Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2004

Commission File Number: 001-11981

MUNICIPAL MORTGAGE & EQUITY, LLC

(443) 263-2900
(Registrant’s telephone number, including area code)

     Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 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 such reports), and (2) has been subject to such filing requirements for the past 90 days. þ Yes o No

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

     The Registrant had 35,015,253 common shares outstanding as of November 3, 2004.

MUNICIPAL MORTGAGE & EQUITY, LLC
INDEX TO FORM 10-Q

Forward-Looking Information

     This Quarterly Report on Form 10-Q contains forward-looking statements, which involve certain risks and uncertainties. Assumptions contained in various portions of this Quarterly Report on Form 10-Q involve judgments with respect to, among other things, future economic market conditions and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond the control of the Company. Although the Company believes that the assumptions underlying the forward-looking information included herein are reasonable, any of the assumptions could be inaccurate. Therefore, there can be no assurance that such forward-looking information will prove to be accurate. In light of the significant uncertainties inherent in forward-looking information, the inclusion of such information should not be regarded as a representation by the Company or any other person that the objectives and plans of the Company will be achieved.

PART I.
FINANCIAL INFORMATION

2

Item 1. Financial Statements.

MUNICIPAL MORTGAGE & EQUITY, LLC
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
(unaudited)

The accompanying notes are an integral part of these financial statements.

3

The accompanying notes are an integral part of these financial statements.

5

The accompanying notes are an integral part of these financial statements.

9

MUNICIPAL MORTGAGE & EQUITY, LLC
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

NOTE 1 — BASIS OF PRESENTATION

     Municipal Mortgage & Equity, LLC (“ MuniMae ” and, together with its subsidiaries, the “ Company ”) provides debt and equity financing to developers of multifamily housing and other real estate investments. The Company invests in tax-exempt bonds, or interests in bonds, issued by state and local governments or their agencies or authorities to finance multifamily housing developments. These tax-exempt bonds are not general obligations of state and local governments, or the agencies or authorities that issue the bonds. The multifamily housing developments, as well as the rents paid by the tenants, typically secure these investments. The Company also invests in other housing-related debt and equity investments, including equity investments in real estate operating partnerships; tax-exempt bonds, or interests in bonds, secured by student housing or assisted living developments; and tax-exempt bonds issued by community development districts to finance the development of community infrastructure supporting single-family housing or commercial developments and secured by specific payments or assessments pledged by the local improvement district that issues the bonds (“ CDD bonds ”). Interest income derived from the majority of the Company’s bond investments is exempt income for Federal income tax purposes.

     The Company is also a tax credit syndicator and a mortgage banker. As a syndicator, the Company acquires and sells to investors interests in partnerships that receive and distribute to investors low-income housing tax credits. The Company earns syndication fees on the placement of these interests with investors. The Company also earns fees for providing guarantees on certain tax credit equity funds and for managing the low-income housing tax credit equity funds it has syndicated. Mortgage banking activities include the origination of, investment in and servicing of investments in multifamily housing, both for its own account and on behalf of third parties. These investments generate taxable income.

     MuniMae was organized in 1996 as a Delaware limited liability company. As a limited liability company, the Company combines many of the limited liability, governance and management characteristics of a corporation with the pass-through income features of a partnership. Since MuniMae is classified as a partnership for Federal income tax purposes, MuniMae is not itself subject to Federal and, in most cases, state and local income taxes. Instead, each shareholder must include his or her distributive share of MuniMae’s income, deductions and credits on the shareholder’s income tax return. Most of the Company’s mortgage banking and tax credit syndication activities are conducted through subsidiaries classified as corporations for Federal income tax purposes, which do not have the pass-through income features of a partnership.

10

     The condensed consolidated financial statements include the accounts of MuniMae, its wholly owned subsidiaries, its majority owned subsidiaries and variable interest entities (“ VIEs ”) where the Company was determined to be the primary beneficiary of the VIE. All significant intercompany balances and transactions have been eliminated.

     In 1999, the Company placed a substantial portion of its tax-exempt bonds and residual interests in bond securitizations in an indirect subsidiary of the Company, MuniMae TE Bond Subsidiary, LLC (“ TE Bond Sub ”). TE Bond Sub sold Series A, Series B and Series A-1 and Series B-1 Cumulative Preferred Shares (collectively, the “ TE Bond Sub Preferred Shares ”) to institutional investors in May 1999, June 2000 and October 2001, respectively. In October 2004, TE Bond Sub sold $73.0 million of additional preferred shares (see further discussion in Note 15). The TE Bond Sub Preferred Shares have a senior claim to the income derived from the investments owned by TE Bond Sub. Any income from TE Bond Sub available after payment of the cumulative distributions of the TE Bond Sub Preferred Shares is allocated to the Company, which holds all of the common equity interests. As a result, the assets of TE Bond Sub and its subsidiaries, while indirectly controlled by MuniMae and thus included in the consolidated financial statements of the Company, are legally owned by TE Bond Sub and are not available to the creditors of the Company. The Company’s common equity interest in TE Bond Sub was $298.3 million and $267.0 million at September 30, 2004 and December 31, 2003, respectively.

     The Company’s common equity interest in TE Bond Sub was pledged as collateral to secure the Company’s total return swap associated with a term loan. The balance outstanding on the term loan was $10.0 million and $38.0 million at September 30, 2004 and December 31, 2003, respectively. The common equity interest in TE Bond Sub held by MuniMae is subject to the claims of the creditors of MuniMae and in certain circumstances could be foreclosed.

     On July 1, 2003, the Company acquired the Housing and Community Investing (“ HCI ”) business of Lend Lease Corporation Limited (“ Lend Lease ”) for $102.0 million in cash. HCI is a syndicator of low-income housing tax credit equity investments. The acquisition of this affordable housing tax credit syndication operation has enhanced the Company’s competitive position, and as a result the Company is one of the nation’s leaders in the affordable housing industry. The HCI business is owned by MMA Financial TC Corp. (“ TC Corp ”), a wholly owned subsidiary of the Company. The Company’s results for September 30, 2004 reflect a full nine months of activity from TC Corp.

     Of the total purchase price for HCI, approximately $75.0 million was allocated to goodwill. The factors contributing to a purchase price including this goodwill included: (a) the Company’s valuation, which focused on HCI’s historical and projected cash flows as well as its business prospects and strategic value, supported the purchase price; (b) the purchase included very few tangible or intangible assets (other than certain asset management contracts) to which significant value could be assigned; and (c) the Company did not assign value to HCI’s customer relationships beyond the asset management contracts acquired.

11

     Of the total purchase price for HCI, approximately $32.0 million was allocated to asset management contracts. The amortizable intangible assets represent existing contracts that relate primarily to monitoring properties underlying the real estate investment vehicles sponsored or structured by HCI to insure these properties are producing expected returns with appropriate risk controls. The fair value assigned to the asset management contracts is based on a valuation model prepared internally using estimates and assumptions provided by management. The Company is amortizing the fair value of each contract on a straight-line basis over the contract’s estimated useful life. The Company amortizes the contract intangible assets at the individual contract level because the fair value of the group of contract intangible assets was allocated to each individual contract intangible asset at the date of acquisition. The weighted average useful life of all these assets is 7.7 years. The Company evaluates its intangible assets subject to amortization for possible impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. If the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the intangible asset are less than the carrying amount at the date of the evaluation, an impairment loss is recognized. The impairment loss is measured as the amount by which the carrying amount exceeds the fair value of the intangible asset.

     Uncertainties regarding contingent liabilities, several litigation matters and an Internal Revenue Service (“ IRS ”) audit of a partnership included in one of the tax credit equity funds sponsored by HCI precluded the Company from finalizing the purchase price allocation as of the closing date of July 1, 2003. These uncertainties included, among other things, judicial determinations on requests for class action certification, potential changes to the scope of the IRS audit and similar factors. During the second and third quarters of 2004, based on evaluation of these matters by management and the Company’s inside counsel, the Company finalized its allocations to these contingent liabilities and recorded a decrease in goodwill of $0.9 million.

     The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (the “ SEC ”) and in the opinion of management contain all adjustments (consisting of only normal recurring accruals) necessary to present a fair statement of the results for the periods presented. These results have been determined on the basis of accounting principles and policies discussed in Note 1 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 (the “ Company’s 2003 Form 10-K ”). Certain information and footnote disclosures normally included in financial statements presented in accordance with generally accepted accounting principles (“ GAAP ”) have been condensed or omitted. The accompanying financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s 2003 Form 10-K. Certain 2003 amounts have been reclassified to conform to the 2004 presentation.

Loan Servicing, Origination and Construction Administration Fees

     The Company earns fees in connection with the servicing of loans for third parties. The Company earns construction administration fees in connection with the servicing of its construction loans. The Company earns origination fees on the origination of tax-exempt bonds. The Company may also earn origination fees on agency bonds and supplemental loans. The fees on bonds and loans, which are carried on the Company’s balance sheet, are deferred and amortized into interest income to approximate a level yield over the estimated life of the related bond or loan.

12

     The fees for servicing loans for others are recognized as income over the period in which the Company performs the associated services.

Brokerage Fees

     The Company’s brokerage fees are earned through its relationship with the Midland Affordable Housing Group Trust (the “ Group Trust ”) (see Note 1 under Mortgage Banking Activities in the Company’s 2003 Form 10-K). The Group Trust commits to make permanent loans to borrowers through arrangements that were originated by the Company. The Company does not provide permanent loan financing to the borrower. The Company earns brokerage fees for establishing the meeting of the borrower and the Group Trust and recognizes revenue when all significant services have been performed, which typically coincides with when the Group Trust commits to extend permanent financing.

Other-than-Temporary Impairments and Valuation Allowances on Investments

     The Company evaluates its investments on an ongoing basis to determine whether other-than-temporary impairments exist or a valuation allowance is needed. The Company considers the credit risk exposure of the investment, the Company’s ability and intent to hold the investment for a period of time to allow for anticipated recoveries in market value, the length of time and extent to which the market value has been less than carrying value, the financial condition of the underlying collateral including the payment status of the investment and general economic and other more specific conditions applicable to the investment, other collateral available to support the investment and whether the Company expects to recover all amounts due under its mortgage obligations on a net present value basis. Third party quotes of securities with similar characteristics or discounted cash flow valuations are used to assist in determining if an impairment exists on investments. If the fair value of the investment is less than its amortized cost and after assessing the above-mentioned factors, it is determined that an other-than-temporary impairment exists, the impairment is recorded currently in earnings and the cost basis of the security is adjusted accordingly. When the Company believes that it is probable that it will not collect all amounts due, including principal and interest, under the terms of an investment, it records a valuation allowance. The Company also evaluates other receivables and advances for collectibility on an ongoing basis. When the Company believes it is probable that it will not collect all amounts due, the balance is written down to its realizable value.

13

Long-Lived Assets

     The Company evaluates its long-lived assets for possible impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. If the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the long-lived asset are less than the carrying amount at the date of the evaluation, an impairment loss is recognized. The impairment loss is measured as the amount by which the carrying amount exceeds the fair value of the long-lived asset.

Syndication of Low-Income Housing Tax Credits

     The Company acquires and sells interests in partnerships (or “ tax credit equity funds ”) that provide low-income housing tax credits for investors. The Company earns syndication fees on the placement of these interests with investors. In conjunction with the sale of these partnership interests, the Company may provide performance guarantees on the underlying real estate project partnerships owned by the tax credit equity funds (“Project Partnerships”) or guarantees to the fund investors. The Company earns fees for providing these guarantees. The Company also earns asset management fees for managing the low-income housing tax credit equity funds syndicated. The Company also acts as general partner of the tax credit equity funds and receives a pro rata share of cash distributions that may be distributed to the tax credit equity funds’ partners pursuant to a sale of the Project Partnerships or their assets. The Company’s general partner interests range from 0.1% to 1.0%. The above-mentioned fees and the Company’s pro rata share of income and losses from the Company’s general partnership interests constitute all sources of income or gain and losses from tax credit syndication transactions. All fees represent normal market rates.

     The Company, through a subsidiary, acquires limited partner interests in Project Partnerships. As investor capital is raised and investors are admitted as limited partners in, or subsequently contribute additional capital to, the tax credit equity funds, the tax credit equity funds acquire those Project Partnership limited partner interests from the subsidiary. The Company evaluates these transfers as real estate transactions, notwithstanding the fact that it is acquiring and transferring limited partner interests and not the underlying real property itself. The Company does not transfer options or contracts to buy properties in its tax credit syndication business.

     The Company’s significant accounting policies that directly relate to the syndication of low-income housing tax credits are described below.

Syndication and Guarantee Fees

     Syndication fees are earned when third party investors are admitted as limited partners into the tax credit equity fund sponsored by the Company. Guarantee fees are earned when the Company provides certain performance guarantees to the limited partners of the tax credit equity fund or indemnifies third party guarantors of the tax credit equity fund with respect to the projected yield of the limited partnership interests. Guarantees are only provided to some of the tax credit equity funds. Syndication fees are recognized when the earnings process is complete and collectibility is reasonably assured. Guarantee fees are recognized ratably over the life of the guarantee. As an additional stipulation, syndication fees are considered earned and are recognized as income upon receipt of the initial cash payment from investors into the syndicated low-income housing tax credit equity funds, provided all of the following have occurred: (1) the investor has made a significant down payment; (2) the properties

14

for funds have been identified; (3) a firm contract exists that requires an investor to fund capital contribution installments; (4) all services required to earn the fee have been performed to contract specifications; and (5) all appropriate documents have been executed. The Company does not receive ownership interests in lieu of syndication or guarantee fees. Since March 31, 2004, as a result of the consolidation of certain tax credit equity funds pursuant to Financial Interpretation No. 46 (Revised), “Consolidation of Variable Interest Entities” (“ FIN 46R ”) (see New Accounting Pronouncements below), syndication fees previously recognized as income have been reclassified as intercompany transactions and have, accordingly, been eliminated in consolidation.

Asset Management Fees

     Asset management fees are earned by the Company for managing the assets of the tax credit equity funds, including monitoring the compliance of the properties with tax credit regulations. The amount of asset management fees due to the Company is outlined in the tax credit equity syndication fund documents. The Company earns asset management fees from the tax credit equity funds on an annual basis calculated based on a percentage of each tax credit equity fund’s invested capital. The asset management fees are paid from available cash from the tax credit equity funds. The Company records asset management fees into income when the amount that the Company will receive is determinable and collection is reasonably assured. These fees are typically paid to the Company annually in arrears. Upon the adoption of FIN 46R, the Company was required to eliminate intercompany asset management fees earned through services provided to tax credit equity funds consolidated by the Company.

15

New Accounting Pronouncements

     In January 2003, the Financial Accounting Standards Board (“ FASB ”) approved Financial Interpretation No. 46, “Consolidation of Variable Interest Entities” (“ FIN 46 ”). FIN 46 requires the consolidation of a company’s equity investment in a VIE if the company is the primary beneficiary of the VIE and if risks are not effectively dispersed among the owners of the VIE. The company is considered to be the primary beneficiary of the VIE if the company absorbs the majority of the losses of the VIE. FIN 46 is effective for VIEs created after January 31, 2003. For any VIE in which the Company held an interest that it acquired before February 1, 2003, FIN 46 was effective for the first interim reporting period beginning after June 15, 2003. In December 2003, FASB approved various amendments to FIN 46 and released FIN 46R. In addition, FASB extended the effective date of FIN 46 until the first reporting period ending after March 15, 2004 for VIEs which are not special purpose entities, and the Company elected to defer adoption of that portion of FIN 46 until that time.

     The Company’s residual interests in bond securitizations represent equity interests in VIEs, and the Company is the primary beneficiary of those VIEs. The Company determined that its bond securitization trusts were special purpose entities (“ SPE s”) and did not qualify for the deferral. Therefore, these securitization trusts were consolidated at December 31, 2003. The Company examined each of its SPEs to determine if it meets the definition of a qualified SPE. Certain of the Company’s SPEs are qualified SPEs and are not consolidated accordingly.

     The Company initially measured the assets and liabilities of the securitization trusts at the carrying amounts.

     The Company has general partnership interests in low-income housing tax credit equity funds where the respective funds have one or more limited partners. The determination of whether the Company is the primary beneficiary of (and must consequently consolidate) a given tax credit equity fund depends on a number of factors, including the number of limited partners and the rights and obligations of the general and limited partners in that fund. Upon adoption of FIN 46R in March 2004, the Company determined that it was the primary beneficiary in certain of the funds it originated where there are multiple limited partners. As a result, the Company consolidated these equity investments at March 31, 2004. The Company’s general partner interests typically represent a one percent or less interest in each fund. For those funds which it consolidates, the Company reports the net assets of the funds, consisting primarily of restricted cash, investments in real estate partnerships and notes payable, in the Company’s consolidated balance sheet. In addition, the limited partnership interests in the funds, owned by third party investors, are reported as a minority interest. The net income (loss) from these tax credit equity funds is reported in the appropriate line items of the

16

Company’s consolidated statement of income. An adjustment for the income (loss) allocable to the limited partners (investors) in the funds is recorded through minority interest expense (income) in the Company’s consolidated statement of income. At March 31, 2004, the Company recorded net assets of these tax credit equity funds of $1.2 billion, consisting primarily of $1.4 billion in investment in partnerships, $129.5 million in restricted assets and $208.7 million in notes payable, which are non-recourse to the Company. The Company recorded $1.2 billion in minority interest in subsidiary companies. As of March 31, 2004, the Company also recorded a $0.5 million cumulative effect of a change in accounting principle as a result of recording the net equity allocable to the Company’s general partner interest in the funds.

     At times, the Company takes ownership of the general partnership interest in the underlying Project Partnerships in which the tax credit equity funds hold investments. For those property-level general partnership interests (a) owned by the Company and (b) relating to Project Partnerships included in tax credit equity funds consolidated pursuant to FIN 46R, the Company has discontinued the equity method of accounting and consolidated the underlying Project Partnership. Such consolidation was recorded in the second quarter and resulted in an increase in assets of $172.0 million, an increase in liabilities of $172.0 million and net income of zero. The Company also has a general partnership interest in certain other low-income housing tax credit equity funds where it has concluded that it is not the primary beneficiary. Accordingly, funds with assets of $970.3 million and liabilities of $90.8 million as of March 31, 2004 have not been consolidated and continue to be accounted for using the equity method.

     The Company initially measured the assets and liabilities of the tax credit equity funds at fair value as of July 1, 2003, the acquisition date of HCI, which was the point in time that the Company first met the criteria to be the primary beneficiary of the VIE. For funds consolidated pursuant to FIN 46R as of March 31, 2004, the fair value was used to record the net assets of the tax credit equity funds when the fair value was less than the carrying amount. For funds where the Company took ownership of the general partnership interest in the underlying Project Partnership in which the fund held an investment, the underlying Project Partnership was recorded at cost in consolidation.

Stock Based Employee Compensation

     The Company accounts for both the non-employee director share plans and the employee share incentive plans (see Note 1 and Note 17 to the Company’s 2003 Form 10-K) under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.” No options were issued pursuant to the plans and, accordingly, no compensation expense was recognized for options issued under the plans for the nine months ended September 30, 2004. The Company issued 7,000 and 30,000 options, respectively, in the first and second quarters of 2003. The Company estimated the fair value of each option awarded using the Black Scholes option-pricing model with the following assumptions:

17

     The following table illustrates the effect on net income and earnings per share if the compensation expense had been determined based on the fair value recognition provisions of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” ( “ FAS 123 ” ) , as amended by Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure.” There would be no effect on net income from the fair value method of accounting under FAS 123 for the three and nine months ended September 30, 2004.

Restatement

     Subsequent to the filing of the March 31, and June 30, 2004 Form 10-Q’s, management determined that the Company had not properly accounted for certain compensation costs associated with an employee compensation arrangement executed during the first quarter of 2004. Accordingly, the Company restated those Form 10-Q’s to recognize the appropriate amount of compensation cost within salaries and benefits in the income statement and accounts payable and accrued expenses in the balance sheet. Corresponding adjustments were made to shareholders’ equity, earnings (loss) per share and cashflows accordingly. This restatement had no effect on the Company’s income tax benefit (expense). No other types of adjustments to the Company’s consolidated financial statements were made in association with the restatement.

18

NOTE 2 — INVESTMENT IN TAX-EXEMPT BONDS

     The Company originates for its own account investments in tax-exempt bonds. Tax-exempt bonds are issued by state and local government authorities to finance multifamily housing developments and other types of real estate. The bonds are typically secured by nonrecourse mortgage loans on the underlying properties.

     The Company invests in other housing-related securities, including tax-exempt bonds issued by community development districts, to finance the development of infrastructure supporting single-family housing or commercial developments and secured by specific payments or assessments pledged by the local improvement district that issues the bonds. The Company also invests in tax-exempt bonds, or interests in bonds, secured by student housing or assisted living developments.

     The Company’s sources of capital to fund these lending activities include proceeds from equity and debt offerings, securitizations, loans from warehousing facilities with various pension funds and commercial banks, and draws on lines of credit. The Company earns interest income from its investment in tax-exempt bonds and taxable loans. The Company also earns origination and construction administration fees, through subsidiaries classified as corporations for Federal income tax purposes, for originating and servicing the bonds during the construction period.

     For a further discussion of the general terms of tax-exempt bonds, see Note 1 to the Company’s 2003 Form 10-K.

     As of September 30, 2004 and December 31, 2003, the Company held $1,220.4 million and $1,044.0 million of tax-exempt bonds, respectively. The following tables summarize the tax-exempt bonds by type.

19

Note: Of the tax-exempt bonds shown in the table above, TE Bond Sub owned bonds with aggregate fair value of $898.1 million and $840.1 million as of September 30, 2004 and December 31, 2003, respectively.

     During the nine months ended September 30, 2004, the Company invested in tax-exempt bonds with a face amount of $290.5 million for $285.1 million. Of the total face amount of $290.5 million, $213.1 million represents the Company’s new primary investments (bonds which the Company originated), $70.1 million reflects new secondary market investments (previously issued bonds purchased from third parties) and $7.3 million reflects the refunding of a non-performing bond that the Company had purchased in 2003.

     The Company structures tax-exempt bonds that allow the borrower to make draws on the bonds throughout the construction period (“ draw down bonds ”). In the year these bonds are originated, the total draws for the year are reported as new primary investments. The Company originated a face amount of $49.5 million in new draw down bonds during the nine months ended September 30, 2004. The Company also funded an additional $33.5 million of existing tax-exempt draw down bonds with a face amount of $33.5 million for the nine months ended September 30, 2004.

     Seven tax-exempt bonds with an amortized cost of $37.7 million were repaid during the nine months ended September 30, 2004. One of the bonds was repaid as a result of a refunding of the bond. The Company continues to hold the refunded bond. The Company recognized a gain of $1.2 million on the repayment of the nonrefunded bonds. In September 2004, the Company both acquired Lakeview by deed in lieu of foreclosure and sold the property for net proceeds of $16.0 million. All activities related to this property have been classified as discontinued operations in the accompanying condensed consolidated statements of income.

20

     Three tax-exempt bonds with an amortized cost of $46.7 million were sold into a securitization trust during the nine months ended September 30, 2004. The Company holds the D-certificate and recognized a loss of $0.5 million on the sale of these bonds.

     In order to facilitate the securitization of certain assets at higher leverage ratios than otherwise available to the Company without the posting of additional collateral, the Company has pledged additional bonds to various pools that act as collateral for senior interests in certain securitization trusts. From time to time, the Company also pledges bonds as collateral for letters of credit, lines of credit, warehouse lending arrangements and other investments and derivative agreements. At September 30, 2004 and December 31, 2003, the total carrying amount of the tax-exempt bonds pledged as collateral was $534.3 million and $452.3 million, respectively.

NOTE 3 — LOANS RECEIVABLE

     The Company’s loans receivable consist primarily of construction loans, permanent loans, supplemental loans and other taxable loans. For a further discussion of the general terms of loans held by the Company and the allowance for loan losses, see the description of mortgage banking activities in Note 1 to the Company’s 2003 Form 10-K. The following table summarizes loans receivable by loan type at September 30, 2004 and December 31, 2003.

Note: Supplemental loans include pre-development loans, bridge loans and other loans.

     The Company had loans receivable held for sale of $43.1 million and $54.5 million at September 30, 2004 and December 31, 2003, respectively. These loans committed for sale are sold to Federal National Mortgage Association (“ Fannie Mae ”), Government National Mortgage Association (“ GNMA ”) and third party conduit lenders. Due to the short time the Company holds these loans, carrying value approximates fair value.

     The Company pledges loans as collateral for the Company’s notes payable, warehouse lending arrangements and line of credit borrowings. In addition, in order to facilitate the securitization of certain assets at higher leverage ratios than otherwise available to the Company without the posting of additional collateral, the Company has pledged additional taxable loans to a pool that acts as collateral for senior interests in certain securitization trusts and credit enhancement facilities. At September 30, 2004 and December 31, 2003, the total carrying amount of the loans receivable pledged as collateral was $623.5 million and $480.1 million, respectively.

NOTE 4 — INVESTMENT IN PARTNERSHIPS

     The Company’s investments in partnerships consist of equity interests in real estate operating partnerships. The Company’s investments in partnerships are accounted for using the equity method. The Company ceases recording losses on an investment in partnership when the cumulative losses and distributions from the partnership exceed the carrying amount of the investment and any advances made by the Company. After the Company’s investment in

21

such partnership reaches zero, cash distributions received from these investments are recorded as income. For partnerships in which the Company is a general partner (for example, the Company’s interests in the tax credit equity syndication funds which it originates), the Company recognizes losses to the extent of its partnership liability, regardless of the Company’s basis in its partnership interest. The following table summarizes investment in partnerships by major category at September 30, 2004 and December 31, 2003:

NOTE 5 — INVESTMENTS IN DERIVATIVE FINANCIAL INSTRUMENTS

     At September 30, 2004 and December 31, 2003, the Company’s investments in derivative financial instruments consisted of interest rate swaps, put option contracts and total return swaps. For a further discussion of the Company’s investments in derivative financial instruments, see Note 7 to the Company’s 2003 Form 10-K. The following table provides certain information with respect to the derivative financial instruments held by the Company at September 30, 2004 and December 31, 2003:

22

Investments in derivative financial instruments:

NOTE 7 — NOTES PAYABLE AND DEBT

     The Company’s notes payable consist primarily of notes payable and advances under line of credit arrangements that are used to: (1) finance construction lending needs; (2) finance working capital needs; (3) warehouse real estate operating partnerships before they are placed into tax credit equity funds; and (4) warehouse permanent loans before they are purchased by third parties. As of September 30, 2004, notes payable also includes factored and mortgage notes payable reflected on the Company’s balance sheet as a result of consolidating certain tax credit equity funds upon adoption of FIN 46R (discussed in Note 1). The factored notes payable are obligations of the limited partners (investors) of the tax-credit funds and collateralized by the investors’ subscription receivables. The factored notes payable are non-recourse and not guaranteed by the Company. The mortgage notes payable are obligations of Project Partnerships, in which the Company is the general partner, and are non-recourse and not guaranteed by the Company. The Company’s short- and long-term debt relates to securitization transactions and other financing transactions that the Company has recorded as borrowings. The following table summarizes notes payable and debt at September 30, 2004 and December 31, 2003:

Covenant Compliance

     As a result of the consolidation of certain assets and liabilities relating to the Company’s tax credit equity syndication business pursuant to FIN 46 as of March 31, 2004, and the reclassification, pursuant to Financial Accounting Standards No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” as of September 30, 2003, as liabilities of the Company’s outstanding preferred shares in a subsidiary company, during the second quarter of 2004 the Company, in the absence of a waiver or amendment, would have been in default of a financial covenant under a $200.0 million short-term line of credit. Consequently, the Company and the lender executed a waiver of this default through June 30, 2004. While under the waiver of default, the Company successfully negotiated an amendment to the line of credit to revise the covenant and cure the

24

default. As of September 30, 2004, $157.2 million of debt was outstanding under this line of credit.

     During the third quarter of 2004, the Company, in the absence of a waiver or amendment, would have been in default of a leverage covenant under a $20.0 million short-term line of credit. Consequently, the Company and the lender executed a waiver of this default. The parties are also negotiating an amendment to the line of credit to address this issue. As of September 30, 2004, $12.6 million of debt was outstanding under this line of credit. The debt is included in lines of credit-unaffiliated entities in the table above.

     As of September 30, 2004 the Company was in compliance with all covenants applicable to other facilities.

NOTE 8 — SUBORDINATE DEBENTURES

     A consolidated indirect wholly owned subsidiary of the Company, Midland Financial Holdings, Inc. (“ MFH ”), formed MFH Financial Trust I (“ MFH Trust ”) in 2003 as a special purpose financing entity. On May 3, 2004, MFH Trust sold to qualified institutional investors $60.0 million in 9.5% Trust Preferred Securities (the “ Trust Preferred Securities ”) having a liquidation amount of $100 per Trust Preferred Security. In September 2004, there was a sale of an additional $24.0 million of Trust Preferred Securities to qualified institutional investors. The $60.0 million of Trust Preferred Securities were sold with an initial purchasers’ discount of $3.15 per Trust Preferred Security or $1.9 million in the aggregate. The additional $24 million of Trust Preferred Securities did not include an initial purchasers’ discount. MFH paid the entire initial purchasers’ discount as well as offering expenses on behalf of MFH Trust. MFH Trust used the proceeds from the offering to purchase Junior Subordinated Debentures (the “ Debentures ”) issued by MFH. The Debentures have substantially the same economic terms as the Trust Preferred Securities. MFH Trust can make distributions to the Trust Preferred Securities only if MFH makes payments on the Debentures. The Debentures are unsecured obligations and are subordinate to all of MFH’s existing and future senior debt.

     The Trust Preferred Securities are guaranteed by MuniMae and MFH. The Trust Preferred Securities bear interest at an annual rate of 9.5% until May 5, 2014, to be adjusted thereafter to a rate which is equal to the greater of (a) 9.5% per annum or (b) the rate per annum which is equal to 6.0% plus the then current U.S. Treasury Note with a maturity nearest to May 5, 2024. The Trust Preferred Securities may be redeemed in whole or in part on May 5, 2014. Cash distributions on the Trust Preferred Securities are paid quarterly. MFH loaned the net proceeds from the $60.0 million offering to one of its subsidiaries, which in turn used the proceeds to pay off inter-company indebtedness to MuniMae. MFH used the net proceeds from the $24.0 million offering to repay a portion of an inter-company loan from MuniMae. MuniMae used these amounts to repay a portion of its indebtedness as well as for general corporate purposes.

     MFH Trust must redeem the Trust Preferred Securities when and to the extent the Debentures are paid at maturity or earlier redeemed. The Company has recorded the Trust Preferred Securities in the accompanying condensed consolidated balance sheet as a long-term liability at the liquidation preference value of $84.0 million. In addition, net offering costs of $ 2.2 million related to the Trust Preferred Securities are recorded as debt issuance costs and included in other assets in the accompanying condensed consolidated balance sheet. The offering costs paid by MFH are amortized to interest expense in the accompanying condensed consolidated income statement over a 10-year period based on the call option of the preferred shares.

NOTE 9 — TAX CREDIT EQUITY GUARANTEE LIABILITY

     As part of the acquisition of HCI (see Note 1), the Company is providing guarantees to Lend Lease related to certain tax credit equity syndication funds where Lend Lease is providing a guarantee to investors or a third party. Subsequent to the acquisition of HCI, the Company has established new guaranteed tax credit equity funds whereby the Company provides a guarantee to a third party or investors.

     When the Company provides a guarantee in connection with the syndication of a tax credit equity fund, the Company is considered to have continuing involvement with the assets of that fund and to have effective control over the assets in the fund. Therefore, the Company accounts for its involvement in these funds under the financing method. Under the financing method, no profit is recognized from Project Partnership sales to tax credit equity funds. The sales value of the Project Partnership is equal to the Company’s original cost basis of the investment. There are no fees charged by the Company to the Project Partnership as part of the syndication transaction. The Company reports the net assets of the tax credit equity funds, consisting primarily of restricted cash and investments in Project Partnerships, in the Company’s consolidated balance sheet. In addition, the investor capital contributions to the tax credit equity funds are reported as a tax credit equity guarantee liability on the Company’s consolidated

25

balance sheet. The net income (loss) from the tax credit equity funds is reported in the appropriate line items of the Company’s consolidated statement of income.

     The Company’s guarantee liability may expire based on the achievement of certain targets by the underlying Project Partnership in the fund or may be outstanding for the life of the tax credit equity fund. When the Company’s liability is relieved by the achievement of certain targets, the tax credit guarantee liability is relieved as the guarantees expire and the related underlying investment in the Project Partnership is de-recognized. Any difference between the carrying value of the de-recognized investment in the Project Partnership and the guarantee liability is reflected as a gain or loss on sale and reported in the Company’s consolidated statement of income. For tax credit equity funds in which the Company’s guarantee obligation remains outstanding for the life of the fund, the guarantee liability is amortized straight line over the life of the fund, which is estimated to be 15 years, and the related amortization is reported in guarantee fees in the Company’s consolidated statement of income.

     When a guarantee is provided in connection with a syndication, the Company reduces syndication fee and asset management fee recognition by the amount of estimated losses. Typically, the Company estimates that no losses will be incurred and the Company has not incurred any losses to date through its guarantees on limited partnership interests.

     The following table shows the changes in the tax credit equity guarantee liability:

NOTE 10 — GUARANTEES, COMMITMENTS AND CONTINGENCIES

     For a discussion of the Company’s commitments and contingencies, see Note 14 to the Company’s 2003 Form 10-K.

     The following table summarizes the Company’s guarantees by type at September 30, 2004. The Company’s maximum exposure under its guarantee obligations is not indicative of the likelihood of the expected loss under the guarantees.