===============================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark one)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2003
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 No. 001-13937
ANTHRACITE CAPITAL, INC.
(Exact name of Registrant as specified in its charter)
MARYLAND 13-3978906
------------------------------------ -------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
40 East 52nd Street
New York, New York 10022
- ------------------------------------ --------------------------
(Address of principal executive office) (Zip Code)
(212) 409-3333
- ------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(g) of the Act: Not Applicable
Securities registered pursuant to Section 12(b) of the Act:
COMMON STOCK, $.001 PAR VALUE NEW YORK STOCK EXCHANGE
9.375% SERIES C CUMULATIVE REDEEMABLE NEW YORK STOCK EXCHANGE
PREFERRED STOCK, $.001 PAR VALUE
(Title of each class) (Name of each exchange on which
registered)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes |X| No |_|
The aggregate market value of the registrant's Common Stock, $.001 par value,
held by non-affiliates of the registrant, computed by reference to the closing
sale price of $12.06 as reported on the New York Stock Exchange on June 30,
2003, was $577,644,055 (for purposes of this calculation, affiliates include
only directors and executive officers of the registrant).
The number of shares of the registrant's Common Stock, $.001 par value,
outstanding as of March 4, 2004 was 50,095,281 shares.
Documents Incorporated by Reference: The registrant's Definitive Proxy
Statement for the 2004 Annual Meeting of Stockholders is incorporated by
reference into Part III.
ANTHRACITE CAPITAL, INC. AND SUBSIDIARIES
2003 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PAGE
----
PART I
Item 1. Business........................................................4
Item 2. Properties ...................................................24
Item 3. Legal Proceedings .............................................24
Item 4. Submission of Matters to a Vote of
Security Holders ..............................................24
PART II
Item 5. Market for the Registrant's Common Equity
and Related Stockholder Matters ...............................25
Item 6. Selected Financial Data .......................................26
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations .................27
Item 7A. Quantitative and Qualitative Disclosures About
Market Risk ...................................................49
Item 8. Financial Statements and Supplementary Data ...................53
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure ........................92
Item 9A. Controls and Procedures........................................92
PART III
Item 10. Directors and Executive Officers of the Registrant ............93
Item 11. Executive Compensation ........................................93
Item 12. Security Ownership of Certain Beneficial
Owners and Management and Related Shareholder Matters .........93
Item 13. Certain Relationships and Related Transactions ................93
Item 14. Principal Accountant Fees and Services.........................93
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on
Form 8-K ......................................................94
Signatures .................................................................95
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
Certain statements contained herein constitute "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995
with respect to future financial or business performance, strategies or
expectations. Forward-looking statements are typically identified by words or
phrases such as "trend," "opportunity," "pipeline," "believe," "comfortable,"
"expect," "anticipate," "current," "intention," "estimate," "position,"
"assume," "potential," "outlook," "continue," "remain," "maintain," "sustain,"
"seek," "achieve" and similar expressions, or future or conditional verbs such
as "will," "would," "should," "could," "may" or similar expressions.
Anthracite Capital, Inc. (the "Company") cautions that forward-looking
statements are subject to numerous assumptions, risks and uncertainties, which
change over time. Forward-looking statements speak only as of the date they
are made, and Anthracite assumes no duty to and does not undertake to update
forward-looking statements. Actual results could differ materially from those
anticipated in forward-looking statements and future results could differ
materially from historical performance.
In addition to factors previously disclosed in Anthracite's Securities and
Exchange Commission (the "SEC") reports and those identified elsewhere in this
report, the following factors, among others, could cause actual results to
differ materially from forward-looking statements or historical performance:
(1) the introduction, withdrawal, success and timing of business
initiatives and strategies;
(2) changes in political, economic or industry conditions, the
interest rate environment or financial and capital markets,
which could result in changes in the value of the Company's
assets;
(3) the relative and absolute investment performance and operations
of the Company's manager, BlackRock Financial Management, Inc.
(the "Manager");
(4) the impact of increased competition;
(5) the impact of capital improvement projects;
(6) the impact of future acquisitions;
(7) the unfavorable resolution of legal proceedings;
(8) the extent and timing of any share repurchases;
(9) the impact, extent and timing of technological changes and the
adequacy of intellectual property protection;
(10) the impact of legislative and regulatory actions and reforms
and regulatory, supervisory or enforcement actions of
government agencies relating to the Company, the Manager or The
PNC Financial Services Group, Inc.;
(11) terrorist activities, which may adversely affect the general
economy, real estate, financial and capital markets, specific
industries, and the Company and the Manager; and
(12) the ability of the Manager to attract and retain highly
talented professionals.
Forward-looking statements speak only as of the date they are made. The
Company does not undertake, and specifically disclaims any obligation, to
publicly release the result of any revisions which may be made to any
forward-looking statements to reflect the occurrence of anticipated or
unanticipated events or circumstances after the date of such statements.
PART I
ITEM 1. BUSINESS
All dollar figures expressed herein are expressed in thousands, except share
or per share amounts.
General
Anthracite Capital, Inc. (the "Company"), a Maryland corporation, is a real
estate finance company that generates income based on the spread between the
interest income on its mortgage loans and securities investments and the
interest expense from borrowings to finance its investments. The Company's
primary activity is investing in high yielding commercial real estate debt.
The Company combines traditional real estate underwriting and capital markets
expertise to exploit the opportunities arising from the continuing integration
of these two disciplines. The Company focuses on acquiring pools of performing
loans in the form of commercial mortgage backed securities ("CMBS"), issuing
secured debt backed by CMBS and providing strategic capital for the commercial
real estate industry in the form of mezzanine loan financing. The Company
commenced operations on March 24, 1998.
The Company's common stock is traded on the New York Stock Exchange under the
symbol "AHR". The Company's primary long-term objective is to distribute
consistent dividends supported by earnings. The Company establishes its
dividend by analyzing the long-term sustainability of earnings given existing
market conditions and the current composition of its portfolio. This includes
an analysis of the Company's credit loss assumptions, general level of
interest rates and projected hedging costs.
The Company is managed by BlackRock Financial Management, Inc. (the
"Manager"), a subsidiary of BlackRock, Inc., a publicly traded (NYSE: BLK)
asset management company with over $309,400,000 of global assets under
management as of December 31, 2003. The Manager provides an operating platform
that incorporates significant asset origination, risk management, and
operational capabilities.
The Company's ongoing investment activities encompass two core investment
activities:
1) Commercial Real Estate Securities
2) Commercial Real Estate Loans
The commercial real estate securities portfolio provides diversification and
high yields that are adjusted for anticipated losses over a long period of
time (typically, a ten-year weighted average life) and can be financed through
the issuance of secured debt that matches the life of the investment.
Commercial real estate loans provide attractive risk adjusted returns over
shorter periods of time through strategic investments in specific property
types or regions. The Company believes these portfolios can serve to provide
stable earnings over long periods of time.
At the end of the third quarter of 2003, the Company decided to accelerate its
strategic reduction of residential mortgage backed securities ("RMBS") due to
the volatility of interest rates and structural changes in the RMBS market.
Historically, the Company has invested its excess liquidity in a portfolio of
RMBS. The continued volatility of this asset class is not consistent with the
Company's objective of maintaining stable earnings and so is being reduced
over time to represent less than 25% of the Company's total portfolio within
the next few quarters, subject to the availability of high yield real estate
assets and other market conditions. In addition, the Company must maintain 55%
of its total assets in qualifying real estate assets for regulatory purposes.
Currently the RMBS portfolio provides a significant portion of this
requirement.
Commercial Real Estate Securities
The Company's principal activity is to underwrite and acquire high yielding
CMBS that are rated below investment grade. The Company's CMBS are securities
backed by pools of loans secured by first mortgages on commercial real estate
throughout the United States. The commercial real estate securing the first
mortgages consist of income producing properties including office buildings,
shopping centers, apartment buildings, industrial properties, healthcare
properties, and hotels, among others. The terms of a typical loan include a
fixed rate of interest, thirty-year amortization, some form of prepayment
protection, and a large interest rate increase if not paid off after ten
years. The loans are originated by various lenders and pooled together in a
trust that issues securities in the form of various classes of fixed rate debt
secured by the cash flows from the underlying loans. The securities issued by
the trust are rated by one or more nationally recognized credit rating
organizations and are rated AAA down to CCC. The security which is affected
first by loan losses is not rated. Generally, the Company does not acquire the
investment grade rated securities from newly-formed trusts. The principal
amount of the pools of loans securing the CMBS securities varies.
Each trust has a designated special servicer. Special servicers are
responsible for carrying out the loan loss mitigation strategies. A special
servicer will also advance funds to a trust to maintain principal and interest
cash flows on the trust's securities so long as it believes there is a
significant probability of recovering those advances from the underlying
borrowers. The special servicer is paid a fee for advancing funds and for its
efforts in carrying out loss mitigation strategies.
The Company focuses on acquiring the securities rated below investment grade
(BB+ or lower). The most subordinated CMBS classes are the first to absorb
realized losses in the loan pools. To the extent there are losses in excess of
the most subordinated class' stated entitlement to principal and interest,
then the remaining CMBS classes will bear such losses in order of their
relative subordination. If a loss of face value, or par, is experienced in the
underlying loans, a corresponding reduction in the par of the lowest rated
security occurs, reducing cash flow. The majority owner of the first loss
position has the right to control the workout process and therefore designate
the special servicer. The Company will generally seek to be in the control
position by purchasing the majority of the non-rated securities and
sequentially rated securities as high as BB+. Typically, the par amount of all
securities that are rated below investment grade represents 3.7.5% - 6.0% of
the par of the underlying loans of newly issued CMBS transactions. This is
known as the subordination level because 3.75% - 6.0% of the loan balance is
subordinated to the senior, investment grade rated securities.
The Company does not typically purchase a BB- rated security unless the
Company is involved in the new issue due diligence process and have a clear
pari-passu alignment of interest with the special servicer, or we can appoint
the special servicer. The Company purchases BB+ and BB rated securities at
their original issue or in the secondary market without necessarily having
control of the workout process. These other below investment grade CMBS do not
absorb losses until the BB- and lower rated securities have experienced losses
of their entire principal amounts. The Company believes the 3.0% - 4.0%
subordination levels of these securities provide additional credit protection
and diversification with an attractive risk return profile.
As of December 31, 2003, the Company owns nine different trusts ("Controlling
Class") where the Company through its investment in subordinated CMBS of such
trusts is in the first loss position. As a result of this investment position,
the Company controls the workout process on $11,043,023 of underlying loans.
The total par amount owned of these Controlling Class securities is $805,032.
The Company does not own the senior securities that represent the remaining
par amount of the underlying mortgage loans. The special servicer on seven of
the nine trusts is Midland Loan Services, Inc.; the special servicer on the
remaining two trusts is GMAC Commercial Mortgage Management, Inc.
The Company also purchases investment grade commercial real estate related
securities in the form of CMBS and unsecured debt of commercial real estate
companies. The addition of these higher rated securities is intended to add
greater stability to the long-term performance of the Company's portfolios as
a whole and to provide greater diversification to optimize secured financing
alternatives. The Company generally seeks to assemble a portfolio of high
quality issues that will maintain consistent performance over the life of the
security.
The Company also acquires CMBS interest only securities ("IOs"). These
securities represent a portion of the interest coupons paid by the underlying
loans. The Company views this portfolio as an attractive relative value versus
other alternatives. These securities do not have significant prepayment risk
because the underlying loans generally have prepayment restrictions.
Furthermore, the credit risk is also mitigated because the IO represents a
portion of all underlying loans, not solely the first loss.
The following table indicates the amounts of each category of commercial real
estate assets the Company owns as of December 31, 2003. The dollar price
("Dollar Price") represents the market value or adjusted purchase price of a
security, respectively, relative to its par value.
Adjusted Loss
Dollar Purchase Dollar Adjusted
Assets Par Market Value Price Price* Price Yield
- ---------------------------------------------------------------------------------------------------------------------
Controlling Class CMBS $806,632 $435,029 53.93 $503,108 62.37 10.17%
Other Below Investment
Grade CMBS 304,207 268,414 88.23 262,826 86.40 8.69%
Investment Grade
Commercial Real
Estate Related Securities 564,688 578,572 102.46 562,585 99.63 5.73%
CMBS IOs 2,623,456 84,493 3.22 83,705 3.19 7.54%
-------------------------------------------------------------------------------
Total $4,298,983 $1,366,508 31.79 $1,412,224 32.85 7.97%
===============================================================================
* The adjusted purchase price represents the amortized cost of the Company's investments.
The Company finances the majority of these portfolios with match funded,
secured term debt through collateralized debt obligation ("CDO") offerings. To
accomplish this, the Company forms a special purpose entity ("SPE") and
contributes a portfolio of mostly below investment grade CMBS, investment
grade CMBS, and unsecured debt of commercial real estate companies in exchange
for the residual interest in the SPE. As this transaction is considered a
financing, the SPE is fully consolidated on the Company's consolidated
financial statements. The SPE will then issue fixed and floating rate debt
secured by the cash flows of the securities in its portfolio. The SPE will
enter into an interest rate swap agreement to convert all floating rate debt
issued to a fixed interest rate, thus matching the cash flow profile of the
underlying portfolio. The structure of the debt also eliminates the mark to
market requirement of other types of financing, thus eliminating the need to
provide additional collateral if the value of the underlying portfolio
declines. The debt issued by the SPE is generally rated AAA down to BB; due to
its residual interest, the Company continues to manage the credit risk of the
underlying portfolio as it did prior to the assets being contributed to the
CDO. The CDO provides an optimal capital structure to maximize returns on
these types of portfolios on a non-recourse basis. Other forms of financing
used for these types of assets include multi-year committed financing
facilities and 30-day reverse repurchase agreements.
Owning commercial real estate loans in this form allows the Company to earn
its loss-adjusted returns over a long period of time while achieving
significant diversification across geographic areas and property types.
The following table indicates the par values of each category of commercial
real estate asset being used to secure the different types of borrowings as of
December 31, 2003:
Par Securing
------------------------------------------------------------------------
CDO Reverse Committed Not
Debt Repo Facilities Financed Total
------------------------------------------------------------------------
Controlling Class CMBS $371,659 $78,091 $143,417 $213,465 $806,632
Other Below Investment
Grade CMBS 258,605 36,252 11,850 7,500 314,207
Investment Grade Commercial Real
Estate Related Securities 228,146 265,712 38,630 22,200 554,688
CMBS IOs - 2,014,213 - 609,243 2,623,456
------------------------------------------------------------------------
Total $858,410 $2,394,268 $193,897 $852,408 $4,298,983
========================================================================
Prior to acquiring Controlling Class securities, the Company performs a
significant amount of due diligence on the underlying loans to ensure their
risk profiles fit the Company's criteria. Loans that do not fit the Company's
criteria are removed from the pool. The debt service coverage ratios are
evaluated to determine if they are appropriate for each asset class. The
average loan to value ratio ("LTV") of the underlying loans is generally 70%
at origination. Due to its greater levels of credit protection, other below
investment grade CMBS are subject to less comprehensive due diligence than
Controlling Class securities.
As part of the underwriting process, the Company assumes a certain amount of
loans will incur losses over time. In performing continuing credit reviews on
the nine trusts, the Company estimates that $261,885 of principal of the
underlying loans will not be recoverable. This amount represents 2.06% of the
underlying loan pools and 32.5% of the par amount of the Controlling Class
securities owned by the Company. This loss assumption is used to compute a
loss adjusted yield, which is then used to report income on the Company's
consolidated financial statements. The weighted average loss adjusted yield
for all Controlling Class securities is 10.17%. For all Controlling Class
securities with a rating of BB- and below, the weighted average loss adjusted
yield is 10.85%. If the loss assumptions prove to be consistent with actual
loss experience, the Company will maintain that level of income for the life
of the security. If actual losses differ from the original loss assumptions, a
change in the original assumptions will be made to restate the yields
accordingly. A write down of the adjusted purchase price or write up of loss
adjusted yields of the security may also be required. (See Item 7A
- -"Quantitative and Qualitative Disclosures About Market Risk" for more
information on the sensitivity of the Company's income and adjusted purchase
price to changes in credit experience.)
Once acquired, the Company uses a performance monitoring system to track the
credit experience of the mortgages in the pools securing both the Controlling
Class and the other below investment grade CMBS. The Company receives
remittance reports monthly from the trustees and closely monitors any
delinquent loans or other issues that may affect the performance of the loans.
The special servicer of a loan pool also assists in this process. The Company
reviews its loss assumptions every quarter using updated payment and debt
service coverage information on each loan in the context of economic trends on
both a national and regional level.
The Company's anticipated yields to maturity on its investments are based upon
a number of assumptions that are subject to certain business and economic
uncertainties and contingencies. Examples of such contingencies include, among
other things, the timing and severity of expected credit losses, the rate and
timing of principal payments (including prepayments, repurchases, defaults,
liquidations, special servicer fees, and other related expenses), the
pass-through or coupon rate, and interest rate fluctuations. Additional
factors that may affect the Company's anticipated yields to maturity on its
Controlling Class CMBS include interest payment shortfalls due to
delinquencies on the underlying mortgage loans and the timing and magnitude of
credit losses on the mortgage loans underlying the Controlling Class CMBS that
are a result of the general condition of the real estate market (including
competition for tenants and their related credit quality) and changes in
market rental rates. As these uncertainties and contingencies are difficult to
predict and are subject to future events, which may alter these assumptions,
no assurance can be given that the Company's anticipated yields to maturity
will be maintained.
Commercial Real Estate Loans
The Company's loan activity is focused on providing mezzanine capital to the
commercial real estate industry. The Company targets well capitalized real
estate operators with strong track records and compelling business plans
designed to enhance the value of their real estate. These loans are generally
subordinated to a senior lender or first mortgage and are priced to reflect a
higher return. The Company has significant experience in closing large,
complex loan transactions and can deliver a timely and competitive financing
package to a part of the real estate industry.
The types of investments in this class include subordinated participations in
first mortgages, loans secured by partnership interests, preferred equity
interests in real estate limited partnerships and loans secured by second
mortgages. The weighted average life of these investments is generally two to
three years and average leverage is 1:1 debt to equity generally funded with
committed financing facilities. These investments have fixed or floating rate
coupons and some provide additional earnings through an internal rate of
return ("IRR") look back or gross revenue participation.
The Company performs significant due diligence before making investments to
evaluate risks and opportunities in this sector. The Company generally focuses
on strong sponsorship, attractive real estate fundamentals, and pricing and
structural characteristics that provide significant control over the
underlying asset.
Since 2001, the Company's activity in this sector has generally been conducted
through Carbon Capital, Inc. ("Carbon"), a private commercial real estate
income opportunity fund. As of December 31, 2003, the Company owns 19.8% of
Carbon and the remainder is owned by various institutional investors. The
Manager also manages Carbon. The Company believes the use of Carbon allows it
to invest in larger institutional quality assets with greater diversification.
The Company's consolidated financial statements include, on a consolidated
basis, its share of the net assets and income of Carbon.
On December 31, 2003, the Company owned commercial real estate loans with a
carrying value of $114,116. The average yield of this portfolio at December
31, 2003 was 11%. The majority of these loans pay interest based on the
one-month London Interbank Offered Rate ("LIBOR"). Commercial real estate
loans with a carrying value of $44,625 were held in Carbon and $69,491 were
held directly. The Company and Carbon each have committed financing facilities
used to finance these assets.
During the year ended December 31, 2003, the Company invested $18,520 in new
loans, received par payoffs of $13,851, and invested $12,081 in Carbon.
Hedging Activities
The Company enters into hedging transactions to protect its investment
portfolio and related borrowings from interest rate fluctuations and other
changes in market conditions. These transactions may include interest rate
swaps, the purchase or sale of interest rate collars, caps or floors, options,
and other hedging instruments. These instruments may be used to hedge as much
of the interest rate risk as the Manager determines is in the best interest of
the Company's stockholders, given the cost of such hedges. The Manager may
elect to have the Company bear a level of interest rate risk that could
otherwise be hedged when the Manager believes, based on all relevant facts,
that bearing such risk is advisable. The Manager has extensive experience in
hedging mortgages, mortgage-related assets and related borrowings with these
types of instruments.
Hedging instruments often are not traded on regulated exchanges, guaranteed by
an exchange or its clearinghouse, or regulated by any U.S. or foreign
governmental authorities. The Company will enter into these transactions only
with counterparties with long-term debt rated "A" or better by at least one
nationally recognized credit rating organization. The business failure of a
counterparty with which the Company has entered into a hedging transaction
will most likely result in a default, which may result in the loss of
unrealized profits. Although the Company generally will seek to reserve for
itself the right to terminate its hedging positions, it may not always be
possible to dispose of or close out a hedging position without the consent of
the counterparty, and the Company may not be able to enter into an offsetting
contract in order to cover its risk. There can be no assurance that a liquid
secondary market will exist for hedging instruments purchased or sold, and the
Company may be required to maintain a position until exercise or expiration,
which could result in losses.
The Company's hedging activities are intended to address both income and
capital preservation. Income preservation refers to maintaining a stable
spread between yields from mortgage assets and the Company's borrowing costs
across a reasonable range of adverse interest rate environments. Capital
preservation refers to maintaining a relatively steady level in the market
value of the Company's capital across a reasonable range of adverse interest
rate scenarios. However, no strategy can insulate the Company completely from
changes in interest rates.
From time to time, the Company may reduce its exposure to market interest
rates by entering into various financial instruments that adjust portfolio
duration. These financial instruments are intended to mitigate the effect of
interest rates on the value of certain assets in the Company's portfolio.
Interest rate swap agreements as of December 31, 2003 and 2002 consisted of
the following:
As of December 31, 2003
---------------------------------------------------------------------------------
Notional Estimated Fair Unamortized Average Remaining
Value Value Cost Term (years)
---------------------------------------------------------------------------------
Cash flow hedges $611,300 $(4,442) 23 6.53
Trading swaps 308,000 1,513 - 3.34
CDO cash flow hedges 454,778 (23,651) - 8.51
CDO timing swaps 171,545 29 - 8.61
CDO libor cap 85,000 1,114 - 9.40
As of December 31, 2002
---------------------------------------------------------------------------------
Notional Estimated Fair Unamortized Average Remaining
Value Value Cost Term (years)
---------------------------------------------------------------------------------
Cash flow hedges $289,000 $(9,151) $ - 1.92
Trading swaps 200,000 (2,797) - 1.60
CDO cash flow hedges 482,287 (33,516) - 9.50
CDO timing swaps 171,545 (138) - 9.61
CDO libor cap 85,000 1,207 1,407 10.40
The counterparties for all of the Company's swaps are Deutsche Bank, AG,
Merrill Lynch Capital Services, Inc., Morgan Stanley Capital Services Inc.,
Goldman Sachs Capital Markets, L.P., and Lehman Special Financing Inc. with
ratings of AA-, A+, A+, A+, and A, respectively.
Futures contracts as of December 31, 2003 and 2002 consisted of the following:
December 31, 2003 December 31, 2002
------------------------ -----------------------------
Number of Estimated Number of Estimated
Contracts Fair Value Contracts Fair Value
----------- ------------ ------------- -------------
U.S. Treasury Notes:
Five-year 30 $(3,302) 3,166 $(350,653)
Ten-year 73 (8,134) 1,126 (126,023)
Financing and Leverage
The Company has financed its assets with the net proceeds of its initial
public offering, follow-on offerings, the issuance of common stock under the
Company's Dividend Reinvestment and Stock Purchase Plan (the "Dividend
Reinvestment Plan"), the issuance of preferred stock, long-term secured
borrowings, short-term borrowings under repurchase agreements, and the lines
of credit discussed below. In the future, operations may be financed by future
offerings of equity securities, as well as unsecured and secured borrowings.
The Company expects that, in general, it will employ leverage consistent with
the type of assets acquired and the desired level of risk in various
investment environments. The Company's governing documents do not explicitly
limit the amount of leverage that the Company may employ. Instead, the Board
of Directors has adopted an indebtedness policy for the Company that limits
total leverage to a maximum 6.0 to 1 debt to equity ratio. At December 31,
2003 and 2002, the Company's debt-to-equity ratio was approximately 4.4 to 1
and 5.3 to 1, respectively. The Company anticipates that it will maintain
debt-to-equity ratios between 2.5 to 1 and 5.5 to 1 in the foreseeable future,
although this ratio may be higher or lower at any time. The Company's
indebtedness policy may be changed by the Board of Directors at any time in
the future.
On May 29, 2002, the Company issued ten tranches of secured debt through a
collateralized debt obligation ("CDO I"). In this transaction, a wholly owned
subsidiary of the Company issued secured debt in the par amount of $419,185
secured by the subsidiary's assets. The adjusted issue price of the CDO I
debt, as of December 31, 2003, is $404,637. Five tranches were issued at a
fixed rate coupon and five tranches were issued at a floating rate coupon with
a combined weighted average remaining maturity of 8.29 years as of December
31, 2003. All floating rate coupons were swapped to fixed rate coupons
resulting in a total fixed rate cost of funds for CDO I of approximately
7.21%.
On December 10, 2002, the Company issued seven tranches of secured debt
through a second collateralized debt obligation ("CDO II"). In this
transaction, a wholly owned subsidiary of the Company issued secured debt in
the par amount of $280,783 secured by the subsidiary's assets. The adjusted
issue price of the CDO II debt as of December 31, 2003 is $280,333. Four
tranches were issued at a fixed rate coupon and three tranches were issued at
a floating rate coupon with a combined weighted average remaining maturity of
8.34 years as of December 31, 2003. All floating rate coupons were swapped to
fixed rate coupons, resulting in a total fixed rate cost of funds for CDO II
of approximately 5.73%.
Included in CDO II was a ramp facility that was utilized to fund the purchase
of an additional $50,000 of par of below investment grade CMBS. The Company
utilized the ramp in February 2003 and July 2003, to contribute $30,000 of par
of CSFB 03-CPN1 and $20,000 of par of GECMC 03-C2, respectively.
The Company has a $185,000 committed credit facility with Deutsche Bank, AG
(the "Deutsche Bank Facility"), which matures on July 15, 2005. The Deutsche
Bank Facility can be used to replace existing reverse repurchase agreement
borrowings and to finance the acquisition of mortgage-backed securities, loan
investments, and investments in real estate joint ventures. As of December 31,
2003 and 2002, the outstanding borrowings under this facility were $82,406 and
$19,189, respectively. Outstanding borrowings under the Deutsche Bank Facility
bear interest at a LIBOR based variable rate.
On July 18, 2002, the Company entered into a $75,000 committed credit facility
with Greenwich Capital, Inc. This facility provides the Company with the
ability to borrow only through July 17, 2004 with the repayment of principal
not due until July 7, 2005. Outstanding borrowings under this credit facility
bear interest at a LIBOR based variable rate. As of December 31, 2003,
outstanding borrowings under this facility were $7,530. As of December 31,
2002, there were no borrowings under this facility.
The Company is subject to various covenants in its lines of credit, including
maintaining a minimum net worth of $305,000 as determined under generally
accepted accounting principles in the United States of America ("GAAP"), a
debt-to-equity ratio not to exceed 5.5 to 1, a minimum cash requirement based
upon certain debt-to-equity ratios, a minimum debt service coverage ratio of
1.5 and a minimum liquidity reserve of $10,000. As of December 31, 2003 and
2002, the Company was in compliance with all such covenants.
On December 2, 1999, the Company authorized and issued 1,200,000 shares of
10.5% Series A Senior Cumulative Redeemable Preferred Stock ("Series A
Preferred Stock") for aggregate proceeds of $30,000. The Series A Preferred
Stock carried a 10.5% coupon and was convertible into shares of common stock
of the Company, par value $0.001 per share (the "Common Stock"), at a price of
$7.35 per share. The Series A Preferred Stock had a seven-year maturity at
which time, at the option of the holders, the shares of preferred stock could
be converted into shares of common stock or liquidated for $28.50 per share.
On December 21, 2001, the sole holder of the Series A Preferred Stock
converted 1,190,000 shares of the Series A Preferred Stock into 4,096,854
shares of Common Stock at a conversion price of $7.26 per share which was
$0.09 per share lower than the original conversion price due to the effects of
anti-dilution provisions in the Series A Preferred Stock. The holder of Series
A Preferred Stock converted the remaining 10,000 shares of Series A Preferred
Stock into 34,427 shares of the Company's Common Stock in March 2002 at a
conversion price of $7.26 per share.
As part of the CORE Cap merger, the Company authorized and issued 2,261,000
shares of Series B Preferred Stock, $0.001 par value per share ("Series B
Preferred Stock"), to CORE Cap stockholders. The Series B Preferred Stock is
perpetual, carries a 10% coupon, has a preference in liquidation as of
December 31, 2003 of $43,942, and is convertible into the Company's Common
Stock at a price of $17.09 per share, subject to adjustment. If converted, the
Series B Preferred Stock would convert into approximately 2,571,423 shares of
the Company's Common Stock. On May 29, 2003, the Company redeemed 155,000
shares at its liquidation value of $25 per share. In 2002, 300,000 shares of
10% Series B Preferred Stock with a liquidation preference of $7,500 were
converted at the stockholder's option into 438,885 shares of the Company's
Common stock.
On May 29, 2003, the Company authorized and issued 2,300,000 shares of 9.375%
Series C Cumulative Redeemable Preferred Stock ("Series C Preferred Stock"),
par value $0.001 per share. The Series C Preferred Stock is perpetual, carries
a 9.375% coupon, and has a preference in liquidation of $57,500. The aggregate
net proceeds to the Company (after deducting underwriting fees and expenses)
were approximately $55,513.
For the year ended December 31, 2003, the Company issued 1,955,919 shares of
Common Stock under its Dividend Reinvestment Plan. Net proceeds to the Company
were approximately $21,134. For the year ended December 31, 2002, the Company
issued 1,455,725 shares of Common Stock under its Dividend Reinvestment Plan
with net proceeds to the Company of approximately $15,920.
For the year ended December 31, 2003, the Company issued 45,000 shares of
Common Stock under a sale agency agreement with Brinson Patrick Securities
Corporation. Net proceeds to the Company were approximately $497.
The Company has entered into reverse repurchase agreements to finance most of
its securities available-for-sale which are not financed under its lines of
credit. The reverse repurchase agreements are collateralized by most of the
Company's securities available-for-sale and bear interest at rates that have
historically moved in close relationship to LIBOR.
Certain information with respect to the Company's collateralized borrowings at
December 31, 2003 is summarized as follows:
Reverse Total
Lines of Repurchase Collateralized Collateralized
Credit Agreements Debt Obligations Borrowings
------------ ----------------- ----------------- ----------------
Commercial Real Estate Securities
Outstanding Borrowings $67,226 $360,629 $684,970 $1,112,825
Weighted average borrowing rate 2.26% 1.46% 6.60% 4.68%
Weighted average remaining maturity days 562 17 3,033 1,906
Estimated fair value of assets pledged $110,652 $423,244 $770,575 $1,304,471
Residential Mortgage Backed Securities
Outstanding Borrowings - $688,006 - $688,006
Weighted average borrowing rate - 1.12% - 1.12%
Weighted average remaining maturity days - 24 - 24
Estimated fair value of assets pledged - $714,296 - $714,296
Real Estate Joint Ventures
Outstanding Borrowings $513 - - $513
Weighted average borrowing rate 3.12% - - 3.12%
Weighted average remaining maturity days 212 - - 212
Estimated fair value of assets pledged $2,750 - - $2,750
Commercial Real Estate Loans
Outstanding Borrowings $22,197 - - $22,197
Weighted average borrowing rate 2.79% - - 2.79%
Weighted average remaining maturity days 254 - - 254
Estimated fair value of assets pledged $33,206 - - $33,206
Certain information with respect to the Company's collateralized borrowings at
December 31, 2002 is summarized as follows:
Reverse Collateralized Total
Lines of Repurchase Debt Collateralized
Credit Agreements Obligations Borrowings
------------- ---------------- ---------------- -----------------
Commercial Real Estate Securities
Outstanding Borrowings $3,185 $26,241 $684,590 $714,016
Weighted average borrowing rate 3.75% 1.73% 6.60% 6.41%
Weighted average remaining maturity days 927 21 3,398 3,263
Estimated fair value of assets pledged $12,160 $41,661 $726,769 $780,590
Residential Mortgage Backed Securities
Outstanding Borrowings - $1,431,641 - $1,431,641
Weighted average borrowing rate 1.37% 1.37%
Weighted average remaining maturity days 21 21
Estimated fair value of assets pledged $1,486,105 $1,486,105
Real Estate Joint Ventures
Outstanding Borrowings $1,337 - - $1,337
Weighted average borrowing rate 3.84% 3.84%
Weighted average remaining maturity days 211 211
Estimated fair value of assets pledged $3,150 $3,150
Commercial Real Estate Loans
Outstanding Borrowings $14,667 - - $14,667
Weighted average borrowing rate 3.28% 3.28%
Weighted average remaining maturity days 465 465
Estimated fair value of assets pledged $22,000 $22,000
At December 31, 2003, the Company's collateralized borrowings had the
following remaining maturities:
Total
Lines of Reverse Repurchase Collateralized Collateralized
Credit Agreements Debt Obligations Borrowings
----------------------------------------------------------------------------
Within 30 days $ - $1,048,635 $ - $1,048,635
31 to 59 days - - - -
Over 60 days 89,936 - 684,970 774,906
---------------------------------------------------------------------------
$89,936 $1,048,635 $684,970 $1,823,541
===========================================================================
As of December 31, 2003, $102,594 of the Company's $185,000 Deutsche Bank
Facility was available for future borrowings and $67,470 of the Company's
$75,000 committed credit facility with Greenwich Capital, Inc. was available.
Under the lines of credit and the reverse repurchase agreements, the
respective lender retains the right to mark the underlying collateral to
estimated market value. A reduction in the value of its pledged assets will
require the Company to provide additional collateral or fund cash margin
calls. From time to time, the Company expects that it will be required to
provide such additional collateral or fund margin calls. The Company maintains
adequate liquidity to meet such calls.
Risks
Risk is an inherent part of investing in high yielding commercial real estate
debt. Risk management is considered to be of paramount importance to the
Company's day-to-day operations. Consequently, the Company devotes significant
resources across all its operations to the identification, measurement,
monitoring, management and analysis of risk.
Conflicts of interest of the Manager may result in decisions that do not fully
reflect stockholders' best interests.
The Company and the Manager have common officers and directors, which may
present conflicts of interest in the Company's dealings with the Manager and
its affiliates, including the Company's purchase of assets originated by such
affiliates. For example, the Company may purchase certain mortgage assets from
PNC Bank, which owns approximately 70% of the outstanding capital stock of the
Manager's parent company, BlackRock, Inc.
The Manager and its employees may engage in other business activities which
could reduce the time and effort spent on the management of the Company. The
Manager also provides services to REITs not affiliated with us. As a result,
there may be a conflict of interest between the operations of the Manager and
its affiliates in the acquisition and disposition of mortgage assets. In
addition, the Manager and its affiliates may from time to time purchase
mortgage assets for their own account and may purchase or sell assets from or
to the Company. Such conflicts may result in decisions and allocations of
mortgage assets by the Manager that are not in the Company's best interests.
Although the Company has adopted investment guidelines, these guidelines give
the Manager significant discretion in investing. The Company's investment and
operating policies and the strategies that the Manager uses to implement those
policies may be changed at any time without the consent of stockholders.
The Company is dependent on the Manager, and the termination by the Company of
its management agreement with the Manager could result in a termination fee.
The Company's success is dependent on the Manager's ability to attract and
retain quality personnel. The market for portfolio managers, investment
analysts, financial advisers and other professionals is extremely competitive.
There can be no assurance the Manager will be successful in its efforts to
recruit and retain the required personnel.
The management agreement between the Company and the Manager provides for base
management fees payable to the Manager without consideration of the
performance of the Company's portfolio and also provides for incentive fees
based on certain performance criteria, which could result in the Manager
recommending riskier or more speculative investments. Termination of the
management agreement between the Company and the Manager by the Company would
result in the payment of a substantial termination fee, which could adversely
affect the Company's financial condition. Termination of the management
agreement by the Company could also adversely affect the Company if the
Company were unable to find a suitable replacement.
There is a limitation on the liability of the Manager.
Pursuant to the management agreement, the Manager will not assume any
responsibility other than to render the services called for under the
management agreement 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 and its directors and officers will not be liable
to the Company, any of its subsidiaries, its unaffiliated directors, its
stockholders or any subsidiary's stockholders for acts performed in accordance
with and pursuant to the management agreement, except by reason of acts
constituting bad faith, willful misconduct, gross negligence or reckless
disregard of their duties under the management agreement. The Company has
agreed to indemnify the Manager and its directors and officers with respect to
all expenses, losses, damages, liabilities, demands, charges and claims
arising from acts of the Manager not constituting bad faith, willful
misconduct, gross negligence or reckless disregard of duties, performed in
good faith in accordance with and pursuant to the management agreement.
Interest rate fluctuations will affect the value of the Company's mortgage
assets, net income and common stock.
Interest rates are highly sensitive to many factors, including governmental
monetary and tax policies, domestic and international economic and political
considerations and other factors beyond the Company's control. Interest rate
fluctuations can adversely affect the income and value of the Company's common
stock in many ways and present a variety of risks, including the risk of a
mismatch between asset yields and borrowing rates, variances in the yield
curve and changing prepayment rates.
The Company's operating results depend in large part on differences between
the income from its assets (net of credit losses) and borrowing costs. The
Company funds a substantial portion of its assets with borrowings which have
interest rates that reset relatively rapidly, such as monthly or quarterly.
The Company anticipates that, in most cases, the income from its assets will
respond more slowly to interest rate fluctuations than the cost of borrowings,
creating a potential mismatch between asset yields and borrowing rates.
Consequently, changes in interest rates, particularly short-term interest
rates, may significantly influence the Company's net income. Increases in
these rates tend to decrease the Company's net income and market value of the
Company's net assets. Interest rate fluctuations that result in the Company's
interest expense exceeding interest income would result in the Company's
incurring operating losses.
The Company also invests in fixed-rate mortgage-backed securities. In a period
of rising interest rates, the Company's interest payments could increase while
the interest the Company earns on its fixed-rate mortgage-backed securities
would not change. This would adversely affect the Company's profitability.
The relationship between short-term and long-term interest rates is often
referred to as the "yield curve." Ordinarily, short-term interest rates are
lower than long-term interest rates. If short-term interest rates rise
disproportionately relative to long-term interest rates (a flattening of the
yield curve), the Company's borrowing costs may increase more rapidly than the
interest income earned on the Company's assets. Because the Company's
borrowings will primarily bear interest at short-term rates and the Company's
assets will primarily bear interest at medium-term to long-term rates, a
flattening of the yield curve tends to decrease the Company's net income and
market value of the Company's net assets. Additionally, to the extent cash
flows from long-term assets that return scheduled and unscheduled principal
are reinvested, the spread between the yields of the new assets and available
borrowing rates may decline and also may tend to decrease the net income and
market value of the Company's net assets. It is also possible that short-term
interest rates may adjust relative to long-term interest rates such that the
level of short-term rates exceeds the level of long-term rates (a yield curve
inversion). In this case, the Company's borrowing costs may exceed the
Company's interest income and operating losses could be incurred.
Interest rate caps on the Company's mortgage-backed securities may adversely
affect the Company's profitability.
The Company's adjustable-rate mortgage-backed securities are typically subject
to periodic and lifetime interest rate caps. Periodic interest rate caps limit
the amount an interest rate can increase during any given period. Lifetime
interest rate caps limit the amount an interest rate can increase through
maturity of a mortgage-backed security. The Company's borrowings are not
subject to similar restrictions. Accordingly, in a period of rapidly
increasing interest rates, the Company could experience a decrease in net
income or a net loss because the interest rates on its borrowings could
increase without limitation while the interest rates on its adjustable-rate
mortgage-backed securities would be limited by caps.
The Company's assets include subordinated commercial mortgage-backed
securities which are subordinate in right of payment to more senior
securities.
The Company's assets include a significant amount of subordinated commercial
mortgage-backed securities, which are the most subordinate class of securities
in a structure of securities secured by a pool of loans and accordingly are
the first to bear the loss upon a restructuring or liquidation of the
underlying collateral and the last to receive payment of interest and
principal. The Company may not recover the full amount or, in extreme cases,
any of its initial investment in such subordinated interests. Additionally,
market values of these subordinated interests tend to be more sensitive to
changes in economic conditions than more senior interests. As a result, such
subordinated interests generally are not actively traded and may not provide
holders thereof with liquidity of investment.
The Company's assets include mezzanine loans which have greater risks of loss
than more senior loans.
The Company's assets include a significant amount of mezzanine loans which
involve a higher degree of risk than long-term senior mortgage loans. In
particular, a foreclosure by the holder of the senior loan could result in the
mezzanine loan becoming unsecured. Accordingly, the Company may not recover
some or all of its investment in such a mezzanine loan. Additionally, the
Company may permit higher loan to value ratios on mezzanine loans than it
would on conventional mortgage loans when the Company is entitled to share in
the appreciation in value of the property securing the loan.
Prepayment rates can increase which would adversely affect yields on the
Company's investments.
The yield on investments in mortgage loans and mortgage-backed securities and
thus the value of the Company's common stock is sensitive to changes in
prevailing interest rates and changes in prepayment rates, which results in a
divergence between the Company's borrowing rates and asset yields,
consequently reducing income derived from the Company's investments.
The Company's ownership of non-investment grade mortgage assets subjects the
Company to an increased risk of loss.
The Company acquires mortgage loans and non-investment grade mortgage-backed
securities, which are subject to greater risk of credit loss on principal and
non-payment of interest in contrast to investments in senior investment grade
securities.
The Company's mortgage loans are subject to certain risks.
The Company acquires, accumulates and securitizes mortgage loans as part of
its investment strategy. While holding mortgage loans, the Company is subject
to risks of borrower defaults, bankruptcies, fraud and special hazard losses
that are not covered by standard hazard insurance. Also, the costs of
financing and hedging the mortgage loans can exceed the interest income on the
mortgage loans. In the event of any default under mortgage loans held by the
Company, the Company will bear the risk of loss of principal to the extent of
any deficiency between the value of the mortgage collateral and the principal
amount of the mortgage loan. In addition, delinquency and loss ratios on the
Company's mortgage loans are affected by the performance of third-party
servicers and special servicers.
The Company invests in multifamily and commercial loans which involve a
greater risk of loss than single family loans.
The Company's investments include multifamily and commercial real estate loans
which are considered to involve a higher degree of risk than single family
residential lending because of a variety of factors, including generally
larger loan balances, dependency for repayment on successful operation of the
mortgaged property and tenant businesses operating therein, and loan terms
that include amortization schedules longer than the stated maturity which
provide for balloon payments at stated maturity rather than periodic principal
payments. In addition, the value of multifamily and commercial real estate can
be affected significantly by the supply and demand in the market for that type
of property.
Limited recourse loans limit the Company's recovery to the value of the
mortgaged property.
A substantial portion of the mortgage loans the Company acquires may contain
limitations on the mortgagee's recourse against the borrower. In other cases,
the mortgagee's recourse against the borrower is limited by applicable
provisions of the laws of the jurisdictions in which the mortgaged properties
are located or by the mortgagee's selection of remedies and the impact of
those laws on that selection. In those cases, in the event of a borrower
default, recourse may be limited to only the specific mortgaged property and
other assets, if any, pledged to secure the relevant mortgage loan. As to
those mortgage loans that provide for recourse against the borrower and their
assets generally, there can be no assurance that such recourse will provide a
recovery in respect of a defaulted mortgage loan greater than the liquidation
value of the mortgaged property securing that mortgage loan.
The volatility of certain mortgaged property values may adversely affect the
Company's mortgage loans.
Commercial and multifamily property values and net operating income derived
therefrom are subject to volatility and may be affected adversely by a number
of factors, including, but not limited to, national, regional and local
economic conditions (which may be adversely affected by plant closings,
industry slowdowns and other factors); local real estate conditions (such as
an oversupply of housing, retail, industrial, office or other commercial
space); changes or continued weakness in specific industry segments;
perceptions by prospective tenants, retailers and shoppers of the safety,
convenience, services and attractiveness of the property; the willingness and
ability of the property's owner to provide capable management and adequate
maintenance; construction quality, age and design; demographic factors;
retroactive changes to building or similar codes; and increases in operating
expenses (such as energy costs).
Leveraging the Company's investments may increase the Company's exposure to
loss.
The Company leverages its investments and thereby increases the volatility of
its income and net asset value which may result in operating or capital
losses. If borrowing costs increase, or if the cash flow generated by the
Company's assets decreases, the Company's use of leverage will increase the
likelihood that the Company will experience reduced or negative cash flow and
reduced liquidity.
The Company's investments may be illiquid and their value may decrease.
Many of the Company's assets are relatively illiquid. In addition, certain of
the mortgage-backed securities that the Company has acquired or will acquire
will include interests that have not been registered under the relevant
securities laws, resulting in a prohibition against transfer, sale, pledge or
other disposition of those mortgage-backed securities except in a transaction
that is exempt from the registration requirements of, or otherwise in
accordance with, those laws. The Company's ability to vary its portfolio in
response to changes in economic and other conditions may be relatively
limited. No assurances can be given that the fair market value of any of the
Company's assets will not decrease in the future.
The Company's hedging transactions can limit the Company's gains and increase
the Company's exposure to losses.
The Company uses hedging strategies that involve risk and that may not be
successful in insulating the Company from exposure to changing interest and
prepayment rates. There can be no assurance that a liquid secondary market
will exist for hedging instruments purchased or sold, and the Company may be
required to maintain a position until exercise or expiration, which could
result in losses.
Failure to maintain REIT status would have adverse tax consequences.
To continue to qualify as a REIT, the Company must comply with requirements
regarding the nature of its assets and its sources of income. If the Company
is compelled to liquidate its mortgage-backed securities, the Company may be
unable to comply with these requirements, ultimately jeopardizing its status
as a REIT.
If in any taxable year the Company fails to qualify as a REIT:
o the Company would be subject to federal and state income
tax on its taxable income at regular corporate rates;
o the Company would not be allowed to deduct distributions
to stockholders in computing its taxable income; and
o unless the Company were entitled to relief under the
United States Internal Revenue Code of 1986, as amended
(the "Code"), the Company would also be disqualified
from treatment as a REIT for the four taxable years
following the year during which the Company lost
qualification.
If the Company fails to qualify as a REIT, the Company might need to borrow
funds or liquidate some investments in order to pay the additional tax
liability. Accordingly, funds available for investment or distribution to the
Company's stockholders would be reduced for each of the years involved.
Qualification as a REIT involves the application of highly technical and
complex provisions of the Code to the Company's operations and the
determination of various factual matters and circumstances not entirely within
the Company's control. There are only limited judicial or administrative
interpretations of these provisions. Although the Company operates in a manner
consistent with the REIT qualification rules, there cannot be any assurance
that the Company is or will remain so qualified.
In addition, the rules dealing with federal income taxation are constantly
under review by persons involved in the legislative process and by the
Internal Revenue Service and the United States Department of the Treasury.
Changes to the tax law could adversely affect the Company's stockholders. The
Company cannot predict with certainty whether, when, in what forms, or with
what effective dates, the tax laws applicable to the Company or its
stockholders may be changed.
Competition may adversely affect the Company's ability to acquire assets.
Because of competition, the Company may not be able to acquire mortgage-backed
securities at favorable yields.
Failure to maintain an exemption from the Investment Company Act of 1940 would
restrict the Company's operating flexibility.
The Company conducts its business so as not to become regulated as an
investment company under the Investment Company Act of 1940, as amended (the
"Investment Company Act"). Accordingly, the Company does not expect to be
subject to the restrictive provisions of the Investment Company Act. Failure
to maintain an exemption from the Investment Company Act would adversely
affect the Company's ability to operate.
The Company may become subject to environmental liabilities.
The Company may become subject to environmental risks when it acquires
interests in properties with material environmental problems. Such
environmental risks include the risk that operating costs and values of these
assets may be adversely affected by the obligation to pay for the cost of
complying with existing environmental laws, ordinances and regulations, as
well as the cost of complying with future legislation. Such laws often impose
liability regardless of whether the owner or operator knows of, or was
responsible for, the presence of such hazardous or toxic substances. The costs
of investigation, remediation or removal of hazardous substances could exceed
the value of the property. The Company's income and ability to make
distributions to stockholders could be affected adversely by the existence of
an environmental liability with respect to the Company's properties.
Operating Policies
The Company has adopted compliance guidelines, including restrictions on
acquiring, holding, and selling assets, to ensure that the Company meets the
requirements for qualification as a REIT under the Internal Revenue Code of
1986, as amended (the "Code"), and is excluded from regulation as an
investment company. Before acquiring any asset, the Manager determines whether
such asset would constitute a "Real Estate Asset" under the REIT provisions of
the Code, as amended. The Company regularly monitors purchases of mortgage
assets and the income generated from such assets, including income from its
hedging activities, in an effort to ensure that at all times the Company's
assets and income meet the requirements for qualification as a REIT and
exclusion under the Investment Company Act of 1940 (the "Investment Company
Act").
The Company's unaffiliated directors review all transactions of the Company on
a quarterly basis to ensure compliance with the operating policies and to
ratify all transactions with PNC Bank (an affiliate of the Manager) and its
affiliates, except that the purchase of securities from PNC Bank and its
affiliates require prior approval. The unaffiliated directors rely
substantially on information and analysis provided by the Manager to evaluate
the Company's operating policies, compliance therewith, and other matters
relating to the Company's investments.
In order to maintain the Company's REIT status, the Company generally intends
to distribute to its stockholders aggregate dividends equaling at least 90% of
its taxable income each year. The Code permits the Company to fulfill this
distribution requirement by the end of the year following the year in which
the taxable income was earned.
Regulation
The Company intends to continue to conduct its business so as not to become
regulated as an investment company under the Investment Company Act. Under the
Investment Company Act, a non-exempt entity that is an investment company is
required to register with the SEC and is subject to extensive, restrictive,
and potentially adverse regulation relating to, among other things, operating
methods, management, capital structure, dividends, and transactions with
affiliates. The Investment Company Act exempts entities that are "primarily
engaged in the business of purchasing or otherwise acquiring mortgages and
other liens on and interests in real estate" ("Qualifying Interests"). Under
current interpretation by the staff of the SEC, to qualify for this exemption,
the Company, among other things, must maintain at least 55% of its assets in
Qualifying Interests. Substantially all of the Company's interests in
residential mortgage backed securities ("RMBS") are Qualifying Interests.
A portion of the CMBS acquired by the Company are collateralized by pools of
first mortgage loans where the Company can monitor the performance of the
underlying mortgage loans through loan management and servicing rights and
when the Company has appropriate workout/foreclosure rights with respect to
the underlying mortgage loans. When such arrangements exist, the Company
believes that the related Controlling Class CMBS constitute Qualifying
Interests for purposes of the Investment Company Act. Therefore, the Company
believes that it should not be required to register as an "investment company"
under the Investment Company Act as long as it continues to invest in a
sufficient amount of such Controlling Class CMBS and/or in other Qualifying
Interests.
If the SEC or its staff were to take a different position with respect to
whether the Company's Controlling Class CMBS constitute Qualifying Interests,
the Company could be required to modify its business plan so that either (i)
it would not be required to register as an investment company or (ii) it would
comply with the Investment Company Act and be able to register as an
investment company. In such event, modification of (i) the Company's business
plan so that it would not be required to register as an investment company
would likely entail a disposition of a significant portion of the Company's
Controlling Class CMBS or the acquisition of significant additional assets,
such as agency pass-through and mortgage-backed securities, which are
Qualifying Interests or (ii) the Company's business plan to register as an
investment company would result in significantly increased operating expenses
and would likely entail significantly reducing the Company's indebtedness
(including the possible prepayment of the Company's short-term borrowings),
which could also require it to sell a significant portion of its assets. No
assurances can be given that any such dispositions or acquisitions of assets,
or deleveraging, could be accomplished on favorable terms. Consequently, any
such modification of the Company's business plan could have a material adverse
effect on the Company. Further, if it were established that the Company were
an unregistered investment company, there would be a risk that the Company
would be subject to monetary penalties and injunctive relief in an action
brought by the SEC, that the Company would be unable to enforce contracts with
third parties, and that third parties could seek to obtain recession of
transactions undertaken during the period it was established that the Company
was an unregistered investment company. Any such results would be likely to
have a material adverse effect on the Company.
Competition
The Company's net income depends, in large part, on the Company's ability to
acquire mortgage assets at favorable spreads over the Company's borrowing
costs. In acquiring mortgage assets, the Company competes with other mortgage
REITs, specialty finance companies, savings and loan associations, banks,
mortgage bankers, insurance companies, mutual funds, institutional investors,
investment banking firms, other lenders, governmental bodies, and other
entities. In addition, there are numerous mortgage REITs with asset
acquisition objectives similar to the Company's, 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. Some of the Company's anticipated competitors are
significantly larger than the Company, have access to greater capital and
other resources, and may have other advantages over the Company. In addition
to existing companies, other companies may be organized for purposes similar
to that of the Company, including companies organized as REITs focused on
purchasing mortgage assets. A proliferation of such companies may increase the
competition for equity capital and thereby adversely affect the market price
of the Company's Common Stock.
Employees
The Company does not have any employees. The Company's officers, each of whom
is a full-time employee of the Manager, perform the duties required pursuant
to the Management Agreement (as defined below) with the Manager and the
Company's bylaws.
Management Agreement
The Company is managed pursuant to a management agreement, dated March 27,
1998, between the Company and the Manager (the "Management Agreement"),
pursuant to which 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. On March 25, 2002, the
Management Agreement was extended for one year through March 27, 2003, with
the approval of the unaffiliated directors, on terms similar to the prior
agreement with the following changes: (i) the incentive fee calculation would
be based upon GAAP earnings instead of funds from operations, (ii) the removal
of the four-year period to value the Management Agreement in the event of
termination and (iii) subsequent renewal periods of the Management Agreement
would be for one year instead of two years. The Board of Directors was advised
by Houlihan Lokey Howard & Zukin Financial Advisors, Inc., a national
investment banking and financial advisory firm, in the renewal process.
On March 6, 2003, the unaffiliated directors approved an extension of the
Management Agreement from its expiration of March 27, 2003 for one year
through March 31, 2004. The terms of the renewed agreement are similar to the
prior agreement except for the incentive fee calculation which would provide
for a rolling four-quarter high watermark rather than a quarterly calculation.
In determining the rolling four-quarter high watermark, the Manager would
calculate the incentive fee based upon the current and prior three quarters'
net income ("Yearly Incentive Fee"). The Manager would be paid an incentive
fee in the current quarter if the Yearly Incentive Fee is greater than what
was paid to the Manager in the prior three quarters cumulatively. The Company
will phase in the rolling four-quarter high watermark commencing with the
second quarter of 2003. Calculation of the incentive fee will be based on GAAP
and adjusted to exclude special one-time events pursuant to changes in GAAP
accounting pronouncements after discussion between the Manager and the
unaffiliated directors. The incentive fee threshold did not change. The high
watermark will be based on the existing incentive fee hurdle, which provides
for the Manager to be paid 25% of the amount of earnings (calculated in
accordance with GAAP) per share that exceeds the product of the adjusted issue
price of the Company's common stock per share ($11.38 as of December 31, 2003)
and the greater of 9.5% or 350 basis points over the ten-year Treasury note.
The Company anticipates that the Management Agreement will be extended prior
to its expiration on March 31, 2004.
The Manager primarily engages in four activities on behalf of the Company: (i)
acquiring and originating mortgage loans and other real estate related assets;
(ii) asset/liability and risk management, hedging of floating rate
liabilities, and financing, management and disposition of assets, including
credit and prepayment risk management; (iii) surveillance and restructuring of
real estate loans and (iv) capital management, structuring, analysis, capital
raising, and investor relations activities. In conducting these activities,
the Manager formulates operating strategies for the Company, arranges for the
acquisition of assets by the Company, arranges for various types of financing
and hedging strategies for the Company, monitors the performance of the
Company's assets, and provides certain administrative and managerial services
in connection with the operation of the Company. At all times, the Manager is
subject to the direction and oversight of the Company's Board of Directors.
The Company may terminate, or decline to renew the term of, the Management
Agreement without cause at any time upon 60 days' written notice by a majority
vote of the unaffiliated directors. Although no termination fee is payable in
connection with a termination for cause, in connection with a termination
without cause, the Company must pay the Manager a termination fee, which could
be substantial. The amount of the termination fee will be determined by
independent appraisal of the value of the Management Agreement. Such appraisal
is to be conducted by a nationally-recognized appraisal firm mutually agreed
upon by the Company and the Manager.
During 2000, the Company completed the acquisition of CORE Cap, Inc. The
merger was a stock for stock acquisition where the Company issued 4,180,552
shares of Common Stock and 2,261,000 shares of its Series B Preferred Stock.
At the time of the CORE Cap acquisition, the Manager agreed to pay GMAC (CORE
Cap, Inc.'s external advisor) $12,500 over a ten-year period ("Installment
Payment") to purchase the right to manage the assets under the existing
management contract ("GMAC Contract"). The GMAC Contract had to be terminated
in order to allow for the Company to complete the merger, as the Company's
management agreement with the Manager did not provide for multiple managers.
As a result, the Manager offered to buy-out the GMAC contract as the Manager
estimated it would receive incremental fees above and beyond the Installment
Payment, and thus was willing to pay for, and separately negotiate, the
termination of the GMAC Contract. Accordingly, the value of the Installment
Payment was not considered in the Company's allocation of its purchase price
to the net assets acquired in the acquisition of CORE Cap, Inc. The Company
agreed that should the Management Agreement with its Manager be terminated,
not renewed or not extended for any reason other than for cause, the Company
would pay to the Manager an amount equal to the Installment Payment less the
sum of all payments made by the Manager to GMAC. As of December 31, 2003, the
Installment Payment would be $8,000 payable over seven years. The Company does
not accrue for this contingent liability.
In addition, the Company has the right at any time during the term of the
Management Agreement to terminate the Management Agreement without the payment
of any termination fee upon, among other things, a material breach by the
Manager of any provision contained in the Management Agreement that remains
uncured at the end of the applicable cure period.
During the third quarter of 2003, the Manager agreed to reduce its management
fees by 20% from its calculated amount for the third and fourth quarter of
2003 and the first quarter of 2004. This revision resulted in $1,046 in
savings to the Company during 2003.
Taxation of the Company
The Company has elected to be taxed as a REIT under the Code, commencing with
its taxable year ended December 31, 1998, and the Company intends to continue
to operate in a manner consistent with the REIT provisions of the Code. The
Company's qualification as a REIT depends on its ability to meet the various
requirements imposed by the Code, through actual operating results, asset
holdings, distribution levels, and diversity of stock ownership.
Provided the Company continues to qualify for taxation as a REIT, it generally
will not be subject to Federal corporate income tax on its net income that is
currently distributed to stockholders. This treatment substantially eliminates
the "double taxation" (at the corporate and stockholder levels) that generally
results from an investment in a corporation. If the Company fails to qualify
as a REIT in any taxable year, its taxable income would be subject to Federal
income tax at regular corporate rates (including any applicable alternative
minimum tax). Even if the Company qualifies as a REIT, it will be subject to
Federal income and excise taxes on its undistributed income.
If in any taxable year the Company fails to qualify as a REIT and, as a
result, incurs additional tax liability, the Company may need to borrow funds
or liquidate certain investments in order to pay the applicable tax, and the
Company would not be compelled to make distributions under the Code. Unless
entitled to relief under certain statutory provisions, the Company would also
be disqualified from treatment as a REIT for the four taxable years following
the year during which qualification is lost. Although the Company currently
intends to operate in a manner designated to qualify as a REIT, it is possible
that future economic, market, legal, tax, or other considerations may cause
the Company to fail to qualify as a REIT or may cause the Board of Directors
to revoke the Company's REIT election.
The Company and its stockholders may be subject to foreign, state, and local
taxation in various foreign, state, and local jurisdictions, including those
in which it or they transact business or reside. The state and local tax
treatment of the Company and its stockholders may not conform to the Company's
Federal income tax treatment.
Website
The Company's website address is www.anthracitecapital.com. The Company makes
available free of charge through its website its Annual Report on Form 10-K,
Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all amendments
to those reports as soon as reasonably practicable after such material is
electronically filed with or furnished to the SEC, and also makes available on
its website the charters for the Audit and Nominating and Corporate Governance
Committee of the Board of Directors and its Codes of Ethics.
ITEM 2. PROPERTIES
The Company does not maintain an office and owns no real property. It does not
pay rent and utilizes the offices of the Manager, located at 40 East 52nd
Street, New York, New York 10022.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any material legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's security holders during
the fourth quarter of 2003 through the solicitation of proxies or otherwise.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The Company's Common Stock has been listed and is traded on the New York Stock
Exchange under the symbol "AHR" since the initial public offering in March
1998. The following table sets forth, for the periods indicated, the high, low
and last sale prices in dollars on the New York Stock Exchange for the
Company's Common Stock and the dividends declared by the Company with respect
to the periods indicated as were traded during these respective time periods.
Last Dividends
2002 High Low Sale Declared
First Quarter....................... 11.86 10.80 11.50 .35
Second Quarter...................... 13.25 11.15 13.25 .35
Third Quarter....................... 13.20 9.40 11.30 .35
Fourth Quarter...................... 11.70 9.90 10.90 .35
2003
First Quarter .................. 12.04 10.27 11.44 .35
Second Quarter ................. 12.89 11.00 12.06 .35
Third Quarter .................. 12.55 9.26 9.65 .28
Fourth Quarter ................. 11.30 9.50 11.07 .28
On March 4, 2004, the closing sale price for the Company's Common Stock, as
reported on the New York Stock Exchange, was $12.90. As of March 4, 2004,
there were approximately 358 record holders of the Common Stock. This figure
does not reflect beneficial ownership of shares held in nominee name.
The following table summarizes information about options outstanding under the
1998 Stock Option Plan:
Weighted
Average
Shares Exercise Price
------------------------------
Outstanding at January 1, 2003 1,560,542 $14.49
Granted 0 0
Exercised (65,400) 8.45
Cancelled (26,792) 15.00
------------
Outstanding at December 31, 2003 1,468,351 $14.75
============
Options exercisable at December 31, 2003 1,468,351* $14.75
============
Weighted-average fair value of
options granted during the
year ended December 31, 2003
(per option) $ -
============
*20,000 options expired in February 2004.
Shares of Common Stock available for future grant under the 1998 Stock Option
Plan at December 31, 2003 were 754,002.
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data set forth below as of and for the years ended
December 31, 2003, 2002, 2001, 2000, and 1999 has been derived from the
Company's audited financial statements. This information should be read in
conjunction with "Item 1. Business" and "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations", as well as the
audited financial statements and notes thereto included in "Item 8. Financial
Statements and Supplementary Data".
For the Year For the Year For the Year For the Year For the Year
Ended Ended Ended Ended Ended
December 31, December 31, December 31, December 31, December 31,
2003 2002 2001 2000 1999
- ----------------------------------------------------------------------------------------------------------------------
(In thousands, except per share data)
Operating Data:
Total income $163,778 $162,445 $131,220 $97,642 $57,511
Interest expense 83,249 65,018 59,400 51,112 25,873
Other operating expenses 11,707 14,850 12,736 9,727 7,407
Other gains (losses) (1) (77,464) (28,949) (910) 2,523 2,442
Cumulative transition adjustment (2) - 6,327 (1,903) - -
Net income (loss) (8,642) 59,955 56,271 39,326 26,673
Net income (loss) available to common
stockholders (16,386) 54,793 47,307 32,261 26,389
Per Share Data:
Net income (loss):
Basic (0.34) 1.18 1.41 1.37 1.27
Diluted (0.34) 1.18 1.35 1.28 1.26
Dividends declared per common share 1.26 1.40 1.29 1.17 1.16
Balance sheet Data:
Total assets 2,393,381 2,639,351 2,627,203 1,033,651 679,662
Long-term obligations 1,975,951 2,233,135 2,244,088 791,397 511,401
Total stockholders' equity 417,430 406,216 383,115 242,254 168,261
(1) Other gains (losses) for the year ended December 31, 2003 of
$(77,464) consist primarily of a loss of $32,426 related to
impairments on assets and a loss of $38,206 related to securities
held-for-trading. Other gains (losses) for the year ended December
31, 2002 of $(28,949) consist primarily of a loss of $10,273 related
to impairments on assets, a loss of $29,255 related to securities
held-for-trading, and a gain of $11,391 related to the sale of
securities available-for-sale. Other gains (losses) for the year
ended December 31, 2001 of $(910) consist primarily of a loss of
$5,702 related to impairments on assets, a loss of $2,604 related to
securities held-for-trading, and a gain of $7,401 related to the sale
of securities available-for-sale.
(2) The cumulative transition adjustment represents the Company's adoption
of SFAS No. 142 and SFAS 133 for the years ended December 31, 2002
and 2001, respectively.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
All dollar figures expressed herein are expressed in thousands, except per
share amounts.
General
Anthracite Capital, Inc. (the "Company") is a commercial real estate finance
company organized as a real estate investment trust ("REIT") that earns income
based on the difference between the yield on its assets and the cost of its
liabilities. The Company's primary long-term objective is to distribute
consistent dividends supported by earnings. The Company's primary focus is the
purchase and origination of high yielding commercial real estate securities
and loans. Over the long term, the Company's earnings are primarily maintained
by consistent credit performance on its commercial real estate investments,
investment performance, stability of the capital structure, and reinvestment
rates.
Exclusive of the writedowns incurred by the Company during 2003, the Company's
commercial real estate credit performance has been within expectations.
Delinquencies and underlying loan losses realized will continue to rise as the
portfolio matures but the Company believes it has adequate loss reserves
reflected in its loss-adjusted yields. The Company's capital structure
strategy is to issue liabilities that match the cash flow characteristics of
its portfolio of investments through the issuance of non-recourse
collateralized debt obligations ("CDOs") in conjunction with fixed rate
preferred stock offerings and common stock offerings.
The Company establishes its dividend by analyzing the long-term sustainability
of earnings given existing market conditions and the current composition of
its portfolio. This includes an analysis of the Company's credit loss
assumptions, reported net interest income, general level of interest rates,
realized gains and losses, and projected hedging costs.
At the end of the third quarter of 2003, the Company decided to accelerate its
strategic reduction of residential mortgage backed securities ("RMBS") due to
the volatility of interest rates and structural changes in the RMBS market.
The shift out of RMBS will decrease the Company's exposure to interest rate
volatility. The pace of reinvestment achieved during the fourth quarter of
2003 is consistent with the portfolio repositioning plan. The Company sold
RMBS to reduce interest rate volatility and replaced them with predominantly
investment grade commercial mortgage backed securities ("CMBS"). The Company
expects earnings to rise when its capital is fully redeployed into higher
yielding non-investment grade commercial real estate assets. The Company
continues to maintain a positive, though controlled, exposure to both long-
and short-term rates through its active hedging strategies. See "Item
7A-Quantitative and Qualitative Disclosures about Market Risk" for a
discussion of interest rates and their effect on earnings and book value.
The Company's earnings for the year ended December 31, 2003 includes a charge
of $0.56 per share which resulted from an increase in expected underlying loan
losses on certain 1998 vintage trusts where the Company through its investment
in subordinated CMBS of such trusts is in the first loss position. As a result
of this investment position, the Company controls the workout process on the
underlying loans ("Controlling Class"). The increase in loss expectations
triggered an impairment charge according to the Company's accounting policies
and as required by the accounting standard EITF 99-20, "Recognition of
Interest Income and Impairment on Purchased and Retained Beneficial Interests
in Securitized Financial Assets" ("EITF") 99-20. The increase in expected
losses on these 1998 vintage Controlling Class CMBS assets will decrease the
Company's income by approximately $0.07 per share annually.
The Company's earnings for the year ended December 31, 2003 also includes a
write down of $0.11 per share on a franchise loan backed security. The Company
determined it was unlikely that further payments will be received from this
franchise loan backed security and wrote this security down to zero, despite
the servicer reporting a par balance of $16,366 as of September 30, 2003. As
of December 31, 2003, the servicer continues to report a par of $16,366.
Additionally during the year ended December 31, 2003 the Company incurred net
realized and unrealized losses of $0.93 per share, which are attributable to
the RMBS portfolio and expenses of hedging that portfolio. To hedge the RMBS
portfolio the Company entered into interest rate swaps and Treasury futures to
reduce exposure to rising interest rates. Each of these hedging instruments
was designated as held-for-trading; therefore, changes in their value were
marked to market through the Company's consolidated statements of operations.
This action significantly reduced the interest rate sensitivity of the
Company's RMBS portfolio. However, the loss in value of the hedges greatly
exceeded the change in value of the assets in the held-for-trading account.
This loss is recorded directly in the consolidated statements of operations
rather than accumulated other comprehensive loss in the consolidated
statements of financial condition.
The table below is a summary of the Company's investments by asset class for
the last five years:
Carrying Value as of December 31,
2003 2002 2001 2000 1999
Amount % Amount % Amount % Amount % Amount %
=========================================================================================================
Commercial real
estate securities $1,366,508 61.6% $ 894,345 35.9% $453,953 20.8% $412,435 42.6% $272,733 42.2%
Commercial real
estate loans(1) 97,984 4.4 88,926 3.6 159,738 7.3 163,541 16.9 69,611 10.7
RMBS 753,219 34.0 1,506,450 60.5 1,570,009 71.9 337,222 34.9 304,462 47.1
U.S. Treasury
securities - - - - - - 54,043 5.6 - -
---------------------------------------------------------------------------------------------------------
Total $2,217,711 100.0% $2,489,721 100.0% $2,183,700 100.0% $967,241 100.0% $646,806 100.0%
---------------------------------------------------------------------------------------------------------
(1) Includes real estate joint ventures and an equity investment.
Commercial Real Estate Securities Portfolio Activity
The Company continues to increase its investments in commercial real estate
securities. Commercial real estate securities include CMBS and investment
grade REIT debt. During the year ended December 31, 2003, the Company
increased its commercial real estate securities portfolio by 53% from $894,345
to $1,366,508. This increase was primarily attributable to the purchase of
CMBS, CMBS interest only securities ("IOs") and investment grade REIT debt
which have a market value as of December 31, 2003 of $462,252, $49,684 and
$24,492, respectively.
The Company's first CDO transaction ("CDO I") was issued as Anthracite CDO
2002 CIBC-1 and closed on May 15, 2002. The Company issued $403,633 of debt
secured by a portfolio of commercial real estate securities with a total par
of $515,880 and an adjusted purchase price of $431,995. On December 10, 2002,
the Company issued another $280,607 of debt through Anthracite CDO 2002-2
secured by a separate portfolio of commercial real estate securities with a
par of $313,444 and an average adjusted purchase price of $289,197. Included
in the Company's second collateralized debt obligation ("CDO II") was a ramp
facility that was utilized to fund the purchase of an additional $50,000 of
par of below investment grade CMBS. The Company utilized the ramp in February
2003 and July 2003, to contribute $30,000 of par of CSFB 03-CPN1 and $20,000
of par of GECMC 03-C2, respectively. The Company retained 100% of the equity
of both CDOs and is recording the transactions on its consolidated financial
statements as a financing.
Collateral as of December 31, 2003 Debt as of December 31, 2003
------------------------------------------------------------------------------------
Adjusted Purchase Loss Adjusted Yield Adjusted Issue Weighted Average Net Spread
Price Price Cost of Funds *
------------------------------------------------------------------------------------- -----------
CDO I $441,428 8.88% $404,637 7.21% 1.67%
CDO II 325,875 7.81% 280,333** 5.73% 2.08%
--------------------------------------------------------------------------------- -----------
Total ** $767,303 8.42% $684,970 6.60% 1.82%
* Weighted Average Cost of Funds is the current cost of funds plus hedging
expenses.
** The Company chose not to sell $22,850 of par of CDO II debt rated
BBB- and BB.
The following table details the par, fair market value, adjusted purchase
price, and loss adjusted yield of the Company's commercial real estate
securities outside of the CDOs as of December 31, 2003:
Adjusted
Fair Market Dollar Purchase Dollar Loss Adjusted
Par Value Price Price Price Yield
-----------------------------------------------------------------------------------
Investment grade CMBS $277,276 $268,593 96.87 $272,853 98.40 4.9%
Investment grade REIT debt 29,000 29,567 101.95 30,210 104.17 5.0%
CMBS rated BB+ to B 186,217 133,868 71.89 150,775 80.97 8.9%
CMBS rated B- or lower 304,358 80,680 26.51 107,653 35.37 12.6%
CMBS IOs 2,623,456 84,493 3.22 83,704 3.19 7.5%
Other CMBS 20,266 20,142 99.39 20,264 99.99 5.7%
-----------------------------------------------------------------------------------
Total $3,440,573 $617,343 17.94 $665,459 19.34 7.4%
The following table details the par, fair market value, adjusted purchase
price and loss adjusted yield of the Company's commercial real estate
securities outside of the CDOs as of December 31, 2002:
Adjusted
Fair Market Dollar Purchase Dollar Loss Adjusted
Par Value Price Price Price Yield
-----------------------------------------------------------------------------------
CMBS rated BB+ to B $ 89,958 $ 59,110 65.71 $ 72,937 81.08 9.0%
CMBS rated B- or lower 280,987 83,386 29.68 116,528 41.47 12.6%
CMBS IOs 935,678 43,634 4.66 42,590 4.55 9.5%
Other CMBS 4,000 3,262 81.55 3,211 80.28 7.0%
-----------------------------------------------------------------------------------
Total $ 1,310,623 $ 189,392 14.45 $ 235,266 17.95 10.83%
Below Investment Grade CMBS and Underlying Loan Performance
The Company divides its below investment grade CMBS investment activity into
two portfolios; Controlling Class CMBS and other below investment grade CMBS.
The distinction between the two is in the controlling class rights the Company
obtains with its investment in Controlling Class CMBS. Controlling Class
rights allow the Company to control the workout and/or disposition of defaults
that occur in the underlying loans. These securities absorb the first losses
realized in the underlying loan pools. The Company's other below investment
grade CMBS have no rights associated with its ownership to control the workout
and/or disposition of underlying loan defaults; however, these investments are
not the first to absorb losses in the underlying pools. The coupon payment on
the non-rated security can also be reduced for special servicer fees charged
to the trust. The next highest rated security in the structure will then
generally be downgraded to non-rated and becomes the first to absorb losses
and expenses from that point on.
During 2003, the Company acquired $53,114 of par of other below investment
grade CMBS and $155,139 of par of new Controlling Class securities. The total
par of the Company's other below investment grade CMBS at December 31, 2003
was $304,207; the average credit protection, or subordination level, of this
portfolio is 6.03%. The total par of the Company's Controlling Class CMBS at
December 31, 2003 was $806,632 and the total par of the loans underlying these
securities was 11,043,023.
The Company's investment in its Controlling Class CMBS by credit rating
category at December 31, 2003 is as follows:
Adjusted
Fair Market Dollar Purchase Dollar Subordination
Par Value Price Price Price Level
-----------------------------------------------------------------------
BB+ $84,503 $73,766 87.29 $72,680 86.01 7.54%
BB 89,945 75,349 83.77 76,842 85.43 6.04%
BB- 101,393 71,285 70.31 81,036 79.92 5.12%
B+ 44,314 28,904 65.22 31,179 70.36 3.43%
B 182,119 105,061 57.69 133,718 73.42 3.06%
B- 83,296 34,160 41.01 51,935 62.35 1.54%
CCC+ 11,924 5,595 46.92 7,129 59.78 1.53%
CCC 70,273 13,375 19.03 22,844 32.51 1.23%
C 8,940 2,531 28.31 2,734 30.58 0.62%
NR 129,925 25,003 19.24 23,011 17.71 n/a
-----------------------------------------------------------------------
Total $806,632 $435,029 53.93 $503,108 62.37
The Company's investment in its Controlling Class CMBS by credit rating
category at December 31, 2002 is as follows:
Adjusted
Fair Market Dollar Purchase Dollar Subordination
Par Value Price Price Price Level
-----------------------------------------------------------------------
BB+ $65,159 $56,543 86.78 $56,181 86.22 8.26%
BB 58,170 48,674 83.68 48,560 83.48 6.73%
BB- 84,972 59,415 69.92 68,623 80.76 5.48%
B+ 32,329 21,533 66.61 23,173 71.68 3.72%
B 168,435 99,815 59.26 125,197 74.33 3.35%
B- 87,231 40,335 46.24 53,415 61.23 2.32%
CCC 70,407 17,715 25.16 28,942 41.11 1.46%
NR 123,349 25,335 20.54 34,171 27.70 n/a
-----------------------------------------------------------------------
Total $690,052 $369,365 53.53 $438,262 63.51
During 2003, the par amount of the Company's Controlling Class CMBS was
reduced by the servicers in the amount of $24,924. Par reductions of $17,275
were related to those securities which the Company incurred an impairment
during the quarter ended June 30, 2003. $7,649 of the $24,924 reduction in par
does not affect the Company's loss adjusted yield on those assets as
shortfalls are expected to occur in Controlling Class CMBS. Other than the
impairment taken during the quarter ended June 30, 2003, the Company currently
does not believe the $7,649 of par reduction requires an impairment or a
change in loss assumptions. Further delinquencies and losses may cause the par
reductions to continue and cause the Company to conclude that a change in loss
adjusted yield is required along with a write down of the adjusted purchase
price through the income statement according to EITF 99-20. Also during 2003,
the loan pools were paid down by $235,497. Pay down proceeds are distributed
to the highest rated CMBS class first and reduce the percent of total
underlying collateral represented by each rating category.
For all of the Company's Controlling Class securities, the Company assumes
that a total of 2.06% of the original loan balance will not be recoverable.
This estimate was developed based on an analysis of individual loan
characteristics and prevailing market conditions at the time of origination.
This loss estimate equates to cumulative expected defaults of approximately 5%
over the life of the portfolio and an average assumed loss severity of 37.6%
of the defaulted loan balance. All estimated workout expenses including
special servicer fees are included in these assumptions. Actual results could
differ materially from these estimated results. See Item 7A -"Quantitative and
Qualitative Disclosures About Market Risk" for a discussion of how differences
between estimated and actual losses could affect Company earnings.
The Company monitors credit performance on a monthly basis and debt service
coverage ratios on a quarterly basis. Using these and other statistics, the
Company maintains watch lists for loans that are delinquent thirty days or
more and for loans that are not delinquent but have issues that the Company's
management believes require close monitoring. The Company plans to perform a
detailed re-underwriting of a substantial number of the underlying loans
supporting its Controlling Class CMBS within the next nine months. Upon
completion, the Company may determine that its GAAP yields and book values
need to be adjusted.
The Company considers delinquency information from the Lehman Brothers Conduit
Guide to be the most relevant benchmark to measure credit performance and
market conditions applicable to its Controlling Class CMBS holdings. The year
of issuance, or vintage year, is important, as older loan pools will tend to
have more delinquencies than newly underwritten loans. The Company owns
Controlling Class CMBS issued in 1998, 1999, 2001, and 2003. Comparable
delinquency statistics referenced by vintage year as a percentage of par
outstanding as of December 31, 2003 are shown in the table below:
Vintage Underlying Delinquencies Lehman Brothers
Year Collateral Outstanding Conduit Guide
-----------------------------------------------------------------------
1998 $7,216,085 2.14% 2.52%
1999 714,757 0.32% 2.41%
2001 911,981 0.00% 1.24%
2003 2,200,200 0.00% 0.13%
-----------------------------------------------------------
Total $11,043,023 1.42%* 1.93%*
* Weighted average based on current principal balance net of defeased loans.
Morgan Stanley also tracks CMBS loan delinquencies for the specific CMBS
transactions with more than $200,000 of collateral and that have been seasoned
for at least one year. This seasoning criterion will generally adjust for the
lower delinquencies that occur in newly originated collateral. As of December
31, 2002, the Morgan Stanley index indicated that delinquencies on 204
securitizations were 2.01%, and as of December 31, 2003, this same index
indicated that delinquencies on 243 securitizations were 2.47%. See Item 7A -
"Quantitative and Qualitative Disclosures About Market Risks" for a detailed
discussion of how delinquencies and loan losses affect the Company.
Delinquencies on the Company's CMBS collateral as a percent of principal
increased in line with expectations. The Company's aggregate delinquency
experience is consistent with comparable data provided in the Lehman Brothers
Conduit Guide.
Of the 26 delinquent loans shown on the chart in Note 2 of the consolidated
financial statements, four loans were real estate owned and being marketed
for sale, four loans were in foreclosure, and the remaining 18 loans were in
some form of workout negotiations. Aggregate realized losses of $38,589 were
realized during year ended December 31, 2003. This brings cumulative net
losses realized to $52,065, which is 19.9% of total estimated losses. These
losses include special servicer and other workout expenses. This experience to
date is in line with the Company's loss expectations. Realized losses are
expected to increase on the underlying loans as the portfolio ages. Special
servicer expenses are also expected to increase as portfolios mature and U.S.
employment activity remains weak.
The Company manages its credit risk through disciplined underwriting,
diversification, active monitoring of loan performance and exercise of its
right to control the workout process for delinquent loans as early as
possible. The Company maintains diversification of credit exposures through
its underwriting process and can shift its focus in future investments by
adjusting the mix of loans in subsequent acquisitions. The comparative
profiles of the loans underlying the Company's CMBS by property type as of
December 31, 2003 and for the two prior years are as follows:
12/31/03 Exposure 12/31/02 Exposure 12/31/01 Exposure
- ----------------------------------------------------------------------------------------------------
% of
Property Type Loan Balance % of Total Loan Balance Total Loan Balance % of Total
- ----------------------------------------------------------------------------------------------------
Multifamily $3,740,791 33.9% $3,302,387 35.3% $3,432,708 34.6%
Retail 3,445,375 31.2 2,704,952 28.9 2,763,045 27.9
Office 1,998,929 18.1 1,550,378 16.6 1,866,338 18.8
Lodging 786,920 7.1 834,854 8.9 853,935 8.6
Industrial 708,064 6.4 589,044 6.3 604,852 6.1
Healthcare 337,333 3.1 346,298 3.7 353,697 3.6
Parking 25,611 0.2 29,743 0.3 35,225 0.4
-----------------------------------------------------------------------------------
Total $11,043,023* 100% $9,357,656** 100% $9,909,800 100%
===================================================================================
* Of this total $304,258 of loans have been "defeased" and are now secured
by Treasury securities, thereby removing real estate and borrower risk.
** Of this total $259,141 of loans have been "defeased" and are now secured
by Treasury securities, thereby removing real estate and borrower risk.
As of December 31, 2003, the fair market value of the Company's holdings of
Controlling Class CMBS is $68,079 lower than the adjusted cost for these
securities. The adjusted purchase price of the Company's Controlling Class
CMBS portfolio as of December 31, 2003 represents approximately 62% of its par
amount. The market value of the Company's Controlling Class CMBS portfolio as
of December 31, 2003 represents approximately 54% of its par amount. As the
portfolio matures, the Company expects to recoup the unrealized loss, provided
that the credit losses experienced are not greater than the credit losses
assumed in the purchase analysis. As of December 31, 2003, the Company
believes there has been no material deterioration in the credit quality of its
portfolio below current expectations.
As the portfolio matures and expected losses occur, subordination levels of
the lower rated classes of a CMBS investment will be reduced. This may cause
the lower rated classes to be downgraded which would negatively affect their
market value and therefore the Company's net asset value. Reduced market value
will negatively affect the Company's ability to finance any such securities
that are not financed through a CDO or similar matched funding vehicle. In
some cases, securities held by the Company may be upgraded to reflect
seasoning of the underlying collateral and thus would increase the market
value of the securities. During 2003 the Company experienced four rating
upgrades and one rating downgrade on its CMBS.
The Company's generally accepted accounting principles in the United States of
America ("GAAP") income for its CMBS securities is computed based upon a
yield, which assumes credit losses would occur. The yield to compute the
Company's taxable income does not assume there would be credit losses, as a
loss can only be deducted for tax purposes when it has occurred. As a result,
for the years 1998 through December 31, 2003, the Company's GAAP income
accrued on its CMBS assets was approximately $26,697 lower than the taxable
income accrued on the CMBS assets.
Commercial Real Estate Loan Activity
The Company's commercial real estate loan portfolio generally emphasizes
larger transactions located in metropolitan markets, as compared to the
typical loan in the CMBS portfolio. The Company has never suffered a loss in
this portfolio. Because the loan portfolio is relatively small and
heterogeneous, the Company has determined it is not necessary to establish a
loan loss reserve.
In June 2003, the borrower submitted payment in an attempt to fully repay the
loan on a Los Angeles office building in connection with the borrower's sale
of the property. Upon the sale of the property securing this loan, and
pursuant to the loan documents, the Company was entitled to a supplemental
exit fee that was to be paid upon repayment of the loan. The borrower has
refused to pay the supplemental exit fee. The Company filed suit on July 15,
2003 against the co-borrowers, MP-555 West Fifth Mezzanine, LLC and MP-808
South Olive Mezzanine, LLC, which are both affiliates of Maguire Properties,
Inc (NYSE: MPG). The suit also names the Guarantor, Robert F. Maguire, III.
The following table summarizes the Company's commercial real estate loan
portfolio by property type as of December 31, 2003, 2002, and 2001:
Loan Outstanding
--------------------------------------------------------------------- Weighted Average
December 31, 2003 December 31, 2002 December 31, 2001 Coupon
Property -----------------------------------------------------------------------------------------------
Type Amount % Amount % Amount % 2003 2002 2001
- -----------------------------------------------------------------------------------------------------------------
Office $57,381 76.4% $69,431 91.4% $86,863 57.6% 9.4% 9.5% 9.3%
Residential 2,794 3.7 3,013 4.0 15,000 9.9 3.8% 3.6% 20.0%
Retail - - 3,500 4.6 - - -% 4.6% -%
Hotel 14,951 19.9 - - 49,091 32.5 6.6% - 8.2%
-----------------------------------------------------------------------------------------------
Total $75,126 100.0% $75,944 100.0% $150,954 100.0% 8.6% 9.2% 10.0%
-----------------------------------------------------------------------------------------------
Recent Events
On February 11, 2004, Hugh R. Frater, the then President and Chief Executive
Officer of the Company, advised the Board of Directors of his resignation from
the Company and his intention to accept a position as Executive Vice President
and Head of Real Estate Finance at The PNC Financial Services Group, Inc.
(NYSE:PNC). Mr. Frater will continue to serve as a member of the Company's
Board of Directors. Christopher A. Milner was appointed President and Chief
Executive Officer and will continue as Chief Investment Officer of the
Company.
During the months of January and February 2004, the Company received $6,596
under the Company's Dividend Reinvestment and Stock Purchase Plan (the
"Divided Reinvestment Plan") and issued 600,328 shares of its Common Stock.
The Company is currently marketing its third collateralized debt obligation
("CDO III"), which it expects to close in March 2004. The Company anticipates
contributing approximately $385,000 par of CMBS and REIT debt to CDO III, and
will contribute an additional $50,000 par of below investment grade CMBS over
the next twelve months.
Critical Accounting Estimates
Management's discussion and analysis of financial condition and results of
operations are based on the amounts reported in the Company's consolidated
financial statements. These financial statements are prepared in accordance
with GAAP. In preparing the financial statements, management is required to
make various judgments, estimates and assumptions that affect the reported
amounts. Changes in these estimates and assumptions could have a material
effect on the Company's consolidated financial statements. The following is a
summary of the Company's accounting policies that are the most affected by
management judgments, estimates and assumptions:
Securities Available-for-sale
The Company has designated its investments in mortgage-backed securities,
mortgage-related securities and certain other securities as
available-for-sale. Securities available-for-sale are carried at estimated
fair value with the net unrealized gains or losses reported as a component of
accumulated other comprehensive income (loss) in stockholders' equity. Many of
these investments are relatively illiquid, and their values must be estimated
by management. In making these estimates, management generally utilizes market
prices provided by dealers who make markets in these securities, but may,
under certain circumstances, adjust these valuations based on management's
judgment. Changes in the valuations do not affect the Company's reported net
income or cash flows, but impact stockholders' equity and, accordingly, book
value per share.
Management must also assess whether unrealized losses on securities reflect a
decline in value which is other than temporary, and, accordingly, write the
impaired security down to its fair value, through earnings. Significant
judgment by management is required in this analysis which includes, but is not
limited to, making assumptions regarding the collectibility of the principal
and interest, net of related expenses, on the underlying loans.
Income on these securities is recognized based upon a number of assumptions
that are subject to uncertainties and contingencies. Examples include, among
other things, the rate and timing of principal payments (including
prepayments, repurchases, defaults and liquidations), the pass-through or
coupon rate and interest rate fluctuations. Additional factors that may affect
the Company's reported interest income on its mortgage securities include
interest payment shortfalls due to delinquencies on the underlying mortgage
loans, the timing and magnitude of credit losses on the mortgage loans
underlying the securities that are a result of the general condition of the
real estate market (including competition for tenants and their related credit
quality) and changes in market rental rates. These uncertainties and
contingencies are difficult to predict and are subject to future events which
may alter the assumptions.
The Company adopted EITF 99-20 on April 1, 2001. The Company recognizes
interest income from its purchased beneficial interests in securitized
financial interests ("beneficial interests") (other than beneficial interests
of high credit quality, sufficiently collateralized to ensure that the
possibility of credit loss is remote, or that cannot contractually be prepaid
or otherwise settled in such a way that the Company would not recover
substantially all of its recorded investment) in accordance with this
guidance. Accordingly, on a quarterly basis, when significant changes in
estimated cash flows from the cash flows previously estimated occur due to
actual prepayment and credit loss experience, the Company calculates a revised
yield based on the current amortized cost of the investment (including any
other-than-temporary impairments recognized to date) and the revised cash
flows. The revised yield is then applied prospectively to recognize interest
income.
Prior to April 1, 2001, the Company recognized income from these beneficial
interests using the effective interest method, based on an anticipated yield
over the projected life of the security. Changes in the anticipated yields
were calculated due to revisions in the Company's estimates of future and
actual credit losses and prepayments. Changes in anticipated yields resulting
from credit loss and prepayment revisions were recognized through a cumulative
catch-up adjustment at the date of the change which reflected the change in
income from the security from the date of purchase through the date of change
in the anticipated yield. The new yield was then used prospectively to account
for interest income. Changes in yields from reduced estimates of losses were
recognized prospectively.
For other mortgage-backed and related mortgage securities, the Company
accounts for interest income under SFAS No. 91, using the effective yield
method which includes the amortization of discount or premium arising at the
time of purchase and the stated or coupon interest payments.
As a result of the closing of CDO I at the end of the first quarter 2002, the
Company reclassified all of its subordinated CMBS on its consolidated
statement of financial condition from available-for-sale to held-to-maturity.
The effect of this reclassification changed the accounting basis for these
securities, prospectively, from fair market value to adjusted cost. However,
in accordance with SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities," ("SFAS No. 133"), the interest rate swap agreements
entered into by the Company to hedge the variable rate exposure of the debt of
CDO I are required to be presented on the balance sheet at their fair market
value. Accordingly, the Company determined that at December 31, 2002, and
going forward, it would classify all of its subordinated CMBS as
available-for-sale securities and record them at fair market value. This is
consistent with the mark to market requirement for the CDO's interest rate
swap agreements.
The reclassification of these securities to available-for-sale from
held-to-maturity increased the recorded value of these securities from
$558,522 to $610,713 with the difference being recorded in other comprehensive
income. The circumstance causing the Company to change this classification was
not considered a permitted circumstance as stated in Statement of Financial
Accounting Standard ("SFAS") No. 115, "Accounting for Certain Investments in
Debt and Equity Securities" ("SFAS No. 115"), and is therefore inconsistent
with the Company's intent regarding its held-to-maturity classification.
Accordingly, the Company will be prohibited from classifying its subordinated
CMBS (current holdings as well as future purchases) as held-to-maturity for a
period of two years.
Securities Held-for-trading
The Company has designated certain other securities as held-for-trading.
Securities held-for-trading are also carried at estimated fair value, but
changes in fair value are included in income. The valuations of these
securities and the interest income recognized are subject to the same
uncertainties as those discussed above.
Mortgage Loans
The Company purchases and originates commercial mortgage loans to be held as
long-term investments. The Company also has an investment in a private
opportunity fund which invests in commercial mortgage loans and is managed by
the Manager. Management must periodically evaluate each loan for possible
impairment. Impairment is indicated when it is deemed probable that the
Company will not be able to collect all amounts due according to the
contractual terms of the loan. If a loan is determined to be impaired, the
Company would establish a reserve for probable losses and a corresponding
charge to earnings. Given the nature of the Company's loan portfolio and the
underlying commercial real estate collateral, significant judgment of
management is required in determining impairment and the resulting loss
allowance which includes but is not limited to making assumptions regarding
the value of the real estate which secures the mortgage loan. To date, the
Company has determined that no loss allowances have been necessary on the
loans in its portfolio or held by the opportunity fund.
Real Estate Joint Ventures
The Company makes investments in real estate entities over which the Company
exercises significant influence, but not control. The real estate held by such
entities must be regularly reviewed for impairment, and would be written down
to its estimated fair value, through earnings, if impairment is determined to
exist. This review involves assumptions about the future operating results of
the real estate and market factors, all of which are subjective and difficult
to predict. To date, the Company has determined that none of the real estate
held by its joint ventures is impaired.
Derivative Instruments
The Company utilizes various hedging instruments (derivatives) to hedge
interest rate and foreign currency exposures or to modify the interest rate or
foreign currency characteristics of related Company investments. All
derivatives are carried at fair value, generally estimated by management based
on valuations provided by the counterparty to the derivative contract. For
accounting purposes, the Company's management must decide whether to designate
these derivatives as hedging borrowings, securities available-for-sale,
securities held-for-trading, or foreign currency exposure. This designation
decision affects the manner in which the changes in the fair value of the
derivatives are reported.
Impairment - Securities
In accordance with SFAS No. 115, when the estimated fair value of the security
classified as available-for-sale has been below amortized cost for a
significant period of time and the Company concludes that it no longer has the
ability or intent to hold the security for the period of time over which the
Company expects the values to recover to amortized cost, the investment is
written down to its fair value. The resulting charge is included in income,
and a new cost basis is established. Additionally, under EITF 99-20, when
significant changes in estimated cash flows from the cash flows previously
estimated occur due to actual prepayment and credit loss experience, and the
present value of the revised cash flows using the current expected yield is
less than the present value of the previously estimated remaining cash flows
(adjusted for cash receipts during the intervening period), an
other-than-temporary impairment is deemed to have occurred. Accordingly, the
security is written down to fair value with the resulting change being
included in income, and a new cost basis established. In both instances, the
original discount or premium is written off when the new cost basis is
established.
The Company performed an analysis of its current underlying loan loss
expectations and credit performance of its 1998 vintage Controlling Class
CMBS. The Company increased expected underlying loan loss expectations on four
securities from three 1998 vintage Controlling Class CMBS transactions. As a
result of the increase in loss expectations, the Company recorded an
impairment charge of $27,014 during the second quarter of 2003, to reduce the
amortized cost of these securities to their fair value, as required by
Emerging Issue Task Force standard 99-20, "Recognition of Interest Income and
Impairment on Purchased and Retained Beneficial Interests in Securitized
Financial Assets" ("EITF 99-20"). Three of the four impaired securities are
not rated and the fourth security is rated CCC by Fitch Ratings. Securities
which are not rated are highly sensitive to changes in the timing of losses
recognized on the underlying loans. Even though actual losses recognized on
the underlying loans to date are still significantly less than original
estimates, the Company believes that losses in 2003 will continue to rise due
to weak conditions in many commercial real estate markets. The Company
believes it was appropriate to increase the total amount of expected losses of
these transactions.
After taking into account the effect of the impairment charge, income is
recognized under EITF 99-20 or SFAS No. 91, as applicable, using the market
yield for the security used in establishing the write-down.
Recently Adopted Accounting Pronouncements
In December 2002, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure, an amendment of FASB Statement No. 123" ("SFAS No. 148"). SFAS No.
148 amends SFAS No. 123, "Accounting For Stock-Based Compensation", ("SFAS No.
123"), to provide alternative methods of transition for a voluntary change to
the fair value based method of accounting for stock-based employee
compensation. In addition, the statement amends the disclosure requirements of
SFAS No. 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based
compensation and the effect of the method used on reported results. The
Company has determined that this Interpretation does not currently impact the
Company's consolidated financial statements.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities" ("SFAS No. 149"). SFAS No. 149
amends and clarifies the accounting for derivative instruments, including
certain derivative instruments embedded in other contracts, and for hedging
activities under SFAS No. 133. SFAS No. 149 is generally effective for
contracts entered into or modified after June 30, 2003 and for hedging
relationships designated after June 30, 2003. The Company's adoption of SFAS
No. 149 on July 1, 2003, as required, did not have a material impact on the
Company's consolidated financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity" ("SFAS No.
150"). SFAS No. 150 addresses the standards for how an issuer classifies and
measures certain financial instruments with characteristics of both
liabilities and equity and requires the issuer to classify a financial
instrument that is within its scope as a liability (or asset in some
circumstances). SFAS No. 150 became effective for all instruments issued after
May 1, 2003 and is required to be applied to all financial instruments as of
July 1, 2003. The adoption of this statement did not have a material impact on
the Company's consolidated financial statements.
In December 2003, the FASB issued a revised version of FASB Interpretation No.
46, "Consolidation of Variable Interest Entities" ("FIN 46R"). FIN 46R
addresses the application of Accounting Research Bulletin No. 51,
"Consolidated Financial Statements," to variable interest entities ("VIE") and
generally would require that the assets, liabilities, and results of
operations of a VIE be consolidated into the financial statements of the
enterprise that has a controlling financial interest in it. The interpretation
provides a framework for determining whether an entity should be evaluated for
consolidation based on voting interests or significant financial support
provided to the entity ("variable interests").
An entity is classified as a VIE if total equity is not sufficient to permit
the entity to finance its activities without additional subordinated financial
support or its equity investors lack the direct or indirect ability to make
decisions about an entity's activities through voting rights, absorb the
expected losses of the entity if they occur or receive the expected residual
returns of the entity if they occur. Once an entity is determined to be a VIE,
its assets, liabilities, and results of operations should be consolidated with
those of its primary beneficiary. The primary beneficiary of a VIE is the
entity which either will absorb a majority of the VIE's expected losses or has
the right to receive a majority of the VIE's expected residual returns. The
expected losses and residual returns of a VIE include expected variability in
its net income or loss, fees to decision makers and fees to guarantors of
substantially all of VIE assets or liabilities and are calculated in
accordance with Statement of Financial Accounting Concept No. 7, "Using Cash
Flow Information and Present Value in Accounting Measurements."
A public enterprise with a variable interest in a VIE must apply FIN 46R to
that VIE no later than the end of the first reporting period that ends after
March 15, 2004, with the exception of special purpose entities ("SPE") as
defined. A public enterprise with a variable interest in an SPE which has been
deemed a VIE must apply FIN 46R to that VIE no later than the end of the first
reporting period that ends after December 15, 2003.
The Company's ownership of the subordinated classes of CMBS from a single
issuer where it maintains the right to control the foreclosure/workout process
on the underlying loans ("Controlling Class CMBS") are variable interests in
SPEs which have been deemed VIEs and therefore subject to the FIN 46R
consolidation criteria. Provided in Paragraph 4(d) of FIN 46R are exceptions
to the consolidation of VIE's specifically, that an enterprise that holds
variable interests in a qualifying special-purpose entity ("QSPE") shall not
consolidate that entity unless that enterprise has the unilateral ability to
cause the entity to liquidate. The requirements regarding the QSPE structure
are contained in SFAS No. 140, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities" ("SFAS No. 140"), and
before March 1, 2001 through SFAS No. 140's predecessor under the same name,
SFAS No. 125. Pursuant to the conceptual framework set forth in FIN 46R, the
Company's management has concluded that the trusts holding its Controlling
Class CMBS were structured as QSPE's. Accordingly, the Company was not
required to consolidate these trusts and therefore, the adoption of FIN 46R
did not have a material impact on the Company's consolidated financial
statements. The Controlling Class CMBS which have been deemed VIEs are
detailed below. The Company's actual loss from its Controlling Class CMBS
investments are limited to the amounts invested in such securities and further
limited to such amounts not financed in its non recourse CDOs. The fair value
of the Controlling Class securities financed in the CDOs is $265,517; the
total fair value of the company's controlling class CMBS is $430,965.
The table below details the purchase date, par of the Company's Controlling
Class securities and the entire par of each Controlling Class issuance owned
by the Company as of December 31, 2003.
Controlling Class Par Held by the
Securities Purchase Date Company Total CMBS Issued
-------------------------------------------------------------------------------
CMAC 1998-C1 July 1998 $74,730 $982,489
CMAC 1998-C2 September 1998 182,970 2,284,406
DLJCM 1998-CG1 June 1998 99,845 1,326,906
GMAC 1998-C1 April 1998 50,437 1,209,899
LBCMT 1998-C1 May 1998 160,315 1,412,385
PNCMA 1999-CM1 November 1999 37,101 714,757
CSFB 2001-CK6 December 2001 71,345 911,981
CSFB 2003-CPN1 February 2003 66,177 999,121
GECMC 2003-C2 July 2003 62,112 1,201,079
--------------------------------------
Total $805,032 $11,043,023
Results of Operations
Net loss for the year ended December 31, 2003 was $(8,642), or $(0.34) per
share (basic and diluted). Net income for the year ended December 31, 2002 was
$59,995, or $1.18 per share (basic and diluted). Net income for the year ended
December 31, 2001 was $56,271, or $1.41 per share ($1.35 diluted). The
decrease in yields on all asset classes is due to lower market interest rates.
The decrease in the yields on the Company's commercial real estate securities
is due to the purchase of higher credit rated assets during 2003. This trend
is expected to reverse as the Company adds high yielding assets to its
portfolio in 2004.
Interest Income: The following table sets forth information regarding the
total amount of income from certain of the Company's interest-earning assets
and the resulting average yields. Information is based on monthly average
adjusted cost basis during the period.
For the Year Ended December 31, 2003
-------------------------------------------
Interest Average Annualized
Income Balance Yield
------------- -------------- --------------
Commercial real estate securities $98,113 $1,128,689 8.69%
Commercial real estate loans 5,875 56,344 10.43%
RMBS 54,504 1,312,641 4.15%
Cash and cash equivalents 964 73,326 1.13%
------------- -------------- --------------
Total $159,456 $2,571,000 6.20%
============= ============== ==============
For the Year Ended December 31, 2002
--------------------------------------------
Interest Average Annualized
Income Balance Yield
--------------------------------------------
Commercial real estate securities $72,205 $730,391 9.89%
Commercial real estate loans 13,997 128,385 10.90%
RMBS 72,524 1,392,389 5.21%
Cash and cash equivalents 1,473 95,996 1.53%
--------------------------------------------
Total $160,199 $2,347,161 6.83%
============================================
For the Year Ended December 31, 2001
---------------------------------------------
Interest Average Annualized
Income Balance Yield
---------------------------------------------
Commercial real estate securities $49,177 $507,227 9.70%
Commercial real estate loans 15,499 122,693 12.63%
RMBS 60,641 965,460 6.28%
Mortgage loan pools 1,575 20,778 7.58%
Cash and cash equivalents 2,581 91,630 2.82%
---------------------------------------------
Total $129,473 $1,707,788 7.58%
=============================================
The following chart reconciles interest income and total income for the years
ended December 31, 2003, 2002 and 2001.
For the Years Ended December 31,
2003 2002 2001
--------------------------------------
Interest Income $159,456 $160,199 $129,473
Earnings from real estate joint ventures 955 1,044 1,667
Earnings from equity investment 3,367 1,202 80
--------------------------------------
Total Income $163,778 $162,445 $131,220
======================================
Interest Expense: The following table sets forth information regarding the
total amount of interest expense from certain of the Company's collateralized
borrowings. Information is based on daily average balances during the period;
the collateralized debt obligations for the year ended December 31, 2003
includes the cost of hedging those transactions.
For the Year Ended December 31, 2003
---------------------------------------------
Interest Average Annualized
Expense Balance Rate
------------- ---------------- -------------
Collateralized debt obligations $ 44,226 $ 684,797 6.46%
Reverse repurchase agreements 18,614 1,460,049 1.27%
Lines of credit and term loan 2,325 45,199 5.14%
------------- ---------------- ------------
Total $ 65,165 $ 2,190,045 2.98%
============= ================ ============
For the Year Ended December 31, 2002
---------------------------------------------
Interest Average Annualized
Expense Balance Rate
------------- ---------------- -------------
Collateralized debt obligations $ 17,374 $ 263,242 6.60%
Reverse repurchase agreements 31,651 1,607,376 1.97%
Lines of credit and term loan 2,451 65,741 3.73%
------------- ---------------- -------------
Total $ 51,476 $ 1,936,359 2.66%
============= ================ ============
For the Year Ended December 31, 2001
---------------------------------------------
Interest Average Annualized
Expense Balance Rate
------------- ---------------- -------------
Reverse repurchase agreements $ 45,126 $ 1,180,115 3.82%
Lines of credit and term loan 8,204 140,468 5.84%
------------- ---------------- -------------
Total $ 53,330 $ 1,320,583 4.04%
============= ================ ============
The foregoing interest expense amounts for the year ended December 31, 2003
does not include $706 of hedge ineffectiveness income, as well as $18,790 of
interest expense related to interest rate hedges outside of the CDOs. The
foregoing interest expense amounts for the year ended December 31, 2002 do not
include hedge ineffectiveness income of $236, as well as $13,778 of interest
expense related to interest rate hedges outside of the CDOs. The foregoing
interest expense amounts for the year ended December 31, 2001 do not include
hedge ineffectiveness expense of $428, as well as $5,643 of interest expense
related to interest rate hedges. See Note 13 of the consolidated financial
statements, Derivative Instruments, for further description of the Company's
hedge ineffectiveness.
Net Interest Margin and Net Interest Spread from the Portfolio: The Company
considers its portfolio to consist of its securities available-for-sale,
mortgage loan pools, commercial mortgage loans, and cash and cash equivalents
because these assets relate to its core strategy of acquiring and originating
high yield loans and securities backed by commercial real estate, while at the
same time maintaining a portfolio of investment grade securities to enhance
the Company's liquidity.
Net interest margin from the portfolio is annualized net interest income
divided by the average market value of interest-earning assets. Net interest
income is total interest income less interest expense relating to
collateralized borrowings. Net interest spread equals the yield on average
assets for the period less the average cost of funds for the period. The yield
on average assets is interest income divided by average amortized cost of
interest earning assets. The average cost of funds is interest expense from
the portfolio divided by average outstanding collateralized borrowings.
The following chart describes the interest income, interest expense, net
interest margin and net interest spread for the Company's portfolio. The
following interest income and interest expense amounts exclude income and
expense related to real estate joint ventures, equity investment and hedge
ineffectiveness.
For the Year Ended December 31,
2003 2002 2001 2000
------------ ------------ ------------ ----------
Interest income $159,456 $160,200 $129,553 $97,294
Interest expense $ 83,930 $ 65,207 $ 57,196 $51,112
Net interest margin 3.08% 4.40% 4.38% 5.55%
Net interest spread 2.68% 4.05% 3.60% 3.78%
Other Expenses: Expenses other than interest expense consist primarily of
management fees and general and administrative expenses. Management fees paid
to the Manager of $9,411 for the year ended December 31, 2003 were comprised
entirely of base management fees. During the third quarter of 2003, the
Manager agreed to reduce the management fees by 20% from its calculated amount
for the third and fourth quarter of 2003 and the first quarter of 2004. This
revision resulted in $1,046 in savings to the Company during 2003. Management
fees paid to the Manager of $12,527 for the year ended December 31, 2002 were
comprised of base management fees of $9,332 and incentive fees of $3,195.
Management fees paid to the Manager of $11,018 for the year ended December 31,
2001 were comprised of base management fees of $7,780 and incentive fees of
$3,238. General and administrative expense of $2,296 for the year ended
December 31, 2003, $2,323 for the year ended December 31, 2002, and $1,717 for
the year ended December 31, 2001 were comprised of accounting agent fees,
custodial agent fees, directors' fees, fees for professional services,
insurance premiums, broken deal expenses, and due diligence costs. General and
administrative expense for the year ended 2001 also includes the amortization
of negative goodwill.
Other Gains (Losses): During the year ended December 31, 2003, the Company
sold a portion of its securities available-for-sale for total proceeds of
$1,466,552, resulting in a realized loss of $6,832. During the year ended
December 31, 2002, the Company sold a portion of its securities
available-for-sale for total proceeds of $1,017,534, resulting in a realized
gain of $11,391. During the year ended December 31, 2001, the Company sold a
portion of its securities available-for-sale for total proceeds of $1,452,577,
resulting in a realized gain of $7,401. The loss on securities
held-for-trading of $38,206, $29,255, and $2,604 for the years ended December
31, 2003, 2002, and 2001, respectively, consisted primarily of realized and
unrealized gains and losses on U.S. Treasury and Agency securities, forward
commitments to purchase or sell agency RMBS and hedges. The foreign currency
loss of $812 and $5 for the years ended December 31, 2002 and 2001,
respectively, relates to the Company's net investment in a commercial mortgage
loan denominated in pounds sterling and associated hedging. The loss on
impairment of assets of $32,426, $10,273, and $5,702 for the years ended
December 31, 2003, 2002, and 2001, respectively, are related to the Company's
writedowns of franchise loan backed securities and Controlling Class CMBS.
Dividends Declared: During the year ended December 31, 2003, the Company
declared dividends to stockholders totaling $61,088, or $1.26 per share, of
which $47,238 was paid during the year and $13,850 was paid on February 2,
2004. During the year ended December 31, 2002, the Company declared dividends
to stockholders totaling $65,368, or $1.40 per share. During the year ended
December 31, 2001, the Company declared dividends to stockholders totaling
$47,458 or $1.29 per share. For U.S. Federal income tax purposes, the
dividends are ordinary income to the Company's stockholders.
Tax Basis Net Income and GAAP Net Income: Net income as calculated for tax
purposes (tax basis net income) was estimated at $46,400 or $0.96 per share
basic and diluted), for the year ended December 31, 2003, compared to a net
loss as calculated in accordance with GAAP of $(8,642), or $(0.34) per share
(basic and diluted).
Tax basis income was $76,000, or $1.53 ($1.52 diluted) per share, for the year
ended December 31, 2002, compared to a net income as calculated in accordance
with GAAP of $59,955, or $1.18 ($1.18 diluted) per share. Tax basis income was
$53,046, or $1.31 ($1.26 diluted) per share, for the year ended December 31,
2001, compared to a net income as calculated in accordance with GAAP of
$56,271, or $1.41 ($1.35 diluted) per share.
Differences between tax basis net income and GAAP net income arise for various
reasons. For example, in computing income from its Controlling Class CMBS for
GAAP purposes, the Company takes into account estimated credit losses on the
underlying loans, whereas for tax basis income purposes, only actual credit
losses are taken into account. Certain general and administrative expenses may
differ due to differing treatment of the deductibility of such expenses for
tax basis income. Also, differences could arise in the treatment of premium
and discount amortization on the Company's securities available-for-sale.
Changes in Financial Condition
Securities Available-for-sale: The Company's securities available-for-sale,
which are carried at estimated fair value, included the following at December
31, 2003 and December 31, 2002:
December 31, December 31,
2003 Estimated 2002 Estimated
Fair Fair
Security Description Value Percentage Value Percentage
------------------------------------------- ---------------- -------------- ----------------- --------------
Commercial mortgage-backed securities:
CMBS IOs $84,493 4.7% $43,634 4.5%
Investment grade CMBS 333,454 18.5 55,120 5.7
Non-investment grade rated subordinated
securities 678,424 37.6 577,371 59.3
Non-rated subordinated securities 25,019 1.4 25,335 2.7
Credit tenant lease 25,696 1.4 9,063 0.9
Investment grade REIT debt 219,422 12.1 183,822 18.9
---------------- -------------- ----------------- --------------
Total CMBS $1,366,508 75.7 $894,345 92.0
---------------- -------------- ----------------- --------------
Single-family residential
mortgage-backed securities:
Agency adjustable rate securities 180,381 10.0 41,299 4.2
Agency fixed rate securities 226,999 12.5 8,833 0.9
Residential CMOs 3,464 0.2 13,834 1.4
Hybrid arms 6,645 0.4 14,751 1.5
Project Loans 22,003 1.2
---------------- -------------- ----------------- --------------
Total RMBS 439,492 24.3 $78,717 8.0
---------------- -------------- ----------------- --------------
---------------- -------------- ----------------- --------------
Total securities available-for-sale $1,806,000 100.0% $973,062 100.0%
================ ============== ================= ==============
The increase in the CMBS and REIT debt is attributable to the attractive
opportunities available to the Company to match fund these assets in the CDO
market.
Borrowings: As of December 31, 2003 and 2002, the Company's debt consisted of
line-of-credit borrowings, CDO debt, term loans and reverse repurchase
agreements, collateralized by a pledge of most of the Company's securities
available-for-sale, securities held-for-trading, and its commercial mortgage
loans. The Company's financial flexibility is affected by its ability to renew
or replace on a continuous basis its maturing short-term borrowings. As of
December 31, 2003 and 2002, the Company has obtained financing in amounts and
at interest rates consistent with the Company's short-term financing
objectives.
Under the lines of credit, term loans, and the reverse repurchase agreements,
the lender retains the right to mark the underlying collateral to market
value. A reduction in the value of its pledged assets would require the
Company to provide additional collateral or fund margin calls. Most of the
Company's reverse repurchase agreements are collateralized by RMBS which can
be readily liquidated.
The following table sets forth information regarding the Company's
collateralized borrowings:
For the Year Ended
December 31, 2003
-----------------------------------------------------
December 31,
2003 Maximum Range of
Balance Balance Maturities
-----------------------------------------------------
CDO debt* $684,970 $685,239 7.9 to 9.7 years
Reverse repurchase agreements 1,048,635 1,858,434 2 to 29 days
Line of credit and term loan borrowings 89,936 89,936 100 to 562 days
-----------------------------------------------------
* Disclosed as adjusted issue price. Total par of the Company's CDO debt as of
December 31, 2003 is $699,553.
For the Year Ended
December 31, 2002
-----------------------------------------------------
December 31,
2002 Maximum Range of
Balance Balance Maturities
-----------------------------------------------------
CDO debt* $684,590 $684,590 8.9 to 10.7 years
Reverse repurchase agreements 1,457,882 1,929,216 3 to 27 days
Line of credit and term loan borrowings 19,189 165,993 211 to 927 days
=====================================================
* Disclosed as adjusted issue price. Total par of CDO debt as of December 31,
2002 is $699,924.
Hedging Instruments: From time to time, the Company may modify its exposure to
market interest rates by entering into various financial instruments that
adjust portfolio duration and short-term rate exposure. These financial
instruments are intended to mitigate the effect of changes in interest rates
on the value of the Company's assets and the cost of borrowing. At December
31, 2003, the Company had outstanding short positions of 30 five-year and 73
ten-year U.S. Treasury Note future contracts. At December 31, 2002, the
Company had outstanding short positions of 3,166 five-year and 1,126 ten-year
U.S. Treasury Note future contracts.
Interest rate swap agreements as of December 31, 2003 and December 31, 2002
consisted of the following:
December 31, 2003
Weighted
Average
Notional Estimated Unamortized Remaining
Value Fair Value Cost Term
Interest rate swaps 919,300 (2,929) 23 5.46 years
Interest rate swaps - CDO 626,323 (23,423) - 9.17 years
------------------------------------------------
Total 1,545,623 (26,352) 23 6.96 years
================================================
December 31, 2002
Weighted
Average
Notional Estimated Unamortized Remaining
Value Fair Value Cost Term
Interest rate swaps 489,000 (11,948) - 1.79 years
Interest rate swaps - CDO 653,832 (33,654) - 9.53 years
------------------------------------------------
Total 1,142,832 (45,602) - 6.22 years
================================================
As of December 31, 2003, the Company had designated $1,066,078 notional of the
interest rate swap agreements as cash flow hedges. As of December 31, 2002,
the Company had designated $791,287 of the interest rate swap agreements as
cash flow hedges of borrowings under reverse repurchase agreements.
Capital Resources and Liquidity
Liquidity is a measurement of the Company's ability to meet cash requirements,
including ongoing commitments to repay borrowings, fund investments, loan
acquisition and lending activities, and for other general business purposes.
The primary sources of funds for liquidity consist of collateralized
borrowings, principal and interest payments on and maturities of securities
available-for-sale, securities held-for-trading, commercial mortgage loans,
and proceeds from the maturity or sales thereof.
The Company finances itself with its own equity, follow-on equity offerings,
preferred stock offerings, secured term debt, committed financing facilities,
and reverse repurchase agreements. An important part of the Company's risk
analysis includes a thorough assessment of the financing alternatives in the
context of the assets being financed.
Reverse repurchase agreements are secured loans generally with a term of 30
days. The interest rate is based on 30-day London Interbank Offered Rate
("LIBOR") plus a spread that is determined based on the asset pledged as
security. The terms include a daily mark to market provision that requires the
posting of additional collateral if the value of the pledged asset declines.
After the 30-day period expires, there is no obligation for the lender to
extend credit for an additional period. This type of financing is generally
available only for more liquid securities. The interest rate charged on
reverse repurchase agreements is usually the lowest relative to the
alternatives due to the lower risk inherent in these transactions.
Committed financing facilities represent multi-year agreements to provide
secured financing for a specific asset class. These facilities include a daily
mark to market provision requiring posting of additional collateral if the
value of the pledged asset declines in excess of a threshold amount. A
significant difference between committed financing facilities and reverse
repurchase agreements is the term of the financing. A committed facility
provider is generally required to provide financing for the full term of the
agreement, usually two to three years, rather than thirty days as generally
used in the reserve repurchase market. This longer term makes the financing of
less liquid assets viable.
Issuance of secured term debt is generally done through a collateralized debt
obligation offering. This entails creating a special purpose entity that holds
assets used to secure the payments required of the debt issued. As this
transaction is considered a financing, the SPE is fully consolidated on the
Company's consolidated financial statements. Asset cash flows are generally
matched with the debt service requirements over their respective lives and an
interest rate swap is used to match the fixed or floating rate nature of the
coupon payments where necessary. This type of transaction is usually referred
to as "match funding" or "term financing" the assets. There is no mark to
market requirement in this structure and the debt cannot be called or
terminated by the bondholders. Furthermore, the debt issued is non-recourse to
the issuer therefore permanent reductions in value do not affect the liquidity
of the Company. However, since the Company expects to earn a positive spread
between the income generated by the assets and the expense of the debt issued,
a permanent impairment of any of the assets would negatively affect the spread
over time.
The Company may issue preferred stock from time to time as a source of
long-term or permanent capital. Preferred stock generally has a fixed coupon
and may have a fixed term in the form of a maturity date or other redemption
or conversion feature. The preferred stockholder typically has the right to a
preferential distribution for dividends and any liquidity proceeds.
Another source of permanent capital is the issuance of common stock through a
follow-on offering. This allows investors to purchase a large block of common
stock in one transaction. A common stock issuance can be accretive to the
Company's book value per share if the issue price per share exceeds the
Company's book value per share. It can also be accretive to earnings per share
if the Company deploys the new capital into assets that generate a risk
adjusted return that exceeds the return of the Company's existing assets.
Furthermore, earnings accretion can also be achieved at reinvestment rates
that are lower than the return on existing assets if common stock is issued at
a premium to book value.
The Company continuously evaluates the market for follow-on common stock
offerings as well as the available opportunities to deploy new capital on an
accretive basis. During 2003 and 2002, the Company did not issue any common
stock in follow-on equity offerings. In 2001, the Company issued 13,690,000
shares of common stock in two follow-on offerings at an average price of $9.35
per share. Additionally, for the years ended December 31, 2003 and 2002,
respectively, the Company issued 1,955,919 and 1,455,725 shares of Common
Stock under its Dividend Reinvestment Plan. Net proceeds to the Company were
approximately $21,134 and $15,920, respectively.
At December 31, 2003, the Company's collateralized borrowings had the
following remaining maturities:
Total
Lines of Reverse Repurchase Collateralized Collateralized
Credit Agreements Debt Obligations Borrowings
-------------------------------------------------------------------------
Within 30 days $ - $1,048,635 $ - $1,048,635
31 to 59 days - - - -
60 days to less than 1 year 15,180 - - 15,180
1 year to 2 years 74,756 - - 74,756
Over 5 years - - 684,970* 684,970
-------------------------------------------------------------------------
$89,936 $1,048,635 $684,970 $1,823,541
=========================================================================
* Comprised of $404,637 of CDO debt with a weighted average remaining maturity
of 8.29 years as of December 31, 2003 and $280,333 of CDO debt with a
weighted average remaining maturity of 8.34 years as of December 31, 2003.
In addition, the Company has no off-balance sheet financing arrangements.
Contingent Liability
During 2000, the Company completed the acquisition of CORE Cap, Inc. The
merger was a stock for stock acquisition where the Company issued 4,180,552
shares of its Common Stock and 2,261,000 shares of its Series B Preferred
Stock. At the time of the CORE Cap acquisition, BlackRock Financial
Management, Inc. (the "Manager") agreed to pay GMAC (CORE Cap, Inc.'s external
advisor) $12,500 over a ten-year period ("Installment Payment") to purchase
the right to manage the assets under the existing management contract ("GMAC
Contract"). The GMAC Contract had to be terminated in order to allow for the
Company to complete the merger, as the Company's management agreement with the
Manager did not provide for multiple managers. As a result the Manager offered
to buy-out the GMAC contract as the Manager estimated it would receive
incremental fees above and beyond the Installment Payment, and thus was
willing to pay for, and separately negotiate, the termination of the GMAC
Contract. Accordingly, the value of the Installment Payment was not considered
in the Company's allocation of its purchase price to the net assets acquired
in the acquisition of CORE Cap, Inc. The Company agreed that should the
Management Agreement with its Manager be terminated, not renewed or not
extended for any reason other than for cause, the Company would pay to the
Manager an amount equal to the Installment Payment less the sum of all
payments made by the Manager to GMAC. As of December 31, 2003, the Installment
Payment would be $8,000 payable over eight years. The Company does not accrue
for this contingent liability.
Transactions with Affiliates
The Company has a Management Agreement with the Manager, a majority owned
indirect subsidiary of The PNC Financial Services Group, Inc. ("PNC Bank") and
the employer of certain directors and officers of the Company, under which the
Manager manages the Company's day-to-day operations, subject to the direction
and oversight of the Company's Board of Directors. On March 25, 2002, the
Management Agreement was extended for one year through March 27, 2003, with
the approval of the unaffiliated directors, on terms similar to the prior
agreement with the following changes: (i) the incentive fee calculation would
be based on GAAP earnings instead of funds from operations, (ii) the removal
of the four-year period to value the Management Agreement in the event of
termination and (iii) subsequent renewal periods of the Management Agreement
would be for one year instead of two years. The Board was advised by Houlihan
Lokey Howard & Zukin Financial Advisors, Inc., a national investment banking
and financial advisory firm, in the renewal process.
On March 6, 2003, the unaffiliated directors approved an extension of the
Management Agreement from its expiration of March 27, 2003 for one year
through March 31, 2004. The terms of the renewed agreement are similar to the
prior agreement except for the incentive fee calculation which would provide
for a rolling four-quarter high watermark rather than a quarterly calculation.
In determining the rolling four-quarter high watermark, the Company would
calculate the incentive fee based upon the current and prior three quarters'
net income. The Manager would be paid an incentive fee in the current quarter
if the incentive fee based upon the current and prior three quarters' net
income ("Yearly Incentive Fee") is greater than what was paid to the Manager
in the prior three quarters cumulatively. The Company will phase in the
rolling four-quarter high watermark commencing with the second quarter of
2003. Calculation of the incentive fee will be based on GAAP and adjusted to
exclude special one-time events pursuant to changes in GAAP accounting
pronouncements after discussion between the Manager and the unaffiliated
directors. The incentive fee threshold did not change. The high watermark will
be based on the existing incentive fee hurdle, which provides for the Manager
to be paid 25% of the amount of earnings (calculated in accordance with GAAP)
per share that exceeds the product of the adjusted issue price of the
Company's common stock per share ($11.38 as of December 31, 2003) and the
greater of 9.5% or 350 basis points over the ten-year Treasury note. The
Company anticipates that the Management Agreement will be extended prior to
its expiration on March 31, 2004.
Pursuant to the March 25, 2002 one-year Management Agreement extension, such
incentive fee was based on 25% of earnings (calculated in accordance with
GAAP) of the Company. For purposes of the incentive compensation calculation,
equity is generally defined as proceeds from issuance of Common Stock before
underwriting discounts and commissions and other costs of issuance. For
purposes of calculating the incentive fee during 2002, the cumulative
transition adjustment of $6,327 resulting from the Company's adoption of SFAS
No. 142 was excluded from earnings in its entirety and included using an
amortization period of three years. The Company incurred $3,195 and $3,238 in
incentive compensation for the years ended December 31, 2002 and 2001,
respectively. There was no incentive fee due to the Manager for the twelve
months ended December 31, 2003.
The Company pays the Manager an annual base management fee equal to a
percentage of the average invested assets of the Company as defined in the
Management Agreement. The base management fee is equal to 1% per annum of the
average invested assets rated less than BB- or not rated, 0.75% of average
invested assets rated BB- to BB+, and 0.20% of average invested assets rated
above BB+. During the third quarter of 2003, the Manager agreed to reduce the
management fees by 20% from its calculated amount for the third and fourth
quarter of 2003 and the first quarter of 2004. This revision resulted in
$1,046 in savings to the Company during 2003.
The Company incurred $9,411, $9,332, and $7,780 in base management fees in
accordance with the terms of the Management Agreement for the years ended
December 31, 2003, 2002, and 2001, respectively. In accordance with the
provisions of the Management Agreement, the Company recorded reimbursements to
the Manager of $66, $14, and $216 for certain expenses incurred on behalf of
the Company during 2003, 2002, and 2001, respectively.
The Company has an administration agreement with the Manager. Under the terms
of the administration agreement, the Manager provides financial reporting,
audit coordination and accounting oversight services to the Company. The
agreement can be cancelled upon 60-day written notice by either party. The
Company pays the Manager a monthly administrative fee at an annual rate of
0.06% of the first $125 million of average net assets, 0.04% of the next $125
million of average net assets and 0.03% of average net assets in excess of
$250 million subject to a minimum annual fee of $120. For the years ended
December 31, 2003, 2002, and 2001, the Company paid administration fees of
$173, $168, and $144, respectively.
The special servicer on seven of the Company's nine Controlling Class trusts
is Midland Loan Services, Inc. ("Midland"), a wholly-owned indirect subsidiary
of PNC Bank. The Company's fees for Midland's services are at market rates.
In March 2001, the Company purchased twelve certificates each representing a
1% interest in different classes of Owner Trust NS I Trust ("Owner Trusts")
for an aggregate investment of $37,868. These certificates were purchased from
PNC Bank. The assets of the Owner Trusts consist of commercial mortgage loans
originated or acquired by an affiliate of PNC Bank. The Company entered into a
$50,000 committed line of credit from PNC Funding Corp. to borrow up to 95% of
the fair market value of the Company's interest in the Owner Trusts.
Outstanding borrowings against this line of credit bear interest at a LIBOR
based variable rate. As of December 31, 2001, there was $13,885 borrowed under
this line of credit. The Company earned $1,468 from the Owner Trusts and paid
interest of approximately $849 to PNC Funding Corp. as interest on borrowings
under a related line of credit for year ended December 31, 2001. During 2001,
the Company sold four Owner Trusts. The gain on the sale of those Owner Trusts
was $35. The outstanding borrowings were repaid prior to the expiration of the
line of credit on March 13, 2002, at which time the remaining Owner Trusts
were sold at a gain of $90.
The Company has entered into a $50 million commitment to acquire shares in
Carbon, a private commercial real estate income opportunity fund managed by
the Manager. The period during which the Company may be required to purchase
shares under the commitment expires in July 2004. The Company does not incur
any additional management or incentive fees to the Manager as a result of its
investment in Carbon. On December 31, 2003, the Company owned 19.8% of the
outstanding shares in Carbon. The Company's remaining commitment at December
31, 2003 was $23,034.
REIT Status: The Company has elected to be taxed as a REIT and therefore must
comply with the provisions of the Code with respect thereto. Accordingly, the
Company generally will not be subject to Federal income tax to the extent of
its distributions to stockholders and as long as certain asset, income, and
stock ownership tests are met. The Company may, however, be subject to tax at
corporate rates or at excise tax rates on net income or capital gains not
distributed.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk: Market risk includes the exposure to loss resulting from changes
in interest rates, credit curve spreads, foreign currency exchange rates,
commodity prices and equity prices. The primary market risks to which the
Company is exposed are interest rate risk and credit curve risk. Interest rate
risk is highly sensitive to many factors, including governmental, monetary and
tax policies, domestic and international economic and political considerations
and other factors beyond the control of the Company. Credit curve risk is
highly sensitive to the dynamics of the markets for commercial mortgage
securities and other loans and securities held by the Company. Excessive
supply of these assets combined with reduced demand will cause the market to
require a higher yield. This demand for higher yield will cause the market to
use a higher spread over the U.S. Treasury securities yield curve, or other
benchmark interest rates, to value these assets. Changes in the general level
of the U.S. Treasury yield curve can have significant effects on the market
value of the Company's portfolio.
The majority of the Company's assets are fixed rate securities valued based on
a market credit spread to U.S. Treasuries. As U.S. Treasury securities are
priced to a higher yield and/or the spread to U.S. Treasuries used to price
the Company's assets is increased, the market value of the Company's portfolio
may decline. Conversely, as U.S. Treasury securities are priced to a lower
yield and/or the spread to U.S. Treasuries used to price the Company's assets
is decreased, the market value of the Company's portfolio may increase.
Changes in the market value of the Company's portfolio may affect the
Company's net income or cash flow directly through their impact on unrealized
gains or losses on securities held-for-trading or indirectly through their
impact on the Company's ability to borrow. Changes in the level of the U.S.
Treasury yield curve can also affect, among other things, the prepayment
assumptions used to value certain of the Company's securities and the
Company's ability to realize gains from the sale of such assets. In addition,
changes in the general level of the LIBOR money market rates can affect the
Company's net interest income. As of December 31, 2003, all of the Company's
liabilities outside of the CDOs are floating rate based on a market spread to
LIBOR. As the level of LIBOR increases or decreases, the Company's interest
expense will move in the same direction.
The Company may utilize a variety of financial instruments, including interest
rate swaps, caps, floors and other interest rate exchange contracts, in order
to limit the effects of fluctuations in interest rates on its operations. The
use of these types of derivatives to hedge interest-earning assets and/or
interest-bearing liabilities carries certain risks, including the risk that
losses on a hedge position will reduce the funds available for payments to
holders of securities and that such losses may exceed the amount invested in
such instruments. A hedge may not perform its intended purpose of offsetting
losses or increased costs. Moreover, with respect to certain of the
instruments used as hedges, the Company is exposed to the risk that the
counterparties with which the Company trades may cease making markets and
quoting prices in such instruments, which may render the Company unable to
enter into an offsetting transaction with respect to an open position. If the
Company anticipates that the income from any such hedging transaction will not
be qualifying income for REIT income purposes, the Company may conduct part or
all of its hedging activities through a to-be-formed corporate subsidiary that
is fully subject to federal corporate income taxation. The profitability of
the Company may be adversely affected during any period as a result of
changing interest rates.
The Company monitors and manages interest rate risk based on a method that
takes into consideration the interest rate sensitivity of the Company's assets
and liabilities, including its preferred stock. The Company's objective is to
acquire assets and match fund the purchase so that interest rate risk
associated with financing these assets is reduced or eliminated. The primary
risks associated with acquiring and financing these assets are mark to market
risk and short-term rate risk. Examples of these financing types include
30-day repurchase agreements and committed borrowing facilities. Certain
secured financing arrangements provide for an advance rate based upon a
percentage of the market value of the asset being financed. Market movements
that cause asset values to decline would require a margin call or a cash
payment to maintain the relationship between asset value and amount borrowed.
A cash flow based CDO is an example of a secured financing vehicle that does
not require a mark to market to establish or maintain a level of financing.
When financed assets are subject to a mark to market margin call, the Company
carefully monitors the interest rate sensitivity of those assets. The duration
of the assets financed which are subject to a mark to market margin call was
2.12 years based on reported GAAP book value as of December 31, 2003.
The Company's reported book value incorporates the market value of the
Company's interest bearing assets but it does not incorporate the market value
of the Company's interest bearing liabilities. The fixed rate interest bearing
liabilities and preferred stock will generally reduce the actual interest rate
risk of the Company from a pure economic perspective even though changes in
the value of these liabilities are not reflected in the Company's book value.
The fixed rate liabilities issued in CDO I and CDO II reduce the Company's
economic duration by approximately 5.0 years. The Series C Preferred Stock
reduces the Company's economic duration by approximately 1.0 year. The
Company's reported book value is not reduced by these liabilities and
therefore is approximately 6.0 years longer than the economic duration. The
Company's duration management strategy focuses on the economic risk and
maintains economic duration within a band of 3.0 to 5.0 years. At December 31,
2003, economic duration was 3.08 years. Earnings per share is analyzed using
the assumptions that interest rates, as defined by the LIBOR curve, increase
or decrease and that the yield curves of the LIBOR rate shocks will be
parallel to each other. Market value in this scenario is calculated using the
assumption that the U.S. Treasury yield curve remains constant even though
changes in both long- and short-term interest rates can occur simultaneously.
Regarding the table below, all changes in income and value are measured as
percentage changes from the respective values calculated in the scenario
labeled as "Base Case." The base interest rate scenario assumes interest rates
as of December 31, 2003. Actual results could differ significantly from these
estimates.
Projected Percentage Change In
Earnings Per Share
Given LIBOR Movements
Change in LIBOR, Projected Change in
+/- Basis Points Earnings per Share
------------------------------------------------------
-100 $(0.026)
-50 $(0.013)
Base Case
+50 $0.013
+100 $0.026
+200 $0.051
Credit Risk: The Company's portfolios of commercial real estate assets are
subject to a high degree of credit risk. Credit risk is the exposure to loss
from loan defaults. Default rates are subject to a wide variety of factors,
including, but not limited to, property performance, property management,
supply/demand factors, construction trends, consumer behavior, regional
economics, interest rates, the strength of the U.S. economy, and other factors
beyond the control of the Company.
All loans are subject to a certain probability of default. Before acquiring a
Controlling Class security, the Company will perform an analysis of the
quality of all of the loans proposed. As a result of this analysis, loans with
unacceptable risk profiles are either removed from the proposed pool or the
Company receives a price adjustment. The Company underwrites its Controlling
Class CMBS investments assuming the underlying loans will suffer a certain
dollar amount of defaults and these defaults will lead to some level of
realized losses. Loss adjusted yields are computed based on these assumptions
and applied to each class of security supported by the cash flow on the
underlying loans. The most significant variables affecting loss adjusted
yields include, but are not limited to, the number of defaults, the severity
of loss that occurs subsequent to a default and the timing of the actual loss.
The different rating levels of CMBS will react differently to changes in these
assumptions. The lowest rated securities (B- or lower) are generally more
sensitive to changes in timing of actual losses. The higher rated securities
(B or higher) are more sensitive to the severity of losses.
The Company generally assumes that all of the principal of a non-rated
security and a significant portion, if not all, of CCC and a portion of B-
rated securities will not be recoverable over time. The loss adjusted yields
of these classes reflect that assumption; therefore, the timing of when the
total loss of principal occurs is the most important assumption in determining
value. The interest coupon generated by a security will cease when there is a
total loss of its principal regardless of whether that principal is paid.
Therefore, timing is of paramount importance because the longer the principal
balance remains outstanding, the more interest coupon the holder receives;
which results in a larger economic return. Alternatively, if principal is lost
faster than originally assumed, there is less opportunity to receive interest
coupon; which results in a lower or possibly negative return. Additional
losses which occur due to greater severity will not have a significant effect
as all principal is already assumed to be non-recoverable.
If actual principal losses on the underlying loans exceed assumptions, the
higher rated securities will be affected more significantly as a loss of
principal may not have been assumed. The Company generally assumes that all
principal will be recovered by classes rated B or higher. The Company manages
credit risk through the underwriting process, establishing loss assumptions
and careful monitoring of loan performance. After the securities have been
acquired, the Company monitors the performance of the loans, as well as
external factors that may affect their value.
Factors that indicate a higher loss severity or acceleration of the timing of
an expected loss will cause a reduction in the expected yield and therefore
reduce the earnings of the Company. Furthermore, the Company may be required
to write down a portion of the adjusted purchase price of the affected assets
through its consolidated statements of financial condition.
For purposes of illustration, a doubling of the losses in the Company's
Controlling Class CMBS, without a significant acceleration of those losses,
would reduce GAAP income going forward by approximately $0.28 per share of
Common Stock per year and cause a significant write down at the time the loss
assumption is changed. The amount of the write down depends on several
factors, including which securities are most affected at the time of the write
down, but is estimated to be in the range of $0.95 to $1.20 per share based on
a doubling of expected losses. A significant acceleration of the timing of
these losses would cause the Company's net income to decrease. The Company's
exposure to a write down is mitigated by the fact that most of these assets
are financed on a non-recourse basis in the Company's CDOs, where a
significant portion of the risk of loss is transferred to the CDO bondholders.
As of December 31, 2003, securities with a total market value of $748,266 are
collateralizing the CDO borrowings of $684,970; therefore, the Company's
residual interest in the two CDOs is 63,296 ($1.28 per share). The CDO
borrowings are not marked to market in accordance with GAAP even though their
economic value will change in response to changes in interest rates and/or
credit spreads.
Asset and Liability Management: Asset and liability management is concerned
with the timing and magnitude of the repricing and/or maturing of assets and
liabilities. It is the Company's objective to attempt to control risks
associated with interest rate movements. In general, management's strategy is
to match the term of the Company's liabilities as closely as possible with the
expected holding period of the Company's assets. This is less important for
those assets in the Company's portfolio considered liquid as there is a very
stable market for the financing of these securities.
Other methods for evaluating interest rate risk, such as interest rate
sensitivity "gap" (defined as the difference between interest-earning assets
and interest-bearing liabilities maturing or repricing within a given time
period), are used but are considered of lesser significance in the daily
management of the Company's portfolio. Management considers this relationship
when reviewing the Company's hedging strategies. Because different types of
assets and liabilities with the same or similar maturities react differently
to changes in overall market rates or conditions, changes in interest rates
may affect the Company's net interest income positively or negatively even if
the Company were to be perfectly matched in each maturity category.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
PAGE
----
Independent Auditors' Report..............................................54
Consolidated Financial Statements:
Consolidated Statements of Financial Condition at
December 31, 2003 and 2002................................................55
Consolidated Statements of Operations
For the Years Ended December 31, 2003, 2002 and 2001......................56
Consolidated Statements of Changes in Stockholders' Equity
For the Years Ended December 31 2003, 2002 and 2001.......................57
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2003, 2002 and 2001......................59
Notes to Consolidated Financial Statements................................60
All schedules have been omitted because either the required information is not
applicable or the information is shown in the financial statements or notes
thereto.
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Anthracite Capital, Inc.
We have audited the accompanying consolidated statements of financial
condition of Anthracite Capital, Inc. and subsidiaries (the "Company") at
December 31, 2003 and 2002, and the related consolidated statements of
operations, changes in stockholders' equity and cash flows for each of the
three years in the period ended December 31, 2003. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. 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, such consolidated financial statements present fairly, in all
material respects, the financial position of Anthracite Capital, Inc. and
subsidiaries at December 31, 2003 and 2002, and the results of their
operations and their cash flows for each of the three years in the period
ended December 31, 2003, in conformity with accounting principles generally
accepted in the United States of America.
As discussed in Note 1 to the consolidated financial statements, on January 1,
2002, the Company adopted the provisions of Statement of Financial Accounting
Standards No. 142 "Goodwill and Other Intangible Assets."
/s/ Deloitte & Touche LLP
New York, New York
March 1, 2004
Anthracite Capital, Inc.
Consolidated Statements of Financial Condition
(in thousands, except per share data)
- ---------------------------------------------------------------------------------------------------------------------------------
December 31, 2003 December 31, 2002
----------------- -----------------
ASSETS
Cash and cash equivalents $ 20,805 $ 24,698
Restricted cash equivalents 12,845 84,485
Securities available-for-sale, at fair value
Subordinated commercial mortgage-backed securities ("CMBS") $ 703,443 $ 602,706
Residential mortgage backed securities ("RMBS") 439,492 78,717
Investment grade securities 663,065 291,639
------------ -------------
Total securities available-for-sale 1,806,000 973,062
Securities held-for-trading, at fair value 313,727 1,427,733
Commercial mortgage loans, net 61,668 65,664
Equity investment in Carbon Capital, Inc. 28,493 14,997
Investments in real estate joint ventures 7,823 8,265
Receivable for investments sold 99,056 -
Other assets 48,429 41,654
------------- --------------
Total Assets $2,398,846 $2,640,558
============= ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Borrowings:
Collateralized debt obligations ("CDOs") $684,970 $684,590
Secured by pledge of subordinated CMBS 100,892 7,295
Secured by pledge of other securities available-for-sale
and cash equivalents 710,968 98,439
Secured by pledge of securities held-for-trading 304,001 1,355,333
Secured by pledge of investments in real estate joint ventures 513 1,337
Secured by pledge of commercial mortgage loans 22,197 14,667
------------ -------------
Total borrowings $1,823,541 $2,161,661
Securities sold, not yet settled 99,551 -
Payable for investments purchased - 524
Distributions payable 14,749 16,589
Other liabilities 43,575 55,568
------------ --------------
Total Liabilities $1,981,416 $2,234,342
------------ --------------
Commitments and Contingencies
Stockholders' Equity:
Common Stock, par value $0.001 per share; 400,000 shares
authorized;
49,464 shares issued and outstanding in 2003;
47,398 shares issued and outstanding in 2002 49 47
10% Series B Preferred Stock, liquidation preference
$43,942 in 2003 and $47,817 in 2002 33,431 36,379
9.375% Series C Preferred stock, liquidation preference
$57,500 in 2003 55,435 -
Additional paid-in capital 536,333 515,180
Distributions in excess of earnings (101,635) (24,161)
Accumulated other comprehensive loss (106,183) (121,229)
------------- --------------
Total Stockholders' Equity 417,430 406,216
------------- --------------
Total Liabilities and Stockholders' Equity $2,398,846 $2,640,558
============= ==============
The accompanying notes are an integral part of these consolidated financial statements.
Anthracite Capital, Inc.
Consolidated Statements of Operations (in thousands, except per share data)
For the year ended For the year ended For the year ended
December 31, 2003 December 31, 2002 December 31, 2001
----------------- ----------------- -----------------
Income:
Interest from securities available-for-sale $ 120,430 $99,308 $ 85,137
Interest from commercial mortgage loans 5,875 13,997 15,499
Interest from mortgage loan pools - - 1,575
Interest from securities held-for-trading 32,187 45,421 24,681
Earnings from real estate joint ventures 955 1,044 1,667
Earnings from equity investment 3,367 1,202 80
Interest from cash and cash equivalents 964 1,473 2,581
----------- ---------- ----------
Total income 163,778 162,445 131,220
----------- ---------- ----------
Expenses:
Interest 76,093 50,987 44,425
Interest - securities held-for-trading 7,156 14,031 14,976
Management and incentive fee 9,411 12,527 11,018
General and administrative expense 2,296 2,323 1,717
----------- ---------- ----------
Total expenses 94,956 79,868 72,136
----------- ---------- ----------
Other gains (losses):
Sale of securities available-for-sale (6,832) 11,391 7,401
Securities held-for-trading (38,206) (29,255) (2,604)
Foreign currency loss - (812) (5)
Loss on impairment of assets (32,426) (10,273) (5,702)
----------- ---------- ----------
Total other loss (77,464) (28,949) (910)
----------- ---------- ----------
(Loss) income before cumulative transition adjustments (8,642) 53,628 58,174
Cumulative transition adjustment-SFAS No. 142 - 6,327 -
Cumulative transition adjustment-SFAS No. 133 - - (1,903)
----------- ---------- ----------
Net (loss) income (8,642) 59,955 56,271
----------- ---------- ----------
Dividends and accretion on Preferred Stock 7,744 5,162 8,964
Net (Loss) Income Available to Common Stockholders $(16,386) $54,793 $47,307
=========== ========== ==========
Net (loss) income per common share, basic:
(Loss) income before cumulative transition adjustment $ (0.34) $ 1.04 $1.47
Cumulative transition adjustment - SFAS No. 142 - 0.14 -
Cumulative transition adjustment - SFAS No. 133 - - (0.06)
----------- ---------- ----------
Net (loss) income $ (0.34) $1.18 $ 1.41
----------- ---------- ----------
Net (loss) income per common share, diluted:
(Loss) income before cumulative transition adjustment $ (0.34) $ 1.04 $ 1.40
Cumulative transition adjustment - SFAS No. 142 - 0.14 -
Cumulative transition adjustment - SFAS No. 133 - - (0.05)
----------- ---------- ----------
Net (loss) income $ (0.34) $ 1.18 $ 1.35
=========== ========== ==========
Weighted average number of shares outstanding:
Basic 48,246 46,411 33,568
Diluted 48,246 46,452 37,616
The accompanying notes are an integral part of these consolidated financial statements.
Anthracite Capital, Inc.
Consolidated Statements of Changes in Stockholders' Equity
for the Years Ended December 31, 2003, 2002 and 2001 (in thousands)
------------
Series Series Accumulated Tota;
Common B C Additional Distributions Other Stock-
Stock, Preferred Preferred Paid-In In Excess Comprehensive Comprehensive holders'
Par Value Stock Stock Capital Of Earnings Loss Income Equity
----------------------------------------------------------------------------------------------
Balance at January 1, 2001 $25 $43,004 $315,533 $ (13,437) $(102,871) $242,254
Net income 56,271 $56,271 56,271
Cumulative transition
adjustment- SFAS No. 133 1,903 1,903 1,903
Unrealized loss on cash
flow hedges (11,941) (11,941) (11,941)
Reclassification adjustments
from cash flow hedges
included in net income 994 994 994
Change in net unrealized
loss on securities
available-for-sale, net of
reclassification adjustment (26,044) (26,044) (26,044)
------------
Other comprehensive loss (35,088)
------------
Comprehensive income $21,183
============
Dividends declared-common stock (47,458) (47,458)
Dividends and accretion on
preferred stock (8,964) (8,964)
Issuance of common stock 15 145,438 145,453
Conversion of Series B preferred
stock to common stock 1 (918) 917 -
Conversion of Series A preferred
stock to common stock 4 30,492 30,496
Compensation cost - stock options 151 151
---------------------------------------------------------------------------------------------
Balance at December 31, 2001 45 42,086 492,531 (13,588) (137,959) 383,115
Net Income 59,955 $59,955 59,955
Unrealized loss on
cash flow hedges (56,769) (56,769) (56,769)
Reclassification adjustments
from cash flow hedges
included in net income 5,619 5,619 5,619
Change in net unrealized loss
on securities available-
for-sale, net of
reclassification adjustment 67,880 67,880 67,880
------------
Other comprehensive income 16,730
------------
Comprehensive income $76,685
============
Dividends declared-common stock (65,366) (65,366)
Dividends declared-preferred stock (5,162) (5,162)
Issuance of common stock 1 16,685 16,686
Conversion of Series B preferred
stock to common stock 1 (5,707) 5,706
Conversion of Series A preferred
stock to common stock 258 258
---------------------------------------------------------------------------------------------
Balance at December 31, 2002 47 36,379 515,180 (24,161) (121,229) 406,216
Net Loss (8,642) $(8,642) (8,642)
Unrealized gain on
cash flow hedges 12,474 12,474 12,474
Reclassification adjustments
from cash flow hedges
included in net loss 7,704 7,704 7,704
Change in net unrealized loss
on securities available-
for-sale, net of
reclassification adjustment (5,132) (5,132) (5,132)
------------
Other comprehensive income 15,046
------------
Comprehensive income $6,404
============
Dividends declared-common stock (61,088) (61,088)
Dividends on preferred stock (7,744) (7,744)
Issuance of common stock 2 22,079 22,081
Issuance of Series C
preferred stock 55,435 55,435
Redemption of Series B
preferred stock (2,948) (926) (3,874)
---------------------------------------------------------------------------------------------
Balance at December 31, 2003 $49 $33,431 $55,435 $536,333 $(101,635) $(106,183) $417,430
=============================================================================================
Disclosure of reclassification adjustment: Years ended December 31,
-----------------------------------------------
2003 2002 2001
-----------------------------------------------
Unrealized holding gain (loss) on
securities available-for-sale 1,700 $ 56,489 $ (33,445)
Reclassification for realized gains
previously recorded as unrealized (6,832) 11,391 7,401
-----------------------------------------------
(5,132) 67,880 (26,044)
===============================================
The accompanying notes are an integral part of these consolidated financial statements.
Anthracite Capital, Inc.
Consolidated Statements of Cash Flow (in thousands)
Years Ended December 31,
2003 2002 2001
--------------------------------------
Cash flows from operating activities:
Net (loss) income $ (8,642) $ 59,955 $ 56,271
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Net sale (purchase) of trading securities 502,577 (878,980) (454,960)
Net loss (gain) on sale of securities 45,038 17,864 (4,797)
Amortization of negative goodwill - - (1,942)
Cumulative transition adjustment - (6,327) 1,903
(Discount accretion) premium amortization, net (2,313) (9,295) 6,376
Compensation cost - stock options - - 151
Loss on impairment of assets 32,426 10,273 5,702
Noncash portion of net foreign currency loss - 276 5
Equity in earnings in excess of distributions from Carbon Capital, Inc. (1,415) (113) -
Decrease (increase) in other assets 10,690 (14,215) 12,803
(Decrease) increase in other liabilities (16,251) 17,067 2,657
--------------------------------------
Net cash provided by (used in) provided by operating activities 562,110 (803,495) (375,831)
--------------------------------------
Cash flows from investing activities:
Purchase of securities available-for-sale (2,043,765) (686,710) (2,383,483)
Principal payments received on securities available-for-sale 299,858 167,570 123,578
Funding of commercial mortgage loans (18,520) (3,370) (56,070)
Repayments received from commercial mortgage loans 13,851 82,865 66,620
Decrease (increase) in restricted cash equivalents 71,640 (47,109) (27,892)
Investment in real estate joint ventures, net - - 1,921
Distributions from joint ventures in excess of earnings 442 52 116
Investment in Carbon Capital, Inc. (12,081) (6,100) (8,784)
Principal payment received on mortgage loan pools - - 10,981
Proceeds from sale of securities available-for-sale and mortgage loan pools 1,466,552 1,017,534 1,452,577
Net payments under hedging securities (8,830) (8,077) (11,973)
--------------------------------------
Net cash provided by (used in) investing activities (230,853) 516,655 (832,409)
--------------------------------------
Cash flows from financing activities:
Net (decrease) increase in borrowings (338,120) 322,965 1,116,596
Proceeds from issuance of Series C preferred stock, net of offering costs 55,435 - -
Proceeds from issuance of common stock, net of offering costs 22,081 16,686 145,803
Redemption of Series B preferred stock (3,874) - -
Dividends paid on common stock (63,826) (64,633) (40,038)
Dividends paid on preferred stock (6,846) (6,551) (8,879)
--------------------------------------
Net cash (used in) provided by financing activities (335,150) 268,467 1,213,482
--------------------------------------
Net (decrease) increase in cash and cash equivalents (3,893) (18,373) 5,242
Cash and cash equivalents, beginning of year 24,698 43,071 37,829
Cash and cash equivalents, end of year --------------------------------------
$ 20,805 $ 24,698 $ 43,071
======================================
Supplemental disclosure of cash flow information:
Interest paid $ 83,159 $ 71,746 $ 54,852
======================================
Investments purchased not settled $ - $ 524 $ 346,913
======================================
Investments sold not settled $ 99,056 $ - $ 344,789
======================================
The accompanying notes are an integral part of these consolidated financial statements.
Anthracite Capital, Inc.
Notes to Consolidated Financial Statements
(In thousands, except share and per share data)
- -------------------------------------------------------------------------------
Note 1 ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
The Company was incorporated in Maryland in November 1997 and commenced
operations on March 24, 1998. The Company's principal business activity is to
invest in a diversified portfolio of CMBS, multifamily, commercial and
residential mortgage loans, and other real estate related assets in the U.S.
and non-U.S. markets. The Company is organized and managed as a single
business segment.
A summary of the Company's significant accounting policies follows:
Use of Estimates
In preparing the financial statements in accordance with GAAP, management is
required to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the dates of the statements of financial condition and revenues and expenses
for the periods covered. Actual results could differ from those estimates and
assumptions. Significant estimates in the financial statements include the
valuation of the Company's investments and an estimate of credit performance
on CMBS investments.
Principles of Consolidation
The consolidated financial statements include the financial statements of the
Company and its wholly-owned subsidiaries. All significant intercompany
balances and transactions have been eliminated in consolidation.
Cash and Cash Equivalents
All highly liquid investments with original maturities of three months or less
are considered to be cash equivalents.
Deferred Financing Costs
Deferred financing costs, which are included in other assets on the Company's
consolidated statements of financial condition, includes issuance costs
related to the Company's debt and is amortized using the straight line method
which method is similar to the amortization results of the effective interest
method.
Securities Available-for-Sale
The Company has designated its investments in mortgage-backed securities,
mortgage-related securities and certain other securities as assets
available-for-sale because the Company may dispose of them prior to maturity
and does not hold them principally for the purpose of selling them in the near
term. Securities available-for-sale are carried at estimated fair value with
the net unrealized gains or losses reported as a component of accumulated
other comprehensive income (loss) in stockholders' equity. Unrealized losses
on securities that reflect a decline in value which is judged by management to
be other than temporary, if any, are charged to earnings. At disposition, the
realized net gain or loss is included in income on a specific identification
basis.
As a result of the closing of the Company's CDO I, at the end of the first
quarter 2002, the Company reclassified all of its subordinated CMBS on the
balance sheet from available-for-sale to held-to-maturity. The effect of this
reclassification changed the accounting basis of these securities,
prospectively, from fair market value to adjusted cost. However, in accordance
with SFAS No. 133, as amended and interpreted, the interest rate swap
agreements entered into by the Company to hedge the variable rate exposure of
the debt of CDO I are required to be presented on the balance sheet at their
fair market value. This difference in treatment caused fluctuations in the
book value of the Company. Accordingly, the Company determined that at
December 31, 2002, and going forward, it will classify all of its subordinated
CMBS as available-for-sale securities and record them at fair market value.
This treatment is consistent with the mark to market requirement for CDO I's
interest rate swap agreements.
The reclassification of these securities to available-for-sale from
held-to-maturity increased the recorded value of these securities from
$558,522 to $610,713 at March 31, 2002 with the difference being recorded in
other comprehensive income. The circumstance which caused the Company to
change this classification was not considered a permitted circumstance as
stated in SFAS No. 115, and is therefore inconsistent with the Company's
intent regarding its held-to-maturity classification. Accordingly, the Company
will be prohibited from classifying its subordinated CMBS (current holdings as
well as future purchases) as held-to-maturity for a period of two years from
March 31, 2002.
The Company adopted the EITF Consensus 99-20 on April 1, 2001. The Company
recognizes interest income from its purchased beneficial interests in
securitized financial interests ("beneficial interests") (other than
beneficial interests of high credit quality, sufficiently collateralized to
ensure that the possibility of credit loss is remote, or that cannot
contractually be prepaid or otherwise settled in such a way that the Company
would not recover substantially all of its recorded investment) in accordance
with this guidance. Accordingly, on a quarterly basis, when significant
changes in estimated cash flows from the cash flows previously estimated occur
due to actual prepayment and credit loss experience, the Company calculates a
revised yield based on the current amortized cost of the investment (including
any other-than-temporary impairments recognized to date) and the revised cash
flows. The revised yield is then applied prospectively to recognize interest
income.
Prior to April 1, 2001, the Company recognized income from these beneficial
interests using the effective interest method, based on an anticipated yield
over the projected life of the security. Changes in the anticipated yields
were calculated due to revisions in the Company's estimates of future and
actual credit losses and prepayments. Changes in anticipated yields resulting
from credit loss and prepayment revisions were recognized through a cumulative
catch-up adjustment at the date of the change which reflected the change in
income from the security from the date of purchase through the date of change
in the anticipated yield. The new yield was then used prospectively to account
for interest income. Changes in yields from reduced estimates of losses were
recognized prospectively.
For other mortgage-backed and related mortgage securities, the Company
accounts for interest income under SFAS No. 91, using the effective yield
method which includes the amortization of discount or premium arising at the
time of purchase and the stated or coupon interest payments. Actual prepayment
and credit loss experience is reviewed quarterly and effective yields are
recalculated when differences arise between prepayments and credit losses
originally anticipated and amounts actually received plus anticipated future
prepayments and credit losses.
In accordance with SFAS No. 115, when the estimated fair value of the security
classified as available-for-sale has been below amortized cost for a
significant period of time and the Company concludes that it no longer has the
ability or intent to hold the security for the period of time over which the
Company expects the values to recover to amortized cost, the investment is
written down to its fair value. The resulting charge is included in income,
and a new cost basis established. Additionally, under EITF 99-20, when
significant changes in estimated cash flows from the cash flows previously
estimated occur due to actual prepayment and credit loss experience, and the
present value of the revised cash flows using the current expected yield is
less than the present value of the previously estimated remaining cash flows
(adjusted for cash receipts during the intervening period), an
other-than-temporary impairment is deemed to have occurred. Accordingly, the
security is written down to fair value with the resulting change being
included in income, and a new cost basis established. In both instances, the
original discount or premium is written off when the new cost basis is
established.
After taking into account the effect of the impairment charge, income is
recognized under EITF 99-20 or SFAS No. 91, as applicable, using the market
yield for the security used in establishing the write-down.
Securities Held-for-trading
The Company has designated certain securities as assets held-for-trading
because the Company intends to hold them for short periods of time. Securities
held-for-trading are carried at estimated fair value with net unrealized gains
or losses included in the consolidated statements of operations.
Mortgage Loans
The Company purchases and originates certain commercial mortgage loans to be
held as long-term investments. Loans held for long-term investment are
recorded at cost at the date of purchase. Premiums and discounts related to
these loans are amortized over their estimated lives using the effective
interest method. Any origination fee income and application fee income, net of
direct costs, associated with originating or purchasing commercial mortgage
loans are deferred and included in the basis of the loans on the consolidated
statements of financial condition. The net fees are amortized over the life of
the loans using the effective interest method. The Company recognizes
impairment on the loans when it is probable that the Company will not be able
to collect all amounts due according to the contractual terms of the loan
agreement. The Company measures impairment (both interest and principle) based
on the present value of expected future cash flows discounted at the loan's
effective interest rate or the fair value of the collateral if the loan is
collateral dependent.
The Company acquired certain residential mortgage loan pools in the CORE Cap
merger (See Note 14 of the consolidated financial statements). Residential
loan pools are treated as available-for-sale debt securities and are carried
at estimated fair value with net unrealized gains or losses reported as a
component of accumulated other comprehensive income (loss) in stockholders'
equity. Unrealized losses that reflect a decline in value, which is judged by
management to be other than temporary, if any, are charged to earnings.
Equity Investments and Real Estate Joint Ventures
Investments in real estate entities over which the Company exercises
significant influence, but not control, are accounted for under the equity
method. The Company recognizes its share of each venture's income or loss, and
reduces its investment balance by distributions received. Real estate held by
such entities is regularly reviewed for impairment, and would be written down
to its estimated fair value if impairment is determined to exist.
Short Sales
As part of its short-term trading strategies (see Note 3 of the consolidated
financial statements), the Company may sell securities that it does not own
("short sales"). To complete a short sale, the Company may arrange through a
broker to borrow the securities to be delivered to the buyer. The proceeds
received by the Company from the short sale are retained by the broker until
the Company replaces the borrowed securities, generally within a period of
less than one month. In borrowing the securities to be delivered to the buyer,
the Company becomes obligated to replace the securities borrowed at their
market price at the time of the replacement, whatever that price may be. A
gain, limited to the price at which the Company sold the security short, or a
loss, unlimited as to dollar amount, will be recognized upon the termination
of a short sale if the market price is less than or greater than the proceeds
originally received. The Company's liability under the short sales is recorded
at fair value, with unrealized gains or losses included in net gain or loss on
securities held-for-trading in the consolidated statement of operations.
The Company is exposed to credit loss in the event of nonperformance by any
broker that holds a deposit as collateral for securities borrowed. However,
the Company does not anticipate nonperformance by any broker.
Forward Commitments - Trading
As part of its short-term trading strategies (see Note 3 of the consolidated
financial statements), the Company may enter into forward commitments to
purchase or sell U.S. Treasury securities or securities issued by Federal Home
Loan Mortgage Corporation ("FHLMC"), Federal National Mortgage Association
("FNMA") or Government National Mortgage Association ("GNMA") (collectively
"Agency Securities"), which obligate the Company to purchase or sell such
securities at a specified date at a specified price. When the Company enters
into such a forward commitment, it will, generally within sixty days or less,
enter into a matching forward commitment with the same or a different
counterparty which entitles the Company to sell (in instances where the
original transaction was a commitment to purchase) or purchase (in instances
where the original transaction was a commitment to sell) the same or similar
securities on or about the same specified date as the original forward
commitment. Any difference between the specified price of the original and
matching forward commitments will result in a gain or loss to the Company.
Changes in the fair value of open commitments are recognized on the
consolidated statement of financial condition and included among assets (if
there is an unrealized gain) or among liabilities (if there is an unrealized
loss). A corresponding amount is included as a component of net gain or loss
on securities held-for-trading in the consolidated statement of operations.
The Company is exposed to interest rate risk on these commitments, as well as
to credit loss in the event of nonperformance by any other party to the
Company's forward commitments. However, the Company does not anticipate
nonperformance by any counterparty.
Financial Futures Contracts - Trading
As part of its short-term trading strategies (see Note 3 of the consolidated
financial statements), the Company may enter into financial futures contracts,
which are agreements between two parties to buy or sell a financial instrument
for a set price on a future date. Initial margin deposits are made upon
entering into futures contracts and can be either cash or securities. During
the period that the futures contract is open, changes in the value of the
contract are recognized as gains or losses on securities held-for-trading by
"marking-to-market" on a daily basis to reflect the market value of the
contract at the end of each day's trading. Variation margin payments are
received or made, depending upon whether gains or losses are incurred.
The Company is exposed to interest rate risk on the contracts, as well as to
credit loss in the event of nonperformance by any other party to the contract.
However, the Company does not anticipate nonperformance by any counterparty.
Derivative Instruments
As part of its asset/liability risk management activities, the Company may
enter into interest rate swap agreements, forward currency exchange contracts
and other financial instruments in order to hedge interest rate and foreign
currency exposures or to modify the interest rate or foreign currency
characteristics of related items in its consolidated statement of financial
condition.
Income and expense from interest rate swap agreements that are, for accounting
purposes, designated as cash flow hedges are recognized as a net adjustment to
the interest expense of the hedged item and changes in fair value are
recognized as a component of accumulated other comprehensive income (loss) in
stockholder's equity. Income and expense from interest rate swap agreements
that are, for accounting purposes, designated as trading derivatives are
recognized as a net adjustment to total other gain/(loss) and changes in fair
value are recognized in the consolidated statements of operations. The fair
market value of all swaps is included among assets (if there is an unrealized
gain) or among liabilities (if there is an unrealized loss). Changes in fair
value are collateralized with cash or cash equivalents and are recorded in the
consolidated statements of financial condition as restricted cash. A
corresponding amount is included as a component of accumulated other
comprehensive income (loss) in stockholders' equity. The Company accounts for
revenue and expense from the interest rate swap agreements designated as cash
flow hedges under the accrual basis over the period to which the payment
relates. Amounts paid to acquire these instruments are capitalized and
amortized over the life of the instrument. Amortization of capitalized fees
paid as well as payments received under these agreements are recorded as an
adjustment to interest expense. If the underlying hedged securities are sold,
the amount of unrealized gain or loss in accumulated other comprehensive
income (loss) relating to the corresponding interest rate swap agreement is
included in the determination of gain or loss on the sale of the securities.
If interest rate swap agreements are terminated, the associated gain or loss
is deferred over the shorter of the remaining term of the swap agreement, or
the underlying hedged item, provided that the underlying hedged item has not
been sold.
Income and expense from interest rate swap agreements that are, for accounting
purposes, designated as trading derivatives are recognized as a net adjustment
to total other gain (loss). During the term of the interest rate swap
agreement, changes in fair value are recognized in the consolidated statements
of operations and included among assets (if there is an unrealized gain) or
among liabilities (if there is an unrealized loss). Changes in fair value are
collateralized with cash or cash equivalents and are recorded in the
consolidated statements of financial condition as restricted cash. A
corresponding amount is included as loss on securities held for trading in the
consolidated statement of operations. The Company accounts for revenue and
expense from the interest rate swap agreements classified as trading
derivatives under the accrual basis over the period to which the payment
relates. Amounts paid to acquire these instruments are capitalized and
amortized over the life of the instrument. Amortization of capitalized fees
paid as well as payments received under these agreements are recorded as an
adjustment to loss on securities held for trading in the consolidated
statement of operations.
Revenue and expense from forward currency exchange contracts are recognized as
a net adjustment to foreign currency gain or loss. During the term of the
forward currency exchange contracts, changes in fair value are recognized in
the consolidated statement of financial condition and included among assets
(if there is an unrealized gain) or among liabilities (if there is an
unrealized loss). A corresponding amount is included as a component of net
foreign currency gain or loss in the consolidated statement of operations.
Financial futures contracts that are, for accounting purposes, designated as
hedging securities held-for-trading, are carried at fair value, with changes
in fair value included in the consolidated statement of operations.
The Company monitors its hedging instruments throughout their terms to ensure
that they remain effective for their intended purpose. The Company is exposed
to interest rate and/or currency risk on these hedging instruments, as well as
to credit loss in the event of nonperformance by any other party to the
Company's hedging instruments. The Company's policy is to enter into hedging
agreements with counterparties rated A or better.
Stock Options
The options issued under the 1998 Stock Option Plan, options covering 979,426
shares of the Company's Common Stock, were granted prior to December 15, 1998
to individuals deemed to be employees. The Company adopted the disclosure-only
provisions of SFAS No. 123 for such options. No compensation cost for these
options has been recorded in the consolidated statement of operations because
all options granted had an exercise price equal to or above the market value
of the underlying Common Stock on the date of grant. Had compensation cost for
these options been determined based on the fair value of the options at the
grant date consistent with the provisions of SFAS No. 123, the Company's net
income per share would not have changed in any period preceded.
For the options to purchase 786,915 shares of the Company's Common Stock,
granted to non-employees under the 1998 Stock Option Plan, compensation cost
is accrued based on the estimated fair value of the options issued and
amortized over the vesting period. Because vesting of the options is
contingent upon the recipient continuing to provide services to the Company to
the vesting date, the Company estimates the fair value of the non-employee
options at each period end, up to the vesting date, and adjusts expensed
amounts accordingly. The value of these non-employee options at each period
end was negligible and all options were fully vested by March 2002. There were
no options granted in 2003, 2002 or 2001.
Negative Goodwill
Negative goodwill reflected the excess of the estimated fair value of the net
assets acquired in the CORE Cap Inc. merger (See Note 14 of the consolidated
financial statements) over the purchase price for such assets. Negative
goodwill was being amortized using the straight-line method from the date of
acquisition over the weighted average lives of the assets acquired in the
merger that the Company intended to retain. Negative goodwill, net, was $6,327
at December 31, 2001. Pursuant to the implementation of SFAS No. 142 (See
Recently Adopted Accounting Pronouncements), the Company recognized the
unamortized negative goodwill balance in income during the first quarter of
2002.
Income Taxes
The Company has elected to be taxed as a REIT and to comply with the
provisions of the Code with respect thereto. Accordingly, the Company
generally will not be subject to Federal income tax to the extent of its
distributions to stockholders and as long as certain asset, income and stock
ownership tests are met. As of December 31, 2003, the Company had a Federal
capital loss carryover of approximately $76,892 available to offset future
capital gains.
Recently Adopted Accounting Pronouncements
In July 2001, the FASB issued SFAS No. 141, "Business Combinations" ("SFAS No.
141"), and SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS No.
142"). These standards change the accounting for business combinations by,
among other things, prohibiting the use of pooling-of-interests accounting and
requiring companies to stop amortizing goodwill and certain intangible assets
with indefinite useful lives. Instead, goodwill and intangible assets deemed
to have indefinite useful lives will be subject to an annual review for
impairment. The new standards were effective for the Company in the first
quarter of 2002. Upon adoption of SFAS No. 142, the Company recorded a
one-time, noncash adjustment of approximately $6,327 to write off the
unamortized balance of its negative goodwill. Such charge is non-operational
in nature and is reflected as a cumulative effect of an accounting change in
the accompanying consolidated statement of operations. Amortization of
negative goodwill was $1,942 for the year ended December 31, 2001.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others." The Interpretation elaborates on the
disclosures to be made by a guarantor in its financial statements about its
obligations under certain guarantees that it has issued. It also clarifies
that a guarantor is required to recognize, at the inception of a guarantee, a
liability for the fair value of the obligation undertaken in issuing the
guarantee. The disclosure provisions of this Interpretation were effective for
the Company's December 31, 2002 consolidated financial statements. The initial
recognition and initial measurement provisions of this Interpretation are
applicable on a prospective basis to guarantees issued or modified after
December 31, 2002. The adoption of this Interpretation does not have a current
impact the Company's consolidated financial statements.
In December 2002, the FASB issued SFAS No. 148. SFAS No. 148 amends SFAS No.
123 to provide alternative methods of transition for a voluntary change to the
fair value based method of accounting for stock-based employee compensation.
In addition, the statement amends the disclosure requirements of SFAS No. 123
to require prominent disclosures in both annual and interim financial
statements about the method of accounting for stock-based compensation and the
effect of the method used on reported results. The Company has determined that
this Interpretation does not currently impact the Company's consolidated
financial statements.
In April 2003, the FASB issued SFAS No. 149. SFAS 149 amends and clarifies the
accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
No. 133. SFAS No. 149 is generally effective for contracts entered into or
modified after June 30, 2003 and for hedging relationships designated after
June 30, 2003. The Company's adoption of SFAS No. 149 on July 1, 2003, as
required, did not have a material impact on the Company's consolidated
financial statements.
In May 2003, the FASB issued SFAS No. 150. SFAS No. 150 addresses the
standards for how an issuer classifies and measures certain financial
instruments with characteristics of both liabilities and equity and requires
the issuer to classify a financial instrument that is within its scope as a
liability (or asset in some circumstances). SFAS No. 150 became effective for
financial instruments issued or modified after May 31, 2003 and is otherwise
effective at the beginning of the first interim period beginning after June
15, 2003. The adoption of this Statement did not have a material impact on the
Company's consolidated financial statements.
In December 2003, the FASB issued a revised version of FASB Interpretation No.
46, "Consolidation of Variable Interest Entities" ("FIN 46R"). FIN 46R
addresses the application of Accounting Research Bulletin No. 51,
"Consolidated Financial Statements," to VIEs and generally would require that
the assets, liabilities and results of operations of a VIE be consolidated
into the financial statements of the enterprise that has a controlling
financial interest in it. The interpretation provides a framework for
determining whether an entity should be evaluated for consolidation based on
voting interests or significant financial support provided to the entity
("variable interests").
An entity is classified as a VIE if total equity is not sufficient to permit
the entity to finance its activities without additional subordinated financial
support or its equity investors lack the direct or indirect ability to make
decisions about an entity's activities through voting rights, absorb the
expected losses of the entity if they occur or receive the expected residual
returns of the entity if they occur. Once an entity is determined to be a VIE,
its assets, liabilities and results of operations should be consolidated with
those of its primary beneficiary. The primary beneficiary of a VIE is the
entity which either will absorb a majority of the VIE's expected losses or has
the right to receive a majority of the VIE's expected residual returns. The
expected losses and residual returns of a VIE include expected variability in
its net income or loss, fees to decision makers and fees to guarantors of
substantially all of VIE assets or liabilities.
A public enterprise with a variable interest in a VIE must apply FIN 46R to
that VIE no later than the end of the first reporting period that ends after
March 15, 2004, with the exception of SPEs as defined. A public enterprise
with a variable interest in an SPE which has been deemed a VIE must apply FIN
46R to that VIE no later than the end of the first reporting period that ends
after December 15, 2003.
The Company's ownership of the subordinated classes of CMBS from a single
issuer where it maintains the right to control the foreclosure/workout process
on the underlying loans ("Controlling Class CMBS") are variable interests in
SPEs which have been deemed VIEs and therefore subject to the FIN 46R
consolidation criteria. Provided in Paragraph 4(d) of FIN 46R, are exceptions
to the consolidation of VIE's specifically, that an enterprise that holds
variable interests in a qualifying special-purpose entity ("QSPE") shall not
consolidate that entity unless that enterprise has the unilateral ability to
cause the entity to liquidate. The requirements regarding the QSPE structure
are contained in SFAS No. 140, Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities, and before March 1, 2001
through SFAS No. 140's predecessor under the same name, SFAS No. 125. Pursuant
to the conceptual framework set forth in FIN 46R, the Company's management has
concluded that the trusts holding its Controlling Class CMBS were structured
as QSPE's. Accordingly, the Company was not be required to consolidate these
trusts and therefore, the adoption of FIN 46R did not have a material impact on
the Company's consolidated financial statements. The Controlling Class CMBS
which have been deemed VIEs are detailed below. The Company's actual loss from
its Controlling Class CMBS investments is limited to the amounts invested in
such securities and further limited to such amounts not financed in its
non-recourse CDOs. The fair value of the Controlling Class securities financed
in the CDOs is $265,517; the total fair value of the Company's controlling
class CMBS is $430,965.
The table below details the purchase date, par of the Company's Controlling
Class securities and the entire par of each Controlling Class issuance owned
by the Company as of December 31, 2003.
Controlling Class Par Held by the
Securities Purchase Date Company Total CMBS Issued
------------------------------------------------------------------------------
CMAC 1998-C1 July 1998 $74,730 $982,489
CMAC 1998-C2 September 1998 182,970 2,284,406
DLJCM 1998-CG1 June 1998 99,845 1,326,906
GMAC 1998-C1 April 1998 50,437 1,209,899
LBCMT 1998-C1 May 1998 160,315 1,412,385
PNCMA 1999-CM1 November 1999 37,101 714,757
CSFB 2001-CK6 December 2001 71,345 911,981
CSFB 2003-CPN1 February 2003 66,177 999,121
GECMC 2003-C2 July 2003 62,112 1,201,079
--------------------------------------
Total $805,032 $11,043,023
Reclassifications
Certain amounts from 2002 and 2001 have been reclassified to conform to the
2003 presentation.
Note 2 SECURITIES AVAILABLE-FOR-SALE
The Company's securities available-for-sale are carried at estimated fair
value. The amortized cost and estimated fair value of securities
available-for-sale as of December 31, 2003 are summarized as follows:
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Security Description Cost Gain Loss Value
-------------------------------------------------------------------------------------------------------------------------
CMBS:
CMBS interest only strips ("IO's") $ 83,704 $ 1,566 $ (777) $ 84,493
Investment grade CMBS 332,342 7,353 (6,241) 333,454
Non-investment grade rated subordinated securities 742,923 19,322 (83,821) 678,424
Non-rated subordinated securities 23,011 4,840 (2,832) 25,019
Credit tenant lease 25,861 - (165) 25,696
Investment grade REIT debt 204,382 15,736 (696) 219,422
----------------------------------------------------------------------
Total CMBS 1,412,223 48,817 (94,532) 1,366,508
----------------------------------------------------------------------
RMBS:
Agency adjustable rate securities 179,917 464 - 180,381
Agency fixed rate securities 231,333 55 (4,389) 226,999
Residential CMO's 3,404 89 (29) 3,464
Hybrid adjustable rate mortgages ("ARMs") 6,682 - (37) 6,645
Project Loans 21,478 535 (10) 22,003
----------------------------------------------------------------------
Total RMBS 442,814 1,143 (4,465) 439,492
----------------------------------------------------------------------
Total securities available-for-sale $ 1,855,037 $49,960 $(98,997) $1,806,000
======================================================================
As of December 31, 2003, an aggregate of $1,683,952 in estimated fair value of
the Company's securities available-for-sale was pledged to secure its
collateralized borrowings.
The amortized cost and estimated fair value of securities available-for-sale
as of December 31, 2002 are summarized as follows:
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Security Description Cost Gain Loss Value
-----------------------------------------------------------------------------------------------------------------
CMBS:
CMBS IO's $42,591 $1,433 $(390) $43,634
Investment grade CMBS 49,843 5,277 - 55,120
Non-investment grade rated subordinated securities 629,273 19,473 (71,375) 577,371
Non-rated subordinated securities 34,170 1,967 (10,802) 25,335
Credit tenant lease 9,063 - - 9,063
Investment grade REIT debt 174,515 9,464 (157) 183,822
----------------------------------------------------------
Total CMBS 939,455 37,614 (82,724) 894,345
-----------------------------------------------------------
RMBS:
Agency adjustable rate securities 40,964 510 (175) 41,299
Agency fixed rate securities 8,509 324 - 8,833
Residential CMO's 13,356 478 - 13,834
Hybrid Arms 14,541 210 - 14,751
-----------------------------------------------------------
Total RMBS 77,370 1,522 (175) 78,717
-----------------------------------------------------------
Total securities available-for-sale $1,016,825 $39,136 $(82,899) $973,062
=============================================================
As of December 31, 2002, an aggregate of $872,939 in estimated fair value of
the Company's securities available-for-sale was pledged to secure its
collateralized borrowings.
As of December 31, 2003 and 2002, there were 2,163 and 1,883 loans,
respectively, underlying the Controlling Class CMBS held by the Company, with
a principal balance of $11,043,023 and $9,357,656, respectively.
As of December 31, 2003 and 2002, the aggregate estimated fair values by
underlying credit rating of the Company's securities available-for-sale are as
follows:
December 31, 2003 December 31, 2002
Estimated Estimated
Security Rating Fair Value Percentage Fair Value Percentage
-----------------------------------------------------------------------------------------------------------
Agency and agency insured securities $426,915 24% $50,132 5.1%
AAA 238,382 13 72,923 7.5
AA - - 4,448 0.5
A 15,643 1 10,466 1.1
A- 23,126 1 19,116 2.0
BBB+ 106,752 6 93,623 9.6
BBB 146,072 8 101,691 10.4
BBB- 126,313 7 17,957 1.8
BB+ 284,081 16 237,839 24.4
BB 129,401 7 93,290 9.6
BB- 75,316 4 66,844 6.9
B+ 28,904 2 21,533 2.2
B 105,061 6 99,815 10.2
B- 34,160 2 39,035 4.0
CCC+ 5,595 - - -
CCC 13,375 1 19,015 2.0
C 2,531 - - -
Not rated 44,373 2 25,335 2.7
------------------------------------------------------------------
Total securities available-for-sale $1,806,000 100% 973,062 100.0%
==================================================================
The following table shows the Company's fair value and gross unrealized
losses, aggregated by investment category and length of time that individual
securities have been in a continuous unrealized loss position, at December 31,
2003.
Less than 12 Months 12 Months or More Total
----------------------------------------------------------------------------------------------
Gross
Unrealized Gross Gross
Fair Gains Fair Unrealized Fair Unrealized
Value (Losses) Value Losses Value Losses
----------------------------------------------------------------------------------------------
Non-investment grade
rated subordinated
securities $65,969 $362 $612,455 $(64,861) $678,424 $(64,499)
Credit Tenant Lease $25,696 $(165) - - $25,696 $(165)
Agency fixed rate
securities $226,999 $(4,334) - - $226,999 $(4,334)
----------------------------------------------------------------------------------------------
Total temporarily
impaired securities $318,664 $(4,137) $612,455 $(64,861) $931,119 $(68,998)
==============================================================================================
The temporary impairment of the available-for-sale securities results from the
fair value of the securities falling below the amortized cost basis.
Management possesses both the intent and the ability to hold the securities
until maturity, allowing for the anticipated recovery in fair value of the
securities held. As such, management does not believe any of the securities
held other than those impaired during 2003 (see Note 2 of the consolidated
financial statements) are other-than-temporarily impaired at December 31,
2003.
As of December 31, 2003 and 2002, the mortgage loans underlying the
Controlling Class CMBS held by the Company were secured by properties of the
types and at the locations identified below:
Percentage (1) Percentage (1)
------------------------------------------------------------------------------
Property Type 2003 2002 Geographic 2003 2002
Location
------------------------------------------------------------------------------
Multifamily 33.2% 34.3% California 11.7% 12.2%
Retail 30.4 28.1 Texas 10.9 10.6
Office 20.0 18.8 New York 9.8 9.1
Lodging 6.9 8.7 Florida 6.0 6.6
Other (2) 9.5 10.1 Other (2) 61.6 61.5
------------------------ ----------------------
Total 100.0% 100.0% Total 100.0% 100.0%
======================== ======================
(1) Based on a percentage of the total unpaid principal balance of the
underlying loans.
(2) No other individual state comprises more than 5% of the total.
The following table sets forth certain information relating to the aggregate
principal balance and payment status of delinquent mortgage loans underlying
the Controlling Class CMBS held by the Company as of December 31, 2003 and
2002:
2003 2002
-------------------------------------------------------------------------------==--------
Number of % of Number of % of
Principal Loans Collateral Principal Loans Collateral
-----------------------------------------------------------------------------------------
Past due 30 days to 60 days $13,773 3 0.12% $5,476 1 0.06%
Past due 60 days to 90 days 12,162 3 0.11 49,825 10 0.53
Past due 90 days or more 123,242 16 1.12 102,886 19 1.10
Resolved loans - - - - - -
Real Estate owned 18,354 4 0.17 21,830 6 0.23
-----------------------------------------------------------------------------------------
Total Delinquent $167,531 26 1.52% $180,017 36 1.92%
=========================================================================================
Total Principal Balance $11,043,023* 2,317 $9,357,656** 1,883
* Of this total $304,258 of loans have been "defeased" and are now secured
by U.S. Treasury securities, thereby removing real estate and borrower
risk.
** Of this total $259,141 of loans have been "defeased" and are now secured
by U.S Treasury securities, thereby removing real estate and borrower
risk.
Of the 26 delinquent loans as of December 31, 2003, four loans were real
estate owned and being marketed for sale, four loans were in foreclosure and
the remaining 18 loans were in some form of workout negotiations.
The Controlling Class CMBS owned by the Company has a delinquency experience
of 1.48%, which is consistent with industry averages. During 2003, the Company
experienced early payoffs of $235,497 which represents 2.07% of the year-end
pool balance. These loans were paid-off at par with no loss.
To the extent that realized losses, if any, or such resolutions differ
significantly from the Company's original loss estimates, it may be necessary
to reduce or increase the projected yield on the applicable CMBS investment to
better reflect such investment's expected earnings net of expected losses,
from the date of purchase. While realized losses on individual assets may be
higher or lower than original estimates, the Company currently believes its
aggregate loss estimates and yields remain appropriate.
The CMBS held by the Company consist of subordinated securities collateralized
by adjustable and fixed rate commercial and multifamily mortgage loans. The
RMBS held by the Company consist of adjustable rate and fixed rate residential
pass-through or mortgage-backed securities collateralized by adjustable and
fixed rate single-family residential mortgage loans. Agency RMBS were issued
by FHLMC, FNMA or GNMA. Privately issued RMBS were issued by entities other
than FHLMC, FNMA or GNMA. The Company's securities available-for-sale are
subject to credit, interest rate, and/or prepayment risks.
The CMBS owned by the Company provide credit support to the more senior
classes of the related commercial securitization. The Company generally does
not own the senior classes of its below investment grade CMBS. Cash flow from
the mortgages underlying the CMBS generally is allocated first to the senior
classes, with the most senior class having a priority entitlement to cash
flow. Then, any remaining cash flow is allocated generally among the other
CMBS classes in order of their relative seniority. To the extent there are
defaults and unrecoverable losses on the underlying mortgages, resulting in
reduced cash flows, the most subordinated CMBS class will bear this loss
first. To the extent there are losses in excess of the most subordinated
class' stated entitlement to principal and interest, then the remaining CMBS
classes will bear such losses in order of their relative subordination.
As of December 31, 2003 and 2002, the anticipated weighted average unleveraged
yield to maturity based upon adjusted cost of the Company's entire
subordinated CMBS portfolio was 9.7% and 9.8% per annum, respectively, and of
the Company's other securities available-for-sale was 5.1% and 6.8% per annum,
respectively. The Company's anticipated yields to maturity on its subordinated
CMBS and other securities available-for-sale are based upon a number of
assumptions that are subject to certain business and economic uncertainties
and contingencies. Examples of these include, among other things, the rate and
timing of principal payments (including prepayments, repurchases, defaults,
liquidations, and related expenses), the pass-through or coupon rate, and
interest rate fluctuations. Additional factors that may affect the Company's
anticipated yields to maturity on its Controlling Class CMBS include interest
payment shortfalls due to delinquencies on the underlying mortgage loans, and
the timing and magnitude of credit losses on the mortgage loans underlying the
Controlling Class CMBS that are a result of the general condition of the real
estate market (including competition for tenants and their related credit
quality), and changes in market rental rates. As these uncertainties and
contingencies are difficult to predict and are subject to future events which
may alter these assumptions, no assurance can be given that the anticipated
yields to maturity, discussed above and elsewhere, will be achieved.
The agency adjustable rate RMBS held by the Company are subject to periodic
and lifetime caps that limit the amount the interest rates of such securities
can change during any given period and over the life of the loan. As of
December 31, 2003 and 2002, adjustable rate RMBS with a market value of
$27,419 and $41,299, respectively, is included in securities
available-for-sale on the consolidated statement of financial condition.
As of December 31, 2003, the unamortized net discount on all securities
available-for-sale was $2,875,437, which represented 60.79% of the then
remaining face amount of such securities.
During 2003, the Company sold securities available-for-sale for total proceeds
of $1,466,552, resulting in a realized loss of $(6,832). During 2002, the
Company sold securities available-for-sale for total proceeds of $1,017,534,
resulting in a realized gain of $11,391.
Note 3 SECURITIES HELD-FOR-TRADING
Securities held-for-trading are generally RMBS that the Company intends to
hold for a short period of time. During 2003, the Company discontinued its
active short-term trading strategies, which the Company previously had
employed from time to time. The RMBS classified as held-for-trading are
actively hedged using U.S. Treasury futures, interest rate swap agreements,
and forward sales and purchases of agency RMBS.
The Company's securities held-for-trading are carried at estimated fair value.
At December 31, 2003, the Company's securities held-for-trading consisted of
FNMA and FHLMC mortgage pools with an estimated fair value of $313,727 and
short positions of 30 five-year and 73 ten-year U.S. Treasury Note future
contracts, which represented $3,000 and $7,300 in face amount of U.S. Treasury
Notes, respectively. The estimated fair value of the contracts was
approximately $(11,436) at December 31, 2003. At December 31, 2002, the
Company's securities held-for-trading consisted of FNMA and FHLMC mortgage
pools with an estimated fair value of $1,427,733 and short positions of 3,166
five-year and 1,126 ten-year U.S. Treasury Note future contracts, which
represented $316,600 and $112,600 in face amount of U.S. Treasury Notes,
respectively. The estimated fair value of the contracts was approximately
$476,676 at December 31, 2002. Also, at December 31, 2002, the Company had
outstanding a short position of 140 Eurodollar futures of which 35 expired in
each of June, September and December 2003 and 35 expire in March 2004, and an
outstanding short call swaption with a notional amount of $400,000, which
expires in December 2004. During 2002, the Company closed the Eurodollar
future positions and the swaption position.
As of December 31, 2003 and 2002, adjustable rate RMBS with a market value of
$255,557 and $21,864, respectively, is included in securities held-for-trading
on the consolidated statements of financial condition.
The Company's trading strategies are subject to the risk of unanticipated
changes in the relative prices of long and short positions in trading
securities, but are designed to be relatively unaffected by changes in the
overall level of interest rates.
Note 4 COMMERCIAL MORTGAGE LOANS
The following table summarizes the Company's loan investments at December 31,
2003 and 2002:
Scheduled
Date of Maturity/Date
Initial of Repayment Property Par Interest Rate Contractual
Investment or Sale Location Type 2003 2002 2003 2002 Payment
- ------------------------------------------------------------------------------------------------------------------------------
12/17/01 4/9/04 Tyson's Corner, VA (1) Office $22,000 $22,000 8.2% 8.9% Floating
12/20/00 12/19/02 Los Angeles, CA Office - 18,438 - 11.4 Floating
11/7/01 11/11/07 San Francisco, CA (2) Office 10,820 10,909 7.2 7.2 Fixed
11/7/01 11/11/07 San Francisco, CA (2) Office 9,737 9,819 6.7 6.7 Fixed
5/17/02 12/11/04 Midwest (3) Retail - 3,500 - 10.0 Floating
5/17/02 12/11/04 Southwest (3) Residential 2,795 3,013 3.8 3.6 Floating
6/30/03 6/1/10 California/Michigan (1)(4) Hotel 14,916 - 6.6 - Fixed
10/28/03 3/9/05 New York, NY (5) Office 7,000 - 16.8 - Floating
-----------------------
$67,268 $67,679
=======================
(1) The entire principal balance of the Company's investment is pledged to
secure line of credit borrowings.
(2) Two subordinate interests in a $125,000 note secured by one 11-story
office building. The entire principal balance of the Company's investment
is pledged to secure collateralized debt obligations.
(3) Secured by the partnership interests in three super regional malls. The
security interest in each of the malls are cross-collateralized and
contain cross-default provisions. The loan was issued at a discount, which
will amortize to its par value at a yield to maturity of 13.2%. Payments
are interest only and reset monthly based upon a one month LIBOR spread.
The loan was paid off in full on January 10, 2003. In conjunction with
this investment, the Company purchased a 1.46% interest only strip off of
a B Note secured by a portfolio of apartments (5,389 units). Payments
received are the greater of 1.5% or 9.5% less LIBOR+450, based upon a
notional par value.
(4) Represents a subordinate position in a $125,000 first mortgage, secured by
six hotels in California and one hotel in Michigan.
(5) Represents a subordinate interest in a $26,000 mezzanine loan, secured by
partnership interests in a 54 story, landmark office building.
Reconciliation of commercial mortgage loans: Par Book Value
------------- -------------
Balance at January 1, 2002 $142,637 $142,637
Discount accretion - 40
Proceeds from repayment of mortgage loans (81,471) (80,383)
Reduction in notional par value (170) -
Investments in commercial mortgage loans 6,683 3,370
------------- -------------
Balance at December 31, 2002 $67,679 $ 65,664
Discount accretion - 264
Proceeds from repayment of mortgage loans (1) (22,195) (22,780)
Reduction in notional par value (218) -
Investments in commercial mortgage loans 22,002 18,520
------------- -------------
Balance at December 31, 2003 $67,268 $ 61,668
============= =============
(1) Includes principal receivable from Gas Tower Loan.
Note 5 EQUITY INVESTMENT AND REAL ESTATE JOINT VENTURES
On July 20, 2000, the Company made an investment aggregating $5,121 in two
limited partnerships for the purpose of purchasing a ninety nine thousand
square foot office building and a one hundred twenty thousand square foot
office building, both of which are located in suburban Philadelphia. The
Company exercises significant influence, but not control, and accounts for its
investment under the equity method. The Company's ownership interest is 64.81%
in each partnership. The Company receives a preferred return of 12% compounded
on its unreturned capital, which is payable monthly and a share of the
proceeds from a sale or refinancing. The book value of the investment in the
partnerships at December 31, 2003 and 2002 was $2,750 and $3,149,
respectively.
On December 14, 2000, the Company made an investment aggregating approximately
$5,149 in a limited liability company for the purpose of acquiring a five
hundred thousand square foot office and retail complex in Tallahassee,
Florida. The Company exercises significant influence, but not control, and
accounts for its investment under the equity method. The Company's ownership
interest is 36.4% of the limited liability company. The Company receives a
preferred return of 13.25% and a return of capital of $3, which is payable
monthly. The book value of the investment at December 31, 2003 and 2002 was
$5,073 and $5,116, respectively.
On July 20, 2001, the Company entered into a $50,000 commitment to acquire
shares in Carbon, a private commercial real estate income opportunity fund
managed by BlackRock Financial Management, Inc., which is also the manager of
the Company (see Note 10 of the consolidated financial statements). The
Company does not incur any additional management or incentive fees to the
Manager as a result of its investment in Carbon. The period during which the
Company may be required to purchase shares under the commitment, expires in
July 2004. Shares purchased by the Company are as follows:
Number of
Shares
Date Stock issued Issued Amount
- --------------------------------------------------------------------------------
November 19, 2001 Series K Common 8,784 $8,784
October 30, 2002 Series K Common 6,100 $6,100
February 6, 2003 Series K Common 2,680 $2,680
September 15, 2003 Series K Common 5,265 $5,265
October 9, 2003 Series K Common 4,137 $4,137
On December 31, 2003 and 2002, the Company owned 19.8% and 18.8% of the
outstanding shares of Carbon, respectively.
The following tables summarizes the loan investments held by Carbon at
December 31, 2003 and 2002:
Date of Par Interest rate Yield
Initial Scheduled Property Name/ Property
Investment Maturity Location Type 2003 2002 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------
11/19/01 9/11/04 230 Park Avenue Office $10,000 $10,000 7.7% 8.0% 8.8% 9.6%
New York, NY(1)(4)
11/20/01 12/11/07 Landmark Building Office 11,953 12,071 10.0 10.0 16.6 16.6
San Francisco,CA(2)
12/17/01 4/9/04 Greensboro Corp. Office 10,000 10,000 9.0 9.8 19.5 19.6
Center Tysons
Corner, VA(1)
5/17/02 1/10/03 Concordia Portfolio Retail - 14,500 9.9 10.0 20.3 12.5
Midwest (3)
5/17/02 12/11/04 Alliance I/O Residential 11,278 12,487 3.8 3.6 - -
Southwest (3)
10/16/02 11/1/07 311 S. Wacker Dr. Mez. Office 31,710 71,952 9.3 8.0 9.4 8.0
Chicago,IL (4)
11/1/02 11/9/04 Westin St. Francis Hotel - 30,000 6.3 6.8 6.9 6.8
B Note
San Francisco,CA(5)
11/1/02 11/9/04 Westin St.Francis Mez. Hotel 35,000 35,000 10.7 10.8 10.7 10.8
San Francisco,CA
(4)(5)
2/10/03 3/11/08 Pennmark Mixed-use 35,000 - 8.8 - 8.8 -
New York, NY (4)(6)
5/7/03 11/1/04 The Edge Condominium Residential 12,000 - 22.0 - 22.4 -
Chicago, IL (7)
5/9/03 1/09/06 Alliance FQ B Note Residential 8,450 - 7.5 - 7.6 -
Texas (1)(4)(8)
5/9/03 1/09/06 Alliance FQ Mezzanine Residential 6,000 - 15.1 - 15.1 -
Texas (1)(4)(8)
8/19/03 1/14/04 880 Mandalay (4)(9) Residential 6,885 - 7.8 - 8.1 -
Clearwater Beach,FL
9/16/03 3/09/06 Ocean's Resort Hotel 26,375 - 10.7 - 12.2 -
Portfolio
Daytona Beach,FL
(1)(4)(10)
11/10/03 8/18/06 Pointe @ Park Center Residential 9,546 - 7.6 - 7.5 -
Alexandria, VA (9)
11/25/03 11/24/05 Mary Brickell Village Retail 13,640 - 18.0 - 18.4 -
Miami, FL (11)
12/15/03 12/1/06 Independent Square(4) Office 14,000 - 10.0 - 10.0 -
Jacksonville,FL
-------------------- -----------------
$241,837 $196,010 12.1% 9.9%
==================== =================
(1) May be extended at the borrower's option for two additional
twelve-month periods, subject to certain performance hurdles and an
extension fee.
(2) Anthracite Capital, Inc. owns two subordinate interests, which are
senior to the interest owned by Carbon Capital, Inc.
(3) Secured by the partnership interests in three super regional malls.
The loan was paid off in full on January 10, 2003. In conjunction
with the purchase of the Concordia Portfolio, Carbon Capital, Inc.
purchased a 1.46% interest only strip (the "Alliance I/O") off of a B
Note secured by a portfolio of apartments located in Dallas/Fort
Worth and Phoenix. Anthracite Capital, Inc. owns subordinate
interests in these investments, which are pari passu to those owned
by Carbon Capital, Inc.
(4) The entire principal balance is pledged to secure reverse repurchase
agreements.
(5) Represents a subordinate interest in a $160,000 note secured by a
full service hotel and a mezzanine loan, secured by the borrower's
interest in the same property. May be extended at the borrower's
option for three additional twelve-month periods for a .25% extension
fee. There is a fee due for the second and third extension of 0.125%
per extension.
(6) Represents a mezzanine loan secured by ownership interests in the
entity, which owns an apartment and retail development.
(7) Represents a mezzanine construction loan, secured by a second
mortgage and pledge of partnership interests. May be extended at the
borrower's option for two additional six-month periods for a fee of
.50% for the first extension and .75% for the second extension.
Borrower pays a current interest rate of 12% with the remaining 10%
payable at maturity.
(8) Represents a subordinate interest in a $43,000 note secured by three
apartment properties located in Corpus Christi and Houston, Texas and
a mezzanine loan, secured by the borrower's interest in the same
properties.
(9) Represents a subordinate interest in a first mortgage note secured by
a condominium conversion project. In addition to interest payments,
borrower is required to pay a release fee equal to 2.0% of net sales
proceeds per unit.
(10) Interest payments on the loan are based upon a spread to 30-day LIBOR,
subject to a floor of 2.5%. on the first $20,250,000 of principal.
(11) Represents a $13,640 mezzanine construction loan, secured by pledge
of partnership interests. May be extended at the borrower's option
for one additional twelve-month period for a fee of 1%. Borrower pays
a current interest rate of 12% with the remaining 6% plus $354
payable at maturity.
At December 31, 2003, the weighted average interest spread and the weighted
average yield of loan investments held by Carbon was 10.2% and 12.1%,
respectively. At December 31, 2002, the weighted average interest spread and
the weighted average yield of the loan investments held by Carbon was 8.6% and
9.9%, respectively.
Combined summarized financial information of the unconsolidated equity
investment and real estate joint ventures of the Company is as follows:
December 31,
------------------------------------
2003 2002
---------------- ----------------
Balance Sheets:
Real estate property $46,547 $44,342
Commercial mortgage loans, net 225,636 178,429
Other assets 18,709 10,533
---------------- ----------------
Total Assets $290,892 $233,304
================ ================
Mortgage debt $30,536 $30,846
Other liabilities 102,438 103,954
Partners', members' and stockholders' equity 157,918 98,504
---------------- ----------------
Total liabilities, partners', members',
and stockholders' equity $290,892 $233,304
================ ================
Anthracite Capital, Inc.'s share of equity $36,316 $23,262
================ ================
For the years ended December 31,
-------------------------------------------
2003 2002 2001
----------- ------------ ------------
Statements of Operations:
Revenues $30,767 $19,901 $11,119
----------- ------------ ------------
Expenses
Interest expense 7,043 4,877 3,796
Depreciation and amortization 1,824 2,203 1,840
Operating expenses 5,711 5,611 3,560
----------- ------------ ------------
Total expenses 14,578 12,691 9,196
----------- ------------ ------------
Net Income $16,189 7,210 $1,923
=========== ============ ============
Anthracite Capital, Inc.'s share of net income $4,322 $2,246 $1,747
=========== ============ ============
Note 6 FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments" ("SFAS
No. 107"), requires the disclosure of the estimated fair value of financial
instruments. The following table presents the notional amount, carrying value
and estimated fair value of financial instruments as of December 31, 2003 and
2002:
2003 2002
-----------------------------------------------------------------------------------------
Notional Carrying Estimated Notional Carrying Estimated
Amount Value Fair Value Amount Value Fair Value
-----------------------------------------------------------------------------------------
Securities available-for-sale $ - $1,806,000 $1,806,000 $ - $ 973,062 $ 973,062
Securities held-for-trading - 313,727 313,727 - 1,427,733 1,427,733
Commercial mortgage loans - 61,668 61,668 - 65,664 65,664
Secured borrowings - 1,138,571 1,138,571 - 1,477,071 1,477,071
CDO borrowings - 684,970 696,195 - 684,590 693,001
Currency forward contracts - - - - 365 365
Interest rate swap agreements 1,545,623 (26,352) (26,352) 1,142,832 (45,602) (45,602)
Futures 103 (11,436) (11,436) 4,292 (476,676) (476,676)
The currency forward contracts as of December 31, 2002 are comprised of two
offsetting currency forward contracts which net to a notional amount of zero.
Notional amounts are a unit of measure specified in a derivative instrument.
The fair values of the Company's securities available-for-sale, securities
held-for-trading, currency forward contracts and interest rate swap agreements
are based on market prices provided by certain dealers who make markets in
these financial instruments. The fair values reported reflect estimates and
may not necessarily be indicative of the amounts the Company could realize in
a current market exchange. Commercial mortgage loans and secured borrowings
are floating rate instruments, and based on these terms their carrying value
approximates fair value.
Note 7 IMPAIRMENT - CMBS
During 2003, the Company performed an analysis of its current underlying loan
loss expectations and credit performance of its 1998 vintage Controlling Class
CMBS. The Company increased underlying loan loss expectations on four
securities from three 1998 vintage CMBS transactions. As a result of the
increase in loss expectations, the Company recorded an impairment charge of
$27,014 during the second quarter of 2003, to reduce the amortized cost of
these securities to their fair value. The $27,014 impairment charge is
comprised of $19,217 related to the non-rated and CCC rated classes of CMAC
98-C2, $5,573 related to LBCMT 98-C1, and $2,224 related to GMAC 98-C1. Three
of the four impaired securities are not rated and the fourth security is rated
CCC by Fitch Ratings. Securities which are not rated are highly sensitive to
changes in the timing of losses recognized on the underlying loans.
Based on the delinquencies and defaults in the underlying pools, and missed
payments during the fourth quarter of 2002, the Company revised its estimated
future cash flows from its investment in FMACT 1998-BA class B security.
Accordingly, as of December 31, 2002, the Company determined that its
investment was impaired and wrote down the adjusted purchase price of this
security by $10,273 to its estimated fair value and increased the security's
yield from 7.69% to a market yield for a security of this credit quality,
estimated to be 20%. These figures incorporate the assumption that an
additional $31,203 of losses will be experienced by the underlying loan pools
and an estimate of another 1.0% of losses per year over the remaining life of
the trust. This security was part of the CORE Cap acquisition in May of 2000
and was rated AA at that time. The most recent rating of this security was CC
by Fitch Ratings was in December 2002.
During the third quarter of 2003, the Company determined it is unlikely that
further payments will be received from the FMACT 1998-BA class B security and
wrote this security down to zero, despite the servicer reporting a par balance
of $16,366 as of September 30, 2003. As a result, the Company recorded an
impairment charge during the quarter of $5,412.
Note 8 COMMON STOCK
For the year ended December 31, 2003, the Company issued 1,955,919 shares of
Common Stock under its Dividend Reinvestment Plan. Net proceeds to the Company
were approximately $21,134. For the year ended December 31, 2002, the Company
issued 1,455,725 shares of Common Stock under its Dividend Reinvestment and
Stock Purchase Plan. Net proceeds to the Company were approximately $15,920.
For the year ended December 31, 2001, the Company issued 2,228,566 shares of
Common Stock under its Dividend Reinvestment Plan. Net proceeds to the Company
were approximately $22,945.
During the year ended December 31, 2003, the Company declared dividends to
stockholders totaling $61,088 or $1.26 per share, of which $47,238 was paid
during the year and $13,850 was paid on February 2, 2004. During the year
ended December 31, 2002, the Company declared dividends to stockholders
totaling $65,366 or $1.40 per share, of which $48,777 was paid during the year
and $16,589 was paid on January 31, 2003. During the year ended December 31,
2001, the Company declared dividends to stockholders totaling $47,458 or $1.29
per share, of which $31,607 was paid during the year and $15,850 was paid on
January 31, 2002.
For the year ended December 31, 2003, the Company issued 45,000 shares of
Common Stock under a sale agency agreement with Brinson Patrick Securities
Corporation. Net proceeds to the Company were approximately $497.
The following chart details the estimated tax characterization of the
Company's Common Stock dividends with March 31, 2003, June 30, 2003, and
September 30, 2003 record dates. All other Common Stock dividends that have
been paid by the Company are 100% ordinary income.
- --------------------------------------------------------------------------
Cash Taxable Non-taxable
Record Payable Distribution Ordinary Return of
Date Date Per Share Dividend Capital
- --------------------------------------------------------------------------
3/31/03 4/30/03 $0.3500 $0.3344 $0.0156
6/30/03 7/31/03 $0.3500 $0.3344 $0.0156
9/30/03 10/31/03 $0.2800 $0.2675 $0.0125
------------------------------------------------
Total $0.9800 $0.9363 $0.0437
Note 9 PREFERRED STOCK
On May 29, 2003, the Company authorized and issued 2,300,000 shares of Series
C Preferred Stock, including 300,000 shares of Series C Preferred Stock issued
pursuant to an option granted to the underwriters to cover over-allotments.
The Series C Preferred Stock is perpetual, carries a 9.375% coupon and has a
preference in liquidation of $57,500. The aggregate net proceeds to the
Company (after deducting underwriting fees and expenses) were approximately
$55,435.
As part of the CORE Cap merger, the Company authorized and issued 2,261,000
shares of Series B Preferred Stock, $0.001 par value per share, to CORE Cap
stockholders. The Series B Preferred Stock is perpetual, carries a 10% coupon,
has a preference in liquidation as of December 31, 2003 of $43,942, and is
convertible into the Company's Common Stock at a price of $17.09 per share,
subject to adjustment. If converted, the Series B Preferred Stock would
convert into approximately 2,571,423 shares of the Company's Common Stock. On
May 29, 2003, the Company redeemed 155,000 shares at its liquidation value of
$25 per share. In 2002, 300,000 shares of 10% Series B Preferred Stock with a
liquidation preference of $7,500 were converted at the stockholder's option
into 438,885 shares of the Company's Common stock.
As of December 31, 2003, the Company has authorized and unissued 94,394,003
shares of preferred stock.
The following chart details the estimated tax characterization of the
Company's Series B Preferred Stock dividends with March 15, 2003, June 15,
2003, September 15, 2003, and December 15, 2003 record dates. All other Series
B Preferred Stock dividends that have been paid by the Company are 100%
ordinary income.
- --------------------------------------------------------------------------
Cash Taxable Non-taxable
Record Payable Distribution Ordinary Return of
Date Date Per Share Dividend Capital
- --------------------------------------------------------------------------
3/15/03 3/31/03 $0.6250 $0.5963 $0.0287
6/15/03 6/30/03 0.6250 0.5963 0.0287
9/15/03 9/30/03 0.6250 0.5963 0.0287
12/15/03 12/31/03 0.6250 0.5963 0.0287
-------------------------------------------------
Total $2.5000 $2.3853 $0.1147
The following chart details the estimated tax characterization of the
Company's Series C Preferred Stock dividends with July 15, 2003 and October
10, 2003 record dates.
- --------------------------------------------------------------------------
Cash Taxable Non-taxable
Record Payable Distribution Ordinary Return of
Date Date Per Share Dividend Capital
- --------------------------------------------------------------------------
7/15/03 7/31/03 $0.4100 $0.3556 $0.0544
10/10/03 10/31/03 0.5860 0.5083 0.0777
-------------------------------------------------
Total $0.9960 $0.8639 $0.1321
Note 10 TRANSACTIONS WITH AFFILIATES
The Company has a Management Agreement with the Manager, a majority owned
indirect subsidiary of The PNC Financial Services Group, Inc. and the employer
of certain directors and officers of the Company, under which the Manager
manages the Company's day-to-day operations, subject to the direction and
oversight of the Company's Board of Directors. On March 25, 2002, the
Management Agreement was extended for one year through March 27, 2003, with
the approval of the unaffiliated directors, on terms similar to the prior
agreement with the following changes: (i) the incentive fee calculation would
be based on GAAP earnings instead of funds from operations, (ii) the removal
of the four-year period to value the Management Agreement in the event of
termination and (iii) subsequent renewal periods of the Management Agreement
would be for one year instead of two years. The Board was advised by Houlihan
Lokey Howard & Zukin Financial Advisors, Inc., a national investment banking
and financial advisory firm, in the renewal process.
On March 6, 2003, the unaffiliated directors approved an extension of the
Management Agreement from its expiration of March 27, 2003 for one year
through March 31, 2004. The terms of the renewed agreement are similar to the
prior agreement except for the incentive fee calculation which provides for a
rolling four-quarter high watermark rather than a quarterly calculation. In
determining the rolling four-quarter high watermark, the Company calculates
the incentive fee based upon the current and prior three quarters' net income.
The Manager would be paid a Yearly Incentive Fee greater than what was paid to
the Manager in the prior three quarters cumulatively. The Company will phase
in the rolling four-quarter high watermark commencing with the second quarter
of 2003. Calculation of the incentive fee will be based on earnings in
accordance with GAAP and adjusted to exclude special one-time events pursuant
to changes in accounting pronouncements after discussion between the Manager
and the unaffiliated directors. The incentive fee threshold did not change.
The high watermark will be based on the existing incentive fee hurdle, which
provides for the Manager to be paid 25% of the amount of earnings (calculated
in accordance with GAAP) per share that exceeds the product of the adjusted
issue price of the Company's common stock per share ($11.38 as of December 31,
2003) and the greater of 9.5% or 350 basis points over the ten-year Treasury
note. The Company anticipates that the Management Agreement will be extended
prior to its expiration on March 31, 2004.
Pursuant to the March 25, 2002 one-year Management Agreement extension, such
incentive fee was based on 25% of earnings (calculated in accordance with
GAAP) of the Company. For purposes of the incentive compensation calculation,
equity is generally defined as proceeds from issuance of Common Stock before
underwriting discounts and commissions and other costs of issuance. For
purposes of calculating the incentive fee during 2002, the cumulative
transition adjustment of $6,327 resulting from the Company's adoption of SFAS
142 was excluded from earnings in its entirety and included using an
amortization period of three years. The Company incurred $3,195 and $3,238 in
incentive compensation for the years ended December 31, 2002 and 2001,
respectively. There was no incentive fee due to the Manager for the twelve
months ended December 31, 2003.
The Company pays the Manager an annual base management fee equal to a
percentage of the average invested assets of the Company as defined in the
Management Agreement. The base management fee is equal to 1% per annum of the
average invested assets rated less than BB- or not rated, 0.75% of average
invested assets rated BB- to BB+, and 0.20% of average invested assets rated
above BB+. During the third quarter of 2003, the Manager agreed to reduce the
management fees by 20% from its calculated amount for the third and fourth
quarter of 2003 and the first quarter of 2004. This revision resulted in a
$1,046 reduction in fees to be paid by the Company for year ended December 31,
2003.
The Company incurred $9,411, $9,332, and $7,780 in base management fees in
accordance with the terms of the Management Agreement for the years ended
December 31, 2003, 2002 and 2001, respectively. In accordance with the
provisions of the Management Agreement, the Company recorded reimbursements to
the Manager of $66, $14, and $216 for certain expenses incurred on behalf of
the Company during 2003, 2002 and 2001, respectively.
The Company has an administration agreement with the Manager. Under the terms
of the administration agreement, the Manager provides financial reporting,
audit coordination and accounting oversight services to the Company. The
agreement can be cancelled upon 60-day written notice by either party. The
Company pays the Manager a monthly administrative fee at an annual rate of
0.06% of the first $125,000 of average net assets, 0.04% of the next $125,000
of average net assets and 0.03% of average net assets in excess of $250,000
subject to a minimum annual fee of $120. For the years ended December 31,
2003, 2002 and 2001, the Company paid administration fees of $173, $168, and
$144, respectively.
The special servicer on seven of the Company's nine Controlling Class trusts
is Midland Loan Services, Inc. ("Midland"), a wholly-owned indirect subsidiary
of PNC Bank. The Company's fees for Midland's services are at market rates.
In March 2001, the Company purchased twelve certificates each representing a
1% interest in different classes of Owner Trust NS I Trust ("Owner Trusts")
for an aggregate investment of $37,868. These certificates were purchased from
PNC Bank. The assets of the Owner Trusts consist of commercial mortgage loans
originated or acquired by an affiliate of PNC Bank. The Company entered into a
$50,000 committed line of credit from PNC Funding Corp. to borrow up to 95% of
the fair market value of the Company's interest in the Owner Trusts.
Outstanding borrowings against this line of credit bear interest at a LIBOR
based variable rate. As of December 31, 2001, there was $13,885 borrowed under
this line of credit. The Company earned $1,468 from the Owner Trusts and paid
interest of approximately $849 to PNC Funding Corp. as interest on borrowings
under a related line of credit for year ended December 31, 2001. During 2001,
the Company sold four Owner Trusts. The gain on the sale of those Owner Trusts
was $35. The outstanding borrowings were repaid prior to the expiration on
March 13, 2002, at which time the remaining Owner Trusts were sold at a gain
of $90.
The Company has entered into a $50,000 commitment to acquire shares in Carbon,
a private commercial real estate income opportunity fund managed by the
Manager. The period during which the Company may be required to purchase
shares under the commitment expires in July 2004. On December 31, 2003, the
Company owned 19.8% of the outstanding shares of Carbon. The Company's
remaining commitment at December 31, 2003 was $23,034.
During 2000, the Company completed the acquisition of CORE Cap, Inc. The
merger was a stock for stock acquisition where the Company issued 4,180,552
shares of its common stock and 2,261,000 shares of its Series B preferred
stock. At the time of the CORE Cap acquisition, the Manager agreed to pay GMAC
(CORE Cap, Inc.'s external advisor) $12,500 over a ten-year period
("Installment Payment") to purchase the right to manage the assets under the
existing management contract ("GMAC Contract"). The GMAC Contract had to be
terminated in order to allow for the Company to complete the merger, as the
Company's management agreement with the Manager did not provide for multiple
managers. As a result the Manager offered to buy-out the GMAC contract as the
Manager estimated it would receive incremental fees above and beyond the
Installment Payment, and thus was willing to pay for, and separately
negotiate, the termination of the GMAC Contract. Accordingly, the value of the
Installment Payment was not considered in the Company's allocation of its
purchase price to the net assets acquired in the acquisition of CORE Cap, Inc.
The Company agreed that should the Management Agreement with its Manager be
terminated, not renewed or not extended for any reason other than for cause,
the Company would pay to the Manager an amount equal to the Installment
Payment less the sum of all payments made by the Manager to GMAC. As of
December 31, 2003, the Installment Payment would be $8,000 payable over seven
years. The Company does not accrue for this contingent liability.
Note 11 STOCK OPTIONS
The Company has adopted a stock option plan (the "1998 Stock Option Plan")
that provides for the grant of both qualified incentive stock options that
meet the requirements of Section 422 of the Code and non-qualified stock
options, stock appreciation rights and dividend equivalent rights. Stock
options may be granted to the Manager, directors, officers and any key
employees of the Company, directors, officers and key employees of the Manager
and to any other individual or entity performing services for the Company.
The exercise price for any stock option granted under the 1998 Stock Option
Plan may not be less than 100% of the fair market value of the shares of
Common Stock at the time the option is granted. Each option must terminate no
more than ten years from the date it is granted and have vested over either a
two or three-year period. Subject to anti-dilution provisions for stock
splits, stock dividends and similar events, the 1998 Stock Option Plan
authorizes the grant of options to purchase up to an aggregate of 2,470,453
shares of Common Stock.
The following table summarizes information about options outstanding under the
1998 Stock Option Plan:
2003 2002 2001
-----------------------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
-------------------------- ---------------------- -------------------------
Outstanding at January 1 1,560,542 $14.49 1,766,341 $13.87 1,766,341 $13.87
Granted 0 0 0 0 0 0
Exercised (65,400) 8.45 (182,700) 8.33 0 0
Cancelled (26,791) 15.00 (23,099) 15.63 0 0
Outstanding at December 31 1,468,351 $14.75 1,560,542 $14.49 1,766,341 $13.87
========= ========= =========
Options exercisable at December 31 1,468,351* $14.75 1,560,542 $14.49 1,400,554 $13.70
========= ========= =========
*20,000 options expired in February 2004.
The following table summarizes information about options outstanding under
the 1998 Stock Option Plan at December 31, 2003:
Exercise Options Outstanding Remaining Options Exercisable
Price at December 31, 2003 Contractual Life at December 31, 2003
$7.82 3,850 6.1 Years 3,850
8.02 0 9.2 Years 0
8.44 55,000 5.2 Years 55,000
9.11 3,850 5.2 Years 3,850
15.00 1,336,351 4.2 Years 1,336,351
15.58 57,750 3.7 Years 57,750
15.83 11,550 4.2 Years 11,550
============ =========== ==========
$7.82-$15.83 1,468,351 4.3 Years 1,468,351
============ =========== ==========
Shares of Common Stock available for future grant under the 1998 Stock Option
Plan at December 31, 2003 were 754,002.
Note 12 BORROWINGS
The Company's borrowings consist of lines of credit, CDO, and reverse
repurchase borrowings.
The Company has a $185,000 committed credit facility with Deutsche Bank, AG
(the "Deutsche Bank Facility") which matures July 15, 2005. The Deutsche Bank
Facility can be used to replace existing reverse repurchase agreement
borrowings and to finance the acquisition of mortgage-backed securities, loan
investments and investments in real estate joint ventures. As of December 31,
2003 and 2002, the outstanding borrowings under this facility were $82,406 and
$19,189, respectively. Outstanding borrowings under the Deutsche Bank Facility
bear interest at a LIBOR based variable rate.
On July 18, 2002, the Company entered into a $75,000 committed credit facility
with Greenwich Capital, Inc. The facility provides the Company with the
ability to borrow only through July 17, 2004 with the repayment of principal
not due until July 7, 2005. Outstanding borrowings under this credit facility
bear interest at a LIBOR based variable rate. As of December 31, 2003,
outstanding borrowings under this facility were $7,530. There were no
borrowings under this facility as of December 31, 2002.
The Company is subject to various covenants in its lines of credit, including
maintaining a minimum net worth measured on GAAP of $305,000, a debt-to-equity
ratio not to exceed 5.5 to 1, a minimum cash requirement based upon certain
debt-to-equity ratios, a minimum debt service coverage ratio of 1.5 and a
minimum liquidity reserve of $10,000. As of December 31, 2003 and 2002, the
Company was in compliance with all such covenants.
On May 29, 2002, the Company issued ten tranches of secured debt through CDO
I. In this transaction, a wholly owned subsidiary of the Company issued
secured debt in the par amount of $419,185 secured by the subsidiary's assets.
The adjusted issue price of the CDO I debt, as of December 31, 2003, is
$404,637. Five tranches were issued at a fixed rate coupon and five tranches
were issued at a floating rate coupon with a combined weighted average
remaining maturity of 8.29 years as of December 31, 2003. All floating rate
coupons were swapped to fixed rate coupons resulting in a total fixed rate
cost of funds for CDO I of approximately 7.21%. The Company incurred $9,890 of
issuance costs which will be amortized over the weighted average life of the
CDO. The CDO was structured to match fund the cash flows from a significant
portion of the Company's CMBS and unsecured real estate investment trust debt
portfolio (REIT debt). The par amount as of December 31, 2003 of the
collateral securing CDO I consists of 78% CMBS rated B or higher and 22% REIT
debt rated BBB or higher. As of December 31, 2003, the collateral securing the
CDO I has a fair value of $449,709.
On December 10, 2002, the Company issued seven tranches of secured debt
through CDO II. In this transaction, a wholly owned subsidiary of the Company
issued secured debt in the par amount of $280,783 secured by the subsidiary's
assets. The adjusted issue price of the CDO II debt as of December 31, 2003 is
$280,333. Four tranches were issued at a fixed rate coupon and three tranches
were issued at a floating rate coupon with a combined weighted average
remaining maturity of 8.34 years as of December 31, 2003. All floating rate
coupons were swapped to fixed rate coupons resulting in a total fixed rate
cost of funds for CDO II of approximately 5.73%. The Company incurred $6,004
of issuance costs which will be amortized over the weighted average life of
the CDO. The CDO was structured to match fund the cash flows from a
significant portion of the Company's CMBS and unsecured real estate investment
trust debt portfolio (REIT debt). The par amount as of December 31, 2003 of
the collateral securing CDO II consists of 81% CMBS rated B or higher and 19%
REIT debt rated BBB or higher. As of December 31, 2003, the collateral
securing CDO II has a fair value of $320,866.
Proceeds from the CDOs were used to pay off all of the financing of the
Company's CMBS below investment grade portfolio, BBB portfolio and its REIT
debt. Prior to the CDOs, these portfolios were financed with thirty-day
repurchase agreements with various counterparties that marked the assets to
market on a daily basis at interest rates based on 30-day LIBOR. For
accounting purposes, these transactions were treated as a secured financing,
and the debt is non-recourse to the Company.
The Company has entered into reverse repurchase agreements to finance most of
its securities available-for-sale that are not financed under its lines of
credit or from the issuance of its collateralized debt obligations. The
reverse repurchase agreements are collateralized by most of the Company's
securities available-for-sale and bear interest at a LIBOR based variable
rate.
Certain information with respect to the Company's collateralized borrowings as
of December 31, 2003 is summarized as follows:
Lines of
Credit Reverse Collateralized Total
and Term Repurchase Debt Collateralized
Loans Agreements Obligations Borrowings
-------------- --------------- ----------------- ------------------
Outstanding borrowings $89,936 $1,048,635 $684,970 $1,823,541
Weighted average
borrowing rate 2.40% 1.24% 6.60% 3.31%
Weighted average
remaining maturity 484 days 21 days 3,033 days 1,175 days
Estimated fair value of
assets pledged $146,608 $1,137,539 $770,575 $2,054,722
As of December 31, 2003, there were no borrowings outstanding under the lines
of credit that were denominated in pounds sterling.
As of December 31, 2003, the Company's collateralized borrowings had the
following remaining maturities:
Lines of Reverse Collateralized Total
Credit and Repurchase Debt Collateralized
Term Loans Agreements Obligations Borrowings
----------------- --------------- ----------------- -----------------
Within 30 days $ - $1,048,635 $ - $1,048,635
31 to 59 days - - - -
Over 60 days 89,936 - 684,970 774,906
================= =============== ================= =================
$89,936 $1,048,635 $684,970 $1,823,541
================= =============== ================= =================
Certain information with respect to the Company's collateralized borrowings as
of December 31, 2002 is summarized as follows:
Lines of Reverse Collateralized Total
Credit and Repurchase Debt Collateralized
Term Loans Agreements Obligations Borrowings
------------- ------------ ---------------- --------------
Outstanding borrowings $19,189 $1,457,882 $684,590 $2,161,661
Weighted average borrowing rate 3.40% 1.37% 6.60% 3.04%
Weighted average remaining maturity 524 days 21 days 3,398 days 1095 days
Estimated fair value of assets
pledged $37,310 $1,527,766 $726,769 $2,291,845
As of December 31, 2002, there were no borrowings outstanding under the lines
of credit that were denominated in pounds sterling.
As of December 31, 2002, the Company's collateralized borrowings had the
following remaining maturities:
Lines of
Credit Reverse Collateralized Total
and Repurchase Debt Collateralized
Term Loan Agreements Obligations Borrowings
---------------- ---------------- ----------------- ------------------
Within 30 days $ - $1,457,882 $ - $1,457,882
31 to 59 days - - - -
Over 60 days 19,189 - 684,590 703,779
---------------- ---------------- ----------------- ------------------
$19,189 $1,457,882 $684,590 $2,161,661
================ ================= ================= ==================
Under the lines of credit and the reverse repurchase agreements, the
respective lender retains the right to mark the underlying collateral to
estimated market value. A reduction in the value of its pledged assets will
require the Company to provide additional collateral or fund margin calls.
From time to time, the Company expects that it will be required to provide
such additional collateral or fund margin calls.
Note 13 DERIVATIVE INSTRUMENTS
Effective January 1, 2001, the Company adopted SFAS No. 133, as amended, which
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities. All derivatives, whether designated in hedging
relationships or not, are required to be recorded on the balance sheet at fair
value. If the derivative is designated as a fair value hedge, the changes in
the fair value of the derivative and of the hedged item attributable to the
hedged risk are recognized in earnings. If the derivative is designated as a
cash flow hedge, the effective portions of change in the fair value of the
derivative are recorded in other comprehensive income or loss ("OCI") and are
recognized in the income statement when the hedged item affects earnings.
Ineffective portions of changes in the fair value of cash flow hedges are
recognized in earnings. For those swaps designated as cash flow hedges, the
Company will maintain variable rate debt equal to the notional of the
outstanding cash flow hedges. The change in fair value of any cash flow hedges
in excess of variable rate debt would be recognized in earnings.
The Company uses interest rate swaps to hedge exposure to variable cash flows
on portions of its borrowings under reverse repurchase agreements and as
trading derivatives intended to offset changes in fair value related to
securities held as trading assets. On the date in which the derivative
contract is entered, the Company designates the derivative as either a cash
flow hedge or a trading derivative.
The reverse repurchase agreements bear interest at a LIBOR based variable
rate. Increases in the LIBOR rate could negatively impact earnings. The
interest rate swap agreements allow the Company to receive a variable rate
cash flow based on LIBOR and pay a fixed rate cash flow, mitigating the impact
of this exposure.
Interest rate swap agreements contain an element of risk in the event that the
counterparties to the agreements do not perform their obligations under the
agreements. The Company minimizes its risk exposure by entering into
agreements with parties rated at least A or better by Standard & Poor's Rating
Services. Furthermore, the Company has interest rate swap agreements
established with several different counterparties in order to reduce the risk
of credit exposure to any one counterparty. Management does not expect any
counterparty to default on their obligations. As of December 31, 2003, the
counterparties for all of the Company's swaps are Deutsche Bank, AG, Merrill
Lynch Capital Services, Inc., Morgan Stanley Capital Services Inc., Goldman
Sachs Capital Markets, L.P., and Lehman Special Financing Inc. with ratings of
AA-, A+, A+, A+, and A, respectively.
On January 1, 2001, the Company reclassified certain of its adjustable rate
agency debt securities, with an amortized cost of $64,432, from
available-for-sale to held-for-trading. An interest rate swap agreement with a
$25,000 notional amount that had been designated as hedging these debt
securities was similarly reclassified. The unrealized gain of $895 related to
the adjustable rate agency debt securities and the unrealized loss of $2,798
related to the interest rate swap as of January 1, 2001 were reclassified from
OCI and recorded as the cumulative transition adjustment to earnings upon
adoption of SFAS No. 133. The net cumulative effect of adopting SFAS No. 133
was ($1,903) and is reflected as "Cumulative Transition Adjustment - SFAS No.
133" on the consolidated statement of operations.
In addition, on January 1, 2001, the Company re-designated interest rate swap
agreements with notional amounts aggregating $98,000 that had been hedging
available-for-sale debt securities as cash flow hedges of its variable rate
borrowings under reverse repurchase agreements. The fair value of these swap
agreements on January 1, 2001, with a cumulative unrealized loss of ($9,853),
remained in OCI at the date of adoption of FAS 133, and therefore, did not
result in a transition adjustment.
Because of the de-designation and re-designation of the $98,000 interest rate
swaps, the Company is required to reclassify the related unamortized swap
costs of $9,853 recorded in OCI. Reclassification is on a straight-line basis
over the shorter of the life of the swap or the previously hedged assets and
is recognized as a reduction of interest income. For each of the years ended
December 31, 2003, 2002 and 2001, $977 was reclassified as a reduction of
interest income and $244 will be reclassified as a reduction of interest
income each quarter for the next 12 months.
In addition, on January 1, 2001, the Company re-designated interest rate swap
agreements with notional amounts aggregating $57,744 that had been hedging
available-for-sale debt securities to hedges of trading securities. These
interest rate swap agreements were sold in January 2001 and the loss of $795
is included in loss on securities held-for-trading. As of December 31, 2000,
the accumulated loss for these interest rate swaps was $3,226. This
accumulated loss is being reclassified from OCI as a reduction of income from
securities available-for-sale over the weighted average life of the securities
these interest rate swaps were hedging on December 31, 2000. For the year
ended December 31, 2001, $257 was reclassified as a reduction of interest
income. Due to the sale of a portion of the available-for-sale debt securities
that were originally being hedged, a portion of the accumulated loss was
reclassified from OCI into gain/(loss) on the consolidated statements of
financial condition. The amortization of the remaining loss was $150 and $159,
respectively, for each of the years ended December 31, 2003 and 2002. For the
next 12 months, an annual amount of $122 will be reclassified as a reduction
of interest income.
As of December 31, 2003, the Company had interest rate swaps that were
designated as cash flow hedges of borrowings under reverse repurchase
agreements. Cash flow hedges with a fair value of $2,759 are included in other
assets on the consolidated statement of financial condition, and cash flow
hedges with a fair value of $(30,653) are included in other liabilities on the
consolidated statement of financial condition. This liability was
collateralized with the restricted cash equivalents recorded on the Company's
consolidated statement of financial condition. For the year ended December 31,
2003, the fair value of the interest rate swaps increased by $13,180 of which
$706 was deemed ineffective and is included as a reduction of interest
expense. The Company expects that $1,863 currently recorded as a component of
OCI will be recognized in earnings in the next twelve months as the hedged
forecasted transactions occur. The remaining increase in fair value of $12,474
was recorded as a decrease to other comprehensive loss. As of December 31,
2003, the $1,066,078 notional of swaps which were designated as cash flow
hedges had a weighted average remaining term of 7.4 years.
During the year ended December 31, 2003, the Company terminated one of its
interest rate swaps with a notional amount of $200,000 that was designated as
a cash flow hedge of borrowings under reverse repurchase agreements. The
Company will reclassify from OCI as an increase to interest expense the $1,593
loss in value incurred, over 1.9 years, which was the remaining term of the
swap at the time it was closed out. For the year ended December 31, 2003, $476
was reclassified as an increase to interest expense and $212 will be
reclassified as an increase to interest expense each quarter for the next 12
months.
As of December 31, 2003, the Company had interest rate swaps with notional
amounts aggregating $479,545 designated as trading derivatives. Trading
derivatives with a fair value of $1,591 are included in other assets on the
consolidated statement of financial condition, and trading derivatives with a
fair value of $(49) are included in other liabilities on the consolidated
statement of financial condition. Their aggregate fair value at December 31,
2003 of $1,542 is included in other liabilities. For the year ended December
31, 2003, the change in fair value for these trading derivatives was $(714)
and is included as an addition to loss on securities held-for-trading in the
consolidated statement of operations. As of December 31, 2003, the $479,545
notional of swaps which were designated as trading derivatives had a weighted
average remaining term of 5.2 years.
As of December 31, 2002, the Company had interest rate swaps with notional
amounts aggregating $771,287 that were designated as cash flow hedges of
borrowings under reverse repurchase agreements. Their aggregate fair value was
a $42,667 liability included in other liabilities on the consolidated
statement of financial condition. This liability was collateralized with cash
listed as restricted cash on the Company's consolidated statement of financial
condition. For the year ended December 31, 2002, the net change in the fair
value of the interest rate swaps was ($56,553) of which $236 was deemed
ineffective and is included as a reduction of interest expense and the gross
loss of $56,769 was recorded as an increase to other comprehensive loss. As of
December 31, 2002, the $771,287 notional of swaps which were designated as
cash flow hedges had a weighted average remaining term of 6.7 years.
During the year ended December 31, 2002, the Company terminated two of its
interest rate swaps with notional amounts aggregating $290,000 that were
designated as cash flow hedges of borrowings under reverse repurchase
agreements. The Company will reclassify from OCI as an increase to interest
expense the $15,968 loss in value incurred, over 3.4 years, which was the
weighted average remaining term of the swaps at the time they were closed out.
For the year ended December 31, 2002, $425 was reclassified as an increase to
interest expense and $1,275 was reclassified as an increase to interest
expense each quarter for the year ended December 31, 2003.
As of December 31, 2002, the Company had interest rate swaps with notional
amounts aggregating $371,545 designated as trading derivatives. Their
aggregate fair value at December 31, 2002 of ($2,935) is included in other
liabilities. For the year ended December 31, 2002, the change in fair value
for these trading derivatives was $(1,581) and is included as an addition to
loss on securities held-for-trading in the consolidated statement of
operations. As of December 31, 2002, the $371,545 notional of swaps which were
designated as trading derivatives had a weighted average remaining term of 5.3
years.
The Company formally documents all relationships between hedging instruments
and hedged items, as well as its risk-management objectives and strategies for
undertaking various hedge transactions. The Company assesses, both at the
inception of the hedge and on an on-going basis, whether the derivatives that
are used in hedging transactions are highly effective in offsetting changes in
fair values or cash flows of hedged items. When it is determined that a
derivative is not highly effective as a hedge, the Company discontinues hedge
accounting prospectively.
Occasionally, counterparties will require the Company or the Company will
require counterparties to provide collateral for the interest rate swap
agreements in the form of margin deposits. Net deposits are recorded as a
component of other assets or other liabilities. Should the counterparty fail
to return deposits paid, the Company would be at risk for the fair market
value of that asset. At December 31, 2003 and 2002, the balance of such net
margin deposits owed to counterparties as collateral under these agreements
totaled $10,445 and $14,810, respectively.
The implementation of SFAS No. 133 did not change the manner in which the
Company accounts for its forward currency exchange contracts. Hedge accounting
is not applied for these contracts and they are carried at fair value, with
changes in fair value included as a component of net foreign currency gain or
loss in the consolidated statement of operations.
The Company's foreign currency exchange contracts were intended to
economically hedge currency risk in connection with the Company's investment
in the London Loan, which was denominated in pounds sterling. The estimated
fair value of the forward currency exchange contracts was a liability of $365
at December 31, 2002, which change was recognized as a reduction of foreign
currency losses. As of December 31, 2003, the Company did not have economic
exposure to its forward currency exchange contract.
The contracts identified in the remaining portion of this footnote have been
entered into to limit the Company's mark to market exposure to long-term
interest rates.
At December 31, 2003, the Company had outstanding short positions of 30
five-year and 73 ten-year U.S. Treasury Note future contracts, which
represented $3,000 and $7,300 in face amounts of U.S. Treasury Notes,
respectively. The estimated fair value of the contracts was approximately
$(11,436), and the change in fair value related to these contracts is included
as a component of loss on securities held-for-trading. Additionally, the
Company had a forward LIBOR cap with a notional amount of $85,000 and a fair
value at December 31, 2003 of $1,114 which is included in other liabilities.
At December 31, 2002, the Company had outstanding short positions of 3,166
five-year and 1,126 ten-year U.S. Treasury Note future contracts, which
represented $316,600 and $112,600 in face amounts of U.S. Treasury Notes,
respectively. The estimated fair value of the contracts was approximately
$(476,676), and the change in fair value related to these contracts is
included as a component of loss on securities held-for-trading. Additionally,
the Company had a forward LIBOR cap and with a notional amount of $85,000 and
a fair value at December 31, 2002 of $1,207 which is included in other
liabilities.
Note 14 ACQUISITION OF CORE CAP, INC.
During 2000, the Company acquired in a business combination all of the
outstanding capital stock of CORE Cap, Inc. ("CORE Cap"), a private real
estate investment trust investing in mortgage loans and mortgage-backed
securities, in exchange for 4,180,552 shares of the Company's Common Stock and
2,261,000 shares of Series B Preferred Stock. The shares of Common Stock and
Preferred Stock issued by the Company were valued at approximately $71,094 on
May 15, 2000. Pursuant to SFAS No. 142, the Company recognized the December
31, 2001 unamortized negative goodwill balance of $6,327 resulting from this
acquisition in income during the first quarter of 2002.
Note 15 NET INCOME PER SHARE
Net income per share is computed in accordance with SFAS No. 128, "Earnings
Per Share" ("SFAS No. 128"). Basic income per share is calculated by dividing
net income available to common stockholders by the weighted average number of
shares of Common Stock outstanding during the period. Diluted income per share
is calculated using the weighted average number of shares of Common Stock
outstanding during the period plus the additional dilutive effect of common
stock equivalents. The dilutive effect of outstanding stock options is
calculated using the treasury stock method, and the dilutive effect of
preferred stock is calculated using the "if converted" method.
For the year ended December 31,
2003 2002 2001
---------------------------------------------
Numerator:
Net income (loss) available to common stockholders before
cumulative transition adjustment $ (16,386) $ 48,466 $ 49,210
Cumulative transition adjustment - SFAS No. 142 - 6,327 -
Cumulative transition adjustment - SFAS No. 133 - - (1,903)
----------- --------- ----------
Numerator for basic earnings per share $(16,836) $ 54,793 $ 47,307
Effect of 10.5% Series A senior cumulative redeemable preferred stock - - 3,420
----------- --------- ----------
Numerator for diluted earnings per share $(16,836) $ 54,793 $ 50,727
=========== ========= ==========
Denominator:
Denominator for basic earnings per share--weighted average
common shares outstanding 48,246 46,411 33,568
Effect of 10.5% Series A senior cumulative redeemable preferred stock - 7 3,993
Dilutive effect of stock options - 34 55
----------- --------- ----------
Denominator for diluted earnings per share--weighted average
common shares outstanding and common stock equivalents
outstanding 48,246 46,452 37,616
=========== ========= ==========
Basic net (loss) income per weighted average common share:
(Loss) income before cumulative transition adjustment $(0.34) $1.04 $1.47
Cumulative transition adjustment - SFAS No. 142 - 0.14 -
Cumulative transition adjustment - SFAS No. 133 - - (0.06)
----------- --------- ----------
Net (loss) income $(0.34) $1.18 $1.41
=========== ========= ==========
Diluted net (loss) income per weighted average common stock and common stock
equivalents:
(Loss) income before cumulative transition adjustment $(0.34) $1.04 $1.40
Cumulative transition adjustment - SFAS No. 142 - 0.14 -
Cumulative transition adjustment - SFAS No. 133 - - (0.05)
----------- --------- ----------
Net (loss) income $(0.34) $1.18 $1.35
=========== ========= ==========
Total anti-dilutive stock options and warrants excluded from the calculation
of net income (loss) per share were 1,468,351, 1,432,442 and 1,089,754 for the
years ended December 31, 2003, 2002, and 2001, respectively.
Note 16 SUMMARIZED QUARTERLY RESULTS (UNAUDITED)
The following is a presentation of quarterly results of operations:
Quarters Ending
March 31 June 30 September 30 December 31
2003 2002 2003 2002 2003 2002 2003 2002
---------- ----------- ------------ ----------- ------------- ----------- ----------- -----------
Interest Income $42,823 $39,351 $42,410 $38,732 $40,329 $41,754 $38,216 $42,609
---------- ----------- ------------ ----------- -------------- ----------- ----------- ----------
Expenses:
Interest 19,705 11,640 21,737 15,474 21,614 18,836 20,193 19,068
Management fee and
other 3,159 5,983 3,240 2,775 2,666 3,083 2,642 3,009
---------- ----------- ------------ ----------- -------------- ----------- ----------- ----------
Total Expenses 22,864 17,623 24,977 18,249 24,280 21,919 22,835 22,077
---------- ----------- ------------ ----------- -------------- ----------- ----------- ----------
Gain (loss) on sale of
securities available-for-sale 142 (4,079) 3,294 4,154 (4,704) 9,538 (5,564) 1,778
Gain (loss) on securities
held-for-trading (10,404) 4,014 (4,716) (11,914) (28,154) (15,948) 5,068 (5,407)
Foreign currency (loss) gain - (247) - 18 - (151) - (432)
Loss on impairment of assets - - (27,014) - (5,412) - - (10,273)
---------- ----------- ------------ ----------- -------------- ----------- ----------- ----------
Net income before cumulative
transition adjustment 9,697 21,416 (11,003) 12,741 (22,221) 13,274 14,885 6,198
---------- ----------- ------------ ----------- -------------- ----------- ----------- ----------
Cumulative transition - - - - - - - -
adjustment - SFAS No. 133
Cumulative transition
adjustment - SFAS No. 142 - 6,327 - - - - - -
---------- ----------- ------------ ----------- -------------- ----------- ----------- ----------
Net income (loss) 9,697 27,743 (11,003) 12,741 (22,221) 13,274 14,885 6,198
Dividends and accretion on
redeemable convertible
preferred stock 1,195 1,389 1,611 1,382 2,491 1,196 2,446 1,195
---------- ----------- ------------ ----------- -------------- ----------- ----------- ----------
Net income (loss) available
to common stockholders $8,502 $26,354 $(12,614) $11,359 $(24,712) $12,078 $12,439 $5,003
========== =========== ============ =========== ============== =========== =========== ==========
Net income (loss) per share,
basic:
Income before cumulative
transition adjustment $0.18 $0.44 $(0.26) $0.25 $(0.51) $0.26 $0.25 $0.11
Cumulative transition
adjustment - 0.14 - - - - - -
----------- ----------- ------------ ----------- -------------- ----------- ----------- ----------
Net Income $0.18 $0.58 $(0.26) $0.25 $(0.51) $0.26 $0.25 $0.11
=========== =========== ============ =========== ============== =========== =========== ==========
Net income (loss) per share,
diluted:
Income before cumulative
transition adjustment $0.18 $0.44 $(0.26) $0.25 $(0.51) $0.26 $0.25 $0.11
Cumulative transition
adjustment - 0.14 - - - - - -
----------- ----------- ------------ ----------- -------------- ----------- ----------- ----------
Net Income $0.18 $0.58 $(0.26) $0.25 $(0.51) $0.26 $0.25 $0.11
=========== =========== ============ =========== ============== =========== =========== ==========
Note 17 SUBSEQUENT EVENTS
On February 11, 2004, Hugh R. Frater, the then President and Chief Executive
Officer of the Company, advised the Board of Directors of his resignation from
the Company and his intention to accept a position as Executive Vice President
and Head of Real Estate Finance at The PNC Financial Services Group, Inc.
(NYSE:PNC). Mr. Frater will continue to serve as a member of the Company's
Board of Directors. Christopher A. Milner was appointed President and Chief
Executive Officer and will continue as Chief Investment Officer of the
Company.
During the months of January and February 2004, the Company received $6,596
under the Company's Divided Reinvestment Plan and issued 600,328 shares of its
Common Stock.
The Company is currently marketing CDO III, which it expects to close in March
2004. The Company anticipates contributing approximately $385,000 par of CMBS
and REIT debt to CDO III, and will contribute an additional $50,000 par of
below investment grade CMBS over the next twelve months.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures. The Company's
management, with the participation of the Company's Chief Executive
Officer and Chief Financial Officer, has evaluated the effectiveness
of the Company's disclosure controls and procedures (as such term is
defined in Rules 13a-14(c) and 15d-14(c) under the Securities
Exchange Act of 1934, as amended (the "Exchange Act")) as of the end
of the period covered by this report. Based on such evaluation, the
Company's Chief Executive Officer and Chief Financial Officer have
concluded that, as of the end of such period, the Company's
disclosure controls and procedures are effective in alerting them on
a timely basis to material information relating to the Company
(including its consolidated subsidiaries) required to be included in
the Company's reports filed or submitted under the Exchange Act.
(b) Changes in Internal Controls. There has been no change in the
Company's internal control over financial reporting during the
quarter ended December 31, 2003 that has materially affected, or is
reasonably likely to materially affect, such internal control over
financial reporting.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Incorporated by reference to the Company's Definitive Proxy Statement
for the 2004 Annual Meeting of Stockholders.
ITEM 11. EXECUTIVE COMPENSATION
Incorporated by reference to the Company's Definitive Proxy Statement
for the 2004 Annual Meeting of Stockholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
Incorporated by reference to the Company's Definitive Proxy Statement
for the 2004 Annual Meeting of Stockholders.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated by reference to the Company's Definitive Proxy Statement
for the 2004 Annual Meeting of Stockholders.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Incorporated by reference to the Company's Definitive Proxy Statement
for the 2004 Annual Meeting o Stockholders.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1) Financial statements
See index to Financial statements at item 8 of this report.
(a)(3) Exhibit Index
*3.1 Articles of Amendment and Restatement of the Registrant
*3.2 Bylaws of the Registrant
*3.3 Form of Articles Supplementary of the Registrant establishing
10% Cumulative Convertible Series B Preferred Stock.
*3.4 Articles Supplementary of the Registrant establishing 9.375%
Series C Cumulative Redeemable Preferred Stock.
*10.1 Investment Advisory Agreement between the Registrant and
BlackRock Financial Management, Inc.
*10.2 Amendment No. 1 to the Investment Advisory Agreement between
the Registrant and BlackRock Financial Management, Inc.
*10.3 Amendment No. 2 to the Investment Advisory Agreement between
the Registrant and BlackRock Financial Management, Inc.
*10.4 Amendment No.3 to the Investment Advisory Agreement between
the Registrant and BlackRock Financial Management, Inc.
*10.5 Form of 1998 Stock Option Incentive Plan
21.1 Subsidiaries of the Registrant
23.1 Consent of Deloitte & Touche LLP
24.1 Power of Attorney (included on signature page hereto)
31.1 Certification of Chief Executive Officer
31.2 Certification of Chief Financial Officer
32.1 Section 1350 Certification of Chief Executive Officer and
Chief Financial Officer
* Previously filed.
(b) Reports on Form 8-K.
During the last quarter of the year ended December 31, 2003, the
Company filed the following reports on Form 8-K:
On October 31, 2003, the Company filed a current report on Form 8-K
to report under Item 5, 7 and 12 the Company's third quarter 2003
results.
On December 10, 2003, the Company filed an amendment to the current
report on Form 8-K filed on October 31, 2003, to correct a clerical
error contained in Exhibit 99.1 of the current report on Form 8-K.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Registrant has duly caused this report
to be signed on its behalf by the undersigned, thereunto duly authorized.
ANTHRACITE CAPITAL, INC.
Date: March 10, 2004 By:/s/ Christopher A. Milner
-----------------------------------
Christopher A. Milner
President and Chief Executive Officer
(duly authorized representative)
KNOW ALL MEN BY THESE PRESENTS, that each individual whose signature
appears below constitutes and appoints Richard M. Shea his true and lawful
attorney-in-fact and agents with full power of substitution and
resubstitution, for his name, place and stead, in any and all capacities, to
sign any and all amendments (including post-effective amendments) to this Form
10-K and to file the same with all exhibits thereto, and all documents in
connection therewith, with the Securities and Exchange Commission, granting
unto said attorneys-in-fact and agents, and each of them, full power and
authority to do and perform each and every act and thing requisite and
necessary to be done, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents or any of them, or their or his substitute or
substitutes, may lawfully do or cause to be done by virtue hereof. This power
of attorney may be executed in counterparties.
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this report has been signed below by the following persons on behalf
of the Registrant and in the capacities and on the dates indicated.
Date: March 10, 2004 By: /s/ Christopher A. Milner
___________________________________
Christopher A. Milner
President and Chief Executive
Officer
Date: March 10, 2004 By: /s/ Richard M. Shea
___________________________________
Richard M. Shea
Chief Financial Officer and Chief
Operating Officer
Date: March 10, 2004 By: /s/ Laurence D. Fink
___________________________________
Laurence D. Fink
Chairman of the Board of Directors
Date: March 10, 2004 By: /s/ Hugh R. Frater
___________________________________
Hugh R. Frater
Director
Date: March 10, 2004 By: /s/ Donald G. Drapkin
___________________________________
Donald G. Drapkin
Director
Date: March 10, 2004 By: /s/ Carl F. Guether
___________________________________
Carl F. Guether
Director
Date: March 10, 2004 By: /s/ Jeffrey C. Keil
___________________________________
Jeffrey C. Keil
Director
Date: March 10, 2004 By: /s/ Ralph Schlosstein
___________________________________
Ralph Schlosstein
Director
Date: March 10, 2004 By: /s/ Leon T. Kendall
___________________________________
Leon T. Kendall
Director