UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the quarter ended June 30, 2003
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
incorporation or organization) Identification No.)
787 Seventh Avenue, New York, N.Y. 10019
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (212) 841-2000
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 3 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 whether the Registrant is an accelerated filer
(as defined in Exchange Act Rule 12b-2). Yes |_| No |X|
All outstanding shares of Common Stock were held by BNP PARIBAS, the
Registrant's parent Company, at June 30, 2003
Number of Shares of Common Stock outstanding on June 30, 2003: 53,011
Form 10-Q Index
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Part I Page
- ------ ----
Item 1. Financial Statements
Balance Sheets at June 30, 2003 (Unaudited) and December 31, 2002 3
Statements of Income (Unaudited) for the Three Months and Six Months Ended June 30, 2003
and June 30, 2002 4
Statements of Comprehensive Income (Unaudited) for the Three Months and Six Months Ended
June 30, 2003 and June 30, 2002 5
Statements of Changes in Redeemable Common Securities,
Preferred Securities and Securityholders' Equity (Unaudited) for the
Three Months Ended March 31, 2003 and June 30, 2003 6
Statements of Cash Flows (Unaudited) for the Six Months Ended
June 30, 2003 and June 30, 2002 7
Notes to Financial Statements (Unaudited) 8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operation 16
Item 3. Quantitative and Qualitative Disclosures about Market Risk 21
Item 4. Controls and Procedures 25
Part II
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Item 1. Legal Proceedings 26
Item 2. Changes in Securities and Use of the Proceeds 26
Item 3. Defaults upon Senior Securities 26
Item 4. Submission of Matters to a Vote of Securityholders 26
Item 5. Other Information 26
Item 6. Exhibits and Current Reports on Form 8-K 26
Part I
Item 1.
FINANCIAL STATEMENTS
BNP U.S. FUNDING L.L.C.
BALANCE SHEETS
(in thousands, except per share data)
June 30, 2003 December 31, 2002
------------- -----------------
(unaudited)
ASSETS
Cash and cash equivalents $ 46,004 $ 40,180
Investment securities (Notes 3 and 4)
Available-for-sale, at fair value 1,052,682 1,013,910
Receivable arising from payment for securities, pursuant
to the application of SFAS 125, as replaced by
SFAS 140 (Note 3) 51,392 85,660
Accounts receivable 511 1,052
Accrued interest receivable 8,163 8,400
Other asset 2,287 1,683
----------- -----------
TOTAL ASSETS $ 1,161,039 $ 1,150,885
=========== ===========
LIABILITIES
Accrued interest payable $ 4,193 $ 2,634
Accrued expenses 193 204
Other liabilities 91,895 86,023
----------- -----------
TOTAL LIABILITIES 96,281 88,861
----------- -----------
Redeemable common securities, par value and redeemable
value $10,000 per security; 150,000 securities authorized,
53,011 securities issued and outstanding (Note 5) 530,110 530,110
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 489 1,044
Accumulated other comprehensive income 30,011 26,548
Retained earnings 4,148 4,322
----------- -----------
TOTAL REDEEMABLE COMMON SECURITIES,
PREFERRED SECURITIES AND
SECURITYHOLDERS' EQUITY 1,064,758 1,062,024
----------- -----------
TOTAL LIABILITIES AND TOTAL REDEEMABLE
COMMON SECURITIES, PREFERRED
SECURITIES AND SECURITYHOLDERS' EQUITY $ 1,161,039 $ 1,150,885
=========== ===========
The accompanying Notes to Financial Statements are an integral part of these
statements.
BNP U.S. FUNDING L.L.C.
STATEMENTS OF INCOME (UNAUDITED)
(in thousands, except per share data)
For the Three Months For the Six Months
Ended June 30, Ended June 30,
------------------------------ ------------------------------
2003 2002 2003 2002
------------- ------------- ------------- -------------
INTEREST INCOME
Collateralized Mortgage Obligations:
Floating-Rate REMICs $ 108 $ 267 $ 238 $ 599
Fixed-Rate REMICs 281 855 754 1,630
Mortgage Backed Securities:
Agency ARMs 200 523 440 1,234
Agency Hybrid ARMs 318 692 737 1,533
Agency DUSs 1,406 1,532 2,718 2,984
Agency Debentures 3,942 6,585 8,153 10,610
Interest on deposits 89 212 191 365
----------- ----------- ----------- ----------
Total 6,344 10,666 13,231 18,955
----------- ----------- ----------- ----------
NONINTEREST INCOME (EXPENSE)
Other financial instrument 909 - 605 -
Fees and expenses (388) (566) (720) (860)
----------- ----------- ----------- ----------
521 (566) (115) (860)
----------- ----------- ----------- ----------
NET INCOME APPLICABLE TO PREFERRED AND
REDEEMABLE COMMON SECURITIES $ 6,865 $ 10,100 $ 13,116 $ 18,095
=========== =========== =========== ==========
NET INCOME PER REDEEMABLE
COMMON SECURITY $ (235.42) $ (174.39) $ (117.50) $ (23.58)
=========== =========== =========== ==========
The accompanying Notes to Financial Statements are an integral part of these
statements.
BNP U.S. FUNDING L.L.C.
STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
(in thousands)
For the Three Months For the Six Months
Ended June 30, Ended June 30,
-------------------------- -------------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
NET INCOME $ 6,865 $ 10,100 $ 13,116 $ 18,095
OTHER COMPREHENSIVE INCOME
Net change in unrealized gain in fair value
of available-for-sale securities that are not
treated as collateral (Note 3) and that are
not hedged by derivative instruments 2,977 5,838 3,463 1,030
--------- --------- --------- ---------
TOTAL OTHER COMPREHENSIVE INCOME 2,977 5,838 3,463 1,030
--------- --------- --------- ---------
COMPREHENSIVE INCOME $ 9,842 $ 15,938 $ 16,579 $ 19,125
========= ========= ========= =========
The accompanying Notes to Financial Statements are an integral part of these
statements.
BNP U.S. FUNDING L.L.C.
STATEMENTS OF CHANGES IN REDEEMABLE COMMON SECURITIES,
PREFERRED SECURITIES AND SECURITYHOLDERS' EQUITY (UNAUDITED)
(in thousands)
For the Three Months Ended March 31, 2003 and June 30, 2003
-----------------------------------------------------------------------------------------------
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, 2002 $ 530,110 $ 500,000 $ 1,044 $ 26,548 $ 4,322 $ 1,062,024
Net income 6,251 6,251
Other comprehensive income 486 486
---------- ---------- -------- --------- -------- ------------
Balance at March 31, 2003 530,110 500,000 1,044 27,034 10,573 1,068,761
Net income 6,865 6,865
Other comprehensive income 2,977 2,977
Additional paid-in capital 5,500 5,500
Dividends paid - preferred
securities (6,055) (13,290) (19,345)
---------- ---------- -------- --------- -------- ------------
Balance at June 30, 2003 $ 530,110 $ 500,000 $ 489 $ 30,011 $ 4,148 $ 1,064,758
========== ========== ======== ========= ======== ============
The accompanying Notes to Financial Statements are an integral part of these
statements.
BNP U.S. FUNDING L.L.C.
STATEMENTS OF CASH FLOWS (UNAUDITED)
(in thousands)
For the Six Months
Ended June 30,
------------------------------------
2003 2002
------------ ------------
OPERATING ACTIVITIES
Net income $ 13,116 $ 18,095
Adjustments to reconcile net income to net cash
provided by operating activities:
Amortization 616 789
Gain on other financial instrument (604) -
Loss (gain) on hedge activity 285 (1,702)
Changes in assets and liabilities:
Interest receivable 237 (1,194)
Accounts receivable 541 1,730
Accrued expenses (11) 85
Accrued interest payable 1,559 1,400
Payable for securities purchased - (9,802)
---------------- ----------------
Net cash provided by operating activities 15,739 9,401
---------------- ----------------
INVESTING ACTIVITIES
Purchase of investment securities:
Agency DUSs (38,122) (9,320)
Agency Debentures (20,038) (9,961)
Agency Fixed Rate REMICs - (10,000)
Proceeds from principal payments of securities
available-for-sale, not treated as collateral 28,028 27,187
Proceeds from principal payments of securities
available-for-sale, treated as collateral 34,062 22,982
---------------- ----------------
Net cash provided by investing activities 3,930 20,888
---------------- ----------------
FINANCING ACTIVITIES
Additional paid-in capital 5,500 -
Cash dividends - preferred securities (19,345) (19,345)
---------------- ----------------
Net cash used in financing activities (13,845) (19,345)
---------------- ----------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 5,824 10,944
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 40,180 31,084
---------------- ----------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 46,004 $ 42,028
================ ================
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) $ 34,268 $ 23,301
The accompanying Notes to Financial Statements are an integral part of these
statements.
FORWARD LOOKING DISCLOSURE STATEMENT
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 Form 10-Q (or any other periodic reporting
documents required by the Securities Exchange Act of 1934 Act, 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 statements were 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
noncumulative preferred securities, Series A, liquidation preference $10,000 per
security (the "Series A Preferred Securities"), to qualified institutional
buyers, 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 Branch contributed additional paid-in capital of
$3,000,000 and $5,500,000, on December 3, 2002, and June 3, 2003, respectively.
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").
The accounting and financial reporting policies of the Company conform to U.S.
generally accepted accounting principles and current industry practices. The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make certain estimates and
assumptions that affect the reported amounts and disclosures and may vary from
actual results.
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
Statements 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 in a manner that
approximates the constant yield method.
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
Series A Preferred Securities $ 19,345,000 December 5, 2002
Series A Preferred Securities $ 19,345,000 June 5, 2003
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 $40,000,000) 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 statements of income.
ACCOUNTING FOR DERIVATIVES AND HEDGING ACTIVITIES
Statement of Financial Accounting Standards No.133 ("SFAS 133"), "Accounting for
Derivative Instruments and Hedging Activities", 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 its financial instruments and
concluded that it holds freestanding derivative instruments but no embedded
derivative instruments at June 30, 2003. 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.
FOREIGN CURRENCY TRANSLATION
Assets denominated in foreign currencies are translated to U.S. 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.
NOTE 3--RECEIVABLE ARISING FROM PAYMENT FOR SECURITIES
Pursuant to the application of SFAS 125, as replaced by Statement of Financial
Accounting Standards No. 140 ("SFAS 140"), "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities" addresses 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, 2003 and December 31, 2002 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 based on management's prepayment assumptions (in thousands):
June 30, 2003
- -------------
Gross Gross
Unrealized Unrealized
Non-Collateral Amortized Cost Gains Losses Fair Value
-------------- -------------- ---------- ---------- ----------
Collateralized Mortgage Obligations:
Floating-Rate REMICs $ 3,596 $ 43 $ -- $ 3,639
Fixed-Rate REMICs 10,000 1,731 -- 11,731
Mortgage Backed Securities:
Agency ARMs 8,316 21 23 8,314
Agency Hybrid ARMs 12,617 194 5 12,806
Agency DUSs 390,343 61,281 -- 451,624
Agency Debentures 506,517 58,051 -- 564,568
---------- ---------- ---------- -----------
Total Non-Collateral $ 931,389 $ 121,321 $ 28 $ 1,052,682
---------- ---------- ---------- -----------
Collateral
- ----------
Collateralized Mortgage Obligations:
Floating-Rate REMICs $ 15,333 $ -- $ 198 $ 15,135
Fixed-Rate REMICs 11,659 104 -- 11,763
Mortgage Backed Securities:
Agency ARMs 9,125 157 13 9,269
Agency Hybrid ARMs 15,275 214 -- 15,489
Agency DUSs -- -- -- --
Agency Debentures -- -- -- --
---------- ---------- ---------- -----------
Total Collateral $ 51,392 $ 475 $ 211 $ 51,656
---------- ---------- ---------- -----------
June 30, 2003 Total Portfolio $ 982,781 $ 121,796 $ 239 $ 1,104,338
- ----------------------------- ========== ========== ========== ===========
December 31, 2002
- -----------------
Gross Gross
Unrealized Unrealized
Non-Collateral Amortized Cost Gains Losses Fair Value
-------------- -------------- ------------- ---------- ----------
Collateralized Mortgage Obligations:
Floating-Rate REMICs $ 6,286 $ 73 $ 2 $ 6,357
Fixed-Rate REMICs 10,654 1,652 -- 12,306
Mortgage Backed Securities:
Agency ARMs 14,182 116 -- 14,298
Agency Hybrid ARMs 18,275 216 7 18,484
Agency DUSs 365,509 53,065 -- 418,574
Agency Debentures 486,760 57,131 -- 543,891
---------- ---------- ---------- -----------
Total Non-Collateral $ 901,666 $ 112,253 $ 9 $ 1,013,910
---------- ---------- ---------- -----------
Collateral
- ----------
Collateralized Mortgage Obligations:
Floating-Rate REMICs $ 19,081 $ 11 $ 186 $ 18,906
Fixed-Rate REMICs 35,655 771 -- 36,426
Mortgage Backed Securities:
Agency ARMs 11,525 213 26 11,712
Agency Hybrid ARMs 19,399 234 35 19,598
Agency DUSs -- -- -- --
Agency Debentures -- -- -- --
---------- ---------- ---------- -----------
Total Collateral $ 85,660 $ 1,229 $ 247 $ 86,642
---------- ---------- ---------- -----------
December 31, 2002 Total Portfolio $ 987,326 $ 113,482 $ 256 $ 1,100,552
- --------------------------------- ========== ========== ========== ===========
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 based on management's prepayment assumptions (Actual maturities
may differ from maturities shown below due to prepayments) (in thousands):
June 30, 2003
- ------------- Due after 1 Due after 5
Due in 1 year through 5 through 10 Due after 10
Non-Collateral or less years years years Total
- -------------- ------------- ----------- ----------- ------------ ---------
Collateralized Mortgage Obligations:
Floating-Rate REMICs $ 2,518 $ 1,078 $ -- $ -- $ 3,596
Fixed-Rate REMICs -- 10,000 -- -- 10,000
Mortgage Backed Securities:
Agency ARMs 4,296 4,020 -- -- 8,316
Agency Hybrid ARMs 2,918 9,699 -- -- 12,617
Agency DUSs -- 247,558 142,785 -- 390,343
Agency Debentures -- 506,517 -- -- 506,517
------------- ------------- --------- ------ ------------
Total Non-Collateral $ 9,732 $ 778,872 $ 142,785 $ -- $ 931,389
------------- ------------- --------- ------ ------------
Collateral
- ----------
Collateralized Mortgage Obligations:
Floating-Rate REMICs $ 6,218 $ 9,115 $ -- $ -- $ 15,333
Fixed-Rate REMICs 11,659 -- -- -- 11,659
Mortgage Backed Securities:
Agency ARMs 461 4,852 122 3,690 9,125
Agency Hybrid ARMs 412 14,863 -- -- 15,275
Agency DUSs -- -- -- -- --
Agency Debentures -- -- -- -- --
------------- ------------- --------- ------ ------------
Total Collateral $ 18,750 $ 28,830 $ 122 $3,690 $ 51,392
------------- ------------- --------- ------ ------------
June 30, 2003 Total Portfolio $ 28,482 $ 807,702 $ 142,907 $3,690 $ 982,781
============= ============= ========= ====== ============
December 31, 2002
- -----------------
Due after 1 Due after 5
Due in 1 year through 5 through 10 Due after 10
Non-Collateral or less years years years Total
- -------------- ------------- ----------- ----------- ------------ ---------
Collateralized Mortgage Obligations:
Floating-Rate REMICs $ 4,854 $ 1,432 $ -- $ -- $ 6,286
Fixed-Rate REMICs 654 10,000 -- -- 10,654
Mortgage Backed Securities:
Agency ARMs 5,373 8,752 -- 57 14,182
Agency Hybrid ARMs 1,074 17,201 -- -- 18,275
Agency DUSs -- 170,495 195,014 -- 365,509
Agency Debentures -- 486,760 -- -- 486,760
------------- ------------- --------- ------ ------------
Total Non-Collateral $ 11,955 $ 694,640 $ 195,014 $ 57 $ 901,666
------------- ------------- --------- ------ ------------
Collateral
- ----------
Collateralized Mortgage Obligations:
Floating-Rate REMICs $ 546 $ 18,535 $ -- $ -- $ 19,081
Fixed-Rate REMICs 35,655 -- -- -- 35,655
Mortgage Backed Securities:
Agency ARMs 198 7,831 2,872 624 11,525
Agency Hybrid ARMs -- 19,399 -- -- 19,399
Agency DUSs -- -- -- -- --
Agency Debentures -- -- -- -- --
------------- ------------- --------- ------ ------------
Total Collateral $ 36,399 $ 45,765 $ 2,872 $ 624 $ 85,660
------------- ------------- --------- ------ ------------
December 31, 2002 Total Portfolio $ 48,354 $ 740,405 $ 197,886 $ 681 $ 987,326
- --------------------------------- ============= ============= ========= ====== ============
The breakdown of the Company's available-for-sale securities by category and
yield, before the result of hedges, is summarized below:
Due after 1 Due after 5
Due in 1 year through 5 through 10 Due after 10 Yield after
June 30, 2003 or less years years years Total Hedging
- ------------- ------------- ----------- ----------- ------------ --------- -----------
Collateralized Mortgage
Obligations:
Floating-Rate REMICs 2.42% 2.04% --% --% 2.22% 2.22%
Fixed-Rate REMICs 6.50 6.74 -- -- 6.58 4.84
Mortgage Backed Securities:
Agency ARMs 4.29 4.29 3.98 4.36 4.30 4.30
Agency Hybrid ARMs 5.29 4.47 -- -- 4.60 4.60
Agency DUSs -- 6.59 6.04 -- 6.38 1.43
Agency Debentures -- 5.97 -- -- 5.97 3.22
----- ----- ----- ----- ----- -----
Total 5.05% 6.06% 6.03% 4.36% 5.99% 2.63%
===== ===== ===== ===== ===== =====
June 30, 2002
- -------------
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 .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%
===== ===== ===== ===== ===== =====
NOTE 5--REDEEMABLE COMMON SECURITIES
General
The Company is authorized to issue up to 150,000 Common Securities; as of June
30, 2003 and December 31, 2002, 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 $479,909 and $718,065 for the periods ended June 30, 2003
and June 30, 2002, respectively. 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 counterparty to all cross currency and interest rate swaps is BNP PARIBAS.
The fair value of these swap transactions is disclosed in Note 7.
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, 2003 and December 31, 2002 were
obtained from independent market sources and are summarized in Note 4. The
carrying values of 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, was
$51,655,738 and $86,641,699 at June 30, 2003 and December 31, 2002,
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 was $(89,607,553)
and $(84,340,226) at June 30, 2003 and December 31, 2002, respectively, and are
reflected in "Other assets" and "Other liabilities".
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.
The fair value of the hedging instruments was $(91,895,202) and $(86,023,329) at
June 30, 2003 and December 31, 2002, respectively, 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 the
six months ended June 30, 2003, the Company recognized a loss of $(285,907) in
current year earnings related to the ineffective portion of fair value hedges.
The Company also recognized a gain of $604,546 in current year earnings related
to a cross currency swap that no longer qualified as a fair value hedging
instrument.
Cash Flow Hedges
For the six months ended June 30, 2003 and 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, 2003 and December 31, 2002, the Company had outstanding interest
rate and cross currency swap agreements with a notional principal amount of
$689,743,265 and $664,908,744, 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 Series A
Preferred Securities and the sale to the Branch of 53,011 Common Securities.
Together, such sales raised net capital of $1,030,115,873, which the Company
used to purchase the Initial Portfolio from the Branch. The Branch has
contributed $5,500,000 and $3,000,000 of additional paid-in capital on June 3,
2003 and December 3, 2002, respectively.
The Company's sole business is to acquire, hold and manage debt instruments,
largely consisting of mortgage obligations, in the Portfolio, 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, 2003
(the "2003 Period") and the Six month period ended June 30, 2002 (the "2002
Period").
For the 2003 Period and 2002 Period, the Company had revenues of $13,231,634 and
$18,955,294, respectively. These amounts consisted of interest income on the
investment securities, the unrealized gain/loss on hedged securities and
derivatives used as hedging instruments, and interest on deposits.
For the 2003 Period and 2002 Period, interest on the securities in the Portfolio
amounted to $24,053,366 and $24,308,698, respectively, representing an aggregate
yield of 5.99% and 5.91%, 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):
2003 2002
--------------------- ---------------------
Floating-Rate REMICs.......... $ 238,044 2.22% $ 599,073 2.75%
Fixed-Rate REMICs............. $ 1,023,517 6.58% $ 1,679,949 5.80%
Agency ARMs................... $ 439,750 4.30% $ 1,234,026 6.08%
Agency Hybrid ARMs............ $ 737,256 4.60% $ 1,533,286 5.00%
Agency DUS.................... $ 12,162,775 6.38% $ 10,140,311 6.30%
Agency Debentures............. $ 9,452,024 5.97% $ 9,122,053 6.11%
The yield on Agency Debentures is based on U.S. dollar denominated securities
which excludes the Japanese Yen denominated securities.
During the 2003 Period, the yields on the Agency DUSs, Agency Debentures and
Fixed-Rate REMICs were approximately 1.43%, 3.22% and 4.84%, respectively, when
taking into account the income from the derivative products used to hedge these
securities. During the 2002 Period, the yields on the Agency DUSs, Agency
Debentures and Fixed-Rate REMICS were 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 2003 Period and the 2002
Period was $992,729,767 and $1,007,497,983, respectively. This reflects the
following prepayments and reinvestments:
PREPAYMENTS 2003 2002
- ----------- ------------ ------------
Floating-Rate REMICs.................. $ 6,416,998 $ 16,111,453
Fixed-Rate REMICs..................... $ 24,650,408 $ 144,938
Agency ARMs........................... $ 8,138,955 $ 12,194,086
Agency Hybrid ARMs.................... $ 9,596,178 $ 19,986,447
Agency DUS ........................... $ 13,287,228 $ 1,732,352
Agency Debentures..................... $ -- $ --
REINVESTMENTS 2003 2002
- ------------- ------------ ------------
Floating-Rate REMICs.................. $ -- $ --
Fixed-Rate REMICs..................... $ -- $ 10,000,000
Agency ARMs........................... $ -- $ --
Agency Hybrid ARMs.................... $ -- $ --
Agency DUS $ 38,121,748 $ 9,319,961
Agency Debentures..................... $ 20,038,400 $ 9,960,584
The Company also recorded interest income from short-term investments for the
2003 Period and 2002 Period of $191,047 and $356,080, 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, 2003, and June 30, 2002, as calculated by aggregate amortized
cost, approximately 48.46% and 50.68%, respectively, 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 51.54% and 49.32%, respectively, consisted of
Agency Debentures. As of June 30, 2003, and June 30, 2002, floating rate
securities accounted for approximately 6.54% and 12.52%, respectively, 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 interest rates received on the
bonds are converted into prevailing floating rates.
The aggregate market value of the securities in the Portfolio as of June 30,
2003 and June 30, 2002 was higher than the amortized cost by approximately
12.37% and 6.82%, respectively, 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 Statements 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 2003 Period and 2002 Period totaled $719,993 and
$860,265, respectively. Operating expenses consisted largely of fees paid to the
Branch under the Services Agreement, fees to 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 for the 2003 Period and 2002 Period was $13,116,188 and
$18,095,029, respectively. As of June 30 2003, the Company has declared and paid
dividends as follows:
Security Amount Date Paid
- -------- ----- ---------
Series A Preferred $19,345,000 June 5, 2003
Series A Preferred $19,345,000 December 5, 2002
Series A Preferred $19,345,000 June 5, 2002
THREE MONTH PERIOD
The following discussion pertains to the Three month period ended June 30, 2003
(the "2003 Quarter") and the Three month period ended June 30, 2002 (the "2002
Quarter").
For the 2003 Quarter and 2002 Quarter, the Company had revenues of $6,344,728
and $10,666,723, respectively. These amounts consisted of interest income on the
investment securities, the unrealized gain/loss on hedged securities and
derivatives used as hedging instruments, and interest on deposits.
For the 2003 Quarter and 2002 Quarter, interest on the securities in the
Portfolio amounted to $12,082,830 and $12,126,136, respectively, representing an
aggregate yield of 6.01% and 5.96%, 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):
2003 2002
--------------------- ---------------------
Floating-Rate REMICs.......... $ 108,464 2.17% $ 267,161 2.68%
Fixed-Rate REMICs............. $ 416,534 6.59% $ 905,180 6.22%
Agency ARMs................... $ 199,998 4.29% $ 522,934 5.52%
Agency Hybrid ARMs............ $ 318,219 4.30% $ 692,018 4.94%
Agency DUSs................... $ 6,294,579 6.40% $ 5,120,104 6.35%
Agency Debentures............. $ 4,745,036 6.00% $ 4,618,739 6.16%
The yield on Agency Debentures is based on U.S. dollar denominated securities
which excludes the Japanese Yen denominated securities.
During the 2003 Quarter, the yields on the Agency DUSs, Agency Debentures and
Fixed-Rate REMICs were approximately 1.43%, 3.09% and 4.45%, respectively, when
taking into account the income from the derivative products used to hedge these
securities. During the 2002 Quarter, the yields on the Agency DUSs, Agency
Debentures and Fixed-Rate REMICS were approximately 1.90%, 5.33%, and 5.88%,
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 2003 Quarter and 2002
Quarter was $993,655,701 and $995,629,297, respectively. This reflects the
following prepayments and reinvestments:
PREPAYMENTS 2003 2002
- ----------- ------------ ------------
Floating-Rate REMICs............ $ 3,029,814 $ 7,123,812
Fixed-Rate REMICs............... $ 11,078,024 $ 67,624
Agency ARMs..................... $ 3,397,790 $ 4,209,579
Agency Hybrid ARMs.............. $ 5,061,559 $ 8,641,838
Agency DUS ..................... $ 12,232,739 $ 870,819
Agency Debentures............... $ -- $ --
REINVESTMENTS 2003 2002
- ------------- ------------ ------------
Floating-Rate REMICs............ $ -- $ --
Fixed-Rate REMICs............... $ -- $ 10,000,000
Agency ARMs..................... $ -- $ --
Agency Hybrid ARMs.............. $ -- $ --
Agency DUS ..................... $ 11,032,204 $ 9,319,961
Agency Debentures............... $ -- $ 9,960,584
The Company also recorded interest income from short-term investments for the
2003 Quarter and 2002 Quarter of $88,680 and $212,055, 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 2003 Quarter and 2002 Quarter totaled $387,951 and
$566,301, respectively. Operating expenses consisted largely of fees paid to the
Branch under the Services Agreement, fees to 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 for the 2003 Quarter and 2002 Quarter was $6,865,385
and $10,100,622, respectively.
Receivable Arising from Payment for Securities
Due to the potential consequences of a Shift Event (as defined in Item 1 Note 2
herein), 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, 2003 and
December 31, 2002, the receivable arising from payment for securities amounted
to $51,391,960 and $85,660,254, respectively. 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. Disclosures required
under SFAS 125, as replaced by SFAS 140, are included in Note 3.
Investment Income
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 ("SFAS 140"), "Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities, a replacement of SFAS 125", 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 statements.
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.
The low interest rate environment has adversely affected the Company's income.
The Company has not declared dividends on the Common Securities since June 2001
in order to retain earnings available for the payment of dividends to the
holders of the Series A Preferred Securities. Dividends to the Preferred
Securityholders may be paid out of (i) net income, determined without regard to
capital gains or losses, or (ii) amounts contributed by the Bank or the Branch
to the Company's capital. In the continued low interest rate environment in
2003, the Branch contributed $5,500,000 of additional paid-in capital, which was
used to facilitate the semi-annual payment of dividends to the holders of the
Series A Preferred Securities.
Based on 2003 projected earnings, the Company may require an additional cash
contribution from the Branch to ensure payment of preferred dividends. The
Company cannot make any assurances that further decreases in interest rates or a
sustained low interest rate environment will not have a further adverse effect
on the Company's income.
BNP PARIBAS Group's total and Tier 1 risk-based capital ratios at June 30 2003
were 12.8% and 8.9%, and at December 31, 2002 were 10.9% 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".
Critical Accounting Policies
Management believes its critical accounting policies relate to recognition and
valuation of financial instruments, as further defined in Item 1, Note 2.
Accounting and Reporting Developments
In May 2003, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 150 ("SFAS No. 150"), "Accounting for
Certain Financial Instruments with Characteristics of both Liabilities and
Equity". The statement requires that an issuer classify financial instruments
that are within its scope as a liability. Many of those instruments were
classified as equity under previous guidance. SFAS No. 150 is effective for all
financial instruments entered into or modified after May 31, 2003. Otherwise, it
is effective at the beginning of the first interim period beginning after June
15, 2003. The adoption of SFAS No. 150 will have no impact on the Company's
unaudited Balance Sheet or Statement of Income.
In April 2003, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS No. 149"), "Amendment of
Statement 133 on Derivative Instruments and Hedging Activities" ("SFAS 149").
SFAS 149 amends and clarifies accounting for derivative instruments, including
certain derivative instruments embedded in other contracts, and for hedging
activities under SFAS No. 133, and decisions made in connection with other FASB
projects dealing with financial instruments and in connection with
implementation issues raised in relation to the application of the definition of
a derivative and characteristics of a derivative that contains financing
components. In addition, it clarifies when a derivative contains a financing
component that warrants special reporting in the unaudited statement of cash
flows. SFAS 149 is effective for contracts entered into or modified after June
30, 2003 and for hedging relationships designated after June 30, 2003. We do not
anticipate SFAS 149 having a material impact on our unaudited Balance Sheet or
Statement of Income.
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 its financial instruments and
concluded that it holds freestanding derivative instruments but no embedded
derivative instruments at June 30, 2003. 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 periods ended June 30, 2003 and June 30, 2002, the Company recognized (loss)
gain of $(285,907) and $1,702,002, respectively, in earnings related to the
ineffective portion of fair value hedges. The fair value of these hedging
instruments was $(91,895,202) at June 30, 2003 and $(86,023,329) at December 31,
2002, 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
exposure.
The outstanding principal amount and estimated fair value as of June 30, 2003,
by each category of investment, is depicted in Item 1.
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.
During the six month period ended June 30, 2003, the interest rate environment
remained at a low but stable level. Therefore, the interest income generated by
the Portfolio was stabilized at the level of income at the end of 2002. This
situation has affected the Company's income through the floating rate component
of the portfolio (floating-rate securities and fixed-rate securities converted
to floating-rate instruments through interest rate swaps). It is anticipated
that this situation may continue for the remainder of 2003, and the income will
remain linked to the evolution of the yield curve.
The Company regularly reviews its hedging requirements. In the future, the
Company expects to enter into additional swaps and unwind part or all of the
initial and any future swaps. This strategy is implemented 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 purchases 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-seven interest rate swaps and six cross
currency swaps with BNP PARIBAS, as set out in the table below. In all but one
of these swaps, the Company pays a fixed coupon and receives floating rate
payments on the notional balances.
Fair Value at
June 30, 2003 Notional Balance
Value Date Maturity Date Fixed Rate Receive Rate (in 000's) (in 000's)
- --------------------- ------------------- ---------------- ------------------------ --------------- ----------------
November 25, 1998 March 26, 2008 JPY 1.75 U.S. Three Month LIBOR $ (2,651) $ 42,000
Plus Six Basis Points
November 25, 1998 October 9, 2007 JPY 2.125 U.S. Three Month LIBOR (4,733) 58,000
Plus Six Basis Points
November 25, 1998 August 25, 2008 U.S. 6.15 U.S. One Month LIBOR (2,951) 18,823
Plus Five Basis Points
May 25, 1999 May 25, 2009 U.S. 6.23 U.S. One Month LIBOR (2,165) 12,180
Plus One and Half Basis
Points
February 12, 1999 March 5, 2007 U.S. 6.68 U.S. Three Month LIBOR (8,915) 50,000
Minus Two Basis Points
February 11, 1999 March 14, 2007 U.S. 6.80 U.S. Three Month LIBOR (9,133) 50,000
Minus Two Basis Points
March 29, 1999 October 9, 2007 JPY 2.125 U.S. Three Month LIBOR (1,611) 30,000
Minus Two and Half Basis
Points
April 6, 1999 October 9, 2007 JPY 2.125 U.S. Three Month LIBOR (2,215) 26,400
Minus One Basis Point
June 25, 1999 June 25, 2009 U.S. 6.06 U.S. One Month LIBOR (4,201) 25,702
Plus Three and Half
Basis Points
February 25, 1999 February 25, 2009 U.S. 5.95 U.S. One Month LIBOR (3,125) 20,465
Plus Three Basis Points
July 1, 1999 June 25, 2009 U.S. 6.39 U.S. One Month LIBOR (2,826) 15,481
Plus Three and Half
Basis Points
September 27, 1999 March 25, 2008 U.S. 6.29 U.S. One Month LIBOR (6,743) 42,473
Plus Five Basis Points
November 26, 1999 April 25, 2009 U.S. 6.04 U.S. One Month LIBOR (2,459) 15,243
Plus Four Basis Points
September 27, 1999 March 25, 2009 U.S. 5.858 U.S. One Month LIBOR (4,168) 27,855
Plus Four Basis Points
August 1, 2000 December 1, 2007 U.S. 6.42 U.S. One Month LIBOR (1,171) 7,000
August 1, 2000 October 1, 2006 U.S. 7.20 U.S. One Month LIBOR (4,749) 28,918
Minus Two Basis Points
June 26, 2000 October 1, 2007 U.S. 6.68 U.S. One Month LIBOR (1,376) 8,191
Plus One and Half Basis
Points
June 26, 2000 October 1, 2008 U.S. 6.26 U.S. One Month LIBOR (1,442) 9,197
October 2, 2000 June 1, 2007 U.S. 7.007 U.S. One Month LIBOR (1,297) 7,394
Minus Two Basis Points
October 2, 2000 July 1, 2007 U.S. 7.405 U.S. One Month LIBOR (1,467) 7,523
Minus Two Basis Points
March 25, 2001 October 25, 2007 U.S. 6.94 U.S. One Month LIBOR (1,589) 9,674
Plus Two Basis Points
September 4, 2001 October 16, 2006 U.S. 7.20 U.S. One Month LIBOR (3,143) 19,279
Plus Two Basis Points
October 2, 2001 October 16, 2006 U.S. 7.20 U.S. One Month LIBOR (1,556) 9,639
Plus Seven Basis Points
January 2, 2002 October 16, 2006 U.S. 7.20 U.S. One Month LIBOR (1,547) 9,639
Plus Ten Basis Points
May 1, 2002 October 25, 2007 U.S. 6.63 U.S. One Month LIBOR (1,534) 9,168
Plus One Basis Point
May 3, 2002 August 25, 2007 U.S. 6.74 U.S. One Month LIBOR (1,730) 10,000
Plus One Basis Point
August 25, 2002 August 25, 2007 U.S. 4.90 U.S. One Month LIBOR (2,589) 26,500
Plus Five Basis Points
September 25, 2002 June 25, 2007 U.S. 7.007 U.S. One Month LIBOR (2,200) 12,786
Plus Seven Basis Points
October 25, 2002 May 25, 2006 U.S. 6.83 U.S. One Month LIBOR (1,224) 9,209
Plus Seven Basis Points
March 21, 2003 February 25, 2009 U.S. 5.945 U.S. One Month LIBOR (4,072) 26,985
Plus Nine Basis Points
May 8, 2003 July 25, 2006 U.S. 7.239 U.S. One Month LIBOR (1,687) 11,019
Plus Seven Basis Points
November 2, 2000 October 9, 2007 JPY 2.125 U.S. Three Month LIBOR 374 15,000
Minus Two Basis Points ----------- -----------
Total Swaps- Fair Value Hedges (Other liabilities) $ (91,895) $ 671,743
- -------------------------------------------------- ----------- -----------
January 17, 2001 March 26, 2008 JPY 1.750 U.S. 5.80 2,287 18,000
----------- -----------
Other Swap (Other asset) $ 2,287 $ 18,000
- ------------------------ ----------- -----------
Total Swap Portfolio $ (89,608) $ 689,743
- -------------------- ============ ===========
The fair value of the swap portfolio was $(89,607,553) and $(84,340,226) at June
30, 2003 and December 31, 2002, respectively. The change in fair value was
primarily due to changes in prevailing market interest rates.
The main feature of the mortgage securities is their sensitivity to the
prepayment of mortgage loans, creating a contraction risk when interest rates
decline and an extension risk when interest rates increase. The estimate of the
prepayment rate is given either by the CPR (Conditional Prepayment Rate) or the
PSA (Public Securities Association) prepayment model. Because of this risk, the
securities are valued based on their average life rather than on their stated
maturity date. The prepayment risk is evaluated and analyzed as this impacts the
structure of the portfolio and the re-investment policy.
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 based on management's prepayment assumptions (see Note 4 under
Item 1 for yield information) (actual maturities may differ from maturities
shown below due to prepayments) (in thousands):
June 30, 2003
-------------
Due Due Due Due Due Due Due
In after after after after after after
Non-Collateral 2003 2003 2004 2005 2006 2007 2008 Total
- -------------- ------ ------ ------ ------ ------ ------ ------ -------
Fixed-Rate Instruments:
Fixed-Rate REMICs.................... $ -- $ -- $ -- $ -- $ 10,000 $ -- $ -- $ 10,000
Agency DUS........................... -- -- -- 87,703 92,920 129,503 80,217 390,343
Agency Debentures ................... -- -- -- 109,970 335,984 60,563 -- 506,517
-------- -------- -------- -------- -------- -------- -------- --------
Total Fixed-Rate Instruments......... -- -- -- 197,673 438,904 190,066 80,217 906,860
-------- -------- -------- -------- -------- -------- -------- --------
Floating-Rate Instruments:
Floating-Rate REMICs................. 2,518 -- 1,078 -- -- -- -- 3,596
Agency ARMs.......................... -- 4,333 3,239 744 -- -- -- 8,316
Agency Hybrid ARMs................... -- 4,752 5,259 1,999 -- 607 -- 12,617
-------- -------- -------- -------- -------- -------- -------- --------
Total Floating-Rate Instruments...... 2,518 9,085 9,576 2,743 -- 607 -- 24,529
-------- -------- -------- -------- -------- -------- -------- --------
Total Non-Collateral................. $ 2,518 $ 9,085 $ 9,576 $200,416 $438,904 $190,673 $ 80,217 $931,389
-------- -------- -------- -------- -------- -------- -------- --------
Collateral
- ----------
Fixed-Rate Instruments:
Fixed-Rate REMICs.................... $ 11,659 $ -- $ -- $ -- $ -- $ -- $ -- $ 11,659
Agency DUS........................... -- -- -- -- -- -- -- --
Agency Debentures ................... -- -- -- -- -- -- -- --
-------- -------- -------- -------- -------- -------- -------- --------
Total Fixed-Rate Instruments......... 11,659 -- -- -- -- -- -- 11,659
-------- -------- -------- -------- -------- -------- -------- --------
Floating-Rate Instruments:
Floating-Rate REMICs................. 97 6,892 7,019 1,325 -- -- -- 15,333
Agency ARMs.......................... 43 418 4,583 --- 269 -- 3,812 9,125
Agency Hybrid ARMs................... -- 412 9,068 5,795 -- -- -- 15,275
-------- -------- -------- -------- -------- -------- -------- --------
Total Floating-Rate Instruments...... 140 7,722 20,670 7,120 269 -- 3,812 39,733
-------- -------- -------- -------- -------- -------- -------- --------
Total Collateral..................... $ 11,799 $ 7,722 $ 20,670 $ 7,120 $ 269 $ -- $ 3,812 $ 51,392
-------- -------- -------- -------- -------- -------- -------- --------
June 30, 2003 Total Portfolio $ 14,317 $ 16,807 $ 30,246 $207,536 $439,173 $190,673 $ 84,029 $982,781
======== ======== ======== ======== ======== ======== ======== ========
December 31, 2002
-----------------
Due Due Due Due Due Due Due
In after after after after after after
Non-Collateral 2003 2003 2004 2005 2006 2007 2008 Total
- -------------- ------ ------ ------ ------ ------ ------ ------ -------
Fixed-Rate Instruments:
Fixed-Rate REMICs.................... $ 654 $ -- $ -- $ -- $ 10,000 $ -- $ -- $ 10,654
Agency DUS........................... -- -- -- 123,994 46,501 114,986 80,028 365,509
Agency Debentures ................... -- -- -- 172,637 314,123 -- -- 486,760
-------- -------- -------- -------- -------- -------- -------- --------
Total Fixed-Rate Instruments......... 654 -- -- 296,631 370,624 114,986 80,028 862,923
-------- -------- -------- -------- -------- -------- -------- --------
Floating-Rate Instruments:
Floating-Rate REMICs................. 4,854 -- 1,432 -- -- -- -- 6,286
Agency ARMs.......................... 5,373 3,791 -- 4,961 -- -- 57 14,182
Agency Hybrid ARMs................... 1,074 15,830 1,371 -- -- -- -- 18,275
-------- -------- -------- -------- -------- -------- -------- --------
Total Floating-Rate Instruments...... 11,301 19,621 2,803 4,961 -- -- 57 38,743
-------- -------- -------- -------- -------- -------- -------- --------
Total Non-Collateral................. $ 11,955 $ 19,621 $ 2,803 $301,592 $370,624 $114,986 $ 80,085 $901,666
-------- -------- -------- -------- -------- -------- -------- --------
Collateral
- ----------
Fixed-Rate Instruments:
Fixed-Rate REMICs.................... $ 35,655 $ -- $ -- $ -- $ -- $ -- $ -- $ 35,655
Agency DUS........................... -- -- -- -- -- -- -- --
Agency Debentures ................... -- -- -- -- -- -- -- --
-------- -------- -------- -------- -------- -------- -------- --------
Total Fixed-Rate Instruments......... 35,655 -- -- -- -- -- -- 35,655
-------- -------- -------- -------- -------- -------- -------- --------
Floating-Rate Instruments:
Floating-Rate REMICs................. 546 8,331 10,204 -- -- -- -- 19,081
Agency ARMs.......................... 198 5,805 1,322 331 373 1,384 2,112 11,525
Agency Hybrid ARMs................... -- 13,622 -- 5,777 -- -- -- 19,399
-------- -------- -------- -------- -------- -------- -------- --------
Total Floating-Rate Instruments...... 744 27,758 11,526 6,108 373 1,384 2,112 50,005
-------- -------- -------- -------- -------- -------- -------- --------
Total Collateral..................... $ 36,399 $ 27,758 $ 11,526 $ 6,108 $ 373 $ 1,384 $ 2,112 $ 85,660
-------- -------- -------- -------- -------- -------- -------- --------
December 31, 2002 Total Portfolio $ 48,354 $ 47,379 $ 14,329 $307,700 $370,997 $116,370 $ 82,197 $987,326
======== ======== ======== ======== ======== ======== ======== ========
Item 4.
CONTROLS AND PROCEDURES
Within the 90 days prior to the date of this quarterly report for the period
ended June 30, 2003, the Company carried out an evaluation under the supervision
and with the participation of the Company's management, including the President
and Chief Financial Officer, of the effectiveness of the design and operation of
the Company's disclosure controls and procedures. There are inherent limitations
to the effectiveness of any system of disclosure controls and procedures,
including the possibility of human error and the circumvention or overriding of
the controls and procedures. Accordingly, even effective disclosure controls and
procedures can only provide reasonable assurance of achieving their control
objectives. Based upon and as of the date of each of the Company's evaluations,
the President and Chief Financial Officer concluded that the disclosure controls
and procedures are effective to provide reasonable assurance that the
information required to be disclosed in the reports the Company files and
submits under the Exchange Act is recorded, processed, summarized and reported
as when required. There has been no change in the Company's internal control
over financial reporting during the Company's quarter ended June 30, 2003 that
has materially affected, or is reasonably likely to materially affect, the
Company's internal control over financial reporting.
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 dividends
31.1) Certification of Chief Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
31.2) Certification of President pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
32) Certification pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
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, 2003 By /s/ Oliver Meisel
--------------------
Olivier Meisel
President and
Director
Date: August 14, 2003 By /s/ Thomas Clyne
--------------------
Thomas Clyne
Chief Financial Officer
and Director