SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: MARCH 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _______________ TO _________________
COMMISSION FILE NUMBER: 1-13447
ANNALY MORTGAGE MANAGEMENT, INC.
(Exact name of Registrant as specified in its Charter)
MARYLAND 22-3479661
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
1211 AVENUE OF THE AMERAICAS SUITE 2902
NEW YORK, NEW YORK
(Address of principal executive offices)
10036
(Zip Code)
(212) 696-0100
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all documents
and reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period
that the Registrant was required to file such reports), and (2) has been subject
to such filing requirements for the past 90 days:
Yes X No
--- ---
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchnage Act):
Yes X No
--- ---
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes
of stock, as of the lastest practicable date:
Class Outstanding at May 12, 2003
Common Stock, $.01 par value 93,994,998
ANNALY MORTGAGE MANAGEMENT, INC.
FORM 10-Q
INDEX
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Statements of Financial Condition- March 31, 2003 (Unaudited) and December 31, 2002 1
Statements of Operations (Unaudited) for the quarters ended March 31, 2003 and 2002 2
Statements of Stockholders' Equity (Unaudited) for the quarter ended March 31, 2003 3
Statements of Cash Flows (Unaudited) for the quarters ended March 31, 2003 and 2002 4
Notes to Financial Statements (Unaudited) 5-11
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 12-22
Item 3. Quantitative and Qualitative Disclosure about Market Risk 23-24
Item 4. Controls and Procedures
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 25
SIGNATURES 26
CERTIFICATIONS 26-30
PART I.
ITEM 1. FINANCIAL STATEMENTS
ANNALY MORTGAGE MANAGEMENT, INC.
STATEMENTS OF FINANCIAL CONDITION
(dollars in thousands)
MARCH 31, 2003 DECEMBER 31,
(UNAUDITED) 2002
------------------- -------------------
ASSETS
Cash and cash equivalents $945 $726
Mortgage-Backed Securities, at fair value 11,674,910 11,551,857
Federal Home Loan Bank Debentures, at fair value 643,160 -
Receivable for Mortgage-Backed Securities sold 304,766 55,954
Accrued interest receivable 50,087 49,707
Other assets 873 840
------------------- -------------------
Total assets $12,674,741 $11,659,084
=================== ===================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Repurchase agreements $10,192,049 $10,163,174
Payable for Mortgage-Backed Securities purchased 1,335,427 338,691
Accrued interest payable 15,915 14,935
Dividends payable 50,789 57,499
Other liabilities 2,816 2,812
Accounts payable 1,033 1,907
------------------- -------------------
Total liabilities 11,598,029 10,579,018
------------------- -------------------
Stockholders' Equity:
Common stock: par value $.01 per share; 500,000,000
Authorized, 84,647,484 and 84,569,206 shares issued
and outstanding, respectively 846 846
Additional paid-in capital 1,004,370 1,003,200
Accumulated other comprehensive gain 71,000 75,511
Retained earnings 496 509
------------------- -------------------
Total stockholders' equity 1,076,712 1,080,066
------------------- -------------------
Total liabilities and stockholders' equity $12,674,741 $11,659,084
=================== ===================
See notes to financial statements.
1
PART I.
ITEM 1. FINANCIAL STATEMENTS
ANNALY MORTGAGE MANAGEMENT, INC
STATEMENTS OF OPERATIONS
(dollars in thousands, except per share data)
(UNAUDITED)
For the Quarter For the Quarter
Ended March 31, Ended March 31,
2003 2002
-------------------------------------
INTEREST INCOME $87,500 $92,900
INTEREST EXPENSE 44,048 40,012
----------------- ------------------
NET INTEREST INCOME 43,452 52,888
GAIN ON SALE OF MORTGAGE-BACKED SECURITIES 11,020 3,410
GENERAL AND ADMINISTRATIVE EXPENSES 3,697 3,255
----------------- ------------------
NET INCOME 50,775 53,043
----------------- ------------------
OTHER COMPREHENSIVE INCOME:
Unrealized gain (loss) on available-for-sale securities 6,509 (4,257)
Less: reclassification adjustment for net gains
included in net income (11,020) (3,410)
----------------- ------------------
Other comprehensive (loss) (4,511) (7,667)
----------------- ------------------
COMPREHENSIVE INCOME $46,264 $45,376
================= ==================
NET INCOME PER SHARE:
Basic $0.60 $0.69
================= ==================
Diluted $0.60 $0.69
================= ==================
AVERAGE NUMBER OF SHARES OUTSTANDING:
Basic 84,606,786 76,709,836
================= ==================
Diluted 84,837,390 77,017,431
================= ==================
See notes to financial statements.
2
PART I.
ITEM 1. FINANCIAL STATEMENTS
ANNALY MORTGAGE MANAGEMENT, INC.
STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE QUARTER ENDED MARCH 31, 2003
(dollars in thousands, except per share data)
(UNAUDITED)
Common Additional Other
Stock Paid-In Comprehensive Retained Comprehensive
Par Value Capital Income Earnings Income Total
------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2002 $846 $1,003,200 $509 $75,511 $1,080,066
Net Income $50,775 50,775
Other comprehensive income:
Unrealized net gains on securities,
net of reclassification adjustment (4,511) (4,511)
---------------
Comprehensive income $46,264 46,264
===============
Exercise of stock options - 215 215
Proceeds from direct purchase - 955 955
Dividends declared for the quarter
ended March 31, 2003,
$0.60 per average share (50,788) (50,788)
-------------------------- -------------------------------------
BALANCE, MARCH 31, 2003 $846 $1,044,370 $496 $71,000 $1,076,712
========================== =====================================
See notes to financial statements.
3
PART I.
ITEM 1. FINANCIAL STATEMENTS
ANNALY MORTGAGE MANAGEMENT, INC
STATEMENTS OF CASH FLOWS
(dollars in thousands)
(UNAUDITED)
For the Quarter Ended For the Quarter Ended
March 31, March 31,
2003 2002
-------------------------------------------
Cash flows from operating activities:
Net income $50,775 $53,043
Adjustments to reconcile net income to net cash
provided by operating activities:
Market value adjustment on long-term repurchase
agreement 103 37
Increase in accrued interest receivable (379) (4,498)
Increase in other assets (33) (195)
Decrease in accrued interest payable 980 5,413
Amortization of mortgage premiums and discounts, net 48,519 17,891
Gain on sale of Mortgage-Backed Securities (11,020) (3,410)
Stock option expense 2 62
Decrease (increase) in accounts payable (875) 87
--------------------- ---------------------
Net cash provided by operating activities 88,072 68,430
--------------------- ---------------------
Cash flows from investing activities:
Purchase of Mortgage-Backed Securities (2,297,069) (3,838,616)
Purchase of FHLB Debentures (171,000) -
Proceeds from sale of Mortgage-Backed Securities 536,246 393,462
Principal payments of Mortgage-Backed Securities 1,871,524 1,092,991
--------------------- ---------------------
Net cash used in investing activities (60,299) (2,352,163)
--------------------- ---------------------
Cash flows from financing activities:
Proceeds from repurchase agreements 24,295,758 19,827,609
Principal payments on repurchase agreements (24,266,982) (17,856,038)
Proceeds from exercise of stock options 215 220
Proceeds from direct purchase 953 559
Net proceeds from offerings - 347,337
Dividends paid (57,499) (35,896)
--------------------- ---------------------
Net cash provided by financing activities (27,555) 2,283,791
--------------------- ---------------------
Net increase (decrease) in cash and cash equivalents 219 58
Cash and cash equivalents, beginning of period 726 429
--------------------- ---------------------
Cash and cash equivalents, end of period $945 $487
===================== =====================
Supplemental disclosure of cash flow information:
Interest paid $43,068 $34,599
===================== =====================
Noncash financing activities:
Net change in unrealized (loss) on available-for-sale
securities ($4,511) ($7,667)
===================== =====================
Dividends declared, not yet paid $50,789 $52,223
===================== =====================
See notes to financial statements.
4
ANNALY MORTGAGE MANAGEMENT, INC.
NOTES TO FINANCIAL STATEMENTS
FOR THE QUARTERS ENDED MARCH 31, 2003 AND 2002
(UNAUDITED)
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Annaly Mortgage Management, Inc. (the "Company") was incorporated in
Maryland on November 25, 1996. The Company commenced its operations of
purchasing and managing an investment portfolio of Mortgage-Backed Securities on
February 18, 1997, upon receipt of the net proceeds from the private placement
of equity capital. An initial public offering was completed on October 14, 1997.
A summary of the Company's significant accounting policies follows:
Basis of Presentation - The accompanying unaudited financial statements
have been prepared in conformity with the instructions to Form 10-Q and Article
10, Rule 10-01 of Regulation S-X for interim financial statements. Accordingly,
they do not include all of the information and footnotes required by accounting
principles generally accepted in the United States of America ("GAAP"). The
interim financial statements for the three month period are unaudited; however,
in the opinion of the Company's management, all adjustments, consisting only of
normal recurring accruals, necessary for a fair statement of the results of
operations have been included. These unaudited financials statements should be
read in conjunction with the audited financial statements included in the
Company's Annual Report on form 10-K for the year ended December 31, 2002. The
nature of the Company's business is such that the results of any interim period
are not necessarily indicative of results for a full year.
Cash and Cash Equivalents - Cash and cash equivalents includes cash on hand
and money market funds. The carrying amounts of cash equivalents approximates
their value.
Mortgage-Backed Securities and FHLB Debentures - The Company invests
primarily in mortgage pass-through certificates, collateralized mortgage
obligations and other Mortgage-Backed Securities representing interests in or
obligations backed by pools of mortgage loans (collectively, "Mortgage-Backed
Securities"). The Company also invests in Federal Home Loan Bank Debentures. The
Mortgage-Backed Securities and Federal Home Loan Bank Debentures are
collectively referred to herein as "Investment Securities."
Statement of Financial Accounting Standards No. 115, Accounting for Certain
Investments in Debt and Equity Securities, requires the Company to classify its
investments as either trading investments, available-for-sale investments or
held-to-maturity investments. Although the Company generally intends to hold
most of its Investment Securities until maturity, it may, from time to time,
sell any of its Investment Securities as part of its overall management of its
statement of financial condition. Accordingly, this flexibility requires the
Company to classify all of its Investment Securities as available-for-sale. All
assets classified as available-for-sale are reported at fair value, based on
market prices provided by certain dealers who make markets in these financial
instruments, with unrealized gains and losses excluded from earnings and
reported as a separate component of stockholders' equity.
Unrealized losses on Investment Securities that are considered other than
temporary, as measured by the amount of decline in fair value attributable to
factors other than temporary, are recognized in income and the cost basis of the
Mortgage-Backed Securities is adjusted. There were no such adjustments for the
quarters ended March 31, 2003 and 2002.
Interest income is accrued based on the outstanding principal amount of the
Investment Securities and their contractual terms. Premiums and discounts
associated with the purchase of the Mortgage-Backed Securities are amortized
into interest income over the lives of the securities using the interest method.
Investment Securities transactions are recorded on the trade date.
Purchases of newly issued securities are recorded when all significant
uncertainties regarding the characteristics of the securities are removed,
generally shortly before settlement date. Realized gains and losses on such
transactions are determined on the specific identification basis.
5
Credit Risk - At March 31, 2003 and December 31, 2002, the Company has
limited its exposure to credit losses on its portfolio of Mortgage-Backed
Securities by only purchasing securities issued by Federal Home Loan Mortgage
Corporation ("FHLMC"), Federal National Mortgage Association ("FNMA"),
Government National Mortgage Association ("GNMA"), or Federal Home Loan Bank
("FHLB"). The payment of principal and interest on the FHLMC and FNMA
Mortgage-Backed Securities are guaranteed by those respective agencies and the
payment of principal and interest on the GNMA Mortgage-Backed Securities are
backed by the full-faith-and-credit of the U.S. government. At March 31, 2003
and December 31, 2002 all of the Company's Mortgage-Backed Securities have an
actual or implied "AAA" rating.
Repurchase Agreements -The Company finances the acquisition of its
Mortgage-Backed Securities through the use of repurchase agreements. Repurchase
agreements are treated as collateralized financing transactions and are carried
at their contractual amounts, including accrued interest, as specified in the
respective agreements. Accrued interest is recorded as a separate line item.
Income Taxes - The Company has elected to be taxed as a Real Estate
Investment Trust ("REIT") and intends to comply with the provisions of the
Internal Revenue Code of 1986, as amended (the "Code") with respect thereto.
Accordingly, the Company will not be subjected to Federal income tax to the
extent of its distributions to shareholders and as long as certain asset, income
and stock ownership tests are met.
Use of Estimates - The preparation of financial statements in conformity
with accounting principles generally accepted in the United States of America
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 estimate.
New Accounting Pronouncement - In December 2002, the FASB issued Statement
of Financial Accounting Standard (SFAS) No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosures, an Amendment of FASB Statement No.
123." This Statement provides alternative methods of transition for companies
who voluntarily change to the fair value-based method of accounting for
stock-based employee compensation in accordance with SFAS No. 123, "Accounting
for Stock-Based Compensation." (SFAS 123). SFAS No. 148 does not permit the use
of the original SFAS No. 123 prospective method of transition for changes to the
fair value based method made in fiscal years beginning after December 15, 2003.
The Statement also requires prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based compensation
and the effect of the method used on reported results. This Statement is
effective upon issuance.
2. MORTGAGE-BACKED SECURITIES
The following table pertains to the Company's Mortgage-Backed Securities
classified as available-for-sale as of March 31, 2003, which are carried at
their fair value:
Federal Home Loan Federal National Government National
Mortgage Mortgage Mortgage Total Mortgage-
Corporation Association Association Backed Securities
-------------------------------------------------------------------------------
(dollars in thousands)
Mortgage-Backed
Securities, gross $4,930,045 $6,013,425 $368,240 $11,311,710
Unamortized discount (407) (62) - (469)
Unamortized premium 109,266 171,477 9,086 289,829
-------------------------------------------------------------------------------
Amortized cost 5,038,904 6,184,840 377,326 11,601,070
Gross unrealized gains 29,677 67,778 1,242 98,697
Gross unrealized losses (15,846) (8,772) (239) (24,857)
-------------------------------------------------------------------------------
Estimated fair value $5,052,735 $6,243,846 $378,329 $11,674,910
===============================================================================
Gross Unrealized Gross Unrealized Estimated Fair
Amortized Cost Gain Loss Value
-------------------------------------------------------------------------------
Adjustable rate $7,221,316 $36,140 ($15,027) $7,242,429
Fixed rate 4,379,754 62,557 (9,830) 4,432,481
-------------------------------------------------------------------------------
Total $11,601,070 $98,697 ($24,857) $11,674,910
===============================================================================
6
The following table pertains to the Company's Mortgage-Backed Securities
classified as available-for-sale as of December 31, 2002, which are carried at
their fair value:
Federal Home Loan Federal National Government
Mortgage Mortgage National Mortgage Total Mortgage-
Corporation Association Association Backed Securities
------------------------------------------------------------------------------
(dollars in thousands)
Mortgage-Backed
Securities, gross $5,120,929 $5,860,987 $220,468 $11,202,384
Unamortized discount (544) (120) - (664)
Unamortized premium 105,872 164,071 4,684 274,627
------------------------------------------------------------------------------
Amortized cost 5,226,257 6,024,938 225,152 11,476,347
Gross unrealized gains 31,731 58,239 537 90,507
Gross unrealized losses (9,554) (5,318) (125) (14,997)
------------------------------------------------------------------------------
Estimated fair value $5,248,434 $6,077,859 $225,564 $11,551,857
==============================================================================
Gross Unrealized Gross Unrealized Estimated Fair
Amortized Cost Gain Loss Value
------------------------------------------------------------------------------
Adjustable rate $7,144,741 $35,349 ($12,424) $7,167,666
Fixed rate 4,331,606 55,158 (2,573) 4,384,191
------------------------------------------------------------------------------
Total $11,476,347 $90,507 ($14,997) $11,551,857
==============================================================================
The adjustable rate Mortgage-Backed Securities are limited by periodic caps
(generally interest rate adjustments are limited to no more than 1% every six
months) and lifetime caps. The weighted average lifetime cap was 10.3% at March
31, 2003 and 8.8% at December 31, 2002.
During the quarter ended March 31, 2003, the Company realized $11,020,000
in net gains from sales of Mortgage-Backed Securities. During the quarter ended
March 31, 2002, the Company realized $3,410,000 in gains from sales of
Mortgage-Backed Securities.
3. FHLB DEBENTURES
The Company acquired $646,000,000 in Federal Home Loan Bank Debentures,
which are classified as available-for-sale. The market value at March 31, 2003
was $643,160,000. The Federal Home Loan Bank Debentures are adjustable rate with
a weighted average lifetime cap of 8.0% and they are callable by the Federal
Home Loan Bank.
7
4. REPURCHASE AGREEMENTS
The Company had outstanding $10,192,049,000 and $10,163,174,000 of
repurchase agreements with a weighted average borrowing rate of 1.67% and 1.72%,
and a weighted average remaining maturity of 111 days and 124 days as of March
31, 2003 and December 31, 2002, respectively.
At March 31, 2003 and December 31, 2002, the repurchase agreements had the
following remaining maturities:
March 31, 2003 December 31, 2002
(dollars in thousands)
-----------------------------------------------
Within 30 days $7,354,790 $7,778,003
30 to 59 days 1,041,920 816,906
60 to 89 days 218,775 104,500
90 to 119 days - -
Over 120 days 1,576,564 1,463,765
-----------------------------------------------
Total $10,192,049 $10,163,174
===============================================
5. OTHER LIABILITIES
In 2001, the Company entered into a repurchase agreement maturing in July
2004, at which time, the repurchase agreement gives the buyer the right to
extend, in whole or in part, in three-month increments up to July 2006. The
repurchase agreement has a principal value of $100,000,000. The Company accounts
for the extension option as a separate interest rate floor liability carried at
fair value. The initial fair value of $1,200,000 allocated to the extension
option resulted in a similar discount on the repurchase agreement borrowings
that is being amortized over the initial term of 3 years using the effective
yield method. At December 31, 2002, the fair value of this interest rate floor
was a $2,816,000 and was classified as other liabilities.
6. COMMON STOCK
During the quarter ending March 31, 2003, the Company declared dividends to
shareholders totaling $50,788,000 or $0.60 per share, which was paid on April
30, 2003. During the quarter ended March 31, 2003, 25,372 options were exercised
under the long-term compensation plan at $215,000. Also, 52,906 shares were
purchased in the dividend reinvestment and direct purchase program at $955,000.
During the Company's year ending December 31, 2002, the Company declared
dividends to shareholders totaling $223,602,000, or $2.67 per share, of which
$166,102,000 was paid during the year and $57,499,000 was paid on January 29,
2003. During the year ended December 31, 2002, 97,095 options were exercised at
$1,090,000. Total shares exchanged upon exercise of the stock options were 4,444
at a value of $76,000. Through the Equity Shelf Program, the Company raised
$28,103,000 in net proceeds and issued 1,481,000 shares. Also, 165,480 shares
were purchased in dividend reinvestment and share purchase plan, totaling
$3,009,000. The Company completed an offering of common stock in the first
quarter issuing 23,000,000 shares, with aggregate net proceeds of $347,337,000.
8
7. EARNINGS PER SHARE (EPS)
For the quarter ended March 31, 2003, the reconciliation is as follows:
For the Quarter Ended March 31, 2003
-----------------------------------------------------------
Income Shares Per-Share
(Numerator) (Denominator) Amount
-----------------------------------------------------------
(dollars in thousands, except per share data)
Net income $50,775
-------------------
Basic earnings per share $50,775 84,606,786 $0.60
=====================
Effect of dilutive
securities:
Dilutive stock options 230,604
--------------------------------------
Diluted earnings per share $50,775 84,837,390 $0.60
===========================================================
Options to purchase 6,250 shares of stock were outstanding and considered
anti-dilutive as their exercise price exceeded the average stock price for the
quarter
For the quarter ended March 31, 2002, the reconciliation is as follows:
For the Quarter Ended March 31, 2002
-----------------------------------------------------------
Income Per-Share
(Numerator) Shares Amount
(Denominator)
-----------------------------------------------------------
(dollars in thousands, except per share data)
Net income $53,043
-------------------
Basic earnings per share $53,043 76,709,836 $0.69
=====================
Effect of dilutive
securities:
Dilutive stock options 307,595
--------------------------------------
Diluted earnings per share $53,043 77,017,431 $0.69
===========================================================
8. LONG-TERM STOCK INCENTIVE PLAN
The Company has adopted a long term stock incentive plan for executive
officers, key employees and nonemployee directors (the "Incentive Plan"). The
Incentive Plan authorizes the Compensation Committee of the board of directors
to grant awards, including incentive stock options as defined under Section 422
of the Code ("ISOs") and options not so qualified ("NQSOs"). The Incentive Plan
authorizes the granting of options or other awards for an aggregate of the
greater of 500,000 shares or 9.5% of the fully diluted outstanding shares of the
Company's common stock.
The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" ("APB 25") and related
interpretations in accounting for its employee stock options because the
alternative fair value accounting provided for under Statement of Financial
Accounting Standard ("SFAS") No. 123, "Accounting for Stock-Based Compensation",
as amended by SFAS No. 148, requires use of option valuation models that were
not developed for use in valuing employee stock options. Under APB 25, because
the exercise price of the Company's employee stock options equals the market
price of the underlying stock on the date of grant, no compensation expense is
recognized.
9
There were no stock options granted during the quarters ended March 31,
2003 and 2002.
Because the Company's employee stock options have characteristics
significantly different from those of traded options and changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not provide a reliable single
measure of the fair value of its employee stock options. The Black-Scholes
option pricing model was developed for use in estimating the fair value of
traded options that have no vesting restrictions and are freely transferable.
All available option pricing models require the input of highly subjective
assumptions including the expected stock price volatility.
The following table illustrates the effect on net income and earnings per
share if the company had applied the fair value recognition provisions of FASB
Statement No. 123, Accounting for Stock-Based Compensation, to stock-based
employee compensation.
For the Quarter Ended March 31,
2003 2002
---------------------------------------------
(dollars in thousands, except per share data)
Net income, as reported $50,775 $53,043
Deduct: Total stock-based employee compensation
expense determined under fair value based method (7) (16)
---------------------------------------------
Pro-forma net income $50,768 $53,027
=============================================
Net income per share, as reported
Basic $0.60 $0.69
Diluted $0.60 $0.69
Pro-forma net income per share
Basic $0.60 $0.69
Diluted $0.60 $0.69
9. COMPREHENSIVE INCOME
The Company adopted Statement of Financial Accounting Standards No. 130,
Reporting Comprehensive Income. Statement No. 130 requires the reporting of
comprehensive income in addition to net income from operations. Comprehensive
income is a more inclusive financial reporting methodology that includes
disclosure of certain financial information that historically has not been
recognized in the calculation of net income. The Company at March 31, 2003 and
December 31, 2002 held securities classified as available-for-sale. At March 31,
2003, the net unrealized gain totaled $71,000,000 and at December 31, 2002, the
net unrealized gains totaled $75,511,000.
10. LEASE COMMITMENTS
The Corporation has a noncancelable lease for office space, which commenced
in May 2002 and expires in December 2009.
The Corporation's aggregate future minimum lease payments are as follows:
Total per Year
(dollars in thousands)
-----------------------
2003 500
2004 500
2005 500
2006 530
2007 532
Thereafter 1064
-----------------------
Total remaining lease payments $3,626
=======================
10
11. RELATED PARTY TRANSACTION
Officers and employees of the Company are actively involved in managing
Mortgage-Backed Securities and other fixed income assets for institutional
clients through Fixed Income Discount Advisory Company ("FIDAC"). FIDAC is a
registered investment adviser, which is owned 100% by the Chief Executive
Officer of Annaly Mortgage Management, Inc. Our management currently allocates
rent and other general and administrative expenses in the amounts of 90% and 10%
to Annaly and FIDAC, respectively.
12. INTEREST RATE RISK
The primary market risk to the Company is interest rate risk. Interest
rates are highly sensitive to many factors, including governmental monetary and
tax policies, domestic and international economic and political considerations
and other factors beyond the Company's control. Changes in the general level of
interest rates can affect net interest income, which is the difference between
the interest income earned on interest-earning assets and the interest expense
incurred in connection with the interest-bearing liabilities, by affecting the
spread between the interest-earning assets and interest-bearing liabilities.
Changes in the level of interest rates also can affect the value of the
Mortgage-Backed Securities and the Company's ability to realize gains from the
sale of these assets.
The Company seeks to manage the extent to which net income changes as a
function of changes in interest rates by matching adjustable-rate assets with
variable-rate borrowings. In addition, although the Company has not done so to
date, the Company may seek to mitigate the potential impact on net income of
periodic and lifetime coupon adjustment restrictions in the portfolio of
Mortgage-Backed Securities by entering into interest rate agreements such as
interest rate caps and interest rate swaps.
Changes in interest rates may also have an effect on the rate of mortgage
principal prepayments and, as a result, prepayments on Mortgage-Backed
Securities. The Company will seek to mitigate the effect of changes in the
mortgage principal repayment rate by balancing assets purchased at a premium
with assets purchased at a discount. To date, the aggregate premium exceeds the
aggregate discount on the Mortgage-Backed Securities. As a result, prepayments,
which result in the expensing of unamortized premium, will reduce net income
compared to what net income would be absent such prepayments.
13. SUBSEQUENT EVENT
On April 1, 2003 the Company raised approximately net proceeds of $151.2
million in equity in a secondary offering of 9,300,700 shares of common stock.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Special Note Regarding Forward-Looking Statements
Certain statements contained in this quarterly report, and certain
statements contained in our future filings with the Securities and Exchange
Commission (the "SEC" or the "Commission"), in our press releases or in our
other public or shareholder communications may not be, based on historical facts
and are "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Forward-looking statements which are
based on various assumptions, (some of which are beyond our control) may be
identified by reference to a future period or periods, or by the use of
forward-looking terminology, such as "may," "will," "believe," "expect,"
"anticipate," "continue," or similar terms or variations on those terms, or the
negative of those terms. Actual results could differ materially from those set
forth in forward-looking statements due to a variety of factors, including, but
not limited to, changes in interest rates, changes in yield curve, changes in
prepayment rates, the availability of mortgage backed securities for purchase,
the availability of financing and, if available, the terms of any financing. For
a discussion of the risks and uncertainties which could cause actual results to
differ from those contained in the forward-looking statements, see our 2002 Form
10-K. We do not undertake, and specifically disclaim any obligation, to publicly
release the result of any revisions which may be made to any forward-looking
statements to reflect the occurrence of anticipated or unanticipated events or
circumstances after the date of such statements.
Overview
Annaly Mortgage Management, Inc. ("we" or "us") is a real estate
investment trust, ("REIT") that owns and manages a portfolio of Mortgage-Backed
Securities. Our principal business objective is to generate net income for
distribution to our stockholders from the spread between the interest income on
our Mortgage-Backed Securities and the costs of borrowing to finance our
acquisition of Mortgage-Backed Securities.
Critical Accounting Policies
Management's discussion and analysis of financial condition and results of
operations is based on the amounts reported our financial statements. These
financial statements are prepared in accordance with accounting principles
generally accepted in the United States of America. In preparing the financial
statements, management is required to make various judgments, estimates and
assumptions that affect the reported amounts. Changes in these estimates and
assumptions could have a material effect our financial statements. The following
is a summary our policies that is the most affected by management's judgments,
estimates and assumptions.
Market Valuation of Securities: All assets classified as available-for-sale
are reported at fair value, based on market prices. Our policy is to obtain
market values from three independent sources and record the market value of the
securities based on the average of the three.
Amortization of premiums and accretion of discounts: Premiums and discounts
associated with the purchase of the Mortgage-Backed Securities are amortized
into interest income over the lives of the securities using the interest method.
Our policy for estimating prepayment speeds for calculating the effective yield
is to evaluate historical performance, street consensus prepayment speeds, and
current market conditions.
Results of Operations: For the Quarters Ended March 31, 2003 and 2002
Net Income Summary
For the quarter ended March 31, 2003, our net income was $50.8 million, or
$0.60 basic earnings per average share, as compared to $53.0 million, or $0.69
basic earnings per average share, for the quarter ended March 31, 2002. We
attribute the decrease in net income for the quarter ended March 31, 2003, over
the quarter ended March 31, 2002, to the decline in the interest rate spread
between the rate on interest-earning assets and the cost of funds for
interest-bearing liabilities. We compute our net income per share by dividing
net income by the weighted average number of shares of outstanding common stock
during the period, which was 84,606,786 for the quarter ended March 31, 2003 and
76,709,836 for the quarter ended March 31, 2002. Dividends per shares
outstanding for the quarter ended March 31, 2003 was $0.60 per share, or $50.8
million in total. Dividends per weighted average number of shares outstanding
for the quarter ended March 31, 2002 was $0.63 per share, or $52.2 million in
total. Our return on average equity was 18.83% for the quarter ended March 31,
2003 and 25.32% for the quarter ended March 31, 2002. The decline in the return
on average equity resulted for the declining interest rate spread.
12
Net Income Summary
------------------
(dollars in the thousands, except for per share data)
-----------------------------------------------------
(ratios are annualized)
-----------------------
Quarter ended Quarter ended
March 31, 2003 March 31, 2002
--------------------- ---------------------
Interest Income $87,500 $92,990
Interest Expense 44,048 40,012
--------------------- ---------------------
Net Interest Income 43,452 52,888
Gain on Sale of Mortgage-Backed Securities 11,020 3,410
General and Administrative Expenses 3,697 3,255
--------------------- ---------------------
Net Income $50,775 $53,043
===================== =====================
Average Number of Basic Shares Outstanding 84,606,786 76,709,836
Average Number of Diluted Shares
Outstanding 84,837,390 77,017,431
Basic Net Income Per Share $0.60 $0.69
Diluted Net Income Per Share $0.60 $0.69
Average Total Assets $12,169,401 $8,987,862
Average Equity $1,079,113 $838,022
Annualized Return on Average Assets 1.67% 2.36%
Annualized Return on Average Equity 18.83% 25.32%
Interest Income and Average Earning Asset Yield
We had average earning assets of $10.8 billion and $7.6 billion for the
quarters ended March 31, 2003 and 2002, respectively. Our primary source of
income for the quarters ended March 31, 2003 and 2002 was interest income. A
portion of our income was generated by gains on the sales of our Mortgage-Backed
Securities. Our interest income was $87.5 million for the quarter ended March
31, 2003 and $92.9 million for the quarter ended March 31, 2002. Our yield on
average earning assets was 3.23% and 4.88% for the same respective periods. Our
average earning asset balance increased by $3.2 billion and interest income
decreased by $5.5 million for the quarter ended March 31, 2003 as compared to
the quarter ended March 31, 2002, even with the substantial increase in the
average asset base. The overall interest income decreased. The decline was the
direct result in the reduction in yield from 4.88% for the quarter ended March
31, 2002 to 3.23% for the quarter ended March 31, 2003. The table below shows
our average balance of interest earning assets, our yield on average earning
assets and our interest income for the quarter ended March 31, 2003, the year
ended December 31, 2002 and the four quarters in 2002.
13
Average Earning Asset Yield
---------------------------
(ratios for the quarters have been annualized)
----------------------------------------------
Yield on
Average
Average Average Average Yield on Yield on Interest
Cash Investment Earning Average Cash Investment Earning Interest
Equivalents Securities Assets Equivalents Securities Assets Income
----------------------------------------------------------------------------------
(dollars in thousands)
For the Quarter Ended March 31, 2003 - $10,837,147 $10,837,147 - 3.23% 3.23% $87,500
- ---------------------------------------------------------------------------------------------------------------------------
For the Year Ended December 31, 2002 $2 $9,575,365 $9,575,367 1.14% 4.22% 4.22% $404,165
For the Quarter Ended December 31, 2002 $2 $10,400,894 $10,400,896 0.88% 3.56% 3.56% $92,641
For the Quarter Ended September 30, 2002 $2 $10,661,228 $10,661,230 1.14% 4.10% 4.10% $109,201
For the Quarter Ended June 30, 2002 $2 $9,629,332 $9,629,334 1.23% 4.55% 4.55% $109,423
For the Quarter Ended March 31, 2002 $2 $7,610,006 $7,610,008 1.29% 4.88% 4.88% $92,900
The constant prepayment rate ("CPR") on our Mortgage-Backed Securities for
the quarters ended March 31, 2003 and 2002 were 41% and 29%, respectively. CPR
is an assumed rate of prepayment for our Mortgage-Backed Securities, expressed
as an annual rate of prepayment relative to the outstanding principal balance of
our Mortgage-Backed Securities. CPR does not purport to be either a historical
description of the prepayment experience of our Mortgage-Backed Securities or a
prediction of the anticipated rate of prepayment of our Mortgage-Backed
Securities.
Principal prepayments had a negative effect on our earning asset yield for
the quarters ended March 31, 2003 and 2002 because we adjust our rates of
premium amortization and discount accretion monthly based upon the effective
yield method, which takes into consideration changes in prepayment speeds.
Interest Expense and the Cost of Funds
We anticipate that our largest expense will be the cost of borrowed funds.
We had average borrowed funds of $10.5 billion and total interest expense of
$44.0 million for the quarter ended March 31, 2003. We had average borrowed
funds of $7.2 billion and total interest expense of $40.0 million for the
quarter ended March 31, 2002. Our average cost of funds was 1.68% for the
quarter ended March 31, 2003 and 2.23% for the quarter ended March 31, 2002. The
cost of funds rate decreased 0.55% and the average borrowed funds increased by
$3.3 billion for the quarter ended March 31, 2003 when compared to the quarter
ended March 31, 2002. Interest expense for the quarter increased 10% due to the
large increase in the average repurchase balance, even though the cost of funds
rate decreased.
With our current asset/liability management strategy, changes in our cost
of funds are expected to be closely correlated with changes in short-term LIBOR,
although we have choosen to extend the maturity of our liabilities. Our average
cost of funds was 0.34% above average one-month LIBOR and 0.35% above average
six-month LIBOR for the quarter ended March 31, 2003. Our average cost of funds
was 0.38% above average one-month LIBOR and 0.17% above average six-month LIBOR
for the quarter ended March 31, 2002.
The table below shows our average borrowed funds and average cost of funds
as compared to average one-month and average six-month LIBOR for the quarter
ended March 31, 2003, the year ended December 31, 2002 and the four quarters in
2002.
14
Average Cost of Funds
---------------------
(ratios for the quarters have been annualized)
----------------------------------------------
Average One- Average Cost
Month LIBOR of Funds Average Cost of
Average Average Average Average Relative to Relative to Funds Relative to
Borrowed Interest Cost of One-Month Six-Month Average Six- Average One- Average Six-
Funds Expense Funds LIBOR LIBOR Month LIBOR Month LIBOR Month LIBOR
--------------------------------------------------------------------------------------------------
(dollars in thousands)
For the Quarter Ended
March 31, 2003 $10,463,252 $44,048 1.68% 1.34% 1.33% .01% 0.34% 0.35%
- ----------------------------------------------------------------------------------------------------------------------------
For the Year Ended
December 31, 2002 $9,128,933 $191,758 2.10% 1.77% 1.88% (0.11%) 0.33% 0.22%
For the Quarter Ended
December 31, 2002 $10,097,676 $49,874 1.98% 1.57% 1.55% 0.02% 0.41% 0.43%
For the Quarter Ended
September 30, 2002 $10,122,840 $54,012 2.13% 1.82% 1.82% - 0.31% 0.31%
For the Quarter Ended
June 30, 2002 $9,102,992 $47,860 2.10% 1.85% 2.11% (0.26%) 0.25% (0.01%)
For the Quarter Ended
March 31, 2002 $7,192,222 $40,012 2.23% 1.85% 2.06% (0.21%) 0.38% 0.17%
Net Interest Income
Our net interest income, which equals interest income less interest
expense, totaled $43.5 million for the quarter ended March 31, 2003 and $52.9
million for the quarter ended March 31, 2002. Our net interest income decreased
because of the decline in the interest rate spread. Our net interest spread,
which equals the yield on our average assets for the period less the average
cost of funds for the period, was 1.55% for the quarter ended March 31, 2003 as
compared to 2.65% for the quarter ended March 31, 2002. This 110 basis point
increase in spread income is reflected in the decline in net interest income.
The table below shows our interest income by earning asset type, average
earning assets by type, total interest income, interest expense, average
repurchase agreements, average cost of funds, and net interest income for the
quarter ended March 31, 2003, the year ended December 31, 2002, and the four
quarters in 2002.
Net Interest Income
-------------------
(ratios for the quarters have been annualized)
----------------------------------------------
Yield on
Average Interest Average Average
Investment Income on Average Total Interest Balance of Average Net
Securities Investment Cash Interest Earning Repurchase Interest Cost of Interest
Held Securities Equivalents Income Assets Agreements Expense Funds Income
-------------------------------------------------------------------------------------------------
(dollars in thousands)
For the Quarter Ended
March 31, 2003 $10,837,147 $87,500 - $87,500 3.23% $10,463,251 $44,048 1.68% $43,452
- -------------------------------------------------------------------------------------------------------------------------
For the Year Ended
December 31, 2002 $9,575,365 $404,165 $2 $404,165 4.22% $9,128,933 $191,758 2.10% $212,407
For the Quarter Ended
December 31, 2002 $10,400,894 $92,641 $2 $92,641 3.56% $10,097,676 $49,874 1.98% $42,767
For the Quarter Ended
September 30, 2002 $10,661,228 $109,201 $2 $109,201 4.10% $10,122,840 $54,012 2.13% $55,189
For the Quarter Ended
June 30, 2002 $9,629,332 $109,423 $2 $109,423 4.55% $9,102,992 $47,860 2.10% $61,563
For the Quarter Ended
March 31, 2002 $7,610,006 $92,900 $2 $92,900 4.88% $7,192,222 $40,012 2.23% $52,888
15
Gains and Losses on Sales of Mortgage-Backed Securities
For the quarter ended March 31, 2003, we sold Mortgage-Backed Securities
with an aggregate historical amortized cost of $744.4 million for an aggregate
gain of $11.0 million. For the quarter ended March 31, 2002, we sold
Mortgage-Backed Securities with an aggregate historical amortized cost of $390.1
million for an aggregate gain of $3.4 million. The difference between the sale
price and the historical amortized cost of our Mortgage-Backed Securities is a
realized gain and increases income accordingly. We do not expect to sell assets
on a frequent basis, but may from time to time sell existing assets to move into
new assets, which our management believes might have higher risk-adjusted
returns, or to manage our balance sheet as part of our asset/liability
management strategy.
Credit Losses
We have not experienced credit losses on our Mortgage-Backed Securities to
date. We have limited our exposure to credit losses on our Mortgage-Backed
Securities by purchasing only securities issued or guaranteed by FNMA, FHLMC,
GNMA and FHLB which, although not rated, carry an implied "AAA" rating.
General and Administrative Expense
General and administrative ("G&A") expenses were $3.7 million for the
quarter ended March 31, 2003 and $3.3 for the quarter ended March 31, 2002. G&A
expenses as a percentage of average assets was 0.12% and 0.14% on an annualized
basis for the quarters ended March 31, 2003 and 2002, respectively. G&A expenses
as a percentage of average equity was 1.37% and 1.55% on an annualized basis for
the quarters ended March 31, 2003 and 2002, respectively. Increases in salaries
were the primary reason for the overall increase in G&A. We are
internally managed and continues to be a low cost provider. Even though G&A
expenses increased by $400,000 for the quarter ended March 31, 2003, when
compared to the quarter ended March 31, 2002, G&A as a percentage of average
equity was 0.18% less than the first quarter of 2002.
G&A Expenses and Operating Expense Ratios
-----------------------------------------
Total G&A Total G&A
Total G&A Expenses/Average Assets Expenses/Average
Expenses (annualized) Equity (annualized)
-----------------------------------------------------------------
(dollars in thousands)
For the Quarter Ended March 31, 2003 $3,697 0.12% 1.37%
- ---------------------------------------------------------------------------------------------------------------
For the Year Ended December 31, 2002 $13,963 0.13% 1.43%
For the Quarter Ended December 31, 2002 $3,904 0.13% 1.44%
For the Quarter Ended September 30, 2002 $3,268 0.12% 1.22%
For the Quarter Ended June 30, 2002 $3,536 0.13% 1.37%
For the Quarter Ended March 31, 2002 $3,255 0.14% 1.55%
Net Income and Return on Average Equity
Our net income was $50.8 million for the quarter ended March 31, 2003 and
$53.0 million for the quarter ended March 31, 2002. Our return on average equity
was 18.83% for the quarter ended March 31, 2003 and 25.3% for the quarter ended
March 31, 2002. The decline in net income was the result of a declining interest
rate spread, which was only partially offset by an increase in gains on the sale
of mortgage backed securities. The table below shows our net interest income,
gain on sale of Mortgage-Backed Securities and G&A expenses each as a percentage
of average equity, and the return on average equity for the quarters ended March
31, 2003, the year ended December 31, 2002, and for the four quarters in 2002.
16
Components of Return on Average Equity
--------------------------------------
(Ratios for all Quarters are annualized)
----------------------------------------
Gain on Sale of
Mortgage-Backed G&A Return on
Net Interest Securities/Average Expenses/Average Average
Income/Average Equity Equity Equity Equity
-----------------------------------------------------------------------------
For the Quarter Ended March 31, 2003 16.11% 4.09% 1.37% 18.83%
- ------------------------------------------------------------------------------------------------------------------------
For the Year Ended December 31, 2002 21.72% 2.15% 1.43% 22.44%
For the Quarter Ended December 31, 2002 15.80% 4.27% 1.44% 18.63%
For the Quarter Ended September 30, 2002 20.68% 1.78% 1.22% 21.24%
For the Quarter Ended June 30, 2002 23.93% 0.52% 1.37% 23.08%
For the Quarter Ended March 31, 2002 25.24% 1.63% 1.55% 25.32%
Financial Condition
Investment Securities
All of our Mortgage-Backed Securities at March 31, 2003 were
adjustable-rate or fixed-rate Mortgage-Backed Securities backed by single-family
mortgage loans. All of the mortgage assets underlying these Mortgage-Backed
Securities were secured with a first lien position on the underlying
single-family properties. All our Mortgage-Backed Securities were FHLMC, FNMA or
GNMA mortgage pass-through certificates or collateralized mortgage obligations
("CMOs"), which carry an actual or implied "AAA" rating. We mark-to-market all
of our Mortgage Backed Securities at liquidation value.
All of our Federal Home Loan Bank Debentures are adjustable rate in nature,
which carry an implied "AAA" rating. We mark-to-market all of our Federal Home
Loan Bank Debentures at liquidation value.
We accrete discount balances as an increase in interest income over the
life of discount Mortgage-Backed Securities and we amortize premium balances as
a decrease in interest income over the life of premium Mortgage-Backed
Securities. At March 31, 2003 and 2002, we had on our balance sheet a total of
$469,000 and $1.9 million respectively, of unamortized discount (which is the
difference between the remaining principal value and current historical
amortized cost of our Mortgage-Backed Securities acquired at a price below
principal value) and a total of $289.8 million and $194.9 million, respectively,
of unamortized premium (which is the difference between the remaining principal
value and the current historical amortized cost of our Mortgage-Backed
Securities acquired at a price above principal value).
We received mortgage principal repayments of $1.9 billion for the quarter
ended March 31, 2003 and $1.1 billion for the quarter ended March 31, 2002.
Given our current portfolio composition, if mortgage principal prepayment rates
were to increase over the life of our Mortgage-Backed Securities, all other
factors being equal, our net interest income would decrease during the life of
these Mortgage-Backed Securities as we would be required to amortize our net
premium balance into income over a shorter time period. Similarly, if mortgage
principal prepayment rates were to decrease over the life of our Mortgage-Backed
Securities, all other factors being equal, our net interest income would
increase during the life of these Mortgage-Backed Securities, as we would
amortize our net premium balance over a longer time period.
The table below summarizes our Investment Securities at March 31, 2003,
December 31, 2002, September 30, 2002, June 30, 2002, and March 31, 2002.
17
Investment Securities
---------------------
Amortized Estimated Fair Weighted
Net Amortized Cost/Principal Estimated Fair Value/Principal Average
Principal Value Premium Cost Value Value Value Yield
------------------------------------------------------------------------------------------------
(dollars in thousands)
At March 31, 2003 $11,957,710 $289,360 $12,247,070 102.42% $12,318,070 103.01% 2.83%
- --------------------------------------------------------------------------------------------------------------------------
At December 31, 2002 $11,202,384 $273,963 $11,476,347 102.45% $11,551,857 103.12% 3.25%
At September 30, 2002 $11,170,379 $244,777 $11,415,156 102.19% $11,489,538 102.86% 3.67%
At June 30, 2002 $10,833,374 $224,114 $11,057,488 102.07% $11,124,771 102.69% 3.90%
At March 31, 2002 $9,982,678 $193,048 $10,175,726 101.93% $10,206,228 102.24% 4.31%
The tables below set forth certain characteristics of our Mortgage-Backed
Securities. The index level for adjustable-rate Mortgage-Backed Securities is
the weighted average rate of the various short-term interest rate indices, which
determine the coupon rate.
Adjustable-Rate Investment Security Characteristics
---------------------------------------------------
Weighted Weighted Weighted Weighted Weighted Principal Value at
Average Average Average Average Term Weighted Average Period End as % of
Coupon Index Net to Next Average Asset Total Investment
Principal Value Rate Level Margin Adjustment Lifetime Cap Yield Securities
---------------------------------------------------------------------------------------------------------
(dollars in thousands)
At March 31, 2003 $7,716,248 3.93% 2.31% 1.62% 13 months 10.04% 2.20% 64.53%
- -------------------------------------------------------------------------------------------------------------------------------
At December 31, 2002 $7,007,062 4.10% 2.51% 1.59% 11 months 10.37% 2.33% 62.55%
At September 30, 2002 $7,583,147 4.37% 2.80% 1.57% 10 months 10.36% 2.90% 67.89%
At June 30, 2001 $7,939,126 4.57% 2.96% 1.61% 12 months 10.46% 3.17% 73.28%
At March 31, 2001 $7,248,832 4.94% 3.25% 1.69% 16 months 10.73% 3.52% 72.61%
Fixed-Rate Investment Security Characteristics
----------------------------------------------
Principal Value at
Weighted Weighted Period End as % of
Average Coupon Average Asset Total Investment
Principal Value Rate Yield Securities
----------------------------------------------------------------
(dollars in thousands)
At March 31, 2003 $4,241,462 6.53% 3.98% 35.47%
- --------------------------------------------------------------------------------------
At December 31, 2002 $4,195,322 6.76% 4.78% 37.45%
At September 30, 2002 $3,587,232 6.95% 5.29% 32.11%
At June 30, 2002 $2,894,248 7.09% 5.91% 26.72%
At March 31, 2002 $2,733,846 7.01% 6.40% 27.39%
At March 31, 2003 we held Investment Securities with coupons linked to the
one-month, six month, and twelve month LIBOR, six month average auction,
12-month cumulative average, six-month CD rate, one-year, two-year, three-year,
and five-year Treasury indices, and a step-up FHLB Debenture.
18
Adjustable-Rate Mortgage-Backed Securities by Index
---------------------------------------------------
March 31, 2003
--------------
One- Twelve- Six-Month 12-Month 1-Year 2-Year 3-Year 5-Year
Month Six-Month Month Auction Moving Six-Month Treasury Treasury Treasury Treasury FHLB
LIBOR LIBOR LIBOR Average Average CD Rate Index Index Index Index Debenture
-------------------------------------------------------------------------------------------------------
Weighted Average
Term to Next
Adjustment 1mo. 20 mo. 32 mo. 5 mo. 1 mo. 2 mo. 21 mo. 7 mo. 19 mo. 29 mo. 43 mo.
Weighted Average
Annual Period Cap None 2.00% 2.00% 1.00% None 1.00% 1.88% 2.00% 2.00% 2.00% 3.65%
Weighted Average
Lifetime Cap at
March 31, 2003 8.96% 11.48% 10.57% 12.99% 10.75% 11.57% 11.45% 11.92% 12.88% 12.59% 7.25%
Mortgage Principal
Value as Percentage
of Mortgage- Backed
Securities at
March 31, 2003 28.27% 0.26% 3.74% 0.02% 0.82% 0.12% 27.90% 0.02% 0.76% 0.33% 2.30%
At December 31, 2002 we held Investment Securities with coupons linked to
the one-month and six month, LIBOR, six month average auction, 12-month
cumulative average, six-month CD rate, and one-year, two-year, three-year, and
five-year Treasury indices.
Adjustable-Rate Mortgage-Backed Securities by Index
---------------------------------------------------
December 31, 2002
-----------------
Six-Month 12-Month 1-Year 2-Year 3-Year 5-Year
Auction Moving Six-Month Treasury Treasury Treasury Treasury
One-Month LIBOR Six-Month LIBOR Average Average CD Rate Index Index Index Index
----------------------------------------------------------------------------------------------------
Weighted Average Term to
Next Adjustment 1 mo. 41 mo. 2 mo. 1 mo. 2 mo. 22 mo. 10 mo. 20 mo. 31 mo.
Weighted Average Annual
Period Cap None 2.00% 2.00% None 1.00% 1.93% 2.00% 2.00% 2.00%
Weighted Average Lifetime
Cap at December 31, 2002 9.01% 11.31% 13.00% 10.37% 11.60% 11.83% 11.93% 12.83% 12.57%
Mortgage Principal Value as
Percentage of Mortgage-
Backed Securities at
December 31, 2002 32.43% 0.33% 0.03% 0.58% 0.14% 27.67% 0.03% 0.92% 0.42%
Borrowings
To date, our debt has consisted entirely of borrowings collateralized by a
pledge of our Mortgage-Backed Securities. These borrowings appear on our balance
sheet as repurchase agreements. At March 31, 2003, we had established
uncommitted borrowing facilities in this market with twenty-three lenders in
amounts, which we believe, are in excess of our needs. All of our
Mortgage-Backed Securities are currently accepted as collateral for these
borrowings. However, we limit our borrowings, and thus our potential asset
growth, in order to maintain unused borrowing capacity and thus increase the
liquidity and strength of our balance sheet.
For the quarter ended March 31, 2003, the term to maturity of our
borrowings ranged from one day to three years, with a weighted average original
term to maturity of 197 days. For the quarter ended March 31, 2002, the term to
maturity of our borrowings ranged from one day to three years, with a weighted
average original term to maturity of 187 days. At March 31, 2003, the weighted
average cost of funds for all of our borrowings was 1.67% and the weighted
average term to next rate adjustment was 111 days. At March 31, 2002, the
weighted average cost of funds for all of our borrowings was 5.22% and the
weighted average term to next rate adjustment was 26 days.
19
Liquidity
Liquidity, which is our ability to turn non-cash assets into cash, allows
us to purchase additional Mortgage-Backed Securities and to pledge additional
assets to secure existing borrowings should the value of our pledged assets
decline. Potential immediate sources of liquidity for us include cash balances
and unused borrowing capacity. Unused borrowing capacity will vary over time as
the market value of our Mortgage-Backed Securities varies. Our balance sheet
also generates liquidity on an on-going basis through mortgage principal
repayments and net earnings held prior to payment as dividends. Should our needs
ever exceed these on-going sources of liquidity plus the immediate sources of
liquidity discussed above, we believe that our Mortgage-Backed Securities could
in most circumstances be sold to raise cash. The maintenance of liquidity is one
of the goals of our capital investment policy. Under this policy, we limit asset
growth in order to preserve unused borrowing capacity for liquidity management
purposes.
Stockholders' Equity
We use "available-for-sale" treatment for our Investment Securities; we
carry these assets on our balance sheet at estimated market value rather than
historical amortized cost. Based upon this "available-for-sale" treatment, our
equity base at March 31, 2003 was $1.1 billion or $12.72 per share. If we had
used historical amortized cost accounting, our equity base at March 31, 2003
would have been $1.0 million, or $11.88 per share. Our equity base at March 31,
2002 was $1.0 billion, or $12.17 per share. If we had used historical amortized
cost accounting, our equity base at March 31, 2002 would have been $978.2
million, or $11.80 per share. During the quarter ended March 31, 2003, we raised
$1.2 million through the exercise of stock options and the dividend reinvestment
and share purchase plan. During the quarter ended March 31, 2002, we raised
additional capital in the amount of $347.3 million in a secondary offering.
With our "available-for-sale" accounting treatment, unrealized fluctuations
in market values of assets do not impact our GAAP or taxable income but rather
are reflected on our balance sheet by changing the carrying value of the asset
and stockholders' equity under "Accumulated Other Comprehensive Income (Loss)."
By accounting for our assets in this manner, we hope to provide useful
information to stockholders and creditors and to preserve flexibility to sell
assets in the future without having to change accounting methods.
As a result of this mark-to-market accounting treatment, our book value and
book value per share are likely to fluctuate far more than if we used historical
amortized cost accounting. As a result, comparisons with companies that use
historical cost accounting for some or all of their balance sheet may not be
meaningful.
The table below shows unrealized gains and losses on the Investment
Securities in our portfolio.
Unrealized Gains and Losses
---------------------------
(dollars in thousands)
At At At At At
March 31, December 31, September 30, June 30, March 31,
2003 2002 2002 2002 2002
------------------------------------------------------------------
Unrealized Gain $98,768 $90,507 $93,254 $75,832 $46,894
Unrealized Loss (27,768) (14,997) (18,872) (8,549) (16,392)
------------------------------------------------------------------
Net Unrealized Gain $71,000 $75,510 $74,382 $67,283 $30,502
==================================================================
Net Unrealized Gain as Percentage of Investment
Securities Principal Value 0.59% 0.67% 0.67% 0.62% 0.31%
Net Unrealized Gain as Percentage of Investment
Securities Amortized Cost 0.59% 0.67% 0.65% 0.61% 0.30%
Unrealized changes in the estimated net market value of Investment
Securities have one direct effect on our potential earnings and dividends:
positive mark-to-market changes increase our equity base and allow us to
increase our borrowing capacity while negative changes decrease our equity base
and tend to limit borrowing capacity under our capital investment policy. A very
large negative change in the net market value of our Investment Securities might
impair our liquidity position, requiring us to sell assets with the likely
result of realized losses upon sale. "Unrealized Net Gains on Available for Sale
Securities" was $71.0 million, or 0.59% of the amortized cost of our Investment
Securities at March 31, 2003. "Unrealized Net Gains on Available for Sale
Securities" was $75.5 million or 0.67% of the amortized cost of our Investment
Securities at December 31, 2002.
20
The table below shows our equity capital base as reported and on a
historical amortized cost basis at March 31, 2003, December 31, 2002, September
30, 2002, June 30, 2002 and March 31, 2002. Issuances of common stock, the level
of earnings as compared to dividends declared, and other factors influence our
historical cost equity capital base. The reported equity capital base is
influenced by these factors plus changes in the "Unrealized Net Losses on Assets
Available for Sale" account.
Stockholders' Equity
--------------------
Historical Net Unrealized Gains Reported Historical Reported Equity
Amortized Cost (Losses) on Assets Equity Base Amortized Cost (Book Value) Per
Equity Base Available for Sale (Book Value) Equity Per Share Share
---------------------------------------------------------------------------------------
(dollars in thousands, except per share data)
At March 31, 2003 $1,005,712 $71,000 $1,076,712 $11.88 $12.72
- ---------------------------------------------------------------------------------------------------------------
At December 31, 2002 $1,004,555 $75,511 $1,080,066 $11.88 $12.77
At September 30, 2002 $1,010,623 $74,382 $1,085,005 $11.96 $12.84
At June 30, 2002 $982,348 $67,283 $1,049,631 $11.84 $12.65
At March 31, 2002 $978,186 $30,502 $1,008,688 $11.80 $12.17
Leverage
Our debt-to-reported equity ratio at March 31, 2003 and March 31, 2002 was
9.5:1 and 8.3:1, respectively. We generally expect to maintain a ratio of
debt-to-equity of between 8:1 and 12:1, although the ratio may vary from this
range from time to time based upon various factors, including our management's
opinion of the level of risk of our assets and liabilities, our liquidity
position, our level of unused borrowing capacity and over-collateralization
levels required by lenders when we pledge assets to secure borrowings.
Our target debt-to-reported equity ratio is determined under our capital
investment policy. Should our actual debt-to-equity ratio increase above the
target level due to asset acquisition or market value fluctuations in assets, we
will cease to acquire new assets. Our management will, at that time, present a
plan to our Board of Directors to bring us back to our target debt-to-equity
ratio; in many circumstances, this would be accomplished in time by the monthly
reduction of the balance of our Mortgage-Backed Securities through principal
repayments.
Asset/Liability Management and Effect of Changes in Interest Rates
We continually review our asset/liability management strategy with respect
to interest rate risk, mortgage prepayment risk, credit risk and the related
issues of capital adequacy and liquidity. We seek attractive risk-adjusted
stockholder returns while maintaining a strong balance sheet.
We seek to manage the extent to which our net income changes as a function
of changes in interest rates by matching adjustable-rate assets with
variable-rate borrowings. In addition, although we have not done so to date, we
may seek to mitigate the potential impact on net income of periodic and lifetime
coupon adjustment restrictions in our portfolio of Mortgage-Backed Securities by
entering into interest rate agreements such as interest rate caps and interest
rate swaps.
Changes in interest rates may also have an effect on the rate of mortgage
principal prepayments and, as a result, prepayments on Mortgage-Backed
Securities. We will seek to mitigate the effect of changes in the mortgage
principal repayment rate by balancing assets we purchase at a premium with
assets we purchase at a discount. To date, the aggregate premium exceeds the
aggregate discount on our Mortgage-Backed Securities. As a result, prepayments,
which result in the expensing of unamortized premium, will reduce our net income
compared to what net income would be absent such prepayments.
21
Inflation
Virtually all of our assets and liabilities are financial in nature. As a
result, interest rates and other factors drive our performance far more than
does inflation. Changes in interest rates do not necessarily correlate with
inflation rates or changes in inflation rates. Our financial statements are
prepared in accordance with GAAP and our dividends based upon our net income as
calculated for tax purposes; in each case, our activities and balance sheet are
measured with reference to historical cost or fair market value without
considering inflation.
Other Matters
We calculate that our qualified REIT assets, as defined in the Internal
Revenue Code, are 100% of our total assets at March 31, 2003 and 2002, as
compared to the Internal Revenue Code requirement that at least 75% of our total
assets be qualified REIT assets. We also calculate that 100% of our revenue
qualifies for the 75% source of income test, and 100% of our revenue qualifies
for the 95% source of income test, under the REIT rules for the quarters ended
March 31, 2003 and 2002. We also met all REIT requirements regarding the
ownership of our common stock and the distribution of our net income. Therefore,
as of March 31, 2003 and 2002, we believe that we qualified as a REIT under the
Internal Revenue Code.
We at all times intend to conduct our business so as not to become
regulated as an investment company under the Investment Company Act. If we were
to become regulated as an investment company, then our use of leverage would be
substantially reduced. The Investment Company Act exempts entities that are
"primarily engaged in the business of purchasing or otherwise acquiring
mortgages and other liens on and interests in real estate" (qualifying
interests). Under current interpretation of the staff of the SEC, in order to
qualify for this exemption, we must maintain at least 55% of our assets directly
in qualifying interests. In addition, unless certain mortgage securitites
represent all the certificates issued with respect to an underlying pool of
mortgages, the Mortgage-Backed Securities may be treated as securities separate
from the underlying mortgage loans and, thus, may not be considered qualifying
interests for purposes of the 55% requirement. We calculate that as of March 31,
2003 and 2002 we were in compliance with this requirement.
22
ITEM. 3 QUANTITATIVE AND QUALITIATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK
Market risk is the exposure to loss resulting from changes in interest
rates, foreign currency exchange rates, commodity prices and equity prices. The
primary market risk to which we are exposed is interest rate risk, which is
highly sensitive to many factors, including governmental monetary and tax
policies, domestic and international economic and political considerations and
other factors beyond our control. Changes in the general level of interest rates
can affect our net interest income, which is the difference between the interest
income earned on interest-earning assets and the interest expense incurred in
connection with our interest-bearing liabilities, by affecting the spread
between our interest-earning assets and interest-bearing liabilities. Changes in
the level of interest rates also can affect the value of our Mortgage-Backed
Securities and our ability to realize gains from the sale of these assets. We
may utilize a variety of financial instruments; including interest rate swaps,
caps, floors and other interest rate exchange contracts, in order to limit the
effects of interest rates on our operations. If we use these types of
derivatives to hedge the risk of interest-earning assets or interest-bearing
liabilities, we may be subject to certain risks, including the risk that losses
on a hedge position will reduce the funds available for payments to holders of
securities and that the losses may exceed the amount we invested in the
instruments. To date, we have not purchased any hedging instruments.
Our profitability and the value of our portfolio may be adversely affected
during any period as a result of changing interest rates. The following table
quantifies the potential changes in net interest income and portfolio value
should interest rates go up or down 25, 50, and 100 basis points, assuming the
yield curves of the rate shocks will be parallel to each other and the current
yield curve. All changes in income and value are measured as percentage changes
from the projected net interest income and portfolio value at the base interest
rate scenario. The base interest rate scenario assumes interest rates at March
31, 2003 and various estimates regarding prepayment and all activities are made
at each level of rate shock. Actual results could differ significantly from
these estimates.
Projected Percentage Change in Projected Percentage Change in
Change in Interest Rate Net Interest Income Portfolio Value
- ---------------------------------------------------------------------------------------------
- -100 Basis Points -7% 1%
- -50 Basis Points -3% 1%
- -25 Basis Points -1% -
Base Interest Rate
+25 Basis Points 4% (1%)
+50 Basis Points 3% (1%)
+100 Basis Points 2% (2%)
ASSET AND LIABILITY MANAGEMENT
Asset and liability management is concerned with the timing and magnitude
of the repricing of assets and liabilities. We attempt to control risks
associated with interest rate movements. Methods for evaluating interest rate
risk include an analysis of our interest rate sensitivity "gap", which is the
difference between interest-earning assets and interest-bearing liabilities
maturing or repricing within a given time period. A gap is considered positive
when the amount of interest-rate sensitive assets exceeds the amount of
interest-rate sensitive liabilities. A gap is considered negative when the
amount of interest-rate sensitive liabilities exceeds interest-rate sensitive
assets. During a period of rising interest rates, a negative gap would tend to
adversely affect net interest income, while a positive gap would tend to result
in an increase in net interest income. During a period of falling interest
rates, a negative gap would tend to result in an increase in net interest
income, while a positive gap would tend to affect net interest income adversely.
Because different types of assets and liabilities with the same or similar
maturities may react differently to changes in overall market rates or
conditions, changes in interest rates may affect net interest income positively
or negatively even if an institution were perfectly matched in each maturity
category.
23
The following table sets forth the estimated maturity or repricing of our
interest-earning assets and interest-bearing liabilities at March 31, 2003. The
amounts of assets and liabilities shown within a particular period were
determined in accordance with the contractual terms of the assets and
liabilities, except adjustable-rate loans, and securities are included in the
period in which their interest rates are first scheduled to adjust and not in
the period in which they mature. Mortgage-Backed Securities reflect estimated
prepayments that were estimated based on analyses of broker estimates, the
results of a prepayment model that we utilized and empirical data. Our
management believes that these assumptions approximate actual experience and
considers them reasonable; however, the interest rate sensitivity of our assets
and liabilities in the table could vary substantially if different assumptions
were used or actual experience differs from the historical experience on which
the assumptions are based.
More than 1
Within 3 Year to 3 3 Years and
Months 4-12 Months Years Over Total
--------------------------------------------------------------------------
(dollars in thousands)
Rate Sensitive Assets:
Investment Securities $3,660,612 $950,270 $2,468,640 $4,878,188 $11,957,710
Rate Sensitive Liabilities:
Repurchase Agreements 8,615,485 112,700 1,463,864 - 10,192,049
--------------------------------------------------------------------------
Interest rate sensitivity gap ($4,954,873) $837,570 $1,004,776 $4,878,188 $1,765,661
==========================================================================
Cumulative rate sensitivity gap ($4,954,873) ($4,117,303) ($3,112,527) $1,765,661
==========================================================================
Cumulative interest rate
sensitivity gap as a percentage
of total rate-sensitive assets (41%) (34%) (26%) 15%
Our analysis of risks is based on management's experience, estimates,
models and assumptions. These analyses rely on models which utilize estimates of
fair value and interest rate sensitivity. Actual economic conditions or
implementation of investment decisions by our management may produce results
that differ significantly form the estimates and assumptions used in our models
and the projected results shown in the above tables and in this report. These
analyses contain certain forward-looking statements and are subject to the safe
harbor statement set forth under the heading, "Special Note Regarding
Forward-Looking Statements."
ITEM 4. CONTROLS AND PROCEDURES
As of March 31, 2003, an evaluation was performed under the supervision and
with the participation of our management, including the Chairman of the board of
directors, Chief Executive Officer and President and the Chief Financial Officer
and Treasurer, of the effectiveness of the design and operation of our
disclosure controls and procedures. Based on that evaluation, our management,
including the Chairman of the board of directors, Chief Executive Officer and
President and the Chief Financial Officer and Treasurer, concluded that our
disclosure controls and procedures were effective as of March 31, 2003. There
have been no significant changes in our internal controls or in other factors
that could significantly affect internal controls subsequent to March 31, 2003.
24
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit Index
Exhibit Number Exhibit Description
99.1 Certification of Chief Executive Officer regarding
Periodic Report containing Financial Statements.
99.2 Certification of Chief Financial Officer regarding
Periodic Report containing Financial Statements.
(b) Reports of Form 8-K
We filed the following current reports on Form 8-K subsequent to the first
quarter 2003:
We filed a Form 8-K on April 29, 2003 for our press release dated April 25,
2003
We filed a Form 8-K on April 1, 2003 with respect to our entering into a
Underwriting Agreement with UBS Warburg LLC, Merrill Lynch, Pierce, Fenner &
Smith Incorporated, and U.S. Bancorp Piper Jaffray Inc. as representatives of
the several underwriters (collectively, the "Underwriters"), relating to the
sale of 8,200,000 shares of common stock, par value $0.01 per share (the "Common
Stock"), and the granting of an over-allotment option for an additional
1,100,700 shares of Common Stock to the Underwriters to fulfill over-allotments.
25
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ANNALY MORTGAGE MANAGEMENT, INC.
Dated: May 13, 2003 By:/s/ Michael A.J. Farrell
---------------------------
Michael A.J. Farrell
(Chairman of the Board, Chief Executive Officer,
President and authorized officer of registrant)
Dated: May 13, 2003 By:/s/ Kathryn F. Fagan
---------------------------
Kathryn F. Fagan
(Chief Financial Officer and Treasurer
principal financial and chief accounting officer)
I, Michael A.J. Farrell, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Annaly Mortgage
Management, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 13, 2003
/s/ Michael A.J. Farrell
------------------------
Michael A.J. Farrell
Chairman of the Board of Directors, Chief Executive
Officer, President and principal executive officer
26
I, Kathryn F. Fagan, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Annaly Mortgage
Management, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 13, 2003
/s/ Kathryn F. Fagan
--------------------
Kathryn F. Fagan
Chief Financial Officer, Treasurer and Principal
Financial Officer
27