Preferred’s ability, as a subsidiary of CapitalCrossing, to make distributions to its stockholders in an amount necessary toretain its REIT qualification. Such a restriction could result in CapitalCrossing Preferred failing to qualify as a REIT. To the extent Capital CrossingPreferred’s REIT taxable income may exceed the actual cash received for aparticular period, Capital Crossing Preferred may not have sufficient liquidityto make distributions necessary to retain its REIT qualification.

 

***Capital CrossingPreferred may redeem the Series A, Series C and Series D preferred shares atany time upon the occurrence of a tax event.***Atany time following the occurrence of certain changes in the tax laws orregulations concerning REITs, Capital Crossing Preferred will have the right toredeem the Series A, Series C and Series D preferred shares in whole, subjectto the prior written approval of the FDIC. Capital Crossing Preferred wouldhave the right to redeem the Series A, Series C and Series D preferred sharesif it received an opinion of counsel to the effect that, as a result of changesto the tax laws or regulations:

 

(1) dividends paid by Capital CrossingPreferred with respect to its capital stock are not fully deductible by it forincome tax purposes; or

 

(2) Capital Crossing Preferred are otherwise unable to qualify as aREIT.

 

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

 

***Capital CrossingPreferred has imposed ownership limitations to protect its ability to qualifyas a REIT, however, if ownership of the common stock of Capital Crossingbecomes concentrated in a small number of individuals Capital CrossingPreferred may fail to qualify as a REIT.***Tomaintain Capital Crossing Preferred’s status as a REIT, not more than 50% invalue of Capital Crossing Preferred’s outstanding shares may be owned, directlyor indirectly, by five or fewer individuals, as defined in the Internal RevenueCode, or the Code, to include certain entities, during the last half of eachtaxable year. Capital Crossing Preferred currently satisfies this requirementbecause for this purpose Capital Crossing Preferred’s common stock held byCapital Crossing is treated as held by Capital Crossing’s stockholders.However, it is possible that the ownership of Capital Crossing might becomesufficiently concentrated in the future such that five or fewer individualswould be treated as having constructive ownership of more than 50% of the valueof Capital Crossing Preferred’s stock. Capital Crossing Preferred may havedifficulty monitoring the daily

 

22

----

 

ownership andconstructive ownership of its outstanding shares and, therefore, CapitalCrossing Preferred cannot provide assurance that it will continue to meet theshare ownership requirement. This risk may be increased in the future asCapital Crossing continues its common stock repurchase programs becauserepurchases may cause ownership in Capital Crossing to become moreconcentrated. In addition, while the fact that the Series A, Series C and theSeries D preferred shares may be redeemed or exchanged will not affect CapitalCrossing Preferred’s REIT status prior to any such redemption or exchange, theredemption or exchange of all or a part of the Series A, Series C and Series Dpreferred shares could adversely affect Capital Crossing Preferred’s ability tosatisfy the share ownership requirements in the future.

 

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

 

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

 

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

 

Capital Crossing Preferred’s methods forevaluating interest rate risk include an analysis of its interest-earningassets maturing or repricing within a given time period. Since Capital CrossingPreferred has no interest-bearing liabilities, a period of 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, 2004. For fixed rateinstruments, the repricing date is the maturity date. For adjustable-rate instruments,the repricing date is deemed to be the earliest possible interest rateadjustment date. Assets that are subject to immediate repricing are placed inthe 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   |       | $                          | 137,898    |                  | $          | —                 |       | $                        | —     |                      | $          | —                   |       | $                     | —     |      | $          | — |   | $ | — |   | $ | 137,898 |   |
| Average  interest rate       |       | 1.10                       | %          |                  |       |                   |       |                     |       |                      |       |                     |       |                  |       |      |       |
| Certificate  of deposit      |       | —                     |       | 200                   |       | —                 |       | —                   |       | —                    |       | —                   |       | —                |       | 200       |       |
| Average  interest rate       |       |                       |       | 1.32                  | %          |                   |       |                     |       |                      |       |                     |       |                  |       |      |       |
| Fixed-rate  loans (1)        |       | —                     |       | 29,014                |       | 19,114                 |       | 12,256                   |       | 8,748                     |       | 5,299                    |       | 8,153                 |       | 82,584    |       |
| Average  interest rate       |       |                       |       | 8.35                  | %          | 8.33                   | %          | 8.06                     | %          | 7.99                      | %          | 7.47                     | %          | 7.10                  | %          |      |       |
| Adjustable-rate  loans(1)    |       | 15,405                     |       | 27,261                |       | 1,867                  |       | 738                      |       | 508                       |       | 175                      |       | —                |       | 45,954    |       |
| Average  interest rate       |       | 8.22                       | %          | 6.68                  | %          | 7.43                   | %          | 6.19                     | %          | 5.92                      | %          | 5.57                     | %          |                  |       |      |       |
|                         |       |                       |       |                  |       |                   |       |                     |       |                      |       |                     |       |                  |       |      |       |
| Total  rate-sensitive assets |       | $                          | 153,303    |                  | $          | 56,475                 |       | $                        | 20,981     |                      | $          | 12,994                   |       | $                     | 9,256      |      | $          | 5,474 |   | $ | 8,153 |   | $ | 266,636 |   |

 

----

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

 

Based on Capital Crossing Preferred’sexperience, management applies the assumption that, on average, approximately22% of the outstanding fixed and adjustable rate loans will prepay annually.

 

At June 30, 2004, the fair value of netloans was $131.1 million as compared to the net carrying value of net loans of$126.1 million. The fair value of interest-bearing deposits in banksapproximates carrying value.

 

23

----

 

**Item 4.****  Controls and Procedures**

 

(a)                                  Evaluationof Disclosure Controls and Procedures.

 

As required by Rule 13a-15 under the Securities Exchange Act of 1934,as amended (the “Exchange Act”), as of June 30, 2004, Capital CrossingPreferred carried out an evaluation under the supervision and with theparticipation of its management, including its Principal Executive Officer andPrincipal Financial Officer, of the effectiveness of the design and operationof Capital Crossing Preferred’s disclosure controls and procedures. Indesigning and evaluating Capital Crossing Preferred’s disclosure controls andprocedures, Capital Crossing Preferred and its management recognize that anycontrols and procedures, no matter how well designed and operated, can provideonly a reasonable assurance of achieving the desired control objectives, andmanagement necessarily was required to apply its judgment in evaluating andimplementing possible controls and procedures. Based upon that evaluation, thePrincipal Executive Officer and Principal Financial Officer concluded that theybelieve Capital 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)                                 Changesin Internal Controls.

 

None.

 

**PART II**

 

**Item 4.  Submission of Matters to a Vote of SecurityHolders**

 

Capital Crossing executed a Written Consent of the Sole CommonStockholder as of June 30, 2004, which was in lieu of the annual meetingof stockholders of Capital Crossing Preferred, for the purpose of setting thenumber of directors and electing directors to serve until the next annualmeeting of stockholders.  CapitalCrossing is the sole stockholder of Capital Crossing Preferred’s CommonStock.  Capital Crossing voted all of itsshares in favor of setting the number of directors at six and electing thefollowing directors:  Nicholas W.Lazares, Richard Wayne, Edward F. Mehm, Jeffrey P. Ross, Douglas Shaw and JohnLapidus.

 

## **Item 6.**  Exhibits and Reports on Form 8-K

## ** **

(a)   Exhibits

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

 

(b)         Reports on Form 8-K

 

None.

 

24

----

 

## **SIGNATURES**

## ** **

Pursuant to therequirements of the Securities Exchange Act of 1934, Capital Crossing PreferredCorporation has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 

##### **CAPITALCROSSING PREFERRED CORPORATION**

 

 
| Date:  August 13, 2004 | By:    | /s/ Richard Wayne                          |   |
|-----------------------------|--------|--------------------------------------------|--------|
|                        |   | Richard Wayne                              |
|                        |   | *President  (Principal Executive Officer)* |
|                        |   |
|                        |   |
| Date: August 13, 2004  | By:    |  /s/ Edward F. Mehm                   |   |
|                        |   | Edward F. Mehm                             |
|                        |   | *Treasurer  (Principal Financial Officer)* |
|                             |        |                                            |        |  |

 

25

----

 

## **EXHIBIT INDEX**

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

 

26

----