Back to GetFilings.com
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: SEPTEMBER 30, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _______________ TO _________________
COMMISSION FILE NUMBER: 1-13447
ANNALY MORTGAGE MANAGEMENT, INC.
(Exact name of Registrant as specified in its Charter)
MARYLAND 22-3479661
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
1211 AVENUE OF THE AMERICAS, SUITE 2902
NEW YORK, NEW YORK
(Address of principal executive offices)
10036
(Zip Code)
(212) 696-0100 (Registrant's
telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all documents and
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days:
Yes _X_ No___
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2) of the Exchange Act:
Yes _X_ No___
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the last practicable date:
Class Outstanding at November 5, 2004
Common Stock, $.01 par value 121,256,222
ANNALY MORTGAGE MANAGEMENT, INC.
FORM 10-Q
INDEX
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Statements of Financial Condition- September 30, 2004 (Unaudited)
and December 31, 2003 1
Statements of Operations and Comprehensive Income (Loss)
(Unaudited) for the quarters and nine months ended
September 30, 2004 and September 30, 2003, respectively. 2
Statements of Stockholders' Equity (Unaudited) for the nine
months ended September 30, 2004 3
Statements of Cash Flows (Unaudited) for the quarters and
nine months ended September 30, 2004 and September 30, 2003
respectively. 4
Notes to Financial Statements (Unaudited) 5-14
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 15-30
Item 3. Quantitative and Qualitative Disclosures about Market Risk 31
Item 4. Controls and Procedures 32
Part II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 33
SIGNATURES 34
CERTIFICATIONS 35-38
PART I.
ITEM 1. FINANCIAL STATEMENTS
ANNALY MORTGAGE MANAGEMENT, INC.
STATEMENTS OF FINANCIAL CONDITION
(DOLLARS IN THOUSANDS, EXCEPT FOR SHARE DATA)
SEPTEMBER 30,
2004
(CONSOLIDATED) DECEMBER 31,
(UNAUDITED) 2003
----------- -----------
ASSETS
Cash and cash equivalents $ 6,772 $ 247
Mortgage-Backed Securities, at fair value 17,571,593 11,956,512
Agency debentures, at fair value 639,437 978,167
Accrued interest receivable 74,291 53,743
Receivable for advisory and service fees 1,637 --
Intangible for customer relationships 15,613 --
Goodwill 23,122 --
Other assets 1,371 1,617
----------- -----------
Total assets $18,333,836 $12,990,286
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Repurchase agreements $15,579,196 $11,012,903
Payable for Mortgage-Backed Securities purchased 999,380 761,115
Accrued interest payable 24,483 14,989
Dividends payable 60,618 45,155
Accounts payable 6,508 2,887
Other liabilities 4,061 4,017
----------- -----------
Total liabilities 16,674,246 11,841,066
----------- -----------
Stockholders' Equity:
7.875% Series A Cumulative Redeemable
Preferred Stock:
8,000,000 authorized, 4,250,000 shares issued
and outstanding 102,708 --
Common stock: par value $.01 per share;
500,000,000 121,235,702 and 96,074,096 shares
issued and outstanding, respectively 1,212 961
Additional paid-in capital 1,638,309 1,194,159
Accumulated other comprehensive income (loss) (91,987) (47,261)
Retained earnings 9,348 1,361
----------- -----------
Total stockholders' equity 1,659,590 1,149,220
----------- -----------
Total liabilities and stockholders' equity $18,333,836 $12,990,286
=========== ===========
See notes to financial statements.
1
PART I.
ITEM 1. FINANCIAL STATEMENTS
ANNALY MORTGAGE MANAGEMENT, INC.
STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
FOR THE FOR THE NINE
QUARTER ENDED FOR THE MONTHS ENDED FOR THE NINE
SEPTEMBER 30, QUARTER ENDED SEPTEMBER 30, MONTHS ENDED
2004 SEPTEMBER 30, 2004 SEPTEMBER 30,
(CONSOLIDATED) 2003 (CONSOLIDATED) 2003
------------------ ------------------- ------------------ -----------------
INTEREST INCOME $138,970 $66,855 $375,545 $248,247
INTEREST EXPENSE 70,173 43,922 176,124 139,740
------------------ ------------------- ------------------ -----------------
NET INTEREST INCOME 68,797 22,933 199,421 108,507
OTHER INCOME:
Investment advisory and service fees, 4,811 - 6,369 -
Gain on sale of mortgage-backed securities 1,350 9,656 4,071 40,907
------------------ ------------------- ------------------ -----------------
TOTAL OTHER INCOME 6,161 9,656 10,440 40,907
------------------ ------------------- ------------------ -----------------
EXPENSES:
Distribution fees 1,024 - 1,322 -
General and administrative expenses 6,159 4,110 17,167 12,008
------------------ ------------------- ------------------ -----------------
TOTAL EXPENSES 7,183 4,110 18,489 12,008
INCOME BEFORE INCOME TAXES 67,775 28,479 191,372 137,406
- -
INCOME TAXES 1,155 2,074
------------------ ------------------- ------------------ -----------------
NET INCOME 66,620 28,479 189,298 137,406
DIVIDENDS ON PREFERRED STOCK 2,082 - 4,080 -
------------------ ------------------- ------------------ -----------------
NET INCOME AVAILABLE TO COMMON SHAREHOLDERS
$64,538 $28,479 $185,218 $137,406
================== =================== ================== =================
NET INCOME PER SHARE AVAILABLE TO COMMON
SHAREHOLDERS:
Basic $0.53 $0.30 $1.58 $1.51
================== =================== ================== =================
Diluted $0.53 $0.30 $1.58 $1.50
================== =================== ================== =================
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING:
Basic 120,802,814 94,685,685 117,208,336 90,929,196
================== =================== ================== =================
Diluted 120,994,191 95,500,486 117,439,248 91,750,472
================== =================== ================== =================
NET INCOME $66,620 28,479 189,298 137,406
------------------ ------------------- ------------------ -----------------
COMPREHENSIVE INCOME (LOSS)
Unrealized gain (loss) on available-for
sale 86,852 (43,405) (40,655) (86,474)
securities
Less: reclassification adjustment for net
gains (losses) included in net income (1,350) (9,656) (4,071) (40,907)
------------------ ------------------- ------------------ -----------------
Other comprehensive income (loss) 85,502 (53,061) (44,726) (127,381)
------------------ ------------------- ------------------ -----------------
COMPREHENSIVE INCOME (LOSS) $152,122 $(24,582) $144,572 $10,025
================== =================== ================== =================
See notes to financial statements.
2
PART I
ITEM 1. FINANCIAL STATEMENTS
ANNALY MORTGAGE MANAGEMENT, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
COMMON ADDITIONAL OTHER
PREFERRED STOCK PAID-IN COMPREHENSIVE COMPREHENSIVE RETAINED
STOCK PAR VALUE CAPITAL INCOME (LOSS) INCOME (LOSS) EARNINGS TOTAL
---------- ----------- ------------- -------------- --------------- ---------- ------------
BALANCE, JANUARY 1, 2004 $ 961 $1,194,159 ($47,261) $ 1,361 $1,149,220
Net Income $ 58,843 58,843
Other comprehensive income:
Unrealized net gain on securities,
net of reclassification adjustment 51,761 51,761
--------------
Comprehensive income $110,604 110,604
==============
Proceeds from issuance of 7.87%
Series A cumulative redeemable
preferred stock $102,870 102,870
Exercise of stock options 459 459
Proceeds from direct purchase and
dividend reinvestment 1 734 735
Net proceeds from equity shelf program 10 20,041 20,051
Net proceeds from follow-on offering 207 363,385 363,592
Common dividend declared for the
quarter ended March 31, 2004,
$0.50 per share (58,943) (58,943)
---------- ----------- ------------- --------------- ---------- ------------
BALANCE, MARCH 31, 2004 102,870 1,179 1,578,778 4,500 1,261 1,688,588
Net Income $ 63,835 63,835
Other comprehensive loss:
Unrealized net loss on securities,
net of reclassification adjustment (181,989) (181,989)
--------------
Comprehensive loss ($118,154) (118,154)
==============
Preferred stock offering (162) (162)
Exercise of stock options 202 202
Proceeds from direct purchase and
dividend reinvestment 1 1,208 1,209
Common shares issued in FIDAC
acquisition 22 40,478 40,500
Preferred dividend for the quarter
ended June 30, 2004, $0.47 per share (1,998) (1,998)
Common dividend declared for the
quarter ended June 30, 2004,
$0.48 per share (57,674) (57,674)
---------- ----------- ------------- --------------- ---------- ------------
BALANCE, JUNE 30, 2004 102,708 1,202 1,620,666 (177,489) 5,424 1,552,511
Net Income $ 66,620 66,620
Other comprehensive income:
Unrealized net gain on securities,
net of reclassification adjustment 85,502 85,502
--------------
Comprehensive income $152,122 152,122
==============
Proceeds from dividend reinvestment 175 175
Net proceeds from equity shelf program 10 17,468 17,478
Preferred dividend declared for the
quarter ended September 30, 2004,
$0.49 per share (2,082) (2,082)
Common dividend declared for the
quarter ended September 30, 2004,
$0.50 per share (60,614) (60,614)
---------- ----------- ------------- --------------- ---------- ------------
BALANCE, SEPTEMBER 30, 2004 $102,708 $1,212 $1,638,309 ($91,987) $9,348 $1,659,590
========== =========== ============= =============== ========== ============
See notes to financial statements.
3
PART I
ITEM 1. FINANCIAL STATEMENTS
ANNALY MORTGAGE MANAGEMENT, INC.
STATEMENTS OF CASH FLOWS
(UNAUDITED)
(DOLLARS IN THE THOUSANDS)
FOR THE QUARTER FOR THE QUARTER FOR THE NINE FOR THE NINE
ENDED ENDED MONTHS ENDED MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2004 2003 2004 2003
----------------- ------------------ ---------------- ------------------
CASH FLOWS FROM OPERATING ACTIVITIES: $66,620 $28,479 $189,298 $137,406
Net income
Adjustments to reconcile net income to net cash
provided by operating activities:
Amortization of Mortgage Backed Securities
premiums and discounts, net 39,692 72,047 137,334 178,180
Amortization of intangibles 56 -- 74 -
Gain on sale of Mortgage-Backed Securities (1,350) (9,656) (4,071) (40,907)
Stock option expense -- -- 307 60
Market value adjustment on long-term
repurchase Agreement 631 (313) 108 1,783
Decrease (increase) in accrued interest receivable,
net of interest purchased on securities 1,680 4,071 (19,366) (4,248)
Decrease (increase) in other assets 309 (129) (878) (394)
Decrease (increase) in advisory and service fees
receivable 7 -- (74) -
Increase (decrease) in accrued interest payable 4,524 (2,919) 9,493 (1,067)
Increase in accounts payable 2,459 945 2,812 1,240
----------------- ------------------ ---------------- ------------------
Net cash provided by operating activities 114,628 92,525 315,037 272,053
----------------- ------------------ ---------------- ------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of Mortgage-Backed Securities (2,365,948) (2,571,157) (10,898,374) (9,788,410)
Purchase of Agency debentures -- (394,940) (250,000) (1,735,940)
Proceeds from sale of Mortgage-Backed Securities 130,671 596,487 414,768 2,708,880
Proceeds from called Agency debentures 345,000 575,000 595,000 746,000
Principal payments of Mortgage-Backed Securities 1,582,969 2,686,374 4,921,041 6,736,696
Cash from FIDAC acquisition -- 2,526
----------------- ------------------ ---------------- ------------------
Net cash provided by (used in) investing
activities (307,308) 891,764 (5,215,039) (1,332,774)
----------------- ------------------ ---------------- ------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from repurchase agreements 38,197,654 32,273,478 104,975,795 87,956,308
Principal payments on repurchase agreements (37,960,601) (33,234,016) (100,409,722) (86,917,886)
Proceeds from exercise of stock options -- 17 355 327
Proceeds from direct purchase and dividend
reinvestment 175 1,004 2,118 3,306
Net proceeds from follow-on offerings -- 34,725 363,592 186,040
Proceeds from preferred offering -- -- 102,708 --
Net proceeds from equity shelf program 17,479 -- 37,530 --
Dividends paid (59,754) (56,420) (165,849) (164,720)
----------------- ------------------ ---------------- ------------------
Net cash provided by (used in)
financing activities 194,953 (981,212) 4,906,527 1,063,375
----------------- ------------------ ---------------- ------------------
Net increase in cash and cash equivalents 2,273 3,077 6,525 2,655
Cash and cash equivalents, beginning of period 4,499 304 247 726
----------------- ------------------ ---------------- ------------------
Cash and cash equivalents, end of period 6,772 $3,381 6,772 $3,381
================= ================== ================ ==================
Supplemental disclosure of cash flow information:
Interest paid $65,649 $46,842 $166,631 $140,807
================= ================== ================ ==================
Noncash financing activities:
Net change in unrealized loss on available-for-
sale securities net of reclassification adjustment $85,502 ($53,061) ($44,726) ($127,381)
================= ================== ================ ==================
Dividends declared, not yet paid $60,618 $26,876 $60,618 $26,876
================= ================== ================ ==================
Noncash investing and financing activities:
Noncash acquisition of FIDAC -- -- $40,500 --
================= ================== ================ ==================
See notes to financial statements.
4
ANNALY MORTGAGE MANAGEMENT, INC.
NOTES TO FINANCIAL STATEMENTS
FOR THE QUARTERS AND NINE MONTHS ENDED SEPTEMBER 30, 2004 AND SEPTEMBER 30, 2003
(UNAUDITED)
- --------------------------------------------------------------------------------
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Annaly Mortgage Management, Inc. (the "Company") was incorporated in
Maryland on November 25, 1996. The Company commenced its operations of
purchasing and managing an investment portfolio of mortgage-backed securities on
February 18, 1997, upon receipt of the net proceeds from the private placement
of equity capital. An initial public offering was completed on October 14, 1997.
The Company acquired Fixed Income Discount Advisory Company ("FIDAC") on June 4,
2004 (See Note 2). FIDAC is a registered investment advisor and is a taxable
REIT subsidiary of the Company.
A SUMMARY OF THE COMPANY'S SIGNIFICANT ACCOUNTING POLICIES FOLLOWS:
BASIS OF PRESENTATION - The accompanying unaudited financial statements
have been prepared in conformity with the instructions to Form 10-Q and Article
10, Rule 10-01 of Regulation S-X for interim financial statements. Accordingly,
they do not include all of the information and footnotes required by accounting
principles generally accepted in the United States of America ("GAAP"). The
interim financial statements are unaudited; however, in the opinion of the
Company's management, all adjustments, consisting only of normal recurring
accruals, necessary for a fair statement of the results of operations have been
included. These unaudited financial statements should be read in conjunction
with the audited financial statements included in the Company's Annual Report on
Form 10-K for the year ended December 31, 2003. The nature of the Company's
business is such that the results of any interim period are not necessarily
indicative of results for a full year. Certain reclassifications have been made
to prior period financial statements, where appropriate, to conform to the
current period presentation. The consolidated unaudited financial statements as
of and for the quarter ended September 30, 2004 include the accounts of the
Company and, from June 4, 2004, of FIDAC. All material intercompany balances
have been eliminated.
CASH AND CASH EQUIVALENTS - Cash and cash equivalents includes cash on
hand and money market funds. The carrying amounts of cash equivalents
approximate their value.
MORTGAGE-BACKED SECURITIES AND AGENCY DEBENTURES - The Company invests
primarily in mortgage pass-through certificates, collateralized mortgage
obligations and other mortgage-backed securities representing interests in or
obligations backed by pools of mortgage loans (collectively, "Mortgage-Backed
Securities"). The Company also invests in Federal Home Loan Bank ("FHLB"),
Federal Home Loan Mortgage Corporation ("FHLMC"), and Federal National Mortgage
Association ("FNMA") debentures. The Mortgage-Backed Securities and agency
debentures are collectively referred to herein as "Investment Securities."
Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting
for Certain Investments in Debt and Equity Securities," requires the Company to
classify its Investment Securities as either trading investments,
available-for-sale investments or held-to-maturity investments. Although the
Company generally intends to hold most of its Investment Securities until
maturity, it may, from time to time, sell any of its Investment Securities as
part of its overall management of its portfolio. Accordingly, SFAS No. 115
requires the Company to classify all of its Investment Securities as
available-for-sale. All assets classified as available-for-sale are reported at
estimated fair value, based on market prices provided by certain dealers who
make markets in these financial instruments, with unrealized gains and losses
excluded from earnings and reported as a separate component of stockholders'
equity.
Unrealized losses on Investment Securities that are considered other than
temporary, as measured by the amount of decline in fair value attributable to
factors other than temporary, are recognized in income and the cost basis of the
Investment Securities is adjusted. There were no such adjustments for the
quarters ended September 30, 2004 or September 30, 2003.
5
Interest income is accrued based on the outstanding principal amount of
the Investment Securities and their contractual terms. Premiums and discounts
associated with the purchase of the Investment Securities are amortized into
interest income over the projected lives of the securities using the interest
method. The Company's policy for estimating prepayment speeds for calculating
the effective yield is to evaluate historical performance, street consensus
prepayment speeds, and current market conditions.
Investment Securities transactions are recorded on the trade date.
Purchases of newly issued securities are recorded when all significant
uncertainties regarding the characteristics of the securities are removed,
generally shortly before settlement date. Realized gain and losses on sale of
Investment Securities are determined on the specific identification basis.
CREDIT RISK - At September 30 2004 and December 31, 2003, the Company has
limited its exposure to credit losses on its portfolio of Investment Securities
by only purchasing securities issued by FHLMC, FNMA, Government National
Mortgage Association ("GNMA"), or FHLB. The payment of principal and interest on
the FHLMC and FNMA Mortgage-Backed Securities are guaranteed by those respective
agencies and the payment of principal and interest on the GNMA Mortgage-Backed
Securities are backed by the full-faith-and-credit of the U.S. government. At
September 30 2004 and December 31, 2003 all of the Company's Investment
Securities have an actual or implied "AAA" rating.
REPURCHASE AGREEMENTS - The Company finances the acquisition of its
Investment Securities through the use of repurchase agreements. Repurchase
agreements are treated as collateralized financing transactions and are carried
at their contractual amounts, including accrued interest, as specified in the
respective agreements. Accrued interest is recorded as a separate line item on
the statement of financial condition.
INCOME TAXES - The Company has elected to be taxed as a Real Estate
Investment Trust ("REIT") and intends to comply with the provisions of the
Internal Revenue Code of 1986, as amended (the "Code"), with respect thereto.
Accordingly, the Company will not be subjected to federal income tax to the
extent of its distributions to shareholders and as long as certain asset, income
and stock ownership tests are met. The Company and FIDAC have made a joint
election to treat FIDAC as a taxable REIT subsidiary. As such, FIDAC will be
taxable as a domestic C corporation and subject to federal and state and local
income taxes based upon its taxable income.
USE OF ESTIMATES - The preparation of financial statements in conformity
with GAAP requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. Actual results could
differ from those estimates.
RECENT ACCOUNTING PRONOUNCEMENTS - In March 2004, the Emerging Issues Task
Force, or EITF, reached a consensus on Issue No. 03-1, THE MEANING OF
OTHER-THAN-TEMPORARY IMPAIRMENT AND ITS APPLICATION TO CERTAIN INVESTMENTS. This
Issue provides clarification with respect to the meaning of other-than-temporary
impairment and its application to investments classified as either
available-for-sale or held-to-maturity under SFAS, No. 115, ACCOUNTING FOR
CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES, (including individual
securities and investments in mutual funds), and investments accounted for under
the cost method or the equity method. Certain provisions of this Issue have been
deferred to a later date.
2. FIXED INCOME DISCOUNT ADVISORY COMPANY
MERGER WITH FIXED INCOME DISCOUNT ADVISORY COMPANY
In June 2001, the FASB issued SFAS No. 141, "Business Combinations," which
provides that all business combinations initiated after June 30, 2001 be
accounted for using the purchase method. Under the purchase method, net assets
and results of operations of acquired companies are included in the consolidated
financial statements from the date of acquisition. In addition, SFAS 141
provides that the cost of an acquired entity must be allocated to the assets
acquired, including identifiable intangible assets, and the liabilities assumed
based on their estimated fair values at the date of acquisition. The excess of
cost over the fair value of the net assets acquired must be recognized as
goodwill.
6
On December 31, 2003, the Company entered into a merger agreement with
FIDAC. At the annual meeting of the Company's shareholders held on May 27, 2004,
shareholders voted to approve the merger. The merger closed before the opening
of business on June 4, 2004. The merger was accounted for using the purchase
method of accounting in accordance with SFAS No. 141. Accordingly, the
consolidated balance sheet as of September 30, 2004 includes the effects of the
merger and the Company's application of the purchase method of accounting.
Additionally, the consolidated statements of operations and cash flows for the
respective periods ended September 30, 2004 include the results of the Company
and FIDAC for the period from June 4, 2004 to September 30, 2004.
Upon completion of the merger and pursuant to the merger agreement, FDC
Merger Sub, ("Merger Sub"), the Company's wholly owned subsidiary created solely
for the purpose of effectuating the merger, merged with and into FIDAC. As a
result of the merger, Merger Sub ceased to exist, and FIDAC is the surviving
corporation and operates as the Company's wholly owned taxable REIT subsidiary.
At the time of the merger, each FIDAC shareholder received approximately 2,935
shares of the Company's common stock for each share of FIDAC stock the
shareholder owned and has the right to receive additional shares of the
Company's common stock in the future, based on FIDAC achieving specific
performance goals.
The Company maintains its Real Estate Investment Trust ("REIT") status for
U.S. federal income tax purposes and the Company and FIDAC made a taxable REIT
subsidiary election. The taxable REIT subsidiary is fully subject to corporate
income tax. Income from the taxable REIT subsidiary may be retained by the
subsidiary or distributed to the parent REIT company.
The value of the shares of the Company's common stock issued to the FIDAC
shareholders immediately upon the consummation of the acquisition was fixed at
$40,500,000 based upon the closing price of the Company's common stock on
December 31, 2003, and was paid on June 4, 2004 by delivering 2,201,080 shares
of the Company's common stock.
A summary of the fair values of the net assets acquired is as follows:
(dollars in thousands)
- ------------------------------------------------------ -------------------------
Cash and cash equivalents $ 2,526
Receivable for advisory fees and services 1,564
Other assets 591
Customer relationships 15,613
FIDAC trademark 250
Non-compete agreements 140
Goodwill 22,905
Accounts payable (748)
-------------------------
Total fair value of net assets, including
acquisition cost $42,841
=========================
The total amount of goodwill represents the purchase price in excess of the fair
value of the net assets acquired. Under SFAS No. 142, "Goodwill and Other
Intangible Assets," goodwill is not amortized, but tested at least annually for
impairment. Customer relationships are deemed by the Company to have an
indefinite life based on a lack of attrition history and management's
expectation of continued service to FIDAC clients and, accordingly, are not
amortized. Instead, they are required to be tested at least annually for
impairment. FIDAC trademark and non-compete agreements are considered intangible
assets subject to amortization over their estimated life of three years and one
year, respectively. For the quarter ended September 30, 2004, amortization
expense related to these intangibles was $56,000. A deferred tax liability of
$126,000 arising from the temporary difference between the book and tax basis
relating to these amortizable intangible is included in "Other liabilities" in
the Statement of Financial Condition as of September 30, 2004.
7
3. MORTGAGE-BACKED SECURITIES
The following table pertains to the Company's Mortgage-Backed Securities
classified as available-for-sale as of September 30, 2004 and December 31, 2003,
which are carried at their fair value:
FEDERAL HOME FEDERAL NATIONAL GOVERNMENT TOTAL
LOAN MORTGAGE MORTGAGE NATIONAL MORTGAGE MORTGAGE-BACKED
SEPTEMBER 30, 2004 CORPORATION ASSOCIATION ASSOCIATION SECURITIES
------------------- --------------------- -------------------- ------------------
(dollars in thousands)
Mortgage-Backed Securities, gross $5,857,749 $11,035,187 $355,966 $17,248,902
Unamortized discount (215) (433) (117) (765)
Unamortized premium 128,309 275,808 5,803 409,920
------------------- --------------------- -------------------- ------------------
Amortized cost 5,985,843 11,310,562 361,652 17,658,057
Gross unrealized gains 11,388 12,103 1,297 24,788
Gross unrealized losses (31,843) (77,251) (2,158) (111,252)
------------------- --------------------- -------------------- ------------------
Estimated fair value $5,965,388 $11,245,414 $360,791 $17,571,593
=================== ===================== ==================== ==================
GROSS UNREALIZED GROSS UNREALIZED ESTIMATED FAIR
AMORTIZED COST GAIN LOSS VALUE
------------------- --------------------- -------------------- ------------------
(dollars in thousands)
Adjustable rate $12,922,827 $21,417 ($66,272) $12,877,972
Fixed rate 4,735,230 3,371 (44,980) 4,693,621
------------------- --------------------- -------------------- ------------------
Total $17,658,057 $24,788 ($111,252) 17,571,593
=================== ===================== ==================== ==================
FEDERAL HOME FEDERAL NATIONAL GOVERNMENT TOTAL
LOAN MORTGAGE MORTGAGE NATIONAL MORTGAGE MORTGAGE-BACKED
DECEMBER 31, 2003 CORPORATION ASSOCIATION ASSOCIATION SECURITIES
------------------- --------------------- --------------------- -----------------
(dollars in thousands)
Mortgage-Backed Securities, gross $3,763,364 $7,509,544 $419,223 $11,692,130
Unamortized discount (198) (209) (1,441)
(1,034)
Unamortized premium 87,726 206,580 7,005 301,311
------------------- --------------------- --------------------- -----------------
Amortized cost 3,850,892 7,715,090 426,019 11,992,000
Gross unrealized gains 8,301 16,133 452 24,886
Gross unrealized losses (18,114) (39,984) (2,277) (60,374)
------------------- --------------------- --------------------- -----------------
Estimated fair value $3,841,079 $7,691,239 $424,194 $11,956,512
=================== ===================== ===================== =================
GROSS UNREALIZED GROSS UNREALIZED ESTIMATED FAIR
AMORTIZED COST GAIN LOSS VALUE
------------------- --------------------- --------------------- -----------------
(dollars in thousands)
Adjustable rate $8,565,873 $13,118 ($35,490) $8,543,501
Fixed rate 3,426,127 11,768 (24,884) 3,413,011
------------------- --------------------- --------------------- -----------------
Total $11,992,000 $24,886 ($60,374) $11,956,512
=================== ===================== ===================== =================
8
Mortgage-Backed Securities with a carrying value of $2.0 billion were in a
continuous unrealized loss position over 12 months at September 30, 2004 in the
amount of $34.3 million. Mortgage-Backed Securities with a carrying value of
$10.8 billion were in a continuous unrealized loss position for less than 12
months at September 30, 2004 in the amount of $77.0 million. Mortgage-Backed
Securities with a carrying value of $809.0 million were in a continuous
unrealized loss position over 12 months at December 31, 2003 in the amount of
$8.2 million. Mortgage-Backed Securities with a carrying value of $6.7 billion
were in a continuous unrealized loss position for less than 12 months at
December 31, 2003 in the amount of $52.2 million. The reason for the decline in
value of these securities is solely due to increases in interest rates. All of
the Mortgage-Backed Securities are "AAA" rated or carry an implied "AAA" rating.
These investments are not considered other-than-temporarily impaired since the
Company has the ability and intent to hold the investments for a period of time,
to maturity, if necessary, sufficient for a forecasted market price recovery up
to or beyond the cost of the investments. Also, the Company is guaranteed
payment on the par value of the securities.
The adjustable rate Mortgage-Backed Securities are limited by periodic
caps (generally interest rate adjustments are limited to no more than 1% every
nine months) and lifetime caps. The weighted average lifetime cap was 10.1% at
September 30, 2004 and 9.9% at December 31, 2003.
During the nine months ended September 30, 2004, the Company realized $4.1
million in net gains from sales of Mortgage-Backed Securities. During the nine
months ended September 30, 2003, the Company realized $40.9 million in net gains
from sales of Mortgage-Backed Securities.
4. AGENCY DEBENTURES
At September 30, 2004, the Company owned callable agency debentures
totaling $645.0 million par value and a total unamortized discount of $40,000.
FHLMC, FNMA, and FHLB are the issuers of the debentures. All of the Company's
agency debentures are classified as available-for-sale. The agency debentures
had carrying values of $639.4 million and $978.2 million at September 30, 2004
and December 31, 2003, respectively. The agency debentures with a carrying value
of $389.8 million have been in a continuous unrealized loss position over 12
months at September 30, 2004 in the amount of $5.3 million. The agency
debentures with a carrying value of $249.6 million were in a continuous
unrealized loss position for less than 12 months at September 30, 2004 in the
amount of $335,000. The debentures with a carrying value of $978.2 million were
in a continuous unrealized loss position for less than 12 months at December 31,
2003 in the amount of $11.8 million. The Company's agency debentures are
adjustable rate and fixed rate with a weighted average lifetime cap of 3.48% at
September 30, 2004 and 5.80% at December 31, 2003. All of the agency debentures
carry an implied "AAA" rating. These investments are not considered
other-than-temporarily impaired since the Company has the ability and intent to
hold the investments for a period of time, to maturity, if necessary, sufficient
for a forecasted market price recovery up to or beyond the cost of the
investments. Also, the Company is guaranteed payment on the par value of the
agency debentures.
5. REPURCHASE AGREEMENTS
The Company had outstanding $15.6 billion and $11.0 billion of repurchase
agreements with weighted average borrowing rates of 1.99% and 1.51%, and
weighted average remaining maturities of 109 days and 90 days as of September
30, 2004 and December 31, 2003, respectively. Investment securities pledged as
collateral under these repurchase agreements had an estimated fair value of
$17.3 billion at September 30, 2004.
At September 30, 2004 and December 31, 2003, the repurchase agreements had
the following remaining maturities:
SEPTEMBER 30, 2004 DECEMBER 31, 2003
(dollars in thousands)
-------------------------------------------------------------
Within 30 days $12,522,847 $ 8,589,184
30 to 59 days 516,026 709,552
60 to 89 days 140,323 -
90 to 119 days 400,000 -
Over 120 days 2,000,000 1,714,167
------------------------------- -----------------------------
Total $15,579,196 $11,012,903
=============================== =============================
9
6. OTHER LIABILITIES
In 2001, the Company entered into a repurchase agreement maturing in July
2004, at which time the repurchase agreement gives the buyer the right to
extend, in whole or in part, in three-month increments up to July 2006. In July
2004, the buyer extended the repurchase agreement, in whole, for the next three
months, with the right to further extend in October 2004. The repurchase
agreement has a principal amount of $100,000,000, included in repurchase
agreements on the statement of financial condition. The Company accounts for the
extension option as a separate interest rate floor liability carried at fair
value. The initial fair value of $1.2 million allocated to the extension option
resulted in a similar discount on the repurchase agreement borrowings that is
being amortized over the initial term of three years using the effective yield
method. At September 30, 2004 and December 31, 2003, the fair value of this
interest rate floor was $4.1 million and $4.0 million, respectively, and is
included in other liabilities in the Statement of Financial Condition.
7. PREFERRED STOCK AND COMMON STOCK
During the quarter ended September 30, 2004, the Company declared
dividends to common shareholders totaling $60.6 million or $0.50 per share,
which were paid on October 27, 2004. During the quarter ended September 30,
2004, the Company declared dividends to preferred shareholders totaling $2.1
million or $0.49 per share, which were paid on September 30, 2004. On January
21, 2004, the Company entered into an underwriting agreement pursuant to which
the Company raised net proceeds of approximately $363.6 million in an offering
of 20,700,000 shares of common stock. On March 31, 2004, the Company entered
into an underwriting agreement pursuant to which the Company raised net proceeds
of approximately $102.9 million through an offering of 4,250,000 shares of
7.875% Series A Cumulative Redeemable Preferred Stock, which settled on April 5,
2004. During the nine months ended September 30, 2004, 2,103,525 shares of the
Company's common stock were issued through the Equity Shelf Program, totaling
net proceeds of $37.5 million. During the nine months ended September 30, 2004,
40,250 options were exercised under the long-term compensation plan at $662,000.
Also, 116,760 common shares were sold through the dividend reinvestment and
direct purchase program for $2.1 million during the nine months ended September
30, 2004.
8. EARNINGS PER SHARE AVAILABLE TO COMMON SHAREHOLDERS
For the quarter ended September 30, 2004, the reconciliation is as
follows:
FOR THE QUARTER ENDED SEPTEMBER 30, 2004
(Amounts in thousands, except per share amounts)
--------------------------------------------------
Weighted Average
Income Shares Per-Share
(Numerator) (Denominator) Amount
--------------------------------------------------
Net income available to
common shareholders $64,538
-----------------
Basic earnings per share $64,538 120,803 $0.53
===============
Effect of dilutive securities:
Dilutive stock options 191
----------------- ----------------
Diluted earnings per share $64,538 120,994 $0.53
================= ================ ===============
Options to purchase 1,289,250 shares of common stock were outstanding and
considered anti-dilutive as their exercise price exceeded the average stock
price for the quarter ended September 30, 2004.
10
For the quarter ended September 30, 2003, the reconciliation is as
follows:
FOR THE QUARTER ENDED SEPTEMBER 30, 2003
(dollars in thousands, except per share amounts)
--------------------------------------------------
Weighted Average
Income Shares Per-Share
(Numerator) (Denominator) Amount
--------------------------------------------------
Net income $28,479
-----------------
Basic earnings per share $28,479 94,686 $0.30
===============
Effect of dilutive securities:
Dilutive stock options 814
----------------- ----------------
Diluted earnings per share $28,479 95,500 $0.30
================= ================ ===============
Options to purchase 12,500 shares of common stock were outstanding and
considered anti-dilutive as their exercise price exceeded the average stock
price for the quarter ended September 30, 2003.
For the nine months ended September 30, 2004, the reconciliation is as
follows:
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004
(Amounts in thousands, except per share amounts)
--------------------------------------------------
Weighted Average
Income Shares Per-Share
(Numerator) (Denominator) Amount
--------------------------------------------------
Net income available to
common shareholders $185,218
-----------------
Basic earnings per share 185,218 117,208 $1.58
===============
Effect of dilutive securities:
Dilutive stock options 231
----------------- ----------------
Diluted earnings per share $185,218 117,439 $1.58
================= ================ ===============
Options to purchase 12,500 shares of common stock were outstanding and
considered anti-dilutive as their exercise price exceeded the average stock
price for the nine months ended September 30, 2004.
For the nine months ended September 30, 2003, the reconciliation is as
follows:
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003
(Amounts in thousands, except per share amounts)
--------------------------------------------------
Weighted Average
Income Shares Per-Share
(Numerator) (Denominator) Amount
--------------------------------------------------
Net income $137,406
-----------------
Basic earnings per share 137,406 90,929 $1.51
===============
Effect of dilutive securities:
Dilutive stock options 821
----------------- ----------------
Diluted earnings per share $137,406 91,750 $1.50
================= ================ ===============
Options to purchase 12,500 shares of common stock were outstanding and
considered anti-dilutive as their exercise price exceeded the average stock
price for the nine months ended September 30, 2003.
11
9. LONG-TERM STOCK INCENTIVE PLAN
The Company has adopted a long term stock incentive plan for executive
officers, key employees and non employee directors (the "Incentive Plan"). The
Incentive Plan authorizes the Compensation Committee of the board of directors
to grant awards, including non-qualified options as well as incentive stock
options as defined under Section 422 of the Code . The Incentive Plan authorizes
the granting of options or other awards for an aggregate of the greater of
500,000 shares or 9.5% of the diluted outstanding shares of the Company's common
stock.
The following table sets forth activity relating to the Company's stock
options awards:
For the nine months ended September 30,
---------------------------------------------------------------------
2004 2003
------------------------------------ --------------------------------
Weighted Weighted
Number of Average Number of Average
Shares Exercise Price Shares Exercise Price
------------------- ---------------- --------------- ----------------
Options outstanding at the beginning of period 1,063,259 $14.28 512,706 $8.59
Granted 639,750 17.39 643,450 18.00
Exercised (40,250) 8.81 (37,622) 8.69
Expired -- -- -- --
------------------- ---------------- --------------- ----------------
Options outstanding at the end of period 1,662,759 $15.61 1,118,534 $14.00
=================== ================ =============== ================
The following table summarizes information about stock options outstanding
at September 30, 2004:
Weighted Average
Weighted Average Remaining Contractual
Range of Exercise Prices Options Outstanding Exercise Price Life (Years)
- ------------------------------- ----------------------- ------------------------ ---------------------------
$7.94-$19.99 1,650,259 $15.57 8.2
$20.00-$29.99 12,500 20.53 3.2
----------------------- ------------------------ ---------------------------
1,662,759 $15.61 8.1
======================= ======================== ===========================
The Company accounts for the incentive plan under the intrinsic value
method in accordance with APB Opinion No. 25, Accounting for Stock Issued to
Employees, and related Interpretations. No stock-based employee compensation
cost is reflected in net income, as all options granted under those plans had an
exercise price equal to the market value of the underlying common stock on the
date of grant. The following table illustrates the effect on net income and
earnings per share if the Company had applied the fair value recognition
provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation,
to stock-based employee compensation:
For the quarter ended For the nine months ended
(dollars in thousands, except per share data)
September 30, September 30, September 30, September 30,
2004 2003 2004 2003
--------------- --------------- --------------- ---------------
Net income available to common shareholders, as reported $64,538 $28,479 $185,218 $137,406
Deduct: Total stock-based employee compensation
expense determined under fair value based method (38) (29) (112) (86)
--------------- --------------- --------------- ---------------
Pro-forma net income available to common $28,450 $137,320
shareholers $64,500 $185,106
=============== =============== =============== ===============
Net income per share available to common shareholders, as reported
Basic $0.53 $0.30 $1.58 $1.51
Diluted $0.53 $0.30 $1.58 $1.50
Pro-forma net income per share available to common shareholders
Basic $0.53 $0.30 $1.58 $1.51
Diluted $0.53 $0.30 $1.58 $1.50
12
10. LEASE COMMITMENTS
The Company has a noncancelable lease for office space, which commenced in
May 2002 and expires in December 2009.
The Company's aggregate future minimum lease payments are as follows:
Total per Year
(dollars in thousands)
2004 (remainder of year) $ 125
2005 500
2006 530
2007 532
2008 532
2009 532
------------------------
Total remaining lease payments $2,751
========================
11. INTEREST RATE RISK
The primary market risk to the Company is interest rate risk. Interest
rates are highly sensitive to many factors, including governmental monetary and
tax policies, domestic and international economic and political considerations
and other factors beyond the Company's control. Changes in the general level of
interest rates can affect net interest income, which is the difference between
the interest income earned on interest-earning assets and the interest expense
incurred in connection with the interest-bearing liabilities, by affecting the
spread between the interest-earning assets and interest-bearing liabilities.
Changes in the level of interest rates also can affect the value of the
Investment Securities and the Company's ability to realize gains from the sale
of these assets. A decline in the value of the Investment Securities pledged as
collateral for borrowings under repurchase agreements could result in the
counterparties demanding additional collateral pledges or liquidation of some of
the existing collateral to reduce borrowing levels.
The Company seeks to manage the extent to which net income changes as a
function of changes in interest rates by matching adjustable-rate assets with
variable-rate borrowings. In addition, although the Company has not done so to
date, the Company may seek to mitigate the potential impact on net income of
periodic and lifetime coupon adjustment restrictions in the portfolio of
Investment Securities by entering into interest rate agreements such as interest
rate caps and interest rate swaps.
Changes in interest rates may also have an effect on the rate of mortgage
principal prepayments and, as a result, prepayments on Mortgage-Backed
Securities. The Company will seek to mitigate the effect of changes in the
mortgage principal repayment rate by balancing assets purchased at a premium
with assets purchased at a discount. To date, the aggregate premium exceeds the
aggregate discount on the Mortgage-Backed Securities. As a result, prepayments,
which result in the expensing of unamortized premium, will reduce net income
compared to what net income would be absent such prepayments.
13
12. SUBSEQUENT EVENT
On October 14, 2004, the Company entered into an underwriting agreement
pursuant to which the Company raised net proceeds of approximately $74.5 million
through an offering of 3,162,500 shares of 7.875% Series A Cumulative Redeemable
Preferred Stock, which settled on October 19, 2004.
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain statements contained in this quarterly report, and certain
statements contained in our future filings with the Securities and Exchange
Commission (the "SEC" or the "Commission"), in our press releases or in our
other public or shareholder communications may not be, based on historical facts
and are "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Forward-looking statements which are
based on various assumptions, (some of which are beyond our control) may be
identified by reference to a future period or periods, or by the use of
forward-looking terminology, such as "may," "will," "believe," "expect,"
"anticipate," "continue," or similar terms or variations on those terms, or the
negative of those terms. Actual results could differ materially from those set
forth in forward-looking statements due to a variety of factors, including, but
not limited to, changes in interest rates, changes in yield curve, changes in
prepayment rates, the availability of mortgage backed securities for purchase,
the availability of financing and, if available, the terms of any financing, and
risks associated with the investment advisory business of FIDAC, including the
removal by FIDAC's clients of assets FIDAC manages, FIDAC's regulatory
requirements, and competition in the investment advisory business. For a
discussion of the risks and uncertainties which could cause actual results to
differ from those contained in the forward-looking statements, see our 2003 Form
10-K. We do not undertake, and specifically disclaim any obligation, to publicly
release the result of any revisions which may be made to any forward-looking
statements to reflect the occurrence of anticipated or unanticipated events or
circumstances after the date of such statements.
OVERVIEW
We are a real estate investment trust that owns and manages a portfolio of
mortgage-backed securities and agency debentures. Our principal business
objective is to generate net income for distribution to our stockholders from
the spread between the interest income on our investment securities and the
costs of borrowing to finance our acquisition of investment securities. Our
wholly owned subsidiary is a registered investment advisor that generates
advisory and service fee income.
We are primarily engaged in the business of investing, on a leveraged
basis, in mortgage pass-through certificates, collateralized mortgage
obligations and other mortgage-backed securities representing interests in or
obligations backed by pools of mortgage loans (collectively, "Mortgage-Backed
Securities"). We also invest in Federal Home Loan Bank ("FHLB"), Federal Home
Loan Mortgage Corporation ("FHLMC"), and Federal National Mortgage Association
("FNMA") debentures. The Mortgage-Backed Securities and agency debentures are
collectively referred to herein as "Investment Securities."
Under our capital investment policy, at least 75% of our total assets must
be comprised of high-quality mortgage-backed securities and short-term
investments. High quality securities means securities that (1) are rated within
one of the two highest rating categories by at least one of the nationally
recognized rating agencies, (2) are unrated but are guaranteed by the United
States government or an agency of the United States government, or (3) are
unrated but are determined by us to be of comparable quality to rated
high-quality Mortgage-Backed Securities.
The remainder of our assets, comprising not more than 25% of our total
assets, may consist of other qualified REIT real estate assets which are unrated
or rated less than high quality, but which are at least "investment grade"
(rated "BBB" or better by Standard & Poor's Corporation ("S&P") or the
equivalent by another nationally recognized rating agency) or, if not rated,
determined by us to be of comparable credit quality to an investment which is
rated "BBB" or better.
We may acquire Mortgage-Backed Securities backed by single-family
residential mortgage loans as well as securities backed by loans on
multi-family, commercial or other real estate-related properties. To date, all
of the Mortgage-Backed Securities that we have acquired have been backed by
single-family residential mortgage loans.
15
We have elected to be taxed as a REIT for federal income tax purposes.
Pursuant to the current federal tax regulations, one of the requirements of
maintaining our status as a REIT is that we must distribute at least 90% of our
REIT taxable income (determined without regard to the deduction for dividends
paid and by excluding any net capital gain) to our stockholders, subject to
certain adjustments.
The results of our operations are affected by various factors, many of
which are beyond our control. The results of our operations primarily depend on,
among other things, the amount of our net interest income, the market value of
our assets and the supply of and demand for such assets. Our net interest
income, which reflects the amortization of purchase premiums, varies primarily
as a result of changes in interest rates, borrowing costs and prepayment speeds,
the behavior of which involves various risks and uncertainties. Prepayment
speeds, as reflected by the Constant Prepayment Rate, or CPR, and interest rates
vary according to the type of investment, conditions in financial markets,
competition and other factors, none of which can be predicted with any
certainty. In general, as prepayment speeds on our Mortgage-Backed Securities
portfolio increase, related purchase premium amortization increases, thereby
reducing the net yield on such assets. The CPR on our Mortgage Backed Securities
portfolio averaged 25% and 48% for the quarters ended September 30, 2004 and
September 30, 2003, respectively. Since changes in interest rates may
significantly affect our activities, our operating results depend, in large
part, upon our ability to effectively manage interest rate risks and prepayment
risks while maintaining our status as a REIT.
The following table presents the CPR experienced on our Mortgage-Backed
Securities portfolio, on an annualized basis, for the following quarterly
periods :
Quarter Ended CPR
- ------------- ---
September 30, 2004 25%
June 30, 2004 33%
March 31, 2004 31%
December 31, 2003 37%
September 30, 2003 48%
We believe that the CPR in future periods will depend, in part, on changes
in and the level of market interest rates across the yield curve, with higher
CPRs expected during periods of declining interest rates and lower CPRs expected
during periods of rising interest rates.
We have extended contractual maturities on borrowings, such that our
weighted average term to next rate adjustment on our repurchase agreements was
109 days at September 30, 2004, as compared to 90 days at December 31, 2003.
The table below provides quarterly information regarding our average balances,
interest income, interest expense, yield on assets, cost of funds and net
interest income for the following quarterly periods presented.
16
Yield on
Average Interest Average
Investment Total Average Balance of Total Average Net
Securities Interest Earning Repurchase Interest Cost of Interest
Held (1) Income Assets Agreements Expense Funds Income
----------- -------- ---- ----------- ------- ---- -------
(ratios for the quarters have been annualized, dollars in thousands)
Quarter Ended September 30, 2004 $16,562,971 $138,970 3.36% $15,568,691 $70,173 1.80% $68,797
Quarter Ended June 30, 2004 $16,649,072 $122,234 2.94% $15,880,353 $55,648 1.40% $66,586
Quarter Ended March 31, 2004 $14,452,245 $114,341 3.16% $13,587,211 $50,303 1.48% $64,038
Quarter Ended December 31, 2003 $11,799,730 $89,186 3.02% $11,235,908 $42,264 1.50% $46,922
Quarter Ended September 30, 2003 $12,577,165 $66,855 2.13% $12,186,985 $43,922 1.44% $22,933
Quarter Ended June 30, 2003 $12,815,290 $93,892 2.93% $12,311,329 $51,770 1.68% $42,122
Quarter Ended March 31, 2003 $10,837,147 $87,500 3.23% $10,463,251 $44,048 1.68% $43,452
(1) Does not reflect unrealized gains/(losses).
We continue to explore alternative business strategies, alternative
investments and other strategic initiatives to complement our core business
strategy of investing, on a leveraged basis, in high quality Investment
Securities. No assurance, however, can be provided that any such strategic
initiative will or will not be implemented in the future.
CRITICAL ACCOUNTING POLICIES
Management's discussion and analysis of financial condition and results of
operations is based on the amounts reported in our financial statements. These
financial statements are prepared in conformity with accounting principles
generally accepted in the United States of America. In preparing the financial
statements, management is required to make various judgments, estimates and
assumptions that affect the reported amounts. Changes in these estimates and
assumptions could have a material effect on our financial statements. The
following is a summary of our policies most affected by management's judgments,
estimates and assumptions. These policies have not changed during 2004.
Market valuation of Investment Securities: All assets classified as
available-for-sale are reported at fair value, based on market prices. Although
we generally intend to hold most of our Investment Securities until maturity, we
may, from time to time, sell any of our Investment Securities as part our
overall management of our portfolio. Accordingly, we are required to classify
all of our Investment Securities as available-for-sale. Our policy is to obtain
market values from three independent sources and record the market value of the
securities based on the average of the three. The investments with unrealized
losses are not considered other-than-temporarily impaired since the Company has
the ability and intent to hold the investments for a period of time to maturity
if necessary, sufficient for a forecasted market price recovery up to or beyond
the cost of the investments. Unrealized losses on Investment Securities that are
considered other than temporary, as measured by the amount of decline in fair
value attributable to factors other than temporary, are recognized in income and
the cost basis of the Investment Securities is adjusted. There were no such
adjustments for the quarters ended September 30, 2004 and September 30, 2003.
Investment Securities transactions are recorded on the trade date. If in
the future, management determines an impairment to be other-than temporary we
may need to realize a loss that would have an impact on future income.
Interest income: Interest income is accrued based on the outstanding
principal amount of the outstanding principal amount of the Investment
Securities and their contractual terms. Premiums and discounts associated with
the purchase of the Investment Securities are amortized into interest income
over the projected lives of the securities using the interest method. Our policy
for estimating prepayment speeds for calculating the effective yield is to
evaluate historical performance, street consensus prepayment speeds, and current
market conditions. If our estimate of prepayments is incorrect, we may be
required to make an adjustment to the amortization or accretion of premiums and
discounts that would have an impact on future income.
17
Repurchase Agreements: We finance the acquisition of our Investment
Securities through the use of repurchase agreements. Repurchase agreements are
treated as collateralized financing transactions and are carried at their
contractual amounts, including accrued interest, as specified in the respective
agreements. Accrued interest is recorded as a separate line item on the
statements of financial condition.
Income Taxes: We have elected to be taxed as a Real Estate Investment
Trust ("REIT") and intend to comply with the provisions of the Internal Revenue
Code of 1986, as amended (the "Code"), with respect thereto. Accordingly, the
Company will not be subjected to federal income tax to the extent of its
distributions to shareholders and as long as certain asset, income and stock
ownership tests are met. The Company and FIDAC have made a joint election to
treat FIDAC as a taxable REIT subsidiary. As such, FIDAC will be taxable as a
domestic C corporation and subject to federal and state and local income taxes
based upon its taxable income.
RESULTS OF OPERATIONS: FOR THE QUARTERS AND NINE MONTHS ENDED SEPTEMBER 30, 2004
AND SEPTEMBER 30, 2003
NET INCOME SUMMARY
For the quarter ended September 30, 2004, our net income was $66.6
million, or $0.53 basic earnings per share available for common shareholders, as
compared to $28.5 million, or $0.30 basic earnings per average share, for the
quarter ended September 30, 2003. We attribute the increase in total net income
for the quarter ended September 30, 2004, over the quarter ended September 30,
2003 to the increased asset base and increase in the interest rate spread. The
increased asset base was the result of deploying additional capital of
approximately $548.5 million from September 30, 2003 to September 30, 2004, into
our strategy. The increase in net income per share available to common
shareholders was primarily due to the increase in net interest income because of
the increase in the interest rate spread from 0.69% to 1.56%. For the quarter
ended September 30, 2004, gain on sale of Mortgage-Backed Securities was $1.4
million, as compared to $9.7 million, for the quarter ended September 30, 2003.
Dividends for the quarter ended September 30, 2004, were $0.50 per share of
common stock, or $60.6 million in total, and $0.49 per share of preferred stock,
or $2.1 million in total. Dividends per share for the quarter ended September
30, 2003 were $0.28 per share of common stock, or $26.9 million in total. Our
return on average equity was 16.59% for the quarter ended September 30, 2004 and
9.98% for the quarter ended September 30, 2003. The increase in return on
average equity resulted primarily from the increase in net interest spread
primarily from the decline in the weighted average CPR from 48% for the quarter
ended September 30, 2003 to 25% for the quarter ended September 30, 2004.
For the nine months ended September 30, 2004, our net income was $189.3
million, or $1.58 basic earnings per share, as compared to $137.4 million, or
$1.51 basic earnings per average share available to common shareholders, for the
nine months ended September 30, 2003. We attribute the increase in net income
for the nine months ended September 30, 2004, over the nine months ended
September 30, 2003 to the increased asset base, as discussed above. For the nine
months ended September 30, 2004, gain on sale of Mortgage-Backed Securities was
$4.1 million, as compared to $40.9 million, for the nine months ended September
30, 2003. Dividends for the nine months ended September 30, 2004, were $1.48 per
share of common stock, or $177.2 million in total and $0.96 per share of
preferred stock or $4.1 million in total. Dividends for the nine months ended
September 30, 2003 were $1.48 per share, or $134.1 million in total. Our return
on average equity was 16.69% for the nine months ended September 30, 2004 and
16.42% for the nine months ended September 30, 2003. The increase in the return
on average equity resulted primarily from the decline in gains on sale of
Mortgage-Backed Securities.
18
NET INCOME SUMMARY
(ratios for the quarter have been annualized, dollars in the thousands, except for per share data)
--------------------------------------------------------------------------------------------------
Quarter Nine months
ended Quarter Ended Nine months
September 30, ended September 30, Ended
2004 September 30, 2004 September 30,
(Consolidated) 2003 (Consolidated) 2003
---------------- ---------------- --------------- ------------------
Interest income $138,970 $66,855 $375,545 $248,247
Interest expense 70,173 43,922 176,124 139,740
---------------- ---------------- --------------- ------------------
Net interest income 68,797 22,933 199,421 108,507
Gain on sale of Mortgage Backed Securities 1,350 9,656 4,071 40,907
Investment advisory and service fees 4,811 - 6,369 -
Distribution fees (1,024) - (1,322) -
General and administrative expenses (6,159) (4,110) (17,167) (12,008)
---------------- ---------------- --------------- ------------------
Income before income taxes $67,775 $28,479 $191,372 $137,406
Income taxes 1,155 2,074 -
---------------- ---------------- --------------- ------------------
Net income $66,620 $28,479 $189,298 $137,406
================ ================ =============== ==================
Weighted average number of basic common shares outstanding 120,802,814 94,685,685 117,208,336 90,929,196
Weighted average number of diluted common shares outstanding 120,994,191 95,500,486 117,439,248 91,750,472
Basic net income per share available to common
shareholders $0.53 0.30 $1.58 $1.51
Diluted net income per share available to common
shareholders $0.53 0.30 $1.58 $1.50
Average total assets $17,788,296 $13,775,543 $16,726,393 $12,971,228
Average total equity $1,606,051 $1,153,583 $1,512,477 $1,115,986
Annualized return on average assets 1.50% 0.83% 1.51% 1.41%
Annualized return on average equity 16.59% 9.88% 16.69% 16.42%
INTEREST INCOME AND AVERAGE EARNING ASSET YIELD
We had average earning assets of $16.6 billion and $12.6 billion for the
quarters ended September 30, 2004 and September 30, 2003, respectively. Our
primary source of income for the quarters ended September 30, 2004 and 2003 was
interest income. A portion of our income was generated by gains on the sales of
our Mortgage-Backed Securities. Our interest income was $139.0 million for the
quarter ended September 30, 2004 and $66.9 million for the quarter ended
September 30, 2003. The yield on average investment securities increased from
2.13% for the quarter ended September 30, 2003 to 3.36% for the quarter ended
September 30, 2004. Our average earning asset balance increased by $4.0 billion
and interest income increased by $72.1 million for the quarter ended September
30, 2004 as compared to the quarter ended September 30, 2003. The increase was
the direct result of the increased asset base and the increase in the interest
rate spread. The yield increased for the comparable periods. The average coupon
rate at September 30, 2004 was 4.44%, as compared to 4.42% at September 30,
2003. The prepayment speeds decreased to 25% CPR for the quarter ended September
30, 2004, from 48% CPR for the quarter ended September 30, 2003. The increase in
coupon, in conjunction with lower prepayment speeds, resulted in an increase in
yield of 123 basis points.
We had average earning assets of $15.9 billion and $12.1 billion for the
nine months ended September 30, 2004 and September 30, 2003, respectively. Our
primary source of income for the quarters ended September 30, 2004 and September
30, 2003 was interest income. A portion of our income was generated by gains on
the sales of our Mortgage-Backed Securities. Our interest income was $375.5
million for the nine months ended September
19
30, 2004 and $248.2 million for the nine months ended September 30, 2003. The
yield on average investment securities increased to 3.15% for the nine months
ended September 30, 2004, from 2.74% for the nine months ended September 30,
2003. Our average earning asset balance increased by $3.8 billion and interest
income increased by $127.3 million for the nine months ended September 30, 2004
as compared to the nine months ended September 30, 2003.
The table below shows our average balance of interest earning assets, our
yield on average earning assets and our interest income for the quarters ended
September 30, 2004, June 30, 2004, March 31, 2004, the year ended December 31,
2003 and the four quarters in 2003.
AVERAGE EARNING ASSET YIELD
(RATIOS FOR THE QUARTERS HAVE BEEN ANNUALIZED, DOLLARS IN THOUSANDS)
Average
Average Yield on Constant
Investment Investment Prepayment Interest
Securities Securities Rate Income
---------- ---------- ---------- --------
Quarter Ended September 30, 2004 $16,562,971 3.36% 25% $138,970
Quarter Ended June 30, 2004 $16,649,072 2.94% 33% $122,234
Quarter Ended March 31, 2004 $14,452,245 3.16% 31% $114,341
- --------------------------------------------------------------------------------
Year Ended December 31, 2003 $12,007,333 2.81% 37% $337,433
Quarter Ended December 31, 2003 $11,799,730 3.02% 37% $89,186
Quarter Ended September 30, 2003 $12,577,165 2.13% 48% $66,855
Quarter Ended June 30, 2003 $12,815,290 2.93% 44% $93,892
Quarter Ended March 31, 2003 $10,837,147 3.23% 41% $87,500
The constant prepayment rate ("CPR") on our Mortgage-Backed Securities for
the quarters ended September 30, 2004 and September 30, 2003 was 25% and 48%,
respectively. CPR is an assumed rate of prepayment for our Mortgage-Backed
Securities, expressed as an annual rate of prepayment relative to the
outstanding principal balance of our Mortgage-Backed Securities. CPR does not
purport to be either a historical description of the prepayment experience of
our Mortgage-Backed Securities or a prediction of the anticipated rate of
prepayment of our Mortgage-Backed Securities. The homeowners' prepayment option
makes the average term yield and performance of a mortgage-backed security
uncertain because of the uncertainty in timing of the return of principal. In
general, prepayments decrease the total yield on a bond purchased at a premium,
because prepayments will reduce the life of the security and the period over
which the premium is amortized. The total amortization for the quarters ended
September 30, 2004 and September 30, 2003 was $39.7 million, $72.0,
respectively. The total amortization for the nine months ended September 30,
2004 and September 30, 2003 was $137.3 million and $178.2 million respectively.
Principal prepayments had a negative effect on our earning asset yield for
the quarters ended September 30, 2004 and September 30, 2003 because we adjust
our rates of premium amortization and discount accretion monthly based upon the
effective yield method, which takes into consideration changes in prepayment
speeds.
INTEREST EXPENSE AND THE COST OF FUNDS
We anticipate that our largest expense will be the cost of borrowed funds.
We had average borrowed funds of $15.6 billion and total interest expense of
$70.1 million for the quarter ended September 30, 2004. We had average borrowed
funds of $12.2 billion and total interest expense of $43.9 million for the
quarter ended September 30, 2003. Our average cost of funds was 1.80% for the
quarter ended September 30, 2004 and 1.44% for the quarter ended September 30,
2003. The cost of funds rate increased by 36 basis points and the average
borrowed funds increased by $3.4 billion for the quarter ended September 30,
2004 when compared to the quarter ended September 30, 2003. Interest expense for
the quarter increased by $26.2 million due to the substantial increase in the
average repurchase balance and the increase in the cost of funds rate. The
increase in the average repurchase balance was the result of our implementing
our leveraged strategy after the completion of the equity offerings in the first
quarter 2004, in addition to equity acquired through the equity shelf program,
the direct purchase and dividend reinvestment plan, and options exercised. Since
a substantial portion of our repurchase agreements are short term, changes in
market rates are directly reflected in our interest expense. Our average cost of
funds was 0.21% above average one-month LIBOR and 0.17% below average six-month
LIBOR for the quarter ended September 30, 2004. Our average
20
cost of funds was 0.33% above average one-month LIBOR and 0.27% above average
six-month LIBOR for the quarter ended September 30, 2003.
We had average borrowed funds of $15.0 billion and total interest expense
of $176.1 million for the nine months ended September 30, 2004. We had average
borrowed funds of $11.7 billion and total interest expense of $139.7 million for
the nine months ended September 30, 2003. Our average cost of funds was 1.56%
for the nine months ended September 30, 2004 and 1.60% for the nine months ended
September 30, 2003. The cost of funds rate decreased 4 basis points and the
average borrowed funds increased by $3.3 billion for the nine months ended
September 30, 2004 when compared to the nine months ended September 30, 2003.
Interest expense for the nine months increased by $36.4 million due to the
substantial increase in the average repurchase balance even though the cost of
funds rate decreased. The increase in the average repurchase balance was the
result of our implementing our leveraged strategy after the completion of the
equity offerings in addition to equity acquired through the equity shelf
program, the direct purchase and dividend reinvestment plan, and options
exercised.
The table below shows our average borrowed funds and average cost of funds
as compared to average one-month and average six-month LIBOR for the quarters
ended September 30, 2004, June 30, 2004, March 31, 2004, the year ended December
31, 2003 and the four quarters in 2003.
AVERAGE COST OF FUNDS
(RATIOS FOR THE QUARTERS HAVE BEEN ANNUALIZED, DOLLARS IN THOUSANDS)
Average
Average Average Cost of
One-Month Cost of Funds
LIBOR Funds Relative
Relative Relative to
Average Average Average Average to Average to Average Average
Borrowed Interest Cost of One-Month Six-Month Six-Month One-Month Six-Month
Funds Expense Funds LIBOR LIBOR LIBOR LIBOR LIBOR
-------- -------- ------- --------- --------- ---------- ---------- ---------
Quarter Ended September 30, 2004 $15,568,691 $70,173 1.80% 1.59% 1.97% (0.38%) 0.21% (0.17%)
Quarter Ended June 30, 2004 $15,880,353 $55,648 1.40% 1.15% 1.54% (0.39%) 0.25% (0.14%)
Quarter Ended March 31, 2004 $13,587,211 $50,303 1.48% 1.10% 1.18% (0.08%) 0.38% 0.30%
- -----------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 2003 $11,549,368 $182,004 1.58% 1.21% 1.23% (0.02%) 0.37% 0.35%
Quarter Ended December 31, 2003 $11,235,908 $42,264 1.50% 1.13% 1.23% (0.10%) 0.37% 0.27%
Quarter Ended September 30, 2003 $12,186,985 $43,922 1.44% 1.11% 1.17% (0.06%) 0.33% 0.27%
Quarter Ended June 30, 2003 $12,311,329 $51,770 1.68% 1.26% 1.20% 0.06% 0.42% 0.48%
Quarter Ended March 31, 2003 $10,463,252 $44,048 1.68% 1.34% 1.33% 0.01% 0.34% 0.35%
NET INTEREST INCOME
Our net interest income which equals interest income less interest
expense, totaled $68.8 million for the quarter ended September 30, 2004 and
$22.9 million for the quarter ended September 30, 2003. Our net interest income
increased because of the increase in our assets that resulted from the common
stock and preferred stock offerings in the first quarter of 2004 as well as the
increase in our spread income. Our net interest spread, which equals the yield
on our average assets for the period less the average cost of funds for the
period, was 1.56% for the quarter ended September 30, 2004 as compared to 0.69%
for the quarter ended September 30, 2003. This 87 basis point increase was a
result of the increase of the weighted average coupon at September 30, 2004 of
4.44% from 4.36% at September 30, 2003, and the improvement in CPR discussed
above. The increase in yield was only partially offset by the 36 basis point
increase in the cost of funds.
21
Our net interest income totaled $199.4 million for the nine months ended
September 30, 2004 and $108.5 million for the nine months ended September 30,
2003. Our net interest income increased because of our increase in assets that
resulted from the common stock and preferred stock equity offerings in the first
quarter of 2004,as well as the increase in our spread income. Our net interest
spread, which equals the yield on our average assets for the period less the
average cost of funds for the period, was 1.59% for the nine months ended
September 30, 2004 as compared to 1.14% for the quarter ended September 30,
2003.
The table below shows our interest income by earning asset type, average
earning assets by type, total interest income, interest expense, average
repurchase agreements, average cost of funds, and net interest income for the
quarters ended September 30, 2004, June 30, 2004, March 31, 2004, the year ended
December 31, 2003, and the four quarters in 2003.
NET INTEREST INCOME
(RATIOS FOR THE QUARTERS HAVE BEEN ANNUALIZED, DOLLARS IN THOUSANDS)
Yield
on
Average Average Average Net
Investment Total Interest Balance of Average Net Interest
Securities Interest Earning Repurchase Interest Cost of Interest Rate
Held Income Assets Agreements Expense Funds Income Spread
---------- -------- -------- ---------- -------- ------- -------- --------
Quarter Ended September 30, 2004 $16,562,971 $138,970 3.36% $15,568,691 $70,173 1.80% $68,797 1.56%
Quarter Ended June 30, 2004 $16,649,072 $122,234 2.94% $15,880,353 $55,648 1.40% $66,586 1.54%
Quarter Ended March 31, 2004 $14,452,245 $114,341 3.16% $13,587,211 $50,303 1.48% $64,038 1.68%
- -------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 2003 $12,007,333 $337,433 2.81% $11,549,368 $182,004 1.58% $155,429 1.23%
Quarter Ended December 31, 2003 $11,799,730 $89,186 3.02% $11,235,908 $42,264 1.50% $46,922 1.52%
Quarter Ended September 30, 2003 $12,577,165 $66,855 2.13% $12,186,985 $43,922 1.44% $22,933 0.69%
Quarter Ended June 30, 2003 $12,815,290 $93,892 2.93% $12,311,329 $51,770 1.68% $42,122 1.25%
Quarter Ended March 31, 2003 $10,837,147 $87,500 3.23% $10,463,252 $44,048 1.68% $43,452 1.55%
INVESTMENT ADVISORY AND SERVICE FEES
FIDAC is a registered investment advisor which generally receives annual
net investment advisory fees of approximately 10 to 15 basis points of the gross
assets it manages, assists in managing or supervises. At September 30, 2004,
FIDAC had under management approximately $1.7 billion in net assets and $13.9
billion in gross assets, compared to $1.5 billion in net assets and $13.6
billion in gross assets at December 31, 2003. Investment advisory and service
fees for the quarter ended September 30, 2004 totaled $3.8 million, net of fees
paid to third parties pursuant to distribution service agreements for
facilitating and promoting distribution of shares of FIDAC's clients. For the
quarter ended September 30, 2004, such fees were $1.0 million.
GAINS AND LOSSES ON SALES OF MORTGAGE-BACKED SECURITIES
For the quarter ended September 30, 2004, our gain on the sale of
Mortgage-Backed Securities declined by $8.3 million as compared with the quarter
ended September 30, 2003. For the quarter ended September 30, 2004, we sold
Mortgage-Backed Securities with an aggregate historical amortized cost of $129.3
million for an aggregate gain of $1.4 million. For the quarter ended September
30, 2003, we sold Mortgage-Backed Securities with an aggregate historical
amortized cost of $377.0 million for an aggregate gain of $9.7 million. For the
nine months ended September 30, 2004, our gain on the sale of Mortgage-Backed
Securities declined by $36.8 million as compared with the nine months ended
September 30, 2003. For the nine months ended September 30, 2004, we sold
Mortgage-Backed Securities with an aggregate historical amortized cost of $279.3
million for an aggregate gain of $4.1 million. For the nine months ended
September 30, 2003, we sold Mortgage-Backed Securities with an aggregate
historical amortized cost of $2.7 billion for an aggregate gain of $40.9
million. The difference between the sale price and the historical amortized cost
of our Mortgage-Backed Securities is a realized gain and increases income
accordingly. We do not expect to sell assets on a frequent basis, but may from
time to time sell existing assets to acquire assets, which our management
believes might have higher risk-adjusted returns as part of our asset/liability
management strategy. There have been an insignificant amount of loss from the
sale of securities during the periods.
22
GENERAL AND ADMINISTRATIVE EXPENSE
General and administrative ("G&A") expenses were $6.2 million for the
quarter ended September 30, 2004 and $4.1 million for the quarter ended
September 30, 2003. G&A expenses as a percentage of average assets were 0.14%
and 0.12% for the quarters ended September 30, 2004 and September 30, 2003
respectively. G&A expenses as a percentage of average equity were 1.53% and
1.42% on an annualized basis for the quarters ended September 30, 2004 and
September 30, 2003, respectively. The increase in G&A expenses of $2.1 million
for the quarter ended September 30, 2004, was primarily the result of increased
salaries, D&O insurance and additional costs related to the FIDAC Merger.
G&A expenses were $17.2 million for the nine months ended September 30,
2004 and $12.0 million for the nine months ended September 30, 2003. G&A
expenses as a percentage of average assets were 0.14% and 0.12% on an annualized
basis for the nine months ended September 30, 2004 and September 30, 2003,
respectively. G&A expenses as a percentage of average equity was 1.51% and 1.42%
on an annualized basis for the nine months ended September 30, 2004 and
September 30, 2003, respectively.
G&A EXPENSES AND OPERATING EXPENSE RATIOS
(RATIOS FOR THE QUARTERS HAVE BEEN ANNUALIZED, DOLLARS IN THOUSANDS)
Total G&A Total G&A
Total G&A Expenses/Average Expenses/Average
Expenses Assets (annualized) Equity (annualized)
Quarter Ended September 30, 2004 $6,159 0.14% 1.53%
Quarter Ended June 30, 2004 $5,643 0.13% 1.39%
Quarter Ended March 31, 2004 $5,790 0.15% 1.63%
- ----------------------------------------- ------------------ ----------------------- ---------------------
Year Ended December 31, 2003 $16,233 0.13% 1.45%
Quarter Ended December 31, 2003 $4,225 0.13% 1.47%
Quarter Ended September 30, 2003 $4,110 0.12% 1.42%
Quarter Ended June 30, 2003 $4,201 0.12% 1.50%
Quarter Ended March 31, 2003 $3,697 0.12% 1.37%
NET INCOME AND RETURN ON AVERAGE EQUITY
Our net income was $66.6 million for the quarter ended September 30, 2004
and $28.5 million for the quarter ended September 30, 2003. Our annualized
return on average equity was 16.59 % for the quarter ended September 30, 2004
and 9.88% for the quarter ended September 30, 2003. Our net income was $189.3
million for the nine months ended September 30, 2004 and $137.4 million for the
nine months ended September 30, 2003. Our annualized return on average equity
was 16.69% for the nine months ended September 30, 2004 and 16.42% for the nine
months ended September 30, 2003. The table below shows our net interest income,
investment advisory and service fees, gain on sale of Mortgage-Backed
Securities, G&A expenses, and income taxes each as a percentage of average
equity, and the return on average equity for the quarters ended September 30,
2004, June 30, 2004, March 31, 2004, the year ended December 31, 2003, and for
the four quarters in 2003.
23
COMPONENTS OF RETURN ON AVERAGE EQUITY
(RATIOS FOR ALL QUARTERS ARE ANNUALIZED)
Net
Investment
Advisory and
service Gain on Sale of
Net Interest Fees/ Mortgage-Backed G&A Income Return on
Income/Average Average Securities/Average Expenses/Average Taxes/Average Average
Equity Equity Equity Equity Equity Equity
-------------- ------------ ------------------ ---------------- ------------- ---------
Quarter Ended September 30, 2004 17.13% 0.94% 0.34% 1.53% 0.29% 16.59%
Quarter Ended June 30, 2004 16.44% 0.31% 0.52% 1.39% 0.12% 15.76%
Quarter Ended March 31, 2004 18.05% -- 0.17% 1.63% -- 16.59%
- ------------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 2003 13.85% -- 3.64% 1.45% -- 16.04%
Quarter Ended December 31, 2003 16.36% -- -- 1.47% -- 14.89%
Quarter Ended September 30, 2003 7.95% -- 3.35% 1.42% -- 9.88%
Quarter Ended June 30, 2003 15.06% -- 7.23% 1.50% -- 20.79%
Quarter Ended March 31, 2003 16.11% -- 4.09% 1.37% -- 18.83%
FINANCIAL CONDITION
INVESTMENT SECURITIES
All of our Mortgage-Backed Securities at September 30, 2004 were
adjustable-rate or fixed-rate Mortgage-Backed Securities backed by single-family
mortgage loans. All of the mortgage assets underlying these Mortgage-Backed
Securities were secured with a first lien position on the underlying
single-family properties. All our Mortgage-Backed Securities were FHLMC, FNMA or
GNMA mortgage pass-through certificates or collateralized mortgage obligations,
which carry an actual or implied "AAA" rating. We mark-to-market all of our
Mortgage Backed Securities to fair value.
All of our agency debentures are callable and carry an implied "AAA"
rating. We mark-to-market all of our agency debentures to fair value.
We accrete discount balances as an increase in interest income over the
life of discount Investment Securities and we amortize premium balances as a
decrease in interest income over the life of premium Investment Securities. At
September 30, 2004 and December 31, 2003, we had on our statement of financial
condition a total of $805,000 and $1.5 million, respectively, of unamortized
discount (which is the difference between the remaining principal value and
current historical amortized cost of our Investment Securities acquired at a
price below principal value) and a total of $409.9 million and $323.9 million,
respectively, of unamortized premium (which is the difference between the
remaining principal value and the current historical amortized cost of our
Investment Securities acquired at a price above principal value).
We received mortgage principal repayments of $1.6 billion for the quarter
ended September 30, 2004 and $2.7 billion for the quarter ended September 30,
2003. Given our current portfolio composition, if mortgage principal prepayment
rates were to increase over the life of our Mortgage-Backed Securities, all
other factors being equal, our net interest income would decrease during the
life of these Mortgage-Backed Securities as we would be required to amortize our
net premium balance over a shorter time period. Similarly, if mortgage principal
prepayment rates were to decrease over the life of our Mortgage-Backed
Securities, all other factors being equal, our net interest income would
increase during the life of these Mortgage-Backed Securities, as we would
amortize our net premium balance over a longer time period.
24
The table below summarizes our Investment Securities at September 30,
2004, June 30, 2004, March 31, 2004, December 31, 2003, September 30, 2003, June
30, 2003 and March 31, 2003.
INVESTMENT SECURITIES
(DOLLARS IN THOUSANDS)
Estimated
Amortized Fair Weighted
Principal Net Amortized Cost/Principal Estimated Value/Principal Average
Amount Premium Cost Amount Fair Value Amount Yield
----------- -------- ----------- -------------- ----------- --------------- --------
At September 30, 2004 $17,893,902 $409,115 $18,303,017 102.29% $18,211,030 101.77% 3.36%
At June 30, 2004 $16,914,635 $384,648 $17,299,283 102.27% $17,121,795 101.22% 3.04%
At March 31, 2004 $17,662,596 $412,563 $18,075,159 102.34% $18,079,598 102.36% 2.72%
- ------------------------------------------------------------------------------------------------------------------------
At December 31, 2003 $12,682,130 $299,810 $12,981,940 102.36% $12,934,679 101.99% 2.96%
At September 30, 2003 $12,363,260 $293,694 $12,656,954 102.38% $12,605,085 101.96% 2.35%
At June 30, 2003 $13,939,447 $322,838 $14,262,285 102.32% $14,263,475 102.32% 2.87%
At March 31, 2003 $11,957,710 $289,360 $12,247,070 102.42% $12,318,070 103.01% 2.83%
The tables below set forth certain characteristics of our Investment
Securities. The index level for adjustable-rate Investment Securities is the
weighted average rate of the various short-term interest rate indices, which
determine the coupon rate.
ADJUSTABLE-RATE INVESTMENT SECURITIES CHARACTERISTICS
(DOLLARS IN THOUSANDS)
Weighted Principal Amount
Weighted Weighted Weighted Average Weighted at Period End as
Average Average Average Term to Weighted Average % of Total
Principal Coupon Index Net Next Average Asset Investment
Amount Rate Level Margin Adjustment Lifetime Cap Yield Securities
----------- -------- -------- -------- ---------- ------------ -------- ----------------
At September 30, 2004 12,645,118 4.12% 2.34% 1.78% 25 months 10.12% 3.06% 70.67%
At June 30, 2004 $11,806,171 3.95% 2.19% 1.76% 29 months 10.07% 2.73% 69.80%
At March 31, 2004 $13,059,967 3.90% 2.20% 1.70% 30 months 9.77% 2.91% 73.94%
- ---------------------------------------------------------------------------------------------------------------------------------
At December 31, 2003 $9,294,934 3.85% 2.25% 1.60% 23 months 9.86% 2.47% 73.29%
At September 30, 2003 $8,498,116 3.76% 2.17% 1.59% 22 months 9.75% 1.77% 68.74%
At June 30, 2003 $8,889,012 3.69% 2.18% 1.51% 18 months 9.70% 2.47% 63.77%
At March 31, 2003 $7,716,248 3.93% 2.31% 1.62% 13 months 10.04% 2.20% 64.53%
FIXED-RATE INVESTMENT SECURITIES CHARACTERISTICS
(DOLLARS IN THOUSANDS)
Principal
Amount at
Period End as
Weighted Weighted % of Total
Principal Average Coupon Average Investment
Amount Rate Asset Yield Securities
---------- -------------- ----------- ---------------
At September 30, 2004 $5,248,784 5.19% 4.08% 29.33%
At June 30, 2004 $5,108,464 5.15% 3.77% 30.20%
At March 31, 2004 $4,602,629 5.53% 3.41% 26.06%
- --------------------------------------------------------------------------------
At December 31, 2003 $3,387,197 5.77% 4.29% 26.71%
At September 30, 2003 $3,865,171 5.86% 3.63% 31.26%
At June 30, 2003 $5,050,434 5.97% 3.58% 36.23%
At March 31, 2003 $4,241,462 6.53% 3.98% 35.47%
25
The following tables provide information on adjustable-rate investment
securities by index at September 30, 2004 and December 31, 2003.
ADJUSTABLE-RATE INVESTMENT SECURITIES BY INDEX
SEPTEMBER 30, 2004
National
Six- 12- 11th Financial Six- 1-Year 2-Year 3-Year 5-Year Monthly
One- Six- Twelve Month Month District Average Month Treas- Treas- Treas- Treas- Federal
Month Month Month Auction Moving Cost of Mortgage CD ury ury ury ury Cost of
Libor Libor Libor Average Average Funds Rate Rate Index Index Index Index Funds
----- ------ ------ ------- ------- -------- --------- ------ ------ ------ ------ ------ -------
Weighted Average Term
to Next Adjustment 1mo. 28 mo. 35 mo. 5 mo. 1 mo. 1 mo. 12 mo. 3 mo. 27 mo. 13 mo. 16 mo. 30 mo. 1 mo.
Weighted Average
Annual Period Cap 8.01% 1.00% 2.16% 1.00% 0.17% None 2.00% 1.00% 1.84% 2.00% 2.00% 2.00% 2.00
Weighted Average
Lifetime Cap at
September 30, 2004 8.88% 9.76% 10.05% 13.03% 10.65% 12.33% 10.58% 11.64% 10.35% 11.92% 12.96% 12.61% 13.39%
Investment Principal
Amount as Percent-
age of Investment
Securities at
September 30, 2004 9.85% 2.61% 21.16% 0.01% 0.25% 1.15% 0.01% 0.05% 34.27% 0.01% 0.30% 0.08% 0.91%
ADJUSTABLE-RATE INVESTMENT SECURITIES BY INDEX
DECEMBER 31, 2003
Six- 12- 11th Six- 1-Year 2-Year 3-Year 5-Year Monthly
One- Six- Twelve Month Month District Interest Month Treas- Treas- Treas- Treas- Federal
Month Month Month Auction Moving Cost of Rate CD ury ury ury ury Cost of
Libor Libor Libor Average Average Funds Step Up Rate Index Index Index Index Funds
----- ------ ------ ------- ------- -------- -------- ------ ------ ------ ------ ------ -------
Weighted Average Term
to Next Adjustment 1mo. 25 mo. 34 mo. 2 mo. 1 mo. 1 mo. 175 mo. 2 mo. 23 mo. 15 mo. 16 mo. 26 mo. 1 mo.
Weighted Average
Annual Period Cap None 2.14% 2.09% 1.00% 0.14% None 2.00% 1.00% 1.88% 2.00% 2.00% 2.00% None
Weighted Average
Lifetime Cap at
December 31, 2003 8.88% 9.88% 10.12% 13.04% 10.70% 12.42% 6.76% 11.62% 10.05% 11.92% 12.89% 12.63% 13.40%
Investment Principal
Amount as Percent-
age of Investment
Securities at
December 31, 2003 17.26% 1.73% 12.00% 0.01% 0.53% 2.13% 2.21% 0.09% 35.10% 0.01% 0.44% 0.17% 1.61%
BORROWINGS
To date, our debt has consisted entirely of borrowings collateralized
by a pledge of our Investment Securities. These borrowings appear on our balance
sheet as repurchase agreements. At September 30, 2004, we had established
uncommitted borrowing facilities in this market with 29 lenders in amounts,
which we believe, are in excess of our needs. All of our Investment Securities
are currently accepted as collateral for these borrowings. However, we limit our
borrowings, and thus our potential asset growth, in order to maintain unused
borrowing capacity and thus increase the liquidity and strength of our statement
of financial condition.
For the quarter ended September 30, 2004, the term to maturity of our
borrowings ranged from one day to three years, with a weighted average original
term to maturity of 215 days. For the quarter ended September 30, 2003, the term
to maturity of our borrowings ranged from one day to three years, with a
weighted average original term to maturity of 171 days. At September 30, 2004,
the weighted average cost of funds for all of our borrowings was 1.99% and the
weighted average term to next rate adjustment was 109 days. At September 30,
2003, the weighted average cost of funds for all of our borrowings was 1.46% and
the weighted average term to next rate adjustment was 74 days.
26
LIQUIDITY
Liquidity, which is our ability to turn non-cash assets into cash, allows
us to purchase additional investment securities and to pledge additional assets
to secure existing borrowings should the value of our pledged assets decline.
Potential immediate sources of liquidity for us include cash balances and unused
borrowing capacity. Unused borrowing capacity will vary over time as the market
value of our investment securities varies. Our statement of financial condition
also generates liquidity on an on-going basis through mortgage principal
repayments and net earnings retained prior to payment as dividends. Should our
needs ever exceed these on-going sources of liquidity plus the immediate sources
of liquidity discussed above, we believe that in most circumstances our
investment securities could be sold to raise cash. The maintenance of liquidity
is one of the goals of our capital investment policy. Under this policy, we
limit asset growth in order to preserve unused borrowing capacity for liquidity
management purposes.
At present, we have entered into uncommitted facilities with 29 lenders
for borrowings in the form of repurchase agreements. Borrowings under our
repurchase agreements increased by $4.6 billion to $15.6 billion at September
30, 2004, from $11.0 billion at December 31, 2003. This increase in leverage was
facilitated by the increase in our equity capital as a result of the issuance of
common stock and preferred stock primarily through public offerings in the first
quarter of 2004.
We anticipate that, upon repayment of each borrowing under a repurchase
agreement, we will use the collateral immediately for borrowing under a new
repurchase agreement. We have not at the present time entered into any
commitment agreements under which the lender would be required to enter into new
repurchase agreements during a specified period of time, nor do we presently
plan to have liquidity facilities with commercial banks.
Under our repurchase agreements, we may be required to pledge additional
assets to our repurchase agreement counterparties (i.e., lenders) in the event
the estimated fair value of the existing pledged collateral under such
agreements declines and such lenders demand additional collateral (a "margin
call"), which may take the form of additional securities or cash. Specifically,
margin calls result from a decline in the value of the our Mortgage-Backed
Securities securing our repurchase agreements, prepayments on the mortgages
securing such Mortgage-Backed Securities and to changes in the estimated fair
value of such Mortgage-Backed Securities generally due to principal reduction of
such Mortgage-Backed Securities from scheduled amortization and resulting from
changes in market interest rates and other market factors. Through September 30,
2004, we did not have any margin calls on our repurchase agreements that we were
not able to satisfy with either cash or additional pledged collateral. However,
should prepayment speeds on the mortgages underlying our Mortgage-Backed
Securities and/or market interest rates suddenly increase, margin calls on our
repurchase agreements could result, causing an adverse change in our liquidity
position.
The following table summarizes the effect on our liquidity and cash flows
from contractual obligations for repurchase agreements and the non-cancelable
office lease at September 30, 2004.
There-
2004 2005 2006 2007 2008 after
----------- -------- -------- ---------- ---- ----
(dollars in thousands)
Repurchase agreements $13,179,196 $950,000 $350,000 $1,100,000 -- --
Long-term lease
obligations 125 500 530 532 $532 $532
----------- -------- -------- ---------- ---- ----
Total $13,179,321 $950,500 $350,530 $1,100,532 $532 $532
=========== ======== ======== ========== ==== ====
STOCKHOLDERS' EQUITY
During the quarter ending September 30, 2004, we declared dividends to
common shareholders totaling $60.6 million or $0.50 per share, which were paid
on October 27, 2004. During the quarter ended September 30, 2004,we declared
dividends to preferred shareholders totaling $2.1 million or $0.49 per share,
which were paid on September 30, 2004. On January 21, 2004, we entered into an
underwriting agreement pursuant to which the Company raised net proceeds of
approximately $363.6 million in equity in an offering of 20,700,000 shares of
common stock. On March 31, 2004, we entered into an underwriting agreement
pursuant to which we raised net proceeds of approximately $102.9 million in net
proceeds through an offering of 4,250,000 shares of 7.875% Series A Cumulative
Redeemable Preferred Stock, which settled on April 5, 2004. During the quarter
ended September 30,
27
2004, 1,076,125 shares were issued through the Equity Shelf Program resulting in
net proceeds of $17.5 million. During the quarter ended September 30, 2004, 50
options were exercised under the long-term compensation plan resulting in net
proceeds of $432. An additional 10,818 shares were purchased in the dividend
reinvestment and direct purchase program resulting in net proceeds of $175,000.
During the nine months ended September 30, 2004, 2,103,525 shares of the
Company's common stock were issued through the Equity Shelf Program resulting in
net proceeds of $37.5 million, During the nine months ended September 30, 2004,
40,250 options were exercised under the long-term compensation plan resulting in
net proceeds of $662,000, and 116,760 common shares were sold through the
dividend reinvestment and direct purchase program resulting in net proceeds of
$2.1 million .
The FIDAC acquisition was completed on June 4, 2004. We issued 2,201,080
common shares to the shareholders of FIDAC, based on the December 31, 2003
closing price of $18.40. We continue to operate as a self-managed and
self-advised real estate investment trust, with FIDAC operating as our
wholly-owned taxable REIT subsidiary.
With our "available-for-sale" accounting treatment, unrealized
fluctuations in market values of assets do not impact our GAAP or taxable income
but rather are reflected on our balance sheet by changing the carrying value of
the asset and stockholders' equity under "Accumulated Other Comprehensive Income
(Loss)." By accounting for our assets in this manner, we hope to provide useful
information to stockholders and creditors and to preserve flexibility to sell
assets in the future without having to change accounting methods.
As a result of this mark-to-market accounting treatment, our book value
and book value per share are likely to fluctuate far more than if we used
historical amortized cost accounting. As a result, comparisons with companies
that use historical cost accounting for some or all of their balance sheet may
not be meaningful.
The table below shows unrealized gains and losses on the Investment
Securities in our portfolio.
UNREALIZED GAINS AND LOSSES
(dollars in thousands)
AT AT AT AT AT AT AT
SEPTEMBER 30, JUNE 30, MARCH 31, DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31,
2004 2004 2004 2003 2003 2003 2003
-------------- ------------ ------------ -------------- --------------- ------------- -------------
Unrealized Gain $24,788 $ 27,603 $53,912 $24,886 $27,439 $51,208 $98,768
Unrealized Loss (116,775) (205,092) (49,412) (72,147) (79,309) (50,018) (27,768)
-------------- ------------ ------------ -------------- --------------- ------------- -------------
Net Unrealized Gain (Loss) (91,987) ($177,489) $4,500 ($47,261) $(51,870) $1,190 $71,000
============== ============ ============ ============== =============== ============= =============
Net Unrealized Gain
(Loss) as % of Investment
Securities' Principal (0.51%) (1.05%) 0.03% (0.37%) (0.41%) 0.01% 0.59%
Amount
Net Unrealized Gain
(Loss) as % of Investment
Securities' Amortized Cost (0.50%) (1.03%) 0.03% (0.37%) (0.41%) 0.01% 0.59%
Although unrealized changes in the estimated net market value of
Investment Securities do not impact our GAAP or taxable income, such unrealized
changes have one direct effect on our potential earnings and dividends: positive
mark-to-market changes increase our equity and allow us to increase our
borrowing capacity under our capital investment policy while negative changes
decrease our equity and limit our borrowing capacity under our capital
investment policy. A very large negative change in the net market value of our
Investment Securities might impair our liquidity position, requiring us to sell
assets with the likely result of realized losses upon sale.
As discussed above, because we use "available-for-sale" treatment for our
Investment Securities; we carry these assets on our balance sheet at estimated
market value rather than historical amortized cost. Based upon this
"available-for-sale" treatment, our common equity base at September 30, 2004 was
$1.6 billion, or a book value of $12.84 per common share. If we had used
historical amortized cost accounting, our common equity base at September 30,
2004 would have been $1.6 billion, or $13.60 per common share. Our equity base
at December 31, 2003 was $1.1 billion, or $11.96 per share. If we had used
historical amortized cost accounting, our equity base at
28
December 31, 2003 would have been $1.2 billion, or $12.45 per share.
The table below shows our equity capital base as reported and on a
historical amortized cost basis at September 30, 2004, June 30, 2004, March 31,
2004,, December 31, 2003, September 30, 2003, June 30, 2003 and March 31, 2003.
Issuances of common stock, the level of earnings as compared to dividends
declared, and other factors influence our historical cost equity capital base.
The reported equity capital base is influenced by these factors plus changes in
the "Unrealized Net Gains (Losses) on Assets Available for Sale" account.
STOCKHOLDERS' EQUITY
7.875% Series A
Cumulative Net Unrealized Reported Reported Common
Redeemable Historical Gains (Losses) on Common Stock Historical Stock Equity
Preferred Stock: Common Stock Assets Available Equity Base Common Stock (Book Value)
4,250,000 shares Equity Base for Sale (Book Value) Equity Per Share Per Share
---------------- ------------ ----------------- ------------ ---------------- ---------------
(dollars in thousands, except per share data)
At September 30, 2004 $102,708 $1,648,869 ($91,987) $1,556,882 $13.60 $12.84
At June 30, 2004 $102,708 $1,627,292 ($177,489) $1,449,803 $13.54 $12.07
At March 31, 2004 $102,870 $1,581,218 $4,500 $1,585,718 $13.42 $13.45
- ---------------------------------------------------------------------------------------------------------------------------------
At December 31, 2003 -- $1,196,481 $(47,261) $1,149,220 $12.45 $11.96
At September 30, 2003 -- $1,197,598 $(51,870) $1,145,728 $12.48 $11.94
At June 30, 2003 -- $1,160,248 $ 1,190 $1,161,438 $12.34 $12.35
At March 31, 2003 -- $1,005,712 $ 71,000 $1,076,712 $11.88 $12.72
LEVERAGE
Our debt-to-reported equity ratio at September 30, 2004 and September 30,
2003 was 9.4:1 and 9.8:1, respectively. We generally expect to maintain a ratio
of debt-to-equity of between 8:1 and 12:1, although the ratio may vary from this
range from time to time based upon various factors, including our management's
opinion of the level of risk of our assets and liabilities, our liquidity
position, our level of unused borrowing capacity and over-collateralization
levels required by lenders when we pledge assets to secure borrowings.
Our target debt-to- equity ratio is determined under our capital
investment policy. Should our actual debt-to-equity ratio increase above the
target level due to asset acquisition or market value fluctuations in assets, we
will cease to acquire new assets. Our management will, at that time, present a
plan to our Board of Directors to bring us back to our target debt-to-equity
ratio; in many circumstances, this would be accomplished over time by the
monthly reduction of the balance of our Mortgage-Backed Securities through
principal repayments.
ASSET/LIABILITY MANAGEMENT AND EFFECT OF CHANGES IN INTEREST RATES
We continually review our asset/liability management strategy with respect
to interest rate risk, mortgage prepayment risk, credit risk and the related
issues of capital adequacy and liquidity. We seek attractive risk-adjusted
stockholder returns while maintaining a strong balance sheet.
We seek to manage the extent to which our net income changes as a function
of changes in interest rates by matching adjustable-rate assets with
variable-rate borrowings. In addition, although we have not done so to date, we
may seek to mitigate the potential impact on net income of periodic and lifetime
coupon adjustment restrictions in our portfolio of Investment Securities by
entering into interest rate agreements such as interest rate caps and interest
rate swaps.
Changes in interest rates may also have an effect on the rate of mortgage
principal prepayments and, as a result, prepayments on Mortgage-Backed
Securities. We will seek to mitigate the effect of changes in the mortgage
principal repayment rate by balancing assets we purchase at a premium with
assets we purchase at a discount. To date, the aggregate premium exceeds the
aggregate discount on our Mortgage-Backed Securities. As a result, prepayments,
which result in the expensing of unamortized premium, will reduce our net income
compared to what
29
net income would be absent such prepayments.
OFF-BALANCE SHEET ARRANGEMENTS
The Company has not had, and at September 30, 2004 does not have, any
off-balance sheet arrangements that have or are reasonably likely to have a
current or future effect on the Company's financial condition, changes in
financial condition, revenues or expenses, results of operations, liquidity,
capital expenditures or capital resources that is material to investors.
INFLATION
Virtually all of our assets and liabilities are financial in nature. As a
result, interest rates and other factors drive our performance far more than
does inflation. Changes in interest rates do not necessarily correlate with
inflation rates or changes in inflation rates. Our financial statements are
prepared in accordance with GAAP and our dividends based upon our net income as
calculated for tax purposes; in each case, our activities and balance sheet are
measured with reference to historical cost or fair market value without
considering inflation.
CAPITAL RESOURCES
At September 30, 2004, we had no material commitments for capital
expenditures.
OTHER MATTERS
We calculate that our qualified REIT assets, as defined in the Internal
Revenue Code, were 100% of our total assets at September 30, 2004 and December
31, 2003, as compared to the Internal Revenue Code requirement that at least 75%
of our total assets be qualified REIT assets. We also calculate that 92% of our
revenue qualifies for the 75% source of income test, and 97 % and 100% of our
revenue qualifies for the 95% source of income test, under the REIT rules for
the quarters ended September 30, 2004 and September 30, 2003, respectively. We
also met all REIT requirements regarding the ownership of our common stock and
the distribution of our net income. Therefore, as of September 30, 2004 and
December 31, 2003, we believe that we qualified as a REIT under the Internal
Revenue Code.
We at all times intend to conduct our business so as not to become
regulated as an investment company under the Investment Company Act. If we were
to become regulated as an investment company, then our use of leverage would be
substantially reduced. The Investment Company Act exempts entities that are
"primarily engaged in the business of purchasing or otherwise acquiring
mortgages and other liens on and interests in real estate" (qualifying
interests). Under current interpretation of the staff of the SEC, in order to
qualify for this exemption, we must maintain at least 55% of our assets directly
in qualifying interests. In addition, unless certain mortgage securitites
represent all the certificates issued with respect to an underlying pool of
mortgages, the Mortgage-Backed Securities may be treated as securities separate
from the underlying mortgage loans and, thus, may not be considered qualifying
interests for purposes of the 55% requirement. We calculate that as of September
30, 2004 and December 31, 2003 we were in compliance with this requirement.
30
ITEM. 3 QUANTITATIVE AND QUALITIATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK
Market risk is the exposure to loss resulting from changes in interest
rates, foreign currency exchange rates, commodity prices and equity prices. The
primary market risk to which we are exposed is interest rate risk, which is
highly sensitive to many factors, including governmental monetary and tax
policies, domestic and international economic and political considerations and
other factors beyond our control. Changes in the general level of interest rates
can affect our net interest income, which is the difference between the interest
income earned on interest-earning assets and the interest expense incurred in
connection with our interest-bearing liabilities, by affecting the spread
between our interest-earning assets and interest-bearing liabilities. Changes in
the level of interest rates also can affect the value of our Mortgage-Backed
Securities and our ability to realize gains from the sale of these assets. We
may utilize a variety of financial instruments; including interest rate swaps,
caps, floors and other interest rate exchange contracts, in order to limit the
effects of interest rates on our operations. If we use these types of
derivatives to hedge the risk of interest-earning assets or interest-bearing
liabilities, we may be subject to certain risks, including the risk that losses
on a hedge position will reduce the funds available for payments to holders of
securities and that the losses may exceed the amount we invested in the
instruments. To date, we have not purchased any hedging instruments.
Our profitability and the value of our portfolio may be adversely affected
during any period as a result of changing interest rates. The following table
quantifies the potential changes in net interest income and portfolio value
should interest rates go up or down 25, 50, and 100 basis points, assuming the
yield curves of the rate shocks will be parallel to each other and the current
yield curve. All changes in income and value are measured as percentage changes
from the projected net interest income and portfolio value at the base interest
rate scenario. The base interest rate scenario assumes interest rates at
September 30, 2004 and various estimates regarding prepayment and all activities
are made at each level of rate shock. Actual results could differ significantly
from these estimates.
Projected Projected
Percentage Change in Percentage Change in
Change in Interest Rate Net Interest Income Portfolio Value
- -------------------------- -------------------------- --------------------------
- -100 Basis Points (10.71%) 1.03%
- -75 Basis Points (10.22%) 0.79%
- -50 Basis Points (7.89%) 0.51%
- -25 Basis Points (4.07%) 0.27%
Base Interest Rate - -
+25 Basis Points 3.04% (0.34%)
+50 Basis Points 5.01% (0.73%)
+75 Basis Points 6.12% (1.12%)
+100 Basis Points 6.18% (1.54%)
ASSET AND LIABILITY MANAGEMENT
Asset and liability management is concerned with the timing and magnitude
of the repricing of assets and liabilities. We attempt to control risks
associated with interest rate movements. Methods for evaluating interest rate
risk include an analysis of our interest rate sensitivity "gap", which is the
difference between interest-earning assets and interest-bearing liabilities
maturing or repricing within a given time period. A gap is considered positive
when the amount of interest-rate sensitive assets exceeds the amount of
interest-rate sensitive liabilities. A gap is considered negative when the
amount of interest-rate sensitive liabilities exceeds interest-rate sensitive
assets. During a period of rising interest rates, a negative gap would tend to
adversely affect net interest income, while a positive gap would tend to result
in an increase in net interest income. During a period of falling interest
rates, a negative gap would tend to result in an increase in net interest
income, while a positive gap would tend to affect net interest income adversely.
Because different types of assets and liabilities with the same or similar
maturities may react differently to changes in overall market rates or
conditions, changes in interest rates may affect net interest
31
income positively or negatively even if an institution were perfectly matched in
each maturity category.
The following table sets forth the estimated maturity or repricing of our
interest-earning assets and interest-bearing liabilities at September 30, 2004.
The amounts of assets and liabilities shown within a particular period were
determined in accordance with the contractual terms of the assets and
liabilities, except adjustable-rate loans, and securities are included in the
period in which their interest rates are first scheduled to adjust and not in
the period in which they mature. The interest rate sensitivity of our assets and
liabilities in the table could vary substantially if based on actual prepayment
experience.
More than
Within 3 1 Year to 3 Years and
Months 4-12 Months 3 Years Over Total
---------------- ----------------- ---------------- ---------------- --------------
(dollars in thousands)
Rate Sensitive Assets:
Investment Securities $2,450,869 $1,292,120 $5,762,649 $8,388,263 $17,893,901
Rate Sensitive Liabilities:
Repurchase Agreements 13,179,196 950,000 1,450,000 -- 15,579,196
---------------- ----------------- ---------------- ---------------- --------------
Interest rate sensitivity gap ($10,728,327) $342,120 $4,312,649 $8,388,263 $2,314,705
================ ================= ================ ================ ==============
Cumulative rate sensitivity gap ($10,728,327) ($10,386,207) ($6,073,558) $2,314,705
================ ================= ================ ================ ==============
Cumulative interest rate
sensitivity gap as a percentage of (60%) (58%) (34%) 13%
total rate-sensitive assets
Our analysis of risks is based on management's experience, estimates, models and
assumptions. These analyses rely on models which utilize estimates of fair value
and interest rate sensitivity. Actual economic conditions or implementation of
investment decisions by our management may produce results that differ
significantly form the estimates and assumptions used in our models and the
projected results shown in the above tables and in this report. These analyses
contain certain forward-looking statements and are subject to the safe harbor
statement set forth under the heading, "Special Note Regarding Forward-Looking
Statements."
ITEM 4. CONTROLS AND PROCEDURES
As of September 30, 2004, a review and evaluation was performed under the
supervision and with the participation of our management, including our Chairman
of the board of directors, Chief Executive Officer and President and our Chief
Financial Officer and Treasurer, of the effectiveness of the design and
operation of our disclosure controls and procedures. Based on that review and
evaluation, our management, including our Chairman of the board of directors,
Chief Executive Officer and President and our Chief Financial Officer and
Treasurer, concluded that our disclosure controls and procedures were effective
as of September 30, 2004. There have been no significant changes in our internal
controls or in other factors that could significantly affect internal controls
subsequent to September 30, 2004. There were no significant material weaknesses
identified in the course of such review and, therefore, no corrective measures
were taken by us.
32
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibits
The exhibits required by this item are set forth on the Exhibit Index attached
hereto.
Exhibit Number Exhibit Description
31.1 Certification of Chief Executive Officer, pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer, pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer, pursuant to 18 U.S.C.
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
32.2 Certification of Chief Financial Officer, pursuant to 18 U.S.C.
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
33
SIGNATURES
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 thereunto duly authorized.
ANNALY MORTGAGE MANAGEMENT, INC.
Dated: November 5, 2004 By:/s/ Michael A.J. Farrell
-------------------------
Michael A.J. Farrell
(Chairman of the Board,
Chief Executive Officer,
President and authorized
officer of registrant)
Dated: November 5, 2004 By:/s/ Kathryn F. Fagan
---------------------
Kathryn F. Fagan
(Chief Financial Officer and
Treasurer and principal financial
and chief accounting officer)