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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED: DECEMBER 31, 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 (I.R.S. EMPLOYER IDENTIFICATION NUMBER)
INCORPORATION OF ORGANIZATION)
1211 AVENUE OF THE AMERICAS, SUITE 2902
NEW YORK, NEW YORK 10036
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(212) 696-0100
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
COMMON STOCK, PAR VALUE $.01 PER SHARE NEW YORK STOCK EXCHANGE
7.875% SERIES A CUMULATIVE REDEEMABLE PREFERRED STOCK NEW YORK STOCK EXCHANGE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
NONE.
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED
TO BE FILED BY SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING
THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS
REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING
REQUIREMENTS FOR THE PAST 90 DAYS:
YES X NO
INDICATE BY CHECK MARK IF DISCLOSURE OF DELINQUENT FILERS PURSUANT TO ITEM 405
OF REGULATION S-K IS NOT CONTAINED HEREIN, AND WILL NOT BE CONTAINED, TO THE
BEST OF REGISTRANT'S KNOWLEDGE, IN DEFINITIVE PROXY OR INFORMATION STATEMENTS
INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-K OR ANY AMENDMENT TO THIS
FORM 10-K. [ ]
INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS AN ACCELERATED FILER (AS
DEFINED IN RULE 12B-2 OF THE ACT). YES X NO
--- ---
AT JUNE 30, 2004, THE AGGREGATE MARKET VALUE OF THE VOTING STOCK HELD BY
NON-AFFILIATES OF THE REGISTRANT WAS $1,991,760,199
THE NUMBER OF SHARES OF THE REGISTRANT'S COMMON STOCK OUTSTANDING ON MARCH 1
2005 WAS 121,272,323.
DOCUMENTS INCORPORATED BY REFERENCE
THE REGISTRANT INTENDS TO FILE A DEFINITIVE PROXY STATEMENT PURSUANT TO
REGULATION 14A WITHIN 120 DAYS OF THE END OF THE FISCAL YEAR ENDED DECEMBER 31,
2004. PORTIONS OF SUCH PROXY STATEMENT ARE INCORPORATED BY REFERENCE INTO PART
III OF THIS FORM 10-K.
ANNALY MORTGAGE MANAGEMENT, INC.
- --------------------------------------------------------------------------------
2004 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PART I
PAGE
ITEM 1. BUSINESS 1
ITEM 2. PROPERTIES 25
ITEM 3. LEGAL PROCEEDINGS 25
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 25
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS 26
ITEM 6. SELECTED FINANCIAL DATA 28
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS 30
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 46
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 48
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE 48
ITEM 9A. CONTROLS AND PROCEDURES 48
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 49
ITEM 11. EXECUTIVE COMPENSATION 49
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AND RELATED STOCKHOLDER MATTERS 49
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 49
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES 49
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K 50
FINANCIAL STATEMENTS F-1
SIGNATURES II-1
EXHIBIT INDEX II-2
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain statements contained in this annual 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 our wholly owned
subsidiary, Fixed Income Discount Advisory Company (which we refer to as 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, please see the
information under the caption "Risk Factors" described in this 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.
PART I
ITEM 1. BUSINESS
THE COMPANY
BACKGROUND
Annaly Mortgage Management, Inc. owns, manages, and finances a
portfolio of investment securities, including mortgage pass-through
certificates, collateralized mortgage obligations (or CMOs), agency callable
debentures, and other securities representing interests in or obligations backed
by pools of mortgage loans. 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 cost of borrowings to finance our
acquisition of investment securities. We are a Maryland corporation that
commenced operations on February 18, 1997. We are self-advised and self-managed.
The Company acquired Fixed Income Discount Advisory Company ("FIDAC") on June 4,
2004 (See Note 2 to the Financial Statements). FIDAC is a registered investment
advisor and is a taxable REIT subsidiary of the Company.
We have financed our purchases of investment securities with the net
proceeds of equity offerings and borrowings under repurchase agreements whose
interest rates adjust based on changes in short-term market interest rates.
We have elected and believe that we are organized and have operated in
a manner that enables us to be taxed as a real estate investment trust (or REIT)
under the Internal Revenue Code of 1986, as amended (or the Code). If we qualify
for taxation as a REIT, we generally will not be subject to federal income tax
on our taxable income that is distributed to our stockholders. Therefore,
substantially all of our assets, other than FIDAC, our taxable REIT subsidiary,
consist of qualified REIT real estate assets (of the type described in Section
856(c)(5)(B) of the Code). We have financed our purchases of investment
securities with the net proceeds of equity offerings and borrowings under
repurchase agreements whose interest rates adjust based on changes in short-term
market interest rates.
As used herein, "Annaly," the "Company," "we," "our" and similar terms
refer to Annaly Mortgage Management, Inc., unless the context indicates
otherwise.
ASSETS
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
1
are guaranteed by the United States government or an agency of the United States
government, or (3) are unrated but we determine them 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, we
determine them 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.
To date, all of the mortgage-backed securities that we have acquired
have been agency mortgage-backed securities which, although not rated, carry an
implied "AAA" rating. Agency mortgage-backed securities are mortgage-backed
securities for which a government agency or federally chartered corporation,
such as the Federal Home Loan Mortgage Corporation ("FHLMC"), the Federal
National Mortgage Association ("FNMA"), or the Government National Mortgage
Association ("GNMA"), guarantees payments of principal or interest on the
securities. Agency mortgage-backed securities consist of agency pass-through
certificates and CMOs issued or guaranteed by an agency. Pass-through
certificates provide for a pass-through of the monthly interest and principal
payments made by the borrowers on the underlying mortgage loans. CMOs divide a
pool of mortgage loans into multiple tranches with different principal and
interest payment characteristics.
At December 31, 2004, approximately 62% of our investment securities
were adjustable-rate pass-though certificates, approximately 29% of our
investment securities were fixed-rate pass-through certificates or CMOs, and
approximately 9% of our investment securities were CMO floaters. Our
adjustable-rate pass-through certificates are backed by adjustable-rate mortgage
loans and have coupon rates which adjust over time, subject to interest rate
caps and lag periods, in conjunction with changes in short-term interest rates.
CMO floaters are tranches of mortgage-backed securities where the interest rate
adjusts in conjunction with changes in short-term interest rates. Our fixed-rate
pass-through certificates are backed by fixed-rate mortgage rates which do not
adjust over time. CMO floaters may be backed by fixed-rate mortgage loans or,
less often, by adjustable-rate mortgage loans. In this Form 10-K, except where
the context indicates otherwise, we use the term "adjustable-rate securities" or
"adjustable-rate investment securities" to refer to adjustable-rate pass-through
certificates, CMO floaters, and Agency debentures. At December 31, 2004, the
weighted average yield on our portfolio of earning assets was 3.43% and the
weighted average term to next rate adjustment on adjustable rate securities was
24 months.
We also invest in Federal Home Loan Bank ("FHLB"), FHLMC, and FNMA
debentures. We refer to the mortgage-backed securities and agency debentures
collectively as "Investment Securities." We intend to continue to invest in
adjustable-rate pass-through certificates, fixed-rate mortgage-backed
securities, CMO floaters, and Agency debentures. Although we have not done so to
date, we may also invest on a limited basis in mortgage derivative securities
representing the right to receive interest only or a disproportionately large
amount of interest. We have not and will not invest in real estate mortgage
investment conduit ("REMIC") residuals, other CMO residuals or any
mortgage-backed securities, such as inverse floaters, which have imbedded
leverage as part of their structural characteristics.
BORROWINGS
We attempt to structure our borrowings to have interest rate adjustment
indices and interest rate adjustment periods that, on an aggregate basis,
correspond generally to the interest rate adjustment indices and periods of our
adjustable-rate investment securities. However, periodic rate adjustments on our
borrowings are generally more frequent than rate adjustments on our investment
securities. At December 31, 2004, the weighted average cost of funds for all of
our borrowings was 2.46%, the weighted average original term to maturity was 211
days, and the weighted average term to next rate adjustment of these borrowings
was 111 days.
We generally expect to maintain a ratio of debt-to-equity of between
8:1 and 12:1, although the ratio may vary from time to time depending upon
market conditions and other factors that our management deems relevant. For
purposes of calculating this ratio, our equity is equal to the value of our
investment portfolio on a mark-to-market basis,
2
less the book value of our obligations under repurchase agreements and other
collateralized borrowings. At December 31, 2004, our ratio of debt-to-equity was
9.8:1.
HEDGING
To the extent consistent with our election to qualify as a REIT, we may
enter into hedging transactions to attempt to protect our investment securities
and related borrowings against the effects of major interest rate changes. This
hedging would be used to mitigate declines in the market value of our investment
securities during periods of increasing or decreasing interest rates and to
limit or cap the interest rates on our borrowings. These transactions would be
entered into solely for the purpose of hedging interest rate or prepayment risk
and not for speculative purposes. To date, we have not entered into any hedging
transactions.
COMPLIANCE WITH REIT AND INVESTMENT COMPANY REQUIREMENTS
We constantly monitor our investment securities and the income from
these securities and, to the extent we enter into hedging transactions in the
future, we will monitor income from our hedging transactions as well, so as to
ensure at all times that we maintain our qualification as a REIT and our exempt
status under the Investment Company Act of 1940, as amended.
MANAGEMENT
The following table sets forth certain information as of March 4, 2005
concerning our executive officers:
- ------------------------------------ -------------- ------------------------------------------------------------------
NAME AGE POSITION HELD WITH THE COMPANY
- ------------------------------------ -------------- ------------------------------------------------------------------
Michael A.J. Farrell 53 Chairman of the Board, Chief Executive Officer and President
- ------------------------------------ -------------- ------------------------------------------------------------------
Wellington J. Denahan-Norris 41 Vice Chairman of the Board and Chief Investment Officer
- ------------------------------------ -------------- ------------------------------------------------------------------
Kathryn F. Fagan 38 Chief Financial Officer and Treasurer
- ------------------------------------ -------------- ------------------------------------------------------------------
Jennifer S. Karve 34 Executive Vice President
- ------------------------------------ -------------- ------------------------------------------------------------------
James P. Fortescue 31 Senior Vice President and Repurchase Agreement Manager
- ------------------------------------ -------------- ------------------------------------------------------------------
Kristopher Konrad 30 Senior Vice President and Portfolio Mangager
- ------------------------------------ -------------- ------------------------------------------------------------------
Jeremy Diamond 41 Executive Vice President
- ------------------------------------ -------------- ------------------------------------------------------------------
Ronald Kazel 37 Executive Vice President--Business Development
- ------------------------------------ -------------- ------------------------------------------------------------------
Rose-Marie Lyght 31 Senior Vice-President and Portfolio Manager
- ------------------------------------ -------------- ------------------------------------------------------------------
R. Nicholas Singh 45 Executive Vice President, General Counsel, Secretary and Chief
Compliance Officer
- ------------------------------------ -------------- ------------------------------------------------------------------
Mr. Farrell and Ms. Denahan-Norris have an average of 24 years
experience in the investment banking and investment management industries where,
in various capacities, they have each managed portfolios of mortgage-backed
securities, arranged collateralized borrowings and utilized hedging techniques
to mitigate interest rate and other risk within fixed-income portfolios. Ms.
Fagan is a certified public accountant and, prior to becoming our Chief
Financial Officer and Treasurer, served as Chief Financial Officer and
Controller of a publicly owned savings and loan association. Mrs. Karve has
worked for us since December 1996. Mr. Diamond joined Annaly in March 2002. From
1990 to 2002 he was President of Grant's Financial Publishing. Mr. Kazel is in
charge of business development for FIDAC and Annaly and Mr. Kazel joined Annaly
in December 2001. Prior to joining FIDAC and Annaly, Mr. Kazel was a Senior
Vice-
3
President in Friedman Billings Ramsey's financial services investment banking
group. Ms. Lyght joined Annaly in April 1999. Mr. Singh joined Annaly in
February 2005. Prior to that, he was a partner in the law firm of McKee Nelson
LLP, and prior to that, a partner in Sidley Austin Brown & Wood LLP. We had 30
full-time employees at December 31, 2004.
DISTRIBUTIONS
To maintain our qualification as a REIT, we must distribute substantially
all of our taxable income to our stockholders for each year. We have done this
in the past and intend to continue to do so in the future. We also have declared
and paid regular quarterly dividends in the past and intend to do so in the
future. We have adopted a dividend reinvestment plan to enable holders of common
stock to reinvest dividends automatically in additional shares of common stock.
BUSINESS STRATEGY
GENERAL
Our principal business objective is to generate income for distribution
to our stockholders, primarily from the net cash flows on our investment
securities. Our net cash flows result primarily from the difference between the
interest income on our investment securities and borrowing costs of our
repurchase agreements and from dividends we receive from FIDAC. To achieve our
business objective and generate dividend yields, our strategy is:
o to purchase mortgage-backed securities, the majority of which we
expect to have adjustable interest rates based on changes in
short-term market interest rates;
o to acquire mortgage-backed securities that we believe:
- we have the necessary expertise to evaluate and manage;
- we can readily finance;
- are consistent with our balance sheet guidelines and risk
management objectives; and
- provide attractive investment returns in a range of scenarios;
o to finance purchases of mortgage-backed securities with the
proceeds of equity offerings and, to the extent permitted by our
capital investment policy, to utilize leverage to increase
potential returns to stockholders through borrowings;
o to attempt to structure our borrowings to have interest rate
adjustment indices and interest rate adjustment periods that, on
an aggregate basis, generally correspond to the interest rate
adjustment indices and interest rate adjustment periods of our
adjustable-rate mortgage-backed securities;
o to seek to minimize prepayment risk by structuring a diversified
portfolio with a variety of prepayment characteristics and through
other means; and
o to issue new equity or debt and increase the size of our balance
sheet when opportunities in the market for mortgage-backed
securities are likely to allow growth in earnings per share.
We believe we are able to obtain cost efficiencies through our
facilities-sharing arrangement with FIDAC and by virtue of our management's
experience in managing portfolios of mortgage-backed securities and arranging
collateralized borrowings. We will strive to become even more cost-efficient
over time by:
o seeking to raise additional capital from time to time in order to
increase our ability to invest in mortgage-backed securities;
4
o striving to lower our effective borrowing costs over time by
seeking direct funding with collateralized lenders, rather than
using financial intermediaries, and investigating the possibility
of using commercial paper and medium term note programs;
o improving the efficiency of our balance sheet structure by
investigating the issuance of uncollateralized subordinated debt,
preferred stock and other forms of capital; and
o utilizing information technology in our business, including
improving our ability to monitor the performance of our investment
securities and to lower our operating costs.
MORTGAGE-BACKED SECURITIES
GENERAL
To date, all of the mortgage-backed securities that we have acquired
have been agency mortgage-backed securities which, although not rated, carry an
implied "AAA" rating. Agency mortgage-backed securities are mortgage-backed
securities where a government agency or federally chartered corporation, such as
FHLMC, FNMA or GNMA, guarantees payments of principal or interest on the
securities. Agency mortgage-backed securities consist of agency pass-through
certificates and CMOs issued or guaranteed by an agency.
Even though to date we have only acquired securities with an implied
"AAA" rating, under our capital investment policy, we have the ability to
acquire securities of lower quality. Under our policy, at least 75% of our total
assets must be high quality mortgage-backed securities and short-term
investments. High quality securities are securities (1) that are rated within
one of the two highest rating categories by at least one of the nationally
recognized rating agencies, (2) that are unrated but are guaranteed by the
United States government or an agency of the United States government, or (3)
that are unrated or whose ratings have not been updated but that our management
determines are of comparable quality to rated high quality mortgage-backed
securities.
Under our capital investment policy, the remainder of our assets,
comprising not more than 25% of total assets, may consist of mortgage-backed
securities and 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 S&P or the equivalent by another nationally recognized rating
organization) or, if not rated, we determine them to be of comparable credit
quality to an investment which is rated "BBB" or better. We intend to structure
our portfolio to maintain a minimum weighted average rating (including our
deemed comparable ratings for unrated mortgage-backed securities) of our
mortgage-backed securities of at least single "A" under the S&P rating system
and at the comparable level under the other rating systems.
Our allocation of investments among the permitted investment types may
vary from time-to-time based on the evaluation by our board of directors of
economic and market trends and our perception of the relative values available
from these types of investments, except that in no event will our investments
that are not high quality exceed 25% of our total assets.
We intend to acquire only those mortgage-backed securities that we
believe we have the necessary expertise to evaluate and manage, that are
consistent with our balance sheet guidelines and risk management objectives and
that we believe we can readily finance. Since we generally hold the
mortgage-backed securities we acquire until maturity, we generally do not seek
to acquire assets whose investment returns are attractive in only a limited
range of scenarios. We believe that future interest rates and mortgage
prepayment rates are very difficult to predict. Therefore, we seek to acquire
mortgage-backed securities which we believe will provide acceptable returns over
a broad range of interest rate and prepayment scenarios.
At December 31, 2004, our mortgage-backed securities consist of
pass-through certificates and collateralized mortgage obligations issued or
guaranteed by FHLMC, FNMA or GNMA. We have not, and will not, invest in REMIC
residuals, other CMO residuals or mortgage-backed securities, such as inverse
floaters, which have imbedded leverage as part of their structural
characteristics.
5
DESCRIPTION OF MORTGAGE-BACKED SECURITIES
The mortgage-backed securities that we acquire provide funds for
mortgage loans made primarily to residential homeowners. Our securities
generally represent interests in pools of mortgage loans made by savings and
loan institutions, mortgage bankers, commercial banks and other mortgage
lenders. These pools of mortgage loans are assembled for sale to investors (like
us) by various government, government-related and private organizations.
Mortgage-backed securities differ from other forms of traditional debt
securities, which normally provide for periodic payments of interest in fixed
amounts with principal payments at maturity or on specified call dates. Instead,
mortgage-backed securities provide for a monthly payment, which consists of both
interest and principal. In effect, these payments are a "pass-through" of the
monthly interest and principal payments made by the individual borrower on the
mortgage loans, net of any fees paid to the issuer or guarantor of the
securities. Additional payments result from prepayments of principal upon the
sale, refinancing or foreclosure of the underlying residential property, net of
fees or costs which may be incurred. Some mortgage-backed securities, such as
securities issued by GNMA, are described as "modified pass-through." These
securities entitle the holder to receive all interest and principal payments
owed on the mortgage pool, net of certain fees, regardless of whether the
mortgagors actually make mortgage payments when due.
The investment characteristics of pass-through mortgage-backed
securities differ from those of traditional fixed-income securities. The major
differences include the payment of interest and principal on the mortgage-backed
securities on a more frequent schedule, as described above, and the possibility
that principal may be prepaid at any time due to prepayments on the underlying
mortgage loans or other assets. These differences can result in significantly
greater price and yield volatility than is the case with traditional
fixed-income securities.
Various factors affect the rate at which mortgage prepayments occur,
including changes in interest rates, general economic conditions, the age of the
mortgage loan, the location of the property and other social and demographic
conditions. Generally prepayments on mortgage-backed securities increase during
periods of falling mortgage interest rates and decrease during periods of rising
mortgage interest rates. We may reinvest prepayments at a yield that is higher
or lower than the yield on the prepaid investment, thus affecting the weighted
average yield of our investments.
To the extent mortgage-backed securities are purchased at a premium,
faster than expected prepayments result in a faster than expected amortization
of the premium paid. Conversely, if these securities were purchased at a
discount, faster than expected prepayments accelerate our recognition of income.
CMOs may allow for shifting of prepayment risk from slower-paying
tranches to faster-paying tranches. This is in contrast to mortgage pass-through
certificates where all investors share equally in all payments, including all
prepayments, on the underlying mortgages.
FHLMC CERTIFICATES
FHLMC is a privately-owned government-sponsored enterprise created
pursuant to an Act of Congress on July 24, 1970. The principal activity of FHLMC
currently consists of the purchase of mortgage loans or participation interests
in mortgage loans and the resale of the loans and participations in the form of
guaranteed mortgage-backed securities. FHLMC guarantees to each holder of FHLMC
certificates the timely payment of interest at the applicable pass-through rate
and ultimate collection of all principal on the holder's pro rata share of the
unpaid principal balance of the related mortgage loans, but does not guarantee
the timely payment of scheduled principal of the underlying mortgage loans. The
obligations of FHLMC under its guarantees are solely those of FHLMC and are not
backed by the full faith and credit of the United States. If FHLMC were unable
to satisfy these obligations, distributions to holders of FHLMC certificates
would consist solely of payments and other recoveries on the underlying mortgage
loans and, accordingly, defaults and delinquencies on the underlying mortgage
loans would adversely affect monthly distributions to holders of FHLMC
certificates.
FHLMC certificates may be backed by pools of single-family mortgage
loans or multi-family mortgage loans. These underlying mortgage loans may have
original terms to maturity of up to 40 years. FHLMC certificates may be issued
under cash programs (composed of mortgage loans purchased from a number of
sellers) or guarantor programs (composed of mortgage loans acquired from one
seller in exchange for certificates representing interests in the mortgage loans
purchased).
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FHLMC certificates may pay interest at a fixed rate or an adjustable
rate. The interest rate paid on adjustable-rate FHLMC certificates ("FHLMC
ARMs") adjusts periodically within 60 days prior to the month in which the
interest rates on the underlying mortgage loans adjust. The interest rates paid
on certificates issued under FHLMC's standard ARM programs adjust in relation to
the Treasury index. Other specified indices used in FHLMC ARM programs include
the 11th District Cost of Funds Index published by the Federal Home Loan Bank of
San Francisco, LIBOR and other indices. Interest rates paid on fully-indexed
FHLMC ARM certificates equal the applicable index rate plus a specified number
of basis points. The majority of series of FHLMC ARM certificates issued to date
have evidenced pools of mortgage loans with monthly, semi-annual or annual
interest adjustments. Adjustments in the interest rates paid are generally
limited to an annual increase or decrease of either 100 or 200 basis points and
to a lifetime cap of 500 or 600 basis points over the initial interest rate.
Certain FHLMC programs include mortgage loans which allow the borrower to
convert the adjustable mortgage interest rate to a fixed rate. Adjustable-rate
mortgages which are converted into fixed-rate mortgage loans are repurchased by
FHLMC or by the seller of the loan to FHLMC at the unpaid principal balance of
the loan plus accrued interest to the due date of the last adjustable rate
interest payment.
FNMA CERTIFICATES
FNMA is a privately-owned, federally-chartered corporation organized
and existing under the Federal National Mortgage Association Charter Act. FNMA
provides funds to the mortgage market primarily by purchasing home mortgage
loans from local lenders, thereby replenishing their funds for additional
lending. FNMA guarantees to the registered holder of a FNMA certificate that it
will distribute amounts representing scheduled principal and interest on the
mortgage loans in the pool underlying the FNMA certificate, whether or not
received, and the full principal amount of any such mortgage loan foreclosed or
otherwise finally liquidated, whether or not the principal amount is actually
received. The obligations of FNMA under its guarantees are solely those of FNMA
and are not backed by the full faith and credit of the United States. If FNMA
were unable to satisfy its obligations, distributions to holders of FNMA
certificates would consist solely of payments and other recoveries on the
underlying mortgage loans and, accordingly, defaults and delinquencies on the
underlying mortgage loans would adversely affect monthly distributions to
holders of FNMA.
FNMA certificates may be backed by pools of single-family or
multi-family mortgage loans. The original term to maturity of any such mortgage
loan generally does not exceed 40 years. FNMA certificates may pay interest at a
fixed rate or an adjustable rate. Each series of FNMA ARM certificates bears an
initial interest rate and margin tied to an index based on all loans in the
related pool, less a fixed percentage representing servicing compensation and
FNMA's guarantee fee. The specified index used in different series has included
the Treasury Index, the 11th District Cost of Funds Index published by the
Federal Home Loan Bank of San Francisco, LIBOR and other indices. Interest rates
paid on fully-indexed FNMA ARM certificates equal the applicable index rate plus
a specified number of basis points. The majority of series of FNMA ARM
certificates issued to date have evidenced pools of mortgage loans with monthly,
semi-annual or annual interest rate adjustments. Adjustments in the interest
rates paid are generally limited to an annual increase or decrease of either 100
or 200 basis points and to a lifetime cap of 500 or 600 basis points over the
initial interest rate. Certain FNMA programs include mortgage loans which allow
the borrower to convert the adjustable mortgage interest rate of the ARM to a
fixed rate. Adjustable-rate mortgages which are converted into fixed-rate
mortgage loans are repurchased by FNMA or by the seller of the loans to FNMA at
the unpaid principal of the loan plus accrued interest to the due date of the
last adjustable rate interest payment. Adjustments to the interest rates on FNMA
ARM certificates are typically subject to lifetime caps and periodic rate or
payment caps.
GNMA CERTIFICATES
GNMA is a wholly owned corporate instrumentality of the United States
within the Department of Housing and Urban Development ("HUD"). The National
Housing Act of 1934 authorizes GNMA to guarantee the timely payment of the
principal of and interest on certificates which represent an interest in a pool
of mortgages insured by the Federal Housing Administration ("FHA") or partially
guaranteed by the Department of Veterans Affairs and other loans eligible for
inclusion in mortgage pools underlying GNMA certificates. Section 306(g) of the
Housing Act provides that the full faith and credit of the United States is
pledged to the payment of all amounts which may be required to be paid under any
guaranty by GNMA.
At present, most GNMA certificates are backed by single-family mortgage
loans. The interest rate paid on GNMA certificates may be a fixed rate or an
adjustable rate. The interest rate on GNMA certificates issued under GNMA's
standard ARM program adjusts annually in relation to the Treasury index.
Adjustments in the interest rate are
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generally limited to an annual increase or decrease of 100 basis points and to a
lifetime cap of 500 basis points over the initial coupon rate.
SINGLE-FAMILY AND MULTI-FAMILY PRIVATELY-ISSUED CERTIFICATES
Single-family and multi-family privately-issued certificates are
pass-through certificates that are not issued by one of the agencies and that
are backed by a pool of conventional single-family or multi-family mortgage
loans. These certificates are issued by originators of, investors in, and other
owners of mortgage loans, including savings and loan associations, savings
banks, commercial banks, mortgage banks, investment banks and special purpose
"conduit" subsidiaries of these institutions.
While agency pass-through certificates are backed by the express
obligation or guarantee of one of the agencies, as described above,
privately-issued certificates are generally covered by one or more forms of
private (i.e., non-governmental) credit enhancements. These credit enhancements
provide an extra layer of loss coverage in the event that losses are incurred
upon foreclosure sales or other liquidations of underlying mortgaged properties
in amounts that exceed the equity holder's equity interest in the property.
Forms of credit enhancements include limited issuer guarantees, reserve funds,
private mortgage guaranty pool insurance, over-collateralization and
subordination.
Subordination is a form of credit enhancement frequently used and
involves the issuance of classes of senior and subordinated mortgage-backed
securities. These classes are structured into a hierarchy to allocate losses on
the underlying mortgage loans and also for defining priority of rights to
payment of principal and interest. Typically, one or more classes of senior
securities are created which are rated in one of the two highest rating levels
by one or more nationally recognized rating agencies and which are supported by
one or more classes of mezzanine securities and subordinated securities that
bear losses on the underlying loans prior to the classes of senior securities.
Mezzanine securities, as used in this Form 10-K, refers to classes that are
rated below the two highest levels, but no lower than a single "B" rating under
the S&P rating system (or comparable level under other rating systems) and are
supported by one or more classes of subordinated securities which bear realized
losses prior to the classes of mezzanine securities. Subordinated securities, as
used in this Form 10-K, refers to any class that bears the "first loss" from
losses from underlying mortgage loans or that is rated below a single "B" level
(or, if unrated, we deem it to be below that level). In some cases, only classes
of senior securities and subordinated securities are issued. By adjusting the
priority of interest and principal payments on each class of a given series of
senior-subordinated mortgage-backed securities, issuers are able to create
classes of mortgage-backed securities with varying degrees of credit exposure,
prepayment exposure and potential total return, tailored to meet the needs of
sophisticated institutional investors.
COLLATERALIZED MORTGAGE OBLIGATIONS AND MULTI-CLASS PASS-THROUGH
SECURITIES
We may also invest in CMOs and multi-class pass-through securities.
CMOs are debt obligations issued by special purpose entities that are secured by
mortgage loans or mortgage-backed certificates, including, in many cases,
certificates issued by government and government-related guarantors, including,
GNMA, FNMA and FHLMC, together with certain funds and other collateral.
Multi-class pass-through securities are equity interests in a trust composed of
mortgage loans or other mortgage-backed securities. Payments of principal and
interest on underlying collateral provide the funds to pay debt service on the
CMO or make scheduled distributions on the multi-class pass-through securities.
CMOs and multi-class pass-through securities may be issued by agencies or
instrumentalities of the U.S. Government or by private organizations. The
discussion of CMOs in the following paragraphs is similarly applicable to
multi-class pass-through securities.
In a CMO, a series of bonds or certificates is issued in multiple
classes. Each class of CMOs, often referred to as a "tranche," is issued at a
specific coupon rate (which, as discussed below, may be an adjustable rate
subject to a cap) and has a stated maturity or final distribution date.
Principal prepayments on collateral underlying a CMO may cause it to be retired
substantially earlier than the stated maturity or final distribution date.
Interest is paid or accrues on all classes of a CMO on a monthly, quarterly or
semi-annual basis. The principal and interest on underlying mortgages may be
allocated among the several classes of a series of a CMO in many ways. In a
common structure, payments of principal, including any principal prepayments, on
the underlying mortgages are applied to the classes of the series of a CMO in
the order of their respective stated maturities or final distribution dates, so
that no payment of principal will be made on any class of a CMO until all other
classes having an earlier stated maturity or final distribution date have been
paid in full.
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Other types of CMO issues include classes such as parallel pay CMOs,
some of which, such as planned amortization class CMOs ("PAC bonds"), provide
protection against prepayment uncertainty. Parallel pay CMOs are structured to
provide payments of principal on certain payment dates to more than one class.
These simultaneous payments are taken into account in calculating the stated
maturity date or final distribution date of each class which, as with other CMO
structures, must be retired by its stated maturity date or final distribution
date but may be retired earlier. PAC bonds generally require payment of a
specified amount of principal on each payment date so long as prepayment speeds
on the underlying collateral fall within a specified range.
Other types of CMO issues include targeted amortization class CMOs (or
TAC bonds), which are similar to PAC bonds. While PAC bonds maintain their
amortization schedule within a specified range of prepayment speeds, TAC bonds
are generally targeted to a narrow range of prepayment speeds or a specified
prepayment speed. TAC bonds can provide protection against prepayment
uncertainty since cash flows generated from higher prepayments of the underlying
mortgage-related assets are applied to the various other pass-through tranches
so as to allow the TAC bonds to maintain their amortization schedule.
A CMO may be subject to the issuer's right to redeem the CMO prior to
its stated maturity date, which may diminish the anticipated return on our
investment. Privately-issued CMOs are supported by private credit enhancements
similar to those used for privately-issued certificates and are often issued as
senior-subordinated mortgage-backed securities. We will only acquire CMOs or
multi-class pass-through certificates that constitute debt obligations or
beneficial ownership in grantor trusts holding mortgage loans, or regular
interests in REMICs, or that otherwise constitute qualified REIT real estate
assets under the Internal Revenue Code (provided that we have obtained a
favorable opinion of our tax advisor or a ruling from the IRS to that effect).
ADJUSTABLE-RATE MORTGAGE PASS-THROUGH CERTIFICATES AND FLOATING RATE
MORTGAGE-BACKED SECURITIES
Most of the mortgage pass-through certificates we acquire are
adjustable-rate mortgage pass-through certificates. This means that their
interest rates may vary over time based upon changes in an objective index, such
as:
o LIBOR OR THE LONDON INTERBANK OFFERED RATE. The interest rate that
banks in London offer for deposits in London of U.S. dollars.
o TREASURY INDEX. A monthly or weekly average yield of benchmark
U.S. Treasury securities, as published by the Federal Reserve
Board.
o CD RATE. The weekly average of secondary market interest rates on
six-month negotiable certificates of deposit, as published by the
Federal Reserve Board.
These indices generally reflect short-term interest rates. The underlying
mortgages for adjustable-rate mortgage pass-through certificates are
adjustable-rate mortgage loans ("ARMs").
We also acquire CMO floaters. One or more tranches of a CMO may have
coupon rates that reset periodically at a specified increment over an index such
as LIBOR. These adjustable-rate tranches are sometime known as CMO floaters and
may be backed by fixed or adjustable-rate mortgages.
There are two main categories of indices for adjustable-rate mortgage
pass-through certificates and floaters: (1) those based on U.S. Treasury
securities, and (2) those derived from calculated measures such as a cost of
funds index or a moving average of mortgage rates. Commonly utilized indices
include the one-year Treasury note rate, the three-month Treasury bill rate, the
six-month Treasury bill rate, rates on long-term Treasury securities, the 11th
District Federal Home Loan Bank Costs of Funds Index, the National Median Cost
of Funds Index, one-month or three-month LIBOR, the prime rate of a specific
bank, or commercial paper rates. Some indices, such as the one-year Treasury
rate, closely mirror changes in market interest rate levels. Others, such as the
11th District Home Loan Bank Cost of Funds Index, tend to lag changes in market
interest rate levels. We seek to diversify our investments in adjustable-rate
mortgage pass-through certificates and floaters among a variety of indices and
reset periods so that we are not at any one time unduly exposed to the risk of
interest rate fluctuations. In selecting adjustable-rate mortgage pass-through
certificates and floaters for investment, we will also consider the liquidity of
the market for the different mortgage-backed securities.
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We believe that adjustable-rate mortgage pass-through certificates and
floaters are particularly well-suited to our investment objective of high
current income, consistent with modest volatility of net asset value, because
the value of adjustable-rate mortgage pass-through certificates and floaters
generally remains relatively stable as compared to traditional fixed-rate debt
securities paying comparable rates of interest. While the value of
adjustable-rate mortgage pass-through certificates and floaters, like other debt
securities, generally varies inversely with changes in market interest rates
(increasing in value during periods of declining interest rates and decreasing
in value during periods of increasing interest rates), the value of
adjustable-rate mortgage pass-through certificates and floaters should generally
be more resistant to price swings than other debt securities because the
interest rates on these securities move with market interest rates.
Accordingly, as interest rates change, the value of our shares should
be more stable than the value of funds which invest primarily in securities
backed by fixed-rate mortgages or in other non-mortgage-backed debt securities,
which do not provide for adjustment in the interest rates in response to changes
in market interest rates.
Adjustable-rate mortgage pass-through certificates and floaters
typically have caps, which limit the maximum amount by which the interest rate
may be increased or decreased at periodic intervals or over the life of the
security. To the extent that interest rates rise faster than the allowable caps
on the adjustable-rate mortgage pass-through certificates and floaters, these
securities will behave more like fixed-rate securities. Consequently, interest
rate increases in excess of caps can be expected to cause these securities to
behave more like traditional debt securities than adjustable-rate securities
and, accordingly, to decline in value to a greater extent than would be the case
in the absence of these caps.
Adjustable-rate mortgage pass-through certificates and floaters, like
other mortgage-backed securities, differ from conventional bonds in that
principal is to be paid back over the life of the security rather than at
maturity. As a result, we receive monthly scheduled payments of principal and
interest on these securities and may receive unscheduled principal payments
representing prepayments on the underlying mortgages. When we reinvest the
payments and any unscheduled prepayments we receive, we may receive a rate of
interest on the reinvestment which is lower than the rate on the existing
security. For this reason, adjustable-rate mortgage pass-through certificates
and floaters are less effective than longer-term debt securities as a means of
"locking in" longer-term interest rates. Accordingly, adjustable-rate mortgage
pass-through certificates and floaters, while generally having less risk of
price decline during periods of rapidly rising interest rates than fixed-rate
mortgage-backed securities of comparable maturities, have less potential for
capital appreciation than fixed-rate securities during periods of declining
interest rates.
As in the case of fixed-rate mortgage-backed securities, to the extent
these securities are purchased at a premium, faster than expected prepayments
would accelerate our amortization of the premium. Conversely, if these
securities were purchased at a discount, faster than expected prepayments would
accelerate our recognition of income.
As in the case of fixed-rate CMOs, floating-rate CMOs may allow for
shifting of prepayment risk from slower-paying tranches to faster-paying
tranches. This is in contrast to mortgage pass-through certificates where all
investors share equally in all payments, including all prepayments, on the
underlying mortgages.
OTHER FLOATING RATE INSTRUMENTS
We may also invest in structured floating-rate notes issued or
guaranteed by government agencies, such as FNMA and FHLMC. These instruments are
typically structured to reflect an interest rate arbitrage (i.e., the difference
between the agency's cost of funds and the income stream from specified assets
of the agency) and their reset formulas may provide more attractive returns than
other floating rate instruments. The indices used to determine resets are the
same as those described above.
MORTGAGE LOANS
As of December 31, 2004, we have not invested directly in mortgage
loans, but we may from time-to-time invest a small percentage of our assets
directly in single-family, multi-family or commercial mortgage loans. We expect
that the majority of these mortgage loans would be ARM pass-through
certificates. The interest rate on an ARM pass-through certificate is typically
tied to an index (such as LIBOR or the interest rate on Treasury bills), and is
adjustable periodically at specified intervals. These mortgage loans are
typically subject to lifetime interest rate caps and periodic interest rate or
payment caps. The acquisition of mortgage loans generally involves credit risk.
We may obtain credit
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enhancement to mitigate this risk; however, there can be no assurances that we
will able to obtain credit enhancement or that credit enhancement would mitigate
the credit risk of the underlying mortgage loans.
CAPITAL INVESTMENT POLICY
ASSET ACQUISITIONS
Our capital investment policy provides that at least 75% of our total
assets will be comprised of high quality mortgage-backed securities and
short-term investments. The remainder of our assets (comprising not more than
25% of total assets), may consist of mortgage-backed securities and 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) or, if
not rated, are determined by us to be of comparable credit quality to an
investment which is rated "BBB" or better.
Our capital investment policy requires that we structure our portfolio
to maintain a minimum weighted average rating (including our deemed comparable
ratings for unrated mortgage-backed securities) of our mortgage-backed
securities of at least single "A" under the S&P rating system and at the
comparable level under the other rating systems. To date, all of the
mortgage-backed securities we have acquired have been pass-through certificates
or CMOs issued or guaranteed by FHLMC, FNMA or GNMA which, although not rated,
have an implied "AAA" rating.
We intend to acquire only those mortgage-backed securities that we
believe we have the necessary expertise to evaluate and manage, that we can
readily finance and that are consistent with our balance sheet guidelines and
risk management objectives. Since we expect to hold our mortgage-backed
securities until maturity, we generally do not seek to acquire assets whose
investment returns are only attractive in a limited range of scenarios. We
believe that future interest rates and mortgage prepayment rates are very
difficult to predict and, as a result, we seek to acquire mortgage-backed
securities which we believe provide acceptable returns over a broad range of
interest rate and prepayment scenarios.
Among the asset choices available to us, our policy is to acquire those
mortgage-backed securities which we believe generate the highest returns on
capital invested, after consideration of the following:
o the amount and nature of anticipated cash flows from the asset;
o our ability to pledge the asset to secure collateralized
borrowings;
o the increase in our capital requirement determined by our capital
investment policy resulting from the purchase and financing of the
asset; and
o the costs of financing, hedging, managing and reserving for the
asset.
Prior to acquisition, we assess potential returns on capital employed over the
life of the asset and in a variety of interest rate, yield spread, financing
cost, credit loss and prepayment scenarios.
We also give consideration to balance sheet management and risk
diversification issues. We deem a specific asset which we are evaluating for
potential acquisition as more or less valuable to the extent it serves to
increase or decrease certain interest rate or prepayment risks which may exist
in the balance sheet, to diversify or concentrate credit risk, and to meet the
cash flow and liquidity objectives our management may establish for our balance
sheet from time-to-time. Accordingly, an important part of the asset evaluation
process is a simulation, using risk management models, of the addition of a
potential asset and our associated borrowings and hedges to the balance sheet
and an assessment of the impact this potential asset acquisition would have on
the risks in and returns generated by our balance sheet as a whole over a
variety of scenarios.
We focus primarily on the acquisition of adjustable-rate
mortgage-backed securities, including floaters. We have, however, purchased a
significant amount of fixed-rate mortgage-backed securities and may continue to
do so in the future if, in our view, the potential returns on capital invested,
after hedging and all other costs, would exceed the returns available from other
assets or if the purchase of these assets would serve to reduce or diversify the
risks of our balance sheet.
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Although we have not yet done so, we may purchase the stock of mortgage
REITs or similar companies when we believe that these purchases would yield
attractive returns on capital employed. When the stock market valuations of
these companies are low in relation to the market value of their assets, these
stock purchases can be a way for us to acquire an interest in a pool of
mortgage-backed securities at an attractive price. We do not, however, presently
intend to invest in the securities of other issuers for the purpose of
exercising control or to underwrite securities of other issuers.
We may acquire newly issued mortgage-backed securities, and also may
seek to expand our capital base in order to further increase our ability to
acquire new assets, when the potential returns from new investments appears
attractive relative to the return expectations of stockholders. We may in the
future acquire mortgage-backed securities by offering our debt or equity
securities in exchange for the mortgage-backed securities.
We generally intend to hold mortgage-backed securities for extended
periods. In addition, the REIT provisions of the Internal Revenue Code limit in
certain respects our ability to sell mortgage-backed securities. We may decide
however to sell assets from time to time, for a number of reasons, including our
desire to dispose of an asset as to which credit risk concerns have arisen, to
reduce interest rate risk, to substitute one type of mortgage-backed security
for another, to improve yield or to maintain compliance with the 55% requirement
under the Investment Company Act, or generally to re-structure the balance sheet
when we deem advisable. Our board of directors has not adopted any policy that
would restrict management's authority to determine the timing of sales or the
selection of mortgage-backed securities to be sold.
We do not invest in principal-only interests in mortgage-backed
securities, residual interests, accrual bonds, inverse-floaters, two-tiered
index bonds, cash flow bonds, mortgage-backed securities with imbedded leverage
or mortgage-backed securities that would be deemed unacceptable for
collateralized borrowings, excluding shares in mortgage REITs.
As a requirement for maintaining REIT status, we will distribute to
stockholders aggregate dividends equaling at least 90% of our REIT taxable
income (determined without regard to the deduction for dividends paid and by
excluding any net capital gain) for each taxable year. We will make additional
distributions of capital when the return expectations of the stockholders appear
to exceed returns potentially available to us through making new investments in
mortgage-backed securities. Subject to the limitations of applicable securities
and state corporation laws, we can distribute capital by making purchases of our
own capital stock or through paying down or repurchasing any outstanding
uncollateralized debt obligations.
Our asset acquisition strategy may change over time as market
conditions change and as we evolve.
CREDIT RISK MANAGEMENT
We have not taken on credit risk to date, but may do so in the future.
In that event, we will review credit risk and other risk of loss associated with
each investment and determine the appropriate allocation of capital to apply to
the investment under our capital investment policy. Our board of directors will
monitor the overall portfolio risk and determine appropriate levels of provision
for loss.
CAPITAL AND LEVERAGE
We expect generally to maintain a debt-to-equity ratio of between 8:1
and 12:1, although the ratio may vary from time-to-time depending upon market
conditions and other factors our management deems relevant, including the
composition of our balance sheet, haircut levels required by lenders, the market
value of the mortgage-backed securities in our portfolio and "excess capital
cushion" percentages (as described below) set by our board of directors from
time to time. For purposes of calculating this ratio, our equity (or capital
base) is equal to the value of our investment portfolio on a mark-to-market
basis less the book value of our obligations under repurchase agreements and
other collateralized borrowings. At December 31, 2004, our ratio of
debt-to-equity was 9.8:1.
Our goal is to strike a balance between the under-utilization of
leverage, which reduces potential returns to stockholders, and the
over-utilization of leverage, which could reduce our ability to meet our
obligations during adverse market conditions. Our capital investment policy
limits our ability to acquire additional assets during times when our
debt-to-equity ratio exceeds 12:1. Our capital base represents the approximate
liquidation value of our investments and approximates the market value of assets
that we can pledge or sell to meet over-collateralization requirements for our
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borrowings. The unpledged portion of our capital base is available for us to
pledge or sell as necessary to maintain over-collateralization levels for our
borrowings.
We are prohibited from acquiring additional assets during periods when
our capital base is less than the minimum amount required under our capital
investment policy, except as may be necessary to maintain REIT status or our
exemption from the Investment Company Act of 1940, as amended (the "Investment
Company Act"). In addition, when our capital base falls below our risk-managed
capital requirement, our management is required to submit to our board of
directors a plan for bringing our capital base into compliance with our capital
investment policy guidelines. We anticipate that in most circumstances we can
achieve this goal without overt management action through the natural process of
mortgage principal repayments. We anticipate that our capital base is likely to
exceed our risk-managed capital requirement during periods following new equity
offerings and during periods of falling interest rates and that our capital base
could fall below the risk-managed capital requirement during periods of rising
interest rates.
The first component of our capital requirements is the current
aggregate over-collateralization amount or "haircut" the lenders require us to
hold as capital. The haircut for each mortgage-backed security is determined by
our lenders based on the risk characteristics and liquidity of the asset.
Haircut levels on individual borrowings generally range from 3% for certain
FHLMC, FNMA or GNMA mortgage-backed securities to 20% for certain
privately-issued mortgage-backed securities. At December 31, 2004, the weighted
average haircut level on our securities was 3.95%. Should the market value of
our pledged assets decline, we will be required to deliver additional collateral
to our lenders to maintain a constant over-collateralization level on our
borrowings.
The second component of our capital requirement is the "excess capital
cushion." This is an amount of capital in excess of the haircuts required by our
lenders. We maintain the excess capital cushion to meet the demands of our
lenders for additional collateral should the market value of our mortgage-backed
securities decline. The aggregate excess capital cushion equals the sum of
liquidity cushion amounts assigned under our capital investment policy to each
of our mortgage-backed securities. We assign excess capital cushions to each
mortgage-backed security based on our assessment of the mortgage-backed
security's market price volatility, credit risk, liquidity and attractiveness
for use as collateral by lenders. The process of assigning excess capital
cushions relies on our management's ability to identify and weigh the relative
importance of these and other factors. In assigning excess capital cushions, we
also give consideration to hedges associated with the mortgage-backed security
and any effect such hedges may have on reducing net market price volatility,
concentration or diversification of credit and other risks in the balance sheet
as a whole and the net cash flows that we can expect from the interaction of the
various components of our balance sheet.
Our capital investment policy stipulates that at least 25% of the
capital base maintained to satisfy the excess capital cushion must be invested
in AAA-rated adjustable-rate mortgage-backed securities or assets with similar
or better liquidity characteristics.
A substantial portion of our borrowings are short-term or variable-rate
borrowings. Our borrowings are implemented primarily through repurchase
agreements, but in the future may also be obtained through loan agreements,
lines of credit, dollar-roll agreements (an agreement to sell a security for
delivery on a specified future date and a simultaneous agreement to repurchase
the same or a substantially similar security on a specified future date) and
other credit facilities with institutional lenders and issuance of debt
securities such as commercial paper, medium-term notes, CMOs and senior or
subordinated notes. We enter into financing transactions only with institutions
that we believe are sound credit risks and follow other internal policies
designed to limit our credit and other exposure to financing institutions.
We expect to continue to use repurchase agreements as our principal
financing device to leverage our mortgage-backed securities portfolio. 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. At present, we have entered into uncommitted facilities with 32
lenders for borrowings in the form of repurchase agreements. 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. We may, however, enter into such commitment agreements in the future. We
enter into repurchase agreements primarily with national broker-dealers,
commercial banks and other lenders which typically offer this type of financing.
We enter into collateralized borrowings only with financial institutions meeting
credit standards approved by our board of directors, and we monitor the
financial condition of these institutions on a regular basis.
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A repurchase agreement, although structured as a sale and repurchase
obligation, acts as a financing under which we effectively pledge our
mortgage-backed securities as collateral to secure a short-term loan. Generally,
the other party to the agreement makes the loan in an amount equal to a
percentage of the market value of the pledged collateral. At the maturity of the
repurchase agreement, we are required to repay the loan and correspondingly
receive back our collateral. While used as collateral, the mortgage-backed
securities continue to pay principal and interest which are for our benefit. In
the event of our insolvency or bankruptcy, certain repurchase agreements may
qualify for special treatment under the Bankruptcy Code, the effect of which,
among other things, would be to allow the creditor under the agreement to avoid
the automatic stay provisions of the Bankruptcy Code and to foreclose on the
collateral agreement without delay. In the event of the insolvency or bankruptcy
of a lender during the term of a repurchase agreement, the lender may be
permitted, under applicable insolvency laws, to repudiate the contract, and our
claim against the lender for damages may be treated simply as an unsecured
creditor. In addition, if the lender is a broker or dealer subject to the
Securities Investor Protection Act of 1970, or an insured depository institution
subject to the Federal Deposit Insurance Act, our ability to exercise our rights
to recover our securities under a repurchase agreement or to be compensated for
any damages resulting from the lender's insolvency may be further limited by
those statutes. These claims would be subject to significant delay and, if and
when received, may be substantially less than the damages we actually incur.
Substantially all of our borrowing agreements require us to deposit
additional collateral in the event the market value of existing collateral
declines, which may require us to sell assets to reduce our borrowings. We have
designed our liquidity management policy to maintain a cushion of equity
sufficient to provide required liquidity to respond to the effects under our
borrowing arrangements of interest rate movements and changes in market value of
our mortgage-backed securities, as described above. However, a major disruption
of the repurchase or other market that we rely on for short-term borrowings
would have a material adverse effect on us unless we were able to arrange
alternative sources of financing on comparable terms.
Our articles of incorporation and bylaws do not limit our ability to
incur borrowings, whether secured or unsecured.
INTEREST RATE RISK MANAGEMENT
To the extent consistent with our election to qualify as a REIT, we
follow an interest rate risk management program intended to protect our
portfolio of mortgage-backed securities and related debt against the effects of
major interest rate changes. Specifically, our interest rate risk management
program is formulated with the intent to offset the potential adverse effects
resulting from rate adjustment limitations on our mortgage-backed securities and
the differences between interest rate adjustment indices and interest rate
adjustment periods of our adjustable-rate mortgage-backed securities and related
borrowings.
Our interest rate risk management program encompasses a number of
procedures, including the following:
o we attempt to structure our borrowings to have interest rate
adjustment indices and interest rate adjustment periods that, on
an aggregate basis, generally correspond to the interest rate
adjustment indices and interest rate adjustment periods of our
adjustable-rate mortgage-backed securities; and
o we attempt to structure our borrowing agreements relating to
adjustable-rate mortgage-backed securities to have a range of
different maturities and interest rate adjustment periods
(although substantially all will be less than one year).
We adjust the average maturity adjustment periods of our borrowings on
an ongoing basis by changing the mix of maturities and interest rate adjustment
periods as borrowings come due and are renewed. Through use of these procedures,
we attempt to minimize the differences between the interest rate adjustment
periods of our mortgage-backed securities and related borrowings that may occur.
Although we have not done so to date, we may purchase from time-to-time
interest rate swaps, interest rate collars, interest rate caps or floors,
"interest only" mortgage-backed securities and similar instruments to attempt to
mitigate the risk of the cost of our variable rate liabilities increasing at a
faster rate than the earnings on our assets during a period of rising interest
rates or to mitigate prepayment risk. We may hedge as much of the interest rate
risk as our management determines is in our best interests, given the cost of
the hedging transactions and the need to maintain our
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status as a REIT. This determination may result in our electing to bear a level
of interest rate or prepayment risk that could otherwise be hedged when
management believes, based on all relevant facts, that bearing the risk is
advisable.
We seek to build a balance sheet and undertake an interest rate risk
management program which is likely to generate positive earnings and maintain an
equity liquidation value sufficient to maintain operations given a variety of
potentially adverse circumstances. Accordingly, our interest rate risk
management program addresses both income preservation, as discussed above, and
capital preservation concerns. For capital preservation, we monitor our
"duration." This is the expected percentage change in market value of our assets
that would be caused by a 1% change in short and long-term interest rates. To
monitor duration and the related risks of fluctuations in the liquidation value
of our equity, we model the impact of various economic scenarios on the market
value of our mortgage-backed securities and liabilities. At December 31, 2004,
we estimate that the duration of our assets was 1.7%. We believe that our
interest rate risk management program will allow us to maintain operations
throughout a wide variety of potentially adverse circumstances. Nevertheless, in
order to further preserve our capital base (and lower our duration) during
periods when we believe a trend of rapidly rising interest rates has been
established, we may decide to enter into or increase hedging activities or to
sell assets. Each of these actions may lower our earnings and dividends in the
short term to further our objective of maintaining attractive levels of earnings
and dividends over the long term.
We may elect to conduct a portion of our hedging operations through one
or more subsidiary corporations, each of which we would elect to treat as a
"taxable REIT subsidiary." To comply with the asset tests applicable to us as a
REIT, we could own 100% of the voting stock of such subsidiary, provided that
the value of the stock that we own in all such taxable REIT subsidiaries does
not exceed 20% of the value of our total assets at the close of any calendar
quarter. A taxable subsidiary, such as FIDAC, would not elect REIT status and
would distribute any net profit after taxes to us and its other stockholders.
Any dividend income we receive from the taxable subsidiary (combined with all
other income generated from our assets, other than qualified REIT real estate
assets) must not exceed 25% of our gross income.
We believe that we have developed a cost-effective asset/liability
management program to provide a level of protection against interest rate and
prepayment risks. However, no strategy can completely insulate us from interest
rate changes and prepayment risks. Further, as noted above, the federal income
tax requirements that we must satisfy to qualify as a REIT limit our ability to
hedge our interest rate and prepayment risks. We monitor carefully, and may have
to limit, our asset/liability management program to assure that we do not
realize excessive hedging income, or hold hedging assets having excess value in
relation to total assets, which could result in our disqualification as a REIT,
the payment of a penalty tax for failure to satisfy certain REIT tests under the
Internal Revenue Code, provided the failure was for reasonable cause. In
addition, asset/liability management involves transaction costs which increase
dramatically as the period covered by the hedging protection increases.
Therefore, we may be unable to hedge effectively our interest rate and
prepayment risks.
PREPAYMENT RISK MANAGEMENT
We seek to minimize the effects of faster or slower than anticipated
prepayment rates through structuring a diversified portfolio with a variety of
prepayment characteristics, investing in mortgage-backed securities with
prepayment prohibitions and penalties, investing in certain mortgage-backed
security structures which have prepayment protections, and balancing assets
purchased at a premium with assets purchased at a discount. We monitor
prepayment risk through periodic review of the impact of a variety of prepayment
scenarios on our revenues, net earnings, dividends, cash flow and net balance
sheet market value.
FUTURE REVISIONS IN POLICIES AND STRATEGIES
Our board of directors has established the investment policies and
operating policies and strategies set forth in this Form 10-K. The board of
directors has the power to modify or waive these policies and strategies without
the consent of the stockholders to the extent that the board of directors
determines that the modification or waiver is in the best interests of our
stockholders. Among other factors, developments in the market which affect our
policies and strategies or which change our assessment of the market may cause
our board of directors to revise our policies and strategies.
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POTENTIAL ACQUISITIONS, STRATEGIC ALLIANCES AND OTHER INVESTMENTS
From time-to-time we have had discussions with other parties regarding
possible transactions including acquisitions of other businesses or assets,
investments in other entities, joint venture arrangements, or strategic
alliances. To date, except for the acquisition of FIDAC, none of these
discussions have gone beyond the preliminary stage. We have also considered from
time-to-time entering into related businesses, although to date we have not
entered into such businesses.
We may, from time-to- time, continue to explore possible acquisitions,
investments, joint venture arrangements and strategic alliances. Prior to making
any equity investment, we will consult with our tax advisors.
DIVIDEND REINVESTMENT AND SHARE PURCHASE PLAN
We have adopted a dividend reinvestment and share purchase plan. Under
the dividend reinvestment feature of the plan, existing shareholders can
reinvest their dividends in additional shares of our common stock. Under the
share purchase feature of the plan, new and existing shareholders can purchase
shares of our common stock. We have an effective shelf registration statement on
Form S-3 which initially registered 2,000,000 shares that could be issued under
the plan. We still sell shares covered by this registration statement under the
plan.
LEGAL PROCEEDINGS
There are no material pending legal proceedings to which we are a party
or to which any of our property is subject.
AVAILABLE INFORMATION
Our investor relations website is WWW.ANNALY.COM. We make available on
this website under "Financial Reports and SEC filings," free of charge, our
annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on
Form 8-K and amendments to those reports as soon as reasonably practicable after
we electronically file or furnish such materials to the SEC.
COMPETITION
We believe that our principal competition in the acquisition and holding
of the types of mortgage-backed securities we purchase are financial
institutions such as banks, savings and loans, life insurance companies,
institutional investors such as mutual funds and pension funds, and certain
other mortgage REITs. Some of our competitors have greater financial resources
and access to capital than we do. Our competitors, as well as of additional
competitors which may emerge in the future, may increase the competition for the
acquisition of mortgage-backed securities, which in turn may result in higher
prices and lower yields on assets.
RISK FACTORS
An investment in our stock involves a number of risks. Before making an
investment decision, you should carefully consider all of the risks described in
this Form 10-K. If any of the risks discussed in this Form 10-K actually occur,
our business, financial condition and results of operations could be materially
adversely affected. If this were to occur, the trading price of our stock could
decline significantly and you may lose all or part of your investment.
RISKS RELATED TO OUR BUSINESS
AN INCREASE IN THE INTEREST PAYMENTS ON OUR BORROWINGS RELATIVE TO THE INTEREST
WE EARN ON OUR INVESTMENT SECURITIES MAY ADVERSELY AFFECT OUR PROFITABILITY
We earn money based upon the spread between the interest payments we
earn on our investment securities and the interest payments we must make on our
borrowings. If the interest payments on our borrowings increase relative to the
interest we earn on our investment securities, our profitability may be
adversely affected.
The interest payments on our borrowings may increase relative to the
interest we earn on our adjustable-rate investment securities for various
reasons discussed in this section.
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o DIFFERENCES IN TIMING OF INTEREST RATE ADJUSTMENTS ON OUR INVESTMENT
SECURITIES AND OUR BORROWINGS MAY ADVERSELY AFFECT OUR PROFITABILITY
We rely primarily on short-term borrowings to acquire investment
securities with long-term maturities. Accordingly, if short-term interest rates
increase, this may adversely affect our profitability.
Most of the investment securities we acquire are adjustable-rate
securities. This means that their interest rates may vary over time based upon
changes in an objective index, such as:
- LIBOR. The interest rate that banks in London offer for deposits
in London of U.S. dollars.
- TREASURY RATE. A monthly or weekly average yield of benchmark U.S.
Treasury securities, as published by the Federal Reserve Board.
- CD RATE. The weekly average of secondary market interest rates on
six-month negotiable certificates of deposit, as published by the
Federal Reserve Board.
These indices generally reflect short-term interest rates. On December
31, 2004, approximately 71% of our investment securities were adjustable-rate
securities.
The interest rates on our borrowings similarly vary with changes in an
objective index. Nevertheless, the interest rates on our borrowings generally
adjust more frequently than the interest rates on our adjustable-rate investment
securities. For example, on December 31, 2004, our adjustable-rate investment
securities had a weighted average term to next rate adjustment of 24 months,
while our borrowings had a weighted average term to next rate adjustment of 111
days. Accordingly, in a period of rising interest rates, we could experience a
decrease in net income or a net loss because the interest rates on our
borrowings adjust faster than the interest rates on our adjustable-rate
investment securities.
o INTEREST RATE CAPS ON OUR INVESTMENT SECURITIES MAY ADVERSELY AFFECT OUR
PROFITABILITY
Our adjustable-rate investment securities are typically subject to
periodic and lifetime interest rate caps. Periodic interest rate caps limit the
amount an interest rate can increase during any given period. Lifetime interest
rate caps limit the amount an interest rate can increase through maturity of an
investment security. Our borrowings are not subject to similar restrictions.
Accordingly, in a period of rapidly increasing interest rates, we could
experience a decrease in net income or experience a net loss because the
interest rates on our borrowings could increase without limitation while the
interest rates on our adjustable-rate investment securities would be limited by
caps.
o BECAUSE WE ACQUIRE FIXED-RATE SECURITIES, AN INCREASE IN INTEREST RATES MAY
ADVERSELY AFFECT OUR PROFITABILITY
While the majority of our investments consist of adjustable-rate
investment securities, we also invest in fixed-rate mortgage-backed securities.
In a period of rising interest rates, our interest payments could increase while
the interest we earn on our fixed-rate mortgage-backed securities would not
change. This would adversely affect our profitability. On December 31, 2004,
approximately 29% of our investment securities were fixed-rate securities.
AN INCREASE IN PREPAYMENT RATES MAY ADVERSELY AFFECT OUR PROFITABILITY
The mortgage-backed securities we acquire are backed by pools of
mortgage loans. We receive payments, generally, from the payments that are made
on these underlying mortgage loans. When borrowers prepay their mortgage loans
at rates that are faster than expected, this results in prepayments that are
faster than expected on the mortgage-backed securities. These faster than
expected prepayments may adversely affect our profitability.
We often purchase mortgage-backed securities that have a higher
interest rate than the market interest rate at the time. In exchange for this
higher interest rate, we must pay a premium over the market value to acquire the
security. In accordance with accounting rules, we amortize this premium over the
term of the mortgage-backed security. If the mortgage-backed security is prepaid
in whole or in part prior to its maturity date, however, we must expense all or
a part of the remaining unamortized portion of the premium that was prepaid at
the time of the prepayment. This adversely
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affects our profitability. On December 31, 2004, approximately 98% of the
mortgage-backed securities we owned were acquired at a premium.
Prepayment rates generally increase when interest rates fall and
decrease when interest rates rise, but changes in prepayment rates are difficult
to predict. Prepayment rates also may be affected by conditions in the housing
and financial markets, general economic conditions and the relative interest
rates on fixed-rate and adjustable-rate mortgage loans.
We may seek to reduce prepayment risk by acquiring mortgage-backed
securities at a discount. If a discounted security is prepaid in whole or in
part prior to its maturity date, we will earn income equal to the amount of the
remaining discount. This will improve our profitability if the discounted
securities are prepaid faster than expected. On December 31, 2004, approximately
1% of the mortgage-backed securities we owned were acquired at a discount.
We also can acquire mortgage-backed securities that are less affected
by prepayments. For example, we can acquire CMOs, a type of mortgage-backed
security. CMOs divide a pool of mortgage loans into multiple tranches that allow
for shifting of prepayment risks from slower-paying tranches to faster-paying
tranches. This is in contrast to pass-through or pay-through mortgage-backed
securities, where all investors share equally in all payments, including all
prepayments. As discussed below, the Investment Company Act of 1940 (or the
Investment Company Act) imposes restrictions on our purchase of CMOs. On
December 31, 2004, approximately 27% of our mortgage-backed securities were CMOs
and approximately 73% of our mortgage-backed securities were pass-through or
pay-through securities.
While we seek to minimize prepayment risk to the extent practical, in
selecting investments we must balance prepayment risk against other risks and
the potential returns of each investment. No strategy can completely insulate us
from prepayment risk.
AN INCREASE IN INTEREST RATES MAY ADVERSELY AFFECT OUR BOOK VALUE
Increases in interest rates may negatively affect the market value of
our investment securities. Our fixed-rate securities, generally, are more
negatively affected by these increases. In accordance with accounting rules, we
reduce our book value by the amount of any decrease in the market value of our
investment securities.
OUR STRATEGY INVOLVES SIGNIFICANT LEVERAGE
We seek to maintain a ratio of debt-to-equity of between 8:1 and 12:1,
although our ratio may at times be above or below this amount. We incur this
leverage by borrowing against a substantial portion of the market value of our
investment securities. By incurring this leverage, we can enhance our returns.
Nevertheless, this leverage, which is fundamental to our investment strategy,
also creates significant risks.
o OUR LEVERAGE MAY CAUSE SUBSTANTIAL LOSSES
Because of our significant leverage, we may incur substantial losses if
our borrowing costs increase. Our borrowing costs may increase for any of the
following reasons:
- short-term interest rates increase;
- the market value of our investment securities decreases;
- interest rate volatility increases; or
- the availability of financing in the market decreases.
o OUR LEVERAGE MAY CAUSE MARGIN CALLS AND DEFAULTS AND FORCE US TO SELL
ASSETS UNDER ADVERSE MARKET CONDITIONS
Because of our leverage, a decline in the value of our investment
securities may result in our lenders initiating margin calls. A margin call
means that the lender requires us to pledge additional collateral to
re-establish the ratio of the value of the collateral to the amount of the
borrowing. Our fixed-rate mortgage-backed securities generally are more
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susceptible to margin calls as increases in interest rates tend to more
negatively affect the market value of fixed-rate securities.
If we are unable to satisfy margin calls, our lenders may foreclose on
our collateral. This could force us to sell our investment securities under
adverse market conditions. Additionally, in the event of our bankruptcy, our
borrowings, which are generally made under repurchase agreements, may qualify
for special treatment under the Bankruptcy Code. This special treatment would
allow the lenders under these agreements to avoid the automatic stay provisions
of the Bankruptcy Code and to liquidate the collateral under these agreements
without delay.
o LIQUIDATION OF COLLATERAL MAY JEOPARDIZE OUR REIT STATUS
To continue to qualify as a REIT, we must comply with requirements
regarding our assets and our sources of income. If we are compelled to liquidate
our investment securities, we may be unable to comply with these requirements,
ultimately jeopardizing our status as a REIT.
o WE MAY EXCEED OUR TARGET LEVERAGE RATIOS
We seek to maintain a ratio of debt-to-equity of between 8:1 and 12:1.
However, we are not required to stay within this leverage ratio. If we exceed
this ratio, the adverse impact on our financial condition and results of
operations from the types of risks described in this section would likely be
more severe.
o WE MAY NOT BE ABLE TO ACHIEVE OUR OPTIMAL LEVERAGE
We use leverage as a strategy to increase the return to our investors.
However, we may not be able to achieve our desired leverage for any of the
following reasons:
- we determine that the leverage would expose us to excessive risk;
- our lenders do not make funding available to us at acceptable
rates; or
- our lenders require that we provide additional collateral to cover
our borrowings.
o WE MAY INCUR INCREASED BORROWING COSTS WHICH WOULD ADVERSELY AFFECT OUR
PROFITABILITY
Currently, all of our borrowings are collateralized borrowings in the
form of repurchase agreements. If the interest rates on these repurchase
agreements increase, it would adversely affect our profitability.
Our borrowing costs under repurchase agreements generally correspond to
short-term interest rates such as LIBOR or a short-term Treasury index, plus or
minus a margin. The margins on these borrowings over or under short-term
interest rates may vary depending upon:
- the movement of interest rates;
- the availability of financing in the market; or
- the value and liquidity of our investment securities.
IF WE ARE UNABLE TO RENEW OUR BORROWINGS AT FAVORABLE RATES, OUR PROFITABILITY
MAY BE ADVERSELY AFFECTED
Since we rely primarily on short-term borrowings, our ability to
achieve our investment objectives depends not only on our ability to borrow
money in sufficient amounts and on favorable terms, but also on our ability to
renew or replace on a continuous basis our maturing short-term borrowings. If we
are not able to renew or replace maturing borrowings, we would have to sell our
assets under possibly adverse market conditions.
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WE HAVE NOT USED DERIVATIVES TO MITIGATE OUR INTEREST RATE AND PREPAYMENT RISKS
Our policies permit us to enter into interest rate swaps, caps and
floors and other derivative transactions to help us mitigate our interest rate
and prepayment risks described above. However, we have determined in the past
that the cost of these transactions outweighs the benefits. In addition, we will
not enter into derivative transactions if we believe they will jeopardize our
status as a REIT. If we decide to enter into derivative transactions in the
future, these transactions may mitigate our interest rate and prepayment risks
but cannot insulate us from these risks.
OUR INVESTMENT STRATEGY MAY INVOLVE CREDIT RISK
We may incur losses if there are payment defaults under our investment
securities.
To date, all of our mortgage-backed securities have been agency
certificates and agency debentures which, although not rated, carry an implied
"AAA" rating. Agency certificates are mortgage pass-through certificates where
Freddie Mac, Fannie Mae or Ginnie Mae guarantees payments of principal or
interest on the certificates. Agency debentures are debt instruments issued by
Freddie Mac, Fannie Mae, or the FHLB.
Even though we have only acquired "AAA" securities so far, pursuant to
our capital investment policy, we have the ability to acquire securities of
lower credit quality. Under our policy:
- 75% of our investments must have a "AA" or higher rating by S&P,
an equivalent rating by a similar nationally recognized rating
organization or our management must determine that the investments
are of comparable credit quality to investments with these
ratings;
- the remaining 25% of our investments must have a "BBB" or higher
rating by S&P, or an equivalent rating by a similar nationally
recognized rating organization, or our management must determine
that the investments are of comparable credit quality to
investments with these ratings. Securities with ratings of "BBB"
or higher are commonly referred to as "investment grade"
securities; and
- we seek to have a minimum weighted average rating for our
portfolio of at least "A" by S&P.
If we acquire mortgage-backed securities of lower credit quality, we
may incur losses if there are defaults under those mortgage-backed securities or
if the rating agencies downgrade the credit quality of those mortgage-backed
securities.
WE HAVE NOT ESTABLISHED A MINIMUM DIVIDEND PAYMENT LEVEL
We intend to pay quarterly dividends and to make distributions to our
stockholders in amounts such that all or substantially all of our taxable income
in each year (subject to certain adjustments) is distributed. This enables us to
qualify for the tax benefits accorded to a REIT under the Code. We have not
established a minimum dividend payment level and our ability to pay dividends
may be adversely affected for the reasons described in this section. All
distributions will be made at the discretion of our Board of Directors and will
depend on our earnings, our financial condition, maintenance of our REIT status
and such other factors as our Board of Directors may deem relevant from time to
time.
BECAUSE OF COMPETITION, WE MAY NOT BE ABLE TO ACQUIRE MORTGAGE-BACKED SECURITIES
AT FAVORABLE YIELDS
Our net income depends, in large part, on our ability to acquire
mortgage-backed securities at favorable spreads over our borrowing costs. In
acquiring mortgage-backed securities, we compete with other REITs, investment
banking firms, savings and loan associations, banks, insurance companies, mutual
funds, other lenders and other entities that purchase mortgage-backed
securities, many of which have greater financial resources than us. As a result,
in the future, we may not be able to acquire sufficient mortgage-backed
securities at favorable spreads over our borrowing costs.
WE ARE DEPENDENT ON OUR KEY PERSONNEL
We are dependent on the efforts of our key officers and employees,
including Michael A. J. Farrell, our Chairman of the board of directors, Chief
Executive Officer, and President, Wellington J. Denahan-Norris, our Vice
Chairman and Chief Investment Officer, Kathryn F. Fagan, our Chief Financial
Officer and Treasurer, and Jennifer S. Karve, our
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Executive Vice President. The loss of any of their services could have an
adverse effect on our operations. Although we have employment agreements with
each of them, we cannot assure you they will remain employed with us.
WE AND OUR SHAREHOLDERS ARE SUBJECT TO CERTAIN TAX RISKS
o OUR FAILURE TO QUALIFY AS A REIT WOULD HAVE ADVERSE TAX CONSEQUENCES
We believe that since 1997 we have qualified for taxation as a REIT for
federal income tax purposes. We plan to continue to meet the requirements for
taxation as a REIT. Many of these requirements, however, are highly technical
and complex. The determination that we are a REIT requires an analysis of
various factual matters and circumstances that may not be totally within our
control. For example, to qualify as a REIT, at least 75% of our gross income
must come from real estate sources and 95% of our gross income must come from
real estate sources and certain other sources that are itemized in the REIT tax
laws. We are also required to distribute to stockholders at least 90% of our
REIT taxable income (determined without regard to the deduction for dividends
paid and by excluding any net capital gain). Even a technical or inadvertent
mistake could jeopardize our REIT status. Furthermore, Congress and the Internal
Revenue Service (or IRS) might make changes to the tax laws and regulations, and
the courts might issue new rulings that make it more difficult or impossible for
us to remain qualified as a REIT.
If we fail to qualify as a REIT, we would be subject to federal income
tax at regular corporate rates. Also, unless the IRS granted us relief under
certain statutory provisions, we would remain disqualified as a REIT for four
years following the year we first fail to qualify. If we fail to qualify as a
REIT, we would have to pay significant income taxes and would therefore have
less money available for investments or for distributions to our stockholders.
This would likely have a significant adverse effect on the value of our
securities. In addition, the tax law would no longer require us to make
distributions to our stockholders.
On October 22, 2004, President Bush signed the American Jobs Creation
Act of 2004 (the 2004 Act), which, among other things, amends the rules
applicable to REIT qualification. In particular, the 2004 Act provides that a
REIT that fails the quarterly asset tests for one or more quarters will not lose
its REIT status as a result of such failure if either (i) the failure is
regarded as a de minimis failure under standards set out in the 2004 Act, or
(ii) the failure is greater than a de minimis failure but is attributable to
reasonable cause and not willful neglect. In the case of a greater than de
minimis failure, however, the REIT must pay a tax and must remedy the failure
within 6 months of the close of the quarter in which the failure was identified.
In addition, the 2004 Act provides relief for failures of other tests imposed as
a condition of REIT qualification, as long as the failures are attributable to
reasonable cause and not willful neglect. A REIT would be required to pay a
penalty of $50,000, however, in the case of each failure. The above-described
changes apply for taxable years of REITs beginning after the date of enactment.
o WE HAVE CERTAIN DISTRIBUTION REQUIREMENTS
As a REIT, 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). The required distribution limits the amount we have
available for other business purposes, including amounts to fund our growth.
Also, it is possible that because of the differences between the time we
actually receive revenue or pay expenses and the period we report those items
for distribution purposes, we may have to borrow funds on a short-term basis to
meet the 90% distribution requirement.
o WE ARE ALSO SUBJECT TO OTHER TAX LIABILITIES
Even if we qualify as a REIT, we may be subject to certain federal,
state and local taxes on our income and property. Any of these taxes would
reduce our operating cash flow.
o RECENT TAX LEGISLATION COULD AFFECT THE VALUE OF OUR STOCK
On May 28, 2003, President Bush signed the Jobs and Growth Tax Relief
and Reconciliation Act of 2003 (the "Act"), which, among other things, reduces
the rate at which individual stockholders are subject to tax on dividends paid
by regular C corporations to a maximum rate of 15%. Generally, REITs are tax
advantaged relative to C corporations because, unlike C corporations, REITs are
allowed a deduction for dividends paid, which, in most cases, allows a REIT to
avoid paying corporate level federal income tax on its earnings. The provisions
of the Act reducing the rate at which
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individual stockholders pay tax on dividend income from C corporations may serve
to mitigate this tax advantage and may cause individuals to view an investment
in a C corporation as more attractive than an investment in a REIT. This may
adversely affect the value of our stock.
o LIMITS ON OWNERSHIP OF OUR COMMON STOCK COULD HAVE ADVERSE CONSEQUENCES TO
YOU AND COULD LIMIT YOUR OPPORTUNITY TO RECEIVE A PREMIUM ON OUR STOCK
To maintain our qualification as a REIT for federal income tax
purposes, not more than 50% in value of the outstanding shares of our capital
stock may be owned, directly or indirectly, by five or fewer individuals (as
defined in the federal tax laws to include certain entities). Primarily to
facilitate maintenance of our qualification as a REIT for federal income tax
purposes, our charter will prohibit ownership, directly or by the attribution
provisions of the federal tax laws, by any person of more than 9.8% of the
lesser of the number or value of the issued and outstanding shares of our common
stock and will prohibit ownership, directly or by the attribution provisions of
the federal tax laws, by any person of more than 9.8% of the lesser of the
number or value of the issued and outstanding shares of any class or series of
our preferred stock. Our board of directors, in its sole and absolute
discretion, may waive or modify the ownership limit with respect to one or more
persons who would not be treated as "individuals" for purposes of the federal
tax laws if it is satisfied, based upon information required to be provided by
the party seeking the waiver and upon an opinion of counsel satisfactory to the
board of directors, that ownership in excess of this limit will not otherwise
jeopardize our status as a REIT for federal income tax purposes.
The ownership limit may have the effect of delaying, deferring or
preventing a change in control and, therefore, could adversely affect our
shareholders' ability to realize a premium over the then-prevailing market price
for our common stock in connection with a change in control.
o A REIT CANNOT INVEST MORE THAN 20% OF ITS TOTAL ASSETS IN THE STOCK OR
SECURITIES OF ONE OR MORE TAXABLE REIT SUBSIDIARIES; THEREFORE, FIDAC
CANNOT CONSTITUTE MORE THAN 20% OF OUR TOTAL ASSETS
A taxable REIT subsidiary is a corporation, other than a REIT or a
qualified REIT subsidiary, in which a REIT owns stock and which elects taxable
REIT subsidiary status. The term also includes a corporate subsidiary in which
the taxable REIT subsidiary owns more than a 35% interest. A REIT may own up to
100% of the stock of one or more taxable REIT subsidiaries. A taxable REIT
subsidiary may earn income that would not be qualifying income if earned
directly by the parent REIT. Overall, at the close of any calendar quarter, no
more than 20% of the value of a REIT's assets may consist of stock or securities
of one or more taxable REIT subsidiaries.
The stock and securities of FIDAC, our only taxable REIT subsidiary,
are expected to represent less than 20% of the value of our total assets.
Furthermore, we intend to monitor the value of our investments in the stock and
securities of FIDAC (and any other taxable REIT subsidiary in which we may
invest) to ensure compliance with the above-described 20% limitation. We cannot
assure you, however, that we will always be able to comply with the 20%
limitation so as to maintain REIT status.
o TAXABLE REIT SUBSIDIARIES ARE SUBJECT TO TAX AT THE REGULAR CORPORATE
RATES, ARE NOT REQUIRED TO DISTRIBUTE DIVIDENDS, AND THE AMOUNT OF
DIVIDENDS A TAXABLE REIT SUBSIDIARY CAN PAY TO ITS PARENT REIT MAY BE
LIMITED BY REIT GROSS INCOME TESTS
A taxable REIT subsidiary must pay income tax at regular corporate
rates on any income that it earns. FIDAC will pay corporate income tax on its
taxable income, and its after-tax net income will be available for distribution
to us. Such income, however, is not required to be distributed.
Moreover, the annual gross income tests that must be satisfied to
ensure REIT qualification may limit the amount of dividends that we can receive
from FIDAC and still maintain our REIT status. Generally, not more than 25% of
our gross income can be derived from non-real estate related sources, such as
dividends from a taxable REIT subsidiary. If, for any taxable year, the
dividends we received from FIDAC, when added to our other items of non-real
estate related income, represented more than 25% of our total gross income for
the year, we could be denied REIT status, unless we were able to demonstrate,
among other things, that our failure of the gross income test was due to
reasonable cause and not willful neglect.
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The limitations imposed by the REIT gross income tests may impede our
ability to distribute assets from FIDAC to us in the form of dividends. Certain
asset transfers may, therefore, have to be structured as purchase and sale
transactions upon which FIDAC recognizes taxable gain.
o IF INTEREST ACCRUES ON INDEBTEDNESS OWED BY A TAXABLE REIT SUBSIDIARY TO
ITS PARENT REIT AT A RATE IN EXCESS OF A COMMERCIALLY REASONABLE RATE, OR
IF TRANSACTIONS BETWEEN A REIT AND A TAXABLE REIT SUBSIDIARY ARE ENTERED
INTO ON OTHER THAN ARM'S-LENGTH TERMS, THE REIT MAY BE SUBJECT TO A PENALTY
TAX
If interest accrues on an indebtedness owed by a taxable REIT
subsidiary to its parent REIT at a rate in excess of a commercially reasonable
rate, the REIT is subject to tax at a rate of 100% on the excess of (i) interest
payments made by a taxable REIT subsidiary to its parent REIT over (ii) the
amount of interest that would have been payable had interest accrued on the
indebtedness at a commercially reasonable rate. A tax at a rate of 100% is also
imposed on any transaction between a taxable REIT subsidiary and its parent REIT
to the extent the transaction gives rise to deductions to the taxable REIT
subsidiary that are in excess of the deductions that would have been allowable
had the transaction been entered into on arm's-length terms. We will scrutinize
all of our transactions with FIDAC in an effort to ensure that we do not become
subject to these taxes. We cannot assure you, however, that we will be able to
avoid application of these taxes.
RISKS OF OWNERSHIP OF OUR COMMON STOCK
ISSUANCES OF LARGE AMOUNTS OF OUR STOCK COULD CAUSE THE MARKET PRICE OF OUR
COMMON STOCK TO DECLINE.
As of March 1, 2005, 121,272,323 shares of our common stock were
outstanding. If we issue a significant number of shares of common stock or
securities convertible into common stock in a short period of time, there could
be a dilution of the existing common stock and a decrease in the market price of
the common stock.
WE MAY CHANGE OUR POLICIES WITHOUT STOCKHOLDER APPROVAL.
Our board of directors and management determine all of our policies,
including our investment, financing and distribution policies. Although they
have no current plans to do so, they may amend or revise these policies at any
time without a vote of our stockholders. Policy changes could adversely affect
our financial condition, results of operations, the market price of our common
stock or our ability to pay dividends or distributions.
OUR GOVERNING DOCUMENTS AND MARYLAND LAW IMPOSE LIMITATIONS ON THE ACQUISITION
OF OUR COMMON STOCK AND CHANGES IN CONTROL THAT COULD MAKE IT MORE DIFFICULT FOR
A THIRD PARTY TO ACQUIRE US.
MARYLAND BUSINESS COMBINATION ACT
The Maryland General Corporation Law establishes special requirements
for "business combinations" between a Maryland corporation and "interested
stockholders" unless exemptions are applicable. An interested stockholder is any
person who beneficially owns 10% or more of the voting power of our
then-outstanding voting stock. Among other things, the law prohibits for a
period of five years a merger and other similar transactions between us and an
interested stockholder unless the board of directors approved the transaction
prior to the party's becoming an interested stockholder. The five-year period
runs from the most recent date on which the interested stockholder became an
interested stockholder. The law also requires a super majority stockholder vote
for such transactions after the end of the five-year period. This means that the
transaction must be approved by at least:
o 80% of the votes entitled to be cast by holders of outstanding
voting shares; and
o two-thirds of the votes entitled to be cast by holders of
outstanding voting shares other than shares held by the
interested stockholder or an affiliate of the interested
stockholder with whom the business combination is to be
effected.
As permitted by the Maryland General Corporation Law, we have elected
not to be governed by the Maryland business combination statute. We made this
election by opting out of this statute in our articles of incorporation. If,
however, we amend our articles of incorporation to opt back in to the statute,
the business combination statute could
23
have the effect of discouraging offers to acquire us and of increasing the
difficulty of consummating any such offers, even if our acquisition would be in
our stockholders' best interests.
MARYLAND CONTROL SHARE ACQUISITION ACT
Maryland law provides that "control shares" of a Maryland corporation
acquired in a "control share acquisition" have no voting rights except to the
extent approved by a vote of the stockholders. Two-thirds of the shares eligible
to vote must vote in favor of granting the "control shares" voting rights.
"Control shares" are shares of stock that, taken together with all other shares
of stock the acquirer previously acquired, would entitle the acquirer to
exercise voting power in electing directors within one of the following ranges
of voting power:
o One-tenth or more but less than one third of all voting power;
o One-third or more but less than a majority of all voting
power; or
o A majority or more of all voting power.
Control shares do not include shares of stock the acquiring person is
entitled to vote as a result of having previously obtained stockholder approval.
A "control share acquisition" means the acquisition of control shares, subject
to certain exceptions.
If a person who has made (or proposes to make) a control share
acquisition satisfies certain conditions (including agreeing to pay expenses),
he may compel our board of directors to call a special meeting of stockholders
to consider the voting rights of the shares. If such a person makes no request
for a meeting, we have the option to present the question at any stockholders'
meeting.
If voting rights are not approved at a meeting of stockholders then,
subject to certain conditions and limitations, we may redeem any or all of the
control shares (except those for which voting rights have previously been
approved) for fair value. We will determine the fair value of the shares,
without regard to voting rights, as of the date of either:
o the last control share acquisition; or
o the meeting where stockholders considered and did not approve
voting rights of the control shares.
If voting rights for control shares are approved at a stockholders'
meeting and the acquirer becomes entitled to vote a majority of the shares of
stock entitled to vote, all other stockholders may obtain rights as objecting
stockholders and, thereunder, exercise appraisal rights. This means that you
would be able to force us to redeem your stock for fair value. Under Maryland
law, the fair value may not be less than the highest price per share paid in the
control share acquisition. Furthermore, certain limitations otherwise applicable
to the exercise of dissenters' rights would not apply in the context of a
control share acquisition. The control share acquisition statute would not apply
to shares acquired in a merger, consolidation or share exchange if we were a
party to the transaction. The control share acquisition statute could have the
effect of discouraging offers to acquire us and of increasing the difficulty of
consummating any such offers, even if our acquisition would be in our
stockholders' best interests.
REGULATORY RISKS
LOSS OF INVESTMENT COMPANY ACT EXEMPTION WOULD ADVERSELY AFFECT US.
We intend to conduct our business so as not to become regulated as an
investment company under the Investment Company Act. If we fail to qualify for
this exemption, our ability to use leverage would be substantially reduced, and
we would be unable to conduct our business as described in this Form 10-K.
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. Under the current interpretation of the SEC
staff, in order to qualify for this exemption, we must maintain at least 55% of
our assets directly in these qualifying real estate interests. Mortgage-backed
securities that do not represent all of the certificates issued with respect to
an
24
underlying pool of mortgages may be treated as securities separate from the
underlying mortgage loans and, thus, may not qualify for purposes of the 55%
requirement. Our ownership of these mortgage-backed securities, therefore, is
limited by the provisions of the Investment Company Act. In addition, in meeting
the 55% requirement under the Investment Company Act, we treat as qualifying
interests mortgage-backed securities issued with respect to an underlying pool
as to which we hold all issued certificates. If the SEC or its staff adopts a
contrary interpretation, we could be required to sell a substantial amount of
our mortgage-backed securities, under potentially adverse market conditions.
Further, in order to insure that we at all times qualify for the exemption from
the Investment Company Act, we may be precluded from acquiring mortgage-backed
securities whose yield is somewhat higher than the yield on mortgage-backed
securities that could be purchased in a manner consistent with the exemption.
The net effect of these factors may be to lower our net income.
COMPLIANCE WITH PROPOSED AND RECENTLY ENACTED CHANGES IN SECURITIES LAWS AND
REGULATIONS ARE LIKELY TO INCREASE OUR COSTS.
The Sarbanes-Oxley Act of 2002 and rules and regulations promulgated by
the SEC and the New York Stock Exchange have increased the scope, complexity and
cost of corporate governance, reporting and disclosure practices. We believe
that these rules and regulations will make it more costly for us to obtain
director and officer liability insurance, and we may be required to accept
reduced coverage or incur substantially higher costs to obtain coverage. These
rules and regulations could also make it more difficult for us to attract and
retain qualified members of management and our board of directors, particularly
to serve on our audit committee.
ISSUANCES OF SHARES TO FIDAC SHAREHOLDERS
As a result of our acquisition of FIDAC, FIDAC shareholders may receive
additional shares of our common stock as an earn-out in 2005, 2006, and 2007
worth up to $49,500,000 if FIDAC meets specific performance goals under the
merger agreement. We cannot calculate how many shares we will issue under the
earn-out provisions since that will vary depending upon whether and the extent
to which FIDAC achieves specific performance goals. Even if FIDAC achieves
specific performance goals for a fiscal year, the number of additional shares to
be issued to the FIDAC shareholders will vary depending on our average share
price for the first 20 trading days of the following fiscal year.
ITEM 2. PROPERTIES
Our executive and administrative office is located at 1211 Avenue of
the Americas, Suite 2902 New York, New York 10036, telephone 212-696-0100. This
office is leased under a non-cancelable lease expiring December 31, 2009.
ITEM 3. LEGAL PROCEEDINGS
At December 31, 2004, there were no pending legal proceedings to which
we were a party, or to which any of our property was subject.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We did not submit any matters to a vote of our stockholders during the
fourth quarter of 2004.
25
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock began trading publicly on October 8, 1997 and is
traded on the New York Stock Exchange under the trading symbol "NLY". As of
March 1, 2005, we had 121,272,323 shares of common stock issued and outstanding
which were held by approximately 120,000 holders of record.
The following table sets forth, for the periods indicated, the high,
low, and closing sales prices per share of our common stock as reported on the
New York Stock Exchange composite tape and the cash dividends declared per share
of our common stock.
Stock Prices
High Low Close
First Quarter ended March 31, 2004 $21.22 $18.15 $18.02
Second Quarter ended June 30, 2004 $19.63 $15.94 $16.09
Third Quarter ended September 30, 2004 $18.44 $15.95 $16.71
Fourth Quarter ended December 31, 2004 $20.53 $16.33 $19.62
High Low Close
First Quarter ended March 31, 2003 $19.55 $16.54 $17.47
Second Quarter ended June 30, 2003 $20.80 $17.43 $19.91
Third Quarter ended September 30, 2003 $21.10 $16.13 $16.42
Fourth Quarter ended December 31, 2003 $19.00 $15.65 $18.40
Common Dividends
Declared Per Share
First Quarter ended March 31, 2004 $0.50
Second Quarter ended June 30, 2004 $0.48
Third Quarter ended September 30, 2004 $0.50
Fourth Quarter ended December 31, 2004 $0.50
First Quarter ended March 31, 2003 $0.60
Second Quarter ended June 30, 2003 $0.60
Third Quarter ended September 30, 2003 $0.28
Fourth Quarter ended December 31, 2003 $0.47
We intend to pay quarterly dividends and to distribute to our
stockholders all or substantially all of our taxable income in each year
(subject to certain adjustments). This will enable us to qualify for the tax
benefits accorded to a REIT under the Code. We have not established a minimum
dividend payment level and our ability to pay dividends may be adversely
affected for the reasons described under the caption "Risk Factors." All
distributions will be made at the discretion of our board of directors and will
depend on our earnings, our financial condition, maintenance of our REIT status
and such other factors as our board of directors may deem relevant from time to
time. No dividends can be paid on our common stock unless we have paid full
cumulative dividends on our preferred stock. From the date of issuance of our
preferred stock through December 31, 2004, we have paid full cumulative
dividends on our preferred stock.
26
EQUITY COMPENSATION PLAN INFORMATION
We have adopted a long term stock incentive plan for executive
officers, key employees and nonemployee directors (the "Incentive Plan"). The
Incentive Plan authorizes the Compensation Committee of the board of directors
to grant awards, including incentive stock options as defined under Section 422
of the Code ("ISOs") and options not so qualified ("NQSOs"). 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 outstanding shares of our common stock.
For a description of our Incentive Plan, see Note 9 to the Financial Statements.
The following table provides information as of December 31, 2004,
concerning shares of our common stock authorized for issuance under our existing
Incentive Plan.
Number of securities
remaining available for
Number of securities to be Weighted-average exercise future issuance under
issued upon exercise of price of outstanding Incentive Plan (excluding
Plan Category outstanding options options previously issued)
- ------------------------------- ---------------------------- ---------------------------- ----------------------------
Incentive Plan approved by
shareholders 1,645,721 $15.66 9,874,264(1)
Incentive Plan not approved
by shareholders -- -- --
---------------------------- ---------------------------- ----------------------------
Total 1,645,721 $15.66 9,874,264
============================ ============================ ============================
(1) The Incentive Plan authorizes the granting of options or other awards for an
aggregate of the greater of 500,000 or 9.5% of the outstanding shares on a fully
diluted basis of our common stock. ( (121,263,000 *9.5%)-1,645,721)
27
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data are derived from our audited
financial statements for the years ended December 31, 2004, 2003, 2002, 2001,
and 2000. The selected financial data should be read in conjunction with the
more detailed information contained in the Financial Statements and Notes
thereto and "Management's Discussion and Analysis of Financial Condition and
Results of Operations" included elsewhere in this Form 10-K.
SELECTED FINANCIAL DATA
(DOLLARS IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
FOR THE YEAR
ENDED FOR THE YEAR FOR THE YEAR FOR THE YEAR FOR THE YEAR
DECEMBER 31, ENDED ENDED ENDED ENDED
2004 DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
(CONSOLIDATED) 2003 2002 2001 2000
------------------------------------------------------------------------------
STATEMENT OF OPERATIONS DATA:
Interest income $532,328 $337,433 $404,165 $263,058 $109,750
Interest expense 270,116 182,004 191,758 168,055 92,902
------------------------------------------------------------------------------
Net interest income $262,212 $155,429 $212,407 $95,003 $16,848
Investment advisory and service fees 12,512 -- -- -- --
Gain on sale of mortgage-backed securities 5,215 40,907 21,063 4,586 2,025
Distribution fees 2,860 -- -- -- --
General and administrative expenses
(G&A expense) 24,029 16,233 13,963 7,311 2,286
------------------------------------------------------------------------------
Income before taxes 253,050 180,103 219,507 92,278 16,587
Income taxes 4,458 -- -- -- --
------------------------------------------------------------------------------
Net income 248,592 180,103 219,507 92,278 16,587
Dividend on preferred stock 7,745 -- -- -- --
------------------------------------------------------------------------------
Net income available to common shareholders $240,847 $180,103 $219,507 $92,278 $16,587
==============================================================================
Basic net income per average common share $2.04 $1.95 $2.68 $2.23 $1.18
Diluted net income per average common share $2.03 $1.94 $2.67 $2.21 $1.15
Dividends declared per common share $1.98 $1.95 $2.67 $1.75 $1.15
Dividends declared per preferred share $1.45 -- -- -- --
DECEMBER 31,
2004 DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
BALANCE SHEET DATA: (CONSOLIDATED) 2003 2002 2001 2000
------------------------------------------------------------------------------
Mortgage-Backed Securities, at fair value $19,038,386 $11,956,512 $11,551,857 $7,575,379 $1,978,219
Agency Debentures, at fair value 390,509 978,167 -- -- --
Total assets $19,560,299 12,990,286 11,659,084 7,717,314 2,035,029
Repurchase agreements $16,707,879 11,012,903 10,163,174 6,367,710 1,628,359
Total liabilities 17,859,829 11,841,066 10,579,018 7,049,957 1,899,386
Stockholders' equity 1,700,470 1,149,220 1,080,066 667,357 135,642
Number of common shares outstanding 121,263,000 96,074,096 84,569,206 59,826,975 14,522,978
FOR THE YEAR
ENDED FOR THE YEAR FOR THE YEAR FOR THE YEAR FOR THE YEAR
DECEMBER 31, ENDED ENDED ENDED ENDED
2004 DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
OTHER DATA: (CONSOLIDATED) 2003 2002 2001 2000
------------------------------------------------------------------------------
Average total assets $17,293,174 $12,975,039 $10,486,423 $5,082,852 $1,652,459
Average investment securities 16,399,184 12,007,333 9,575,365 4,682,778 1,564,228
Average borrowings 15,483,118 11,549,368 9,128,933 4,388,900 1,449,999
Average equity 1,550,076 1,122,633 978,107 437,376 117,727
Yield on average interest earning assets 3.25% 2.81% 4.22% 5.62% 7.02%
Cost of funds on average interest bearing
liabilities 1.74% 1.58% 2.10% 3.83% 6.41%
Interest rate spread 1.51% 1.23% 2.12% 1.79% 0.61%
28
FOR THE YEAR
ENDED FOR THE YEAR FOR THE YEAR FOR THE YEAR FOR THE YEAR
DECEMBER 31, ENDED ENDED ENDED ENDED
2004 DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
FINANCIAL RATIOS: (CONSOLIDATED) 2003 2002 2001 2000
------------------------------------------------------------------------------
Net interest margin (net interest
income/average total assets) 1.52% 1.20% 2.03% 1.87% 1.02%
G&A expense as a percentage of average
total assets 0.14% 0.13% 0.13% 0.14% 0.14%
G&A expense as a percentage of average
equity 1.55% 1.45% 1.43% 1.67% 1.94%
Return on average total assets 1.44% 1.39% 2.09% 1.82% 1.00%
Return on average equity 16.04% 16.04% 22.44% 21.10% 14.09%
29
ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
OVERVIEW
We are a self-managed 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.
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 we determine them 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, we
determine them 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.
30
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 its 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. Our results of operations primarily depend on,
among other things, the level 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 29% and 42% for the years ended December 31, 2004 and 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 quarterly periods
presented.
QUARTER ENDED CPR
- ------------- ---
December 31, 2004 27%
September 30, 2004 25%
June 30, 2004 33%
March 31, 2004 31%
December 31, 2003 42%
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 contractual maturity on our repurchase agreements was 211 days
at December 31, 2004, as compared to 203 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 quarterly periods presented.
Yield on
Average Average Average
Investment Total Interest Balance of Total Average
Securities Interest Earning Repurchase Interest Cost of Net Interest
Held (1) Income Assets Agreements Expense Funds Income
------------ ------------ ---------- -------------- ------------- --------- ------------
(ratios for the quarters have been annualized, dollars in thousands)
Quarter Ended
December 31, 2004 $17,932,449 $156,783 3.50% $16,896,216 $93,992 2.23% $62,791
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
(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.
31
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 at least three independent sources and record the market
value of the securities based on the average of the three. Management evaluates
securities for other-than-temporary impairment at least on a quarterly basis,
and more frequently when economic or market concerns warrant such evaluation.
Consideration is given to (1) the length of time and the extent to which the
fair value has been less than cost, (2) the financial condition and near-term
prospects of the issuer, and (3) the intent and ability of the Company to retain
its investment in the issuer for a period of time sufficient to allow for any
anticipated recovery in fair value. 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 years ended December 31, 2004, 2003 or 2002. 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 or accreted 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.
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
NET INCOME SUMMARY
For the year ended December 31, 2004, our net income was $248.6 million
or $2.04 basic earnings per average share available for common shareholders, as
compared to $180.1 million or $1.95 basic earnings per average share for the
year ended December 31, 2003. For the year ended December 31, 2002, our net
income was $219.5 million, or $2.68 basic earnings per average share available
for common shareholders. Net income per average share increased by $0.09 and
total net income increased $68.5 million for the year ended December 31, 2004,
when compared to the year ended December 31, 2003. We attribute the increase in
total net income for the year ended December 31, 2004 over the year
32
ended December 31, 2003 as being due to the increased asset base and the
interest rate spread. The increased asset base was the result of deploying
additional capital of approximately $581.0 million from December 31, 2003 to
December 31, 2004 into our strategy. Also, the addition of $12.5 million
advisory fee income from FIDAC for seven months of the year aided the increased
revenue of the combined companies. The interest rate spread increased from 1.23%
to 1.51%. The total amortization for the year ended December 31, 2004 was $179.6
million and for the year ended December 31, 2003 was $216.6 million. For the
year ended December 31, 2004, gain on sale of Mortgage-Backed Securities was
$5.2 million, as compared to $40.9 million for the year ended December 31, 2003.
Even with the substantial decline in gain on sale of Mortgage-Backed Securities,
the increase in spread income resulted in an increase in earnings per share year
over year.
Net income per average share decreased by $0.73 and total net income
decreased $39.4 million for the year ended December 31, 2003, when compared to
the year ended December 31, 2002. The reason for the decline in net income was
due to the interest rate spread decreasing to 1.23% in 2003 from 2.12% for the
prior year. The primary reason for the decline in interest rate spread is the
amortization of premium paid on the mortgage-backed securities. The total
amortization for the year ended December 31, 2003 was $216.6 million and for the
year ended December 31, 2002 was $106.2 million. The trend of record prepayment
levels began to decline in the fourth quarter of the year 2003 This was
evidenced by the amortization for the fourth quarter of $38.4 million, in
comparison to the third quarter of 2003 of $72.0 million
Dividends per share for the year ended December 31, 2004 were $1.98 per
share, or $245.6 million in total Dividends per share for the year ended
December 31, 2003 were $1.95 per share, or $179.3 million in total. .Dividends
per share for the year ended December 31, 2002 were $2.67 per share, or $223.6
million in total. Our return on average equity was 16.04% for the year ended
December 31, 2004, 16.04% for the year ended December 31, 2003, and 22.44% for
the year ended December 31, 2002. The table below presents the net income
summary for the years ended December 31, 2004, 2003, 2002, 2001, and 2000.
NET INCOME SUMMARY
(DOLLARS IN THE THOUSANDS, EXCEPT FOR PER SHARE DATA)
Year Ended Year Ended Year Ended Year Ended Year Ended
December December 31, December 31, December 31, December
31, 2004 2003 2002 2001 31, 2000
-------------- --------------- -------------- --------------- -------------
Interest income $532,328 $337,433 $404,165 $263,058 $109,750
Interest expense 270,116 182,004 191,758 168,055 92,902
-------------- --------------- -------------- --------------- -------------
Net interest income 262,212 155,429 $212,407 $95,003 $16,848
Investment advisory and service fees 12,512 -- -- -- --
Gain on sale of mortgage-backed securities 5,215 40,907 21,063 4,586 2,025
Distribution fees 2,860 -- - -- --
General and administrative expenses 24,029 16,233 13,963 7,311 2,286
-------------- --------------- -------------- --------------- -------------
Income before income taxes 253,050 180,103 219,507 92,278 16,587
Income taxes 4,458 -- -- -- --
-------------- --------------- -------------- --------------- -------------
Net income 248,592 180,103 219,507 92,278 16,587
Dividend on preferred stock 7,745 -- -- -- --
-------------- --------------- -------------- --------------- -------------
Net income available to common shareholders $240,847 $180,103 $219,507 $92,278 $16,587
============== =============== ============== =============== =============
Weighted average number of basic common shares
outstanding 118,223,330 92,215,352 82,044,141 41,439,631 14,089,436
Weighted average number of diluted common shares
outstanding 118,459,145 93,031,253 82,282,883 41,857,498 14,377,459
Basic net income per share available to common
shareholders $2.04 $1.95 $2.68 $2.23 $1.18
Diluted net income per share available to common
shareholders $2.03 $1.94 $2.67 $2.21 $1.15
Average total assets $17,293,174 $12,975,039 $10,486,423 $5,082,852 $1,652,459
Average equity 1,550,076 1,122,633 978,107 437,376 117,727
Return on average total assets 1.44% 1.39% 2.09% 1.82% 1.00%
Return on average equity 16.04% 16.04% 22.44% 21.10% 14.09%
33
INTEREST INCOME AND AVERAGE EARNING ASSET YIELD
We had average earning assets of $16.4 billion for the year ended
December 31, 2004. We had average earning assets of $12.0 billion for the year
ended December 31, 2003. We had average earning assets of $9.6 billion for the
year ended December 31, 2002. Our primary source of income is interest income. A
portion of our income was generated by gains on the sales of our Mortgage-Backed
Securities of $5.2 million, $40.9 million, and $21.1 million for the years ended
December 31, 2004, 2003 and 2002, respectively. Our interest income was $532.3
million for the year ended December 31, 2004, $337.4 million for the year ended
December 31, 2003, and $404.2 million for the year ended December 31, 2002. The
yield on average investment securities was 3.25%, 2.81%, and 4.22% for the same
respective periods. Our average earning asset balance increased by $4.4 billion
for the year ended December 31, 2004 in comparison to the prior year. The
increase was the direct result of the increased asset base and the increase in
the interest rate yields. The weighted average coupon rate at December 31, 2004
was 4.53%, as compared to 4.36% at December 31, 2003. The prepayment speeds
decreased to 29% CPR for the year ended December 31, 2004, from 42% CPR for the
year ended December 31, 2003. The increase in coupon, in conjunction with lower
prepayment speeds, resulted in an increase in yield of 44 basis points for the
year 2004, when compared to 2003. The declining yield of 2.81% for the year
ended December 31, 2003, as compared to the yield of 4.22% for the year ended
December 31, 2002 were the direct result of increased amortization on our assets
due to the rise in prepayments speeds to 42% CPR for the year ended December 31,
2003, from 33% CPR for the year ended December 31, 2002, especially in the third
quarter of 2003. The homeowners' prepayment option makes the average term, yield
and performance of a mortgage-backed security uncertain because of the
uncertainty in timing the return of principal. In general, prepayments decrease
the total yield on a bond purchased at a premium, because over the life of the
bond that premium has to be amortized. The faster prepayments, the shorter the
life of the security, which results in increased amortization. The table below
shows our average balance of cash equivalents and investment securities, the
yields we earned on each type of earning assets, our yield on average earning
assets and our interest income for the years ended December 31, 2004, 2003,
2002, 2001, and 2000, and the four quarters in 2004.
AVERAGE EARNING ASSET YIELD
(RATIOS FOR THE FOUR QUARTERS IN 2004 ARE ANNUALIZED, DOLLARS IN THOUSANDS)
Yield on Average
Average Average Constant
Investment Investment Prepayment Interest
Securities Securities Rate Income
---------- ---------- ---- ------
For the Year Ended December 31, 2004 $16,399,184 3.25% 29% $532,328
For the Year Ended December 31, 2003 $12,007,333 2.81% 42% $337,433
For the Year Ended December 31, 2002 $9,575,365 4.22% 33% $404,165
For the Year Ended December 31, 2001 $4,682,778 5.62% 27% $263,058
For the Year Ended December 31, 2000 $1,564,228 7.02% 11% $109,750
- -------------------------------------------------------------------------------------------------------------
For the Quarter Ended December 31, 2004 $17,932,449 3.50% 27% $156,783
For the Quarter Ended September 30, 2004 $16,562,971 3.36% 25% $138,970
For the Quarter Ended June 30, 2004 $16,649,072 2.94% 33% $122,234
For the Quarter Ended March 31, 2004 $14,452,245 3.16% 31% $114,341
The Constant Prepayment Rate decreased to 29% for the year ended
December 31, 2004, as compared to 42% for the year ended December 31, 2003 and
33% for the year ended December 31, 2002. The total amortization for the year
ended December 31, 2004, 2003, and 2002 was $179.6 million , $216.6 million, and
$106.2 million, respectively. For the first, second, third, and fourth quarters
of 2004, amortization was $41.5 million, $56.1 million, $39.7 million, and $42.3
million, respectively. The second quarter experienced the highest level of
prepayments and the third and fourth quarters were materially unchanged,
providing evidence that the trend of higher prepayments is continuing.
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 $15.5 billion and total interest expense
of $270.1 million for the year ended December 31, 2004. We had average borrowed
funds of $11.5 billion and total interest expense of $182.0 million for the year
ended December 31, 2003. We
34
had average borrowed funds of $9.1 billion and total interest expense of $191.8
million for the year ended December 31, 2002. Our average cost of funds was
1.74% for the year ended December 31, 2004 and 1.58% for the year ended December
31, 2003 and 2.10% for the year December 31, 2002. The cost of funds rate
increased by 16 basis points and the average borrowed funds increased by $4.0
billion for the year ended December 31, 2004 when compared to the year ended
December 31, 2003. Interest expense for the year increased by $88.1 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. The cost of funds rate decreased by 52 basis points
and the average borrowed funds increased by $2.4 billion for the year ended
December 31, 2003, when compared to the year ended December 31, 2002. Interest
expense for the year ended December 31, 2003 declined $9.8 million over the
previous year, even with the increase in the average borrowed funds for the
year. 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 0.24% above average one-month LIBOR and 0.06% below
average six-month LIBOR for the year ended December 31, 2004. Our average cost
of funds was 0.37% above average one-month LIBOR and 0.35% above average
six-month LIBOR for the year ended December 31, 2003.
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 years
ended December 31, 2004, 2003, 2002, 2001, and 2000 and the four quarters in
2004.
AVERAGE COST OF FUNDS
(Ratios for the four quarters in 2004 have been annualized,
dollars in thousands)
Average Average
One-Month Average Cost Cost of
LIBOR of Funds Funds
Relative to Relative to Relative to
Average Average Average Average Average Average Average
Borrowed Interest Cost of One-Month Six-Month Six-Month One-Month Six-Month
Funds Expense Funds LIBOR LIBOR LIBOR LIBOR LIBOR
----------- ----------- --------- --------- --------- ----------- ----------- ------------
For the Year Ended
December 31 2004 $15,483,118 $270,116 1.74% 1.50% 1.80% (0.30%) 0.24% (0.06%)
For the Year Ended
December 31, 2003 $11,549,368 $182,004 1.58% 1.21% 1.23% (0.02%) 0.37% 0.35%
For the Year Ended
December 31, 2002 $9,128,933 $191,758 2.10% 1.77% 1.88% (0.11%) 0.33% 0.22%
For the Year Ended
December 31, 2001 $4,388,900 $168,055 3.83% 3.88% 3.73% 0.15% (0.05%) 0.10%
For the Year Ended
December 31, 2000 $1,449,999 $92,902 6.41% 6.41% 6.66% (0.25%) - (0.25%)
- ------------------------------------------------------------------------------------------------------------------------------
For the Quarter Ended
December 31, 2004 $16,896,216 $93,992 2.23% 2.14% 2.48% (0.34%) 0.09% (0.25%)
For the Quarter Ended
September 30, 2004 $15,568,691 $70,173 1.80% 1.59% 1.97% (0.38%) 0.21% (0.17%)
For the Quarter Ended
June 30, 2004 $15,880,353 $55,648 1.40% 1.15% 1.54% (0.39%) 0.25% (0.14%)
For the Quarter Ended
March 31, 2004 $13,587,211 $50,303 1.48% 1.10% 1.18% (0.08%) 0.38% 0.30%
NET INTEREST INCOME
Our net interest income which equals interest income less interest
expense, totaled $262.2 million for the year ended December 31, 2004, $155.4 for
the year ended December 31, 2003 and $212.4 million for the year ended December
31, 2002. Our net interest income increased because of the increase in our
assets that resulted from the common stock and preferred stock offerings during
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 1.51% for the year ended December 31, 2004 as
compared to 1.23% for the year ended December 31, 2003. This 28 basis point
increase was a result of the increase of the weighted average coupon at December
31, 2004 of 4.53% from 4.36% at December 31, 2003, and the improvement in CPR
discussed above. The increase in yield was only partially
35
offset by the 16 basis point increase in the cost of funds. Our net interest
income decreased $57.0 million for the year ended December 31, 2003 over the
prior year. This was the direct result of the CPR, which increased from 33% in
2002 in the prior year to 42% in 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
years ended December 31, 2004, 2003, 2002, 2001, and 2000 and the four quarters
in 2004.
NET INTEREST INCOME
(Ratios for the four quarters in 2004 have been annualized,
dollars in thousands)
Average Average Net
Investment Total Yield Average Balance of Average Net Interest
Securities Interest Interest Repurchase Interest Cost of Interest Rate
Held Income Earning Assets Agreements Expense Funds Income Spread
---------- ---------- -------------- ------------ ----------- --------- ---------- --------
For the Year Ended
December 31, 2004 $16,399,184 $532,328 3.25% $15,483,118 $270,116 1.74% $262,212 1.51%
For the Year Ended
December 31, 2003 $12,007,333 $337,433 2.81% $11,549,368 $182,004 1.58% $155,429 1.23%
For the Year Ended
December 31, 2002 $9,575,365 $404,165 4.22% $9,128,933 $191,758 2.10% $212,407 2.12%
For the Year Ended
December 31, 2001 $4,682,778 $263,058 5.62% $4,388,900 $168,055 3.83% $95,003 1.79%
For the Year Ended
December 31, 2000 $1,564,228 $109,750 7.02% $1,449,999 $92,902 6.41% $16,848 0.61%
- -------------------------------------------------------------------------------------------------------------------------------
For the Quarter Ended
December 31, 2004 $17,932,449 $156,783 3.50% $16,896,216 $93,992 2.23% $62,791 1.27%
For the Quarter Ended
September 30, 2004 $16,562,971 $138,970 3.36% $15,568,691 $70,173 1.80% $68,797 1.56%
For the Quarter Ended
June 30, 2004 $16,649,072 $122,234 2.94% $15,880,353 $55,648 1.40% $66,586 1.54%
For the Quarter Ended
March 31, 2004 $14,452,245 $114,341 3.16% $13,587,211 $70,173 1.48% $64,038 1.68%
INVESTMENT ADVISORY AND SERVICE FEES
FIDAC is a registered investment advisor that 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 December 31, 2004,
FIDAC had under management approximately $1.9 billion in net assets and $15.9
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 year ended December 31, 2004 totaled $9.7 million, net of fees paid
to third parties pursuant to distribution service agreements for facilitating
and promoting distribution of shares of FIDAC's clients. FIDAC's net advisory
fees were included in the consolidated statements post the merger dated June 4,
2004.
GAINS AND LOSSES ON SALES OF MORTGAGE-BACKED SECURITIES
For the year ended December 31, 2004, we sold mortgage-backed
securities with an aggregate historical amortized cost of $591.7 million for an
aggregate gain of $5.2 million. For the year ended December 31, 2003, we sold
mortgage-backed securities with an aggregate historical amortized cost of $2.8
billion for an aggregate gain of $40.9 million. For the year ended December 31,
2002, we sold mortgage-backed securities with an aggregate historical amortized
cost of $2.0 billion for an aggregate gain of $21.1 million The gain on sale of
assets for the year ended December 31, 2004 declined by $35.7 million. During
the year ended December 31, 2003 the amount of sale was higher than
historically, with a bulk of the liquidations in the second quarter. Due to
declining rates, fixed rate securities had significantly appreciated and it was
determined by the Company's management to take advantage of the appreciation.
The gain on sale of assets for the year ended December 31, 2003 increased by
$19.8 million over the prior year. 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 move into new assets,
which our management believes might have higher risk-adjusted returns, or to
manage our balance sheet as part of our asset/liability management strategy.
There have been insignificant losses from the sale of securities during the
periods.
36
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative ("G&A") expenses were $24.0 million for the
year ended December 31, 2004, $16.2 million for the year ended December 31,
2003, and $14.0 million for the year ended December 31, 2002. G&A expenses as a
percentage of average total assets was 0.14%, 0.13%, and 0.13%, for the years
ended December 31, 2004, 2003, and 2002, respectively. The increase in G&A
expenses of $7.8 million for the year December 31, 2004, was primarily the
result of increased salaries, directors and officers insurance and additional
costs related to the FIDAC merger. Staff increased from 20 at the end of 2003 to
30 at the end of 2004. G&A expense has increased proportionately with our
increased capital base and the growth in staff from 15 at the end of 2002 to 20
at the end of 2003. Salaries and bonuses for the years ended December 31, 2004,
2003, 2002, and 2001 were $17.2 million, $11.5 million, $10.8 million, and $4.7
million. Even with the increased asset base, G&A expense as a percentage of
average assets has not increased significantly. The table below shows our total
G&A expenses as compared to average total assets and average equity for the
years ended December 31, 2004, 2003, 2002, 2001, and 2000, and the four quarters
in 2004.
G&A EXPENSES AND OPERATING EXPENSE RATIOS
(Ratios for the four quarters in 2004 have been annualized,
dollars in thousands)
Total G&A Total G&A
Expenses/Average Expenses/Average
Total G&A Expenses Assets Equity
------------------ ---------------- ----------------
For the Year Ended December 31, 2004 $24,029 0.14% 1.55%
For the Year Ended December 31, 2003 $16,233 0.13% 1.45%
For the Year Ended December 31, 2002 $13,963 0.13% 1.43%
For the Year Ended December 31, 2001 $7,311 0.14% 1.67%
For the Year Ended December 31, 2000 $2,286 0.14% 1.94%
- ------------------------------------------------------------------------------------------------------
For the Quarter Ended December 31, 2004 $6,862 0.14% 1.63%
For the Quarter Ended September 30, 2004 $6,159 0.14% 1.53%
For the Quarter Ended June 30, 2004 $5,643 0.13% 1.39%
For the Quarter Ended March 31, 2004 $5,790 0.15% 1.63%
NET INCOME AND RETURN ON AVERAGE EQUITY
Our net income was $248.6 million for the year ended December 31, 2004,
$180.1 million for the year ended December 31, 2003, and $219.5 million for the
year ended December 31, 2002. Our return on average equity was 16.04% for the
year ended December 31, 2004, 16.04% for the year ended December 31, 2003, and
22.44% for the year ended December 31, 2002. We attribute the increase in total
net income for the year ended December 31, 2004 over the year ended December 31,
2003 due to the increased asset base and the interest rate spread. The increased
asset base was the result of deploying additional capital of approximately
$581.0 million from December 31, 2003 to December 31, 2004 into our strategy. To
a lesser extent, the seven months of advisory fee income from FIDAC aided in the
income growth.
Even though total net income increased, the return on average equity
remained unchanged at 16.04%. Net income decreased by $39.4 million in the year
2003 over the previous year, due to the declining interest rate spread In
addition to spread income, we were able to take advantage of appreciation in
asset value in 2003, 2002, and 2001. The table below shows our net interest
income, net 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 years ended December
31, 2004, 2003, 2002, 2001, and 2000, and for the four quarters in 2004.
37
COMPONENTS OF RETURN ON AVERAGE EQUITY
(Ratios for the four quarters in 2004 have been annualized)
Net Investment
Advisory and Gain on Sale of
Net Interest Service Mortgage-Backed G&A Income Return on
Income/Average Fees/Average Securities/ Expenses/Average Taxes/Average Average
Equity Equity Average Equity Equity Equity Equity
-------------- -------------- -------------- ---------------- ------------- ---------
For the Year Ended December 31, 2004 16.92% 0.62% 0.34% 1.55% 0.29% 16.04%
For the Year Ended December 31, 2003 13.85% -- 3.64% 1.45% -- 16.04%
For the Year Ended December 31, 2002 21.72% -- 2.15% 1.43% -- 22.44%
For the Year Ended December 31, 2001 21.72% -- 1.05% 1.67% -- 21.10%
For the Year Ended December 31, 2000 14.31% -- 1.72% 1.94% -- 14.09%
- -----------------------------------------------------------------------------------------------------------------------------------
For the Quarter Ended December 31, 2004 14.95% 1.10% 0.27% 1.63% 0.57% 14.12%
For the Quarter Ended September 30, 2004 17.13% 0.94% 0.34% 1.53% 0.29% 16.59%
For the Quarter Ended June 30, 2004 16.44% 0.31% 0.52% 1.39% 0.12% 15.76%
For the Quarter Ended March 31, 2004 18.05% -- 0.17% 1.63% -- 16.59%
FINANCIAL CONDITION
INVESTMENT SECURITIES
All of our Mortgage-Backed Securities at December 31, 2004, 2003, and
2002 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 CMOs, which carry an
implied "AAA" rating. We mark-to-market all of our earning assets 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
December 31, 2004, 2003, and 2002 we had on our balance sheet a total of $1.1
million, 1.5 million and $664,000, 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 $427.0 million, $301.3 million and $274.6 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 $6.5 billion for the year
ended December 31, 2004, $8.3 billion for the year ended December 31, 2003, and
$4.7 billion for the year ended December 31, 2002. The overall prepayment speed
for the year ended December 31, 2004, 2003, and 2002 was 29%, 42%, and 33%
respectively. During the year ended December 31, 2004, the CPR declined to 29%,
from 42%, due to a decline in refinancing activity. During the year ended
December 31, 2003, the annual prepayment speed was the highest in our history at
42%. The result was record returns of principal for the year, relative to the
asset size. 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 into income 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.
38
The table below summarizes our Investment Securities at December 31,
2004, 2003, 2002, 2001, and 2000, and September 30, 2004, June 30, 2004, and
March 31, 2004.
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 December 31, 2004 $19,123,902 $425,792 $19,549,694 102.23% $19,428,895 101.59% 3.43%
At December 31, 2003 $12,682,130 $299,810 $12,981,940 102.36% $12,934,679 101.99% 2.96%
At December 31, 2002 $11,202,384 $273,963 $11,476,347 102.45% $11,551,857 103.12% 3.25%
At December 31, 2001 $7,399,941 $137,269 $7,537,210 101.86% $7,575,379 102.37% 4.41%
At December 31, 2000 $1,967,967 $23,296 $1,991,263 101.18% $1,978,219 100.52% 7.09%
- ----------------------------------------------------------------------------------------------------------------------------------
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%
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 SECURITY CHARACTERISTICS
(dollars in thousands)
Principal
Amount at
Weighted Period End
Weighted Weighted Average Weighted Weighted as % of
Average Average Weighted Term to Average Average Total
Principal Coupon Index Average Net Next Lifetime Asset Investment
Amount Rate Level Margin Adjustment Cap Yield Securities
----------- -------- -------- ----------- ---------- -------- --------- ----------
At December 31, 2004 $13,544,872 4.23% 2.45% 1.78% 24 months 10.12% 3.24% 70.83%
At December 31, 2003 $9,294,934 3.85% 2.25% 1.60% 23 months 9.86% 2.47% 73.29%
At December 31, 2002 $7,007,062 4.10% 2.51% 1.59% 11 months 10.37% 2.33% 62.55%
At December 31, 2001 $5,793,250 5.90% 3.95% 1.95% 24 months 11.49% 3.87% 78.29%
At December 31, 2000 $1,454,356 7.61% 5.76% 1.85% 15 months 11.47% 7.24% 73.90%
- ----------------------------------------------------------------------------------------------------------------------------
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%
FIXED-RATE INVESTMENT SECURITY CHARACTERISTICS
(dollars in thousands)
Weighted Weighted Principal Amount as % of
Principal Average Coupon Average Total Investment
Amount Rate Asset Yield Securities
---------- -------------- ----------- ------------------------
At December 31, 2004 $5,579,030 5.24% 3.89% 29.17%
At December 31, 2003 $3,387,196 5.77% 4.29% 26.71%
At December 31, 2002 $4,195,322 6.76% 4.78% 37.45%
At December 31, 2001 $1,606,691 6.92% 6.33% 21.71%
At December 31, 2000 $513,611 6.62% 6.68% 26.10%
- ---------------------------------------------------------------------------------------------------
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, 2004 and 2003, we held investment securities with
coupons linked various indices. The following tables detail the portfolio
characteristics by index.
39
ADJUSTABLE-RATE INVESTMENT SECURITIES BY INDEX
DECEMBER 31, 2004
National
Six- 12- 11th Financial Monthly
One- Six- Twelve Month Month District Average Six- 1-Year 2-Year 3-Year 5-Year Federal
Month Month Month Auction Moving Cost of Mortgage Month Treasury Treasury Treasury Treasury Cost of
Libor Libor Libor Average Average Funds Rate CD Rate Index Index Index Index Funds
------ ------ ------ ------- ------- -------- -------- ------- -------- -------- -------- -------- -------
Weighted Average Term
to Next Adjustment 1 mo. 27 mo. 34 mo. 2 mo. 1 mo. 0 mo. 5 mo. 3 mo. 25 mo. 10 mo. 17 mo. 31 mo. 0 mo.
Weighted Average
Annual Period Cap 8.01% 1.07% 2.18% 1.00% 0.17% 0.82% 2.00% 1.00% 1.86% 2.00% 2.00% 2.00% 2.00%
Weighted Average
Lifetime Cap at
December 31, 2004 8.88% 9.86% 10.08% 13.03% 10.65% 12.13% 10.58% 11.66% 10.31% 11.92% 12.96% 12.59% 13.39%
Investment Principal
Value as Percentage
of Investment
Securities at
December 31, 2004 8.67% 2.50% 22.96% 0.01% 0.22% 0.98% 0.01% 0.05% 34.31% 0.01% 0.25% 0.07% 0.79%
ADJUSTABLE-RATE INVESTMENT SECURITIES BY INDEX
DECEMBER 31, 2003
Six- 12- 11th Monthly
One- Six- Twelve Month Month District Interest Six- 1-Year 2-Year 3-Year 5-Year Federal
Month Month Month Auction Moving Cost of Rate Month Treasury Treasury Treasury Treasury Cost of
Libor Libor Libor Average Average Funds Step Up CD Rate Index Index Index Index Funds
------ ------ ------ ------- ------- -------- -------- ------- -------- -------- -------- -------- -------
Weighted Average Term
to Next Adjustment 1 mo. 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
Value as Percentage
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 December 31, 2004, we had established
uncommitted borrowing facilities in this market with 32 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 balance
sheet.
For the year ended December 31, 2004, the term to maturity of our
borrowings ranged from one day to three years, with a weighted average original
term to maturity of 211 days at December 31, 2004. For the year ended December
31, 2003, the term to maturity of our borrowings ranged from one day to three
years, with a weighted average original term to maturity of 203 days at December
31, 2003. For the year ended December 31, 2002, the term to maturity of our
borrowings ranged from one day to three years, with a weighted average original
term to maturity of 166 days at December 31, 2002.
At December 31, 2004, the weighted average cost of funds for all of our
borrowings was 2.46% and the weighted average term to next rate adjustment was
111 days. At December 31, 2003, the weighted average cost of funds for all of
our borrowings was 1.51% and the weighted average term to next rate adjustment
was 90 days. At December 31, 2002, the weighted average cost of funds for all of
our borrowings was 1.72% and the weighted average term to next rate adjustment
was 124 days.
40
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 balance sheet also
generates liquidity on an on-going basis through mortgage principal repayments
and net earnings held 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.
Borrowings under our repurchase agreements increased by $5.7 million to
$16.7 billion at December 31, 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 primarily through public offerings
during 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 December 31,
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 December 31, 2004.
(DOLLARS IN THOUSANDS)
ONE TO THREE THREE TO MORE THAN
WITHIN ONE YEAR YEARS FIVE YEARS FIVE YEARS TOTAL
--------------- ----- ---------- ---------- -----
Repurchase Agreements $14,957,879 $1,750,000 -- -- $16,707,879
Long-term operating lease obligations 500 1,062 1,064 -- 2,626
Employment contracts 8,432 -- -- -- 8,432
---------------- --------------- ------------ -------------- ---------------
Total $14,966,811 $1,751,062 $1,064 -- $16,718,937
================ =============== ============ ============== ===============
STOCKHOLDERS' EQUITY
During the year ended December 31, 2004, we declared dividends to
common shareholders totaling $237.9 million or $1.98 per share, of which $60.6
million was paid on January 27, 2005. During the year ended December 31, 2004,
we declared and paid dividends to preferred shareholders totaling $7.7 million
or $1.45 per share. 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. On October 14, 2004,
the Company entered into an underwriting agreement pursuant to which the Company
41
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.
During the year ended December 31, 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 year ended December 31, 2004, options were
exercised under the long-term compensation plan at $856,000. Also, 127,020
common shares were sold through the dividend reinvestment and direct purchase
program for $2.3 million during the year ended December 31, 2004.
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.
FIDAC's shareholders may also receive additional shares of our common
stock as an earn-out in 2005and 2006 worth up to $49,500,000 if FIDAC meets
specific performance goals under the merger agreement. We cannot calculate how
many shares we will issue under the earn-out provisions since that will vary
depending upon whether and the extent to which FIDAC achieves specific
performance goals. Even if FIDAC achieves specific performance goals for a
fiscal year, the number of additional shares to be issued to the FIDAC
shareholders will vary depending on our average share price for the first 20
trading days of the following fiscal year.
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)
2004 2003 2002 2001 2000
-------------- ------------ -------------- ------------ ---------------
Unrealized Gain $23,021 $24,886 $90,507 $53,935 $ 3,020
Unrealized Loss (143,821) (72,147) (14,996) (15,766) (16,064)
-------------- ------------ -------------- ------------ ---------------
Net Unrealized Gain (Loss) ($120,800) ($47,261) $75,511 $38,169 ($13,044)
============== ============ ============== ============ ===============
Net Unrealized Gain (Loss) as % of
Investment Securities Principal Amount (0.63%) (0.37%) 0.67% 0.52% (0.66%)
Net Unrealized Gain (Loss) as % of
Investment Securities Amortized Cost (0.62%) (0.37%) 0.67% 0.51% (0.66%)
42
Unrealized changes in the estimated net market value of investment
securities have one direct effect on our potential earnings and dividends:
positive marked-to-market changes increase our equity base and allow us to
increase our borrowing capacity while negative changes tend to limit 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. The net unrealized gains (loss) on available for sale securities was
$(120.8) million, or (0.62%) of the amortized cost of our investment securities
as of December 31, 2004, $(47.3) million, or (0.37%) of the amortized cost of
our investment securities as of December 31, 2003 and $75.5 million, or 0.67% of
the amortized cost of our investment securities as of December 31, 2002.
Mortgage-Backed Securities with a carrying value of $2.2 billion were in a
continuous unrealized loss position over 12 months at December 31, 2004 in the
amount of $34.1 million. Mortgage-Backed Securities with a carrying value of
$13.1 billion were in a continuous unrealized loss position for less than 12
months at December 31, 2004 in the amount of $105.3 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 agency debentures with a
carrying value of $390.5 million were in a continuous unrealized loss position
over 12 months at December 31, 2004 in the amount of $4.5 million. 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 3.71% at December 31, 2004
and 5.80% at December 31, 2003. 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 table below shows our equity capital base as reported and on a
historical amortized cost basis at December 31, 2004, 2003, 2002, 2001, and
2000, and September 30, 2004, June 30, 2004 and March 31, 2004. 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 "Net Unrealized
Gains (Losses) on Assets Available for Sale" account.
43
STOCKHOLDERS' EQUITY
7.875% Series
A Cumulative
Redeemable Net Unrealized
Preferred Gains (Losses)
stock: Historical on Assets Reported Historical Reported Equity
7,412,500 Amortized Cost Available for Equity Base Amortized Cost (Book Value) Per
shares Equity Base Sale (Book Value) Equity Per Share Share
-------------- --------------- -------------- ------------ ---------------- ----------------
(dollars in thousands, except per share data)
At December 31, 2004 $177,077 $1,821,270 $(120,800) $1,700,470 $13.56 $12.56
At December 31, 2003 -- $1,196,481 $(47,261) $1,149,220 $12.45 $11.96
At December 31, 2002 -- $1,004,555 $75,511 $1,080,066 $11.88 $12.77
At December 31, 2001 -- $629,188 $38,169 $667,357 $10.52 $11.15
At December 31, 2000 -- $148,686 ($13,044) $135,642 $10.24 $9.34
- -------------------------------------------------------------------------------------------------------------------------------
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
LEVERAGE
Our debt-to-equity ratio at December 31, 2004, 2003, and 2002 was
9.8:1, 9.6:1, and 9.4:1, 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. Our goal is to provide
attractive risk-adjusted stockholder returns while maintaining what we believe
is 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 affect 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 net income would be absent such prepayments.
OFF-BALANCE SHEET ARRANGEMENTS
We do not have any relationships with unconsolidated entities or
financial partnerships, such as entities often referred to as structured finance
or special purpose entities, which would have been established for the purpose
of facilitating off-balance sheet arrangements or other contractually narrow or
limited purposes. Further, we have not guaranteed any obligations of
unconsolidated entities nor do we have any commitment or intent to provide
additional
44
funding to any such entities. As such, we are not materially exposed to any
market, credit, liquidity or financing risk that could arise if we had engaged
in such relationships.
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.
OTHER MATTERS
We calculate that our qualified REIT assets, as defined in the Internal
Revenue Code, are 100% of our total assets at December 31, 2004and 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 93.3% and 93.7%,
respectively, of our revenue qualifies for the 75% source of income test, and
100% of our revenue qualifies for the 95% source of income test, under the REIT
rules for the years ended December 31, 2004 and 2003. We also met all REIT
requirements regarding the ownership of our common stock and the distribution of
our net income. Therefore, as of December 31, 2004, 2003, 2002, and 2001 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 of 1940, as
amended (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 December 31, 2004, 2003, 2002, and 2001
we were in compliance with this requirement.
45
ITEM 7A 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. 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 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
investment 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 by 75 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 December 31,
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 Percentage Change in Projected Percentage Change in
Change in Interest Rate Net Interest Income Portfolio Value
- ----------------------------------------------------------------------------------------------------------------------
- -75 Basis Points (5.45%) 0.72%
- -50 Basis Points (3.58%) 0.50%
- -25 Basis Points (1.75%) 0.29%
Base Interest Rate
+25 Basis Points 1.66% (0.30%)
+50 Basis Points 3.22% (0.64%)
+75 Basis Points 4.67% (1.04%)
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 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 December 31,
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.
46
More than 1 3 Years and
Within 3 Months 4-12 Months Year to 3 Years Over Total
(dollars in thousands)
-------------------------------------------------------------------------------------
Rate Sensitive Assets:
Investment Securities $ 2,242,980 $2,048,119 $6,434,659 $8,398,144 $19,123,902
(Principal)
Rate Sensitive Liabilities:
Repurchase Agreements 14,657,879 300,000 1,750,000 -- 16,707,879
---------------- ----------------- ---------------- ---------------- ----------------
Interest rate sensitivity gap ($12,414,899) $1,748,119 $4,684,659 $8,398,144 $2,416,023
================ ================= ================ ================ ================
Cumulative rate sensitivity gap ($12,414,899) ($10,666,780) ($5,982,121) $2,416,023
================ ================= ================ ================
Cumulative interest rate
sensitivity gap as a percentage
of total rate-sensitive assets (64.92%) (55.78%) (31.28%) 12.63%
================ ================= ================ ================
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."
47
ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our financial statements and the related notes, together with the
Report of Independent Registered Public Accounting Firm thereon, are set forth
on pages F-1 through F-16 of this Form 10-K.
ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A CONTROLS AND PROCEDURES
Our management, including our Chief Executive Officer (the "CEO") and
Chief Financial Officer (the "CFO"), reviewed and evaluated the effectiveness of
the design and operation of our disclosure controls and procedures (as defined
in Rule 13a-15(e) of the Securities Exchange Act) as of the end of the period
covered by this annual report. Based on that review and evaluation, the CEO and
CFO have concluded that our current disclosure controls and procedures, as
designed and implemented, (1) were structured to ensure that material
information regarding Annaly and its sole subsidiary is made known to our
management, including our CEO and CFO, by our employees and (2) were effective
in providing reasonable assurance that information the Company must disclose in
its periodic reports under the Securities Exchange Act is recorded, processed,
summarized and reported within the time periods prescribed by the SEC's rules
and forms. There have been no significant changes in our internal controls or in
other factors that could significantly affect our internal controls subsequent
to the date of their evaluation. There were no significant material weaknesses
identified in the course of such review and evaluation and, therefore, we have
taken no corrective measures.
MANAGEMENT REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
DATED: MARCH 7, 2005
Management of the Company is responsible for establishing and
maintaining adequate internal control over financial reporting. Internal control
over financial reporting is defined in Rules 13a-15(f) under the Securities
Exchange Act as a process designed by, or under the supervision of, the
Company's principal executive and principal financial officers and effected by
the Company's Board of Directors, management and other personnel to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles and includes those policies and
procedures that:
o pertain to the maintenance of records that in reasonable detail
accurately and fairly reflect the transactions and dispositions of the
assets of the Company;
o provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance
with generally accepted accounting principles, and that receipts and
expenditures of the Company are being made only in accordance with
authorizations of management and directors of the Company; and
o provide reasonable assurance regarding prevention or timely detection
of unauthorized acquisition, use or disposition of the Company's assets
that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. As a result, even systems
determined to be effective can provide only reasonable assurance regarding the
preparation and presentation of financial statements. Moreover, projections of
any evaluation of effectiveness to future periods are subject to the risks that
controls may become inadequate because of changes in conditions or that the
degree of compliance with the policies or procedures may deteriorate.
The Company's management assessed the effectiveness of the Company's
internal control over financial reporting as of December 31, 2004. In making
this assessment, the Company's management used criteria set forth by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO) in
Internal Control-Integrated Framework.
48
Based on its assessment, the Company's management believes that, as of
December 31, 2004, the Company's internal control over financial reporting was
effective based on those criteria.
The Company's independent registered public accounting firm, Deloitte &
Touch, LLP, have issued an audit report on management's assessment of the
Company's internal control over financial reporting. This report appears on page
F-1 of this annual report on Form 10-K.
PART III
ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by Item 10 as to our directors is incorporated
herein by reference to the proxy statement to be filed with the SEC within 120
days after December 31, 2004. The information required by Item 10 as to our
compliance with Section 16(a) of the Securities Exchange Act of 1934 is
incorporated by reference to the proxy statement to be filed with the SEC within
120 days after December 31, 2004.
We have adopted a Code of Business Conduct and Ethics within the
meaning of Item 406(b) of Regulation S-K. This Code of Business Conduct and
Ethics applies to our principal executive officer, principal financial officer
and principal accounting officer. This Code of Business Conduct and Ethics is
publicly available on our website at www.annaly.com. If we make substantive
amendments to this Code of Business Conduct and Ethics or grant any waiver,
including any implicit waiver, we intend to disclose these events on our
website.
ITEM 11 EXECUTIVE COMPENSATION
The information required by Item 11 is incorporated herein by reference
to the proxy statement to be filed with the SEC within 120 days after December
31, 2004.
ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The information required by Item 12 is incorporated herein by reference
to the proxy statement to be filed with the SEC within 120 days after December
31, 2004.
ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is incorporated herein by reference
to the proxy statement to be filed with the SEC within 120 days after December
31, 2004.
ITEM 14 PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by Item 14 is incorporated herein by reference
to the proxy statement to be filed with the SEC within 120 days after December
31, 2004.
49
PART IV
ITEM 15 EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Documents filed as part of this report:
1. Financial Statements.
2. Schedules to Financial Statements:
All financial statement schedules not included have been omitted
because they are either inapplicable or the information required is provided in
our Financial Statements and Notes thereto, included in Part II, Item 8, of this
Annual Report on Form 10-K.
3. Exhibits:
EXHIBIT INDEX
Exhibit Exhibit Description
Number
3.1 Articles of Incorporation of the Registrant (incorporated by reference
to Exhibit 3.1 to the Registrant's Registration Statement on Form S-11
(Registration No. 333-32913) filed with the Securities and Exchange
Commission on August 5, 1997).
3.2 Articles of Amendment and Restatement of the Articles of Incorporation
of the Registrant (incorporated by reference to Exhibit 3.2 to the
Registrant's Registration Statement on Form S-11 (Registration No.
333-32913) filed with the Securities and Exchange Commission on August
5, 1997).
3.3 Articles of Amendment of the Articles of Incorporation of the
Registrant (incorporated by reference to Exhibit 3.1 of the
Registrant's Registration Statement on Form S-3 (Registration Statement
333-74618) filed with the Securities and Exchange Commission on June
12, 2002).
3.4 Bylaws of the Registrant, as amended (incorporated by reference to
Exhibit 3.3 to the Registrant's Registration Statement on Form S-11
(Registration No. 333-32913) filed with the Securities and Exchange
Commission on August 5, 1997).
4.1 Specimen Common Stock Certificate (incorporated by reference to Exhibit
4.1 to Amendment No. 1 to the Registrant's Registration Statement on
Form S-11 (Registration No. 333-32913) filed with the Securities and
Exchange Commission on September 17, 1997).
4.2 Specimen Series A Preferred Stock Certificate (incorporated by
reference to Exhibit 4.1 of the Registrant's Registration Statement on
Form 8-A filed with the SEC on April 1, 2004).
4.3 Specimen Preferred Stock Certificate (incorporated by reference to
Exhibit 4.2 to the Registrant's Registration Statement on Form S-3
(Registration No. 333-74618) filed with the Securities and Exchange
Commission on December 5, 2001).
10.1 Long-Term Stock Incentive Plan (incorporated by reference to Exhibit
10.3 to the Registrant's Registration Statement on Form S-11
(Registration No. 333-32913) filed with the Securities and Exchange
Commission on August 5, 1997).*
10.2 Form of Master Repurchase Agreement (incorporated by reference to
Exhibit 10.7 to the Registrant's Registration Statement on Form S-11
(Registration No. 333-32913) filed with the Securities and Exchange
Commission on August 5, 1997).
10.3 Amended and Restated Employment Agreement, effective as of June 4, 2004
between the Registrant and Michael A.J. Farrell.*
10.4 Amended and Restated Employment Agreement, effective as of June 4,
2004, between the Registrant and Wellington J. Denahan-Norris.*
50
10.5 Amended and Restated Employment Agreement, effective as of June 4, 2004
between the Registrant and Kathryn F. Fagan.*
10.6 Amended and Restated Employment Agreement, effective as of June 4,
2004, between the Registrant and Jennifer S. Karve.*
10.7 Amended and Restated Employment Agreement, effective as of June 4,
2004, between the Registrant and James P. Fortescue.*
10.8 Amended and Restated Employment Agreement, effective as of June 4,
2004, between the Registrant and Jeremy Diamond.*
10.9 Amended and Restated Employment Agreement, effective as of June 4,
2004, between the Registrant and Ronald D. Kazel.*
10.10 Amended and Restated Employment Agreement, effective as of June 4,
2004, between the Registrant and Rose-Marie Lyght.*
10.11 Amended and Restated Employment Agreement, effective as of June 4,
2004, between the Registrant and Kristopher R. Konrad.*
10.12 Employment Agreement, dated February 14, 2005, between the Registrant
and R. Nicholas Singh (incorporated by reference to Exhibit 10.1 to the
Registrant's Form 8-K filed with the Securities and Exchange Commission
on February 16, 2005).*
10.13 Agreement and Plan of Merger, dated as of December 31, 2003, by and
among the Registrant, Fixed Income Discount Advisory Company, FDC
MergerSub, Inc., Michael A.J. Farrell, Wellington J. Denahan, Jennifer
S. Karve, Kathryn F. Fagan, Jeremy Diamond, Ronald D. Kazel, Rose-Marie
Lyght, Kristopher R. Konrad, and James P. Fortescue (incorporated by
reference to Exhibit 99.2 to the Registrant's Form 8-K filed with the
Securities and Exchange Commission on January 2, 2004).
23.1 Consent of Independent Auditors.
31.1 Certification of Michael A.J. Farrell, Chairman, Chief Executive
Officer, and President of the Registrant, 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 Kathryn F. Fagan, Chief Financial Officer and
Treasurer of the Registrant, 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 Michael A.J. Farrell, Chairman, Chief Executive
Officer, and President of the Registrant, pursuant to 18 U.S.C. Section
1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
32.2 Certification of Kathryn F. Fagan, Chief Financial Officer and
Treasurer of the Registrant, pursuant to 18 U.S.C. Section 1350 as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
* Exhibit Numbers 10.1 and 10.3-10.12 are management contracts or compensatory
plans required to be filed as Exhibits to this Form 10-K.
51
ANNALY MORTGAGE MANAGEMENT, INC.
FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
PAGE
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM F-1
FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2004, 2003, and 2002:
Statements of Financial Condition F-2
Statements of Operations and Comprehensive Income (Loss) F-3
Statements of Stockholders' Equity F-4
Statements of Cash Flows F-5
Notes to Financial Statements F-6-F-18
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Annaly Mortgage Management, Inc.
We have audited the accompanying statements of financial condition of
Annaly Mortgage Management, Inc (the "Company") as of December 31, 2004 and
2003, and the related statements of operations and comprehensive income,
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 2004. We also have audited management's assessment, included
in the Management Report On Internal Control Over Financial Reporting included
at Item 9A, that the Company maintained effective internal control over
financial reporting as of December 31, 2004, based on criteria established in
INTERNAL CONTROL--INTEGRATED FRAMEWORK issued by the Committee of Sponsoring
Organizations of the Treadway Commission. The Company's management is
responsible for these financial statements, for maintaining effective internal
control over financial reporting, and for its assessment of the effectiveness of
internal control over financial reporting. Our responsibility is to express an
opinion on these financial statements, an opinion on management's assessment,
and an opinion on the effectiveness of the Company's internal control over
financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement and whether effective
internal control over financial reporting was maintained in all material
respects. Our audit of financial statements included examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. Our
audit of internal control over financial reporting included obtaining an
understanding of internal control over financial reporting, evaluating
management's assessment, testing and evaluating the design and operating
effectiveness of internal control, and performing such other procedures as we
considered necessary in the circumstances. We believe that our audits provide a
reasonable basis for our opinions.
A company's internal control over financial reporting is a process
designed by, or under the supervision of, the company's principal executive and
principal financial officers, or persons performing similar functions, and
effected by the company's board of directors, management, and other personnel to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial
reporting, including the possibility of collusion or improper management
override of controls, material misstatements due to error or fraud may not be
prevented or detected on a timely basis. Also, projections of any evaluation of
the effectiveness of the internal control over financial reporting to future
periods are subject to the risk that the controls may become inadequate because
of changes in conditions, or that the degree of compliance with the policies or
procedures may deteriorate.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of the Company as of
December 31, 2004 and 2003, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 2004, in conformity
with accounting principles generally accepted in the United States of America.
Also in our opinion, management's assessment that the Company maintained
effective internal control over financial reporting as of December 31, 2004, is
fairly stated, in all material respects, based on the criteria established in
Internal Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Furthermore, in our opinion, the
Company maintained, in all material respects, effective internal control over
financial reporting as of December 31, 2004, based on the criteria established
in Internal Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission.
New York, New York
March 7, 2005
F-1
ANNALY MORTGAGE MANAGEMENT, INC.
STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 2004 AND 2003
(DOLLARS IN THOUSANDS, EXCEPT FOR SHARE DATA)
DECEMBER 31, 2004
(CONSOLIDATED) DECEMBER 31, 2003
----------------- -----------------
ASSETS
Cash and cash equivalents $ 5,853 $ 247
Mortgage-Backed Securities, at fair value 19,038,386 11,956,512
Agency debentures, at fair value 390,509 978,167
Receivable for Mortgage-Backed Securities sold 1,025 --
Accrued interest receivable 81,557 53,743
Receivable for advisory and service fees 2,359 --
Intangible for customer relationships 15,613 --
Goodwill 23,122 --
Other assets 1,875 1,617
----------- -----------
Total assets $19,560,299 $12,990,286
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Repurchase agreements $16,707,879 $11,012,903
Payable for Mortgage-Backed Securities purchased 1,044,683 761,115
Accrued interest payable 35,721 14,989
Dividends payable 60,632 45,155
Other liabilities 2,819 4,017
Accounts payable 8,095 2,887
----------- -----------
Total liabilities 17,859,829 11,841,066
----------- -----------
Stockholders' Equity:
7.875% Series A Cumulative Redeemable Preferred Stock:
8,000,000 authorized 7,412,500 shares issued and outstanding 177,077 --
Common stock: par value $.01 per share; 500,000,000 authorized,
121,263,000 and 96,074,096 shares
issued and outstanding, respectively 1,213 961
Additional paid-in capital 1,638,635 1,194,159
Accumulated other comprehensive loss (120,800) (47,261)
Retained earnings 4,345 1,361
----------- -----------
Total stockholders' equity 1,700,470 1,149,220
----------- -----------
Total liabilities and stockholders' equity $19,560,299 $12,990,286
=========== ===========
See notes to financial statements.
F-2
ANNALY MORTGAGE MANAGEMENT, INC.
STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
FOR THE FOR THE FOR THE
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
2004 2003 2002
(CONSOLIDATED)
-------------- ------------ ------------
INTEREST INCOME $532,328 $337,433 $404,165
INTEREST EXPENSE 270,116 182,004 191,758
----------- ---------- ----------
NET INTEREST INCOME 262,212 155,429 212,407
OTHER INCOME:
Investment advisory and service fees 12,512 -- --
Gain on sale of mortgage-backed securities 5,215 40,907 21,063
----------- ---------- ----------
TOTAL OTHER INCOME 17,727 196,336 233,470
----------- ---------- ----------
EXPENSES:
Distribution fees 2,860 -- --
General and administrative expenses 24,029 16,233 13,963
----------- ---------- ----------
TOTAL EXPENSES 26,889 16,233 13,963
----------- ---------- ----------
INCOME BEFORE INCOME TAXES 253,050 180,103 219,507
INCOME TAXES 4,458 -- --
----------- ---------- ----------
NET INCOME 248,592 180,103 219,507
DIVIDEND ON PREFERRED STOCK 7,745 -- --
----------- ---------- ----------
NET INCOME AVAILABLE TO COMMON SHAREHOLDERS $240,847 $180,103 $219,507
=========== ========== ==========
NET INCOME PER SHARE AVAILABLE TO COMMON
SHAREHOLDERS:
Basic $2.04 $1.95 $2.68
=========== ========== ==========
Diluted $2.03 $1.94 $2.67
=========== ========== ==========
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING:
Basic 118,223,330 92,215,352 82,044,141
=========== ========== ==========
Diluted 118,459,145 93,031,253 82,282,883
=========== ========== ==========
NET INCOME $248,592 $180,103 $219,507
----------- ---------- ----------
COMPREHENSIVE INCOME (LOSS):
Unrealized gain (loss) on available-for sale
securities (68,324) (81,865) 58,405
Less: reclassification adjustment for net
gains (losses) included in net income (5,215) (40,907) (21,063)
----------- ---------- ----------
Other comprehensive income (loss) (73,539) (122,772) 37,342
----------- ---------- ----------
COMPREHENSIVE INCOME (LOSS) $175,053 $57,331 $256,849
=========== ========== ==========
See notes to financial statements.
F-3
ANNALY MORTGAGE MANAGEMENT, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2004 (CONSOLIDATED), 2003, AND 2002
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
OTHER
COMMON ADDITIONAL ACCUMULATED
PREFERRED STOCK PAID-IN COMPREHENSIVE RETAINED
STOCK PAR VALUE CAPITAL INCOME (LOSS) EARNINGS TOTAL
--------- --------- ----------- ------------- --------- ----------
BALANCE, DECEMBER 31, 2001 $598 $623,986 $38,169 $4,604 $667,357
Net Income 219,507
Other comprehensive income:
Unrealized net gain on securities,
net of reclassification adjustment 37,342
Comprehensive income 256,849
Exercise of stock options 1 1,089 1,090
Shares exchanged upon exercise of stock options (76) (76)
Net proceeds from direct purchase and dividend reinvestment 2 3,007 3,009
Net proceeds from equity shelf program 15 28,088 28,103
Net proceeds from follow-on offering 230 347,106 347,336
Common dividends declared, $2.67 per share (223,602) (223,602)
--------- --------- ----------- ------------- --------- ----------
BALANCE, DECEMBER 31, 2002 $846 $1,003,200 $75,511 $ 509 $1,080,066
Net Income 180,103
Other comprehensive loss:
Unrealized net loss on securities,
net of reclassification adjustment (122,772)
Comprehensive income 57,331
Exercise of stock options 1 913 914
Net proceeds from direct purchase and dividend reinvestment 2 4,199 4,201
Net proceeds from follow-on offering 93 151,222 151,315
Net proceeds from equity shelf program offering 19 34,625 34,644
Common dividends declared, $1.95 per share (179,251) (179,251)
--------- --------- ----------- ------------- --------- ----------
BALANCE, DECEMBER 31, 2003 $961 $1,194,159 ($47,261) $1,361 $1,149,220
Net Income 248,592
Other comprehensive loss: Unrealized net loss on securities,
net of reclassification adjustment (73,539)
Comprehensive income 175,053
Exercise of stock options 1 855 856
Net proceeds from direct purchase and dividend reinvestment 1 2,285 2,286
Net proceeds from follow-on offering 207 363,385 363,592
Common shares issued in FIDAC transaction 22 40,478 40,500
Net proceeds from preferred offering $177,077 177,077
Net proceeds from equity shelf program 21 37,473 37,494
Preferred dividends declared, $1.45 per share (7,745) (7,745)
Common dividends declared, $1.98 per share (237,863) (237,863)
--------- --------- ----------- ------------- --------- ----------
BALANCE, DECEMBER 31, 2004 $177,077 $1,213 $1,638,635 ($120,800) $4,345 $1,700,470
========= ========= =========== ============= ========= ==========
See notes to financial statements.
F-4
ANNALY MORTGAGE MANAGEMENT, INC.
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
(DOLLARS IN THOUSANDS)
FOR THE YEAR ENDED FOR THE YEAR FOR THE YEAR ENDED
DECEMBER 31, ENDED DECEMBER 31,
2004 DECEMBER 31, 2002
(CONSOLIDATED) 2003
-------------- ------------- ------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $248,592 $180,103 $219,507
Adjustments to reconcile net income to net cash -- --
provided by operating activities:
Amortization of premiums and discounts, net 179,602 216,570 106,198
Amortization of intangibles 130 -- --
Gain on sale of Mortgage-Backed Securities (5,215) (40,907) (21,063)
Stock option expense 317 121 240
Market value adjustment on long-term repurchase
agreement (1,133) 1,607 1,204
Decrease (increase) in accrued interest receivable, net of (27,964) (2,833) (2,903)
interest purchased on securities
Decrease (increase) in other assets (1,749) (776) (641)
Decrease (increase) in advisory and service fees
receivable (795) -- --
Increase (decrease) in accrued interest payable 20,732 55 (1,109)
Increase in accounts payable 4,400 979 673
------------- ------------- ------------
Net cash provided by operating activities 416,917 354,919 302,106
------------- ------------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of Mortgage-Backed Securities (14,147,323) (11,404,133) (11.079.561)
Purchase of Agency debentures (250,000) (1,735,940) --
Proceeds from sale of Mortgage-Backed Securities 596,962 2,899,267 2,076,800
Proceeds from called agency debentures 845,000 746,000 --
Principal payments of Mortgage-Backed Securities 6,495,911 8,290,724 4,728,666
Cash from FIDAC acquisition 2,526 -- --
------------- ------------- ------------
Net cash used in investing activities (6,456,924) (1,204,082) (4,274,095)
------------- ------------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from repurchase agreements 152,739,827 117,066,588 87,463,924
Principal payments on repurchase agreements (147,045,071) (116,217,261) (83,668,862)
Proceeds from exercise of stock options 539 792 774
Proceeds from direct purchase and dividend
reinvestment 2,286 4,201 3,010
Net proceeds from follow-on offerings 363,592 151,315 347,336
Proceeds from preferred offering 177,077 -- --
Net proceeds from equity shelf program 37,494 34,644 28,103
Dividends paid (230,131) (191,595) (201,999)
------------- ------------- ------------
Net cash provided by financing activities 6,045,613 848,684 3,972,286
------------- ------------- ------------
Net increase (decrease) in cash and cash equivalents 5,606 (479) 297
Cash and cash equivalents, beginning of year 247 726 429
------------- ------------- ------------
Cash and cash equivalents, end of year 5,853 247 726
============= ============= ============
Supplemental disclosure of cash flow information:
Interest paid $249,384 $181,949 $190,650
============= ============= ============
Noncash financing activities:
Net change in unrealized loss on available-for-
sale securities net of reclassification adjustment ($73,539) ($122,772) $37,342
============= ============= ============
Dividends declared, not yet paid $60,632 $45,155 $57,499
============= ============= ============
Noncash investing and financing activities:
Noncash acquisition of FIDAC $40,500 -- --
============= ============= ============
See notes to financial statements.
F-5
ANNALY MORTGAGE MANAGEMENT, INC.
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMPER 31, 2004, 2003 AND 2002
- --------------------------------------------------------------------------------
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 consolidated financial statements as of and
for the year ended December 31, 2004 include the accounts of the Company and
FIDAC. All material intercompany balances have been eliminated. Certain
reclassifications have been made to prior year financial statements, where
appropriate, to conform to the current year presentation.
Cash and Cash Equivalents - Cash and cash equivalents include cash on
hand and money market funds.
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.
Management evaluates securities for other-than-temporary impairment at
least on a quarterly basis, and more frequently when economic or market concerns
warrant such evaluation. Consideration is given to (1) the length of time and
the extent to which the fair value has been less than cost, (2) the financial
condition and near-term prospects of the issuer, and (3) the intent and ability
of the Company to retain its investment in the issuer for a period of time
sufficient to allow for any anticipated recovery in fair value. 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 year ended
December 31, 2004, 2003, or 2002.
SFAS No. 107, DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS,
requires disclosure of the fair value of financial instruments for which it is
practicable to estimate that value. The fair value of mortgage-backed securities
and agency debentures available-for-sale and futures contracts is equal to their
carrying value presented in the balance sheet. The fair value of cash and cash
equivalents, accrued interest receivable, receivable for mortgage-backed
securities sold, receivable for advisory fees, repurchase agreements, and
payable for mortgage-backed securities purchased, dividends payable, accounts
payable, and accrued interest payable, generally approximates cost as of
December 31, 2004, due to the short-term nature of these securities.
F-6
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 or
accreted 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 gains and losses on sale of
Investment Securities are determined on the specific identification basis.
Credit Risk - At December 31, 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 is backed by the full-faith-and-credit of the U.S.
government. At December 31, 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 payable 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 accounting principles generally accepted in the United States of
America ("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.
Intangible assets - The Company's acquisition of FIDAC is 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, the cost of FIDAC 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
is recognized as goodwill.
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, and investments
accounted for under the cost method or the equity method. Certain provisions of
this Issue have been deferred to a later date. This Issue is not expected to
have a significant impact on the Company's financial statements when adopted.
F-7
On December 16, 2004, the Financial Accounting Standards Board (FASB)
issued SFAS No. 123, (Revised 2004) - share-Based Payment ("SFAS No. 123R").
SFAS 123R, which replaces SFAS No. 123, requires the Company to measure and
recognize in the financial statements the compensation cost relating to
share-based payment transactions. The compensation cost should be reassured
based on the fair value of the equity instruments issued. SFAS No. 123R is
effective as of the first interim or annual reporting period that begins after
June 15, 2005. The adoption of SFAS No. 123R is not expected to have a
significant impact on the Company's financial statements when adopted as of July
1, 2005.
2. FIXED INCOME DISCOUNT ADVISORY COMPANY
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 December 31,2004 includes the effects of the
merger and the Company's application of the purchase method of accounting.
Additionally, the consolidated statements of operations and of cash flows for
the respective periods ended December 31, 2004 include the results of the
Company and FIDAC for the period from June 4, 2004 to December 31, 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. FIDAC's shareholders may also receive additional shares of
our common stock as an earn-out in 2005and 2006 worth up to $49,500,000 if FIDAC
meets specific performance goals under the merger agreement. We cannot calculate
how many shares we will issue under the earn-out provisions since that will vary
depending upon whether and the extent to which FIDAC achieves specific
performance goals. Even if FIDAC achieves specific performance goals for a
fiscal year, the number of additional shares to be issued to the FIDAC
shareholders will vary depending on our average share price for the first 20
trading days of the following fiscal year.
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.
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
being 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 year ended December 31, 2004, amortization expense
related to these intangibles was $130,000. A deferred tax liability of $104,000
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 December 31, 2004.
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
=======
F-8
3. MORTGAGE-BACKED SECURITIES
The following tables pertain to the Company's Mortgage-Backed
Securities classified as available-for-sale as of December 31, 2004 and 2003,
which are carried at their fair value:
FEDERAL HOME LOAN FEDERAL NATIONAL GOVERNMENT NATIONAL TOTAL MORTGAGE-BACKED
DECEMBER 31, 2004 MORTGAGE CORPORATION MORTGAGE ASSOCIATION MORTGAGE ASSOCIATION SECURITIES
---------------------- --------------------- --------------------- ---------------------
(dollars in thousands)
Mortgage-Backed
Securities, gross $6,063,131 $12,061,462 $604,310 $18,728,903
Unamortized discount (171) (843) (109) (1,123)
Unamortized premium 130,211 288,217 8,528 426,956
---------------------- --------------------- --------------------- ---------------------
Amortized cost 6,193,171 12,348,836 612,729 19,154,736
Gross unrealized gains 11,534 9,905 1,582 23,021
Gross unrealized losses (39,429) (97,890) (2,052) (139,371)
---------------------- --------------------- --------------------- ---------------------
Estimated fair value $6,165,276 $12,260,851 $612,259 $19,038,386
====================== ===================== ===================== =====================
AMORTIZED COST GROSS UNREALIZED GAIN GROSS UNREALIZED LOSS ESTIMATED FAIR VALUE
---------------------- --------------------- --------------------- ---------------------
(dollars in thousands)
Adjustable rate $13,833,122 $20,713 ($93,796) $13,760,039
Fixed rate 5,321,614 2,308 (45,575) 5,278,347
---------------------- --------------------- --------------------- ---------------------
Total $19,154,736 $23,021 ($139,371) $19,038,386
====================== ===================== ===================== =====================
FEDERAL HOME LOAN FEDERAL NATIONAL GOVERNMENT NATIONAL TOTAL MORTGAGE-BACKED
DECEMBER 31, 2003 MORTGAGE CORPORATION MORTGAGE ASSOCIATION MORTGAGE ASSOCIATION SECURITIES
---------------------- --------------------- --------------------- ---------------------
(dollars in thousandS)
Mortgage-Backed
Securities, gross $3,763,364 $7,509,544 $419,223 $11,692,130
Unamortized discount (198) (1,034) (209) (1,441)
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
====================== ===================== ===================== =====================
AMORTIZED COST GROSS UNREALIZED GAIN GROSS UNREALIZED LOSS ESTIMATED FAIR 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
====================== ===================== ===================== =====================
Actual maturities of mortgage-backed securities are generally shorter
than stated contractual maturities. Actual maturities of the Company's
mortgage-backed securities are affected by the contractual lives of the
underlying mortgages, periodic payments of principal, and prepayments of
principal. The following table summarizes the
F-9
Company's mortgage-backed securities on December 31, 2004 and 2003 according to
their estimated weighted-average life classifications:
December 31, 2004 December 31, 2003
Weighted-Average Life Fair Value Amortized Cost Fair Value Amortized Cost
(dollars in thousands)
- --------------------------------------------------------------------------------------------------------------------------
Less than one year $ 357,135 $ 359,433 $ 743,137 $ 744,571
Greater than one year and less than five years 14,623,143 14,705,212 8,240,101 8,254,989
Greater than or equal to five years 4,058,108 4,090,091 2,973,274 2,992,440
----------------------------------------------------------------------
Total $19,038,386 $19,154,736 $11,956,512 $11,992,000
======================================================================
The weighted-average lives of the mortgage-backed securities at
December 31, 2004 and 2003 in the table above are based upon data provided
through subscription-based financial information services, assuming constant
principal prepayment rates to the reset date of each security. The prepayment
model considers current yield, forward yield, steepness of the yield curve,
current mortgage rates, mortgage rate of the outstanding loans, loan age, margin
and volatility.
Mortgage-Backed Securities with a carrying value of $2.2 billion were
in a continuous unrealized loss position over 12 months at December 31, 2004 in
the amount of $34.1 million. Mortgage-Backed Securities with a carrying value of
$13.1 billion were in a continuous unrealized loss position for less than 12
months at December 31, 2004 in the amount of $105.3 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 is 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
December 31, 2004 and 9.9% at December 31, 2003.
During the year ended December 31, 2004, the Company realized $5.2
million in net gains from sales of Mortgage-Backed Securities. During year ended
December 31, 2003, the Company realized $40.9 million in net gains from sales of
Mortgage-Backed Securities.
F-10
4. AGENCY DEBENTURES
At December 31, 2004, the Company owned callable agency debentures
totaling $395.0 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. All agency debentures
had carrying values of $390.5 million and $978.2 million at December 31, 2004
and December 31, 2003, respectively. The agency debentures with a carrying value
of $390.5 million were in a continuous unrealized loss position over 12 months
at December 31, 2004 in the amount of $4.5 million. All 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 3.71% at December 31, 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 $16.7 billion and $11.0 billion of
repurchase agreements with weighted average borrowing rates of 2.46% and 1.51%,
and weighted average remaining maturities of 111 days and 90 days as of December
31, 2004 and December 31, 2003, respectively. Investment Securities pledged as
collateral under these repurchase agreements had an estimated fair value of
$17.4 billion at December 31, 2004.
At December 31, 2004 and December 31, 2003, the repurchase agreements
had the following remaining maturities:
DECEMBER 31, 2004 DECEMBER 31, 2003
(dollars in thousands)
-----------------------------------------------
Within 30 days $13,059,810 $ 8,589,184
30 to 59 days 1,598,069 709,552
60 to 89 days -- --
90 to 119 days -- --
Over 120 days 2,050,000 1,714,167
------------------ ----------------------------
Total $16,707,879 $11,012,903
================== ============================
6. OTHER LIABILITIES
In 2001, the Company entered into a repurchase agreement maturing in
July 2004, at which time the repurchase agreement gave the buyer the right to
extend, in whole or in part, in three-month increments up to July 2006. In
October 2004, the buyer extended the repurchase agreement, in whole, for the
next three months, with the right to further extend in January, 2005, which the
buyer did extend. 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 December 31, 2004 and December
31, 2003, the fair value of this interest rate floor was $2.7 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 year ended December 31, 2004, the Company declared dividends
to common shareholders totaling $237.9 million or $1.98 per share, of which
$60.6 million were paid on January 27, 2005. During the year ended December 31,
2004, the Company declared and paid dividends to preferred shareholders totaling
$7.7 million or $1.45 per share. 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
F-11
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.
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.During the twelve months
ended December 31, 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 year ended December 31, 2004, 57,000 options were exercised under the
long-term compensation plan at $856,000. Also, 127,020 common shares were sold
through the dividend reinvestment and direct purchase program for $2.3 million
during the year ended December 31, 2004.
On April 1, 2003 the Company entered into an underwriting agreement
pursuant to which the Company raised net proceeds of approximately $151.3
million in equity in an offering of 9,300,700 shares of common stock. During the
year ended December 31, 2003, 1,879,600 shares were issued through the Equity
Shelf Program, totaling net proceeds of $34.6 million. During the year ended
December 31, 2003, 92,697 options were exercised under the long-term
compensation plan at $914,000. Also, 231,893 shares were purchased in the
dividend reinvestment and direct purchase program at $4.2 million.
During the year ended December 31, 2002, the Company completed an
offering of common stock in the first quarter issuing 23,000,000 shares, with
aggregate net proceeds of approximately $347.3 million. Through the Equity Shelf
Program, the Company raised $28.1 million in net proceeds and issued 1,484,100
shares. During the year ended December 31, 2002, 97,095 options were exercised
at $1.1 million. Total shares exchanged upon exercise of the stock options were
4,444 at a value of $76,000. Also, 165,480 shares were purchased in dividend
reinvestment and share purchase plan, totaling $3.0 million.
8. EARNINGS PER SHARE (EPS)
For the year ended December 31, 2004, the reconciliation is as follows:
FOR THE YEAR ENDED DECEMBER 31, 2004
(Amounts in thousands, except per share amounts)
-----------------------------------------------------------
Weighted Average
Income Shares Per-Share
(Numerator) (Denominator) Amount
-----------------------------------------------------------
Net income available to common shareholders $240,847
-------------------
Basic earnings per common share $240,847 118,223 $2.04
=================
Effect of dilutive securities:
Dilutive stock options 236
------------------- ---------------------
Diluted earnings per common share $240,847 118,459 $2.03
=================== ===================== =================
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 year ended December 31, 2004.
F-12
For the year ended December 31, 2003, the reconciliation is as follows:
FOR THE YEAR ENDED DECEMBER 31, 2003
(dollars in thousands, except per share amounts)
---------------------------------------------------------
Weighted Average
Income Shares Per-Share
(Numerator) (Denominator) Amount
---------------------------------------------------------
Net income $180,103
-------------------
Basic earnings per share $180,103 92,215 $1.95
=================
Effect of dilutive securities:
Dilutive stock options 816
------------------- -------------------
Diluted earnings per share $180,103 93,031 $1.94
=================== =================== =================
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 year ended December 31, 2003.
For the year ended December 31, 2002, the reconciliation is as follows:
FOR THE YEAR ENDED DECEMBER 31, 2002
(Amounts in thousands, except per share amounts)
---------------------------------------------------------
Weighted Average
Income Shares Per-Share
(Numerator) (Denominator) Amount
---------------------------------------------------------
Net income available to common shareholders $219,507
-------------------
Basic earnings per share 219,507 82,044 $2.68
=================
Effect of dilutive securities:
Dilutive stock options 239
------------------- -------------------
Diluted earnings per share $219,507 82,283 $2.67
=================== =================== =================
Options to purchase 6,250 shares of common stock were outstanding and
considered anti-dilutive as their exercise price exceeded the average stock
price for the year ended December 31, 2002.
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:
F-13
2004 2003 2002
--------------------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Number of Exercise Number of Exercise Number of Exercise
Shares Price Shares Price Shares Price
--------------------------------------------------------------------------------
Options outstanding at the
beginning of period 1,063,259 $14.28 512,706 $8.59 635,826 $8.48
Granted 639,750 17.39 643,450 $18.00 6,250 $20.35
Exercised (57,288) 9.40 (92,697) 8.54 (97,095) 8.75
Expired -- -- (200) $17.97 (32,275) $8.28
--------------------------------------------------------------------------------
Options outstanding at the
end of period 1,645,721 $15.66 1,063,259 $14.28 512,706 $8.59
================================================================================
The following table summarizes information about stock options outstanding at
December 31, 2004:
Weighted Average
Weighted Average Remaining Contractual
Range of Exercise Prices Options Outstanding Exercise Price Life (Years)
- ----------------------------------------------------------------------------------------------------
$7.94-$19.99 1,633,221 $15.62 7.95
$20.00-$29.99 12,500 20.53 2.98
--------------------------------------------------------------------
1,645,721 $15.66 7.91
====================================================================
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 SFAS No. 123, Accounting for Stock-Based Compensation, to
stock-based employee compensation:
For the year ended December 31,
(dollars in thousands, except per share data)
2004 2003 2002
-----------------------------------------------
Net income available to common shareholders, as
reported $240,847 $180,103 $219,507
Deduct: Total stock-based employee compensation
expense determined under fair value based method (149) (48) (33)
-----------------------------------------------
Pro-forma net income available to common
shareholers $240,698 $180,055 $219,474
===============================================
Net income per share available to common shareholders, as reported
Basic $2.04 $1.95 $2.68
Diluted $2.03 $1.94 $2.67
Pro-forma net income per share available to common shareholders
Basic $2.03 $1.95 $2.68
Diluted $2.03 $1.94 $2.67
F-14
9. INCOME TAXES
Annaly has elected to be taxed as a Real Estate Investment Trust status
under the Internal Revenue Code. In connection with the Company's merger with
FIDAC effective June 4, 2004, FIDAC elected taxable REIT subsidiary status under
the Internal Revenue Code. As a REIT, the Company is not subject to Federal
income tax on earnings distributed to its shareholders. Most states recognize
REIT status as well. The Company has decided to distribute the majority of its
income and retain a portion of the permanent difference between book and taxable
income arising from Internal Revenue Code Section 162(m) pertaining to employee
remuneration.
During the year ended December 31, 2004, the Company recorded $4.5
million of income tax expense for income attributable to taxable REIT subsidiary
and the portion of earnings retained based on Code Section 162(m) limitations.
The Company's effective tax rate was 45% for the year ended December 31, 2004.
Such rate differed from the federal statutory rate as a result of state and
local taxes and permanent difference pertaining to employee remuneration as
discussed above. During the years ended December 31, 2003 and 2002, 100% of the
taxable income of the Company was distributed and as a result, the Company was
not subject to income taxes.
11. 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)
2005 500
2006 530
2007 532
2008 532
2009 532
----------------------
Total remaining lease payments $2,626
======================
12. 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
F-15
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.
F-16
13. SUMMARIZED QUARTERLY RESULTS (UNAUDITED)
The following is a presentation of the quarterly results of operations
for the year ended December 31, 2004.
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
2004 2004 2004 2004
(dollars in thousands, except per share data)
----------------------------------------------------------------------
Interest income $114,341 $122,234 $138,970 $156,783
Interest expense 50,303 55,648 70,173 93,992
----------------- ---------------- ----------------- -----------------
Net interest income 64,038 66,586 68,797 62,791
Investment advisory and service fees -- 1,260 4,811 6,143
Gain on sale of Mortgage-Backed Securities 595 2,126 1,350 1,144
Distribution fees -- (298) (1,024) (1,538)
General and administrative expenses (5,790) (5,643) (6,159) (6,862)
----------------- ---------------- ----------------- -----------------
Income before income taxes $58,843 $64,031 $67,775 $61,678
Income taxes -- 494 1,155 2,384
----------------- ---------------- ----------------- -----------------
Net income $58,843 $63,537 $66,620 $59,294
Dividends on preferred stock 1,998 2,082 3,665
----------------- ---------------- ----------------- -----------------
Net income available to commons shareholders $58,843 $61,837 $64,538 $55,629
================= ================ ================= =================
Weighted average number of basic common shares
outstanding 112,506,206 118,276,509 120,802,814 121,246,246
================= ================ ================= =================
Weighted average number of diluted common shares
outstanding 112,804,001 118,469,756 120,994,191 121,514,941
================= ================ ================= =================
Net income per share available to common shareholders:
Basic $0.52 $0.52 $0.53 $0.46
Diluted $0.52 $0.52 $0.53 $0.46
The following is a presentation of the quarterly results of operations
for the year ended December 31, 2003.
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
2003 2003 2003 2003
(dollars in thousands, except per share data)
----------------------------------------------------------------------
Interest income $ 87,500 $ 93,892 $ 66,855 $ 89,186
Interest expense 44,048 51,770 43,922 42,264
----------------- ---------------- ----------------- -----------------
Net interest income 43,452 42,122 22,933 46,922
================= ================ ================= =================
Gain on sale of Mortgage-Backed Securities 11,020 20,231 9,656 --
General and administrative expenses (3,697) (4,201) (4,110) (4,225)
----------------- ---------------- ----------------- -----------------
Net income $ 50,775 $ 58,152 $ 28,479 $ 42,697
================= ================ ================= =================
Weighted average number of basic common shares
outstanding 84,606,786 93,384,128 94,685,685 96,027,468
================= ================ ================= =================
Weighted average number of diluted common shares
outstanding 84,837,390 93,588,024 95,500,486 96,232,899
================= ================ ================= =================
Net income per share available to common shareholders:
Basic $0.60 $0.62 $0.30 $0.44
Diluted $0.60 $0.62 $0.30 $0.44
F-17
The following is a presentation of the quarterly results of operations
for the year ended December 31, 2002.
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
2002 2002 2002 2002
(dollars in thousands, except per share data)
----------------------------------------------------------------------
Interest income from investment securities $ 92,900 $ 109,423 $ 109,201 $ 92,641
Interest expense on repurchase agreements 40,012 47,860 54,012 49,874
----------------- ---------------- ----------------- -----------------
Net interest income 52,888 61,563 55,189 42,767
Gain on sale of Mortgage-Backed Securities 3,410 1,343 4,747 11,563
General and administrative expenses (3,255) (3,536) (3,268) (3,904)
----------------- ---------------- ----------------- -----------------
Net income $ 53,043 $ 59,370 $ 56,668 $ 50,426
================= ================ ================= =================
Weighted average number of basic common shares
outstanding 76,709,836 82,910,206 83,668,422 84,525,171
Weighted average number of diluted common shares
outstanding 77,017,431 83,186,865 83,939,870 84,766,747
Net income per share available to common shareholders:
Basic $0.69 $0.72 $0.68 $0.60
Diluted $0.69 $0.71 $0.68 $0.60
******
F-18
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, in the city of New York,
State of New York.
ANNALY MORTGAGE MANAGEMENT, INC.
Date: March 4, 2005 By: /s/ Michael A. J. Farrell
Michael A. J. Farrell
Chairman, Chief Executive Officer, and President
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the date indicated.
Signature Title Date
/s/ KEVIN P. BRADY Director March 4, 2005
Kevin P. Brady
/s/ SPENCER I. BROWNE Director March 4, 2005
Spencer Browne
/s/ KATHRYN F. FAGAN Chief Financial Officer and Treasurer March 4, 2005
(principal financial and accounting
Kathryn F. Fagan officer)
/s/ MICHAEL A.J. FARRELL Chairman of the Board, Chief Executive March 4, 2005
Officer, President and Director
Michael A. J. Farrell (principal executive officer)
/s/ JONATHAN D. GREEN Director March 4, 2005
Jonathan D. Green
/s/ JOHN A. LAMBIASE Director March 4, 2005
John A. Lambiase
/s/ E. WAYNE NORDBERG Director March 4, 2005
E. Wayne Nordberg
/s/ DONNELL A. SEGALAS Director March 4, 2005
Donnell A. Segalas
/s/ WELLINGTON DENAHAN-NORRIS Vice Chairman of the Board and Director March 4, 2005
Wellington Denahan-Norris
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EXHIBIT INDEX
Exhibit Exhibit Description
Number
3.1 Articles of Incorporation of the Registrant (incorporated by reference
to Exhibit 3.1 to the Registrant's Registration Statement on Form S-11
(Registration No. 333-32913) filed with the Securities and Exchange
Commission on August 5, 1997).
3.2 Articles of Amendment and Restatement of the Articles of Incorporation
of the Registrant (incorporated by reference to Exhibit 3.2 to the
Registrant's Registration Statement on Form S-11 (Registration No.
333-32913) filed with the Securities and Exchange Commission on August
5, 1997).
3.3 Articles of Amendment of the Articles of Incorporation of the
Registrant (incorporated by reference to Exhibit 3.1 of the
Registrant's Registration Statement on Form S-3 (Registration Statement
333-74618) filed with the Securities and Exchange Commission on June
12, 2002).
3.4 Bylaws of the Registrant, as amended (incorporated by reference to
Exhibit 3.3 to the Registrant's Registration Statement on Form S-11
(Registration No. 333-32913) filed with the Securities and Exchange
Commission on August 5, 1997).
4.1 Specimen Common Stock Certificate (incorporated by reference to Exhibit
4.1 to Amendment No. 1 to the Registrant's Registration Statement on
Form S-11 (Registration No. 333-32913) filed with the Securities and
Exchange Commission on September 17, 1997).
4.2 Specimen Series A Preferred Stock Certificate (incorporated by
reference to Exhibit 4.1 of the Registrant's Registration Statement on
Form 8-A filed with the SEC on April 1, 2004).
4.3 Specimen Preferred Stock Certificate (incorporated by reference to
Exhibit 4.2 to the Registrant's Registration Statement on Form S-3
(Registration No. 333-74618) filed with the Securities and Exchange
Commission on December 5, 2001).
10.1 Long-Term Stock Incentive Plan (incorporated by reference to Exhibit
10.3 to the Registrant's Registration Statement on Form S-11
(Registration No. 333-32913) filed with the Securities and Exchange
Commission on August 5, 1997).*
10.2 Form of Master Repurchase Agreement (incorporated by reference to
Exhibit 10.7 to the Registrant's Registration Statement on Form S-11
(Registration No. 333-32913) filed with the Securities and Exchange
Commission on August 5, 1997).
10.3 Amended and Restated Employment Agreement, effective as of June 4, 2004
between the Registrant and Michael A.J. Farrell.*
10.4 Amended and Restated Employment Agreement, effective as of June 4,
2004, between the Registrant and Wellington J. Denahan-Norris.*
10.5 Amended and Restated Employment Agreement, effective as of June 4, 2004
between the Registrant and Kathryn F. Fagan.*
10.6 Amended and Restated Employment Agreement, effective as of June 4,
2004, between the Registrant and Jennifer S. Karve.*
10.7 Amended and Restated Employment Agreement, effective as of June 4,
2004, between the Registrant and James P. Fortescue.*
10.8 Amended and Restated Employment Agreement, effective as of June 4,
2004, between the Registrant and Jeremy Diamond.*
10.9 Amended and Restated Employment Agreement, effective as of June 4,
2004, between the Registrant and Ronald D. Kazel.*
10.10 Amended and Restated Employment Agreement, effective as of June 4,
2004, between the Registrant and Rose-Marie Lyght.*
10.11 Amended and Restated Employment Agreement, effective as of June 4,
2004, between the Registrant and Kristopher R. Konrad.*
10.12 Employment Agreement, dated February 14, 2005, between the Registrant
and R. Nicholas Singh (incorporated by reference to Exhibit 10.1 to the
Registrant's Form 8-K filed with the Securities and Exchange Commission
on February 16, 2005).*
10.13 Agreement and Plan of Merger, dated as of December 31, 2003, by and
among the Registrant, Fixed Income Discount Advisory Company, FDC
MergerSub, Inc., Michael A.J. Farrell, Wellington J. Denahan, Jennifer
S. Karve, Kathryn F. Fagan, Jeremy Diamond, Ronald D. Kazel, Rose-Marie
Lyght, Kristopher R. Konrad, and James P. Fortescue (incorporated by
reference to Exhibit 99.2 to the Registrant's Form 8-K filed with the
Securities and Exchange Commission on January 2, 2004).
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23.1 Consent of Independent Auditors.
31.1 Certification of Michael A.J. Farrell, Chairman, Chief Executive
Officer, and President of the Registrant, 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 Kathryn F. Fagan, Chief Financial Officer and
Treasurer of the Registrant, 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 Michael A.J. Farrell, Chairman, Chief Executive
Officer, and President of the Registrant, pursuant to 18 U.S.C. Section
1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
32.2 Certification of Kathryn F. Fagan, Chief Financial Officer and
Treasurer of the Registrant, pursuant to 18 U.S.C. Section 1350 as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
* Exhibit Numbers 10.1 and 10.3-10.12 are management contracts or compensatory
plans required to be filed as Exhibits to this Form 10-K.
II-3