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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
X Annual report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the year ended December 31, 1998 or
Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to
Commission File Number: 1-13991
AMERICA FIRST MORTGAGE INVESTMENTS, INC.
(Exact name of registrant as specified in its charter)
Maryland 13-3974868
(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification No.)
399 Park Avenue, 36th Floor, New York, New York 10022
(Address of principal executive offices) (Zip Code)
(212) 935-8760
(Registrant's telephone number, including area code)
Securities Registered Pursuant to Section 12(b) of the Act:
Title of Each Class Name of Exchange on which Registered
---------------------------- ------------------------------------
Common Stock, $.01 par value New York Stock Exchange
Securities Registered Pursuant to Section 12(g) of the Act:
None
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Indicate by check mark whether the registrants (1) have 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
registrants were required to file such reports) and (2) have been subject to
such filing requirements for the past 90 days. Yes X No ___
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K (229.405 of the chapter) is not contained herein,
and will not be contained, to the best of the registrant's knowledge, in
definitive proxy or information statements incorporated by reference in
Part III of this Form 10-K or any amendment to this Form 10-K. [ ]
The aggregate market value of the common stock on March 22, 1999, based on the
final sales price per share as reported in The Wall Street Journal on March
23, 1999, was $41,892,535.
The number of shares of the Registrant's common stock outstanding on
March 22, 1999, was 9,055,142.
DOCUMENTS INCORPORATED BY REFERENCE
Definitive proxy statement relating to the Company's 1999 Annual Meeting of
Stockholders to be filed hereafter (incorporated into Part III hereof).
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TABLE OF CONTENTS
Page
PART I
Item 1. Business. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Item 2. Properties. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Item 3. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . 11
Item 4. Submission of Matters to a Vote of Security Holders . . . . . . . . 11
PART II
Item 5. Market for Registrant's Common Equity and
Related Stockholder Matters . . . . . . . . . . . . . . . . . . . . 12
Item 6. Selected Financial Data . . . . . . . . . . . . . . . . . . . . . . 12
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations . . . . . . . . . . . . . . . . . . . . . . . 14
Item 7A. Quantitative and Qualitative Disclosures About Market Risk. . . . . 18
Item 8. Financial Statements and Supplementary Data . . . . . . . . . . . . 20
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure. . . . . . . . . . . . . . . . . . . . . . . . 40
PART III
Item 10. Directors and Executive Officers of the Registrant . . . . . . . . 40
Item 11. Executive Compensation . . . . . . . . . . . . . . . . . . . . . . 40
Item 12. Security Ownership of Certain Beneficial Owners and Management . . 40
Item 13. Certain Relationships and Related Transactions . . . . . . . . . . 40
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K. . 40
SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42
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PART I
Item 1. Business.
THE COMPANY
America First Mortgage Investments, Inc. (the "Company") is engaged in the
business of investing in mortgaged-backed securities and mortgages. Its
principal business objective is to generate net income for distribution to its
stockholders resulting from the spread between the interest income it earns on
its investments and the costs of capital to finance its investments. The
Company's business and investment strategy is discussed in more detail below.
The Company has elected to be taxed as a real estate investment trust (a
"REIT"). One of the requirements of maintaining its status as a REIT is that
the Company distribute at least 95% of its annual taxable net income to its
stockholders, subject to certain adjustments. For additional information, one
should refer to the information under "Certain Federal Income Tax
Considerations," below.
The Company was incorporated in Maryland on July 24, 1997, but did not begin
business operations until April 10, 1998, when the Company consummated a
merger transaction (the "Merger") with America First Participating/Preferred
Equity Mortgage Fund Limited Partnership ("PREP Fund 1"), America First PREP
Fund 2 Limited Partnership ("PREP Fund 2") and America First PREP Fund 2
Pension Series Limited Partnership ("Pension Fund") (collectively referred to
as the "PREP Funds"). As a result of the Merger, PREP Fund 1 and PREP Fund 2
were merged into the Company and Pension Fund became a partnership subsidiary
of the Company. The Company issued a total of 9,035,084 shares of its common
stock to former partners of PREP Fund 1, PREP Fund 2 and Pension Fund. Upon
completion of the Merger, the Company began implementing the investment
strategy described below. The Company's investment strategy differs from that
of the PREP Funds.
The Company is an externally managed REIT. As such it has no employees of its
own. The Company has entered into an Advisory Agreement with America First
Mortgage Advisory Company (the "Advisor"), which is a subsidiary of America
First Companies L.L.C. ("America First"). Under the Advisory Agreement, the
Advisor provides day to day management of the Company's operations. The
executive officers of the Company are employees of America First and are
officers of the Advisor. More information relating to the Company's
management is discussed under "Executive Officers of the Company" in Item 4
below and in the Company's Proxy Statement relating to its 1999 Annual Meeting
of Shareholders.
BUSINESS AND INVESTMENT STRATEGY
The Company is in a different business from that of the PREP Funds. The PREP
Funds were formed to provide construction and permanent financing for
apartment complexes and retirement living facilities. The PREP Funds provided
this financing by making equity investments as a limited partner in the
limited partnerships that owned these apartment complexes and retirement
living facilities and by making loans to the such limited partnerships that
were secured by first mortgages on these apartment complexes. In order to
reduce the risk of these investments, each of the loans originated by the PREP
Funds was made in the form of mortgage-backed security that was insured or
guaranteed as to principal and interest by an agency of the U.S. government,
such as the Federal Housing Administration ("FHA") or the Government National
Mortgage Association (GNMA). In addition, the PREP Fund acquired
mortgage-backed securities backed by pools of single-family mortgages that
were insured or guaranteed by GNMA, the Federal National Mortgage Association
(FNMA), or the Federal Home Loan Mortgage Corporation (FHLMC). Upon
consummation of the Merger, the Company acquired all of the assets of the PREP
Funds. However, unlike the PREP Funds, the Company is not in the business of
originating mortgage loans or otherwise providing financing for apartment
projects or retirement living facilities.
The Company is engaged in the business of investing in mortgages and
mortgage-backed securities acquired in the secondary market from investment
banks, savings and loans, banks and other mortgage banking institutions. The
Company is not in the business of originating mortgage loans or providing
other types of financing to the owners of real estate. While the Company has
the authority to hold other types of investments, including those it inherited
from the PREP Funds, its principal investment strategy is to acquire mortgages
and mortgage-backed securities financed through the use of leverage. See
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"Financing Strategy," below. During the period from the consummation of the
Merger through December 31, 1998, the Company purchased 13 positions in
mortgage backed securities for an aggregate purchase cost of approximately
$232.5 million.
The Company's investment policy requires that at least 70% of its investment
portfolio consist of mortgage securities or mortgage loans that are either (i)
insured or guaranteed as to principal and interest by an agency of the U.S.
government, such as GNMA, FNMA or FHLMC, (ii) rated in one of the two highest
rating categories by either Standard & Poor's or Moody's, or (iii) considered
to be of equivalent credit quality as determined by the Advisor and approved
by the Company's investment committee. The remainder of the Company's assets
may be either: (i) mortgage assets rated at least investment grade or
considered to be of equivalent credit quality by the Advisor with approval
from the Company's investment committee; (ii) direct investment (mezzanine or
equity) in multifamily apartment properties; (iii) limited partnerships, real
estate investment trusts or closed-end funds owning a portfolio of mortgage
assets; or (iv) other corporate or government fixed income instruments that
provide increased call protection relative to the Company's mortgage
securities.
At December 31, 1998, approximately 91% of the Company's assets consisted of
mortgage-backed securities insured or guaranteed by GNMA, FNMA or FHLMC
(Agency Certificates) backed by single-family mortgage loans. Remaining
assets at that date consisted of interests in limited partnerships owning
apartment properties, non-voting preferred stock in a corporation owning
interests in limited partnerships owning retirement living facilities and
certain corporate debt and equity securities. The Company is in the process
of divesting itself of certain of these other assets and will use net proceeds
from the sale of these assets to acquire additional mortgage assets which are
consistent with its investment strategy.
The Company intends that at least 66% of its mortgage assets be
adjustable-rate mortgages or mortgage-backed securities ("ARMs"). At December
31, 1998, approximately 80% of the Company's mortgage assets were ARMs.
Included within the Company's ARMs portfolio are hybrid ARMs which have an
interest rate that is fixed for an initial period of time, generally three to
five years, which then convert to an adjustable rate for the balance of the
term of the loan. Many ARMs are indexed to the one-year constant maturity
treasury ("CMT") rate with interest rates that are reset annually. Other ARMs
are indexed to the London Interbank Offered Rate (LIBOR), the six-month
certificate of deposit rate, the six-month CMT rate or the 11th District Cost
of Funds Index. ARMs that are indexed to the CMT are generally subject to a
limitation on the amount of the annual interest rate change. This limit is
usually 1% or 2% per year. Generally, all ARMS have lifetime limits on
interest rate increases over the initial interest rate. In general, such
lifetime interest rate caps do not exceed 600 basis points over the initial
interest rate.
FINANCING STRATEGY
The Company intends to finance the acquisition of additional mortgages and
mortgage-backed securities by borrowing against its portfolio of mortgage
assets and investing the proceeds of the borrowings in additional mortgage
assets. The Company does not currently intend to publicly offer additional
shares of its common stock or other debt or equity securities. When fully
invested, the Company plans to maintain an equity-to-assets ratio of
approximately 8% to 10%. The equity-to-assets ratio was approximately 27% as
of December 31, 1998. Since commencing its business operations on April 10,
1998, the Company has pursued a conservative approach to investing in
additional mortgage assets. This conservative approach has been in response
to a mortgage market in which the spread between interest rates on fixed-rate
mortgages and on ARMs has become quite narrow. In addition, the difference
between short-term and long-term interest rates has been relatively small
since the Company began operations. These factors have limited the
availability of ARMs in the secondary market and resulted in an increase in
the price of ARM securities. Accordingly, the Company has taken a disciplined
approached to investing in additional ARMs during 1998 and, therefore, was
not yet fully invested as of the end of the year.
The Company's borrowings will be financed primarily at short-term borrowing
rates through the utilization of repurchase agreements. A repurchase
agreement, although structured as a sale and repurchase obligation, operates
as a financing under which the Company effectively pledges its
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mortgage assets as collateral to secure a short-term loan which is equal in
value to a specified percentage of the market value of the pledged collateral.
Repurchase agreements take the form of a sale of the pledged collateral to a
lender at an agreed upon price in return for such lender's simultaneous
agreement to resell the same securities back to the borrower at a future date
(the maturity of the borrowing) at a higher price. The price difference is
the cost of borrowing under these agreements. The Company will retain
beneficial ownership of the pledged collateral, including the right to
distributions. At the maturity of a repurchase agreement, the Company will be
required to repay the loan and concurrently will receive back its pledged
collateral from the lender or will rollover such agreement at the then
prevailing financing rate. The repurchase agreements may require the Company
to pledge additional assets to the lender in the event the market value of any
existing pledged collateral declines.
Repurchase agreements tend to be short-term in nature, and should the
providers of the repurchase agreements decide not to renew, the Company must
either refinance these obligations prior to maturity or be in a position to
retire the obligations. If during the term of a repurchase agreement, a
lender should file for bankruptcy, the Company might experience difficulty
recovering its pledged assets and may have an unsecured claim against the
lender's assets.
To reduce its exposure, the Company enters into repurchase agreements only
with financially sound institutions whose holding or parent company's
long-term debt rating is single A or better as determined by both Standard and
Poor's and Moody's, where applicable. If this minimum criteria is not met,
then the Company will not enter into repurchase agreements with such
counterparty without the specific approval of its Board of Directors. In the
event an existing counterparty is downgraded below single A, the Company will
seek Board approval before entering into additional repurchase agreements with
such counterparty. In addition, once the Company is fully invested, it
intends to enter into repurchase agreements with at least four lenders with a
maximum exposure to each lender of three times the Company's shareholders'
equity.
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RISK FACTORS
The results of the Company's operations are affected by various factors, many
of which are beyond the control of the Company. The results of the Company's
operations depend on, among other things, the level of net interest income
generated by the Company's mortgage assets, the market value of its assets and
the supply of and demand for such assets. The Company's net interest income
varies primarily as a result of changes in short-term interest rates,
borrowing costs and prepayment rates, the behavior of which involves various
risks and uncertainties as set forth below. Prepayment rates, interest rates
and borrowing costs depend on the specific type of asset, conditions in
financial markets, competition and other factors, none of which can be
predicted with any certainty. Since changes in interest rates may
significantly affect the Company's activities, the operating results of the
Company depend, in large part, upon the ability of the Company to effectively
manage its interest rate and prepayment risks while maintaining its status as
a REIT.
INTEREST RATE RISKS
The Company has financed the acquisition of additional mortgage assets through
borrowings under numerous repurchase agreements. As a result, the Company is
exposed to the following principal interest rate risks:
The cost of the Company's borrowings under its repurchase agreements is
based on the prevailing short-term market rates that adjust over periods
of one to 12 months. However, a substantial majority of the Company's
mortgage assets have either fixed interest rates or interest rates that
reset only every six to 12 months.
There is no limitation on the interest rate that the Company could have
to pay in order to borrow money to finance its mortgage assets. However,
the ability to raise interest rates on its assets is limited, either
because such rates are fixed for the life of the asset or, in the case of
ARMs, the ability to raise interest rates is limited on both an annual
basis and over the term of the ARM. Generally, interest rates on ARMs
can change a maximum of 100 or 200 basis points per annum and only up to
600 basis points from the initial interest rate over the term of the ARM.
The cost of the Company's borrowing is generally based on LIBOR while
interest rates on its ARM portfolio are primarily based on one-year CMT
rates. Therefore, any increase in the LIBOR relative to the CMT rates
will result in an increase in the Company's borrowing cost that is not
matched by a corresponding increase in the interest earnings on its ARM
portfolio.
In any of these cases, increasing short-term interest rates may cause the
Company's financing costs to increase faster than it is able to increase
interest rates on its ARMs. As a result, the net interest margin earned by
the Company will be reduced or eliminated during such periods. Accordingly,
in a period of increasing interest rates, the Company could experience a
decrease in net interest income or a net loss because the interest rates on
borrowings could adjust faster than the interest rates on the Company's ARMs.
Such a lowering of the Company's net interest income could negatively impact
the level of dividend distributions made by the Company and reduce the market
price of its common stock.
In order to mitigate its interest rate risks, the Company intends to have a
substantial majority of its mortgage assets consist of ARMs rather than fixed
rate mortgages. This allows the Company to increase its interest income
during period of rising interest rates. While the lag in its ability to reset
interest rates on its ARMs portfolio relative to changes in the interest rates
it pays on its liabilities and the annual and lifetime limitations on
adjustments to interest rates on ARMs can negatively affect earnings over the
short term, the ability to make interest rate adjustments on the ARMs does
help mitigate this risk over a longer time period.
The Company's policy is to maintain an asset/borrowings repricing gap (as
measured by the average time period to assets repricing, less the average time
period to liability repricing) at less than 24 months when its leverage ratio
is less than 5 to 1 and at less than 18 months when its leverage ratio is
greater than 5 to 1. At December 31, 1998, the Company's leverage ratio
equaled 3.73 to 1 and the repricing gap stood at approximately 15.4 months.
For purposes of this analysis, equity assets, zero coupon
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Treasury securities and assets of long duration purchased as a hedge against
prepayments are excluded from the calculation.
As discussed above, the relationship between LIBOR and the CMT can change over
time. At December 31, 1998, the one-year LIBOR was 5.1% and the one-year CMT
was 4.5%. However, as of December 31, 1998, the average interest rate on the
Company's CMT based ARMs was 212 basis points over the CMT. Therefore, the
LIBOR index would have to increase by approximately 160 basis points relative
to the CMT in order to eliminate the positive spread between the yield on
these ARMs and the Company's cost of borrowing. During 1998, the largest
differential between the one-year LIBOR and one-year CMT was 83 basis points
and the average differential was 49.5 basis points.
Lifetime interest rate caps on ARMs could impact the earnings on the Company's
assets. However, based on the assets available in the current market, such an
impact should only occur if the one-month LIBOR rate increased to
approximately 10%. This rate was at 5.03% at December 31, 1998. The Company
may attempt to partially offset the potential negative effect of lifetime
maximum interest rates on its ARMs through the purchase of interest rate
caps. An interest rate cap agreement is a contractual agreement whereby the
Company pays a fee in exchange for the right to receive payments equal to the
difference between a contractually specified interest rate and a periodically
determined future interest rate times a specified principal, or notional
amount. Such interest rate cap agreements are subject to the risk that the
other party to the agreement will not be able to perform its obligations.
Although the Company would seek to enter interest rate agreements only with
financially sound institutions and to monitor the financial strength of such
institutions on a periodic basis, no assurance can be given that the Company
can avoid such third party risks. As of December 31, 1998, the Company had
not utilized this hedging strategy.
As a part of its hedging strategy, the Company may engage in limited amounts
of the buying and selling of mortgage derivative securities or other
derivative products including interest rate swap agreements, financial futures
contracts and options. Although the Company and its Predecessor have not
historically used such instruments, it is not precluded from doing so. In the
future, management anticipates using such instruments only as hedges to manage
interest rate risk. Management does not anticipate entering into derivatives
for speculative or trading purposes. Any such strategies will be selected by
the Advisor and approved by the Company's investment committee. While the
Company may hedge certain risks associated with interest rate increases, no
hedging strategy can insulate the Company completely from interest rate
risks. In addition, there can be no assurance that any such hedging
activities will have the desired impact on the Company's results of operations
or financial condition. Hedging typically involves costs, including
transaction costs, which increase dramatically as the period covered by the
hedge increases and which also increase during periods of rising and volatile
interest rates. Such hedging costs may cause the Company to conclude that a
particular hedging transaction is not appropriate for the Company, thereby
affecting the Company's ability to mitigate interest rate risk. As of
December 31, 1998, the Company had not entered into any interest rate hedging
agreements.
PREPAYMENT RISKS
In general, the borrower under a mortgage loan may prepay the loan at any time
without penalty or premium. Prepayments result when the homeowner sells his
home or decides to either retire or refinance his existing mortgage loan. In
addition, defaults and foreclosures have the same effect as a prepayment in
that no future interest payments are earned on the mortgage. Prepayments
usually can be expected to increase when mortgage interest rates decrease
significantly and decrease when mortgage interest rates increase, although
such effects are not entirely predictable. Prepayment experience also may be
affected by the conditions in the housing and financial markets, general
economic conditions and the relative interest rates on fixed-rate and
adjustable-rate mortgage loans. During the latter part of 1998, prepayments
were at historically high levels due to mortgage interest rate declines and
the narrowing of the difference between long-term and short-term interest
rates.
Prepayments are the primary feature of mortgage-backed securities that
distinguishes them from other types of bonds. While a certain percentage of
the pool of mortgage loans underlying a mortgage-backed security are expected
to prepay during a given period of time, the actual rate of prepayment can,
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and often does, vary significantly from the anticipated rate of prepayment.
Accordingly, the Company incurs a risk that its mortgage assets will prepay at
a more rapid pace than anticipated. The potential negative impact on the
Company of prepayments is twofold. In the first instance, prepayments reduce
the amount of the Company's interest earning assets. In addition, if the
Company has paid more than par for a mortgage-backed security, this premium is
amortized against earnings over the life of the security. Higher than
expected prepayments lead to an increase in premium amortization, which
reduces the Company's earnings.
One way the Company seeks to reduce its exposure to prepayment risk is to
purchase mortgage assets trading closer to par. In the current marketplace,
ARM securities are trading at a premium of from 1% to 4% over par depending on
seasoning and the interest rate. The Company's current policy is to maintain
the average purchase price of the Company's mortgage portfolio at less than
103.5% of par. The Company's weighted average purchase price for the mortgage
assets it acquired in 1998 was approximately 101.5% of par. Another way the
Company will seek to address this risk is to use less leverage in less
advantageous market environments. While this strategy may not maximize
earnings potential in the short term, it should lead to more predictable
earnings with less potential risk to capital.
The Company seeks to minimize prepayment risk through a number of other means,
including structuring a diversified portfolio with a variety of prepayment
characteristics. An additional natural hedge to prepayment risk is for the
Company to maintain a position in direct investments (mezzanine or equity) in
multifamily properties collateralizing mortgage loans owned by the Company.
These assets do not face prepayment risk and should increase in value in a
declining interest rate environment where prepayments would have the largest
negative impact. Another potential hedge for the Company is to hold zero
coupon Treasury securities or other assets of long duration which increase in
value when interest rates decline. As of December 31, 1998, the Company did
not own any zero coupon Treasury securities. No strategy, however, can
completely insulate the Company from prepayment risks arising from the effects
of interest rate changes.
RISKS ASSOCIATED WITH LEVERAGE
The Company's financing strategy is designed to increase the size of its
mortgage investment portfolio by borrowing a substantial portion of the market
value of its mortgage assets. If the interest income on the mortgage assets
purchased with borrowed funds fails to cover the cost of the borrowings, the
Company will experience net interest losses and may experience net losses.
Such losses could be increased substantially as a result of the Company's
substantial leverage.
The ability of the Company to achieve its investment objectives depends on its
ability to borrow money in sufficient amounts and on favorable terms.
Currently, all of the Company's borrowings are collateralized borrowings in
the form of repurchase agreements. The ability of the Company to enter into
repurchase agreements in the future will depend on the market value of the
mortgage assets pledged to secure the specific borrowings, the availability of
financing, and other conditions then applicable in the lending market. The
Company may effect additional borrowings through using other types of
collateralized borrowings, loan agreements, lines of credit, dollar-roll
agreements and other credit facilities with institutional lenders or through
the issuance of debt securities. The cost of borrowings under repurchase
agreements generally corresponds to LIBOR plus or minus a margin, although
such agreements may not expressly incorporate a LIBOR index. The cost of
borrowings under other sources of funding which the Company may use may refer
or correspond to other short-term indices, plus or minus a margin. Through
increases in haircuts (i.e., the over-collateralization amount required by a
lender), decreases in the market value of the Company's mortgage assets,
increases in interest rate volatility, and changes in the availability of
financing in the market, the Company may not be able to achieve the degree of
leverage it believes to be optimal. As a result, the Company may be less
profitable than it would be otherwise.
RISKS OF DECLINE IN MARKET VALUE OF MORTGAGES
The value of interest bearing obligations such as mortgages and
mortgage-backed securities will move inversely with interest rates.
Accordingly, in a rising interest rate environment, the value of such
instruments will decline. Because the interest earned on ARMs may increase as
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interest rates increase, the values of these assets are generally less
sensitive to changes in interest rates than are fixed rate instruments.
Therefore, in order to mitigate this risk, the Company intends to maintain a
substantial majority of its mortgage assets as ARMs. Currently, ARMs
constitute approximately 80% of the Company's total mortgage assets.
A decline in the market value of the Company's mortgage assets may limit the
Company's ability to borrow or result in lenders initiating margin calls
(i.e., requiring a pledge of cash or additional mortgage assets to
re-establish the ratio of the amount of the borrowing to the value of the
collateral). The Company could be required to sell mortgage assets under
adverse market conditions in order to maintain liquidity. If these sales were
made at prices lower than the amortized cost of the mortgage assets, the
Company would experience losses. A default by the Company under its
collateralized borrowings could also result in a liquidation of the
collateral, and a resulting loss of the difference between the value of the
collateral and the amount borrowed.
Additionally, in the event of a bankruptcy of the Company, certain repurchase
agreements may qualify for special treatment under the Bankruptcy Code, the
effect of which is, among other things, to allow the creditors under such
agreements to avoid the automatic stay provisions of the Bankruptcy Code and
to liquidate the collateral under such agreements without delay. To the
extent the Company is compelled to liquidate mortgage assets qualifying as
Qualified REIT Real Estate Assets to repay borrowings, the Company may be
unable to comply with the REIT provisions of the Internal Revenue Code
regarding assets and sources of income requirements, ultimately jeopardizing
the Company's status as a REIT.
CREDIT RISKS ASSOCIATED WITH INVESTMENTS
The holder of a mortgage or mortgage-backed security assumes a risk that the
borrowers may default in their obligations to make full and timely payments
of principal and interest. The Company seeks to mitigate this risk of credit
loss by requiring at least 70% of its investment portfolio consist of mortgage
or mortgage securities that are either (i) insured or guaranteed as to
principal and interest by an agency of the U.S. government, such as GNMA, FNMA
or FHLMC, (ii) rated in one of the two highest rating categories by either
Standard and Poor's or Moody's, or (iii) considered to be of equivalent credit
quality as determined by the Advisor and approved by the Company's investment
committee. The remainder of the Company's assets may be either (i) mortgage
assets rated at least investment grade or considered to be of equivalent
credit quality by the Advisor with approval from the Company's investment
committee; (ii) direct investment (mezzanine or equity) in multi-family
projects collateralizing mortgage loans owned by the Company; (iii)
investments in limited partnerships, real estate investment trusts or
closed-end funds owning a portfolio of mortgage assets; or (iv) other fixed
income instruments (corporate or government) that provide increased call
protection relative to the Company's mortgage assets. Currently, these other
fixed income instruments are below investment grade in quality. These other
below investment grade fixed income instruments constituted less than 3% of
total assets as of December 31, 1998. As of December 31, 1998, approximately
91% of the Company's assets consisted of mortgage-backed securities insured or
guaranteed by the U.S. government or an agency thereof.
RISKS OF ASSET CONCENTRATION
Although the Company seeks geographic diversification of the properties
underlying its mortgage assets, it does not set specific limitations on the
aggregate percentage of underlying properties which may be located in any one
area. Consequently, properties underlying such mortgage assets may be located
in the same or a limited number of geographical regions. Adverse changes in
the economic conditions of the geographic regions in which the properties
securing mortgage assets are concentrated likely would have an adverse effect
on real estate values, interest rates and prepayment rates and increase the
risk of default by the obligors on the underlying mortgage loans.
Accordingly, the Company's results of operations could be adversely affected.
INVESTMENT COMPANY ACT
The Company at all times intends to conduct its business so as to not become
regulated as an investment company under the Investment Company Act of 1940.
If the Company were to become regulated as an investment company, then, among
other things, the Company's ability to use leverage would be substantially
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reduced. The Investment Company Act exempts entities that are "primarily
engaged in the business of purchasing or otherwise acquiring mortgages and
other liens on and interests in real estate" (i.e. "Qualifying Interests").
Under the current interpretation of the staff of the SEC, in order to qualify
for this exemption, the Company must maintain at least 55% of its assets
directly in Qualifying Interests. In addition, unless certain mortgage
securities represent an undivided interest in the entire pool backing such
mortgage securities (i.e. "whole pool" mortgage securities), such mortgage
securities may be treated as securities separate from the underlying mortgage
loan, thus, may not be considered Qualifying Interests for purposes of the 55%
exemption requirement. Accordingly, the Company monitors its compliance with
this requirement in order to maintain its exempt status. As of December 31,
1998, the Company determined that it is in and has maintained compliance with
this requirement.
CERTAIN FEDERAL INCOME TAX CONSIDERATIONS
The following discussion summarizes certain Federal income tax considerations
to the Company and its stockholders. This discussion is based on existing
Federal income tax law, which is subject to change, possibly retroactively.
This discussion does not address all aspects of Federal income taxation that
may be relevant to a particular stockholder in light of its personal
investment circumstances or to certain types of investors subject to special
treatment under the Federal income tax laws (including financial institutions,
insurance companies, broker-dealers and, except to the extent discussed below,
tax-exempt entities and foreign taxpayers) and it does not discuss any aspects
of state, local or foreign tax law. This discussion assumes that stockholders
will hold their common stock as a "capital asset" (generally, property held
for investment) under the Internal Revenue Code of 1986, as amended (the
"Code"). Stockholders are advised to consult their tax advisors as to the
specific tax consequences to them of purchasing, holding and disposing of the
common stock, including the application and effect of Federal, state, local
and foreign income and other tax laws.
GENERAL
The Company has elected to become subject to tax as a REIT, for Federal income
tax purposes, commencing with the taxable year ending December 31, 1998.
Management currently expects that the Company will continue to operate in a
manner that will permit the Company to maintain its qualifications as a REIT.
This treatment will permit the Company to deduct dividend distributions to its
stockholders for Federal income tax purposes, thus effectively eliminating the
"double taxation" that generally results when a corporation earns income and
distributes that income to its stockholders. There can be no assurance that
the Company will continue to qualify as a REIT in any particular taxable year,
given the highly complex nature of the rules governing REITs, the ongoing
importance of factual determinations and the possibility of future changes in
the circumstances of the Company. If the Company failed to qualify as a REIT
in any particular year, it would be subject to Federal income tax as a
regular, domestic corporation, and its stockholders would be subject to tax in
the same manner as stockholders of such corporation. In this event, the
Company could be subject to potentially substantial income tax liability in
respect of each taxable year that it fails to qualify as a REIT, and the
amount of earnings and cash available for distribution to its stockholders
could be significantly reduced or eliminated. The following is a brief
summary of certain technical requirements that the Company must meet on an
ongoing basis in order to qualify, and remain qualified, as a REIT under the
Code.
STOCK OWNERSHIP TESTS
The capital stock of the Company must be held by at least 100 persons and no
more than 50% of the value of such capital stock may be owned, directly or
indirectly, by five or fewer individuals at all times during the last half of
the taxable year. Under the Code, most tax-exempt entities including employee
benefit trusts and charitable trusts (but excluding trusts described in 401(a)
and exempt under 501(a)) are generally treated as individuals for these
purposes. These stock ownership requirements must be satisfied by the Company
each taxable year. The Company must solicit information from certain of its
shareholders to verify ownership levels and its Articles of Incorporation
provide restrictions regarding the transfer of the Company's shares in order
to aid in meeting the stock ownership requirements. If the Company were to
fail either of the stock ownership tests, it would generally be disqualified
from REIT status, unless, in the case of the "five or fewer" requirement, the
recently enacted "good faith" exemption is available.
- 8 -
ASSET TESTS
The Company must generally meet the following asset tests (the "REIT Asset
Tests") at the close of each quarter of each taxable year: (a) at least 75% of
the value of the Company's total assets must consist of Qualified REIT Real
Estate Assets, government securities, cash, and cash items (the "75% Asset
Test"); and (b) the value of securities held by the Company but not taken into
account for purposes of the 75% Asset Test must not exceed (i) 5% of the value
of the Company's total assets in the case of securities of any one
non-government issuer, and (ii) 10% of the outstanding voting securities of
any such issuer.
The Company does not expect that the value of any non-qualifying security of
any one entity would ever exceed 5% of the Company's total assets, and the
Company does not expect to own more than 10% of any one issuer's voting
securities. The Company intends to monitor closely the purchase, holding and
disposition of its assets in order to comply with the REIT Asset Tests. In
particular, the Company intends to limit and diversify its ownership of any
assets not qualifying as Qualified REIT Real Estate Assets to less than 25% of
the value of the Company's assets and to less than 5%, by value, of any single
issuer. If it is anticipated that these limits would be exceeded, the Company
intends to take appropriate measures, including the disposition of
non-qualifying assets, to avoid exceeding such limits.
GROSS INCOME TESTS
The Company must generally meet the following gross income tests (the "REIT
Gross Income Tests") for each taxable year: (a) at least 75% of the Company's
gross income must be derived from certain specified real estate sources
including interest income and gain from the disposition of Qualified REIT Real
Estate Assets or "qualified temporary investment income" (i.e., income derived
from "new capital" within one year of the receipt of such capital) (the "75%
Gross Income Test") and; (b) at least 95% of the Company's gross income for
each taxable year must be derived from sources of income qualifying for the
75% Gross Income Test, or from dividends, interest, and gains from the sale of
stock or other securities (including certain interest rate swap and cap
agreements, options, futures and forward contracts entered into to hedge
variable rate debt incurred to acquire Qualified REIT Real Estate Assets) not
held for sale in the ordinary course of business (the "95% Gross Income Test").
The Company intends to maintain its REIT status by carefully monitoring its
income, including income from hedging transactions and sales of mortgage
assets, to comply with the REIT Gross Income Tests. In particular, the
Company will treat income generated by its interest rate caps and other
hedging instruments, if any, as non-qualifying income for purposes of the 95%
Gross Income Tests unless it receives advice from counsel that such income
constitutes qualifying income for purposes of such test. Under certain
circumstances, for example, (i) the sale of a substantial amount of Mortgage
Assets to repay borrowings in the event that other credit is unavailable or
(ii) unanticipated decrease in the qualifying income of the Company which may
result in the non-qualifying income exceeding 5% of gross income, the Company
may be unable to comply with certain of the REIT Gross Income Tests. See
"Taxation of the Company" below for a discussion of the tax consequences of
failure to comply with the REIT Provisions of the Code.
DISTRIBUTION REQUIREMENT
The Company must generally distribute to its stockholders an amount equal to
at least 95% of the Company's REIT taxable income before deductions of
dividends paid and excluding net capital gain.
TAXATION OF THE COMPANY
In any year in which the Company qualifies as a REIT, the Company will
generally not be subject to federal income tax on that portion of its REIT
taxable income or capital gain which is distributed to its stockholders. The
Company will, however, be subject to Federal income tax at normal corporate
income tax rates upon any undistributed taxable income or capital gain.
Notwithstanding its qualification as a REIT, the Company may also be subject
to tax in certain other circumstances. If the Company fails to satisfy either
the 75% or the 95% Gross Income Test, but nonetheless maintains its
qualification as a REIT because certain other requirements are met, it will
generally be subject to a 100% tax on the greater of the amount by which the
Company fails either the 75% or the 95% Gross Income Test. The Company will
- 9 -
also be subject to a tax of 100% on net income derived from any "prohibited
transaction," and if the Company has (i) net income from the sale or other
disposition of "foreclosure property" which is held primarily for sale to
customers in the ordinary course of business or (ii) other non-qualifying
income from foreclosure property, it will be subject to Federal income tax on
such income at the highest corporate income tax rate. In addition, if the
Company fails to distribute during each calendar year at least the sum of (i)
85% of its REIT ordinary income for such year and (ii) 95% of its REIT capital
gain net income for such year, the Company would be subject to a 4% Federal
excise tax on the excess of such required distribution over the amounts
actually distributed during the taxable year, plus any undistributed amount of
ordinary and capital gain net income from the preceding taxable year. The
Company may also be subject to the corporate alternative minimum tax, as well
as other taxes in certain situations not presently contemplated. If the
Company fails to qualify as a REIT in any taxable year and certain relief
provisions of the Code do not apply, the Company would be subject to Federal
income tax (including any applicable alternative minimum tax) on its taxable
income at the regular corporate income tax rates. Distributions to
stockholders in any year in which the Company fails to qualify as a REIT would
not be deductible by the company, nor would they generally be required to be
made under the Code. Further, unless entitled to relief under certain other
provisions of the Code, the Company would also be disqualified from
re-electing REIT status for the four taxable years following the year in which
it became disqualified.
The Company intends to monitor on an ongoing basis its compliance with the
REIT requirements described above. In order to maintain its REIT status, the
Company will be required to limit the types of assets that the Company might
otherwise acquire, or hold certain assets at times when the Company might
otherwise have determined that the sale or other disposition of such assets
would have been more prudent.
TAXATION OF STOCKHOLDERS
Distributions (including constructive distributions) made to holders of common
stock other than tax-exempt entities (and not designated as capital gain
dividends) will generally be subject to tax as ordinary income to the extent
of the Company's current and accumulated earnings and profits as determined
for Federal income tax purposes. If the amount distributed exceeds a
stockholder's allocable share of such earnings and profits, the excess will be
treated as a return of capital to the extent of the stockholder's adjusted
basis in the common stock, which will not be subject to tax, and thereafter as
a taxable gain from the sale or exchange of a capital asset.
Distributions designated by the Company as capital gain dividends will
generally be subject to tax as long-term capital gain to stockholders, to the
extent that the distribution does not exceed the Company's actual net capital
gain for the taxable year. Distributions by the Company, whether
characterized as ordinary income or as capital gain, are not eligible for the
corporate dividends received deduction. In the event that the Company realizes
a loss for the taxable year, stockholders will not be permitted to deduct any
share of that loss.
STATE AND LOCAL TAXES
The Company and its stockholders may be subject to state or local taxation in
various jurisdictions, including those in which it or they transact business
or reside. The state and local tax treatment of the Company and its
stockholders may not conform to the Federal income tax consequences discussed
above. Consequently, prospective stockholders should consult their own tax
advisors regarding the effect of state and local tax laws on an investment in
the common stock.
COMPETITION
The Company believes that its principal competitors in the business of
acquiring and holding mortgage assets of the type in which it invests are
financial institutions such as banks and savings and loans, life insurance
companies, institutional investors such as mutual funds and pension funds, and
certain mortgage REITs. Many of the other entities purchasing mortgages and
mortgage-backed securities have greater financial resources than the Company.
The existence of these competitive entities, as well as the possibility of
additional entities forming in the future, may increase the competition for
- 10 -
the acquisition of mortgages and mortgage-backed securities resulting in
higher prices and lower yields on such assets.
Item 2. Properties. The Company does not directly own or lease any physical
properties.
Item 3. Legal Proceedings. There are no material pending legal proceedings
to which the Company or any of its assets are subject.
Item 4. Submission of Matters to a Vote of Security Holders. No matter was
submitted during the fourth quarter of the fiscal year ending December 31,
1998 to a vote of the Company's security holders.
Executive Officers of the Company.
The Company's executive officers are as follows:
Name Position Held Position Held Since
- - ----------------------- -------------------------- -------------------
Stewart Zimmerman President and Chief 1998
Executive Officer
Gary Thompson Chief Financial Officer 1998
and Treasurer
William S. Gorin Executive Vice President 1998
and Secretary
Ronald A. Freydberg Senior Vice President 1998
Stewart Zimmerman, 54, serves as President and Chief Executive Officer of the
Company. He served as Executive Vice President of America First Companies
L.L.C. since January 1989, during which time he has served in a number of
positions: President and Chief Operating Officer of America First REIT, Inc.;
President of several America First Mortgage funds including America First
Participating/Preferred Equity Mortgage Fund, America First PREP Fund 2
Limited Partnership, America First PREP Fund 2 Pension Series Limited
Partnership, Capital Source L.P., Capital Source II L.P.-A, America First Tax
Exempt Mortgage Fund Limited Partnership and America First Tax Exempt Fund 2
Limited Partnership. From September 1986 to September 1988, he served as a
Managing Director and Director of Security Pacific Merchant Bank responsible
for Mortgage Trading and Finance. Prior to that time, he served as First Vice
President of E.F. Hutton & Company, Inc., where he was responsible for
mortgage-backed securities trading and sales distribution, and Vice President
of Lehman Brothers, where he was responsible for the distribution of mortgage
products. From 1968 to 1972, Mr. Zimmerman was Vice President of Zenith
Mortgage Company and Zenith East Inc., a national mortgage banking and
brokerage company specializing in the structuring and sales of mortgage assets
to the institutional financial community.
Gary Thompson, 56, serves as Chief Financial Officer of the Company. He
serves as financial vice president of America First Companies L.L.C. and is
responsible for financial accounting and tax reporting for all America First
funds. Prior to 1989, Mr. Thompson was an audit partner at KPMG Peat
Marwick. He is a certified public accountant.
William S. Gorin, 40, serves as Executive Vice President of the Company. From
1989 to 1997, Mr. Gorin held various positions with PaineWebber
Incorporated/Kidder, Peabody & Co. Incorporated, New York, New York, most
recently serving as a First Vice President in the Research Department. Prior
to that position, Mr. Gorin was Senior Vice President in the Special Products
Group. From 1982 to 1988, Mr. Gorin was employed by Shearson Lehman Hutton,
Inc./E.F. Hutton & Company, Inc., New York, New York, in various positions in
corporate finance and direct investments. Mr. Gorin has an MBA from Stanford
University.
Ronald A. Freydberg, 38, serves as Senior Vice President of the Company. From
1995 to 1997, Mr. Freydberg served as a Vice President of Pentalpha Capital,
in Greenwich, Connecticut, where he was a fixed income quantitative analysis
and structuring specialist. In that capacity he designed a variety of
interactive pricing and forecasting models, including a customized subordinate
residential and commercial mortgage-backed analytical program and an ARM REIT
- 11 -
five-year forecasting model. In addition, he worked with various financial
institutions on the acquisition and sale of residential, commercial and
asset-backed securities. From 1988 to 1995, Mr. Freydberg held various
positions with J.P. Morgan & Co. in New York, New York. From 1994 to 1995, he
was with the Global Markets Group. In that position he was involved in all
aspects of commercial mortgage-backed securitization and sale of distressed
commercial real estate, including structuring, due diligence and marketing.
From 1985 to 1988, Mr. Freydberg was employed by Citicorp in New York, New
York.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
(a) Market Information. The Company's common stock began trading on the New
York Stock Exchange on April 10, 1998 under the symbol "MFA." The following
table sets forth the high and low sale prices for the Company's shares of
common stock from April 10, 1998, through December 31, 1998.
Sale Prices
----------------------
High Low
2nd Quarter
(from April 10, 1998) $ 9-3/4 $ 7-1/4
3rd Quarter $ 7-7/8 $ 5-11/16
4th Quarter $ 5-3/4 $ 4-5/16
(b) Investors. The approximate number of common stockholders as of March
22, 1999 was 6,400.
(c) Dividends. The Company currently pays cash dividends on a quarterly
basis. Total cash dividends declared by the Company to common stockholders
during the fiscal year ended December 31, 1998, were $7,234,050 ($.795 per
share). For tax purposes the dividends declared on December 15, 1998, will be
treated as a 1999 dividend for shareholders and partially taxable in 1999. As
part of the Merger transaction, the Company committed to pay dividends in the
first year following the Merger of at least $1.06 per common share, to be paid
in four equal quarterly installments. The portion of the dividend exceeding
the taxable income of the Company during the period represents a non-taxable
return of capital. There is no commitment by the Company to distribute
amounts in excess of taxable income beyond the first year of operations. The
Company intends to continue to distribute to its shareholders an amount equal
to at least 95% of the Company's taxable income before deductions of dividends
paid and excluding net capital gains in order to maintain its REIT status.
See Item 7, Management's Discussion and Analysis of Financial Conditions and
Results of Operations, for information regarding the sources of funds used for
dividends and for a discussion of factors, if any, which may adversely affect
the Company's ability to make pay dividends at the same levels in 1999 and
thereafter.
Item 6. Selected Financial Data.
For financial accounting purposes, PREP Fund 1 is considered the sole
predecessor to the Company and, accordingly, the historical operating results
presented in this report as those of the "Predecessor" are those of PREP Fund
1. Under generally accepted accounting principles, the Merger was accounted
for as a purchase by PREP Fund 1 of 100% of the assigned limited partnership
interests (known as "BUCs") of PREP Fund 2 and approximately 99% of the BUCs
of Pension Fund. As a result of this treatment, the Company, as the successor
to PREP Fund 1, recorded all of the assets and liabilities of PREP Fund 1 at
their book value, but was required to record the assets of PREP Fund 2 and
Pension Fund at their fair value as of the date of the Merger. The amount by
which the fair value of the Company's stock issued to the BUC holders of PREP
Fund 2 and Pension Fund exceeded the fair value of the total net assets of
PREP Fund 2 and Pension Fund was recorded as goodwill by the Company.
- 12 -
Set forth below is selected financial data for the Company (for periods after
April 9, 1998) and the Predecessor (for periods up to April 9, 1998). The
information set forth below should be read in conjunction with the
consolidated and combined financial statements and notes to the consolidated
and combined financial statements filed in response to Item 8 hereof.
Company and Predecessor Company and
As of or for the Year Ended December 31, 1998 Predecessor Predecessor
---------------------------------------------
As of or As of or
Company Predecessor for the for the
From April 10 to Through Year Ended Year Ended
December 31, 1998 April 9 Total Dec. 31, 1997 Dec. 31, 1996
----------------- -------------- ------------- ------------- -------------
Operating Data:
Mortgage securities income $ 7,626,742 $ 613,793 $ 8,240,535 $ 2,654,975 $ 3,011,347
Corporate securities income 164,738 - 164,738 - -
Interest income on temporary cash investments
and U.S. government securities 439,889 148,799 588,688 569,624 442,931
Income from other investments 581,716 145,167 726,883 606,582 504,611
Gain on sale of investments 414,951 - 414,951 - -
General and administrative expenses (1,674,114) (421,293) (2,095,407) (1,405,514) (895,961)
Interest expense on borrowed funds (4,619,500) - (4,619,500) - -
Minority interest (3,353) - (3,353) - -
------------- -------------- ------------- ------------- -------------
Net income $ 2,931,069 $ 486,466 $ 3,417,535 $ 2,425,667 $ 3,062,928
============= ============== ============= ============= =============
Net income, basic and diluted,
per exchangeable unit $ N/A $ 0.08 $ N/A $ 0.42 $ 0.52
============= ============== ============= ============= =============
Net income, basic and diluted,
per share $ 0.32 $ N/A $ 0.32 $ N/A $ N/A
============= ============== ============= ============= =============
Net income per passthrough certificate $ N/A $ - $ N/A $ - $ 1,201.57
============= ============== ============= ============= =============
Cash distributions/dividends paid or
accrued per exchangeable unit or
common share $ 0.795 $ 0.2649 $ 1.0599 $ 1.0596 $ 1.0596
============= ============== ============= ============= =============
Cash distributions paid or accrued per
passthrough certificate $ - $ - $ - $ - $ 2,428.25
============= ============== ============= ============= =============
Balance Sheet Data:
Investment in mortgage securities $ 241,895,462 $ 33,506,388 $ 37,322,028
============= ============= =============
Investment in corporate securities $ 4,673,127 $ - $ -
============= ============ =============
Investment in preferred stock $ 1,153,800 $ - $ -
============= ============ =============
Total assets- Company $ 264,668,902 $ 1,000 $ -
============= ============ =============
Total assets - Predecessor $ N/A $ 54,439,993 $ 60,144,705
============= ============ =============
Repurchase agreements $ 190,250,084 $ - $ -
============= ============ =============
Total stockholders' equity $ 70,932,757 $ 1,000 $ N/A
============= ============ =============
Total partners' capital $ N/A $ 46,252,826 $ 49,702,829
============= ============= =============
- 13 -
Predecessor Predecessor
As of or As of or
for the for the
Year Ended Year Ended
Dec. 31, 1995 Dec. 31, 1994
------------- -------------
Mortgage securities income $ 3,398,068 $ 3,488,646
Interest income on temporary cash investments
and U.S. government securities 408,645 374,521
Income from other investments 399,746 468,222
General and administrative expenses (834,594) (647,772)
------------- -------------
Net income $ 3,371,865 $ 3,683,617
============= =============
Net income, basic and diluted,
per exchangeable unit $ 0.57 $ 0.62
============= =============
Net income per passthrough certificate $ 1,426.95 $ 1,537.88
============= =============
Cash distributions paid or accrued per
exchangeable unit $ 1.0596 $ 1.0596
============= =============
Cash distributions paid or accrued per
passthrough certificate $ 2,649.00 $ 2,649.00
============= =============
Investment in U.S. government securities $ 5,025,000 $ -
============= =============
Investment in mortgage securities $ 43,103,240 $ 45,810,512
============= =============
Total assets $ 64,566,103 $ 67,833,181
============= =============
Total stockholders' equity/partners' capital $ 53,605,422 $ 56,618,082
============= =============
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
General
The Company was incorporated in Maryland on July 24, 1997, but did not begin
operations until April 10, 1998.
On April 10, 1998, the Company and three partnerships: America First
Participating/Preferred Equity Mortgage Fund Limited Partnership (Prep Fund
1), America First Prep Fund 2 Limited Partnership (Prep Fund 2), America First
Prep Fund 2 Pension Series Limited Partnership (Pension Fund), consummated a
merger transaction whereby their pre-existing net assets and operations or
majority interest in the pre-existing partnership were contributed to the
Company in exchange for 9,035,084 shares of the Company's common stock. For
financial accounting purposes, Prep Fund 1, the largest of the three
Partnerships, was considered the Predecessor entity (the Predecessor) and its
historical operating results are presented in the financial statements
contained herein. The Merger was accounted for using the purchase method of
accounting in accordance with generally accepted accounting principles. Prep
Fund 1 was deemed to be the acquirer of the other Partnerships under the
purchase method. Accordingly, the Merger resulted, for financial accounting
purposes, in the effective purchase by Prep Fund 1 of all the Beneficial Unit
Certificates (BUCs) of Prep Fund 2 and approximately 99% (98% on the date of
the Merger and 1% since the Merger) of the BUCs of Pension Fund. As the
surviving entity for financial accounting purposes, the assets and liabilities
of Prep Fund 1 were recorded by the Company at their historical cost and the
assets and liabilities of Prep Fund 2 and Pension Fund were adjusted to fair
value. The excess of the fair value of stock issued over the fair value of
net assets acquired has been recorded as goodwill in the accompanying balance
sheet of the Company.
Concurrently with the Merger, the Company entered into an Advisory Agreement
with America First Mortgage Advisory Corporation (the "Advisor") and adopted
an investment policy which significantly differed from that pursued by the
- 14 -
predecessor partnerships. This strategy includes leveraged investing in
adjustable rate mortgage securities and mortgage loans. The Company began
implementing this investment strategy in the second quarter of 1998. During
the period from the consummation of the Merger through December 31, 1998, the
Company purchased 13 positions in mortgage backed securities for an aggregate
purchase cost of approximately $232.5 million.
The Company has elected to become subject to tax as a real estate investment
trust (REIT) under the Code beginning with its 1998 taxable year and, as such,
anticipates distributing annually at least 95% of its taxable income, subject
to certain adjustments. Generally, cash for such distributions is expected to
be largely generated from the Company's operations, although the Company may
borrow funds to make distributions. Further, as part of the Merger
transaction, the Company has committed to make distributions in the first year
following the Merger of at least $1.06 per common share, to be paid in four
equal quarterly installments, which is expected to significantly exceed
taxable income. Accordingly, a portion of distributions received by
shareholders in 1998 and 1999 will consist in part of a dividend paid from
earnings and in part of a cash merger payment representing non-taxable return
of capital. There is no commitment by the Company to distribute amounts in
excess of taxable income beyond the first year of operations.
The Company's operations for any period may be affected by a number of factors
including the investment assets held, general economic conditions affecting
underlying borrowers and, most significantly, factors which affect the
interest rate market. Interest rates are highly sensitive to many factors,
including governmental monetary and tax policies, domestic and international
economic and political considerations, and other factors beyond the control of
the Company.
The Merger, other related transactions and on-going implementation of the
change in investment strategy will materially impact the Company's future
operations as compared to those of the Predecessor. Accordingly, the
currently reported financial information is not necessarily indicative of the
Company's future operating results or financial condition.
Liquidity and Capital Resources
The Company requires capital to fund its investment strategy and pay its
operating expenses. The Company's capital sources upon consummation of the
Merger include cash flow from operations and borrowings under repurchase
agreements.
Since the Merger, the Company has primarily financed its mortgage investments
through repurchase agreements totaling $190.2 million with a weighted average
borrowing rate of 5.04% at December 31, 1998. The repurchase agreements have
balances of between $7.6 million and $23.4 million. These arrangements have
original terms to maturity ranging from two months to twelve months and annual
interest rates based on LIBOR. To date, the Company has not had any
significant margin calls on its repurchase agreements.
The Company believes it has adequate financial resources to meet its
obligations as they come due and fund committed dividends as well as to
actively pursue its new investment policy.
Results of Operations
Year Ended December 31, 1998 Compared to 1997
During the year ended December 31, 1998, total interest income for the Company
and the Predecessor increased $5.8 million as compared to total interest
income of the Predecessor for the year ended December 31, 1997. This increase
is a result of the interest generated by mortgage investments acquired in the
merger from Prep Fund 2 and Pension Fund in the Merger as well as the
acquisition of additional mortgage investments during 1998.
The increase in the Company's interest expense on borrowed funds during the
year ended December 31, 1998 compared to that of the Predecessor for
the year ended December 31, 1997, relates to interest expense on
repurchase arrangements used to fund additional investments.
The gain on sale of investments of $414,951 during the year ended December 31,
1998, was due primarily to the payoff of the Company's only participating loan
in the amount of $385,000.
- 15 -
Income from other investments increased as a result of income generated by
other investments acquired from Prep Fund 2 and Pension Fund.
General and administrative expenses for the Company and Predecessor in 1998
increased $689,893 as compared to that of the Predecessor in 1997 as a result
of (i) the management fee payable to the Advisor and (ii) the increased scope
of operations resulting from the Merger.
Year Ended December 31, 1997 Compared to 1996
The decrease in total interest income of $229,679 from 1996 to 1997 is a
result of the continued amortization of the principal balances of the GNMA
Certificates and Single-Family Certificates.
Income from other investments increased $101,971 from 1996 to 1997.
Approximately $151,000 of such increase was due to an increase in cash flow
received by the Predecessor from its investments in partnerships owning
multi-family real estate. This increase was partially offset by a decrease of
approximately $49,000 in interest income on the Predecessor's two
participating loans due primarily to the payoff of one of the participating
loans in April, 1997.
General and administrative expenses increased $509,553 from 1996 to 1997 due
to increases in: (i) salaries and related expenses of approximately $321,000;
(ii) proposed merger transaction costs of approximately $126,000; (iii) travel
and related expenses of approximately $22,000; (iv) administrative fees paid
to the Predecessor's general partner of approximately $7,900; (v) printing
costs of approximately $7,600; and (vi) other general and administrative
expenses of approximately $25,000.
Year 2000
The Company does not own or operate its own computer system and owns no
business or other equipment. However, the operation of the Company's business
relies on the computer system and other equipment maintained by America First
Companies L.L.C., the principal shareholder of the Company's Advisor ("America
First"). In addition, the Company has business relationships with a number of
third parties whose ability to perform their obligations to the Company depend
on such systems and equipment. Some or all of these systems and equipment may
be affected by the inability of certain computer programs and embedded
circuitry to correctly recognize dates occurring after December 31, 1999.
America First has adopted a plan to deal with this so-called "Year 2000
problem" with respect to its information technology ("IT") systems, non-IT
systems and third party business relationships.
State of Readiness
The IT system maintained by America First consists primarily of personal
computers, most of which are connected by a local area network. All
accounting and other record keeping functions relating to the Company that are
conducted in house by America First are performed on this PC-LAN system.
America First does not own or operate any "mainframe" computer systems. The
PC-LAN system runs software programs that America First believes are
compatible with dates after December 31, 1999. America First has engaged a
third party computer consulting firm to review and test its PC-LAN system to
ensure that it will function correctly after that date and expects that this
process, along with any necessary remediation, will be completed by mid-1999.
America First believes any Year 2000 problems relating to its IT systems will
be resolved without significant operational difficulties. However, there can
be no assurance that testing will discover all potential Year 2000 problems or
that it will not reveal unanticipated material problems with the America First
IT systems that will need to be resolved.
Non-IT systems include embedded circuitry such as microcontrollers found in
telephone equipment, security and alarm systems, copiers, fax machines, mail
room equipment, heating and air conditioning systems and other infrastructure
systems that are used by America First in connection with the operation of the
Company's business. America First is reviewing its non-IT systems along with
the providers that service and maintain these systems, with initial emphasis
being placed on those, such as telephone systems, which have been identified
as necessary to America First's ability to conduct the operation of the
Company's business activities. America First expects that any necessary
modification or replacement of such "mission critical" systems will be
accomplished by mid-1999.
- 16 -
The Company has no control over the remediation efforts of third parties with
which it has material business relationships and the failure of certain of
these third parties to successfully remediate their Year 2000 issues could
have a material adverse effect on the Company. Accordingly, America First has
undertaken the process of contacting each such third party to determine the
state of their readiness for Year 2000. Such parties include, but are not
limited to, the obligors on the Company's mortgage securities, the Company's
transfer and paying agent and the financial institutions with which the
Company maintains accounts. America First has received initial assurances
from certain of these third parties that their ability to perform their
obligations to the Company are not expected to be materially adversely
affected by the Year 2000 problem. America First will continue to request
updated information from these material third parties in order to assess their
Year 2000 readiness. If a material third party vendor is unable to provide
assurance to America First that it is, or will be, ready for Year 2000,
America First intends to seek an alternative vendor to the extent practical.
Costs
All of the IT systems and non-IT systems used to conduct the Company's
business operations are owned or leased by America First. The
Company will bear its proportionate share of the costs associated with
surveying the Year 2000 readiness of third parties and with the
identification, remediation and testing of America First's IT and non-IT
systems. However, the Company's share of the costs associated with these
activities is expected to be insignificant. Accordingly, the costs
associated with addressing the Company's Year 2000 issues are not expected to
have a material effect on the Company's results of operations, financial
position or cash flow.
Year 2000 Risks
The Company's Advisor believes that the most reasonably likely worst-case
scenario will be that one or more of the third parties with which it has a
material business relationship will not have successfully dealt with its Year
2000 issues and, as a result, is unable to provide services or otherwise
perform its obligations to the Company. For example, if an obligor on the
Company's mortgage securities encounters a serious and unexpected Year 2000
issue, it may be unable to make a timely payment of principal and interest to
the Company. This, in turn, could cause a delay in dividend payments to
shareholders. In addition, if the Company's transfer and paying agent
experiences Year 2000-related difficulties, it may cause delays in making
dividend payments to shareholders or in the processing of trading of shares.
It is also possible that one or more of the IT and non-IT systems of America
First will not function correctly, and that such problems may make it
difficult to conduct necessary accounting and other record keeping functions
for the Company. However, based on currently available information, the
Company's Advisor does not believe that there will be any protracted systemic
failures of the IT or non-IT systems utilized by America First in connection
with the operation of the Company's business.
Contingency Plans
Because of the progress which America First has made toward achieving Year
2000 readiness, the Company has not made any specific contingency plans with
respect to the IT and non-IT systems of America First. In the event of a Year
2000 problem with its IT system, America First may be required to manually
perform certain accounting and other record-keeping functions. America First
plans to terminate the Company's relationships with material third party
service providers that are not able to represent to America First that they
will be able to successfully resolve their material Year 2000 issues in a
timely manner. However, the Company will not be able to readily terminate its
relationships with all third parties, such as the obligors on its mortgage
securities, who may experience Year 2000 problems. The Company has no
specific contingency plans for dealing with Year 2000 problems experienced
with these third parties.
All forecasts, estimates or other statements in this report relating to the
Year 2000 readiness of the Company and its affiliates are based on
information and assumptions about future events. Such "forward-looking
statements" are subject to various known and unknown risks and uncertainties
that may cause actual events to differ from such statements. Important
factors upon which the Company's Year 2000 forward-looking statements are
based include, but are not limited to, (a) the belief of America First that
- 17 -
the software used in IT systems is already able to correctly read and
interpret dates after December 31, 1999 and will require little or any
remediation; (b) the ability to identify, repair or replace mission critical
non-IT equipment in a timely manner, (c) third parties' remediation of their
internal systems to be Year 2000 ready and their willingness to test their
systems interfaces with those of America First, (d) no third party system
failures causing material disruption of telecommunications, data transmission,
payment networks, government services, utilities or other infrastructure, (e)
no unexpected failures by third parties with which the Company has a
material business relationship and (f) no material undiscovered flaws in
America First's Year 2000 testing process.
Forward Looking Statements
When used in this Form 10-K, in future SEC filings or in press releases or
other written or oral communications, the words or phrases "will likely
result", "are expected to", "will continue", "is anticipated", "estimate",
"project" or similar expressions are intended to identify "forward looking
statements" within the meaning of the Private Securities Litigation Reform
Act of 1995. The Company cautions that such forward looking statements
speak only as of the date made and that various factors including regional
and national economic conditions, changes in levels of market interest
rates, credit and other risks of lending and investment activities, and
competitive and regulatory factors could affect the Company's financial
performance and could cause actual results for future periods to differ
materially from those anticipated or projected.
The Company does not undertake and specifically disclaims any obligation to
update any forward-looking statements to reflect events or circumstances after
the date of such statements.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
The Company seeks to manage the interest rate, market value, liquidity,
prepayment and credit risks inherent in all financial institutions in a
prudent manner designed to insure the longevity of the Company while, at the
same time, seeking to provide an opportunity to shareholders to realize
attractive total rates of return through stock ownership of the Company.
While the Company does not seek to avoid risk, it does seek, to the best of its
ability, to assume risk that can be quantified from historical experience, to
actively manage such risk, to earn sufficient compensation to justify the
taking as such risks and to maintain capital levels consistent with the risks
it does undertake.
Interest Rate Risk
At December 31, 1998, the Company had $194.5 million adjustable-rate assets
and $190.3 million adjustable-rate liabilities. Hybrid mortgage assets, with
fixed-rate coupons for a given period and adjustable rate coupons thereafter,
included approximately $38.6 million of adjustable-rate mortgages with
fixed-rate coupons for three to five years, approximately $63.2 million of
adjustable-rate mortgages with fixed coupons from one to three years and
approximately $92.7 million of adjustable-rate mortgages with interest rates
that adjust within the next 12 months. Fixed rate assets were $47.4 million;
there were no fixed rate liabilities.
At December 31, 1998, the weighted average roll date for the adjustable rate
mortgage assets was approximately 20.7 months while the weighted average
months for expiration of financing was approximately 5.3 months. Therefore,
on average, the Company's cost of funds may rise or fall more quickly than
does its earnings rate on the assets.
At December 31, 1998, the Company owned approximately $92.7 million of
adjustable-rate mortgages with interest rates that adjust within the next 12
months. The weighted average time maturity of the Company's financing at
December 31, 1998 was approximately 5.2 months. As a result, the Company's
net income may vary somewhat as the yield curve between one-month interest
rates and six and twelve-month interest rates varies.
At December 31, 1998, the Company's adjustable-rate assets are dependent on
the one-year CMT rates and liabilities are dependent on LIBOR. These indexes
generally move in parallel, but there can be no assurances that this will
continue to occur.
- 18 -
Market Value Risk
The market value of the Company's assets can fluctuate due to changes in
interest rates and other factors. As discussed in the Note 2 to the Company's
consolidated financial statements, these fluctuations are due to the fact that
substantially all of the Company's investments are "available-for-sale" assets
which are reflected at fair value with the adjustment in the equity section.
Liquidity Risk
The primary liquidity risk of the Company arises from financing long maturity
mortgage assets with short-term debt. Although the interest rate adjustments
of these assets and liabilities are matched within the Company's operating
policies, maturities are not matched.
The Company's assets which are pledged to secure short-term borrowings are
high-quality, liquid assets. As a result, the Company has not had difficulty
rolling over its short-term debt as it matures, even during the period of
reduced financial market liquidity in the fourth quarter of 1998. Still,
the Company cannot give assurances that it will always be able to roll over
its short-term debt.
At December 31, 1998, the Company had unrestricted cash of $6.0 million. In
addition, the Company had $51.6 million in market value of unpledged AAA rated
mortgage securities available to secure additional borrowings or serve as
additional collateral for existing borrowings. The resources the Company had
available to meet margin calls on short-term debt that could be caused by
asset value declines or changes in lender over-collateralization requirement
thus equaled $57.6 million, or 30.3% of short-term debt. As the Company
becomes more fully invested, it is anticipated that the over-collateralization
amount will decline.
Prepayment Risk
As the Company receives repayments of mortgage principal, it amortizes into
income its mortgage premium balances as an expense and its mortgage discount
balances as income. Mortgage premium balances arise when the Company acquires
mortgage assets at a price in excess of the principal value of the mortgages,
or when an asset appreciates and is marked-to-market at a price above par.
Mortgage discount balances arise when the Company acquires mortgage assets at
a price below the principal value of the mortgages, or when an asset
depreciates and is marked-to-market at a price below par. For GAAP, the
premium is amortized based on the effective yield of the asset at each
financial reporting date. For tax purposes, the premium is amortized based on
the asset yield at the purchase date. Therefore if prepayments are higher
than anticipated and the index has declined, it is anticipated that the GAAP
yield will decline and there will be greater premium amortization under tax
than GAAP. At December 31, 1998, unamortized mortgage premium balances for
financial reporting purposes was $2.9 million (1.1% of total assets) and $1.9
million for Federal tax purposes (.7% of total assets) of adjustable rate
assets.
The Company had no long-term debt at December 31, 1998.
In general, the Company believes it will be able to reinvest prepayments at
acceptable yields, however, no assurances can be given that, should
significant prepayments occur, market conditions would be such that acceptable
investments could be identified and the proceeds reinvested.
Tabular Presentation
The information presented in the table below, projected impact on 1999 net
income and net assets based on investments in place on December 31, 1998,
includes all the Company's interest rate sensitive assets and liabilities.
The Company acquires interest-rate sensitive assets and funds them with
interest-rate sensitive liabilities. The Company generally plans to retain
such assets and the associated interest rate risk to maturity.
The table below includes information about the possible future repayments and
interest rates of Company's assets and liabilities and constitutes a
"forward-looking statement." There are many assumptions used to generate this
information and there can be no assurance that assumed events will occur as
assumed or that other events will occur that would affect the outcomes.
Furthermore, future sales, acquisitions, calls, and restructuring could
- 19 -
materially change the Company's interest rate risk profile. The table
quantifies the potential changes in net income should interest rates go up or
down (shocked) by 100 and 200 basis points, assuming the yield curves of the
rate shocks will be parallel to each other. The cash flows associated with
the adjustable rate securities for each rate shock are calculated based on a
variety of assumptions, including prepayment vectors, repurchase rates,
repurchase haircuts, yield on reinvestment of prepayment, and growth in the
portfolio.
When interest rates are shocked, these prepayment assumptions are further
adjusted based on management's best estimate of the effects of changes on
interest rates or prepayment speeds. For example, under current market
conditions, a 100 basis point decline in the interest rates is estimated to
result in a 160% increase in the prepayment rate of the ARM portfolio. The
base interest rate scenario assumes interest rates at December 31, 1998.
Actual results could differ significantly from those estimated in the table
As of December 31, 1998 all interest-rate sensitive liabilities were scheduled
to mature in 1999.
Change in Percentage Change Percentage Change
Interest Rates in Net Income in Net Assets
-------------- ----------------- -----------------
-2% +15.8% -0.7%
-1% +9.3% -1.1%
0 0.0 0.0
1% -9.6% +3.7%
2% -37.5% +3.6%
Item 8. Financial Statements and Supplementary Data.
Index to Financial Statements
Financial Statements: Page
Independent Accountants' Report..........................................22
Consolidated Balance Sheet of the Company as of December 31, 1998, and
Combined Balance Sheet of the Predecessor as of December 31, 1997........23
Consolidated Statements of Income of the Company for the
period April 10, 1998 through December 31, 1998, and Combined
Statements of Income of the Predecessor from January 1, 1998 through
April 9, 1998 and for the years ended December 31, 1997 and December
31, 1996.................................................................24
Consolidated Statements of Stockholders' Equity of the Company for the
period April 10, 1998 through December 31, 1998, and Combined
Statements of Partners' Capital of the Predecessor from January 1, 1998
through April 9, 1998 and for the years ended December 31, 1997, and
December 31, 1996........................................................26
Consolidated Statements of Cash Flows of the Company for the period
April 10, 1998 through December 31, 1998, and Combined Statements of
Cash Flows of the Predecessor from January 1, 1998 through April 9,
1998 and for the years ended December 31, 1997, and December 31, 1996....28
Notes to Consolidated and Combined Financial Statements of Company and
the Predecessor........................................................30
All other schedules are omitted because they are not applicable or the
required information is shown in the consolidated or combined statements
or notes thereto.
Financial statements of one 95%-owned company, a 99% limited partnership
interest in two real estate limited partnerships, a 50% limited partnership
interest in one real estate limited partnership and a 49% interest in one real
estate limited partnership have been omitted because the Company's
- 20 -
proportionate share of the income from continuing operations before income
taxes is less than 20% of the respective consolidated amount, and the
investment in and advances to each entity is less than 20% of consolidated
total assets.
- 21 -
INDEPENDENT ACCOUNTANTS' REPORT
To the Board of Directors of
America First Mortgage Investments, Inc.
In our opinion, the consolidated and combined financial statements listed in
the accompanying index present fairly, in all material respects, the financial
position of America First Mortgage Investments, Inc. and its subsidiaries (the
"Company") as of December 31, 1998, and the results of their operations and
their cash flows for the period from April 10, 1998 through December 31, 1998,
and the financial position of the Company, America First
Participating/Preferred Equity Mortgage Fund Limited Partnership and America
First Participating/Preferred Equity Mortgage Fund as of
December 31, 1997, and the results of their operations and their cash flows for
the period from January 1, 1998 to April 9, 1998, and for each of the two years
ended December 31, 1997 and 1996, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of
the Company's and Fund's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these financial statements in accordance with generally accepted
auditing standards which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management,
and evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for the opinion expressed above.
/s/PricewaterhouseCoopers LLP
New York, New York
March 4, 1999
- 22 -
AMERICA FIRST MORTGAGE INVESTMENTS, INC.
CONSOLIDATED AND COMBINED BALANCE SHEETS
Company and
Company Predecessor
as of as of
Dec. 31, 1998 Dec. 31, 1997
--------------- ---------------
Assets
Investment in mortgage securities (Note 3) $ 241,895,462 $ 33,506,388
Investment in corporate securities (Note 4) 4,673,127 -
Investment in preferred stock 1,153,800 -
Cash and cash equivalents, at cost
which approximates market value 6,045,956 10,427,181
Accrued interest receivable 1,540,576 272,264
Other investments (Note 5) 1,197,341 1,910,686
Investment evaluation fees, net 564,404
Goodwill, net 7,361,338 -
Other assets 801,302 878,074
--------------- ---------------
$ 264,668,902 $ 47,558,997
=============== ===============
Liabilities
Repurchase agreements (Note 6) $ 190,250,084 $ -
Accrued interest payable 795,785 -
Accounts payable 212,085 794,102
Dividends or distributions payable 2,413,803 511,069
--------------- ---------------
193,671,757 1,305,171
--------------- ---------------
Minority interest in Pension Fund (Note 1) 64,388 -
Stockholders' Equity and Partners' Capital
Stockholders' Equity - Company
Common stock, $.01 par value; 10,000,000 shares authorized
9,055,142 issued and outstanding 90,551 1,000
Additional paid in capital 76,203,009 -
Retained earnings (4,302,981) -
Accumulated other comprehensive income (1,057,822) -
Partners' Capital - Predecessor
General Partner - 100
Unit Holders - 45,682,774
Accumulated other comprehensive income - 569,952
--------------- ---------------
70,932,757 46,253,826
--------------- ---------------
$ 264,668,902 $ 47,558,997
=============== ===============
The accompanying notes are an integral part of the consolidated and combined financial statements.
- 23 -
AMERICA FIRST MORTGAGE INVESTMENTS, INC.
CONSOLIDATED AND COMBINED STATEMENTS OF INCOME
For the Year Ended December 31, 1998
------------------------------------
Company Company and
From April 10 to Predecessor
December 31, 1998 Through April 9 Total
----------------- --------------- ---------------
Mortgage securities income $ 7,626,742 $ 613,793 $ 8,240,535
Corporate securities income 164,738 - 164,738
Interest income on temporary cash investments 439,889 148,799 588,688
--------------- --------------- ---------------
Total interest income 8,231,369 762,592 8,993,961
Interest expense on borrowed funds 4,619,500 - 4,619,500
--------------- --------------- ---------------
Net interest income 3,611,869 762,592 4,374,461
--------------- --------------- ---------------
Income from other investments 581,716 145,167 726,883
Gain on sale of investment 414,951 - 414,951
--------------- --------------- ---------------
996,667 145,167 1,141,834
--------------- --------------- ---------------
General and administrative expenses 1,674,114 421,293 2,095,407
Minority interest 3,353 - 3,353
--------------- --------------- ---------------
1,677,467 421,293 2,098,760
--------------- --------------- ---------------
Net income $ 2,931,069 $ 486,466 $ 3,417,535
=============== =============== ===============
Net income allocated to:
General Partner $ 3,931
BUC Holders 482,535
---------------
$ 486,466
===============
Net income, basic and fully diluted, per share $ 0.32 N/A
=============== ===============
Net income, basic and fully diluted, per unit N/A $ 0.08
=============== ===============
Weighted average number of shares outstanding 9,043,172 N/A
Weighted average number of units outstanding N/A 5,775,797
The accompanying notes are an integral part of the consolidated and combined financial statements.
- 24 -
AMERICA FIRST MORTGAGE INVESTMENTS, INC.
CONSOLIDATED AND COMBINED STATEMENTS OF INCOME
Predecessor Predecessor
For the For the
Year Ended Year Ended
Dec. 31, 1997 Dec. 31, 1996
--------------- ----------------
Mortgage securities income $ 2,654,975 $ 3,011,347
Interest income on temporary cash investments
and U.S. government securities 569,624 442,931
--------------- ----------------
Total interest income 3,224,599 3,454,278
--------------- ----------------
Income from other investments 606,582 504,611
--------------- ----------------
General and administrative expenses 1,405,514 895,961
--------------- ----------------
Net income $ 2,425,667 $ 3,062,928
=============== ================
Net income allocated to:
General Partner $ 21,920 $ 29,811
Exchangeable Unit Holders 2,403,747 2,912,960
Passthrough Certificate Holders - 120,157
--------------- ----------------
$ 2,425,667 $ 3,062,928
=============== ================
Net income, basic and fully diluted,
per exchangeable unit $ 0.42 $ 0.52
=============== ================
Net income, basic and diluted,
per passthrough certificate $ - $ 1,201.57
=============== ================
Weighted average number of
exchangeable units outstanding 5,775,797 5,562,320
Weighted average number of
passthrough certificates outstanding - 100
The accompanying notes are an integral part of the consolidated and combined financial statements.
- 25 -
AMERICA FIRST MORTGAGE INVESTMENTS, INC.
CONSOLIDATED AND COMBINED STATEMENTS OF STOCKHOLDERS' EQUITY
Stockholders' Equity - Company
---------------------------------------------------------------------------------
Accumulated
Other
Common Stock Paid-in Retained Comprehensive
# of Shares Amount Capital Earnings Income Total
------------ ------------ ------------ ------------ ------------ ------------
Balance at November 11, 1997 (date of
capitalization) and December 31, 1997 90,621 $ 906 $ 94 $ - $ - $ 1,000
Effects of Merger:
Issuance of stock of the Company in exchange
for Units of the Predecessor 5,775,797 57,758 45,126,359 - - 45,184,117
Issuance of stock of the Company in exchange
for Units of Prep Fund 2 and Pension Fund 3,168,666 31,687 29,949,413 - - 29,981,100
Issuance of stock options - - 942,390 - - 942,390
Comprehensive income:
Net income - - - 2,931,069 - 2,931,069
Other comprehensive income:
Change in classification of mortgage
securities from held-to-maturity to
available-for-sale - - - - (704,828) (704,828)
Net unrealized holding losses arising
during the period - - - - (352,994) (352,994)
------------ ------------ ------------ ------------ ------------ ------------
Comprehensive income - - - 2,931,069 (1,057,822) 1,873,247
Dividends paid or accrued - - - (7,234,050) (7,234,050)
Common stock issued 20,058 200 184,753 - - 184,953
------------ ------------ ------------ ------------ ------------ ------------
Balance at December 31, 1998 9,055,142 $ 90,551 $76,203,009 $(4,302,981) $(1,057,822) $70,932,757
============ ============ ============ ============ ============ ============
The accompanying notes are an integral part of the consolidated and combined financial statements.
- 26 -
AMERICA FIRST MORTGAGE INVESTMENTS, INC.
CONSOLIDATED AND COMBINED STATEMENTS OF PARTNERS' CAPITAL
Partners' Capital - Predecessor
-------------------------------------------------------------------------------
Passthrough Certificate Exchangeable Unit
Holders Holders
-------------------------- -------------------------
General # of
Partner Certificates Amount # of Units Amount Total
-------- ------------ ------------ ---------- ------------ ------------
Partners' Capital-Predecessor (excluding
accumulated other comprehensive income)
Balance at December 31, 1995 $ 100 100 $ 2,271,186 5,562,267 $ 50,525,558 $ 52,796,844
Net income 29,811 - 120,157 - 2,912,960 3,062,928
Cash distributions paid or accrued (Note 3) (29,811) - (242,825) - (5,893,835) (6,166,471)
Purchase of 36,470 units - - 1,241 (36,470) (295,380) (294,139)
Conversion of Passthrough Certificate
Holders to Exchangeable Unit Holders - (100) (2,149,759) 250,000 2,149,759 -
-------- ------------ ------------ ---------- ------------ ------------
Balance at December 31, 1996 100 - - 5,775,797 49,399,062 49,399,162
Net income 21,920 - - - 2,403,747 2,425,667
Cash distributions paid or accrued (Note 3) (21,920) - - - (6,120,035) (6,141,955)
-------- ------------ ------------ ---------- ------------ ------------
Balance at December 31, 1997 100 - - 5,775,797 45,682,774 45,682,874
Net income 3,931 - - - 482,535 486,466
Cash distributions paid or accrued (Note 3) (3,931) - - - (1,530,009) (1,533,940)
-------- ------------ ------------ ----------- ------------ ------------
Balance at April 10, 1998 100 - - 5,775,797 44,635,300 44,635,400
-------- ------------ ------------ ----------- ------------ ------------
Accumulated other comprehensive income
Balance at December 31, 1995 - - 34,779 - 773,799 808,578
Other comprehensive income - - (34,779) - (470,132) (504,911)
-------- ------------ ------------ ---------- ------------ ------------
Balance at December 31, 1996 - - - - 303,667 303,667
Other comprehensive income - - - - 266,285 266,285
-------- ------------ ------------ ---------- ------------ ------------
Balance at December 31, 1997 - - - - 569,952 569,952
Other comprehensive income - - - - (21,235) (21,235)
-------- ------------ ------------ ---------- ------------ ------------
Balance at April 10, 1998 548,717 548,717
-------- ------------ ------------ ---------- ------------ ------------
Issuance of stock of the Company in
exchange for Units of the Predecessor (100) - - (5,775,797) (45,184,017) (45,184,117)
-------- ------------ ------------ ----------- ------------ ------------
Total Partners' Capital-Predecessor
at April 10, 1998 $ - - $ - - $ - $ -
======== ============ ============ ========== ============ ============
The accompanying notes are an integral part of the consolidated and combined
financial statements.
- 27 -
AMERICA FIRST MORTGAGE INVESTMENTS, INC.
CONSOLIDATED AND COMBINED STATEMENTS OF CASH FLOWS
For the Year Ended December 31, 1998
------------------------------------
Company Predecessor
From April 10 to
December 31, 1998 Through April 9 Total
----------------- --------------- ---------------
Cash flows from operating activities
Net income $ 2,931,069 $ 486,466 $ 3,417,535
Adjustments to reconcile net income to
net cash provided by (used in)
operating activities:
Gain on sale of investments (414,951) - (414,951)
Minority interest 3,353 - 3,353
Amortization 308,384 (1,959) 306,425
Decrease (increase) in interest receivable (1,134,069) 8,302 (1,125,767)
Decrease (increase) in other assets (252,473) 6,241 (246,232)
Increase (decrease) in accounts payable (1,860,513) 565,608 (1,294,905)
Increase in accrued interest payable 795,785 - 795,785
-------------- --------------- --------------
Net cash provided by operating activities 376,585 1,064,658 1,441,243
-------------- --------------- --------------
Cash flows from investing activities
Net cash from Merger 4,820,481 - 4,820,481
Principal payments on mortgage securities 46,682,908 867,630 47,550,538
Proceeds from sale of other investments 1,290,000 - 1,290,000
Purchases of mortgage securities (236,107,915) - (236,107,915)
Purchases of corporate securities (4,662,500) - (4,662,500)
Purchases of preferred stock (1,081,773) - (1,081,773)
Decrease (increase) in other investments (58,567) 42,869 (15,698)
Merger transaction costs paid - (729,509) (729,509)
-------------- --------------- --------------
Net cash provided by (used in) investing activities (189,117,366) 180,990 (188,936,376)
-------------- --------------- --------------
Cash flows from financing activities
Net borrowings from repurchase agreements 190,250,084 - 190,250,084
Dividends and distributions paid (5,600,169) (1,535,007) (7,135,176)
-------------- --------------- --------------
Net cash provided by (used in) financing activities 184,649,915 (1,535,007) 183,114,908
-------------- --------------- --------------
Net decrease in cash and cash equivalents (4,090,866) (289,359) (4,380,225)
Cash and temporary cash investments at beginning
of period 10,136,822 10,426,181 10,426,181
--------------- --------------- --------------
Cash and temporary cash investments at end of period $ 6,045,956 $ 10,136,822 $ 6,045,956
=============== =============== ==============
Supplemental disclosure of cash flow information:
Cash paid during the period for interest $ 3,823,715 $ - $ 3,823,715
The accompanying notes are an integral part of the consolidated and combined financial statements.
Supplemental disclosure on non-cash investing activities:
The following assets and liabilities were assumed by the Company in conjunction
with the Merger and issuance of common stock (see Note 1):
Mortgage securities $ 20,420,336 $ - $ 20,420,336
Accrued interest receivable 142,545 - 142,545
Other investments 175,369 - 175,369
Accounts payable 712,888 - 712,888
Distributions payable 265,545 - 265,545
Goodwill of $7,507,902 was recorded by the Company as a result of the Merger.
- 28 -
AMERICA FIRST MORTGAGE INVESTMENTS, INC.
CONSOLIDATED AND COMBINED STATEMENTS OF CASH FLOWS
Company and
Predecessor Predecessor
For the For the
Year Ended Year Ended
Dec. 31, 1997 Dec. 31, 1996
--------------- ---------------
Cash flows from operating activities
Net income $ 2,425,667 $ 3,062,928
Adjustments to reconcile net income to
net cash provided by operating activities:
Amortization (11,860) (31,569)
Decrease in interest receivable 33,342 68,881
Decrease in other assets 325 2,017
Increase (decrease) in accounts payable 623,186 (3,383)
--------------- ---------------
Net cash provided by operating activities 3,070,660 3,098,874
--------------- ---------------
Cash flows from investing activities
Principal payments on mortgage securities 4,116,822 5,355,906
Proceeds from sale of other investments 2,100,000 -
Merger transaction costs paid (859,642) -
Increase in other investments (675,643) (14,036)
Maturity of U.S. government securities - 5,000,000
--------------- ---------------
Net cash provided by investing activities 4,681,537 10,341,870
--------------- ---------------
Cash flows from financing activities
Distributions paid (6,143,343) (6,683,157)
Issuance of stock 1,000 -
Purchase of Units - (294,139)
--------------- ---------------
Net cash used in financing activities (6,142,343) (6,977,296)
--------------- ---------------
Net increase in cash and cash equivalents 1,609,854 6,463,448
Cash and temporary cash investments at beginning
of year 8,817,327 2,353,879
--------------- --------------
Cash and temporary cash investments at end of year $ 10,427,181 $ 8,817,327
=============== ===============
The accompanying notes are an integral part of the consolidated and combined financial statements.
- 29 -
AMERICA FIRST MORTGAGE INVESTMENTS, INC.
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
DECEMBER 31, 1998
1. Organization
America First Mortgage Investments, Inc. (the Company) was incorporated in
Maryland on July 24, 1997, but had no operations prior to April 10, 1998.
On April 10, 1998, (the Merger Date) the Company and three partnerships:
America First Participating/Preferred Equity Mortgage Fund Limited Partnership
(Prep Fund 1), America First Prep Fund 2 Limited Partnership (Prep Fund 2),
America First Prep Fund 2 Pension Series Limited Partnership (Pension Fund),
consummated a merger transaction whereby their pre-existing net assets and
operations or majority interest in the preexisting partnership were
contributed to the Company in exchange for 9,035,084 shares of the Company's
common stock. For financial accounting purposes, Prep Fund 1, the largest of
the three partnerships, was considered the Predecessor entity (the
Predecessor) and its historical operating results are presented in the
financial statements contained herein. The Merger was accounted for using the
purchase method of accounting in accordance with generally accepted accounting
principles. Prep Fund 1 was deemed to be the acquirer of the other
partnerships under the purchase method. Accordingly, the Merger resulted, for
financial accounting purposes, in the effective purchase by Prep Fund 1 of all
the Beneficial Unit Certificates (BUCs) of Prep Fund 2 and approximately 99%
of the BUCs of Pension Fund. As the surviving entity for financial accounting
purposes, the assets and liabilities of Prep Fund 1 were recorded by the
Company at their historical cost and the assets and liabilities of Prep Fund 2
and Pension Fund were adjusted to fair value. The excess of the fair value of
stock issued over the fair value of net assets acquired has been recorded as
goodwill in the accompanying balance sheet.
The Company has entered into an advisory agreement with America First Mortgage
Advisory Company (the Advisor) which provides advisor services in connection
with the conduct of the Company's business activities.
2. Summary of Significant Accounting Policies
A) Method of Accounting
The accompanying 1998 consolidated and combined financial statements
include the consolidated accounts of the Company from April 10, 1998
through December 31, 1998, and the combined accounts of the Company,
Prep Fund 1 and America First Participating/Preferred Equity Mortgage
Fund (the managing general partner of Prep Fund 1) (together referred
to as the Predecessor) for periods prior to the Merger. The financial
statements are prepared on the accrual basis of accounting in accordance
with generally accepted accounting principles.
The consolidated financial statements include the accounts of the
Company and its subsidiaries, Pension Fund and America First Capital
Associates Limited Partnership Six (the general partner of Pension Fund).
All significant intercompany transactions and accounts have been
eliminated in consolidation. In addition, as more fully discussed in Note
5, the Company has an investment in a corporation and investments in four
real estate limited partnerships, none of which are controlled by the
Company. These investments are accounted for under the equity method.
Neither the corporation nor the real estate limited partnerships are
consolidated for income tax purposes.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
B) Cash and Cash Equivalents
Cash and cash equivalents include cash on hand and highly liquid
investments with original maturities of three months or less. The
carrying amount of cash equivalents approximates their fair value.
- 30 -
C) Mortgage Securities and Corporate Securities
Statement of Financial Accounting Standards No. 115, "Accounting for
Certain Investments in Debt and Equity Securities" (SFAS 115), requires
the Company to classify its investments in mortgage securities and
corporate securities (collectively referred to as investment securities)
as either held-to-maturity, available-for-sale or trading. In order to be
prepared to respond to potential future opportunities in the market, to
sell mortgage securities in order to optimize the portfolio's total return
and to retain its ability to respond to economic conditions that require
the Company to sell assets in order to maintain an appropriate level of
liquidity, the Company has classified all its mortgage securities as
available-for-sale. Although the Company generally intends to hold most
of its mortgage securities until maturity, it may, from time to time, sell
any of its mortgage securities as part of its overall management of its
business. Accordingly, to maintain flexibility, the Company currently
classifies all of its mortgage securities as available-for-sale.
Certain mortgage securities classified as available-for-sale on the
December 31, 1998, balance sheet of the Company were classified as
held-to-maturity on the December 31, 1997 balance sheet of the
Predecessor. (See Note 3).
Mortgage securities which were classified as held-to-maturity were carried
at amortized cost. Mortgage securities classified as available-for-sale
are reported at fair value, with unrealized gains and losses excluded from
earnings and reported as a separate component of stockholders' equity or
partners' capital.
Corporate securities are classified as held-to-maturity and are carried at
amortized cost.
Unrealized losses on mortgage securities that are considered
other-than-temporary, as measured by the amount of decline in fair value
attributable to factors other than temporary, are recognized in income and
the cost basis of the mortgage security is adjusted. Other-than-temporary
unrealized losses are based on management's assessment of various factors
affecting the expected cash flow from the mortgage securities, including
an other-than-temporary deterioration of the credit quality of the
underlying mortgages and/or the credit protection available to the
related mortgage pool.
Gains or losses on the sale of investment securities are based on the
specific identification method.
Interest income is accrued based on the outstanding principal amount of
the investment securities and their contractual terms. Premiums and
discounts associated with the purchase of the investment securities are
amortized into interest income over the lives of the securities using the
effective yield method based on, among other things, anticipated estimated
prepayments. Such calculations are periodically adjusted for actual
prepayment activity.
D) Credit Risk
The Company limits its exposure to credit losses on its investment
portfolio by requiring that at least 70% of its investment portfolio
consist of mortgage securities or mortgage loans that are either
(i) insured or guaranteed as to principal and interest by an agency of
the U.S. government, such as Government National Mortgage Association
(GNMA), Federal National Mortgage Association (FNMA), or Federal Home Loan
Mortgage Corporation (FHLMC), (ii) rated in one of the two highest rating
categories by either Standard & Poor's or Moody's, or (iii) considered to
be of equivalent credit quality as determined by the Advisor and approved
by the Company's investment committee. The remainder of the Company's
assets may be either: (i) mortgage assets rated at least investment grade
or considered to be of equivalent credit quality by the Advisor with
approval from the Company's investment committee; (ii) direct investment
(mezzanine or equity) in multifamily projects collateralizing mortgage
loans owned by the Company; (iii) investments in limited partnerships,
real estate investment trusts or closed-end funds owning a portfolio of
mortgage assets; or (iv) other fixed income instruments (corporate or
government) that provide increased call protection relative to the Company's
mortgage securities. Corporate debt that is rated below investment grade
will be limited to less than 5% of the Company's total assets. As of
December 31, 1998, approximately 91% of the Company's assets consisted of
mortgage
- 31 -
securities insured or guaranteed by the U.S. government or an agency
thereof. At December 31, 1998, management determined no allowance for
credit losses was necessary.
E) Other Investments
Other investments consist of: (i) non-voting preferred stock of a
corporation owning interests in real estate limited partnerships,
(ii) investments in limited partnerships owning real estate,
(iii) direct investments in multifamily projects collateralizing mortgage
loans owned by the Company, and (iv) other real estate investments.
F) Net income per Share
Net income per share is based on the weighted average number of common
shares and common equivalent shares (e.g., stock options), if dilutive,
outstanding during the period. Basic net income per share is computed by
dividing net income available to shareholders by the weighted average
number of common shares outstanding during the period. Diluted net
income per share is computed by dividing the diluted net income available
to common shareholders by the weighted average number of common shares and
common equivalent shares outstanding during the period. The common
equivalent shares are calculated using the treasury stock method which
assumes that all dilutive common stock equivalents are exercised and the
funds generated by the exercise are used to buy back outstanding common
stock at the average market price during the reported period.
As more fully discussed in Note 7, options to purchase 520,000 shares of
common stock were issued during the quarter ended June 30, 1998. Because
the average stock price during the quarter was less than the exercise
price, exercise of such options under the treasury stock method would
be anti-dilutive. Accordingly, these potentially dilutive securities were
not considered in fully diluted earnings per share and, as a result, basic
and fully diluted net income per share are the same for such period. With
regard to the Predecessor, basic and diluted net income per Unit of the
Predecessor were the same for all periods presented as no dilutive
equivalent units existed.
G) Comprehensive Income
Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income" requires the Company and the Predecessor to display
and report comprehensive income, which includes all changes in
Stockholders' Equity or Partners' Capital with the exception of additional
investments by or dividends to shareholders of the Company or additional
investments by or distributions to partners of the Predecessor.
Comprehensive income for the Company and the Predecessor include net
income and the change in net unrealized holding gains (losses) on
investments. Comprehensive income for the years ended December 31, 1998,
1997 and 1996 was as follows:
For the Year Ended December 31, 1998
------------------------------------
Company Predecessor Predecessor Predecessor
From April 10 to
December 31, 1998 Through April 9 Total Dec. 31,1997 Dec. 31, 1996
----------------- --------------- --------------- --------------- -------------
Net income $ 2,931,069 $ 486,466 $ 3,417,535 $ 2,425,667 $ 3,062,928
Change in classification of mortgage
securities from held-to-maturity to
available-for-sale (704,828) - (704,828) - -
Change in net unrealized
holding gains (losses) (352,994) (21,235) (374,229) 266,285 (504,911)
--------------- --------------- --------------- --------------- -------------
Comprehensive income $ 1,873,247 $ 465,231 $ 2,338,478 $ 2,691,952 $ 2,558,017
=============== =============== =============== =============== =============
H) Federal Income Taxes
The Company has elected to be taxed as a real estate investment trust
(REIT) under the provisions of the Internal Revenue Code and the
corresponding provisions of state law.
- 32 -
As such, no provision for income taxes has been made in the accompanying
consolidated financial statements.
Since the Predecessor was a partnership and generally not subject to taxes
directly, it did not make a provision for income taxes. The Predecessor's
Beneficial Unit Certificate (BUC) Holders were required to report their
share of the Predecessor's income for federal and state income tax
purposes.
I) Segment Reporting
In 1998, the partnership adopted Statement of Financial Accounting
Standards No. 131, "Disclosures about Segments of an Enterprise and
Related Information" (SFAS 131). SFAS 131 requires that a public business
enterprise report financial and descriptive information about its
reportable operating segments. The adoption of SFAS 131 did not have an
impact on the financial reporting of the Partnership.
J) Reclassifications
Certain prior period amounts have been reclassified to conform with the
current period classification.
K) New Accounting Pronouncement
In June, 1998, the Financial Accounting Standards Board issued Financial
Accounting Standards No. 133, "Accounting for Derivative Instruments and
Hedging Activities " (FAS 133). This statement provides new accounting
and reporting standards for the use of derivative instruments. Adoption
of this statement is required by the Company effective January 1, 2000.
Management intends to adopt the statement as required in fiscal 2000.
Management believes that the impact of such adoption will not be material
to the financial statements. Although the Company and its Predecessor have
not historically used such instruments, it is not precluded from doing so.
In the future, management anticipates using such derivative instruments
only as hedges to manage interest rate risk. Management does not anticipate
entering into derivatives for speculative or trading purposes.
3. Mortgage Securities
The following table present the Company's mortgage securities as of December
31, 1998 and the Predecessor's mortgage securities as of December 31, 1997.
December 31, 1998 December 31, 1997
----------------- ----------------
GNMA Certificates $ 59,452,502 $ 30,905,173
FNMA Certificates 159,686,597 2,601,215
FHLMC Certificates 22,756,363 -
----------------- -----------------
$ 241,895,462 $ 33,506,388
================= =================
At December 31, 1998, mortgage securities consisted of pools of
adjustable-rate mortgage securities with a carrying value of $194,542,316 and
fixed-rate mortgage securities with a carrying value of $47,353,146. At
December 31, 1997, mortgage securities consisted of fixed-rate Mortgage
Securities.
The Government National Mortgage Association (GNMA) Certificates are backed by
first mortgage loans on multifamily residential properties and pools of
single-family properties. The GNMA Certificates are debt securities issued
by a private mortgage lender and are guaranteed by GNMA as to the full and
timely payment of principal and interest on the underlying loans.
The Federal National Mortgage Association (FNMA) Certificates are backed by
first mortgage loans on pools of single-family properties. The FNMA
Certificates are debt securities issued by FNMA and are guaranteed by FNMA as
to the full and timely payment of principal and interest on the underlying
loans.
Federal Home Loan Mortgage Corporation (FHLMC) Certificates are backed by
first mortgage loans on pools of single-family properties. The FHLMC
Certificates are debt securities issued by FHLMC and are guaranteed by FHLMC
- 33 -
as to the full and timely payment of principal and interest on the underlying
loans.
The following tables presents the amortized cost, gross unrealized gains,
gross unrealized losses and fair value of mortgage securities for the Company
and the Predecessor as of December 31, 1998 and 1997,
respectively:
As of December 31, 1998 - Company
Available-for-sale
------------------
Amortized cost $ 242,142,861
Gross unrealized gains 1,177,638
Gross unrealized losses (1,425,037)
------------------
Fair value $ 241,895,462
==================
As of December 31, 1997 - Predecessor
Available-for-Sale Held-to-Maturity Total
------------------ ---------------- ---------------
Amortized cost $ 18,884,194 $ 14,052,242 $ 32,936,436
Gross unrealized gains 606,486 658,816 1,265,302
Gross unrealized losses (36,534) - (36,534)
------------------ ---------------- ---------------
Fair value $ 19,454,146 $ 14,711,058 $ 34,165,204
================== ================ ===============
The mortgage securities classified as available-for-sale are carried at their
fair value and the mortgage securities classified as held-to-maturity are
carried at their amortized cost.
Certain securities classified as available-for-sale on the December 31, 1998,
balance sheet of the Company were classified as held-to-maturity on the
December 31, 1997 balance sheet of the Predecessor. Based on the differing
investment objectives of the Company, it was determined that it would be more
appropriate to classify such securities as available-for-sale rather than
held-to-maturity. Accordingly, on the Merger Date, such securities were
transferred from the held-to-maturity classification to the available-for-sale
classification. The total amortized cost, net unrealized holding losses and
the aggregate fair value of the securities transferred were $14,027,386,
$704,828 and $13,322,558, respectively.
As of December 31, 1998, the Company had commitments to purchase two Mortgage
Securities with a current face value totaling approximately $16,627,816.
4. Corporate Securities
Corporate securities are classified as held-to-maturity. At December 31,
1998, the total amortized cost, gross unrealized gains and fair value of the
corporate securities were $4,673,127, $273,123 and $4,946,250.
5. Other Investments
Other investments consisted of the following:
As of As of
Dec. 31, 1998 Dec. 31, 1997
Company Predecessor
------------- -------------
Investment in Retirement Centers Corporation $ 349,076 $ -
Investment in and advances to real estate limited partnerships 848,265 1,050,686
Investment in participating loans - 860,000
------------- -------------
Total $ 1,197,341 $ 1,910,686
============= =============
- 34 -
The Company's investment in Retirement Centers Corporation (RCC) represents a
95% ownership interest in such corporation. The Company owns 100% of the
non-voting preferred stock of RCC and a third party owns 100% of the
common stock. RCC owns limited partnership interests in five real
estate limited partnerships which operate assisted living centers. Interests
in such limited partnerships were formerly owned by the Predecessor and Prep
Fund 2. The Company accounts for its investment in RCC on the equity method.
Investments in and advances to real estate limited partnerships consist of
investments in or advances made to four limited partnerships which own the
properties underlying certain mortgage securities owned by the Company or its
Predecessor. These investments are not insured or guaranteed but rather are
collateralized by the value of the real estate underlying the real estate
owned by such limited partnerships. They are accounted for under the equity
method of accounting. Certain of the investments have a zero carrying value
and, as such, earnings are recorded only to the extent distributions are
received. Such investments have not been reduced below zero through
recognition of allocated investment losses since neither the Company nor its
Predecessor have any legal obligation to provide additional cash support to
the underlying property partnerships as they are not the general partner, nor
have they indicated any commitment to provide this support.
The Company had no investments in participating loans at December 31, 1998.
The $860,000 in participating loans at December 31, 1997 were collateralized
by a first mortgage loan on a multifamily property. The Company sold this
investment in May, 1998 for $1,245,000.
6. Repurchase Agreements
The Company has entered into several repurchase agreements to finance Mortgage
Securities purchased since the Merger Date.
As of December 31, 1998, the Company had outstanding balances of $190,250,084
under 13 repurchase agreements with a weighted average borrowing rate of 5.04%
and a weighted average remaining maturity of 5.2 months. As of December 31,
1998, all of the Company's borrowings were fixed-rate term repurchase
agreements with original maturities that range from two to twelve months.
At December 31, 1998, the repurchase agreements had the following remaining
maturities:
Within 30 days $ 40,641,585
30 to 90 days 57,296,499
90 days to one year 92,312,000
-------------
$190,250,084
=============
The repurchase agreements are collateralized by the Company's Mortgage
Securities with a principal balance of approximately $238,486,160 and bear
interest at rates that are LIBOR based.
7. Stockholders' Equity
1997 Stock Option Plan
- - ---------------------
The Company has a 1997 Stock Option Plan (the Plan) which authorizes the
granting of options to purchase an aggregate of up to 1,000,000 shares of the
Company's common stock, but not more than 10% of the total outstanding shares
of the Company's common stock. The Plan authorizes the Board of Directors, or
a committee of the Board of Directors, to grant Incentive Stock Options (ISOs)
as defined under section 422 of the Internal Revenue Code, Non-Qualified Stock
Options (NQSOs) and Dividend Equivalent Rights (DERs) to eligible persons,
other than non-employee directors. Non-employee directors are eligible to
receive grants of NQSOs with DERs pursuant to the provisions of the Plan. The
exercise price for any options granted to eligible persons under the Plan
shall not be less than the fair market value of the common stock on the day of
the grant. The options expire if not exercised ten years after the date
granted.
- 35 -
During the quarter ended June 30, 1998, there were 500,000 ISOs granted to buy
common shares at an exercise price of $9.375 per share, of which 125,000 were
vested and exercisable. In addition, there were 20,000 NQSOs issued at an
exercise price of $9.375 per share, of which 5,000 were vested and
exercisable. Prior to this grant, no other options were outstanding and no
additional options were granted through December 31, 1998. As of December 31,
1998, no options have been exercised.
In addition to options, 500,000 and 20,000 DERs were granted on the ISOs and
NQSOs, respectively, during the quarter ended June 30,1998, based on the
provisions of the Plan. DERs vest on the same basis as the options and
payments are made on vested DERs only. Vested DERs are paid only to the
extent of ordinary income and not on returns of capital. Dividends paid on
ISOs are charged to stockholders' equity when declared and dividends paid on
NQSOs are charged to earnings when declared. For 1998, the Company recorded a
$42,500 charge to stockholders' equity associated with the DERs on ISOs and a
$1,700 charge to earnings associated with DERs on NQSOs.
The options and related DERs issued were accounted for under the provisions of
SFAS 123, "Accounting for Stock Based Compensation". Because the ISOs were
not issued to officers who are direct employees of the Company, ISOs granted
were accounted for under the option value method and a periodic charge will be
recognized based on the vesting schedule. The charge of options which vested
at date of grant were included as capitalized transaction costs in connection
with the Merger. Management estimated the value of the ISOs at the date of
grant to be approximately $1.88 per share using a Black-Scholes valuation
model, as adjusted for the discounted value of dividends not to be received
under the unvested DERs. In the absence of comparable historical market
information for the Company, management utilized assumptions consistent with
activity of a comparable peer group of companies including an estimated option
life of five years, a 25% volatility rate and a risk-free rate of 5.5% and a
dividend yield of 0% (because of the DERs). During 1998, as part of
operations, the Company reflected an earnings charge of approximately
$170,154, representing the value of ISOs/DERs granted over their vesting
period. NQSOs granted were accounted for using the intrinsic method and,
accordingly, no earnings charge was reflected since the exercise price was
equal to the fair market value of the common stock at the date of the grant.
Dividends/Distributions
- - -----------------------
The Company declared the following dividends during 1998:
Declaration Date Record Date Payment Date Amount per Share
- - ---------------- ----------- ------------ ----------------
June 18, 1998 June 30, 1998 August 14, 1998 $ .265
September 9, 1998 September 30, 1998 November 16, 1998 $ .265
December 15, 1998 December 31, 1998 February 19, 1999 $ .265
Cash distributions paid by the Company consisted in part of a dividend paid
from earnings and in part a return of capital. For tax purposes, the dividend
declared on December 15, 1998, will be treated as a 1999 event for
shareholders. Cash distributions paid or accrued by the Predecessor were
$.2649 per Unit prior to the Merger in 1998 and $1.0596 per Unit in 1997.
8. Related Party Transactions
The Advisor manages the operations and investments of the Company and performs
administrative services for the Company. In turn, the Advisor receives a
management fee payable monthly in arrears in an amount equal to 1.10% per
annum of the first $300 million of Stockholders' Equity of the Company, plus
.80% per annum of the portion of Stockholders' Equity of the Company above
$300 million. The Company also pays the Advisor, as incentive compensation
for each fiscal quarter, an amount equal to 20% of the dollar amount by which
the annualized Return on Equity for such fiscal quarter exceeds the amount
necessary to provide an annualized Return on Equity equal to the Ten-Year U.S.
Treasury Rate plus 1%. During the period from April 10, 1998 (Merger Date) to
December 31, 1998, the Advisor earned a base management fee of $590,875. The
Advisor received incentive compensation of approximately $2,800 in 1998.
- 36 -
America First Properties Management Company L.L.C., (the Manager), provides
property management services for certain of the multifamily properties in
which the Company has an interest. The Manager also provided property
management services to certain properties previously associated with the
Predecessor which were acquired in the Merger. The Manager receives a
management fee equal to a stated percentage of the gross revenues generated by
the properties under management, ranging from 4.5% to 5% of gross revenues.
Such fees paid by the Company in 1998 for periods after the Merger Date
amounted to $250,912 and such fees paid by the Predecessor for the period in
1998 prior to the Merger Date amounted to $45,527. Fees paid by the
Predecessor were $222,682 and $189,657 in 1997 and 1996, respectively.
Prior to the Merger Date, the general partner of the Predecessor (AFCA 3) was
entitled to an administrative fee of .35% per annum of the outstanding amount
of investments of the Predecessor to be paid by the Predecessor to the extent
such amount is not paid by property owners. AFCA 3 earned administrative fees
of $53,617, $225,813 and $237,337 in 1998, 1997 and 1996, respectively. Of
such amounts, $38,659, $195,816 and $187,902 in 1998, 1997 and 1996
respectively, were paid by the Predecessor and the remainder was paid by
owners of real properties financed by the Predecessor. During 1997, AFCA 3
also received administrative fees of $88,780 in conjunction with the repayment
of one of its investments in participating loans.
Prior to the Merger Date, substantially all of Predecessor's general and
administrative expenses and certain costs capitalized by the Predecessor were
paid by AFCA 3 or an affiliate and reimbursed by the Predecessor. The amounts
of such expenses reimbursed to AFCA 3 or an affiliate were $165,439 in 1998
$1,935,423 in 1997 and $665,811 in 1996. The capitalized costs consist of
transaction costs incurred in conjunction with the merger described in Note 1.
9. Fair Value of Financial Instruments
The following methods and assumptions were used by the Company in estimating
the fair value of its financial instruments:
Investments in mortgage securities, corporate securities and preferred
stock: Fair values are based on broker quotes or amounts obtained from
independent pricing sources.
Cash and cash equivalents: Fair value approximates the carrying value of
such assets.
Repurchase agreements: Fair value approximates the carrying value of such
liabilities.
At December 31, 1998 At December 31, 1997
------------------------------------- --------------------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
------------ --------------- ------------- --------------
Investment in mortgage securities $ 241,895,462 $ 241,895,462 $ 33,506,388 $ 34,165,204
Investment in corporate securities 4,673,127 4,946,250 - -
Investment in preferred stock 1,153,800 1,153,800 - -
Cash and cash equivalents 6,045,956 6,045,956 10,427,181 10,427,181
Repurchase agreements 190,250,084 190,250,084 - -
- 37 -
10. Pro Forma Financial Statements (Unaudited)
The following summary pro forma information includes the effects of the
Merger. The pro forma operating data for the years ended December 31,
1998 and December 31, 1997 are presented as if the Merger had been completed
on January 1, 1998 and 1997, respectively.
Pro Forma
Statement of Operations
For the For the
Year Ended Year Ended
Dec. 31, 1998 Dec. 31, 1997
--------------- ---------------
Mortgage securities income $ 8,982,060 $ 4,226,210
Corporate securities income 164,738 -
Interest income on temporary cash investments 727,889 834,601
--------------- ---------------
Total interest income 9,874,687 5,060,811
Interest expense on borrowed funds 4,619,500 -
--------------- ---------------
Net interest income 5,255,187 5,060,811
--------------- ---------------
Income from other investments 801,076 805,249
Gain on sale of investments 426,607 -
--------------- ---------------
1,227,683 805,249
--------------- ---------------
General and administrative expenses 2,863,236 2,718,128
Minority interest 3,353 -
--------------- ---------------
2,866,589 2,718,128
--------------- ---------------
Net income $ 3,616,281 $ 3,147,932
=============== ===============
Net income, basic and fully diluted, per share $ .40 $ .35
=============== ===============
Weighted average number of shares outstanding 9,043,172 9,043,172
The pro forma financial information is not necessarily indicative of what the
consolidated results of operations of the Company would have been as of and
for the periods indicated, nor does it purport to represent the results of
operations for future periods.
- 38 -
11. Summary of Quarterly Results of Operations (Unaudited)
Predecessor Predecessor Company Company Company
First Second Second Third Fourth
From January 1, 1998, to Quarter Quarter Quarter Quarter Quarter
December 31, 1998 Through April 9 From April 10
(Company and Predecessor) -------------- -------------- -------------- -------------- ------------
Total income $ 907,759 $ - $ 1,773,422 $ 1,409,413 $ 1,425,701
Total expenses (421,293) - (540,392) (532,741) (600,982)
Minority interest - - 7,977 (10,124) (1,206)
-------------- -------------- -------------- -------------- ------------
Net income $ 486,466 $ - $ 1,241,007 $ 866,548 $ 823,513
============== ============== ============== ============== ============
Net income, basic and diluted,
per share or exchangeable unit $ .08 $ - $ .13 $ .10 $ .09
============== ============== ============== ============== ============
First Second Third Fourth
From January 1, 1997, to December 31, 1997 Quarter Quarter Quarter Quarter
(Predecessor) -------------- -------------- -------------- --------------
Total income $ 1,670,836 $ 1,620,763 $ 1,604,746 $ 1,225,425
Total expenses (868,417) (935,199) (907,630) (984,857)
-------------- -------------- -------------- --------------
Net income $ 802,419 $ 685,564 $ 697,116 $ 240,568
============== ============== ============== ==============
Net income, basic and diluted,
per exchangeable unit $ 0.14 $ 0.12 $ 0.12 $ 0.04
============== ============== ============== ==============
12. Subsequent Events
On January 25, 1999, the Company acquired six FNMA whole-pool mortgage-backed
certificates with an aggregate remaining principal balance of $85.5 million
(FNMA Certificates). The FNMA Certificates bear interest at rates ranging
from 5.84% to 7.84% per annum. The total purchase price paid for the FNMA
Certificates, including accrued interest, was approximately $86.7 million.
The acquisitions were financed in part with the proceeds of various
LIBOR-based repurchase agreements aggregating $84.8 million and the remainder
from cash reserves of the Company.
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Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure. There were no disagreements with the Company's or
Predecessor's independent accountants on accounting principles and practices
or financial disclosure during the fiscal years ended December 31, 1998 and
1997.
PART III
Item 10. Directors and Executive Officers of Registrant. The information
about Directors required to be furnished pursuant to this Item 10 is
incorporated by reference to the Company's definitive proxy statement for its
1999 Annual Meeting of Stockholders to be filed with the Securities and
Exchange Commission pursuant to Regulation 14A within 120 days after December
31, 1998 (the "Proxy Statement") under the heading "Election of Directors."
Information about the executive officers of the Company is shown under Item 4
of this filing.
Section 16(a) of the Securities and Exchange Act of 1934 requires the
Company's directors and executive officers, and certain persons who own more
than ten percent of the Company's common stock, to file with the Securities
and Exchange Commission (the "SEC") reports of their ownership of Company
common stock. Officers, directors and greater-than-ten-percent shareowners
are required by SEC regulation to furnish the Company with copies of all
Section 16(a) reports they file. Based solely upon review of the copies of
such reports received by the Company and written representations from each
such person who did not file an annual report with the SEC (Form 5) that no
other reports were required, the Company believes that, except as set forth
below, there was compliance for the year ended December 31, 1998 with all
Section 16(a) filing requirements applicable to the Company's officers,
directors and greater-than-ten-percent beneficial owners.
The Initial Statement of Beneficial Ownership of Securities on Form 3 was
filed late for each of the directors and executive officers of the Company.
Item 11. Executive Compensation. The information required to be furnished
pursuant to this Item 11 is incorporated by reference to the Proxy Statement.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information required to be furnished pursuant to this Item 12 is
incorporated by reference to the Proxy Statement under the heading "Voting
Securities and Beneficial Ownership Thereof by Principal Stockholders,
Directors and Officers."
Item 13. Certain Relationships and Related Transactions. The information
required to be furnished pursuant to this Item 13 is incorporated by reference
to the Proxy Statement under the heading "Certain Relationships and Related
Transactions."
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) The following documents are filed as part of this report:
1. Consolidated and Combined Financial Statements. The consolidated and
combined financial statements of the Company and the Predecessor, together
with the Independent Accountants' Report thereon, are set forth on pages 22
through 39 of this Form 10-K and are incorporated herein by
reference.
2. Financial Statement Schedules. The information required to be set forth in
the financial statement schedules is shown in the Notes to Consolidated and
Combined Financial Statements filed in response to Item 8 hereof.
3. Exhibits. The following exhibits were filed as required to be set forth
in the financial statement schedules is shown in the Notes to Combined
Financial Statements filed in response to Item 8 hereof.
2.1 Agreement and Plan of Merger by and among the Company,
America First Participating/Preferred Equity Mortgage Fund
Limited Partnership, America First Prep Fund 2 Limited
Partnership, America First Prep Fund 2 Pension Series
Limited Partnership and certain other parties, dated as of
July 29, 1997 (incorporated herein by reference to Exhibit
- 40 -
2.1 of the Registration Statement on Form S-4 dated
February 12, 1998, filed by the Company pursuant to the
Securities Act of 1933 (Commission File No. 333-46179)).
3.1 Amended and Restated Articles of Incorporation of the
Company (incorporated herein by reference from Form 8-K
dated April 10, 1998, filed by the Company pursuant to
the Securities Exchange Act of 1934 (Commission File No.
1-13991)).
3.2 Amended and Restated Bylaws of the Company (incorporated
herein by reference from Form 8-K dated April 10, 1998,
filed by the Company pursuant to the Securities Exchange
Act of 1934 (Commission File No. 1-13991)).
3.3 Agreement of Limited Partnership, dated May 25, 1988, of
America First Prep Fund 2 Pension Series Limited
Partnership (incorporated herein by reference to Form
10-K, dated December 31, 1988, filed with the
Securities and Exchange Commission (File No. 33-13407)).
4.1 Specimen of Common Stock Certificate of the Company.
(incorporated herein by reference to Exhibit 4.1 of the
Registration Statement on Form S-4 dated February 12, 1998,
filed by the Company pursuant to the Securities
Act of 1933 (Commission File No. 333-46179)).
10.1 Advisory Agreement, dated April 9, 1998, by and between
the Company and the Advisor (incorporated herein by
reference from Form 8-K dated April 10, 1998 filed by
the Company pursuant to the Securities Exchange Act of
1934 (Commission File No. 1-13991)).
10.2 Employment Agreement of Stewart Zimmerman (incorporated
herein by reference to Exhibit 10.2 of the Registration
Statement on Form S-4 dated February 12, 1998, filed by
the Company pursuant to the Securities Act of 1933
(Commission File No. 333-46179)).
10.3 Employment Agreement of William S. Gorin (incorporated
herein by reference to Exhibit 10.3 of the Registration
Statement on Form S-4 dated February 12, 1998, filed by
the Company pursuant to the Securities Act of 1933
(Commission File No. 333-46179)).
10.4 Employment Agreement of Ronald A. Freydberg (incorporated
herein by reference to Exhibit 10.4 of the Registration
Statement on Form S-4 dated February 12, 1998, filed by
the Company pursuant to the Securities Act of 1933
(Commission File No. 333-46179)).
10.5 1997 Stock Option Plan of the Company (incorporated herein
by reference from Form 8-K dated April 10, 1998, filed by
the Company pursuant to the Securities Exchange Act of
1934 (Commission File No. 1-13991)).
10.6 Form of Dividend Reinvestment Plan (incorporated herein by
reference to Appendix C of the Registration Statement on
Form S-4 dated February 12, 1998, filed by the Company
pursuant to the Securities Act of 1933 (Commission File No.
333-46179)).
21. Subsidiaries of the Registrant
24. Power of Attorney
27. Financial Data Schedule
(b) Reports on Form 8-K
The Registrant did not file any reports on Form 8-K during the
fourth quarter of the year for which this report is filed.
- 41 -
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities
Exchange Act of 1934, the Company has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Date: March 29, 1999 America First Mortgage Investments, Inc.
By /s/ Stewart Zimmerman
Stewart Zimmerman
Chief Executive Officer
- 42 -
Pursuant to the requirements of the Securities Act of 1934, this report has
been signed below by the following persons on behalf of the Company and in
the capacities and on the dates indicated.
Date: March 29, 1999 By /s/ Michael B. Yanney*
Michael B. Yanney
Chairman of the Board
Date: March 29, 1999 By /s/ Stewart Zimmerman
Stewart Zimmerman
Chief Executive Officer and Director
Date: March 29, 1999 By /s/ Gary Thompson
Gary Thompson
Chief Financial Officer
Date: March 29, 1999 By /s/ Michael L. Dahir*
Michael L. Dahir
Director
Date: March 29, 1999 By /s/ George V. Janzen*
George V. Janzen
Director
Date: March 29, 1999 By /s/ George H. Krauss*
George H. Krauss
Director
Date: March 29, 1999 By /s/ Gregor Medinger*
Gregor Medinger
Director
Date: March 29, 1999 By /s/ W. David Scott*
W. David Scott
Director
* By Stewart Zimmerman, Attorney-in-fact
/s/ Stewart Zimmerman
Stewart Zimmerman
- 43 -
EXHIBIT 21
SUBSIDIARIES OF THE REGISTRANT
America First Prep Fund 2 Pension Series Limited Partnership
America First Capital Associates Limited Partnership Six
- 44 -
EXHIBIT 24
POWER OF ATTORNEY
- 45 -
POWER OF ATTORNEY
The undersigned hereby appoints Stewart Zimmerman as his agent and
attorney-in-fact for the purpose of executing and filing all reports on Form
10-K relating to the year ending December 31, 1998, and any amendments
thereto, required to be filed with the Securities and Exchange Commission by
America First Mortgage Investments, Inc. and America First PREP Fund 2 Pension
Series Limited Partnership.
IN WITNESS WHEREOF, the undersigned has executed this Power of Attorney as of
the 1st day of February 1999.
/s/ Michael B. Yanney
Michael B. Yanney
- 46 -
POWER OF ATTORNEY
The undersigned hereby appoints Stewart Zimmerman as his agent and
attorney-in-fact for the purpose of executing and filing all reports on Form
10-K relating to the year ending December 31, 1998, and any amendments
thereto, required to be filed with the Securities and Exchange Commission by
America First Mortgage Investments, Inc. and America First PREP Fund 2 Pension
Series Limited Partnership.
IN WITNESS WHEREOF, the undersigned has executed this Power of Attorney as of
the 1st day of February 1999.
/s/ Michael L. Dahir
Michael L. Dahir
- 47 -
POWER OF ATTORNEY
The undersigned hereby appoints Stewart Zimmerman as his agent and
attorney-in-fact for the purpose of executing and filing all reports on Form
10-K relating to the year ending December 31, 1998, and any amendments
thereto, required to be filed with the Securities and Exchange Commission by
America First Mortgage Investments, Inc. and America First PREP Fund 2 Pension
Series Limited Partnership.
IN WITNESS WHEREOF, the undersigned has executed this Power of Attorney as of
the 1st day of February 1999.
/s/ George V. Janzen
George V. Janzen
- 48 -
POWER OF ATTORNEY
The undersigned hereby appoints Stewart Zimmerman as his agent and
attorney-in-fact for the purpose of executing and filing all reports on Form
10-K relating to the year ending December 31, 1998, and any amendments
thereto, required to be filed with the Securities and Exchange Commission by
America First Mortgage Investments, Inc. and America First PREP Fund 2 Pension
Series Limited Partnership.
IN WITNESS WHEREOF, the undersigned has executed this Power of Attorney as of
the 1st day of February 1999.
/s/ George H. Krauss
George H. Krauss
- 49 -
POWER OF ATTORNEY
The undersigned hereby appoints Stewart Zimmerman as his agent and
attorney-in-fact for the purpose of executing and filing all reports on Form
10-K relating to the year ending December 31, 1998, and any amendments
thereto, required to be filed with the Securities and Exchange Commission by
America First Mortgage Investments, Inc. and America First PREP Fund 2 Pension
Series Limited Partnership.
IN WITNESS WHEREOF, the undersigned has executed this Power of Attorney as of
the 1st day of February 1999.
/s/ Gregor Medinger
Gregor Medinger
- 50 -
POWER OF ATTORNEY
The undersigned hereby appoints Stewart Zimmerman as his agent and
attorney-in-fact for the purpose of executing and filing all reports on Form
10-K relating to the year ending December 31, 1998, and any amendments
thereto, required to be filed with the Securities and Exchange Commission by
America First Mortgage Investments, Inc. and America First PREP Fund 2 Pension
Series Limited Partnership.
IN WITNESS WHEREOF, the undersigned has executed this Power of Attorney as of
the 1st day of February 1999.
/s/ W. David Scott
W. David Scott
- 51 -