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: SEPTEMBER 30, 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
incorporation or organization) Identification No.)
1211 AVENUE OF THE AMERICAS, SUITE 2902
NEW YORK, NEW YORK
(Address of principal executive offices)
10036
(Zip Code)
(212) 696-0100
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all documents and
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days:
Yes X No
----- ----
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2) of the Exchange Act:
Yes X No
----- ----
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
stock, as of the last practicable date:
Class Outstanding at November 12, 2003
Common Stock, $.01 par value 96,013,214
Annaly Mortgage Management, Inc.
FORM 10-Q
INDEX
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Statements of Financial Condition- September 30, 2003 (Unaudited) and December 31, 2002 1
Statements of Operations (Unaudited) for the quarters and nine months ended 2
September 30, 2003 and 2002
Statements of Stockholders' Equity (Unaudited) for the nine months ended September 30, 2003 3
Statements of Cash Flows (Unaudited) for the quarters and nine months ended 4
September 30, 2003 and 2002
Notes to Financial Statements (Unaudited) 5-13
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 15-25
Item 3. Quantitative and Qualitative Disclosures about Market Risk 26
Item 4. Controls and Procedures 27
Part II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 28
SIGNATURES 29
CERTIFICATIONS 30-33
PART I.
ITEM 1. FINANCIAL STATEMENTS
ANNALY MORTGAGE MANAGEMENT, INC.
STATEMENTS OF FINANCIAL CONDITION
(dollars in thousands, except for share data)
SEPTEMBER DECEMBER 31,
30, 2003 2002
(UNAUDITED)
------------ ------------
ASSETS
Cash and cash equivalents $3,381 $726
Mortgage-Backed Securities, at fair value 11,628,271 11,551,857
Agency Debentures, at fair value 976,814 -
Receivable for Mortgage-Backed Securities sold 177,304 55,954
Accrued interest receivable 53,955 49,707
Other assets 1,233 840
------------ ------------
Total assets $12,840,958 $11,659,084
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Repurchase agreements $11,201,897 $10,163,174
Payable for Mortgage-Backed Securities purchased 445,148 338,691
Accrued interest payable 13,868 14,935
Dividends payable 26,876 57,499
Other liabilities 4,294 2,812
Accounts payable 3,147 1,907
------------ ------------
Total liabilities 11,695,230 10,579,018
------------ ------------
Stockholders' Equity:
Common stock: par value $.01 per share; 500,000,000
Authorized 95,964,915 and 84,569,206 shares issued
and outstanding, respectively 960 846
Additional paid-in capital 1,192,819 1,003,200
Accumulated other comprehensive gain (loss) (51,870) 75,511
Retained earnings 3,819 509
------------ ------------
Total stockholders' equity 1,145,728 1,080,066
------------ ------------
Total liabilities and stockholders' equity $12,840,958 $11,659,084
============ ============
See notes to financial statements.
1
PART I.
ITEM 1. FINANCIAL STATEMENTS
ANNALY MORTGAGE MANAGEMENT, INC.
STATEMENTS OF OPERATIONS
(UNAUDITED)
(dollars in thousands, except per share amounts)
For the For the For the Nine For the Nine
Quarter Ended Quarter Ended Months Ended Months Ended
September 30, September 30, September 30, September 30,
2003 2002 2003 2002
------------------------------- -------------- -----------------
INTEREST INCOME $66,855 $109,201 $248,247 $311,524
INTEREST EXPENSE 43,922 54,012 139,740 141,884
-------------- --------------- -------------- -----------------
NET INTEREST INCOME 22,933 55,189 108,507 169,640
GAIN ON SALE OF MORTGAGE- BACKED
SECURITIES 9,656 4,747 40,907 9,500
GENERAL AND ADMINISTRATIVE
EXPENSES 4,110 3,268 12,008 10,059
-------------- --------------- -------------- -----------------
NET INCOME 28,479 56,668 137,406 169,081
-------------- --------------- -------------- -----------------
OTHER COMPREHENSIVE INCOME (LOSS):
Unrealized gain (loss) on
available-
for-sale securities (43,405) 11,846 (86,474) 45,713
Less: reclassification
adjustment
for net gains included in net
income (9,656) (4,747) (40,907) (9,500)
-------------- --------------- -------------- -----------------
Other comprehensive income (loss) (53,061) 7,099 (127,381) 36,213
-------------- --------------- -------------- -----------------
COMPREHENSIVE INCOME (LOSS) $(24,582) $63,767 $10,025 $205,294
============== =============== ============== =================
NET INCOME PER SHARE:
Basic $0.30 $0.68 $1.51 $2.08
============== =============== ============== =================
Diluted $0.30 $0.68 $1.50 $2.07
============== =============== ============== =================
WEIGHTED AVERAGE NUMBER OF SHARES
OUTSTANDING:
Basic 94,685,685 83,668,422 90,929,196 81,206,156
============== =============== ============== =================
Diluted 95,500,486 83,939,870 91,750,472 81,490,436
============== =============== ============== =================
See notes to financial statements.
2
PART I
ITEM 1. FINANCIAL STATEMENTS
ANNALY MORTGAGE MANAGEMENT, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003
(UNAUDITED)
(dollars in thousands, except per share amounts)
Common Additional Other
Stock Paid-In Comprehensive Retained Comprehensive
Par Capital Income Earnings Income Total
Value
---------------------------------------------------------------
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 loss 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 and dividend
reinvestment - 955 955
Dividends declared for the quarter
ended March 31, 2003,
$0.60 per share (50,788) (50,788)
----------------- ---------------------------------
BALANCE, MARCH 31, 2003 $846 $1,004,370 $496 $71,000 $1,076,712
Net Income $58,152 58,152
Other comprehensive income:
Unrealized net loss on securities,
net of reclassification adjustment (69,810) (69,810)
-------------
Comprehensive loss $(11,658) (11,658)
=============
Exercise of stock options - 154 154
Proceeds from direct purchase and dividend
reinvestment 1 1,346 1,347
Proceeds from subsequent offering 93 151,222 151,315
Dividends declared for the quarter
ended June 30, 2003,
$0.60 per share (56,432) (56,432)
----------------- ---------------------------------
BALANCE, JUNE 30, 2003 $940 $1,157,092 $2,216 $1,190 $1,161,438
Net Income $28,479 28,479
Other comprehensive income:
Unrealized net loss on securities,
net of reclassification adjustment (53,061) (53,060)
-------------
Comprehensive loss $(24,582) (24,581)
=============
Exercise of stock options - 17 17
Proceeds from direct purchase and dividend
reinvestment 1 1,004 1,005
Proceeds from equity shelf program offering 19 34,706 34,725
Dividends declared for the quarter
ended September 30, 2003,
$0.28 per average share (26,876) (26,876)
----------------- ---------------------------------
BALANCE, SEPTEMBER 30, 2003 $960 $1,192,819 $3,819 $(51,870)$1,145,728
================= =================================
See notes to financial statements.
3
PART I
ITEM 1. FINANCIAL STATEMENTS
ANNALY MORTGAGE MANAGEMENT, INC.
STATEMENTS OF CASH FLOWS
(UNAUDITED)
(dollars in the thousands)
For the For the For the NineFor the Nine
Quarter Quarter Months Months
Ended Ended Ended Ended
September September September September
30, 30, 30, 2003 30, 2002
2003 2002
------------------------------------------------
Cash flows from operating activities:
Net income $28,479 $56,668 $137,406 $169,081
Adjustments to reconcile net income to net cash
provided by operating activities:
Amortization of mortgage premiums and
discounts, net 72,047 28,229 178,180 65,917
Gain on sale of Mortgage-Backed Securities (9,656) (4,747) (40,907) (9,500)
Stock option expense - - 60 163
Market value adjustment on long-term
repurchase agreement (313) 1,252 1,783 883
Decrease (increase) in accrued interest receivable 4,071 903 (4,248) (3,146)
Increase in other assets (129) (15) (394) (1,061)
(Decrease) increase in accrued interest payable (2,919) 7,325 (1,067) 11,992
Increase in accounts payable 945 233 1,240 1,084
------------------------------------------------
Net cash provided by operating activities 92,525 89,848 272,053 235,413
------------------------------------------------
Cash flows from investing activities:
Purchase of Mortgage-Backed Securities (2,571,157) (2,021,616) (9,788,410) (8,011,359)
Purchase of agency debentures (394,940) - (1,735,940) -
Proceeds from sale of Mortgage-Backed Securities 596,487 321,237 2,708,880 1,129,673
Proceeds from callable agency debentures 575,000 - 746,000 -
Principal payments of Mortgage-Backed
Securities 2,686,374 1,014,235 6,736,696 2,972,127
------------------------------------------------
Net cash provided by (used in) in investing
activities 891,764 (686,144) (1,332,774) (3,909,559)
------------------------------------------------
Cash flows from financing activities:
Proceeds from repurchase agreements 32,273,478 18,851,415 87,956,308 60,801,326
Principal payments on repurchase agreements (33,234,016)(18,226,432)(86,917,886)(57,359,369)
Proceeds from exercise of stock options 17 123 327 608
Proceeds from direct purchase and dividend
reinvestment 1,004 859 3,306 2,249
Net proceeds from offerings 34,725 28,102 186,040 375,439
Dividends paid (56,420) (56,415) (164,720) (144,534)
------------------------------------------------
Net cash provided by (used in) financing
activities (981,212) 597,652 1,063,375 3,675,719
------------------------------------------------
Net increase in cash and cash equivalents 3,077 1,356 2,655 1,573
Cash and cash equivalents, beginning of period 304 646 726 429
------------------------------------------------
Cash and cash equivalents, end of period $3,381 $2,002 $3,381 $2,002
================================================
Supplemental disclosure of cash flow information:
Interest paid $46,842 $46,687 $140,807 $129,892
================================================
Noncash financing activities:
Net change in unrealized (loss) gain on available-
for-sale securities net of reclassification
adjustment $(53,061) $7,099 $(127,381) $36,213
================================================
Dividends declared, not yet paid $26,876 $57,465 $26,876 $57,465
================================================
See notes to financial statements.
4
ANNALY MORTGAGE MANAGEMENT, INC.
NOTES TO FINANCIAL STATEMENTS
FOR THE QUARTERS AND NINE MONTHS ENDED SEPTEMBER 30, 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 primarily Mortgage-Backed
Securities and Agency Securities (as defined below) 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 periods 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 Agency Debentures - The Company invests
primarily in mortgage pass-through certificates, collateralized mortgage
obligations and other mortgage-backed securities representing interests in or
obligations backed by pools of mortgage loans (collectively, "Mortgage-Backed
Securities"). The Company also invests in Federal Home Loan Bank ("FHLB"),
Federal Home Loan Mortgage Corporation ("FHLMC"), and Federal National Mortgage
Association ("FNMA") debentures. The Mortgage-Backed Securities and agency
debentures are collectively referred to herein as "Investment Securities."
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 nine months ended September 30, 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 Investment Securities are amortized into
interest income over the lives of the securities using the interest method.
5
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.
Credit Risk - At September 30, 2003 and December 31, 2002, the Company
has limited its exposure to credit losses on its portfolio of Investment
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 and FHLB
Investment 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 September 30,
2003 and December 31, 2002 all of the Company's Investment Securities have an
actual or implied "AAA" rating.
Repurchase Agreements -The Company finances the acquisition of its
Investment Securities through the use of repurchase agreements. Repurchase
agreements are treated as collateralized financing transactions and are carried
at their contractual amounts, including accrued interest, as specified in the
respective agreements. Accrued interest is recorded as a separate line item.
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 GAAP requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
6
2. MORTGAGE-BACKED SECURITIES
The following table pertains to the Company's Mortgage-Backed
Securities classified as available-for-sale as of September 30, 2003, which are
carried at their fair value:
Federal Home Loan Federal National Government National Total Mortgage-Backed
Mortgage Corporation Mortgage Association Mortgage Association Securities
---------------------- --------------------- --------------------- ---------------------
(dollars in thousands)
Mortgage-Backed
Securities, gross $3,886,310 $7,105,907 $381,044 $11,373,261
Unamortized discount (19) (1,070) - (1,089)
Unamortized premium 84,525 203,973 6,345 294,843
---------------------- --------------------- --------------------- ---------------------
Amortized cost 3,970,816 7,308,810 387,389 11,667,015
Gross unrealized gains 12,075 14,891 473 27,439
Gross unrealized losses (20,406) (43,340) (2,437) (66,183)
---------------------- --------------------- --------------------- ---------------------
Estimated fair value $3,962,485 $7,280,361 $385,425 $11,628,271
====================== ===================== ===================== =====================
Amortized Cost Gross Unrealized Gain Gross Unrealized Loss Estimated Fair Value
---------------------- --------------------- --------------------- ---------------------
(dollars in thousands)
Adjustable rate $ 7,740,589 $23,197 $(29,228) $ 7,734,558
Fixed rate 3,926,426 4,242 (36,955) 3,893,713
---------------------- --------------------- --------------------- ---------------------
Total $11,667,015 $27,439 $(66,183) $11,628,271
====================== ===================== ===================== =====================
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 National Total Mortgage-Backed
Mortgage Corporation Mortgage Association Mortgage Association Securities
---------------------- --------------------- --------------------- ---------------------
(dollars in thousands)
Mortgage-Backed
Securities, gross $5,120,929 $5,860,987 $ 220,468 $11,202,384
Unamortized discount (544) - (664)
(120)
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 90,507
537
Gross unrealized losses (9,554) (5,318) (125) (14,997)
---------------------- --------------------- --------------------- ---------------------
Estimated fair value $5,248,434 $ 6,077,859 $ 225,564 $11,551,857
====================== ===================== ===================== =====================
7
Amortized Cost Gross Unrealized Gain Gross Unrealized Loss Estimated Fair 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 10.2% at
September 30, 2003 and 8.8% at December 31, 2002.
During the nine months ended September 30, 2003, the Company realized
$40.9 million in gains from sales of Mortgage-Backed Securities. During the nine
months ended September 30, 2002, the Company realized $9.5 million in gains from
sales of Mortgage-Backed Securities.
3. AGENCY DEBENTURES
At September 30, 2003, the Company owned callable agency debentures
totaling $990.0 million par value. FHLMC, FNMA, and FHLB are the issuers of the
debentures. All of the Company's agency debentures are classified as
available-for-sale. The unrealized loss on the Company's agency debentures at
September 30, 2003 was $13.1 million. The Company's agency debentures are
adjustable rate and fixed rate with a weighted average lifetime cap of 5.80%.
4. REPURCHASE AGREEMENTS
The Company had outstanding $11.2 billion and $10.2 billion of
repurchase agreements with a weighted average borrowing rate of 1.46% and 1.72%
and a weighted average remaining maturity of 74 days and 124 days as of
September 30, 2003 and December 31, 2002, respectively.
At September 30, 2003 and December 31, 2002, the repurchase agreements
had the following remaining maturities:
September 30, 2003 December 31, 2002
------------------------------- ----------------------------
(dollars in thousands)
Within 30 days $ 9,484,851 $ 7,778,003
30 to 59 days 252,980 816,906
60 to 89 days - 104,500
90 to 119 days - -
Over 120 days 1,464,066 1,463,765
------------------------------- ----------------------------
Total $11,201,897 $10,163,174
=============================== ============================
5. OTHER LIABILITIES
In July 2001, the Company entered into a repurchase agreement maturing
in July 2004 which grants the buyer the right to extend the agreement, 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 $1,205,000 allocated to the interest rate floor 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
September 30, 2003, the fair value of this interest rate floor was a $4,294,000
and was classified as other liabilities.
8
6. COMMON STOCK
During the nine months ended September 30, 2003, the Company declared
dividends to shareholders totaling $134,096,000 or $1.48 per share, which
$26,876,000 was paid on October 29, 2003. On April 1, 2003 the Company entered
into an underwriting agreement pursuant to which the Company raised net proceeds
of approximately $151.3 million in equity in a subsequent offering of 9,300,700
shares of common stock. During the nine months ended September 30, 2003,
1,879,600 shares were issued through the Equity Shelf Program, totaling net
proceeds of $34.7 million. During the nine months ended September 30, 2003,
37,622 options were exercised under the long-term compensation plan at $387,000.
Also, 177,787 shares were purchased in the dividend reinvestment and direct
purchase program at $3,305,000.
During the Company's year ended 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, the Company completed an offering
of common stock in the first quarter issuing 23,000,000 shares, with aggregate
net proceeds of approximately $347,337,000. Through the Equity Shelf Program,
the Company raised $28,103,000 in net proceeds and issued 1,484,100 shares.
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. Also, 165,480 shares were purchased in dividend
reinvestment and share purchase plan, totaling $3,009,000.
7. EARNINGS PER SHARE (EPS)
For the quarter ended September 30, 2003, the reconciliation is as
follows:
For the Quarter Ended September 30, 2003
(dollars in thousands, except per share amounts)
------------------- --------------------- ---------------------
Weighted Average
Income Shares Per-Share
(Numerator) (Denominator) Amount
------------------- --------------------- ---------------------
Net income $28,479
-------------------
Basic earnings per share $28,479 94,686 $0.30
=====================
Effect of dilutive securities:
Dilutive stock options 814
------------------- ---------------------
Diluted earnings per share $28,479 95,500 $0.30
=================== ===================== =====================
Options to purchase 12,500 shares of stock were outstanding and
considered anti-dilutive as their exercise price exceeded the average stock
price for the quarter.
9
For the quarter ended September 30, 2002, the reconciliation is as
follows:
For the Quarter Ended September 30, 2002
(dollars in thousands, except per share amounts)
---------------------------------------------------------------
Weighted Average
Income Shares Per-Share
(Numerator) (Denominator) Amount
------------------- --------------------- ---------------------
Net income $56,668
-------------------
Basic earnings per share $56,668 83,668 $0.68
=====================
Effect of dilutive securities:
Dilutive stock options 271
------------------- ---------------------
Diluted earnings per share $56,668 83,939 $0.68
=================== ===================== =====================
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 nine months ended September 30, 2003, the reconciliation is as
follows:
For the Nine Months Ended September 30, 2003
(dollars in thousands, except per share amounts)
---------------------------------------------------------------
Weighted Average
Income Shares Per-Share
(Numerator) (Denominator) Amount
------------------- --------------------- ---------------------
Net income $137,406
-------------------
Basic earnings per share $137,406 90,929 $1.51
=====================
Effect of dilutive securities:
Dilutive stock options 821
------------------- ---------------------
Diluted earnings per share $137,406 91,750 $1.50
=================== ===================== =====================
Options to purchase 12,500 shares of stock were outstanding and
considered anti-dilutive as their exercise price exceeded the average stock
price for the nine months ended September 30, 2003.
10
For the nine months ended September 30, 2002, the
reconciliation is as follows:
For the Nine Months Ended September 30, 2002
(dollars in thousands, except per share amounts)
---------------------------------------------------------------
Weighted Average
Income Shares Per-Share
(Numerator) (Denominator) Amount
------------------- --------------------- ---------------------
Net income $169,081
-------------------
Basic earnings per share $169,081 81,206 $2.08
=====================
Effect of dilutive securities:
Dilutive stock options 284
------------------- ---------------------
Diluted earnings per share $169,081 81,490 $2.07
=================== ===================== =====================
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 nine months ended September 30, 2002.
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 following table sets forth activity relating to the Company's stock
options awards
For the nine months ended September For the nine months ended September
30, 2003 30, 2002
Weighted Average Weighted Average
Number of Shares Exercise Price Number of Shares Exercise Price
Options outstanding at
the beginning of period 512,706 $8.59 635,826 $8.48
Granted 643,450 18.00 6,250 20.35
Exercised (37,622) 8.69 (77,032) 8.87
Expired - - (32,275) 8.28
-------------------- ------------------ ------------------ -------------------
Options outstanding at
the end of period 1,118,534 $14.00 532,769 $8.58
==================== ================== ================== ===================
Options exercisable
at end of period 346,514 $8.90 319,198 $8.71
11
The following table summarizes information about stock options
outstanding at September 30, 2003:
Range of Exercise Prices Options Outstanding Weighted Average Exercise Weighted Average Remaining
Price Contractual Life (Years)
$7.94-$19.99 1,106,034 $13.93 8.2
$20.00-$29.99 12,500 20.53 4.3
---------------------------- ---------------------------- ----------------------------
1,118,534 $14.00 8.1
============================ ============================ ============================
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 SFAS No. 123, 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.
There were 643,450 stock options granted during the nine months ended September
30, 2003. There were 6,250 stock options granted during the nine months ended
September 30, 2002. The weighted average fair value at date of grant for stock
options granted during the nine months ended September 30, 2003 and 2002 was
$1.52 and $0.83 per option, respectively. The fair value of stock options at
date of grant was estimated using the Black-Scholes option pricing model
utilizing the following weighted average assumptions:
For the Nine Months Ended September 30,
2003 2002
---------------------------------------------
Risk-free interest rate 4.28% 2.49%
Expected option life in years 9.95 5
Expected stock price volatility 29% 22%
Expected dividend yield 9.15% 11.28%
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 For the Nine Months Ended
September 30, September 30,
2003 2002 2003 2002
----------- ------------- ---------------- --------------
Net income, as reported $28,479 $56,668 $137,406 $169,081
Deduct: Total stock-based employee compensation
expense determined under fair value based method
(29) (5) (86) (14)
----------- ------------- ---------------- --------------
Pro-forma net income $28,450 $56,663 $137,320 $169,067
=========== ============= ================ ==============
Net income per share, as reported
Basic $0.30 $0.68 $1.51 $2.08
Diluted $0.30 $0.68 $1.50 $2.07
Pro-forma net income per share $0.30 $0.68 $1.51 $2.08
Basic $0.30 $0.68 $1.50 $2.07
Diluted
12
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 September 30, 2003
and December 31, 2002 held securities classified as available-for-sale. At
September 30, 2003, the net unrealized loss totaled $51.9 million and at
December 31, 2002, the net unrealized gain totaled $75.5 million.
10. LEASE COMMITMENTS
The Company 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:
(dollars in thousands)
------------------------
2003 500
2004 500
2005 500
2006 530
2007 532
Thereafter 1,064
------------------------
Total remaining lease payments $3,626
========================
11. RELATED PARTY TRANSACTION
Michael A.J. Farrell, our Chairman of the Board, Chief Executive Officer
and President, Wellington J. Denahan, our Vice Chairman and Chief Investment
Officer, Kathryn F. Fagan, our Chief Financial Officer and Treasurer, Jennifer
A. Stephens, our Executive Vice President and Secretary, and other of the
Company's officers and employees are the shareholders of Fixed Income Discount
Advisory Company (or FIDAC). Mr. Farrell, Ms. Denahan and other officers and
employees are actively involved in managing mortgage-backed securities and other
fixed income assets on behalf of FIDAC.
Mr. Farrell, on behalf of FIDAC, approached the Company about the
possibility of acquiring FIDAC. The Company's board of directors formed a
special committee of independent directors to consider this matter and the
special committee retained independent counsel and an independent financial
adviser to assist it. The special committee has determined that the Company
should explore the possible acquisition of FIDAC.
The Company is currently engaged in discussions with FIDAC regarding the
Company's potential acquisition of FIDAC, the outcome of which is uncertain. The
price and terms of the proposed acquisition of FIDAC have not yet been
determined. The Company's management believes, however, that if a transaction
were to go forward the purchase price will be payable in shares of the Company's
common stock.
No assurances can be made as to whether or when the Company will acquire
FIDAC. The Company cannot predict the terms and conditions of the proposed
acquisition. Either party may at any time determine not to proceed with this
proposed acquisition without any further obligation. In addition, the Company
cannot be sure of the potential consequences of acquiring or not acquiring
FIDAC.
If the Company is able to reach an agreeement to acquire FIDAC, the
proposed acquisition will be submitted to a vote of our stockholders.
13
If we are able to reach an agreement to acquire FIDAC, we expect that
the proposed acquisition will be submitted to a vote of our stockholders.
Our management currently allocates rent and other general and
administrative expenses in the amounts of 90% and 10% to the Company 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
Investment 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.
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Special Note Regarding Forward-Looking Statements
Certain statements contained in this quarterly report, and certain
statements contained in our future filings with the Securities and Exchange
Commission (the "SEC" or the "Commission"), in our press releases or in our
other public or shareholder communications may not be, based on historical facts
and are "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Forward-looking statements which are
based on various assumptions, (some of which are beyond our control) may be
identified by reference to a future period or periods, or by the use of
forward-looking terminology, such as "may," "will," "believe," "expect,"
"anticipate," "continue," or similar terms or variations on those terms, or the
negative of those terms. Actual results could differ materially from those set
forth in forward-looking statements due to a variety of factors, including, but
not limited to, changes in interest rates, changes in yield curve, changes in
prepayment rates, the availability of mortgage backed securities for purchase,
the availability of financing and, if available, the terms of any financing. 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 that owns and manages a portfolio of Investment Securities
which consist of Mortgage-Backed Securities and agency debentures. Our principal
business objective is to generate net income for distribution to our
stockholders from the spread between the interest income on our Investment
Securities and the costs of borrowing to finance our acquisition of Investment
Securities.
Critical Accounting Policies
Management's discussion and analysis of financial condition and results
of operations is based on the amounts reported in our financial statements.
These financial statements are prepared in conformity with GAAP. In preparing
the financial statements, management is required to make various judgments,
estimates and assumptions that affect the reported amounts. Changes in these
estimates and assumptions could have a material effect our financial statements.
The following is a summary our policies that is 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 Investment 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 and Nine months ended September 30,
2003 and 2002
Net Income Summary
For the quarter ended September 30, 2003, our net income was $28.5
million, or $0.30 basic earnings per average share, as compared to $56.7
million, or $0.68 basic earnings per average share, for the quarter ended
September 30, 2002. We attribute the decrease in net income for the quarter
15
ended September 30, 2003, over the quarter ended September 30, 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 believe the decline
in net income is due to the extremely high levels of mortgage refinancings which
resulted in very high levels of premium amortization on our Investment
Securities. 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 94,685,685 for the quarter ended September 30, 2003 and 83,668,422 for
the quarter ended September 30, 2002. Dividends per share outstanding for the
quarter ended September 30, 2003 was $0.28 per share, or $26.9 million in total.
Dividends per actual share outstanding for the quarter ended September 30, 2002
was $0.68 per share, or $57.5 million in total. Our return on average equity was
9.88 % for the quarter ended September 30, 2003 and 21.24% for the quarter ended
September 30, 2002. The decline in the return on average equity resulted from
the declining interest rate spread.
For the nine months ended September 30, 2003, our net income was $137.4
million, or $1.51 basic earnings per average share, as compared to $169.1
million, or $2.08 basic earnings per average share, for the nine months ended
September 30, 2002. We attribute the decrease in net income for the nine month
period ended September 30, 2003, over the nine month period ended September 30,
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.
As noted above, the extremely high levels of premium amortization on our
Investment Securities has reduced our net income, primarily in the third quarter
of 2003. 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 90,929,196 for the nine months ended September 30, 2003 and 81,206,156
for the nine months ended September 30, 2002. Dividends per actual share
outstanding for the nine months ended September 30, 2003 was $1.48 per share, or
$134.1 million in total. Dividends per actual share outstanding for the nine
months ended September 30, 2002 was $1.99 per share, or $166.1 million in total.
Our annualized return on average equity was 16.42% for the nine months ended
September 30, 2003 and 23.67% for the nine months ended September 30, 2002.
Net Income Summary
(dollars in the thousands, except for per-share amounts)
Quarter Ended Quarter Ended Nine Months Nine Months
September Ended Ended
September 30, 30, 2002 September 30, September 30,
2003 2003 2002
---------------- --------------- --------------- ----------------
Interest Income $66,855 $109,201 $248,247 $311,524
Interest Expense 43,922 54,012 139,740 141,884
---------------- --------------- --------------- ----------------
Net Interest Income 22,933 55,189 108,507 169,640
Gain on Sale of Investment Securities 9,656 4,747 40,907 9,500
General and Administrative Expenses 4,110 3,268 12,008 10,059
---------------- --------------- --------------- ----------------
Net Income $28,479 $56,668 $137,406 $169,081
================ =============== =============== ================
Weighted Average Number of Basic Shares
Outstanding 94,685,685 83,668,422 90,929,196 81,206,156
Weighted Average Number of Diluted Shares
Outstanding 95,500,486 83,939,870 91,750,472 81,490,436
Basic Net Income Per Share 0.30 0.68 $1.51 $2.08
Diluted Net Income Per Share 0.30 0.68 $1.50 $2.07
Average Total Assets $13,775,543 $11,398,653 $12,971,228 $10,193,258
Average Equity $1,153,583 $1,067,212 $1,115,986 $952,617
Annualized Return on Average Assets 0.83% 1.99% 1.41% 2.21%
Annualized Return on Average Equity 9.88% 21.24% 16.42% 23.67%
16
Interest Income and Average Earning Asset Yield
We had average earning assets of $12.6 billion and $10.7 billion for
the quarters ended September 30, 2003 and 2002, respectively. Our primary source
of income for the quarters ended September 30, 2003 and 2002 was interest
income. A portion of our income was generated by gains on the sales of our
Investment Securities. Our interest income was $66.9 million for the quarter
ended September 30, 2003 and $109.2 million for the quarter ended September 30,
2002. Our yield on average earning assets was 2.13% and 4.10% for the same
respective periods. Our average earning asset balance increased by $1.9 billion
and interest income decreased by $42.3 million for the quarter ended September
30, 2003 as compared to the quarter ended September 30, 2002, due to the
substantial decline in the yield on interest-earning assets because of increased
premium amortization. The decline in the yield was the result of increased
prepayment speeds and reduced coupons.
We had average earning assets of $12.1 billion and $9.3 billion for the
nine months ended September 30, 2003 and 2002, respectively. Our interest income
was $248.2 million for the nine months ended September 30, 2003 and $311.5
million for the nine months ended September 30, 2002. Our yield on average
earning assets was 2.74 % and 4.47 % for the same respective periods. Our
average earning asset balance increased by $2.8 billion and interest income
decreased by $63.3 million for the nine months ended September 30, 2003 as
compared to the nine months ended September 30, 2002. The average earning assets
increased as a result of the equity offering in the second quarter of 2003 and
the equity shelf program in the third quarter of 2002. The table below shows our
average balance of cash equivalents and investment securities, the yields we
earned on each type of earning asset, our yield on average earning assets and
our interest income for the quarter ended September 30, 2003, June 30, 2003
March 31, 2003, the year ended December 31, 2002 and the four quarters in 2002.
Average Earning Asset Yield
(dollars in thousands)
(ratios for the quarters have been annualized )
Yield on
Yield on Yield on Average
Average Average Average Average Average Interest
Cash Investment Earning Cash Investment Earning Interest
EquivalentsSecurities Assets Equivalents Securities Assets Income
For the Quarter Ended September 30,2003 - $12,577,165 $12,577,165 - 2.13% 2.13% $66,855
For the Quarter Ended June 30, 2003 - $12,815,290 $12,815,290 - 2.93% 2.93% $93,892
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, $2 $10,661,228 $10,661,230 1.14% 4.10% 4.10% $109,201
2002
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 September 30, 2003 and 2002 48% and 34% 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 September 30, 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 had average borrowed funds of $12.2 billion and total interest
expense of $43.9 million for the quarter ended September 30, 2003. We had
average borrowed funds of $10.1 billion and total interest expense of $54.0
million for the quarter ended September 30, 2002. Our average cost of funds was
1.44 % for the quarter ended September 30, 2003 and 2.13% for the quarter ended
September 30, 2002. The cost of funds rate decreased
69 basis points and the average borrowed funds increased by $2.1 billion for
the quarter ended September 30, 2003 when compared to the quarter ended
September 30, 2002. Interest expense for the quarter decreased 19% due to the
large decline in the average cost of funds.
17
We had average borrowed funds of $11.7 billion and total interest
expense of $139.7 million for the nine months ended September 30, 2003. We had
average borrowed funds of $8.8 billion and total interest expense of $141.9
million for the nine months ended September 30, 2002. Our average cost of funds
was 1.60 % for the nine months ended September 30, 2003 and 2.15 % for the nine
months ended September 30, 2002. The cost of funds rate decreased 55 basis
points and the average borrowed funds increased by $2.9 billion for the nine
months ended September 30, 2003 when compared to the nine months ended September
30, 2002.
The table below shows our average borrowed funds, interest expense and
average cost of funds as compared to average one-month and average six-month
LIBOR for the quarters ended September 30, 2003, June 30, 2003, March 31, 2003,
the year ended December 31, 2002 and the four quarters in 2002.
Average Cost of Funds
(dollars in thousands)
(ratios for the quarters have been annualized)
Average
One-Month Average Cost Average Cost
LIBOR Less of Funds of Funds Less
Average Average Average Average Average Less Average to Average
Borrowed InterestCost of One-MonthSix-Month Six-Month One-Month Six-Month
Funds Expense Funds LIBOR LIBOR LIBOR LIBOR LIBOR
For the Quarter Ended
September 30, 2003 $12,186,985 $43,922 1.44% 1.11% 1.17% (0.06%) 0.33% 0.27%
For the Quarter Ended
June 30, 2003 $12,311,329 $51,770 1.68% 1.26% 1.20% 0.06% 0.42% 0.48%
For the Quarter Ended
March 31, 2003 $10,463,252 $44,048 1.68% 1.34% 1.33% 0.01% 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%
Our net interest income, which equals interest income less interest
expense, totaled $22.9 million for the quarter ended September 30, 2003 and
$55.2 million for the quarter ended September 30, 2002. Our net interest income
decreased because of the decline in net interest spread. This decline in spread
is the direct result of the low interest rate environment and the high
prepayment speeds. 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
0.69% for the quarter ended September 30, 2003 as compared to 1.97% for the
quarter ended September 30, 2002. This 128 basis point decrease in spread income
is reflected in the decrease in net interest income.
Our net interest income, which equals interest income less interest
expense, totaled $108.5 million for the nine months ended September 30, 2003 and
$169.6 million for the nine months ended September 30, 2002. Our net interest
income declined for the nine month period due to the large amount of prepayments
and the lower interest rate environment. 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 1.14% for the nine months ended September 30, 2003 as
compared to 2.32% for the nine months ended September 30, 2002. This 118 basis
point increase in spread income is reflected in the increase in net interest
income.
The table below shows our average investment securities and cash
equivalents, total interest income, yield on assets interest expense, average
repurchase agreements, average cost of funds, and net interest income for the
quarters ended September 30, 2003, June 30, 2003, March 31, 2003, the year ended
December 31, 2002, and each of the four quarters in 2002.
18
Net Interest Income
(dollars in thousands)
(ratios for the quarters have been annualized)
Yield
on
Average Interest Average Average Average
Investment Income on Total Interest Balance of Cost Net
Securities Investment Average Cash Interest Earning Repurchase Interest of Interest
Held Securities Equivalents Income Assets Agreements Expense Funds Income
------------ ---------- ------------- -------- -------- ------------ --------- -------- -------
For the Quarter
Ended
September 30, 2003 $12,577,165 $66,855 - $66,855 2.13% $12,186,985 $43,922 1.44% $22,933
For the Quarter
Ended $12,815,290 $93,892 - $93,892 2.93% $12,311,329 $51,770 1.68% $42,122
June 30, 2003
For the Quarter
Ended $10,837,147 $87,500 - $87,500 3.23% $10,463,251 $44,048 1.68% $43,452
March 31, 2003
--------------------------------------------------------------------------------------------------------------------
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 $10,661,228 $109,201 $2 $109,201 4.10% $10,122,840 $54,012 2.13% $55,189
September 30,
2002
For the Quarter
Ended $9,629,332 $109,423 $2 $109,423 4.55% $9,102,992 $47,860 2.10% $61,563
June 30, 2002
For the Quarter
Ended $7,610,006 $92,900 $2 $92,900 4.88% $7,192,222 $40,012 2.23% $52,888
March 31, 2002
Gains and Losses on Sales of Mortgage-Backed Securities
For the quarter ended September 30, 2003, we sold Mortgage-Backed
Securities with an aggregate historical amortized cost of $377.0 million for an
aggregate gain of $9.7 million. For the quarter ended September 30, 2002, we
sold Mortgage-Backed Securities with an aggregate historical amortized cost of
$393.7 million for an aggregate gain of $4.7 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 statement of financial condition as part
of our asset/liability management strategy. During the quarter ended September
30, 2003, we had $575.0 million of callable agency debentures called at par.
There was no gain or loss associated with the call on the securities.
For the nine months ended September 30, 2003, we sold Mortgage-Backed
Securities with an aggregate historical amortized cost of $2.7 billion for an
aggregate gain of $40.9 million. For the nine months ended September 30, 2002,
we sold Mortgage-Backed Securities with an aggregate historical amortized cost
of $1.1 billion for an aggregate gain of $9.5 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. During the nine
months ended September 30, 2003, we had $746 million of callable agency
debentures called at par. There was no gain or loss associated with the call on
the securities.
General and Administrative Expense
General and administrative ("G&A") expenses were $4.1 million for the
quarter ended September 30, 2003 and $3.3 million for the quarter ended
September 30, 2002. G&A expenses as a percentage of average assets was 0.12% for
the quarter ended September 30, 2003 and 0.12% for the quarter ended September
30, 2002, on an annualized basis. G&A expenses as a percentage of average equity
was 1.42% and 1.22% on an annualized basis for the quarters ended September 30,
2003 and 2002, respectively. The Company is internally managed and continues to
be a low-cost provider. Even though G&A expenses increased by $800,000 for the
quarter ended September 30, 2003, when compared to the quarter ended September
30, 2002, G&A as a percentage of average assets remained unchanged.
19
G&A Expenses and Operating Expense Ratios
(dollars in thousands)
Total G&A Total G&A
Expenses/Average Expenses/Average
Total G&A Assets Equity
Expenses (annualized) (annualized)
- -
For the Quarter Ended September 30, 2003 $4,110 0.12% 1.42%
For the Quarter Ended June 30, 2003 $4,201 0.12% 1.50%
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 $28.5 million for the quarter ended September 30,
2003 and $56.7 million for the quarter ended September 30, 2002. Our return on
average equity was 9.88% for the quarter ended September 30, 2003 and 21.24% for
the quarter ended September 30, 2002. Our net income was $137.4 million for the
nine months ended September 30, 2003 and $169.1 million for the nine months
ended September 30, 2002. The decline in net interest income was only partially
offset by the increase in gain on sale of securities and decrease in interest
expense. 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 September 30,
2003, June 30, 2003, March 31, 2003, the year ended December 31, 2002, and for
each of the four quarters in 2002.
Components of Return on Average Equity
(Ratios for all Quarters are annualized)
Gain on Sale of
Net Interest Mortgage-Backed G&A Return on
Income/Average Securities/Averag Expenses/Average Average
Equity Equity Equity Equity
---------------------------------------------------------------
For the Quarter Ended September 30, 2003 7.95% 3.35% 1.42% 9.88%
For the Quarter Ended June 30, 2003 15.06% 7.23% 1.50% 20.79%
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 September 30, 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 earning assets at fair value.
20
All of our Agency Debentures are callable and carry an implied
"AAA" rating. We mark-to-market all of our Agency Debentures at fair value.
We accrete discount balances as an increase in interest income over the
life of discount Investment Securities and we amortize premium balances as a
decrease in interest income over the life of premium Investment Securities. At
September 30, 2003 and December 31, 2002, we had on our Statement of Financial
Condition a total of $1.2 million and $664,000 million respectively, of
unamortized discount (which is the difference between the remaining principal
value and current historical amortized cost of our Investment Securities
acquired at a price below principal value) and a total of $294.8 million and
$274.6 million, respectively, of unamortized premium (which is the difference
between the remaining principal value and the current historical amortized cost
of our Investment Securities acquired at a price above principal value).
We received mortgage principal repayments of $2.7 billion for the
quarter ended September 30, 2003 and $1.0 billion for the quarter ended
September 30, 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 September 30,
2003, June 30, 2003, March 31, 2003, December 31, 2002, September 30, 2002, June
30, 2002, and March 31, 2002.
Investment Securities
(dollars in thousands)
Estimated
Amortized Fair Weighted
Net Amortized Cost/Principal Estimated Value/Principal Average
Principal Value Premium Cost Value Fair Value Value l Yield
At September 30, 2003 $12,363,260 $293,694 $12,656,954 102.38% $12,605,085 101.96% 2.35%
At June 30, 2003 $13,939,447 $322,838 $14,262,285 102.32% $14,263,475 102.32% 2.87%
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 Investment
Securities. The index level for adjustable-rate Investment Securities is the
weighted average rate of the various short-term interest rate indices, which
determine the coupon rate.
Adjustable-Rate Investment Security Characteristics
(dollars in thousands)
Weighted Principal Value
Weighted Weighted Weighted Average Weighted at Period End as
Average Average Average Term to Weighted Average % of Total
Principal Coupon Index Net Next Average Asset Mortgage-Backed
Value Rate Level Margin Adjustment Lifetime Cap Yield Securities
At September 30, 2003 $8,498,116 3.76% 2.17% 1.59% 22 months 9.75% 1.77% 68.74%
At June 30, 2003 $8,889,012 3.69% 2.18% 1.51% 18 months 9.70% 2.47% 63.77%
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, 2002 $7,939,126 4.57% 2.96% 1.61% 12 months 10.46% 3.17% 73.28%
At March 31, 2002 $7,248,832 4.94% 3.25% 1.69% 16 months 10.73% 3.52% 72.61%
- -------------------------------------------------------------------------------------------------------------------------
21
Fixed-Rate Investment Security Characteristics
(dollars in thousands)
Principal Value at
Weighted Period End as % of
Weighted Average Average Asset Total Investment
Principal Value Coupon Rate Yield Securities
At September 30, 2003 $3,865,171 5.86% 3.63% 31.26%
At June 30, 2003 $5,050,434 5.97% 3.58% 36.23%
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%
- ----------------------------------------------------------------------------------------------------------
Adjustable-Rate Investment Securities by Index
September 30, 2003
12-Month 11th
Twelve Moving District
Six-Month Month Six-Month Average Cost of Interest Six-Month 1-Year 2-Year 3-Year 5-Year
One-Month Libor Libor Auction Funds Rate CD Rate Treasury TreasuryTreasury Treasury
Libor Average Step Up Index Index Index Index
Weighted Average Term to
1mo. 27 mo. 30 mo. 5 mo. 1 mo. 1 mo. 179 mo. 2 mo. 22 mo. 10 mo. 17 mo. 25 mo.
Next Adjustment
Weighted Average Annual
Period Cap None 2.22% 2.00% 1.00% 0.15% None 2.00% 1.00% 1.88% 2.00% 2.00% 2.00%
Weighted Average
Lifetime 8.86% 9.77% 10.22% 13.01% 10.72% 12.30% 6.76% 11.63% 10.14% 11.96% 12.88% 12.62%
Cap at September 30,
2003
Investment Principal
Value
as Percentage of
Investment
Securities at
September 30, 2003 19.15% 1.14% 8.81% 0.02% 0.62% 1.03% 2.26% 0.10% 34.85% 0.02% 0.53% 0.21%
Adjustable-Rate Investment Securities by Index
December 31, 2002
Six-Month 12-Month 2-Year
Auction Moving 1-Year Treasury 3-Year 5-Year
One-Month Six-Month Average Average Six-Month Treasury Index Treasury Treasury
LIBOR LIBOR CD Rate 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%
Investment Principal Value
as
Percentage of Investment-
Securities at
December 31, 2002 32.43% 0.33% 0.03% 0.58% 0.14% 27.67% 0.03% 0.92% 0.42%
22
Borrowings
To date, our debt has consisted entirely of borrowings collateralized
by a pledge of our Investment Securities. These borrowings appear on our
statement of financial condition as repurchase agreements. At September 30,
2003, we had established uncommitted borrowing facilities in this market with
twenty-six lenders in amounts, which we believe, are in excess of our needs. All
of our Investment Securities are currently accepted as collateral for these
borrowings. However, we limit our borrowings, and thus our potential asset
growth, in order to maintain unused borrowing capacity and thus increase the
liquidity and strength of our statement of financial condition.
For the quarter ended September 30, 2003 the term to maturity of our
borrowings ranged from one day to three years, with a weighted average original
term to maturity of 171 days. For the quarter ended September 30, 2002, the term
to maturity of our borrowings ranged from one day to three years, with a
weighted average original term to maturity of 218 days. At September 30, 2003,
the weighted average cost of funds for all of our borrowings was 1.46% and the
weighted average term to next rate adjustment was 74 days. At September 30,
2002, the weighted average cost of funds for all of our borrowings was 2.09% and
the weighted average term to next rate adjustment was 139 days.
Liquidity
Liquidity, which is our ability to turn non-cash assets into cash,
allows us to purchase additional Investment Securities and to pledge additional
assets to secure existing borrowings should the value of our pledged assets
decline. 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 Investment Securities varies. Our Statement of Financial
Condition 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 Investment 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 Statement of Financial Condition at estimated fair
value rather than historical amortized cost. Based upon this
"available-for-sale" treatment, our equity base at September 30, 2003 was $1.1
billion, or $11.94 per share. If we had used historical amortized cost
accounting, our equity base at September 30, 2003 would have been $1.2 billion,
or $12.48 per share. Our equity base at September 30, 2002 was $1.1 billion, or
$12.84 per share. If we had used historical amortized cost accounting, our
equity base at September 30, 2002 would have been $1.0 billion, or $11.96 per
share.
With our "available-for-sale" accounting treatment, unrealized
fluctuations in market values of assets do not impact our taxable income but
rather are reflected on our Statement of Financial Condition 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.
23
Unrealized Gains and Losses
(dollars in thousands)
At At At At At At At
Sept. 30, June 30, March 31, Dec. 31, Sept. 30, June 30, March 31,
2003 2003 2003 2002 2002 2002 2002
-----------------------------------------------------------------------------------
Unrealized Gain $ 27,439 $51,208 $ 98,768 $90,507 $93,254 $75,832 $46,894
Unrealized Loss (79,309) (50,018) (27,768) (14,997) (18,872) (8,549) (16,392)
-----------------------------------------------------------------------------------
Net Unrealized Gain (loss) $(51,870) $ 1,190 $71,000 $75,510 $74,382 $67,283 $30,502
===================================================================================
Net Unrealized Gain (loss) as % of
Investment Securities Principal Value (0.41)% 0.01% 0.59% 0.67% 0.67% 0.62% 0.31%
Net Unrealized Gain (loss) as % of
Investment Securities Amortized Cost (0.41)% 0.01% 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 Loss on Available for Sale
Securities" was $51.8 million, or (0.41)% of the amortized cost of our
Investment Securities at September 30, 2003. "Unrealized Net Gain on Available
for Sale Securities" was $75.5 million or 0.67% of the amortized cost of our
Investment Securities at December 31, 2002.
The table below shows our equity capital base as reported and on a
historical amortized cost basis at September 30, 2003, June 30, 2003, 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 Gains (Losses) on Assets Available for Sale" account.
Stockholders' Equity
(dollars in thousands, except per share amounts)
Net Unrealized Historical
Historical Gains (Losses) on GAAP Reported Amortized Cost GAAP Reported
Amortized Cost Assets Available Equity Base Equity Per Equity (Book
Equity Base for Sale (Book Value) Share Value) Per Share
At September 30, 2003 $1,197,598 $(51,870) $1,145,728 $12.48 $11.94
At June 30, 2003 $1,160,248 $ 1,190 $1,161,438 $12.34 $12.35
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- equity ratio at September 30, 2003 and September 30, 2002
was 9.8:1 and 9.0:1 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.
24
Our target debt-to-equity ratio is determined under our capital
investment policy. Should our actual debt-to-equity ratio increase above the
target level due to asset acquisition or market value fluctuations in assets, we
will cease to acquire new assets. Our management will, at that time, present a
plan to our Board of Directors to bring us back to our target debt-to-equity
ratio; in many circumstances, this would be accomplished in time by the monthly
reduction of the balance of our Investment 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 statement of
financial condition.
We seek to manage the extent to which our net income changes as a
function of changes in interest rates by matching adjustable-rate assets with
variable-rate borrowings. In addition, although we have not done so to date, we
may seek to mitigate the potential impact on net income of periodic and lifetime
coupon adjustment restrictions in our portfolio of Investment Securities by
entering into interest rate agreements such as interest rate caps and interest
rate swaps.
Changes in interest rates may also have an effect on the rate of
mortgage principal prepayments and, as a result, prepayments on Mortgage-Backed
Securities. We will seek to mitigate the effect of changes in the mortgage
principal repayment rate by balancing assets we purchase at a premium with
assets we purchase at a discount. To date, the aggregate premium exceeds the
aggregate discount on our Mortgage-Backed Securities. As a result, prepayments,
which result in the expensing of unamortized premium, will reduce our net income
compared to what net income would be absent such prepayments.
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 statement of
financial condition 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% and 100% of our total assets at September 30, 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 September 30, 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 September 30, 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 of 1940, as
amended. If we were to become regulated as an investment company, then our use
of leverage would be substantially reduced. The Investment Company Act of 1940,
as amended, 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 September 30, 2003 and 2002 we were in compliance with this
requirement.
25
ITEM. 3 QUANTITATIVE AND QUALITATIVE 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 Investment
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 75 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 September 30, 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
- ---------------------------------------- -------------------------------------- --------------------------------------
- -75 Basis Points (3.06%) 0.62%
- -50 Basis Points (2.03%) 0.43%
- -25 Basis Points (1.01%) 0.22%
Base Interest Rate
+25 Basis Points 4.35% (0.24%)
+50 Basis Points 7.15% (0.50%)
+75 Basis Points 14.53% (0.77%)
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 the amount of
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.
26
The following table sets forth the estimated maturity or repricing of
our interest-earning assets and interest-bearing liabilities at September 30,
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 Months Year to 3 Years 3 Years and
4-12 Months Over Total
==================================== ---------------- ----------------- ---------------- ---------------- --------------
(dollars in thousands)
Rate Sensitive Assets:
Investment Securities $2,895,717 $1,033,838 $3,547,517 $4,886,188 $12,363,260
Rate Sensitive Liabilities:
Repurchase Agreements 9,737,831 324,066 1,140,000 11,201,897
---------------- ----------------- ---------------- ---------------- --------------
Interest rate sensitivity gap ($6,842,114) $709,772 $2,407,517 $4,886,188 $1,161,363
================ ================= ================ ================ ==============
Cumulative rate sensitivity gap ($6,842,114) ($6,132,342) ($3,724,825) $1,161,363
================ ================= ================ ================ ==============
Cumulative interest rate
sensitivity gap as a percentage of
total rate-sensitive assets (55%) (50%) (30%) 9%
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 from 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 September 30, 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 our 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 our Chief Financial Officer and Treasurer, concluded that our
disclosure controls and procedures were effective as of September 30, 2003.
There have been no significant changes in our internal controls or in other
factors that could significantly affect internal controls subsequent to
September 30, 2003. There were no significant material weaknesses identified in
the course of such review and evaluation and, therefore, we have taken no
corrective measures.
27
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit Index
Exhibit Number Exhibit Description
31.1 Certification of Chief Executive Officer, pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
31.2 Certification of Chief Financial Officer, pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
32.1 Certification of Chief Executive Officer, 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer, 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports of Form 8-K
We filed a current report on Form 8-K on July 28, 2003, reporting under
Item 12 and attaching our press release dated July 28, 2003, which announced our
earnings for the quarter ended June 30, 2003.
We filed a current report on Form 8-K on August 12, 2003 reporting
under Items 5 and 7 and which announced that we had entered into an amended and
restated sales agency agreement, dated August 12, 2003, with UBS Securities LLC
and attaching a copy of the amended and restated sales agency agreement.
We filed a current report on Form 8-K on September 9, 2003 reporting
under Items 7, 9 and 12 and attaching our press release dated September 9, 2003,
which provided earnings guidance for the third quarter of 2003.
The following current report on Form 8-K was filed by the Company
subsequent to the third quarter of 2003:
We filed a current report on Form 8-K on October 21, 2003 reporting
under Item 12 and attaching our press release dated October 21, 2003, which
announced our financial results for the third quarter of 2003.
28
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: November 12, 2003 By:/s/ Michael A.J. Farrell
-------------------------
Michael A.J. Farrell
(Chairman of the Board and Chief Executive
Officer
(authorized officer of registrant)
Dated: November 12, 2003 By:/s/ Kathryn F. Fagan
---------------------
Kathryn F. Fagan
Chief Financial Officer and Treasurer
(principal financial and chief accounting
officer)
29