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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
FOR THE FISCAL YEAR ENDED: DECEMBER 31, 1999
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: 1-13485
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
MARYLAND 33-0741174
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
445 MARINE VIEW AVENUE, SUITE 230
DEL MAR, CALIFORNIA 92014
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (619) 350-5000
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
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COMMON STOCK ($.01 PAR VALUE) NEW YORK STOCK EXCHANGE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
At March 1, 2000, the aggregate market value of the voting stock held by
non-affiliates was $37.9 million, based on the closing price of the common stock
on the New York Stock Exchange.
As of March 1, 2000, there were 8,055,500 shares of the registrant's common
stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive Proxy Statement issued in
connection with the Annual Meeting of Stockholders of the registrant to be held
on May 24, 2000, are incorporated herein by reference into Part III.
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TABLE OF CONTENTS
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PART I
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 28
Item 3. Legal Proceedings........................................... 28
Item 4. Submission of Matters to a Vote of Security Holders......... 28
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters....................................... 29
Item 6. Selected Financial Data..................................... 30
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 31
Item 7a. Quantitative and Qualitative Disclosure About Market
Risks..................................................... 36
Item 8. Financial Statements and Supplementary Data................. 36
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................. 36
Item 10. Directors and Executive Officers of the Registrant.......... 37
Item 11. Executive Compensation...................................... 37
Item 12. Security Ownership of Certain Beneficial Owners and
Management................................................ 37
Item 13. Certain Relationships and Related Transactions.............. 37
Item 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K....................................................... 37
Exhibit Index......................................................... 38
Financial Statements.................................................. F-1
Signatures............................................................ S-1
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ITEM 1. BUSINESS
The statements contained in this Form 10-K that are not purely historical
are forward looking statements, including statements regarding the Company's
expectations, hopes, beliefs, intentions, or strategies regarding the future.
Statements which use the words "expects", "will", "may", "anticipates", "goal",
"intends", "seeks", "strategy" and derivatives of such words are forward looking
statements. These forward looking statements, including statements regarding
changes in the Company's future income, Mortgage Asset portfolio, financings,
plans to create origination capability, ways the Company may seek to grow
income, management expectations regarding future provisions for loan losses, and
the Company's belief in the adequacy of loan losses, are based on information
available to the Company on the date hereof, and the Company assumes no
obligation to update any such forward looking statement. It is important to note
that the Company's actual results could differ materially from those in such
forward looking statements. Among the factors that could cause actual results to
differ materially are the factors set forth below under the heading "Business
Risks". In particular, the Company's future income could be affected by interest
rate increases, high levels of prepayments, Mortgage Loan defaults, reductions
in the value of retained interest in securitizations, and inability to acquire
or finance new Mortgage assets.
GENERAL
American Residential Investment Trust, Inc. (the "Company") was
incorporated in the State of Maryland on February 6, 1997, and is a real estate
investment trust ("REIT"). The Company acquires non-conforming adjustable-rate
and fixed-rate, single-family whole loans (collectively, "Mortgage Loans")
through bulk purchases in the capital markets and through purchases from
originators. The Company has in the past, and may in the future, acquire
Mortgage Securities. It finances its acquisitions with equity and secured
borrowings. The Company generally earns interest on the portion of its portfolio
financed with equity and earns a net interest spread on the portion of its
portfolio financed with secured borrowings. The Company is structured as a real
estate investment trust, thereby generally eliminating federal taxes at the
corporate level on income it distributes to stockholders.
The Company has entered into an agreement with Home Asset Management
Corporation (the "Manager") to manage the day-to-day operations of the Company
(the "Management Agreement"). Accordingly, the Company's success depends
significantly on the Manager. Pursuant to the terms of the Management Agreement,
the Manager advises the Company's Board of Directors with respect to the
formulation of investment criteria and preparation of policy guidelines, and is
compensated based upon the principal amount and type of Mortgage Securities and
Mortgage Loans, (collectively, "Mortgage Assets") held by the Company. The
Manager may also earn incentive fees based on the level of net income of the
Company. See "The Management Agreement."
INVESTMENTS
Mortgage Loans
The Company acquires non-conforming, adjustable-rate and fixed-rate
residential Mortgage Loans primarily through bulk purchases from the capital
markets and from other financial institutions. The Company also invests in
Mortgage Loans which it acquires directly from originators. Although the Company
invested in agency mortgage-backed securities and privately issued
mortgage-backed securities (collectively, "Mortgage Securities") backed by
conforming loans in the past, the Company believes that it can enhance the
overall yield of its Mortgage Asset portfolio by investing primarily in
non-conforming Mortgage Loans, which generally are relatively higher yielding
(adjusted for risk) than conforming Mortgage Loans and Mortgage Securities.
The Company only acquires those Mortgage Loans which the Company believes
it has the expertise (with the advice of the Manager) to evaluate and manage and
which are consistent with the Company's balance sheet guidelines and risk
management objectives. The Company also considers (i) the amount and nature of
anticipated cash flows from the Mortgage Assets, (ii) the Company's ability to
pledge the Mortgage
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Loans to secure collateralized borrowings, (iii) the increase in the Company's
capital requirements resulting from the purchase and financing of the Mortgage
Loans, as determined pursuant to the Company's capital policies, and (iv) the
costs of financing, hedging, managing, servicing, securitizing and providing for
credit losses on the Mortgage Assets. Prior to the acquisition of Mortgage
Loans, potential returns on capital employed are assessed over the life of the
Mortgage Loans and in a variety of interest rates, yield spread, financing cost,
credit loss, and prepayment scenarios. The Board of Directors of the Company can
revise the Company's investment policies at its sole discretion, subject to
approval by a majority of the Company's directors who are not employees or
officers of the Company.
The Company initially finances acquisitions of Mortgage Loans with short
term borrowings which generally mature in one year or less. The Company's
objective is to permanently finance its Mortgage Loans ("Bond Collateral") with
long-term non-recourse securitizations. Mortgage Loans are financed with
borrowings that will bear interest at rates which periodically adjust to the
applicable market rate. See "Funding."
All of the Mortgage Loans held by the Company as of December 31, 1999 are
non-conforming Mortgage Loans. The Mortgage Loans are non-conforming primarily
as a result of credit rating of the borrower and consist predominantly of "A-"
and "B" grade, non-conforming Mortgage Loans and to a lesser extent, "C" and "D"
grade Mortgage Loans. The Company grades each Mortgage Loan based predominantly
on the mortgage credit rating of the borrower. See "Underwriting."
Non-conforming Mortgage Loans generally are subject to greater frequency of
delinquency and loss than conforming Mortgage Loans. See "Business Risks --
Borrower Credit May Decrease Value of Mortgage Loans." Accordingly, lower credit
grade Mortgage Loans normally bear a higher rate of interest and are subject to
higher fees (including prepayment fees and late payment penalties) than
conforming Mortgage Loans.
For the year 1999, the Company acquired Mortgage Loans with an aggregate
carrying value of approximately $990.6 million. The majority of these Mortgage
Loans were subsequently pledged as Bond Collateral for securitizations. At
December 31, 1999, the Company had approximately $1.2 billion of Bond
Collateral.
REMIC Certificates
The Company diversified its residential Mortgage Loan sales activities in
1998 to include the securitization of Mortgage Loans through a Real Estate
Mortgage Investment Conduit ("REMIC"). The REMIC, which consisted of pooled
adjustable-rate first-lien mortgages, was issued by American Residential
Holdings, Inc. ("Holdings"), a non-REIT, taxable affiliate of the Company, to
the public through the registration statement of the related underwriter. The
retained interest in securitization consists of assets generated by the
Company's loan securitization. These assets, REMIC subordinate certificates,
were valued at approximately $6.6 million at December 31, 1999.
While the Company does not currently intend to acquire additional residual
interests issued by REMICs, subordinate interests in Mortgage Securities or
interest-only Mortgage Securities, it is not prohibited from doing so under the
terms of its Capital Policy. Residual interests, if acquired by a REIT, would
generate excess inclusion income. See "Federal Income Tax
Consequences -- Taxation of Stockholders."
MORTGAGE LOAN ACQUISITIONS
Acquisitions
The Company has acquired the majority of its Mortgage Loans to date on a
bulk basis. In some cases, the Mortgage Loans are purchased directly from large
originators and in other cases through a Wall Street investment bank. Bulk
packages are usually greater than $50 million in size and can be as much as $400
to $500 million.
In addition to acquiring Mortgage Loans through bulk purchases in the
capital markets, the Manager has leveraged the expertise of its executive
officers in the residential Mortgage Loan industry and continues to purchase
Mortgage Loans on behalf of the Company directly from the originators. Under
this program, the
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Manager has (i) identified segments of the residential Mortgage Loan market that
meet its general criteria for potential originations, (ii) arranges for the
acquisition by the Company of Mortgage Loans originated, hence avoiding certain
loan broker or other intermediary fees, and (iii) arranges for the servicing of
the Mortgage Loans by originators or by entities experienced in servicing the
particular types of Mortgage Loans involved.
Mortgage Loan Origination
Having established a base portfolio through the use of large bulk
acquisitions of loans, the Company's business plan for 2000 includes the
origination of non-conforming and subprime, residential mortgage loans. Creating
an origination capability would enable the Company to replenish the existing
portfolio as natural runoff occurs. Under the Company's plan, the consumer (or
broker working on behalf of a consumer) will submit, via the internet or
telephone, mortgage applications that are then underwritten by a qualified
underwriter in accordance with the Company's underwriting guidelines prior to
funding. The Company is establishing controls which seek to ensure the loans
comply with regulatory requirements and meet the Company's credit guidelines.
The Company will offer both fixed-rate and adjustable-rate mortgage loans. In
order to be competitive in the market place, the Company plans to offer
competitive pricing, and a well-trained staff to provide frequent and effective
responses during the origination process. The Company is in the process of
obtaining the required licenses in several targeted states.
The origination plan is designed to lower the Company's cost of acquiring
loans (and, as a result, reduce loan level premium amortization expense on new
loans) as well as enable more favorable loan characteristics. The Company
expects to begin originating loans in the 2nd quarter of 2000. The positive
impacts (of lower premium amortization and more favorable loan characteristics)
on the Company's results of operations are not expected to be material until
2001. There can be no assurance that the new origination program will be
successful.
Pricing
Mortgage Loans acquired on a bulk basis have been priced on either a
negotiated basis with the sellers or pursuant to a bidding process. The Company
sets investment criteria for the Manager to use in developing bids. The criteria
includes risk-adjusted yield requirements. In each case, different prices will
be established for the various types of Mortgage Loans to be acquired or
originated based on current market conditions, the expected financing costs,
prepayment assumptions and loan loss expectations.
Underwriting
The Company reviews the aggregate attributes of a package of Mortgage
Loans, as specified by the seller of the Mortgage Loans, to determine if the
package conforms to the Company's acquisition criteria. If the Company then
elects to purchase a package of Mortgage Loans, the Company reviews the Mortgage
Loan documentation for conformance to the seller's specifications. In evaluating
a package of Mortgage Loans to be acquired on a bulk basis, the Company reviews
the loan documentation for a large sample, sometimes up to 100%, of the Mortgage
Loans to be acquired. To date, all of the Company's underwriting reviews have
been performed by a nationally recognized third party underwriting review firm
or in-house personnel. The Company also obtains representations and warranties
from the seller with respect to the quality and terms of the Mortgage Loans
being acquired.
The Company considers a variety of factors in determining whether to
acquire a package of Mortgage Loans. These factors generally include the credit
grade and income history of each borrower, the loan-to-value ratio for each
property, the prepayment penalties for the Mortgage Loans, the weighted average
coupon of the Mortgage Loans and the documentation required for approval of the
Mortgage Loans. The Company may also consider other factors with respect to any
individual package under consideration.
Underwriting standards are applied by or on behalf of a lender to evaluate
the borrower's credit standing and repayment ability, and the value and adequacy
of the related mortgaged property as collateral. In general, a prospective
borrower applying for a Mortgage Loan is required to fill out a detailed
application designed to provide to the underwriting officer pertinent credit
information. As part of the description of the borrower's
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financial condition, the borrower generally is required to provide a current
list of assets and liabilities and a statement of income and expenses, as well
as an authorization to apply for a credit report which summarizes the borrower's
credit history with local merchants and lenders and any record of bankruptcy. In
most cases, an employment verification is obtained from an independent source
(typically the borrower's employer) which verifies among other things, the
length of employment with that organization, the current salary, and whether it
is expected that the borrower will continue such employment in the future. If a
prospective borrower is self-employed, the borrower may be required to submit
copies of signed tax returns. The borrower may also be required to authorize
verification of deposits at financial institutions where the borrower has demand
or savings accounts.
In most cases, the lender's analysis of the borrower's credit report
includes review of a credit score produced by an independent credit-scoring
firm, such as Fair, Issac and Company ("FICO"). Credit scores estimate, on a
relative basis, which borrowers are most likely to default on Mortgage Loans.
Lower scores imply higher default risks relative to higher scores. FICO scores
are empirically derived from historical credit bureau data and represent a
numerical weighing of a borrower's credit characteristics over a two year
period. A FICO score is generated through the statistical analysis of a number
of credit-related characteristics and variables. Common characteristics include
the following: the number of credit lines (trade lines), payment history, past
delinquencies, severity of delinquencies, current levels of indebtedness, types
of credit and length of credit history. Attributes are the specific values of
each characteristic. A scorecard (the model) is created with weights or points
assigned to each attribute. An individual loan applicant's credit score is
derived by summing together the attribute weights for that applicant.
Substantially all of the Company's Mortgage Assets as of December 31, 1999
are residential Mortgage Loans made to borrowers with credit ratings below the
conforming Mortgage Loan underwriting guidelines. The following matrix generally
describes the underwriting criteria employed by the originators of the Mortgage
Loans in evaluating the credit quality of non-conforming Mortgage Loans.
MAXIMUM MORTGAGE MAXIMUM
DELINQUENCIES DEBT-TO-INCOME
CREDIT LEVEL DURING LAST YEAR CONSUMER CREDIT RATIOS
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A/A- Up to two 30-day Generally good credit for the last two years, with 45%
minor derogatory accounts permitted. Overall
credit paid as agreed. No bankruptcy, discharge,
or notice of default filings during preceding two
years.
B Up to four 30-day Satisfactory credit with recurring 30-day accounts 50%
or two 30-day and & minor 60-day accounts. Isolated judgements and
one 60-day charge- offs permitted on a case-by-case basis. No
bankruptcy, discharge, or notice of default
filings during preceding two years.
C Up to two 60-day Generally fair credit, but the applicant has 55%
and one 90-day likely experienced significant credit problems in
the past, including judgements, charge-offs and
collection accounts. On a case-by-case basis, a
notice of default/foreclosure filing may have
occurred in the last twelve months with a good
explanation. Not currently in bankruptcy, but may
have recently occurred with proof of
dismissal/discharge.
C-/D Up to one 120-day Generally poor credit, as the applicant may be 60%
currently experiencing significant credit
problems, including being subject to notice of
default/foreclosure fillings or currently in
bankruptcy.
The borrowers credit level usually impacts the maximum loan to (property)
value ratio as well as the interest rate on the mortgage. Typically, at the time
of origination, "A-" loans do not exceed 90% loan to value; "B" loans do not
exceed 85% loan to value; "C" loans do not exceed 75% loan to value and "C-/D"
loans do not exceed 65% loan to value.
As of December 31, 1999 more than 70% of the Company's Mortgage Assets were
grade "A/A-" at the time of origination and approximately 20% of the Mortgage
Loans were graded "B". At December 31, 1999
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the weighted average original loan to property value ratio for the Company's
Mortgage Assets was approximately 79%.
In determining the adequacy of the mortgaged property as collateral, an
appraisal is made of each property considered for financing. The appraiser is
required to inspect the property and verify that it is in good condition and
that construction, if new, has been completed. The appraisal is based on the
market value of comparable homes, the estimated rental income (if considered
applicable by the appraiser) and the cost of replacing the home. The value of
the property being financed, as indicated by the appraisal, must be such that it
currently supports, and is anticipated to support in the future, the outstanding
Mortgage Loan balance.
Once all applicable employment, credit and property information is
received, a determination generally is made as to whether the prospective
borrower has sufficient monthly income available to meet (i) the borrower's
monthly obligations on the proposed Mortgage Loan (determined on the basis of
the monthly payments due in the year of origination) and other expenses related
to the mortgaged property (such as property taxes and hazard insurance), and
(ii) monthly housing expenses and other financial obligations and monthly living
expenses. The underwriting standards may be permitted to vary in appropriate
cases where factors such as low loan-to-value ratios or other compensating
factors exist.
SERVICING
The Company has acquired Mortgage Loans on both a "servicing released"
basis (i.e., the Company acquired both the Mortgage Loans and the rights to
service them) and on a "servicing retained" basis (i.e., the Company acquired
the Mortgage Loans but not the rights to service the Mortgage Loans). Generally,
whether the Mortgage Loans are acquired on a servicing released or servicing
retained basis is determined pursuant to negotiations with the seller.
The Company has contracted with subservicers to provide servicing at a cost
of a fixed percentage of the outstanding mortgage balance and the right to hold
escrow account balances and retain certain ancillary charges. In addition, for a
small portion of the Mortgage Loans, the Company will pay the subservicer a
fixed dollar fee plus a percentage of the outstanding Mortgage Loan balance and
a percentage of all amounts collected. The Company believes that the selection
of third party sub-servicers was more cost effective than establishing a
servicing department within the Company. However, part of the Company's
responsibility is to continually monitor the performance of the sub-servicers
through monthly performance reviews. Depending on these sub-servicer reviews,
the Company may in the future form a separate collection group to assist the
sub-servicer in the servicing of these loans. The Company has arranged for the
servicing of the Mortgage Loans with servicing entities that have particular
expertise and experience in the types of Mortgage Loans being acquired. See
"Business Risks -- Loans Serviced by Third Parties."
FUNDING
The Company employs a debt financing strategy to increase its investment in
Mortgage Assets. By using the Company's Mortgage Assets as collateral to borrow
funds, the Company is able to purchase Mortgage Assets with significantly
greater value than its equity. The Company has a targeted leverage ratio of
between 10% and 12%, which is generally greater than the levels of many other
companies that invest in Mortgage Assets, including many commercial banks,
savings and loans, and government agencies. See "Capital Guidelines".
The Company's financing strategy is designed to maintain a cushion of
equity sufficient to provide required liquidity to respond to the effects under
its borrowing arrangements of interest rate movements and changes in the market
value of its Mortgage Assets. However, a major disruption of the reverse
repurchase or other markets relied on by the Company for short-term borrowings
could have a material adverse effect on the Company unless the Company was able
to arrange alternative sources of financing. The Company continues to finance
its acquisition of Mortgage Assets primarily through reverse repurchase
agreements and uses securitizations (for permanent long-term financings) and, to
a lesser extent, uses lines of credit and other financings.
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Reverse Repurchase Agreements (short-term borrowings)
The Company currently finances a portion of Mortgage Assets through a form
of borrowing known as reverse repurchase agreements. In a reverse repurchase
agreement transaction, the Company agrees to sell a Mortgage Asset and
simultaneously agrees to repurchase the same Mortgage Asset one day to six
months later at a higher price with the price differential representing the
interest expense. These transactions constitute collateralized borrowings for
the Company, based on the market value of the Company's Mortgage Assets. The
Company generally will retain beneficial ownership of the Mortgage Security,
including the right to distributions on the collateral and the right to vote.
Upon a payment default under any such reverse repurchase agreement, the lending
party may liquidate the collateral.
The Company's reverse repurchase agreements generally require the Company
to pledge cash or additional Mortgage Assets in the event the market value of
existing collateral declines. To the extent that cash reserves are insufficient
to cover such deficiencies in collateral, the Company may be required to sell
Mortgage Assets to reduce the borrowings. The Company currently uses one
facility that can be used to finance the acquisition of Mortgage Loans. The
Company intends to enter into additional committed reverse repurchase
agreements.
At December 31, 1999, short-term total borrowings outstanding were $119.0
million, with Mortgage Loans with a par value of $122.0 million pledged to
secure such borrowings. The short-term borrowings were undertaken pursuant to
reverse repurchase agreements. At December 31, 1999, the weighted average
borrowing rate for short-term debt was 6.05% per annum. Upon the expiration of
each reverse repurchase agreement, the Company refinances the debt on a daily
basis at the new market rate. Accordingly, in a period of increasing interest
rates, the Company's interest expense could increase substantially prior to the
time that the Company's interest income with respect to such Mortgage Loans
increase. See "Business Risks -- Interest Rate Increases May Reduce Income From
Operations." The Company has entered into reverse repurchase agreements
primarily with national broker/dealers, commercial banks and other lenders who
typically offer such financing. The Manager and the Company will monitor the
need for such commitment agreements and may enter into such commitment
agreements in the future if deemed favorable to the Company. See "Business
Risks -- Failure to Renew Or Obtain Adequate Funding May Adversely Affect
Results of Operations." There can be no assurance that the Company will be able
to continue to borrow funds using reverse repurchase agreements or otherwise
finance its Mortgage Loans.
In the event of the insolvency or bankruptcy of the Company, the creditor
under reverse repurchase agreements may be allowed to avoid the automatic stay
provisions of the Bankruptcy Code and to foreclose on the collateral agreements
without delay. In the event of insolvency or bankruptcy of a lender during the
term of a reverse repurchase agreement, the lender may be permitted to repudiate
the contract, and the Company's claim against the lender for damages therefrom
may be treated simply as one of the unsecured creditors. Should this occur, the
Company's claims would be subject to significant delay and, if received, may be
substantially less than the damages actually suffered by the Company.
Securitizations (long-term borrowings)
The Company intends to continue to securitize Mortgage Loans as part of its
overall financing strategy. Securitization is the process of pooling Mortgage
Loans and issuing equity securities, such as mortgage pass-through certificates,
or debt securities, such as Collateralized Mortgage Obligations ("CMOs"). The
Company intends to securitize its Mortgage Loans primarily by issuing structured
debt. Under this approach, for accounting purposes, the Mortgage Loans so
securitized remain on the balance sheet as assets and the debt obligations
(i.e., the CMOs) appear as liabilities. A structured debt securitization is
generally expected to result in substituting one type of debt financing for
another, as proceeds from the structured debt issuance are applied against
preexisting borrowings (i.e., borrowings under reverse repurchase agreements).
The structured debt securities issued will constitute limited recourse, long
term financing, the payments on which generally correspond to the payments on
the Mortgage Loans serving as collateral for the debt. Such financings are not
subject to a margin call if a rapid increase in rates would reduce the value of
the underlying Mortgage Loans and, hence, reduce the liquidity risk to the
Company for the Mortgage Loans so financed.
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The decision to issue CMOs will be based on the Company's current and
future investment needs, market conditions and other factors. Each issue of CMOs
is fully payable from the principal and interest payments on the underlying
Mortgage Loans collateralizing such debt, any cash or other collateral required
to be pledged as a condition to receiving the desired rating on the debt, and
any investment income on such collateral. The Company earns the net interest
spread between the interest income on the Mortgage Loans securing the CMOs and
the interest and other expenses associated with the CMO financing. The net
interest spread may be directly impacted by the levels of prepayment of the
underlying Mortgage Loans and, to the extent each CMO class has variable rates
of interest, may be affected by changes in short-term interest rates.
If the Company issues CMOs for financing purposes, it will seek an
investment grade rating for such CMOs by a nationally recognized rating agency.
To secure such a rating, it is often necessary to pledge collateral in excess of
the principal amount of the CMOs to be issued, or to obtain other forms of
credit enhancements such as additional mortgage loan insurance. The need for
additional collateral or other credit enhancements depends upon factors such as
the type of collateral provided and the interest rates paid thereon, the
geographic concentration of the mortgaged property securing the collateral and
other criteria established by the rating agency. The pledge of additional
collateral would reduce the capacity of the Company to raise additional funds
through short-term secured borrowings or additional CMOs and diminish the
potential expansion of its investment portfolio. As a result, the Company's
objective is to pledge additional collateral for CMOs only in the amount
required to obtain an investment grade rating for the CMOs by a nationally
recognized rating agency. Total credit loss exposure to the Company is limited
to the equity invested in the CMOs at any point in time.
The Company believes that under prevailing market conditions, an issuance
of CMOs receiving other than an investment grade rating would require payment of
an excessive yield to attract investors. No assurance can be given that the
Company will achieve the ratings it plans to seek for the CMOs.
In connection with the securitization of "B" and "C" Mortgage Loans, the
levels of subordination required as credit enhancement for the more senior
classes of securities issued in connection therewith would be higher than those
with respect to its "A" grade non-conforming Mortgage Loans. Thus, to the extent
that the Company retains any of the subordinated securities created in
connection with such securitizations and losses with respect to such pools of
"B" and "C" grade Mortgage Loans or Mortgage Loans secured by second liens are
higher than expected, the Company's future operations could be adversely
affected.
During 1998, the Company securitized Mortgage Loans in a CMO through its
wholly owned subsidiary, American Residential Eagle, Inc. ("Eagle"), by issuing
collateralized mortgage bonds "Long-Term Debt" through a Financial Asset
Securitization Investment Trust ("FASIT"). The bonds were assigned to a FASIT
trust and trust certificates evidencing the assets of the trust were sold to
investors. The trust certificates were issued in classes representing senior,
mezzanine, and subordinate payment priorities. Payments received on
single-family mortgage loans ("Bond Collateral") are used to make payments on
the Long-Term Debt. The obligations under the Long Term Debt are payable solely
from the Bond Collateral and are otherwise non-recourse to the Company. The
maturity of each class of trust certificates is directly affected by the rate of
principal repayments on the related Bond Collateral. The Long-Term Debt is also
subject to redemption according to the specific terms of the indenture pursuant
to which the bonds were issued and the FASIT trust. As a result, the actual
maturity of the Long-Term Debt is likely to occur earlier than its stated
maturity.
Also, during 1998, the Company securitized Mortgage Loans in a "REMIC"
through an affiliate, Holdings. The Company accounted for the REMIC
securitization as a sale of Mortgage Loans and recorded a gain on the
transaction. The Company, through Holdings, retained an interest in this
securitization having a fair value of $6.6 million as of December 31, 1999. The
value of this residual interest is subject to all of the same risks impacting
the Company relative to the level of prepayments, increasing interest rates,
credit exposure and liquidity. A decline in the value of this investment could
adversely impact book equity and the Company's financial condition and results
of operation.
During 1999, the Company issued, through Eagle and its wholly owned
subsidiary, American Residential Eagle 2 ("Eagle 2"), three new series of
mortgage backed bonds (Long-Term Debt). Two series of the bonds were
non-recourse obligations of a trust formed and wholly-owned by Eagle. All series
of bonds were secured
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by the assets of the trust, which consist of both adjustable rate and fixed rate
mortgage loans secured by first liens on one- to four-family residential
properties. Payments received on Bond Collateral are used to make payments on
the Long-Term Debt. Payments received on the mortgage loans in excess of
obligations due under the Long-Term Debt are remitted to the Company on a
monthly basis by the an independent trustee. The obligations under the Long-Term
Debt are payable solely from the Bond Collateral and are otherwise non-recourse
to the Company. The maturity of the bonds is directly affected by the rate of
principal repayments on the related Bond Collateral. The Long-Term Debt is also
subject to redemption by the Company according to the specific terms of the
indenture pursuant to which the bonds were issued. As a result, the actual
maturity of the Long-Term Debt is likely to occur earlier than its stated
maturity.
At December 31, 1999, total long-term borrowings outstanding were
approximately $1.1 billion with Mortgage Loans valued at approximately $1.2
billion pledged to secure such borrowings. These borrowings are carried on the
balance sheet at historical cost, which approximates market value.
CAPITAL GUIDELINES
The Company's capital management goal is to strike a balance between the
under-utilization of leverage, which could reduce potential returns to
stockholders, and the over-utilization of leverage, which could reduce the
Company's ability to meet its obligations during period of adverse market
conditions. For this purpose, the Company has established various risk
management policies and processes. For example, the Company and its Board of
Directors regularly review the Company's leverage and exposure to liquidity
risks to determine leverage ranges and the level of new Mortgage Asset
acquisition activity. For limited periods, the Company may exceed its desired
leverage range, but it is anticipated that in most circumstances the desired
leverage will be achieved over time without specific action by the Company or
the Manager through the natural process of mortgage principal repayments and
increases in Mortgage Loan acquisition activities. The Company anticipates that
the actual leverage is likely to be the lowest during periods following new
equity offerings and during periods of falling interest rates and that the
actual leverage is likely to be the highest during periods after the acquisition
of large bulk Mortgage Loan packages. The Board of Directors has the discretion
to modify the Company's policies and restrictions without stockholder consent.
There are no restrictions on the Company's ability to incur debt and there can
be no assurance the level of debt that the Company is authorized to incur will
not be increased by the Board of Directors. See "Business Risks -- Policies and
Strategies May Be Revised at the Discretion of the Board of Directors."
The Company, with the advice of the Manager, assigns to each Mortgage Asset
a specified amount of capital to be maintained against it by aggregating three
key components. The first component of the Company's capital allocation process
is the current aggregate over-collateralization amount or "haircut" the lenders
require the Company to hold as capital. The Company is required to pledge as
collateral Mortgage Assets with a market value that exceeds the amount it
borrows. The haircut for each Mortgage Asset is determined by the lender based
on the risk characteristics and liquidity of that Mortgage Asset. For example,
haircut levels on individual borrowings could range from 3% to 5% for Mortgage
Securities and Mortgage Loans.
The second component of the Company's capital Allocation process is the
"liquidity capital cushion." The Company expects that substantially all of its
reverse repurchase agreements will require the Company to deposit additional
collateral in the event the market value of existing collateral declines. The
liquidity cushion is an additional amount of capital in excess of the haircut
maintained by the Company designed to assist the Company in meeting the demands
of the lenders for additional collateral should the market value of the
Company's Mortgage Assets decline. Alternatively, the Company might sell
Mortgage Assets to reduce the borrowings. See "Business Risks -- Investments in
Mortgage Assets May Be Illiquid."
The third component of the Company's capital allocation process is the
"capital cushion" assigned to each Mortgage Asset based on the Manager's
assessment of the Mortgage Asset's credit risk. This represents an assessment of
the risk of delinquency, default or loss on individual Mortgage Assets.
Finally, the Board of Directors establishes, subject to revision from time
to time, leverage and cash reserve guidelines based on the composition of assets
and liabilities and assessments of capital call risks. The
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Board of Directors reviews on a periodic basis various analyses prepared by the
Manager of the risks inherent in the Company's balance sheet, including an
analysis of the effects of various scenarios on the Company's net cash flow, net
income, dividends, liquidity and net market value. Should the Board of Directors
determine, in its discretion, that leverage or the minimum required cash
reserves are either too low or too high, the Board of Directors will raise or
lower capital guidelines accordingly.
At December 31, 1999, book equity capital to total fair value of the
Company's Assets was approximately 6.67%. This ratio is lower than the ratio the
Company has traditionally maintained, principally because of the premium
write-down of approximately $12.3 million taken in the fourth quarter of 1999
related to the CMO/ FASIT portfolio. See ("Item 7. Management's Discussion and
Analysis of Financial Conditions and Results of Operations"). This percentage
may fluctuate from time to time, as the composition of the balance sheet
changes, haircut levels required by lenders change, the value of the Mortgage
Assets change and as the capital cushion percentages are adjusted over time. The
Company will actively monitor and adjust, if necessary, its policies and
processes, both on an aggregate portfolio level as well as on an individual pool
or Mortgage Loan basis. The Company expects to take into consideration current
market conditions and a variety of interest rate scenarios, performance of
hedges, performance of Mortgage Assets, credit risk, prepayments of Mortgage
Assets, the restructuring of Mortgage Assets, general economic conditions,
potential issuance of additional equity, pending acquisitions or sales of
Mortgage Assets, Mortgage Loan securitizations and the general availability of
financing.
RISK MANAGEMENT
Prior to arranging the acquisition of Mortgage Assets by the Company, the
Manager gives consideration to balance sheet management and risk diversification
issues. A specific Mortgage Asset which is being evaluated for potential
acquisition is deemed more or less valuable to the Company to the extent it
serves to increase or decrease certain interest rate or prepayment risks which
may exist in the balance sheet, to diversify or concentrate credit risk, and to
meet the cash flow and liquidity objectives the Company may establish for its
balance sheet from time to time. Accordingly, an important part of the Mortgage
Assets evaluation process is a simulation, using the Manager's risk management
model, of the addition of proposed Mortgage Assets and its associated borrowings
and hedgings to the balance sheet and an assessment of the impact any proposed
acquisition of Mortgage Assets would have on the risks in, and returns generated
by, the Company's balance sheet as a whole over a variety of scenarios.
Interest Rate Risk Management
To the extent consistent with its election to qualify as a REIT, the
Company has implemented certain processes and utilizes interest rate agreements
and other hedging instruments intended to protect the Company against
significant changes in interest rates.
The Manager hedges the Company's Mortgage Asset portfolio to offset the
potential adverse effects from (i) the differences between the interest rate
adjustment period of its Mortgage Assets and related borrowings (gap risk) See
"ITEM 7a. Quantitative and Qualitative Disclosure About Market Risk", (ii)
lifetime and periodic rate adjustment caps on its Mortgage Assets, and (iii) the
differences between interest rate adjustment indices of its Mortgage Assets and
related borrowings (basis risk). The gap risk (mismatch of assets and
liabilities) is especially acute with fixed rate Mortgage Loans and intermediate
adjustable Mortgage Loans. Intermediate adjustable Mortgage Loans are fixed for
a set period and then convert to a six-month adjustable rate. The fixed period
is usually two to five years. The Manager monitors and evaluates the results of
its hedging strategy and adjusts its hedging strategy as it deems is in the best
interest of the Company.
The Company recognizes the need to hedge these specific interest rate risks
associated with its Mortgage Asset portfolio and has sought the hedging
instrument most appropriate for the specific risk. The Company may enter into
additional types of hedging transactions in the future if Management believes
there exists a significant risk to operations.
Hedging involves transaction and other costs, and such costs increase as
the period covered by the hedging protection increases and also increase in
periods of rising and fluctuating interest rates. For example,
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in a typical interest rate cap agreement, the cap purchaser makes an initial
lump sum cash payment to the cap seller in exchange for the sellers' promise to
make cash payments to the purchaser on fixed dates during the contract term if
prevailing interest rates exceed the rate specified in the interest rate cap
agreement. Because of the cost involved, the Company may be prevented from
effectively hedging its interest rate risks without significantly reducing the
Company's return on equity.
The un-amortized cost of the interest rate cap agreements, ("cap") at
December 31, 1999 was approximately $1.6 million. Cap premiums are amortized
from the effective date of the cap through the termination date on a
straight-line basis. For the year ended December 31, 1999, the interest rate cap
agreement amortization expense was approximately $797,000. There was $104,000 in
income from the cap agreements during this period. There was approximately $1.1
million of floor expense during this period. There were two expirations of cap
and floor agreements during 1999 with a combined notional amount of
approximately $750 million. For the year ended December 31, 1999, cap expense
equaled approximately 0.13% of the average balance of the Company's Mortgage
Assets and 0.12% of the average balance of the Company's interest bearing
liabilities. For such period, the cap expense was approximately 2.30% of net
interest income from Mortgage Assets. At December 31, 1999, the cap range of
strike rates was 6.3% to 8.1% and the weighted average strike rate was
approximately 6.9%. At December 31, 1999 cap agreements had a combined notional
amount of $650 million. Some of the Company's interest rate cap agreements have
strike rates and/or notional face amounts which vary over time. All of the
interest rate caps reference the one month LIBOR.
Mortgage derivative securities can also be effective hedging instruments in
certain situations as the value and yields of some of these securities tend to
increase as interest rates rise and tend to decrease in value and yields as
interest rates decline, while the experience for others is the converse. As part
of the Company's hedging program, the Manager will monitor on an ongoing basis
the interest rate risks which arise as asset and liability characteristics
change and or in fluctuating interest rate environments. The Manager will
consider alternative methods and costs of hedging such risks, which may include
the use of mortgage derivative securities. The Company intends to limit its
purchases of mortgage derivative securities to investments that qualify as
Qualified REIT Assets, as defined below, so that income from such securities
will constitute qualifying income for purposes of the 95% and 75% of income
tests, as defined below. The Company does not currently intend to, but may in
the future, enter into interest rate swap agreements, buy and sell financial
futures contracts and options on financial futures contracts and trade forward
contracts as a hedge against future interest rate changes; however, the Company
will not invest in these instruments unless the Company and the Manager are
exempt from the registration requirements of the Commodities Exchange Act or
otherwise comply with the provisions of that act. The REIT provisions of the
Code may restrict the Company's ability to purchase hedges and may severely
restrict the Company's ability to employ other strategies. In all its hedging
transactions, the Company will contract only with counterparties that the
Company believes are sound credit risks. See "Requirements for Qualification as
a REIT -- Gross Income Tests."
Certain of the federal income tax requirements that the Company must
satisfy to qualify as a REIT limit the Company's ability to fully hedge its
interest rate and prepayment risks. The Manager monitors carefully, and may have
to limit, the Company's asset/liability management program to assure that it
does not realize excessive hedging income, or hold hedging assets having excess
value in relation to total assets, which would result in the Company's
disqualification as a REIT or, in the case of excess hedging income, the payment
of a penalty tax for failure to satisfy certain REIT income tests under the
Code, provided such failure was for reasonable cause. In addition,
asset/liability management involves transaction costs which increase
dramatically as the period covered by the hedging protection increases.
Therefore, the Company may be prevented from effectively hedging its interest
rate and prepayment risks. See "Federal Income Tax Consequences -- Requirements
for Qualification as a REIT."
In particular, income from hedging the Company's variable rate borrowings
(other than with hedging instruments that are Qualified REIT Assets) qualifies
for the 95% of income test, but not for the 75% of income test, for REIT
qualification. The Company must limit its income from such hedging or the sale
of hedging contracts, along with other types of income that qualifies for the
95% of income test, but not for the
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75% of income test, to less than 25% of the Company's gross revenues. In
addition, hedging instruments, such as swaps, caps, floors, collars, and
financial futures contracts, are securities for purposes of the quarterly asset
tests for REIT qualification. The Company must ascertain that securities,
including the hedging instruments (other than hedging instruments that are
Qualified REIT Assets), issued by a single issuer do not account for 5% or more
of the value of the Company's assets as of the last day of each calendar
quarter. The Company does not expect to encounter material problems complying
with these tests.
Although the Company believes that, with the advice of the Manager, it has
developed a cost effective interest rate risk management program to provide a
level of protection against interest rate risks, developing an effective program
is complex and no program can insulate the Company from the effects of interest
rate changes. Further, the cost of hedging transactions and the federal tax laws
applicable to REITs may limit the Company's ability to fully hedge its interest
rate risks.
Prepayment Risk Management Process
The Company has sought to minimize the effects on operations caused by
faster than anticipated prepayment rates by lowering premiums paid to acquire
mortgages and by purchasing Mortgage Loans with prepayment penalties. Prepayment
penalties typically expire 2 to 5 years from origination and the penalty
(subject to state-by-state laws) can range from approximately $800 to $4,000 on
a $100,000 loan. There can be no assurance that the Company's efforts to reduce
prepayment rates will be successful.
The borrowers' prepayment of principal included only the principal repaid
which was not part of the normal amortization of the loan. The borrowers
repayment of principal is the total payment of principal for the period.
The amortized cost of the Company's total Mortgage Assets at December 31,
1999 was equal to 103.7% of the face value of the Mortgage Assets. The amortized
cost of Mortgage Loans at December 31, 1999 was equal to 103.6% of the face
value of the Mortgage Loan, and the amortized cost of the Company's Bond
Collateral at December 31, 1999 was equal to 103.7% of the face value of the
Bond Collateral.
Credit Risk Management
The Company reviews with the Manager credit risks and other risks of loss
associated with each investment and determines the appropriate allocation of
capital to apply to such investment. In addition, the Company attempts to
diversify its Mortgage Asset portfolio to avoid undue geographic, issuer,
industry and certain other types of concentrations. The Company has obtained
protection against some risks from sellers and servicers through representations
and warranties and other appropriate documentation. The Board of Directors
monitors the overall portfolio risk and will increase the allowance for Mortgage
Loan losses when it believes appropriate.
In order to reduce the credit risks associated with acquisitions of
Mortgage Loans, the Company, with the advice of the Manager (i) employs a
quality control program, (ii) acquires Mortgage Loans that represent a broad
range of moderate risks as opposed to a concentrated risk, (iii) monitors the
credit quality of newly acquired and existing Mortgage Assets, and (iv)
periodically adjusts the Mortgage Loan loss allowances. See "Management's
Discussion and Analysis of Financial Conditions and Results of Operations". The
Company also has arranged for servicing of its Mortgage Loans with servicing
entities that have particular expertise and experience in the types of Mortgage
Loans acquired and monitor the performance of these servicers monthly. See
"Business Risks -- Borrower Credit May Decrease Value of Mortgage Loans,"
"Characteristics of Underlying Property May Decrease Value of Mortgage Loans,"
and "Loans Serviced by Third Parties."
The Company may sell Mortgage Assets from time to time for a number of
reasons, including, without limitation, to dispose of Mortgage Assets as to
which credit risk concerns have arisen, to seek to reduce interest rate risk, to
substitute one type of Mortgage Asset for another to seek to improve yield or to
maintain compliance with the 55% requirement under the Investment Company Act,
and generally to restructure the balance sheet when Management deems such action
advisable. The REIT Provisions of the Code limit in certain respects the ability
of the Company to sell Mortgage Assets.
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FEDERAL INCOME TAX CONSEQUENCES
The Company intends to maintain its status as a REIT for federal income tax
purposes. A corporation qualifying as a REIT may avoid corporate income taxation
by distributing dividends equal to its taxable income to its stockholders
annually. The Company is organized in conformity with the requirements for
qualification and taxation as a REIT under the Internal Revenue Code of 1986, as
amended (the "Code").
The provisions of the Code are highly technical and complex. This summary
is not intended to be a detailed discussion of all applicable provisions of the
Code, the rules and regulations promulgated thereunder, or the administrative
and judicial interpretations thereof. The Company has not obtained a ruling from
the Internal Revenue Service (the "Service") with respect to tax considerations
relevant to its organization or operation, or to an acquisition of its common
stock. This summary is not intended to be a substitute for prudent tax planning,
and each shareholder of the Company is urged to consult its own tax advisor with
respect to these and other federal, state and local tax consequences of the
acquisition, ownership and disposition of shares of the common stock of the
Company and any potential changes in applicable law.
REQUIREMENTS FOR QUALIFICATION AS A REIT
To qualify for tax treatment as a REIT under the Code, the Company must
meet certain tests which are described in brief below.
Stock Ownership Tests
For all taxable years after the first taxable year for which a REIT
election is made, the Company's shares of stock must be transferable and must be
held by a minimum of 100 persons for at least 335 days of a 12 month year (or a
proportionate part of a short tax year). The Company must also use the calendar
year as its taxable year. In addition, at all times during the second half of
each taxable year, no more than 50% in value of the shares of any class of the
stock of the Company may be owned directly or indirectly by five or fewer
individuals. The Company intends to satisfy both the 100 stockholder and 50%/5
stockholder individual ownership limitations described above for as long as it
seeks qualification as a REIT. The Company uses the calendar year as its taxable
year for income tax purposes.
Asset Tests
On the last day of each calendar quarter, at least 75% of the value of the
Company's assets must consist of Qualified REIT Assets, government securities,
cash and cash items (the "75% of assets test"). The Company believes that
substantially all of its assets are and will continue to be Qualified REIT
Assets. Qualified REIT Assets include interests in real property, interests in
Mortgage Loans secured by real property and interests in REMICs.
On the last day of each calendar quarter, of the investments in securities
not included in the 75% of assets test, the value of any one issuer's securities
may not exceed 5% by value of the Company's total assets, and the Company may
not own more than 10% of any one issuer's outstanding voting securities. See
"Proposed Tax Legislation" below. If such limits are ever exceeded, the Company
intends to take appropriate remedial action to dispose of such excess assets
within the 30 day period after the end of the calendar quarter, as permitted
under the Code.
Gross Income Tests
The Company must satisfy the following income-based tests for each year in
order to qualify as a REIT.
1. The 75% Test. At least 75% of the Company's gross income (the "75%
of income test") for the taxable year must be derived from qualified REIT
assets. The investments that the Company has made and intends to make will
give rise primarily to mortgage interest qualifying under the 75% of income
test.
2. The 95% Test. In addition to deriving 75% of its gross income from
the sources listed above, at least an additional 20% of the Company's gross
income for the taxable year must be derived from those
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sources, or from dividends, interest or gains from the sale of disposition
of stock or other securities that are not dealer property (the "95% of
income test"). In order to help ensure compliance with the 95% of income
test and the 75% of income test, the Company intends to limit substantially
all of the assets that it acquires to Qualified REIT Assets. The policy of
the Company to maintain REIT status may limit the type of assets, including
hedging contracts, that the Company otherwise might acquire.
If the Company fails to satisfy one or both of the 75% or 95% of income
tests for any year, it may face either (a) assuming such failure was for
reasonable cause and not willful neglect, a 100% tax on the greater of the
amounts of income by which it failed to comply with the 75% test of income or
the 95% of income test, reduced by estimated related expenses or (b) loss of
REIT status.
Distribution Requirement
The Company must distribute to its stockholders on a pro rata basis an
amount equal to (i) 95% of its taxable income before deduction of dividends paid
and excluding net capital gain, plus (ii) 95% of the excess of the net income
from foreclosure property over the tax imposed on such income by the Code less
(iii) any "excess noncash income" (the "95% distribution test"). The Company
intends to make distributions to its stockholders in amounts sufficient to meet
the 95% distribution test.
A nondeductible excise tax, equal to 4% of the excess of such required
distributions over the amounts actually distributed will be imposed on the
Company for each calendar year to the extent that dividends paid during the year
(or declared during the last quarter of the year and paid during January of the
succeeding year) are less than the sum of (i) 85% of the Company's "ordinary
income," (ii) 95% of the Company's capital gain net income plus, and (iii)
income not distributed in earlier years.
Recordkeeping Requirements
As a REIT, the Company is required to maintain records regarding the actual
and constructive ownership of its shares, and other information, and within 30
days after the end of its taxable year, to demand statements from persons owning
above specified level of the Company's shares (generally shareholders owning
more than 1% of the Company's outstanding stock). The Company must maintain, as
part of the Company's records, a list of those persons failing or refusing to
comply with this demand. Stockholders who fail or refuse to comply with the
demand must submit a statement with their tax returns setting forth the actual
stock ownership and other information. The Company also is required to maintain
permanent records of its assets as of the last day of each calendar quarter. The
Company intends to maintain the records and demand statements as required by
these regulations.
TAXATION OF STOCKHOLDERS
For any taxable year in which the Company is treated as a REIT for federal
income purposes, amounts distributed by the Company to its stockholders will be
included by the stockholders as ordinary income for federal income tax purposes
unless properly designated by the Company as capital gain dividends. In the
latter case, the distributions will be taxable to the stockholders as long-term
capital gains. Any loss on the sale or exchange of shares of the stock of the
Company held by a stockholder for six months or less will be treated as a
long-term capital loss to the extent of any capital gain dividend received on
the stock held by such stockholders. If the Company makes distributions to its
stockholders in excess of its current and accumulated operations and profits,
those distributions will be considered first a tax-free return of capital,
reducing the tax basis of a stockholder's share until the tax basis is zero.
Such distributions in excess of the tax basis will be taxable as gain realized
from the sale of the Company's shares.
Distributions by the Company will not be eligible for the dividends
received deduction for corporations. Stockholders may not deduct any net
operating losses or capital losses of the Company.
The Company does not expect to acquire or retain residual interests issued
by REMICs. Such residual interests, if acquired by a REIT, would generate excess
inclusion income that, among other things, is fully
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taxable as unrelated business taxable income ("UBTI") to Tax Exempt Entities.
Potential investors, and in particular Tax Exempt Entities, are urged to consult
with their tax advisors concerning this issue.
The Company will notify stockholders after the close of the Company's
taxable year as to the portions of the distributions which constitute ordinary
income, return of capital and capital gain. Dividends and distributions declared
in the last quarter of any year payable to stockholders of record on a specified
date in such month will be deemed to have been received by the stockholders and
paid by the Company on December 31 of the record year, provided that such
dividends are paid before February 1 of the following year.
RECENT TAX LEGISLATION
Recently adopted legislation, H.R. 1180, contains several provisions
affecting REITs. After the effective date of the bill, December 31, 2000 (i.e.,
beginning with the 2001 tax year), REITs will be able to own directly the stock
of taxable subsidiaries. At present, REITs are generally limited to holding
non-voting preferred stock in taxable affiliates. The value of all taxable
subsidiaries of a REIT will be limited to 20% of the total value of the REIT's
assets. Existing taxable subsidiaries will have to be converted to qualified
taxable REIT subsidiaries after December 31, 2000, unless the existing taxable
subsidiary has been in place since July 12, 1999 and there has been no material
change in the taxable subsidiary's assets or business since that time. In
addition, a REIT will be subject to a 100% penalty tax equal to any rents or
charges that the REIT imposed on the taxable subsidiary in excess of the arm's
length price for comparable services.
The minimum dividend distributions of a REIT will have to equal 90% of
taxable income, down from 95% of taxable income under current law. This
provision will also first be effective beginning with the 2001 tax year. Under
this provision, the Company will be able to retain a greater percentage of its
after-tax earnings if desired.
In its year 2001 budget the Clinton Administration has included a proposal
that would increase the amount of a REIT's taxable income that must be
distributed during the year in order to avoid imposition of the 4% excise tax
from the current 85% to 98%. The Administration also proposed a provision that
would bar an entity from electing REIT status if 50% or more of its stock was
owned by another corporation.
Management does not believe that these proposals will have a material
effect on the Company's business and operations.
INVESTMENT COMPANY ACT
The Company at all times intends to conduct its business so as not to
become regulated as an investment company under the Investment Company Act of
1940. If the Company were to become regulated as an investment company, then the
Company's use of leverage would be substantially reduced. The Investment Company
Act of 1940 exempts entities that are "primarily engaged in the business of
purchasing or otherwise acquiring mortgages and other liens on and interest in
real estate" ("Qualifying Interests"). Under current interpretation of the staff
of the Securities and Exchange Commission, in order to qualify for this
exemption, the Company must maintain at least 55% of its assets directly in
Qualifying Interests. In addition, unless certain mortgage securities represent
all the certificates issued with respect to an underlying pool of mortgages,
such mortgage 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.
COMPETITION
The Company's net interest income will depend, in large part, on the
Company's ability to acquire Mortgage Assets on acceptable terms and at
favorable spreads over the Company's borrowing costs. There can be no assurance
that the Company will be able to acquire sufficient Mortgage Assets at spreads
above the Company's cost of funds. In acquiring Mortgage Assets, the Company
will compete with investment banking firms, savings and loan associations,
banks, mortgage bankers, insurance companies, mutual funds, other lenders,
FHLMC, FNMA, GNMA and other entities purchasing Mortgage Assets, many of which
have greater financial resources than the Company. In addition, there are
several REITs similar to the Company,
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and others may be organized in the future. The effect of the existence of
additional REITs may be to increase competition for the available supply of
Mortgage Assets suitable for purchase by the Company. The Company will face
competition from companies already established in these markets. There can be no
assurance that the Company will be able to successfully compete with its
competition.
EMPLOYEES
Currently, the Company and the Manager each employ five executive officers
and ten additional employees. Each of the executive officers has between 11 and
25 years, and collectively, they have an average of 24 years of experience in
the residential mortgage industry. Four executive officers worked together
previously as a management team.
THE MANAGEMENT AGREEMENT
Term of the Management Agreement and Termination Fee
The Company entered into a Management Agreement with the Manager for an
initial term of two years beginning February 11, 1997. The Management Agreement
will be renewed automatically for successive one year periods unless a notice of
non-renewal is timely delivered by the Company. The Company may elect to prevent
the automatic renewal of the Management Agreement only by vote of both a
majority of the Board of Directors and a majority of the directors who are not
executive officers or employees of the Company followed by delivery of a written
notice of non-renewal to the Manager at least 60 days prior to the end of the
then-current period of the Management Agreement. At the December 1999 Board
meeting, the Board of Directors did not bring the Management Agreement up for
discussion, therefore; the next opportunity for the Board to terminate the
contract will be February 11, 2001. The Management Agreement will terminate at
the expiration of the then-current period in which such notice of non-renewal is
delivered. Upon non-renewal of the Management Agreement without cause, a
termination fee will be payable to the Manager. See "Management Fees." In
addition, the Company has the right to terminate the Management Agreement at any
time upon the happening of certain specified events, after notice and an
opportunity to cure, including a material breach by the Manager of any provision
contained in the Management Agreement. Upon such a termination for cause, no
termination fee will be payable to the Manager.
Administrative Services Provided by the Manager
The Manager is responsible for the day-to-day operations of the Company and
performs such services and activities relating to the assets and operations of
the Company as may be appropriate, including:
(i) serving as the Company's consultant with respect to the
formulation of investment criteria and the preparation of policy
guidelines;
(ii) assisting the Company in developing criteria for Mortgage Asset
purchase commitments that are specifically tailored to the Company's long
term investment objectives and making available to the Company its
knowledge and experience with respect to Mortgage Loan underwriting
criteria;
(iii) representing the Company in connection with the purchase of, and
commitment to purchase, Mortgage Assets, including the formation of
Mortgage Asset purchase commitment criteria;
(iv) arranging for the issuance of Mortgage Securities from pools of
Mortgage Loans and providing the Company with supporting services in
connection with the creation of Mortgage Securities;
(v) furnishing reports and statistical and economic research to the
Company regarding the Company's activities and the performance of the
Manager;
(vi) monitoring and providing to the Board of Directors on an ongoing
basis price information and other data, which price information and other
data shall be obtained from certain nationally recognized dealers and other
entities that maintain markets in Mortgage Assets as selected by the Board
of Directors
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from time to time, and providing advice to the Board of Directors to aid
the Board of Directors in the selection of such dealers and other entities;
(vii) administering the day-to-day operations of the Company and
performing and supervising the performance of such other administrative
functions necessary in the management of the Company as may be agreed upon
by the Manager and the Board of Directors, including the collection of
revenues and the payment of the Company's expenses, debts and obligations
and maintenance of appropriate computer services to perform such
administrative functions;
(viii) designating a servicer and/or subservicer for those Mortgage
Loans sold to the Company by originators that have elected not to service
such Mortgage Loans and arranging for the monitoring and administering of
such servicer and subservicer;
(ix) counseling the Company in connection with policy decisions to be
made by the Board of Directors;
(x) evaluating and recommending hedging strategies to the Board of
Directors and, upon approval by the Board of Directors, facilitating the
implementation and monitoring the performance of these strategies;
(xi) supervising compliance with the REIT Provisions of the Code and
Investment Company Act of 1940 status, including setting up a system to
monitor hedging activities on a periodic basis for such compliance;
(xii) establishing quality control procedures for the Mortgage Assets
of the Company, including audits of Mortgage Loan underwriting files and
the hiring of any agents with such particular knowledge and expertise as
may be appropriate to perform any such quality control procedures, and
administering, performing and supervising the performance of the quality
control procedures of the Company and performing and supervising the
performance of such other functions related thereto necessary or advisable
to assist in the performance of such procedures and the attainment of the
purposes thereof;
(xiii) upon request by and in accordance with the directions of the
Board of Directors, investing or reinvesting any money of the Company;
(xiv) conducting, or causing to be conducted, a legal document review
of each Mortgage Loan acquired to verify the accuracy and completeness of
the information contained in the Mortgage Loans, security instruments and
other pertinent documents in the mortgage file;
(xv) providing the Company with data processing, legal and
administrative services to the extent required to implement the business
strategy of the Company;
(xvi) providing all actions necessary for compliance by the Company
with all federal, state and local regulatory requirements applicable to the
Company in respect of its business activities, including preparing or
causing to be prepared all financial statements required under applicable
regulations and contractual undertakings and all reports and documents, if
any, required under the Securities Exchange Act of 1934, as amended;
(xvii) providing all actions necessary to enable the Company to make
required federal, state and local tax filings and reports and to generally
enable the Company to maintain its status as a REIT, including soliciting
stockholders for required information to the extent provided in the REIT
Provisions of the Code;
(xviii) communicating on behalf of the Company with the holders of the
equity and debt securities of the Company as required to satisfy the
reporting and other requirements of any governmental bodies or agencies and
to maintain effective relations with such holders; and
(xix) performing such other services as may be required from time to
time for management and other activities relating to the assets of the
Company as the Board of Directors shall reasonably request or the Manager
shall deem appropriate under the particular circumstances.
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Except in certain circumstances, the Manager may not assign its rights and
duties under the Management Agreement, in whole or in part, without the written
consent of the Company and the consent of a majority of the Company's
independent directors who are not affiliated with the Manager.
Servicing of the Mortgage Loans
The Company has acquired certain of its Mortgage Loans on a servicing
released basis. The Manager has entered into contracts with other parties to
provide sub-servicing for the Company. The Manager will monitor the
sub-servicing of the Mortgage Loans. Such monitoring includes, but not be
limited to, the following: (i) serving as the Company's consultant with respect
to the servicing of Mortgage Loans; (ii) collection of information and
submission of reports pertaining to the Mortgage Loans and to moneys remitted to
the Manager or the Company by any servicer; (iii) periodic review and evaluation
of the performance of each servicer to determine its compliance with the terms
and conditions of the applicable subservicing or servicing agreement and, if
deemed appropriate, recommending to the Company the termination of such
agreement; (iv) acting as a liaison between servicers and the Company and
working with servicers to the extent necessary to improve their servicing
performance; (v) review of and recommendations as to fire losses, easement
problems and condemnation, delinquency and foreclosure procedures with regard to
the Mortgage Loans; (vi) review of servicer's delinquency, foreclosure and other
reports on Mortgage Loans; (vii) supervising claims filed under any mortgage
insurance policies; and (viii) enforcing the obligation of any servicer to
repurchase Mortgage Loans from the Company.
Limits of Responsibility
Pursuant to the Management Agreement, the Manager will not assume any
responsibility other than to render the services called for thereunder and will
not be responsible for any action of the Company's Board of Directors in
following or declining to follow its advice or recommendations. The Manager, its
directors, officers, stockholders and employees will not be liable to the
Company, any issuer of Mortgage Securities, any subsidiary of the Company, the
Company's independent directors, the Company's stockholders or any subsidiary's
stockholders for acts performed in accordance with and pursuant to the
Management Agreement, except by reason of acts or omissions constituting bad
faith, willful misconduct, gross negligence or reckless disregard of their
duties under the Management Agreement. The Manager does not have significant
assets other than its interest in the Management Agreement. Consequently, there
can be no assurance that the Company would be able to recover any damages for
claims it may have against the Manager. The Company has agreed to indemnify the
Manager, and its respective directors, officers, stockholders and employees with
respect to all expenses, losses, damages, liabilities, demands, charges and
claims arising from any acts or omissions of the Manager made in good faith in
the performance of its duties under the Management Agreement and not
constituting bad faith, willful misconduct, gross negligence or reckless
disregard of its duties. The Management Agreement does not limit or restrict the
right of the Manager or any of its officers, directors, employees or affiliates
to engage in any business or to render services of any kind to any other person,
including the purchase of, or rendering advice to others purchasing Mortgage
Assets which meet the Company's policies and criteria, except that the Manager
and its officers, directors or employees will not be permitted to provide for
any such services to any residential mortgage REIT, other than the Company or
another REIT sponsored by the Manager or its affiliates, which has operating
policies and strategies different in one or more material respects from those of
the Company, as confirmed by a majority of the independent directors of the
Company
Relationship between the Manager and the Company
In addition to the Management Agreement between the Manager and the
Company, the Manager also has limited rights in the shares of the Company's
common stock held by MDC REIT Holdings, LLC ("MDC-REIT") an intermediate holding
company. The Manager contributed $20 million in 1997 to MDC-REIT which used the
funds to acquire the shares of the Company's common stock. In exchange for its
contribution to MDC-REIT, the Manager received a senior right to receive
distributions from MDC-REIT equal to 5% per quarter of the capital contributed
by the Manager, compounded quarterly to the extent unpaid.
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After payment of the preference amount in full, the Manager has a right to
receive approximately 50% of any remaining distributions in repayment of its
capital contribution. The Manager has also been appointed to oversee the
day-to-day operations of MDC-REIT. However, after payment in full of its
preference amount and return of its capital contribution, the Manager will have
no further rights to distributions from MDC-REIT. MDC-REIT's sole asset is its
shares of the Company's common stock and its sole source of income is dividends
declared by the Company.
Management Fees
The Manager receives an annual base management fee payable monthly in
arrears of an amount representing the monthly portion of the per annum
percentage of "gross mortgage assets" of the Company and its subsidiaries. These
fees shall be applicable during the entire operational stage of the Company's
business. The Company pays to the Manager the following management fees and
incentive compensation:
- 1/8 of 1% per year, paid monthly (the "Agency Percentage"), of the
principal amount of Agency Securities;
- 3/8 of 1% per year, paid monthly (the "Non-Agency Percentage"), of the
principal amount of all other Mortgage Assets; and
- 25% of the amount by which the Company's net income (calculated prior to
deduction of this incentive compensation fee) exceeds the annualized
return on equity equal to the average Ten Year U.S. Treasury Rate plus
2%.
The term "gross mortgage assets" means for any month the aggregate book
value of the consolidated Mortgage Assets of the Company and its subsidiaries,
before allowances for depreciation or bad debts or other similar noncash
allowances, computed at the end of such month prior to any dividend distribution
made during each month.
The incentive compensation calculation and payment are made quarterly in
arrears. The term "Return on Equity" is calculated for any quarter by dividing
the Company's Net Income for the quarter by its Average Net Worth for the
quarter. For such calculations, the "Net Income" of the Company means the net
income of the Company determined in accordance with GAAP before the Manager's
incentive compensation, the deduction for dividends paid and net operating loss
deductions arising from losses in prior periods. A deduction for the Company's
interest expenses for borrowed money is taken when calculating Net Income.
"Average Net Worth" for any period means (i) $20,165,000 plus (ii) the
arithmetic average of the sum of the gross proceeds from any offering of its
equity securities by the Company, before deducting any underwriting discount and
commissions and other expenses and costs relating to the offering, plus the
Company's retained earnings (without taking into account any losses incurred in
prior periods and excluding amounts reflecting taxable income to be distributed
as dividends and amounts reflecting valuation allowance adjustments) computed by
taking the daily average of such values during such period. The definition
"Return on Equity" is used only for purposes of calculating the incentive
compensation payable, and is not related to the actual distributions received by
stockholders. The incentive compensation payments to the Manager are made before
any income distributions are made to the stockholders of the Company.
The Manager's base management fee is calculated by the Manager within 15
days after the end of each month, and such calculation is promptly delivered to
the Company. The Company is obligated to pay the amount of the final base
management fee in excess of the amount paid to the Manager at the beginning of
the month pursuant to the Manager's good faith estimate within 30 days after the
end of each month. The Company pays the incentive fee with respect to each
fiscal quarter within 15 days following the delivery to the Company of the
Manager's written statement setting forth the computation of the incentive fee
for such quarter. The Manager computes the annual incentive fee within 45 days
after the end of each fiscal year, and any required adjustments are paid by the
Company or the Manager within 15 days after the delivery of the Manager's
written computation to the Company.
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Termination Fees
The Company may elect to prevent the automatic renewal of the Management
Agreement by vote of both a majority of the Board of Directors and a majority of
the directors who are not executive officers or employees of the Company
followed by delivery of a written notice of non-renewal to the Manager at least
60 days prior to the end of the then-current period of the Management Agreement.
The Management Agreement shall terminate at the expiration of the then-current
period in which such notice of non-renewal is delivered. Upon non-renewal of the
Management Agreement without cause, a termination fee will be payable to the
Manager, in an amount equal to the greater of (i) the fair value of the
Management Agreement as established by an independent appraiser, or (ii) three
times the total of the base and incentive compensation fees paid to the Manager
for the four most recently completed calendar quarters ending on or prior to the
date of termination. In addition, the Company has the right to terminate the
Management Agreement at any time upon the occurrence of certain specified
events, after notice and an opportunity to cure, including a material breach by
the Manager of any provision contained in the Management Agreement. Upon such a
termination for cause, no termination fee will be payable to the Manager. In
December 1999, the Board of Directors unanimously agreed to extend the
management contract for one additional year. The next opportunity for the Board
to terminate the contract will be February 11, 2001. The Management Agreement
will terminate at the expiration of the then-current period in which such notice
of non-renewal is delivered.
Expenses
The Company pays all operating expenses, except those specifically required
to be borne by the Manager under the Management Agreement. The operating
expenses required to be borne by the Manager include the compensation and other
employment costs of the Manager's officers in their capacities as such and the
cost of office space and out-of-pocket costs, equipment and other personnel
required for performance of the Company's day-to-day operations. The expenses
that are paid by the Company will include issuance and transaction costs
incident to the acquisition, disposition and financing of investments, regular
legal and auditing fees and expenses, the fees and expenses of the Company's
directors, premiums for directors' and officers' liability insurance, premiums
for fidelity and errors and omissions insurance, subservicing expenses, the
costs of printing and mailing proxies and reports to stockholders, and the fees
and expenses of the Company's custodian and transfer agent, if any. The Company,
rather than the Manager, is also required to pay expenses associated with
litigation and other extraordinary or non-recurring expenses. Expense
reimbursements are made monthly.
Salary Reimbursements
The Company employs certain employees of the Manager involved in the
day-to-day operations of the Company, including the Company's executive
officers, so that such employees may maintain certain benefits that are
available only to employees of the Company under the Code. These benefits
include the ability to receive incentive stock options under the 1997 Stock
Option Plan and to participate in the Company's Employee Stock Purchase Plan. In
order to receive the aggregate benefits of the Management Agreement originally
negotiated between the Company and the Manager, the Company pays the base
salaries of such employees and is reimbursed quarterly by the Manager for all
costs incurred with respect to such payments. At December 31, 1999 the Company
had advanced approximately $273,000 to the Manager for payroll advances.
BUSINESS RISKS
Interest Rate Increases May Reduce Income From Operations
The majority of the Company's Mortgage Loans have a repricing frequency of
two years or less, while substantially all of the Company's borrowings have a
repricing frequency of one month or less. Accordingly, the interest rates on the
Company's borrowings may be based on interest rate indices which are different
from, and adjust more rapidly than, the interest rate indices of its related
Mortgage Loans. Consequently, increases in (short term) interest rates may
significantly influence the Company's net interest income. While increases in
short term interest rates will increase the yields on a portion of the Company's
adjustable-rate Mortgage
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Loans, rising short term rates will also increase the cost of borrowings by the
Company. To the extent such costs rise more than the yields on such Mortgage
Loans, the Company's net interest income will be reduced or a net interest loss
may result. The Company mitigates some of its "gap" risk by purchasing interest
rate hedges (referred to as "caps"), however potential income from these hedges
may only partially offset the adverse impact of rising borrowing costs.
The value of retained interest in securitization could be adversely
impacted by increases in short term interest rates which may negatively impact
the Company's financial condition and results of operations.
High Levels of Mortgage Asset Prepayments Will Reduce Operating Income
The level of prepayments of mortgage assets purchased with a premium by the
Company directly impacts the level of amortization of capitalized premiums.
Mortgage Asset prepayment rates generally increase when new Mortgage Loan
interest rates fall below the current interest rates on Mortgage Loans.
Prepayment experience also may be affected by the expiration of prepayment
penalty clauses, the ability of the borrower to obtain a more favorable Mortgage
Loan, geographic location of the property securing the adjustable-rate Mortgage
Loans, the assumability of a Mortgage Loan, conditions in the housing and
financial markets and general economic conditions. The level of prepayments is
also subject to the same seasonal influences as the residential real estate
industry with prepayment rates generally being highest in the summer months and
lowest in the winter months. The Company experienced high levels of prepayments
during 1999 on its CMO/FASIT segment of its Mortgage Loan portfolio due
principally to the fact that the underlying adjustable rate loans were subject
to their first initial interest rate adjustment (after being fixed for the first
two years), prepayment penalty clauses were expired and borrowers were able to
secure more favorable rates by refinancing. The Company anticipates that overall
prepayment rates are likely to continue at relatively high levels for an
indefinite period on the CMO/FASIT segment of the portfolio, and that prepayment
rates will increase on the other segments of the Mortgage Loan portfolio as the
underlying loans are subject to rate increases and prepayment penalties expire.
There can be no assurance that the Company will be able to achieve or maintain
lower prepayment rates or that prepayment penalty income will offset premium
amortization expense. Accordingly, the Company's financial condition and results
of operations could be materially adversely affected.
As of December 31, 1999 approximately 76% of the Mortgage Loan portfolio
had prepayment penalty clauses, with a weighted average of 20 months remaining
before prepayment penalties expire. Prepayment penalty clauses serve as a
deterrent to early prepayments and the penalties collected help to offset the
premium amortization expense. However, prepayment penalty fees may be in an
amount which is less than the figure which would fully compensate the Company
for its remaining capitalized premiums, and prepayment penalty provisions may
expire before the prepayment occurs.
Borrower Credit May Decrease Value of Mortgage Assets
During the time the Company holds Mortgage Loans Held-for-Investment, Bond
Collateral or Retained Interest in Securitizations it is subject to credit
risks, including risks of borrower defaults, bankruptcies and special hazard
losses that are not covered by standard hazard insurance (such as those
occurring from earthquakes or floods). In the event of a default on any Mortgage
Loan held by the Company or mortgage underlying Retained Interest in
Securitization, the Company will bear the risk of loss of principal to the
extent of any deficiency between the value of the secured property and the
amount owing on the Mortgage Loan, less any payments from an insurer or
guarantor. Although the Company has established an allowance for Mortgage Loan
losses, in view of its limited operating history and lack of experience with the
Company's current Mortgage Loans, and Mortgage Loans that it may acquire, there
can be no assurance that any allowance for Mortgage Loan losses which is
established will be sufficient to offset losses on Mortgage Loans in the future.
Credit risks associated with non-conforming Mortgage Loans, especially
sub-prime Mortgage Loans, may be greater than those associated with Mortgage
Loans that conform to Fannie Mae ("FNMA") and Freddie Mac ("FHLMC") guidelines.
The principal difference between sub-prime Mortgage Loans and conforming
Mortgage Loans typically include one or more of the following: worse credit and
income histories of the
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mortgagors, higher loan-to-value ratios, reduced or alternative documentation
required for approval of the mortgagors, different types of properties securing
the Mortgage Loans, higher loan sizes and the mortgagor's non-owner occupancy
status with respect to the mortgaged property. As a result of these and other
factors, the interest rates charged on non-conforming Mortgage Loans are often
higher than those charged for conforming Mortgage Loans. The combination of
different underwriting criteria and higher rates of interest may lead to higher
delinquency rates and/or credit losses for non-conforming as compared to
conforming Mortgage Loans and thus require high loan loss allowances. All of the
Company's Mortgage Loans at December 31, 1999 were originated as sub-prime
Mortgage Loans.
Even assuming that properties secured by the Mortgage Loans held by the
Company provide adequate security for such Mortgage Loans, substantial delays
could be encountered in connection with the foreclosure of defaulted Mortgage
Loans, with corresponding delays in the receipt of related proceeds by the
Company. State and local statutes and rules may delay or prevent the Company's
foreclosure on or sale of the mortgaged property and typically prevent the
Company from receiving net proceeds sufficient to repay all amounts due on the
related Mortgage Loan.
Defaulted Mortgage Loans also cease to be eligible collateral for reverse
repurchase borrowings, and therefore have to be financed by the Company from
other funds until ultimately liquidated. The Company attempts to mitigate this
risk by utilizing long-term financing vehicles. At December 31, 1999, 10.9% of
the Company's borrowings for Mortgage Assets were in the form reverse repurchase
borrowings
Accumulation Risk Associated with Mortgage Loans Held-for-Investment
At various points in time, the Company purchases and holds Mortgage Loans
which are primarily financed with short-term reverse repurchase agreements.
Typically mortgages are accumulated for one to six months and then securitized
and transferred into Bond Collateral. During the accumulation period the loans
are financed with short-term reverse repurchase agreements. Although the reverse
repurchase agreements are committed, lenders have the right to mark the mortgage
collateral to market and potentially increase the Company's cash equity
investment in the mortgage collateral. During periods of rising interest rates
or turbulent market conditions, the market value of these loans may be adversely
impacted. At December 31, 1999 there were 1,006 Mortgage Loans with a principal
balance of $122.0 million being financed by short-term reverse repurchase
agreements.
Inability to Acquire Mortgage Assets
The Company's net interest income will depend, in large part, on the
Company's ability to acquire Mortgage Assets on acceptable terms and at
favorable spreads over the Company's borrowing costs. There can be no assurance
that the Company will be able to replenish the Mortgage Asset portfolio as
prepayments occur. In acquiring Mortgage Assets, the Company will compete with
numerous other financial institutions. The effect of the existence of these
competitors may be to increase competition for the available supply or price of
Mortgage Assets suitable for purchase by the Company. There can be no assurance
that the Company will be able to successfully compete with its competition.
To the extent that the Company is unable to fully invest in a sufficient
amount of Mortgage Loans meeting its criteria, the Company's results of
operations will be materially adversely affected.
The Company may acquire Mortgage Assets with geographic, originators,
insurer and other types of concentrations. Accordingly, a significant portion of
the Company's Mortgage Assets may be subject to the risks associated with a
single type of occurrence. In the event of such an occurrence, the adverse
effects on the Company's results of operations will be significantly greater
than if the Company's Mortgage Assets were diversified with respect to such
factors.
The Company's ability to acquire Mortgage Assets is also dependent on the
availability of financing to fund these acquisitions. See "Failure to Renew or
Obtain Adequate Funding May Adversely Affect Results of Operations.
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Prepayments, Credit Losses and Increases in Short term Interest May Adversely
Affect the Value of Retained Interest in Securitization
In 1998, the Company diversified its residential Mortgage Loan sales
activities to include the securitization of such loans through a Real Estate
Mortgage Investment Conduit ("REMIC"). The REMIC consisted of pooled, first-lien
mortgages and was issued by Holdings to the public through a registration
statement of an underwriter. The interest-only strip referred to as the Class
"X" Certificate was created in the process of the securitization and transferred
from Holdings to Eagle. The value of this investment is impacted by the level of
future prepayments, credit loss and net interest spread on the underlying
mortgages. A decline in the value of this investment could adversely affect the
Company's financial condition and results of operations.
Failure to Successfully Manage Interest Rate Risks May Adversely Affect
Results of Operations
The Company will follow a program intended to protect against interest rate
changes. However, developing an effective interest rate risk management strategy
is complex and no management strategy can completely insulate the Company from
risks associated with interest rate changes. In addition, hedging involves
transaction costs. In the event the Company hedges against interest rate risks,
the Company may substantially reduce its net income. Further, the federal tax
laws applicable to REITs may limit the Company's ability to fully hedge its
interest rate risks. Such federal tax laws may prevent the Company from
effectively implementing hedging strategies that, absent such restrictions,
would best insulate the Company from the risks associated with changing interest
rates. See "Business -- Risk Management -- Interest Rate Risk Management."
Currently, the Company has entered into hedging transactions which seek to
protect only against gap risk associated with significant increases in interest
rates Accordingly, the Company may not be adequately protected against risks
associated with interest rate increases and such increases could adversely
affect the Company's financial condition and results of operations.
In the event that the Company purchases interest rate caps or other
interest rate derivatives to hedge against gap risk, basis risk or lifetime,
periodic rate or payment caps, and the provider of such caps on interest rate
derivatives becomes financially unsound or insolvent, the Company may be forced
to unwind such caps on its interest rate derivatives with such provider and may
take a loss thereon. The Company intends to purchases interest rate caps and
derivatives only from financially sound institutions and monitors the financial
strength of such institutions on a periodic basis, but no assurance can be given
that the Company can avoid such third party risks.
Failure to Renew or Obtain Adequate Funding May Adversely Affect Results of
Operations
The Company currently relies on short term borrowings to fund the initial
acquisitions of Mortgage Loans. Accordingly, the ability of the Company to
achieve its investment objectives depends on its ability (i) to borrow money in
sufficient amounts and on favorable terms, (ii) to renew or replace on a
continuous basis its maturing short term borrowings and (iii) to successfully
leverage its Mortgage Assets. In addition, the Company is dependent upon a few
lenders to provide the primary credit facilities for its purchases of Mortgage
Assets. Any failure to obtain or renew adequate funding under these facilities
or other financings on favorable terms, could reduce the Company's net interest
income and have a material adverse effect on the Company's operations. The
Company's reverse repurchase financing facility expires within one year. The
Company expects to renew this facility and obtain additional financing from
other sources. There can be no assurances that this facility will be renewed.
In the event the Company is not able to renew or replace maturing
short-term borrowings, the Company could be required to sell Mortgage Loans
Held-for-Investment under adverse market conditions and could incur losses as a
result. Any event or development, such as a sharp rise in interest rates or
increasing market concern about the value or liquidity of a type or types of
Mortgage Assets in which the Company's Mortgage Asset portfolio is concentrated,
will reduce the market value of the Mortgage Assets, which would likely cause
lenders to require additional collateral.
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Due to the underlying loan to collateral values established by the
Company's lenders, the Company may be subject to calls for additional capital in
the event of adverse market conditions. Such conditions include (i) higher than
expected levels of prepayments on Mortgage Loans and (ii) sudden increases in
interest rates. Although its long-term financing agreements are non-recourse,
net interest income from the Bond Collateral can be "trapped" to pay down debt
in order for the Company to maintain its collateral value requirements. As such,
the Company would not be able to use this income to purchase loans or pay
dividends. There can be no assurances that the Company will not be required to
reduce or cease new loan purchases activity or dividends should it be required
to divert cash flow to maintain collateral requirements. See
"Business -- Funding," and "-- Capital Guidelines."
The Company is not subject to statutory, regulatory or third party
limitations on incurring debt. Accordingly, there are no restrictions on the
Company's ability to incur debt and there can be no assurance that the level of
debt that the Company incurs will not be increased by the Board of Directors.
See "Policies and Strategies May Be Revised at the Discretion of the Board of
Directors."
The Company has historically relied upon securitization as a means of
securing long-term debt. There can be no assurances that this asset-backed
securitization vehicle will be available to the Company in the future.
Investments in Mortgage Assets May Be Illiquid
Although the Company expects that a majority of the Company's investments
will be in Mortgage Assets for which a resale market exists, certain of the
Company's investments may lack a regular trading market and may be illiquid. In
addition, during turbulent market conditions, the liquidity of all of the
Company's Mortgage Assets may be adversely impacted. There is no limit to the
percentage of the Company's investments that may be invested in illiquid
Mortgage Assets. In the event the Company requires additional cash as a result
of a margin call pursuant to its financing agreements or otherwise, the Company
may be required to liquidate Mortgage Assets on unfavorable terms. The Company's
inability to liquidate Mortgage Assets could render it insolvent.
Loans Serviced by Third Parties
All of the Company's Mortgage Loans are serviced by subservicers. The
Company continually monitors the performance of the subservicers through
performance reviews, comparable statistics for delinquencies and on-site visits.
The Company has on occasion determined that subservicers have not followed
standard collection and servicing practices related to the Company's Mortgage
Loans which the Company believes have lead to increased delinquencies and higher
loan losses on selected defaulted Mortgage Loans segments. The Company and the
Manager continue to monitor these servicers, have put these entities on notice
of such deficiencies, and has instituted other mitigating processes. The Company
has arranged for servicing with entities that have particular expertise in
non-conforming Mortgage Loans. Although the Company has established these
relationships and procedures, there can be no assurance that these subservicers
will service the Company's Mortgage Loans in such a way as to minimize
delinquency rates and/or credit losses and not cause an adverse effect on the
Company's results of operations.
The Direct Origination of Residential Mortgages is Subject to A Variety of
Business Risks Including Overhead Exposure, Regulatory Oversight, Competition
and Possible Interest Rate Exposure Associated With Commitments to Fund
Mortgages
The Company intends to begin originating Mortgage Loans during 2001. The
business of originating Mortgage Loans is subject to various risks such as
overhead costs that may not be offset by origination fees and revenues, risks
associated with non-compliance with various sate and federal laws covering
mortgage lending practices, disclosures and loan documentation, pressure on
profit margins caused by a very competitive mortgage marketplace, and potential
exposure to interest rate risk in the event that the Company makes commitments
to borrowers to fund loans at a certain interest rate and prevailing interest
rates increase. The Company and the Manager intend to use the extensive
experience and skill of its executive team and
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employees, and to hire additional highly experienced staff, to manage all of the
risks inherent in originating mortgages, but there can be no such assurances
that all of these risks will be fully mitigated..
The Management Agreement does not limit or restrict the right of the
Manager or any of its officers, directors, employees or affiliates to engage in
any business or to render services of any kind to any other person, including
purchasing, or rendering advice to others purchasing, Mortgage Assets which meet
the Company's policies and criteria, except that the Manager and its officers,
directors, or employees will not be permitted to provide any such services to
any REIT which invests primarily in residential Mortgage Assets, other than the
Company.
Characteristics of Underlying Property May Decrease Value of Mortgage Loans
Although the Company intends to seek geographic diversification of the
properties which are collateral for the Company's Mortgage Loans, it does not
intend to set specific diversification requirements (whether by state, zip code
or other geographic measure). Concentration in any one geographic area will
increase the exposure of the Company's Mortgage Assets to the economic and
natural hazard risks associated with that area.
Certain properties securing Mortgage Loans may be contaminated by hazardous
substances resulting in reduced property values. If the Company forecloses on a
defaulted Mortgage Loan collateralized by such property, the Company may be
subject to environmental liabilities regardless of whether the Company was
responsible for the contamination. The results of the Company's Mortgage Loan
acquisition program may also be affected by various factors, many of which are
beyond the control of the Company, such as (i) local and other economic
conditions affecting real estate values, (ii) interest rate levels and the
availability of credit to refinance such Mortgage Loans at or prior to maturity,
and (iii) increased operating costs, including energy costs, real estate taxes
and costs of compliance with regulations.
Default of Manager under Securities Purchase Agreement; Restrictive Covenants
In connection with the private financing of the Manager and the Company,
the Company, the Manager and MDC-REIT entered into a Securities Purchase
Agreement dated as of February 11, 1997 (the "Securities Purchase Agreement")
with the institutional investors therein (the "Investors") providing for, among
other things, the purchase by the Investors of senior secured notes of the
Manager due February 11, 2002 (the "Notes"). Pursuant to the Securities Purchase
Agreement, the Company must comply with various covenants, including covenants
restricting the Company's investment, hedging and leverage policies, leverage
ratio and indebtedness levels, and business and tax status. These restrictions
may limit the Company's ability to adequately respond to changing market
conditions, even when such changes may be in the best interest of the Company,
which could have a material adverse effect on the Company's financial condition
and results of operations.
The Manager's default on its obligations with respect to the Notes, could
result in a default and termination of the Management Agreement, in which case
the operations of the Company could be materially and adversely affected pending
either the engagement of a new manager or the development internally of the
resources necessary to manage the operation of the Company. The Manager is
currently in default of its covenants. The senior note holders have not issued
waivers, however the parties continue to operate under the terms of the
Management Agreement. In addition, MDC-REIT has pledged 1.6 million shares of
its common stock of the Company to secure the Manager's obligations under the
Securities Purchase Agreement. As a result of the defaults under the Securities
Purchase Agreement, the pledged shares could be transferred to the holders of
the Notes, who will then have certain demand registration rights.
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EXECUTIVE OFFICERS OF THE COMPANY
The following table presents certain information concerning the executive
officers of the Company:
NAME AGE POSITION(1)
---- --- -----------
John M. Robbins(2)................ 52 Chairman of the Board, Chief Executive Officer
Jay M. Fuller(2).................. 49 President, Chief Operating Officer
Judith A. Berry................... 46 Executive Vice President and
Chief Financial Officer
Rollie O. Lynn.................... 45 Senior Vice President, Capital Markets
Lisa S. Faulk..................... 41 Senior Vice President, Operations
- ---------------
(1) Each executive officer holds the same position with the Manager.
(2) Mr. Robbins and Mr. Fuller are founders of the Company.
JOHN M. ROBBINS has served as Chairman of the Board of Directors and Chief
Executive Officer and Director of the Company since its formation in February
1997. Prior to joining the Company, Mr. Robbins was Chairman of the Board of
American Residential Mortgage Corporation from 1990 until 1994 and President of
American Residential Mortgage Corporation from the time he co-founded it in 1983
until 1994. He also served as Executive Vice President of Imperial Savings
Association from 1983 to 1987. Mr. Robbins has worked in the mortgage banking
industry since 1973. Mr. Robbins has served two terms on the Board of Governors
and the Executive Committee of the Mortgage Association of America and was
appointed to its first Board of Directors. He has also served on FNMA's National
Advisory Board. Mr. Robbins is currently a director of Garden Fresh Restaurant
Corporation, Accredited Home Lenders and is a trustee of the University of San
Diego.
JAY M. FULLER has served as President, Chief Operating Officer and Director
of the Company since its formation in February 1997. Prior to joining the
Company Mr. Fuller served as President of Victoria Mortgage from 1995 to 1996.
Mr. Fuller was an Executive Vice President and Chief Administration Officer of
American Residential Mortgage Corporation from 1985 to 1994 and Senior Vice
President from 1983 to 1985. In these capacities, at various times, Mr. Fuller
was responsible for, among other things, Mortgage Loan originations and
servicing for American Residential Mortgage Corporation. Mr. Fuller has worked
in the mortgage banking industry continuously since 1975. Mr. Fuller currently
serves on the Board of Directors of Friends of Santa Fe Christian Schools.
JUDITH A. BERRY has served as Executive Vice President and Chief Financial
Officer of the Company since June, 1999. From 1996 to 1999 Ms. Berry was
President of Directors Acceptance, the Subprime Mortgage Division of Norwest
Mortgage, Inc. Ms. Berry was Executive Vice President and Chief Financial
Officer of American Residential Mortgage Corporation from 1989 to 1994. Between
1984 and 1989, she was Senior Vice President of Acquisitions and New Business
Development for American Residential Mortgage Corporation. Ms. Berry was an
audit manager for Arthur Young, now Ernst & Young from 1978 to 1984. Ms. Berry
received a BS in Business Administration from San Diego State University in 1977
and is a Certified Public Accountant in California.
ROLLIE O. LYNN has served as Senior Vice President, Capital Markets,
responsible for the areas of portfolio management for the Company since its
formation in February 1997. Prior to joining the Company, Mr. Lynn served as
Vice President, Capital Markets, of Long Beach Mortgage Company responsible for
managing, hedging and trading the firm's non-conforming residential Mortgage
Loans. Prior to joining Long Beach Mortgage, Mr. Lynn served as Vice President,
Secondary Marketing, of American Residential Mortgage Corporation from 1991 to
1994, as Vice President, Capital Markets, of Imperial Savings from 1988 to 1992,
and as Vice President of Great American First Savings Bank of San Diego from
1985 to 1988. Mr. Lynn has worked in the mortgage banking business continuously
since 1977. Mr. Lynn received two Bachelor of Arts degrees in 1976 from
California State University at Chico. Mr. Lynn is a licensed real estate broker
in California.
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LISA S. FAULK has served as Senior Vice President, Operations, of the
Company since October 1997. Prior to joining the Company, Ms. Faulk served as
Vice President, Conduit Underwriting, for Advanta Mortgage Corporation where she
managed the Conduit Division's underwriting, funding and processing functions in
the non-conforming credit markets. Ms. Faulk was Vice President, Manager Credit
Risk Review, for Homefed Bank, Federal Savings Bank from 1984 to 1993.
GLOSSARY
AS USED IN THIS FORM 10-K, THE CAPITALIZED AND OTHER TERMS LISTED BELOW
HAVE THE MEANINGS INDICATED.
"AGENCY SECURITIES" means mortgage participation certificates issued by
FHLMC, FNMA or GNMA. These securities entitle the holder to receive a
pass-through of principal and interest payments on the underlying pool of
Mortgage Loans and are issued or guaranteed by federal government sponsored
agencies.
"BASIS RISK" is the difference and timing of the index used to adjust the
interest rate (yield) on assets, and the index used to adjust the interest rate
on liabilities.
"CMO" means Collateralized Mortgage Obligation.
"CODE" means the Internal Revenue Code of 1986, as amended.
"COUPON RATE" means, with respect to Mortgage Assets, the annualized cash
interest income annually received from the asset, expressed as a percentage of
the face value of the asset.
"EARNING ASSETS" means, with respect to Mortgage Assets, the annualized
cash interest income actually received from the asset, expressed as a percentage
of the face value of the asset.
"EQUITY-FUNDED LENDING" means the portion of the Company's earning assets
acquired using the Company's equity capital.
"FASIT" means Financial Asset Securitization Investment Trust.
"FHLMC" means the Federal Home Loan Mortgage Corporation.
"FNMA" means the Federal National Mortgage Association.
"FULLY-INDEXED RATE" means, with respect to adjustable-rate Mortgage
Assets, the rate that would be paid by the borrower ("gross") or received by the
Company as owner of the Mortgage Assets ("net") if the coupon rate on the
adjustable-rate Mortgage Assets were able to adjust immediately to a market rate
without being subject to adjustment periods, periodic caps, or life caps. It is
equal to the current yield of the adjustable-rate Mortgage Assets index plus the
gross or net margin.
"GAP RISK" means the timing difference (mis-match) between the repricing of
interest rate sensitive assets and interest rate sensitive liabilities.
"GNMA" means the Government National Mortgage Association.
"INTEREST RATE ADJUSTMENT INDICES" means, in the case of Mortgage Assets,
any of the objective indices based on the market interest rates of a specified
debt instrument (such as United States Treasury Bills in the case of the
Treasury Index and United States dollar deposits in London in the case of LIBOR)
or based on the average interest rate of a combination of debt instruments (such
as the 11th District Cost of Funds Index), used as a reference base to reset the
interest rate for each adjustment period on the Mortgage Asset, and in the case
of borrowings, is used herein to mean the market interest rates of a specified
debt instrument (such as reverse repurchase agreements for Mortgage Securities)
as well as any of the objective indices described above that are used as a
reference base to reset the interest rate for each adjustable period under the
related borrowing instrument.
"INTEREST RATE ADJUSTMENT PERIOD" means, in the case of Mortgage Assets,
the period of time set forth in the debt instrument that determines when the
interest rate is adjusted and, with respect to borrowings, is used to mean the
term to maturity of a short term, fixed-rate debt instrument (such as a 30-day
reverse repurchase
26
29
agreement) as well as the period of time set forth in a long term,
adjustable-rate debt instrument that determines when the interest rate is
adjusted.
"LIFETIME INTEREST RATE CAP" or "LIFE CAP" means the maximum coupon rate
that may accrue during any period over the term of an adjustable-rate Mortgage
Loan or, in the case of a Mortgage Security, the maximum weighted average coupon
rate that may accrue during any period over the term of such Mortgage Security.
"LIQUIDITY CAPITAL CUSHION" is a term defined in the Company's Capital
Policy. It represents a portion of the capital the Company is required to
maintain as part of this policy in order to continue to make asset acquisitions.
The liquidity capital cushion is that part of the required capital base which is
in excess of the Company's haircut requirements.
"MORTGAGE ASSETS" means Mortgage Securities, Mortgage Loans
Held-for-Investment and Bond Collateral.
"MORTGAGE LOANS" means Mortgage Loans secured by residential or mixed use
properties.
"MORTGAGE SECURITIES" means Agency Mortgage-Backed Securities and Privately
Issued Mortgage-Backed Securities.
"NONCONFORMING MORTGAGE LOANS" means conventional single-family and
multifamily Mortgage Loans that do not conform to one or more requirements of
CHLMC or FNMA for participation in one or more of such agencies' mortgage loss
credit support programs.
"PERIODIC INTEREST RATE CAP" or "PERIODIC CAP" means the maximum change in
the coupon rate permissible under the terms of the loan at each coupon
adjustable date. Periodic caps limit both the speed by which the coupon rate can
adjust upwards in a rising interests rate environment and the speed by which the
coupon rate can adjust downwards in a falling rate environment.
"PRIVATELY ISSUED SECURITIES" means mortgage participation certificates
issued by certain private institutions. These securities entitle the holder to
receive a pass-through of principal and interest payments on the underlying pool
of Mortgage Loans and are issued or guaranteed by the private institution.
"REIT PROVISIONS OF THE CODE" means sections 856 through 860 of the Code.
"REMIC" means Real Estate Mortgage Investment Conduit.
"SPREAD LENDING" means the portion of the Company's earning assets acquired
using borrowed funds.
"TEN YEAR U.S. TREASURY RATE" for a quarterly period shall mean the
arithmetic average of the weekly per annum Ten Year Average Yields published by
the Federal Reserve Board during such quarter. In the event that the Federal
Reserve Board does not publish a weekly per annum ten Year Average Yield during
any week in a quarter, then the Ten Year U.S. Treasury Rate for such week shall
be the weekly per annum Ten Year Average Yield published by any Federal Reserve
Bank or by any U.S. Government department or agency selected by the Company for
such week. In the event that the Company determines in good faith that for any
reason the Company cannot determine the Ten Year U.S. Treasury Rate for any
quarter as provided above, then the Ten Year U.S. Treasury Rate for such quarter
shall be the arithmetic average of the Per Annum average yields to maturity
based upon the daily closing bids during such quarter for each of the issues of
actively traded marketable U.S. treasury fixed interest rate securities (other
than securities which can, at the option of the holder, be surrendered at face
value in payment of any federal estate tax) with a final maturity date not less
than eight nor more than twelve years from the date of each such quotation, as
chosen and for each business day or less frequently if daily quotations shall
not be generally available in each such quarterly period in New York City and
quoted to the Company by at least three recognized dealers in U.S. Government
securities selected by the Company.
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30
ITEM 2. PROPERTIES
The Company's and the Manager's executive offices are located at 445 Marine
View Avenue, Suite 230, Del Mar, California. The Company and the Manager
currently occupy approximately 7,000 square feet of space. The Manager leases
facilities pursuant to a lease expiring in April 1, 2000. The cost for this
space for the year ended December 31, 1999, was approximately $166,000.
Management believes that these facilities are adequate for the Company's and the
Manager's foreseeable needs.
ITEM 3. LEGAL PROCEEDINGS
At December 31, 1999, there were no material pending legal proceedings to
which the Company was a party or of which any of its property was subject.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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31
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock began trading on October 29, 1997 and is traded
on the New York Stock Exchange under the trading symbol INV. As of December 31,
1999, the Company had 8,055,500 shares of common stock issued and outstanding
which was held by 53 holders of record.
The following table sets forth, for the periods indicated, the high, low
and closing sales prices per share of common stock as reported on the New York
Stock Exchange composite tape common stock.
STOCK PRICES
--------------------
HIGH LOW CLOSE
---- --- -----
1999
Year ended December 31, 1999................................ 8 3/4 5 7/16 6 7/8
Fourth quarter ended December 31, 1999...................... 8 3/4 5 1/2 6 7/8
Third quarter ended September 30, 1999...................... 8 3/8 7 1/16 8 3/8
Second quarter ended June 30, 1999.......................... 8 1/2 7 1/16 7 3/8
First quarter ended March 31, 1999.......................... 8 1/4 5 7/16 8 1/4
1998
Year ended December 31, 1998................................ 14 5/16 3 3/4 5 3/8
Fourth quarter ended December 31, 1998...................... 6 1/4 3 3/4 5 3/8
Third quarter ended September 30, 1998...................... 10 5/32 4 7/8 6 1/4
Second quarter ended June 30, 1998.......................... 12 11/16 9 9 11/16
First quarter ended March 31, 1998.......................... 14 5/16 11 5/16 12
1997
Fourth quarter ended December 31, 1997...................... 16 5/8 11 7/16 11 7/8
The Company intends to pay quarterly dividends and to make such
distributions to its stockholders in amounts such that all or substantially all
of its taxable income (subject to certain adjustments) is distributed so as to
qualify for the tax benefits accorded to a REIT under the Code. However, net
earnings on a GAAP basis differs from taxable income primarily due to net
earnings on a GAAP basis being based on the accrual method of accounting while
taxable income more closely resembles cash flow. All distributions will be made
by the Company at the discretion of the Board of Directors and will depend on
the operations of the Company, financial condition of the Company, maintenance
of REIT status and such other factors as the Board of Directors may deem
relevant from time to time.
The following table sets forth, for the periods indicated, the dividends
paid in 1997, 1998, 1999 and 2000:
CASH DIVIDEND
- -----------------------------------------------------------
DATE AMOUNT
DECLARED DATE PAID PER SHARE
-------- --------- ---------
12/16/99 1/31/00........................ 0.30
10/21/99 11/8/99........................ 0.27
7/21/99 8/6/99......................... 0.25
4/22/99 5/10/99........................ 0.20
12/17/98 1/28/99........................ 0.15
10/15/98 11/2/98........................ 0.12
7/14/98 7/31/98........................ 0.28
4/14/98 4/30/98........................ 0.28
12/19/97 1/21/98........................ 0.16
10/21/97 10/29/97....................... 0.32
7/17/97 7/17/97........................ 0.27
5/1/97 5/1/97......................... 0.09
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ITEM 6. SELECTED FINANCIAL DATA
The following selected Statement of Operations and Balance Sheet data as of
December 31, 1999, 1998 and 1997, and for the years ended December 31, 1999 and
1998 and for the period from February 11, 1997 (commencement of operations)
through December 31, 1997, has been derived from the Company's consolidated
financial statements audited by KPMG LLP, independent auditors, whose report
with respect thereto appears on page F-2. Such selected financial data should be
read in conjunction with those consolidated financial statements and the
accompanying notes thereto and with "Management's Discussion and Analysis of
Financial Conditions and Results of Operations" also included elsewhere herein.
FOR THE PERIOD FROM
FEBRUARY 11, 1997
(COMMENCEMENT OF
FOR THE FOR THE OPERATIONS)
YEAR ENDED YEAR ENDED THROUGH
DECEMBER 31, 1999 DECEMBER 31, 1998 DECEMBER 31, 1997
----------------- ----------------- -------------------
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
STATEMENT OF OPERATIONS DATA:
Total interest income....................... $ 79,119 $ 68,407 $ 14,096
Total interest expense...................... 49,644 45,190 9,517
Premium amortization........................ 16,625 13,311 1,797
Premium write-down.......................... 12,294 -- --
Provision for loan losses................... 3,650 3,470 --
Loss on sale of mortgage-backed
securities............................... -- 5,912 --
Operating expenses.......................... 5,205 4,082 379
Net income (loss)........................... (3,850) (1,214) 2,403
Net income (loss) per share of common
stock -- basic........................... (0.48) (0.15) 0.83
Net income (loss) per share of common
stock -- diluted......................... (0.48) (0.15) 0.82
Weighted average number of
shares -- basic.......................... 8,055,500 8,090,772 2,879,487
Weighted average number of
shares -- diluted........................ 8,055,500 8,090,772 2,929,009
Dividends declared per share................ 1.02 0.83 0.84
Noninterest expense as percent of average
assets................................... 0.90% 2.21% 0.13%
AS OF AS OF AS OF
DECEMBER 31, 1999 DECEMBER 31, 1998 DECEMBER 31, 1997
----------------- ----------------- -----------------
(DOLLARS IN THOUSANDS)
BALANCE SHEET DATA:
Mortgage securities available-for-sale, net.... $ -- $ 6,617 $387,099
Mortgage loans held-for-investment, net,
pledged...................................... 126,216 179,009 162,762
Bond collateral, mortgage loans................ 1,153,731 417,808 --
Total assets................................... 1,313,342 656,772 561,834
Short-term debt................................ 119,003 166,214 451,288
Long-term debt, net............................ 1,103,258 385,290 --
Stockholders' equity........................... 86,854 101,971 106,569
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The statements contained in this Form 10-K that are not purely historical
are forward looking statements, including statements regarding the Company's
expectations, hopes, beliefs, intentions, or strategies regarding the future.
Statements which use the words "expects", "will", "may", "anticipates", "goal",
"intends", "seeks", "strategy" and derivatives of such words are forward looking
statements. These forward looking statements, including statements regarding
changes in the Company's future income, Mortgage Asset portfolio, financings,
plans to create origination capability, ways the Company may seek to grow
income, management expectations regarding future provisions for loan losses, and
the Company's belief in the adequacy of loan losses, are based on information
available to the Company on the date hereof, and the Company assumes no
obligation to update any such forward looking statement. It is important to note
that the Company's actual results could differ materially from those in such
forward looking statements. Among the factors that could cause actual results to
differ materially are the factors set forth under item 1 under the heading
"Business Risks". In particular, the Company's future income could be affected
by interest rate increases, high levels of prepayments, Mortgage Loan defaults,
reductions in the value of retained interest in securitizations, and inability
to acquire or finance new Mortgage assets.
OVERVIEW
The Company's revenue primarily consists of interest income generated from
its Mortgage Assets and its cash and investment balances (collectively, "earning
assets"), income generated by equity in income of American Residential Holdings,
Inc., management fees, and prepayment penalty income.
The Company funds its acquisitions of earning assets with both its equity
capital and with borrowings. For that portion of the Company's earning assets
funded with equity capital ("equity-funded lending"), net interest income is
derived from the average yield on earning assets. Due to the adjustable-rate
nature of the majority of its earning assets, the Company expects that income
from this source will tend to increase as interest rates rise and will tend to
decrease as interest rates fall, but only after the expiration of any initial
fixed teaser periods and then only periodically once or twice each year.
For that portion of the Company's earning assets funded with borrowings
("spread lending"), the resulting net interest income is a function of the
volume of spread lending and the difference between the Company's average yield
on earning assets and the cost of borrowed funds. Income from spread lending
will generally decrease following an increase in short term interest rates due
to increases in borrowing costs but a lag in adjustments to the earning asset
yields. Yields on adjustable rate loans generally adjust based on a short term
interest rate index, but the majority of the Company's earning assets are
adjustable rate loans which are subject to an initial fixed teaser period of 2
years, and then adjust periodically every six months. Income from spread lending
will generally increase following a fall in short term interest rates as
borrowing costs decline and downward adjustments to earning asset yields lag
behind. The Company purchases interest rate cap agreements to partially offset
the impacts of significant increases in short term interest rates and the loss
of spread income which occurs when borrowing rates (which generally adjust
monthly) increase more than earning asset yields (which generally adjust only
after the expiration of any fixed teaser periods and then only periodically,
once or twice a year).
The Company's primary expenses, beside its borrowing costs, are
amortization of loan purchase premiums, provision for loan losses, management
and administrative expenses and hedging costs. Premiums are amortized in
relation to actual portfolio repayments on each segment of the portfolio, so the
level of premium amortization expense is linked to the amount of capitalized
loan purchase premiums for each portfolio and the level of repayments in each
portfolio group. Management fees and administrative costs are generally based on
the size of the earning asset portfolio, and to a lesser degree, the level of
loan purchase activity. Hedging costs are based on size of the portfolio subject
to gap risk and the market prices for interest rate cap agreements.
During the fourth quarter of 1999 the Company recorded approximately $12.3
million write-down of its Bond Collateral, Mortgage Loans. The write-down was
related to a particular segment of the portfolio that had been purchased at a
significant premium and subsequently experienced high prepayments. This
write-down
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34
generated a net loss for 1999 of approximately $3.9 million but served to reduce
the un-amortized premiums on the portfolio from 7.17% at December 31, 1998 to
3.69% at December 31, 1999.
The Company may seek to generate growth in net income in a variety of ways,
including through (i) improving productivity by increasing the size of the
earning assets, (ii) changing the mix of Mortgage Asset types among the earning
assets and lowering premiums paid in an effort to improve returns and reduce the
Company's sensitivity to prepayments, (issuing new common stock and increasing
the size of the earning assets, and (iii) increasing the efficiency with which
the Company uses its equity capital over time by maintaining the Company's use
of debt when prudent and by issuing subordinated debt, preferred stock or other
forms of debt and equity. There can be no assurance, however, that the Company's
efforts will be successful or that the Company will increase or maintain its
income level.
Results of Operations
For the year ended December 31, 1999 the Company generated a net loss of
approximately $3.9 million and net loss per share of common stock diluted of
$0.48 compared to the year ended December 31, 1998 when the Company generated a
net loss of approximately $1.2 million and net loss per share of common
stock-diluted of $0.15. For the period February 11, 1997 (commencement of
operations) through December 31, 1997 the Company generated net income of
approximately $2.4 million and diluted net income per share of $0.82. The net
loss in 1999 was directly attributable to the write-down of premium on Bond
Collateral, Mortgage Loans in the amount of approximately $12.3 million. These
loans were purchased in 1997 when non-conforming loans were selling
significantly above par. The net loss in 1998 was directly attributable to the
loss on sale of Mortgage Securities available-for-sale and the provision for
loan losses. Due to market conditions in 1998, i.e. high prepayments, fueled by
declining interest rates and the need to lower leverage, the majority of the
Company's Mortgage Securities available-for-sale were sold during the fourth
quarter of 1998. This sale resulted in a loss of approximately $5.9 million.
The growth in Mortgage Asset interest income of $9.7 million and net
interest spread of $6.3 million between the years ended December 31, 1999 and
1998 was primarily due to an increase in the Company's Mortgage Assets held
during the year, higher asset yields due to a change in the composition of
Mortgage Assets, and, relative to net interest spread, offset by higher interest
expense associated with an increase in borrowings and an increase in borrowing
rates during the second half of 1999. The growth in Mortgage Asset interest
income of $53.7 million and net interest spread of 18.6 million between the year
ended December 31, 1998 and the period February 11, 1997 (commencement of
operations) through December 31, 1997, was also due to an increase in the
Company's Mortgage Assets held during the period and higher asset yields due to
a change in the composition of Mortgage Assets.
Net interest income decreased $9.4 million between the years ended December
31, 1999 and 1998 due to higher premium amortization and premium write-downs,
offset by the increase in net interest spread. Net interest income increased
$7.1 million between the year ended December 31, 1998 and the period February
11, 1997 (commencement of operations) through December 31, 1997. This increase
was due to an increase in the Company's Mortgage Assets held during the year.
Premium amortization expense represents the amortization of purchase
premiums paid for Mortgage Loans acquired in excess of the par value of the
loans. Actual repayment rates (the amount of principal repayments during a
period compared to the beginning principal balance) are applied to the remaining
unamortized premium to calculate amortization expense. Premium amortization
expense was approximately $16.6 million for the year ended December 31, 1999,
approximately $13.3 million for the year ended December 31, 1998, and
approximately $1.8 million for the period from February 11, 1997 (commencement
of operations) through December 31, 1997. Higher premium amortization expense is
due to growth in Bond Collateral and associated amortization of related purchase
premiums and higher levels of repayments in the CMO/FASIT segment of the Bond
Collateral portfolio, the oldest and most expensive portion of Mortgage Loans.
Additionally, increased levels of prepayments in the fourth quarter of 1999 on
the CMO/FASIT
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35
segment of Bond Collateral, Mortgage Loans lead to a premium write-down of $12.3
million in the fourth quarter of 1999. The following chart represents constant
repayment rates ("CPRs"):
CPR RATES
DECEMBER 31, 1999
--------------------------------------
LIFETIME SIX MONTHS THREE MONTHS
-------- ---------- ------------
Bond collateral:
CMO/FASIT 1998-1................................ 35.6% 50.6% 56.2%
CMO 1999-1...................................... 19.4 19.1 20.5
CMO 1999-2...................................... 12.6 -- 12.1
CMO/REMIC 1999-A................................ 12.8 -- 12.7
CPR RATES
DECEMBER 31, 1998
--------------------------------------
LIFETIME SIX MONTHS THREE MONTHS
-------- ---------- ------------
Bond collateral:
CMO/FASIT 1998-1................................ 24.6% 25.5% 27.6%
At December 31, 1999, unamortized premiums as a percentage of the remaining
principal amount of Bond Collateral, Mortgage Loans were 3.71%, as compared to
8.16% at December 31, 1998, primarily due to the writedown of premium on the
CMO/FASIT portfolio. The chart below provides a breakdown of prepayment coverage
and the weighted average months remaining until the next interest rate
adjustment for each segment of the Mortgage Loan portfolio:
AS OF DECEMBER 31, 1999
-----------------------------------------------------------------
WEIGHTED WEIGHTED
PERCENTAGE OF AVERAGE MONTHS AVERAGE
LOANS WITH REMAINING ON MONTHS UNTIL
PRINCIPAL PREPAYMENT PREPAYMENT INITIAL INTEREST
BALANCE PENALTIES COVERAGE* RATE ADJUSTMENT
---------- ------------- -------------- ----------------
(DOLLARS IN THOUSANDS)
Mortgage Loans Held-for-Investment... $ 122,036 86% 31 27
========== == == ==
Bond Collateral, Mortgage Loans:
CMO/FASIT 1998-1................... $ 210,584 52% 8 1
CMO 1999-1......................... 200,884 71 16 7
CMO 1999-2......................... 385,795 85 26 16
CMO/REMIC 1999-A................... 319,606 80 22 16
---------- -- -- --
$1,116,869 75% 20 11
========== == == ==
- ---------------
* Prepayment coverage is the number of months remaining before the prepayment
clause in the mortgage loan contracts expire and borrowers may prepay the loan
without prepayment penalty charges.
Most of the intermediate adjustable rate mortgages in the CMO/FASIT segment
of the Bond Collateral portfolio have reached their first contractual interest
rate adjustment (increase) and prepayment penalties on these loans have expired,
resulting in a higher probability of refinancing and principal prepayments. The
Company anticipates that prepayment rates on the newer Mortgage Loans will
increase as these predominately adjustable rate loans reach their initial
adjustments or when prepayment penalty clauses expire. There can be no assurance
that the Company will be able to achieve or maintain lower prepayment rates or
that prepayment rates will not increase. The Company's financial condition and
results of operations could be materially adversely affected if prepayments
continue at high levels. Net interest income, after premium amortization,
premium write-down and provision for loan losses, decreased 148.1% from
approximately $6.4 million in income for the year ended December 31, 1998 to a
loss of approximately $3.1 million for the year ended December 31, 1999 due
primarily to higher premium amortization and the premium write-down of
approximately $12.3 million, offset by higher net interest spread discussed
above. Net interest income, after premium amortization and provision for loan
losses, increased 131.3% from $2.8 million for the period February 11, 1997
(commencement of operations) through December 31, 1997, to $6.4 million for the
year
33
36
ended December 31, 1998, offset by higher premium amortization and provision for
loan loss, due to increases in net interest spread.
During 1999, other operating income increased approximately $2.1 million
over the year ended December 31, 1998 primarily due to an increase of
approximately $3.0 million in prepayment penalty income, and an increase in the
size of the Mortgage Loan portfolio and the proportion of loans with prepayment
penalties. This increase was offset by a decrease in equity in income of
American Residential Holdings, Inc. of approximately $945,000. This decrease is
due to the fact that no loan sales occurred in 1999 compared to a sale and REMIC
securitization in 1998 by American Residential Holdings, Inc. During 1998, the
Company generated prepayment penalty income of approximately $806,000 and
management fee income of approximately $420,000. There was no income from
prepayment penalty or management fees for the period February 11, 1997
(commencement of operations) through December 31, 1997.
For the year ended December 31, 1999, other expenses increased
approximately $1.1 million (excluding the loss on sale of Mortgage Securities
available-for-sale of approximately $5.9 million in 1998) over the year ended
December 31, 1998. During 1999 there was a loss on the sale of real estate owned
of $349,000 and management fees increased approximately $1.1 million as a result
of the Company's increase in Mortgage Loans. General and administrative expenses
decreased approximately $317,000 from the year ended December 31, 1998 to the
year ended December 31, 1999. Other expenses increased from $379,000 for the
period February 11, 1997 (commencement of operations) through December 31, 1997
to approximately $4.1 million for the year ended December 31, 1998 (excluding
the loss on sale of Mortgage Securities available-for-sale of approximately $5.9
million in 1998). The increase in general and administrative expenses between
the period February 11, 1997 (commencement of operations) through December 31,
1997, and the year ended December 31, 1998 is primarily the result of the
Company's increased management fees which resulted from the increase in the
Company's Mortgage Assets.
The Company held Mortgage Assets of approximately $1.3 billion as of
December 31, 1999, comprised of Mortgage Loans held-for-investment, net pledged,
of approximately $126.2 million and Bond Collateral, of approximately $1.2
billion. The Company held Mortgage Assets of approximately $603.4 million as of
December 31, 1998. Mortgage Assets at December 31, 1998 were comprised of
Mortgage Securities available-for-sale, of approximately $6.6 million, Mortgage
Loans held-for-investment, pledged, of approximately $179.0 million and Bond
Collateral, of approximately $417.8 million. This compares to Mortgage Assets
with a carrying value of approximately $549.9 million at December 31, 1997,
comprised of Mortgage Securities available-for-sale, of approximately $387.1
million, including approximately $3.3 million net unrealized loss recorded as of
the year end, and Mortgage Loans held-for-investment, pledged of approximately
$162.8 million.
Liquidity and Capital Resources
During the year ended December 31, 1999, net cash provided by operating
activities was approximately $27.7 million. The difference between net cash
provided by operating activities and the net loss of approximately $3.9 million
was primarily the result of amortization and write down of mortgage asset
premiums and provision for loan losses. During the year ended December 31, 1998,
net cash provided by operating activities was approximately $10.7 million. The
difference between net cash provided by operating activities and the net loss of
approximately $1.2 million was primarily the result of amortization of mortgage
asset premiums and provisions for loan losses. Both amortization of mortgage
premium and provisions for loan losses are non-cash charges. During the period
from February 11, 1997 (commencement of operations) through December 31, 1997,
net cash provided by operating activities was approximately $1.3 million. Net
cash provided by operating activities was negatively impacted by an increase in
accrued interest receivable, offset by an increase in accrued interest payable.
There were no Mortgage Assets held at February 11, 1997 and, therefore, the
total accrued interest receivables at December 31, 1997 negatively affected
cash. Net cash for the period was positively affected by an increase in accrued
interest payable, premium amortization, other accrued expenses, and management
fees payable.
34
37
Net cash used in investing activities for the year ended December 31, 1999
was approximately $717.2 million. Net cash used for the year was negatively
affected by the purchase of Mortgage Loans in the amount of approximately $990.6
million, and the purchase of interest rate cap agreements of approximately $1.7
million. Net cash used in investing activities for the year ended December 31,
1999 was positively affected by principal payments of approximately $266.2
million, sale of mortgage securities of approximately $3.2 million and proceeds
from the sale of real estate owned of approximately $5.6 million. Net cash used
in investing activities for the year ended December 31, 1998 was approximately
$74.9 million. Net cash used for the year was negatively affected by the
purchase of Mortgage Loans in the amount of approximately $649.6 million, the
purchase of the retained interest in securitization of approximately $6.7
million, and the purchase of interest rate cap agreements of approximately $1.0
million. Net cash used in investing activities for the year ended December 31,
1998 was positively affected by principal payments of approximately $250.8
million and sale of Mortgage Assets of approximately $331.3 million. Net cash
used in investing activities for the period from February 11, 1997 (commencement
of operations) through December 31, 1997 was approximately $555.5 million. Net
cash used for the period was negatively affected by the purchase of Mortgage
Assets in the amount of approximately $593.8 and positively affected by
principal prepayments of approximately $38,800.
For the year ended December 31, 1999, net cash provided by financing
activities was approximately $663.5 million offset by the payment of dividends
totaling $7 million. Net cash provided by financing activities was positively
affected by the issuance of long-term debt in the amount of approximately $958.3
million and an increase in net borrowings from long-term debt of approximately
$7.1 million. Net cash provided by financing activities was negatively impacted
by a decrease in net borrowings from reverse repurchase agreements of
approximately $47.2 million, payments on long-term debt of approximately $244.3
million and dividends paid of approximately $7.0 million. For the year ended
December 31, 1998, net cash provided by financing activities was approximately
$93.0 million offset by the payment of dividends totaling $6.8 million. Net cash
provided by financing activities was positively affected by the issuance of
long-term debt in the amount of approximately $457.0 million. Net cash provided
by financing activities was negatively impacted by a decrease in net borrowings
from reverse repurchase agreements of approximately $285.1 million, payments on
long-term debt of approximately $71.6 million, dividends paid of approximately
$6.8 million and purchase of the common stock of $492,000. For the period from
February 11, 1997 (commencement of operations) through December 31, 1997, net
cash provided by financing activities was $560.1 million offset by the payment
of dividends totaling $1.1 million. Net cash provided was primarily from
borrowings under reverse repurchase agreements and net proceeds received from
the issuance of common stock in the Company's private placement of common stock
in February 1997 and the Company's initial public offering (the "Offering") of
6,500,000 shares of its common stock par value $0.01 per share. The Offering was
completed in November 3, 1997 at an initial offering price of $15.00 per share.
The Company raised $89.7 million in the Offering, net of $6.3 million
underwriting discount and $1.5 million in other offering expenses.
Although the 1998 U.S. economy was one of the healthiest in decades, much
of the world was experiencing financial crisis. Economic woes of Russia, Japan,
China, Brazil and others shook the confidence of the U.S. markets. Concurrently,
failures at Crimmie Mae, a Commercial Mortgage REIT, and hedge funds, such as
Long Term Capital, as well as sizeable losses arising from some residential
sub-prime originators caused volatility in the price of U.S. financial assets
and eventually led to a liquidity crisis in the fall of 1998. The liquidity
crisis had a negative effect on the Mortgage REIT industry. Financial lines
utilized to accumulate Mortgage assets were reduced or made unavailable by Wall
Street firms and banks.
Financial turmoil in world economics, and a domestic liquidity crisis may
return. The Company intends to renew its existing reverse repurchase financing
facility when it expires in July, 2000 and to secure commitments from additional
firms for similar financing. There can be no assurance that the Company will be
able to secure new short or long-term financing or that financing will be
available at favorable terms. See "Business Risks -- Failure to Renew or Obtain
Adequate Funding May Adversely Affect Results of Operations."
35
38
ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS
Repricing of Interest-Earning Assets and Interest-Bearing Liabilities
The following table sets forth the amounts of interest-earning assets and
interest-bearing liabilities outstanding at December 31, 1999, which are
anticipated by the Company to reprice in each of the future time periods shown.
The amount of assets and liabilities shown which reprice during a particular
period were determined based on contractual maturity. Asset balances have not
been adjusted for expected prepayments. All principal prepayments on Bond
Collateral, Mortgage Loans are used to reduce long-term debt. For fair value of
financial instruments as of December 31, 1999, see Note 10. Fair Value of
Financial Instruments" (dollars in thousands):
AT DECEMBER 31, 1999
---------------------------------------------------------------------------------------------------
MORE THAN MORE THAN MORE THAN MORE THAN MORE THAN
3 MONTHS 3 MONTHS TO 6 MONTHS TO 1 YEAR TO 3 YEARS TO 5 YEARS TO FAIR
OR LESS 6 MONTHS 1 YEAR 3 YEARS 5 YEARS 10 YEARS TOTAL VALUE
--------- ----------- ----------- --------- ---------- ---------- --------- ---------
Interest-earning assets:
Cash and cash
equivalents............. 8,550 -- -- -- -- -- 8,550 8,550
Mortgage loans held-for-
investment, net,
pledged................. -- -- -- 126,216 -- -- 126,216 125,705
Bond collateral........... 195,341 125,832 28,784 659,137 19,837 124,800 1,153,731 1,142,810
Retained interest in
securitization(1)....... 6,610 -- -- -- -- -- 6,610 6,610
Interest rate
agreements.............. 1,556 -- -- -- -- -- 1,556 1,294
Due from affiliate........ 394 -- -- -- -- -- 394 394
--------- -------- -------- ------- ------ ------- --------- ---------
Total
interest-earning
assets............ 212,451 125,832 28,784 785,353 19,837 124,800 1,297,057 1,285,363
========= ======== ======== ======= ====== ======= ========= =========
Interest-bearing
liabilities:
Short-term debt........... 119,003 -- -- -- -- -- 119,003 119,003
Long-term debt, net....... 985,175 -- -- -- -- 118,083 1,103,258 1,103,258
Due to affiliate.......... 597 -- -- -- -- -- 597 597
--------- -------- -------- ------- ------ ------- --------- ---------
Total
interest-bearing
liabilities....... 1,104,775 -- -- -- -- 118,083 1,222,858 1,222,858
========= ======== ======== ======= ====== ======= ========= =========
Interest rate sensitivity
gap(2).................. (892,324) 125,832 28,784 785,353 19,837 6,717 74,199 62,505
Cumulative interest rate
sensitivity gap......... (892,324) (766,492) (737,708) 47,645 67,482 74,199
- ---------------
(1) Retained Interest in Securitization represents a residual interest only
strip acquired in a REMIC securitization and sale completed by Holdings. The
majority of the underlying mortgages have a contractual re-pricing average
of more than 6 months to one year, while the undelying financing costs
adjust monthly.
(2) Interest rate sensitivity gap represents the difference between net
interest-earning assets and interest-bearing liabilities.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements of the Company and the related notes,
together with the Independent Auditor's Report thereon are set forth on pages
F-2 through F-25 on this Form 10-K.
ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
36
39
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by Item 10 with respect to directors is
incorporated herein by reference to the information contained under the headings
"Election of Directors" and "Section 16(a) Beneficial Ownership Reporting
Compliance" in the Company's definitive Proxy Statement for the Company's annual
meeting of stockholders to be held May 24, 2000 (the "Proxy Statement"). The
information required with respect to executive officers is set forth in Item 1
of this report under the caption "Executive Officers of the Company."
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 is incorporated herein by reference to
the information contained under the heading "Executive Compensation and Other
Matters" in the Company's Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 is incorporated herein by reference to
the information contained under the heading "Stock Ownership of Certain
Beneficial Owners and Management" in the Company's Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is incorporated herein by reference to
the information contained under the headings "Compensation Committee Interlocks
and Insider Participation" and "Certain Transactions" in the Company's Proxy
Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT, SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents filed as part of this report:
1. The following Financial Statements of the Company are included in
Part II, Item 8 of this Annual Report on Form 10K:
Independent Auditors' Report;
Consolidated Balance Sheets as of December 31, 1999 and 1998;
Consolidated Statements of Operations and Comprehensive Income (Loss)
for the years ended December 31, 1999 and December 31, 1998 and for the
period from February 11, 1997 (commencement of operations) through
December 31, 1997;
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 1999 and December 31, 1998 and for the period from February
11, 1997 (commencement of operations) through December 31, 1997;
Consolidated Statements of Cash Flows for the years ended December 31,
1999 and December 31, 1998 and for the period from February 11, 1997
(commencement of operations) through December 31, 1997;
Notes to Consolidated Financial Statements
2. Financial Statement Schedules.
All financial statement schedules have been omitted because they are
either inapplicable or the information required is provided in the
Company's Financial Statements and Notes thereto, included in Part II, Item
8 of this Annual Report on Form 10-K.
37
40
3. Exhibits:
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
---------- -----------
*3.1 Articles of Amendment and Restatement of the Registrant
*3.2 Amended and Restated Bylaws of the registrant
*4.1 Registration Rights agreement dated February 11, 1997
**4.2 Articles Supplementary dated February 22, 1999
**4.3 Rights Plan by and between the Company and American Stock
Transfer and Trust Company dated as of February 2, 1999
****4.4 Indenture dated as of June 1, 1998 between American
Residential Eagle Bond Trust 1999-2 (a wholly-owned,
consolidated subsidiary of the Registrant) and First Union
National Bank, as Trustee
*****4.5 Indenture dated as of April 1, 1999 between American
Residential Eagle Bond Trust 1999-1 (a wholly-owned,
consolidated subsidiary of the Registrant) and Norwest Bank
Minnesota, National Association, as Trustee
******4.6 Indenture dated as of July 1, 1999 between American
Residential Eagle Bond Trust 1999-2 (a wholly-owned,
consolidated subsidiary of the Registrant) and Norwest Bank
Minnesota, National Association, as Trustee
*10.1 Management Agreement between the Registrant and Home Asset
Management Corp. dated February 11, 1997 and Amendment
thereto
*+10.2 Employment and Noncompetition Agreement between Home Asset
Management Corp. and John Robbins dated February 11, 1997
and Amendment thereto
*+10.3 Employment and Noncompetition Agreement between Home Asset
Management Corp. and Jay Fuller dated February 11, 1997 and
Amendment thereto
*+10.5 Rollie Lynn Employment Letter dated January 7, 1997 and
amendment thereto
***+10.5a Lisa Faulk Employment Letter, as amended
10.5b Judith A. Berry Employment and Noncompetition Agreement
*+10.6 1997 Stock Incentive Plan
*+10.7 Form of 1997 Stock Option Plan as amended
*+10.8 Form of 1997 Outside Directors Stock Option Plan
*+10.9 Form of Employee Stock Purchase Plan
*10.10 Securities Purchase Agreement between Registrant, Home Asset
Management Corp. and MDC REIT Holdings, LLC dated February
11, 1997
*+10.11 Form of Subscription Agreement dated February 11, 1997
*10.12 Secured Promissory Note dated June 25, 1997
*10.13 Lease Agreement with Louis and Louis dated March 7, 1997
*+10.14 Form of Indemnity Agreement
***10.15 Master Repurchase Agreement -- Confidential Treatment
Requested and Granted
***21.1 Subsidiaries of Registrant
23.1 Consent of KPMG LLP
27.1 Financial Data Schedule
38
41
- ---------------
* Incorporated by reference to Registration Statement on Form S-11 (File
No. 333-33679)
+ Management Contract or Compensatory Plan
** Incorporated by reference to Current Reports on Form 8-K (File No.
001-13485)
*** Incorporated by reference to the Company's Annual Report on Form 10-K for
the Fiscal year ended 1997
**** Incorporated by reference to Current Reports on Form 8-K (File No.
333-47311)
***** Incorporated by reference to Current Reports on Form 8-K (File No.
333-5932)
****** Incorporated by reference to Current Reports on Form 8-K (File No.
333-70189-01)
(b) Reports on Form 8-K:
Current Report (File No. 001-13485)
39
42
FINANCIAL STATEMENTS AND INDEPENDENT AUDITORS' REPORT
FOR INCLUSION IN FORM 10-K
FILED WITH
SECURITIES AND EXCHANGE COMMISSION
DECEMBER 31, 1999
INDEX TO FINANCIAL STATEMENTS
PAGE
----
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.
Report of Independent Auditors.............................. F-2
Consolidated Balance Sheets................................. F-3
Consolidated Statements of Operations and Comprehensive
Income (Loss)............................................. F-4
Consolidated Statements of Stockholders' Equity............. F-5
Consolidated Statements of Cash Flows....................... F-6
Notes to Consolidated Financial Statements.................. F-7
F-1
43
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
American Residential Investment Trust, Inc.
Del Mar, California:
We have audited the accompanying consolidated balance sheets of American
Residential Investment Trust, Inc. and subsidiaries (the Company) as of December
31, 1999 and 1998, and the related consolidated statements of operations and
comprehensive income (loss), stockholders' equity and cash flows for the years
ended December 31, 1999 and 1998 and for the period from February 11, 1997
(commencement of operations) through December 31, 1997. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of the Company
as of December 31, 1999 and 1998, and the results of their operations and their
cash flows for the years ended December 31, 1999 and 1998, and for the period
from February 11, 1997 (commencement of operations) through December 31, 1997 in
conformity with generally accepted accounting principles.
KPMG LLP
San Diego, California
January 28, 2000
F-2
44
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
ASSETS
DECEMBER 31, DECEMBER 31,
1999 1998
------------ ------------
Cash and cash equivalents................................... $ 8,550 $ 34,645
Mortgage securities available-for-sale, net................. -- 6,617
Mortgage loans held-for-investment, net, pledged............ 126,216 179,009
Bond collateral, mortgage loans............................. 1,153,731 417,808
Bond collateral, real estate owned.......................... 5,187 490
Retained interest in securitization......................... 6,610 8,762
Interest rate cap agreements................................ 1,556 674
Accrued interest receivable................................. 9,665 7,265
Due from affiliate.......................................... 394 606
Investment in American Residential Holdings, Inc............ 881 708
Other assets................................................ 552 188
---------- --------
$1,313,342 $656,772
========== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Short-term debt........................................... $ 119,003 $166,214
Long-term debt, net....................................... 1,103,258 385,290
Accrued interest payable.................................. 619 1,226
Due to affiliate.......................................... 597 386
Accrued expenses and other liabilities.................... 176 477
Management fees payable................................... 418 --
Accrued dividends......................................... 2,417 1,208
---------- --------
Total liabilities................................. 1,226,488 554,801
---------- --------
Stockholders' Equity:
Preferred stock, par value $.01 per share; 1,000 shares
authorized; no shares issued and outstanding........... -- --
Common stock, par value $.01 per share; 25,000,000 shares
authorized; 8,055,500 shares issued and outstanding.... 81 81
Additional paid-in-capital................................ 109,271 109,271
Accumulated other comprehensive income (loss)............. (2,500) 550
Accumulated deficit....................................... (19,998) (7,931)
---------- --------
Total stockholders' equity........................ 86,854 101,971
---------- --------
$1,313,342 $656,772
========== ========
See accompanying notes to consolidated financial statements.
F-3
45
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
FOR THE PERIOD FROM
FEBRUARY 11, 1997
(COMMENCEMENT OF
FOR THE FOR THE OPERATIONS)
YEAR ENDED YEAR ENDED THROUGH
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1999 1998 1997
------------ ------------ -------------------
Interest income:
Mortgage assets................................... $77,367 $67,667 $13,975
Cash and cash equivalents and investments......... 3,531 1,819 253
Interest rate cap and floor agreement expense..... (1,779) (1,079) (132)
------- ------- -------
Total interest income..................... 79,119 68,407 14,096
Interest expense.................................... 49,644 45,190 9,517
------- ------- -------
Net interest spread................................. 29,475 23,217 4,579
Premium amortization........................... 16,625 13,311 1,797
Premium write-down............................. 12,294 -- --
------- ------- -------
Net interest income................................. 556 9,906 2,782
Provision for loan losses...................... 3,650 3,470 --
------- ------- -------
Net interest income (loss) after provision for loan
losses............................................ (3,094) 6,436 2,782
------- ------- -------
Other operating income:
Management fee income............................. 472 420 --
Equity in income of American Residential
Holdings, Inc.................................. 173 1,118 --
Prepayment penalty income......................... 3,774 806 --
Gain on sale of mortgage securities
available-for-sale............................. 30 -- --
------- ------- -------
Total other operating income.............. 4,449 2,344 --
------- ------- -------
Net operating income................................ 1,355 8,780 2,782
Other expenses:
Loss on sale of mortgage securities
available-for-sale............................. -- 5,912 --
Loss on sale of real estate owned, net............ 349 -- --
Management fees................................... 3,557 2,466 283
General and administrative expenses............... 1,299 1,616 96
------- ------- -------
Total other expenses...................... 5,205 9,994 379
------- ------- -------
Net income (loss)................................... (3,850) (1,214) 2,403
------- ------- -------
Other comprehensive income (loss):
Unrealized holding gains.......................... -- 550 --
Unrealized holding losses......................... (3,050) (2,612) (3,300)
Reclassification adjustment included in income.... -- 5,912 --
------- ------- -------
Unrealized holding losses arising during the
period, net.................................... (3,050) 3,850 (3,300)
------- ------- -------
Comprehensive income (loss)......................... $(6,900) $ 2,636 $ (897)
======= ======= =======
Net income (loss) per share of common
stock -- basic.................................... $ (0.48) $ (0.15) $ 0.83
Net income (loss) per share of common
stock -- diluted.................................. (0.48) (0.15) 0.82
Dividends per share of common stock................. 1.02 0.83 0.84
See accompanying notes to consolidated financial statements.
F-4
46
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
ACCUMULATED
OTHER
COMMON STOCK ADDITIONAL COMPREHENSIVE CUMULATIVE
------------------- PAID-IN INCOME/ DIVIDENDS ACCUMULATED
SHARES AMOUNT CAPITAL (LOSS) DECLARED DEFICIT TOTAL
--------- ------ ---------- ------------- ---------- ----------- --------
Initial capital contribution
February 11, 1997........... 1,614,000 $16 $ 20,149 $ -- $ -- $ -- $ 20,165
Proceeds from sale of stock,
net of offering costs of
$7,798...................... 6,500,000 65 89,637 -- -- -- 89,702
Other comprehensive loss...... -- -- -- (3,300) -- -- (3,300)
Net income.................... -- -- -- -- -- 2,403 2,403
Dividends declared............ -- -- -- -- (2,401) -- (2,401)
--------- --- -------- ------- -------- ------- --------
Balance December 31, 1997..... 8,114,000 81 109,786 (3,300) (2,401) 2,403 106,569
--------- --- -------- ------- -------- ------- --------
Purchase and retirement of
common stock................ (58,500) -- (492) -- -- -- (492)
Offering costs................ -- -- (23) -- -- -- (23)
Other comprehensive income.... -- -- -- 3,850 -- -- 3,850
Net loss...................... -- -- -- -- -- (1,214) (1,214)
Dividends declared............ -- -- -- -- (6,719) -- (6,719)
--------- --- -------- ------- -------- ------- --------
Balance December 31, 1998..... 8,055,500 81 109,271 550 (9,120) 1,189 101,971
--------- --- -------- ------- -------- ------- --------
Other comprehensive loss...... -- -- -- (3,050) -- -- (3,050)
Net loss...................... -- -- -- -- -- (3,850) (3,850)
Dividends declared............ -- -- -- -- (8,217) -- (8,217)
--------- --- -------- ------- -------- ------- --------
Balance December 31, 1999..... 8,055,500 $81 $109,271 $(2,500) $(17,337) $(2,661) $ 86,854
========= === ======== ======= ======== ======= ========
See accompanying notes to consolidated financial statements.
F-5
47
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
FOR THE PERIOD FROM
FEBRUARY 11, 1997
FOR THE FOR THE (COMMENCEMENT OF
YEAR ENDED YEAR ENDED OPERATIONS) THROUGH
DECEMBER 31, 1999 DECEMBER 31, 1998 DECEMBER 31, 1997
----------------- ----------------- -------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)........................................... $ (3,850) $ (1,214) $ 2,403
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Amortization and write down of mortgage asset
premiums.............................................. 28,919 13,311 1,797
Amortization of interest rate cap agreements............ 797 779 132
Amortization of CMO capitalized costs................... 446 -- --
Amortization of CMO premium............................. (158) (79) --
Provision for loan losses............................... 3,650 3,470 --
Equity in undistributed income of American Residential
Holdings, Inc......................................... (173) (1,118) --
Increase in deposits to REMIC subordinate certificates
and overcollateralization account..................... (898) (1,513) --
Gain on sale of mortgage securities..................... (30) -- --
Loss on sale of real estate owned....................... 349 -- --
Increase in accrued interest receivable................. (950) (2,096) (5,169)
(Increase) decrease in other assets..................... (364) 43 (231)
(Increase) decrease in due from affiliate............... 212 (337) (269)
Increase (decrease) in accrued interest payable......... (607) (613) 1,839
Increase (decrease) in accrued expenses and management
fees payable.......................................... 117 (363) 840
Increase in due to affiliate............................ 211 386 --
--------- --------- ---------
Net cash provided by operating activities........... 27,671 10,656 1,342
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of mortgage securities available-for-sale........ -- -- (431,037)
Purchases of mortgage loans held-for-investment........... (990,557) (649,605) (162,762)
Purchase of interest rate cap agreements.................. (1,679) (1,042) (543)
Purchase of retained interest in securitization........... -- (6,699) --
Principal payments on mortgage securities
available-for-sale...................................... 3,428 150,101 38,841
Principal payments on mortgage loans
held-for-investment..................................... 27,531 29,089 --
Principal payments on bond collateral..................... 235,223 71,586 --
Proceeds from sale of mortgage securities
available-for-sale...................................... 3,225 227,760 --
Proceeds from sale of mortgage loans
held-for-investment..................................... -- 103,525 --
Proceeds from sale of real estate owned................... 5,602 -- --
Investment in American Residential Holdings, Inc.......... -- (475) --
Dividends recorded from American Residential Holdings,
Inc..................................................... -- 885 --
--------- --------- ---------
Net cash used in investing activities............... (717,227) (74,875) (555,501)
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of long-term debt................................ 958,319 457,011 --
Increase (decrease) in net borrowings from short-term
debt.................................................... (47,211) (285,074) 451,288
Net proceeds from stock issuance.......................... -- (23) 109,867
Purchase of common stock.................................. -- (492) --
Increase in net borrowings from long-term debt............ 7,054 -- --
Debt issuance cost........................................ (3,439) -- --
Dividends paid............................................ (7,008) (6,809) (1,103)
Payments on long-term debt................................ (244,254) (71,642) --
--------- --------- ---------
Net cash provided by financing activities........... 663,461 92,971 560,052
Net increase (decrease) in cash and cash equivalents........ (26,095) 28,752 5,893
Cash and cash equivalents at beginning of period............ 34,645 5,893 --
--------- --------- ---------
Cash and cash equivalents at end of period.................. $ 8,550 $ 34,645 $ 5,893
========= ========= =========
Supplemental information -- interest paid................... $ 48,830 $ 45,463 $ 7,697
========= ========= =========
Non-cash transactions:
Dividends declared and unpaid............................. $ 2,417 $ 1,208 $ 1,298
========= ========= =========
Transfer from mortgage loans held-for-investment, net to
bond collateral......................................... $ 664,006 $ 497,653 $ --
========= ========= =========
Transfers from bond collateral to real estate owned....... $ 11,029 $ 490 $ --
========= ========= =========
See accompanying notes to consolidated financial statements.
F-6
48
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES
Basis of Financial Statement Presentation
The consolidated financial statements include the accounts of American
Residential Investment Trust, Inc. ("AmRES"), a Maryland corporation, American
Residential Eagle, Inc., ("Eagle"), a Delaware special purpose corporation and
wholly-owned subsidiary of AmRES and American Residential Eagle 2, Inc. ("Eagle
2"), a Delaware limited purpose corporation and wholly-owned subsidiary of Eagle
(collectively "AmRIT"). Substantially all of the assets of Eagle and Eagle 2 are
pledged or subordinated to support long-term debt in the form of collateralized
mortgage bonds ("Long-Term Debt") and are not available for the satisfaction of
general claims of AmRIT. American Residential Holdings, Inc. ("Holdings"), is an
affiliate of AmRES and accounted for under the equity method. AmRIT and Holdings
are together referred to as (the "Company"). The Company's exposure to loss on
the assets pledged as collateral is limited to its net investment, as the
Long-Term Debt is non-recourse to the Company. All significant intercompany
balances and transactions with Eagle and Eagle 2 have been eliminated in the
consolidation of AmRIT. Certain amounts for prior periods have been reclassified
to conform with the current year's presentation.
During the first half of 1998, the Company formed Holdings, through which a
portion of the Company's non-conforming adjustable-rate and fixed-rate,
single-family whole loans (collectively, "Mortgage Loans"), acquisition and
finance activities are conducted. AmRIT owns all of the preferred stock and has
a non-voting 95% economic interest in Holdings. Because AmRIT does not control
Holdings, its investment in Holdings is accounted for under the equity method.
Under this method, original equity investments in Holdings are recorded at cost
and adjusted by AmRIT's share of earnings or losses and decreased by dividends
received.
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management of the Company 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 consolidated financial statements and the reported amounts of revenue and
expenses during the reported period. Actual results could differ from those
estimates.
Organization
AmRES commenced operations on February 11, 1997. AmRES was financed through
a private equity funding from its manager, Home Asset Management Corporation
(the "Manager"). AmRES operates as a mortgage real estate investment trust
("REIT") which has elected to be taxed as a REIT for Federal income tax
purposes, which generally will allow AmRES to pass its income through to its
stockholders without payment of corporate level Federal income tax, provided
that the Company distributes at least 95% of its taxable income to stockholders.
During 1998, AmRES formed Eagle, a special-purpose finance subsidiary. Holdings,
a non-REIT, taxable affiliate of the Company, was established during the first
half of 1998. During 1999, AmRES formed Eagle 2, a limited-purpose corporation
and wholly-owned subsidiary of Eagle. The Company acquires residential mortgage
loans ("Mortgage Loans"). These Mortgage Loans are typically secured by
single-family real estate properties throughout the United States. The Company
utilizes both debt and equity to finance its acquisitions. The Company may also
use securitization techniques to enhance the value and liquidity of the
Company's Mortgage Loans and may sell Mortgage Loans from time to time.
The Company sold residential mortgage loans in the second quarter of 1998
through the use of a Real Estate Mortgage Investment Conduit ("REMIC"). The
REMIC, which consisted of pooled adjustable-rate first-lien mortgages, was
issued by Holdings to the public through the registration statement of the
related underwriter.
F-7
49
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Cash and Cash Equivalents
For purposes of the statement of cash flows, cash and cash equivalents
include cash on hand and highly liquid investments with original maturities of
three months or less.
Mortgage Assets
The Company's Mortgage Assets consist of interests in mortgage securities
which have been securitized by others prior to acquisition by the Company
(Mortgage Securities) and Mortgage Loans secured by residential properties
(Mortgage Loans).
Mortgage Securities
AmRIT classifies its investments as either trading investments,
available-for-sale investments or held-to-maturity investments. Although AmRIT
generally intends to hold most of its Mortgage Securities until maturity, it
may, from time to time, sell any of its Mortgage Securities as part of its
overall management of its balance sheet. Accordingly, this flexibility requires
AmRIT to classify all of its Mortgage Securities as available-for-sale. All
Mortgage Securities classified as available-for-sale are reported at fair value,
with unrealized gains and losses excluded from operations and reported as a
separate component of stockholders' equity, as accumulated other comprehensive
income (loss). A decline in the market value of any available-for-sale security
below cost that is deemed to be other than temporary results in an impairment
which is charged to operations and a new basis for the security is established.
Interest income is accrued based on the outstanding principal amount of the
Mortgage Securities and their contractual terms. Premiums relating to Mortgage
Securities are amortized into interest income over the lives of the Mortgage
Securities using the interest method. Gains or losses on the sale of Mortgage
Securities are based on the specific identification method.
Mortgage Loans Held-For-Investment and Bond Collateral
Mortgage loans held-for-investment and Bond Collateral include various
types of adjustable-rate and fixed-rate loans secured by mortgages on
single-family residential real estate properties. Premiums related to these
loans are amortized over their estimated lives using the interest method. Loans
are continually evaluated for collectibility and, if appropriate, the loan may
be placed on non-accrual status. Generally, loans are placed in non-accrual
status that are in foreclosure or non-performing bankruptcy, i.e. loans in
bankruptcy and not performing according to the bankruptcy plan that is
established with the trustee. When loans are placed on non-accrual status, all
interest previously accrued but not collected is reversed against current period
interest income. Income on non-accrual loans is subsequently recognized only to
the extent that cash is received and the loans principal balance is deemed
collectible. Loans are restored to accrual status when loans become well secured
and are in the process of collection.
The Company considers a loan to be impaired when, based upon current
information and events, it believes it will be unable to collect all amounts due
according to the contractual terms of the loan agreement. Given the homogeneous
nature of the loan portfolio, loan are evaluated for impairment collectively.
Many factors are considered in the determination of impairment. The measurement
of collateral dependent loans is based on the fair value of the loan's
collateral.
Allowance for Loan Losses
The Company maintains an allowance for losses on Mortgage Loans
Held-for-Investment and Bond Collateral, Mortgage Loans at an amount which it
believes is sufficient to provide adequate protection against losses in the
mortgage loan portfolio. The allowance for losses is determined primarily on the
basis of management's judgment of net loss potential including specific
allowances for known impaired loans, changes
F-8
50
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
in the nature and volume of the portfolio, value of the collateral and current
economic conditions that may affect the borrower's ability to pay. A provision
is recorded for all loans or portions thereof deemed to be uncollectible thereby
increasing the allowance for loan losses. Subsequent recoveries on mortgage
loans previously charged off are credited to the allowance.
Interest Rate Cap Agreements
The Company uses interest rate cap agreements (the "Cap Agreements") for
interest rate risk protection. The Cap Agreements are purchased primarily to
reduce the Company's gap risk (the timing difference or mis-match between the
repricing of interest rate sensitive assets and interest rate sensitive
liabilities). The Company periodically evaluates the effectiveness of these Cap
Agreements under various interest rate scenarios.
The cost of the Cap Agreements are amortized over the life of the Cap
Agreements using the straight-line method. The Company has credit risk to the
extent counterparties to the Cap Agreements do not perform their obligations
under the Cap Agreements. In order to lessen this risk and to achieve
competitive pricing, the Company has entered into Cap Agreements only with
counterparties which are investment grade rated.
Income Taxes
AmREIT has elected to be taxed as a REIT and complies with REIT provisions
of the Internal Revenue Code (the "Code") and the corresponding provisions of
State law. Accordingly, AmREIT will not be subject to federal or state income
tax to the extent of its distributions to stockholders. In order to maintain its
status as a REIT, AmREIT is required, among other requirements, to distribute at
least 95% of its taxable income.
Income (Loss) per Share
The following table illustrates the computation of basic and diluted income
(loss) per share (in thousands, except share and per share data):
FOR THE
PERIOD FROM
FEBRUARY 11, 1997
FOR THE FOR THE (COMMENCEMENT
YEAR ENDED YEAR ENDED OF OPERATIONS)
DECEMBER 31, DECEMBER 31, THROUGH
1998 1999 DECEMBER 31, 1997
------------ ------------ -----------------
Numerator:
Numerator for basic income (loss) per
share net earnings................... $ (3,850) $ (1,214) $ 2,403
Denominator:
Denominator for basic income per
share -- weighted average number of
common shares outstanding during the
period............................... 8,055,500 8,090,772 2,879,487
Incremental common shares attributable to
exercise of outstanding options......... -- -- 49,522
---------- ---------- ----------
Denominator for diluted income per
share................................... 8,055,500 8,090,772 2,929,009
Basic income (loss) per share............. $ (0.48) $ (0.15) $ 0.83
Diluted income (loss) per share........... $ (0.48) $ (0.15) $ 0.82
At December 31, 1999, 1998 and 1997 there were 791,400, 695,900 and
414,200, respectively, of options that were antidilutive and, therefore, not
included in the calculation above.
F-9
51
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Comprehensive Income (Loss)
The Company recognizes comprehensive income (loss) as part of the Statement
of Operations and Comprehensive Income (Loss) and is disclosed as part of
stockholders' equity in accumulated other comprehensive income (loss).
Comprehensive income (loss) consists of net income (loss) and net unrealized
gains (losses) on retained interest in securitization.
Segments
The Company adopted the provisions of SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information," in 1998. This statement
establishes standards for the way companies report information about operating
segments in annual financial statements. It also establishes standards for
related disclosures about products and services, geographic areas and major
customers. The Company has determined that it does not have any separately
reportable business segments as of December 31, 1999.
Recent Accounting Developments
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, (collectively referred to as
derivatives) and for hedging activities. It requires that an entity recognize
all derivatives as either assets or liabilities in the balance sheet and measure
those instruments at fair value. If certain conditions are met, a derivative may
be specifically designated as (a) a hedge of the exposure to changes in the fair
value of a recognized asset or liability or an unrecognized firm commitment, (b)
a hedge of the exposure to variable cash flows of a forecasted transaction, or
(c) a hedge of the foreign currency exposure of a net investment in a foreign
operation, an unrecognized firm commitment, an available-for-sale security, or a
foreign-currency-denominated forecasted transaction.
Under SFAS No. 133, an entity that elects to apply hedge accounting is
required to establish at the inception of the hedge the method it will use for
assessing the effectiveness of the hedging derivative and the measurement
approach for determining the ineffective aspect of the hedge. Those methods must
be consistent with the entity's approach to managing risk.
SFAS No. 133 amends SFAS No. 32, "Foreign Currency Translation," to permit
special accounting for a hedge of a foreign currency forecasted transaction with
a derivative. It supersedes SFAS No. 80, "Accounting for Futures Contracts,"
SFAS No. 105, "Disclosure of Information about Financial Instruments with Off-
Balance-Sheet Risk and Financial Instruments with Concentrations of Credit
Risk," and SFAS No. 119, "Disclosure about Derivative Financial Instruments and
Fair Value of Financial Instruments." It amends SFAS No. 107, "Disclosures about
Fair Value of Financial Instruments," to include in SFAS No. 107 the disclosure
provisions about concentrations of credit risk from SFAS No. 105. This Statement
also nullifies or modifies the consensus reached in a number of issues addressed
by the Emerging Issues Task Force.
In June, 1999, the FASB issued SFAS No. 137, "Accounting for Derivative
Instruments and Hedging Activities -- Deferral of the Effective Date of FASB
Statement No. 133, an Amendment of FASB Statement No. 133". SFAS No. 137 defers
the effective date of SFAS No. 133 for one year. SFAS No. 133, as amended, is
now effective for all fiscal quarters of all fiscal years beginning after June
15, 2000. The Company is in the process of determining the impact of adopting
SFAS No. 133.
F-10
52
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2. MORTGAGE SECURITIES AVAILABLE FOR SALE, NET
AmREIT's mortgage participation certificates issued by FHLMC, FNMA or GNMA
("Agency Securities") and mortgage participation certificates issued by certain
private institutions ("Privately Issued Securities") (collectively, "Mortgage
Securities") consisted of the following (dollars in thousands):
FEDERAL HOME FEDERAL NATIONAL
LOAN MORTGAGE MORTGAGE
CORPORATION ASSOCIATION TOTAL
------------- ---------------- ------
AT DECEMBER 31, 1998
Mortgage Securities available-for-sale,
principal................................... $4,345 $2,232 $6,577
Unamortized premium........................... 17 23 40
------ ------ ------
Amortized cost................................ 4,362 2,255 6,617
------ ------ ------
Fair Value.................................... $4,362 $2,255 $6,617
====== ====== ======
On July 26, 1999, AmREIT sold the remaining Mortgage Securities
available-for-sale. The book value of these assets at the time of sale was
approximately $3.2 million and there was a gain on sale of approximately
$30,000.
NOTE 3. MORTGAGE LOANS HELD-FOR-INVESTMENT, NET, PLEDGED
AmREIT purchases certain non-conforming Mortgage Loans to be held as
long-term investments. At December 31, 1999 and 1998, Mortgage Loans held for
investment consist of the following (dollars in thousands):
1999 1998
-------- --------
Mortgage loans held-for-investment, principal.......... $122,036 $171,420
Unamortized premium.................................... 4,343 8,406
Allowance for loan losses.............................. (163) (817)
-------- --------
$126,216 $179,009
======== ========
A summary of the activity in the allowance for loan losses is as follows
(dollars in thousands):
1999 1998 1997
------- ------- ----
Balance beginning of period.............................. $ 817 $ -- $ --
Provision charged to operating expense................... 1,025 1,109 --
Allowance acquired....................................... -- 2,438 760
Transfer to CMO/FASIT.................................... (1,679) (2,730) --
------- ------- ----
Balance end of period.................................... $ 163 $ 817 $760
======= ======= ====
At December 31, 1999 and 1998, the weighted average net coupon on the
Mortgage Loans was 9.17% and 9.31%, respectively, per annum. All Mortgage Loans
have a repricing frequency of five years or less. At December 31, 1999 and 1998,
approximately 29% and 46%, respectively, of the collateral was located in
California with no other state representing more than 6% and 7%, respectively.
As of December 31, 1999 and 1997, there were no Mortgage Loans on
non-accrual status. There were $2.3 million Mortgage Loans on non accrual status
as of December 31, 1998. Interest income of $981,000 would have been recorded
for the year ended December 31, 1998 on Mortgage Loans Held-for-Investment, net,
pledged, and Bond Collateral, Mortgage Loans (See Note 4) if non-accrual loans
had been on a current basis, in accordance with their original terms.
F-11
53
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4. BOND COLLATERAL, MORTGAGE LOANS
AmRIT has pledged collateral in order to secure the Long-Term Debt issued
in the form of CMOs. Bond Collateral consists primarily of adjustable-rate,
conventional, 30-year mortgage loans secured by first liens on one- to
four-family residential properties. All Bond Collateral is pledged to secure
repayment of the related Long-Term Debt obligation. All principal and interest
(less servicing and related fees) on the Bond Collateral is remitted to a
trustee and is available for payment on the Long-Term Debt obligation. The
obligations under the Long-Term Debt are payable solely from the Bond Collateral
and are otherwise non-recourse to AmRIT.
The components of the Bond Collateral at December 31, 1999 and 1998 are
summarized as follows (dollars in thousands):
CMO/REMIC CMO CMO CMO/FASIT
1999-A 1999-2 1999-1 1998-1 TOTAL
SECURITIZATION SECURITIZATION SECURITIZATION SECURITIZATION BOND COLLATERAL
-------------- -------------- -------------- -------------- ---------------
AT DECEMBER 31, 1999
Mortgage loans............... $319,606 $385,795 $200,884 $210,584 $1,116,869
Unamoritized premium......... 12,227 14,284 8,622 6,279 41,412
Allowance for loan losses.... (298) (332) (1,443) (2,477) (4,550)
-------- -------- -------- -------- ----------
$331,535 $399,747 $208,063 $214,386 $1,153,731
======== ======== ======== ======== ==========
Weighted average net
coupon..................... 9.39% 9.03% 8.91% 10.15% 9.32%
Unamortized premium as a
percent of mortgage
loans...................... 3.83% 3.70% 4.29% 2.98% 3.71%
AT DECEMBER 31, 1998
Mortgage loans............... $390,875 $ 390,875
Unamoritized premium......... 31,899 31,899
Allowance for loan losses.... (4,966) (4,966)
-------- ----------
$417,808 $ 417,808
======== ==========
Weighted average net
coupon..................... 9.55% 9.55%
Unamortized premium as a
percent of mortgage
loans...................... 8.16% 8.16%
At December 31, 1999 and 1998, approximately 38% and 39%, respectively of
the collateral was located in California for the CMO/FASIT 1998-1 and no other
state represented more than 8% and 7%, respectively. At December 31, 1999,
approximately 38% of the collateral was located in California for the CMO 1999-1
and no other state represented more than 7%. At December 31, 1999, approximately
21% of the collateral was located in California for the CMO 1999-2 and no other
state represented more than 7%. At December 31, 1999, approximately 13% of the
collateral was located in Michigan for the CMO/REMIC 1999-A and no other state
represented more than 10%.
Impaired loans included in the Company's Bond Collateral, Mortgage Loans as
of December 31, 1999 and 1998 were approximately $37.5 and $11.8 million,
respectively At December 31, 1998, impaired loans had an aggregate specific
related allowance amount of approximately $2.6 million. There was no specific
related allowance for 1999.
F-12
54
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
A summary of the activity in the allowance for loan losses is as follows
(dollars in thousands):
1999 1998
------- ------
Balance beginning of period............................... $ 4,966 $ --
Provision charged to operating expense.................... 2,625 2,361
Loans charged-off net of recoveries....................... (873) --
Charge offs upon transfer to real estate owned............ (2,536) (125)
Reclassification to interest allowance.................... (1,311) --
Transfer from mortgage loans held-for-investment.......... 1,679 2,730
------- ------
Balance end of period..................................... $ 4,550 $4,966
======= ======
NOTE 5. BOND COLLATERAL, REAL ESTATE OWNED
The Company owned 68 properties and 7 properties as of December 31, 1999
and 1998. respectively. Upon transfer of the loans to real estate owned, the
Company recorded a corresponding charge against the allowance for loan losses to
write-down the real estate owned to fair value less estimated cost of disposal.
At December 31, 1999 and 1998, real estate owned totaled approximately $5.2
million and $490,000, respectively.
NOTE 6. RETAINED INTEREST IN SECURITIZATION
Retained interest in securitization consists of assets generated and
retained in conjunction with the Company's 1998-1 REMIC securitization. A
summary of these assets at December 31, 1999 and 1998 were as follows (dollars
in thousands):
1999 1998
------- ------
REMIC subordinate certificates............................ $ 6,950 $6,699
Overcollateralization account............................. 2,160 1,513
Unrealized gain (loss).................................... (2,500) 550
------- ------
$ 6,610 $8,762
======= ======
The Company classified the 1998-1 REMIC securities as available-for-sale
securities and carries them at market value. The fair value of the retained
interest is determined by computing the present value of the excess of the
weighted-average coupon of the residential mortgages sold (9.32%) over the sum
of: (1) the coupon on the senior interest (5.95%), and (2) a servicing fee paid
to the servicer of the residential mortgages (0.50%) and other fees, and taking
into account expected estimated losses to be incurred on the portfolio of
residential mortgages sold over the estimated lives of the residential mortgages
and using an estimated future average prepayment assumption of 35% per year for
1999 and 25% per year for 1998. The prepayment assumption used in estimating the
cash flows is based on recent evaluations of the actual prepayments of the
related portfolio and on market prepayment rates on new portfolios of similar
residential mortgages, taking into consideration the current interest rate
environment and its expected impact on the estimated future prepayment rate. The
estimated cash flows expected to be received by the Company are discounted at an
interest rate that the Company believes is commensurate with the risk of holding
such a financial instrument. The rate used to discount the cash flows coming out
of the trust was approximately 12%. To the extent that actual future excess cash
flows are different from estimated excess cash flows, the fair value of the
Company's retained interest could change.
Under the terms of the securitization, the retained interest is required to
build over-collateralization to specified levels using the excess cash flows
described above until set percentages of the securitized portfolio are attained.
Future cash flows to the retained interest holder are all held by the REMIC
trust until a specific percentage of either the original or current certificate
balance is attained which percentage can be raised if
F-13
55
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
certain charge-offs and delinquency ratios are exceeded. The certificate
holders' recourse for credit losses is limited to the amount of
over-collateralization held in the REMIC trust. Upon maturity of the
certificates or upon exercise of an option ("clean up call") to repurchase all
the remaining residential mortgages once the balance of the residential
mortgages in the trust are reduced to 10% of the original balance of the
residential mortgages in the trust, any remaining amounts in the trust are
distributed. The current amount of any over-collateralization balance held by
the trust is recorded as part of the retained interest.
In future periods, the Company will recognize additional revenue from the
retained interest if the actual performance of the mortgage loans is higher than
the original estimate or the Company may increase the estimated fair value of
the retained interest. If the actual performance of the mortgage loans is lower
than the original estimate, then an adjustment to the carrying value of the
retained interest may be required if the estimated fair value of the retained
interest is less than its carrying value.
NOTE 7. INTEREST RATE CAP AGREEMENTS
The amortized cost of the Company's interest rate cap agreements was $1.6
million net of accumulated amortization of $1.1 million and $674,000 net of
accumulated amortization of $368,000 at December 31, 1999 and 1998,
respectively.
Cap Agreements
The Company had four outstanding Cap Agreements at December 31, 1999 and
1998. Potential future earnings from each of these Cap Agreements are based on
variations in the one month London Interbank Offered Rate ("LIBOR"). The Cap
Agreements at December 31, 1999 and 1998 have contractually stated notional
amounts which vary over the life of the Cap Agreements. Under these Cap
Agreements the Company will receive cash payments should the agreed-upon
reference rate, one month LIBOR, increase above the strike rates of the Cap
Agreements. There was approximately $104 thousand in income for the year ended
December 31, 1999 for Cap Agreements, offset by $797,000 in Cap Agreement
amortization. No earnings were recognized in 1998 or 1997 for Cap Agreements.
All of the adjustable-rate mortgage securities and mortgage loans are
limited by periodic caps (generally interest rate adjustments are limited to no
more than 1% every six months) and lifetime interest rate caps.
Floor Agreements
The Company had no outstanding floor agreements at December 31, 1999. The
Company had two outstanding floor agreements at December 31, 1998. Each of the
floor agreements at December 31, 1998 have contractually stated notional amounts
which vary over the life of the floor agreements. Under these floor agreements
the Company will make cash payments should the agreed-upon reference rate, one
month LIBOR, decrease below the strike rates of the floor agreements.
Approximately $1.1 million floor agreement expense was included in hedge expense
in 1999 and approximately $300,000 was recognized in 1998. No expense was
recorded in 1997 for floor agreements.
F-14
56
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Interest rate agreements outstanding at December 31, 1999 and 1998 are as
follows (dollars in thousands):
1999
---------------------------------------------------------------
AVERAGE CAP FLOOR
NOTIONAL FACE STRIKE STRIKE
AMOUNT RATE RATE INDEX EXPIRES
------------- ------ ------ ----------- -----------
Lehman Brothers................. $ 44,994 8.105% -- 1 mo. LIBOR April, 2000
CS First Boston................. 85,378 8.114% -- 1 mo. LIBOR April, 2000
First Union..................... 364,000 6.750% -- 1 mo. LIBOR July, 2001
Bear Stearns.................... 200,000 6.250% -- 1 mo. LIBOR Sept., 2000
1998
---------------------------------------------------------------
AVERAGE CAP FLOOR
NOTIONAL FACE STRIKE STRIKE
AMOUNT RATE RATE INDEX EXPIRES
------------- ------ ------ ----------- -----------
Lehman Brothers................ $ 56,159 8.101% -- 1 mo. LIBOR April, 2000
CS First Boston................ 85,378 8.114% -- 1 mo. LIBOR April, 2000
Bear Stearns................... 450,000 5.800% 5.500% 1 mo. LIBOR May, 1999
Bankers Trust.................. 300,000 6.000% 5.250% 1 mo. LIBOR Nov., 1999
NOTE 8. SHORT-TERM DEBT
The Company has entered into reverse repurchase agreements with two lenders
to finance the acquisition of Mortgage Loans. The Company has a $100 million
committed and $100 million uncommitted agreement with Bear Stearns, expiring on
July 31, 2000, and a $100 million committed agreement with Morgan Stanley
Mortgage Corporation, Inc. which expires March 10, 2000. When the reverse
repurchase agreements are in use, they are collateralized by a portion of the
Company's Mortgage Loans.
At December 31, 1999 and 1998, the Company had approximately $119.0 million
and $166.2 million, respectively of Mortgage Loans reverse repurchase agreements
outstanding with a weighted average borrowing rate of 6.05% and 5.68%,
respectively. The maximum month end balance and the average balance outstanding
for the twelve months ended December 31, 1999 were approximately $406.0 million
and $141.3 million, respectively. The maximum month end balance and the average
balance outstanding for the twelve months ended December 31, 1998 were
approximately $942.0 million and $499.2 million, respectively. The weighted
average remaining maturity was one day for both 1999 and 1998.
At December 31, 1999 and 1998, the Mortgage Loans reverse repurchase
agreements had the following characteristics (dollars in thousands):
DECEMBER 31, 1999
----------------------------------------
REPURCHASE UNDERLYING INTEREST RATE
LIABILITY COLLATERAL (PER ANNUM)
---------- ---------- -------------
Bear Stearns....................................... $119,003 $122,017 6.05%
-------- -------- ----
$119,003 $122,017 6.05%
======== ======== ====
DECEMBER 31, 1998
----------------------------------------
REPURCHASE UNDERLYING INTEREST RATE
LIABILITY COLLATERAL (PER ANNUM)
---------- ---------- -------------
Bear Stearns....................................... $161,773 $166,937 5.66%
Residential Funding Corporation.................... 4,441 4,483 6.32
-------- -------- ----
$166,214 $171,420 5.68%
======== ======== ====
F-15
57
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 9. LONG-TERM DEBT, NET
During the second quarter of 1998, AmRIT, through its wholly owned
subsidiary, Eagle, issued approximately $457.0 million of collateralized
mortgage bonds (Long-Term Debt) through a Financial Asset Securitization
Investment Trust (FASIT). The bonds were assigned to a FASIT trust and trust
certificates evidencing the assets of the trust were sold to investors. The
trust certificates were issued in classes representing senior, mezzanine, and
subordinate payment priorities. Payments received on single-family mortgage
loans ("Bond Collateral") are used to make payments on the Long-Term Debt. The
obligations under the Long Term Debt are payable solely from the Bond Collateral
and are otherwise non-recourse to AmRIT. The maturity of each class of trust
certificates is directly affected by the rate of principal repayments on the
related Bond Collateral. The Long-Term Debt is also subject to redemption
according to the specific terms of the indenture pursuant to which the bonds
were issued and the FASIT trust. As a result, the actual maturity of the
Long-Term Debt is likely to occur earlier than its stated maturity.
During the second quarter of 1999, AmRIT, through its wholly owned
subsidiary, Eagle, issued approximately $229.0 million of a single class of
mortgage backed notes (Long-Term Debt). The notes are principally secured by the
assets of the trust, which consist primarily of fixed and adjustable rate
mortgage loans secured by first liens on one- to four-family residential
properties. Payments received on the mortgage loans ("Bond Collateral") are used
to make payments on the Long-Term Debt. The obligations under the Long-Term Debt
are payable solely from the Bond Collateral and are otherwise non-recourse to
AmRIT. The maturity of the notes is directly affected by the rate of principal
repayments on the related Bond Collateral. The Long-Term Debt is also subject to
redemption according to the specific terms of the indenture pursuant to which
the notes were issued. As a result, the actual maturity of the Long-Term Debt is
likely to occur earlier than its stated maturity.
During the third quarter of 1999, AmRIT, through its wholly owned
subsidiary, Eagle, issued approximately $394.1 million of Series 1999-2 mortgage
backed bonds (Long-Term Debt) in two classes. The bonds are non-recourse
obligations of a trust formed and wholly-owned by Eagle. The Class A-1 Bonds of
approximately $332.4 million are secured by the assets of the trust, which
consist of approximately $339.8 million in adjustable-rate mortgage loans
secured by first liens on one- to four-family residential properties. The
interest rate for the Class A-1 Bonds is variable based on one-month LIBOR. The
Class A-2 Bonds of approximately $61.7 million are secured by approximately $63
million in fixed-rate mortgage loans secured by first liens on one- to
four-family residential properties. The interest rate on the Class A-2 Bonds is
7.09%. Payments received on the mortgage loans securing the bonds ("Bond
Collateral") are used to make payments on the Long-Term Debt. Payments received
on the mortgage loans in excess of obligations due under the Long-Term Debt
agreement are remitted to the Company on a monthly basis by the Bond Trustee.
The obligations under the Long-Term Debt are payable solely from the Bond
Collateral and are otherwise non-recourse to AmRIT. While the stated maturity of
the bonds is July 25, 2029, the actual maturity of the bonds is directly
affected by the rate of principal repayments on the related Bond Collateral. The
Long-Term Debt is also subject to redemption by the Company according to the
specific terms of the indenture pursuant to which the bonds were issued. As a
result, the actual maturity of the Long-Term Debt is likely to occur earlier
than its stated maturity.
During the third quarter of 1999, Greenwich Capital Financial Products,
Inc. ("GCFP") conveyed to AmRIT, Mortgage Loans consisting of first lien,
fully-amortizing, residential mortgage loans ("Mortgage Loans") with original
terms to maturity of 30 years and an aggregate scheduled principal balance as of
the close of business on August 1, 1999 of $335.2 million. AmRIT then conveyed
an interest in the Mortgage Loans to Greenwich Financial Asset Securities Corp.
in exchange for a specified cash sum and certain REMIC securities. Under
generally accepted accounting principles, the transaction was treated as an
issuance of Long Term Debt, Series 1999-A, secured by the Mortgage Loans. The
Series 1999-A Long-Term Debt consists of two classes: Class A-1 which had an
initial principal amount of approximately $335.2 million and
F-16
58
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Class S-1 which is an interest only class. The interest rate for the Class A-1
is variable based on the one-month LIBOR. The interest rate for the Class S-1
begins at 3.5%, declines by 0.5% each year for two years and then declines to
0.00% at the end of year three. The stated maturity for the Class A-1 is August,
2029, however, since the maturity of the debt is directly affected by the rate
of principal repayments of the related Mortgage Loans, the actual maturity of
the Class A-1 is likely to occur earlier than its stated maturity.
AmRIT conveyed to Eagle, which in turn conveyed to Eagle 2, AmRIT's
remaining interest in the Mortgage Loans (subject to the Series 1999-A Long Term
Debt) and received as payment a combination of cash and credit for an additional
capital contribution. Pursuant to a Financing Agreement with GCFP, Eagle 2
pledged its interest in the Mortgage Loans as collateral to secure a term loan
made to it by GCFP, and directed the Trustee to remit all collections,
distributions or other income with respect to the Mortgage Loans (net of amounts
due on the Series 1999-A Long Term Debt) directly to GCFP to prepay outstanding
principal and interest.
The initial principal amount of the loan under the Financing Agreement was
equal to 55% of the market value (as defined therein) of the Mortgage Loans (or
approximately $7.1 million). To maintain a substantial level of over
collateralization during the term of the loan, the Financing Agreement requires
Eagle 2 to maintain a specified level of collateral (including the mortgage
Loans and any additional collateral pledged by Eagle 2). In the event that the
collateral value of the Mortgage Loans and other pledged collateral is
determined to be less than required, GCFP may require Eagle 2 to deliver
additional cash, securities or additional collateral or to repay principal in
the amount of such deficiency; the failure to do so would constitute an event of
default. The loan matures on February 26, 2001.
The components of the Long-Term Debt at December 31, 1999 and December 31,
1998, along with selected other information are summarized below (dollars in
thousands):
CMO/REMIC CMO CMO CMO/FASIT
1999-A 1999-2 1999-1 1998-1 TOTAL
SECURITIZATION SECURITIZATION SECURITIZATION SECURITIZATION SECURITIZATION
-------------- -------------- -------------- -------------- --------------
AT DECEMBER 31, 1999
Long-Term debt.................... $317,057 $376,855 $198,228 $208,120 $1,100,260
CMO premium, net.................. -- -- 237 237
Capitalized costs on long-term
debt............................ (30) (1,679) (1,299) (329) (3,337)
-------- -------- -------- -------- ----------
Total Long-Term debt.............. $317,027 $375,176 $196,929 $208,028 $1,097,160
======== ======== ======== ======== ==========
Weighted average financing
costs........................... 5.57% 6.11% 5.94% 5.98% 5.90%
AT DECEMBER 31, 1998
Long-Term debt.................... $385,239 $ 385,239
CMO premium, net.................. 396 396
Capitalized costs on long-term
debt............................ (345) (345)
-------- ----------
Total Long-Term debt.............. $385,290 $ 385,290
======== ==========
Weighted Average Financing
Costs........................... 5.33% 5.33%
======== ==========
Additionally, in conjunction with the 1999-A Securitization, the Company
received additional financing from GCFP. At December 31, 1999, the balance of
Long-Term-Debt was approximately $6.1 million. AmRIT has guaranteed the payment
and performance when due (whether at stated maturity, by acceleration or
otherwise) of all obligations of Eagle 2 to GCFP under the Financing Agreement.
NOTE 10. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair value of financial instruments amounts have been
determined by the Company's management using available market information and
appropriate valuation methodologies; however, consider-
F-17
59
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
able judgement is necessarily required to interpret market data to develop
estimates of fair value. Accordingly, the estimates presented herein are not
necessarily indicative of the amounts the Company could realize in a current
market exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value amounts.
The fair value as of December 31, 1999 and 1998 is as follows (dollars in
thousands):
1999 1998
------------------------ --------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
---------- ---------- -------- --------
Assets:
Cash and cash equivalents.................. $ 8,550 $ 8,550 $ 34,645 $ 34,645
Mortgage securities available-for-sale..... -- -- 6,617 6,617
Mortgage loans held-for-investment......... 126,216 125,705 179,009 179,009
Bond collateral............................ 1,153,731 1,142,810 417,808 417,808
Retained interest in securitization........ 6,610 6,610 8,762 8,762
Interest rate cap agreements............... 1,556 1,294 674 (1,529)
Due from affiliate......................... 394 394 606 606
Liabilities:
Short-term debt............................ 119,003 119,003 166,214 166,214
Long-term debt............................. 1,103,258 1,103,258 385,290 385,290
Due to affiliate........................... 597 597 386 386
The following describes the methods and assumptions used by the Company in
estimating fair values.
Cash and Cash Equivalents
The carrying amount for cash and cash equivalents approximates fair value
because these instruments are demand deposits and money market mutual funds and
do not present unanticipated interest rate or credit concerns.
Retained Interest in Securitization
This security is classified as available-for-sale and as such is carried at
fair value. See "Notes to the Consolidated Financial Statements -- Note 6.
Retained Interest in Securitization" for a description of the valuation
methodology.
Mortgage Securities available-for-sale and Mortgage Loans Held-for-Investment
The fair value for Mortgage Securities available-for-sale and Mortgage
Loans and held-for-investment is estimated based on quoted market prices from
dealers and brokers for similar types of Mortgage Assets.
The fair value for Bond Collateral is estimated based on quoted market
prices from dealers and brokers for similar types of mortgage loans.
Interest Rate Cap Agreements
The fair value of interest rate cap agreements is estimated based on quoted
market prices from dealers and brokers.
F-18
60
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Due from Affiliate
The fair value of due from affiliate approximates the carrying amount
because of the short-term nature of the asset.
Short-Term Debt
The fair value of reverse repurchase agreements approximates the carrying
amounts because of the short term nature of the liabilities.
Long-Term Debt
The fair value of long-term debt is estimated based upon comparable rates
on similar debt instruments.
Due to Affiliate
The fair value of due to affiliate approximates the carrying amount because
of the short-term nature of the liability.
NOTE 11. STOCK OPTION PLANS
The Company has adopted the 1997 Stock Incentive Plan (the "Incentive
Plan") and the 1997 Stock Option Plan (the "Option Plan") for executive officers
and key employees and has adopted the 1997 Outside Directors Option Plan (the
"Directors Plan") for directors who are not employees of the Company.
The Incentive Plan, the Option Plan and the Directors Plan authorize the
Board of Directors (or a committee appointed by the Board of Directors) to grant
incentive stock options ("ISOs"), as defined under section 422 of the Code,
options not so qualified ("NQSOs"), and stock appreciation rights ("SAR's") to
such eligible recipients.
F-19
61
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
During the period from February 11, 1997 (commencement of operations)
through December 31, 1999, the Company granted 1,021,100 options as follows:
TOTAL OPTIONS W/
ISO NON-QUALIFIED OPTIONS SAR'S
------- ------------- --------- ----------
1997 STOCK INCENTIVE PLAN:
February 11, 1997 @ 12.50/share............. 99,200 216,000 315,200 280,000
1997 STOCK OPTION PLAN:
October 27, 1997 @ 15.00/share.............. 104,801 232,999 337,800 --
December 15, 1997 @ 15.00/share............. 4,267 72,133 76,400 --
1997 OUTSIDE DIRECTORS STOCK OPTIONS:
October 27, 1997 @ 15.00/share.............. -- 30,000 30,000 --
------- ------- --------- -------
Options Issued at December 31, 1997........... 208,268 551,132 759,400 280,000
------- ------- --------- -------
1997 STOCK OPTION PLAN:
April 8, 1998 @ 13.69/share................. 9,000 -- 9,000 --
October 1, 1998 @ 6.13/share................ 2,500 -- 2,500 --
------- ------- --------- -------
Options Issued in 1998........................ 11,500 -- 11,500 --
Options Forfeited in 1998..................... (26,667) (48,333) (75,000)
------- ------- --------- -------
Net Options Forfeited in 1998................. (15,167) (48,333) (63,500) --
------- ------- --------- -------
1997 STOCK OPTION PLAN:
April 19, 1999 @ 8.06/share................. 2,500 -- 2,500 --
April 30, 1999 @ 7.50/share................. 1,500 -- 1,500 --
May 6, 1999 @ 7.25/share.................... 224,700 -- 224,700 --
June 16, 1999 @ 7.50/share.................. 100,000 -- 100,000 --
July 16, 1999 @ 7.75/share.................. 35,000 -- 35,000 --
August 16, 1999 @ 7.06/share................ 5,000 -- 5,000 --
1997 OUTSIDE DIRECTORS STOCK OPTIONS:
May 19, 1999 @ 7.88/share................... 30,000 -- 30,000 --
------- ------- --------- -------
Options Issued in 1999........................ 398,700 -- 398,700 --
Options Forfeited in 1999..................... (32,567) (40,933) (73,500) --
------- ------- --------- -------
Options Issued at December 31, 1999........... 366,133 (40,933) 325,200 --
------- ------- --------- -------
Total Options Issued at December 31, 1999..... 559,234 461,866 1,021,100 280,000
======= ======= ========= =======
The Incentive Plan was adopted on February 11, 1997 (the "Effective Date"),
and a total 315,200 shares of common stock have been reserved for issuance. All
stock options granted under the Incentive Plan vest at the earlier of a
four-year period from the date of grant or once the Company issues an aggregate
of $150 million of new equity, and will expire within ten years after the date
of grant.
The Company also has adopted the 1997 Employee Stock Purchase Plan (the
"Purchase Plan") which permits eligible employees to purchase common stock at a
discount through accumulated payroll deductions. No shares were issued under the
Purchase Plan as of December 31, 1999.
F-20
62
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
As of December 31, 1999, The following options were reserved for issuance
under the Company's option plans:
1997
1997 OUTSIDE
1997 1997 EMPLOYEE DIRECTOR
STOCK STOCK STOCK STOCK
INCENTIVE OPTION PURCHASE OPTION
PLAN PLAN PLAN PLAN TOTAL
--------- ------- -------- -------- ---------
Total Options Authorized................ 315,200 774,800 20,000 60,000 1,170,000
Total Options Issued.................... 300,800 660,300 -- 60,000 1,021,100
------- ------- ------ ------ ---------
Options Reserved for Issuance........... 14,400 114,500 20,000 -- 148,900
======= ======= ====== ====== =========
In November 1995, the FASB issued Statement of Financial Accounting
Standards No. 123 (SFAS 123), "Accounting for Stock Based Compensation." This
statement establishes financial accounting standards for stock-based employee
compensation plans. SFAS 123 permits the Company to choose either a new fair
value based method or the current APB Opinion 25 Intrinsic value based method of
accounting for its stock-based compensation arrangements. SFAS 123 requires pro
forma disclosures of net income (loss) computed as if the fair value based
method had been applied for in financial statements of companies that continue
to follow current practice in accounting for such arrangements under Opinion 25.
SFAS 123 applies to all stock-based employee compensation plans in which an
employer grants shares of its stock or other equity instruments to employees
except for employees stock ownership plans. SFAS 123 also applies to plans in
which the employer incurs liabilities to employees in amounts based on the price
of the employer's stock, i.e., stock option plans, stock purchase plans,
restricted stock plans, and stock appreciation rights. The statement also
specifies the accounting for transactions in which a company issues stock
options or other equity instruments for services provided by non employees or to
acquire goods or services from the outside supplies or vendors.
The Company elected to apply the APB Opinion 25 in accounting for its
plans: the 1997 Stock Incentive Plan, 1997 Stock Option Plan, 1997 Employee
Stock Purchase Plan and 1997 Outside Directors Stock Option Plan and,
accordingly, no compensation cost has been recognized in the financial
statements. Had the Company determined compensation cost based on the fair value
at the grant date for its stock options exercisable under SFAS No. 123, the
Company's net income (loss) and income (loss) per share for the years ended
December 31, 1999 and 1998 and for the period from February 11, 1997
(commencement of operations) through December 31, 1997 would have decreased to
the pro forma amounts indicated below (dollars in thousands except per share
data):
FOR THE PERIOD FROM
FEBRUARY 11, 1997
FOR THE FOR THE (COMMENCEMENT OF
YEAR ENDED YEAR ENDED OPERATIONS) THROUGH
DECEMBER 31, 1999 DECEMBER 31, 1998 DECEMBER 31, 1997
----------------- ----------------- --------------------
Net income (loss) as reported........... $(3,850) $(1,214) $2,403
======= ======= ======
Pro forma net income (loss)............. $(4,197) $(1,440) $2,186
======= ======= ======
Basic income (loss) per share as
reported.............................. $ (0.48) $ (0.15) $ 0.83
======= ======= ======
Diluted income (loss) per share as
reported.............................. $ (0.48) $ (0.15) $ 0.82
======= ======= ======
Pro forma basic income (loss) per
share................................. $ 0.52 $ 0.18 $ 0.76
======= ======= ======
Pro forma diluted income (loss) per
share................................. $ 0.52 $ 0.18 $ 0.75
======= ======= ======
The derived fair value of the options granted during the years ended
December 31, 1999 and 1998 and the period from February 11, 1997 (commencement
of operations) through December 31, 1997 was approximately $606,000, $46,000 and
$1.1 million respectively, or a per option fair value of $1.52, $5.11 and $1.77
respectively, using the Black-Scholes option pricing model with the following
assumptions for 1999;
F-21
63
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
a weighted average expected dividend yield of 13.63%, a weighted average
risk-free interest rate of 5.53%, expected life of 5 years, and expected
volatility of 60.89%, for 1998; a weighted average expected dividend yield of
7.46%, a weighted average risk-free interest rate of 5.52%, expected life of 5
years for employees and 4 years for board members, and expected volatility of
62%, and for 1997; a weighted average expected dividend yield of 7.36%, a
weighted average risk-free interest rate of 5.59%, expected life of 5 years, and
expected volatility of 20%.
NOTE 12. STOCKHOLDERS' EQUITY
On February 11, 1997, the Company issued 1,614,000 shares of common stock
at a price of $12.50 per share of common stock. The Company received proceeds of
approximately $20.2 million, net of issuance costs of $10,000. On November 3,
1997, the Company issued 6,500,000 shares of common stock at a price of $15.00
per share of common stock. The Company received proceeds of approximately $89.7
million, net of issuance costs of approximately $7.8 million. During 1998, the
Company repurchased 58,500 shares of common stock. The Company paid
approximately $492,000 for the repurchased shares.
On December 19, 1997, the Company declared a dividend of $1.3 million or
$0.16 per share. The dividend was paid on January 21, 1998 to holders of record
of common stock as of December 31, 1997. On October 21, 1997, the Company
declared a dividend of $519,000 or $0.32 per share of common stock. This
dividend was paid on October 29, 1997 to holders of record of common stock as of
September 30, 1997. On July 17, 1997, the Company declared a dividend of
$438,000 or $0.27 per share of common stock. This dividend was paid on July 17,
1997 to holders of record of common stock as of June 30, 1997. On May 1, 1997,
the Company declared a dividend of $146,000 or $0.09 per share of common stock.
This dividend was paid on May 1, 1997 to holders of record of common stock as of
March 31, 1997.
On December 17, 1998, the Company declared a dividend of $1.2 million or
$0.15 per share. The dividend was paid on January 28, 1999 to holders of record
of common stock as of December 31, 1998. On October 15, 1998, the Company
declared a dividend of $967,000 or $0.12 per share. This dividend was paid on
November 2, 1998 to holders of record of common stock as of October 26, 1998. On
July 13, 1998, the Company declared a dividend of $2.3 million or $0.28 per
share. This dividend was paid on July 31, 1998 to holders of record of common
stock as of July 24, 1998. On April 14, 1998, the Company declared a dividend of
$2.3 million or $0.28 per share. This dividend was paid on April 30, 1998 to
holders of record of common stock as of April 24, 1998.
On December 16, 1999, the Company declared a dividend of $2.4 million or
$0.30 per share. The dividend was paid on January 31, 2000 to holders of record
of common stock as of December 31, 1999. On October 21, 1999, the Company
declared a dividend of $2.2 million or $0.27 per share dividend payable on
November 8, 1999 to stockholders of record as of November 1, 1999. On July 21,
1999, the Company declared dividend of $2.0 million or $0.25 per share. The
dividend was paid on August 6, 1999 to stockholders of record as of July 30,
1999. On April 22, 1999 the Company declared a dividend of $1.6 million or $0.20
per share. The dividend was paid on May 10, 1999 to stockholders of record as of
May 3, 1999.
On February 8, 1999, the Company adopted a Stockholder Rights Plan ("the
Plan") designed to enable all Company stockholders to realize the full value of
their investment and to provide for fair and equal treatment for all
stockholders in the event that an unsolicited attempt is made to acquire the
Company. The adoption of the Plan is intended as a means to guard against any
potential use of takeover tactics designed to gain control of the Company
without paying all stockholders full and fair value for their stock. The
distribution of the Rights is not in response to any proposal to acquire the
Company and the Board is not aware of any such effort.
F-22
64
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Under the Plan, stockholders will receive one Right to purchase one
one-hundredth of a share of a new series of preferred stock for each outstanding
share of the Company's common stock held of record at the close of business on
February 26, 1999, or thereafter.
The Rights, which will trade with the common stock, become exercisable to
purchase one one-hundredth of a share of the new preferred stock, at $30.00 per
Right, when someone acquires 15% or more of the Company's common stock or
announces a tender offer which could result in such person owning 15% or more of
the common stock. Each one one-hundredth of a share of the new preferred stock
has terms designed to make it substantially the economic equivalent of one share
of common stock. The Rights can be redeemed by the Board for $0.01. Under
certain circumstances, if someone acquires 15% or more of the common stock, the
Rights permit stockholders other than the acquiror to purchase common stock
having a market value of twice the exercise price of the Rights, in lieu of the
preferred stock. In addition, in the event of certain business combinations, the
Rights permit purchase of the common stock of an acquiror at a 50% discount.
Rights held by the acquiror will become null and void in both cases. The rights
expire on February 2, 2009. The Rights distribution will not be taxable to
stockholders and will be issued to stockholders of record on February 26, 1999.
NOTE 13. STOCK SPLIT AND AUTHORIZED SHARES
On August 6, 1997, the Company authorized a 0.8-for-one reverse stock split
of all of the outstanding shares of common stock. All references in the
financial statements to the number of shares, per share amounts and prices of
the Company's common stock have been retroactively restated to reflect the
decreased number of shares of common stock outstanding. On October 20, 1997, the
Company increased the number of total authorized shares of common stock to
25,000,000 from 4,000,000. Under the articles of incorporation, as amended on
October 20, 1997, the Company is authorized to issue any class of capital stock,
common stock or preferred stock, up to the aggregate authorized amount of
25,001,000 shares, all of which has been initially designated as common stock.
All unissued shares may be reclassified by the Company's Board of Directors as
one or more series of preferred stock.
NOTE 14. MANAGEMENT AGREEMENT
Effective February 11, 1997, the Company entered into a Management
Agreement with the Manager for an initial term of two years, to provide
management services to the Company. The agreement automatically renews unless
terminated by AmRES.
The Manager receives management fees and incentive compensation as follows:
- 1/8 of 1% per year, to be paid monthly, of the principal amount of agency
securities;
- 3/8 of 1% per year, to be paid monthly, of the principal amount of all
Mortgage Loans other than agency securities; and
- 25% of the amount by which the Company's net income (before deducting the
amount to be paid as incentive compensation) exceeds the annualized
return on equity equal to the average ten year U.S. Treasury Rate plus
2%.
Management fees of approximately $3.5 million, $2.4 million and $249,000
were recorded for the years ended December 31, 1999, 1998 and for the period
from February 11, 1997 (commencement of operations) through December 31, 1997,
respectively. The incentive compensation is calculated for each fiscal quarter,
and paid to the Manager quarterly in arrears before any income distributions are
made to stockholders. There was no incentive compensation for the year ended
December 31, 1999. For the year ended December 31, 1998, and for the period from
February 11, 1997 (commencement of operations) through December 31, 1997
incentive compensation was approximately $24,000 and $34,000, incentive
compensation, respectively.
F-23
65
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The Company will employ certain employees of the Manager involved in the
day-to-day operations of the Company, including the Company's executive
officers, so that such employees may maintain certain benefits that are
available only to employees of the Company under the Code. These benefits
include the ability to receive incentive stock options under the 1997 Stock
Option Plan and to participate in the Company's Employee Stock Purchase Plan. In
order to receive the aggregate benefits of the Management Agreement originally
negotiated between the Company and the Manager, the Company will pay the base
salaries of such employees and will be reimbursed by the Manager for all costs
incurred with respect to such payments.
The Manager's default on certain debt, could result in a default and
termination of the Management Agreement, in which case the operations of the
Company could be materially and adversely affected pending either the engagement
of a new manager or the development internally of the resources necessary to
manage the operation of the Company. The Manager is currently in default of
certain debt covenants. The senior note holders have not issued waivers, however
the parties continue to operate under the original terms of the Management
Agreement. In addition, MDC Reit Holdings, LLC ("MDC-REIT") has pledged 1.6
million shares of its common stock of the Company to secure the Manager's
obligations under the Securities Purchase Agreement. As a result of the defaults
under the Securities Purchase Agreement, the pledged shares could be transferred
to the holders of the Notes, who will then have certain demand registration
rights.
NOTE 15. RELATED PARTY TRANSACTIONS
During the year ended December 31, 1998, the Company purchased
approximately $24 million of Mortgage Loans from an affiliated entity of one of
its directors. These purchases were made in the normal course of business at
terms consistent with the Company's general purchasing policies.
On June 1, 1998, the Company sold approximately $98.2 million par value
Mortgage Loans to Holdings for total consideration of $103.5 million. Management
believes the loans were sold at fair value at the time of the transaction.
On June 30, 1998, Holdings transferred the Class "X" Certificate to the
Company as part of the purchase price of Mortgage Loans purchased from the
Company on June 1, 1998. The Class "X" Certificate had a fair value of $6.6
million at the time of the transfer.
F-24
66
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 16. SELECTED QUARTERLY FINANCIAL DATA
Selected quarterly financial data for 1999 and 1998 is as follows (dollars
in thousands, except per share data):
FOR THE FOR THE FOR THE FOR THE
QUARTER ENDED QUARTER ENDED QUARTER ENDED QUARTER ENDED
DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31,
1999 1999 1999 1999
------------- ------------- ------------- -------------
Total interest income................. $25,846 $22,060 $17,027 $14,186
Interest expense...................... 17,798 14,159 9,614 8,073
Premium amortization.................. 4,035 4,853 4,022 3,715
Premium write-down.................... 12,294 -- -- --
Provision for loan losses............. 942 804 954 950
Net interest income (loss)............ (9,224) 2,244 2,437 1,449
Other operating income................ 1,142 1,389 992 926
Other expenses........................ 1,574 1,467 1,404 760
Net income (loss)..................... (9,655) 2,166 2,025 1,614
Net income (loss) per share of common
stock -- basic...................... (1.20) 0.27 0.25 0.20
Net income (loss) per share of common
stock -- diluted.................... (1.20) 0.27 0.25 0.20
FOR THE FOR THE FOR THE FOR THE
QUARTER ENDED QUARTER ENDED QUARTER ENDED QUARTER ENDED
DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31,
1998 1998 1998 1998
------------- ------------- ------------- -------------
Total interest income................. $16,622 $18,412 $18,965 $14,408
Interest expense...................... 10,169 12,733 13,153 9,135
Premium amortization.................. 3,755 4,241 3,401 1,914
Provision for loan losses............. 2,756 296 282 136
Net interest income (loss)............ (58) 1,142 2,129 3,223
Other operating income................ 409 765 1,148 22
Loss on sale of
mortgage-backed-securities.......... 5,912 -- -- --
Other expenses........................ 1,201 906 1,008 967
Net income (loss)..................... (6,761) 1,001 2,269 2,277
Net income (loss) per share of common
stock -- basic...................... (0.83) 0.12 0.28 0.28
Net income (loss) per share of common
stock -- diluted.................... (0.83) 0.12 0.28 0.28
NOTE 17. COMMITMENTS AND CONTINGENCIES
On January 28, 2000, the Company sold $66.0 million in Mortgage Loans
Held-for-Investment back to the originator that sold these loans to the Company
during the fourth quarter of 1999. Certain irregularities were discovered during
the Company's routine post-funding quality control review related to
underwriting compliance and loan documents. The buyback was pursuant to certain
representations and warranty obligations of the originator related to
underwriting criteria and regulatory compliance.
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67
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form 10-K and has duly caused this Form 10-K to be
signed on its behalf by the undersigned, thereto duly authorized, in the City of
San Diego, State of California, on the 30th day of March, 2000.
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.
By: /s/ JOHN M. ROBBINS
-------------------------------------------
John M. Robbins
Chief Executive Officer
SIGNATURE TITLE DATE
--------- ----- ----
By: /s/ JOHN M. ROBBINS Chairman of the Board and March 30, 2000
------------------------------------------------- Chief Executive Officer
John M. Robbins (Principal Executive Officer)
By: /s/ JAY M. FULLER President Chief Operating March 30, 2000
------------------------------------------------- Officer (Principal Operating
Jay M. Fuller Officer)
By: /s/ JUDITH A. BERRY Chief Financial Officer March 30, 2000
------------------------------------------------- (Principal Financial and
Judith A. Berry Accounting Officer)
By: /s/ JAMES BROWN Director March 30, 2000
-------------------------------------------------
H. James Brown
By: /s/ DAVID DE LEEUW Director March 30, 2000
-------------------------------------------------
David De Leeuw
By: /s/ RAY MCKEWON Director March 30, 2000
-------------------------------------------------
Ray McKewon
By: /s/ RICHARD J. PRATT, PH.D. Director March 30, 2000
-------------------------------------------------
Richard J. Pratt, Ph.D.
By: /s/ MARK J. REIDY, PH.D. Director March 30, 2000
-------------------------------------------------
Mark J. Reidy, Ph.D.
S-1