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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, 2000
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
- --- EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
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COMMISSION FILE NUMBER: 001-11914
THORNBURG MORTGAGE, INC.
(Exact name of Registrant as specified in its Charter)
MARYLAND 85-0404134
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
119 E. MARCY STREET
SANTA FE, NEW MEXICO 87501
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (505) 989-1900
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of Exchange on Which Registered
- ------------------------------------- ---------------------------------------
Common Stock ($.01 par value) New York Stock Exchange
Series A 9.68% Cumulative Convertible New York Stock Exchange
Preferred Stock ($.01 par value)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
Regulation S-K is not contained herein, and will not be contained, to the best
of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
At March 5, 2001, the aggregate market value of the voting stock held by
non-affiliates was $232,449,369, based on the closing price of the common stock
on the New York Stock Exchange.
Number of shares of Common Stock outstanding at March 5 , 2001: 21,719,178
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the Registrant's definitive Proxy Statement dated March 28,
2001, issued in connection with the Annual Meeting of Shareholders of the
Registrant to be held on April 26, 2001, are incorporated by reference
into Parts I and III.
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THORNBURG MORTGAGE, Inc.
2000 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PART I
Page
----
ITEM 1. BUSINESS . . . . . . . . . . . . . . . . . . . . . . 4
ITEM 2. PROPERTIES . . . . . . . . . . . . . . . . . . . . . 21
ITEM 3. LEGAL PROCEEDINGS. . . . . . . . . . . . . . . . . . 21
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. 21
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED SHAREHOLDER MATTERS. . . . . . . . . . . 22
ITEM 6. SELECTED FINANCIAL DATA. . . . . . . . . . . . . . . 25
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS. . . . 26
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE
ABOUT MARKET RISKS. . . . . . . . . . . . . . . . . 45
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. . . . . 45
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE. . . . . . . . . 45
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. 45
ITEM 11. EXECUTIVE COMPENSATION. . . . . . . . . . . . . . . 45
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT . . . . . . . . . . . . . . . . . . . . 45
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS . . 45
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND
REPORTS ON FORM 8-K . . . . . . . . . . . . . . . . 46
FINANCIAL STATEMENTS . . . . . . . . . . . . . . . . . . . . . . F-1
SIGNATURES
EXHIBIT INDEX
3
PART I
ITEM 1. BUSINESS
GENERAL
Thornburg Mortgage, Inc., including subsidiaries, (the "Company") is a mortgage
acquisition company that primarily invests in adjustable-rate mortgage ("ARM")
assets comprised of ARM securities and ARM loans, thereby providing capital to
the single family residential housing market. ARM securities represent
interests in pools of ARM loans, which often include guarantees or other credit
enhancements against losses from loan defaults. While the Company is not a bank
or savings and loan, its business purpose, strategy, method of operation and
risk profile are best understood in comparison to such institutions. The
Company leverages its equity capital using borrowed funds, invests in ARM assets
and seeks to generate income based on the difference between the yield on its
ARM assets portfolio and the cost of its borrowings. The corporate structure of
the Company differs from most lending institutions in that the Company is
organized for tax purposes as a real estate investment trust ("REIT") and
therefore generally passes through substantially all of its earnings to
shareholders without paying federal or state income tax at the corporate level.
See "Federal Income Tax Considerations -- Requirements for Qualification as a
REIT". The Company has two qualified REIT subsidiaries which are involved in
financing its mortgage loan assets. The two financing subsidiaries, Thornburg
Mortgage Funding Corporation and Thornburg Mortgage Acceptance Corporation, are
consolidated in the Company's financial statements and federal and state tax
returns.
Thornburg Mortgage Home Loans, Inc.
The Company has formed Thornburg Mortgage Home Loans, Inc. ("TMHL") as a
wholly-owned REIT subsidiary to conduct the Company's mortgage loan acquisition
and mortgage loan origination activities. Retail mortgage origination is the
newest channel for acquiring ARM loans for the Company's portfolio. TMHL
commenced operations during the second quarter of 2000. In the fourth quarter
of 2000, all of the Company's ARM loans and servicing rights were transferred
to TMHL, as were the obligations to buy, finance and securitize all ARM loans.
Effective December 1, 2000, TMHL and its subsidiaries began operating as taxable
entities. To facilitate the securitization and financing of loans by TMHL, two
special purpose subsidiaries of TMHL have been created: Thornburg Mortgage
Funding Corporation II and Thornburg Mortgage Acceptance Corporation II.
TMHL acquires mortgage loans through three channels: bulk acquisitions,
correspondent lending and retail originations. TMHL finances the loans through
two warehouse borrowing arrangements, pools loans for securitization and sale to
the parent's REIT operation, and occasionally sells loans to third parties. As a
taxable REIT subsidiary, TMHL has more flexibility in trading and securitizing
assets than a REIT qualified subsidiary.
TMHL originates ARM loans based upon the Company's underwriting standards and
ARM product designs. It also offers other standard loan products, including
fixed-rate loans, that are originated and sold to third-party investors. The
Company expects to avoid establishing an expensive infrastructure involving
substantial fixed costs generally associated with operating a mortgage banking
operation by utilizing private-label "fee based" third-party vendors who (1)
specialize in the underwriting, processing and closing of mortgage loans and (2)
a subservicer to provide the capability to service the loans originated. The
Company believes these third-party service providers have developed both
efficiencies and expertise through specialization that afford the Company an
opportunity to enter the mortgage origination and loan servicing business in a
cost effective manner with very little "up front" investment. This approach
also insulates the Company from the expenses and risks associated with mortgage
lending business cycles: hiring additional staff to meet heavy demand and then
laying off workers as lending activity declines.
4
Thornburg Brand Development and Company Name Change
The Company instituted a new marketing approach in conjunction with affiliates
aimed at developing brand recognition of the Thornburg name. As a part of
redefining its marketing message, the Company has formally changed its corporate
name to Thornburg Mortgage, Inc. This new name more accurately reflects the
expanded business of the Company from purely an asset manager to a value-added
operating enterprise that originates and services mortgage loans as well as
manages a portfolio of high quality mortgage assets on a low cost basis.
OPERATING POLICIES AND STRATEGIES
Investment Strategies
Historically, the Company has relied solely on an investment strategy to
purchase ARM securities and ARM loans originated and serviced by other mortgage
lending institutions In 1999, the Company expanded its acquisition strategy to
include acquiring assets that meet Thornburg underwriting guidelines through a
new correspondent lending program which currently includes approximately thirty
financial institutions approved by the Company. In 2000, the Company began
originating loans directly through its mortgage banking subsidiary, TMHL.
Currently, TMHL is licensed to lend in nineteen states but over the next two
years TMHL intends to be licensed to lend nationwide. In becoming an originator
of loans for its own portfolio, the Company offers its loan products to target
markets of higher quality, more sophisticated borrowers. This approach is
consistent with the Company's emphasis on acquiring high credit quality loans.
By increasing its sources for mortgage loans, the Company expects to enhance its
ability to acquire high quality assets at attractive prices.
The Company purchases ARM assets from broker-dealers and financial institutions
that regularly make markets in these assets. The Company also purchases ARM
assets from other mortgage suppliers, including mortgage bankers, banks, savings
and loans, investment banking firms, home builders and other firms involved in
originating, packaging and selling mortgage loans. The Company believes it has a
competitive advantage in the acquisition and investment of these mortgage
securities and mortgage loans because of the low cost of its operations relative
to traditional mortgage investors like banks and savings and loans. Like
traditional financial institutions, the Company seeks to generate income for
distribution to its shareholders primarily from the difference between the
interest income on its ARM assets and the financing costs associated with
carrying its ARM assets.
In 1998, the Company began investing in hybrid ARM assets ("Hybrid ARMs") which
are included in the Company's references to ARM securities and ARM loans.
Hybrid ARMs are typically 30 year loans that have a fixed rate of interest for
an initial period, generally 3 to 10 years, and then convert to an
adjustable-rate for the balance of the term of the Hybrid ARM. In keeping with
the Company's policy of minimizing interest rate risk in its portfolio, the
Hybrid ARMs are generally financed with fixed rate debt for the period in which
their interest rate is fixed. See "Hedging Strategies".
The Company's mortgage assets portfolio may consist of either agency or
privately issued securities (generally publicly registered) mortgage
pass-through securities, multi-class pass-through securities, collateralized
mortgage obligations ("CMOs"), collateralized bond obligations ("CBOs"),
generally backed by high quality mortgage backed securities, ARM loans, Hybrid
ARMs, fixed-rate mortgage-backed securities that have an expected duration of
one year or less or short-term investments that either mature within one year or
have an interest rate that reprices within one year. The Company will not
invest more than 30% of its ARM assets in Hybrid ARMs, increased to 35% by the
Company's Board of directors in January 2001, and will limit its interest rate
repricing mismatch (the difference between the remaining fixed-rate period of a
Hybrid ARM and the maturity of the fixed-rate liability funding a Hybrid ARM) to
a duration of no more than one year. Hybrid ARMs with fixed-rate periods of
greater than five years are further limited to no more than 10% of the Company's
ARM assets. As with all its Hybrid ARMs, the Company will hedge the interest
rate risk of financing the longer Hybrid ARMs consistent with its hedging
strategies. See "Hedging Strategies".
The Company's investment policy requires the Company to invest at least 70% of
total assets in High Quality adjustable and variable rate mortgage securities
and short-term investments. High Quality means:
(1) securities that are unrated but are guaranteed by the U.S. Government or
issued or guaranteed by an agency of the U.S. Government;
(2) securities which are rated within one of the two highest rating
categories by at least one of either Standard & Poor's or Moody's
Investors Service, Inc. (the "Rating Agencies"); or
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(3) securities that are unrated or whose ratings have not been updated but
are determined to be of comparable quality (by the rating standards of
at least one of the Rating Agencies) to a High Quality rated mortgage
security, as determined by the Manager (as defined below) and approved
by the Company's Board of Directors; or
(4) the portion of ARM or hybrid loans that have been deposited into a trust
and have received a credit rating of AA or better from at least one
Rating Agency.
The remainder of the Company's ARM portfolio, comprising not more than 30% of
total assets, may consist of Other Investment assets, which may include:
(1) adjustable or variable rate pass-through certificates, multi-class
pass-through certificates or CMOs backed by loans on single-family,
multi-family, commercial or other real estate-related properties so long
as they are rated at least Investment Grade at the time of purchase.
"Investment Grade" generally means a security rating of BBB or Baa or
better by at least one of the Rating Agencies;
(2) ARM loans secured by first liens on single-family residential
properties, generally underwritten to "A" quality standards, and
acquired for the purpose of future securitization (see description
of "A" quality in "Portfolio of Mortgage Assets - ARM and Hybrid ARM
Loans"); or
(3) a limited amount, currently $70 million as authorized by the Board of
Directors, of less than investment grade classes of ARM securities that
are created as a result of the Company's loan acquisition and
securitization efforts.
Since inception, the Company has generally invested less than 15%, currently
approximately 3%, of its total assets in Other Investment assets, excluding
loans held for securitization. Despite the generally higher yield, the Company
does not expect to significantly increase its investment in Other Investment
securities. This is primarily due to the difficulty of financing such assets at
reasonable financing terms and values through all economic cycles.
The Company does not invest in REMIC residuals or other CMO residuals and,
therefore does not create excess inclusion income or unrelated business taxable
income for tax exempt investors. Therefore, the Company is a mortgage REIT
eligible for purchase by tax exempt investors, such as pension plans, profit
sharing plans, 401(k) plans, Keogh plans and Individual Retirement Accounts
("IRAs").
Acquisition of ARM and Hybrid ARM Loans
Through TMHL, the Company acquires existing pools of ARM loans, acquires
individual loans directly from loan originators, and originates mortgage loans
on a retail basis. All loans acquired from third parties and ARM loans
originated by the Company are intended to be securitized and then held in the
ARM securities portfolio as high quality assets. Acquiring and originating ARM
loans for securitization is expected to benefit the Company by providing: (i)
greater control over the quality and types of ARM assets acquired; (ii) the
ability to acquire ARM assets at lower prices so that the amount of the premium
to be amortized will be reduced in the event of prepayment; (iii) additional
sources of new whole-pool ARM assets; and (iv) potentially higher yielding
investments in its portfolio.
Mortgage Acquisitions
The Company acquires third-party originated residential ARM and Hybrid ARM whole
loans utilizing two processes which the Company calls the Bulk Acquisition
Method ("Bulk Method") and the Flow Acquisition Method ("Flow Method"). The
Bulk Method, which the Company began utilizing in 1997, involves a number of the
Company's established relationships with mortgage originators, or mortgage
aggregators, who sell the Company pools of whole loans at market prices, with or
without the servicing rights. In many cases the Company buys the servicing
rights along with the loans and the Company then services the loans using its
third-party subservicer, who performs the loan servicing function for a fee.
In the Bulk Method, the loans are originated using the seller's loan products,
programs and underwriting guidelines. Additionally, the credit review of the
borrower, the appraisal of the property and the quality control procedures are
performed by the originator. The Company generally only considers the purchase
of loans when all of the borrowers have had their incomes and assets verified,
their credit checked and appraisals of the properties have been obtained. The
Company then obtains an independent underwriter's review, performed by a
third-party for the benefit of the Company, which entails a review of the
application processing, underwriting and loan closing methodologies used by the
originators in qualifying a borrower for a loan. In addition, the Company
utilizes its own personnel to re-review some of the individual loans in order to
insure the highest possible loan quality. The Company generally does not review
all of the loans in a bulk package of loans, but rather selects loans for
underwriting review based upon specific criteria such as property location, loan
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size, effective loan-to-value ratios, borrowers' credit score and other criteria
the Company believes to be important indicators of credit risk. Additionally,
prior to the purchase of loans, the Company obtains representations and
warranties from each seller stating that each loan meets the seller's
underwriting standards and other requirements. The breach of such
representations and warranties in regards to a loan can result in the seller
having an obligation to repurchase the loan.
In the Flow Method, which the Company began utilizing in the first half of 1999,
the Company acquires mortgage loans largely from correspondent lenders using the
Company's internally developed loan programs and underwriting criteria. This
means that the correspondent originates the individual loans using the Company's
established credit and program guidelines. In select cases, some correspondents
sell their own loan products to the Company which are originated according to
the correspondents' pre-approved product specifications and underwriting
guidelines. All correspondents are pre-qualified by the Company to determine
their financial strength and the soundness of their own established in-house
mortgage procedures. Each borrower's credit and the value of each property is
underwritten by the correspondents to the Company's approved specifications.
This is the same process used by originators/sellers in the Bulk Method except
that in the Flow Method all of the application processing, loan underwriting,
credit approval and appraisal guidelines have been developed or pre-approved by
the Company to meet the Company's own credit criteria and portfolio
requirements.
Prior to closing, all of the loans acquired in the Flow Method are then
subjected to further compliance review by either 1) by the Company's staff or 2)
mortgage insurance companies which use the Company's guidelines to review the
loans to insure product quality and compliance with the Company's guidelines.
The six mortgage insurance companies chosen by the Company to perform this
function use a two-step loan approval process. After the primary underwriting
and quality control review are performed by the originator/seller, but prior to
the purchase of the loans by the Company, all of the higher risk/higher LTV
loans are placed through an automated underwriting system created by Fannie Mae
called "Desktop Underwriter." This is the same system used by Fannie Mae in
connection with all of their own loan purchases. Secondly, all loans are then
screened by the mortgage insurance company personnel or the Company's staff to
verify their compliance to the Company's guidelines. After closing, a select
number of these loans are then subjected to an additional quality control review
performed by a third-party which again verifies that the loan was properly
underwritten and to confirm that the loan documents are complete and properly
executed. All of the loans acquired through the Flow Method are assigned a
"Risk Evaluation Score" or "Mortgage Score" by each of the mortgage insurance
companies. The risk score evaluates not only the borrower's credit but also the
geographic location of the property, the economic viability of the area, the
general market conditions and the loan product chosen by the borrower. The
Company believes that obtaining risk scores will help in reducing the Company's
securitization costs by insuring that the Company purchases the highest quality
mortgage loans with the lowest risk possible.
Historically, mortgage loans acquired through either the Bulk or Flow Method
were acquired, generally, with the servicing rights remaining with the
originator/seller. In the third quarter of 2000, the Company began purchasing
the servicing rights for most of the loans acquired. By owning the servicing
rights, the Company intends to provide borrowers with high quality customer
service along with loan modification and refinance opportunities. These efforts
are designed to lower prepayments speeds on the portfolio through customer
retention. In cases where the Company buys the servicing rights along with the
loans, the Company contracts with a qualified loan servicer, as subservicer, to
perform the loan servicing function for a fee. The subservicer performs the
servicing function on a "private label basis" or in the name of the Company.
For each loan purchase, the Company obtains representations and warranties from
the seller stating that each loan meets the Company's approved underwriting
standards and other requirements. The breach of such representations and
warranties in regards to a loan can result in the seller having an obligation to
repurchase the loan.
In both methods, the Company uses its in-house staff as well as third-party
credit underwriters to verify the credit quality of the borrowers as well as the
soundness of the mortgage collateral securing the individual loans. As added
security, the Company uses the services of a third-party document custodian to
insure the quality and accuracy of all individual mortgage loan closing
documents, which are then held in safekeeping with the third-party document
custodian. As a result, all of the original individual loan closing documents
that are signed by the borrower, other than the original credit verification
documents, are examined, verified and held by the custodian.
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Loan Origination
The Company originates mortgage loans through TMHL. As of February 20, 2001,
TMHL is licensed to originate loans in the following nineteen states and, by
2002, TMHL is expected to be licensed nationwide as a mortgage lender.
Alaska Kentucky New Mexico
Arkansas Louisiana North Carolina
Colorado Maryland Oklahoma
Connecticut Massachusetts South Carolina
Indiana Mississippi Texas
Iowa Missouri Utah
Kansas
The Company's retail lending strategy is to utilize its portfolio lending
capability, its competitive advantages and its technology to become the mortgage
lender of the future, which is a low cost, low overhead, efficient lender that
provides attractive and innovative mortgage products, competitive mortgage
rates, and a high level of customer service. By eliminating intermediaries
between the borrower and the Company, an investor in mortgage assets, the
Company expects to originate loans at attractive yields while still offering
borrowers competitive mortgage rates. In expanding into the retail origination
business, the Company intends to continue its strategy of acquiring only quality
mortgages with the same emphasis on loan quality as in its current loan
acquisition activities.
In 2000, the Company began originating loans directly with borrowers using one
of two origination channels. The Company started to originate loans using a
call center, where borrowers call the Company, inquire about loan products and
interest rates, seek advice and counseling regarding qualifying for a loan and
the approval process. This channel began operation on a pilot basis with
Company staff in 2000. In 2001, this channel will be expanded to employ
third-party call center specialists versed in mortgage loan origination where
prospective borrowers are able to apply for a loan over the telephone. A
completed mortgage loan application along with a request for additional
supporting documentation is sent to the borrower for signature. Thornburg
Mortgage loan processors, or their third-party agents, are responsible for
working with the borrower to complete the processing of the loan application,
obtain a final loan approval and schedule the loan for closing.
By the second quarter of 2001, the Company also expects to offer mortgages
on-line utilizing third-party, private label web-based origination systems. In
this instance, prospective borrowers will be able to look up mortgage loan
product and interest rate information through the Company's website, submit an
application on-line and obtain a pre-approval of their loan. Once a mortgage
loan application has been submitted, a Thornburg Mortgage representative will be
assigned the responsibility of completing the loan process on behalf of the
borrower.
The mortgage origination process is a labor intensive, document intensive
business that requires significant back office systems and personnel. The
Company has contracted with a third-party "back office" mortgage service
provider to provide all of the loan processing, underwriting, documentation and
closing functions required to originate and close mortgage loans. Additionally,
another third-party service provider has staffed a mortgage loan call center for
the benefit of the Company. These services are provided on a "private label"
basis, meaning that all of these representatives will identify themselves as
being Thornburg Mortgage representatives. The benefit to the Company of this
arrangement is that the Company pays for these services as it uses them, without
a significant investment in personnel, systems, office space and equipment.
Regardless of the origination channel, the Company's borrowers will be able to
track the progress of their mortgage loan application as it makes its way
through processing, underwriting and closing using the Thornburg Mortgage
website. In this way, prospective borrowers are able to stay fully informed
regarding the status of their loan application.
The Company has also contracted with a third-party to provide private label loan
servicing for loans which the Company originates or purchases on a servicing
released basis. This third-party subservicer collects mortgage loan payments,
manages escrow accounts, provides monthly statements and notices to borrowers,
offers on-line mortgage servicing information and provides customer service,
loan collection, loss mitigation, foreclosure, bankruptcy and REO management
services. The fees paid by the Company for this service are based on a fixed
rate schedule based on the number of loans serviced. A third-party service
provider using the name Thornburg Mortgage is providing all of these
loan-servicing functions.
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Securitization of ARM Loans
The Company acquires ARM loans for its portfolio with the intention of
securitizing them in such a way as to maximize the amount of high quality
securities that can be created from an accumulation of the ARM loans. In order
to facilitate the securitization of its loans, the Company generally retains a
subordinate interest in the loans which provides a limited amount of credit
enhancement, and often purchases an insurance policy from a third-party
financial guarantor that "wraps" the remaining balance of the loans to a credit
rating of AA or better. Upon securitization, the Company then owns the high
quality ARM securities and the subordinate certificates in its portfolio and
finances the high quality securities in the repurchase agreement market, or
issues debt obligations in the capital markets as an alternative financing
source to the repurchase agreement market.
The Company also securitizes its conforming balance loans through a program
provided by Fannie Mae. See "Fannie Mae Loan Programs". The Company exchanges
pools of its loans with balances no greater than $252,000 in 2000 and $275,000
in 2001 for a Fannie Mae Mortgage-Backed Security or MBS. As described in the
"Fannie Mae Loan Programs" below, the Company receives an MBS which pays the
Company interest and principal derived from the interest and principal payments
on the underlying mortgages less a fee paid to the servicer of the loans and
less a guaranty fee paid to Fannie Mae. In this way, the Company no longer has
any credit exposure to the pool of mortgages and has exchanged the pool of
mortgages for a High Quality asset. The Company also negotiates with Fannie Mae
to securitize non-conforming products in this manner, although occasionally the
Company will retain the credit exposure for the pool.
Financing Strategies
The Company employs a leveraging strategy to increase its assets by borrowing
against its ARM assets and then using the proceeds to acquire additional ARM
assets. By leveraging its portfolio in this manner, the Company expects to
maintain an equity-to-assets ratio between 8% and 10%, when measured on a
historical cost basis. The Company believes that this level of capital is
sufficient to allow the Company to continue to operate in interest rate
environments in which the Company's borrowing rates might exceed its portfolio
yield. These conditions could occur when the interest rate adjustments on the
ARM assets lag the interest rate increases in the Company's variable rate
borrowings or when the interest rate of the Company's variable rate borrowings
are mismatched with the interest rate indices of the Company's ARM assets. The
Company also believes that this capital level is adequate to protect the Company
from having to sell assets during periods when the value of its ARM assets are
declining. If the ratio of the Company's equity-to-total assets, measured on a
historical cost basis, falls below 8%, the Company will take action to increase
its equity-to-assets ratio to 8% of total assets or greater, when measured on a
historical cost basis, through normal portfolio amortization, raising equity
capital, sale of assets or other steps as necessary.
The Company's ARM assets are financed primarily at short-term borrowing rates
and can be financed utilizing reverse repurchase agreements, dollar-roll
agreements, borrowings under lines of credit and other secured or unsecured
financings which the Company may establish with approved institutional lenders.
Prior to 1998, reverse repurchase agreements had been the primary source of
financing utilized by the Company to finance its ARM assets. Since 1998,
however, the Company has diversified its financing sources by issuing debt in
the capital markets as described below. As of December 31, 2000, capital
markets debt represents 16% of the Company's total debt obligations. Generally,
upon repayment of each reverse repurchase agreement, the ARM assets used to
collateralize the financing will immediately be pledged to secure a new reverse
repurchase agreement. The Company has established lines of credit and
collateralized financing agreements with twenty-six different financial
institutions.
Reverse repurchase agreements take the form of a simultaneous sale of pledged
assets to a lender at an agreed upon price in return for the lender's agreement
to resell the same assets back to the borrower at a future date (the maturity of
the borrowing) at a higher price. The price difference is the cost of borrowing
under these agreements. In the event of the insolvency or bankruptcy of a
lender during the term of a reverse repurchase agreement, provisions of the
Federal Bankruptcy Code, if applicable, may permit the lender to consider the
agreement to resell the assets to be an executory contract that, at the lender's
option, may be either assumed or rejected by the lender. If a bankrupt lender
rejects its obligation to resell pledged assets to the Company, the Company's
claim against the lender for the damages resulting therefrom may be treated as
one of many unsecured claims against the lender's assets. These claims would be
subject to significant delay and, if and when payments are received, they may be
substantially less than the damages actually suffered by the Company. To
mitigate this risk the Company enters into collateralized borrowings with only
financially sound institutions approved by the Board of Directors, including a
majority of unaffiliated directors, and monitors the financial condition of such
institutions on a regular, periodic basis.
9
The Company also utilizes capital market transactions by issuing debt
collateralized by specific pools of ARM assets that are placed in a trust. The
financing of ARM assets in this way eliminates the risk of margin calls on the
financing of those ARM assets and limits the Company's exposure to credit risk
on the ARM and Hybrid ARM loans collateralizing such debt. The Company receives
a credit rating on the debt based on the quality of the ARM assets, amount of
any credit enhancement obtained and subordination levels of the debt proscribed
by the rating agency(ies), all of which affects the interest rate at which the
debt can be issued. The principal and interest payments on the debt are paid by
the trust out of the cash flows received on the collateral. By utilizing such a
structure, the Company can issue either floating rate debt indexed to various
indices that more closely matches the characteristics of the collateralized ARM
assets, depending upon market constraints and conditions, or fixed rate debt
that corresponds to the characteristics of collateralized Hybrid ARM loans.
The Company also enters into financing facilities for whole loans. The Company
uses these credit lines to finance its acquisition of whole loans while it is
accumulating loans for securitization or until more permanent financing is
arranged in a capital markets collateralized debt transaction. In 1998, the
Company utilized two whole loan financing facilities that provided the Company
with uncommitted lines of credit based on the market value of its whole loans.
Uncommitted lines of credit are generally less expensive than a committed line
of credit, but during periods of market turmoil, uncommitted lines of credit can
be terminated by the counterparty with little notice to the Company and at a
time when the Company would have difficulty in replacing the line of credit.
Therefore, beginning in 1999, the Company decided to negotiate and pay a fee for
committed facilities as well as continue to utilize uncommitted facilities.
During January 2001, the Company renewed one committed facility in the amount of
$150,000,000, which the Company can increase to $300,000,000 for an additional
fee, and has another committed facility for $150,000,000 which can also be
expanded to $300,000,000 for a fee. The Company also has one uncommitted
facility available.
The Company mitigates its interest-rate risk from borrowings by selecting
maturities that approximately match the interest-rate adjustment periods on its
ARM assets. Accordingly, borrowings bear variable or short-term fixed (one year
or less) interest rates. Generally, the borrowing agreements require the
Company to deposit additional collateral in the event the market value of
existing collateral declines, which, in dramatically rising interest rate
markets, could require the Company to sell assets to reduce the borrowings.
The Company's Bylaws limit borrowings, excluding the collateralized borrowings
in the form of reverse repurchase agreements, dollar-roll agreements and other
forms of collateralized borrowings discussed above, to no more than 300% of the
Company's net assets, on a consolidated basis, unless approved by a majority of
the unaffiliated directors. This limitation generally applies only to unsecured
borrowings of the Company. For this purpose, the term "net assets" means the
total assets (less intangibles) of the Company at cost, before deducting
depreciation or other non-cash reserves, less total liabilities, as calculated
at the end of each quarter in accordance with generally accepted accounting
principles. Accordingly, the 300% limitation on unsecured borrowings does not
affect the Company's ability to finance its total assets with collateralized
borrowings.
Hedging Strategies
The Company makes use of hedging transactions to mitigate the impact of certain
adverse changes in interest rates on its net interest income and fair value
changes of its ARM assets. In general, ARM assets have a maximum lifetime
interest rate cap, or ceiling, meaning that each ARM asset contains a
contractual maximum rate. This lifetime interest rate cap is a component of the
fair value of an ARM asset and can effect the Company's net interest income.
The borrowings incurred by the Company to finance its ARM assets portfolio are
not subject to equivalent interest rate caps. Accordingly, the Company
purchases interest rate cap agreements ("Cap Agreements") and options on
interest rate futures ("Options Contracts") to prevent the Company's borrowing
costs from exceeding the lifetime maximum interest rate on its ARM assets.
These Cap Agreements and Options Contracts have the effect of offsetting a
portion of the Company's borrowing costs if prevailing interest rates exceed the
rate specified in the Cap Agreement or Options Contract. A Cap Agreement or
Option Contract is a contractual agreement for which the Company pays a fee,
which may at times be financed, typically to either a commercial bank or
investment banking firm. Pursuant to the terms of the Cap Agreements and Option
Contacts owned as of December 31, 2000 that hedge the lifetime maximum interest
rate on its ARM assets, the Company will receive cash payments if the applicable
index, generally the one-month, three-month, six-month LIBOR index or Prime,
increases above certain specified levels, which range from 7.10% to 13.00% and
average approximately 10.04%. The fair value of these Cap Agreements generally
increases when general market interest rates increase and decreases when market
interest rates decrease, helping to partially offset changes in the fair value
of the Company's ARM assets related to the effect of the lifetime interest rate
cap.
10
In addition, ARM assets are generally subject to periodic caps. Periodic caps
generally limit the maximum interest rate coupon change on any interest rate
coupon adjustment date to either a maximum of 1% per semiannual adjustment or 2%
per annual adjustment. The borrowings incurred by the Company do not have
similar periodic caps. The Company generally does not hedge against the risk of
its borrowing costs rising above the periodic interest rate cap level on the ARM
assets because the contractual future interest rate adjustments on the ARM
assets will cause their interest rates to increase over time and reestablish the
ARM assets' interest rate to a spread over the then current index rate. The
Company attempts to mitigate the effect of periodic caps in several ways.
First, the yield on the Company's ARM assets can change by more that the 1% or
2% per periodic interest rate adjustment limitation depending upon how
prepayment activity changes as interest rates change. Secondly, beginning in
1998, the Company began to acquire variable rate CMOs and CBOs ("Floaters"),
Hybrid ARMs and certain other ARM loans that do not have a periodic cap. As of
December 31, 2000, approximately $2.315 billion of the Company's ARM securities
and ARM loans did not have periodic caps or were Hybrid ARMs, representing
approximately 56% of total ARM assets.
The Hybrid ARMs have an initial fixed rate period, generally 3 to 10 years.
Since the Company's borrowings are generally short-term, the Company enters into
interest rate swap agreements that limit its interest rate repricing mismatch
(the difference between the remaining fixed-rate period of a Hybrid ARM and the
maturity of the fixed-rate liability funding a Hybrid ARM) to a duration of no
more than one year. In accordance with the terms of these swap agreements, the
Company pays a fixed rate of interest during the term of the agreements, and
receives a payment that varies monthly with the one month LIBOR Index. The
Company generally enters into a swap that amortizes at an agreed upon prepayment
rate based on the Company's estimate of the expected rate of principal
amortization of the Hybrid ARMs being financed. In similar fashion, the Company
has purchased Cap Agreements to limit the interest rate of financing Hybrid ARMs
during their fixed rate term, generally for three to ten years. In general, the
cost of financing Hybrid ARMs hedged with Cap Agreements is capped at a rate
that is 0.75% to 1.00% below the fixed Hybrid ARM interest rate.
The Company may also enter into interest rate swap agreements to manage the
average interest rate reset period on its borrowings. In accordance with the
terms of the swap agreements, the Company pays a fixed rate of interest during
the term of the agreements and receives a payment that varies monthly with the
one month LIBOR Index. These agreements have the effect of fixing the Company's
borrowing costs on a similar amount of swaps owned by the Company and, as a
result, the Company reduces the interest rate variability of its borrowings.
The Company may also use interest rate swap agreements from time to time to
change from one interest rate index to another interest rate index and thus
decrease further the basis risk between the Company's interest yielding assets
and the financing of such assets.
The ARM assets held by the Company were generally purchased at prices greater
than par. The Company is amortizing the premiums paid for these assets over
their expected lives using the level yield method of accounting. To the extent
that the prepayment rate on the Company's ARM assets differs from expectations,
the Company's net interest income will be affected. Prepayments generally
increase when mortgage interest rates fall below the interest rates on ARM
loans. To the extent there is an increase in prepayment rates, resulting in a
shortening of the expected lives of the Company's ARM assets, the Company's net
income and, therefore, the amount available for dividends could be adversely
affected. To mitigate the adverse effect of an increase in prepayments on the
Company's ARM assets, the Company has purchased ARM assets at prices at or below
par, however the Company's portfolio of ARM assets is currently held at a net
premium. The Company may also purchase limited amounts of "principal only"
mortgage derivative assets backed by either fixed-rate mortgages or ARM assets
as a hedge against the adverse effect of increased prepayments. To date, the
Company has not purchased any "principal only" mortgage derivative assets.
The Company also enters into hedging transactions in connection with the
purchase of Hybrid ARMs to minimize the impact of changes in financing rates
between the trade date and the settlement date. Generally, the Company hedges
the cost of obtaining future fixed-rate financing by entering into a commitment
to sell similar duration fixed-rate mortgage-backed securities ("MBS") on the
trade date and settles the commitment by purchasing the same fixed-rate MBS on
the purchase date. Realized gains and losses are deferred and amortized as a
yield adjustment to the financing over the fixed-rate period of the Hybrid ARMs.
11
The Company may enter into other hedging-type transactions designed to protect
its borrowings costs or portfolio yields from interest rate changes. The
Company may also purchase "interest only" mortgage derivative assets or other
derivative products for purposes of mitigating risk from interest rate changes.
The Company has not, to date, entered into these types of transactions, but may
do so in the future. In 1999, the Board of Directors approved an expansion of
the financial instruments with which the Company currently implements its
hedging strategies. In addition to the instruments described above, the Company
will also utilize from time to time futures contracts and options on futures
contracts on the Eurodollar, Fed Funds, Treasury bills and Treasury notes and
similar financial instruments. In order to utilize these instruments the
Company became registered and received an exemption from being classified as a
"Commodity Pool Operator" by the Commodities and Futures Trade Commission.
Effective January 1, 2001, the Company implemented Financial Accounting
Standards No. 133, Accounting for Derivative Instruments and Hedging Activities
("SFAS 133"). SFAS No. 133 established a framework of accounting rules that
standardizes accounting and reporting for all derivative instruments and
requires that all derivative financial instruments be carried on the balance
sheet at fair value. The Company expects to continue to use derivative
instruments to the extent the Company believes that the use of and the
accounting of the derivative instruments meets the Company's financial goals.
However, it is likely that the Company's future quarterly earnings will vary to
a greater degree than they might otherwise as a result of hedging with
derivative instruments.
Hedging transactions currently utilized by the Company generally are designed to
protect the Company's net interest income during periods of changing market
interest rates. The Company does not intend to hedge for speculative purposes.
Further, no hedging strategy can completely insulate the Company from risk, and
certain of the federal income tax requirements that the Company must satisfy to
qualify as a REIT limit the Company's ability to hedge, particularly with
respect to hedging against periodic cap risk. The Company carefully monitors
and may have to limit its hedging strategies to ensure that it does not realize
excessive hedging income, or hold hedging assets having excess value in relation
to total assets. See "Federal Income Tax Considerations - Requirements for
Qualification as a REIT".
Operating Restrictions
The Board of Directors has established the Company's operating policies and any
revisions in the operating policies and strategies require the approval of the
Board of Directors, including a majority of the unaffiliated directors. Except
as otherwise restricted, the Board of Directors has the power to modify or alter
the operating policies without the consent of shareholders. Developments in the
market which affect the operating policies and strategies mentioned herein or
which change the Company's assessment of the market may cause the Board of
Directors (including a majority of the unaffiliated directors) to revise the
Company's operating policies and financing strategies.
In the event the rating of an ARM security held by the Company is reduced by the
Rating Agencies to below Investment Grade after acquisition by the Company, the
asset may be retained in the Company's investment portfolio if the Manager
recommends that it be retained and the recommendation is approved by the Board
of Directors (including a majority of the unaffiliated directors).
The Company has elected to qualify as a REIT for tax purposes. The Company has
made a taxable REIT subsidiary election with respect to TMHL, in order to
facilitate the origination, securitization, sale and servicing of residential
mortgage loans. In addition, the Company has adopted certain compliance
guidelines which include restrictions on the acquisition, holding and sale of
assets. Prior to the acquisition of any asset, the Company determines whether
such asset will constitute a "Qualified REIT Asset" as defined by the Internal
Revenue Code of 1986, as amended (the "Code"). Substantially all the assets
that the Company has acquired and will acquire for investment are expected to be
Qualified REIT Assets. This policy limits the investment strategies that the
Company may employ.
The Company closely monitors its purchases of ARM assets and the income from
such assets, including from its hedging strategies, so as to ensure at all times
that it maintains its qualification as a REIT. The Company developed certain
accounting systems and testing procedures with the help of qualified accountants
and tax experts to facilitate its ongoing compliance with the REIT provisions of
the Code. See "Federal Income Tax Considerations - Requirements for
Qualification as a REIT". No changes in the Company's investment policies and
operating policies and strategies, including credit criteria for mortgage asset
investments, may be made without the approval of the Company's Board of
Directors, including a majority of the unaffiliated directors.
12
The Company at all times intends to conduct its business so as not to become
regulated as an investment company under the Investment Company Act of 1940.
The Investment Company Act exempts entities that are "primarily engaged in the
business of purchasing or otherwise acquiring mortgages and other liens on and
interests in real estate" ("Qualifying Interests"). Under current
interpretation of the staff of the SEC, in order to qualify for this exemption,
the Company must maintain at least 55% of its assets directly in Qualifying
Interests. In addition, unless certain mortgage assets represent all the
certificates issued with respect to an underlying pool of mortgages, such
mortgage assets may be treated as assets separate from the underlying mortgage
loans and, thus, may not be considered Qualifying Interests for purposes of the
55% requirement. The Company closely monitors its compliance with this
requirement and intends to maintain its exempt status. Up to the present, the
Company has been able to maintain its exemption through the purchase of whole
pool government agency and privately issued ARM securities and loans that
qualify for the exemption. See "Portfolio of Mortgage Assets - Pass-Through
Certificates - Privately Issued ARM Pass-Through Certificates".
The Company does not purchase any assets from or enter into any servicing or
administrative agreements (other than the Management Agreement) with any
entities affiliated with the Manager. Any changes in this policy would be
subject to approval by the Board of Directors, including a majority of the
unaffiliated directors.
PORTFOLIO OF MORTGAGE ASSETS
As of December 31, 2000, ARM assets comprised approximately 99% of the Company's
total assets. The Company has invested in the following types of mortgage
assets in accordance with the operating policies established by the Board of
Directors and described in "Business - Operating Policies and Strategies -
Operating Restrictions".
PASS-THROUGH CERTIFICATES
The Company's investments in mortgage assets are concentrated in High Quality
ARM pass-through certificates which account for approximately 75% of ARM assets
held. These High Quality ARM pass-through certificates consist of Agency
Certificates and privately issued ARM pass-through certificates that meet the
High Quality credit criteria. These High Quality ARM pass-through certificates
acquired by the Company represent interests in ARM loans which are secured
primarily by first liens on single-family (one-to-four units) residential
properties, although the Company may also acquire ARM pass-through certificates
secured by liens on other types of real estate-related properties. The Company
also includes in this category of assets a portion of the ARM and Hybrid ARM
loans that have been deposited in a trust and held as collateral for its notes
payable in the amount equivalent to the AAA portion of the debt issued by the
trust. The ARM pass-through certificates, including the ARM and Hybrid ARM
loans collateralizing notes payable, acquired by the Company are generally
subject to periodic interest rate adjustments, as well as periodic and lifetime
interest rate caps which limit the amount an ARM security's interest rate can
change during any given period.
The following is a discussion of each type of pass-through certificate held by
the Company as of December 31, 2000:
Freddie Mac ARM Programs
Freddie Mac is a shareholder-owned government sponsored enterprise created
pursuant to an Act of Congress on July 24, 1970. The principal activity of
Freddie Mac consists of the purchase of first lien, conventional residential
mortgages, including both whole loans and participation interests in such
mortgages and the resale of the loans and participations in the form of
guaranteed mortgage assets. During 2000, Freddie Mac purchased $21.2 billion of
ARM loans to securitize into ARM certificates and as of December 31, 2000, there
was $46.8 billion of all types of Freddie Mac ARM certificates outstanding, of
which Freddie Mac held $12.6 billion in its own portfolio.
Each Freddie Mac ARM Certificate issued to date has been issued in the form of a
pass-through certificate representing an undivided interest in a pool of ARM
loans purchased by Freddie Mac. The ARM loans included in each pool are fully
amortizing, conventional mortgage loans with original terms to maturity of up to
40 years secured by first liens on one-to-four unit family residential
properties or multi-family properties. The interest rate paid on Freddie Mac
ARM Certificates adjust periodically on the first day of the month following the
month in which the interest rates on the underlying mortgage loans adjust.
13
Freddie Mac guarantees to each holder of its ARM Certificates the timely payment
of interest at the applicable pass-through rate and ultimate collection of all
principal on the holder's pro rata share of the unpaid principal balance of the
related ARM loans, but does not guarantee the timely payment of scheduled
principal of the underlying mortgage loans. The obligations of Freddie Mac
under its guarantees are solely those of Freddie Mac and are not backed by the
full faith and credit of the U.S. Government. If Freddie Mac were unable to
satisfy such obligations, distributions to holders of Freddie Mac ARM
Certificates would consist solely of payments and other recoveries on the
underlying mortgage loans and, accordingly, monthly distributions to holders of
Freddie Mac ARM Certificates would be affected by delinquent payments and
defaults on such mortgage loans.
Fannie Mae ARM Programs
Fannie Mae is a federally chartered and privately owned corporation organized
and existing under the Federal National Mortgage Association Charter Act.
Fannie Mae provides funds to the mortgage market primarily by purchasing home
mortgage loans from mortgage loan originators, thereby replenishing their funds
for additional lending. Fannie Mae established its first ARM programs in 1982
and currently has several ARM programs under which ARM certificates may be
issued, including programs for the issuance of assets through REMICs under the
Code. During 2000, Fannie Mae purchased $18.1 billion of ARM loans to
securitize into ARM certificates and issued $25.7 billion of Fannie Mae ARM
certificates. As of December 31, 2000, Fannie Mae held $27.1 billion of ARM
certificates in its own portfolio.
Each Fannie Mae ARM Certificate issued to date has been issued in the form of a
pass-through certificate representing a fractional undivided interest in a pool
of ARM loans formed by Fannie Mae. The ARM loans included in each pool are
fully amortizing conventional mortgage loans secured by a first lien on either
one-to-four family residential properties or multi-family properties. The
original term to maturity of the mortgage loans generally does not exceed 40
years. Fannie Mae has issued several different series of ARM Certificates.
Each series bears an initial interest rate and margin tied to an index based on
all loans in the related pool, less a fixed percentage representing servicing
compensation and Fannie Mae's guarantee fee.
Fannie Mae guarantees to the registered holder of a Fannie Mae ARM Certificate
that it will distribute amounts representing scheduled principal and interest
(at the rate provided by the Fannie Mae ARM Certificate) on the mortgage loans
in the pool underlying the Fannie Mae ARM Certificate, whether or not received,
and the full principal amount of any such mortgage loan foreclosed or otherwise
finally liquidated, whether or not the principal amount is actually received.
The obligations of Fannie Mae under its guarantees are solely those of Fannie
Mae and are not backed by the full faith and credit of the U.S. Government. If
Fannie Mae were unable to satisfy such obligations, distributions to holders of
Fannie Mae ARM Certificates would consist solely of payments and other
recoveries on the underlying mortgage loans and, accordingly, monthly
distributions to holders of Fannie Mae ARM Certificates would be affected by
delinquent payments and defaults on such mortgage loans.
Privately Issued ARM Pass-Through Certificates
Privately issued ARM Pass-Through Certificates are structured similar to the
Agency Certificates discussed above but are issued by originators of, and
investors in, mortgage loans, including savings and loan associations, savings
banks, commercial banks, mortgage banks, investment banks and special purpose
subsidiaries of such institutions. Privately issued ARM pass-through
certificates are usually backed by a pool of non-conforming conventional
adjustable-rate mortgage loans and are generally structured with one or more
types of credit enhancement, including pool insurance, guarantees, or
subordination. Accordingly, the privately issued ARM pass-through certificates
typically are not guaranteed by an entity having the credit status of Freddie
Mac or Fannie Mae.
Privately issued ARM pass-through certificates credit enhanced by mortgage pool
insurance provide the Company with an alternative source of ARM assets (other
than Agency ARM assets) that meet the Qualifying Interests test for purposes
maintaining the Company's exemption under the Investment Company Act of 1940.
Since the inception of the Company in 1993, most of the providers of mortgage
pool insurance have stopped providing such insurance. Although, in 1999, the
Company was successful in negotiating a new pool insurance policy for a one of
the privately-issued ARM Pass-Through Certificates it purchased. Since these
opportunities are rare, the Company has increased its investment in Agency ARM
securities and in whole loans as its primary sources of Qualifying Interests in
real estate.
14
COLLATERALIZED MORTGAGE OBLIGATIONS ("CMOS"), MULTI-CLASS PASS-THROUGH ASSETS
AND COLLATERALIZED BOND OBLIGATIONS ("CBOS")
CMOs are debt obligations, ordinarily issued in series and most commonly backed
by a pool of fixed rate mortgage loans or pass-through certificates, each of
which consists of several serially maturing classes. Multi-class pass-through
securities are equity interests in a trust composed of similar underlying
mortgage assets. Generally, principal and interest payments received on the
underlying mortgage-related assets securing a series of CMOs or multi-class
pass-through securities are applied to principal and interest due on one or more
classes of the CMOs of such series or to pay scheduled distributions of
principal and interest on multi-class pass-throughs.
The CBOs acquired by the Company, like CMOs, are debt obligations, but, in the
case of CBOs, are secured by security interests in portfolios of high quality,
low duration, mortgage-backed, asset-backed and other fixed and floating rate
securities managed by third-parties. The Company only acquires CBOs that have
portfolios that consist primarily of either real estate qualifying assets or
high quality mortgage backed securities. In a CBO transaction, principal and
interest payments are used to pay current period interest and any excess is
reinvested into the portfolio. The amount of proceeds at maturity, on the CBO
classes owned by the Company, is generally dependent upon the total rate of
return performance of the underlying collateral and can result in a final
redemption value that is less than the face value of the investment. CBOs
typically don't amortize monthly, rather they mature on a specific maturity
date.
Scheduled payments of principal and interest on the mortgage-related assets and
other collateral securing a series of CMOs, CBOs or multi-class pass-throughs
are intended to be sufficient to make timely payments of principal and interest
on such issues or securities and to retire each class of such obligations at
their stated maturity.
Multi-class pass-through securities backed by ARM assets or ARM loans owned by
the Company are typically structured into classes designated as senior classes,
mezzanine classes and subordinated classes. The Company also owns variable rate
classes of CMOs and CBOs that are backed by both fixed- and adjustable-rate
mortgages that are issued by Freddie Mac, Fannie Mae and other private issuers.
The senior classes in a multi-class pass-through security generally have first
priority over all cash flows and consequently have the least amount of credit
risk since principal losses are generally covered by mortgage pool insurance
policies or are charged against the subordinated classes in order of
subordination. As a result of these features, the senior classes receive the
highest credit rating from Rating Agencies of the series of classes for each
multi-class pass-through security.
The mezzanine classes of a multi-class pass-through security generally have a
slightly greater risk of principal loss than the senior classes since they
provide some credit enhancement to the senior classes. In most, but not all,
instances, mezzanine classes participate on a pro-rata basis with senior classes
in their right to receive cash flow and have expected lives similar to the
senior classes. In other instances, mezzanine classes are subordinate in their
right to receive cash flow and have average lives that are longer than the
senior classes. However, in all cases, a mezzanine class has a similar or
slightly lower credit rating than the senior class from the Rating Agencies.
Generally, the mezzanine classes that the Company has acquired are rated High
Quality.
Subordinated classes are junior in the right to receive payment from the
underlying mortgages to other classes of a multi-class pass-through security.
The subordination provides credit enhancement to the senior and mezzanine
classes. Subordinated classes may be at risk for some payment failures on the
mortgage loans securing or underlying such assets and generally represent a
greater level of credit risk as they are responsible for bearing the risk of
credit loss on all of the outstanding loans underlying a CMO, CBO or multi-class
pass-through. As a result of being subject to more credit risk, subordinated
classes generally have lower credit ratings relative to the senior and mezzanine
classes.
The subordinated classes which the Company has acquired were all rated at least
Investment Grade at the time of purchase by one of the Rating Agencies, and in
certain cases are High Quality, or were created as part of the Company's process
of securitizing whole loans. The subordinated classes acquired by the Company
in the open market are limited in amount and bear yields which the Company
believes are commensurate with the increased risks involved. In general, the
Company acquires subordinated classes when they are seasoned and when the more
senior classes of the multi-class security have been paid down to levels that
mitigate the risk of non-payment on the subordinate classes.
15
The market for subordinated classes is not extensive and at times may be
illiquid. In addition, the Company's ability to sell subordinated classes is
limited by the REIT Provisions of the Code. The Company has not purchased any
subordinated classes that are not Qualified REIT Assets. The subordinated
classes acquired by the Company, which are not High Quality, together with the
Company's other investments in Other Investment assets, may not, in the
aggregate, comprise more than 30% of the Company's total assets, in accordance
with the Company's investment policy.
The variable rate classes of CMOs and CBOs, or Floaters, owned by the Company
generally float at a spread to the one-month LIBOR index and are backed by
mortgages that are either fixed-rate or are adjustable-rate mortgages indexed to
the one-year U. S. Treasury yield or a Cost of Funds index.
ARM AND HYBRID ARM LOANS
The ARM and Hybrid ARM loans the Company has acquired are all first mortgages on
single-family residential properties. Some have additional collateral in the
form of pledged financial assets. The Company acquires loans that are generally
underwritten to "A" quality standards. The Company considers loans to be "A"
quality when they are underwritten in such a way as to assure that the borrower
has adequate verified income to make the required loan payment, adequate
verified equity in the underlying property, and by the borrower's willingness
and ability to repay the mortgage as demonstrated by a good credit history. As
a result, the loans acquired by the Company are generally fully documented loans
to borrowers with good credit histories, adequate income to support the monthly
mortgage payment, adequate assets to close the loan, generally with 80% or lower
effective loan-to-value ratios based on independently appraised property values
or are seasoned loans with good payment history.
When acquiring ARM and Hybrid ARM loans, either originated specifically for the
Company or when the Company acquires pools of loans in bulk, the Company focuses
its attention on key aspects of a borrower's profile and the characteristics of
a mortgage loan product that the Company believes are most important in insuring
excellent loan performance and minimal credit exposure. The Company's loan
programs generally focus on larger down payments, excellent borrower credit
history (as measured by a credit report and a credit score) and a conservative
appraisal process. If an ARM or Hybrid ARM loan acquired has a
loan-to-property-value that is above 80%, then the borrower is required to pay
for private mortgage insurance providing additional protection to the Company
against credit risk. The loans acquired have original maturities of forty years
or less. The ARM and Hybrid ARM loans are either fully amortizing or are
interest only, generally up to ten years, and fully amortizing thereafter. All
ARM loans acquired bear an interest rate that is tied to an interest rate index
and some have periodic and lifetime constraints on how much the loan interest
rate can change on any predetermined interest rate reset date. In general, the
interest rate on each ARM loan resets at a frequency that is either monthly,
semi-annually or annually. The ARM loans generally adjust based upon the
following indices: a U.S. Treasury Bill index, a LIBOR index, a Certificate of
Deposit index, a Cost of Funds index or Prime. The Hybrid ARM loans have an
initial fixed rate period, generally 3 to 10 years, and then they convert to an
ARM loan with the features of an ARM loan described above.
16
RISK FACTORS
FORWARD-LOOKING STATEMENTS
In accordance with the Private Securities Litigation Reform Act of 1995
(the "1995 Act"), the Company can obtain a "Safe Harbor" for forward-looking
statements by identifying those statements and by accompanying those statements
with cautionary statements, which identify factors that could cause actual
results to differ from those in the forward-looking statements. Accordingly,
the following information contains or may contain forward-looking statements:
(1) information included in this Annual Report on Form 10-K, including, without
limitation, statements made regarding investments in ARM securities and ARM
loans, and Hybrid ARM loans, hedging, leverage, interest rates and statements in
Item 7, Management's Discussion and Analysis of Financial Condition and Results
of Operations, (2) information included in future filings by the Company with
the Securities and Exchange Commission including, without limitation, statements
with respect to growth, projected revenues, earnings, returns and yields on its
portfolio of mortgage assets, the impact of interest rates, costs, and business
strategies and plans, and (3) information contained in the Company's Annual
Report or other written material, releases and oral statements issued by or on
behalf of, the Company, including, without limitation, statements with respect
to growth, projected revenues, net income, returns and yields on its portfolio
of mortgage assets, the impact of interest rates, costs and business strategies
and plans.
The following is a summary of the factors the Company believes important
and that could cause actual results to differ from the Company's expectations.
The Company is publishing these factors pursuant to the 1995 Act. Such factors
should not be construed as exhaustive or as an admission regarding the adequacy
of disclosure made by the Company prior to the effective date of the 1995 Act.
Readers should understand that many factors govern whether any forward-looking
statement will be or can be achieved. Any one of those factors could cause
actual results to differ materially from those projected. No assurance is or
can be given that any important factor set forth below will be realized in a
manner so as to allow the Company to achieve the desired or projected results.
The words "believe," "except," "anticipate," "intend," "aim," "expect," "will,"
and similar words identify forward-looking statements. The Company cautions
readers that the following important factors, among others, could affect the
Company's actual results and could cause the Company's actual consolidated
results to differ materially from those expressed in any forward-looking
statements made by or on behalf of the Company.
- - A Dramatic Increase in Short-term Interest Rates
- - The Effectiveness of Using Various Interest Rate Derivative Instruments
for Hedging ARM Assets or Borrowing Costs
- - The Ability to Acquire Attractively Priced and Underwritten ARM and Hybrid
ARM Loans and Securities
- - Interest Rate Repricing Mismatch Between Asset Yields and Borrowing Rates
- - A Decline in the Market Value of ARM Securities and Loans, Which Would
Result in Margin Calls
- - Unanticipated Levels of Prepayment Rates
- - A Flattening or Inversion of the Yield Curve Between Short and Long-Term
Interest Rates
- - The Use of Substantial Borrowed Funds to Enhance Returns
- - Risk of Credit Loss Associated with Acquiring, Accumulating and
Securitizing ARM Loans
- - Interest Rate Risks Associated with any Future Unhedged Portion of the
Fixed Term of Hybrid ARMs
- - The Loss of Key Personnel
- - Fundamental Changes in Investment Policies and Strategies
- - Fluctuations or Variability of Dividend Distributions
- - Capital Stock Price Volatility
- - Uncertainty Associated With New Business Lines
- - Additional Investment in New Business Lines
17
COMPETITION
In acquiring ARM assets, the Company competes with other mortgage REITs,
investment banking firms, savings and loan associations, banks, mortgage
bankers, insurance companies, mutual funds, other lenders, Fannie Mae, Freddie
Mac and other entities purchasing ARM assets, many of which have greater
financial resources than the Company. The existence of these competitive
entities, as well as the possibility of additional entities forming in the
future, may increase the competition for the acquisition of ARM assets resulting
in higher prices and lower yields on such mortgage assets.
EMPLOYEES
As of December 31, 2000, the Company had no employees. Thornburg Mortgage
Advisory Corporation (the "Manager") carries out the day to day operations of
the Company, subject to the supervision of the Board of Directors and under the
terms of a management agreement discussed below.
THE MANAGEMENT AGREEMENT
The Company has entered into a management agreement (the "Management Agreement")
with Thornburg Mortgage Advisory Corporation (the "Manager") for a ten-year
term, with an annual review required each year. Upon a termination by the
Company, other than for cause, the Management Agreement provides for a minimum
fee to be paid to the Manager. The Management Agreement also provides that in
the event a person or entity obtains more than 20% of the Company's common
stock, if the Company is combined with another entity, or if the Company
terminates the Agreement other than for cause, the Company is obligated to
acquire substantially all of the assets of the Manager through an exchange of
shares with a value based on a formula tied to the Manager's net profits. The
Company has the right to terminate the Management Agreement upon the occurrence
of certain specific events, including a material breach by the Manager of any
provision contained in the Management Agreement.
The Manager at all times is subject to the supervision of the Company's Board of
Directors and has only such functions and authority as the Company may delegate
to it. 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.
The Manager receives a per annum base management fee on a declining scale based
on average shareholders' equity, adjusted for liabilities that are not incurred
to finance assets ("Average Shareholders' Equity" or "Average Net Invested
Assets" as defined in the Agreement), payable monthly in arrears. The base
management fee formula is subject to an annual increase based on any increase in
the Consumer Price Index over the previous twelve month period. The Manager is
also entitled to receive, as incentive compensation for each fiscal quarter, an
amount equal to 20% of the Net Income of the Company, before incentive
compensation, in excess of the amount that would produce an annualized Return on
Equity equal to 1% over the Ten Year U.S. Treasury Rate. In addition, the
wholly-owned subsidiaries of the Company entered into separate Management
Agreements with the Manager for additional management services. The Management
Agreement also provides that expenses related to acquiring, securitizing,
selling, hedging, and servicing the Company's portfolio of ARM loans are
reimbursable to the Manager by the Company. For further information regarding
the base management fee, incentive compensation reimbursable expenses and
applicable definitions, see the Company's Proxy Statement dated March 28, 2001
under the caption "Certain Relationships and Related Transactions".
Subject to the limitations set forth below, the Company pays all operating
expenses except those specifically required to be paid by the Manager under the
Management Agreement. The operating expenses required to be paid by the Manager
include the compensation of the Company's personnel who are performing
management services for the Manager and the cost of office space, equipment and
other personnel required for the management of the Company's day-to-day
operations. The expenses that will be paid by the Company will include costs
incident to the acquisition, disposition, securitization and financing of
mortgage loans, compensation and expenses of the Company's operating personnel,
regular legal and auditing fees and expenses, the fees and expenses of the
Company's directors, the costs of printing and mailing proxies and reports to
shareholders, the fees and expenses of the Company's custodian and transfer
agent, if any, and reimbursement of any obligation of the Manager for any New
Mexico Gross Receipts Tax liability. The expenses required to be paid by the
Company which are attributable to the operations of the Company shall be limited
to an amount per year equal to the greater of 2% of the Average Net Invested
Assets of the Company or 25% of the Company's Net Income for that year. The
18
determination of Net Income for purposes of calculating the expense limitation
will be the same as for calculating the Manager's incentive compensation except
that it will include any incentive compensation payable for such period.
Expenses in excess of such amount will be paid by the Manager, unless the
unaffiliated directors determine that, based upon unusual or non-recurring
factors, a higher level of expenses is justified for such fiscal year. In that
event, such expenses may be recovered by the Manager in succeeding years to the
extent that expenses in succeeding quarters are below the limitation of
expenses. The Company, rather than the Manager, will also be required to pay
expenses associated with litigation and other extraordinary or non-recurring
expenses. Expense reimbursement will be made monthly, subject to adjustment at
the end of each year.
The transaction costs incident to the acquisition and disposition of
investments, the incentive compensation and the New Mexico Gross Receipts Tax
liability will not be subject to the 2% limitation on operating expenses.
Expenses excluded from the expense limitation are those incurred in connection
with the servicing of mortgage loans, the raising of capital, the acquisition of
assets, interest expenses, taxes and license fees, non-cash costs and the
incentive management fee.
FEDERAL INCOME TAX CONSIDERATIONS
GENERAL
The Company has elected to be treated as a REIT for federal income tax purposes.
In brief, if certain detailed conditions imposed by the REIT provisions of the
Code are met, electing entities that invest primarily in real estate and
mortgage loans, and that otherwise would be taxed as corporations are, with
certain limited exceptions, not taxed at the corporate level on their taxable
income that is currently distributed to their shareholders. This treatment
eliminates most of the "double taxation" (at the corporate level and then again
at the shareholder level when the income is distributed) that typically results
from the use of corporate investment vehicles.
In the event that the Company does not qualify as a REIT in any year, it would
be subject to federal income tax as a domestic corporation and the amount of the
Company's after-tax cash available for distribution to its shareholders would be
reduced. The Company believes it has satisfied the requirements for
qualification as a REIT since commencement of its operations in June 1993. The
Company intends at all times to continue to comply with the requirements for
qualification as a REIT under the Code, as described below.
REQUIREMENTS FOR QUALIFICATION AS A REIT
To qualify for tax treatment as a REIT under the Code, the Company must meet
certain tests, which are described briefly below.
Ownership of Common Stock
For all taxable years after the first taxable year for which a REIT election is
made, the Company's shares of capital stock must be held by a minimum of 100
persons for at least 335 days of a 12 month year (or a proportionate part of a
short tax year). In addition, at all times during the second half of each
taxable year, no more than 50% in value of the capital stock of the Company may
be owned directly or indirectly by five or fewer individuals. The Company is
required to maintain records regarding the actual and constructive ownership of
its shares, and other information, and to demand statements from persons owning
above a specified level of the REIT's shares (as long as the Company has over
200 but fewer than 2,000 shareholders of record, only persons holding 1% or more
of the Company's outstanding shares of capital stock) regarding their ownership
of shares. The Company must keep a list of those shareholders who fail to reply
to such a demand.
The Company is required to use the calendar year as its taxable year for income
tax purposes.
Nature of Assets
On the last day of each calendar quarter at least 75% of the value of the
Company's assets must consist of Qualified REIT Assets, government assets, cash
and cash items. The Company expects that substantially all of its assets will
continue to be Qualified REIT Assets. On the last day of each calendar quarter,
of the investments in assets not included in the foregoing 75% assets test, the
19
value of securities issued by any one issuer may not exceed 5% in value of the
Company's total assets and the Company may not own more than 10% of any one
issuer's outstanding securities (with an exception for a qualified electing
taxable REIT subsidiary). Under that exception, the aggregate value of
businesses undertaken by a REIT through taxable subsidiaries is limited to 20%
or less of the REIT's total assets. The Company believes that it has satisfied
this exception with respect to its ownership of TMHL. Pursuant to its compliance
guidelines, the Company monitors the purchase and holding of its assets in order
to comply with the above asset tests.
The Company may from time to time hold, through one or more taxable REIT
subsidiaries, assets that, if held directly by the Company, could otherwise
generate income that would have an adverse effect on the Company's qualification
as a REIT or on certain classes of the Company's shareholders. The Company does
not reasonably expect that the value of such taxable subsidiaries, in the
aggregate, will ever exceed 20% of the Company's assets.
Sources of Income
The Company must meet the following separate income-based tests each year:
1. THE 75% TEST. At least 75% of the Company's gross income for the
taxable year must be derived from Qualified REIT Assets including interest
(other than interest based in whole or in part on the income or profits of any
person) on obligations secured by mortgages on real property or interests in
real property. The investments that the Company has made and will continue to
make will give rise primarily to mortgage interest qualifying under the 75%
income test.
2. THE 95% TEST. In addition to deriving 75% of its gross income
from the sources listed above, at least an additional 20% of the Company's gross
income for the taxable year must be derived from those sources, or from
dividends, interest or gains from the sale or disposition of stock or other
assets that are not dealer property. The Company intends to limit substantially
all of the assets that it acquires (other than stock in certain affiliate
corporations as discussed below) to Qualified REIT Assets. The policy of the
Company to maintain REIT status may limit the type of assets, including hedging
contracts and other assets, that the Company otherwise might acquire.
Distributions
The Company must distribute to its shareholders on a pro rata basis each year an
amount equal to at least (i) 95% of its taxable income before deduction of
dividends paid and excluding net capital gain, plus (ii) 95% of the excess of
the net income from foreclosure property over the tax imposed on such income by
the Code, less (iii) any "excess noncash income". The Company intends to make
distributions to its shareholders in sufficient amounts to meet the distribution
requirement. As a result of legislation enacted in 1999 and effective for 2001
and thereafter, the Company will have to distribute an amount calculated by
substituting 90% for 95% in the foregoing formula.
The Service has ruled that if a REIT's dividend reinvestment plan (the "DRP")
allows shareholders of the REIT to elect to have cash distributions reinvested
in shares of the REIT at a purchase price equal to at least 95% of fair market
value on the distribution date, then such cash distributions qualify under the
95% distribution test. The Company believes that its DRP complies with this
ruling.
TAXATION OF THE COMPANY'S SHAREHOLDERS
For any taxable year in which the Company is treated as a REIT for federal
income purposes, amounts distributed by the Company to its shareholders out of
current or accumulated earnings and profits will be includable by the
shareholders as ordinary income for federal income tax purposes unless properly
designated by the Company as capital gain dividends. Distributions of the
Company will not be eligible for the dividends received deduction for
corporations. Shareholders may not deduct any net operating losses or capital
losses of the Company.
If the Company makes distributions to its shareholders in excess of its current
and accumulated earnings and profits, those distributions will be considered
first a tax-free return of capital, reducing the tax basis of a shareholder's
shares until the tax basis is zero. Such distributions in excess of the tax
basis will be taxable as gain realized from the sale of the Company's shares.
The Company will withhold 30% of dividend distributions to shareholders that the
Company knows to be foreign persons unless the shareholder provides the Company
with a properly completed IRS form for claiming the reduced withholding rate
under an applicable income tax treaty.
20
The provisions of the Code are highly technical and complex. This summary is
not intended to be a detailed discussion of all applicable provisions of the
Code, the rules and regulations promulgated thereunder, or the administrative
and judicial interpretations thereof. The Company has not obtained a ruling
from the Internal Revenue Service with respect to tax considerations relevant to
its organization or operation, or to an acquisition of its common stock. This
summary is not intended to be a substitute for prudent tax planning, and each
shareholder of the Company is urged to consult its own tax advisor with respect
to these and other federal, state and local tax consequences of the acquisition,
ownership and disposition of shares of stock of the Company and any potential
changes in applicable law.
ITEM 2. PROPERTIES
The Company's principal executive offices are located in Santa Fe, New
Mexico and are provided by the Manager in accordance with the
Management Agreement. The Company's wholly-owned subsidiaries have
their principal offices in Santa Fe, New Mexico and are leased from
the Manager.
ITEM 3. LEGAL PROCEEDINGS
At December 31, 2000, there were no pending legal proceedings to which
the Company was a party or of which any of its property was subject.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's shareholders
during the fourth quarter of 2000.
21
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER
MATTERS
The Company's common stock is traded on the New York Stock Exchange under the
trading symbol "TMA". As of February 21, 2001, the Company had 21,719,178
shares of common stock outstanding which were held by 1,792 holders of record
and approximately 14,300 beneficial owners.
The following table sets forth, for the periods indicated, the high, low and
closing sales prices per share of common stock as reported on the New York Stock
Exchange composite tape and the cash dividends declared per share of common
stock.
Cash
Stock Prices Dividends
------------------------- Declared
2000 High Low Close Per Share
- ---- -------- ------- ------ ------------
Fourth Quarter ended December 31, 2000 $ 9.81 $ 8.63 $ 9.06 $ 0.25 (1)
Third Quarter ended September 30, 2000 9.50 7.38 9.38 0.25
Second Quarter ended June 30, 2000 . . 8.88 7.19 7.19 0.23
First Quarter ended March 31, 2000 . . 9.13 7.06 7.38 0.23
1999
- ----
Fourth Quarter ended December 31, 1999 $ 9.19 $ 7.94 $ 8.25 $ 0.23 (2)
Third Quarter ended September 30, 1999 10.88 8.25 8.81 0.23
Second Quarter ended June 30, 1999 . . 11.38 7.56 10.00 0.23
First Quarter ended March 31, 1999 . . 10.00 7.44 8.63 0.23
1998
- ----
Fourth Quarter ended December 31, 1998 $ 9.50 $ 5.63 $ 7.63 $ 0.23
Third Quarter ended September 30, 1998 13.63 7.19 9.00 - (3)
Second Quarter ended June 30, 1998 . . 16.13 10.50 11.88 0.30
First Quarter ended March 31, 1998 . . 18.50 14.75 15.88 0.375
- -----------------
(1) The fourth quarter of 2000 dividend was declared in January 2001 and paid
in February 2001.
(2) The fourth quarter of 1999 dividend was declared in January 2000 and paid
in February 2000.
(3) On August 17, 1998, the Company's Board of Directors announced that
dividends on common stock, in the future, would be declared after each
quarter-end rather than during the applicable quarter.
The Company intends to pay quarterly dividends and to make such distributions to
its shareholders in such amounts that all or substantially all of its taxable
income each year (subject to certain adjustments) is distributed, so as to
qualify for the tax benefits accorded to a REIT under the Code. All
distributions will be made by the Company at the discretion of the Board of
Directors and will depend on the earnings and financial condition of the
Company, maintenance of REIT status and such other factors as the Board of
Directors may deem relevant from time to time.
DIVIDEND REINVESTMENT PLAN
The Company has a Dividend Reinvestment and Stock Purchase Plan (the "DRP") that
allows both common and preferred shareholders to have their dividends reinvested
in additional shares of common stock and to purchase additional shares. The
common stock to be acquired for distribution under the DRP may be purchased at
the Company's discretion from the Company at a discount from the then prevailing
market price or in the open market. Shareholders and non-shareholders also can
make additional purchases of stock monthly, subject to a minimum of $100 ($500
for non-shareholders) and a maximum of $5,000 for each optional cash purchase.
Continental Stock Transfer & Trust Company (the "Agent"), the Company's transfer
agent, is the Trustee and administrator of the DRP. Additional information
about the details of the DRP and a prospectus are available from the Agent or
the Company. Shareholders who own stock that is registered in their own name
and want to participate must deliver a completed enrollment form to the Agent.
Forms are available from the Agent or the Company. Shareholders who own stock
that is registered in a name other than their own (e.g., broker or bank nominee)
and want to participate must either request the broker or nominee to participate
on their behalf or request that the broker or nominee re-register the stock in
the shareholder's name and deliver a completed enrollment form to the Agent.
22
ADOPTION OF SHAREHOLDER RIGHTS AGREEMENT
On January 25, 2001, the Board of Directors adopted a Shareholder Rights
Agreement (the "Rights Agreement"). This summary description of the Rights does
not purport to be complete and is qualified in its entirety by reference to the
Rights Agreement.
Pursuant to the Rights Agreement, the Board of Directors declared a dividend
distribution of one Preferred Stock Purchase Right (a "Right") for each
outstanding share of common stock, par value $0.01 per share, of the Company
(the "Common Stock") to shareholders of record as of the close of business on
March 9, 2001 (the "Record Date"). In addition, one Right will automatically
attach to each share of Common Stock issued between the Record Date and the
Distribution Date (as defined herein). Each Right entitles the registered holder
thereof to purchase from the Company a unit (a "Preferred Unit") consisting of
one one-thousandth of a share of Series B Cumulative Preferred Stock, par value
$0.01 per share (the "Preferred Stock"), at a cash exercise price of $50.00 per
Preferred Unit (the "Exercise Price"), subject to adjustment.
Initially, the Rights are not exercisable and are attached to and trade with the
Common Stock outstanding as of, and all Common Stock issued after, the Record
Date. The Rights will separate from the Common Stock, separate certificates will
be distributed to holders of the Common Stock and the Rights will become
exercisable upon the earlier of (i) the close of business on the 10th calendar
day following the earlier of (a) the date of the first public announcement that
a person or a group of affiliated or associated persons has acquired beneficial
ownership of 9.8% or more of the outstanding Common Stock (an "Acquiring
Person"), or (b) the date on which the Company first has notice or otherwise
determines that a person has become an Acquiring Person (the earlier of (a) and
(b), the "Stock Acquisition Date"), or (ii) the close of business on the 10th
business day following the commencement of a tender offer or exchange offer that
would result, upon its consummation, in a person or group becoming the
beneficial owner of 9.8% or more of the outstanding Common Stock (the earlier of
(i) and (ii), the "Distribution Date"). The Rights Agreement exempts from the
definition of Acquiring Person any person who the Board of Directors determines
acquired 9.8% or more of the Common Stock inadvertently, if that person promptly
divests itself of enough Common Stock to reduce the number of shares
beneficially owned by that person to below the 9.8% threshold. The Rights
Agreement also exempts from the definition of Acquiring Person any person in
connection with which the Board of Directors approved the transaction which
otherwise would have resulted in that person becoming an Acquiring Person.
Until the Distribution Date (or the earlier redemption, exchange or expiration
of the Rights), (i) the Rights will be evidenced by the Common Stock
certificates and will be transferred with and only with those Common Stock
certificates, (ii) new Common Stock certificates issued after the Record Date
will include a notation incorporating the Rights Agreement by reference, and
(iii) the surrender for transfer of any certificate for Common Stock will also
constitute the transfer of the Rights associated with the Common Stock
represented by that certificate.
The Rights are not exercisable until the Distribution Date and will expire at
the close of business on January 25, 2011, unless previously redeemed or
exchanged by the Company as described below.
As soon as practicable after the Distribution Date, Right Certificates will be
mailed to holders of record of Common Stock as of the close of business on the
Distribution Date and, thereafter, the separate Right Certificates alone will
represent the Rights. Except as otherwise determined by the Board of Directors,
only Common Stock issued prior to the Distribution Date will be issued with
Rights.
If a Stock Acquisition Date occurs, provision will be made so that each holder
of a Right (other than an Acquiring Person or associates or affiliates thereof,
whose Rights will become null and void) thereafter has the right to receive upon
exercise that number of shares of Common Stock having a market value of two
times the exercise price of the Right (that right being referred to as the
"Subscription Right"). If, at any time following the Distribution Date: (i) the
Company consolidates with, or merges with and into, any Acquiring Person or any
associate or affiliate thereof, and the Company is not the continuing or
surviving corporation, (ii) any Acquiring Person or any associate or affiliate
thereof consolidates with the Company, or merges with and into the Company and
the Company is the continuing or surviving corporation of that merger and, in
connection with that merger, all or part of the Common Stock is changed into or
exchanged for stock or other securities of any other person or cash or any other
property, or (iii) 50% or more of the Company's assets or earning power is sold,
mortgaged or otherwise transferred, each holder of a Right will thereafter have
the right to receive, upon exercise, capital stock of the acquiring company
having a market value equal to two times the exercise price of the Right (that
right being referred to as the "Merger Right"). Each holder of a Right will
continue to have the Merger Right whether or not that holder has exercised the
Subscription Right, but Rights that are or were beneficially owned by an
Acquiring Person may (under certain circumstances specified in the Rights
Agreement) become null and void.
23
At any time after a Stock Acquisition Date occurs, the Board of Directors may,
at its option, exchange Common Stock or Preferred Units for all or any part of
the then outstanding and exercisable Rights (which excludes Rights held by an
Acquiring Person) at an initial exchange ratio of one share of Common Stock or
one Preferred Unit per Right. However, the Board of Directors generally will not
be empowered to effect any such exchange at any time after any person becomes
the beneficial owner of 50% or more of the Common Stock.
The Exercise Price payable, and the number of Preferred Units or other
securities or property issuable, upon exercise of the Rights are subject to
adjustment from time to time to prevent dilution (i) in the event of a share
dividend on, or a subdivision, combination or reclassification of, the Preferred
Stock, (ii) if holders of the Preferred Stock are granted certain rights or
warrants to subscribe for Preferred Stock or convertible securities at less than
the current market price of the Preferred Stock, or (iii) upon the distribution
to holders of the Preferred Stock of evidences of indebtedness or assets
(excluding regular quarterly cash dividends) or of subscription rights or
warrants (other than those referred to in (i) and (ii)).
With certain exceptions, no adjustment in the Exercise Price will be required
until cumulative adjustments amount to at least 1% of the Exercise Price. The
Company is not obligated to issue fractional Preferred Units. If the Company
elects not to issue fractional Preferred Units, in lieu thereof an adjustment in
cash will be made based on the fair market value of the Preferred Stock on the
last trading date prior to the date of exercise.
The Rights may be redeemed in whole, but not in part, at a price of $0.01 per
Right (payable in cash, Common Stock or other consideration considered
appropriate by the Board of Directors) by the Board of Directors only until the
earlier of the close of business on (i) the calendar day after the Stock
Acquisition Date, and (ii) the expiration date of the Rights Agreement.
Immediately upon any action of the Board of Directors ordering redemption of the
Rights, the Rights will terminate and thereafter the only right of the holders
of Rights will be to receive the redemption price.
The Rights Agreement may be amended by the Board of Directors in its sole
discretion until the earlier of the Distribution Date and the date on which the
rights become nonredeemable, as described above. After the earlier of those two
dates, the Board of Directors may, subject to certain limitations set forth in
the Rights Agreement, amend the Rights Agreement only to cure any ambiguity,
defect or inconsistency, to shorten or lengthen any time period, or to make
changes that do not adversely affect the interests of Rights holders (excluding
the interests of an Acquiring Person or associates or affiliates thereof).
Until a Right is exercised, the holder will have no rights as a shareholder of
the Company (beyond those as an existing shareholder), including the right to
vote or to receive dividends. While the distribution of the Rights will not be
taxable to shareholders or to the Company, shareholders may, depending upon the
circumstances, recognize taxable income if the Rights become exercisable for
Preferred Units, other securities of the Company or other consideration, or for
common stock of an acquiring company.
The Rights have certain anti-takeover effects. The Rights will cause
substantial dilution to a person or group that attempts to acquire the Company
in a transaction not approved by the Board of Directors. The Rights should not
interfere with any merger or other business combination approved by the Board of
Directors, since the Rights Agreement may be amended prior to the Distribution
Date, as described above, and the Rights may be redeemed until the calendar day
after a Stock Acquisition Date, as described above.
24
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data are derived from audited financial
statements of the Company for the years ended December 31, 2000, 1999, 1998,
1997 and 1996. The selected financial data should be read in conjunction with
the more detailed information contained in the Financial Statements and Notes
thereto and "Management's Discussion and Analysis of Financial Conditions and
Results of Operations" included elsewhere in this Form 10-K (Amounts in
thousands, except per share data).
OPERATIONS STATEMENT HIGHLIGHTS
2000 1999 1998 1997 1996
-------- -------- -------- -------- --------
Net interest income . . . . . . . . . . . . . . . . $36,630 $34,015 $31,040 $49,064 $30,345
Net income. . . . . . . . . . . . . . . . . . . . . $29,165 $25,584 $22,695 $41,402 $25,737
Basic earnings per share. . . . . . . . . . . . . . $ 1.05 $ 0.88 $ 0.75 $ 1.95 $ 1.73
Diluted earnings per share. . . . . . . . . . . . . $ 1.05 $ 0.88 $ 0.75 $ 1.94 $ 1.73
Average common shares . . . . . . . . . . . . . . . 21,506 21,490 21,488 18,048 14,874
Distributable income per common share . . . . . . . $ 1.07 $ 0.99 $ 0.84 $ 1.98 $ 1.76
Dividends declared per common share . . . . . . . . $ 0.94 $ 0.92 $ 0.905 $ 1.97 $ 1.65
Yield on net int.-earning assets (Portfolio Margin) 0.86% 0.77% 0.64% 1.30% 1.29%
Return on average common equity . . . . . . . . . . 6.90% 5.81% 4.80% 12.72% 11.68%
Noninterest expense to average assets . . . . . . . 0.16% 0.12% 0.13% 0.21% 0.21%
BALANCE SHEET HIGHLIGHTS
As of December 31
---------------------------------------------------------------
2000 1999 1998 1997 1996
----------- ----------- ----------- ----------- -----------
Adjustable-rate mortgage assets. . . . . . . . $4,139,461 $4,326,098 $4,268,417 $4,638,694 $2,727,875
Total assets . . . . . . . . . . . . . . . . . $4,190,167 $4,375,965 $4,344,633 $4,691,115 $2,755,358
Shareholders' equity (1). . . . . . . . . . . $ 395,965 $ 394,241 $ 395,484 $ 380,658 $ 238,005
Historical book value per share (2). . . . . . $ 15.30 $ 15.28 $ 15.34 $ 15.53 $ 14.67
Market value adjusted book value per share (3) $ 11.67 $ 11.40 $ 11.45 $ 14.42 $ 13.70
Number of common shares outstanding. . . . . . 21,572 21,490 21,490 20,280 16,219
Yield on ARM assets. . . . . . . . . . . . . . 7.06% 6.38% 5.86% 6.38% 6.64%
- -----------------------------------------------
(1) Shareholders' equity before unrealized market value adjustments.
(2) Shareholders' equity before unrealized market value adjustments, excluding preferred stock, divided by
common shares outstanding.
(3) Shareholders' equity, excluding preferred stock, divided by common shares outstanding.
25
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FINANCIAL CONDITION
At December 31, 2000, the Company held total assets of $4.190 billion, $4.139
billion of which consisted of ARM assets. That compares to $4.376 billion in
total assets and $4.326 billion of ARM assets at December 31, 1999. Since
commencing operations, the Company has purchased either ARM securities (backed
by agencies of the U.S. government or privately-issued, generally publicly
registered, mortgage assets, most of which are rated AA or higher by at least
one of the Rating Agencies) or ARM loans generally originated to "A" quality
underwriting standards. At December 31, 2000, 93.7% of the assets held by the
Company, including cash and cash equivalents, were High Quality assets, far
exceeding the Company's investment policy minimum requirement of investing at
least 70% of its total assets in High Quality ARM assets and cash and cash
equivalents. Of the ARM assets owned by the Company at year-end, 80.3% are in
the form of adjustable-rate pass-through certificates or ARM loans. The
remainder are floating rate classes of CMOs (15.9%) or investments in floating
rate classes of CBOs (3.8%) backed primarily by mortgaged-backed securities.
The following table presents a schedule of ARM assets owned at December 31, 2000
and December 31, 1999 classified by High Quality and Other Investment assets and
further classified by type of issuer and by ratings categories.
ARM ASSETS BY ISSUER AND CREDIT RATING
(Dollar amounts in thousands)
December 31, 2000 December 31, 1999
------------------------- --------------------------
Carrying Portfolio Carrying Portfolio
Value Mix Value Mix
----------- --------- ---------- ----------
HIGH QUALITY:
Freddie Mac/Fannie Mae $2,187,180 52.9% $2,068,152 47.8%
Privately Issued:
AAA/Aaa Rating 1,309,584 (1) 31.6 1,585,099 (1) 36.6
AA/Aa Rating 351,499 8.5 459,858 10.6
----------- --------- ---------- ----------
Total Privately Issued 1,661,083 40.1 2,044,957 47.2
----------- --------- ---------- ----------
----------- --------- ---------- ----------
Total High Quality 3,848,263 93.0 4,113,109 95.0
----------- --------- ---------- ----------
OTHER INVESTMENT:
Privately Issued:
A Rating 13,724 0.3 49,995 1.2
BBB/Baa Rating 72,114 1.7 84,929 2.0
BB/Ba Rating and Other 40,947 (1) 1.0 46,963 (1) 1.1
Whole loans 164,413 4.0 31,102 0.7
----------- --------- ---------- ----------
Total Other Investment 291,198 7.0 212,989 5.0
----------- --------- ---------- ----------
Total ARM Portfolio $4,139,461 100.0% $4,326,098 100.0%
=========== ========= ========== ==========
- ----------------------
(1) The AAA Rating category includes $615.7 million and $781.8 million of whole
loans as of December 31, 2000 and 1999, respectively, that have been credit
enhanced to AAA by a combination of an insurance policy purchased from a
third-party and an unrated subordinated certificate retained by the Company
in the amount of $32.1 and $32.3 million as of December 31, 2000 and 1999,
respectively. The subordinated certificate is included in the BB/Ba Rating
and Other category.
As of December 31, 2000, the Company had reduced the cost basis of its ARM
securities by $1,869,000 due to estimated credit losses (other than temporary
declines in fair value). The estimated credit losses for ARM securities relate
to Other Investments that the Company purchased at a discount that included an
26
estimate of credit losses and to loans that the Company has securitized for its
own portfolio. Additionally, during the year ended December 31, 2000, in
accordance with its credit policies, the Company provided for estimated credit
losses on the subordinated classes of its securitized loans in the amount of
$207,000 and recorded a $951,000 provision for estimated credit losses on its
loan portfolio. During 2000, the Company sold two REO properties for a combined
loss of $59,000. As of December 31, 2000, the Company's ARM loan portfolio
included 8 loans that are considered seriously delinquent (60 days or more
delinquent) with an aggregate balance of $4.4 million. The ARM loan portfolio
also includes one property ("REO") that the Company acquired as the result of a
foreclosure process in the amount of $0.6 million. The average original
effective loan-to-value ratio on these 8 delinquent loans and REO is
approximately 61%. As of December 31, 2000, the Company had an allowance for
estimated credit losses for loans and REO of $3.1 million. The Company believes
this level of allowances is adequate to cover estimated losses from these loans
and REO properties. The Company's credit reserve policy regarding ARM loans is
to record a provision based on the outstanding principal balance of loans
(including loans securitized by the Company for which the Company has retained
first loss exposure), subject to adjustment on certain loans or pools of loans
based upon factors such as, but not limited to, age of the loans, borrower
payment history, low loan-to-value ratios, historical loss experience, current
economic conditions and quality of underwriting standards applied by the
originator.
The following table classifies the Company's portfolio of ARM assets by type of
interest rate index.
ARM ASSETS BY INDEX
(Dollar amounts in thousands)
December 31, 2000 December 31, 1999
----------------------- -----------------------
Carrying Portfolio Carrying Portfolio
Value Mix Value Mix
---------- ----------- ---------- -----------
ARM ASSETS:
INDEX:
One-month LIBOR $ 651,502 15.7% $ 680,449 15.7%
Three-month LIBOR 158,512 3.8 170,384 3.9
Six-month LIBOR 430,908 10.4 626,616 14.5
Six-month Certificate of Deposit 230,934 5.6 304,621 7.0
Six-month Constant Maturity Treasury 22,330 0.5 37,781 0.9
One-year Constant Maturity Treasury 1,402,764 33.9 1,359,229 31.4
Cost of Funds 164,697 4.0 213,800 5.0
---------- ----------- ---------- -----------
3,061,647 73.9 3,392,880 78.4
---------- ----------- ---------- -----------
HYBRID ARM ASSETS 1,077,814 26.1 933,218 21.6
---------- ----------- ---------- -----------
$4,139,461 100.0% $4,326,098 100.0%
========== =========== ========== ===========
The ARM portfolio had a current weighted average coupon of 7.75% at December 31,
2000. This consisted of an average coupon of 6.77% on the hybrid portion of the
portfolio and an average coupon of 8.11% on the rest of the portfolio. If the
non-hybrid portion of the portfolio had been "fully indexed," the weighted
average coupon would have been approximately 7.46%, based upon the current
composition of the portfolio and the applicable indices. As of December 31,
1999, the ARM portfolio had a weighted average coupon of 7.08%. This consisted
of an average coupon of 6.54% on the hybrid portion of the portfolio and an
average coupon of 7.22% on the rest of the portfolio. If the non-hybrid portion
of the portfolio had been "fully indexed," the weighted average coupon would
have been approximately 7.79%, based upon the composition of the portfolio and
the applicable indices at the time. The higher average interest coupon on the
ARM portfolio as of December 31, 2000 compared to the end of 1999 is reflective
of Federal Reserve Board interest rate increases that had been occurring from
June of 1999 through the second quarter of 2000. Late in the fourth quarter
interest rates began to decrease and the Federal Reserve Board, January 2001,
has taken action to lower short-term interest rates further and, as a result,
the average interest rate on the ARM portion of the portfolio is expected to
decline to a lower "fully indexed" rate during 2001.
At December 31, 2000, the current yield of the ARM assets portfolio was 7.06%,
compared to 6.38% as of December 31, 1999, with an average term to the next
repricing date of 308 days as of December 31, 2000, compared to 344 days as of
December 31, 1999. As of December 31, 2000, hybrid ARMs comprised 26.1% of the
total ARM portfolio, up from 21.6% as of the end of 1999. The Company finances
27
its hybrid ARM portfolio with longer term borrowings such that the duration
mismatch of the hybrid ARMs and the corresponding borrowings is one year or
less. The current yield includes the impact of the amortization of applicable
premiums and discounts, the cost of hedging, the amortization of the deferred
gains from hedging activity and the impact of principal payment receivables.
The increase in the yield of 0.68% as of December 31, 2000, compared to December
31, 1999, is primarily due to the increased weighted average interest rate
coupon discussed above, which increased by 0.67%. The change in the yield
adjustment from amortizing the net portfolio premium had the effect of
decreasing the yield by 0.04%. The yield improved as a result of lower hedging
cost, which decreased by 0.08%, as higher cost hedges matured and were replaced
with lower cost hedges. The impact of non-interest earning principal payment
receivables increased during the year 2000, decreasing the portfolio yield by
0.03% as of year-end.
The following table presents various characteristics of the Company's ARM and
Hybrid ARM loan portfolio as of December 31, 2000. This information pertains to
loans held for securitization, loans held as collateral for the notes payable
and loans TMA has securitized for its own portfolio for which the Company
retained credit loss exposure.
ARM AND HYBRID ARM LOAN PORTFOLIO CHARACTERISTICS
Average High Low
--------- ----------- -------
Unpaid principal balance. $282,890 $5,160,000 $1,978
Coupon rate on loans. . . 7.67% 10.13% 5.50%
Pass-through rate . . . . 7.35% 9.73% 5.23%
Pass-through margin . . . 1.98% 3.48% 0.36%
Lifetime cap. . . . . . . 12.90% 16.75% 9.75%
Original Term (months). . 355 480 72
Remaining Term (months) . 322 444 30
Geographic Distribution (Top 5 States): Property type:
California 28.17% Single-family 65.46%
Florida 9.66 DeMinimus PUD 20.38
Georgia 7.16 Condominium 9.22
New York 6.23 Other 4.94
Colorado 4.55
Occupancy status: Loan purpose:
Owner occupied 85.60% Purchase 60.73%
Second home 10.41 Cash out refinance 22.06
Investor 3.99 Rate & term refinance 17.21
Documentation type: Periodic Cap:
Full/Alternative 93.98% None 53.38%
Other 6.02 2.00% 45.19
1.00% 0.41
Average effective original 0.50% 1.02
loan-to-value: 68.73%
During the year ended December 31, 2000, the Company purchased $861.5 million of
ARM securities, 96.8% of which were High Quality assets, and $176.0 million of
ARM loans generally originated to "A" quality underwriting standards. Of the
ARM assets acquired during 2000, approximately 35% were Hybrid ARMs, 7% were
indexed to LIBOR and 58% were indexed to U.S. Treasury bill rates. Since 1997,
the Company has emphasized purchasing assets at substantially lower prices
relative to par in order to reduce the potential impact of future prepayments.
As a result, the Company emphasized the acquisition of ARM and Hybrid ARM assets
and high quality floating rate collateralized mortgages. In doing so, the
average premium/(discount) paid for ARM assets acquired in 2000, 1999 and 1998
was (0.42%), 0.45% and 1.09% of par, respectively, as compared to 3.29% of par
in 1997 when the Company emphasized the purchase of seasoned ARM assets. In
part, as a result of this strategy, the Company's unamortized net premium as a
percent of par decreased to 1.64% as of December 31, 2000, compared to 1.95% as
of December 31, 1999 and down from 2.83% as of the end of 1997.
28
During 2000, the Company sold $120.0 million of ARM assets. These sales
consisted of securities and one loan, that generally did not fit the Company's
current portfolio parameters, as well as two REO properties. The Company sold
ARM assets in the amount of $18.6 million during 1999. These sales consisted of
a mixture of securities and loans as well as one REO property. The Company
monitors the performance of its individual ARM assets and generally sells an
asset when there is an opportunity to replace it with an ARM asset that has an
expected higher long-term yield or more attractive interest rate
characteristics. The Company is presented with investment opportunities in the
ARM assets market on a daily basis and management evaluates such opportunities
against the performance of its existing portfolio. At times, the Company is
able to identify opportunities that it believes will improve the total return of
its portfolio by replacing selected assets. In managing the portfolio, the
Company may realize either gains or losses in the process of replacing selected
assets.
For the quarter ended December 31, 2000, the Company's mortgage assets paid down
at an approximate average annualized constant prepayment rate of 18% compared to
16% during the same period of 1999. The annualized constant prepayment rate
averaged approximately 17% during the full year of 2000 compared to 24% during
1999. When prepayment experience exceeds expectations due to sustained
increased prepayment activity, the Company has to amortize its premiums over a
shorter time period, resulting in a reduced yield to maturity on the Company's
ARM assets. Conversely, if actual prepayment experience is less than the
assumed constant prepayment rate, the premium would be amortized over a longer
time period, resulting in a higher yield to maturity. The Company monitors its
prepayment experience on a monthly basis in order to adjust the amortization of
the net premium, as appropriate.
The fair value of the Company's portfolio of ARM assets classified as
available-for-sale improved by 0.12% to a negative adjustment of 2.28% of the
portfolio as of December 31, 2000, from a negative adjustment of 2.40% as of
December 31, 1999. Additionally, this is a 0.67% improvement from the negative
adjustment of 2.97% as of September 30, 2000. This price improvement is
primarily due to the decrease in short-term interest rates that was occurring at
year-end and the relatively high interest rate on the Company's ARM portfolio,
compared to the interest rate on mortgage products being originated. The amount
of the negative adjustment to fair value on the ARM assets classified as
available-for-sale decreased to $78.4 million as of December 31, 2000, from
$83.4 million as of December 31, 1999 and $101.0 million as of September 30,
2000.
The Company has purchased Cap Agreements and Options Contracts in order to hedge
exposure to changing interest rates. The majority of the Cap Agreements and all
of the Options Contracts have been purchased to limit the Company's exposure to
risks associated with the lifetime interest rate caps of its ARM assets should
interest rates rise above specified levels. These hedging instruments act to
reduce the effect of the lifetime or maximum interest rate cap limitation.
These hedging instruments purchased by the Company will allow the yield on the
ARM assets to continue to rise in a high interest rate environment just as the
Company's cost of borrowings would continue to rise, since the borrowings do not
have any interest rate cap limitation. At December 31, 2000, the Cap Agreements
and Options Contracts owned by the Company that are designated as a hedge
against the lifetime interest rate cap on ARM assets had a remaining notional
balance of $2.520 billion with an average final maturity of 2.2 years, compared
to a remaining notional balance of $2.810 billion with an average final maturity
of 2.2 years at December 31, 1999. Pursuant to the terms of these hedging
instruments, the Company will receive cash payments if the one-month,
three-month or six-month LIBOR index increases above certain specified levels,
which range from 7.10% to 12.50% and average approximately 10.04%. The Company
has also entered into Cap Agreements with a notional balance of $104.1 million
as of December 31, 2000, compared to $134.6 million as of December 31, 1999, in
connection with hedging the fixed rate period of its Hybrid ARM assets. In
doing so, the Company establishes a maximum cost of financing the Hybrid ARM
assets during the term of the designated Cap Agreements that generally
corresponds to within one year of the initial fixed rate term of Hybrid ARM
assets. The Cap Agreements hedging Hybrid ARM assets as of December 31, 2000
would receive cash payments if the one-month LIBOR Index increases above certain
specified levels, which range from 5.75% to 6.00% and average approximately
5.94% and have a remaining term of 2.6 years. The fair value of Cap Agreements
and Options Contracts also tend to increase when general market interest rates
increase and decrease when market interest rates decrease, helping to partially
offset changes in the fair value of the Company's ARM assets. At December 31,
2000, the fair value of the Company's Cap Agreements and Options Contracts was
$1.3 million, $2.4 million less than the amortized cost of these hedging
instruments.
29
The following table presents information about the Company's Cap Agreement and
Options Contract portfolio that is designated as a hedge against the lifetime
interest rate cap on ARM assets as of December 31, 2000:
CAP AGREEMENTS/OPTIONS CONTRACTS STRATIFIED BY STRIKE PRICE
(Dollar amounts in thousands)
Hedged Weighted Cap Agreement/ Weighted
ARM Assets Average Options Contract Average Remaining
Balance (1) Life Cap Notional Balance Strike Price Term
- ------------ --------- ----------------- ------------- -----------------
$ 26,958 8.01% $ 26,000 7.10% 2.2 Years
201,434 8.35 200,000 7.50 3.0
516,647 9.76 519,760 8.00 1.5
25,779 10.61 25,000 9.00 1.7
60,404 10.73 60,544 9.50 1.7
362,451 11.29 362,132 10.00 1.7
199,968 11.77 200,852 10.50 1.3
454,099 12.38 452,652 11.00 2.6
279,392 12.89 280,000 11.50 3.6
359,346 13.93 360,777 12.00 2.7
25,020 16.53 32,562 12.50 1.0
- ------------ --------- ----------------- ------------- -----------------
$ 2,511,498 11.51% $ 2,520,279 10.04% 1.9 Years
============ ========= ================= ============= =================
- ------------------
(1) Excludes ARM assets that do not have life caps or are hybrids that are
match funded during a fixed rate period, in accordance with the Company's
investment policy.
As of December 31, 2000, the Company was a counterparty to twenty-two interest
rate swap agreements ("Swaps") having an aggregate notional balance of $623.4
million. As of December 31, 2000, these Swaps had a weighted average remaining
term of 2.4 years. In accordance with these Swaps, the Company will pay a fixed
rate of interest during the term of these Swaps and receive a payment that
varies monthly with the one-month LIBOR rate. All of these Swaps were entered
into in connection with the Company's acquisition of Hybrid ARMs and commitments
to acquire Hybrid ARMs. As a result of entering into these Swaps and the Cap
Agreements that also hedge the fixed rate period of Hybrid ARMs, the Company has
reduced the interest rate variability of its cost to finance its ARM assets by
increasing the average period until the next repricing of its borrowings from 25
days to 191 days. The Swaps hedge the cost of financing Hybrid ARMs to within a
one year duration of their fixed rate term, generally three to ten years. The
average remaining fixed rate term of the Company's Hybrid ARM assets as of
December 31, 2000 was 2.9 years. The Company has also entered into one delayed
Swap Agreement that becomes effective for a one-year term, beginning in April of
2002. This delayed Swap Agreement has a notional balance of $100 million and is
designated to hedge the interest rate exposure of Hybrid ARM assets upon the
termination of the other Swap Agreements.
RESULTS OF OPERATIONS - 2000 COMPARED TO 1999
For the year ended December 31, 2000, the Company's net income was $29,165,000,
or $1.05 per share (Diluted EPS), based on a weighted average of 21,506,000
shares outstanding. That compares to $25,584,000, or $0.88 per share (Diluted
EPS), based on a weighted average of 21,490,000 shares outstanding for the year
ended December 31, 1999. Net interest income for the year totaled $36,630,000,
compared to $34,015,000 for the same period in 1999. Net interest income is
comprised of the interest income earned on portfolio assets less interest
expense from borrowings. During 2000, the Company recorded a net gain on the
sale of ARM assets of $287,000 as compared to a net gain of $47,000 during 1999.
Additionally, during 2000, the Company reduced its earnings and the carrying
value of its ARM assets by reserving $1,158,000 for estimated credit losses,
compared to $2,867,000 during 1999. During 2000, the Company incurred operating
expenses of $6,594,000, consisting of a base management fee of $4,158,000, a
performance-based fee of $46,000 and other operating expenses of $2,390,000.
During 1999, the Company incurred operating expenses of $5,611,000, consisting
of a base management fee of $4,088,000 and other operating expenses of
$1,523,000.
30
The Company's return on average common equity was 6.90% for the year ended
December 31, 2000 compared to 5.81% for the year ended December 31, 1999.
During the fourth quarter of 2000, the Company's return on equity rose to 7.37%,
compared to 6.56% during the third quarter of 2000. The table below highlights
the historical trend and the components of return on average common equity
(annualized) and the 10-year U. S. Treasury average yield during each respective
quarter which is applicable to the computation of the performance fee:
COMPONENTS OF RETURN ON AVERAGE COMMON EQUITY (1)
ROE in
Excess of
Net Gain (Loss) G & A Net 10-Year 10-Year
For the Interest Provision on ARM Expense Preferred Income/ US Treas US Treas
Quarter Income/ For Losses/ Sales/ (2)/ Performance Dividend/ Equity Average Average
Ended Equity Equity Equity Equity Fee/ Equity Equity (ROE) Yield Yield
- ------------ --------- ------------ ----------- -------- ------------ ---------- -------- ---------- ---------
Mar 31, 1998 14.13% 0.48% 1.89% 1.62% 0.94% 2.06% 10.91% 5.60% 5.31%
Jun 30, 1998 9.15% 0.53% 1.76% 1.58% - 1.96% 6.83% 5.60% 1.23%
Sep 30, 1998 6.82% 0.66% 0.89% 1.54% - 1.97% 3.54% 5.24% -1.70%
Dec 31, 1998 7.27% 0.76% -4.88% 1.57% - 2.01% -1.95% 4.66% -6.61%
Mar 31, 1999 8.07% 0.84% - 1.58% - 2.05% 3.60% 4.98% -1.38%
Jun 30, 1999 11.17% 0.85% 0.04% 1.70% - 2.05% 6.60% 5.54% 1.06%
Sep 30, 1999 11.48% 0.94% 0.02% 1.76% - 2.05% 6.75% 5.88% 0.87%
Dec 31, 1999 11.09% 0.89% - 1.86% - 2.05% 6.29% 6.14% 0.15%
Mar 31, 2000 11.47% 0.41% - 1.81% - 2.06% 7.20% 6.47% 0.73%
Jun 30, 2000 10.74% 0.47% 0.06% 1.78% - 2.05% 6.50% 6.18% 0.32%
Sep 30, 2000 11.01% 0.33% - 2.07% - 2.05% 6.56% 5.89% 0.67%
Dec 31, 2000 11.77% 0.21% 0.29% 2.37% 0.06% 2.05% 7.37% 5.57% 1.80%
------------------
(1) Average common equity excludes unrealized gain (loss) on available-for-sale ARM securities.
(2) Excludes performance fees.
The Company's return on equity was higher in this past quarter compared to the
prior quarter primarily because the yield on the Company's ARM portfolio
increased more than its cost of funds, improving the net interest spread for the
respective quarters from an average of 0.26% for the third quarter of 2000 to
0.30% for the fourth quarter of 2000. The yield on the Company's ARM portfolio
increased from 6.99% for the third quarter of 2000 to 7.09% for the fourth
quarter, an improvement of 0.10%. The Company's average cost of funds for the
most recent quarter increased by 0.05%, from 6.73% for the prior quarter to
6.78% for the fourth quarter of 2000. Based on market interest rates as of
December 31, 2000, Federal Reserve Board actions to decrease short-term interest
rates early in 2001 and interest rate re-pricing characteristics of the
Company's ARM portfolio and borrowings, the Company expects that its cost of
funds will decrease at a faster pace than its ARM portfolio will decline in
yield, increasing the Company's portfolio margin during the first quarter of
2001. However, there is uncertainty regarding future Federal Reserve actions to
increase or decrease interest rates in the future and the effect these actions
may have on the ARM portfolio prepayment rate over the course of 2001.
31
The following table presents the components of the Company's net interest income
for the years ended December 31, 2000 and 1999:
COMPARATIVE NET INTEREST INCOME COMPONENTS
(Dollar amounts in thousands)
2000 1999
--------- ---------
Coupon interest income on ARM assets $306,142 $289,991
Amortization of net premium (16,273) (26,634)
Amortization of Cap Agreements (2,386) (5,352)
Amortization of deferred gain from hedging 1,183 906
Cash and cash equivalents 1,307 1,454
--------- ---------
Interest income 289,973 260,365
--------- ---------
Reverse repurchase agreements 202,309 163,807
AAA notes payable 52,336 58,893
Other borrowings 3,512 105
Interest rate swaps (4,814) 3,545
--------- ---------
Interest expense 253,343 226,350
--------- ---------
Net interest income $ 36,630 $ 34,015
========= =========
As presented in the table above, the Company's net interest income was $2.6
million higher during 2000 compared to 1999. The Company's interest income was
$29.6 million higher, primarily due to higher interest rates and a lower level
of net premium amortization, in part due to slower prepayments during 2000 as
compared to 1999. The Company's amortization expense for Cap Agreements has
also declined, improving interest income further. This amortization expense has
declined as the Company's more expensive Cap Agreements have expired and have
been replaced with less expensive Cap Agreements and because a larger proportion
of the Company's ARM portfolio consists of ARMs that do not have lifetime caps
and Hybrid ARMs that are generally match funded during their fixed rate period,
eliminating any need to hedge their lifetime cap during their fixed rate period.
The Company's interest expense increased by $27.0 million, primarily due to
higher interest rates. It is important to note that the Company received a
benefit from its use of Swaps to hedge the fixed rate period of Hybrid ARMs,
decreasing its interest expense by $4.8 million during 2000 compared to an
expense of $3.5 million during 1999. The Company's use of hedges has mitigated
the effect of rising short-term interest rates on the financing of its Hybrid
ARMs and was an important factor in the Company's ability to increase earnings
and improve return on equity in the year 2000 as compared to 1999.
32
The following table reflects the average balances for each category of the
Company's interest earning assets as well as the Company's interest bearing
liabilities, with the corresponding effective rate of interest annualized for
the years ended December 31, 2000 and 1999:
AVERAGE BALANCE AND RATE TABLE
(Dollar amounts in thousands)
For the Year Ended For the Year Ended
----------------------- ----------------------
December 31, 2000 December 31, 1999
----------------------- ----------------------
Average Effective Average Effective
Balance Rate Balance Rate
----------- ---------- ---------- ----------
Interest Earning Assets:
Adjustable-rate mortgage assets $4,233,933 6.82% $4,378,998 5.92%
Cash and cash equivalents 19,332 6.76 21,679 4.71
----------- ---------- ---------- ----------
4,253,265 6.82 4,400,677 5.92
----------- ---------- ---------- ----------
Interest Bearing Liabilities:
Borrowings 3,875,118 6.54 4,026,970 5.62
----------- ---------- ---------- ----------
Net Interest Earning Assets and Spread $ 378,147 0.28% $ 373,707 0.30%
=========== ========== ========== ==========
Yield on Net Interest Earning Assets (1) 0.86% 0.77%
========== ==========
(1) Yield on Net Interest Earning Assets is computed by dividing annualized net
interest income by the average daily balance of interest earning assets.
As a net result of the yield on the Company's interest-earning assets increasing
to 6.82% during 2000 from 5.92% during 1999 and the Company's cost of funds
increasing to 6.54% from 5.62%, its net interest income increased by $2,615,000.
This increase in net interest income is primarily the result of a favorable
rate variance, partially offset by a less significant unfavorable volume
variance. There was a net favorable rate variance of $2,736,000, which
consisted of a favorable variance of $39,657,000 resulting from the higher yield
on the Company's ARM assets portfolio and other interest-earning assets and an
unfavorable variance of $36,921,000 resulting from the increase in the Company's
cost of funds. The slightly lower average amount of interest earning assets
during 2000 produced an unfavorable volume variance of $10,049,000, but this was
almost entirely offset by a lower average balance of borrowings which produced a
favorable volume variance of $9,928,000, resulting in a net unfavorable volume
variance of only $122,000.
33
The following table highlights the components of net interest spread and the
annualized yield on net interest-earning assets as of each applicable quarter
end:
COMPONENTS OF NET INTEREST SPREAD AND YIELD ON NET INTEREST EARNING ASSETS (1)
(Dollar amounts in millions)
Yield on
Average Wgt Avg Yield on Net
As of the Interest Fully Weighted Interest Net Interest
Quarter Earning Indexed Average Yield Earning Cost of Interest Earning
Ended Assets Coupon Coupon Adj (2) Assets Funds Spread Assets
- ------------ --------- -------- --------- ------- --------- ------------ ------------- ---------
Mar 31, 1998 $ 4,859.7 7.47% 7.47% 1.23% 6.24% 5.74% 0.50% 0.92%
Jun 30, 1998 $ 4,918.3 7.51% 7.44% 1.50% 5.94% 5.81% 0.13% 0.56%
Sep 30, 1998 $ 4,963.7 6.97% 7.40% 1.52% 5.88% 5.78% 0.09% 0.46%
Dec 31, 1998 $ 4,526.2 6.79% 7.28% 1.42% 5.86% 5.94% (3) -0.08% (3) 0.61%
Mar 31, 1999 $ 4,196.4 6.85% 7.03% 1.31% 5.71% 5.36% 0.35% 0.63%
Jun 30, 1999 $ 4,405.3 7.10% 6.85% 1.11% 5.74% 5.40% 0.34% 0.82%
Sep 30, 1999 $ 4,552.1 7.20% 6.85% 0.76% 6.09% 5.74% 0.35% 0.82%
Dec 31, 1999 $ 4,449.0 7.51% 7.08% 0.70% 6.38% 6.47% (3) -0.09% (3) 0.81%
Mar 31, 2000 $ 4,471.0 7.77% 7.26% 0.68% 6.58% 6.32% 0.26% 0.83%
Jun 30, 2000 $ 4,344.6 7.87% 7.48% 0.59% 6.89% 6.75% 0.14% 0.81%
Sep 30, 2000 $ 4,066.1 7.84% 7.68% 0.68% 7.00% 6.72% 0.28% 0.88%
Dec 31, 2000 $ 4,131.4 7.46% 7.75% 0.69% 7.06% 6.75% (3) 0.31% (3) 0.93%
-----------------
(1) Yield on Net Interest Earning Assets is computed by dividing
annualized net interest income for the applicable quarter by the
average daily balance of interest earning assets during the quarter.
(2) Yield adjustments include the impact of amortizing premiums and
discounts, the cost of hedging activities, the amortization of
deferred gains from hedging activities and the impact of principal
payment receivables. The following table presents these Components of
the Yield Adjustments on ARM Assets for the dates presented in the
table above.
(3) The year-end cost of funds and net interest spread are commonly
affected by significant, but generally temporary, year-end pressures
that raise the Company's cost of financing mortgage assets over
year-end. The effect generally begins during the latter part of
November and continues through January.
COMPONENTS OF THE YIELD ADJUSTMENTS ON ARM ASSETS
Amort of
Impact of Deferred Gain
As of the Premium/ Principal From Total
Quarter Discount Payments Hedging Hedging Yield
Ended Amort Receivable Activity Activity Adjustment
- ------------ --------- ----------- --------- --------------- -----------
Mar 31, 1998 0.98% 0.16% 0.13% (0.04)% 1.23%
Jun 30, 1998 1.24% 0.17% 0.13% (0.04)% 1.50%
Sep 30, 1998 1.25% 0.18% 0.13% (0.04)% 1.52%
Dec 31, 1998 1.18% 0.14% 0.14% (0.04)% 1.42%
Mar 31, 1999 1.09% 0.10% 0.15% (0.03)% 1.31%
Jun 30, 1999 0.87% 0.13% 0.13% (0.02)% 1.11%
Sep 30, 1999 0.51% 0.13% 0.13% (0.01)% 0.76%
Dec 31, 1999 0.51% 0.09% 0.11% (0.01)% 0.70%
Mar 31, 2000 0.57% 0.07% 0.07% (0.03)% 0.68%
Jun 30, 2000 0.46% 0.10% 0.06% (0.03)% 0.59%
Sep 30, 2000 0.56% 0.10% 0.05% (0.03)% 0.68%
Dec 31, 2000 0.54% 0.13% 0.05% (0.03)% 0.69%
34
As of December 31, 2000, the Company's yield on its ARM assets portfolio,
including the impact of the amortization of premiums and discounts, the cost of
hedging, the amortization of deferred gains from hedging activity and the impact
of principal payment receivables, was 7.06%, compared to 6.38% as of December
31, 1999-- an increase of 0.68%. The Company's cost of funds as of December 31,
2000, was 6.75%, compared to 6.47% as of December 31, 1999 -- an increase of
0.28%. As a result of these changes, the Company's net interest spread as of
December 31, 2000 was 0.31%, compared to --0.09% as of December 31, 1999 --
an increase of 0.40%. The increase in the Company's cost of funds as of year
end, compared to September 30, 2000, is generally the impact of year end
pressures on short-term interest rates that typically cause a temporary rise in
the interest rate on the Company's borrowings.
The Company's spreads and net interest income has also been negatively impacted
since early 1998 by the spread relationship between U.S. Treasury rates and
LIBOR. This spread relationship has impacted the Company negatively because a
portion of the Company's ARM portfolio is indexed to U.S. Treasury rates and the
interest rates on all of the Company's borrowings tend to change with changes in
LIBOR. The Company has been reducing its exposure to ARM assets that are
indexed to U.S. Treasury rates through the product mix of its sales and
acquisitions in order to reduce the negative impact of this situation. In March
of 2000, the U.S. Treasury announced that it would adjust its monthly auction of
one-year treasury bills to quarterly and that it would cease auctioning the
one-year treasury bill next year. As a consequence, a shortage of one-year
bills has developed, increasing its cost and lowering its yield. Therefore, the
relationship between the one-year treasury index and LIBOR was negatively
impacted beginning with the second quarter of 2000 after improving during 1999
and early 2000. The Company does not know when or if this relationship will
improve, although, now that the U.S. Treasury has ceased to auction new one-year
treasury bills and is considering several new methods to compute the one-year
index, the Company believes that any of new methods being considered may improve
the relationship. The following table presents historical data since the year
the Company commenced operations regarding this relationship as well as data
regarding the percent of the Company's ARM portfolio that is indexed to U.S.
Treasury rates. As presented in the table below, the Company has reduced the
proportion of its ARM portfolio that is indexed to one-year U.S. Treasury rates
to 33.9% at December 31, 2000 from 49.0% as of the end of 1997. The data is as
follows:
ONE-YEAR U.S. TREASURY RATES COMPARED TO ONE- AND THREE-MONTH LIBOR RATES
Average Spread
Between 1 Year
U.S. Treasury Percent of ARM
Average 1 Year Average 1 and 3 Rates and 1 & 3 Portfolio Indexed
U.S. Treasury Month LIBOR Month LIBOR to 1 Year U.S.
For the Year Ended Rates During Rates During Rates During Treasury Rates at
December 31, Period Period Period End of Period
- ------------------ --------------- ---------------- ---------------- ------------------
1993 3.43% 3.25% 0.18% 20.9%
1994 5.32% 4.61% 0.71% 15.5%
1995 5.94% 6.01% -0.07% 19.3%
1996 5.52% 5.48% 0.04% 45.4%
1997 5.63% 5.69% -0.06% 49.0%
1998 5.05% 5.57% -0.52% 34.7%
1999 5.08% 5.33% -0.25% 31.4%
2000 6.11% 6.47% -0.36% 33.9%
The Company's provision for estimated credit losses decreased in 2000 compared
to 1999, in part, because the Company discontinued reducing the cost basis of
two securities that the Company now believes have been reduced to a cost basis
that fully reflects its estimate of credit losses for these two securities. The
outlook for estimated loss on these two securities has improved as the
underlying loans have been paying off and real estate values have improved,
primarily in the California market. Additionally, during the third quarter of
2000, the Company decided to reduce its rate of providing for losses on its
whole loan credit exposure. During the Company's third quarter review of the
level of its loan loss reserves and after considering its identifiable loss
exposure to currently delinquent loans and the lack of any significant losses to
date recorded in the portfolio, the Company concluded that its loan loss
reserves had reached a level that it was appropriate to reduce the rate at which
the Company is recording provisions. Since the commencement of acquiring whole
loans in 1997, the Company has only experienced a loss on one loan, in the
35
amount of $59,000, which was fully reserved and occurred in 2000. The Company
will continue to review economic conditions and the quality of its loan
portfolio and periodically adjust the rate at which it provides for losses. The
Company's provision for estimated loan losses is based on a number of factors
including, but not limited to, the outstanding principal balance of loans,
historical loss experience, current economic conditions, borrower payment
history, age of loans, loan-to-value ratios and underwriter standards applied by
the originator. The Company includes the outstanding balance of loans which it
has securitized and retained an exposure to credit losses, although the credit
losses in certain securitization structures may be limited by third-party credit
enhancement agreements. As of December 31, 2000, the Company's whole loans,
including those held as collateral for the notes payable and those that the
Company has securitized but retained credit loss exposure, accounted for 28.2%
of the Company's portfolio of ARM assets or $1.165 billion.
During 2000, the Company realized $287,000 in gains and no losses on the sale of
$120.0 million of ARM assets. The gain from the sale of ARM securities during
2000 included $48,000 of gains that were the result of the Company's
re-securitization of Other Investment ARM securities and the subsequent sale of
AAA and AA rated securities resulting from this re-securitization. The Company
retained a AAA rated interest only security and the subordinate classes of the
re-securitization in connection with this transaction. As a result of this
transaction, the Company improved its liquidity, the credit quality of its ARM
portfolio and recorded a small gain.
During 1999, the Company realized a net gain from the sale of ARM assets in the
amount of $47,000. The sales during 1999 were a combination of securities and
loans and one sale of a real estate property that the Company acquired through
foreclosure, which was sold for a $10,000 gain.
As a REIT, the Company is required to declare dividends amounting to 85% of each
year's taxable income by the end of each calendar year and to have declared
dividends amounting to 95% (90% effective 2001) of its taxable income for each
year by the time it files its applicable tax return and, therefore, generally
passes through substantially all of its earnings to shareholders without paying
federal income tax at the corporate level. As of December 31, 2000, the Company
had met all of the dividend distribution requirements of a REIT. Since the
Company, as a REIT, pays its dividends based on taxable earnings, the dividends
may at times be more or less than reported earnings. The following table
provides a reconciliation between the Company's earnings as reported based on
generally accepted accounting principles and the Company's taxable income before
its' common dividend deduction:
RECONCILIATION OF REPORTED NET INCOME TO TAXABLE NET INCOME
(Dollar amounts in thousands)
Years Ending December 31,
--------------------------
2000 1999
------------ ------------
Net income $ 29,165 $ 25,584
Additions:
Provision for credit losses 1,147 2,867
Net compensation related items 554 362
Non-REIT Subsidiary taxable loss 70 -
Deductions:
Dividend on Series A Preferred Shares (6,679)(1) (6,679)
Actual credit losses on ARM securities (941) (776)
Use of capital loss carry forward (230) (47)
------------ ------------
Taxable net income available to common $ 23,086 $ 21,311
============ ============
- -------------
(1) Excludes the preferred dividend declared December 15, 2000 and paid
January 10, 2001.
For the year ended December 31, 2000, the Company's ratio of operating expenses
to average assets was 0.16% compared to 0.12% for 1999. The Company's other
expenses increased by approximately $867,000, primarily due the operations of
the Company's taxable mortgage banking subsidiary, the expenses related to the
discontinued efforts to acquire a federally chartered financial institution,
expenses associated with the Company's issuance of DERs and PSRs and due to
other corporate matters. The Company's expense ratios are among the lowest of
any company originating and investing in mortgage assets, giving the Company
what it believes to be a significant competitive advantage over more traditional
mortgage portfolio lending institutions such as banks and savings and loans.
36
This competitive advantage enables the Company to operate with less risk, such
as credit and interest rate risk, and still generate an attractive long-term
return on equity when compared to these more traditional mortgage portfolio
lending institutions. The Company pays the Manager an annual base management
fee, generally based on average shareholders' equity, not assets, as defined in
the Management Agreement, payable monthly in arrears as follows: 1.15% of the
first $300 million of Average Shareholders' Equity, plus 0.85% of Average
Shareholders' Equity above $300 million. Since this management fee is based on
shareholders' equity and not assets, this fee increases as the Company
successfully accesses capital markets and raises additional equity capital and
is, therefore, managing a larger amount of invested capital on behalf of its
shareholders. In order for the Manager to earn a performance fee, the rate of
return on the shareholders' investment, as defined in the Management Agreement,
must exceed the average ten-year U.S. Treasury rate during the quarter plus 1%.
As presented in the following table, the performance fee is a variable expense
that fluctuates with the Company's return on shareholders' equity relative to
the average 10-year U.S. Treasury rate.
The following table highlights the quarterly trend of operating expenses as a
percent of average assets:
ANNUALIZED OPERATING EXPENSE RATIOS
Management Fee & Total
For the Other Expenses/ Performance Fee/ G & A Expense/
Quarter Ended Average Assets Average Assets Average Assets
- ------------- ----------------- ----------------- ---------------
Mar 31, 1998 0.10% 0.06% 0.16%
Jun 30, 1998 0.10% - 0.10%
Sep 30, 1998 0.10% - 0.10%
Dec 31, 1998 0.11% - 0.11%
Mar 31, 1999 0.12% - 0.12%
Jun 30, 1999 0.12% - 0.12%
Sep 30, 1999 0.13% - 0.13%
Dec 31, 1999 0.13% - 0.13%
Mar 31, 2000 0.13% - 0.13%
Jun 30, 2000 0.13% - 0.13%
Sep 30, 2000 0.16% - 0.16%
Dec 31, 2000 0.18% - 0.18%
RESULTS OF OPERATIONS - 1999 COMPARED TO 1998
For the year ended December 31, 1999, the Company's net income was $25,584,000,
or $0.88 per share (Diluted EPS), based on a weighted average of 21,490,000
shares outstanding. That compares to $22,695,000, or $0.75 per share (Diluted
EPS), based on a weighted average of 21,488,000 shares outstanding for the year
ended December 31, 1998. Net interest income for the year totaled $34,015,000,
compared to $31,040,000 for the same period in 1998. Net interest income is
comprised of the interest income earned on portfolio assets less interest
expense from borrowings. During 1999, the Company recorded a net gain on the
sale of ARM assets of $47,000 as compared to a net loss of $278,000 during 1998.
Additionally, during 1999, the Company reduced its earnings and the carrying
value of its ARM assets by reserving $2,867,000 for estimated credit losses,
compared to $2,032,000 during 1998. During 1999, the Company incurred operating
expenses of $5,611,000, consisting of a base management fee of $4,088,000 and
other operating expenses of $1,523,000. During 1998, the Company incurred
operating expenses of $6,035,000, consisting of a base management fee of
$4,142,000, a performance-based fee of $759,000 and other operating expenses of
$1,134,000. Total operating expenses decreased as a percentage of average
assets to 0.12% for 1999, compared to 0.13% for 1998.
The Company's return on average common equity was 5.81% for the year ended
December 31, 1999 compared to 4.80% for the year ended December 31, 1998. The
improved return on average common equity was primarily the result of a higher
net interest spread during 1999 as compared to 1998. The Company's cost of
funds during 1999 was 0.16% lower compared to 1998 and the yield on the
Company's interest earning assets was 0.04% lower during 1999 compared to 1998.
As a result, the Company's net interest margin averaged 0.30% during 1999
compared to 0.18% during 1998.
37
The following table presents the components of the Company's net interest income
for the years ended December 31, 1999 and 1998:
COMPARATIVE NET INTEREST INCOME COMPONENTS
(Dollar amounts in thousands)
1999 1998
---------- ---------
Coupon interest income on ARM assets $ 289,991 $ 35,983
Amortization of net premium (26,634) (46,101)
Amortization of Cap Agreements (5,352) (5,444)
Amort. of deferred gain from hedging 906 1,889
Cash and cash equivalents 1,454 705
---------- ---------
Interest income 260,365 287,032
---------- ---------
Reverse repurchase agreements 163,807 251,462
Notes payable 58,893 2,811
Other borrowings 105 632
Interest rate swaps 3,545 1,087
---------- ---------
Interest expense 226,350 255,992
---------- ---------
Net interest income $ 34,015 $ 31,040
========== =========
As presented in the table above, the Company's net interest income increased by
$3.0 million in 1999 compared to 1998. Amortization of net premium decreased by
$19.5 million. In 1999 the amortization of net premium was 9.2% of coupon
interest income on ARM assets as compared to 13.7% in 1998, reflecting, in part,
the decreased rate of ARM prepayments in 1999 as compared to 1998.
The following table reflects the average balances for each category of the
Company's interest earning assets as well as the Company's interest bearing
liabilities, with the corresponding effective rate of interest annualized for
the years ended December 31, 1999 and 1998:
AVERAGE BALANCE AND RATE TABLE
(Dollar amounts in thousands)
For the Year Ended For the Year Ended
December 31, 1999 December 31, 1998
-------------------------- ------------------------
Average Effective Average Effective
Balance Rate Balance Rate
------------- ----------- ----------- -----------
Interest Earning Assets:
Adjustable-rate mortgage assets $ 4,378,998 5.92% $ 4,800,772 5.96%
Cash and cash equivalents 21,679 4.71 16,214 4.35
------------- ---------- ------------ -----------
4,400,677 5.92 4,816,986 5.96
------------ -----------
Interest Bearing Liabilities:
Borrowings 4,026,970 5.62 4,430,167 5.78
Net Interest Earning Assets and Spread $ 373,707 0.30% $ 386,819 0.18%
============= =========== =========== ===========
Yield on Net Interest Earning Assets (1) 0.77% 0.64%
=========== ===========
(1) Yield on Net Interest Earning Assets is computed by dividing annualized net
interest income by the average daily balance of interest earning assets.
As a result of the Company's cost of funds declining to 5.62% during 1999 from
5.78% during 1998, which was partially offset by a decline in the yield on the
Company's interest-earning assets to 5.92% during 1999 from 5.96% during 1998,
net interest income increased by $2,975,000. This increase in net interest
income is a combination of rate and volume variances. There was a net favorable
rate variance of $4,883,000, which was the result of the lower cost of funds,
partially offset by the lower yield on the Company's ARM assets portfolio and
other interest-earning assets. The decreased average size of the Company's
portfolio during 1999 compared to 1998 contributed to less net interest income
in the amount of $1,908,000. The average balance of the Company's
interest-earning assets was $4.401 billion during 1999 compared to $4.817
billion during 1998 -- a decrease of 8.6%.
38
As of December 31, 1999, the Company's yield on its ARM assets portfolio,
including the impact of the amortization of premiums and discounts, the cost of
hedging, the amortization of deferred gains from hedging activity and the impact
of principal payment receivables, was 6.38%, compared to 5.86% as of December
31, 1998-- an increase of 0.52%. The Company's cost of funds as of December 31,
1999, was 6.47%, compared to 5.94% as of December 31, 1998 -- an increase of
0.53%. As a result of these changes, the Company's net interest spread as of
December 31, 1999 was -0.09%, compared to -0.08% as of December 31, 1998.
The increase in the Company's cost of funds as of year end is generally the
impact of year end pressures on short-term interest rates that were magnified by
concerns regarding Y2K that combined to cause a temporary rise in the interest
rate on the Company's borrowings. The Company's cost of funds reflects, in
part, the increase in one-month LIBOR that occurred at the end of November which
increased by approximately 0.87% on November 24, 1999. During the month of
December, the Company's cost of funds increased by 0.46%. By the end of January
2000, the Company's cost of funds had decreased by 0.44%, in part reflecting a
decrease in one-month LIBOR at the end of December of approximately 0.65%. The
Company's portfolio yield is not as sensitive to changes in one-month LIBOR.
The Company's portfolio yield increased by 0.10% in December and an additional
0.06% by the end of January 2000.
The Company's provision for losses increased to $2.9 million for 1999 from $2.0
million for 1998. The provision for losses increases as the Company acquires
and securitizes whole loans. The provision for estimated loan losses is based
on a number of pertinent factors as discussed earlier. As of December 31, 1999,
the Company's whole loans, including those held as collateral for the notes
payable and those that the Company has securitized but retained credit loss
exposure, accounted for 25.7% of the Company's portfolio of ARM assets compared
to 24.5% as of December 31, 1998.
During 1999, the Company realized a net gain from the sale of ARM assets in the
amount of $47,000 compared to a net loss of $278,000 during 1998. The sales
during 1999 were a combination of securities and loans that did not meet the
current investment criteria for the Company's ARM portfolio and one sale of a
real estate property that the Company acquired through foreclosure, which was
sold for a $10,000 gain. The 1998 sales generally fall into two categories.
During the first nine months of 1998, the Company realized a net gain on the
sale of ARM assets in the amount $3,780,000 as part of the Company's ongoing
portfolio management. These sales reflect the Company's desire to manage the
portfolio with a view to enhancing the total return of the portfolio over the
long-term while generating current earnings during this period of fast
prepayments and narrow interest spreads. The Company monitors the performance
of its individual ARM assets and selectively sells an asset when there is an
opportunity to replace it with an ARM asset that has an expected higher
long-term yield or more attractive interest rate characteristics. The Company
sold $511.8 million of ARM assets during the first nine months of 1998, most of
which were either indexed to a Cost of Funds index, the one-year U. S. Treasury
index or were prepaying faster than expected. During the first nine months of
1998 when the Company sold selected assets, it was able to reinvest the proceeds
in ARM assets that were indexed to indices preferred by the Company and at
prices that reflected current market assumptions regarding prepayments speeds
and interest rates and thus far, as a whole, they have been performing better
than the portfolio acquired before 1998. During the fourth quarter of 1998,
the Company sold assets for the primary purpose of maintaining adequate levels
of liquidity at a time when the mortgage finance market experienced a sudden
liquidity crises and, thus, was able to avoid the forced liquidation of any of
its assets by its mortgage finance counterparties. However, the Company
realized a net loss of $4,059,000 on these sales.
As a REIT, the Company was required to declare dividends amounting to 85% of
each year's taxable income by the end of each calendar year and to have declared
dividends amounting to 95% of its taxable income for each year by the time it
files its applicable tax return and, therefore, generally passes through
substantially all of its earnings to shareholders without paying federal income
tax at the corporate level. For 2001 and thereafter, the Company must
distribute dividends equal to 90% of its taxable income. As of December 31,
1999, the Company had met all of the dividend distribution requirements of a
REIT. Since the Company, as a REIT, pays its dividends based on taxable
earnings, the dividends may at times be more or less than
39
reported earnings. The following table provides a reconciliation between the
Company's earnings as reported based on generally accepted accounting principles
and the Company's taxable income before its' common dividend deduction:
RECONCILIATION OF REPORTED NET INCOME TO TAXABLE NET INCOME
(Dollar amounts in thousands)
Years Ending December 31,
----------------------------
1999 1998
------------- -------------
Net income $ 25,584 $ 22,695
Additions:
Provision for credit losses 2,867 2,032
Net compensation related items 362 (209)
Non-deductible capital losses (47) 278
Deductions:
Dividend on Series A Preferred Shares (6,679) (5,009)
Actual credit losses on ARM securities (776) (1,766)
------------- -------------
Taxable net income available to common $ 21,311 $ 18,021
============= =============
For the year ended December 31, 1999, the Company's ratio of operating expenses
to average assets was 0.12% compared to 0.13% for 1998. The primary reason for
the decline in this ratio is that the Manager did not receive any performance
fee in 1999 compared to earning a performance fee of $759,000 in 1998. The
Company's other expenses did increase by approximately $389,000, primarily due
to increased usage of legal services in connection with the Company's financing
and securitization of loans and other general corporate matters.
MARKET RISKS
The market risk management discussion and the amounts estimated from the
analysis that follows are forward-looking statements regarding market risk that
assume that certain market conditions occur. Actual results may differ
materially from these projected results due to changes in the Company's ARM
portfolio and borrowings mix and due to developments in the domestic and global
financial and real estate markets. Developments in the financial markets
include the likelihood of changing interest rates and the relationship of
various interest rates and their impact on the Company's ARM portfolio yield,
cost of funds and cashflows. The analytical methods utilized by the Company to
assess and mitigate these market risks should not be considered projections of
future events or operating performance.
As a financial institution that has only invested in U.S. dollar denominated
instruments, primarily residential mortgage instruments, and has only borrowed
money in the domestic market, the Company is not subject to foreign currency
exchange or commodity price risk, but rather the Company's market risk exposure
is limited solely to interest rate risk. Interest rate risk is defined as the
sensitivity of the Company's current and future earnings to interest rate
volatility, variability of spread relationships, the difference in repricing
intervals between the Company's assets and liabilities and the effect interest
rates may have on the Company's cashflows, especially ARM portfolio prepayments.
Interest rate risk impacts the Company's interest income, interest expense and
the market value on a large portion of the Company's assets and liabilities.
The management of interest rate risk attempts to maximize earnings and to
preserve capital by minimizing the negative impacts of changing market rates,
asset and liability mix and prepayment activity.
The table below presents the Company's consolidated interest rate risk using the
static gap methodology. This method reports the difference between interest
rate sensitive assets and liabilities at specific points in time as of December
31, 2000, based on the earlier of term to repricing or the term to repayment of
the asset or liability. The table does not include assets and liabilities that
are not interest rate sensitive such as payment receivables, prepaid expenses,
payables and accrued expenses. The table provides a projected repricing or
maturity based on scheduled rate adjustments, scheduled payments, and estimated
prepayments. For many of the Company's assets and certain of the Company's
liabilities, the maturity date is not determinable with certainty. In general,
the Company's ARM assets can be prepaid before contractual amortization and/or
maturity. Likewise, the Company's AAA rated notes payable are paid down as the
related ARM asset collateral pays down. The static gap report reflects the
Company's investment policy that allows for only the acquisition of ARM assets
that reprice within one year, short-term fixed rate assets with an average life
of one year or less or Hybrids ARMs that are match funded to within a duration
mismatch of one-year.
40
The difference between assets and liabilities repricing or maturing in a given
period is one approximate measure of interest rate sensitivity. More assets
than liabilities repricing in a period (a positive gap) implies earnings will
rise as interest rates rise and decline as interest rates decline. More
liabilities repricing than assets (a negative gap) implies declining income as
rates rise and increasing income as rates decline. The static gap analysis does
not take into consideration constraints on the repricing of the interest rate of
ARM assets in a given period resulting from periodic and lifetime cap features
nor the behavior of various indexes applicable to the Company's assets and
liabilities. Different interest rate indexes exhibit different degrees of
volatility in the same interest rate environment due to other market factors
such as, but not limited to, government fiscal policies, market concern
regarding potential credit losses, changes in spread relationships among
different indexes and global market disruptions.
The use of interest rate instruments such as Swaps, Cap Agreements and Option
Contracts are integrated into the Company's interest rate risk management. The
notional amounts of these instruments are not reflected in the Company's balance
sheet. The Swaps and Caps that hedge the Company's Hybrid ARMs are included in
the static gap report for purposes of analyzing interest rate risk because they
have the affect of adjusting the repricing characteristics of the Company's
liabilities. The Cap Agreements and Option Contracts that hedge the lifetime
cap on the Company's ARM assets are not considered in a static gap report
because they do not effect the timing of the repricing of the instruments they
hedge, but rather they, in effect, remove the limit on the amount of interest
rate change that can occur relative to the applicable hedged asset.
INTEREST RATE SENSITIVITY GAP ANALYSIS
(Dollar amounts in millions)
December 31, 2000
Over 3 Over 6
3 Months Months to Months to Over
or less 6 Months 1 Year 1 Year Total
------------- ------------ --------- ---------- ----------
Interest-earning assets:
ARM securities $ 1,644,011 $ 561,635 $530,296 $ - $2,735,942
ARM loans 289,229 55,201 13,543 - 357,973
Hybrid ARM loans 77,643 64,174 135,048 823,319 1,100,184
Cash and cash equivalents 13,105 - - - 13,105
------------- ------------ --------- ---------- ----------
Total interest-earning assets 2,023,988 681,010 678,887 823,319 4,207,204
------------- ------------ --------- ---------- ----------
Interest-bearing liabilities:
Reverse repurchase agreements 2,941,134 13,739 - - 2,954,873
Notes payable 603,910 - - - 603,910
Whole Loan Financing 158,593 - - - 158,593
Swaps (578,828) 44,547 85,971 448,310 -
------------- ------------ --------- ---------- ----------
Total interest-bearing
liabilities 3,124,809 58,286 85,971 448,310 3,717,376
------------- ------------ --------- ---------- ----------
Interest rate sensitivity gap $ (1,100,821) $ 622,724 $592,916 $ 375,009 $ 489,828
============= ============ ========= ========= ==========
Cumulative interest rate
sensitivity gap $ (1,100,821) $ (478,097) $114,819 $ 489,828
============= ============ ========= ==========
Cumulative interest rate sensitivity
gap as a percentage of total assets
before market value adjustments (25.79)% (11.20)% 2.69% 11.48%
============= ============ ========= ==========
41
The Company generally ends each year with a significant sensitivity to liability
repricing due to year-end aberrations in the cost of financing mortgage assets.
Although the Company begins the process of financing many of its mortgage assets
over year-end as early as the third quarter, the Company has a significant
amount of assets that are in term reverse repurchase agreements that have an
interest rate that re-sets monthly and that are collateralizing the Company's
notes payable that also have an interest rate that re-sets monthly, as well as
other assets that are not financed over year-end until close to the end of the
year. As a result, the Company typically re-finances assets during the latter
part of the year with short maturity borrowings in order to avoid locking in
year-end rates for a longer maturity. In this way, assets that are financed
close to year-end at unusually high rates have an opportunity to be re-financed
at lower rates soon after year-end, which has been a common seasonal fluctuation
applicable to financing mortgage assets.
Although the static gap methodology is widely accepted in identifying interest
rate risk, it does not take into consideration changes that may occur such as,
but not limited to, changes in investment and financing strategies, changes in
market spreads and relationships among different indexes, changes in hedging
strategy, changes in prepayment speeds and changes in business volumes.
Accordingly, the Company makes extensive usage of an earnings simulation model
to analyze its level of interest rate risk. This analytical technique used to
measure and manage interest rate risk includes the impact of all
on-balance-sheet and off-balance-sheet financial instruments.
There are a number of key assumptions made in using the Company's earnings
simulation model. These key assumptions include changes in market conditions
that effect interest rates, the pricing of ARM products, the availability of ARM
products, the availability and the cost of financing for ARM products. Other
key assumptions made in using the simulation model include prepayment speeds,
management's investment, financing and hedging strategies and the issuance of
new equity. The Company typically runs the simulation model under a variety of
hypothetical business scenarios that may include different interest rate
scenarios, different investment strategies, different prepayment possibilities
and other scenarios that provide the Company with a range of possible earnings
outcomes in order to assess potential interest rate risk. The assumptions used
represent the Company's estimate of the likely effect of changes in interest
rates and do not necessarily reflect actual results. The earnings simulation
model takes into account periodic and lifetime caps embedded in the Company's
ARM assets in determining the earnings at risk.
At December 31, 2000, based on the earnings simulation model, the Company's
potential earnings at risk to a gradual, parallel 100 basis point rise in market
interest rates over the next twelve months was approximately 8.7% of projected
2001 net income. The assumptions used in the earnings simulation model are
inherently uncertain and as a result, the analysis cannot precisely predict the
impact of higher interest rates on net income. Actual results would differ from
simulated results due to timing, magnitude and frequency of interest rate
changes, changes in prepayment speed other than what was assumed in the model,
changes in other market conditions and management strategies to offset its
potential exposure, among other factors. This measure of risk represents the
Company's exposure to higher interest rates at a particular point in time. The
Company's actual risk is always changing. The Company continuously monitors the
Company's risk profile as it changes and alters its strategies as appropriate in
its view of the likely course of interest rates and other developments in the
Company's business.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary source of funds for the year ended December 31, 2000
consisted of reverse repurchase agreements, which totaled $2.962 billion,
collateralized notes payable, which had a balance of $603.9 million and whole
loan financing facilities, which had a balance of $158.6 million. The Company's
other significant sources of funds for the year ended December 31, 2000
consisted primarily of payments of principal and interest from its ARM assets in
the amount of $1.161 billion. In the future, the Company expects its primary
sources of funds will consist of borrowed funds under reverse repurchase
agreement transactions with one- to twelve-month maturities, funds borrowed from
whole loan financing facilities, capital market financing transactions
collateralized by ARM and hybrid loans, proceeds from monthly payments of
principal and interest on its ARM assets portfolio and occasional asset sales.
The Company's liquid assets generally consist of unpledged ARM assets, cash and
cash equivalents.
Total borrowings outstanding at December 31, 2000, had a weighted average
effective cost of 6.91%. The reverse repurchase agreements had a weighted
average remaining term to maturity of 2.3 months and the collateralized AAA
notes payable had a final maturity of January 25, 2029, but will be paid down as
the ARM assets collateralizing the notes are paid down. The whole loan
financing facilities are committed facilities that mature in January 2001 and
March 2003, subject to annual review. As of December 31, 2000, $1.357 billion
42
of the Company's borrowings were variable-rate term reverse repurchase
agreements. Term reverse repurchase agreements are committed financings with
original maturities that range from two months to twelve months. The interest
rates on these term reverse repurchase agreements are indexed to either the one-
or three-month LIBOR rate and reprice accordingly. The interest rate on the
collateralized AAA notes adjusts monthly based on changes in one-month LIBOR.
The interest rates on the whole loan financing facilities are indexed to the
one-month LIBOR index and are subject to either daily or monthly adjustment.
The Company has arrangements to enter into reverse repurchase agreements with 26
different financial institutions and on December 31, 2000, had borrowed funds
with 12 of these firms. Because the Company borrows money under these agreements
based on the fair value of its ARM assets and because changes in interest rates
can negatively impact the valuation of ARM assets, the Company's borrowing
ability under these agreements could be limited and lenders may initiate margin
calls in the event interest rates change or the value of the Company's ARM
assets decline for other reasons. Additionally, certain of the Company's ARM
assets are rated less than AA by the Rating Agencies (approximately 3.0%) and
have less liquidity than assets that are rated AA or higher. Other mortgage
assets which are rated AA or higher by the Rating Agencies derive their credit
rating based on a mortgage pool insurer's rating. As a result of either changes
in interest rates, credit performance of a mortgage pool or a downgrade of a
mortgage pool issuer, the Company may find it difficult to borrow against such
assets and, therefore, may be required to sell certain mortgage assets in order
to maintain liquidity. If required, these sales could be at prices lower than
the carrying value of the assets, which would result in losses. The Company had
adequate liquidity throughout the year ended December 31, 2000. Company
believes it will continue to have sufficient liquidity to meet its future cash
requirements from its primary sources of funds for the foreseeable future
without needing to sell assets.
As of December 31, 2000, the Company had $603.9 million of AAA collateralized
notes outstanding, which are not subject to margin calls. Due to the structure
of the collateralized notes, their financing is not based on market value or
subject to subsequent changes in mortgage credit markets, as is the case of the
reverse repurchase agreement arrangements.
As of December 31, 2000, the Company had entered into three whole loan financing
facilities. The Company borrows money under these facilities based on the fair
value of the ARM loans. Therefore, the amount of money available to the Company
under these facilities is subject to margin call based on changes in fair value,
which can be negatively effected by changes in interest rates and other factors,
including the delinquency status of individual loans. One of the whole loan
financing facilities has a committed borrowing capacity of $150 million, with an
option to increase this amount to $300 million. This facility matures in
January 2001. During the first quarter of 2000, the Company entered into a
second committed whole loan financing facility that also has a borrowing
capacity of $150 million. This second committed facility matures in March of
2003, subject to an annual review and extension by both parties. The third
facility is for an unspecified amount of uncommitted borrowing capacity and does
not have a specific maturity date. As of December 31, 2000, the Company had
$158.6 million borrowed against these whole loan financing facilities at an
effective cost of 7.05%.
In December 1996, the Company's Registration Statement on Form S-3, registering
the sale of up to $200 million of additional equity securities, was declared
effective by the Securities and Exchange Commission. This registration
statement includes the possible issuances of common stock, preferred stock,
warrants or shareholder rights. As of December 31, 2000, the Company had $109
million of its securities registered for future sale under this Registration
Statement.
During 1998, the Board of Directors approved a common stock repurchase program
of up to 1,000,000 shares at prices below book value, subject to availability of
shares and other market conditions. The Company did not repurchase any shares
during 2000. To date, the Company has repurchased 500,016 shares at an average
price of $9.28 per share.
The Company has a Dividend Reinvestment and Stock Purchase Plan (the "DRP")
designed to provide a convenient and economical way for existing shareholders to
automatically reinvest their dividends in additional shares of common stock and
for new and existing shareholders to purchase shares, as defined in the DRP.
During 2000, the Company purchased shares in the open market on behalf of the
participants in its DRP instead of issuing new shares below book value. In
accordance with the terms and conditions of the DRP, the Company pays the
brokerage commission in connection with these purchases.
EFFECTS OF INTEREST RATE CHANGES
Changes in interest rates impact the Company's earnings in various ways. While
the Company only invests in ARM assets, rising short-term interest rates may
temporarily negatively affect the Company's earnings and conversely falling
short-term interest rates may temporarily increase the Company's earnings. This
impact can occur for several reasons and may be mitigated by portfolio
43
prepayment activity as discussed below. First, the Company's borrowings will
react to changes in interest rates sooner than the Company's ARM assets because
the weighted average next repricing date of the borrowings is usually a shorter
time period. Second, interest rates on ARM loans are generally limited to an
increase of either 1% or 2% per adjustment period (commonly referred to as the
periodic cap) and the Company's borrowings do not have similar limitations.
Third, the Company's ARM assets lag changes in the indices due to the notice
period provided to ARM borrowers when the interest rates on their loans are
scheduled to change. The periodic cap only affects the Company's earnings when
interest rates move by more than 1% per six-month period or 2% per year.
Interest rates can also affect the Company's net return on its Hybrid ARMs (net
of the cost of financing Hybrid ARMs). The Company has estimates the duration
of the fixed rate period of its Hybrid ARM and has a policy to hedge the
financing of the Hybrid ARMs for the duration of the fixed rate period less one
year. The financing of the unhedged fixed rate remaining period of one year or
less is subject to prevailing interest rates on the remaining balance of the
Hybrid ARMs at the expiration of the hedged period. As a result, if the cost of
funds on borrowings is higher at the expiration of the hedged period, the
Company's net interest spread on the remaining balance of a Hybrid ARM asset
will be affected unfavorably and conversely, if the cost of funds on borrowings
is lower, the net interest spread will be affected favorably.
Interest rate changes may also impact the Company's ARM assets and borrowings
differently because the Company's ARM assets are indexed to various indices
whereas the interest rate on the Company's borrowings generally move with
changes in LIBOR. Although the Company has always favored acquiring LIBOR based
ARM assets in order to reduce this risk, LIBOR based ARMs are not generally well
accepted by homeowners in the U.S. As a result, the Company has acquired ARM
assets indexed to a mix of indices in order to diversify its exposure to changes
in LIBOR in contrast to changes in other indices. During times of global
economic instability, U.S. Treasury rates generally decline because foreign and
domestic investors generally consider U.S. Treasury instruments to be a safe
haven for investments. The Company's ARM assets indexed to U.S. Treasury rates
then decline in yield as U.S. Treasury rates decline, whereas the Company's
borrowings and other ARM assets may not be affected by the same pressures or to
the same degree. As a result, the Company's income can improve or decrease
depending on the relationship between the various indices that the Company's ARM
assets are indexed to compared to changes in the Company's cost of funds.
The rate of prepayment on the Company's mortgage assets may increase if interest
rates decline, or if the difference between long-term and short-term interest
rates diminishes. Increased prepayments would cause the Company to amortize the
premiums paid for its mortgage assets faster, resulting in a reduced yield on
its mortgage assets. Additionally, to the extent proceeds of prepayments cannot
be reinvested at a rate of interest at least equal to the rate previously earned
on such mortgage assets, the Company's earnings may be adversely affected.
Conversely, the rate of prepayment on the Company's mortgage assets may decrease
if interest rates rise, or if the difference between long-term and short-term
interest rates increases. Decreased prepayments would cause the Company to
amortize the premiums paid for its ARM assets over a longer time period,
resulting in an increased yield on its mortgage assets. Therefore, in rising
interest rate environments where prepayments are declining, not only would the
interest rate on the ARM assets portfolio increase to re-establish a spread over
the higher interest rates, but the yield also would rise due to slower
prepayments. The combined effect could significantly mitigate other negative
effects that rising short-term interest rates might have on earnings.
Lastly, because the Company only invests in ARM assets and approximately 8% to
10% of such mortgage assets are purchased with shareholders' equity, the
Company's earnings, over time, will tend to increase, after an initial
short-term decline, following periods when short-term interest rates have risen
and decrease, after an initial short-term increase, following periods when
short-term interest rates have declined. This is because the financed portion
of the Company's portfolio of ARM assets will, over time, reprice to a spread
over the Company's cost of funds, while the portion of the Company's portfolio
of ARM assets that are purchased with shareholders' equity will generally have a
higher yield in a higher interest rate environment and a lower yield in a lower
interest rate environment.
OTHER MATTERS
The Company calculates its Qualified REIT Assets, as defined in the Internal
Revenue Code of 1986, as amended (the "Code"), to be 99.7% of its total assets,
compared to the Code requirement that at least 75% of its total assets must be
Qualified REIT Assets. The Company also calculates that 97.9% of its 2000
revenue qualifies for the 75% source of income test and 100% of its 2000 revenue
qualifies for the 95% source of income test under the REIT rules. The Company
also met all REIT requirements regarding the ownership of its common stock and
the distributions of its net income. Therefore, as of December 31, 2000, the
Company believes that it will continue to qualify as a REIT under the provisions
of the Code.
44
The Company at all times intends to conduct its business so as not to become
regulated as an investment company under the Investment Company Act of 1940. If
the Company were to become regulated as an investment company, the Company's use
of leverage would be substantially reduced. The Investment Company Act exempts
entities that are "primarily engaged in the business of purchasing or otherwise
acquiring mortgages and other liens on and interests in real estate"
("Qualifying Interests"). Under current interpretation of the staff of the SEC,
in order to qualify for this exemption, the Company must maintain at least 55%
of its assets directly in Qualifying Interests. In addition, unless certain
mortgage assets represent all the certificates issued with respect to an
underlying pool of mortgages, such mortgage assets may be treated as assets
separate from the underlying mortgage loans and, thus, may not be considered
Qualifying Interests for purposes of the 55% requirement. As of December 31,
2000, the Company calculates that it is in compliance with this requirement.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information called for by Item 7A is incorporated by
reference from the information in Item 7 under the caption
"Market Risk" set forth on pages 40 through 42 in this Form 10-K.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements of the Company, the related notes and
schedules to the financial statements, together with the Reports
of Independent Accountants thereon are set forth on pages F-3
through F-25 in this Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by Item 10 is incorporated herein by
reference to the definitive Proxy Statement dated March 28, 2001
pursuant to General Instruction G(3).
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 is incorporated herein by
reference to the definitive Proxy Statement dated March 28, 2001
pursuant to General Instruction G(3).
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 is incorporated herein by
reference to the definitive Proxy Statement dated March 28, 2001
pursuant to General Instruction G(3).
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is incorporated herein by
reference to the definitive Proxy Statement dated March 28, 2001
pursuant to General Instruction G(3).
45
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents filed as part of this report:
1. The following Financial Statements of the Company are
included in Part II, Item 8 of this Annual Report on
Form-K:
Reports of Independent Accountants;
Consolidated Balance Sheets as of December 31, 2000
and 1999;
Consolidated Statements of Operations for the years
ended December 31, 2000, 1999 and 1998;
Consolidated Statements of Shareholders' Equity for the
years ended December 31, 2000, 1999 and 1998;
Consolidated Statements of Cash Flows for the years
ended December 31, 2000, 1999 and 1998 and Notes to
Consolidated Financial Statements.
2. Schedules to Consolidated Financial Statements:
All consolidated financial statement schedules are
included in Part II, Item 8 of this Annual Report on
Form-K.
3. Exhibits:
See "Exhibit Index".
(b) Reports on Form 8-K:
None
46
THORNBURG MORTGAGE, INC
AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AND
REPORTS OF INDEPENDENT ACCOUNTANTS
For Inclusion in Form 10-K
Filed with
Securities and Exchange Commission
December 31, 2000
THORNBURG MORTGAGE, INC
AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
FINANCIAL STATEMENTS:
Reports of Independent Accountants F-3
Consolidated Balance Sheets F-5
Consolidated Statements of Operations F-6
Consolidated Statements of Shareholders' Equity F-7
Consolidated Statements of Cash Flows F-8
Notes to Consolidated Financial Statements F-9
FINANCIAL STATEMENT SCHEDULE:
Schedule IV - Mortgage Loans on Real Estate F-24
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders
Thornburg Mortgage, Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, shareholders' equity and cash flows
present fairly, in all material respects, the financial position of Thornburg
Mortgage, Inc. and its subsidiaries at December 31, 2000 and 1999, and the
results of their operations and their cash flows for each of the two years in
the period ended December 31, 2000 in conformity with accounting principles
generally accepted in the United States of America. In addition, in our
opinion, the accompanying financial statement schedule presents fairly, in all
material respects, the information set forth therein when read in conjunction
with the related consolidated financial statements. These financial statements
and the financial statement schedule are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements and the financial statement schedule based on our audits. We
conducted our audits of these statements in accordance with auditing standards
generally accepted in the United States of America, which 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, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
New York, New York
January 24, 2001
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders
Thornburg Mortgage, Inc.
We have audited the accompanying consolidated statements of operations,
shareholders' equity and cash flows of Thornburg Mortgage, Inc. and Subsidiaries
for the year ended December 31, 1998. 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 audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements of Thornburg Mortgage,
Inc. and Subsidiaries referred to above present fairly, in all material
respects, the results of their operations and their cash flows for the year
ended December 31, 1998 in conformity with generally accepted accounting
principles.
/s/ McGladrey & Pullen, LLP
New York, New York
January 20, 1999
F-4
THORNBURG MORTGAGE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands)
December 31
------------------------
2000 1999
----------- -----------
ASSETS
Adjustable-rate mortgage ("ARM") assets (Notes 2 and 3)
ARM securities $3,359,352 $3,391,467
Collateral for collateralized notes 615,696 903,529
ARM loans held for securitization 164,413 31,102
----------- -----------
4,139,461 4,326,098
Cash and cash equivalents (Note 3) 13,105 10,234
Accrued interest receivable 32,730 31,928
Prepaid expenses and other 4,871 7,705
----------- -----------
$4,190,167 $4,375,965
=========== ===========
LIABILITIES
Reverse repurchase agreements (Note 3) $2,961,617 $3,022,511
Collateralized notes payable (Note 3) 603,910 886,722
Other borrowings (Note 3) 158,593 21,289
Payable for assets purchased 124,942 110,415
Accrued interest payable 20,519 18,864
Dividends payable (Note 5) 1,670 1,670
Accrued expenses and other 1,378 3,607
----------- -----------
3,872,629 4,065,078
----------- -----------
COMMITMENTS (Note 2)
SHAREHOLDERS' EQUITY (Note 5)
Preferred stock: par value $.01 per share;
2,760 shares authorized; 9.68% Cumulative
Convertible Series A, 2,760 and 2,760 issued
and outstanding, respectively; aggregate preference in
liquidation $69,000 65,805 65,805
Common stock: par value $.01 per share;
47,240 shares authorized, 22,072 and 21,990 shares
issued and 21,572 and 21,490 outstanding, respectively 221 220
Additional paid-in-capital 343,036 342,026
Accumulated other comprehensive income (loss) (78,427) (82,489)
Notes receivable from stock sales (5,318) (4,632)
Retained earnings (deficit) (3,113) (5,377)
Treasury stock: at cost, 500 and 500 shares respectively (4,666) (4,666)
----------- -----------
317,538 310,887
----------- -----------
$4,190,167 $4,375,965
=========== ===========
See Notes to Consolidated Financial Statements.
F-5
THORNBURG MORTGAGE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except per share data)
Year ended December 31
----------------------------------
2000 1999 1998
---------- ---------- ----------
Interest income from ARM assets and cash equivalents $ 289,973 $ 260,365 $ 287,032
Interest expense on borrowed funds (253,343) (226,350) (255,992)
---------- ---------- ----------
Net interest income 36,630 34,015 31,040
---------- ---------- ----------
Gain (loss) on sale of ARM assets 287 47 (278)
Provision for credit losses (1,158) (2,867) (2,032)
Management fee (Note 7) (4,158) (4,088) (4,142)
Performance fee (Note 7) (46) - (759)
Other operating expenses (2,390) (1,523) (1,134)
---------- ---------- ----------
NET INCOME $ 29,165 $ 25,584 $ 22,695
========== ========== ==========
Net income $ 29,165 $ 25,584 $ 22,695
Dividend on preferred stock (6,679) (6,679) (6,679)
---------- ---------- ----------
Net income available to common shareholders $ 22,486 $ 18,905 $ 16,016
========== ========== ==========
Basic earnings per share $ 1.05 $ 0.88 $ 0.75
========== ========== ==========
Diluted earnings per share $ 1.05 $ 0.88 $ 0.75
========== ========== ==========
Average number of common shares outstanding 21,506 21,490 21,488
========== ========== ==========
See Notes to Consolidated Financial Statements.
F-6
THORNBURG MORTGAGE ASSET CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Three Years Ended December 31, 1999
(Dollar amounts in thousands, except per share data)
Notes
Accum. Receiv-
Addit- Other able
Pref- ional Compre- From Retained Compre-
erred Common Paid-in hensive Stock Earnings/ Treasury hensive
Stock Stock Capital Income Sales (Deficit) Stock Income Total
------- ------ -------- --------- -------- ---------- -------- --------- ---------
Balance, December 31, 1997 . . . . . $65,805 $ 203 $315,240 $(19,445) $ (2,698) $ (951) $ - $358,154
Comprehensive income:
Net income. . . . . . . . . . . . 22,695 $22,695 22,695
Other comprehensive income:
Available-for-sale assets:
Fair value adjustment, net. . - - - (61,157) - - - (61,157) (61,157)
Deferred gain on sale of
hedges, net of amortization . - - - (1,546) - - - (1,546) (1,546)
---------
Other comprehensive loss. . . . . $(40,008)
=========
Issuance of common stock (Note 5). . - 17 26,259 - (1,934) - 24,342
Purchase of treasury stock (Note 5). - - - - - (4,666) (4,666)
Interest from notes receivable from
stock sales . . . . . . . . . . . 257 257
Dividends declared on preferred
stock - $2.42 per share . . . . . . - - - - - (6,679) - (6,679)
Dividends declared on common
stock - $0.905 per share. . . . . . - - - - - (19,577) - (19,577)
------- ------ -------- --------- -------- ---------- -------- --------- ---------
Balance, December 31, 1998 . . . . . 65,805 220 341,756 (82,148) (4,632) (4,512) (4,666) 311,823
Comprehensive income:
Net income. . . . . . . . . . . . 25,584 $ 25,584 25,584
Other comprehensive income:
Available-for-sale assets:
Fair value adjustment, net. . - - - 307 - - - 307 307
Deferred gain on sale of
hedges, net of amortization . - - - (648) - - - (648) (648)
---------
Other comprehensive income. . . . $(25,243)
=========
Interest from notes receivable
from stock sales . . . . . . . . . 270 270
Dividends declared on preferred
stock - $2.42 per share . . . . . . - - - - - (6,679) - (6,679)
Dividends declared on common
stock - $0.92 per share. . . . . . . - - - - - (19,770) - (19,770)
------- ------ -------- --------- -------- ---------- -------- ---------
Balance, December 31, 1999 . . . . . $65,805 $ 220 $342,026 $(82,489) $(4,632) $ (5,377) $(4,666) $310,887
Comprehensive income:
Net income. . . . . . . . . . . . 29,165 $ 29,165 29,165
Other comprehensive income:
Available-for-sale assets:
Fair value adjustment, net. . - - - 4,927 - - - 4,927 4,927
Deferred gain on sale of
hedges, net of amortization . - - - (865) - - - (865) (865)
---------
Other comprehensive income. . . . $ 33,227
=========
Issuance of common stock (Note 5). . - 1 730 - (686) - 45
Interest from notes receivable from
stock sales . . . . . . . . . . . . 280 280
Dividends declared on preferred
stock - $2.42 per share . . . . . . - - - - - (6,679) - (6,679)
Dividends declared on common
stock - $0.92 per share. . . . . . - - - - - (20,222) - (20,222)
------- ------ -------- --------- -------- ---------- -------- ---------
Balance, December 31, 2000 . . . . . $65,805 $ 221 $343,036 $(78,427) $(5,318) $ (3,113) $(4,666) $317,538
======= ====== ======== ========= ======== ========== ======== =========
See Notes to Consolidated Financial Statements.
F-7
THORNBURG MORTGAGE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollar amounts in thousands)
Year ended December 31
--------------------------------------
2000 1999 1998
---------- ------------ ------------
Operating Activities:
Net income $ 29,165 $ 25,584 $ 22,695
Adjustments to reconcile net income to
net cash provided by operating activities:
Amortization 17,476 31,080 49,657
Net realized (gain) loss from investing activities (287) (47) 278
Provision for credit losses 1,158 2,867 2,032
Decrease (increase) in accrued interest receivable (802) 6,011 414
Decrease (increase) in prepaid expenses and other 2,834 (5,859) (1,557)
Increase (decrease) in accrued interest payable 1,655 (12,650) (8,235)
Increase (decrease) in accrued expenses and other (2,229) 397 1,994
---------- ------------ ------------
Net cash provided by operating activities 48,970 47,383 67,278
---------- ------------ ------------
Investing Activities:
Available-for-sale securities:
Purchases (736,568) (1,244,341) (1,501,961)
Proceeds on sales 120,149 9,922 929,999
Proceeds from calls 4,288 6,234 138,926
Principal payments 682,624 1,026,098 1,651,450
Collateral for collateralized notes payable:
Principal payments 284,326 239,737 13,416
ARM Loans:
Purchases (176,027) (35,417) (1,092,238)
Principal payments 9,029 9,339 115,081
Proceeds on sales 107 8,775 2,043
Purchase of interest rate cap and floor agreements (1,048) (1,853) (1,081)
---------- ------------ ------------
Net cash provided by investing activities 186,880 18,494 255,635
---------- ------------ ------------
Financing Activities:
Net borrowings from (repayments of) reverse repurchase agreements (60,894) 155,304 (1,402,963)
Net borrowings from (repayments of) collateralized notes (282,813) (240,459) 1,127,181
Net borrowings from (repayments of) other borrowings 137,303 19,260 (7,989)
Proceeds from common stock issued 45 - 24,342
Purchase of treasury stock - - (4,666)
Dividends paid (26,900) (26,449) (36,396)
Interest from notes receivable from stock sales 280 270 229
---------- ------------ ------------
Net cash (used in) financing activities (232,979) (92,074) (300,262)
---------- ------------ ------------
Net increase (decrease) in cash and cash equivalents 2,871 (26,197) 22,651
Cash and cash equivalents at beginning of year 10,234 36,431 13,780
---------- ------------ ------------
Cash and cash equivalents at end of year $ 13,105 $ 10,234 $ 36,431
========== ============ ============
Supplemental disclosure of cash flow information and non-cash
investing and financing activities are included in Notes 2 and 3.
See Notes to Consolidated Financial Statements.
F-8
THORNBURG MORTGAGE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Thornburg Mortgage, Inc., formerly Thornburg Mortgage Asset
Corporation, was incorporated in Maryland on July 28, 1992. The
Company commenced its operations of purchasing and managing for
investment a portfolio of adjustable-rate mortgage assets on June 25,
1993, upon receipt of the net proceeds from the initial public
offering of the Company's common stock.
A summary of the Company's significant accounting policies follows:
CASH AND CASH EQUIVALENTS
Cash and cash equivalents includes cash on hand and highly liquid
investments with original maturities of three months or less. The
carrying amount of cash equivalents approximates their value.
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of
Thornburg Mortgage, Inc (together with its subsidiaries referred
to hereafter as the "Company") and its wholly-owned bankruptcy
remote special purpose finance subsidiaries, Thornburg Mortgage
Funding Corporation ("TMFC"), Thornburg Mortgage Acceptance
Corporation ("TMAC") and a taxable mortgage banking subsidiary,
Thornburg Mortgage Home Loans, Inc. ("TMHL") and its special
purpose finance subsidiaries, Thornburg Mortgage Funding
Corporation II, Thornburg Mortgage Acceptance Corporation II.
TMFC and TMAC are wholly-owned qualified REIT subsidiaries and
are consolidated with the Company for financial statement and tax
reporting purposes. TMHL and its subsidiaries have operated as
taxable REIT subsidiaries since December 1, 2000 and are
consolidated with the Company for financial statement purposes
and are not consolidated with the Company for tax reporting
purposes. All material intercompany accounts and transactions are
eliminated in consolidation.
ADJUSTABLE-RATE MORTGAGE ASSETS
The Company's adjustable-rate mortgage ("ARM") assets are
comprised of ARM securities, ARM loans and collateral for notes
payable, which also consists of ARM securities and ARM loans.
Included in the Company's ARM assets are hybrid ARM securities
and loans ("Hybrid ARMs") that have a fixed interest rate for an
initial period, generally three to ten years, and then convert to
an adjustable-rate for their remaining term to maturity.
Management has made the determination that all of its ARM
securities should be designated as available-for-sale in order to
be prepared to respond to potential future opportunities in the
market, to sell ARM securities in order to optimize the
portfolio's total return and to retain its ability to respond to
economic conditions that might require the Company to sell assets
in order to maintain an appropriate level of liquidity. Since all
ARM securities are designated as available-for-sale, they are
reported at fair value, with unrealized gains and losses excluded
from earnings and reported in accumulated other comprehensive
income as a separate component of shareholders' equity.
Management has the intent and ability to hold the Company's ARM
loans for the foreseeable future and until maturity or payoff.
Therefore, they are carried at their unpaid principal balances,
net of unamortized premium or discount and allowance for loan
losses.
The collateral for the notes payable includes ARM securities and
ARM loans which are accounted for in the same manner as the ARM
securities and ARM loans that are not held as collateral.
Premiums and discounts associated with the purchase of the ARM
assets are amortized into interest income over the lives of the
assets using the effective yield method adjusted for the effects
of estimated prepayments.
F-9
ARM asset transactions are recorded on the date the ARM assets
are purchased or sold. Purchases of new issue ARM securities and
all ARM loans are recorded when all significant uncertainties
regarding the characteristics of the assets are removed and, in
the case of loans, underwriting due diligence has been completed,
generally shortly before the settlement date. Realized gains and
losses on ARM asset transactions are determined on the specific
identification basis.
CREDIT RISK
The Company limits its exposure to credit losses on its portfolio
of ARM securities by only purchasing ARM securities that have an
investment grade rating at the time of purchase and have some
form of credit enhancement or are guaranteed by an agency of the
federal government. An investment grade security generally has a
security rating of BBB or Baa or better by at least one of two
nationally recognized rating agencies, Standard & Poor's, Inc. or
Moody's Investor Services, Inc. (the "Rating Agencies").
Additionally, the Company has also purchased ARM loans and limits
its exposure to credit losses by restricting its whole loan
purchases to ARM loans generally originated to "A" quality
underwriting standards or loans that have at least five years of
pay history and/or low loan to property value ratios. The Company
further limits its exposure to credit risk by limiting its
investment in investment grade securities that are rated A, or
equivalent, BBB, or equivalent, or ARM loans originated to "A"
quality underwriting standards ("Other Investments") to no more
than 30% of the portfolio, including the subordinate classes of
securities retained as part of the Company's securitization of
loans.
The Company monitors the delinquencies and losses on the
underlying mortgage loans backing its ARM securities. If the
credit performance of the underlying mortgage loans is not as
expected, the Company makes a provision for probable credit
losses at a level deemed appropriate by management to provide for
known losses as well as estimated losses inherent in its ARM
securities portfolio. The provision is based on management's
assessment of numerous factors affecting its portfolio of ARM
assets including, but not limited to, current economic
conditions, delinquency status, credit losses to date on
underlying mortgages and remaining credit protection. The
provision for ARM securities is made by reducing the cost basis
of the individual security for the decline in fair value which is
other than temporary, and the amount of such write-down is
recorded as a realized loss, thereby reducing earnings.
The Company also makes a monthly provision for estimated credit
losses on its portfolio of ARM loans, which is an increase to the
allowance for loan losses. The provision for estimated credit
losses on loans is based on loss statistics of the real estate
industry for similar loans, taking into consideration factors
including, but not limited to, underwriting characteristics,
seasoning, geographic location and current economic conditions.
When a loan or a portion of a loan is deemed to be uncollectible,
the portion deemed to be uncollectible is charged against the
allowance and subsequent recoveries, if any, are credited to the
allowance. Additionally, once a loan is 90 days or more
delinquent, the Company adjusts the value of the accrued interest
receivable to what it believes to be collectible and generally
stops accruing interest on the loan.
Credit losses on pools of loans that are held as collateral for
notes payable are also covered by third-party insurance policies
that protect the Company from credit losses above a specified
level, limiting the Company's exposure to credit losses on such
loans. The Company makes a monthly provision for estimated credit
losses on these loans the same as it does for loans that are not
held as collateral for notes payable, except, it takes into
consideration its maximum exposure.
Provisions for credit losses do not reduce taxable income and
thus do not affect the dividends paid by the Company to
shareholders in the period the provisions are taken. Actual
losses realized by the Company do reduce taxable income in the
period the actual loss is realized and would affect the dividends
paid to shareholders for that tax year.
DERIVATIVE FINANCIAL INSTRUMENTS
INTEREST RATE CAP AGREEMENTS
The Company purchases interest rate cap agreements ("Cap
Agreements") to manage interest rate risk. To date, most of the
Cap Agreements purchased limit the Company's risks associated
with the lifetime or maximum interest rate caps of its ARM assets
should interest rates rise above specified levels. These Cap
Agreements reduce the effect of the lifetime cap feature so that
F-10
the yield on the ARM assets will continue to rise in high
interest rate environments as the Company's cost of borrowings
also continue to rise. In similar fashion, the Company has
purchased Cap Agreements to limit the financing rate of the
Hybrid ARMs during their fixed rate term, generally for three to
ten years. In general, the cost of financing Hybrid ARMs hedged
with Cap Agreements is capped at a rate that is 0.75% to 1.00%
below the fixed Hybrid ARM interest rate.
All Cap Agreements are classified as a hedge against
available-for-sale assets or ARM loans and are carried at their
fair value with unrealized gains and losses reported as a
separate component of equity. The carrying value of the Cap
Agreements is included in ARM securities on the balance sheet.
The Company purchases Cap Agreements by incurring a one-time fee
or premium. The amortization of the premium paid for the Cap
Agreements is included in interest income as a contra item (i.e.,
expense) and, as such, reduces interest income over the lives of
the Cap Agreements.
Realized gains and losses resulting from the termination of the
Cap Agreements that were hedging assets classified as
held-to-maturity were deferred as an adjustment to the carrying
value of the related assets and are being amortized into interest
income over the terms of the related assets. Realized gains and
losses resulting from the termination of Cap Agreements that were
hedging assets classified as available-for-sale were initially
reported in a separate component of equity, consistent with the
reporting of those assets, and are thereafter amortized as a
yield adjustment.
INTEREST RATE OPTIONS CONTRACTS
The Company purchases options on interest rate futures ("Options
Contracts") to manage interest rate risk in the same manner as
Cap Agreements. To date, the Options Contracts purchased limit
the Company's risk associated with the lifetime or maximum
interest rate caps of its ARM assets should interest rates rise
above specified levels. These Options Contracts reduce the effect
of the lifetime cap feature so that the yield on the ARM assets
will continue to rise in high interest rate environments as the
Company's cost of borrowings also continue to rise.
All Options Contracts are classified as a hedge against
available-for-sale assets or ARM loans and are carried at their
fair value with unrealized gains and losses reported as a
separate component of equity. The carrying value of the Options
Contracts is included in ARM securities on the balance sheet. The
Company purchases Options Contracts by incurring a one-time fee
or premium. The amortization of the premium paid for the Options
Contracts is included in interest income as a contra item (i.e.,
expense) and, as such, reduces interest income over the lives of
the Options Contracts.
INTEREST RATE SWAP AGREEMENTS
The Company enters into interest rate swap agreements (Swap
Agreements) in order to manage its interest rate exposure when
financing its ARM assets. In general, Swap Agreements have been
utilized by the Company in two ways. Swap Agreements are used as
a cost effective way to lengthen the average repricing period of
its variable rate and short-term borrowings. Additionally, as the
Company acquires Hybrid ARMs, it also enters into Swap Agreements
in order to manage the interest rate repricing mismatch (the
difference between the remaining duration of a Hybrid ARM and the
maturity of the borrowing funding a Hybrid ARM) to a mismatched
duration of approximately one year or less. Revenues and expenses
from the Swap Agreements are accounted for on an accrual basis
and recognized as a net adjustment to interest expense.
Realized gains and losses resulting from the termination and
replacement of Swap Agreements, are recorded as basis adjustments
to the hedged liabilities and are thereafter amortized as a yield
adjustment over the remaining term of the Swap Agreements. The
terminated and replacement Swap Agreements generally have the
same terms and conditions other than the fixed rate. The
amortization of the realized gains and losses as a yield
adjustment to the fixed rate of the replacement Swap Agreement
results in approximately the same fixed cost between the
terminated and replacement Swap Agreements. The Company
terminates and replaces Swap Agreements as an additional source
of liquidity when it is able to do so while maintaining
compliance to its hedging policies.
All Swap Agreements are classified as a liability hedge against
the Company's borrowings. As a result, the unrealized gains and
losses on Swap Agreements are off balance sheet and are discussed
in Note 4.
F-11
OTHER HEDGING ACTIVITY
The Company also enters into hedging transactions in connection
with the purchase of Hybrid ARMs between the trade date and the
settlement date. Generally, the Company hedges the cost of
obtaining future fixed rate financing by entering into a
commitment to sell similar duration fixed-rate mortgage-backed
securities ("MBS") on the trade date and settles the commitment
by purchasing the same fixed-rate MBS on the purchase date.
Realized gains and losses are deferred and amortized as a yield
adjustment over the fixed rate period of the financing.
INCOME TAXES
The Company, excluding TMHL and its subsidiaries, has elected to
be taxed as a Real Estate Investment Trust ("REIT") and complies
with the provisions of the Internal Revenue Code of 1986, as
amended (the "Code") with respect thereto. Accordingly, the
Company will not be subject to Federal income tax on that portion
of its income that is distributed to shareholders and as long as
certain asset, income and stock ownership tests are met. TMHL and
each of its subsidiaries became taxable REIT subsidiaries on
December 1, 2000 and, as such, they are subject to both federal
and state corporate income tax. For the period December 1, 2000
through December 31, 2000, TMHL had an immaterial taxable loss.
NET EARNINGS PER SHARE
Basic EPS amounts are computed by dividing net income (adjusted
for dividends declared on preferred stock) by the weighted
average number of common shares outstanding. Diluted EPS amounts
assume the conversion, exercise or issuance of all potential
common stock instruments unless the effect is to reduce a loss or
increase the earnings per common share.
F-12
Following is information about the computation of the earnings per share data
for the years ended December 31, 2000, 1999 and 1998 (Amounts in thousands
except per share data):
Earnings
Income Shares Per Share
-------- ------ ----------
2000
Net income $29,165
Less preferred stock dividends (6,679)
--------
Basic EPS, income available to
common shareholders 22,486 21,506 $ 1.05
==========
Effect of dilutive securities:
Stock options - 13
-------- ------
Diluted EPS $22,486 21,519 $ 1.05
======== ====== ==========
1999
Net income $25,584
Less preferred stock dividends (6,679)
--------
Basic EPS, income available to
common shareholders 18,905 21,490 $ 0.88
==========
Effect of dilutive securities:
Stock options - -
-------- ------
Diluted EPS $18,905 21,490 $ 0.88
======== ====== ==========
1998
Net income $22,695
Less preferred stock dividends (6,679)
Basic EPS, income available to
common shareholders 16,016 21,488 $ 0.75
==========
Effect of dilutive securities:
Stock options - -
-------- ------
Diluted EPS $16,016 21,488 $ 0.75
======== ====== ==========
The Company has granted options to directors and officers of the
Company and employees of the Manager to purchase 210,022, 186,779
and 59,784 shares of common stock at average prices of $7.43,
$8.90 and $14.82 per share during the years ended December 31,
2000, 1999 and 1998, respectively. The conversion of preferred
stock was not included in the computation of diluted EPS for any
year because such conversion would increase the diluted EPS.
RECENT ACCOUNTING PRONOUNCEMENTS
On January 1, 2001, the Company adopted Statement of Financial
Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities ("SFAS 133"). SFAS 133
established a framework of accounting rules that standardize
accounting and reporting for all derivative instruments. SFAS 133
requires that all derivative financial instruments be carried on
the balance sheet at fair value. The adoption of this standard
did not affect the Company's previously issued financial
statements up to and including those as of December 31, 2000. In
the first quarter of 2001, the Company will report the SFAS 133's
impact as a cumulative effect of a change in accounting
principle. The Company currently expects the cumulative
adjustment required by SFAS to decrease "other comprehensive
income" by approximately $600,000 and to decrease "Net income" by
approximately $300,000.
F-13
In September of 2000, the Financial Accounting Standards Board
issued SFAS No. 140, Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities. The Company
has adopted the disclosure requirements relation to
securitization transactions in its 2000 financial statements.
Other provisions of this standard will be applied prospectively
in the Company's fiscal quarter starting April 1, 2000. The
Company does not expect the implementation of this standard to
materially affect the Company's reported results of operations
and financial position.
USE OF ESTIMATES
The preparation of financial statements in conformity with
generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
NOTE 2. ADJUSTABLE-RATE MORTGAGE ASSETS AND INTEREST RATE CAP AGREEMENTS
The following tables present the Company's ARM assets as of December
31, 2000 and 1999. The ARM securities classified as available-for-sale
are carried at their fair value, while the ARM loans are carried at
their amortized cost basis (dollar amounts in thousands):
December 31, 2000:
Available-
for-Sale Collateral for
ARM Securities Notes Payable ARM Loans Total
---------------- --------------- ----------- -----------
Principal balance outstanding $ 3,359,301 $ 606,686 $ 165,131 $4,131,118
Net unamortized premium 56,759 11,759 (567) 67,951
Allowance for losses (1,869) (2,949) (151) (4,969)
Cap agreements 3,705 200 - 3,905
Principal payment receivable 19,883 - - 19,883
---------------- --------------- ----------- -----------
Amortized cost, net 3,437,779 615,696 164,413 4,217,888
---------------- --------------- ----------- -----------
Gross unrealized gains 7,526 45 2,029 9,600
Gross unrealized losses (85,953) (10,499) (97) (96,549)
---------------- --------------- ----------- -----------
Fair value $ 3,359,352 $ 605,242 $ 166,345 $4,130,939
================ =============== =========== ===========
Carrying value $ 3,359,352 $ 615,696 $ 164,413 $4,139,461
================ =============== =========== ===========
December 31, 1999:
Available-
for-Sale Collateral for
ARM Securities Notes Payable ARM Loans Total
---------------- --------------- ----------- -----------
Principal balance outstanding $ 3,388,160 $ 890,701 $ 31,649 $4,310,510
Net unamortized premium 70,409 14,045 (445) 84,009
Deferred gain from hedging (351) - - (351)
Allowance for losses (1,930) (2,106) (102) (4,138)
Cap agreements 4,923 320 - 5,243
Principal payment receivable 13,610 569 - 14,179
Amortized cost, net 3,474,821 903,529 31,102 4,409,452
Gross unrealized gains 5,462 29 65 5,556
---------------- --------------- ----------- -----------
Gross unrealized losses (88,816) (13,165) (170) (102,151)
---------------- --------------- ----------- -----------
Fair value $ 3,391,467 $ 890,393 $ 30,997 $4,312,857
================ =============== =========== ===========
Carrying value $ 3,391,467 $ 903,529 $ 31,102 $4,326,098
================ =============== =========== ===========
During 2000, the Company realized $287,000 in gains and no losses on
the sale of $120.0 million of ARM assets. During 1999, the Company
realized $52,000 in gains and $5,000 in losses on the sale of $18.6
million of ARM assets, and during 1998, the Company realized
$4,634,000 in gains and $4,912,000 in losses on the sale of $932.3
million of ARM assets. All of the ARM securities sold were classified
as available-for-sale. During 1998, approximately $379 million of
securities previously classified as held-to-maturity were reclassified
as available-for-sale.
F-14
During 2000, the Company securitized $162.8 million of ARM loans into
$159.3 million High Quality ARM securities and $3.5 million of
subordinated securities, all of which are retained by the Company for
its ARM portfolio.
During the year ended December 31, 2000, in accordance with its credit
policies, the Company provided for estimated credit losses on the
subordinated classes of its securitized loans in the amount of
$207,000 and recorded a $951,000 provision for estimated credit losses
on its loan portfolio. During the year 2000, the Company sold two REO
properties for a combined loss of $59,000.
The following tables summarize ARM loan delinquency information as of
December 31, 2000 and 1999 (dollar amounts in thousands):
2000
----
Percent
Loan Loan of ARM Percent of
Delinquency Status Count Balance Loans (1) Total Assets
- ------------------ -------- ----------- ------------- -------------
60 to 89 days 3 $ 447 0.04% 0.01%
90 days or more - - - -
In foreclosure 5 3,980 0.34 0.10
-------- ----------- ------------- -------------
8 $ 4,427 0.38% 0.11%
======== =========== ============= =============
1999
----
Percent
Loan Loan of ARM Percent of
Delinquency Status Count Balance Loans (1) Total Assets
- ------------------- -------- -------- ----------- -------------
60 to 89 days 1 $ 110 0.01% 0.00%
90 days or more - - - -
In foreclosure 10 5,450 0.49 0.12
-------- -------- ----------- -------------
11 $ 5,560 0.50% 0.12%
======== ======== =========== =============
(1) ARM loans includes loans that the Company has securitized and retained
first loss credit exposure for total amounts of $1.165 billion and $1.108
billion at December 31, 2000 and 1999, respectively.
The following table summarizes the activity for the allowance for
losses on ARM loans for the year ended December 31, 2000 and
1999 (dollar amounts in thousands):
2000 1999
--------- ---------
Beginning balance $ 2,208 $ 804
Provision for losses 951 1,404
Charge-offs, net (59) 0
--------- ---------
Ending balance $ 3,100 $ 2,208
========= =========
As of December 31, 2000, the Company owned one real estate property as
a result of foreclosing on a delinquent loan in the aggregate amount
of $0.6 million, which is included in collateral for collateralized
notes on the balance sheet. The Company believes that its current
level of reserves is adequate to cover any estimated loss, should one
occur, from the sale of this property.
As of December 31, 2000, the Company had commitments to purchase $42.7
million of ARM loans.
The average effective yield on the ARM assets owned was 7.09% as of
December 31, 2000 and 6.38% as of December 31, 1999. The average
effective yield is based on historical cost and includes the
amortization of the net premium paid for the ARM assets, the Cap
Agreements and Option Contracts, the impact of ARM principal payment
receivables and the amortization of deferred gains from hedging
activity.
As of December 31, 2000 and December 31, 1999, the Company had
purchased Cap Agreements and Options Contracts with a remaining
notional amount of $2.624 billion and $2.945 billion, respectively.
The notional amount of the Cap Agreements and Options Contracts
purchased decline at a rate that is expected to approximate the
amortization of the ARM assets. Under these Cap Agreements and Options
Contracts, the Company will receive cash payments should the
one-month, three-month or six-month London InterBank Offer Rate
("LIBOR") increase above the contract rates of these hedging
instruments that range from 5.75% to 12.50% and average approximately
9.88%. Of the Cap Agreements and Options Contracts owned by the
Company as of December 31, 2000, $104.1 million are hedging the cost
of financing Hybrid ARMs and $2.520 billion are hedging the lifetime
interest rate cap of ARM assets. The Company's ARM assets portfolio
had an average lifetime interest rate cap of 11.77%. The Cap
Agreements and Options Contracts had an average maturity of 2.3 years
as of December 31, 2000. The initial aggregate notional amount of the
F-15
Cap Agreements declines to approximately $2.346 billion over the
period of the agreements, which expire between 2000 and 2004. The
Company has credit risk to the extent that the counterparties to the
Cap Agreements do not perform their obligations under the Cap
Agreements. If one of the counterparties does not perform, the Company
would not receive the cash to which it would otherwise be entitled
under the conditions of the Cap Agreement. In order to mitigate this
risk and to achieve competitive pricing, the Company has entered into
Cap Agreements with six different counterparties, five of which are
rated AAA and one is rated A, but the Company has a two-way collateral
agreement protecting its credit exposure with this counterparty.
NOTE 3. REVERSE REPURCHASE AGREEMENTS, COLLATERALIZED NOTES PAYABLE AND OTHER
BORROWINGS
The Company has entered into reverse repurchase agreements to finance
most of its ARM assets. The reverse repurchase agreements are
short-term borrowings that are collateralized by the market value of
the Company's ARM securities and bear interest rates that have
historically moved in close relationship to LIBOR.
As of December 31, 2000, the Company had outstanding $2.962 billion of
reverse repurchase agreements with a weighted average borrowing rate
of 6.80% and a weighted average remaining maturity of 2.3 months. As
of December 31, 2000, $1.357 billion of the Company's borrowings were
variable-rate term reverse repurchase agreements with original
maturities that range from two months to twelve months. The interest
rates of these term reverse repurchase agreements are indexed to
either the one- or three-month LIBOR rate and reprice accordingly. The
reverse repurchase agreements at December 31, 2000 were collateralized
by ARM assets with a carrying value of $3.166 billion, including
accrued interest.
At December 31, 2000, the reverse repurchase agreements had the
following remaining maturities (dollar amounts in thousands):
Within 30 days $ 1,520,837
31 to 89 days 365,655
90 days or greater 1,075,125
--------------
$ 2,961,617
==============
As of December 31, 2000, the Company had entered into three whole loan
financing facilities. One of the whole loan financing facilities has a
committed borrowing capacity of $150 million, with an option to
increase this amount to $300 million. This facility matures in January
2001 and is in the process of being extended for an additional year.
During the first quarter of 2000, the Company entered into a second
committed whole loan financing facility that also has a borrowing
capacity of $150 million. This second committed facility matures in
March of 2003, subject to an annual review and extension by both
parties. The third facility is for an unspecified amount of
uncommitted borrowing capacity and does not have a specific maturity
date. As of December 31, 2000, the Company had $158.6 million borrowed
against these whole loan financing facilities at an effective cost of
7.05%. The amount borrowed on the whole loan financing agreements at
December 31, 2000 was collateralized by ARM loans with a carrying
value of $164.2 million, including accrued interest.
One of the whole loan financing facility, discussed above, is a
securitization transaction in which the Company transfers groups of
whole loans to a wholly-owned bankruptcy remote special purpose
subsidiary. The subsidiary in turn simultaneously transfers its
interest in the loans to a trust which issues beneficial interests in
the loans in the form of a note and a subordinated certificate, which
are then used to collateralize borrowings.
On December 18, 1998, the Company, through a wholly-owned bankruptcy
remote special purpose finance subsidiary, issued $1.144 billion of
notes payable ("Notes") collateralized by ARM loans and ARM
securities. As part of this transaction, the Company retained
ownership of a subordinated certificate in the amount of $32.4
million, which represents the Company's maximum exposure to credit
losses on the loans collateralizing the Notes. As of December 31,
2000, the Notes had a net balance of $603.9 million, an effective
interest cost of 7.38%, which changes each month at a spread to
one-month LIBOR. As of December 31, 2000, these Notes were
collateralized by ARM loans with a principal balance of $638.8
million. The Notes mature on January 25, 2029 and are callable by the
Company at par once the balance of the Notes is reduced to 25% of
their original balance. In connection with the issuance and
F-16
modification of the Notes, the Company incurred costs of approximately
$6.0 million, which is being amortized over the expected life of the
Notes. Since the Notes are paid down as the collateral pays down, the
amortization of the issuance cost will be adjusted periodically based
on actual payment experience. If the collateral pays down faster than
currently estimated, then the amortization of the issuance cost will
increase and the effective cost of the Notes will increase and,
conversely, if the collateral pays down slower than currently
estimated, then the amortization of issuance cost will be decreased
and the effective cost of the Notes will also decrease.
As of December 31, 2000, the Company was a counterparty to twenty-two
interest rate swap agreements ("Swaps") having an aggregate notional
balance of $623.4 million. As of December 31, 2000, these Swaps had a
weighted average remaining term of 2.4 years. In accordance with these
Swaps, the Company will pay a fixed rate of interest during the term
of these Swaps and receive a payment that varies monthly with the
one-month LIBOR rate. As a result of entering into these Swaps and the
Cap Agreements that also hedge the fixed rate period of Hybrid ARMs,
the Company has reduced the interest rate variability of its cost to
finance its ARM assets by increasing the average period until the next
repricing of its borrowings from 25 days to 191 days. All of these
Swaps were entered into in connection with the Company's acquisition
of Hybrid ARMs. The Swaps hedge the cost of financing Hybrid ARMs
during their fixed rate term, generally three to ten years. As of
December 31, 2000, the Swap Agreements were collateralized by ARM
assets with a carrying value of $5.9 million, including accrued
interest.
The total cash paid for interest was $249.6 million, $233.3 million
and $267.9 million for 2000, 1999 and 1998 respectively.
NOTE 4. FAIR VALUE OF FINANCIAL INSTRUMENTS AND OFF-BALANCE SHEET CREDIT RISK
The following table presents the carrying amounts and estimated fair
values of the Company's financial instruments at December 31, 2000 and
December 31, 1999. FASB Statement No. 107, Disclosures About Fair
Value of Financial Instruments, defines the fair value of a financial
instrument as the amount at which the instrument could be exchanged in
a current transaction between willing parties, other than in a forced
or liquidation sale (dollar amounts in thousands):
The following table presents the carrying amounts and estimated fair
values of the Company's financial instruments at December 31, 2000 and
December 31, 1999. FASB Statement No. 107, Disclosures About Fair
Value of Financial Instruments, defines the fair value of a financial
instrument as the amount at which the instrument could be exchanged in
a current transaction between willing parties, other than in a forced
or liquidation sale (dollar amounts in thousands):
December 31, 2000 December 31, 1999
----------------------- -----------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
----------- ---------- ---------- -----------
Assets:
ARM assets $4,137,943 $4,129,421 $4,318,301 $4,305,060
Cap Agreements/Option Contracts 1,518 1,518 7,797 7,797
Liabilities:
Collateralized notes payable 603,910 605,927 886,722 889,305
Other borrowings 158,593 158,593 21,289 21,289
Swap agreements (334) 7,259 749 (11,527)
The above carrying amounts for assets are combined in the balance
sheet under the caption adjustable-rate mortgage assets. The carrying
amount for securities, which are categorized as available-for-sale, is
their fair value whereas the carrying amount for loans, which are
categorized as held for the foreseeable future, is their amortized
cost.
The fair values of the Company's ARM securities, Cap Agreements and
Option Contracts are generally based on market prices provided by
certain dealers who make markets in these financial instruments or
third-party pricing services. If the fair value of an ARM security is
not reasonably available from a dealer or a third-party pricing
service, management estimates the fair value based on characteristics
of the security it receives from the issuer and available market
information. The fair values for ARM loans is estimated by the Company
by using the same pricing models employed by the Company in the
process of determining a price to bid for loans in the open market,
taking into consideration the aggregated characteristics of groups of
loans such as, but not limited to, collateral type, index, margin,
life cap, periodic cap, underwriting standards, age and delinquency
experience. The fair value of the Company's collateralized notes
payable and interest rate swap agreements, which are off-balance sheet
financial instruments, are based on market values provided by dealers
who are familiar with the terms of the notes and swap agreements. The
fair values reported reflect estimates and may not necessarily be
indicative of the amounts the Company could realize in a current
market exchange. Cash and cash equivalents, interest receivable,
reverse repurchase agreements, other borrowings and other liabilities
are reflected in the financial statements at their amortized cost,
which approximates their fair value because of the short-term nature
of these instruments.
F-17
The Company's transactions in interest rate swap agreements and
hedging activity using commitments to sell securities create
off-balance-sheet risk. These instruments involve market and credit
risk that is not recognized on the balance sheet. The principal risk
related to the swap agreements is the possibility that a counterparty
to the agreement may be unable or unwilling to meet the terms of the
agreement. With respect to commitments to sell securities, there is a
risk that the change in the value of the hedged item may not
substantially offset the change in the value of the commitment. The
Company reduces counterparty risk by dealing only with several
experienced counterparties with AA or better credit ratings or a
two-way collateral agreement is required.
NOTE 5. COMMON AND PREFERRED STOCK
In 1997, the Company issued 2,760,000 shares of Series A 9.68%
Cumulative Convertible Preferred Stock at a price of $25 per share.
Net proceeds from this issuance totaled $65.8 million. The dividends
are cumulative commencing on the issue date and are payable quarterly,
in arrears. The dividends per share are equal to the greater of (i)
$0.605 per quarter, or (ii) the quarterly dividend declared on the
Company's common stock. Each share is convertible at the option of the
holder at any time into one share of common stock. The preferred
shares are redeemable by the Company on and after December 31, 1999,
in whole or in part, as follows: (i) for one share of common stock
plus accumulated, accrued but unpaid dividends, provided that for 20
trading days within any period of 30 consecutive trading days the
closing price of the common stock equals or exceeds the conversion
price of $25, or (ii) for cash at the issue price of $25, plus any
accumulated, accrued but unpaid dividends through the redemption date.
In the event of liquidation, the holders of the preferred shares will
be entitled to receive out of the assets of the Company, prior to any
distribution to the common shareholders, the issue price of $25 per
share in cash, plus any accumulated, accrued and unpaid dividends. The
Company has not, nor does it have any currents plans to exercise its
redemption rights at this time.
During 2000 and 1999, the Company did not issue any shares of common
stock under its Dividend Reinvestment and Stock Purchase Plan. During
1998, the Company issued 1,581,550 shares of common stock under this
plan and received net proceeds of $24.4 million.
During 2000, stock options for 82,797 shares of common stock were
exercised at an average price of $8.83 and $685.7 thousand of notes
receivable were executed in connection with the exercise of these
options and the Company received net proceeds of $45.3 thousand.
During 1999, there were no exercises of stock options. During 1998,
stock options for 128,377 shares of common stock were exercised at an
average price of $15.23 and $2.0 million of notes receivable were
executed in connection with the exercise of these options.
On July 13, 1998, the Board of Directors approved a common stock
repurchase program of up to 500,000 shares at prices below book value,
subject to availability of shares and other market conditions. On
September 18, 1998, the Board of Directors expanded this program by
approving the repurchase of up to an additional 500,000 shares. The
Company did not repurchase any shares of common stock during 2000 or
1999. To date, the Company has repurchased 500,016 shares of common
stock under this program at an average price of $9.28 per share.
F-18
The following table presents information regarding the Company's
common and preferred dividends declared for the 2000, 1999 and 1998
fiscal years:
28% (1) 20% (1) Return
Ordinary Capital Capital of
Income Gains Gains Capital Total
--------- -------- -------- ------- -----------
Common Dividends:
2000 $ 0.9400 $ - $ - $ - $0.940 (2)
1999 0.9200 - - - 0.920 (2)
1998 0.8412 - - 0.0638 0.905 (2)
Preferred Dividends:
2000 $ 2.420 $ - $ - $ - $2.420 (3)
1999 2.420 - - - 2.420 (3)
1998 2.420 - - - 2.265 (3)
(1) Maximum federal tax rate applicable to capital gains
(2) $0.25, $0.23 and $0.50 of dividends was declared and paid in the
following fiscal years for 2000, 1999 and 1998, respectively.
(3) $0.605, $0.605 and $0.605 was paid in the following fiscal year
for 2000, 1999, and 1998, respectively.
The $0.605 preferred dividend declared on December 15, 2000 and paid
on January 10, 2001 will be taken as a dividend deduction on the
Company's 2000 income tax return and is therefore taxable income for
preferred shareholders for 2000, as well as the four preferred
dividends paid during 2000.
NOTE 6. STOCK OPTION PLAN
The Company has a Stock Option and Incentive Plan (the "Plan") which
authorizes the granting of options to purchase an aggregate of up to
1,800,000 shares, but not more than 5% of the outstanding shares of
the Company's common stock. The Plan authorizes the Board of
Directors, or a committee of the Board of Directors, to grant
Incentive Stock Options ("ISOs") as defined under section 422 of the
Internal Revenue Code of 1986, as amended, options not so qualified
("NQSOs"), Dividend Equivalent Rights ("DERs"), Stock Appreciation
Rights ("SARs"), and Phantom Stock Rights ("PSRs").
The exercise price for any options granted under the Plan may not be
less than 100% of the fair market value of the shares of the common
stock at the time the option is granted. Options become exercisable
six months after the date granted and will expire ten years after the
date granted, except options granted in connection with an offering of
convertible preferred stock, in which case such options become
exercisable if and when the convertible preferred stock is converted
into common stock.
The Company usually grants DERs at the same time as it grants ISOs and
NQSOs. The number of PSRs issued are based on the level of the
Company's dividends and on the price of the Company's stock on the
related dividend payment date and is equivalent to the cash that
otherwise would be paid on the outstanding DERs and previously issued
PSRs.
During 2000, there were 215,500 DERs granted and 28,765 PSRs issued.
As of the December 31, 2000, there were 367,974 DERs outstanding, of
which 339,813 were vested, and 44,827 PSRs outstanding. The Company
recorded an expense associated with the DERs and the PSRs of $274,000,
$92,000 and $11,000 for the years ended December 31, 2000, 1999 and
1998, respectively.
Notes receivable from stock sales result from the Company selling
shares of common stock through the exercise of stock options partially
for consideration for notes receivable. The notes mature between 2006
and 2009 and accrue interest at rates that range from 5.47% to 6.25%
per annum. In addition, the notes are full recourse promissory notes
and are secured by a pledge of the shares of the Common Stock
acquired. Interest, which is credited to paid-in-capital, is payable
quarterly, with the balance due at the maturity of the notes. The
payment of the notes will be accelerated only upon the sale of the
shares of Common Stock pledged for the notes. The notes may be prepaid
at any time at the option of each borrower. As of December 31, 2000,
there were $5.3 million of notes receivable from stock sales
outstanding.
F-19
The Company adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation." Accordingly, no compensation cost has been recognized
for the Company's stock option plan. Had compensation cost for the
Company's stock option plan been determined based on the fair value at
the grant date for awards in 2000, 1999 and 1998 consistent with the
provisions of SFAS No. 123, the Company's net earnings and earnings
per share would have been reduced to the pro forma amounts indicated
in the table below. The fair value of each option grant is estimated
on the date of grant using the Black-Scholes option-pricing model
(dollar amounts in thousands, except per share data).
2000 1999 1998
--------- --------- ---------
Net income - as reported $ 29,165 $ 25,584 $ 22,695
Net income - pro forma 28,989 25,428 22,629
Basic EPS - as reported 1.05 0.88 0.75
Basic EPS - pro forma 1.04 0.87 0.74
Diluted EPS - as reported 1.05 0.88 0.75
Diluted EPS - pro forma 1.04 0.87 0.74
Assumptions:
Dividend yield 10.00% 10.00% 10.00%
Expected volatility 32.4% 30.1% 25.60%
Risk-free interest rate 6.29% 5.48% 5.68%
Expected lives 7 years 7 years 7 years
Information regarding options is as follows:
2000 1999 1998
--------------------- ------------------ ------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
---------- --------- --------- ------- --------- -------
Outstanding, beginning of year 789,473 $ 15.494 612,402 $17.549 680,995 $17.353
Granted 210,022 7.426 186,779 8.897 59,784 14.817
Exercised (82,797) 8.829 - - (128,377) 15.234
Expired - - 9,708 18.227 - -
---------- --------- --------- ------- --------- -------
Outstanding, end of year 916,698 $ 14.248 789,473 $15.494 612,402 $17.549
========== ========= ========= ======= ========= =======
Weighted average fair value of
options granted during the year $ 0.93 $ 0.93 $ 1.22
Options exercisable at year end 804,053 631,828 479,482
The following table summarizes information about stock options
outstanding at December 31, 2000:
Options Outstanding Options Exercisable
----------------------- ---------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Options Contractual Exercise Exercisable Exercise
Range of Exercise Prices Outstanding Life (Yrs) Price At 12/31/00 Price
------------------------- ----------- ------------ --------- ----------- --------
$ 7.375 - $12.4375 332,311 9.0 $ 8.167 332,311 $ 8.167
$ 14.375 - $16.125 320,428 3.6 15.343 320,428 15.343
$ 17.500 - $20.000 178,279 6.2 19.586 65,634 18.876
$ 22.625 85,680 6.5 22.625 85,680 22.625
------------------------- ----------- ------------ --------- ----------- --------
$ 7.375 - $22.625 916,698 6.4 $ 14.248 804,053 $ 13.442
========================= =========== ============ ========= =========== ========
In January 2001, outstanding stock options for 578,303 shares at
option exercise prices of $15.00 per share and above were voluntarily
surrendered and cancelled by the officers and directors of the Company
and employees of the Manager who held the options. The cancelled
options will be returned to the Plan and will be available for future
option grants under the Plan.
F-20
NOTE 7. TRANSACTIONS WITH AFFILIATES
The Company has a Management Agreement (the "Agreement") with
Thornburg Mortgage Advisory Corporation ("the Manager"). Under the
terms of this Agreement, the Manager, subject to the supervision of
the Company's Board of Directors, is responsible for the management of
the day-to-day operations of the Company and provides all personnel
and office space. According to the terms of the Agreement, certain
defined expenses of the Manager are reimbursed by the Company,
principally expenses of the Company's taxable mortgage banking
subsidiary related to mortgage loan acquisition, selling, servicing
and securitization activities. The Agreement provides for an annual
review by the unaffiliated directors of the Board of Directors of the
Manager's performance under the Agreement.
The Company pays the Manager an annual base management fee based on
average shareholders' equity, adjusted for liabilities that are not
incurred to finance assets ("Average Shareholders' Equity" or "Average
Net Invested Assets" as defined in the Agreement) payable monthly in
arrears as follows: 1.15% of the first $300 million of Average
Shareholders' Equity, plus 0.85% of Average Shareholders' Equity above
$300 million. In addition, the three wholly-owned subsidiaries of the
Company and the two wholly-owned subsidiaries of TMHL have entered
into separate Management Agreements with the Manager for additional
management services for a combined amount of $1,200 per month, paid in
arrears.
On October 17, 2000, the Board of Directors and the Manager agreed to
amendments to the Agreement that included a 0.05% increase to the base
management fee formula, effective immediately, and a cost of living
clause that will adjust the base management fee formula by the change
in the Consumer Price Index over the previous twelve month period,
effective as of each annual review of the Agreement. The 0.05%
adjustment to the base management fee formula is expected to increase
the cost of the base management fee by approximately $200,000 on an
annual basis. This amendment to the Agreement is reflected in the base
management fee formula discussed in the preceding paragraph.
For the years ended December 31, 2000, 1999 and 1998, the Company paid
the Manager $4,158,000, $4,088,000 and $4,142,000, respectively, in
base management fees in accordance with the terms of the Management
Agreements.
The Manager is also entitled to earn performance based compensation in
an amount equal to 20% of the Company's annualized net income, before
performance based compensation, above an annualized Return on Equity
equal to the ten year U.S. Treasury Rate plus 1%. For purposes of the
performance fee calculation, equity is generally defined as proceeds
from issuance of common stock before underwriter's discount and other
costs of issuance, plus retained earnings. For the year ended December
31, 2000, the Company earned performance based compensation in the
amount of $46,000, in accordance with the terms of the Agreement. For
the year ended December 31, 1999, the Company did not pay the Manager
any performance based compensation because the Company's net income,
as measured by Return on Equity, did not exceed the ten-year U.S.
Treasury Rate plus 1%. For the year ended December 31, 1998, the
Company paid the Manager $759,000 in performance based compensation in
accordance with the terms of the Agreement.
During 2000, the Company's mortgage banking subsidiary, TMHL,
reimbursed the Manager $75,000 for expenses, primarily related to the
acquisition of loans, in accordance with the terms of the Agreement.
Additionally, the Company reimbursed the Manager and other affiliated
companies $95,000 for certain other direct expenses of the Company,
primarily related to shareholder relation, public relation and
marketing consulting services.
Beginning in 1999, the Company's subsidiaries, except TMHL, entered
into separate lease agreements with the Manager for office space in
Santa Fe, New Mexico. During 2000 and 1999, the combined amount of
rent paid to the Manager was $31,000 and $10,000, respectively.
F-21
NOTE 8. NET INTEREST INCOME ANALYSIS
The following table summarizes the amount of interest income and
interest expense and the average effective interest rate for the
periods ended December 31, 2000, 1999 and 1998 (dollar amounts in
thousands):
2000 1999 1998
------------------- ---------------- ---------------
Average Average Average
Amount Rate Amount Rate Amount Rate
--------- -------- --------- ----- -------- -----
Interest Earning Assets:
ARM assets $288,666 6.82% $258,911 5.92% $286,327 5.96%
Cash and cash equivalents 1,307 6.76 1,454 4.71 705 4.35
--------- -------- --------- ----- -------- -----
289,973 6.82 260,365 5.92 287,032 5.96
--------- -------- --------- ----- -------- -----
Interest Bearing Liabilities:
Borrowings 253,343 6.54 226,350 5.62 255,992 5.78
--------- -------- --------- ----- -------- -----
Net Interest Earning Assets and Spread $ 36,630 0.28% $ 34,015 0.30% $ 31,040 0.18%
========= ======== ========= ===== ======== =====
Yield on Net Interest Earning Assets (1) 0.86% 0.77% 0.64%
======== ===== =====
(1) Yield on Net Interest Earning Assets is computed by dividing annualized net
interest income by the average daily balance of interest earning assets.
The following table presents the total amount of change in interest
income/expense from the table above and presents the amount of change
due to changes in interest rates versus the amount of change due to
changes in volume (dollar amounts in thousands):
2000 versus 1999 1999 versus 1998
---------------------------- ------------------------------
Rate Volume Total Rate Volume Total
------- --------- -------- -------- --------- ---------
Interest Income:
ARM assets $39,645 $ (9,890) $29,755 $(2,477) $(24,938) $(27,415)
Cash and cash equivalents 12 (159) (147) 382 366 748
------- --------- -------- -------- --------- ---------
39,657 (10,049) 29,608 (2,095) (24,572) (26,667)
------- --------- -------- -------- --------- ---------
Interest Expense:
Borrowings 36,921 (9,928) 26,993 (6,979) (22,663) (29,642)
------- --------- -------- -------- --------- ---------
Net interest income $ 2,736 $ (121) $ 2,615 $ 4,884 $ (1,909) $ 2,975
======= ========= ======== ======== ========= =========
F-22
NOTE 9. SUMMARIZED QUARTERLY RESULTS (UNAUDITED)
The following is a presentation of the quarterly results of operations
(amounts in thousands, except per share amounts):
Year Ended December 31, 2000
------------------------------------------
Fourth Third Second First
Quarter Quarter Quarter Quarter
--------- --------- --------- ---------
Interest income from ARM assets and cash $ 73,150 $ 71,017 $ 73,152 $ 72,654
Interest expense on borrowed funds (63,567) (62,039) (64,400) (63,337)
--------- --------- --------- ---------
Net interest income 9,583 8,978 8,752 9,317
--------- --------- --------- ---------
Gain (loss) on ARM assets 238 - 49 -
Provision for credit losses (176) (270) (381) (331)
General and administrative expenses (1,976) (1,692) (1,453) (1,473)
Dividend on preferred stock (1,669) (1,670) (1,670) (1,670)
--------- --------- --------- ---------
Net income available to common shareholders $ 6,000 $ 5,346 $ 5,297 $ 5,843
========= ========= ========= =========
Basic EPS $ 0.28 $ 0.25 $ 0.25 $ 0.27
========= ========= ========= =========
Diluted EPS $ 0.28 $ 0.25 $ 0.25 $ 0.27
========= ========= ========= =========
Average number of common shares outstanding 21,553 21,490 21,490 21,490
========= ========= ========= =========
Year Ended December 31, 1999
------------------------------------------
Fourth Third Second First
Quarter Quarter Quarter Quarter
--------- --------- --------- ---------
Interest income from ARM assets and cash $ 69,678 $ 67,955 $ 63,087 $ 59,645
Interest expense on borrowed funds (60,633) (58,623) (54,015 (53,079)
--------- --------- --------- ---------
Net interest income 9,045 9,332 9,072 6,566
--------- --------- --------- ---------
Gain (loss) on ARM assets (3) 15 35 -
Provision for credit losses (728) (764) (689) (686)
General and administrative expenses (1,518) (1,428) (1,384) (1,281)
Dividend on preferred stock (1,669) (1,670) (1,670) (1,670)
--------- --------- --------- ---------
Net income available to common shareholders $ 5,127 $ 5,485 $ 5,364 $ 2,929
========= ========= ========= =========
Basic EPS $ 0.24 $ 0.26 $ 0.25 $ 0.14
========= ========= ========= =========
Diluted EPS $ 0.24 $ 0.26 $ 0.25 $ 0.14
========= ========= ========= =========
Average number of common shares outstanding 21,490 21,490 21,490 21,490
========= ========= ========= =========
F-23
SCHEDULE IV - Mortgage Loans on Real Estate
Column A, Description: The Company's whole loan portfolio at December 31, 2000,
which consists of only first mortgages on single-family residential housing, is
stratified as follows (dollar amounts in thousands):
Column A (continued) Column B Column C Column G Column H
- -------------------------- ------------ -------- ----------- -----------------------
Description(4)
Range of Number Final Carrying Principal Amount of
Carrying Amounts of Interest Maturity Amount of Loans Delinquent as to
of Mortgages Loans Rate Date Mortgages(3) Principal or Interest
- ------------------------ -------- ------------ ------- ------------ -----------------------
ARM Loans:
$ 0 - 250 535 5.38 - 9.61 Various $ 71,603 $ 443
251 - 500 285 6.36 - 9.36 Various 99,545 -
501 - 750 104 6.86 - 9.11 Various 62,970 -
751 - 1,000 50 7.23 - 8.86 Various 45,304 -
over 1,000 46 6.61 - 9.73 Various 66,134 3,450
-------- ------------ -----------------------
1,020 345,556 3,893
-------- ------------ -----------------------
Hybrid Loans:
0 - 250 1,075 5.61 - 9.36 Various 140,227 534
251 - 500 446 5.61 - 9.00 Various 157,805 -
501 - 750 117 5.61 - 9.00 Various 71,027 -
751 - 1,000 58 6.36 - 8.73 Various 52,596 -
over 1,000 22 6.13 - 8.73 Various 36,075 -
-------- ------------ -----------------------
1,718 457,730 534
-------- ------------ -----------------------
Premium 11,193
Allowance for losses (2) (3,100)
-------- ------------ -----------------------
2,738 $811,379 $ 4,427
======== ============ =======================
Notes:
(1) Reconciliation of carrying amounts of mortgage loans:
Balance at December 31, 1999 $843,834
Additions during 2000:
Loan purchases 176,027
Deductions during 2000:
Collections of principal 170,983
Cost of mortgage loans sold 106
Cost of mortgage loans securitized 33,673
Cost of mortgage loans transferred to REO 624
Provision for losses 951
Amortization of premium 2,145
--------
208,482
--------
Balance at December 31, 2000 $811,379
========
F-24
(2) The provision for losses is based on management's assessment of various
factors.
(3) Cost for Federal income taxes is the same.
(4) The geographic distribution of the Company's whole loan portfolio at
December 31, 2000 is as follows:
Number of
State or Territory Loans Carrying Amount
----------------------- ---------- -----------------
Arizona 60 $ 17,692
California 597 260,149
Colorado 65 37,883
Connecticut 42 15,915
Florida 361 85,062
Georgia 180 55,424
Illinois 59 15,505
Massachusetts 53 13,675
Michigan 122 22,383
Missouri 121 22,064
New Jersey 114 32,705
New York 215 52,344
Pennsylvania 46 11,192
Texas 86 20,097
Washington 40 11,890
Other states, less than
50 loans each 577 129,306
Premium 11,193
Allowance for losses (3,100)
---------- -----------------
TOTAL 2,738 $ 811,379
========== =================
F-25
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of
1934, the Registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
THORNBURG MORTGAGE, INC.
(Registrant)
Dated: March 26, 2001 /s/ Garrett Thornburg
---------------------------------------------
Garrett Thornburg
Chairman of the Board of Directors and
Chief Executive Officer
(Principal Executive Officer)
Dated: March 26, 2001 /s/ Richard P. Story
---------------------------------------------
Richard P. Story
Chief Financial Officer and Treasurer
(Principal Accounting Officer)
Pursuant to the requirements of the Securities and Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Capacity Date
- ------------------------- ----------------------- --------------
/s/ Garrett Thornburg Chairman of the Board, March 26, 2001
- -------------------------
Garrett Thornburg Director and Chief
Executive Officer
/s/ Larry A. Goldstone President, Director and March 26, 2001
- -------------------------
Larry A. Goldstone Chief Operating Officer
/s/ David A. Ater Director March 26, 2001
- -------------------------
David A. Ater
/s/ Joseph H. Badal Director March 26, 2001
- -------------------------
Joseph H. Badal
/s/ Ike Kalangis Director March 26, 2001
- -------------------------
Ike Kalangis
/s/ Owen M. Lopez Director March 26, 2001
- -------------------------
Owen M. Lopez
/s/ James H. Lorie Director March 26, 2001
- -------------------------
James H. Lorie
/s/ Francis I. Mullin III Director March 26, 2001
- -------------------------
Francis I. Mullin
/s/ Stuart C. Sherman Director March 26, 2001
- -------------------------
Stuart C. Sherman
Exhibit Index
Sequentially
Numbered
Exhibit Number Exhibit Description Page
- -------------- -------------------------------------------------------------- ------------
1.1 Sales Agency Agreement (a)
3.1 Articles of Incorporation of the Registrant (b)
3.1.1 Articles of Amendment to Articles of Incorporation
dated June 29, 1995 (c)
3.1.2 Articles Supplementary dated January 21, 1997 (d)
3.1.3 Amendment to Articles of Incorporation dated
April 27, 2000 (e)
3.1.4 Form of Articles Supplementary for Series B Cumulative
Preferred Stock * 75
3.2 Amended and Restated Bylaws of the Registrant (f)
3.2.1.1 Amendment to the Restated Bylaws of the Registrant (g)
3.3 Audit Committee Charter dated January 25, 2001 (n)
4.1 Specimen Common Stock Certificates (b)
4.2 Specimen Preferred Stock Certificates (d)
4.3 Form of Common Stock Certificate * 81
4.4 Form of Preferred Stock Certificate for Series B
Cumulative Preferred Stock * 83
4.5 Form of Right Certificate * 85
10.1 Management Agreement between the Registrant and
Thornburg Mortgage Advisory Corporation dated July 15, 1999 (h)
10.1.1 Amendment No. 1 to the Management Agreement dated
October 17, 2000 (i)
10.2 Form of Servicing Agreement (b)
10.3 Form of 1992 Stock Option and Incentive Plan as amended and
restated March 14, 1997 (j)
10.3.1 Amendment dated December 16, 1997 to the amended and restated
1992 Stock Option and Incentive Plan (k)
10.3.2 Amendment dated April 15, 1999 to the amended and restated
1992 Stock Option and Incentive Plan (h)
10.4 Form of Dividend Reinvestment and Stock Purchase Plan (l)
10.5 Trust Agreement dated as of December 1, 1998 (m)
10.6 Indenture Agreement dated as of December 1, 1998 (m)
10.7 Sales and Service Agreement dated as of December 1, 1998 (m)
10.8 Form of Shareholder Rights Agreement * 91
22. Notice and Proxy Statement for the Annual Meeting of
Shareholders to be held on April 26, 2001 (n)
- -----------------------------
* Being filed herewith.
(a) Previously filed with Registrant's Form 8-K dated October 10, 1995 and
incorporated herein by reference pursuant to Rule 12b-32.
(b) Previously filed as part of Form S-11 which went effective on June 18, 1993
and incorporated herein by reference pursuant to Rule 12b-32.
(c) Previously filed with Registrant's Form 10-Q dated June 30, 1995 and
incorporated herein by reference pursuant to Rule 12b-32.
(d) Previously filed as part of Form 8-A dated January 17, 1997 and
incorporated herein by reference pursuant to Rule 12b-32.
(e) Previously filed with Registrant's Form 10-Q dated March 31, 2000 and
incorporated herein by reference pursuant to Rule 12b-32. (f) Previously
filed as part of Form S-8 dated July 1, 1994 and incorporated herein by
reference pursuant to Rule 12b-32.
(g) Previously filed with Registrant's Form 10-Q dated September 30, 1999 and
incorporated herein by reference pursuant to Rule 12b-32.
(h) Previously filed with Registrant's Form 10-Q dated June 30, 1999 and
incorporated herein by reference pursuant to Rule 12b-32.
(i) Previously filed with Registrant's Form 10-Q dated September 30, 2000 and
incorporated herein by reference pursuant to Rule 12b-32.
(j) Previously filed with Registrant's Form 10-K dated December 31, 1996 and
incorporated herein by reference pursuant to Rule 12b-32.
(k) Previously filed with Registrant's Form 10-K dated December 31, 1997 and
incorporated herein by reference pursuant to Rule 12b-32.
(l) Previously filed as Exhibit 4 to Registrant's registration statement on
Form S-3D dated September 24, 1997 and incorporated herein by reference
pursuant to Rule 12b-32.
(m) Previously filed with Registrant's Form 10-K dated December 31, 1998 and
incorporated herein by reference pursuant to Rule 12b-32.
(n) Filed on March 28, 2001 and incorporated by reference pursuant to Rule
12-b32.
B-1