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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(MARK ONE)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
- ------ EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED: DECEMBER 31, 1997
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: 001-11914
THORNBURG MORTGAGE ASSET CORPORATION
(Exact name of Registrant as specified in its Charter)
MARYLAND 85-0404134
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
119 E. MARCY STREET
SANTA FE, NEW MEXICO 87501
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (505) 989-1900
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of Exchange on Which Registered
- ------------------------------------- ------------------------------------
Common Stock ($.01 par value) New York Stock Exchange
Series A 9.68% Cumulative Convertible
Preferred Stock ($.01 par value) New York Stock Exchange
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
-------- --------
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
Regulation S-K is not contained herein, and will not be contained, to the best
of 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. [ ]
At March 16, 1998, the aggregate market value of the voting stock held by
non-affiliates was $340,084,062, based on the closing price of the common stock
on the New York Stock Exchange.
Number of shares of Common Stock outstanding at March 16, 1998: 21,107,131
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the Registrant's definitive Proxy Statement dated March 30, 1998,
issued in connection with the Annual Meeting of Shareholders of the
Registrant to be held on April 30, 1998, are incorporated by reference into
Parts I and III.
THORNBURG MORTGAGE ASSET CORPORATION
1997 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PART I
Page
ITEM 1. BUSINESS.................................................... 3
ITEM 2. PROPERTIES.................................................. 14
ITEM 3. LEGAL PROCEEDINGS........................................... 14
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS......... 14
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED SHAREHOLDER MATTERS.......................... 15
ITEM 6. SELECTED FINANCIAL DATA..................................... 16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS............ 17
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................. 28
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE...................... 28
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.......... 29
ITEM 11. EXECUTIVE COMPENSATION...................................... 29
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT............................................... 29
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS............. 29
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND
REPORTS ON FORM 8-K...................................... 29
FINANCIAL STATEMENTS................................................. F-1
SIGNATURES
EXHIBIT INDEX
PART I
ITEM 1. BUSINESS
GENERAL
Thornburg Mortgage Asset Corporation (the "Company") is a mortgage acquisition
company that primarily invests in adjustable-rate mortgage ("ARM") assets
comprised of ARM securities and ARM loans, thereby indirectly providing capital
to the single family residential housing market. ARM securities represent
interests in pools of ARM loans, which often include guarantees or other credit
enhancements against losses from loan defaults. While the Company is not a bank
or savings and loan, its business purpose, strategy, method of operation and
risk profile are best understood in comparison to such institutions. The Company
leverages its equity capital using borrowed funds, invests in ARM assets and
seeks to generate income based on the difference between the yield on its ARM
assets portfolio and the cost of its borrowings. The corporate structure of the
Company differs from most lending institutions in that the Company is organized
for tax purposes as a real estate investment trust ("REIT") and therefore
generally passes through substantially all of its earnings to shareholders
without paying federal or state income tax at the corporate level. See "Federal
Income Tax Considerations -- Requirements for Qualification as a REIT".
OPERATING POLICIES AND STRATEGIES
Investment Strategies
The Company's investment strategy is to purchase ARM securities and ARM loans
originated and serviced by other mortgage lending institutions. Increasingly,
mortgage lending is being conducted by mortgage lenders who specialize in the
origination and servicing of mortgage loans and then sell these loans to other
mortgage investment institutions, such as the Company. The Company believes it
has a competitive advantage in the acquisition and investment of these mortgage
securities and mortgage loans because of the low cost of its operations relative
to traditional mortgage investors like banks and savings and loans. Like
traditional financial institutions, the Company seeks to generate income for
distribution to its shareholders primarily from the difference between the
interest income on its ARM assets and the financing costs associated with
carrying its ARM assets.
The Company purchases ARM assets from broker-dealers and financial institutions
that regularly make markets in these assets. The Company can also purchase ARM
assets from other mortgage suppliers, including mortgage bankers, banks, savings
and loans, investment banking firms, home builders and other firms involved in
originating, packaging and selling mortgage loans.
The Company's mortgage assets portfolio may consist of either agency or
privately issued securities (generally publicly registered) mortgage
pass-through securities, multiclass pass-through securities, collateralized
mortgage obligations ("CMOs"), ARM loans or short-term investments that either
mature within one year or have an interest rate that reprices within one year.
The Company's investment policy is to invest at least 70% of total assets in
High Quality adjustable and variable rate mortgage securities and short-term
investments. High Quality means:
(1) securities that are unrated but are guaranteed by the U.S. Government
or issued or guaranteed by an agency of the U.S. Government;
(2) securities which are rated within one of the two highest rating
categories by at least one of either Standard & Poor's or Moody's
Investors Service, Inc. (the "Rating Agencies"); or
(3)securities that are unrated or whose ratings have not been updated but are
determined to be of comparable quality (by the rating standards of at
least one of the Rating Agencies) to a High Quality rated mortgage
security, as determined by the Manager (as defined below) and approved by
the Company's Board of Directors.
The remainder of the Company's ARM portfolio, comprising not more than 30% of
total assets, may consist of Other Investment assets, which may include:
(1)adjustable or variable rate pass-through certificates, multi-class
pass-through certificates or CMOs backed by loans on single-family,
multi-family, commercial or other real estate-related properties so long
as they are rated at least Investment Grade at the time of purchase.
"Investment Grade" generally means a security rating of BBB or Baa or
better by at least one of the Rating Agencies;
(2)ARM loans secured by first liens on single-family residential properties,
generally underwritten to "A" quality standards, and acquired for the
purpose of future securitization; or
(3)a limited amount, currently $20 million as authorized by the Board of
Directors, of less than investment grade classes of ARM securities that
are created as a result of the Company's loan acquisition and
securitization efforts.
Since inception, the Company has generally invested less than 15%, currently
approximately 6%, of its total assets in Other Investment assets. The Company
believes that, due to recent changes in the mortgage industry and the current
real estate environment, a strategy to selectively increase its investment in
Other Investment assets can provide attractive benefits to the Company such that
the total return of these investments would be commensurate with their higher
risk and not significantly affect the ARM portfolio's overall high credit
quality. By increasing its investment in Other Investment assets, specifically
classes of multi-class pass-through certificates, the Company may benefit from
future credit rating upgrades as senior classes of these securities pay off or
have the potential to increase in value as a result of the appreciation of
underlying real estate values.
The Company also acquires ARM loans for the purpose of future securitization
into ARM securities for the Company's investment portfolio. The Company believes
that its strategy to increase its investment in Other Investment assets and to
securitize ARM loans that it acquires will provide the Company with higher
yielding investments and give the Company greater control over the
characteristics of the ARM securities originated and held in its investment
portfolio. The Company plans on securitizing the loans that it acquires in order
to continue its current strategy of owning high quality, liquid ARM securities
and financing them in the reverse repurchase market because the Company believes
this strategy will increase the portfolio's total return and result in a higher
net spread when considering the cost of financing and credit provisions. In
pursuing this strategy the Company will likely have a higher degree of credit
risk than when acquiring securities directly from the market. However, any
additional credit risk will be consistent with the Company's objectives of
maintaining a portfolio with a high level of credit quality that provides an
attractive return on equity.
On March 23, 1998, the Board of directors approved an expansion of the Company's
investment strategies to include portfolio investments in "Hybrid ARMs", which
are loans or securities backed by Hybrid ARM loans. Hybrid ARM loans have an
interest rate that is fixed for an initial period of time, generally 3 to 5
years, and then convert to an adjustable-rate for the balance of the term of the
loan. The Company will not invest more than 20% of its ARM assets in Hybrid ARMs
and will limit its interest rate repricing mismatch (the difference between the
remaining fixed-rate period of a Hybrid ARM and the maturity of the fixed-rate
liability funding a Hybrid ARM) to approximately one year.
The Company does not invest in REMIC residuals or other CMO residuals and,
therefore does not create excess inclusion income or unrelated business taxable
income for tax exempt investors. Therefore, the Company is a mortgage REIT
eligible for purchase by tax exempt investors, such as pension plans, profit
sharing plans, 401(k) plans, Keogh plans and Individual Retirement Accounts
("IRAs").
Financing Strategies
The Company employs a leveraging strategy to increase its assets by borrowing
against its ARM assets and then uses the proceeds to acquire additional ARM
assets. By leveraging its portfolio in this manner, the Company expects to
maintain an equity-to-assets ratio between 8% to 10%, when measured on a
historical cost basis. The Company believes that this level of capital is
sufficient to allow the Company to continue to operate in interest rate
environments in which the Company's borrowing rates might exceed its portfolio
yield. These conditions could occur when the interest rate adjustments on the
ARM assets lag the interest rate increases in the Company's variable rate
borrowings or when the interest rate of the Company's variable rate borrowings
are mismatched with the interest rate indices of the Company's ARM assets. The
Company also believes that this capital level is adequate to protect the Company
from having to sell assets during periods when the value of its ARM assets are
declining. If the ratio of the Company's equity-to-total assets, measured on a
historical cost basis, falls below 8%, then, the Company will take action to
increase its equity-to-assets ratio to 8% of total assets or greater, when
measured on a historical cost basis, through normal portfolio amortization,
raising equity capital, sale of assets or other steps as necessary.
The Company's ARM assets are financed primarily at short-term borrowing rates
and can be financed utilizing reverse repurchase agreements, dollar-roll
agreements, borrowings under lines of credit and other secured or unsecured
financings which the Company may establish with approved institutional lenders.
To date, reverse repurchase agreements have been the primary source of financing
utilized by the Company to finance its ARM assets. Generally, upon repayment of
each reverse repurchase agreement the ARM assets used to collateralize the
financing will immediately be pledged to secure a new reverse repurchase
agreement. The Company has established lines of credit and collateralized
financing agreements with twenty-four different financial institutions.
Reverse repurchase agreements take the form of a simultaneous sale of pledged
assets to a lender at an agreed upon price in return for the lender's agreement
to resell the same assets 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. In the event of the insolvency or bankruptcy of a lender
during the term of a reverse repurchase agreement, provisions of the Federal
Bankruptcy Code, if applicable, may permit the lender to consider the agreement
to resell the assets to be an executory contract that, at the lender's option,
may be either assumed or rejected by the lender. If a bankrupt lender rejects
its obligation to resell pledged assets to the Company, the Company's claim
against the lender for the damages resulting therefrom may be treated as one of
many unsecured claims against the lender's assets. These claims would be subject
to significant delay and, if and when payments are received, they may be
substantially less than the damages actually suffered by the Company. To
mitigate this risk the Company enters into collateralized borrowings with only
financially sound institutions approved by the Board of Directors, including a
majority of unaffiliated directors, and monitors the financial condition of such
institutions on a regular, periodic basis.
The Company mitigates its interest-rate risk from borrowings by selecting
maturities that approximately match the interest-rate adjustment periods on its
ARM assets. Accordingly, borrowings bear variable or short-term fixed (one year
or less) interest rates. Generally, the borrowing agreements require the Company
to deposit additional collateral in the event the market value of existing
collateral declines, which, in dramatically rising interest rate markets, could
require the Company to sell assets to reduce the borrowings.
The Company's Bylaws limit borrowings, excluding the collateralized borrowings
in the form of reverse repurchase agreements, dollar-roll agreements and other
forms of collateralized borrowings discussed above, to no more than 300% of the
Company's net assets, on a consolidated basis, unless approved by a majority of
the unaffiliated directors. This limitation generally applies only to unsecured
borrowings of the Company. For this purpose, the term "net assets" means the
total assets (less intangibles) of the Company at cost, before deducting
depreciation or other non-cash reserves, less total liabilities, as calculated
at the end of each quarter in accordance with generally accepted accounting
principles. Accordingly, the 300% limitation on unsecured borrowings does not
affect the Company's ability to finance its total assets with collateralized
borrowings.
Hedging Strategies
The Company makes use of hedging transactions to mitigate the impact of certain
adverse changes in interest rates on its net interest income. In general, ARM
assets have a maximum lifetime interest rate cap, or ceiling, meaning that each
ARM security contains a contractual maximum rate. The borrowings incurred by the
Company to finance its ARM assets portfolio are not subject to equivalent
interest rate caps. Accordingly, the Company purchases interest rate cap
agreements to prevent the Company's borrowing costs from exceeding the lifetime
maximum interest rate on its ARM assets. These agreements have the effect of
offsetting a portion of the Company's borrowing costs if prevailing interest
rates exceed the rate specified in the cap agreement. An interest rate cap
agreement is a contractual agreement whereby the Company pays a fee, which may
at times be financed, typically to either a commercial bank or investment
banking firm, in exchange for the right to receive payments equal to the
difference between a contractually specified cap rate level and a periodically
determined future interest rate times a contractually specified principal, or
notional, amount. These agreements also may appreciate in value as interest
rates rise, though not usually by as much as the market value of its ARM assets
would decline, which would thereby offset some of the decline in the market
value of the Company's portfolio of ARM assets.
In addition, ARM assets are generally subject to periodic caps. Periodic caps
generally limit the maximum interest rate change on any interest rate adjustment
date to either a maximum of 1% per semiannual adjustment or 2% per annual
adjustment. The borrowings incurred by the Company do not have similar periodic
caps. The Company generally does not hedge against the risk of its borrowing
costs rising above the periodic interest rate cap level on the ARM assets
because the contractual future interest rate adjustments on the ARM assets will
cause their interest rates to increase over time and reestablish the ARM assets'
interest rate to a spread over the then current index rate.
The Company has also entered into interest rate swap agreements. In accordance
with the terms of the swap agreements, the Company pays a fixed rate of interest
during the term of the agreements and receives a payment that varies monthly
with the one month LIBOR Index. These agreements have the effect of fixing the
Company's borrowing costs on a similar amount of swaps owned by the Company and,
as a result, the Company reduces the interest rate variability of its
borrowings. The Company may also use interest rate swap agreements from time to
time to change from one interest rate index to another interest rate index and
thus decrease further the basis risk between the Company's interest yielding
assets and the financing of such assets.
The ARM assets held by the Company were generally purchased at prices greater
than par. The Company is amortizing the premiums paid for these assets over
their expected lives using the level yield method of accounting. To the extent
that the prepayment rate on the Company's ARM assets differs from expectations,
the Company's net interest income will be affected. Prepayments generally
increase when mortgage interest rates fall below the interest rates on ARM
loans. To the extent there is an increase in prepayment rates, resulting in a
shortening of the expected lives of the Company's ARM assets, the Company's net
income and, therefore, the amount available for dividends could be adversely
affected. To mitigate the adverse effect of an increase in prepayments on the
Company's ARM assets, the Company has purchased ARM assets at prices at or below
par, however the Company's portfolio of ARM assets is currently held at a net
premium. The Company may also purchase limited amounts of "principal only"
mortgage derivative assets backed by either fixed-rate mortgages or ARM assets
as a hedge against the adverse effect of increased prepayments. To date, the
Company has chosen not to purchase any "principal only" mortgage derivative
assets.
The Company may enter into other hedging-type transactions designed to protect
its borrowings costs or portfolio yields from interest rate changes. Such
transactions may include the purchase or sale of interest rate futures contracts
or options on interest rate futures contracts. The Company may also purchase
"interest only" mortgage derivative assets or other derivative products for
purposes of mitigating risk from interest rate changes. The Company has not, to
date, entered into these types of transactions, but may do so in the future. The
Company will not invest in any futures transactions unless the Company and
Thornburg Mortgage Advisory Corporation (the "Manager") are exempt from the
registration requirements of the Commodities Exchange Act or otherwise comply
with the provisions of that Act.
Hedging transactions currently utilized by the Company generally are designed to
protect the Company's net interest income during periods when the Company's
borrowing costs exceed the maximum lifetime interest rates on its ARM assets.
The Company does not intend to hedge for speculative purposes. Further, no
hedging strategy can completely insulate the Company from risk, and certain of
the federal income tax requirements that the Company must satisfy to qualify as
a REIT limit the Company's ability to hedge, particularly with respect to
hedging against periodic cap risk. The Company carefully monitors and may have
to limit its hedging strategies to ensure that it does not realize excessive
hedging income, or hold hedging assets having excess value in relation to total
assets. See "Federal Income Tax Considerations - Requirements for Qualification
as a REIT".
Acquisition of ARM Loans
The Company has established relationships with mortgage originators who are
originating and, in certain cases, securitizing ARM loans for the Company's
investment portfolio, based on the Company's specific pricing and underwriting
criteria. The Company has also acquired existing pools of ARM loans for future
securitization. Acquiring ARM loans for future securitization is expected to
benefit the Company by providing: (i) additional sources of new whole-pool ARM
assets; (ii) greater control over the types of ARM loans originated; (iii) the
ability to acquire ARM loans at lower prices so that the amount of the premium
to be amortized will be reduced in the event of prepayment; and (iv) potentially
higher yielding investments in its portfolio.
The Company either performs due diligence itself, or hires specialized due
diligence companies to review packages of ARM loans offered by loan originators
based upon agreed upon underwriting criteria. The Company carefully reviews the
ARM loans offered for sale or the work of the contracted underwriting companies
and makes the final decision as to which ARM loans will be ultimately accepted
or rejected in a pool of ARM loans being acquired.
The sellers of the ARM loan packages purchased by the Company usually retain the
servicing rights to the ARM loans in the packages but in cases where they do
not, the Company has contracted with outside loan servicing companies to perform
loan servicing functions for an agreed upon fee as a more cost effective method
for servicing the Company's loans rather than starting a loan servicing
business. The Company views loan servicing as a mature business that has reached
an efficient level of operation through technology and accumulation of sizable
servicing portfolios and does not believe, at this time, that it would be cost
effective for the Company to develop an internal loan servicing capability.
Securitization of ARM Loans
The Company creates, through securitization, ARM securities with substantially
all ARM loans that it acquires. The Company purchases ARM loans for
securitization when it believes that it can earn a higher yield on these
mortgage assets created through securitization than on comparable mortgage
securities purchased in the market or in order to facilitate its compliance with
its exemption from the Investment Company Act of 1940. See "Operating
Restrictions" below. Following the securitization process, the Company intends
to hold the newly created ARM securities in its investment portfolio and will
retain a limited amount of the risk of future credit loss as part of its
securitization program.
Operating Restrictions
The Board of Directors has established the Company's operating policies and any
revisions in the operating policies and strategies require the approval of the
Board of Directors, including a majority of the unaffiliated directors. Except
as otherwise restricted, the Board of Directors has the power to modify or alter
the operating policies without the consent of shareholders. Developments in the
market which affect the operating policies and strategies mentioned herein or
which change the Company's assessment of the market may cause the Board of
Directors (including a majority of the unaffiliated directors) to revise the
Company's operating policies and financing strategies.
In the event the rating of an ARM security held by the Company is reduced by the
Rating Agencies to below Investment Grade after acquisition by the Company, the
asset may be retained in the Company's investment portfolio if the Manager
recommends that it be retained and the recommendation is approved by the Board
of Directors (including a majority of the unaffiliated directors).
The Company has elected to qualify as a REIT for tax purposes. The Company has
adopted certain compliance guidelines which include restrictions on the
acquisition, holding and sale of assets. Prior to the acquisition of any asset,
the Company determines whether such asset will constitute a Qualified REIT Asset
as defined by the Internal Revenue Code of 1986, as amended (the "Code").
Substantially all the assets that the Company has acquired and will acquire for
investment are expected to be Qualified REIT Assets. This policy limits the
investment strategies that the Company may employ.
The Company closely monitors its purchases of ARM assets and the income from
such assets, including from its hedging strategies, so as to ensure at all times
that it maintains its qualification as a REIT. The Company developed certain
accounting systems and testing procedures with the help of qualified accountants
and tax experts to facilitate its ongoing compliance with the REIT provisions of
the Code. See "Federal Income Tax Considerations - Requirements for
Qualification as a REIT". No changes in the Company's investment policies and
operating policies and strategies, including credit criteria for mortgage asset
investments, may be made without the approval of the Company's Board of
Directors, including a majority of the unaffiliated directors.
The Company at all times intends to conduct its business so as not to become
regulated as an investment company under the Investment Company Act of 1940. 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" ("Qualifying Interests"). Under 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 assets represent all the certificates issued
with respect to an underlying pool of mortgages, such mortgage assets may be
treated as assets separate from the underlying mortgage loans and, thus, may not
be considered Qualifying Interests for purposes of the 55% requirement. The
Company closely monitors its compliance with this requirement and intends to
maintain its exempt status. Up to the present, the Company has been able to
maintain its exemption through the purchase of whole pool government agency and
privately issued ARM assets that qualify for the exemption. See "Portfolio of
Mortgage Assets - Pass-Through Certificates - Privately Issued ARM Pass-Through
Certificates".
The Company does not purchase any assets from or enter into any servicing or
administrative agreements (other than the Management Agreement) with any
entities affiliated with the Manager. Any changes in this policy would be
subject to approval by the Board of Directors, including a majority of the
unaffiliated directors.
PORTFOLIO OF MORTGAGE ASSETS
As of December 31, 1997, ARM assets comprised approximately 99% of the Company's
total assets. The Company has invested in the following types of mortgage assets
in accordance with the operating policies established by the Board of Directors
and described in "Business - Operating Policies and Strategies - Operating
Restrictions".
PASS-THROUGH CERTIFICATES
The Company's investments in mortgage assets are concentrated in High Quality
ARM pass-through certificates which account for approximately 95% of ARM assets
held. These High Quality ARM pass-through certificates consist of Agency
Certificates and privately issued ARM pass-through certificates that meet the
High Quality credit criteria. These High Quality ARM pass-through certificates
acquired by the Company represent interests in ARM loans which are secured
primarily by first liens on single-family (one-to-four units) residential
properties, although the Company may also acquire ARM pass-through certificates
secured by liens on other types of real estate-related properties. The ARM
pass-through certificates acquired by the Company are generally subject to
periodic interest rate adjustments, as well as periodic and lifetime interest
rate caps which limit the amount an ARM security's interest rate can change
during any given period.
The following is a discussion of each type of pass-through certificate held by
the Company as of December 31, 1997:
FHLMC ARM Programs
FHLMC is a shareholder-owned government sponsored enterprise created pursuant to
an Act of Congress on July 24, 1970. The principal activity of FHLMC consists of
the purchase of first lien, conventional residential mortgages, including both
whole loans and participation interests in such mortgages and the resale of the
loans and participations in the form of guaranteed mortgage assets. During 1997,
FHLMC issued $9.0 billion of FHLMC ARM certificates and as of December 31, 1997,
there was $49.0 billion of all types of FHLMC ARM certificates outstanding, of
which FHLMC held $10.4 billion in its own portfolio.
Each FHLMC ARM Certificate issued to date has been issued in the form of a
pass-through certificate representing an undivided interest in a pool of ARM
loans purchased by FHLMC. The ARM loans included in each pool are fully
amortizing, conventional mortgage loans with original terms to maturity of up to
40 years secured by first liens on one-to-four unit family residential
properties or multi-family properties. The interest rate paid on FHLMC ARM
Certificates adjust periodically on the first day of the month following the
month in which the interest rates on the underlying mortgage loans adjust.
FHLMC guarantees to each holder of its ARM Certificates the timely payment of
interest at the applicable pass-through rate and ultimate collection of all
principal on the holder's pro rata share of the unpaid principal balance of the
related ARM loans, but does not guarantee the timely payment of scheduled
principal of the underlying mortgage loans. The obligations of FHLMC under its
guarantees are solely those of FHLMC and are not backed by the full faith and
credit of the U.S. Government. If FHLMC were unable to satisfy such obligations,
distributions to holders of FHLMC ARM Certificates would consist solely of
payments and other recoveries on the underlying mortgage loans and, accordingly,
monthly distributions to holders of FHLMC ARM Certificates would be affected by
delinquent payments and defaults on such mortgage loans.
FNMA ARM Programs
FNMA is a federally chartered and privately owned corporation organized and
existing under the Federal National Mortgage Association Charter Act. FNMA
provides funds to the mortgage market primarily by purchasing home mortgage
loans from mortgage loan originators, thereby replenishing their funds for
additional lending. FNMA established its first ARM programs in 1982 and
currently has several ARM programs under which ARM certificates may be issued,
including programs for the issuance of assets through REMICs under the Code.
During 1997, FNMA issued $20.8 billion of FNMA ARM certificates and as of
December 31, 1997, there was $71.0 billion of all types of FNMA ARM certificates
outstanding, of which FNMA held $11.4 billion in its own portfolio.
Each FNMA ARM Certificate issued to date has been issued in the form of a
pass-through certificate representing a fractional undivided interest in a pool
of ARM loans formed by FNMA. The ARM loans included in each pool are fully
amortizing conventional mortgage loans secured by a first lien on either
one-to-four family residential properties or multi-family properties. The
original terms to maturities of the mortgage loans generally do not exceed 40
years. FNMA has issued several different series of ARM Certificates. Each series
bears an initial interest rate and margin tied to an index based on all loans in
the related pool, less a fixed percentage representing servicing compensation
and FNMA's guarantee fee.
FNMA guarantees to the registered holder of a FNMA ARM Certificate that it will
distribute amounts representing scheduled principal and interest (at the rate
provided by the FNMA ARM Certificate) on the mortgage loans in the pool
underlying the FNMA ARM Certificate, whether or not received, and the full
principal amount of any such mortgage loan foreclosed or otherwise finally
liquidated, whether or not the principal amount is actually received. The
obligations of FNMA under its guarantees are solely those of FNMA and are not
backed by the full faith and credit of the U.S. Government. If FNMA were unable
to satisfy such obligations, distributions to holders of FNMA ARM Certificates
would consist solely of payments and other recoveries on the underlying mortgage
loans and, accordingly, monthly distributions to holders of FNMA ARM
Certificates would be affected by delinquent payments and defaults on such
mortgage loans.
Privately Issued ARM Pass-Through Certificates
Privately issued ARM Pass-Through Certificates are structured similar to the
Agency Certificates discussed above but are issued by originators of, and
investors in, mortgage loans, including savings and loan associations, savings
banks, commercial banks, mortgage banks, investment banks and special purpose
subsidiaries of such institutions. Privately issued ARM pass-through
certificates are usually backed by a pool of non-conforming conventional
adjustable-rate mortgage loans and are generally structured with one or more
types of credit enhancement, including pool insurance, guarantees, or
subordination. Accordingly, the privately issued ARM pass-through certificates
typically are not guaranteed by an entity having the credit status of FHLMC or
FNMA.
Privately issued ARM pass-through certificates credit enhanced by mortgage pool
insurance provided the Company with an alternative source of ARM assets (other
than Agency ARM assets) that meet the Qualifying Interests test for purposes
maintaining the Company's exemption under the Investment Company Act of 1940.
Since the inception of the Company in 1993, most of the providers of mortgage
pool insurance have stopped providing such insurance. Therefore, the Company has
become more reliant on the purchase of Agency ARM securities as its source of
Qualifying Interests in real estate and acquires ARM loans in order to be able
to increase its flexibility when meeting its Investment Company Act
requirements.
COLLATERALIZED MORTGAGE OBLIGATIONS ("CMOS") AND MULTICLASS PASS-THROUGH ASSETS
CMOs are debt obligations, ordinarily issued in series and most commonly backed
by a pool of fixed rate mortgage loans or pass-through certificates, each of
which consists of several serially maturing classes. Multiclass pass-through
securities are equity interests in a trust composed of similar underlying
mortgage assets. Generally, principal and interest payments received on the
underlying mortgage-related assets securing a series of CMOs or multiclass
pass-through securities are applied to principal and interest due on one or more
classes of the CMOs of such series or to pay scheduled distributions of
principal and interest on multiclass pass-throughs. Scheduled payments of
principal and interest on the mortgage-related assets and other collateral
securing a series of CMOs or multiclass pass-throughs are intended to be
sufficient to make timely payments of principal and interest on such issues or
securities and to retire each class of such obligations at their stated
maturity.
Multiclass pass-through securities backed by ARM assets or ARM loans owned by
the Company are typically structured into classes designated as senior classes,
mezzanine classes and subordinated classes. The Company also owns variable rate
classes of CMO's which are backed by both fixed- and adjustable-rate mortgages.
The senior classes in a multiclass pass-through security generally have first
priority over all cash flows and consequently have the least amount of credit
risk since principal losses are generally covered by mortgage pool insurance
policies or are charged against the subordinated classes in order of
subordination. As a result of these features, the senior classes receive the
highest credit rating from Rating Agencies of the series of classes for each
multiclass pass-through security.
The mezzanine classes of a multiclass pass-through security generally have a
slightly greater risk of principal loss than the senior classes since they
provide some credit enhancement to the senior classes. In most, but not all,
instances, mezzanine classes participate on a pro-rata basis with senior classes
in their right to receive cash flow and have expected lives similar to the
senior classes. In other instances, mezzanine classes are subordinate in their
right to receive cash flow and have average lives that are longer than the
senior classes. However, in all cases, a mezzanine class generally has a similar
or slightly lower credit rating than the senior class from the Rating Agencies.
Generally, the mezzanine classes that the Company has acquired are rated High
Quality.
Subordinated classes are junior in the right to receive payment from the
underlying mortgages to other classes of a multiclass pass-through security. The
subordination provides credit enhancement to the senior and mezzanine classes.
Subordinated classes may be at risk for some payment failures on the mortgage
loans securing or underlying such assets and generally represent a greater level
of credit risk as they are responsible for bearing the risk of credit loss on
all of the outstanding loans underlying a CMO or multi-class pass-through. As a
result of being subject to more credit risk, subordinated classes generally have
lower credit ratings relative to the senior and mezzanine classes from the
Rating Agencies.
The Subordinated classes which the Company has acquired are all rated at least
Investment Grade at the time of purchase by one of the Rating Agencies and in
certain cases are High Quality. Also, the Subordinated classes acquired by the
Company are limited in amount and bear yields which the Company believes are
commensurate with the increased risks involved.
The market for Subordinated classes is not extensive and at times may be
illiquid. In addition, the Company's ability to sell Subordinated classes is
limited by the REIT Provisions of the Code. The Company has not purchased any
Subordinated classes that are not Qualified REIT Assets. The Subordinated
classes acquired by the Company, which are not High Quality, together with the
Company's other investments in Other Investment assets, may not, in the
aggregate, comprise more than 30% of the Company's total assets, in accordance
with the Company's investment policy.
The variable rate classes of CMOs owned by the Company generally float at a
spread to the one-month LIBOR index and are backed by mortgages that are either
fixed-rate or are adjustable-rate mortgages indexed to the one-year U. S.
Treasury yield or a Cost of Funds index.
ARM LOANS
The ARM loans the Company has acquired are all first mortgages on single-family
residential homes. Some have additional collateral in the form of pledged
financial assets that provides the Company with additional credit protection in
exchange for a simpler application and approval process. The loans are
originated to "A" quality underwriting guidelines or are seasoned loans with
over five years or more of good payment history and/or low loan to property
value ratios.
Going forward, when acquiring ARM loans originated specifically for the Company,
the Company is focusing its attention on key aspects of a borrower's profile and
the characteristics of a mortgage loan product that the Company believes are
most important in insuring excellent loan performance and minimal credit
exposure. As such, the Company's loan programs focus on larger down payments,
excellent borrower credit history (as measured by a credit report and a credit
score) and a conservative appraisal process. If an ARM loan acquired has a loan
to property value that is above 80%, then the borrower is required to pay for
private mortgage insurance providing additional protection to the Company
against credit risk. The ARM loans acquired have original maturities of forty
years or less. The ARM loans are either fully amortizing or are interest only
for up to ten years and fully amortizing thereafter. As an ARM loan, the ARM
loans acquired all bear an interest rate that is tied to an interest rate index
with both periodic and lifetime constraints on how much the loan interest rate
can change on any predetermined interest rate reset date. In general, the
interest rate on each ARM loan resets at a frequency that is either monthly,
semi-annually or annually. The indices the ARM loans are tied to are generally a
U.S. Treasury Bill index, LIBOR, Certificate of Deposit, a Cost of Funds index
or Prime.
COMPETITION
In acquiring ARM assets, the Company competes with other mortgage REITs,
investment banking firms, savings and loan associations, banks, mortgage
bankers, insurance companies, mutual funds, other lenders, FNMA, FHLMC and other
entities purchasing ARM assets, many of which 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 the acquisition of ARM assets resulting in higher prices and
lower yields on such mortgage assets.
EMPLOYEES
As of December 31, 1997, the Company had no employees. The Manager carries out
the day to day operations of the Company, subject to the supervision of the
Board of Directors and under the terms of a Management Agreement discussed
below.
THE MANAGEMENT AGREEMENT
On June 17, 1994, the Company renewed its Management Agreement with Thornburg
Mortgage Advisory Corporation, the Manager, for a term of five years, with an
annual review required each year. On December 15, 1995, the Agreement was
amended to provide that in the event a person or entity obtains more than 20% of
the Company's common stock, if the Company is combined with another entity, or
if the Company terminates the Agreement other than for cause, the Company is
obligated to acquire substantially all of the assets of the Manager through an
exchange of shares with a value based on a formula tied to the Manager's net
profits. The Company has the right to terminate the Management Agreement upon
the occurrence of certain specific events, including a material breach by the
Manager of any provision contained in the Management Agreement.
The Manager at all times is subject to the supervision of the Company's Board of
Directors and has only such functions and authority as the Company may delegate
to it. The Manager is responsible for the day-to-day operations of the Company
and performs such services and activities relating to the assets and operations
of the Company as may be appropriate.
The Manager receives a per annum base management fee on a declining scale based
on average shareholders' equity, adjusted for liabilities that are not incurred
to finance assets ("Average Shareholders' Equity" or "Average Net Invested
Assets" as defined in the Agreement), payable monthly in arrears. The Manager is
also entitled to receive, as incentive compensation for each fiscal quarter, an
amount equal to 20% of the Net Income of the Company, before incentive
compensation, in excess of the amount that would produce an annualized Return on
Equity equal to 1% over the Ten Year U.S. Treasury Rate. For further information
regarding the base management fee, incentive compensation and applicable
definitions, see the Company's Proxy Statement dated March 23, 1998 under the
caption "Certain Relationships and Related Transactions".
Subject to the limitations set forth below, the Company pays all operating
expenses except those specifically required to be paid by the Manager under the
Management Agreement. The operating expenses required to be paid by the Manager
include the compensation of the Company's officers and the cost of office space,
equipment and other personnel required for the Company's day-to-day operations.
The expenses that will be paid by the Company will include issuance and
transaction costs incident to the acquisition, disposition and financing of
investments, regular legal and auditing fees and expenses, the fees and expenses
of the Company's directors, the costs of printing and mailing proxies and
reports to shareholders, the fees and expenses of the Company's custodian and
transfer agent, if any, and reimbursement of any obligation of the Manager for
any New Mexico Gross Receipts Tax liability. The expenses required to be paid by
the Company which are attributable to the operations of the Company shall be
limited to an amount per year equal to the greater of 2% of the Average Net
Invested Assets of the Company or 25% of the Company's Net Income for that year.
The determination of Net Income for purposes of calculating the expense
limitation will be the same as for calculating the Manager's incentive
compensation except that it will include any incentive compensation payable for
such period. Expenses in excess of such amount will be paid by the Manager,
unless the unaffiliated directors determine that, based upon unusual or
non-recurring factors, a higher level of expenses is justified for such fiscal
year. In that event, such expenses may be recovered by the Manager in succeeding
years to the extent that expenses in succeeding quarters are below the
limitation of expenses. The Company, rather than the Manager, will also be
required to pay expenses associated with litigation and other extraordinary or
non-recurring expenses. Expense reimbursement will be made monthly, subject to
adjustment at the end of each year.
The transaction costs incident to the acquisition and disposition of
investments, the incentive compensation and the New Mexico Gross Receipts Tax
liability will not be subject to the 2% limitation on operating expenses.
Expenses excluded from the expense limitation are those incurred in connection
with the servicing of mortgage loans, the raising of capital, the acquisition of
assets, interest expenses, taxes and license fees, non-cash costs and the
incentive management fee.
FEDERAL INCOME TAX CONSIDERATIONS
GENERAL
The Company has elected to be treated as a REIT for federal income tax purposes.
In brief, if certain detailed conditions imposed by the REIT provisions of the
Code are met, entities that invest primarily in real estate investments and
mortgage loans, and that otherwise would be taxed as corporations are, with
certain limited exceptions, not taxed at the corporate level on their taxable
income that is currently distributed to their shareholders. This treatment
eliminates most of the "double taxation" (at the corporate level and then again
at the shareholder level when the income is distributed) that typically results
from the use of corporate investment vehicles.
In the event that the Company does not qualify as a REIT in any year, it would
be subject to federal income tax as a domestic corporation and the amount of the
Company's after-tax cash available for distribution to its shareholders would be
reduced. The Company believes it has satisfied the requirements for
qualification as a REIT since commencement of its operations in June 1993. The
Company intends at all times to continue to comply with the requirements for
qualification as a REIT under the Code, as described below.
REQUIREMENTS FOR QUALIFICATION AS A REIT
To qualify for tax treatment as a REIT under the Code, the Company must meet
certain tests which are described briefly below.
Ownership of Common Stock
For all taxable years after the first taxable year for which a REIT election is
made, the Company's shares of capital stock must be held by a minimum of 100
persons for at least 335 days of a 12 month year (or a proportionate part of a
short tax year). In addition, at all times during the second half of each
taxable year, no more than 50% in value of the capital stock of the Company may
be owned directly or indirectly by five or fewer individuals. The Company is
required to maintain records regarding the actual and constructive ownership of
its shares, and other information, and to demand statements from persons owning
above a specified level of the REIT's shares (as long as the Company has over
200 or more shareholders, only persons holding 1% or more of the Company's
outstanding shares of capital stock) regarding their ownership of shares. The
Company must keep a list of those shareholders who fail to reply to such a
demand.
The Company is required to use the calendar year as its taxable year for income
purposes.
Nature of Assets
On the last day of each calendar quarter at least 75% of the value of the
Company's assets must consist of Qualified REIT Assets, government assets, cash
and cash items. The Company expects that substantially all of its assets will
continue to be Qualified REIT Assets. On the last day of each calendar quarter,
of the investments in assets not included in the foregoing 75% assets test, the
value of securities issued by any one issuer may not exceed 5% in value of the
Company's total assets and the Company may not own more than 10% of any one
issuer's outstanding voting securities. Pursuant to its compliance guidelines,
the Company intends to monitor closely the purchase and holding of its assets in
order to comply with the above assets tests.
Sources of Income
The Company must meet the following separate income-based tests each year:
1. THE 75% TEST. At least 75% of the Company's gross income for the taxable
year must be derived from Qualified REIT Assets including interest (other than
interest based in whole or in part on the income or profits of any person) on
obligations secured by mortgages on real property or interests in real property.
The investments that the Company has made and will continue to make will give
rise primarily to mortgage interest qualifying under the 75% income test.
2. THE 95% TEST. In addition to deriving 75% of its gross income from the
sources listed above, at least an additional 20% of the Company's gross income
for the taxable year must be derived from those sources, or from dividends,
interest or gains from the sale or disposition of stock or other assets that are
not dealer property. The Company intends to limit substantially all of the
assets that it acquires to Qualified REIT Assets. The policy of the Company to
maintain REIT status may limit the type of assets, including hedging contracts
and other assets, that the Company otherwise might acquire.
3. THE 30% LIMIT. For 1997 and prior years, the Company was required to
derive less than 30% of its gross income from the sale or other disposition of
(i) Qualified REIT Assets held for less than four years, other than foreclosure
property or property involuntarily or compulsorily converted through
destruction, condemnation or similar events, (ii) stock or assets held for less
than one year (including hedges) and (iii) property in a prohibited transaction.
As a result of the Company's having to limit such gains, the Company may have
had to hold mortgage loans and mortgage assets for four or more years and assets
and hedges (other than assets and hedges that are Qualified REIT Assets) for one
year or more at times when the Company might otherwise have determined that the
disposition of such assets for short-term gains might be advantageous in order
to ensure that it maintains compliance with the 30% source of income limit. The
U. S. Congress repealed the 30% limit effective for 1998 and thereafter.
Distributions
The Company must distribute to its shareholders on a pro rata basis each year an
amount equal to at least (i) 95% of its taxable income before deduction of
dividends paid and excluding net capital gain, plus (ii) 95% of the excess of
the net income from foreclosure property over the tax imposed on such income by
the Code, less (iii) any "excess noncash income". The Company intends to make
distributions to its shareholders in sufficient amounts to meet this 95%
distribution requirement.
The Service has ruled that if a REIT's dividend reinvestment plan (the "DRP")
allows shareholders of the REIT to elect to have cash distributions reinvested
in shares of the REIT at a purchase price equal to at least 95% of fair market
value on the distribution date, then such cash distributions qualify under the
95% distribution test. The Company believes that its DRP complies with this
ruling.
TAXATION OF THE COMPANY'S SHAREHOLDERS
For any taxable year in which the Company is treated as a REIT for federal
income purposes, amounts distributed by the Company to its shareholders out of
current or accumulated earnings and profits will be includable by the
shareholders as ordinary income for federal income tax purposes unless properly
designated by the Company as capital gain dividends.
Distributions of the Company will not be eligible for the dividends received
deduction for corporations. Shareholders may not deduct any net operating losses
or capital losses of the Company.
Any loss on the sale or exchange of shares of the common stock of the Company
held by a shareholder for six months or less will be treated as a long-term
capital loss to the extent of any capital gain dividend received on the common
stock held by such shareholders.
If the Company makes distributions to its shareholders in excess of its current
and accumulated earnings and profits, those distributions will be considered
first a tax-free return of capital, reducing the tax basis of a shareholder's
shares until the tax basis is zero. Such distributions in excess of the tax
basis will be taxable as gain realized from the sale of the Company's shares.
The Company will withhold 30% of dividend distributions to shareholders that the
Company knows to be foreign persons unless the shareholder provides the Company
with a properly completed IRS form for claiming the reduced withholding rate
under an applicable income tax treaty.
Under the Code, if a portion of the Company's assets were treated as a taxable
mortgage pool or if the Company were to hold REMIC residual interests, a portion
of the Company's dividends would be treated as unrelated business taxable income
("UBTI") for pension plans and other tax exempt entities. The Company believes
that it does not engage in activities that would cause any portion of the
Company's income to be taxable as UBTI for pension plans and similar tax exempt
shareholders. The Company believes that its shares of stock will be treated as
publicly offered securities under the plan asset rules of the Employment
Retirement Income Security Act ("ERISA") for Qualified Plans.
The provisions of the Code are highly technical and complex. This summary is not
intended to be a detailed discussion of all applicable provisions of the Code,
the rules and regulations promulgated thereunder, or the administrative and
judicial interpretations thereof. The Company has not obtained a ruling from the
Internal Revenue Service with respect to tax considerations relevant to its
organization or operation, or to an acquisition of its common stock. This
summary is not intended to be a substitute for prudent tax planning, and each
shareholder of the Company is urged to consult its own tax advisor with respect
to these and other federal, state and local tax consequences of the acquisition,
ownership and disposition of shares of stock of the Company and any potential
changes in applicable law.
ITEM 2. PROPERTIES
The Company's principal executive offices are located in Santa Fe, New
Mexico and are provided by the Manager in accordance with the Management
Agreement.
ITEM 3. LEGAL PROCEEDINGS
At December 31, 1997, there were no pending legal proceedings to which
the Company was a party or of which any of its property was subject.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's shareholders during
the fourth quarter of 1997.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
The Company's common stock began trading on June 25, 1993, and is traded on the
New York Stock Exchange under the trading symbol TMA. As of January 31, 1998,
the Company had 20,742,325 shares of common stock issued and outstanding which
were held by 1,348 holders of record and approximately 19,600 beneficial owners.
The following table sets forth, for the periods indicated, the high, low and
closing sales prices per share of common stock as reported on the New York Stock
Exchange composite tape and the cash dividends declared per share of common
stock.
Stock Prices Cash
--------------------------------- Dividends
Declared
High Low Close Per Share
--------- --------- --------- ----------
1997
Fourth Quarter ended December 31, 1997 22 1/4 15 7/8 16 1/2 $0.50
Third Quarter ended September 30, 1997 24 9/16 20 21 $0.50
Second Quarter ended June 30, 1997 22 1/8 17 3/4 21 1/2 $0.49
First Quarter ended March 31, 1997 22 7/8 18 3/4 19 $0.48
1996
Fourth Quarter ended December 31, 1996 21 1/2 16 1/8 21 3/8 $0.45
Third Quarter ended September 30, 1996 17 5/8 14 7/8 16 1/4 $0.40
Second Quarter ended June 30, 1996 17 14 1/8 16 1/4 $0.40
First Quarter ended March 31, 1996 16 5/8 14 1/8 14 3/8 $0.40
1995
Fourth Quarter ended December 31, 1995 15 7/8 14 1/8 15 3/4 $0.38
Third Quarter ended September 30, 1995 15 1/2 13 14 1/2 $0.25
Second Quarter ended June 30, 1995 14 7/8 8 1/4 13 5/8 $0.15
First Quarter ended March 31, 1995 10 7 3/8 9 $0.15
The Company intends to pay quarterly dividends and to make such distributions to
its shareholders in such amounts that all or substantially all of its taxable
income each year (subject to certain adjustments) is distributed, so as to
qualify for the tax benefits accorded to a REIT under the Code. All
distributions will be made by the Company at the discretion of the Board of
Directors and will depend on the earnings and financial condition of the
Company, maintenance of REIT status and such other factors as the Board of
Directors may deem relevant from time to time.
The Company has a Dividend Reinvestment and Stock Purchase Plan (the "DRP") that
allows both common and preferred shareholders to have their dividends reinvested
in additional shares of common stock and to purchase additional shares. The
common stock to be acquired for distribution under the DRP may be purchased at
the Company's discretion from the Company at a discount from the then prevailing
market price or in the open market. Shareholders and non-shareholders also can
make additional purchases of stock monthly , subject to a minimum of $100 ($500
for non-shareholders) and a maximum of $5,000 for each optional cash purchase.
Continental Stock Transfer & Trust Company (the "Agent"), the Company's transfer
agent, is the Trustee and administrator of the DRP. Additional information about
the details of the DRP and a prospectus are available from the Agent or the
Company. Shareholders who own stock that is registered in their own name and
want to participate must deliver a completed enrollment form to the Agent. Forms
are available from the Agent or the Company. Shareholders who own stock that is
registered in a name other than their own (e.g., broker or bank nominee) and
want to participate must either request the broker or nominee to participate on
their behalf or request that the broker or nominee re-register the stock in the
shareholder's name and deliver a completed enrollment form to the Agent.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data are derived from audited financial
statements of the Company for the years ended December 31, 1997, 1996, 1995,
1994 and 1993. The selected financial data should be read in conjunction with
the more detailed information contained in the Financial Statements and Notes
thereto and "Management's Discussion and Analysis of Financial Conditions and
Results of Operations" included elsewhere in this Form 10-K (Amounts in
thousands, except per share data).
OPERATIONS STATEMENT HIGHLIGHTS
1997 1996 1995 1994 1993
---------- ----------- ----------- ---------- ----------
Net interest income $ 49,064 $ 30,345 $ 13,496 $ 13,055 $ 3,157
Net income $ 41,402 $ 25,737 $ 10,452 $ 11,946 $ 2,572
Basic earnings per common share $ 1.95 $ 1.73 $ 0.88 $ 1.02 $ 0.36
Diluted earnings per common share $ 1.94 $ 1.73 $ 0.88 $ 1.02 $ 0.36
Average number of common shares outstanding 18,048 14,874 11,927 11,759 7,174
Distributable income per common share $ 1.98 $ 1.76 $ 0.92 $ 1.02 $ 0.36
Dividends declared per common share $ 1.97 $ 1.65 $ 0.93 $ 1.00 $ 0.29
Noninterest expense as percent of average assets 0.21% 0.21% 0.13% 0.11% 0.18%(1)
BALANCE SHEET HIGHLIGHTS
As of December 31
---------------------------------------------------------------
1997 1996 1995 1994 1993
----------- ----------- ----------- ----------- -----------
Adjustable-rate mortgage assets $ 4,638,694 $ 2,727,875 $ 1,995,287 $ 1,727,469 $ 1,320,169
Total assets $ 4,691,115 $ 2,755,358 $ 2,017,985 $ 1,751,832 $ 1,364,429
Shareholders' equity (2) $ 380,658 $ 238,005 $ 182,312 $ 180,035 $ 170,326
Number of common shares outstanding 20,280 16,219 12,191 11,773 11,748
Yield on adjustable-rate mortgage assets 6.38% 6.64% 6.73% 5.66% 4.03%
Effective spread on net interest-earning assets 0.96% 1.34% 1.11% 0.17% 0.90%(1)
Return on average assets 0.92% 1.09% 0.56% 0.66% 0.82%(1)
- -----------------------------------
(1) Annualized; the Company commenced operations on June 25, 1993.
(2) Shareholders' equity before mark-to-market adjustment
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Certain information contained in this Annual Report constitute "Forward-Looking
Statements" within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Exchange Act, which can be identified by the use
of forward-looking terminology such as "may," "will," "expect," "anticipate,"
"estimate," or "continue" or the negatives thereof or other variations thereon
or comparable terminology. Investors are cautioned that all forward-looking
statements involve risks and uncertainties including, but not limited to, risks
related to the future level and relationship of various interest rates,
prepayment rates and the timing of new programs. The statements in the "Risk
Factors" of the Company's Prospectus Supplement dated July 14, 1997 constitute
cautionary statements identifying important factors, including certain risks and
uncertainties, with respect to such forward-looking statements that could cause
the actual results, performance or achievements of the Company to differ
materially from those reflected in such forward-looking statements.
FINANCIAL CONDITION
At December 31, 1997, the Company held total assets of $4.691 billion, $4.639
billion of which consisted of ARM assets. That compares to $2.755 billion in
total assets and $2.728 billion of ARM assets at December 31, 1996. Since
commencing operations, the Company has purchased either ARM securities (backed
by agencies of the U.S. government or privately-issued, generally publicly
registered, mortgage assets, most of which are rated AA or higher by at least
one of the Rating Agencies) or ARM loans generally originated to "A" quality
underwriting standards. At December 31, 1997, 94.3% of the assets held by the
Company were High Quality assets, far exceeding the Company's investment policy
minimum requirement of investing at least 70% of its total assets in High
Quality ARM assets and cash and cash equivalents. Of the ARM assets currently
owned by the Company, 97.4% are in the form of adjustable-rate pass-through
certificates. The remainder are floating rate classes of CMOs, investments in
floating rate classes of trusts backed by mortgaged-backed assets or ARM loans.
The following table presents a schedule of ARM assets owned at December 31, 1997
and December 31, 1996 classified by High Quality and Other Investment assets and
further classified by type of issuer and by ratings categories.
ARM ASSETS BY ISSUER AND CREDIT RATING
(Dollar amounts in thousands)
December 31, 1997 December 31, 1996
------------------------- -------------------------
Carrying Portfolio Carrying Portfolio
Value Mix Value Mix
------------ ----------- ------------ -----------
HIGH QUALITY:
FHLMC/FNMA $ 3,117,937 67.2% $ 1,474,842 54.1%
Privately Issued:
AAA/Aaa Rating 476,615 10.3 260,031 9.5
AA/Aa Rating 782,206 16.8 862,727 31.6
----------- ----------- ----------- -----------
Total Privately Issued 1,258,821 27.1 1,122,758 41.1
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Total High Quality 4,376,758 94.3 2,597,600 95.2
----------- ----------- ----------- -----------
OTHER INVESTMENT:
Privately Issued:
A Rating 115,055 2.5 106,531 3.9
BBB/Baa Rating 17,625 0.4 14,017 0.5
BB/Ba Rating and Other 10,269 0.2 9,727 0.4
Whole loans 118,987 2.6 - 0.0
----------- ----------- ----------- -----------
Total Other Investment 261,936 5.7 130,275 4.8
----------- ----------- ----------- -----------
Total ARM Portfolio $ 4,638,694 100.0% $ 2,727,875 100.0%
=========== =========== =========== ===========
As of December 31, 1997, the Company had reduced the cost basis of its ARM
securities in the amount of $1,739,000 due to potential future credit losses
(other than temporary declines in fair value). At this time, the Company is
providing for potential future credit losses on two securities that have an
aggregate carrying value of $13.1 million, which represent less than 0.3% of the
Company's total portfolio of ARM assets. Both of these assets are performing and
have some minimal remaining credit support to mitigate the Company's exposure to
potential future credit losses.
Additionally, during 1997, the Company recorded a $42,000 provision for
potential credit losses on its loan portfolio, although no actual losses have
been realized in the loan portfolio to date. The Company's credit reserve policy
regarding ARM loans is to record a monthly provision of 0.15% (annualized rate)
on the outstanding principal balance of loans (including loans securitized by
the Company for which the Company has retained first loss exposure), subject to
adjustment on certain loans or pools of loans based upon factors such as, but
not limited to, age of the loans, borrower payment history, low loan-to-value
ratios and quality of underwriting standards applied by the originator.
The following table classifies the Company's portfolio of ARM assets by type of
interest rate index.
ARM ASSETS BY INDEX
(Dollar amounts in thousands)
December 31, 1997 December 31, 1996
------------------------- -------------------------
Carrying Portfolio Carrying Portfolio
Value Mix Value Mix
------------ ----------- ------------ -----------
INDEX:
One-month LIBOR $ 115,198 2.5% $ 10,646 0.4%
Three-month LIBOR 31,215 0.7 - 0.0
Six-month LIBOR 1,489,802 32.1 1,252,884 46.0
Six-month Certificate of 278,386 6.0 69,348 2.5
Deposit
Six-month Constant 66,669 1.4 8,841 0.3
Maturity Treasury
One-year Constant 2,271,914 49.0 1,238,892 45.4
Maturity Treasury
Cost of Funds 385,510 8.3 147,264 5.4
=========== =========== =========== ===========
$ 4,638,694 100.0% $ 2,727,875 100.0%
=========== =========== =========== ===========
The portfolio had a current weighted average coupon of 7.56% at December 31,
1997. If the portfolio had been "fully indexed," the weighted average coupon
would have been approximately 7.64%, based upon the current composition of the
portfolio and the applicable indices. As of December 31, 1996, the portfolio had
a weighted average coupon of 7.57%. If the portfolio had been "fully indexed,"
the weighted average coupon would have been approximately 7.61%, based upon the
composition of the portfolio and the applicable indices at that time.
At December 31, 1997, the current yield of the ARM assets portfolio was 6.38%,
compared to 6.64% as of December 31, 1996, with an average term to the next
repricing date of 110 days as of December 31, 1997, compared to 105 days as of
December 31, 1996. The current yield includes the impact of the amortization of
applicable premiums and discounts, the cost of hedging, the amortization of the
deferred gains from hedging activity and the impact of principal payment
receivables.
The reduction in the yield as of December 31, 1997, compared to December 31,
1996, is primarily because of the higher rate of ARM portfolio prepayments which
occurred during 1997. The higher level of prepayments increased the amount of
premium amortization expense and increased the impact of non-interest earning
assets in the form of principal payment receivables. Higher premium amortization
and a higher balance of principal payment receivables decreased the ARM
portfolio yield by 0.30% as of the end of 1997 compared to the end of 1996,
which was partially offset by a 0.05% decrease in the net cost of hedging.
During the year ended December 31, 1997, the Company purchased $2.930 billion of
ARM securities, 99.8% of which were High Quality assets, and $123.2 million of
ARM loans generally originated to "A" quality underwriting standards or seasoned
loans with over five years of good payment history and/or low loan-to-value
ratios. Included in the $2.930 billion of ARM securities purchased during 1997,
$103.1 million were ARM loans that the Company securitized in connection with
their purchase. Of the ARM assets acquired during 1997, approximately 50% were
indexed to U.S. Treasury bill rates, 35% were indexed to LIBOR, 8% were indexed
to a Cost of Funds Index and the remaining 7% to other indices. Although a
larger proportion of fixed-rate loans compared to ARM loans are being originated
in the current market, the Company has continued to find sufficient attractive
ARM asset acquisition opportunities to reinvest its cash flows and to continue
its asset growth while maintaining the high credit quality profile of the ARM
portfolio. During 1997, the Company placed particular emphasis on acquiring
seasoned ARM assets, which are ARM assets comprised of loans that were
originated over five years ago. These ARM assets have been prepaying at a slower
rate than newly originated ARM assets. The Company believes, partially as a
result of this strategy, that it has been experiencing lower prepayment activity
in its ARM portfolio than it otherwise would have, which contributes to a higher
and more stable ARM portfolio yield.
The Company sold ARM assets in the amount of $189.0 million at a net gain of
$1,189,000 during 1997. These sales reflect the Company's desire to manage the
portfolio with a view to enhancing the total return of the portfolio. The
Company monitors the performance of its individual ARM assets and selectively
sells an asset when there is an opportunity to replace it with an ARM asset that
has an expected higher long-term yield or more attractive interest rate
characteristics. Most of the ARM assets sold in 1997 were prepaying faster than
expected and had yields at the time of sale approximately 0.50% below the
portfolio average yield at the time. The Company is presented with investment
opportunities in the ARM assets market on a daily basis and management evaluates
such opportunities against the performance of its existing ARM assets. At times,
the Company is able to identify opportunities that it believes will improve the
total return of its ARM assets portfolio by replacing selected assets. In
managing the portfolio, the Company may at times realize either gains or losses
in the process of replacing selected assets when it believes it has identified
better investment opportunities in order to improve long-term total return.
For the quarter ended December 31, 1997, the Company's mortgage assets paid down
at an approximate average annualized constant prepayment rate of 24%. The
annualized constant prepayment rate averaged approximately 22% during the full
year of 1997, having averaged approximately 22% during the first half of the
year and 23% during the second half of the year. When prepayment experience
exceeds expectations due to sustained increased prepayment activity, the Company
has to amortize its premiums over a shorter time period, resulting in a reduced
yield to maturity on the Company's ARM assets. Conversely, if actual prepayment
experience is less than the assumed constant prepayment rate, the premium would
be amortized over a longer time period, resulting in a higher yield to maturity.
The Company monitors its prepayment experience on a monthly basis in order to
adjust the amortization of the net premium, as appropriate.
The fair value price of the Company's portfolio of ARM assets classified as
available-for-sale improved by 0.13% from a negative adjustment of 0.65% of the
portfolio as of December 31, 1996, to a negative adjustment of 0.52% as of
December 31, 1997. Despite this relative price improvement, because of the
increased size of the portfolio, the amount of the negative adjustment to fair
value on the ARM assets classified as available-for-sale increased from $14.7
million as of December 31, 1996, to $21.7 million as of December 31, 1997. The
improvement in the fair value price relative to the amortized cost basis of the
assets is generally a result of: (i) the upward repricing of the interest rates
on the Company's ARM assets relative to their respective indexes; and (ii) an
increased demand for ARM assets as reflected in the price at which similar ARM
assets traded in the open market during the year. During the fourth quarter of
1997, the fair value price of the Company's ARM assets did decline from a
negative price adjustment of 0.18% as of September 30, 1997, to a negative
adjustment of 0.52% as of December 31, 1997. This price decline was primarily
because of increased future prepayment expectations which have the effect of
shortening the average life of the Company's ARM assets and decreasing their
market value.
The Company has purchased Cap Agreements in order to limit its exposure to risks
associated with the lifetime interest rate caps of its ARM assets should
interest rates rise above specified levels. The Cap Agreements act to reduce the
effect of the lifetime or maximum interest rate cap limitation. The Cap
Agreements purchased by the Company will allow the yield on the ARM assets to
continue to rise in a high interest rate environment just as the Company's cost
of borrowings would continue to rise, since the borrowings do not have any
interest rate cap limitation. At December 31, 1997, the Cap Agreements owned by
the Company had a remaining notional balance of $4.156 billion with an average
final maturity of 3.1 years, compared to a remaining notional balance of $2.266
billion with an average final maturity of 3.0 years at December 31, 1996.
Pursuant to the terms of the Cap Agreements, the Company will receive cash
payments if the one-month, three-month or six-month LIBOR index increases above
certain specified levels, which range from 7.50% to 13.00% and average
approximately 10.19%. The fair value of these Cap Agreements also tends to
increase when general market interest rates increase and decrease when market
interest rates decrease, helping to partially offset changes in the fair value
of the Company's ARM assets. At December 31, 1997, the fair value of the Cap
Agreements was $1.9 million, $11.2 million less than the amortized cost of the
Cap Agreements.
The following table presents information about the Company's Cap Agreement
portfolio as of December 31, 1997:
CAP AGREEMENTS STRATIFIED BY STRIKE PRICE
(Dollar amounts in thousands)
Hedged Weighted Cap Weighted
ARM Average Agreement Average
Securities Life Cap Notional Strike Remaining
Balance (1) Balance Price Term
------------- ----------- ------------- ----------- --------------
$ 446,484 9.31% $ 487,551 7.50% 2.4 Years
385,396 10.06 344,195 8.00 3.7
157,392 10.50 207,143 8.50 2.2
222,507 10.12 323,607 9.00 2.0
148,278 10.84 156,717 9.50 2.8
324,637 11.03 329,131 10.00 4.4
514,472 11.41 464,992 10.50 2.8
467,179 12.01 392,071 11.00 3.8
381,791 12.53 575,431 11.50 4.4
591,189 12.95 590,605 12.00 3.0
232,371 13.54 186,617 12.50 2.4
253,911 14.39 97,466 13.00 2.1
28,080 None N/A N/A N/A
----------- =========== =========== =========== ==============
$ 4,153,687 11.60% $ 4,155,526 10.19% 3.1 Years
=========== =========== =========== =========== ==============
(1) 90% of the ARM securities' balance, which approximates the financed portion.
As of December 31, 1997, the Company was a counterparty to six different
interest rate swap agreements that substantially offset each other with an
aggregate net notional balance of $30 million. Due to the offsetting and short
remaining term of these agreements, they had no effect on the average period to
the next repricing of the Company's borrowings. The average period to the next
repricing of the Company's borrowings was 33 days as of December 31, 1997. Five
of the agreements are cancelable beginning in the first quarter of 1998 and have
a final maturity during the first quarter of 1999. The remaining agreement
matures during the first quarter of 1998.
RESULTS OF OPERATIONS - 1997 COMPARED TO 1996
For the year ended December 31, 1997, the Company's net income was $41,402,000,
or $1.95 per share (Basic EPS), based on a weighted average of 18,047,955 shares
outstanding. That compares to $25,737,000, or $1.73 per share (Basic EPS), based
on a weighted average of 14,873,700 shares outstanding for the year ended
December 31, 1996. This 61% increase in earnings -- a 13% increase on a
per-share basis -- was achieved despite a 21% increase in the average number of
shares outstanding during the two periods. Net interest income for the year
totaled $49,064,000, compared to $30,345,000 for the same period in 1996, an
increase of 62%. Net interest income is comprised of the interest income earned
on mortgage investments less interest expense from borrowings. During 1997, the
Company recorded a gain on the sale of ARM securities of $1,189,000 as compared
to a gain of $1,362,000 during 1996. Additionally, during 1997, the Company
reduced its earnings and the carrying value of its ARM assets by reserving
$886,000 for potential credit losses, compared to $990,000 during 1996. During
1997, the Company incurred operating expenses of $7,965,000, consisting of a
base management fee of $3,664,000, a performance-based fee of $3,363,000 and
other operating expenses of $938,000. During 1996, the Company incurred
operating expenses of $4,980,000, consisting of a base management fee of
$1,872,000, a performance-based fee of $2,462,000 and other operating expenses
of $646,000. Total operating expenses decreased as a percentage of net interest
income to 16.2% for 1997, compared to 16.4% for 1996, thereby contributing to
the Company's improved net earnings.
The Company's return on average common equity for the year ended December 31,
1997 was 12.72%, compared to 11.68% for the same period in 1996. The Company's
return on average common equity was 11.63% for the quarter ended December 31,
1997, compared to 12.37% for the same period in 1996.
The table below highlights the historical trend and the components of return on
average common equity (annualized):
COMPONENTS OF RETURN ON AVERAGE COMMON EQUITY (1)
Net Interest Provision Gain(Loss) G & A Performance Preferred Net
For The Income/ For Losses/ on ARM Expense (2)/ Fee/ Dividend/ Income/
Quarter Ended Equity Equity Sales/Equity Equity Equity Equity Equity (ROE)
- ------------------------------------------------------------------------------------------------------------------
Mar 31, 1995 2.58% - -1.47% 1.02% - - 0.09%
Jun 30, 1995 5.51% - - 1.04% - - 4.47%
Sep 30, 1995 9.85% - 0.09% 1.07% 0.34% - 8.54%
Dec 31, 1995 11.94% - 0.11% 1.05% 0.97% - 10.03%
Mar 31, 1996 13.37% - 0.03% 1.04% 1.27% - 11.08%
Jun 30, 1996 13.14% - - 1.00% 0.92% - 11.22%
Sep 30, 1996 13.42% 0.34% 0.88% 1.03% 1.07% - 11.86%
Dec 31, 1996 14.99% 1.32% 1.38% 1.46% 1.23% - 12.37%
Mar 31, 1997 18.85% 0.32% 0.01% 1.65% 1.43% 2.07% 13.40%
Jun 30, 1997 19.48% 0.34% 0.03% 1.81% 1.25% 2.67% 13.45%
Sep 30, 1997 17.66% 0.30% 0.45% 1.64% 1.24% 2.23% 12.70%
Dec 31, 1997 15.62% 0.33% 1.06% 1.59% 1.01% 2.12% 11.63%
- ------------
(1) Average common equity excludes unrealized gain (loss) on available-for-sale ARM assets.
(2) Excludes performance fees.
The decline in the Company's return on common equity from the fourth quarter of
1996 to the fourth quarter of 1997 is primarily due to the decline in the net
interest spread between the Company's interest-earning assets and
interest-bearing liabilities from 0.92% as of December 31, 1996, to 0.47% as of
December 31, 1997. The primary reasons for this decline were the change in the
relationship between the one-year U. S. Treasury yield and LIBOR, the impact of
increased ARM prepayment speeds and an increase in the Company's cost of funds
during the fourth quarter of 1997. From March 31, 1997, to December 31, 1997,
the one-year U.S. Treasury yield declined by approximately 0.51% while LIBOR
rates remained substantially the same. During the entire year, LIBOR rates
increased by 0.23%. Approximately 50% of the Company's ARM assets are indexed to
the one-year U. S. Treasury bill yield and, therefore, the yield on such assets
declined with the index. Conversely, the interest rate on the Company's
borrowings is generally LIBOR-based and, thus, increased by 0.19% during 1997.
To put this in historical perspective, the one-year U.S. Treasury bill yield had
a spread of -0.26% to the average of the one-and three-month LIBOR rate as of
December 31, 1997, compared to having a spread of -0.02% at December 31, 1996,
0.04% on average during 1996 and -0.07% on average during 1995. For the
five-year period from 1993 to 1997, the average spread was 0.15%. The Company
does not know when or if the relationship between the one-year U. S. Treasury
bill yield and LIBOR will return to these historical norms, but the Company's
spreads would be expected to improve if that occurs. The Company's ARM portfolio
yield also was lower during the fourth quarter of 1997 compared to the fourth
quarter of 1996 because of an increase in the prepayment rate of ARM assets.
During the fourth quarter of 1997, the average prepayment rate was 24%, compared
to 21% during the comparable period in 1996. The impact of this was to increase
the average amount of non-interest-earning assets in the form of principal
payments receivable as well as to increase the amortization expense related to
writing off the Company's premiums and discounts. The Company generally
amortizes its premiums and discounts on a monthly basis based on the most recent
three-month average of the prepayment rate of its ARM assets, thereby adjusting
its amortization to current market conditions, which is reflected in the yield
of the ARM portfolio.
For the year ended December 31, 1997, the Company's taxable income after
preferred dividends was $35,741,000, or $1.98 per weighted average common share
outstanding. Taxable income in 1997 excludes loss provisions of $886,000 and an
expense of $32,000 for Dividend Equivalent Rights and Phantom Stock Right
grants, but includes actual credit losses of $96,000 and a compensation expense
of $232,000 related to the exercise of Non-Incentive Stock Options. For the year
ended December 31, 1996, the Company's taxable income was $26,159,000, or $1.76
per weighted average common share outstanding. Taxable income in 1996 was
reduced by the net capital loss carryforward of $568,000 on the sale of ARM
assets during 1995 and excludes loss provisions of $990,000 recorded in 1996. As
a REIT, the Company is required to declare dividends amounting to 85% of each
year's taxable income by the end of each calendar year and to have declared
dividends amounting to 95% of its taxable income for each year by the time it
files its applicable tax return. Therefore, the Company generally passes through
substantially all of its earnings to shareholders without paying federal income
tax at the corporate level. Since the Company, as a REIT, pays its dividends
based on taxable earnings, the dividends may at times be more or less than
reported earnings. As of December 31, 1997, the Company had a retained deficit
of $951,000 because its dividends, which consisted entirely of taxable income,
were higher than its reported earnings, principally because of loss provisions
recorded that are not deductible for tax purposes until actually realized.
The following table highlights the quarterly dividend history of the Company's
common shares:
COMMON DIVIDEND SUMMARY
(Dollar amounts in thousands, except per share amounts)
Common Common Cumulative
Taxable Taxable Net Dividend Dividend Undistributed
For The Net Income Per Declared Per Pay-out Taxable
Quarter Ended Income (1) Share (2) Share (2) Ratio (3) Net Income
- ------------- ------------- -------------- ------------- ------------- ------------
Mar 31, 1995 $ 701 $ 0.06 $ 0.15 252% (874)
Jun 30, 1995 1,993 0.17 0.15 89% (634)
Sep 30, 1995 3,791 0.32 0.25 79% 139
Dec 31, 1995 4,535 0.37 0.38 102% 41
Mar 31, 1996 5,118 0.41 0.40 97% 188
Jun 30, 1996 6,169 0.42 0.40 103% (18)
Sep 30, 1996 6,708 0.42 0.40 96% 250
Dec 31, 1996 8,164 0.50 0.45 89% 1,115
Mar 31, 1997 8,224 0.50 0.48 95% 1,505
Jun 30, 1997 8,573 0.51 0.49 99% 1,603
Sep 30, 1997 9,737 0.51 0.50 100% 1,560
Dec 31, 1997 9,207 0.46 0.50 110% 629
- -------------
(1) Taxable net income after preferred dividends.
(2) Weighted average common shares outstanding.
(3) Common dividend declared divided by applicable quarter's taxable income
available to common shareholders.
Despite the fact that the Company's cost of funds increased from 5.67% in 1996
to 5.76% in 1997, its net interest income increased during this same time
period, primarily due to the increased size of the Company's portfolio. Net
interest income increased by $18,719,000, which is a combination of rate and
volume variances. There was a combined favorable rate variance of $623,000,
which consisted of a favorable variance of $2,691,000 resulting from the higher
yield on the Company's ARM assets portfolio and other interest-earning assets
and an unfavorable variance of $2,068,000 resulting from an increase in the
Company's cost of funds. The increased average size of the Company's portfolio
during 1997 compared to 1996 contributed to higher net interest income in the
amount of $18,096,000. The average balance of the Company's interest-earning
assets was $3.777 billion during 1997 compared to $2.351 billion during 1996 --
an increase of 61%.
The following table highlights the components of net interest spread and the
annualized yield on net interest-earning assets:
COMPONENTS OF NET INTEREST SPREAD AND YIELD ON NET INTEREST-EARNING ASSETS (1)
(Dollar amounts in millions)
ARM Assets
------------------------------
Average Wgt. Avg. Yield on Yield on
Interest- Fully Weighted Interest- Net Net Interest-
As of the Earning Indexed Average Yield Earning Cost of Interest Earning
Quarter Ended Assets Coupon Coupon Adj.(2) Assets Funds Spread Assets
- -----------------------------------------------------------------------------------------------------------
Mar 31, 1995 $ 1,748.7 8.46% 6.33% 0.26% 6.07% 6.33% -0.26% 0.49%
Jun 30, 1995 1,809.7 7.94% 6.77% 0.40% 6.37% 6.21% 0.16% 0.55%
Sep 30, 1995 1,864.3 7.93% 7.24% 0.58% 6.66% 6.04% 0.62% 1.04%
Dec 31, 1995 1,975.6 7.51% 7.42% 0.69% 6.73% 6.05% 0.68% 1.11%
Mar 31, 1996 2,025.8 7.56% 7.48% 0.99% 6.49% 5.60% 0.89% 1.32%
Jun 30, 1996 2,248.2 7.83% 7.28% 0.85% 6.43% 5.59% 0.84% 1.32%
Sep 30, 1996 2,506.0 7.80% 7.31% 0.80% 6.51% 5.71% 0.80% 1.32%
Dec 31, 1996 2,624.4 7.61% 7.57% 0.93% 6.64% 5.72% 0.92% 1.34%
Mar 31, 1997 2,950.6 7.93% 7.53% 0.89% 6.65% 5.67% 0.98% 1.54%
Jun 30, 1997 3,464.1 7.75% 7.57% 0.90% 6.67% 5.77% 0.90% 1.39%
Sep 30, 1997 4,143.7 7.63% 7.65% 1.07% 6.58% 5.79% 0.79% 1.22%
Dec 31, 1997 4,548.9 7.64% 7.56% 1.18% 6.38% 5.91% 0.47% 0.96%
- ------------
(1)Yield on Net Interest-Earning Assets is computed by dividing annualized
net interest income by the average daily balance of interest-earning
assets.
(2)Yield adjustments include the impact of amortizing premiums and discounts,
the cost of hedging activities, the amortization of deferred gains from
hedging activities and the impact of principal payment receivables. The
following table presents these components of the yield adjustments for the
dates presented in the table above:
COMPONENTS OF THE YIELD ADJUSTMENTS ON ARM ASSETS
Amort. of
Impact of Deferred
Premium/ Principal Gain from Total
As of the Discount Payments Hedging Hedging Yield
Quarter Ended Amort. Receivable Activity Activity Adjustment
- ------------- --------- ---------- ---------- ------------- -----------
Mar 31, 1995 0.22% 0.02% 0.21% -0.19% 0.26%
Jun 30, 1995 0.26% 0.03% 0.28% -0.17% 0.40%
Sep 30, 1995 0.37% 0.06% 0.31% -0.16% 0.58%
Dec 31, 1995 0.43% 0.10% 0.32% -0.16% 0.69%
Mar 31, 1996 0.77% 0.11% 0.31% -0.20% 0.99%
Jun 30, 1996 0.67% 0.07% 0.27% -0.16% 0.85%
Sep 30, 1996 0.57% 0.08% 0.25% -0.10% 0.80%
Dec 31, 1996 0.69% 0.09% 0.23% -0.08% 0.93%
Mar 31, 1997 0.63% 0.13% 0.19% -0.07% 0.89%
Jun 30, 1997 0.66% 0.13% 0.16% -0.05% 0.90%
Sep 30, 1997 0.85% 0.12% 0.15% -0.05% 1.07%
Dec 31, 1997 0.94% 0.14% 0.14% -0.04% 1.18%
The Company's ARM assets portfolio generated a yield of 6.56% during 1997,
compared to 6.45% during 1996. The Company's cost of funds during 1997 was
5.76%, compared to 5.67% during 1996, primarily as a result of higher short-term
interest rates available to the Company for financing purposes. Despite the fact
that the Company's cost of funds increased, the Company's net spread increased
to 0.80% for 1997 from a spread of 0.78% for 1996 -- an increase of 0.02%. The
Company's yield on net interest-earning assets, which includes the impact of
shareholders' equity, rose to 1.30% for 1997 from 1.29% for 1996. The following
table reflects the average balances for each category of the Company's
interest-earning assets as well as the Company's interest-bearing liabilities
with the corresponding effective rate of interest annualized for the years ended
December 31, 1997, and December 31, 1996:
AVERAGE BALANCE AND RATE TABLE
(Dollar amounts in thousands)
For the Year Ended For the Year Ended
December 31, 1997 December 31, 1996
--------------------- --------------------
Average Effective Average Effective
Balance Rate Balance Rate
--------------------- --------------------
Interest-Earning Assets:
ARM assets $ 3,755,064 6.56% $ 2,336,900 6.45%
Cash and cash equivalents 21,774 5.57 14,200 5.29
------------------- -------------------
3,776,838 6.56 2,351,100 6.45
------------------- -------------------
Interest-Bearing Liabilities:
Borrowings 3,446,913 5.76 2,138,236 5.67
------------------- -------------------
Net Interest-Earning Assets $ 329,925 0.80% $ 212,864 0.78%
and Spread =================== ===================
Yield on Net 1.30% 1.29%
Interest-Earning Assets (1) ========= =========
- -----------------------------
(1) Yield on Net Interest-Earning Assets is computed by dividing annualized
net interest income by the average daily balance of interest-earning assets.
As of the end of 1997, the Company's yield on its ARM assets portfolio,
including the impact of the amortization of premiums and discounts, the cost of
hedging, the amortization of deferred gains from hedging activity and the impact
of principal payment receivables, was 6.38%, compared to 6.64% as of the end of
1996 -- a decrease of 0.26%. The Company's cost of funds as of December 31,
1997, was 5.91%, compared to 5.72% as of December 31, 1996 -- an increase of
0.19%. This increase was primarily the result of financing a portion of the ARM
portfolio over 1997 year-end at a time when LIBOR interest rates increased
suddenly late in November due to year-end pressures. Fortunately the Company,
expecting this to occur, already had financed most of its portfolio over
year-end before the LIBOR increase and, thus, was able to avoid the full
potential impact. Subsequent to year-end, LIBOR interest rates have generally
returned to their previous level, which will be reflected in first quarter 1998
interest rate spreads. As a result of these changes, the Company's net interest
spread as of the end of 1997 was 0.47%, compared to 0.92% as of the end of 1996
- -- a decrease of 0.45%.
During 1997, the Company realized a net gain from the sale of ARM securities in
the amount of $1,189,000, compared to a gain of $1,362,000 during 1996.
Additionally, the Company recorded a provision for credit losses in the amount
of $886,000 during the year ended December 31, 1997, although the Company only
incurred actual credit losses of $96,000 during the year, compared to a
provision for credit losses in the amount of $990,000 during 1996 with no actual
credit losses. The Company provided for additional credit losses because its
review of underlying ARM collateral indicates potential for some loss on two ARM
securities, which are being carried at their current market value of $13.1
million, or 0.3% of the Company's ARM portfolio. The Company also has a policy
to regularly record a provision for possible credit losses on its portfolio of
ARM loans.
For both years ended December 31, 1997 and 1996, the Company's ratio of
operating expenses to average assets was 0.21%. The Company's operating expense
ratio is well below the average of other more traditional mortgage portfolio
lending institutions such as banks and savings and loans. The Company pays the
Manager an annual base management fee, generally based on average shareholders'
equity, not assets, as defined in the Management Agreement, payable monthly in
arrears as follows: 1.1% of the first $300 million of Average Shareholders'
Equity, plus 0.8% of Average Shareholders' Equity above $300 million. Since this
management fee is based on shareholders' equity and not assets, this fee
increases as the Company successfully accesses capital markets and raises
additional equity capital and is, therefore, managing a larger amount of
invested capital on behalf of its shareholders. In order for the Manager to earn
a performance fee, the rate of return on the shareholders' investment, as
defined in the Management Agreement, must exceed the average ten-year U.S.
Treasury rate during the quarter plus 1%. During 1997, the Manager earned a
performance fee of $3,363,000. During 1997, after paying this performance fee,
the Company's return on common equity was 12.72%. As presented in the following
table, the performance fee is a variable expense that fluctuates with the
Company's return on shareholders' equity relative to the average 10-year U.S.
Treasury rate. As the Company's return on shareholders' equity declined during
the fourth quarter of 1997, the performance fee also declined, to an annualized
0.05% of average assets during the fourth quarter. See Note 7 to the Financial
Statements for a discussion of the management fee formulas.
The following table highlights the quarterly trend of operating expenses as a
percent of average assets:
ANNUALIZED OPERATING EXPENSE RATIOS
Management Fee
& Other Performance Total
For The Expenses/ Fee/ G & A Expense/
Quarter Ended Average Assets Average Assets Average Assets
- ---------------- ---------------- ---------------- ----------------
Mar 31, 1995 0.10% 0.00% 0.10%
Jun 30, 1995 0.10% 0.00% 0.10%
Sep 30, 1995 0.10% 0.03% 0.13%
Dec 31, 1995 0.10% 0.09% 0.19%
Mar 31, 1996 0.09% 0.12% 0.21%
Jun 30, 1996 0.10% 0.09% 0.19%
Sep 30, 1996 0.10% 0.10% 0.20%
Dec 31, 1996 0.13% 0.11% 0.24%
Mar 31, 1997 0.14% 0.11% 0.25%
Jun 30, 1997 0.13% 0.09% 0.22%
Sep 30, 1997 0.12% 0.09% 0.21%
Dec 31, 1997 0.12% 0.05% 0.17%
RESULTS OF OPERATIONS - 1996 COMPARED TO 1995
For the year ended December 31, 1996, the Company's net income was $25,737,000,
or $1.73 per share (Basic EPS), based on a weighted average of 14,873,700 shares
outstanding, compared to $10,452,000, or $0.88 per share (Basic EPS), based on a
weighted average of 11,926,996 shares outstanding for the year ended December
31, 1995. Net interest income for 1996 totaled $30,345,000, compared to
$13,496,000 for the same period in 1995. Net interest income includes the
interest income earned on mortgage investments less interest expense from
borrowings. The Company recorded a net gain from the sale of ARM assets in the
amount of $1,362,000 during 1996, compared to a net loss of $568,000 during
1995. Additionally, during 1996, the Company reduced its earnings and the
carrying value of its ARM assets by reserving $990,000 for potential credit
losses. During 1996, the Company incurred operating expenses of $4,980,000,
consisting of a base management fee of $1,872,000, a performance-based fee of
$2,462,000 and other operating expenses of $646,000. During 1995, the Company
incurred operating expenses of $2,476,000, consisting of a base management fee
of $1,390,000, a performance-based fee of $596,000 and other operating expenses
of $490,000.
For the year ended December 31, 1996, the Company's taxable income was
$26,159,000, or $1.76 per weighted average share outstanding.
The improvement in the Company's net interest income during 1996 compared to
1995 was $16,849,000. As presented in the table below, the Company had, on
average, $212.9 million more interest-earning assets than interest-bearing
liabilities during 1996. The improvement in the Company's net interest income
was primarily the result of the higher yield on the $212.9 million of net
interest-earning assets in 1996 compared to 1995 and in part due to the higher
average balances of total interest-earning assets and interest-bearing
liabilities at a positive spread.
The weighted average coupon of the ARM assets portfolio (the rate of interest
actually received before the impact of yield adjustments such as hedging cost
and amortization of premiums and discounts) was 7.57% as of December 31, 1996,
compared to 7.42% as of December 31, 1995 -- a rise of 0.15%. This improvement
in the weighted average portfolio coupon was more than offset by additional
premium amortization resulting from increased prepayment activity during 1996.
The Company's mortgage assets paid down at an approximate average annualized
constant prepayment rate of 26% during 1996, whereas the constant prepayment
rate averaged approximately 18% during the full year of 1995. As a result, the
yield on the Company's ARM assets portfolio was 6.64% at December 31, 1996, a
decline of 0.09% from 6.73% at December 31, 1995. Also, during the year ended
December 31, 1996, the Company's cost of funds declined by 0.33%. As of December
31, 1996, the interest rate on the Company's borrowings was 5.72%, compared to
6.05% as of December 31, 1995. As a result of these changes, the Company's net
interest spread as of December 31, 1996 was 0.92%, compared to a 0.68% as of
December 31, 1995.
The following table reflects the average balances for each category of the
Company's interest-earning assets as well as the Company's interest-bearing
liabilities, with the corresponding effective rate of interest annualized for
the years ended December 31, 1996, and December 31, 1995:
AVERAGE BALANCE AND RATE TABLE
(Dollar amounts in thousands)
For the Year Ended For the Year Ended
December 31, 1996 December 31, 1995
--------------------- --------------------
Average Effective Average Effective
Balance Rate Balance Rate
--------------------- --------------------
Interest-Earning Assets:
ARM assets $ 2,336,900 6.45% $ 1,836,154 6.31%
Cash and cash equivalents 14,200 5.29 13,352 5.89
------------------- -------------------
2,351,100 6.45 1,849,506 6.31
------------------- -------------------
Interest-Bearing Liabilities:
Borrowings 2,138,236 5.67 1,676,981 6.15
------------------- -------------------
Net Interest-Earning Assets $ 212,864 0.78% $ 172,525 0.16%
and Spread =================== ===================
Yield on Net 1.29% 0.73%
Interest-Earning Assets (1) ========= =========
- -----------------------------
(1) Yield on Net Interest-Earning Assets is computed by dividing annualized
net interest income by the average daily balance of interest-earning assets.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary source of funds for the years ended December 31, 1997 and
1996 consisted of reverse repurchase agreements, which totaled $4.270 billion
and $2.459 billion at the respective year ends. The Company's other significant
sources of funds for the years ended December 31, 1997 and 1996 consisted of
payments of principal and interest from the ARM assets in the amounts of $1.1
billion and $713.7 million, respectively, and the proceeds from the sale of ARM
assets in the amounts of $190.2 million and $277.6 million, respectively. In the
future, the Company expects its primary sources of funds will consist of
borrowed funds under reverse repurchase agreement transactions with one- to
twelve-month maturities, of monthly payments of principal and interest on its
ARM assets portfolio and possibly asset sales as needed. The Company's liquid
assets generally consist of unpledged ARM assets, cash and cash equivalents.
Total borrowings incurred at December 31, 1997, had a weighted average interest
rate of 5.92% and a weighted average remaining term to maturity of 2.2 months.
As of December 31, 1997, $1.687 billion of the Company's borrowings were
variable-rate term reverse repurchase agreements. Term reverse repurchase
agreements are committed financings with original maturities that range from
three months to two years. The interest rates on these term reverse repurchase
agreements are indexed to either the one-, three- or six-month LIBOR rate and
reprice accordingly.
The Company has borrowing arrangements with 24 different financial institutions
and on December 31, 1997, had borrowed funds under reverse repurchase agreements
with 16 of these firms. Because the Company borrows money based on the fair
value of its ARM assets and because increases in short-term interest rates can
negatively impact the valuation of ARM assets, the Company's borrowing ability
could be limited and lenders may initiate margin calls in the event short-term
interest rates increase or the value of the Company's ARM assets declines for
other reasons. Additionally, certain of the Company's ARM assets are rated less
than AA by the Rating Agencies and have less liquidity than assets that are
rated AA or higher. Other mortgage assets which are rated AA or higher by the
Rating Agencies derive their credit rating based on a mortgage pool insurer's
rating. As a result of either changes in interest rates, credit performance of a
mortgage pool or a downgrade of a mortgage pool issuer, the Company may find it
difficult to borrow against such assets and, therefore, may be required to sell
certain mortgage assets in order to maintain liquidity. If required, these sales
could be at prices lower than the carrying value of the assets, which would
result in losses. For the year ended December 31, 1997, the Company had adequate
cash flow, liquid assets and unpledged collateral with which to meet its margin
requirements during such periods. Further, the Company believes it will continue
to have sufficient liquidity to meet its future cash requirements from its
primary sources of funds for the foreseeable future without needing to sell
assets.
In December 1996, the Company's Registration Statement on Form S-3, registering
the sale of up to $200 million of additional assets, was declared effective by
the Securities and Exchange Commission. This registration statement includes the
possible issuances of common stock, preferred stock, warrants or shareholder
rights.
In January 1997, the Company issued 2,760,000 shares of Series A 9.68%
Cumulative Convertible Preferred Stock at a price of $25 per share. Net proceeds
from this issuance totaled $65.8 million.
In May 1997, the Company issued 861,850 shares of common stock at a price of
$19.50 per share. Net proceeds from this issuance totaled $16.2 million.
In July 1997, the Company issued 2,100,000 shares of common stock at a price of
$22.625 per share. Net proceeds from this issuance totaled $45.0 million. Upon
completion of this issuance of common stock, the Company had $109 million of its
securities registered for future sale under the Company's Registration
Statement.
The Company has a Dividend Reinvestment and Stock Purchase Plan (the "DRP")
designed to provide a convenient and economical way for existing shareholders to
automatically reinvest their dividends in additional shares of common stock and
for new and existing shareholders to purchase shares at a discount to the
current market price of the common stock, as defined in the DRP. As a result of
1997 participation in the DRP, the Company issued 912,590 new shares of common
stock and received $18.0 million of new equity capital.
EFFECTS OF INTEREST RATE CHANGES
Changes in interest rates impact the Company's earnings in various ways. While
the Company only invests in ARM assets, rising short-term interest rates may
temporarily negatively affect the Company's earnings and conversely falling
short-term interest rates may temporarily increase the Company's earnings. This
impact can occur for several reasons and may be mitigated by portfolio
prepayment activity as discussed below. First, the Company's borrowings will
react to changes in interest rates sooner than the Company's ARM assets because
the weighted average next repricing date of the borrowings is usually a shorter
time period. Second, interest rates on ARM loans are generally limited to an
increase of either 1% or 2% per adjustment period (commonly referred to as the
periodic cap) and the Company's borrowings do not have similar limitations.
Third, the Company's ARM assets lag changes in the indices due to the notice
period provided to ARM borrowers when the interest rate on their loans are
scheduled to change. The periodic cap only affects the Company's earnings when
interest rates move by more than 1% per six-month period or 2% per year.
The rate of prepayment on the Company's mortgage assets may decrease if interest
rates rise, or if the difference between long-term and short-term interest rates
increases. Decreased prepayments would cause the Company to amortize the
premiums paid for its ARM assets over a longer time period, resulting in an
increased yield on its mortgage assets. Therefore, in rising interest rate
environments where prepayments are declining, not only would the interest rate
on the ARM assets portfolio increase to re-establish a spread over the higher
interest rates, but the yield also would rise due to slower prepayments. The
combined effect could significantly mitigate other negative effects that rising
short-term interest rates might have on earnings.
Conversely, the rate of prepayment on the Company's mortgage assets may increase
if interest rates decline, or if the difference between long-term and short-term
interest rates diminishes. Increased prepayments would cause the Company to
amortize the premiums paid for its mortgage assets faster, resulting in a
reduced yield on its mortgage assets. Additionally, to the extent proceeds of
prepayments cannot be reinvested at a rate of interest at least equal to the
rate previously earned on such mortgage assets, the Company's earnings may be
adversely affected.
Lastly, because the Company only invests in ARM assets and approximately 8% to
9% of such mortgage assets are purchased with shareholders' equity, the
Company's earnings over time will tend to increase following periods when
short-term interest rates have risen and decrease following periods when
short-term interest rates have declined. This is because the financed portion of
the Company's portfolio of ARM assets will, over time, reprice to a spread over
the Company's cost of funds, while the portion of the Company's portfolio of ARM
assets that are purchased with shareholders' equity will generally have a higher
yield in a higher interest rate environment and a lower yield in a lower
interest rate environment.
OTHER MATTERS
The Company calculates its Qualified REIT Assets, as defined in the Internal
Revenue Code of 1986, as amended (the "Code"), to be 99.7% of its total assets,
compared to the Code requirement that at least 75% of its total assets must be
Qualified REIT Assets. The Company also calculates that 99.5% of its revenue
qualifies for the 75% source of income test and 100% of its revenue qualifies
for the 95% source of income test under the REIT rules. Furthermore, the
Company's revenues during the year ended December 31, 1997, subject to the 30%
income limitation under the REIT rules amount to 0.85% of total revenue. The
Company also met all REIT requirements regarding the ownership of its common
stock and the distributions of its net income. Therefore, as of December 31,
1997, the Company believes that it will continue to qualify as a REIT under the
provisions of the Code.
The Company at all times intends to conduct its business so as not to become
regulated as an investment company under the Investment Company Act of 1940. If
the Company were to become regulated as an investment company, the Company's use
of leverage would be substantially 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"
("Qualifying Interests"). Under 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 assets represent all the certificates issued with respect to an
underlying pool of mortgages, such mortgage assets may be treated as assets
separate from the underlying mortgage loans and, thus, may not be considered
Qualifying Interests for purposes of the 55% requirement. As of December 31,
1997, the Company calculates that it is in compliance with this requirement.
The Company has reviewed its computer systems and has determined that they are
in compliance with the requirements of the year 2000. The Company also believes
that because of its internal systems and controls and the nature of its
financial contracts, it is not likely to incur any material disruptions,
expenses or losses in connection with any external relationship related to the
year 2000.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements of the Company, the related notes and schedules
to the financial statements, together with the Independent Auditor's
Report thereon are set forth on pages F-3 through F-21 on this Form
10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by Item 10 is incorporated herein by reference
to the definitive Proxy Statement dated March 30, 1998 pursuant to
General Instruction G(3).
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 is incorporated herein by reference
to the definitive Proxy Statement dated March 30, 1998 pursuant to
General Instruction G(3).
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 is incorporated herein by reference
to the definitive Proxy Statement dated March 30, 1998 pursuant to
General Instruction G(3).
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is incorporated herein by reference
to the definitive Proxy Statement dated March 30, 1998 pursuant to
General Instruction G(3).
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents filed as part of this report:
1. The following Financial Statements of the Company are included
in Part II, Item 8 of this Annual Report on Form-K:
Independent Auditors' Report; Balance Sheets as of December 31,
1997 and 1996; Statements of Operations for the years ended
December 31, 1997, 1996 and 1995; Statements of Shareholders'
Equity for the years ended December 31, 1997, 1996 and 1995;
Statements of Cash Flows for the years ended December 31, 1997,
1996 and 1995 and Notes to Financial Statements.
2. Schedules to Financial Statements:
All financial statement schedules are included in Part II, Item
8 of this Annual Report on Form-K.
3. Exhibits:
See "Exhibit Index".
(b) Reports on Form 8-K:
None
THORNBURG MORTGAGE ASSET CORPORATION
FINANCIAL STATEMENTS
AND
INDEPENDENT AUDITOR'S REPORT
For Inclusion in Form 10-K
Filed with
Securities and Exchange Commission
December 31, 1997
THORNBURG MORTGAGE ASSET CORPORATION
INDEX TO FINANCIAL STATEMENTS
PAGE
FINANCIAL STATEMENTS:
Independent Auditor's Report F-3
Balance sheets F-4
Statements of operations F-5
Statement of shareholders' equity F-6
Statements of cash flows F-7
Notes to financial statements F-8
FINANCIAL STATEMENT SCHEDULE:
Schedule IV - mortgage loans on real estate F-20
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors
Thornburg Mortgage Asset Corporation
Santa Fe, New Mexico
We have audited the accompanying balance sheets of Thornburg Mortgage Asset
Corporation as of December 31, 1997 and 1996 and the related statements of
operations, shareholders' equity and cash flows for each of the three years in
the period ended December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards 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. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Thornburg Mortgage Asset
Corporation as of December 31, 1997 and 1996, and the results of its operations
and its cash flows for each of the three years in the period ended December 31,
1997 in conformity with generally accepted accounting principles.
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The supplemental Schedule IV is presented
for purposes of complying with the Securities and Exchange Commission's rules
and is not a part of the basic financial statements. This schedule has been
subjected to the auditing procedures applied in our audits of the basic
financial statements and, in our opinion, is fairly stated in all material
respects in relation to the basic financial statements taken as a whole.
/s/ McGLADREY & PULLEN, LLP
McGLADREY & PULLEN, LLP
New York, New York
January 15, 1998
===============================================================================
THORNBURG MORTGAGE ASSET CORPORATION
===============================================================================
BALANCE SHEETS
(Amounts in thousands)
December 31
-------------------------------------
1997 1996
------------------ -----------------
ASSETS
Adjustable-rate mortgage ("ARM") assets (Notes 2 and 3)
ARM securities $ 4,519,707 $ 2,727,875
ARM loans held for securitization 118,987 -
---------------- ----------------
4,638,694 2,727,875
Cash and cash equivalents 13,780 3,693
Accrued interest receivable 38,353 23,563
Prepaid expenses and other 289 227
---------------- ----------------
$ 4,691,116 $ 2,755,358
================ ================
LIABILITIES
Reverse repurchase agreements (Note 3) $ 4,270,170 $ 2,459,132
Other borrowings (Note 3) 10,018 14,187
Payable for assets purchased - 32,683
Accrued interest payable 39,749 18,747
Dividends payable (Note 5) 11,810 7,299
Accrued expenses and other 1,215 1,112
---------------- ----------------
4,332,962 2,533,160
---------------- ----------------
COMMITMENTS (Note 2)
SHAREHOLDERS' EQUITY (Note 5)
Preferred stock: par value $.01 per share;
2,760 shares authorized; 9.68% Cumulative
Convertible Series A, 2,760 and none issued
and outstanding, respectively; aggregate
preference in liquidation $69,000 65,805 -
Common stock: par value $.01 per share;
47,240 shares authorized, 20,280 and 16,219
shares issued and outstanding, respectively 203 162
Additional paid-in-capital 315,240 233,177
Available-for-sale assets:
Unrealized gain (loss) (Note 2) (22,504) (15,807)
Realized deferred hedging gain 3,059 4,541
Notes receivable from stock sales (2,698) -
Retained earnings (deficit) (951) 125
---------------- ----------------
358,154 222,198
---------------- ----------------
$ 4,691,116 $ 2,755,358
================ ================
See Notes to Financial Statements.
===============================================================================
THORNBURG MORTGAGE ASSET CORPORATION
===============================================================================
STATEMENTS OF OPERATIONS
(Amounts in thousands, except per share data)
Year ended December 31
-------------------------------------------
1997 1996 1995
------------- ------------- -------------
Interest income from ARM assets and cash $ 247,721 $ 151,511 $ 116,617
Interest expense on borrowed funds (198,657) (121,166) (103,121)
----------- ----------- -----------
Net interest income 49,064 30,345 13,496
----------- ----------- -----------
Gain (loss) on sale of ARM assets 1,189 1,362 (568)
Provision for credit losses (886) (990) -
Management fee (Note 7) (3,664) (1,872) (1,390)
Performance fee (Note 7) (3,363) (2,462) (596)
Other operating expenses (938) (646) (490)
----------- ----------- -----------
NET INCOME $ 41,402 $ 25,737 $ 10,452
=========== =========== ===========
Net income $ 41,402 $ 25,737 $ 10,452
Dividend on preferred stock (6,251) - -
----------- ----------- -----------
Net income available to common shareholders $ 35,151 $ 25,737 $ 10,452
=========== =========== ===========
Basic earnings per share $ 1.95 $ 1.73 $ 0.88
=========== =========== ===========
Diluted earnings per share $ 1.94 $ 1.73 $ 0.88
=========== =========== ===========
Average number of common shares outstanding 18,048 14,874 11,927
=========== =========== ===========
See Notes to Financial Statements.
================================================================================
THORNBURG MORTGAGE ASSET CORPORATION
================================================================================
STATEMENTS OF SHAREHOLDERS' EQUITY
Three Years Ended December 31, 1997
(Dollar amounts in thousands, except per share data)
Available-for-Sale Assets
-------------------------
Realized Notes
Additional Deferred Receivable
Preferred Common Paid-in Unrealized Gain From From Stock Retained
Stock Stock Capital Gain (Loss) Hedging Sales Earnings Total
--------- -------- ----------- ------------ ----------- ---------- ---------- ---------
Balance, December 31, 1994 $ - $ 118 $ 170,466 $ (60,052) $ 9,259 $ - $ 192 $ 119,983
Issuance of common
stock (Note 5) - 4 5,242 - - - - 5,246
Available-for-Sale
Assets:
Fair value
adjustment, net
of amortization - - - 38,217 - - - 38,217
Deferred gain on
sale of hedges,
net of amortization - - - - (2,250) - - (2,250)
Net income - - - - - - 10,452 10,452
Dividends declared on
common stock - $0.93 per
share - - - - - - (11,171) (11,171)
-------- -------- ---------- ---------- ---------- --------- --------- --------
Balance, December 31, 1995 - 122 175,708 (21,835) 7,009 - (527) 160,477
Issuance of common
stock (Note 5) - 40 57,469 - - - - 57,509
Available-for-Sale
Assets:
Fair value
adjustment, net
of amortization - - - 6,028 - - - 6,028
Deferred gain on
sale of hedges,
net of amortization - - - - (2,468) - - (2,468)
Net income - - - - - - 25,737 25,737
Dividends declared on
common stock -
$1.65 per share - - - - - - (25,085) (25,085)
-------- -------- ---------- ---------- ---------- --------- --------- --------
Balance, December 31, 1996 - 162 233,177 (15,807) 4,541 - 125 222,198
Series A preferred
stock issued, net of
issuance cost (Note 5) 65,805 - - - - - - 65,805
Issuance of common
stock (Note 5) - 41 82,063 - - (2,698) - 79,406
Available-for-Sale
Assets:
Fair value
adjustment, net
of amortization - - - (6,697) - - - (6,697)
Deferred gain on
sale of hedges, net of
amortization - - - - (1,482) - - (1,482)
Net income - - - - - - 41,402 41,402
Dividends declared on
preferred stock -
$2.265 per share - - - - - - (6,251) (6,251)
Dividends declared on
common stock -
$1.97 per share - - - - - - (36,227) (36,227)
-------- -------- ---------- ---------- ---------- --------- --------- --------
Balance, December 31, 1997 $ 65,805 $ 203 $ 315,240 $ (22,504) $ 3,059 $ ( 2,698) $ (951) $ 358,154
======== ======== ========== ========== ========== ========= ========= ========
See Notes to Financial Statements.
===============================================================================
THORNBURG MORTGAGE ASSET CORPORATION
===============================================================================
STATEMENTS OF CASH FLOWS
(Dollar amounts in thousands)
Year ended December 31
-------------------------------------------
1997 1996 1995
------------- ------------- -------------
Operating Activities:
Net income $ 41,402 $ 25,737 $ 10,452
Adjustments to reconcile net
income to net cash provided by
operating activities:
Amortization 24,665 14,346 4,699
Net realized (gain) loss from
investing activities (303) (372) 568
Decrease (increase) in accrued
interest receivable (14,789) (4,785) (5,329)
Decrease (increase) in prepaid
expenses and other (62) 33 (193)
Increase (decrease) in accrued
interest payable 21,002 8,840 3,349
Increase (decrease) in accrued
expenses and other 101 433 463
----------- ----------- -----------
Net cash provided by operating
activities 72,016 44,232 14,009
----------- ----------- -----------
Investing Activities:
Available-for-sale securities:
Purchases (2,929,746) (1,583,678) (548,672)
Proceeds on sales 190,196 277,594 75,374
Proceeds on call 67,202 - -
Principal payments 756,379 441,722 201,583
Held-to-maturity securities:
Principal payments 63,120 111,684 78,268
ARM Loans:
Purchases (123,211) - -
Principal payments 4,092 - -
Purchase of interest rate cap
agreements (4,074) (631) (403)
----------- ----------- -----------
Net cash (used in) investing
activities (1,976,042) (753,309) (193,850)
----------- ----------- -----------
Financing Activities:
Net borrowings from reverse
repurchase agreements 1,811,038 678,278 178,920
Repayments of other borrowings (4,169) (4,259) (3,208)
Proceeds from preferred stock
issued 65,805 - -
Proceeds from common stock issued 79,406 57,509 5,246
Dividends paid (37,967) (22,418) (8,305)
----------- ----------- -----------
Net cash provided by financing
activities 1,914,113 709,110 172,653
----------- ----------- -----------
Net increase (decrease) in cash and
cash equivalents 10,087 33 (7,188)
Cash and cash equivalents at
beginning of period 3,693 3,660 10,848
----------- ----------- -----------
Cash and cash equivalents at end of
period $ 13,780 $ 3,693 $ 3,660
=========== =========== ===========
Supplemental disclosure of cash flow information and non-cash
investing and financing activities are included in Note 3.
See Notes to Financial Statements
THORNBURG MORTGAGE ASSET CORPORATION
NOTES TO FINANCIAL STATEMENTS
NOTE 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Thornburg Mortgage Asset Corporation (the "Company") was incorporated
in Maryland on July 28, 1992. The Company commenced its operations of
purchasing and managing for investment a portfolio of adjustable-rate
mortgage assets on June 25, 1993, upon receipt of the net proceeds from
the initial public offering of the Company's common stock.
A summary of the Company's significant accounting policies follows:
CASH AND CASH EQUIVALENTS
Cash and cash equivalents includes cash on hand and highly liquid
investments with original maturities of three months or less. The
carrying amount of cash equivalents approximates their value.
ADJUSTABLE-RATE MORTGAGE ASSETS
The Company's adjustable-rate mortgage ("ARM") assets are comprised
of both ARM securities and ARM loans.
The Company's policy is to classify each of its ARM securities as
available-for-sale as they are purchased and then monitor each ARM
security for a period of time, generally six to twelve months, prior
to making a determination as to whether the ARM security will be
classified as held-to-maturity. Management has made the
determination that most of its ARM securities should be designated
as available-for-sale in order to be prepared to respond to
potential future opportunities in the market, to sell ARM securities
in order to optimize the portfolio's total return and to retain its
ability to respond to economic conditions that might require the
Company to sell assets in order to maintain an appropriate level of
liquidity. Management re-evaluates the classification of the ARM
securities on a quarterly basis. All ARM securities classified as
held-to-maturity are carried at the fair value of the security at
the time the designation is made and any fair value adjustment to
the cost basis as of the date of the classification is amortized
into interest income as a yield adjustment. All ARM securities
designated as available-for-sale are reported at fair value, with
unrealized gains and losses excluded from earnings and reported as a
separate component of shareholders' equity.
ARM loans that management has the intent and ability to hold for the
foreseeable future and until maturity or payoff are carried at their
unpaid principal balances, net of unamortized premium or discount
and allowance for loan losses.
Premiums and discounts associated with the purchase of the ARM
assets are amortized into interest income over the lives of the
assets using the effective yield method adjusted for the effects of
estimated prepayments.
ARM asset transactions are recorded on the date the ARM assets are
purchased or sold. Purchases of new issue ARM assets are recorded
when all significant uncertainties regarding the characteristics of
the assets are removed, generally shortly before settlement date.
Realized gains and losses on ARM asset transactions are determined
on the specific identification basis.
CREDIT RISK
The Company limits its exposure to credit losses on its portfolio of
ARM securities by only purchasing ARM securities that have an
investment grade rating at the time of purchase and have some form
of credit enhancement or are guaranteed by an agency of the federal
government. An investment grade security generally has a security
rating of BBB or Baa or better by at least one of two nationally
recognized rating agencies, Moody's Investor Services, Inc. or
Standard & Poor's, Inc. (the "Rating Agencies"). Additionally, the
Company has also purchased ARM loans and limits its exposure to
credit losses by restricting its whole loan purchases to ARM loans
generally originated to "A" quality underwriting standards or loans
that have at least five years of pay history and/or low loan to
property value ratios. The Company further limits its exposure to
credit losses by limiting its investment in investment grade
securities that are rated A, or equivalent, BBB, or equivalent, or
ARM loans originated to "A" quality underwriting standards ("Other
Investments") to no more than 30% of the portfolio.
The Company monitors the delinquencies and losses on the underlying
mortgage loans backing its ARM assets. If the credit performance of
the underlying mortgage loans is not as expected, the Company makes
a provision for possible credit losses at a level deemed appropriate
by management to provide for known losses as well as unidentified
potential future losses in its ARM assets portfolio. The provision
is based on management's assessment of numerous factors affecting
its portfolio of ARM assets including, but not limited to, current
and projected economic conditions, delinquency status, credit losses
to date on underlying mortgages and remaining credit protection. The
provision for ARM securities is made by reducing the cost basis of
the individual security for the decline in fair value which is other
than temporary, and the amount of such write-down is recorded as a
realized loss, thereby reducing earnings. The Company also makes a
monthly provision for possible credit losses on its portfolio of ARM
loans which is an increase to the reserve for possible loan losses.
The provision for possible credit losses on loans is based on loss
statistics of the real estate industry for similar loans, taking
into consideration factors including, but not limited to,
underwriting characteristics, seasoning, geographic location and
current and projected economic conditions. When a loan or a portion
of a loan is deemed to be uncollectible, the portion deemed to be
uncollectible is charged against the reserve and subsequent
recoveries, if any, are credited to the reserve.
Provisions for credit losses do not reduce taxable income and thus
do not affect the dividends paid by the Company to shareholders in
the period the provisions are taken. Actual losses realized by the
Company do reduce taxable income in the period the actual loss is
realized and would affect the dividends paid to shareholders for
that tax year.
DERIVATIVE FINANCIAL INSTRUMENTS
INTEREST RATE CAP AGREEMENTS
The Company purchases interest rate cap agreements (the "Cap
Agreements") to limit the Company's risks associated with the
lifetime or maximum interest rate caps of its ARM assets should
interest rates rise above specified levels. The Cap Agreements
reduce the effect of the lifetime cap feature so that the yield on
the ARM assets will continue to rise in high interest rate
environments as the Company's cost of borrowings also continue to
rise.
The Cap Agreements classified as a hedge against held-to-maturity
assets are initially carried at their fair value as of the time the
Cap Agreements and the related assets are designated as
held-to-maturity with an adjustment to equity for any unrealized
gains or losses at the time of the designation. Any adjustment to
equity is thereafter amortized into interest income as a yield
adjustment in a manner consistent with the amortization of any
premium or discount. The Cap Agreements that are classified as a
hedge against available-for-sale assets are carried at fair value
with unrealized gains and losses reported as a separate component of
equity, consistent with the reporting of such assets. The carrying
value of the Cap Agreements are included in ARM assets on the
balance sheet. The amortization of the carrying value of the Cap
Agreements is included in interest income as a contra item (i.e.,
expense) and, as such, reduces interest income over the lives of the
Cap Agreements.
Realized gains and losses resulting from the termination of the Cap
Agreements that are hedging assets classified as held-to-maturity
are deferred as an adjustment to the carrying value of the related
assets and are amortized into interest income over the terms of the
related assets. Realized gains and losses resulting from the
termination of such agreements that are hedging assets classified as
available-for-sale are initially reported in a separate component of
equity, consistent with the reporting of those assets, and are
thereafter amortized as a yield adjustment.
INTEREST RATE SWAP AGREEMENTS
The Company enters into interest rate swap agreements in order to
manage its interest rate exposure when financing its ARM assets.
Revenues and expenses from the interest rate swap agreements are
accounted for on an accrual basis and recognized as a net adjustment
to interest expense.
INCOME TAXES
The Company has elected to be taxed as a Real Estate Investment
Trust ("REIT") and complies with the provisions of the Internal
Revenue Code of 1986, as amended (the "Code") with respect thereto.
Accordingly, the Company will not be subject to Federal income tax
on that portion of its income that is distributed to shareholders
and as long as certain asset, income and stock ownership tests are
met.
NET EARNINGS PER SHARE
The Financial Accounting Standards Board ("FASB") has issued
Statement No. 128, Earnings per Share, which supersedes APB Opinion
No. 15. Statement No. 128 requires the presentation of earnings per
share ("EPS") by all entities that have common stock or potential
common stock, such as options, warrants and convertible securities
outstanding that trade in a public market. Those entities that have
only common stock outstanding are required to present basic EPS
amounts. Basic EPS amounts are computed by dividing net income
(adjusted for dividends declared on preferred stock) by the weighted
average number of common shares outstanding. All other entities are
required to present basic and diluted EPS amounts. Diluted EPS
amounts assume the conversion, exercise or issuance of all potential
common stock instruments unless the effect is to reduce a loss or
increase the earnings per common share.
The Company initially applied Statement No. 128 for the year ended
December 31, 1997, and as required by the Statement, has restated
all per share information for the prior years to conform to the
Statement.
Following is information about the computation of the earnings per
share data for the years ended December 31, 1997, 1996 and 1995
(Amounts in thousands except per share data):
Earnings
Income Shares Per Share
------------ ------------- -------------
1997
Net Income $ 41,402
Less preferred stock dividends (6,251)
------------
Basic EPS, income available to
common shareholders 35,151 18,048 $ 1.95
===========
Effect of dilutive securities:
Stock options 110
----------- ------------
Diluted EPS $ 35,151 18,158 $ 1.94
=========== ============ ===========
Earnings
Income Shares Per Share
------------ ------------ -------------
1996
Net Income $ 25,737
Less preferred stock dividends -
-----------
Basic EPS, income available to
common stockholders 25,737 14,874 $ 1.73
===========
Effect of dilutive securities:
Stock options 37
----------- ------------
Diluted EPS $ 25,737 14,911 $ 1.73
=========== ============ ===========
1995
Net Income $ 10,452
Less preferred stock dividends -
-----------
Basic EPS, income available to
common stockholders 10,452 11,927 $ 0.88
===========
Effect of dilutive securities:
Stock options -
----------- ------------
Diluted EPS $ 10,452 11,927 $ 0.88
=========== ============ ===========
The Company has granted options to directors and officers of the
Company and employees of the Manager to purchase 240,320, 169,099
and 23,791 shares of common stock at average prices of $20.89,
$15.44 and $15.36 per share during the years ended December 31,
1997, 1996 and 1995, respectively. The conversion of preferred stock
was not included in the computation of diluted EPS because such
conversion would increase the diluted EPS.
USE OF ESTIMATES
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.
RECENT ACCOUNTING PRONOUNCEMENTS
On June 30, 1997, the FASB issued SFAS No. 130, Reporting
Comprehensive Income. This statement requires companies to classify
items of other comprehensive income by their nature in a financial
statement and display the accumulated balance of other comprehensive
income separately from retained earnings and additional paid-in
capital in the equity section of a statement of financial position.
The Company intends to comply with the requirements of this
statement in the first quarter of 1998. The Company has determined
that this statement will not result in material changes to the
Company's financial position and results of operations.
NOTE 2. ADJUSTABLE-RATE MORTGAGE ASSETS AND INTEREST RATE CAP AGREEMENTS
Investments in ARM assets consist of both ARM securities backed by ARM
loans and ARM loans, primarily secured by single-family residential
housing.
The following tables present the Company's ARM assets as of December
31, 1997 and December 31, 1996. The ARM securities classified as
available-for-sale are carried at their fair value, while the
held-to-maturity ARM securities and ARM loans are carried at their
amortized cost basis (dollar amounts in thousands):
December 31, 1997:
ARM Securities
---------------------------------------
Available- Held-to-
for-Sale Maturity Total ARM Loans
----------- ----------- ----------- ------------
Amortized cost basis $ 4,147,384 $ 395,803 $ 4,543,187 $ 119,029
Allowance for losses (1,739) - (1,739) (42)
---------- ---------- ---------- ----------
Amortized cost, net 4,145,645 395,803 4,541,448 118,987
---------- ---------- ---------- ----------
Gross unrealized gains 11,075 5,609 16,684 -
Gross unrealized losses (32,816) (2,859) (35,675) -
---------- ---------- ---------- ==========
Fair value $ 4,123,904 $ 398,553 $ 4,522,457 $ 118,987
========== ========== ========== ==========
Carrying value $ 4,123,904 $ 395,803 $ 4,519,707 $ 118,987
========== ========== ========== ==========
December 31, 1996:
ARM Securities
---------------------------------------
Available- Held-to-
for-Sale Maturity Total ARM Loans
----------- ----------- ----------- ------------
Amortized cost basis $ 2,282,991 $ 460,596 $ 2,743,587 $ -
Allowance for losses (990) - (990) -
---------- ---------- ---------- ----------
Amortized cost, net 2,282,001 460,596 2,742,597 -
---------- ---------- ---------- ----------
Gross unrealized gains 7,686 4,169 11,855 -
Gross unrealized losses (22,408) (4,306) (26,714) -
---------- ---------- ---------- ==========
Fair value $ 2,267,279 $ 460,459 $ 2,727,738 $ -
========== ========== ========== ==========
Carrying value $ 2,267,279 $ 460,596 $ 2,727,875 $ -
========== ========== ========== ==========
During 1997, the Company realized $2,179,000 in gains and $990,000 in
losses on the sale of $189.0 million of ARM securities. During 1996,
the Company realized $1,427,000 in gains and $65,000 in losses on the
sale of $276.4 million of ARM securities, and during 1995, the Company
realized $91,000 in gains and $659,000 in losses on the sale of $75.9
million of ARM securities. All of the ARM securities sold were
classified as available-for-sale.
As of December 31, 1997, the Company had reduced the cost basis of its
ARM securities due to potential future credit losses (other than
temporary declines in fair value) in the amount of $1,739,000. At
December 31, 1997, the Company is providing for potential future credit
losses on two assets that have an aggregate carrying value of $13.1
million, which represent less than 0.3% of the Company's total
portfolio of ARM assets. Both of these assets are performing and have
some remaining credit support that mitigate the Company's exposure to
potential future credit losses. Additionally, during 1997, the Company,
in accordance with its credit policies, recorded a $42,000 provision
for potential credit losses on its loan portfolio, although no actual
losses have been realized in the loan portfolio to date. The following
table summarizes the activity for the allowance for losses on ARM loans
for the year ended 1997 (dollar amounts in thousands):
Beginning balance $ 0
Provision for losses 42
Charge-offs, net 0
----------
Ending balance $ 42
==========
As of December 31, 1997, the Company had commitments to purchase $66.5
million of ARM assets.
The average effective yield on the ARM assets owned, including the
amortization of the net premium paid for the ARM assets and the Cap
Agreements, was 6.38% as of December 31, 1997 and 6.64% as of December
31, 1996.
As of December 31, 1997 and December 31, 1996, the Company had
purchased Cap Agreements with a remaining notional amount of $4.156
billion and $2.266 billion, respectively. The notional amount of the
Cap Agreements purchased decline at a rate that is expected to
approximate the amortization of the ARM assets. Under these Cap
Agreements, the Company will receive cash payments should the
one-month, three-month or six-month London InterBank Offer Rate
("LIBOR") increase above the contract rates of the Cap Agreements which
range from 7.50% to 13.00% and average approximately 10.19%. The
Company's ARM assets portfolio had an average lifetime interest rate
cap of 11.60% with an average maturity of 3.1 years as of December 31,
1997. The initial aggregate notional amount of the Cap Agreements
declines to approximately $3.260 billion over the period of the
agreements, which expire between 1999 and 2004. The Company purchased
these Cap Agreements by incurring a one-time fee, or premium. The
premium is amortized, or expensed, over the lives of the Cap Agreements
and decreases interest income on the Company's ARM assets during the
period of amortization. The Company has credit risk to the extent that
the counterparties to the cap agreements do not perform their
obligations under the Cap Agreements. If one of the counterparties does
not perform, the Company would not receive the cash to which it would
otherwise be entitled under the conditions of the Cap Agreement. In
order to mitigate this risk and to achieve competitive pricing, the
Company has entered into Cap Agreements with six different
counterparties, five of which are rated AAA, and one is rated AA.
NOTE 3. REVERSE REPURCHASE AGREEMENTS AND OTHER BORROWINGS
The Company has entered into reverse repurchase agreements to finance
most of its ARM assets. The reverse repurchase agreements are
short-term borrowings that are secured by the market value of the
Company's ARM assets and bear interest rates that have historically
moved in close relationship to LIBOR.
As of December 31, 1997, the Company had outstanding $4.270 billion of
reverse repurchase agreements with a weighted average borrowing rate of
5.91% and a weighted average remaining maturity of 2.1 months. As of
December 31, 1997, $1.687 billion of the Company's borrowings were
variable-rate term reverse repurchase agreements with original
maturities that range from one month to two years. The interest rates
of these term reverse repurchase agreements are indexed to either the
one-, two-, three- or six-month LIBOR rate and reprice accordingly. The
reverse repurchase agreements at December 31, 1997 were collateralized
by ARM assets with a carrying value of $4.482 billion, including
accrued interest.
At December 31, 1997, the reverse repurchase agreements had the
following remaining maturities (dollar amounts in thousands):
Within 30 days $ 1,676,268
31 to 89 days 1,526,069
90 days to one year 1,067,833
===========
$ 4,270,170
===========
As of December 31, 1997, the Company was a counterparty to six
different interest rate swap agreements that substantially offset each
other with an aggregate notional balance of $650 million. Due to the
offsetting nature of these agreements and their short remaining term,
they had no effect on the average period of next repricing of the
Company's borrowings. Five of the agreements are cancelable beginning
in the first quarter of 1998 and have a final maturity during the first
quarter of 1999. The remaining agreement matures during the first
quarter of 1998.
The Company has a line of credit agreement which provides for
short-term borrowings of up to $25 million collateralized by the
Company's principal and interest receivables. As of December 31, 1997,
there was no balance outstanding under this agreement.
As of December 31, 1997, the Company had financed a portion of its
portfolio of interest rate cap agreements with $10.0 million of other
borrowings which require quarterly or semi-annual payments until the
year 2000. These borrowings have a weighted average fixed rate of
interest of 7.91% and have a weighted average remaining maturity of 2.0
years. The other borrowings financing cap agreements at December 31,
1997 were collateralized by ARM assets with a carrying value of $14.4
million, including accrued interest, and $500,000 of cash and cash
equivalents. The aggregate maturities of these other borrowings are as
follows (dollar amounts in thousands):
1998 $ 4,509
1999 4,877
2000 632
-----------
$ 10,018
===========
The total cash paid for interest was $177.9 million, $112.2 million and
$100.4 million for 1997, 1996 and 1995 respectively.
NOTE 4. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents the carrying amounts and estimated fair
values of the Company's financial instruments at December 31, 1997 and
December 31, 1996. FASB Statement No. 107, Disclosures About Fair Value
of Financial Instruments, defines the fair value of a financial
instrument as the amount at which the instrument could be exchanged in
a current transaction between willing parties, other than in a forced
or liquidation sale (dollar amounts in thousands):
December 31, 1997 December 31, 1996
------------------------ --------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
------------------------- -------------------------
Assets:
ARM assets $ 4,634,612 $ 4,639,513 $ 2,689,727 $ 2,692,521
Cap agreements 4,082 1,931 5,465 2,535
Liabilities:
Other borrowings 10,018 10,321 14,187 14,744
Swap agreements (50) 184 (7) 440
The above carrying amounts for assets are combined in the balance sheet
under the caption adjustable-rate mortgage assets. The carrying amount
for assets categorized as available-for-sale is their fair value
whereas the carrying amount for assets held-to-maturity or held for the
foreseeable future is their amortized cost.
The fair values of the Company's ARM securities and cap agreements are
based on market prices provided by certain dealers who make markets in
these financial instruments. The fair values for ARM loans are based on
market prices for similar securitized loans, adjusted for differences
in loan characteristics. The fair value of the Company's long-term debt
and interest rate swap agreements, which are off-balance sheet
financial instruments, are based on market values provided by dealers
who are familiar with the terms of the long-term debt and swap
agreements. The fair values reported reflect estimates and may not
necessarily be indicative of the amounts the Company could realize in a
current market exchange. Cash and cash equivalents, interest
receivable, reverse repurchase agreements and other liabilities are
reflected in the financial statements at their amortized cost, which
approximates their fair value because of the short-term nature of these
instruments.
NOTE 5. COMMON AND PREFERRED STOCK
In January 1997, the Company issued 2,760,000 shares of Series A 9.68%
Cumulative Convertible Preferred Stock at a price of $25 per share
pursuant to its Registration Statement on Form S-3 declared effective
in December 1996. Net proceeds from this issuance totaled $65.8
million. The dividends are cumulative commencing on the issue date and
are payable quarterly, in arrears. The dividends per share are equal to
the greater of (i) $0.605 per quarter, or (ii) the quarterly dividend
declared on the Company's common stock. Each share is convertible at
the option of the holder at any time into one share of common stock.
The preferred shares are redeemable by the Company on and after
December 31, 1999, in whole or in part, as follows: (i) for one share
of common stock plus accumulated, accrued but unpaid dividends,
provided that for 20 trading days within any period of 30 consecutive
trading days the closing price of the common stock equals or exceeds
the conversion price of $25, or (ii) for cash at the issue price of
$25, plus any accumulated, accrued but unpaid dividends through the
redemption date. In the event of liquidation, the holders of the
preferred shares will be entitled to receive out of the assets of the
Company, prior to any distribution to the common shareholders, the
issue price of $25 per share in cash, plus any accumulated, accrued and
unpaid dividends.
In May 1997, the Company issued 861,850 shares of common stock at a
price of $19.50 per share pursuant to its Registration Statement on
Form S-3 declared effective in December 1996. Net proceeds from this
issuance totaled $16.2 million.
In July 1997, the Company issued 2,100,000 shares of common stock at a
price of $22.625 per share pursuant to its Registration Statement on
Form S-3 declared effective in December 1996. Net proceeds from this
issuance totaled $45.0 million. Upon completion of this issuance of
common stock, the Company had $109 million of its securities registered
for future sale under this Registration Statement.
During 1997, the Company issued 912,590 shares of common stock under
its Dividend Reinvestment and Stock Purchase Plan and received net
proceeds of $18.0 million. During 1996, the Company issued 347,434
shares of common stock under this plan and received net proceeds of
$5.4 million, and during 1995, the Company issued 269,461 shares of
common stock under this plan and received net proceeds of $3.1 million.
During 1997, stock options for 186,071 shares of common stock were
exercised at an average price of $15.71. The Company received net
proceeds of $0.2 million, and $2.7 million of notes receivable were
executed in connection with the exercise of certain options. During
1996, stock options for 23,595 shares of common stock were exercised at
an average price of $15.41 that generated net proceeds of $0.4 million.
During the Company's 1997 fiscal year, the Company declared dividends
to shareholders totaling $1.97 per common share, of which $1.47 was
paid during 1997 and $0.50 was paid on January 12, 1998, and $2.265 per
preferred share, of which $1.66 was paid during 1997 and $0.605 was
paid on January 12, 1998. During the Company's 1996 fiscal year, the
Company declared dividends to shareholders totaling $1.65 per common
share, of which $1.20 was paid during 1996 and $0.45 was paid on
January 12, 1997. During the Company's 1995 fiscal year, the Company
declared dividends to shareholders totaling $0.93 per common share. For
federal income tax purposes, $0.01 of the 1997 dividend was capital
gains subject to a maximum tax rate of 28%, and $0.05 of the 1997
dividend was capital gains subject to a maximum tax rate of 20%, and
$0.03 of the 1996 dividend was long-term capital gains. The remainder
of the dividends paid for fiscal years 1997, 1996 and 1995 was ordinary
income to the Company's shareholders.
NOTE 6. STOCK OPTION PLAN
The Company has a Stock Option and Incentive Plan (the "Plan") which
authorizes the granting of options to purchase an aggregate of up to
1,800,000 shares, but not more than 5% of the 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 of
1986, as amended, options not so qualified ("NQSOs"), Dividend
Equivalent Rights ("DERs"), Stock Appreciation Rights ("SARs"), and
Phantom Stock Rights ("PSRs").
The exercise price for any options granted under the Plan may not be
less than 100% of the fair market value of the shares of the common
stock at the time the option is granted. Options become exercisable six
months after the date granted and will expire ten years after the date
granted, except options granted in connection with an offering of
convertible preferred stock, in which case such options become
exercisable if and when the convertible preferred stock is converted
into common stock.
The Company issued DERs at the same time as ISOs and NQSOs based upon a
formula defined in the Plan. During 1997 the number of DERs issued was
based on 25% of the ISOs and NQSOs granted during 1997. The number of
PSRs issued are based on the level of the Company's dividends and on
the price of the Company's stock on the related dividend payment date
and is equivalent to the cash that otherwise would be paid on the
outstanding DERs and previously issued PSRs.
During the year ended December 31, 1997, there were 240,320 options
granted to buy common shares at an average exercise price of $20.89
along with 60,081 DERs. As of December 31, 1997, the Company had
680,995 options outstanding at exercise prices of $9.375 to $22.625 per
share, 476,875 of which were exercisable. The weighted average exercise
price of the options outstanding was $17.35 per share. As of the year
ended December 31, 1997, there were 60,081 DERs granted, of which
31,101 were vested, and 965 PSRs granted. In addition, the Company
recorded an expense associated with the DERs and the PSRs of $32,000
for the year ending December 31, 1997.
Notes receivable from stock sales result from the Company selling
shares of common stock through the exercise of stock options in
exchange for notes receivable. The notes are full recourse promissory
notes bearing interest at 6.00% and are collateralized by the stock
issued upon exercise of the stock options. Interest, which is credited
to paid-in-capital, is payable quarterly and principal is due in 2006.
The Company adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation." Accordingly, no compensation cost has been recognized
for the Company's stock option plan. Had compensation cost for the
Company's stock option plan been determined based on the fair value at
the grant date for awards in 1997 consistent with the provisions of
SFAS No. 123, the Company's net earnings and earnings per share would
have been reduced to the pro forma amounts indicated in the table
below. The fair value of each option grant is estimated on the date of
grant using the Black-Scholes option-pricing model (dollar amounts in
thousands, except per share data).
1997 1996 1995
------------- ------------ ------------
Net income - as reported $ 41,402 $ 25,737 $ 10,452
Net income - pro forma 41,093 25,551 10,435
Basic EPS - as reported 1.95 1.73 0.88
Basic EPS - pro forma 1.93 1.72 0.87
Diluted EPS - as reported 1.94 1.73 0.88
Diluted EPS - pro forma 1.92 1.71 0.87
Assumptions:
Dividend yield 10.00% 10.00% 10.00%
Expected volatility 21.50% 23.30% 36.20%
Risk-free interest rate 6.40% 6.52% 7.06%
Expected lives 7 years 7 years 7 years
Information regarding options is as follows:
1997 1996 1995
------------------- -------------------- -------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
-------- --------- -------- ---------- -------- ---------
Outstanding, beginning of year 626,746 $ 15.510 482,078 $ 15.529 488,284 $ 15.538
Granted 240,320 20.888 169,099 15.439 23,791 15.358
Exercised (186,071) 15.711 (23,595) 15.407 - -
Expired - - (836) 14.375 (29,997) 15.556
--------- -------- -------- --------- -------- --------
Outstanding, end of year 680,995 $ 17.353 626,746 $ 15.511 482,078 $ 15.528
========= ======== ======== ========= ======== ========
Weighted average fair value of
options granted during the year $ 1.29 $ 1.10 $ 0.73
Options exercisable at year end 476,875 613,413 482,078
The following table summarizes information about stock options outstanding at
December 31, 1997:
Options Outstanding Options Exercisable
------------------------- -------------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Range of Exercise Options Contractual Exercise Exercisable Exercise
Prices Outstanding Life (Yrs) Price At 12/31/97 Price
- ------------------- ----------- ------------- ---------- ------------- ----------
$9.375 147 7.2 $ 9.375 147 $ 9.375
$14.375 - $16.125 427,195 6.4 15.315 427,195 15.315
$19.000 - $22.625 253,653 9.3 20.789 49,533 19.365
- ------------------- ----------- ------------- ---------- ------------ ---------
$9.375 - $22.625 680,995 7.5 17.353 476,875 15.734
=================== =========== ============= ======== ============ ========
NOTE 7. TRANSACTIONS WITH AFFILIATES
The Company has a Management Agreement (the "Agreement") with Thornburg
Mortgage Advisory Corporation ("the Manager"). Under the terms of this
Agreement, the Manager, subject to the supervision of the Company's
Board of Directors, is responsible for the management of the day-to-day
operations of the Company and provides all personnel and office space.
The Agreement provides for an annual review by the unaffiliated
directors of the Board of Directors of the Manager's performance under
the Agreement.
The Company pays the Manager an annual base management fee based on
average shareholders' equity, adjusted for liabilities that are not
incurred to finance assets ("Average Shareholders' Equity" or "Average
Net Invested Assets" as defined in the Agreement) payable monthly in
arrears as follows: 1.1% of the first $300 million of Average
Shareholders' Equity, plus 0.8% of Average Shareholders' Equity above
$300 million.
For the years ended December 31, 1997, 1996 and 1995, the Company paid
the Manager $3,664,000, $1,872,000 and $1,390,000, respectively, in
base management fees in accordance with the terms of the Agreement.
The Manager is also entitled to earn performance based compensation in
an amount equal to 20% of the Company's annualized net income, before
performance based compensation, above an annualized Return on Equity
equal to the ten year U.S. Treasury Rate plus 1%. For purposes of the
performance fee calculation, equity is generally defined as proceeds
from issuance of common stock before underwriter's discount and other
costs of issuance, plus retained earnings. For the years ended December
31, 1997, 1996 and 1995, the Company paid the Manager $3,363,000,
$2,462,000 and $596,000, respectively, in performance based
compensation in accordance with the terms of the Agreement.
NOTE 8. NET INTEREST INCOME ANALYSIS
The following table summarizes the amount of interest income and
interest expense and the average effective interest rate for the
periods ended December 31, 1997, 1996 and 1995 (dollar amounts in
thousands):
1997 1996 1995
------------------- -------------------- ------------------
Average Average Average
Amount Rate Amount Rate Amount Rate
--------- -------- --------- -------- --------- --------
Interest Earning Assets:
ARM assets $ 246,507 6.56% $ 150,759 6.45% $ 115,830 6.31%
Cash and cash equivalents 1,214 5.57 752 5.29 787 5.98
-------- ------- -------- ------- -------- -------
247,721 6.56 151,511 6.44 116,617 6.31
-------- ------- -------- ------- -------- -------
Interest Bearing Liabilities:
Borrowings 198,657 5.76 121,166 5.67 103,121 6.15
-------- ------- -------- ------- -------- -------
Net Interest Earning Assets
and Spread $ 49,064 0.80% $ 30,345 0.77% $ 13,496 0.16%
======== ======= ======== ====== ======== =======
Yield on Net Interest
Earning Assets (1) 1.30% 1.29% 0.73%
======= ======= =======
- -----------------------------
(1) Yield on Net Interest Earning Assets is computed by dividing annualized net
interest income by the average daily balance of interest earning assets.
The following table presents the total amount of change in interest
income/expense from the table above and presents the amount of change
due to changes in interest rates versus the amount of change due to
changes in volume (dollar amounts in thousands):
1997 versus 1996 1996 versus 1995
-------------------------- --------------------------
Rate Volume Total Rate Volume Total
-------- -------- -------- -------- -------- --------
Interest Income:
ARM assets $ 2,651 $93,097 $95,748 $ 2,625 $32,304 $34,929
Cash and cash equivalents 40 422 462 (80) 45 (35)
------- ------- ------- ------- ------- -------
2,691 93,519 96,210 2,545 32,349 34,894
------- ------- ------- ------- ------- -------
Interest Expense:
Borrowings 2,068 75,423 77,491 (8,092) 26,137 18,045
------- ------- ------- ------- ------- -------
Net interest income $ 623 $18,096 $18,719 $10,637 $ 6,212 $16,849
======= ======= ======= ======= ======= =======
NOTE 9. SUMMARIZED QUARTERLY RESULTS (UNAUDITED)
The following is a presentation of the quarterly results of operations
(amounts in thousands, except per share amounts):
Year Ended December 31, 1997
-------------------------------------------------
Fourth Third Second First
Quarter Quarter Quarter Quarter
---------- ----------- ----------- ----------
Interest income from ARM assets and cash $ 73,011 $ 68,088 $ 57,623 $ 48,999
Interest expense on borrowed funds (60,680) (54,862) (45,448) (37,667)
---------- ---------- ---------- ----------
Net interest income 12,331 13,226 12,175 11,332
---------- ---------- ---------- ----------
Gain (loss) on ARM assets 566 112 (189) (186)
General and administrative expenses (2,047) (2,156) (1,911) (1,851)
Dividend on preferred stock (1,670) (1,670) (1,670) (1,241)
---------- ---------- ----------- ----------
Net income available to common shareholders $ 9,180 $ 9,512 $ 8,405 $ 8,054
========== ========== ========== =========
Basic EPS $ 0.46 $ 0.50 $ 0.50 $ 0.49
========== ========= ========== ==========
Diluted EPS $ 0.46 $ 0.49 $ 0.50 $ 0.49
========== ========= ========== ==========
Average number of common shares outstanding 19,860 19,152 16,817 16,311
========== ========== ========== ==========
Year Ended December 31, 1996
-------------------------------------------------
Fourth Third Second First
Quarter Quarter Quarter Quarter
---------- ----------- ----------- ----------
Interest income from ARM assets and cash $ 42,955 $ 40,173 $ 35,680 $ 32,702
Interest expense on borrowed funds (33,978) (32,221) (28,455) (26,512)
---------- ---------- ---------- ----------
Net interest income 8,977 7,952 7,225 6,190
---------- ---------- ---------- ----------
Gain (loss) on ARM assets 39 320 - 13
General and administrative expenses (1,607) (1,244) (1,056) (1,072)
Dividend on preferred stock - - - -
---------- ---------- ----------- ----------
Net income available to common shareholders $ 7,409 $ 7,028 $ 6,169 $ 5,131
========== ========== ========== =========
Basic EPS $ 0.46 $ 0.44 $ 0.42 $ 0.41
========== ========= ========== ==========
Diluted EPS $ 0.46 $ 0.44 $ 0.42 $ 0.41
========== ========= ========== ==========
Average number of common shares outstanding 16,207 16,080 14,844 12,335
========== ========== ========== ==========
Year Ended December 31, 1995
-------------------------------------------------
Fourth Third Second First
Quarter Quarter Quarter Quarter
---------- ----------- ----------- ----------
Interest income from ARM assets and cash $ 32,561 $ 30,178 $ 27,998 $ 25,880
Interest expense on borrowed funds (27,101) (25,757) (25,541) (24,722)
---------- ---------- ---------- ----------
Net interest income 5,460 4,421 2,457 1,158
---------- ---------- ---------- ----------
Gain (loss) on ARM assets 49 42 - (659)
General and administrative expenses (925) (630) (464) (457)
Dividend on preferred stock - - - -
---------- ---------- ----------- ----------
Net income available to common shareholders $ 4,584 $ 3,833 $ 1,993 $ 42
========== ========== ========== =========
Basic EPS $ 0.38 $ 0.33 $ 0.17 $ 0.00
========== ========= ========== ==========
Diluted EPS $ 0.38 $ 0.33 $ 0.17 $ 0.00
========== ========= ========== ==========
Average number of common shares outstanding 12,103 11,947 11,874 11,781
========== ========== ========== ==========
SCHEDULE IV - Mortgage Loans on Real Estate
Column A, Description: The Company's whole loan portfolio at December 31, 1997,
which consists of only first mortgages on single-family residential housing, is
stratified as follows (dollar amounts in thousands):
Column A (continued) Column B Column C Column G Column H
-------------------------- --------
Description (4)
Principal
Amount of
Loans
Subject to
Range of Number Final Carrying Delinquent
Carrying Amounts of Maturity Amount of Principal
of Mortgages Loans Interest Rate Date Mortgages (3) Interest
---------------- ------ ------------- --------- ------------- ----------
$ 0 - 250 308 5.375 - 9.000 Various $ 42,973 $ 167
251 - 500 114 6.000 - 8.612 Various 37,587
501 - 750 20 6.000 - 8.000 Various 12,592
751 - 1,000 13 6.375 - 7.875 Various 11,436
over 1,000 8 6.375 - 7.875 Various 11,407
Premium 3,034
Allowance for
losses (2) (42)
====== ========== ==========
463 $ 118,987 $ 167
====== ========== ==========
Notes:
(1) Reconciliation of carrying amounts of mortgage loans:
Balance at December 31, 1996 $ -
Additions during 1997:
Loan purchases 123,211
Deductions during 1997:
Collections of principal 4,092
Provision for losses 42
Amortization of premium 90
--------
4,224
--------
Balance at December 31, 1997 $ 118,987
========
(2) The provision for losses is based on management's assessment of various factors.
(3) Cost for Federal income taxes is the same.
(4) The geographic distribution of the Company's whole loan portfolio at
December 31, 1997 is as follows:
Number
State or of Carrying
Territory Loans Amount
----------------- --------- ---------------
California 111 $ 38,276
Connecticut 8 1,823
Florida 183 30,401
Georgia 12 4,744
Maine 5 1,034
Michigan 5 1,344
New Jersey 16 5,828
New York 48 11,932
Puerto Rico 9 2,557
Texas 8 3,241
Other states,
less than 58 14,815
4 loans each
Premium 3,034
Allowance for losses (42)
========= ===============
TOTAL 463 $ 118,987
========= ===============
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of
1934, the Registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
THORNBURG MORTGAGE ASSET CORPORATION
(Registrant)
Dated: March 30, 1998 /s/ H. Garrett Thornburg, Jr.
-----------------------------
H. Garrett Thornburg, Jr.
Chairman of the Board of Directors and
Chief Executive Officer
(Principal Executive Officer)
Dated: March 30, 1998 /s/ Richard P. Story
--------------------
Richard P. Story
Chief Financial Officer and Treasurer
(Principal Accounting Officer)
Pursuant to the requirements of the Securities and Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Capacity Date
/s/ H. Garrett Thornburg, Jr. Chairman of the Board, March 30, 1998
- -----------------------------
H. Garrett Thornburg, Jr. Director and Chief
Executive Officer
/s/ Larry A. Goldstone President, Director and March 30, 1998
- ------------------------
Larry A. Goldstone Chief Operating Officer
/s/ David A. Ater Director March 30, 1998
- ------------------------
David A. Ater
/s/ Joseph H. Badal Director March 30, 1998
- ------------------------
Joseph H. Badal
/s/ Owen M. Lopez Director March 30, 1998
- ------------------------
Owen M. Lopez
/s/ James H. Lorie Director March 30, 1998
- ------------------------
James H. Lorie
/s/ Stuart C. Sherman Director March 30, 1998
- ------------------------
Stuart C. Sherman
Exhibit Index
Sequentially
Numbered
Exhibit Number Exhibit Description Page
- -------------- --------------------------------------------------- ------------
1.1 Sales Agency Agreement (a)
3.1 Articles of Incorporation of the Registrant (b)
3.1.1 Articles of Amendment to Articles of Incorporation
dated June 29, 1995 (c)
3.1.2 Articles Supplementary dated January 21, 1997 (d)
3.2 Amended and Restated Bylaws of the Registrant (e)
4.1 Specimen Common Stock Certificates (b)
4.2 Specimen Preferred Stock Certificates (d)
10.1 Management Agreement between the Registrant and
Thornburg Mortgage Advisory Corporation dated
June 17, 1994 (e)
10.1.1 Amendment to Management Agreement dated
June 16, 1995 (a)
10.1.2 Amendment to Management Agreement dated
December 15, 1995 (f)
10.1.3 Amendment to Management Agreement dated
September 18, 1996 (g)
10.2 Form of Servicing Agreement (b)
10.3 Form of 1992 Stock Option and Incentive Plan as
amended and restated March 14, 1997 (h)
10.3.1 Amendment dated December 16, 1997 to the amended
and restated 1992 Stock Option and Incentive Plan *... 52
10.4 Form of Dividend Reinvestment and Stock Purchase
Plan (i)
22. Notice and Proxy Statement for the Annual Meeting
of Shareholders to be held on April 30, 1998 (j)
27 Financial Data Schedule *
* Being filed herewith.
(a)Previously filed with Registrant's Form 8-K dated October 10, 1995 and
incorporated herein by reference pursuant to Rule 12b-32.
(b)Previously filed as part of Form S-11 which went effective on June 18, 1993
and incorporated herein by reference pursuant to Rule 12b-32.
(c)Previously filed with Registrant's Form 10-Q dated June 30, 1995 and
incorporated herein by reference pursuant to Rule 12b-32.
(d)Previously filed as part of Form 8-A dated January 17, 1997 and incorporated
herein by reference pursuant to Rule 12b-32.
(e)Previously filed as part of Form S-8 dated July 1, 1994 and incorporated
herein by reference pursuant to Rule 12b-32.
(f)Previously filed with Registrant's Form 10-K dated December 31, 1995 and
incorporated herein by reference pursuant to Rule 12b-32.
(g)Previously filed with Registrant's Form 10-Q dated September 30, 1996 and
incorporated herein by reference pursuant to Rule 12b-32.
(h)Previously filed with Registrant's Form 10-K dated December 31, 1996 and
incorporated herein by reference pursuant to Rule 12b-32.
(i)Previously filed as Exhibit 4 to Registrant's registration statement on
Form S-3D dated September 24, 1997 and incorporated herein by reference
pursuant to Rule 12b-32.
(j)Previously filed on March 30, 1998 and incorporated by reference pursuant to
Rule 12-b32.