Securities and Exchange Commission
Washington, D.C. 20549
Form 10-Q
Quarterly Report under Section 13 or 15 (d)
Of The Securities Exchange Act of 1934
For the Quarter Ended: June 30, 2002 Commission File Number: 000-23745
BNP U.S. FUNDING L.L.C.
-----------------------
(Exact name of registrant as specified in its charter)
Delaware 13-3972207
-------- ----------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or organization)
787 Seventh Avenue, New York, New York
--------------------------------------
(Address of principal executive offices)
10019
-----
(Zip Code)
(212) 841-2000
--------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [x] No [ ]
Common Stock, $10,000 Par Value 53,011
------------------------------- ------
Number of shares outstanding of the issuer's class of common stock
on June 30, 2002
Form 10-Q Index
Part I Page
Item 1. Financial Statements - BNP U.S. FUNDING L.L.C.:
Balance Sheet at June 30, 2002 and December 31, 2001 3
Statement of Income for the Six months ended June 30, 2002 and 4
June 30, 2001
Statement of Comprehensive Income for the quarters ended 5
June 30, 2002 and June 30, 2001
Statement of Changes in Securityholders' Equity for the quarters 6
ended June 30, 2002 and June 30, 2001
Statement of Cash Flows for the quarters ended June 30, 2002 7
and June 30, 2001
Notes to Financial Statements 8
Item 2. Management's Discussion and Analysis of Financial Condition 16
and Results of Operation
Item 3. Quantitative and Qualitative Disclosures about Market Risk 20
Part II
Item 1. Legal Proceedings 24
Item 2. Changes in Securities and Use of the Proceeds 24
Item 3. Defaults Upon Senior Securities 24
Item 4. Submission of Matters to a Vote of Securityholders 24
Item 5. Other Information 24
Item 6. Exhibits and Current Reports on Form 8-K 24
Part I Item 1.
BNP U.S. FUNDING L.L.C.
BALANCE SHEET
(in thousands, except per share data)
June 30, 2002 December 31, 2001
----------------- -----------------
ASSETS:
Cash and cash equivalents $ 42,028 $ 31,084
Investment securities (Notes 3 and 4)
Available-for-sale, at fair value 939,744 905,989
Receivable arising from payment for securities,
pursuant to the application of SFAS 125, as replaced by SFAS
140 (Note 3) 111,954 135,255
Accounts receivable 441 2,171
Accrued interest receivable 8,518 7,324
----- -----
TOTAL ASSETS $ 1,102,685 $ 1,081,823
============ ============
LIABILITIES:
Accrued interest payable 2,578 1,178
Accrued expenses 222 137
Payable for securities purchased --- 9,802
Other liabilities 48,403 19,004
------ ------
TOTAL LIABILITIES 51,203 30,121
------------ ------------
Redeemable common securities, par value and redeemable
value $10,000 per security; 150,000 securities
authorized, 53,011 securities issued and outstanding 530,110 530,110
(Note 5)
Preferred securities, liquidation preference $10,000 per
security; 150,000 securities authorized, 50,000
securities issued and outstanding 500,000 500,000
Additional paid in capital 6 6
Accumulated other comprehensive income 14,460 13,430
Retained earnings 6,906 8,156
------------ ------------
TOTAL REDEEMABLE COMMON SECURITIES, PREFERRED SECURITIES
AND SECURITYHOLDERS' EQUITY 1,051,482 1,051,702
------------ ------------
TOTAL LIABILITIES AND TOTAL REDEEMABLE COMMON SECURITIES,
PREFERRED SECURITIES AND SECURITYHOLDERS' EQUITY $ 1,102,685 $ 1,081,823
============ ============
The accompanying Notes to Financial Statements are an integral part of these
Statements.
BNP U.S. FUNDING L.L.C.
STATEMENT OF INCOME
(in thousands, except per share data)
Three-month period Three-month period
ended June 30, ended June 30,
2002(unaudited) 2001(unaudited)
--------------- ---------------
INTEREST INCOME:
Collateralized Mortgage Obligations:
Floating-Rate REMICs $ 267 $ 973
Fixed-Rate REMICs 855 786
Mortgage Backed Securities:
Agency ARMs 523 1,087
Agency Hybrid ARMs 692 1,472
Agency DUSs 1,532 3,494
Agency Debentures 6,585 5,657
Interest on Deposits 212 545
----- -----
Total 10,666 14,014
------ ------
NONINTEREST EXPENSE:
Fees and expenses 566 384
----- -----
NET INCOME APPLICABLE TO PREFERRED AND $ 10,100 $ 13,630
REDEEMABLE COMMON SECURITIES ========== ==========
NET INCOME PER REDEEMABLE COMMON SECURITY $ (174.39) $ (107.81)
========== ==========
Six-month period Six-month period
ended June 30, ended June 30,
2002(unaudited) 2001(unaudited)
---------------- ----------------
INTEREST INCOME:
Collateralized Mortgage Obligations:
Floating-Rate REMICs $ 599 $ 2,268
Fixed-Rate REMICs 1,630 1,618
Mortgage Backed Securities:
Agency ARMs 1,234 2,400
Agency Hybrid ARMs 1,533 3,164
Agency DUSs 2,984 7,610
Agency Debentures 10,610 12,109
Interest on Deposits 365 929
----- -----
Total 18,955 30,098
------ ------
NONINTEREST EXPENSE:
Fees and expenses 860 618
----- -----
Cumulative effect of the change in --- 939
accounting principle for Derivatives ------ ------
and Hedging activities (SFAS133)
NET INCOME APPLICABLE TO PREFERRED AND $ 18,095 $ 30,419
REDEEMABLE COMMON SECURITIES ========== ==========
NET INCOME PER REDEEMABLE COMMON SECURITY $ (23.58) $ 208.90
========== ==========
The accompanying Notes to Financial Statements are an integral part of
these Statements.
BNP U.S. FUNDING L.L.C.
STATEMENT OF COMPREHENSIVE INCOME
(in thousands)
Three-month period Three-month period
ended ended
June 30, 2002 June 30, 2001
(unaudited) (unaudited)
--------------------- ----------------------
NET INCOME $ 10,100 $ 13,630
OTHER COMPREHENSIVE INCOME:
Net change in unrealized gain
(loss) in fair value of available-for-sale
securities that are not treated as
collateral (Note 3) and that are not
hedged by derivative instruments 5,838 (2,838)
---------- -----------
COMPREHENSIVE INCOME $ 15,938 $ 10,792
========== ===========
Six-month period Six-month period
ended ended
June 30, 2002 June 30, 2001
(unaudited) (unaudited)
------------------ ------------------
NET INCOME $ 18,095 $ 30,419
OTHER COMPREHENSIVE INCOME:
Net change in unrealized gain
(loss) in fair value of available-for-sale
securities that are not treated as
collateral (Note 3) and that are not
hedged by derivative instruments 1,030 2,634
Transition adjustment pursuant to the
application of SFAS 133 --- (939)
---------- ----------
OTHER COMPREHENSIVE INCOME 1,030 1,695
---------- ----------
COMPREHENSIVE INCOME $ 19,125 $ 32,114
========== ==========
The accompanying Notes to Financial Statements are an integral part of these
Statements.
BNP U.S. FUNDING L.L.C.
STATEMENT OF CHANGES IN REDEEMABLE COMMON SECURITIES, PREFERRED
SECURITIES AND SECURITYHOLDERS' EQUITY
(in thousands)
TOTAL REDEEMABLE
ACCUMULATED COMMON SECURITIES,
REDEEMABLE ADDITIONAL OTHER PREFERRED SECURITIES
COMMON PREFERRED PAID IN COMPREHENSIVE RETAINED AND SECURITYHOLDERS'
SECURITIES SECURITIES CAPITAL INCOME EARNINGS EQUITY
---------- ---------- ---------- ------------- -------- --------------------
Balance at December 31, 2000 530,110 500,000 6 3,739 5,288 1,039,143
-------- ------- ----- -------- ------- -----------
Net income 30,419 30,419
Other comprehensive income 1,695 1,695
Dividends Paid - Preferred (19,345) (19,345)
Securities
Dividends Paid--Common --- --- --- --- (10,719) (10,719)
Securities ------- ------- ----- -------- ------- -----------
Balance at June 30, 2001 $ 530,110 $ 500,000 $ 6 $ 5,434 $ 5,643 $ 1,041,193
========= ========= ===== ======== ======= ===========
Balance at December 31, 2001 530,110 500,000 6 13,430 8,156 1,051,702
--------- --------- ----- -------- ------- -----------
Net income 18,095 18,095
Other comprehensive income 1,030 1,030
Dividends Paid - Preferred (19,345) (19,345)
Securities
Dividends Paid--Common --- --- --- --- --- ---
Securities ------- ------- ----- -------- ------- -----------
Balance at June 30, 2002 $ 530,110 $ 500,000 $ 6 $ 14,460 $ 6,906 $ 1,051,482
========= ========= ===== ======== ======= ===========
The accompanying Notes to Financial Statements are an integral part of these
Statements.
BNP U.S. FUNDING L.L.C.
STATEMENT OF CASH FLOWS
(in thousands)
Six-month period Six-month period
ended ended
June 30, 2002 June 30, 2001
(unaudited) (unaudited)
-------------------- ---------------------
OPERATING ACTIVITIES:
Net income $ 18,095 $ 30,419
Adjustments to reconcile net income to cash provided
from operating activities:
Premium amortization 789 593
Net change in interest receivable (1,194) 776
Net change in accounts receivable 1,730 ---
Net change in accrued expenses 85 36
Net change in accrued interest payable 1,400 209
Net change in payable for securities purchased (9,802) ---
(Gain)/loss on hedge activity (1,702) (510)
Cumulative effect of the change in accounting principle for --- (939)
derivatives and hedging activities (SFAS 133) ----- -----
Net cash provided from operating activities 9,401 30,584
----- ------
INVESTING ACTIVITIES:
Purchase of investment securities:
Agency Debentures (9,961) (18,000)
Agency DUSs (9,320) (9,971)
Agency Fixed REMICs (10,000) ---
Proceeds from principal payments of securities
available-for-sale, not treated as collateral 27,187 25,882
Proceeds from principal payments of securities
available-for-sale, Treated as collateral 22,982 28,715
------ ------
Net cash provided (used) by investing activities 20,888 26,626
------ ------
FINANCING ACTIVITIES:
Cash dividends - preferred securities (19,345) (19,345)
Cash dividends - common securities --- (10,719)
----- --------
Net cash provided (used) by financing activities (19,345) (30,064)
-------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 10,944 27,146
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 31,084 30,373
------ ------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 42,028 $ 57,519
====== ======
NONCASH FINANCING AND INVESTING ACTIVITIES:
Decrease in receivable arising from payment
for securities, pursuant to the application
of SFAS #125, as replaced by SFAS 140, (Note 3) 23,301 29,233
The accompanying Notes to Financial Statements are an integral part of these
Statements.
From time to time, the company may publish, verbally or in written form,
forward-looking statements relating to such matters as anticipated financial
performance, economic conditions, interest rate levels, investment prospects and
similar matters. In fact, this quarterly report on Form 10-Q (or any other
periodic reporting documents required by the Securities Exchange Act of 1934, as
amended) may contain forward-looking statements reflecting the current views of
the Company concerning potential future events or developments. The Private
Securities Litigation Reform Act of 1995 (the "Act") provides a "safe harbor"
for forward-looking statements. In order to comply with the terms of the "safe
harbor," the Company cautions investors that any forward-looking statements made
by the Company are not guarantees of future performance and that a variety of
factors could cause the Company's actual results and experience to differ
materially from the anticipated results or other expectations expressed in the
Company's forward-looking statements. The risks and uncertainties which may
affect the operations, performance, development and results of the Company's
business include, but are not limited to, the following: uncertainties relating
to economic conditions and interest rate levels, and uncertainties relating to
government and regulatory policies. Readers are cautioned not to place undue
reliance on these forward-looking statements, which speak only as of the date
the statement was made.
NOTE 1--ORGANIZATION AND BASIS OF PRESENTATION
BNP U.S. Funding L.L.C. (the "Company" or the "Registrant") is a Delaware
limited liability company formed on October 14, 1997 for the purpose of
acquiring and holding certain types of eligible securities that generate net
income for distribution to the holders of its Series A Preferred Securities (as
defined below) and its redeemable Common Securities (as defined below). The
Company has no subsidiaries and is a wholly owned subsidiary of the New York
Branch (the "Branch") of BNP PARIBAS (formerly, Banque Nationale de Paris), a
societe anonyme or limited liability corporation organized under the laws of the
Republic of France (the "Bank", "BNP PARIBAS" or "BNPP"). The Company was
continued pursuant to the Amended and Restated Limited Liability Company
Agreement of the Company (the "Company's Charter" or the "Charter") entered into
on December 5, 1997 by the Branch.
The Company was initially capitalized on October 14, 1997 with the issuance to
the Branch of one share of the Company's redeemable common securities, $10,000
par value (the "Common Securities"). On December 5, 1997 (inception), the
Company commenced operations concurrent with the issuance of 50,000 Series A,
liquidation preference $10,000 per security, (the "Series A Preferred
Securities") to qualified institutional buyers pursuant to Rule 144A under the
Securities Act of 1933, as amended, and the issuance of an additional 53,010
Common Securities to the Branch. These issuances raised in the aggregate
$1,030,115,873 of net capital (including $5,873 of additional paid in capital).
This entire amount was used to acquire a portfolio of debt securities (the
"Initial Portfolio") at their fair values from the Branch.
The Company entered into a services agreement (the "Services Agreement") with
the Branch on December 5, 1997 pursuant to which the Branch maintains the
securities portfolio of the Company (the "Portfolio") and performs other
administrative functions. All of the Company's officers and employees are
officers or employees of the Branch or the Bank. The securities in the Portfolio
are held by Citibank N.A., acting as trustee (the "Trustee") under the trust
agreement between the Company and Citibank N.A. dated December 1, 1997 (the
"Trust Agreement").
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
INVESTMENT SECURITIES:
Investments in debt securities are classified as available-for-sale and are
carried at fair value. The debt securities can be categorized as hedged or
non-hedged securities. For the hedged securities, changes in the fair market
value of both the securities and the derivatives used as hedging instruments
(cross currency and interest rate swaps) are reported in current earnings in the
Statement of Income, pursuant to application of SFAS 133, (see below,
"Accounting for Derivatives and Hedging Activities"). Unrealized gains and
losses on the non-hedged securities are reported as a component of "Other
Comprehensive Income".
Interest on securities is included in interest income and is recognized using
the interest method. Premiums and discounts are amortized using the effective
interest method and are recognized in interest income.
CASH AND CASH EQUIVALENTS:
Cash and cash equivalents include cash and short-term deposits with original
maturities of three months or less.
DIVIDENDS:
Dividends on the Series A Preferred Securities, when, as and if declared by the
Company's Board of Directors, are payable semi-annually in arrears on a
non-cumulative basis on the fifth day of June and December of each year,
commencing June 5, 1998, at a rate per annum of 7.738% of the liquidation
preference through and including December 5, 2007. Thereafter, dividends, when,
as and if declared by the Company's Board of Directors, will be payable
quarterly in arrears on the third Wednesday of March, June, September, and
December of each year and will be calculated on a weekly basis in each quarter
at a rate per annum of the liquidation preference equal to 2.8% per annum above
one-week LIBOR for the week concerned as determined on the related LIBOR
Determination Date. Holders of Common Securities are entitled to receive
dividends when, as and if declared by the Company's Board of Directors out of
the Company's net income not required to be applied to fund dividends with
respect to the Series A Preferred Securities.
To date, the Company has declared and paid dividends as follows:
Security Amount Date Paid
- ----------------------------- ------------ -------------
Series A Preferred Securities $ 19,345,000 June 5, 1998
Common Securities $ 5,347,365 June 22, 1998
Series A Preferred Securities $ 19,345,000 December 5, 1998
Common Securities $ 8,787,127 December 15, 1998
Series A Preferred Securities $ 19,345,000 June 5, 1999
Common Securities $ 8,454,284 June 15, 1999
Series A Preferred Securities $ 19,345,000 December 5, 1999
Common Securities $ 10,352,672 December 15, 1999
Series A Preferred Securities $ 19,345,000 June 5, 2000
Common Securities $ 12,508,486 June 19, 2000
Series A Preferred Securities $ 19,345,000 December 5, 2000
Common Securities $ 14,792,297 December 19, 2000
Series A Preferred Securities $ 19,345,000 June 5, 2001
Common Securities $ 10,718,708 June 19, 2001
Series A Preferred Securities $ 19,345,000 December 5, 2001
Series A Preferred Securities $ 19,345,000 June 5, 2002
If the Bank's financial condition were to deteriorate with the consequence that
a Shift Event (as defined below) were to occur, substantially all of the Common
Securities would be redeemed automatically without prior redemption of the
Series A Preferred Securities and dividends payable on each Series A Preferred
Security could be substantially reduced or completely eliminated. In addition,
if the Bank's Tier 1 risk-based capital ratio were to decline below the minimum
percentage required by French banking regulations (currently 4%), the Company
would pay a special dividend consisting of all of the Company's net assets
(other than assets having a total market value of approximately $40 million) to
the Bank as holder of the Common Securities.
A "Shift Event" would be deemed to have occurred if (i) the Bank's total
risk-based capital ratio or Tier 1 risk-based capital ratio were to decline
below the minimum percentages required by French banking regulations, (ii) the
Bank were to become subject to certain specified receivership proceedings or
(iii) the French Banking Commission (Commission bancaire), in its sole
discretion, were to notify the Bank and the Company that it has determined that
the Bank's financial condition was deteriorating such that either of the
foregoing clauses (i) or (ii) would apply in the near term. French banking
regulations currently require French banks to maintain a minimum total
risk-based capital ratio of at least 8.0% and a minimum Tier 1 risk-based
capital ratio of at least 4.0%.
The Company may not pay dividends or make other distributions on the Common
Securities or the Series A Preferred Securities if, after giving effect to the
distributions, the Company's liabilities would exceed the fair value of its
assets. Additionally, as long as any Series A Preferred Securities are
outstanding, except during a Shift Period (i.e., following the occurrence of a
Shift Event causing a shift in dividend preference and before the termination
thereof), the amount of dividends on the Common Securities in any fiscal year
may not exceed the amount by which the net income of the Company for such fiscal
year exceeds the stated dividends on the Series A Preferred Securities scheduled
to be paid during such fiscal year irrespective of whether dividends on the
Series A Preferred Securities are in fact declared and paid. Additionally, other
than during a Shift Period, no dividends may be declared, paid or set apart for
payment on the Common Securities (a) with respect to any period of time included
in any Dividend Period unless full dividends have been or contemporaneously are
declared and paid, or declared and a sum sufficient for the payment thereof is
set apart for such payment on the Series A Preferred Securities for the
then-current Dividend Period and (b) the Company may not declare, pay or set
apart funds for any dividends or other distributions with respect to any Common
Securities unless and until (x) full dividends on the Series A Preferred
Securities for the two most recent preceding Dividend Periods are declared and
paid, or declared and a sum sufficient for payment has been paid over to the
dividend disbursing agent for payment of such dividends and (y) the Company has
declared a cash dividend on the Series A Preferred Securities at the annual
dividend rate for the then-current Dividend Period, and sufficient funds have
been paid over to the dividend disbursing agent for payment of such cash
dividends for such then-current Dividend Period.
NET INCOME PER REDEEMABLE COMMON SECURITY:
Net income per redeemable common security is calculated by dividing net income
after preferred dividends by the weighted average number of Common Securities
outstanding.
INCOME TAXES:
The Company expects to be treated as a partnership for U.S. Federal income tax
purposes. As a partnership is not a taxable entity, the Company will not be
subject to U.S. federal, state and local income tax on its income. Instead, each
securityholder is required to take into account its allocable share of items of
income, gain, loss and deduction of the partnership in computing its U.S.
Federal tax liability. Accordingly, the Company has made no provision for income
taxes in the accompanying statement of income.
ACCOUNTING FOR DERIVATIVES AND HEDGING ACTIVITIES:
SFAS 133 requires that an entity measure all derivatives at fair value and
recognize those derivatives as either assets or liabilities on the balance
sheet. The change in the derivative's fair value is generally to be recognized
in current period earnings. However, if certain conditions are met, a derivative
may be specifically designated as a hedge of an exposure to changes in fair
value, variability of cash flows, or certain foreign currency exposures.
The Company has made an assessment of all their financial instruments and
concluded that it holds freestanding derivative instruments but no embedded
derivative instruments at June 30, 2002. As part of its asset management
activities the Company uses foreign exchange and interest rate swaps to modify
the interest rate and foreign exchange characteristics of existing assets. The
interest rate swaps have a high correlation between the instrument and the asset
being hedged, both at inception and throughout the hedge period.
The Company adopted SFAS 133 as of January 1, 2001. The SFAS 133 transition
adjustments resulted in a cumulative-effect-type adjustment of $938,670 and
$(938,670) to net income and accumulated other comprehensive income,
respectively, as of January 1, 2001.
FOREIGN CURRENCY TRANSLATION:
Assets denominated in foreign currencies are translated to US dollars using
applicable rates of exchange.
All of the Company's assets denominated in a foreign currency are included in
its available-for-sale securities portfolio and their foreign currency exchange
risk is hedged by means of cross-currency swaps. In accordance with the
requirements of SFAS 133, the change in fair value, due to the change in the
foreign currency exchange rate, of both the hedged securities and the hedging
instruments is recorded in current period earnings.
Revenues and expenses are translated monthly at amounts which approximate
weighted average exchange rates.
RECLASSIFICATION:
Certain amounts have been reclassified to conform with current year
presentation.
NOTE 3--RECEIVABLE ARISING FROM PAYMENT FOR SECURITIES, PURSUANT TO THE
APPLICATION OF SFAS 125, AS REPLACED BY SFAS 140:
Statement of Financial Accounting Standards No.140, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities" ("SFAS
140") governs the accounting for the transfer of financial assets. Under SFAS
140 transfers of financial assets that do not meet certain sale accounting
requirements must be accounted for as a secured borrowing transaction with a
pledge of collateral.
Due to the potential consequences of a Shift Event (as described above), the
Company's purchase of the Initial Portfolio from the Branch did not meet certain
SFAS 125, as replaced by SFAS 140 sale accounting requirements. Therefore, the
purchase of the Initial Portfolio has been accounted for as a secured borrowing
transaction with a pledge of collateral. In accounting for this transaction as a
secured borrowing transaction in accordance with SFAS 125, as replaced by SFAS
140, the Company has recorded a receivable in an amount equal to the remaining
amount paid to the Branch to acquire the Initial Portfolio. In this case,
however, having delivered the securities in the Initial Portfolio to the
Company, neither the Branch nor BNPP has any further obligation to the Company
to repay any part of the purchase price for the Initial Portfolio or otherwise
to repurchase or redeem any securities in the Initial Portfolio.
The Company has not sold or repledged the collateral; the securities within the
Initial Portfolio mature or prepay over time. As they do, the Company recognizes
the cash proceeds as a reduction in the receivable arising from payment for
securities. The collateral at June 30, 2002 and December 31, 2001 is reported in
Note 4 below.
NOTE 4--INVESTMENT SECURITIES:
The amortized cost and estimated fair value of available-for-sale securities
were as follows ($ in 000's) based on management's assumptions:
Gross Gross
Unrealized Unrealized
June 30, 2002 Non-Collateral Amortized Cost Gains Losses Fair Value
- ---------------------------- -------------- ------------ ------------ ------------
Collateralized Mortgage Obligations:
Floating-Rate REMICs $ 10,831 $ 316 $ 33 $ 11,114
Fixed-Rate REMICs 10,751 1,054 --- 11,805
Mortgage Backed Securities:
Agency ARMs 21,109 569 78 21,600
Agency Hybrid ARMs 26,422 512 15 26,919
Agency DUSs 318,679 23,728 --- 342,407
Agency Debentures 486,347 39,552 --- 525,899
------- ------ ------- -------
Total $ 874,139 $ 65,731 $ 126 $ 939,744
========== ========= ========== ==========
Gross Gross
Unrealized Unrealized
June 30, 2002 Collateral Amortized Cost Gains Losses Fair Value
- ------------------------ -------------- ------------ ------------ ------------
Collateralized Mortgage Obligations:
Floating-Rate REMICs $ 25,214 $ 63 $ 400 $ 24,877
Fixed-Rate REMICs 46,838 1,670 --- 48,508
Mortgage Backed Securities:
Agency ARMs 14,534 204 93 14,645
Agency Hybrid ARMs 25,368 253 30 25,591
Agency DUSs --- --- --- ---
Agency Debentures --- --- --- ---
------- ------- ------- -------
Total $ 111,954 $ 2,190 $ 523 $ 113,621
========== ======== ========== ==========
June 30, 2002 Total Portfolio $ 986,093 $ 67,921 $ 649 $1,053,365
- ----------------------------- ========== ======== ========== ==========
Gross Gross
Unrealized Unrealized
December 31, 2001 Non-Collateral Amortized Cost Gains Losses Fair Value
- -------------------------------- -------------- ------------ ------------ ------------
Collateralized Mortgage Obligations:
Floating-Rate REMICs $ 18,943 $ 17 $ 18 $ 18,942
Fixed-Rate REMICs 897 25 --- 922
Mortgage Backed Securities:
Agency ARMs 27,785 914 --- 28,699
Agency Hybrid ARMs 37,258 1,488 69 38,677
Agency DUSs 311,110 17,588 --- 328,698
Agency Debentures 476,520 19,009 5,478 490,051
------- ------ ----- -------
Total $ 872,513 $ 39,041 $ 5,565 $ 905,989
========== ======== ========== ==========
Gross Gross
Unrealized Unrealized
December 31, 2001 Collateral Amortized Cost Gains Losses Fair Value
- ---------------------------- -------------- ------------ ------------ ------------
Collateralized Mortgage Obligations:
Floating-Rate REMICs $ 33,266 $ 168 $ 102 $ 33,332
Fixed-Rate REMICs 46,814 1,199 --- 48,013
Mortgage Backed Securities:
Agency ARMs 20,078 535 16 20,597
Agency Hybrid ARMs 35,097 1,340 --- 36,437
Agency DUSs --- --- --- ---
Agency Debentures --- --- --- ---
---------- --------- ---------- ----------
Total $ 135,255 $ 3,242 $ 118 $ 138,379
========== ========= ========== ==========
December 31, 2001 Total Portfolio $1,007,768 $ 42,283 $ 5,683 $1,044,368
- --------------------------------- ========== ========= ========== ==========
The breakdown of the Company's available-for-sale securities by category and
expected weighted average life distribution (stated in terms of amortized cost)
is summarized below ($ in 000's) based on management's prepayment assumptions:
Due after 1 Due after 5
Due in 1 year through 5 through 10 Due after 10
June 30, 2002 Non-Collateral or less years years years Total
- ---------------------------- ------------- ----------- ----------- ------------ -----------
Collateralized Mortgage Obligations:
Floating-Rate REMICs $ 9,119 $ 1,712 $ --- $ --- $ 10,831
Fixed-Rate REMICs --- 752 9,999 --- 10,751
Mortgage Backed Securities:
Agency ARMs 51 21,058 --- --- 21,109
Agency Hybrid ARMs 2,166 24,256 --- --- 26,422
Agency DUSs --- 93,149 225,530 --- 318,679
Agency Debentures --- 426,347 60,000 --- 486,347
------------ ------------ ----------- ----------- -----------
Total $ 11,336 $ 567,274 $ 295,529 $ --- $ 874,139
============ ============ =========== =========== ===========
Due after 1 Due after 5
Due in 1 year through 5 through 10 Due after 10
June 30, 2002 Collateral or less years years years Total
- ------------------------ ------------- ----------- ----------- ------------ -----------
Collateralized Mortgage Obligations:
Floating-Rate REMICs $ 1,687 $ 23,527 $ --- $ --- $ 25,214
Fixed-Rate REMICs --- 46,838 --- --- 46,838
Mortgage Backed Securities:
Agency ARMs 587 12,448 722 777 14,534
Agency Hybrid ARMs 1,119 24,249 --- --- 25,368
Agency DUSs --- --- --- --- ---
Agency Debentures --- --- --- --- ---
------------ ------------ ----------- ----------- -----------
Total $ 3,393 $ 107,062 $ 722 $ 777 $ 111,954
============ ============ =========== =========== ===========
June 30, 2002 Total Portfolio $ 14,729 $ 674,336 $ 296,251 $ 777 $ 986,093
- ----------------------------- ============ ============ =========== =========== ===========
Due after 1 Due after 5
Due in 1 year through 5 through 10 Due after 10
December 31, 2001 Non-Collateral or less years years years Total
- ---------------------------------- ------------- ----------- ----------- ------------ -----------
Collateralized Mortgage Obligations:
Floating-Rate REMICs $ 3,192 $ 15,751 $ --- $ --- $ 18,943
Fixed-Rate REMICs --- 897 --- --- 897
Mortgage Backed Securities:
Agency ARMs 241 27,544 --- --- 27,785
Agency Hybrid ARMs --- 37,258 --- --- 37,258
Agency DUSs --- 76,169 234,941 --- 311,110
Agency Debentures --- 216,804 259,716 --- 476,520
------------ ------------ ----------- ----------- -----------
Total $ 3,433 $ 374,423 $ 494,657 $ --- $ 872,513
============ ============ =========== =========== ===========
Due after 1 Due after 5
Due in 1 year through 5 through 10 Due after 10
December 31, 2001 Collateral or less years years years Total
- ---------------------------- ------------- ----------- ----------- ------------ -----------
Collateralized Mortgage Obligations:
Floating-Rate REMICs $ 3,360 $ 29,906 $ --- $ --- $ 33,266
Fixed-Rate REMICs --- 46,814 --- --- 46,814
Mortgage Backed Securities:
Agency ARMs 1,376 17,435 --- 1,267 20,078
Agency Hybrid ARMs --- 35,097 --- --- 35,097
Agency DUSs --- --- --- --- ---
Agency Debentures --- --- --- --- ---
------------ ------------ ----------- ----------- -----------
Total $ 4,736 $ 129,252 $ --- $ 1,267 $ 135,255
============ ============ =========== =========== ===========
December 31, 2001 Total Portfolio $ 8,169 $ 503,675 $ 494,657 $ 1,267 $ 1,007,768
- --------------------------------- ============ ============ =========== =========== ===========
Actual maturities may differ from maturities shown above due to prepayments.
The breakdown of the Company's available-for-sale securities by category and
yield is summarized below. The yield on Agency Debentures is based on U.S.
dollar denominated securities which excludes the Japanese Yen denominated
securities. The yield after hedging does include the Japanese Yen denominated
securities.
Due after 1 Due after 5
Due in 1 year through 5 through 10 Due after 10 Yield after
June 30, 2002 or less years years years Total Hedging
- ------------- ------------- ----------- ------------ ------------ ---------- -----------
Collateralized Mortgage Obligations:
Floating-Rate REMICs 2.77% 2.74% ---% ---% 2.75% 2.75%
Fixed-Rate REMICs --- 6.78 1.12 --- 5.80 5.63
Mortgage Backed Securities:
Agency ARMs 0.95 6.23 6.19 6.01 6.08 6.08
Agency Hybrid ARMs 4.96 5.00 --- --- 5.00 5.00
Agency DUSs --- 7.20 5.97 --- 6.33 1.86
Agency Debentures --- 6.11 --- --- 6.11 4.34
---- ---- ---- ---- ---- ----
Total 3.16% 6.07% 5.77% 6.01% 5.91% 3.67%
====== ====== ====== ====== ====== ======
Due after 1 Due after 5
Due in 1 year through 5 through 10 Due after 10 Yield after
June 30, 2001 or less years years years Total Hedging
- -------------- ------------- ----------- ------------ ------------ ---------- -----------
Collateralized Mortgage Obligations:
Floating-Rate REMICs 5.23% 5.75% ---% ---% 5.73% 5.73%
Fixed-Rate REMICs 7.25 6.41 6.50 --- 6.52 6.52
Mortgage Backed Securities:
Agency ARMs 6.83 6.63 7.56 8.17 6.65 6.65
Agency Hybrid ARMs --- 6.26 6.34 --- 6.27 6.27
Agency DUSs --- 8.79 6.32 --- 6.40 5.20
Agency Debentures --- 6.59 6.47 --- 6.52 6.32
---- ---- ---- ---- ---- ----
Total 6.20% 6.40% 6.37% 8.17% 6.38% 5.84%
====== ====== ====== ====== ====== ======
NOTE 5--REDEEMABLE COMMON SECURITIES:
General
The Company is authorized to issue up to 150,000 Common Securities; as of June
30, 2002 and December 31, 2001, the Company had outstanding 53,011 Common
Securities, all of which were held by the Branch. The Bank has agreed with the
Company in the Contingent Support Agreement that, so long as any Series A
Preferred Securities are outstanding, it will maintain direct or indirect
ownership of 100% of the outstanding Common Securities.
Dividends
Holders of Common Securities are entitled to receive dividends when, as and if
declared by the Company's Board of Directors out of the Company's net income not
required to be applied to fund dividends with respect to the Series A Preferred
Securities; provided that so long as any Series A Preferred Securities are
outstanding, no dividends or other distributions (including redemptions and
purchases) may be made with respect to the Common Securities unless full
dividends on all Series A Preferred Securities have been paid for the current
and the two immediately preceding Dividend Periods (except during a Shift Period
if the Bank does not distribute dividends on its common stock).
Redemption Requirements
If the Bank's financial condition were to deteriorate with the consequence that
a Shift Event were to occur, substantially all the Common Securities would be
redeemed automatically without prior redemption of any Series A Preferred
Securities.
Voting Rights
Subject to the rights, if any, of the holders of Series A Preferred Securities
(in particular the right to remove and replace any Independent Director and to
elect an additional Director, in certain circumstances), all voting rights are
vested in the Common Securities. The holders of Common Securities are entitled
to one vote per security.
Rights Upon Liquidation
In the event of the dissolution, liquidation or winding up of the Company,
whether voluntary or involuntary, after there shall have been paid or set aside
for the holders of all Series A Preferred Securities the full preferential
amounts to which such holders are entitled, the holders of Common Securities
will be entitled to share equally and ratably in any assets remaining after the
payment of all debts and liabilities. Upon a liquidation of the Company during a
Shift Period, the Common Securities will have a preference over the Series A
Preferred Securities to the extent, if any, that the liabilities of the Bank
(including any debt instruments, such as titres participatifs and prets
participatifs) have not been paid in full.
NOTE 6--RELATED PARTY TRANSACTIONS:
The Company entered into a Services Agreement with the Branch on December 5,
1997 pursuant to which the Branch manages the securities portfolio of the
Company and performs other administrative functions. Expenses incurred under
such Agreement were $718,065 as of June 30, 2002 and $410,873 as of June 30,
2001. Under a specific allocation methodology, the costs of personnel servicing
the Company has increased. This allocation is based on actual man-hours devoted
to the activities of the Company and remains at arms length.
The Branch, also serves as the dividend paying agent, registrar, and transfer
agent with respect to the Series A Preferred Securities. The fee is $4,000 per
annum for these services.
The Company maintains a credit balance account with the Branch for clearing
certain transactions.
All of the Company's officers and employees and all but one of the members of
the Company's Board of Directors are officers and employees of the Branch or BNP
PARIBAS.
NOTE 7--FAIR VALUE OF FINANCIAL INSTRUMENTS:
The fair values of securities at June 30, 2002 and December 31, 2001 were
obtained from independent market sources and are summarized in Note 4. The
carrying values of the securities, as shown in Note 4, approximates their fair
value. The fair value of the receivable arising from payment for securities,
pursuant to the application of SFAS 125, as replaced by SFAS 140, approximates
the aggregate carrying value of the investment securities treated as collateral,
which at June 30, 2002 and December 31, 2001 was $113,620,759 and $138,379,090
respectively.
The carrying value of cash and cash equivalents, accounts receivable, accrued
interest receivable, accrued expenses, and accounts payable approximates fair
value.
The fair value of the cross currency and interest rate swaps described in Note 8
below at June 30, 2002 and December 31, 2001 was $(48,402,935), and
$(19,003,975), respectively.
NOTE 8-DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
The Company maintains an overall risk management strategy that incorporates the
use of derivative instruments to hedge the interest rate risk and foreign
currency risk of fixed-income securities. As a result of interest rate or
exchange rate fluctuations, hedged fixed rate assets will appreciate or
depreciate in market value. The effect of this unrealized appreciation or
depreciation is expected to substantially offset the Company's gains or losses
on the derivative instruments that are linked to these hedged assets and
liabilities. The Company considers its use of derivatives to be a prudent method
of managing interest rate and foreign currency rate sensitivity, as it prevents
earnings from being exposed to undue risk posed by changes in interest and
exchange rates in compliance with the Company's policies.
Derivative instruments that are used as part of the Company's interest rate risk
management strategy include interest rate and cross-currency swap contracts that
have indices related to the pricing of specific balance sheet assets and
liabilities. As a matter of policy, the Company does not use highly leveraged
derivative instruments for interest rate risk management. Interest rate swaps
generally involve the exchange of fixed and variable rate interest payments
between two parties, based on a common notional principal amount and maturity
date.
By using derivative instruments, the Company exposes itself to credit and market
risk. If a counterparty fails to fulfill its performance obligations under a
derivative contract, the Company's credit risk will equal the fair value gain in
a derivative. Generally, when the fair value of a derivative contract is
positive, this indicates that the counterparty owes the Company, thus creating a
repayment risk for the Company. When the fair value of a derivative contract is
negative, the Company owes the counterparty and, therefore, assumes no repayment
risk. The Company minimizes the credit (or repayment) risk in derivative
instruments by entering into transactions with BNP PARIBAS S.A. Consequently,
the Company does not require that collateral be provided by the counterparty.
Market risk is the adverse effect that a change in interest rates, currency, or
implied volatility rates might have on the value of a financial instrument. The
Company does not expose itself to market risk by using derivatives but rather
reduces market risk since it uses derivatives only for fair value hedges that
effectively offset fluctuations in the fair value of the hedged items.
The Company formally documents all relationships between derivatives and hedged
items, as well as its risk management objectives and strategies for undertaking
various hedge transactions. This process includes linking all derivatives that
are designated as fair value or cash flow hedges to (1) assets and liabilities
on the balance sheet, (2) firm commitments or (3) forecasted transactions.
Fair Value Hedges
The Company mainly enters into interest rate swaps and cross-currency interest
rate swaps to convert fixed rate Agency Debentures, Agency DUSs and Fixed Rate
REMICs into variable rate securities.
For the period ended June 30, 2002, the Company recognized $1,702,002 in current
year earnings related to the ineffective portion of fair value hedges. The
Company did not recognize any gains or losses in relation to firm commitments
that no longer qualified as fair value hedges. The fair value of these fair
value hedging instruments was $(48,402,935) at June 30, 2002 and $(19,003,975)
at December 31, 2001 and has been recorded in "Other liabilities". It has been
offset, except for the ineffective portion of the hedge, by the revaluation of
the respective hedged investment securities. The fair value of the hedging
instruments does not include accrued interest receivable and payable, which are
shown separately on the balance sheet.
Cash Flow Hedges
For the period ended June 30, 2002, the Company did not enter into cash flow
hedge transactions and it is not the intention of the Company to use interest
rate swaps to convert floating rate financial instruments to fixed rate
financial instruments as part of a cash flow hedge strategy.
At June 30, 2002 and December 31, 2001, the Company had outstanding cross
currency and interest rate swap agreements with a notional principal amount of
$618,079,214 and $590,711,267, respectively.
Item 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
General
The Company was formed on October 14, 1997 and commenced operations on December
5, 1997 by the sale to qualified institutional buyers of 50,000 noncumulative,
preferred securities, Series A, and the sale to the Branch of 53,011 common
securities, $10,000 par value per share. Together, such sales raised net capital
of $1,030,115,873, which the Company used to purchase the portfolio of
securities from the Branch.
The Company's sole business is to acquire, hold and manage debt instruments,
largely consisting of mortgage obligations, which generate net income for
distribution to securityholders. The Company's major source of income is
interest generated by the securities in the Portfolio.
Results of Operations
SIX MONTH PERIOD
The following discussion pertains to the Six-month period ended June 30, 2002
(the "2002 Period") and the Six-month period ended June 30, 2001 (the "2001
Period").
For the 2002 Period and 2001 Period, the Company had revenues of $18,955,294 and
$30,098,594, respectively. This amount consisted of interest income on the
investment securities, the unrealized gain/loss on hedged securities and the
derivatives used as hedging instruments and interest on deposits.
The interest income on the investment securities includes interest income on the
remaining securities in the Initial Portfolio, which are considered to be
collateral held by the Company and which are no longer recognized on the balance
sheet pursuant to new guidance in Statement of Financial Accounting Standards
No. 140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities, a replacement of SFAS 125" ("SFAS 140"), which
modified SFAS 125 in this respect, as explained in Note 3 to the financial
statements. The receivable for the consideration paid to the Branch for the
Initial Portfolio is recognized on the balance sheet and is an asset of similar
size as the remaining securities in the Initial Portfolio. The balance sheet
presentation results from compliance with SFAS 140 but does not reflect the
economic substance of the transaction, as further explained in the section on
the application of SFAS 125 as replaced by SFAS 140 below. For all economic
intent and purposes, the securities in the Initial Portfolio are owned by the
Company and managed as any other investment security, with related revenues
belonging to the Company and recorded as such in the income statement.
For the 2002 and 2001 Period, interest on the securities in the Portfolio
amounted to $24,308,698 and $25,730,451, respectively, representing an aggregate
yield of 5.91% and 6.38%, respectively. Interest earned and average yield with
respect to each category of security in the Portfolio was as follows (yield
based on average amortized cost):
2002 Period 2001 Period
----------- -----------
Floating-Rate REMICs........ $ 599,073 2.75% $2,268,385 5.73%
Fixed-Rate REMICs........... $ 1,679,949 5.80% $1,617,787 6.52%
Agency ARMs................. $ 1,234,026 6.08% $2,400,415 6.65%
Agency Hybrid ARMs.......... $ 1,533,286 5.00% $3,163,878 6.27%
Agency DUSs................. $10,140,311 6.30% $8,697,979 6.40%
Agency Debentures........... $ 9,122,053 6.11% $7,582,007 6.52%
The yield on Agency Debentures is based on U.S. dollar denominated securities
which excludes the Japanese Yen denominated securities.
During the 2002 Period, the yield on the Agency DUSs, Agency Debentures and
Fixed Rate REMICs was approximately 1.86%, 4.34% and 5.63%, respectively, when
taking into account the income from the derivative products used to hedge these
securities.
The average amortized cost of the Portfolio during the 2002 Period and the 2001
Period was $1,007,497,983 and $994,280,079, respectively. This reflects the
following prepayments and reinvestments:
Prepayments 2002 Period 2001 Period
- ----------- ----------- -----------
Floating-Rate REMICs........ $ 16,111,453 $15,046,281
Fixed-Rate REMICs........... $ 144,938 $ 4,558,040
Agency ARMs................. $ 12,194,086 $16,416,716
Agency Hybrid ARMs.......... $ 19,986,447 $16,362,088
Agency DUSs................. $ 1,732,352 $ 2,213,691
Reinvestments 2002 Period 2001 Period
- ------------- ----------- -----------
Floating-Rate REMICs........ --- ---
Fixed-Rate REMICs........... $ 10,000,000 ---
Agency ARMs................. --- ---
Agency Hybrid ARMs.......... --- ---
Agency DUSs................. $ 9,319,961 $ 9,971,282
Agency Debentures........... $ 9,960,584 $18,000,000
The Company also recorded interest income from short-term investments for the
2002 Period and 2001 Period of $365,080 and $929,424, respectively. These
amounts are attributable to the interest earned on (i) interest payments on
securities in the Portfolio, (ii) prepayments of principal pending their
reinvestment and (iii) short-term investments classified as cash equivalents.
As of June 30, 2002, as calculated by aggregate amortized cost, approximately
50.68% of the Portfolio consisted of collateralized mortgage obligations
(Floating-Rate REMICs and Fixed-Rate REMICs) and mortgage backed securities
(Agency ARMs, Agency Hybrid ARMs and Agency DUSs), and approximately 49.32%
consisted of Agency Debentures. Floating Rate securities accounted for
approximately 12.52% of the Portfolio's collateralized mortgage obligations and
mortgage backed securities. In addition, a significant portion of the Agency
Debentures and the Agency DUSs are hedged so that in all but one case, the fixed
rate interest received on the bonds are converted into prevailing floating
rates.
The aggregate market value of the securities in the Portfolio as of June 30,
2002 was higher than the amortized cost by approximately 6.82%, due to a net
decrease in interest rates from the time of their original purchase. For the
hedged securities, changes in the fair market value of both the securities and
the derivatives used as hedging instruments (cross currency and interest rate
swaps) are reported in current earnings in the Statement of Income, pursuant to
application of SFAS 133, (Note 2). Unrealized gains and losses on the non-hedged
securities are reported as a component of "Other Comprehensive Income".
Operating expenses for the 2002 Period and the 2001 Period totaled $860,265 and
$617,933, respectively. Operating expenses consisted largely of fees paid to the
Branch under the Services Agreement, fees of Citibank as Trustee, consulting
fees and audit fees. Under a specific allocation methodology, the costs of
Branch personnel servicing the Company have increased. This allocation is based
on actual man-hours devoted to the activities of the Company and remains at arms
length.
The Company's net income in the 2002 Period was $18,095,029 and for the 2001
Period it was $30,419,271. As of June 30, 2002, the Company has declared and
paid dividends as follows:
Security Amount Date Paid
- ----------------------------- ----------- ------------
Series A Preferred Securities $19,345,000 June 5, 2002
$19,345,000 December 5, 2001
$19,345,000 June 5, 2001
-----------
Common Securities $10,718,708 June 19, 2001
The June 2002 dividends were paid from the Company's retained earnings, produced
from earnings generated from the period December 1, 2001 to May 31, 2002.
THREE MONTH PERIOD
The following discussion pertains to the Three-month period ended June 30, 2002
(the "2002 Period") and the Three-month period ended June 30, 2001 (the "2001
Period").
For the 2002 Period and 2001 Period, the Company had revenues of $10,666,723 and
$14,013,530, respectively. This amount consisted of interest income on the
investment securities, the unrealized gain/loss on hedged securities and the
derivatives used as hedging instruments and interest on deposits.
For the 2002 Period and 2001 Period, interest on the securities in the Portfolio
amounted to $12,126,136 and $12,599,906, respectively, representing an aggregate
yield of 5.84% and 6.30%, respectively. Interest earned and average yield with
respect to each category of security in the Portfolio was as follows (yield
based on average amortized cost):
2002 Period 2001 Period
----------- -----------
Floating-Rate REMICs........ $ 267,161 2.68% $ 973,488 5.17%
Fixed-Rate REMICs........... $ 905,180 6.22% $ 786,223 6.49%
Agency ARMs................. $ 522,934 5.52% $1,087,248 6.42%
Agency Hybrid ARMs.......... $ 692,018 4.94% $1,471,606 6.10%
Agency DUSs................. $ 5,120,104 6.35% $4,473,796 6.40%
Agency Debentures........... $ 4,618,739 6.16% $3,807,545 6.55%
The average amortized cost of the Portfolio during the 2002 Period and the 2001
Period was $995,629,297 and $984,878,782, respectively. This reflects the
following prepayments and reinvestments:
Prepayments 2002 Period 2001 Period
- ----------- ----------- -----------
Floating-Rate REMICs........ $ 7,123,812 $ 9,878,823
Fixed-Rate REMICs........... $ 67,624 $ 1,925,714
Agency ARMs................. $ 4,209,579 $ 9,598,155
Agency Hybrid ARMs.......... $ 8,641,838 $ 10,295,503
Agency DUSs................. $ 870,819 $ 1,521,653
Reinvestments 2002 Period 2001 Period
- ------------- ----------- -----------
Floating-Rate REMICs........ --- ---
Fixed-Rate REMICs........... $10,000,000 ---
Agency ARMs................. --- ---
Agency Hybrid ARMs.......... --- ---
Agency DUSs................. $ 9,319,961 ---
Agency Debentures........... $ 9,960,584 ---
The Company also recorded interest income from short-term investments for the
2002 Period and 2001 Period of $212,055 and $544,761, respectively. These
amounts are attributable to the interest earned on (i) interest payments on
securities in the Portfolio, (ii) prepayments of principal pending their
reinvestment and (iii) short-term investments classified as cash equivalents.
Operating expenses for the 2002 Period and the 2001 Period totaled $566,301 and
$383,382, respectively. Operating expenses consisted largely of fees paid to the
Branch under the Services Agreement, fees of Citibank as Trustee, consulting
fees and audit fees. Under a specific allocation methodology, the costs of
Branch personnel servicing the Company have increased. This allocation is based
on actual man-hours devoted to the activities of the Company and remains at arms
length.
The Company's net income in the 2002 Period was $10,100,622 and for the 2001
Period it was $13,630,148.
Receivable Arising from Payment for Securities Pursuant to the Application of
SFAS 125 as Replaced by SFAS 140
Due to the potential consequences of a Shift Event (defined herein Item 1, Note
2), the Company's purchase of the Initial Portfolio (as defined in Item 1
herein) from the Branch did not meet certain SFAS 125, as replaced by SFAS 140,
sale accounting requirements. Accordingly, the Company recorded at December 5,
1997 a receivable for the consideration paid to the Branch for the Initial
Portfolio treated as collateral. As a legal and economic matter, however, there
is no such receivable since (a) neither the Bank nor the Branch has any
obligation to repay any part of the purchase price for the Initial Portfolio or
to repurchase or redeem any of the securities included therein, and (b) the
Company has no obligation to return any of such securities to the Bank or the
Branch (except in the limited circumstances and to the extent that the
occurrence of a Shift Event under the Charter would require the transfer of any
assets held by the Company at the time). As the securities in the Initial
Portfolio are paid, the receivable will be deemed to be realized by an amount
corresponding to the amount of the payments received. At June 30, 2002 and
December 31, 2001, respectively, the receivable arising from payment for
securities amounted to $111,953,762 and $135,255,432. The decrease in the amount
of such receivable between the two dates reflects the prepayment of securities
in the Initial Portfolio. The Company recognized the cash proceeds of such
prepayments as a reduction in the receivable. Such decreases in the receivable
did not affect the Company's results of operations or cash flow.
Liquidity and Capital Resources
The objective of liquidity management is to ensure the availability of
sufficient cash flows to meet all of the Company's financial commitments. The
Company's sole liquidity needs are to acquire reinvestment securities as
original securities repay or prepay and to pay dividends on the Series A
Preferred Securities. The acquisition of reinvestment securities is funded with
the proceeds of principal repayments or prepayments on original securities, and
the payments of dividends on the Series A Preferred Securities are funded
through interest income from the securities in the Portfolio. Given the limited
scope of its activities (acquiring and holding eligible securities to fund the
payment of dividends on the Series A Preferred Securities and the Common
Securities), and the fact that the Company is prohibited from incurring
indebtedness, the Company believes that its liquidity and capital resources will
be sufficient to meet its liquidity requirements in the short and long term.
BNP PARIBAS Group's total and Tier 1 risk-based capital ratios at June 30, 2002
were 11.6% and 8.1%, which are well above the minimum standards required by
French banking regulations, currently 8% for total risk-based capital and 4% for
Tier 1 risk-based capital. A "shift event" would occur if BNP Paribas'
risk-based capital fell below these minimum standards of 8% and 4%,
respectively. See Note 2 of the attached financial statements for a detailed
explanation of "shift events".
Derivative Instruments and Hedging Activities
The Company has made an assessment of all of its financial instruments and
concluded that it holds freestanding derivative instruments but no embedded
derivative instruments at June 30, 2002. As part of its asset management
activities the Company uses foreign exchange and interest rate swaps to modify
the interest rate and foreign exchange characteristics of existing assets. The
interest rate swaps have a high correlation between the instrument and the asset
being hedged, both at inception and throughout the hedge period.
All of the Company's outstanding hedging transactions are fair value hedges. For
the period ended June 30, 2002, the Company recognized $1,702,002 related to the
ineffective portion of fair value hedges. The Company did not recognize any
gains or losses in relation to firm commitments that no longer qualified as fair
value hedges. The fair value of these fair value hedging instruments was
$(48,402,935) at June 30, 2002 and $(19,003,975) at December 31, 2001 and has
been recorded in "Other liabilities". It has been offset, except for the
ineffective portion of the hedge, by the revaluation of the respective hedged
investment securities. The fair value of the hedging instruments does not
include accrued interest receivable and payable, which are shown separately on
the balance sheet.
For a further discussion on derivative instruments and hedging activities, see
Note 8 to the financial statements.
Item 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Interest Rate Sensitivity
The Company's principal market risk exposure is to changes in interest rates.
This exposure arises from its investments in collateralized mortgage
obligations, mortgage-backed securities, agency debentures, agency DUSs and
certain derivative instruments used by the Company to modify interest rate
exposures.
The outstanding principal amount and estimated fair value as of June 30, 2002,
by each category of investment is depicted in Footnote 4 of the Financial
Statements contained in Item 1 herein.
Interest Rate Risk
The Company's income consists primarily of interest payments on collateralized
mortgage obligations, mortgage-backed securities, agency debentures and agency
DUSs. Currently, the Company uses derivative products to manage a portion of its
interest rate risk.
The first six months of 2002 were characterized by a persistent low interest
rate environment that continues to affect the Company's income and will continue
to weigh on the results in 2002 through the floating rate component of the
portfolio, (floating-rate and fixed-rate securities are converted to
floating-rate instruments through interest rate swaps). Since the market remains
pessimistic about any interest rate movement before year-end, management
believes that the interest income from the portfolio for the second six months
of 2002 should now be stabilized at the level of the interest income for the
second quarter. However, no assurance can be provided that either the market or
floating interest rates has stabilized.
The Company regularly reviews its hedging requirements. In the future, the
Company expects to enter into additional swaps, unwind part or all of the
initial and any future swaps in order to rebalance the fixed and floating mix of
interest obligations (including those arising as a result of previous interest
rate swaps entered into) and the fixed and floating mix of interest payments.
The Company's interest rate management strategy will continue to be rebalanced
with any purchase of new investments. There can be no assurance, however, that
the Company's interest rate risk management strategies will be effective in this
regard.
The Company is a party to twenty-six interest rate swaps and two cross currency
swaps with BNP PARIBAS. In all but one of these swaps, where the Company pays
and receives fixed rate, the Company pays a fixed coupon and receives floating
rate payments on the notional balances as set out below:
(000's omitted)
Fair Value at Notional
June 30, 2002 Balance Value Date Maturity Date Fixed Rate Receive Rate
------------------ ------------ ----------------- ------------------- ------------ -------------------------------
$ (2,903) $ 42,000 November 25, 1998 March 26, 2008 JPY 1.75 US Three Month Libor Plus Six
Basis Points
(5,372) 58,000 November 25, 1998 October 9, 2007 JPY 2.125 US Three Month Libor Plus Six
Basis Points
(1,112) 19,111 November 25, 1998 August 25, 2008 US 6.15 US One Month Libor Plus Five
Basis Points
(1,830) 23,246 May 25, 1999 May 25, 2009 US 6.23 US One Month Libor Plus One and
Half Basis Points
(5,747) 50,000 February 12, 1999 March 5, 2007 US 6.68 US Three Month Libor Minus Two
Basis Points
(5,969) 50,000 February 11, 1999 March 14, 2007 US 6.80 US Three Month Libor Minus Two
Basis Points
(1,947) 30,000 March 29, 1999 October 9, 2007 JPY 2.125 US Three Month Libor Minus Two
and Half Basis Points
(2,532) 26,400 April 6, 1999 October 9, 2007 JPY 2.125 US Three Month Libor Minus One
Basis Point
(1,124) 26,010 June 25, 1999 June 25, 2009 US 6.23 US One Month Libor plus Three
and Half Basis Points
(904) 20,762 February 25, 1999 February 25, 2009 US 5.41 US One Month Libor Plus Three
Basis Points
(951) 15,658 July 1, 1999 June 25, 2009 US 6.39 US One Month Libor Plus Three
and Half Basis Points
(2,987) 43,098 September 27, 1999 March 28, 2008 US 6.29 US One Month Libor Plus Five
Basis Points
(659) 15,446 November 26, 1999 April 25, 2009 US 6.04 US One Month Libor Plus Four
Basis Points
(984) 28,262 September 27, 1999 March 25, 2009 US 5.85 US One Month Libor Plus Four
Basis Points
(622) 7,000 August 1, 2000 December 26, 2007 US 6.42 US One Month Libor
(3,279) 29,244 August 1, 2000 October 16, 2006 US 7.20 US One Month Libor Minus Two
Basis Points
(770) 8,307 June 26, 2000 October 1, 2007 US 6.68 US One Month Libor Plus One and
Half Basis Points
(625) 9,331 June 26, 2000 October 1, 2008 US 6.19 US One Month Libor
221 15,000 November 2, 2000 October 9, 2007 JPY 2.125 US Three Month Libor Minus Two
Basis Points
(793) 7,517 October 2, 2000 June 1, 2007 US 7.024 US One Month Libor Minus Two
Basis Points
(974) 7,588 October 2, 2000 July 1, 2007 US 7.405 US One Month Libor Minus Two
Basis Points
599 18,000 January 17, 2001 March 26, 2008 JPY 1.750 5.80
(1,012) 9,808 March 25, 2001 October 25, 2007 US 6.94 US One Month Libor Plus Two
Basis Points
(2,153) 19,496 September 4, 2001 October 1, 2006 US 7.20 US One Month Libor Plus Two
Basis Points
(1,060) 9,748 October 2, 2001 October 1, 2006 US 7.20 US One Month Libor Plus Seven
Basis Points
(1,049) 9,748 January 2, 2002 October 16, 2006 US 7.20 US One Month Libor Plus Ten
Basis Points
(841) 9,299 May 1, 2002 October 25, 2007 US 6.63 US One Month Libor Plus One
Basis Points
(1,024) 10,000 May 3, 2002 August 25, 2007 US 6.74 US One Month Libor Plus One
----------- --------- Basis Points
$ (48,403) $ 618,079
=========== =========
The fair value of the cross currency and interest rate swaps was $(48,402,935)
and $(19,003,975) at June 30, 2002 and December 31, 2001, respectively. The
change in fair value was primarily due to changes in prevailing market interest
rates.
The breakdown of the Company's available-for-sale securities by category and
weighted average life distribution (stated in terms of amortized cost) is
summarized below ($ in 000's) based on management's prepayment assumptions:
Due in Due after Due after Due after Due after Due after Due after
At June 30, 2002 Non-Collateral 2002 2002 2003 2004 2005 2006 2007 Total
- ------------------------------- -------- --------- --------- --------- --------- --------- --------- ---------
Fixed Rate Instruments:
Fixed-Rate REMICs.........................$ --- $ --- $ 752 $ --- $ --- $ 9,999 $ --- $ 10,751
Agency DUS................................ --- --- --- --- 75,752 89,849 153,078 318,679
Agency Debentures ........................ --- --- --- --- 226,557 259,790 --- 486,347
-------- -------- -------- ------- -------- -------- -------- --------
Total Fixed Rate Instruments.............. --- --- 752 --- 302,309 359,638 153,078 815,777
-------- -------- -------- ------- -------- -------- -------- --------
Floating-Rate Instruments:
Floating-Rate REMICs...................... 2,835 6,284 --- 1,712 --- --- --- 10,831
Agency ARMs............................... 51 5,725 12,681 2,652 --- --- --- 21,109
Agency Hybrid ARMs........................ --- 6,941 14,608 4,873 --- --- --- 26,422
-------- -------- -------- ------- -------- -------- -------- --------
Total Floating Rate Instruments........... 2,886 18,950 27,289 9,237 --- --- --- 58,362
-------- -------- -------- ------- -------- -------- -------- --------
Total.....................................$ 2,886 $ 18,950 $ 28,041 $ 9,237 $302,309 $359,638 $153,078 $874,139
======== ======== ======== ======= ======== ======== ======== ========
Due in Due after Due after Due after Due after Due after Due after
At June 30, 2002 Collateral 2002 2002 2003 2004 2005 2006 2007 Total
- --------------------------- -------- --------- --------- --------- --------- --------- --------- ---------
Fixed Rate Instruments:
Fixed-Rate REMICs.........................$ --- $ --- $ 46,838 $ --- $ --- $ --- $ --- $ 46,838
Agency DUS................................ --- --- --- --- --- --- --- ---
Agency Debentures ........................ --- --- --- --- --- --- --- ---
-------- -------- -------- ------- -------- -------- -------- --------
Total Fixed Rate Instruments.............. --- --- 46,838 --- --- --- --- 46,838
-------- -------- -------- ------- -------- -------- -------- --------
Floating-Rate Instruments:
Floating-Rate REMICs...................... 121 1,566 12,663 10,864 --- --- --- 25,214
Agency ARMs............................... 167 2,719 9,206 943 --- --- 1,499 14,534
Agency Hybrid ARMs........................ --- 12,312 13,056 --- --- --- --- 25,368
-------- -------- -------- ------- -------- -------- -------- --------
Total Floating Rate Instruments........... 288 16,597 34,925 11,807 --- --- 1,499 65,116
-------- -------- -------- ------- -------- -------- -------- --------
Total.................................... $ 288 $ 16,597 $ 81,763 $11,807 $ --- $ --- $ 1,499 $111,954
======== ======== ======== ======= ======== ======== ======== ========
At June 30, 2002 Total Portfolio $ 3,174 $ 35,547 $109,804 $21,044 $302,309 $359,638 $154,577 $986,093
- -------------------------------- ======== ======== ======== ======= ======== ======== ======== ========
At December 31, 2001 Due in Due after Due after Due after Due after Due after Due after
Non-Collateral 2002 2002 2003 2004 2005 2006 2007 Total
- --------------------------------- -------- --------- --------- --------- --------- --------- --------- ---------
Fixed Rate Instruments:
Fixed-Rate REMICs.........................$ --- $ 897 $ --- $ --- $ --- $ --- $ --- $ 897
Agency DUS................................ --- --- --- 7,575 68,594 81,029 153,912 311,110
Agency Debentures ........................ --- --- --- --- 216,804 259,716 --- 476,520
-------- -------- -------- ------- -------- -------- -------- ----------
Total Fixed Rate Instruments.............. --- 897 --- 7,575 285,398 340,745 153,912 788,527
-------- -------- -------- ------- -------- -------- -------- ----------
Floating-Rate Instruments:
Floating-Rate REMICs...................... 3,192 8,182 5,370 2,199 --- --- --- 18,943
Agency ARMs............................... 241 17,108 10,436 --- --- --- --- 27,785
Agency Hybrid ARMs........................ --- 3,216 26,412 7,630 --- --- --- 37,258
-------- -------- -------- ------- -------- -------- -------- ----------
Total Floating Rate Instruments........... 3,433 28,506 42,218 9,829 --- --- --- 83,986
-------- -------- -------- ------- -------- -------- -------- ----------
Total.................................... $ 3,433 $ 29,403 $ 42,218 $17,404 $285,398 $340,745 $153,912 $ 872,513
======== ======== ======== ======= ======== ======== ======== ==========
Due in Due after Due after Due after Due after Due after Due after
At December 31, 2001 Collateral 2002 2002 2003 2004 2005 2006 2007 Total
- ------------------------------- -------- --------- --------- --------- --------- --------- --------- ---------
Fixed Rate Instruments:
Fixed-Rate REMICs.........................$ --- $ --- $ --- $ --- $ 46,814 $ --- $ --- $ 46,814
Agency DUS................................ --- --- --- --- --- --- --- ---
Agency Debentures ........................ --- --- --- --- --- --- --- ---
-------- -------- -------- ------- -------- -------- -------- ----------
Total Fixed Rate Instruments.............. --- --- --- --- 46,814 --- --- 46,814
-------- -------- -------- ------- -------- -------- -------- ----------
Floating-Rate Instruments:
Floating-Rate REMICs...................... 3,360 16,470 6,173 7,263 --- --- --- 33,266
Agency ARMs............................... 1,376 9,664 504 3,743 3,524 --- 1,267 20,078
Agency Hybrid ARMs........................ --- 29,234 5,863 --- --- --- --- 35,097
-------- -------- -------- ------- -------- -------- -------- ----------
Total Floating Rate Instruments........... 4,736 55,368 12,540 11,006 3,524 --- 1,267 88,441
-------- -------- -------- ------- -------- -------- -------- ----------
Total.................................... $ 4,736 $ 55,368 $ 12,540 $11,006 $ 50,338 $ --- $ 1,267 $ 135,255
======== ======== ======== ======= ======== ======== ======== ==========
At December 31, 2001 Total Portfolio $ 8,169 $ 84,771 $ 54,758 $28,410 $335,736 $340,745 $155,179 $1,007,768
- ------------------------------------ ======== ======== ======== ======= ======== ======== ======== ==========
Actual maturities may differ from maturities shown above due to prepayments.
Part II
Item 1. Legal Proceedings
None
Item 2. Changes in Securities and Use of the Proceeds
None
Item 3 Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Securityholders
None
Item 5 Other Information
None
Item 6 Exhibits and Current Reports on Form 8-K
A) Exhibits:
11) Computation of net income per common security
12) (a) Computation of ratio of earnings to fixed charges
(b) Computation of ratio of earnings to fixed charges
and preferred security dividend requirements
B) Reports on Form 8-K: NONE
Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereto duly authorized.
BNP U. S. FUNDING L.L.C.
------------------------
Registrant
Date: August 14, 2002 By /s/ Jean-Pierre Beck
--------------------------
Jean-Pierre Beck
President and Director
Date: August 14, 2002 By /s/ Sady Karet
--------------------------
Sady Karet
Treasurer and Director