UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: MARCH 31, 2005
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 incorporation (IRS Employer
or organization) Identification No.)
1211 AVENUE OF THE AMERICAS, SUITE 2902
NEW YORK, NEW YORK
(Address of principal executive offices)
10036
(Zip Code)
(212) 696-0100
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all documents and
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days:
Yes X No___
-----
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2) of the Exchange Act:
Yes X No___
-----
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the last practicable date:
Class Outstanding at April 27, 2005
Common Stock, $.01 par value 121,277,698
ANNALY MORTGAGE MANAGEMENT, INC.
FORM 10-Q
INDEX
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Statements of Financial Condition- March 31, 2005 (Unaudited) and December 31, 2004 1
Statements of Operations and Comprehensive Income (Loss) (Unaudited) for the quarters ended
March 31, 2005 and March 31, 2004 2
Statements of Stockholders' Equity (Unaudited) for the quarter ended March 31, 2005 3
Statements of Cash Flows (Unaudited) for the quarters ended March 31, 2005 and March 31, 2004 4
Notes to Financial Statements (Unaudited) 5-14
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 15-29
Item 3. Quantitative and Qualitative Disclosures about Market Risk 30-31
Item 4. Controls and Procedures 31
Part II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
CERTIFICATIONS
PART I.
ITEM 1. FINANCIAL STATEMENTS
ANNALY MORTGAGE MANAGEMENT, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(DOLLARS IN THOUSANDS, EXCEPT FOR SHARE DATA)
MARCH 31, 2005 DECEMBER 31,
(UNAUDITED) 2004
----------------------------------------
ASSETS
Cash and cash equivalents $ 2,417 $ 5,853
Mortgage-Backed Securities, at fair value 18,702,470 19,038,386
Agency debentures, at fair value 388,593 390,509
Receivable for Mortgage-Backed Securities sold - 1,025
Accrued interest receivable 80,172 81,557
Receivable for advisory and service fees 2,883 2,359
Intangible for customer relationships 15,613 15,613
Goodwill 23,122 23,122
Other assets 1,873 1,875
----------------------------------------
Total assets $19,217,143 $19,560,299
========================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Repurchase agreements $17,438,609 $16,707,879
Payable for Mortgage-Backed Securities purchased 75,165 1,044,683
Accrued interest payable 33,770 35,721
Dividends payable 54,575 60,632
Other liabilities 1,569 2,819
Accounts payable 4,079 8,095
----------------------------------------
Total liabilities 17,607,767 17,859,829
----------------------------------------
Stockholders' Equity:
7.875% Series A Cumulative Redeemable Preferred Stock: 8,000,000 177,077 177,077
authorized, 7,412,500, shares issued and outstanding
Common stock: par value $.01 per share; 500,000,000 authorized,
121,277,698, and 121,263,000 shares issued and outstanding,
respectively 1,213 1,213
Additional paid-in capital 1,638,911 1,638,635
Accumulated other comprehensive loss (213,280) (120,800)
Retained earnings 5,455 4,345
----------------------------------------
Total stockholders' equity 1,609,376 1,700,470
----------------------------------------
Total liabilities and stockholders' equity $19,217,143 $19,560,299
========================================
See notes to financial statements.
1
PART I.
ITEM 1. FINANCIAL STATEMENTS
ANNALY MORTGAGE MANAGEMENT, INC.
STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
FOR THE
QUARTER ENDED FOR THE
MARCH 31, 2005 QUARTER ENDED
(CONSOLIDATED) MARCH 31, 2004
-------------------------------------
INTEREST INCOME $176,289 $114,341
INTEREST EXPENSE 113,993 50,303
-------------------------------------
NET INTEREST INCOME 62,296 64,038
-------------------------------------
OTHER INCOME:
Investment advisory and service fees 6,309 -
Gain on sale of mortgage-backed securities 580 595
-------------------------------------
TOTAL OTHER INCOME 6,889 595
-------------------------------------
EXPENSES:
Distribution fees 1,610 -
General and administrative expenses 6,664 5,365
-------------------------------------
TOTAL EXPENSES 8,274 5,365
-------------------------------------
INCOME BEFORE INCOME TAXES 60,911 59,268
INCOME TAXES 1,578 425
-------------------------------------
NET INCOME 59,333 58,843
DIVIDENDS ON PREFERRED STOCK 3,648 -
-------------------------------------
NET INCOME AVAILABLE TO COMMON SHAREHOLDERS $ 55,685 $ 58,843
=====================================
NET INCOME PER COMMON SHARE
Basic $0.46 $0.52
=====================================
Diluted $0.46 $0.52
=====================================
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING
Basic 121,270,867 112,506,206
=====================================
Diluted 121,564,320 112,804,001
=====================================
NET INCOME $59,333 $ 58,843
-------------------------------------
COMPREHENSIVE INCOME (LOSS)
Unrealized gain (loss) on available-for sale securities (91,900) 52,356
Less: reclassification adjustment for net gains (losses) included
in net income (580) (595)
-------------------------------------
Other comprehensive income (loss) (92,480) 51,761
-------------------------------------
COMPREHENSIVE INCOME (LOSS) ($33,147) $110,604
=====================================
See notes to financial statements.
2
PART I
ITEM 1. FINANCIAL STATEMENTS
ANNALY MORTGAGE MANAGEMENT, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE QUARTER ENDED MARCH 31, 2005
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
COMMON ADDITIONAL ACCUMULATED
PREFERRED STOCK PAID-IN COMPREHENSIVE OTHER RETAINED
STOCK PAR VALUE CAPITAL INCOME (LOSS) COMPREHENSIVE EARNINGS TOTAL
INCOME (LOSS)
----------------------------------------------------------------------------------------
BALANCE, JANUARY 1, 2005 $177,077 $1,213 $1,638,635 ($120,800) $4,345 $1,700,470
Net Income $59,333 59,333
Other comprehensive income:
Unrealized net gain on securities,
net of reclassification adjustment (92,480) (92,480)
--------------
Comprehensive loss ($33,147) (33,147)
==============
Exercise of stock options 99 99
Proceeds from direct purchase and
dividend 177 177
reinvestment
Preferred dividend declared for the
quarter ended (3,648) (3,648)
March 31, 2005, $0.492188 per share
Common dividend declared for the quarter
ended (54,575) (54,575)
March 31, 2005, $0.45 per share
------------------------------------ -------------------------------------
BALANCE, MARCH 31, 2005 $177,077 $1,213 $1,638,911 ($213,280) $5,455 $1,609,376
========================================================================================
See notes to financial statements.
3
PART I
ITEM 1. FINANCIAL STATEMENTS
ANNALY MORTGAGE MANAGEMENT, INC.
STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
FOR THE QUARTER FOR THE QUARTER
ENDED MARCH 31, ENDED MARCH 31,
2005 2004
------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES: $59,333 $58,843
Net income
Adjustments to reconcile net income to net cash provided by operating
activities:
Amortization of Mortgage- Backed Securities premiums and discounts, net 36,067 41,501
Amortization of intangibles 55 -
Gain on sale of Mortgage-Backed Securities (580) (595)
Stock option expense - 217
Market value adjustment on long-term repurchase agreement (1,250) 747
Decrease (increase) in accrued interest receivable, net of purchased
interest 455 (17,703)
Increase in other assets (54) (1,191)
Increase in advisory and service fees receivable (524) -
(Decrease) increase in accrued interest payable (1,951) 6,310
Decrease in accounts payable (4,016) (833)
------------------------------------------
Net cash provided by operating activities 87,535 87,296
------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of Mortgage-Backed Securities (2,361,872) (5,280,945)
Purchase of Agency debentures - (150,000)
Proceeds from sale of Mortgage-Backed Securities 85,946 24,159
Proceeds from called Agency debentures - 100,000
Principal payments on Mortgage-Backed Securities 1,518,228 1,204,219
------------------------------------------
Net cash used in investing activities (757,698) (4,102,567)
------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from repurchase agreements 57,259,546 30,194,192
Principal payments on repurchase agreements (56,528,815) (26,517,895)
Proceeds from exercise of stock options 99 243
Proceeds from direct purchase and dividend reinvestment 177 734
Net proceeds from follow-on offerings - 363,592
Net proceeds from equity shelf program - 20,051
Dividends paid (64,280) (45,155)
------------------------------------------
Net cash provided by financing activities 666,727 4,015,762
------------------------------------------
Net (decrease) increase in cash and cash equivalents (3,436) 491
Cash and cash equivalents, beginning of period 5,853 247
------------------------------------------
Cash and cash equivalents, end of period $2,417 $738
==========================================
Supplemental disclosure of cash flow information:
Interest paid $115,944 $43,993
==========================================
Noncash financing activities:
Net change in unrealized loss on available-for-sale, securities net of
reclassification adjustment ($92,480) $51,761
==========================================
Dividends declared, not yet paid $54,575 $58,942
==========================================
See notes to financial statements.
4
ANNALY MORTGAGE MANAGEMENT, INC.
NOTES TO FINANCIAL STATEMENTS
FOR THE QUARTERS ENDED MARCH 31, 2005 AND 2004
(UNAUDITED)
- --------------------------------------------------------------------------------
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Annaly Mortgage Management, Inc. (the "Company") was incorporated in
Maryland on November 25, 1996. The Company commenced its operations of
purchasing and managing an investment portfolio of mortgage-backed securities on
February 18, 1997, upon receipt of the net proceeds from the private placement
of equity capital. An initial public offering was completed on October 14, 1997.
The Company acquired Fixed Income Discount Advisory Company ("FIDAC") on June 4,
2004 (See Note 2). FIDAC is a registered investment advisor and is a taxable
REIT subsidiary of the Company.
A SUMMARY OF THE COMPANY'S SIGNIFICANT ACCOUNTING POLICIES FOLLOWS:
BASIS OF PRESENTATION - The accompanying unaudited financial statements
have been prepared in conformity with the instructions to Form 10-Q and Article
10, Rule 10-01 of Regulation S-X for interim financial statements. Accordingly,
they do not include all of the information and footnotes required by accounting
principles generally accepted in the United States of America ("GAAP"). The
interim financial statements are unaudited; however, in the opinion of the
Company's management, all adjustments, consisting only of normal recurring
accruals, necessary for a fair statement of the results of operations have been
included. These unaudited financial statements should be read in conjunction
with the audited financial statements included in the Company's Annual Report on
Form 10-K for the year ended December 31, 2004. The nature of the Company's
business is such that the results of any interim period are not necessarily
indicative of results for a full year.
The consolidated financial statements subsequent to June 4, 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 agency debentures issued by Federal
Home Loan Bank ("FHLB"), Federal Home Loan Mortgage Corporation ("FHLMC"), and
Federal National Mortgage Association ("FNMA"). 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 quarters ended
March 31, 2005 and 2004.
5
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 March
31, 2005 and December 31, 2004, due to the short term nature of these
securities.
Interest income is accrued based on the outstanding principal amount of
the Investment Securities and their contractual terms. Premiums and discounts
associated with the purchase of the Investment Securities are amortized into
interest income over the projected lives of the securities using the interest
method. The Company's policy for estimating prepayment speeds for calculating
the effective yield is to evaluate historical performance, street consensus
prepayment speeds, and current market conditions.
Investment Securities transactions are recorded on the trade date.
Purchases of newly issued securities are recorded when all significant
uncertainties regarding the characteristics of the securities are removed,
generally shortly before settlement date. Realized gain and losses on sale of
Investment Securities are determined on the specific identification basis.
CREDIT RISK - The Company has limited its exposure to credit losses on
its portfolio of Investment Securities by only purchasing securities issued by
FHLMC, FNMA, Government National Mortgage Association ("GNMA"), or FHLB. The
payment of principal and interest on the FHLMC and FNMA Mortgage-Backed
Securities are guaranteed by those respective agencies and the payment of
principal and interest on the GNMA Mortgage-Backed Securities are backed by the
full faith and credit of the U.S. government. All of the Company's Investment
Securities have an actual or implied "AAA" rating.
REPURCHASE AGREEMENTS - The Company finances the acquisition of its
Investment Securities through the use of repurchase agreements. Repurchase
agreements are treated as collateralized financing transactions and are carried
at their contractual amounts, including accrued interest, as specified in the
respective agreements. Accrued interest is recorded as a separate line item on
the Statements 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 is taxable
as a domestic corporation and subject to federal and state and local income
taxes based upon its taxable income.
USE OF ESTIMATES - The preparation of financial statements in
conformity with GAAP requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
INTANGIBLE ASSETS - The Company's acquisition of FIDAC was 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 was
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
was 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
6
deferred to a later date. This Issue is not expected to have a significant
impact on the Company's financial statements when adopted.
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 for the Company on January 1, 2006. The adoption of SFAS No. 123R is
not expected to have a significant impact on the Company's financial statements.
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 sheets as of March 31, 2005 and December 31, 2004 include
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 quarter ended March 31, 2005 include the results of the
Company and FIDAC for the period from January 1, 2005 to March 31, 2005.
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 2005 and 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 quarter ended March 31, 2005, amortization expense
related to these intangibles was $56,000. A deferred tax liability of $82,000
arising from the temporary difference between the book and tax basis relating to
these amortizable intangible is included in "Other liabilities" in the
Statements of Financial Condition as of March 31, 2005 and December 31, 2004,
respectively.
7
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
============================
8
3. MORTGAGE-BACKED SECURITIES
The following table pertains to the Company's Mortgage-Backed
Securities classified as available-for-sale as of March 31, 2005 and December
31, 2004, which are carried at their fair value:
FEDERAL HOME FEDERAL NATIONAL GOVERNMENT TOTAL
LOAN MORTGAGE MORTGAGE NATIONAL MORTGAGE MORTGAGE-BACKED
MARCH 31, 2005 CORPORATION ASSOCIATION ASSOCIATION SECURITIES
---------------------------------------------------------------------------------
(dollars in thousands)
Mortgage-Backed Securities, gross $6,068,393 $11,883,068 $541,339 $18,492,800
Unamortized discount (154) (682) (89) (925)
Unamortized premium 129,187 280,467 7,813 417,467
---------------------------------------------------------------------------------
Amortized cost 6,197,426 12,162,853 549,063 18,909,342
Gross unrealized gains 13,817 7,978 1,888 23,683
Gross unrealized losses (63,659) (162,831) (4,065) (230,555)
---------------------------------------------------------------------------------
Estimated fair value $6,147,584 $12,008,000 $546,886 $18,702,470
=================================================================================
GROSS UNREALIZED GROSS UNREALIZED ESTIMATED FAIR
AMORTIZED COST GAIN LOSS VALUE
---------------------------------------------------------------------------------
(dollars in thousands)
Adjustable rate $13,514,252 $22,932 ($137,686) $13,399,498
Fixed rate 5,395,090 751 (92,869) 5,302,972
---------------------------------------------------------------------------------
Total $18,909,342 $23,683 ($230,555) 18,702,470
=================================================================================
FEDERAL HOME FEDERAL NATIONAL GOVERNMENT TOTAL
LOAN MORTGAGE MORTGAGE NATIONAL MORTGAGE MORTGAGE-BACKED
DECEMBER 31, 2004 CORPORATION ASSOCIATION 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
---------------------------------------------------------------------------------
6,193,171 12,348,836 612,729 19,154,736
Amortized cost
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
=================================================================================
GROSS UNREALIZED GROSS UNREALIZED ESTIMATED FAIR
AMORTIZED COST GAIN LOSS 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
=================================================================================
9
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 Company's mortgage-backed
securities on March 31, 2005 and December 31, 2004 according to their estimated
weighted-average life classifications:
March 31, 2005 December 31, 2004
Amortized Amortized
Weighted-Average Life Fair Value Cost Fair Value Cost
(dollars in thousands)
- ----------------------------------------------------------------------------------------------------------------------
Less than one year $ 206,076 $ 208,183 $ 357,135 $ 359,433
Greater than one year and less than five years
14,098,457 14,254,193 14,623,143 14,705,212
Greater than or equal to five years 4,397,937 4,446,966 4,058,108 4,090,091
---------------------------------------------------------------------
Total $18,702,470 $18,909,342 $19,038,386 $19,154,736
=====================================================================
The weighted-average lives of the mortgage-backed securities at March
31, 2005 and December 31, 2004 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 rates of the outstanding loans, loan age,
margin and volatility.
Mortgage-Backed Securities with a carrying value of $3.7 billion were in
a continuous unrealized loss position over 12 months at March 31, 2005 in the
amount of $84.8 million. Mortgage-Backed Securities with a carrying value of
$12.4 billion were in a continuous unrealized loss position for less than 12
months at March 31, 2005 in the amount of $145.8 million. 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. The decline in value of these securities
is solely due to increases in interest rates. All of the Mortgage-Backed
Securities are "AAA" rated or carry an implied "AAA" rating. These investments
are not considered other-than-temporarily impaired since the Company has the
ability and intent to hold the investments for a period of time, to maturity, if
necessary, sufficient for a forecasted market price recovery up to or beyond the
cost of the investments. Also, the Company is guaranteed payment on the par
value of the securities.
The adjustable rate Mortgage-Backed Securities are limited by periodic
caps (generally interest rate adjustments are limited to no more than 1% every
nine months) and lifetime caps. The weighted average lifetime cap was 10.1% at
March 31, 2005 and December 31, 2004.
During the quarter ended March 31, 2005, the Company realized $580,000
in net gains from sales of Mortgage-Backed Securities. During the quarter ended
March 31, 2004, the Company realized $595,000 in net gains from sales of
Mortgage-Backed Securities.
10
4. AGENCY DEBENTURES
The Company owns callable agency debentures totaling $395.0 million par
value, which were issued by FHLMC, FNMA, and FHLB. All of the Company's agency
debentures are classified as available-for-sale. The agency debentures had
carrying values of $388.6 million and $390.5 million at March 31, 2005 and
December 31, 2004, respectively. The agency debentures with a carrying value of
$388.6 million have been in a continuous unrealized loss position over 12 months
at March 31, 2005 in the amount of $6.4 million. The debentures with a carrying
value of $390.5 million were in a continuous unrealized loss position for less
than 12 months at December 31, 2004 in the amount of $4.5 million. The Company's
agency debentures are adjustable rate and fixed rate with a weighted average
lifetime cap of 5.1% at March 31, 2005 and 3.7% at December 31, 2004. 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 $17.4 billion and $16.7 billion of
repurchase agreements with weighted average borrowing rates of 2.78% and 2.46%,
and weighted average remaining maturities of 94 days and 111 days as of March
31, 2005 and December 31, 2004, respectively. Investment securities pledged as
collateral under these repurchase agreements had an estimated fair value of
$18.1 billion and $17.4 billion at March 31, 2005 and December 31, 2005,
respectively.
At March 31, 2005 and December 31, 2004, the repurchase agreements had
the following remaining maturities:
MARCH 31, 2005 DECEMBER 31, 2004
(dollars in thousands)
-------------------------------------------------
Within 30 days $15,388,609 $13,059,810
30 to 59 days - 1,598,069
60 to 89 days - -
90 to 119 days - -
Over 120 days 2,050,000 2,050,000
-------------------------------------------------
Total $17,438,609 $16,707,879
=================================================
6. OTHER LIABILITIES
In 2001, the Company entered into a repurchase agreement maturing in
July 2004. This repurchase agreement provided the buyer the right to extend its
maturity date, in whole or in part, in three-month increments up to July 2006.
The buyer has continuously exercised its right to extend the maturity date, and
the agreement is currently set to mature in July 2005. The repurchase agreement
has a principal amount of $100,000,000, and is included in repurchase agreements
contained in the statements 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 March 31, 2005 and December 31, 2004, the fair value of this interest
rate floor was $1.4 million and $2.7 million, respectively, and is included in
other liabilities in the Statements of Financial Condition.
7. PREFERRED STOCK AND COMMON STOCK
During the quarter ended March 31, 2005, the Company declared dividends to
common shareholders totaling $54.6 million or $0.45 per share, which were paid
on April 27, 2005. During the quarter ended March 31, 2005, the Company declared
dividends to preferred shareholders totaling $3.6 million or $0.492188 per
share, which were paid on March 31, 2005. During the quarter ended March 31,
2005, 5,500 options were exercised under the long-term compensation plan for an
aggregate exercise price of $99,000. Also, 9,198 common shares were sold through
the dividend reinvestment and direct purchase program for $178,000 during the
quarter ended March 31, 2005.
11
During the quarter ending March 31, 2004, the Company declared dividends to
shareholders totaling $58.9 million or $0.50 per share, which was paid on April
28, 2004. On January 21, 2004 the Company entered into an underwriting agreement
pursuant to which the Company raised net proceeds of approximately $363.6
million in equity in an offering of 20,700,000 shares of common stock. On March
31, 2004, the Company raised approximately $102.9 million in net proceeds
through an offering of 4,250,000 shares of 7.875% Series A Cumulative Redeemable
Preferred Stock, which settled on April 5, 2004. During the quarter ended March
31, 2004, 1,027,400 shares were issued through the Equity Shelf Program,
totaling net proceeds of $20.0 million. During the quarter ended March 31, 2004,
28,500 options were exercised under the long-term compensation plan at $459,000.
Also, 36,936 shares were purchased in the dividend reinvestment and direct
purchase program at $734,000.
8. NET INCOME PER COMMON SHARE
The following table presents a reconciliation of the earnings and
shares used in calculating basic and diluted EPS for the quarters March 31, 2005
and 2004.
For the Quarters Ended
March 31, 2005 March 31, 2004
(dollars in thousands)
------------------------------------
Net income $59,333 $58,843
Less: Preferred stock dividend 3,648 -
------------------------------------
Net income available to common shareholders $55,685 $58,843
------------------------------------
Weighted average shares of common stock outstanding-basic 121,271 112,506
Add: Effect of dilutive stock options 293 298
------------------------------------
Weighted average shares of common stock outstanding-diluted 121,564 112,804
====================================
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 each of the quarters ended March 31, 2005 and 2004.
9. LONG-TERM STOCK INCENTIVE PLAN
The Company has adopted a long term stock incentive plan for executive
officers, key employees and non-employee directors (the "Incentive Plan"). The
Incentive Plan authorizes the Compensation Committee of the board of directors
to grant awards, including non-qualified options as well as incentive stock
options as defined under Section 422 of the Code . The Incentive Plan authorizes
the granting of options or other awards for an aggregate of the greater of
500,000 shares or 9.5% of the diluted outstanding shares of the Company's common
stock.
The following table sets forth activity relating to the Company's stock options
awards:
For the Quarters Ended
2005 2004
-------------------------------------------------------------------
Weighted Weighted
Number of Average Number of Average
Shares Exercise Price Shares Exercise Price
- ------------------------------------------------------------------------------------------------------------
Options outstanding at the beginning
of period 1,645,721 $15.66 1,063,259 $14.28
Granted - - - -
Exercised (5,500) 17.97 (28,500) 8.52
Expired - - - -
-------------------------------------------------------------------
Options outstanding at the end of
period. 1,640,221 $15.65 1,034,759 $14.44
===================================================================
12
The following table summarizes information about stock options outstanding at
March 31, 2005:
Weighted Average
Weighted Average Remaining Contractual
Range of Exercise Prices Options Outstanding Exercise Price Life (Years)
- ------------------------------------------------------------------------------------------------------------
$7.94-$19.99 1,627,721 $15.62 7.7
$20.00-$29.99 12,500 20.53 2.7
----------------------------------------------------------------------------
1,640,221 $15.65 7.7
============================================================================
The Company accounts for the Incentive Plan under the intrinsic value
method in accordance with APB Opinion No. 25, Accounting for Stock Issued to
Employees, and related Interpretations. No stock-based employee compensation
cost is reflected in net income, as all options granted under those plans had an
exercise price equal to the market value of the underlying common stock on the
date of grant. The following table illustrates the effect on net income and
earnings per share if the Company had applied the fair value recognition
provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation,
to stock-based employee compensation:
For the Quarter Ended
(dollars in thousands, except
per share data)
-------------------------------
March 31, March 31,
2005 2004
-------------------------------
Net income available to common shareholders, as reported $55,685 $58,843
Deduct: Total stock-based employee compensation expense determined under fair
value based method (36) (28)
-------------------------------
Pro-forma net income available to common shareholers $55,649 $58,815
===============================
Net income per share available to common shareholders, as reported:
Basic $0.46 $0.52
===============================
Diluted $0.46 $0.52
===============================
Pro-forma net income per share available to common shareholders:
Basic $0.46 $0.52
===============================
Diluted $0.46 $0.52
===============================
10. INCOME TAXES
The Company has elected to be taxed as a REIT under the Code. In
connection with the Company's merger with FIDAC effective June 4, 2004, the
Company and FIDAC made a joint election to treat FIDAC as a taxable REIT
subsidiary under the 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 Section 162(m) of the Code pertaining to employee
remuneration.
During the quarter ended March 31, 2005, the Company recorded
$1.6 million of income tax expense for income attributable to FIDAC, its taxable
REIT subsidiary, and the portion of earnings retained based on Code Section
162(m) limitations. During the quarter ended March 31, 2004, the Company
recorded $425,000 of income tax expense for a portion of earnings retained based
on Section 162(m) limitations.
13
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 375
2006 530
2007 532
2008 532
2009 532
------------------------
Total remaining lease payments $2,501
========================
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 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.
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain statements contained in this quarterly report, and certain
statements contained in our future filings with the Securities and Exchange
Commission (the "SEC" or the "Commission"), in our press releases or in our
other public or shareholder communications may not be based on historical facts
and are "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Forward-looking statements which are
based on various assumptions, (some of which are beyond our control) may be
identified by reference to a future period or periods, or by the use of
forward-looking terminology, such as "may," "will," "believe," "expect,"
"anticipate," "continue," or similar terms or variations on those terms, or the
negative of those terms. Actual results could differ materially from those set
forth in forward-looking statements due to a variety of factors, including, but
not limited to, changes in interest rates, changes in yield curve, changes in
prepayment rates, the availability of mortgage backed securities for purchase,
the availability of financing and, if available, the terms of any financing, and
risks associated with the investment advisory business of FIDAC, including the
removal by FIDAC's clients of assets FIDAC manages, FIDAC's regulatory
requirements, and competition in the investment advisory business. For a
discussion of the risks and uncertainties which could cause actual results to
differ from those contained in the forward-looking statements, see our 2004 Form
10-K. We do not undertake, and specifically disclaim any obligation, to publicly
release the result of any revisions which may be made to any forward-looking
statements to reflect the occurrence of anticipated or unanticipated events or
circumstances after the date of such statements.
OVERVIEW
We are a real estate investment trust that owns and manages a portfolio
of mortgage-backed securities and agency debentures. Our principal business
objective is to generate net income for distribution to our stockholders from
the spread between the interest income on our investment securities and the
costs of borrowing to finance our acquisition of investment securities and from
dividends we receive from FIDAC, which earns investment advisory fee income.
FIDAC is our wholly-owned subsidiary, and is a registered investment advisor
that generates advisory and service fee income.
We are primarily engaged in the business of investing, on a leveraged
basis, in mortgage pass-through certificates, collateralized mortgage
obligations and other mortgage-backed securities representing interests in or
obligations backed by pools of mortgage loans (collectively, "Mortgage-Backed
Securities"). We also invest in Federal Home Loan Bank ("FHLB"), Federal Home
Loan Mortgage Corporation ("FHLMC"), and Federal National Mortgage Association
("FNMA") debentures. The Mortgage-Backed Securities and agency debentures are
collectively referred to herein as "Investment Securities."
Under our capital investment policy, at least 75% of our total assets
must be comprised of high-quality mortgage-backed securities and short-term
investments. High quality securities means securities that (1) are rated within
one of the two highest rating categories by at least one of the nationally
recognized rating agencies, (2) are unrated but are guaranteed by the United
States government or an agency of the United States government, or (3) are
unrated but are determined by us to be of comparable quality to rated
high-quality Mortgage-Backed Securities.
The remainder of our assets, comprising not more than 25% of our total
assets, may consist of other qualified REIT real estate assets which are unrated
or rated less than high quality, but which are at least "investment grade"
(rated "BBB" or better by Standard & Poor's Corporation ("S&P") or the
equivalent by another nationally recognized rating agency) or, if not rated,
determined by us to be of comparable credit quality to an investment which is
rated "BBB" or better.
We may acquire Mortgage-Backed Securities backed by single-family
residential mortgage loans as well as securities backed by loans on
multi-family, commercial or other real estate-related properties. To date, all
of the Mortgage-Backed Securities that we have acquired have been backed by
single-family residential mortgage loans.
15
We have elected to be taxed as a REIT for federal income tax purposes.
Pursuant to the current federal tax regulations, one of the requirements of
maintaining our status as a REIT is that we must distribute at least 90% of our
REIT taxable income (determined without regard to the deduction for dividends
paid and by excluding any net capital gain) to our stockholders, subject to
certain adjustments.
The results of our operations are affected by various factors, many of
which are beyond our control. The results of our operations primarily depend on,
among other things, the amount of our net interest income, the market value of
our assets and the supply of and demand for such assets. Our net interest
income, which includes 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. Since changes in interest rates may
significantly affect our activities, our operating results depend, in large
part, upon our ability to effectively manage interest rate risks and prepayment
risks while maintaining our status as a REIT.
The following table presents the CPR experienced on our Mortgage-Backed
Securities portfolio, on an annualized basis, for the following quarterly
periods :
Quarter Ended CPR
- ------------- ---
March 31, 2005 25%
December 31, 2004 27%
September 30, 2004 25%
June 30, 2004 33%
March 31, 2004 31%
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 reduced contractual maturities on borrowings, such that
our weighted average contractual maturity on our repurchase agreements was 159
days at March 31, 2005, as compared to 211 days at December 31, 2004.
The table below provides quarterly information regarding our average
balances, interest income, interest expense, yield on assets, cost of funds and
net interest income for the following quarterly periods presented.
Yield on
Average Average Average Average
Investment Total Interest Balance of Total Cost Net
Securities Interest Earning Repurchase Interest of Interest
Held (1) Income Assets Agreements Expense Funds Income
------------ --------- ---------- ----------- ---------- ------- ----------
(ratios for the quarters have been annualized, dollars in thousands)
Quarter Ended
March 31, 2005 $18,798,200 $176,289 3.75% $17,756,241 $113,993 2.57% $62,296
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).
16
We continue to explore alternative business strategies, alternative
investments and other strategic initiatives to complement our core business
strategy of investing, on a leveraged basis, in high quality Investment
Securities. No assurance, however, can be provided that any such strategic
initiative will or will not be implemented in the future.
CRITICAL ACCOUNTING POLICIES
Management's discussion and analysis of financial condition and results
of operations is based on the amounts reported in our financial statements.
These financial statements are prepared in conformity with accounting principles
generally accepted in the United States of America. In preparing the financial
statements, management is required to make various judgments, estimates and
assumptions that affect the reported amounts. Changes in these estimates and
assumptions could have a material effect on our financial statements. The
following is a summary of our policies most affected by management's judgments,
estimates and assumptions. These policies have not changed during 2005.
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 quarters ended March 31, 2005 and 2004. If in the future,
management determines an impairment to be other-than-temporary we may need to
realize a loss that would have an impact on future income.
INTEREST INCOME: Interest income is accrued based on the outstanding
principal amount of the outstanding principal amount of the Investment
Securities and their contractual terms. Premiums and discounts associated with
the purchase of the Investment Securities are amortized into interest income
over the projected lives of the securities using the interest method. Our policy
for estimating prepayment speeds for calculating the effective yield is to
evaluate historical performance, street consensus prepayment speeds, and current
market conditions. If our estimate of prepayments is incorrect, we may be
required to make an adjustment to the amortization or accretion of premiums and
discounts that would have an impact on future income.
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 is taxable as a
domestic C corporation and subject to federal and state and local income taxes
based upon its taxable income.
17
RESULTS OF OPERATIONS: FOR THE QUARTERS ENDED MARCH 31, 2005 AND 2004
NET INCOME SUMMARY
For the quarter ended March 31, 2005, our net income was $59.3 million,
or $0.46 basic earnings per share available for common shareholders, as compared
to $58.8 million, or $0.52 basic earnings per average share, for the quarter
ended March 31, 2004. We attribute the increase in total net income for the
quarter ended March 31, 2005, over the quarter ended March 31, 2004 to the
increased asset base. The increased asset base was the result of deploying
additional capital of approximately $134.4 million from March 31, 2004 to March
31, 2005. The decrease in net income per common share was primarily due to the
decline in the interest rate spread from 1.68% to 1.18%. For the quarter ended
March 31, 2005, gain on sale of Mortgage-Backed Securities was $580,000 as
compared to $595,000 for the quarter ended March 31, 2004. Dividends for the
quarter ended March 31, 2005, were $0.45 per share of common stock, or $54.6
million in total, and $0.492218 per share of preferred stock, or $3.6 million in
total. Dividends per share for the quarter ended March 31, 2004 were $0.50 per
share of common stock, or $58.9 million in total. Our return on average equity
was 14.34% for the quarter ended March 31, 2005 and 16.59% for the quarter ended
March 31, 2004. The decrease in return on average equity resulted primarily from
the decrease in net interest spread primarily from the increase in the weighted
average cost of funds rate from 1.48% for the quarter ended March 31, 2004 to
2.57% for the quarter ended March 31, 2005, which was only partially offset by
the increase in yield from 3.16% to 3.75%.
NET INCOME SUMMARY
(RATIOS FOR THE QUARTER HAVE BEEN ANNUALIZED, DOLLARS IN THE THOUSANDS,
EXCEPT FOR PER SHARE DATA)
Quarter
ended
March 31, Quarter
2005 ended
(Consolidated) March 31, 2004
----------------------------------
Interest income $176,289 $114,341
Interest expense 113,993 50,303
----------------------------------
Net interest income 62,296 64,038
Gain on sale of Mortgage Backed Securities 580 595
Investment advisory and service fees 6,309 -
Distribution fees (1,610) -
General and administrative expenses (6,664) (5,790)
----------------------------------
Income before income taxes 60,911 58,843
Income taxes 1,578 -
----------------------------------
Net income 59,333 58,843
Dividends on preferred stock 3,648 -
----------------------------------
Net income available to common shareholders $55,685 $58,843
==================================
Weighted average number of basic common shares outstanding 121,270,867 112,506,206
Weighted average number of diluted common shares outstanding 121,564,320 113,259,307
Basic net income per common share $0.46 $0.52
Diluted net income per common share $0.46 $0.52
Average total assets $19,388,721 $15,644,490
Average total equity $1,654,923 $1,418,904
Annualized return on average assets 1.22% 1.50%
Annualized return on average equity 14.34% 16.59%
18
INTEREST INCOME AND AVERAGE EARNING ASSET YIELD
We had average earning assets of $18.8 billion and $14.5 billion for
the quarters ended March 31, 2005 and 2004, respectively. Our primary source of
income for the quarters ended March 31, 2005 and 2004 was interest income. A
portion of our income was generated by gains on the sales of our Mortgage-Backed
Securities. Our interest income was $176.3 million for the quarter ended March
31, 2005 and $114.3 million for the quarter ended March 31, 2004. The yield on
average investment securities increased from 3.16% for the quarter ended March
31, 2004 to 3.75% for the quarter ended March 31, 2005. Our average earning
asset balance increased by $4.3 billion and interest income increased by $62.0
million for the quarter ended March 31, 2005 as compared to the quarter ended
March 31, 2004. The increase was the direct result of the increased asset base
and increase in weighted average yield. The yield increased for the comparable
periods. The average coupon rate at March 31, 2005 was 4.58%, as compared to
4.33% at March 31, 2004. The prepayment speeds decreased to 25% CPR for the
quarter ended March 31, 2005 from 31% CPR for the quarter ended March 31, 2004.
The increase in coupon, in conjunction with lower prepayment speeds, resulted in
an increase in yield of 59 basis points.
The table below shows our average balance of interest earning assets,
our yield on average earning assets and our interest income for the quarter
ended March 31,2005, the year ended December 31, 2004, and the four quarters in
2004.
AVERAGE EARNING ASSET YIELD
(RATIOS FOR THE QUARTERS HAVE BEEN ANNUALIZED, DOLLARS IN THOUSANDS)
Average
Average Yield on Constant
Investment Investment Prepayment Interest
Securities Securities Rate Income
- --------------------------------------------------------------------------------------
Quarter Ended March 31, 2005 $18,798,200 3.75% 25% $176,289
- --------------------------------------------------------------------------------------
Year Ended December 31, 2004 $16,399,184 3.25% 29% $532,328
Quarter Ended December 31, 2004 $17,932,449 3.50% 27% $156,783
Quarter Ended September 30, 2004 $16,562,971 3.36% 25% $138,970
Quarter Ended June 30, 2004 $16,649,072 2.94% 33% $122,234
Quarter Ended March 31, 2004 $14,452,245 3.16% 31% $114,341
- --------------------------------------------------------------------------------------
The Constant Prepayment Rate decreased to 25% for the quarter ended
March 31, 2005, as compared to 31% for the quarter ended March 31, 2004. The
total amortization of premium and discount on Investment Securities for the
quarters ended March 31, 2005 and 2004 was $36.1 million and $41.5 million,
respectively.
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 $17.8 billion and total interest expense
of $114.0 million for the quarter ended March 31, 2005. We had average borrowed
funds of $13.6 billion and total interest expense of $50.3 million for the
quarter ended March 31, 2004. Our average cost of funds was 2.57% for the
quarter ended March 31, 2005 and 1.48% for the quarter ended March 31, 2004. The
cost of funds rate increased by 109 basis points and the average borrowed funds
increased by $4.2 billion for the quarter ended March 31, 2005 when compared to
the quarter ended March 31, 2004. Interest expense for the quarter increased by
$63.7 million due to the substantial increase in the average repurchase balance
and weighted average cost of funds rate. Our average cost of funds was 0.01%
below average one-month LIBOR and 0.45% below average six-month LIBOR for the
quarter ended March 31, 2005. Our average cost of funds was 0.38% above average
one-month LIBOR and 0.30% above average six-month LIBOR for the quarter ended
March 31, 2004.
19
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
quarter ended March 31, 2005, the year ended December 31, 2004 and the four
quarters in 2004.
AVERAGE COST OF FUNDS
(RATIOS FOR THE QUARTERS HAVE BEEN ANNUALIZED, DOLLARS IN THOUSANDS)
Average
Average Average Cost of
One-Month Cost of Funds
LIBOR Funds Relative
Average Relative Relative to
Average Average One- Average to Average to Average Average
Borrowed Interest Cost of Month Six-Month Six-Month One-Month Six-Month
Funds Expense Funds LIBOR LIBOR LIBOR LIBOR LIBOR
------------- ---------- -------- -------- ----------- ------------ ---------- -----------
Quarter Ended March 31, 2005 $17,756,241 $113,993 2.57% 2.58% 3.02% (0.44%) (0.01%) (0.45%)
- --------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 2004 $15,483,118 $270,116 1.74% 1.50% 1.80% (0.30%) 0.24% (0.06%)
Quarter Ended December 31, 2004 $16,896,216 $93,992 2.23% 2.14% 2.48% (0.34%) 0.09% (0.25%)
Quarter Ended September 30, 2004 $15,568,691 $70,173 1.80% 1.59% 1.97% (0.38%) 0.21% (0.17%)
Quarter Ended June 30, 2004 $15,880,353 $55,648 1.40% 1.15% 1.54% (0.39%) 0.25% (0.14%)
Quarter Ended March 31, 2004 $13,587,211 $50,303 1.48% 1.10% 1.18% (0.08%) 0.38% 0.30%
NET INTEREST INCOME
Our net interest income, which equals interest income less interest
expense, totaled $62.3 million for the quarter ended March 31, 2005 and $64.0
million for the quarter ended March 31, 2004. Our net interest income decreased
because of the interest rate spread decreased, even though our asset base
increased. 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 1.18% for the
quarter ended March 31, 2005 as compared to 1.68 % for the quarter ended March
31, 2004. This 50 basis point decrease was a result of the increase in the cost
of funding for the quarter ended March 31, 2005 to 2.57% from 1.48% for the
quarter ended March 31, 2004. The increase in cost of funds was only partially
offset by the increase in yield on assets, which increased to 3.75% for the
quarter ended March 31, 2005, as compared to 3.16% for the quarter ended March
31, 2004.
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
quarter ended March 31, 2005, the year ended December 31, 2004, and the four
quarters in 2004.
NET INTEREST INCOME
(RATIOS FOR THE QUARTERS HAVE BEEN ANNUALIZED, DOLLARS IN THOUSANDS)
Yield on
Average Average Average Net
Investment Total Interest Balance of Average Net Interest
Securities Interest Earning Repurchase Interest Cost of Interest Rate
Held Income Assets Agreements Expense Funds Income Spread
------------- ----------- --------- -------------- ----------- -------- --------- ----------
Quarter Ended March 31, 2005 $18,798,200 $176,289 3.75% $17,756,241 $113,993 2.57% $62,296 1.18%
- -------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 2004 $16,399,184 $532,328 3.25% $15,483,118 $270,116 1.74% $262,212 1.51%
Quarter Ended December 31, 2004 $17,932,449 $156,783 3.50% $16,896,216 $93,992 2.23% $62,791 1.27%
Quarter Ended September 30, 2004 $16,562,971 $138,970 3.36% $15,568,691 $70,173 1.80% $68,797 1.56%
Quarter Ended June 30, 2004 $16,649,072 $122,234 2.94% $15,880,353 $55,648 1.40% $66,586 1.54%
Quarter Ended March 31, 2004 $14,452,245 $114,341 3.16% $13,587,211 $50,303 1.48% $64,038 1.68%
INVESTMENT ADVISORY AND SERVICE FEES
FIDAC is a registered investment advisor which generally receives
annual net investment advisory fees of approximately 10 to 20 basis points of
the gross assets it manages, assists in managing or supervises. At March 31,
2005, FIDAC had under management approximately $2.3 billion in net assets and
$18.6 billion in gross assets, compared to $1.9 billion in net assets and $15.9
billion in gross assets at December 31, 2004. Investment advisory and service
fees for the quarter ended March 31, 2005 totaled $4.7 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
and service fees were included in the consolidated statement of operations and
comprehensive income (loss) post the merger date, June 4, 2004.
20
GAINS AND LOSSES ON SALES OF MORTGAGE-BACKED SECURITIES
For the quarter ended March 31, 2005, we sold Mortgage-Backed
Securities with an aggregate historical amortized cost of $85.4 million for an
aggregate gain of $580,000. For the quarter ended March 31, 2004 we sold
Mortgage-Backed Securities with an aggregate historical amortized cost of $73.6
million for an aggregate gain of $595,000. The difference between the sale price
and the historical amortized cost of our Mortgage-Backed Securities is a
realized gain and increases income accordingly. We do not expect to sell assets
on a frequent basis, but may from time to time sell existing assets to acquire
assets, which our management believes might have higher risk-adjusted returns as
part of our asset/liability management strategy. There has been an insignificant
gross loss from the sale of securities during the periods.
GENERAL AND ADMINISTRATIVE EXPENSE
General and administrative ("G&A") expenses were $6.7 million for the
quarter ended March 31, 2005 and $5.4 million for the quarter ended March 31,
2004. G&A expenses as a percentage of average assets were 0.14% and 0.15% for
the quarters ended March 31, 2005 and March 31, 2004 respectively. G&A expenses
as a percentage of average equity were 1.61% and 1.63% on an annualized basis
for the quarters ended March 31, 2005 and March 31, 2004, respectively. The
increase in G&A expenses of $1.3 million for the quarter ended March 31, 2005,
was primarily the result of increased salaries, directors and officers'
insurance and additional costs related to FIDAC business. G&A expense has
increased proportionately with our increased capital base and the growth in
staff from 23 at the end March 31, 2004 to 30 at March 31, 2005. Even with the
increased asset base, G&A expense as a percentage of average assets declined.
The table below shows our total G&A expenses as compared to average total assets
and average equity for the quarter ended March 31 2005, the year ended December
31, 2004, and the four quarters in 2004.
G&A EXPENSES AND OPERATING EXPENSE RATIOS
(RATIOS FOR THE QUARTERS HAVE BEEN ANNUALIZED, DOLLARS IN THOUSANDS)
Total G&A Total G&A
Total G&A Expenses/Average Expenses/Average
Expenses Assets (annualized) Equity (annualized)
------------------ ----------------------- ---------------------
Quarter Ended March 31, 2005 $6,664 0.14% 1.61%
----------------------------------------------------------------------------------------------------------
Year Ended December 31, 2004 $24,029 0.14% 1.55%
Quarter Ended December 31, 2004 $6,862 0.14% 1.63%
Quarter Ended September 30, 2004 $6,159 0.14% 1.53%
Quarter Ended June 30, 2004 $5,643 0.13% 1.39%
Quarter Ended March 31, 2004 $5,365 0.15% 1.63%
NET INCOME AND RETURN ON AVERAGE EQUITY
Our net income was $59.3 million for the quarter ended March 31, 2005
and $58.8 million for the quarter ended March 31, 2004. Our annualized return on
average equity was 14.34% for the quarter ended March 31, 2005 and 16.59% for
the quarter ended March 31, 2004. We attribute the increase in net income to the
increased asset base and the addition of FIDAC net advisory and service fees.
Primarily due to the decline in net interest spread, the return on average
equity declined. The table below shows our net interest income, investment
advisory and service fees, gain on sale of Mortgage-Backed Securities, G&A
expenses, and income taxes each as a percentage of average equity, and the
return on average equity for the quarter ended March 31, 2005, the year ended
December 31, 2004, and the four quarters in 2004.
COMPONENTS OF RETURN ON AVERAGE EQUITY
(RATIOS FOR ALL QUARTERS ARE ANNUALIZED)
Net
Investment
Advisory and
Service Gain on Sale of
Net Interest Fees/ Mortgage-Backed G&A Income Return on
Income/Average Average Securities/Average Expenses/Average Taxes/Average Average
Equity Equity Equity Equity Equity Equity
--------------- ------------- ------------------ ---------------- ------------- ---------
Quarter Ended March 31, 2005 15.06% 1.13% 0.14% 1.61% 0.38% 14.34%
----------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 2004 16.92% 0.62% 0.34% 1.55% 0.29% 16.04%
Quarter Ended December 31, 2004 14.95% 1.10% 0.27% 1.63% 0.57% 14.12%
Quarter Ended September 30, 2004 17.13% 0.94% 0.34% 1.53% 0.29% 16.59%
Quarter Ended June 30, 2004 16.44% 0.31% 0.52% 1.39% 0.12% 15.76%
Quarter Ended March 31, 2004 18.05% - 0.17% 1.63% - 16.59%
21
FINANCIAL CONDITION
INVESTMENT SECURITIES
All of our Mortgage-Backed Securities at March 31, 2005 were
adjustable-rate or fixed-rate Mortgage-Backed Securities backed by single-family
mortgage loans. All of the mortgage assets underlying these Mortgage-Backed
Securities were secured with a first lien position on the underlying
single-family properties. All our Mortgage-Backed Securities were FHLMC, FNMA or
GNMA mortgage pass-through certificates or collateralized mortgage obligations,
which carry an actual or implied "AAA" rating. We mark-to-market all of our
Mortgage Backed Securities to fair value.
All of our agency debentures are callable and carry an implied "AAA"
rating. We mark-to-market all of our agency debentures to fair value.
We accrete discount balances as an increase in interest income over the
life of discount Investment Securities and we amortize premium balances as a
decrease in interest income over the life of premium Investment Securities. At
March 31, 2005 and December 31, 2004, we had on our statement of financial
condition a total of $925,000 and $1.1 million, respectively, of unamortized
discount (which is the difference between the remaining principal value and
current historical amortized cost of our Investment Securities acquired at a
price below principal value) and a total of $417.5 million and $427.0 million,
respectively, of unamortized premium (which is the difference between the
remaining principal value and the current historical amortized cost of our
Investment Securities acquired at a price above principal value).
We received mortgage principal repayments of $1.5 billion for the
quarter ended March 31, 2005 and $1.2 billion for the quarter ended March 31,
2004. The overall prepayment speed for the year quarter March 31, 2005 declined
to 25%, as compared to 31%, due to a decline in refinancing activity. Given our
current portfolio composition, if mortgage principal prepayment rates were to
increase over the life of our Mortgage-Backed Securities, all other factors
being equal, our net interest income would decrease during the life of these
Mortgage-Backed Securities as we would be required to amortize our net premium
balance over a shorter time period. Similarly, if mortgage principal prepayment
rates were to decrease over the life of our Mortgage-Backed Securities, all
other factors being equal, our net interest income would increase during the
life of these Mortgage-Backed Securities, as we would amortize our net premium
balance over a longer time period.
The table below summarizes our Investment Securities at March 31, 2005,
December 31, 2004, 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 March 31, 2005 $18,887,801 $416,542 $19,304,343 102.21% $19,091,063 101.08% 3.61%
- ----------------------------------------------------------------------------------------------------------------------------
At December 31, 2004 $19,123,902 $425,792 $19,549,694 102.23% $19,428,895 101.59% 3.43%
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.
22
ADJUSTABLE-RATE INVESTMENT SECURITIES CHARACTERISTICS
(DOLLARS IN THOUSANDS)
Weighted Weighted Principal Amount
Weighted Weighted Weighted Average Average at Period End as
Average Average Average Term to Weighted Asset % of Total
Principal Coupon Index Net Next Average Yield Investment
Amount Rate Level Margin Adjustment Lifetime Cap (annualized) Securities
------------- ---------- ---------- ---------- ------------ -------------- ------------ ----------------
At March 31, 2005 $13,464,087 4.29% 2.50% 1.79% 22 months 10.06% 3.46% 71.28%
- --------------------------------------------------------------------------------------------------------------------------------
At December 31, 2004 $13,544,872 4.23% 2.45% 1.78% 24 months 10.12% 3.24% 70.83%
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 SECURITIES CHARACTERISTICS
(DOLLARS IN THOUSANDS)
Principal
Amount at
Weighted Weighted Period End as %
Average Coupon Average of Total
Principal Rate Asset Yield Investment
Amount (annualized) (annualized) Securities
---------------- ---------------- -------------- ------------------
At March 31, 2005 $5,423,714 5.31% 3.99% 28.72%
- ---------------------------------------------------------------------------------------------
At December 31, 2004 $5,579,030 5.24% 3.89% 29.17%
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%
The following tables provide information on adjustable-rate investment
securities by index at March 31, 2005 and December 31, 2004.
ADJUSTABLE-RATE INVESTMENT SECURITIES BY INDEX
MARCH 31, 2005
National
Six- 12- 11- Financial Six- Monthly
One- Six- Twelve Month Month District Average Month 1-Year 2-Year 3-Year 5-Year Federal
Month Month Month Auction Moving Cost of Mortgage CD Treasury Treasury Treasury Treasury Cost of
Libor Libor Libor Average Average Funds Rate Rate Index Index Index Index Funds
------ ------- ------- --------- ------- -------- --------- ------ -------- -------- -------- -------- -------
Weighted Average
Term to Next
Adjustment 1mo. 25 mo. 32 mo. 5 mo. 1 mo. 1 mo. 4 mo. 3 mo. 21 mo. 16 mo. 19 mo. 33 mo. 1 mo.
Weighted Average
Annual
Period Cap 8.02% 0.99% 2.23% 1.00% 0.18% 0.83% 2.00% 1.00% 1.99% 2.00% 2.00% 2.00% 2.00
Weighted
Average
Lifetime Cap
at March
31, 2005 8.90% 9.89% 10.11% 13.03% 10.66% 12.12% 10.58% 11.71% 10.16% 11.92% 12.96% 12.58% 13.38%
Investment
Principal
Amount as
Percentage of
Investment
Securities at
March 31, 2005 8.21% 2.42% 23.39% 0.01% 0.21% 0.94% 0.01% 0.04% 35.01% 0.01% 0.24% 0.06% 0.73%
23
ADJUSTABLE-RATE INVESTMENT SECURITIES BY INDEX
DECEMBER 31, 2004
National
Six- 12- 11- Financial Six- Monthly
One- Six- Twelve Month Month District Average Month 1-Year 2-Year 3-Year 5-Year Federal
Month Month Month Auction Moving Cost of Mortgage CD Treasury Treasury Treasury Treasury Cost of
Libor Libor Libor Average Average Funds Rate 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%
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 March 31, 2005, 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 statement
of financial condition.
For the quarter ended March 31, 2005, the term to maturity of our
borrowings ranged from one day to three years, with a weighted average original
term to maturity of 159 days. For the quarter ended March 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 March 31, 2005, the weighted
average cost of funds for all of our borrowings was 2.78% and the weighted
average term to next rate adjustment was 94 days. At March 31, 2004, the
weighted average cost of funds for all of our borrowings was 1.44% and the
weighted average term to next rate adjustment was 102 days.
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. Our potential immediate sources of liquidity include cash balances and
unused borrowing capacity. Unused borrowing capacity will vary over time as the
market value of our investment securities varies. Liquidity is also generated on
an on-going basis through mortgage principal repayments and net earnings
retained prior to payment as dividends. Should our needs ever exceed these
on-going sources of liquidity plus the immediate sources of liquidity discussed
above, we believe that in most circumstances our investment securities could be
sold to raise cash. The maintenance of liquidity is one of the goals of our
capital investment policy. Under this policy, we limit asset growth in order to
preserve unused borrowing capacity for liquidity management purposes.
Borrowings under our repurchase agreements increased by $2.7 million to
$17.4 billion at March 31, 2005, from $14.7 billion at March 31, 2004. 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
24
into any commitment agreements under which the lender would be required to enter
into new repurchase agreement 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 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 March 31,
2005, 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 at March 31, 2005.
(dollars in thousands)
----------------------
Within One One to Three to More Than Total
Year Three Years Five Years Five Years
--------------- ------------ ------------- ------------ --------------
Repurchase agreements $15,588,609 $1,850,000 - - $17,438,609
Long-term operating lease
obligations 375 1,062 1,064 - 2,501
Employment contracts 6,324 - - - 6,324
--------------- ------------ ------------- ------------ --------------
Total $15,595,308 $1,851,062 $1,064 - $17,447,434
=============== ============ ============= ============ ==============
STOCKHOLDERS' EQUITY
During the quarter ended March 31, 2005, the Company declared dividends to
common shareholders totaling $54.6 million or $0.45 per share, which were paid
on April 27, 2005. During the quarter ended March 31, 2005, the Company declared
dividends to preferred shareholders totaling $3.6 million or $0.492218 per
share, which were paid on March 31, 2005. During quarter ended March 31, 2005,
5,500 options were exercised under the long-term compensation plan for an
aggregate exercise price of $98,835. Also, 9,198 common shares were sold through
the dividend reinvestment and direct purchase program for $177,613 during the
quarter ended March 31, 2005.
During the quarter ending March 31, 2004, the Company declared dividends to
shareholders totaling $58.9 million or $0.50 per share, which was paid on April
28, 2004. On January 21, 2004 the Company entered into an underwriting agreement
pursuant to which the Company raised net proceeds of approximately $363.6
million in equity in an offering of 20,700,000 shares of common stock. On March
31, 2004, the Company raised approximately $102.9 million in net proceeds
through an offering of 4,250,000 shares of 7.875% Series A Cumulative Redeemable
Preferred Stock, which settled on April 5, 2004. During the quarter ended March
31, 2004, 1,027,400 shares were issued through the Equity Shelf Program,
totaling net proceeds of $20.0 million. During the quarter ended March 31, 2004,
28,500 options were exercised under the long-term compensation plan at $459,000.
Also, 36,936 shares were purchased in the dividend reinvestment and direct
purchase program at $734,000.
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
25
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)."
As a result of this mark-to-market accounting treatment, our book value
and book value per share are likely to fluctuate far more than if we used
historical amortized cost accounting. As a result, comparisons with companies
that use historical cost accounting for some or all of their balance sheet may
not be meaningful.
The table below shows unrealized gains and losses on the Investment
Securities in our portfolio.
UNREALIZED GAINS AND LOSSES
(dollars in thousands)
AT AT AT AT AT
MARCH 31, DECEMBER 31, SEPTEMBER 30 JUNE 30 MARCH 31,
2005 2004 2004 2004 2004
-------------- -------------- --------------- ----------- ------------
Unrealized Gain $ 23,683 $23,021 $24,788 $ 27,603 $53,912
Unrealized Loss (236,963) (143,821) (116,775) (205,092) (49,412)
-------------- -------------- --------------- ----------- ------------
Net Unrealized Gain
(Loss) ($213,280) ($120,800) (91,987) ($177,489) $4,500
============== ============== =============== =========== ============
Net Unrealized Gain
(Loss) as % of Investment
Securities' Principal
Amount (1.13%) (0.63%) (0.51%) (1.05%) 0.03%
Net Unrealized Gain
(Loss) as % of Investment
Securities' Amortized Cost (1.11%) (0.62%) (0.50%) (1.03%) 0.03%
Mortgage-Backed Securities with a carrying value of $3.7 billion were in
a continuous unrealized loss position over 12 months at March 31, 2005 in the
amount of $84.8 million. Mortgage-Backed Securities with a carrying value of
$12.4 billion were in a continuous unrealized loss position for less than 12
months at March 31, 2005 in the amount of $145.8 million. 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. 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.
As discussed above, because we use "available-for-sale" treatment for
our Investment Securities, we carry these assets on our balance sheet at
estimated market value rather than historical amortized cost. Based upon this
"available-for-sale" treatment, our common equity base at March 31, 2005 was
$1.6 billion, or a book value of $11.81 per common share. If we had used
historical amortized cost accounting, our common equity base at March 31, 2005
would have been $1.6 billion, or $13.57 per common share. Our equity base at
December 31, 2004 was $1.7 billion, or $12.56 per share. If we had used
historical amortized cost accounting, our equity base at December 31, 2004 would
have been $1.8 billion, or $13.56 per share.
The table below shows our equity capital base as reported and on a
historical amortized cost basis at March 31, 2005, December 31, 2004, 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 "Unrealized Net Gains (Losses)
on Assets Available for Sale" account.
26
STOCKHOLDERS' EQUITY
Net Unrealized
7.875% Series Gains (Losses) Reported Reported Common
A Cumulative Historical on Assets Common Stock Historical Stock Equity
Redeemable Common Stock Available for Equity Base Common Stock (Book Value) Per
Preferred Stock Equity Base Sale (Book Value) Equity Per Share Share
--------------------------------------------------------------------------------------------------------
(dollars in thousands, except per share data)
At March 31, 2005 $177,077 $1,645,579 ($213,280) $1,432,299 $13.57 $11.81
- ------------------------------------------------------------------------------------------------------------------------------
At December 31, 2004 $177,077 $1,821,270 ($120,800) $1,700,470 $13.56 $12.56
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-reported equity ratio at March 31, 2005 and March 31, 2004
was 10.8:1 and 8.7:1, respectively. We generally expect to maintain a ratio of
debt-to-equity of between 8:1 and 12:1, although the ratio may vary from this
range from time to time based upon various factors, including our management's
opinion of the level of risk of our assets and liabilities, our liquidity
position, our level of unused borrowing capacity and over-collateralization
levels required by lenders when we pledge assets to secure borrowings.
Our target debt-to-equity ratio is determined under our capital
investment policy. Should our actual debt-to-equity ratio increase above the
target level due to asset acquisition or market value fluctuations in assets, we
will cease to acquire new assets. Our management will, at that time, present a
plan to our Board of Directors to bring us back to our target debt-to-equity
ratio; in many circumstances, this would be accomplished over time by the
monthly reduction of the balance of our Mortgage-Backed Securities through
principal repayments.
ASSET/LIABILITY MANAGEMENT AND EFFECT OF CHANGES IN INTEREST RATES
We continually review our asset/liability management strategy with
respect to interest rate risk, mortgage prepayment risk, credit risk and the
related issues of capital adequacy and liquidity. We seek attractive
risk-adjusted stockholder returns while maintaining a strong balance sheet.
We seek to manage the extent to which our net income changes as a
function of changes in interest rates by matching adjustable-rate assets with
variable-rate borrowings. In addition, although we have not done so to date, we
may seek to mitigate the potential impact on net income of periodic and lifetime
coupon adjustment restrictions in our portfolio of Investment Securities by
entering into interest rate agreements such as interest rate caps and interest
rate swaps.
Changes in interest rates may also have an effect on the rate of
mortgage principal prepayments and, as a result, prepayments on Mortgage-Backed
Securities. We will seek to mitigate the effect of changes in the mortgage
principal repayment rate by balancing assets we purchase at a premium with
assets we purchase at a discount. To date, the aggregate premium exceeds the
aggregate discount on our Mortgage-Backed Securities. As a result, prepayments,
which result in the expensing of unamortized premium, will reduce our net income
compared to what net income would be absent such prepayments.
OFF-BALANCE SHEET ARRANGEMENTS
The Company has not had, and at March 31, 2005 does not have, any
off-balance sheet arrangements that have or are reasonably likely to have a
current or future effect on the Company's financial condition, changes in
financial condition, revenues or expenses, results of operations, liquidity,
capital expenditures or capital resources that is material to investors.
27
INFLATION
Virtually all of our assets and liabilities are financial in nature. As
a result, interest rates and other factors drive our performance far more than
does inflation. Changes in interest rates do not necessarily correlate with
inflation rates or changes in inflation rates. Our financial statements are
prepared in accordance with GAAP and our dividends based upon our net income as
calculated for tax purposes; in each case, our activities and balance sheet are
measured with reference to historical cost or fair market value without
considering inflation.
CAPITAL RESOURCES
At March 31, 2005, we had no material commitments for capital
expenditures.
OTHER MATTERS
We calculate that our qualified REIT assets, as defined in the Code,
were 100% of our total assets at March 31, 2005 and December 31, 2004, as
compared to the Code requirement that at least 75% of our total assets be
qualified REIT assets. We also calculate that 97% and 94% of our revenue
qualifies for the 75% source of income test, and 99 % and 100% of our revenue
qualifies for the 95% source of income test, under the REIT rules for the
quarters ended March 31, 2005 and March 31, 2004 respectively. We also met all
REIT requirements regarding the ownership of our common stock and the
distribution of our net income. Therefore, as of March 31, 2005 and December 31,
2004, we believe that we qualified as a REIT under the Code.
We at all times intend to conduct our business so as not to become
regulated as an investment company under the Investment Company Act. If we were
to become regulated as an investment company, then our use of leverage would be
substantially reduced. The Investment Company Act exempts entities that are
"primarily engaged in the business of purchasing or otherwise acquiring
mortgages and other liens on and interests in real estate" (qualifying
interests). Under current interpretation of the staff of the SEC, in order to
qualify for this exemption, we must maintain at least 55% of our assets directly
in qualifying interests. In addition, unless certain mortgage securitites
represent all the certificates issued with respect to an underlying pool of
mortgages, the Mortgage-Backed Securities may be treated as securities separate
from the underlying mortgage loans and, thus, may not be considered qualifying
interests for purposes of the 55% requirement. We calculate that as of March 31,
2005 and December 31, 2004 we were in compliance with this requirement.
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ITEM. 3 QUANTITATIVE AND QUALITIATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK
Market risk is the exposure to loss resulting from changes in interest
rates, foreign currency exchange rates, commodity prices and equity prices. The
primary market risk to which we are exposed is interest rate risk, which is
highly sensitive to many factors, including governmental monetary and tax
policies, domestic and international economic and political considerations and
other factors beyond our control. Changes in the general level of interest rates
can affect our net interest income, which is the difference between the interest
income earned on interest-earning assets and the interest expense incurred in
connection with our interest-bearing liabilities, by affecting the spread
between our interest-earning assets and interest-bearing liabilities. Changes in
the level of interest rates also can affect the value of our Mortgage-Backed
Securities and our ability to realize gains from the sale of these assets. We
may utilize a variety of financial instruments; including interest rate swaps,
caps, floors and other interest rate exchange contracts, in order to limit the
effects of interest rates on our operations. If we use these types of
derivatives to hedge the risk of interest-earning assets or interest-bearing
liabilities, we may be subject to certain risks, including the risk that losses
on a hedge position will reduce the funds available for payments to holders of
securities and that the losses may exceed the amount we invested in the
instruments. To date, we have not purchased any hedging instruments.
Our profitability and the value of our portfolio may be adversely
affected during any period as a result of changing interest rates. The following
table quantifies the potential changes in net interest income and portfolio
value should interest rates go up or down 25, 50, and 100 basis points, assuming
the yield curves of the rate shocks will be parallel to each other and the
current yield curve. All changes in income and value are measured as percentage
changes from the projected net interest income and portfolio value at the base
interest rate scenario. The base interest rate scenario assumes interest rates
at March 31, 2005 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
- ---------------------------------------------------------------------------------------------------------
- -100 Basis Points (9.04%) 2.37%
- -75 Basis Points (6.57%) 2.17%
- -50 Basis Points (4.26%) 1.86%
- -25 Basis Points (2.06%) 1.38%
Base Interest Rate - -
+25 Basis Points 1.95% (0.75%)
+50 Basis Points 3.78% (1.63%)
+75 Basis Points 5.55% (2.63%)
+100 Basis Points 7.27% (3.71%)
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
29
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 March 31, 2005.
The amounts of assets and liabilities shown within a particular period were
determined in accordance with the contractual terms of the assets and
liabilities, except adjustable-rate loans, and securities are included in the
period in which their interest rates are first scheduled to adjust and not in
the period in which they mature. The interest rate sensitivity of our assets and
liabilities in the table could vary substantially if based on actual prepayment
experience.
More than 1 3 Years and
Within 3 Months 4-12 Months Year to 3 Years Over Total
---------------- ----------------- ---------------- ---------------- --------------
(dollars in thousands)
Rate Sensitive Assets:
Investment Securities $ 2,552,440 $2,125,572 $6,501,643 $7,708,146 $18,887,801
Rate Sensitive Liabilities:
Repurchase Agreements 15,388,609 2000,000 1,850,000 - 17,438,609
-----------------------------------------------------------------------------------
Interest rate sensitivity gap ($12,836,169) $1,925,572 $4,651,643 $7,708,146 $1,449,192
===================================================================================
Cumulative rate sensitivity gap ($12,836,169) ($10,710,792) ($6,059149) $1,449,192
===================================================================================
Cumulative interest rate
sensitivity gap as a percentage of (68%) (57%) (32%) 8%
total rate-sensitive assets
Our analysis of risks is based on management's experience, estimates,
models and assumptions. These analyses rely on models which utilize estimates of
fair value and interest rate sensitivity. Actual economic conditions or
implementation of investment decisions by our management may produce results
that differ significantly form the estimates and assumptions used in our models
and the projected results shown in the above tables and in this report. These
analyses contain certain forward-looking statements and are subject to the safe
harbor statement set forth under the heading, "Special Note Regarding
Forward-Looking Statements."
ITEM 4. CONTROLS AND PROCEDURES
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 quarterly 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.
During the three months ended March 31, 2005, no change occurred in our
internal control over financial reporting that materially effected, or is likely
to materially effect, our internal control over financial reporting.
30
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibits
The exhibits required by this item are set forth on the Exhibit Index attached
hereto.
Exhibit Number Exhibit Description
31.1 Certification of Chief Executive Officer, pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer, pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer, pursuant to 18
U.S.C. 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer, pursuant to 18
U.S.C. 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
31
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ANNALY MORTGAGE MANAGEMENT, INC.
Dated: May 2, 2005 By: /s/ MICHAEL A.J. FARRELL
-------------------------
Michael A.J. Farrell
(Chairman of the Board, Chief Executive
Officer, President and authorized
officer of registrant)
Dated: May 2, 2005 By: /s/ KATHRYN F. FAGAN
---------------------
Kathryn F. Fagan
(Chief Financial Officer and Treasurer and
principal financial and chief accounting
officer)
32