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MMAB > SEC Filings for MMAB > Form 10-K on 21-Mar-2014All Recent SEC Filings

Show all filings for MUNICIPAL MORTGAGE & EQUITY LLC

Form 10-K for MUNICIPAL MORTGAGE & EQUITY LLC


21-Mar-2014

Annual Report


Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

General Overview

We own and manage a portfolio of real estate related assets. Our primary holdings include a portfolio of bonds, a substantial portion of which are tax-exempt and backed by affordable multifamily rental properties. We also manage tax credit equity funds for third party investors that invest in similar affordable multifamily rental properties. Finally, we own a variety of direct investments in multifamily rental properties and land. Outside of the US, we are in the business of raising, investing in and asset managing private real estate funds that invest primarily in affordable for-sale and rental housing primarily in South Africa.

The Company operates through two reportable segments: US Operations and International Operations.

US Operations

The Company's bond portfolio consisted of 36 bonds totaling $245.6 million (based on fair value and including $50.3 million of bonds eliminated due to consolidation), collateralized by 23 real estate properties at December 31, 2013. This bond portfolio is comprised primarily of multifamily tax-exempt bonds as well as community development district CDD bonds.

MuniMae is also the GP and manager of 13 LIHTC Funds which had $852.5 million of capital invested at December 31, 2013. These funds hold limited partnership interests in 117 affordable multifamily rental properties in the US. The Company's ownership interest in the LIHTC Funds is nominal (ranging from 0.01% to 0.04%); however, the Company is entitled to asset management fees as well as contingent asset management fees based on several factors including the residual value of the LIHTC Funds' underlying multifamily rental properties.

International Operations

All of the Company's International Operations take place through a subsidiary, IHS which is in the business of raising, investing in and asset managing private real estate funds that invest in affordable for-sale and rental housing primarily in South Africa. At December 31, 2013, the Company's ownership interest in IHS is approximately 83%. In addition to earning asset management fees, IHS, as the managing member is entitled to special distributions based on returns generated by the funds it sponsors. IHS currently manages one multi-investor fund (SA Fund), and a real estate partnership for a single-investor (SA Partnership), and is in the process of raising capital for a second multi-investor fund.

Critical Accounting Policies and Estimates

The preparation of our consolidated financial statements is based on the selection and application of US generally accepted accounting principles ("GAAP"), which requires us to make certain estimates and assumptions that affect the reported amounts and classification of the amounts in our consolidated financial statements. These estimates and assumptions require us to make difficult, complex and subjective judgments involving matters that are inherently uncertain. We base our accounting estimates and assumptions on historical experience and on judgments that are believed to be reasonable under the circumstances available to us at the time. Actual results could materially differ from these estimates. We applied our critical accounting policies and estimation methods consistently in all material respects and for all periods presented, and have discussed those policies with our Audit Committee.

We believe the following accounting policies involve a higher degree of judgment and complexity and represent the critical accounting policies and estimates used in the preparation of our consolidated financial statements.

Valuation of Bonds

Bonds available-for-sale include mortgage revenue bonds and other municipal bonds. We account for investments in bonds as available-for-sale debt securities under the provisions of ASC No. 320, "Investments - Debt and Equity Securities." Accordingly, these investments in bonds are carried at fair value with changes in fair value (excluding other-than-temporary impairments) recognized in other comprehensive income. For most of our performing bonds, we estimate fair value using a discounted cash flow methodology; specifically, the Company discounts contractual principal and interest payments, adjusted for expected prepayments. The discount rate for each bond is based on expected investor yield requirements adjusted for bond attributes such as the expected term of the bond, debt service coverage ratio, geographic location and bond size. If observable market quotes are available, we will estimate the fair value based on such quoted prices. For non-performing bonds (i.e., defaulted bonds as well as certain non-defaulted bonds that we deem at risk of default in the near term), we estimate the fair value by discounting the property's expected cash flows and residual proceeds using estimated discount and capitalization rates, less estimated selling costs. However, to the extent available, the Company may estimate fair value based on a sale agreement, a letter of intent to purchase, an appraisal or other indications of fair value as available. There are significant judgments and estimates associated with forecasting the estimated cash flows related to the bonds or the underlying collateral for non-performing bonds, including macroeconomic conditions, interest rates, local and regional real estate market conditions and individual property performance. In addition, the determination of the discount rates applied to these cash flow forecasts involves significant judgments as to current credit spreads and investor return expectations. The bonds reflected on the Consolidated Balance Sheets at December 31, 2013 were priced on average at approximately 87% of the portfolio's unpaid principal balance. Given the size of our portfolio, different judgments as to credit spreads and investor return expectations could result in materially different valuations.

Consolidated Funds and Ventures ("CFVs")

We have numerous investments in partnerships and other entities that primarily hold or develop real estate. In most cases our direct or indirect legal interest in these entities is minimal; however, we apply ASC No. 810 "Consolidation" in order to determine if we need to consolidate any of these entities. There is considerable judgment in assessing whether to consolidate an entity under these accounting principles. Some of the criteria we are required to consider include:

The determination as to whether an entity is a variable interest entity ("VIE").

If the entity is considered a VIE, then the determination of whether we are the primary beneficiary of the VIE is needed and requires us to make judgments regarding: (1) our power to direct the activities of the VIE that most significantly impact the VIE's economic performance, and (2) our obligation to absorb losses of the VIE that could potentially be significant to the VIE or our right to receive benefits from the VIE that could potentially be significant to the VIE. These assessments require a significant analysis of all of the variable interests in an entity, any related party considerations and other features that make such an analysis difficult and highly judgmental.

If the entity is required to be consolidated, then upon initial consolidation, we record the assets, liabilities and noncontrolling interests at fair value. Substantially all of our consolidated entities are investment entities that own real estate or real estate related investments and, as such, there are judgments related to the forecasted cash flows to be generated from the investments such as rental revenue and operating expenses, vacancy, replacement reserves and tax benefits (if any). In addition, we must make judgments about discount rates and capitalization rates.

Income Taxes

Through July 9, 2013, the Company was a partnership for income tax purposes. Effective July 10, 2013, the Company converted from a partnership to a corporation for federal and state income tax purposes by making a check-the-box election with the IRS. As a result of the conversion, the Company will (i) be a direct corporate tax payer, (ii) no longer pass through its income and loss to its shareholders for tax purposes, and (iii) no longer issue each shareholder an annual tax statement on Schedule K-1. This change will also eliminate the ongoing costs of operating as a partnership and is consistent with changes in the nature of the Company's activities.

As a result of the partnership treatment prior to the check-the-box election, all activity of the Company's pass-through entities prior to July 10, 2013 was passed-through directly to the Company's shareholders. During February 2014, those shareholders that held shares as of July 9, 2013 received a final Schedule K-1 for the partial year January 1, 2013 through July 9, 2013, including potential capital gains from the sale of the Company's common shares in TEB. Effective July 10, 2013, all activity of the Company's pass-through entities will be included on the Company's corporate tax return. However, we have significant NOLs related to our corporate entities that we expect will be sufficient to offset federal taxable income and gains for the foreseeable future. Any basis differences in assets that were previously held by the pass-through entity were transferred to the corporation following the election, including any basis differences that were the result of the Company's Section 754 election.

ASC No. 740, "Income Taxes," establishes financial accounting and reporting standards for the effect of income taxes. The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current period and deferred tax assets and liabilities for future tax consequences of events that have been recognized in an entity's financial statements or tax returns. Significant judgment is required in determining and evaluating income tax positions, including assessing the relative merits and risks of various tax treatments considering statutory, judicial and regulatory guidance available regarding the tax position. We establish additional provisions for income taxes when there are certain tax positions that could be challenged and it is more likely than not these positions will not be sustained upon review by taxing authorities. Judgment is also required in assessing the future tax consequences of events that have been recognized in our consolidated financial statements or tax returns as well as the recoverability of our deferred tax assets. In assessing our ability to realize the benefit of our deferred tax assets we consider information such as forecasted earnings, future taxable income and tax planning strategies in measuring the required valuation allowance.

Results of Operations

The following discussion of our consolidated results of operations should be read in conjunction with our financial statements, including the accompanying notes. See "Critical Accounting Policies and Estimates" for more information concerning the most significant accounting policies and estimates applied in determining our results of operations.

The table below summarizes our consolidated financial performance for the years ended December 31, 2013 and 2012:

                                                     For the year ended
                                                        December 31,
(in thousands)                                        2013         2012

Total interest income                              $   37,928   $   65,791
Total interest expense                                 24,252       26,659
Net interest income                                    13,676       39,132

Total fee and other income                              7,910        8,274
Revenue from CFVs                                      21,310       11,212

Total revenues, net of interest expense                42,896       58,618

Operating expenses:
Interest expense                                       14,988       18,542
Operating expenses                                     31,754       28,663
Net impairment on bonds and loan losses                 2,077        1,570
Total expenses from CFVs                               53,708       28,124
Total operating expenses                              102,527       76,899

Net gains (losses) on assets, derivatives and
extinguishment of liabilities                         115,366      (1,693)
Net gains due to real estate consolidation and
foreclosure                                            10,895        5,404
Net gains related to CFVs                              31,795       12,441
Equity in losses from Lower Tier Property
Partnerships                                         (26,609)     (39,391)
Income (loss) from continuing operations before
income taxes                                           71,816     (41,520)
Income tax benefit (expense)                            1,304        (101)
Income from discontinued operations, net of tax        26,727        2,960
Net income (loss)                                      99,847     (38,661)

Income allocable to noncontrolling interests:
Income allocable to perpetual preferred
shareholders of a
   subsidiary company                                 (3,714)      (9,443)
Net losses (income) allocable to noncontrolling
interests
   in CFVs and IHS:
Related to continuing operations                       33,058       48,825
Related to discontinued operations                    (1,351)        2,394
Net income to common shareholders                  $  127,840   $    3,115

Net interest income

The following table summarizes our net interest income for the years ended December 31, 2013 and 2012:

                                                               For the year ended
                                                                  December 31,
(in thousands)                                                  2013         2012

Interest income:
Interest on bonds                                            $    37,280   $ 64,916
Interest on loans and short-term investments                         648        875
Total interest income                                             37,928     65,791
Asset related interest expense:
Senior interests in and debt owed to securitization trusts        11,348     13,011
Mandatorily redeemable preferred shares                            6,508      8,231
Notes payable and other debt, bond related                         5,140      2,991
Notes payable and other debt, non-bond related                     1,256      2,426
Total interest expense                                            24,252     26,659
Total net interest income                                    $    13,676   $ 39,132

Total net interest income decreased by 65.1% or $25.5 million, for the year ended December 31, 2013 as compared to 2012.

Interest on bonds decreased by $27.6 million for the year ended December 31, 2013 as compared to 2012. This decline was mainly due to a $449.8 million decline in the weighted average bond UPB (from $1,038.7 million for the year ended December 31, 2012 to $588.9 million for the year ended December 31, 2013) due primarily to the sale of our common shares in TEB. Partially offsetting this decline was an increase in the weighted average effective interest rate of 8 bps to 6.33%, which was primarily driven by an increase in cash collected on non-accrual bonds.

Asset related interest expense decreased 9.0% or $2.4 million for the year ended December 31, 2013 as compared to 2012. This decrease was mainly due to the transfer of our senior interests in and debt owed to securitization trusts and mandatorily redeemable preferred shares to the purchaser of TEB, as well as a $16.3 million decline in the weighted average balance of our non-bond related notes payable and other debt. These declines were partially offset by the acceleration of unamortized debt issuance costs and discounts in the second quarter of 2013 related to senior interests in and debt owed to securitization trusts ($4.6 million) and mandatorily redeemable preferred shares ($3.2 million) that were transferred to the purchaser of TEB. Also partially offsetting these declines was an increase in bond related notes payable and other debt interest expense as a result of certain bond transfers to the purchaser of TEB that did not qualify for sale accounting; therefore, secured borrowings and the associated interest expense increased.

Other interest expense

The following table summarizes our other interest expense for the years ended December 31, 2013 and 2012:

                                 For the year ended
                                    December 31,
(in thousands)                    2013         2012

Other interest expense:
Subordinate debentures         $    10,741   $ 14,774
Notes payable and other debt         4,247      3,768
Total other interest expense   $    14,988   $ 18,542

Other interest expense (which represents interest expense associated with debt which does not finance interest-bearing assets) decreased $3.6 million for the year ended December 31, 2013 as compared to 2012. This decline was mainly driven by repurchases of outstanding subordinate debentures during 2012 and first quarter 2013 of $42.7 million and $45.5 million, respectively.

Fee and Other Income

The following table summarizes our fee and other income for the years ended
December 31, 2013 and 2012:

                                                           For the year ended
                                                              December 31,
(in thousands)                                            2013           2012

Income on preferred stock investment                   $     5,260    $     5,749
Asset management and advisory fees (recorded in
"Other income")                                                931            882
Syndication fees (recorded in "Other income")                  138            206
Other income                                                 1,581          1,437
Total fee and other income                             $     7,910    $     8,274

Fee and other income decreased by 4.40%, or $0.4 million, for the year ended December 31, 2013 as compared to 2012 mainly due to declines in income on preferred stock as a result of $5.0 million of par share redemptions in July 2012 that carried an average annual dividend rate of 17.5%.

Operating Expenses

The following table summarizes our operating expenses for the years ended
December 31, 2013 and 2012:

                               For the year ended
                                  December 31,
(in thousands)                  2013         2012

Salaries and benefits        $    12,318   $ 10,428
General and administrative         4,699      5,025
Professional fees                  8,492      6,764
Other expenses                     6,245      6,446
Total operating expenses     $    31,754   $ 28,663

Total operating expenses increased 10.8%, or $3.1 million, mainly due to increases in salaries and benefits and professional fees.

Salaries and benefits increased by $1.9 million year over year to $12.3 million for the year ended December 31, 2013 mainly due to increased expenses related to employee stock awards as well as severance expense. During 2013, the Company recognized $1.7 million of salaries and benefits expense related to employee stock option awards as compared to $0.2 million during 2012. Employee stock options are accounted for as liabilities and as the Company's common share price increased during 2013 the related liability increased as well. The Company recognized $0.2 million in severance expense during 2013, but did not recognize any severance expense during 2012.

Professional fees increased $1.7 million for the year ended December 31, 2013 as compared to 2012. This increase was mainly due to $1.5 million of legal and other professional fees incurred during the second quarter of 2013 associated with the TEB sale.

Net Gains (Losses) on Assets, Derivatives and Extinguishment of Liabilities

The following table summarizes our net gains on assets, derivatives and early
extinguishment of liabilities for the years ended December 31, 2013 and 2012:

                                                              For the year ended
                                                                 December 31,
(in thousands)                                                 2013        2012

Net realized gains on bonds                                 $   77,230   $   1,397
Net gains on loans                                               1,535         332
Net gains (losses) on derivatives                                   18     (1,648)
Net gains (losses) on early extinguishment of liabilities       36,583     (1,774)
Total net gains (losses) on bonds, loans, derivatives and
   early extinguishment of liabilities                      $  115,366   $ (1,693)

Net gains on bonds increased $75.8 million for the year ended December 31, 2013 as compared to 2012. Substantially all of this increase was due to realized gains of $75.7 million associated with bonds transferred as part of the TEB sale. These gains had been previously recorded as "Accumulated other comprehensive income" ("AOCI"). As a result of the bonds being transferred to the purchaser of TEB, the Company reduced AOCI by $75.7 million and increased earnings by $75.7 million having no impact on overall common shareholders' equity.

For the year ended December 31, 2013, net gains on early extinguishment of liabilities were $36.6 million as compared to net losses of $1.8 million for 2012. During 2013, we recognized a $37.9 million gain on the repurchase of $45.5 million of subordinate debt UPB for $17.4 million, plus accrued interest. The gain represents the difference between the cash payment of $17.4 million and the carrying value of the debt of $56.9 million, reduced by the acceleration of $1.6 million of debt issuance costs. Partially offsetting this gain was a $1.5 million loss on the redemption of all of the outstanding Series A mandatorily redeemable preferred shares. During 2012, we recognized losses of $2.0 million in the fourth quarter associated with the replacement of our securitization debt that had credit enhancement and liquidity facilities expiring on March 31, 2013 as well as losses of $0.3 million associated with the early termination of five securitization trusts. These losses were partially offset by gains of $0.5 million on repurchases of mandatorily redeemable preferred shares.

During 2013 the Company had $0.8 million of mark-to-market gains on derivatives resulting from rising interest rates during the period, offset by $0.8 million of interest paid. The net losses of $1.6 million for 2012 were comprised of $4.3 million of interest paid, partially offset by $2.7 million of mark-to-market gains. The $2.7 million of mark-to-market gains were primarily related to interest rate swaps that were terminated in the first quarter and fourth quarter of 2012, and a TRS that was terminated in the second quarter of 2012.

Net gains on loans increased $1.2 million for the year ended December 31, 2013 as compared to 2012. The $1.5 million of gains recorded during 2013 were comprised of $1.2 million of cash proceeds received on loans which had no carrying value and lower of cost or market ("LOCOM") gains of $0.3 million. The $0.3 million of gains recorded during 2012 were all related to cash proceeds received on loans which had no carrying value.

Net Gains Due to Real Estate Consolidation and Foreclosure

The following table summarizes our net gains due to real estate consolidation and foreclosure for the years ended December 31, 2013 and 2012:

For the year ended December 31, (in thousands) 2013 2012

Net gains due to real estate consolidation and foreclosure $ 10,895 $ 5,404

Net gains due to real estate consolidation and foreclosure were $10.9 million and $5.4 million for the years ended December 31, 2013 and 2012, respectively.

On April 30, 2013, a non-profit entity consolidated by the Company was assigned the GP interest in three properties for which the Company provided debt financing. On April 30, 2013, we estimated the fair value of our bonds secured by these three properties to be $28.1 million. The UPB of our bonds was $34.4 million and cumulative impairments and cumulative unrealized gains were $6.5 million and $4.5 million, respectively, at the date of consolidation. Upon assignment of the GP interests, the properties were consolidated and our bonds were eliminated against the corresponding mortgage payables of the properties. As a result, the unrealized gains of $4.5 million which were recorded within AOCI were transferred into the consolidated statements of operations and recorded as "Net gains due to real estate and foreclosure" having no impact on common shareholders' equity.

On May 1, 2013, the non-profit entity referred to above was assigned the GP interest in two properties for which the Company provided debt financing. On May 1, 2013, we estimated the fair value of our bonds secured by these two properties to be $9.9 million, of which $0.8 million was recorded as an increase to AOCI at the date of consolidation. The UPB of our bonds was $10.9 million and cumulative impairments and cumulative unrealized gains were $3.7 million and $2.7 million, respectively (including the $0.8 million increase discussed above), at the date of consolidation. Upon assignment of the GP interests, the properties were consolidated and our bonds were eliminated against the corresponding mortgage payables of the properties. As a result, unrealized gains of $2.7 million were transferred out of AOCI and into the consolidated statements of operations and recorded as "Net gains due to real estate and foreclosure." Common shareholders' equity increased $0.8 million as a result of the bond valuation increase recorded on May 1, 2013 just prior to the property consolidation.

On May 31, 2013, the Company took a deed-in-lieu of foreclosure on a property serving as collateral for one of the Company's bonds with an estimated fair value of $7.3 million. The UPB of the bond was $7.3 million and cumulative impairments and cumulative unrealized gains were $0.7 million and $1.3 million, respectively, at the date of consolidation. Upon real estate acquisition, the property was consolidated and the bond was derecognized. As a result, the unrealized gains of $1.3 million which were recorded through AOCI were transferred into the consolidated statements of operations and recorded as "Net gains due to real estate and foreclosure" having no impact on overall equity. On May 31, 2013, immediately after taking the deed-in-lieu of foreclosure, the Company sold the property to a third party for its carrying value.

On August 6, 2013, the Company foreclosed on a property serving as collateral for one of the Company's bonds with an estimated fair value of $10.2 million. The UPB of the bond was $10.2 million and cumulative impairments and cumulative unrealized gains were each $2.4 million at the date of consolidation. Upon foreclosure, the property was consolidated and the bond was derecognized. As a result, the unrealized gains of $2.4 million which were recorded through AOCI were transferred into the consolidated statements of operations and recorded as "Net gains due to real estate and foreclosure" having no impact on overall equity. On August 14, 2013, the Company sold the property to a third party for $10.7 million.

On April 30, 2012, the non-profit entity referred to above was assigned the GP interest in a property for which the Company provided debt financing. On April 30, 2012, we estimated the fair value of our bond interest to be $12.5 million, of which $2.0 million was recorded as an increase to AOCI at the date of consolidation. The UPB of our bond interest was $12.8 million and cumulative impairments and cumulative unrealized gains were $2.9 million and $2.6 million, respectively (including the $2.0 million increase discussed above), at the date . . .

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