External factors that are reasonably likely to affect OFS’s ability to continue to use these marketscomplete securitizations would be those factors that could disrupt the securitization capital market.markets. A disruption in the marketmarkets could prevent OFS from being able to sell the securitiessecuritize its mortgage loans at a favorable price or at all. Factors that could disrupt the securitization marketcapital markets include an international liquidity crisis such as occurred in the fall of 1998, a terrorist attack, outbreak of war or other significant event risk or market specific events such as a default of a comparable type of securitization. If OFS werewas unable to access the securitization market,capital markets, OFS may still be able to finance theits mortgage operations by selling the loans to investors in the whole loan market, but at lower than anticipated margins.
Specific items that may affect OFS’s ability to use the securitizations to finance theirOFS’s specific loans relate primarily to the performance of the loans that have been securitized. Extremely poor loan performance may lead to poor bond performance and investor unwillingness to buy bonds supported by OFS’s collateral. OFS’s financial condition could also have an adverse impact on ourits ability to access the securitization market if there was the perception that ourits financial condition had deteriorated to the point where investors would question OFS’s ability to stand behind theirits representations and warranties made in connection with theirits securitizations (Opteumeven though Opteum has guaranteed the performance of OFS’s representation and warranties). The financial performance and condition of the past securitizations of OFS arewarranties. It is too early to evaluate the impact of the underlying collateral’s performance.performance attributable to the financial performance and condition of the past securitizations of OFS. Additionally, past economic conditions that may have contributed to a favorable performance may not be an indication of future performance should economic conditions change unfavorably.
Opteum believes the primary risk inherent in its investments is the effect of movements in interest rates. This arises because the changes in interest rates on Opteum's borrowings will not be perfectly coordinated with the effects of interest rate changes on the income from, or value of, its investments. Opteum therefore follows an interest rate risk management program designed to offset the potential adverse effects resulting from the rate adjustment limitations on its mortgage related securities. Opteum seeks to minimize differences between the interest rate indices and interest rate adjustment periods of its adjustable-rate mortgage-backed securities and those of its related borrowings.
Opteum's interest rate risk management program encompasses a number of procedures, including the following:
As a result, Opteum expects to be able to adjust the average maturities and reset periods of its borrowings on an ongoing basis by changing the mix of maturities and interest rate adjustment periods as borrowings mature or are renewed. Through the use of these procedures, Opteum attempts to reduce the risk of differences between interest rate adjustment periods of its adjustable-rate mortgage-backed securities and those of its related borrowings.
Because Opteum attempts to match its assets and liabilities from an interest rate perspective and hold its assets to maturity, it expects to have limited exposure to changes in interest rates. However, Opteum will be exposed to changes in interest rates either (i) upon refinancing borrowings that expire before the related assets are repaid or (ii) upon reinvesting (and refinancing) proceeds following the maturity of current investments, if interest rates were to rise substantially.
As a further means of protecting its portfolio against the effects of major interest rate changes Opteum may employ a limited hedging strategy under which it purchases interest rate cap contracts (under which it would generally be entitled to payment if interest rate indices exceed the agreed rates).
Opteum is subject to interest rate risk in connection with its investments in mortgage related securities and its related debt obligations, which are generally repurchase agreements of limited duration that are periodically refinanced at current market rates.
Opteum funds its investments in long-term fixed-rate and hybrid adjustable-rate mortgage-backed securities with short-term borrowings under repurchase agreements. During periods of rising interest rates, the borrowing costs associated with those fixed-rate and hybrid adjustable-rate mortgage-backed securities tend to increase while the income earned on such fixed-rate mortgage-backed securities and hybrid adjustable-rate mortgage-backed securities (during the fixed-rate component of such securities) may remain substantially unchanged. This results in a narrowing of the net interest spread between the related assets and borrowings and may even result in losses. Opteum may enter into interest rate cap contracts or forward funding agreements seeking to mitigate the negative impact of a rising interest rate environment. Hedging techniques will be based, in part, on assumed levels of prepayments of Opteum's fixed-rate and hybrid adjustable-rate mortgage-backed securities. If prepayments are slower or faster than assumed, the life of the mortgage related securities will be longer or shorter, which would reduce the effectiveness of any hedging techniques Opteum may utilize and may result in losses on such transactions. Hedging techniques involving the use of derivative securities are highly complex and may produce volatile returns. Opteum's hedging activity will also be limited by the asset and sources-of-income requirements applicable to it as a REIT.
Opteum invests in fixed-rate and hybrid adjustable-rate mortgage-backed securities. Hybrid adjustable-rate mortgage-backed securities have interest rates that are fixed for the first few years of the loan—typically three, five, seven or 10 years—and thereafter their interest rates reset periodically on the same basis as adjustable-rate mortgage-backed securities. As of December 31, 2005,2006, approximately 20.2%2.7% of Opteum's investment portfolio was comprised of hybrid adjustable-rate mortgage-backed securities. Opteum computes the projected weighted average life of its fixed-rate and hybrid adjustable-rate mortgage-backed securities based on the market's assumptions regarding the rate at which the borrowers will prepay the underlying mortgages. In general, when a fixed-rate or hybrid adjustable-rate mortgage-backed security is acquired with borrowings, Opteum may, but is not required to, enter into interest rate cap contracts or forward funding agreements that effectively cap or fix its borrowing costs for a period close to the anticipated average life of the fixed-rate portion of the related mortgage-backed security. This strategy is designed to protect Opteum from rising interest rates because the borrowing costs are fixed for the duration of the fixed-rate portion of the related mortgage-backed security. However, if prepayment rates decrease in a rising interest rate environment, the life of the fixed-rate portion of the related mortgage-backed security could extend beyond the term of the swap agreement or other hedging instrument. This situation could negatively impact Opteum as borrowing costs would no longer be fixed after the end of the hedging instrument, while the income earned on the fixed-rate or hybrid adjustable-rate mortgage-backed security would remain fixed. This situation may also cause the market value of Opteum's fixed-rate and hybrid adjustable-rate mortgage-backed securities to decline with little or no offsetting gain from the related hedging transactions. In extreme situations, Opteum may be forced to sell assets and incur losses to maintain adequate liquidity.
Opteum also invests in adjustable-rate and hybrid adjustable-rate mortgage-backed securities, which are based on mortgages that are typically subject to periodic and lifetime interest rate caps and floors, which limit the amount by which an adjustable-rate or hybrid adjustable-rate mortgage-backed security's interest yield may change during any given period. However, Opteum's borrowing costs pursuant to its repurchase agreements will not be subject to similar restrictions. Hence, in a period of increasing interest rates, interest rate costs on Opteum's borrowings could increase without limitation by caps, while the interest-rate yields on Opteum's adjustable-rate and hybrid adjustable-rate mortgage-backed securities would effectively be limited by caps. This problem will be magnified to the extent Opteum acquires adjustable-rate and hybrid adjustable-rate mortgage-backed securities that are not based on mortgages which are fully indexed. Further, the underlying mortgages may be subject to periodic payment caps that result in some portion of the interest being deferred and added to the principal outstanding. This could result in Opteum's receipt of less cash income on its adjustable-rate and hybrid adjustable-rate mortgage-backed securities than it needs in order to pay the interest cost on its related borrowings. These factors could lower Opteum's net interest income or cause a net loss during periods of rising interest rates, which would negatively impact Opteum's financial condition, cash flows and results of operations.
Opteum intends to fund a substantial portion of its acquisitions of adjustable-rate and hybrid adjustable-rate mortgage-backed securities with borrowings that have interest rates based on indices and repricing terms similar to, but of somewhat shorter maturities than, the interest rate indices and repricing terms of the mortgage related securities it is financing. Thus, Opteum anticipates that in most cases the interest rate indices and repricing terms of its mortgage related securities and its funding sources will not be identical, thereby creating an interest rate mismatch between assets and liabilities. Therefore, Opteum's cost of funds would likely rise or fall more quickly than would its earnings rate on assets. During periods of changing interest rates, such interest rate mismatches could negatively impact Opteum's financial condition, cash flows and results of operations.
Prepayment rates for existing mortgage related securities generally increase when prevailing interest rates fall below the market rate existing when the underlying mortgages were originated. In addition, prepayment rates on adjustable-rate and hybrid adjustable-rate mortgage-backed securities generally increase when the difference between long-term and short-term interest rates declines or becomes negative. Prepayments of mortgage related securities could harm Opteum's results of operations in several ways. Some adjustable-rate mortgages underlying Opteum's adjustable-rate mortgage-backed securities may bear initial "teaser" interest rates that are lower than their "fully-indexed" rates, which refer to the applicable index rates plus a margin. In the event that such an adjustable-rate mortgage is prepaid prior to or soon after the time of adjustment to a fully-indexed rate, the holder of the related mortgage-backed security would have held such security while it was less profitable and lost the opportunity to receive interest at the fully-indexed rate over the expected life of the adjustable-rate mortgage-backed security. Opteum currently owns mortgage related securities that were purchased at a premium. The prepayment of such mortgage related securities at a rate faster than anticipated would result in a write-off of any remaining capitalized premium amount and a consequent reduction of Opteum's net interest income by such amount. Finally, in the event that Opteum is unable to acquire new mortgage related securities to replace the prepaid mortgage related securities, its financial condition, cash flow and results of operations could be harmed.
Another component of interest rate risk is the effect changes in interest rates will have on the market value of Opteum's assets. Opteum faces the risk that the market value of its assets will increase or decrease at different rates than that of its liabilities, including its hedging instruments.
Opteum primarily assesses its interest rate risk by estimating the duration of its assets and the duration of its liabilities. Duration essentially measures the market price volatility of financial instruments as interest rates change. Opteum generally calculates duration using various financial models and empirical data, and different models and methodologies can produce different duration numbers for the same securities.
The following sensitivity analysis table shows the estimated impact on the fair value of Opteum's interest rate-sensitive investments at December 31, 2005,2006, assuming rates instantaneously fall 100 basis points, rise 100 basis points and rise 200 basis points:
The table below reflects the same analysis presented above but with the figures in the columns that indicate the estimated impact of a 100 basis point fall or rise adjusted to reflect the impact of convexity.
In addition to changes in interest rates, other factors impact the fair value of Opteum's interest rate-sensitive investments and hedging instruments, such as the shape of the yield curve, market expectations as to future interest rate changes and other market conditions. Accordingly, in the event of changes in actual interest rates, the change in the fair value of Opteum's assets would likely differ from that shown above and such difference might be material and adverse to Opteum's stockholders.
Opteum's liabilities, consisting primarily of repurchase agreements, are also affected by changes in interest rates. As rates rise, the value of the underlying asset, or the collateral, declines. In certain circumstances, Opteum could be required to post additional collateral in order to maintain the repurchase agreement position. Opteum maintains a substantial cash position, as well as unpledged assets, to cover these types of situations. As an example, if interest rates increased 200 basis points, as shown on the prior table, Opteum's collateral as of December 31, 20052006 would decline in value by approximately $126.1$88.1 million. Its cash and unpledged assets are currently sufficient to cover such shortfall. There can be no assurance, however, that Opteum will always have sufficient cash or unpledged assets to cover shortfalls in all situations.
OFS may face loss exposure due to fraudulent and negligent acts on the part of loan applicants, employees, mortgage brokers and other third parties. When OFS originates or purchases mortgage loans, OFS relies heavily upon information provided to them by third parties, including information relating to the loan application, property appraisal, title information and employment and income documentation. If any of this information is fraudulently or negligently misrepresented to OFS and such misrepresentation is not detected by OFS prior to loan funding, the value of the loan may be significantly lower than OFS expected. Whether a misrepresentation is made by the loan applicant, the loan broker, one of OFS’s employees, or any other third party, OFS will generally bear the risk of loss associated with it.
OFS’s failure to comply with federal, state or local regulation of, or licensing requirements with respect to, mortgage lending, loan servicing, broker compensation programs, local branch operations or other aspects of OFS’s business could harm OFS’s operations and profitability. As a mortgage lender, loan servicer and broker, OFS is subject to an extensive body of both state and federal law. The volume of new or modified laws and regulations has increased in recent years and, in addition, some individual municipalities have begun to enact laws that restrict loan origination and servicing activities. As a result, it may be more difficult to comprehensively identify and accurately interpret all of these laws and regulations and to properly program OFS’s technology systems and effectively train OFS’s personnel, thereby potentially increasing OFS’s exposure to the risks of noncompliance with these laws and regulations.
| § | administrative enforcement actions. |
OFS’s business could be adversely affected if OFS experienced an interruption in or breach of its communication or information systems or if OFS were unable to safeguard the security and privacy of the personal financial information OFS receives. OFS relies heavily upon communications and information systems to conduct it business. Any material interruption or breach in security of OFS’s communication or information systems or the third-party systems on which OFS relies could cause delays in rendering an underwriting decision or other delays and could result in fewer loan applications being received, applications not closing, slower processing of applications and reduced efficiency in loan servicing. Additionally, in connection with OFS’s loan file due diligence reviews, OFS has access to the personal financial information of the borrowers which is highly sensitive and confidential, and subject to significant federal and state regulation. If a third party were to misappropriate this information, OFS potentially could be subject to both private and public legal actions. Although OFS has policies and procedures designed to safeguard confidential information, OFS can provide no assurance that these policies and safeguards are sufficient to prevent the misappropriation of confidential information, that the policies and safeguards will be deemed compliant with any existing federal or state laws or regulations governing privacy, or with those laws or regulations that may be adopted in the future. Also, in selling its loans OFS must ship these files containing borrower’s confidential information. While in transit, the files may be out of the control of OFS’s safeguarding measures. OFS can still be held liable for access to this information while in transit.
Failure to renew or obtain adequate funding under warehouse repurchase agreements may harm OFS’s lending operations. OFS is currently dependent upon a number of credit facilities for funding of its mortgage loan originations and acquisitions. Any failure to renew or obtain adequate funding under these financing arrangements for any reason, including OFS’s inability to meet the covenants contained in such arrangements, could harm its lending operations and its overall performance.
OFS has credit exposure to representation and warranties with respect to loans OFS sells to the whole loan market. OFS has potential credit and liquidity exposure for loans that are the subject of fraud, irregularities in their loan files or process, or that result in OFS’s breaching the representations and warranties in the contract of sale. In addition, when OFS sells loans to the whole loan market OFS has exposure for loans that default, within certain timeframes. In these cases, OFS may be obligated to repurchase loans at principal value plus accrued interest and a pro-rata amount on any premium paid and any servicing released premium along with any escrow shortage and out of pockets that the buyer may have incurred, which could result in a significant decline in OFS’s available cash. When OFS purchases loans from a third party, through OFS’s Conduit division, that OFS sells into the whole loan market or to a securitization trust, OFS obtains representations and warranties from the counter-partiescounterparties that sold the loans to OFS that generally parallel the representations and warranties OFS provides to OFS’s purchasers. As a result, OFS believes they have the potential for recourse against the seller of the loans. However, if the representations and warranties are not parallel, or if the original seller is not in a financial position to be able to repurchase the loan, OFS may have to use cash resources to repurchase loans which could adversely affect OFS’s liquidity.
Risks associated with movements in interest rates:Interest Rate Risk
Changes in interest rates may harm OFS’s results of operations. OFS’s results of operations are likely to be harmed during any period of unexpected or rapid changes in interest rates. Interest rate changes could affect OFS in the following ways:
| § | a substantial or sustained increase in interest rates could harm OFS’s ability to originate or acquire mortgage loans in expected volumes, which could result in a decrease in OFS’s cash flow and in OFS’s ability to support OFS’s fixed overhead expense levels; |
| § | interest rate fluctuations may harm OFS’s earnings as a result of potential changes in the spread between the interest rates on OFS’s borrowings and the interest rates on OFS’s mortgage assets; |
| § | mortgage prepayment rates vary depending on such factors as mortgage interest rates and market conditions, and changes in anticipated prepayment rates may harm OFS’s earnings; and |
| § | when OFS securitizes loans, the value of the residual interests OFS retains and the income OFS receives from them are based primarily on LIBOR, and an increase in LIBOR reduces the net income OFS receives from, and the value of, these residual interests. |
Hedging against interest rate exposure may adversely affect OFS’s earnings, which could adversely affect cash available for distribution to Opteum’s stockholders. OFS may enter into interest rate swap agreements or pursue other interest rate hedging strategies.
OFS’s hedging activity will vary in scope based on interest rates, the type of mortgage assets held, and other changing market conditions. Interest rate hedging may fail to protect or could adversely affect OFS because, among other things:
| § | interest rate hedging can be expensive, particularly during periods of rising and volatile interest rates; |
| § | hedging instruments involve risk because they often are not traded on regulated exchanges, guaranteed by an exchange or its clearing house, or regulated by any U.S. or foreign governmental authorities; consequently, there are no requirements with respect to record keeping, financial responsibility or segregation of customer funds and positions, and the enforceability of agreements underlying derivative transactions may depend on compliance with applicable statutory, commodity and other regulatory requirements; |
| § | available interest rate hedging may not correspond directly with the interest rate risk for which protection is sought; |
| § | the duration of the hedge may not match the duration of the related liability or asset; |
| § | the credit quality of the party owing money on the hedge may be downgraded to such an extent that it impairs OFS’s ability to sell or assign OFS’s side of the hedging transaction; |
| § | the party owing money in the hedging transaction may default on its obligation to pay, and a default by a party with whom OFS enters into a hedging transaction may result in the loss of unrealized profits; and |
| § | OFS may not be able to dispose of or close out a hedging position without the consent of the hedging counterparty, and OFS may not be able to enter into an offsetting contract in order to cover OFS’s risks. |
When interest rates rise, loans held for sale and any applications in process with locked-in rates decrease in value. To preserve the value of such fixed-rate loans or applications in process with locked-in rates, agreements are executed for mandatory loan sales to be settled at future dates with fixed prices. These sales take the form of forward sales of mortgage-backed securities.
When interest rates decline, fallout may occur as a result of customers withdrawing their applications. In such instances, OFS may be required to purchase back these mandatory delivery agreements at current market prices, possibly incurring losses upon settlement. OFS uses an interest rate hedging program to manage these risks. Through this program, mortgage-backed securities are purchased and sold forward or options are acquired on treasury futures contracts.
Movements in interest rates also impact the value of MSRs. When interest rates decline, the loans underlying the MSRs are generally expected to prepay faster, which reduces the market value of the MSRs. OFS considers the expected increase in loan origination volumes and the resulting additional origination related income as a natural hedge against the expected change in the value of MSRs. Lower mortgage rates generally reduce the fair value of the MSRs, as increased prepayment speeds are highly correlated with lower levels of mortgage interest rates.
Securitization Execution RiskRisks associated with OFS’s securitization strategy:
An interruption or reduction in the securitization market or change in terms offered by this market would hurt OFS’s financial position. OFS is dependent on the securitization market for the sale of OFS’s loans and the securitization market is dependent upon a number of factors, including general economic conditions, conditions in the securities market generally and in the asset-backed securities market specifically. Similarly, poor performance of OFS’s previously securitized loans could harm OFS’s access to the securitization market.
Competition in the securitization market may negatively affect OFS’s net income. Competition in the business of sponsoring securitizations of the type OFS focuses on is increasing as Wall Street broker-dealers, other mortgage REITs, investment management companies, and other financial institutions expand their activities or enter this field. Increased competition could reduce OFS’s securitization margins if OFS has to pay a higher price for the long-term funding of these assets. To the extent that OFS’s securitization margins erode, OFS’s results of operations will be negatively impacted.
Risks associated with OFS’s retained interests in residuals and mortgage servicing rights:Real Estate Market Risk
Geographic concentrationover-concentration of mortgage loans OFS originateoriginates or purchasepurchases increases OFS’s exposure to the economic and natural hazard risks in those areas, especially in California, Georgia and Florida. Over-concentration of loans OFS originates or purchases in any one geographic area increases OFS’s exposure to the economic and natural hazard risks associated with that area.
A prolonged economic slowdown or a decline in the real estate market could harm OFS’s results of operations. A substantial portion of OFS’s mortgage assets consist of single-family mortgage loans or mortgage securities—available-for-sale evidencing interests in single-family mortgage loans. Any sustained period of increased delinquencies, foreclosures or losses could harm OFS’s ability to sell loans, the prices OFS receives for OFS’s loans, the values of OFS’s mortgage loans held for sale or OFS’s residual interests in securitizations.
Current loan performance data may not be indicative of future results. When valuing OFS’s retained interests in securitizations or mortgage servicing rightsMSRs OFS uses projections, estimates and assumptions based on OFS’s experience with mortgage loans. Actual results and the timing of certain events could differ materially in adverse ways from those projected, due to factors including changes in general economic conditions, fluctuations in interest rates, fluctuations in mortgage loan prepayment rates and fluctuations in losses due to defaults on mortgage loans.
The value of the retained interests in residuals and mortgage servicing rightsMSRs are both sensitive to movements in interest rates, prepayment rates, the credit performance of the underlying loans, and market conventions regarding discount rates used to value such assets. The tables below provide results of sensitivity analysis performed on the valuation of retained interests in residuals and mortgage servicing rights.MSRs. In each case, the underlying assumptions used by OFS to value these assets have been stressed to gauge the impact on carrying value.
At December 31, 2006 and December 31, 2005, key economic assumptions and the sensitivity of the current fair value of residual cash flows to the immediate 10 percent10% and 20 percent20% adverse change in those assumptions are as follows:
Balance Sheet Carrying value of retained interests - fair value | $ | 98,010,592 |
Weighted average life (in years) | | 2.62 |
Prepayment assumption (annual rate) | | 32.53% |
Impact on fair value of 10% adverse change | $ | (7,817,000) |
Impact on fair value of 20% adverse change | $ | (16,089,000) |
Expected Credit losses (annual rate) | | 0.61% |
Impact on fair value of 10% adverse change | $ | (3,247,000) |
Impact on fair value of 20% adverse change | $ | (6,419,000) |
Residual Cash-Flow Discount Rate | | 13.96% |
Impact on fair value of 10% adverse change | $ | (3,804,000) |
Impact on fair value of 20% adverse change | $ | (7,392,000) |
| | |
Interest rates on variable and adjustable loans and bonds | | Forward LIBOR Yield Curve |
Impact on fair value of 10% adverse change | $ | (21,265,000) |
Impact on fair value of 20% adverse change | $ | (34,365,000) |
(in thousands)
| | December 31, 2006 | | December 31, 2005 |
Balance Sheet Carrying value of retained interests - fair value | $ | 104,199 | $ | 98,011 |
Weighted average life (in years) | | 4.26 | | 2.62 |
Prepayment assumption (annual rate) | | 37.88% | | 32.53% |
Impact on fair value of 10% adverse change | $ | (8,235) | $ | (7,817) |
Impact on fair value of 20% adverse change | $ | (14,939) | $ | (16,089) |
Expected Credit losses (annual rate) | | 0.56% | | 0.61% |
Impact on fair value of 10% adverse change | $ | (3,052) | $ | (3,247) |
Impact on fair value of 20% adverse change | $ | (6,098) | $ | (6,419) |
Residual Cash-Flow Discount Rate | | 16.03% | | 13.96% |
Impact on fair value of 10% adverse change | $ | (4,575) | $ | (3,804) |
Impact on fair value of 20% adverse change | $ | (8,771) | $ | (7,392) |
| | | | |
Interest rates on variable and adjustable loans and bonds | | Forward LIBOR Yield Curve | | Forward LIBOR Yield Curve |
Impact on fair value of 10% adverse change | $ | (18,554) | $ | (21,265) |
Impact on fair value of 20% adverse change | $ | (39,292) | $ | (34,365) |
At December 31, 2006 and December 31, 2005, key economic assumptions and the sensitivity of the current fair value of mortgage servicing rightsMSRs cash flows to the immediate 10 percent10% and 20 percent20% adverse change in those assumptions are as follows:
Prepayment assumption (annual rate) (PSA) | | 254% |
Impact on fair value of 10% adverse change | $ | (3,615,000) |
Impact on fair value of 20% adverse change | $ | (6,936,000) |
MSR Cash-Flow Discount Rate | | 10.74% |
Impact on fair value of 10% adverse change | $ | (4,856,000) |
Impact on fair value of 20% adverse change | $ | (9,280,000) |
| | December 31, 2006 | | December 31, 2005 |
Prepayment assumption (annual rate) (PSA) | | 424.6 | | 254.0 |
Impact on fair value of 10% adverse change | $ | (3,923) | $ | (3,615) |
Impact on fair value of 20% adverse change | $ | (7,557) | $ | (6,936) |
MSR Cash-Flow Discount Rate | | 14.50% | | 10.74% |
Impact on fair value of 10% adverse change | $ | (3,505) | $ | (4,856) |
Impact on fair value of 20% adverse change | $ | (6,727) | $ | (9,280) |
ITEM 8. Financial Statements and Supplementary Data.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Index to Financial Statements
| Page |
| |
Management’s Report on Internal Control over Financial Reporting | 6873 |
Reports of Independent Registered Public Accounting Firm | 6974 |
Report of Independent Auditors | 76 |
Consolidated Balance Sheets at December 31, 20052006 and 20042005 | 7277 |
Consolidated Statements of Operations for the years ended December 31, 2006, 2005 and 2004 and for the period from September 24, 2003 (inception) through December 31, 2003 ber | 7378 |
Consolidated Statements of Stockholders' Equity for the years ended December 31, 2006, 2005 and 2004 and for the period from September 24, 2003 (inception) through December 31, 2003 | 7479 |
Consolidated Statements of Cash Flows for the years ended December 31, 2006, 2005 and 2004 , and for the period from September 24, 2003 (inception) through December 31, 2003 | 7580 |
Notes to Consolidated Financial Statements | 7782 |
Management’s Report on Internal Control over Financial ReportingMANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of Opteum Inc. (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that:
| (i) | pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; |
| (ii) | provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorization of management and directors of the Company; and |
| (iii) | provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements. |
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005. Management’s assessment on internal controls did not include the internal controls of Opteum Financial Services, LLC which is included in the 2005 consolidated financial statements of the Company and constituted $1.1 billion and $49.9 million of total and net assets, as of December 31, 2005 and $3.4 million and $(6.6) million of total revenues and net income for the year then ended. Management did not assess the effectiveness of internal control over financial reporting at this entity because the Company did not have the ability to conduct an assessment of the acquired entity’s internal controls over financial reporting during the time period from November 3, 2005, date of acquisition, through December 31, 2005, date of management’s assessment.2006. In making its assessment of the effectiveness of internal control, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on ourthe assessment and those criteria, management believes that the Company maintained effective internal control over financial reporting as of December 31, 2005.2006.
The Company’s independent auditors haveregistered public accounting firm has issued an attestation report on management’s assessment of the Company’s internal control over financial reporting. The report is included herein.
/s/ Jeffrey J. Zimmer
Jeffrey J. Zimmer
Chairman, President and Chief Executive Officer
/s/ Robert E. Cauley
Robert E. Cauley
Vice Chairman, Senior Executive Vice President,
Chief Financial Officer and Chief Investment
Officer
March 12, 2007
Report of Independent Registered Public Accounting FirmREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Opteum Inc. (formerly known as Bimini Mortgage Management, Inc.)
We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that Opteum Inc. (formerly known as Bimini Mortgage Management, Inc.) maintained effective internal control over financial reporting as of December 31, 2005,2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Opteum Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’scompany’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
As indicated in the accompanying Management’s Report on Internal Control Over Financial Reporting, management’s assessment of and conclusion on the effectiveness of internal control over financial reporting did not include the internal controls of Opteum Financial Services, LLC, which is included in the 2005 consolidated financial statements of Opteum Inc., and constituted $1.1 billion and $49.9 million of total and net assets, respectively, as of December 31, 2005 and $3.4 million and $(6.6) million of net revenues and net income, respectively, for the year then ended. Our audit of internal control over financial reporting of Opteum Inc. also did not include an evaluation of the internal control over financial reporting of Opteum Financial Services, LLC.
In our opinion, management’s assessment that Opteum Inc. maintained effective internal control over financial reporting as of December 31, 2005,2006, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, Opteum Inc., maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005,2006, based on the COSO criteria.
We also have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Opteum Inc. as of December 31, 20052006 and 2004,2005, and the related consolidated statements of operations, stockholders' equity, and cash flows for the each of the twothree years in the period ended December 31, 2005 and for the period from September 24, 2003 (date of inception) through December 31, 2003 of Opteum Inc.2006 and our report dated March 1, 200612, 2007 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Certified Public Accountants
Miami, FLFlorida
March 1, 200612, 2007
Report of Independent Registered Public Accounting FirmREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Opteum Inc. (formerly known as Bimini Mortgage Management, Inc.)
We have audited the accompanying consolidated balance sheets of Opteum Inc. (the Company) (formerly known as Bimini Mortgage Management, Inc.) as of December 31, 20052006 and 2004,2005, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the twothree years in the period ended December 31, 2005 and2006. Our audit also included the financial statement schedule for the period from September 24, 2003 (date of inception) throughyear ended December 31, 2003.2006 listed in the Index at Item 15b. These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We did not audit the consolidated financial statements of Opteum Financial Services, LLC and subsidiaries, a wholly ownedwholly-owned subsidiary, which statements reflect total assets of $1.1 billion as of December 31, 2005 and total net revenues of $3.4 million for the year then ended. Those statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts of Opteum Financial Services, LLC and subsidiaries, is based solely on the report of other auditors.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the report of other auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of other auditors, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Opteum Inc. as of December 31, 20052006 and 2004,2005, and the results of their operations and their cash flows for each of the twothree years in the period ended December 31, 2005 and for the period from September 24, 3003 (date of inception) through December 31, 2003,2006, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule for the year ended December 31, 2006, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
As discussed in Note 1 to the financial statements, the Company changed its accounting for mortgage servicing rights in connection with the adoption of Statement of Financial Accounting Standard (SFAS) No. 156, Accounting for Servicing of Financial Assets, as of January 1, 2006.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Opteum Inc.’s internal control over financial reporting as of December 31, 2005,2006, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 1, 200612, 2007 expressed an unqualified opinion thereon.
| | /s/ Ernst & Young LLP Certified Public Accountants |
| | | |
Miami, Florida
March 1,12, 2007
REPORT OF INDEPENDENT AUDITORS
To the Stockholders of Opteum
Financial Services, LLC:
We have audited the accompanying consolidated balance sheet of Opteum Financial Services, LLC and subsidiaries (the “Company”) as of December 31, 2005 and the related consolidated statement of operations, stockholders' equity, and cash flows for the period from November 3, 2005 (Date of Acquisition) to December 31, 2005. These financial statements are the responsibility of management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatements. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purposes of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Opteum Financial Services, LLC and subsidiaries as of December 31, 2005 and the results of their operations and their cash flows for the period from November 3, 2005 (Date of Acquisition) to December 31, 2005, in conformity with accounting principles generally accepted in the United States of America.
| | /s/ Deloitte & Touche LLP |
| | | |
February 28, 2006
OPTEUM INC. |
CONSOLIDATED BALANCE SHEETS |
| | December 31, |
| | 2006 | | 2005 |
ASSETS | | | | |
| | | | |
MORTGAGE-BACKED SECURITIES: | | | | |
Pledged to counterparties, at fair value | $ | 2,803,019,180 | $ | 3,493,490,046 |
Unpledged, at fair value | | 5,714,860 | | 539,313 |
| | | | |
TOTAL MORTGAGE-BACKED SECURITIES | | 2,808,734,040 | | 3,494,029,359 |
| | | | |
CASH AND CASH EQUIVALENTS | | 92,506,282 | | 130,510,948 |
RESTRICTED CASH | | - | | 2,310,000 |
MORTGAGE LOANS HELD FOR SALE, NET | | 749,833,599 | | 894,237,630 |
RETAINED INTERESTS, TRADING | | 104,198,721 | | 98,010,592 |
SECURITIES HELD FOR SALE | | 857,788 | | 2,782,548 |
MORTGAGE SERVICING RIGHTS, NET | | 98,859,466 | | 86,081,594 |
RECEIVABLES, NET | | 5,958,329 | | 24,512,118 |
PRINCIPAL PAYMENTS RECEIVABLE | | 12,209,825 | | 21,497,365 |
ACCRUED INTEREST RECEIVABLE | | 14,072,078 | | 15,740,475 |
DERIVATIVE ASSET | | 5,863,963 | | - |
DEFERRED TAX ASSET | | 7,180,598 | | - |
PROPERTY AND EQUIPMENT, NET | | 15,788,078 | | 16,067,170 |
PREPAIDS AND OTHER ASSETS | | 21,571,169 | | 19,321,766 |
| | | | |
| $ | 3,937,633,936 | $ | 4,805,101,565 |
| | | | |
LIABILITIES AND STOCKHOLDERS' EQUITY | | | | |
| | | | |
LIABILITIES: | | | | |
Repurchase agreements | $ | 2,741,679,650 | $ | 3,337,598,362 |
Warehouse lines of credit and drafts payable | | 734,878,632 | | 873,741,429 |
Other secured borrowings | | 121,976,748 | | 104,886,339 |
Junior subordinated notes due to Bimini Capital Trust I & II | | 103,097,000 | | 103,097,000 |
Accrued interest payable | | 17,776,464 | | 30,232,719 |
Unsettled security purchases | | - | | 58,278,701 |
Dividends payable | | 1,266,937 | | - |
Deferred tax liability | | - | | 18,360,679 |
Minority interest in consolidated subsidiary | | 770,563 | | - |
Accounts payable, accrued expenses and other | | 23,753,113 | | 26,417,996 |
TOTAL LIABILITIES | | 3,745,199,107 | | 4,552,613,225 |
| | | | |
COMMITMENTS AND CONTINGENCIES | | | | |
| | | | |
STOCKHOLDERS' EQUITY: | | | | |
Preferred stock, $0.001 par value; 10,000,000 shares authorized; designated, 1,800,000 shares as Class A Redeemable and 2,000,000 shares as Class B Redeemable; at December 31, 2006, no shares issued and outstanding; at December 31, 2005, 1,223,208 Class A Redeemable and no Class B Redeemable issued and outstanding. | | - | | 1,223 |
Class A common stock, $0.001 par value; 98,000,000 shares designated; 24,515,717 shares issued and outstanding at December 31, 2006 and 24,129,042 shares issued and 23,567,242 shares outstanding at December 31, 2005. | | 24,516 | | 24,129 |
Class B common stock, $0.001 par value; 1,000,000 shares designated, 319,388 shares issued and outstanding at December 31, 2006 and 2005. | | 319 | | 319 |
Class C common stock, $0.001 par value; 1,000,000 shares designated, 319,388 shares issued and outstanding at December 31, 2006 and 2005. | | 319 | | 319 |
Additional paid-in capital | | 335,646,460 | | 342,230,342 |
Accumulated other comprehensive loss | | (76,773,610) | | (76,494,378) |
Accumulated deficit | | (66,463,175) | | (8,037,260) |
Treasury Stock; 561,800 shares of Class A common stock, at cost | | - | | (5,236,354) |
| | | | |
STOCKHOLDERS' EQUITY | | 192,434,829 | | 252,488,340 |
| | | | |
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY | $ | 3,937,633,936 | $ | 4,805,101,565 |
See notes to consolidated financial statements. |
OPTEUM INC. |
CONSOLIDATED STATEMENTS OF OPERATIONS |
| | | | | | |
| Year Ended December 31, |
| | 2006 | | 2005 | | 2004 |
| | | | | | |
Interest income, net of amortization of premium and discount | $ | 255,008,719 | $ | 160,640,830 | $ | 49,633,548 |
Interest expense | | (241,483,310) | | (123,658,728) | | (22,634,919) |
| | | | | | |
NET INTEREST INCOME | | 13,525,409 | | 36,982,102 | | 26,998,629 |
| | | | | | |
OTHER INCOME (LOSS) | | 7,397,768 | | (24,866) | | - |
| | | | | | |
SERVICING INCOME (LOSS): | | | | | | |
Servicing fee income | | 26,496,080 | | 3,922,654 | | - |
Amortization of mortgage servicing rights | | (34,694,901) | | (2,429,759) | | - |
NET SERVICING INCOME (LOSS) | | (8,198,821) | | 1,492,895 | | - |
| | | | | | |
NON-INTEREST INCOME: | | | | | | |
GAINS ON MORTGAGE BANKING ACTIVITIES | | 15,458,268 | | 849,760 | | - |
OTHER-THAN-TEMPORARY LOSS ON MORTGAGE-BACKED SECURITIES | | (9,971,471) | | - | | - |
GAINS ON SALES OF MORTGAGE-BACKED SECURITIES | | - | | 1,993,457 | | 95,547 |
GAIN ON SALE OF A 7.5% INTEREST IN CONSOLIDATED SUBSIDIARY | | 2,785,776 | | - | | - |
| | | | | | |
TOTAL NET REVENUES | | 20,996,929 | | 41,293,348 | | 27,094,176 |
| | | | | | |
DIRECT REIT OPERATING EXPENSES | | 987,409 | | 994,784 | | 730,903 |
| | | | | | |
GENERAL AND ADMINISTRATIVE EXPENSES: | | | | | | |
Compensation and related benefits | | 35,003,107 | | 10,986,059 | | 2,497,600 |
Audit, legal and other professional fees | | 8,682,054 | | 1,447,519 | | 329,514 |
Other interest | | 7,586,955 | | 1,093,054 | | - |
Valuation allowance | | 13,319,018 | | 424,236 | | - |
Occupancy and utilities | | 14,410,939 | | 2,356,931 | | 62,232 |
Advertising and marketing | | 5,041,425 | | 982,349 | | - |
Other administrative | | 12,778,380 | | 2,945,745 | | 617,017 |
| | | | | | |
TOTAL GENERAL AND ADMINISTRATIVE EXPENSES | | 96,821,878 | | 20,235,893 | | 3,506,363 |
| | | | | | |
TOTAL EXPENSES | | 97,809,287 | | 21,230,677 | | 4,237,266 |
| | | | | | |
(LOSS) INCOME BEFORE INCOME TAXES | | (76,812,358) | | 20,062,671 | | 22,856,910 |
INCOME TAX BENEFIT | | 27,217,584 | | 4,220,000 | | - |
| | | | | | |
NET (LOSS) INCOME BEFORE MINORITY INTEREST | | (49,594,774) | | 24,282,671 | | 22,856,910 |
MINORITY INTEREST IN CONSOLIDATED SUBSIDIARY | | 48,912 | | - | | - |
NET (LOSS) INCOME | $ | (49,545,862) | $ | 24,282,671 | $ | 22,856,910 |
BASIC AND DILUTED NET (LOSS) INCOME PER SHARE OF: | | | | | | |
CLASS A COMMON STOCK | $ | (2.03) | $ | 1.12 | $ | 1.97 |
| | | | | | |
CLASS B COMMON STOCK | $ | (1.99) | $ | 1.16 | $ | 2.05 |
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING USED IN COMPUTING BASIC AND DILUTED PER SHARE AMOUNTS | | | | | | |
CLASS A COMMON STOCK | | 24,066,018 | | 21,421,501 | | 11,452,258 |
CLASS B COMMON STOCK | | 319,388 | | 319,388 | | 159,694 |
CASH DIVIDENDS DECLARED PER SHARE OF: | | | | | | |
CLASS A COMMON STOCK | $ | 0.46 | $ | 1.45 | $ | 1.97 |
| | | | | | |
CLASS B COMMON STOCK | $ | 0.46 | $ | 1.45 | $ | 1.06 |
|
See notes to consolidated financial statements. |
|
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY |
| | | | | | | | | |
| Common Stock, Amounts at par value | Class A Preferred | Treasury | Additional Paid-in | Accumulated Other Comprehensive | Accumulated | |
| Class A | Class B | Class C | Stock | Stock | Capital | Loss | Deficit | Total |
Balances, December 31, 2003 | $ 4,012 | $ 319 | $ 319 | $ - | $ - | $ 56,597,117 | $ (19,409) | $ (267,167) | $ 56,315,191 |
| | | | | | | | | |
Issuance of Class A common shares as board compensation | 12 | - | - | - | - | 174,374 | - | - | 174,386 |
Sale of Class A common shares in January 2004 | 5,837 | - | - | - | - | 82,858,509 | - | - | 82,864,346 |
Sale of Class A common shares in February 2004 | 158 | - | - | - | - | 2,248,313 | - | - | 2,248,471 |
Sale of Class A common shares in Sept. 2004 | 5,750 | - | - | - | - | 75,875,807 | - | - | 75,881,557 |
Cash dividends declared | - | - | - | - | - | - | - | (23,667,303) | (23,667,303) |
Amortization of equity plan compensation | - | - | - | - | - | 745,756 | - | - | 745,756 |
Reclassify net realized gain on security sales | - | - | - | - | - | - | (95,547) | - | (95,547) |
Sale of class A common shares in December 2004 | 4,600 | - | - | - | - | 66,674,775 | - | - | 66,679,375 |
Net income | - | - | - | - | - | - | - | 22,856,910 | 22,856,910 |
Unrealized loss on available for sale securities, net | - | - | - | - | - | - | (1,040,815) | - | (1,040,815) |
Comprehensive income | - | - | - | - | - | - | - | - | 21,816,095 |
Balances, December 31, 2004 | $ 20,369 | $ 319 | $ 319 | $ - | $ - | $285,174,651 | $ (1,155,771) | $ (1,077,560) | $ 282,962,327 |
| | | | | | | | | |
Issuance of Class A common shares for board compensation and equity plan share exercises | 43 | - | - | - | - | 357,800 | - | - | 357,843 |
Treasury stock purchases | - | - | - | - | (5,236,354) | - | - | - | (5,236,354) |
Issuance of stock for an acquisition | 3,717 | - | - | 1,223 | - | 54,716,654 | - | - | 54,721,594 |
Cash dividends declared | - | - | - | - | - | - | - | (31,242,371) | (31,242,371) |
Amortization of equity plan compensation | - | - | - | - | - | 2,130,132 | - | - | 2,130,132 |
Stock issuance costs | - | - | - | - | - | (148,895) | - | - | (148,895) |
Reclassify net realized gain on security sales | - | - | - | - | - | - | (1,993,457) | - | (1,993,457) |
Net income | - | - | - | - | - | - | - | 24,282,671 | 24,282,671 |
Unrealized loss on available for sale securities, net | - | - | - | - | - | - | (73,345,150) | - | (73,345,150) |
Comprehensive loss | - | - | - | - | - | - | - | - | (49,062,479) |
Balances, December 31, 2005 | $ 24,129 | $ 319 | $ 319 | $ 1,223 | $(5,236,354) | $342,230,342 | $ (76,494,378) | $ (8,037,260) | $ 252,488,340 |
| | | | | | | | | |
Fair value adjustment upon adoption of SFAS No. 156 (see Note 5) | - | - | - | - | - | - | - | 2,621,918 | 2,621,918 |
Issuance of Class A Common Stock for board compensation and equity plan share exercises, net | 253 | - | - | - | - | 978,055 | - | - | 978,308 |
Conversion of Class A Redeemable Preferred Stock into Class A Common Stock | 1,223 | - | - | (1,223) | - | - | - | - | - |
Treasury Stock purchases | - | - | - | - | (4,500,326) | - | - | - | (4,500,326) |
Retirement of Treasury Stock | (1,089) | - | - | - | 9,736,680 | (9,735,591) | - | - | - |
Cash dividends declared | - | - | - | - | - | - | - | (11,501,971) | (11,501,971) |
Amortization of equity plan compensation | - | - | - | - | - | 2,881,935 | - | - | 2,881,935 |
Equity plan shares withheld for statutory minimum withholding taxes | - | - | - | - | - | (579,897) | - | - | (579,897) |
Stock issuance costs, and other adjustments | - | - | - | - | - | (128,384) | - | - | (128,384) |
Net loss | - | - | - | - | - | - | - | (49,545,862) | (49,545,862) |
Unrealized loss on available-for-sale securities, net | - | - | - | - | - | - | (10,250,703) | - | (10,250,703) |
Reclassify other-than-temporary loss on MBS | - | - | - | - | - | - | 9,971,471 | - | 9,971,471 |
Comprehensive loss | - | - | - | - | - | - | - | - | (49,825,094) |
Balances, December 31, 2006 | $ 24,516 | $319 | $ 319 | $ - | $ - | $335,646,460 | $(76,773,610) | $(66,463,175) | $192,434,829 |
| | | | | | | | | |
See notes to consolidated financial statements. |
OPTEUM INC. |
CONSOLIDATED STATEMENTS OF CASH FLOWS |
| | | | | | |
| | Year Ended December 31, |
| | 2006 | | 2005 | | 2004 |
CASH FLOWS FROM OPERATING ACTIVITIES: | | | | | | |
Net (loss) income | $ | (49,545,862) | $ | 24,282,671 | $ | 22,856,910 |
Adjustments to reconcile net (loss) income to net cash provided by operating activities: | | | | | | |
(Gain) on mortgage banking activities | | (15,458,268) | | (849,760) | | - |
Amortization of premium and discount on mortgage backed securities | | (1,983,240) | | 17,370,738 | | 21,391,807 |
Other-than-temporary loss on MBS | | 9,971,471 | | - | | - |
(Increase) in residual interest in asset backed securities | | (6,188,129) | | (3,399,370) | | - |
Originated mortgage servicing rights | | (8,479,647) | | 998,183 | | - |
Decrease in mortgage loans held for sale | | 159,110,610 | | 293,211,577 | | - |
Decrease in securities held for sale | | 1,924,760 | | 846,987 | | - |
Derivative asset | | (5,112,274) | | - | | - |
(Gain) on sale of a 7.5% interest in OFS subsidiary | | (2,785,776) | | - | | - |
Stock compensation | | 3,280,346 | | 2,487,975 | | 920,142 |
Minority interest in the consolidated loss | | (48,912) | | - | | - |
Depreciation and amortization | | 4,383,776 | | 842,113 | | 26,886 |
Deferred income tax benefit | | (27,217,584) | | (4,220,000) | | - |
(Gain) on sales of mortgage-backed securities | | - | | (1,993,457) | | (95,547) |
Changes in operating assets and liabilities: | | | | | | |
Decrease in other receivables, net | | 18,553,789 | | 4,993,820 | | - |
(Increase)/decrease in accrued interest receivable | | 1,668,397 | | (4,362,666) | | (11,306,327) |
(Increase)/decrease in prepaids and other assets | | (2,877,381) | | 3,427,374 | | (711,221) |
(Decrease)/increase in accrued interest payable | | (12,456,255) | | 22,251,890 | | 7,960,743 |
(Decrease)/increase in accounts payable, accrued expenses and other | | (4,537,715) | | (2,770,309) | | 436,589 |
NET CASH PROVIDED BY OPERATING ACTIVITIES | | 62,202,106 | | 353,117,766 | | 41,479,982 |
| | | | | | |
CASH FLOWS FROM INVESTING ACTIVITIES: | | | | | | |
From available-for-sale securities: | | | | | | |
Purchases | | (716,951,195) | | (2,307,378,255) | | (3,409,261,768) |
Sales | | - | | 240,735,761 | | 360,124,493 |
Principal repayments | | 1,344,987,891 | | 1,429,565,048 | | 342,517,917 |
Cash acquired in OFS acquisition, net of costs | | - | | 1,651,892 | | - |
Net cash received from the sale of an interest in a consolidated subsidiary | | 3,605,251 | | - | | - |
Purchases of property and equipment, and other | | (3,476,707) | | (4,671,698) | | (1,988,721) |
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES | | 628,165,240 | | (640,097,252) | | (2,708,608,079) |
| | | | | | |
CASH FLOWS FROM FINANCING ACTIVITIES: | | | | | | |
Decrease (increase) in restricted cash | | 2,310,000 | | 6,352,000 | | (8,662,000) |
Proceeds from Repurchase Agreements | | 22,284,528,415 | | 19,974,952,748 | | 8,638,465,885 |
Principal Payments on Repurchase Agreements | | (22,880,447,127) | | (19,408,517,343) | | (6,056,143,928) |
Decrease in warehouse lines of credit, drafts payable and other secured borrowings | | (119,899,558) | | (279,086,207) | | - |
Net proceeds from trust preferred securities offerings | | - | | 100,030,956 | | - |
Stock issuance costs | | (128,384) | | (148,896) | | - |
Related party debt repaid immediately following acquisition | | - | | (18,333,000) | | - |
Third party debt repaid immediately following acquisition | | - | | (50,223,536) | | - |
Proceeds from sales of common stock, net of issuance costs | | - | | - | | 227,673,749 |
Purchase of treasury stock | | (4,500,326) | | (5,236,354) | | - |
Cash dividends paid | | (10,235,032) | | (31,242,370) | | (23,667,303) |
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES | | (728,372,012) | | 288,547,998 | | 2,777,666,403 |
| | | | | | |
NET CHANGE IN CASH AND CASH EQUIVALENTS | | (38,004,666) | | 1,568,512 | | 110,538,306 |
| | | | | | |
CASH AND CASH EQUIVALENTS, Beginning of the period | | 130,510,948 | | 128,942,436 | | 18,404,130 |
| | | | | | |
CASH AND CASH EQUIVALENTS, End of the period | $ | 92,506,282 | $ | 130,510,948 | $ | 128,942,436 |
|
See note to consolidated financial statements. |
OPTEUM INC. |
CONSOLIDATED STATEMENTS OF CASH FLOWS (CON'T) |
| | | | | | |
| | | | | | |
| | Year Ended December 31, |
| | 2006 | | 2005 | | 2004 |
| | | | | | |
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: | | | | | | |
Cash paid during the period for interest | $ | 261,526,520 | $ | 101,406,838 | $ | 14,197,204 |
| | | | | | |
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES: | | | | | | |
Cash dividends declared and payable, not yet paid | $ | 1,266,937 | $ | - | $ | - |
Unsettled security purchases | $ | - | $ | 58,278,701 | $ | 65,765,630 |
| | | | | | |
OFS acquisition: | | | | | | |
Fair value of assets acquired: | | | | | | |
Cash and cash equivalents | $ | - | $ | 3,431,736 | $ | - |
Loans held for sale | | - | | 1,186,599,447 | | - |
Retained interests, trading | | - | | 94,611,222 | | - |
Mortgage servicing rights, net | | - | | 87,079,777 | | - |
Fixed assets | | - | | 9,919,100 | | - |
Goodwill | | - | | 2,107,130 | | - |
Identifiable intangibles | | - | | 4,042,617 | | - |
Other assets | | - | | 46,203,917 | | - |
Total | | - | | 1,433,994,946 | | - |
| | | | | | |
Fair value of liabilities assumed: | | | | | | |
Deferred income tax liability | | - | | (22,580,679) | | - |
Other liabilities | | - | | (1,354,912,827) | | - |
Issuance of 1,223,208 shares of Class A Redeemable Preferred Stock and 3,717,242 shares of Class A Common Stock, inclusive of cash paid of $1,779,846 | $ | - | $ | 56,501,440 | $ | - |
| | | | | | |
See notes to consolidated financial statements. |
OPTEUM INC. |
CONSOLIDATED BALANCE SHEETS |
| | December 31, |
| | 2005 | | 2004 |
ASSETS | | | | |
| | | | |
MORTGAGE-BACKED SECURITIES: | | | | |
Pledged to counterparties, at fair value | $ | 3,493,490,046 | $ | 2,901,158,559 |
Unpledged, at fair value | | 539,313 | | 72,074,338 |
| | | | |
TOTAL MORTGAGE-BACKED SECURITIES | | 3,494,029,359 | | 2,973,232,897 |
| | | | |
CASH AND CASH EQUIVALENTS | | 130,510,948 | | 128,942,436 |
RESTRICTED CASH | | 2,310,000 | | 8,662,000 |
MORTGAGE LOANS HELD FOR SALE, NET | | 894,237,630 | | - |
RETAINED INTERESTS, TRADING | | 98,010,592 | | - |
SECURITIES HELD FOR SALE | | 2,782,548 | | - |
MORTGAGE SERVICING RIGHTS, NET | | 86,081,594 | | - |
RECEIVABLES, NET | | 24,512,118 | | - |
PRINCIPAL PAYMENTS RECEIVABLE | | 21,497,365 | | 3,419,199 |
ACCRUED INTEREST RECEIVABLE | | 15,740,475 | | 11,377,807 |
PROPERTY AND EQUIPMENT, NET | | 16,067,170 | | 2,050,923 |
PREPAIDS AND OTHER ASSETS | | 19,321,766 | | 732,469 |
| | | | |
| $ | 4,805,101,565 | $ | 3,128,417,731 |
| | | | |
LIABILITIES AND STOCKHOLDERS' EQUITY | | | | |
| | | | |
LIABILITIES: | | | | |
Repurchase agreements | $ | 3,337,598,362 | $ | 2,771,162,957 |
Warehouse lines of credit and drafts payable | | 873,741,429 | | - |
Other secured borrowings | | 104,886,339 | | - |
Junior subordinated notes due to Bimini Capital Trust I & II | | 103,097,000 | | - |
Accrued interest payable | | 30,232,719 | | 7,980,829 |
Unsettled security purchases | | 58,278,701 | | 65,765,630 |
Deferred tax liability | | 18,360,679 | | - |
Accounts payable, accrued expenses and other | | 26,417,996 | | 545,988 |
| | | | |
TOTAL LIABILITIES | | 4,552,613,225 | | 2,845,455,404 |
| | | | |
COMMITMENTS AND CONTINGENCIES | | | | |
| | | | |
STOCKHOLDERS' EQUITY: | | | | |
Preferred stock, $0.001 par value; 10,000,000 shares authorized; designated, 1,800,000 shares as Class A Redeemable and 2,000,000 shares as Class B Redeemable; shares issued and outstanding at December 31, 2005, 1,223,208 Class A Redeemable and no Class B Redeemable; no shares issued and outstanding at December 31, 2004 | | 1,223 | | - |
Class A common stock, $0.001 par value; 98,000,000 shares designated; 24,129,042 shares issued and 23,567,242 shares outstanding at December 31, 2005, 20,368,915 shares issued and outstanding at December 31, 2004 | | 24,129 | | 20,369 |
Class B common stock, $0.001 par value; 1,000,000 shares designated, 319,388 shares issued and outstanding at December 31, 2005 and 2004 | | 319 | | 319 |
Class C common stock, $0.001 par value; 1,000,000 shares designated, 319,388 shares issued and outstanding at December 31, 2005 and 2004 | | 319 | | 319 |
Additional paid-in capital | | 342,230,342 | | 285,174,651 |
Accumulated other comprehensive loss | | (76,494,378) | | (1,155,771) |
Accumulated deficit | | (8,037,260) | | (1,077,560) |
Treasury Stock; 561,800 shares of Class A common stock, at cost | | (5,236,354) | | - |
| | | | |
STOCKHOLDERS' EQUITY | | 252,488,340 | | 282,962,327 |
| | | | |
| $ | 4,805,101,565 | $ | 3,128,417,731 |
| | | | |
See notes to consolidated financial statements. |
OPTEUM INC. |
CONSOLIDATED STATEMENTS OF OPERATIONS |
| | | | | | September 24, 2003 |
| | Year Ended December 31, | | (inception) through |
| | 2005 | | 2004 | | December 31, 2003 |
| | | | | | |
Interest income, net of amortization of premium and discount | $ | 160,640,830 | $ | 49,633,548 | $ | 71,480 |
Interest expense | | (123,658,728) | | (22,634,919) | | (20,086) |
| | | | | | |
NET INTEREST INCOME | | 36,982,102 | | 26,998,629 | | 51,394 |
| | | | | | |
OTHER INCOME | | 824,894 | | - | | - |
| | | | | | |
Servicing fee income | | 3,922,654 | | - | | - |
Amortization of mortgage servicing rights | | (2,429,759) | | - | | - |
NET SERVICING INCOME | | 1,492,895 | | - | | - |
| | | | | | |
GAINS ON SALES OF MORTGAGE-BACKED SECURITIES | | 1,993,457 | | 95,547 | | - |
| | | | | | |
TOTAL NET REVENUES | | 41,293,348 | | 27,094,176 | | 51,394 |
| | | | | | |
DIRECT OPERATING EXPENSES | | 994,784 | | 730,903 | | 45,482 |
| | | | | | |
GENERAL AND ADMINISTRATIVE EXPENSES: | | | | | | |
Compensation and related benefits | | 10,986,059 | | 2,497,600 | | 35,964 |
Directors' fees | | 357,843 | | 174,384 | | - |
Directors' liability insurance | | 283,134 | | 176,265 | | - |
Audit, legal and other professional fees | | 1,136,204 | | 329,514 | | 85,340 |
Other interest expense | | 1,093,054 | | - | | - |
Occupancy and related expenses | | 1,038,401 | | 62,232 | | 13,675 |
Other administrative expenses | | 5,341,198 | | 266,368 | | 138,100 |
| | | | | | |
TOTAL GENERAL AND ADMINISTRATIVE EXPENSES | | 20,235,893 | | 3,506,363 | | 273,079 |
| | | | | | |
INCOME (LOSS) BEFORE INCOME TAXES | | 20,062,671 | | 22,856,910 | | (267,167) |
| | | | | | |
INCOME TAX BENEFIT | | 4,220,000 | | - | | - |
| | | | | | |
NET INCOME (LOSS) | $ | 24,282,671 | $ | 22,856,910 | $ | (267,167) |
| | | | | | |
BASIC AND DILUTED NET INCOME (LOSS) | | | | | | |
PER CLASS A COMMON SHARE | $ | 1.12 | $ | 1.97 | $ | (0.54) |
| | | | | | |
BASIC AND DILUTED NET INCOME PER CLASS B COMMON SHARE | $ | 1.16 | $ | 2.05 | $ | - |
| | | | | | |
WEIGHTED AVERAGE NUMBER OF CLASS A COMMON SHARES OUTSTANDING USED IN COMPUTING BASIC AND DILUTED PER SHARE AMOUNTS | | 21,421,501 | | 11,452,258 | | 497,859 |
| | | | | | |
WEIGHTED AVERAGE NUMBER OF CLASS B COMMON SHARES OUTSTANDING USED IN COMPUTING BASIC AND DILUTED PER SHARE AMOUNTS | | 319,388 | | 159,694 | | - |
| | | | | | |
CASH DIVIDENDS DECLARED PER: | | | | | | |
CLASS A COMMON SHARE | $ | 1.45 | $ | 1.97 | $ | - |
| | | | | | |
CLASS B COMMON SHARE | $ | 1.45 | $ | 1.06 | $ | - |
| | | | | | |
See notes to consolidated financial statements. |
OPTEUM INC. |
CONSOLIDATED STATEMENTS OF CASH FLOWS |
| | | | | | September 24, 2003 |
| | Year Ended December 31, | | (inception) through |
| | 2005 | | 2004 | | December 31, 2003 |
CASH FLOWS FROM OPERATING ACTIVITIES: | | | | | | |
Net income (loss) | $ | 24,282,671 | $ | 22,856,910 | $ | (267,167) |
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: | | | | | | |
Amortization of premium and discount on mortgage backed securities | | 17,370,738 | | 21,391,807 | | - |
Residual interest in asset backed securities | | (3,399,370) | | - | | - |
Originated mortgage servicing rights | | 998,183 | | - | | - |
Decrease in mortgage loans held for sale | | 292,361,817 | | - | | - |
Stock compensation | | 2,487,975 | | 920,142 | | 1,209 |
Depreciation and amortization | | 842,113 | | 26,886 | | 5,452 |
Deferred income tax benefit | | (4,220,000) | | - | | - |
Gain on sales of mortgage-backed securities | | (1,993,457) | | (95,547) | | - |
Changes in operating assets and liabilities: | | | | | | |
Receivables | | 4,993,820 | | - | | - |
Accrued interest receivable | | (4,362,666) | | (11,306,327) | | (71,480) |
Prepaids and other assets | | 3,427,374 | | (711,221) | | (21,248) |
Accrued interest payable | | 22,251,890 | | 7,960,743 | | 20,086 |
Accounts payable, accrued expenses and other | | (2,770,309) | | 436,589 | | 109,399 |
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES | | 352,270,779 | | 41,479,982 | | (223,749) |
| | | | | | |
CASH FLOWS FROM INVESTING ACTIVITIES: | | | | | | |
From available-for-sale securities: | | | | | | |
Purchases | | (2,307,378,255) | | (3,409,261,768) | | (226,719,139) |
Sales | | 240,735,761 | | 360,124,493 | | - |
Principal repayments | | 1,429,565,048 | | 342,517,917 | | - |
Cash acquired in OFS acquisition, net of costs | | 1,651,892 | | - | | - |
Purchases of property and equipment | | (4,671,698) | | (1,988,721) | | (94,540) |
NET CASH USED IN INVESTING ACTIVITIES | | (640,097,252) | | (2,708,608,079) | | (226,813,679) |
| | | | | | |
CASH FLOWS FROM FINANCING ACTIVITIES: | | | | | | |
Decrease (increase) in restricted cash | | 6,352,000 | | (8,662,000) | | - |
Net borrowings under repurchase agreements | | 566,435,405 | | 2,582,321,957 | | 188,841,000 |
Decrease in warehouse lines of credit, drafts payable and other secured borrowings | | (279,086,207) | | - | | - |
Net proceeds from trust preferred securities offerings | | 100,030,956 | | - | | - |
Stock issuance costs | | (148,895) | | - | | - |
Related party debt repaid immediately following acquisition | | (18,333,000) | | - | | - |
Third party debt repaid immediately following acquisition | | (50,223,536) | | - | | - |
Proceeds from sales of common stock, net of issuance costs | | - | | 227,673,749 | | 56,600,558 |
Purchase of Treasury Stock | | (5,236,354) | | - | | - |
Cash dividends paid | | (31,242,371) | | (23,667,303) | | - |
Decrease in securities held for sale | | 846,987 | | - | | - |
NET CASH PROVIDED BY FINANCING ACTIVITIES | | 289,394,985 | | 2,777,666,403 | | 245,441,558 |
| | | | | | |
NET CHANGE IN CASH AND CASH EQUIVALENTS | | 1,568,512 | | 110,538,306 | | 18,404,130 |
| | | | | | |
CASH AND CASH EQUIVALENTS, Beginning of the period | | 128,942,436 | | 18,404,130 | | - |
| | | | | | |
CASH AND CASH EQUIVALENTS, End of the period | $ | $ 130,510,948 | $ | 128,942,436 | $ | 18,404,130 |
| | | | | | |
See note to consolidated financial statements. |
OPTEUM INC. |
CONSOLIDATED STATEMENTS OF CASH FLOWS (CON'T) |
| | | | | | |
| | | | | | September 24, 2003 |
| | Year Ended December 31, | | (inception) through |
| | 2005 | | 2004 | | December 31, 2003 |
| | | | | | |
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: | | | | | | |
Cash paid during the period for interest | $ | 101,406,838 | $ | 14,197,204 | $ | - |
| | | | | | |
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES: | | | | | | |
Unsettled security purchases | $ | 58,278,701 | $ | 65,765,630 | $ | - |
| | | | | | |
OFS acquisition: | | | | | | |
Fair value of assets acquired: | | | | | | |
Cash and cash equivalents | $ | 3,431,736 | | | | |
Loans held for sale | | 1,186,599,447 | | | | |
Retained interests, trading | | 94,611,222 | | | | |
Mortgage servicing rights, net | | 87,079,777 | | | | |
Fixed assets | | 9,919,100 | | | | |
Goodwill | | 2,107,130 | | | | |
Identifiable intangibles | | 4,042,617 | | | | |
Other assets | | 46,203,917 | | | | |
Total | | 1,433,994,946 | | | | |
| | | | | | |
Fair value of liabilities assumed: | | | | | | |
Deferred income tax liability | | (22,580,679) | | | | |
Other liabilities | | (1,354,912,827) | | | | |
Issuance of 1,223,208 shares of Class A Redeemable Preferred Stock and 3,717,242 shares of Class A Common Stock, inclusive of cash paid of $1,779,846 | $ | 56,501,440 | | | | |
| | | | | | |
See notes to consolidated financial statements. |
OPTEUM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 20052006
NOTE 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Organization and Business Description
Opteum Inc. (Opteum), formerly “Biminia Maryland corporation (“Opteum”), was originally formed in September 2003 as Bimini Mortgage Management, Inc. (“Bimini”) for the purpose creating and managing a leveraged investment portfolio consisting of residential mortgage backed securities (“MBS”). Opteum’s shares of Class A Common Stock are listed on the New York Stock Exchange (“NYSE”) and trade under the ticker symbol “OPX.” Opteum’s website is located at http://www.opteum.com.
On November 3, 2005, Opteum, then known as Bimini, acquired Opteum Financial Services, LLC (“OFS”), was incorporated in Maryland on September 24, 2003,a company that originates, buys, sells, and it commenced its planned business activities on December 19, 2003,services residential mortgages from offices throughout the dateUnited States. Upon closing of the initial closingtransaction, OFS became a wholly-owned taxable REIT subsidiary of Bimini. Under the terms of the transaction, Bimini issued 3,717,242 shares of Class A Common Stock and 1,223,208 shares of Class A Redeemable Preferred Stock to the former members of OFS. Bimini also agreed to a private issuancecontingent earn-out of its common stock.up to $17.5 million payable to the former members of OFS on or before November 3, 2010, in cash or, under certain circumstances, additional shares of Class A Redeemable Preferred Stock. The contingent earn-out is based on the achievement by OFS of certain specific financial objectives. For the period ended December 31, 2006, such objectives were not met and there were no payments made in respect of the contingent earn-out.
On February 6,10, 2006, Opteum, announced thatin an effort to more fully leverage OFS’s national brand identity, Bimini changed its board of directors voted unanimously to change its name from Bimini Mortgage Management, Inc. to Opteum Inc. At Opteum’s 2006 Annual Meeting of Stockholders, the shares of Class A Redeemable Preferred Stock issued to the former members of OFS were converted into shares of Opteum’s Class A Common Stock on a one-for-one basis following the approval of such conversion by Opteum’s stockholders.
On February 10,December 21, 2006, Opteum sold to Citigroup Global Markets Realty Corp. (“Citigroup Realty”) a Class B non-voting limited liability company membership interest in OFS, representing 7.5% of all of OFS’s outstanding limited liability company membership interests, for $4.1 million. Immediately following the corporate name change was effectivetransaction, Opteum held Class A voting limited liability company membership interests in OFS representing 92.5% of all of OFS’s outstanding limited liability company membership interests. In connection with the transaction, Opteum also granted Citigroup Realty the option, exercisable on or before December 20, 2007, to acquire additional Class B non-voting limited liability company membership interests in OFS representing 7.49% of all of OFS’s outstanding limited liability company membership interests.
Opteum has elected to be taxed as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended (the “Code”). As a REIT, Opteum is generally not subject to federal income tax on its REIT taxable income provided that it distributes to its stockholders at least 90% of its REIT taxable income on an annual basis. OFS has elected to be treated as a taxable REIT subsidiary and, its NYSE, ticker symbol was changed from “BMM”as such, is subject to “OPX.” The corporate name change leveragesfederal, state and local income taxation. In addition, the brand identityability of OFS to deduct interest paid or accrued to Opteum Financial Services, LLC (OFS),for federal, state and further enhances the integration of Opteum and the associates of OFS. One company and one national brand now represent a unified imagelocal tax purposes is subject to investors, customers and associates.certain limitations.
As used in this document, references to “Opteum,” the parent company, the registrant, “Opteum” and discussions related to REIT qualifying activities or the general management of Opteum’sOpteum Inc.’s investment portfolio of residential mortgage backed securities (MBS) refers(“MBS”) refer solely to “Opteum Inc.” Further, as used in this document, “OFS”, ourreferences to “OFS,” Opteum’s taxable REIT subsidiary (TRS) or our non REITnon-REIT eligible assets refer solely to Opteum Financial Services, LLC. Discussions relatingLLC and its consolidated subsidiaries. References to the “Company” refer to theOpteum and OFS on a consolidated entity (the combination of “Opteum” and our TRS “OFS”).basis. The assets and activities that are not REIT eligible, such as mortgage origination, acquisition and servicing activities, are conducted by OFS.
Opteum Inc. was formed to invest primarily in, but not limited to, residential mortgage related securities issued by the Federal National Mortgage Association (more commonly known as Fannie Mae), the Federal Home Loan Mortgage Corporation (more commonly known as Freddie Mac) and the Government National Mortgage Association (more commonly known as Ginnie Mae).
Opteum has elected to be taxed as a real estate investment trust ("REIT") under the Internal Revenue Code of 1986, as amended (the “Code”). In order to maintain its REIT qualification, Opteum must comply with a number of requirements under federal tax law, including that it must distribute at least 90% of its annual REIT taxable income to its stockholders, subject to certain adjustments.
Merger Agreement
On September 29, 2005, Opteum executed a definitive merger agreement with OFS, a privately held home mortgage lender headquartered in Paramus, New Jersey. OFS has 1,066 associates operating out of 34 offices and lending in 44 states. The transaction, in which OFS became a wholly-owned TRS of Opteum, closed on November 3, 2005 (see Note 2).
Under the terms of the merger agreement, Opteum issued 3,717,242 shares of Class A Common Stock and 1,223,208 shares of Class A Redeemable Preferred Stock to the stockholders of OFS in exchange for 100% of the stock of OFS. The shares of Class A Redeemable Preferred Stock will be convertible into Class A Common Stock of Opteum, on a one-for-one basis, if Opteum’s stockholders eligible to vote approve the conversion at a future stockholder meeting. Opteum also agreed to pay the OFS stockholders a contingent earn-out of up to $17.5 million over the next five years payable in cash, or under certain circumstances, shares of Class B Redeemable Preferred Stock, based on the achievement by OFS of certain specific financial objectives. The three most senior executives of OFS entered into long-term employment contracts upon completion of the merger.
Basis of Presentation and Use of Estimates
The accompanying consolidated financial statements are prepared on the accrual basis of accounting in accordance with U.S. generally accepted accounting principles ("GAAP"principals (“GAAP”). 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. Significant estimates affecting the accompanying financial statements include the fair values of mortgage-backed securities,MBS, the prepayment speeds used to calculate amortization and accretion of premiums and discounts on mortgage-backed securities,MBS, the deferred tax assetliability valuation, the valuation allowance on mortgage loans held for sale, the valuation of derivative financial instrumentsretained interests, trading and the fair value of mortgage servicing rights. Certain December 31, 2005 and 2004 amounts were reclassified to conform to the 2006 presentation.
Opteum owned 100% of OFS until December 21, 2006, when a Class B non-voting interest representing 7.5% of OFS’s then outstanding Limited Liability Company membership interest was sold to Citigroup Realty. Citigroup Realty’s proportionate share in the after-tax results of OFS’s operations are shown in the accompanying consolidated statements of operations, and Citigroup Realty’s interests in the net equity of OFS is reflected as a liability on the accompanying consolidated balance sheets.
The accompanying 2006 consolidated financial statements include the accounts of Opteum and its wholly-ownedmajority-owned subsidiary, OFS, as well the wholly-owned and majority owned subsidiaries of OFS. Opteum usesAll inter-company accounts and transactions have been eliminated from the equity method to accountconsolidated financial statements.
The financial statements for investmentsDecember 31, 2005 include the results of OFS for which it has the ability to exercise significant influence over operating and financial policies. period November 3, 2005 (date of merger) through December 31, 2005.
As further described in Note 11, Opteum has ana common share investment in two trusts used to completein connection with the issuance of Opteum’s junior subordinated notes. Pursuant to the accounting guidance provided in FASBFinancial Accounting Standards Board (“FASB”) Interpretation (“FIN”) No. 46, “Consolidation of Variable Interest Entities,” Opteum’s common shares investment in the trusts are not consolidated in the financial statements of Opteum, and accordingly, these investments are accounted for on the equity method. Consolidated net earnings of Opteum include Opteum’s share of the net earnings (losses) of these companies, if any. All material intercompany accounts and transactions have been eliminated from the consolidated financial statements.
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand and highly liquid investments with original maturities of three months or less. The carrying amount of cash equivalents approximates its fair value at December 31, 20052006 and 2004.2005.
Restricted cash represents cash held on deposit as collateral with certain repurchase agreement counter-partiescounterparties (i.e. lenders). Such amounts may be used to make principal and interest payments on the related repurchase agreements.
Valuation of Mortgage Backed Securities
The valuation of the Company's investments in MBS is governed by Statement of Financial Accounting Standards (“SFAS”) No. 107, Disclosures about Fair Value of Financial Instruments. SFAS No. 107 defines the fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties. All REIT securities are reflected in the Company's financial statements at their estimated fair value as of December 31, 2006, and December 31, 2005. Estimated fair values for MBS are based on the average of third-party broker quotes received and/or independent pricing sources when available. However, the fair values reported reflect estimates and may not necessarily be indicative of the amounts the Company could realize in a current market exchange.
In accordance with GAAP, Opteumthe Company classifies its investments in mortgage backed securitiesMBS as either trading investments, available-for-sale investments or held-to-maturity investments. Management determines the appropriate classification of the securities at the time they are acquired and evaluates the appropriateness of such classifications at each balance sheet date. Although Opteumthe Company intends to hold its mortgage-backed securities (“MBS”)MBS until maturity, it may, from time to time, sell any of its mortgage-backed securitiesMBS as part of the overall management of the business. Opteum currentlyThe Company classifies all of its securities as available-for-sale and assets so classified are carried on the balance sheet at fair value and unrealized gains or losses arising from changes in market valuesfair value are reported as other comprehensive income or loss as a component of stockholders' equity. Other than temporary impairment losses, if any, are reported in earnings.
When the fair value of an available for saleavailable-for-sale security is less than amortized cost, management considers whether there is an other-than-temporary impairment in the value of the security. The decision is based on the credit quality of the issue (agency versus non-agency and for non-agency, the credit performance of the underlying collateral), the security prepayment speeds, and the length of time the security has been in an unrealized loss position. Atposition and the Company's ability and intent to hold securities. As of December 31, 2005, Opteum2006, the Company did not hold any non-agency securities in its portfolio. If, in management's judgment, an other-than-temporary impairment exists, the cost basis of the security is written down in the period to the then-current fair value and the unrealized loss is transferred from accumulated other comprehensive income as an immediate reduction ofrecognized in current earnings (i.e., as if the loss had been realized in the period of impairment).earnings.
Mortgage Loans Held for Sale
Mortgage loans held for sale represent mortgage loans originated and held by the Company pending sale to investors. The mortgages are carried at the lower of cost or market as determined by outstanding commitments from investors or current investor yield requirements calculated on the aggregate loan basis. Deferred net fees or costs are not amortized during the period the loans are held for sale, but are recognizedrecorded when the loan is sold. OFSThe Company generally, but not always, sells or securitizes loans with servicing rights retained. These transfers of financial assets are accounted for as sales for financial reporting purposes when control over the assets has been surrendered. Control over transferred assets is surrendered when:when (i) the assets have been isolated from OFS; the investorCompany; (ii) the purchaser obtains the right, free of conditions that constrain itsuch purchaser from taking advantage of that right, to pledge or exchange the transferred assets:assets and OFS(iii) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. These transactions are treated as sales in accordance with SFAS No. 140Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities. Gains or losses on such sales are recognized at the time legal title transfers to the investor,purchaser and are based upon the difference between the sales proceeds from the final investorpurchaser and the allocated basis of the loan sold, adjusted for net deferred loan fees and certain direct costs and selling costs.
Valuation Allowance
A valuation allowance is recorded to adjust mortgage loans held for sale to the lower of cost or market.
Retained Interest, Trading
OFSThe Company uses warehouse loan arrangements to finance the origination and purchase of pools of principally fixed and adjustable-rate residential first mortgage loans (the “Mortgage Loans”). Subsequent to their origination or purchase, OFS either sells these loansMortgage Loans to third partythird-party institutional investors through bulk sale arrangements or through securitization transactions. OFSThe Company generally makes several representations and warranties regarding the performance of the Mortgage Loans in connection with each sale or securitization. OFS
In a securitization, the Company accumulates the desired amount of Mortgage Loans and securitizes them in order to create marketable securities.
OFS, First, pursuant to a purchase and sale agreement, transfersMortgage Loan Purchase Agreement (“MLPA”), the Company sells Mortgage Loans to Opteum Mortgage Acceptance Corp. (OPMAC), aOMAC, the Company's wholly-owned special purpose entity set-upcreated for the execution of these securitizations.
OPMAC then sells the Mortgage Loans to an institutional third party to serve as Depositor, pursuant to a Mortgage Loan Purchase and Servicing Agreement (“P&S Agreement”). Under this P&S Agreement, OFSMLPA, the Company makes general representations and warranties for the Mortgage Loans sold by OFS.the Company to OMAC.
The DepositorOMAC then deposits the Mortgage Loans purchased from the Company into a Real Estate Mortgage Investment Conduit (“REMIC”) trust (the “REMIC”where, pursuant to a Pooling and Servicing Agreement (“P&S Agreement”) where, the rights to the cash flows associated with such Mortgage Loans are pooled and converted intosold to investors in the form of marketable debt securities pursuant to the P&S Agreement.securities. These securities, issued by the REMIC trust, are divided into different classes of certificates (the “Certificates”) with varying claims to payments received on the Mortgage Loans. These Certificates are transferred to the depositor in exchange for all of its rights in the Mortgage Loans deposited into the REMIC.
Certain Certificates are rated by Moody’s Investors Service, Inc. (“Moody’s”) and Standard & Poor’s (“S&P”). In all of the securitizations, all of the senior certificate classes were rated “AAA” by S&P, and “Aaa” by Moody’s, respectively. In addition, most of the mezzanine classes of certificates, starting with Class M-1 through the lowest respective subordinate class for each offering, with each lower numerical class designation being subordinated to the previous designation (the “Mezzanine Certificates”), were each given investment grade ratings. The subordinate classes not given an investment grade rating were sold through a Private Placement Offering Memorandum. Certain of these Certificates are offered to the public (the “Public Certificates”) pursuant to a prospectus. These Public Certificates are sold to underwriters on the closing date pursuant to an underwriting agreement. The proceeds from the sale of the Public Certificates to the underwriters (less an underwriting discount) and the remaining non-publicly offered Certificates are ultimately transferred to OFSthe Company as partial consideration for the Mortgage Loans sold to the depositorOMAC pursuant to the P&S Agreement.MLPA.
Finally, OFS transferssubsequent to a securitization transaction as described above, the proceeds from the saleCompany typically executes an additional net interest margin (“NIM”) securitization, or “resecuritization” of the Public Certificates and the non-publicly offered Certificates representing the residual interest in the REMIC to OPMAC pursuant to the Purchase and Sale Agreement. The additional non-publicly offered Certificates, representing prepayment penalties and overcollateralizationover-collateralization fundings (the “Underlying Certificates”) are held by OPMAC in anticipation of a net interest margin (“NIM”) securitization. Subsequent to a securitization transaction as described above, OFS executes an additional securitization or “resecuritization” of the Underlying Certificates being held by OPMAC.. This NIM securitization is typically transacted as follows:
OPMACOMAC first deposits the Underlying Certificates into a trust (the “NIM Trust”) pursuant to a deposit trust agreement. The NIM Trust, is a Delaware statutory trust. The NIM Trust, pursuant to an indenture, then issues (i) notes (the “NIM Notes”) representing interests in the Underlying Certificates and (ii) an owner trust certificate (the “Trust“Owner Trust Certificate”) representing the residual interest in the NIM trust.Trust. The NIM Notes wereare sold to third parties via private placement transactions,transactions. The net proceeds from the sale of the NIM Notes and the Owner Trust Certificate isare then transferred from OPMACOMAC to OFS in consideration for the deposit ofCompany. The Owner Trust Certificates from the Underlying Certificates.
Securities Held for Sale
Securities held for saleCompany's various securitizations represent the retained interest, trading on the consolidated balance sheet and are recorded as of the date of purchase or salecarried at fair value. Changesvalue with changes in fair value subsequent to the purchase date are reflected in earnings as gains and losses from investments. Realized gains and losses are determined on a specific identified basis cost basis.earnings.
Mortgage Servicing Rights
OFSThe Company recognizes mortgage servingservicing rights (“MSR”MSRs”) as an asset when separated from the underlying mortgage loans uponin connection with the sale of thesuch loans. Upon sale of a loan, OFSthe Company measures the retained MSRs by allocating the total cost of originating a mortgage loan between the loan and the servicing right based on their relative fair values. FairThe estimated fair value of MSRs is estimated based on expected cash flows consideringdetermined by obtaining a market valuation from a specialist who brokers MSRs. The broker, Interactive Mortgage Advisors, LLC (IMA), is 50% owned by OFS. To determine the market valuation, the broker uses a valuation model that incorporates assumptions relating to the estimate of the cost of servicing the loan, a discount rate, a float value, an inflation rate, ancillary income of the loan, prepayment estimates, historical prepaymentspeeds and default rates portfolio characteristics, interest rates, and other economic factors.that market participants use for acquiring similar servicing rights. Gains or losses on the sale of MSRs are recognized when title and all risks and rewards have irrevocably passed to the buyerpurchaser of such MSRs and there are no significant unresolved contingencies. MSRs are carried
In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Assets. SFAS 156 amends SFAS 140 with respect to the accounting for separately-recognized servicing assets and liabilities. SFAS 156 requires all separately-recognized servicing assets and liabilities to be initially measured at fair value and permits companies to elect, on a class-by-class basis, to account for servicing assets and liabilities on either a lower of cost or market value basis or a fair value measurement basis. The Company elected to early adopt SFAS 156 as of January 1, 2006, and to measure all mortgage servicing assets at fair value (and as one class). Servicing assets and liabilities at December 31, 2005 were accounted for at the lower of amortized cost less accumulated amortization, or fairmarket value. MSRs are amortizedAs a result of adopting SFAS 156, the Company recognized a $2.6 million after-tax ($4.3 million pre-tax) increase in proportion to,retained earnings as of January 1, 2006, representing the cumulative effect adjustment of re-measuring all servicing assets and over the period of, the estimated future net servicing income. Such amortization, which is recorded as a reduction of net servicing revenue in the accompanying consolidated financial statements, was $2.4 million during the year ended December 31, 2005.
For purposes of performing its quarterly impairment evaluation, OFS stratifies its portfolio primarily on the basis of interest rates of the underlying mortgage loans and the type of product associated with the MSRs. OFS measures impairment for each stratum by comparing estimated fair value to the carrying amount. For the period endedliabilities that existed at December 31, 2005, there was no such impairment which would have been recorded asfrom a reductionlower of net servicing revenue.amortized cost or market basis to a fair value basis.
Property and Equipment, net
Property and equipment, net, consisting primarily of computer equipment with a depreciable life of 3 to 5 years, office furniture with a depreciable life of 5 to 12 years, leasehold improvements with a depreciable life of 5 to 15 years, land which has no depreciable life and building with a depreciable life of 30 years, is recorded at acquisition cost and depreciated using the straight-line method over the estimated useful lives of the assets. Asset lives range from fivethree years for computer equipment to thirty years fordepending on the building.type of asset. Property and equipment atas of December 31, 20052006 and 2004December 31, 2005, is net of accumulated depreciation of $606,889$4.3 million and $32,338,$0.6 million, respectively. Depreciation expense for the yeartwelve months ended December 31, 2006, 2005, was $574,551. Depreciation expense for the year ended December 31,and 2004 was $26,886$3.7 million, $0.6 million and it was $5,452 for the period from inception through December 31, 2003.$0.03 million, respectively.
Goodwill and Other Intangible Assets
Goodwill represents the excess of the purchase price of Opteum’s acquisition over the fair value of net assets acquired in a business combination. The Company's goodwill all arose from the OFS merger. Contingent consideration paid in subsequent periods under the terms of the purchaseOFS merger agreement, if any, would be considered acquisition costs and classified as goodwill. Goodwill was $2.1 million as of December 31, 2005.
In accordance with SFAS No. 142,Goodwill and Other Intangible Assets,Opteum will subject the Company subjects its goodwill to at least an annual assessment for impairment by applying a fair value-based test. If the carrying value exceeds the fair value, goodwill is impaired. There wasTo date, there has been no impairment of goodwill as of December 31, 2005.charge recorded for the Company's goodwill.
Derivative Assets and Derivative Liabilities
Opteum Financial Service’sThe Company's mortgage committed pipeline includes interest rate lock commitments (“IRLCs”) that have been extended to borrowers who have applied for loan funding and meet certain defined credit and underwriting criteria. Effective with the adoption of Statement of Financial Accounting Standards (“SFAS”)SFAS No. 133,Accounting for Derivative Instruments and Hedging Activities, as amended, OFSthe Company classifies and accounts for the IRLCs as freestanding derivatives. Accordingly, IRLCs are recorded at their fair value with changes in fair value recorded to current earnings. OFSChanges in fair value of IRLCs are determined based on changes in value of similar loans observed over the period in question. The Company uses other derivative instruments to economically hedge the IRLCs, which are also classified and accounted for as freestanding derivatives.
OFS’sThe Company's risk management objective for its mortgage loans held for sale includes use of mortgage forward delivery contracts designed as fair value derivative instruments to protect earnings from an unexpected change due to a decline in value. Effective with the adoption of SFAS No. 133, OFSthe Company's mortgage forward delivery contracts are recorded at their fair value with changes in fair value recorded to current earnings.
IRLCs and derivative assets or liabilities arising The value of mortgage forward delivery contracts are obtained from OFS’s derivative activities are included in either receivables or accounts payable and accrued liabilities in the accompanying consolidated financial statements. OFSreadily available market sources. The Company also evaluates its contractual arrangements, assets and liabilities for the existence of embedded derivatives.
Derivative assets or liabilities arising from the Company's derivative activities are reported as separate line items in the accompanying consolidated financial statements in “Derivative Asset” or Derivative Liability.” IRLCs are included in Mortgage loans held for sale. Fluctuations in the fair market value of IRLCs and other derivatives employed are reflected in the consolidated statement of operations under the caption “Gains on mortgage banking activities.”
Repurchase Agreements
OpteumThe Company finances the acquisition of its MBS through the use of repurchase agreements. Under these repurchase agreements, Opteum transfersthe Company sells securities to a lenderrepurchase counterparty and agrees to repurchase the same securities in the future for a price that is higher than the original sales price. The difference between the salesales price that Opteumthe Company receives and the repurchase price that Opteumthe Company pays represents interest paid to the lender.repurchase counterparty. Although structured as a sale and repurchase obligation, a repurchase agreement operates as a financing under which Opteumthe Company pledges its securities as collateral to secure a loan which is equal in value to a specified percentage of the estimated fair value of the pledged collateral. OpteumThe Company retains beneficial ownership of the pledged collateral. At the maturity of a repurchase agreement, Opteumthe Company is required to repayrepurchase the loanunderlying MBS and concurrently receives back its pledged collateral from the lenderrepurchase counterparty or, with the consent of the lender, Opteumrepurchase counterparty, the Company may renew such agreement at the then prevailing financing rate. These repurchase agreements may require Opteumthe Company to pledge additional assets to the lenderrepurchase counterparty in the event the estimated fair value of the existing pledged collateral declines. As of December 31, 2006 and 2005, and 2004, Opteumthe Company did not have any margin calls on its repurchase agreements that it was not able to satisfy with either cash or additional pledged collateral.
Original terms to maturity of Opteum'sthe Company's repurchase agreements generally, but not always, range from one month to 36twelve months; however, Opteumthe Company is not precluded from entering into repurchase agreements with shorter or longer maturities. Repurchase agreement transactions are reflected in the financial statements at their cost, which approximates their fair value because of the short-term nature of these instruments. Should a counter-partycounterparty decide not to renew a repurchase agreement at maturity, Opteumthe Company must either refinance elsewhere or be in a position to satisfy this obligation. If, during the term of a repurchase agreement, a lender should filecounterparty files for bankruptcy, Opteum mightthe Company could experience difficulty recovering its pledged assets and may have an unsecured claim against the lender'scounterparty's assets for the difference between the amount loaned to Opteumreceived by the Company and the estimated fair value of the collateral pledged to such lender. At December 31, 2005, Opteum had amounts outstanding under repurchase agreements with fourteen separate lenders with a maximum net exposure (the difference between the amount loaned to Opteum and the estimated fair value of the security pledged by Opteum as collateral) to any single lender of approximately $27.0 million. At December 31, 2004, Opteum had amounts outstanding under repurchase agreements with twelve separate lenders with a maximum net exposure to any single lender of approximately $29.0 million.counterparty.
During 2005, Opteum entered into contracts and paid commitment fees to three lenders providing for an aggregate of $1.85 billion in committed repurchase lines at pre-determined borrowing rates and haircuts for a 364 day period following the commencement date of each contract. Opteum has no obligation to utilize these repurchase lines.
At December 31, 2005, Opteum's repurchase agreements had the following counter-parties, amounts at risk and weighted average remaining maturities:
Repurchase Agreement Counter-parties | | Amount Outstanding ($000) | | Amount at Risk(1) ($000) | Weighted Average Maturity of Repurchase Agreements in Days | Percent of Total Amount Outstanding |
Deutsche Bank Securities, Inc. | $ | 894,748 | $ | 12,018 | 135 | 26.81% |
Nomura Securities International, Inc. | | 623,631 | | 27,010 | 122 | 18.69 |
Cantor Fitzgerald | | 467,638 | | 15,958 | 70 | 14.01 |
Washington Mutual | | 375,345 | | 11,630 | 7 | 11.25 |
Goldman Sachs | | 207,525 | | 7,438 | 44 | 6.22 |
Bear Stearns & Co. Inc. | | 167,610 | | 6,096 | 157 | 5.02 |
UBS Investment Bank, LLC | | 158,781 | | 5,059 | 93 | 4.76 |
Merrill Lynch | | 128,119 | | (7,949) | 96 | 3.84 |
JP Morgan Securities | | 115,807 | | 1,652 | 151 | 3.47 |
Morgan Stanley | | 73,505 | | 1,767 | 26 | 2.20 |
Lehman Brothers | | 62,643 | | 2,399 | 87 | 1.88 |
Countrywide Securities Corp | | 22,930 | | 1,238 | 86 | 0.69 |
Daiwa Securities America Inc. | | 19,732 | | 39 | 188 | 0.58 |
Bank of America Securities, LLC | | 19,584 | | 815 | 27 | 0.58 |
Total | $ | 3,337,598 | $ | 85,170 | | 100.00% |
(1)Equal to the fair value of securities sold, plus accrued interest income, minus the sum of repurchase agreement liabilities, plus accrued interest expense.
At December 31, 2004, Opteum's repurchase agreements had the following counter-parties, amounts at risk and weighted average remaining maturities:
Repurchase Agreement Counter-parties | | Amount Outstanding ($000) | | Amount at Risk(1) ($000) | Weighted Average Maturity of Repurchase Agreements in Days | Percent of Total Amount Outstanding |
UBS Investment Bank, LLC | $ | 512,697 | $ | 29,005 | 64 | 18.5% |
Nomura Securities International, Inc. | | 463,901 | | 26,083 | 99 | 16.7 |
Bank of America Securities, LLC | | 309,270 | | 18,079 | 66 | 11.2 |
Deutsche Bank Securities, Inc. | | 308,645 | | 16,246 | 227 | 11.1 |
Lehman Brothers | | 257,191 | | 8,793 | 81 | 9.3 |
Bear Stearns & Co. Inc. | | 255,229 | | 14,068 | 127 | 9.2 |
Countrywide Securities Corp | | 178,574 | | 8,447 | 43 | 6.4 |
Morgan Stanley | | 119,659 | | 352 | 65 | 4.3 |
Daiwa Securities America Inc | | 114,436 | | 5,287 | 67 | 4.2 |
Goldman Sachs | | 107,822 | | 1,706 | 37 | 3.9 |
Merrill Lynch | | 83,561 | | 2,268 | 172 | 3.0 |
JP Morgan Securities | | 60,178 | | 3,152 | 37 | 2.2 |
Total | $ | 2,771,163 | $ | 133,486 | | 100.0% |
(1)Equal to the fair value of securities sold, plus accrued interest income, minus the sum of repurchase agreement liabilities, plus accrued interest expense.
Interest Income Recognition on MBS
SecuritiesMBS are recorded at cost on the date the securitiesMBS are purchased or sold, which is generally the trade date. Realized gains or losses from securitiesMBS transactions are determined based on the specific identified cost of the securities.MBS. Interest income is accrued based on the outstanding principal amount of the securitiesMBS and their stated contractual terms. Premiums and discounts associated with the purchase of the securitiesMBS are accretedamortized or amortizedaccreted into interest income over the estimated lives of the assetsMBS adjusted for estimated prepayments using the effective interest method. Adjustments are made using the retrospective method to the effective interest computation each reporting periodperiod. The adjustment is based on the actual prepayment experiences to date and the present expectation of future prepayments of the underlying mortgages.mortgages and/or the current value of the indices underlying adjustable rate mortgage securities versus index values in effect at the time of purchase or the last adjustment period.
Gain on Sale of Loans
OFS recognizes gain (or loss)Gains or losses on the sale of loans. Gains or losses on such salesmortgage loans are recognized at the time legal title transfers to the investorpurchaser of such loans based upon the difference between the sales proceeds from the final investorpurchaser and the allocated basis of the loan sold, adjusted for net deferred loan fees and certain direct costs and selling costs. OFSThe Company defers net loan origination costs and fees as a component of the loan balance on the balance sheet. Such costs are not amortized and are recognized into income as a component of the gain or loss upon sale. Accordingly, salaries, commissions, benefits and other operating expenses of $59.9 million, respectively, were capitalized as direct loan origination costs during the twelve months ended December 31, 2006 and reflected in the basis of loans sold for gain on sale calculation purposes. Loan fees related to the origination and funding of mortgage loans held for sale which were also capitalized, were $7.5 million during the year ended at December 31, 2006. The net gain on sale of loans was $850,000 for the periodyear ended December 31, 2005.2006 was $15.5 million. The net gainsgain on sale of loans is included with changes in fair market value of IRLCs and mortgage loans held for the period are a component of Other Incomesale and reported as “Gains on mortgage banking activities” on the Consolidated Statementconsolidated statement of Operations.operations.
Servicing Fee Income
Servicing fee income is generally a fee based on a percentage of the outstanding principal balances of the mortgage loans serviced by OFSthe Company (or by a subservicer where OFSthe Company is the master servicer) and is recorded as income as the installment payments on the mortgages are received by OFSthe Company or the subservicer.
Loan Origination Fees and Costs
Loan fees, discount points, and certain direct origination costs are recorded as an adjustment of the cost of the loan and are included in gain on sales of loans when the loan is sold. Accordingly, salaries, commissions, benefits and other operating expenses have been reduced by $10.3 million during the period ended December 31, 2005, due to direct loan origination costs, including commission costs. Loan fees related to the origination and funding of mortgage loans held for sale are $1.3 million during the period ended December 31, 2005.
Comprehensive Income (Loss)
In accordance with SFAS No. 130,Reporting Comprehensive Income, the Company is required to separately report its comprehensive income (loss) each reporting period. Other comprehensive income refers to revenue, expenses, gains and losses that, under GAAP, are included in comprehensive income but are excluded from net income, as these amounts are recorded directly as an adjustment to stockholders’stockholders' equity. Other comprehensive income (loss) arises from unrealized gains or losses generated from changes in market values of its securities heldclassified as available-for-sale.
Comprehensive (loss) income (loss) is as follows:
| | Year Ended December 31, |
| | 2005 | | 2004 |
Net Income | $ | 24,282,671 | $ | 22,856,910 |
| | | | |
Unrealized loss on available for sale securities, net | | (73,345,150) | | (1,040,815) |
| | | | |
Comprehensive (Loss) Income | $ | (49,062,479) | $ | 21,816,095 |
(in thousands)
| Year Ended December 31, |
| | 2006 | | 2005 | | 2004 |
Net (loss) income | $ | (49,546) | $ | 24,283 | $ | 22,857 |
| | | | | | |
Reclassify other-than-temporary loss on MBS | | 9,971 | | - | | - |
Plus unrealized loss on available-for-sale securities, net | | (10,250) | | (73,345) | | (1,041) |
| | | | | | |
Comprehensive loss | $ | (49,825) | $ | (49,062) | $ | (21,816) |
Stock-Based Compensation
Stock-based compensation isThe Company adopted SFAS No. 123(R), Share-Based Payment, on January 1, 2006, and this adoption did not have an impact on the Company, as the Company had previously accounted for stock-based compensation using the fair value based method prescribed by SFAS No. 123,Accounting for Stock-Based Compensation. The adoption of SFAS No. 123(R), “Share-Based Payment” on January 1, 2006 is not expected to have a significant impact on Opteum. For stock and stock-based awards issued to employees, a compensation charge is recorded against earnings based on the fair value of the award. For transactions with non-employees in which services are performed in exchange for Opteum'sthe Company's common stock or other equity instruments, the transactions are recorded on the basis of the fair value of the service received or the fair value of the equity instruments issued, whichever is more readily measurable at the date of issuance. Opteum's stock-based compensation transactions resulted in an aggregate of $3.2 million of compensation expense for the year ended December 31, 2006, $2.5 million of compensation expense for the year ended December 31, 2005 and $0.9 million of compensation expense for the year ended December 31, 2004 and $1,209 of compensation expense for the period from September 24, 2003 (date of inception) to December 31, 2003.2004.
Earnings Per Share
The Company follows the provisions of SFAS No. 128,Earnings per Share, and the guidance provided in the FASB’sFASB's Emerging Issues Task Force (“EITF”) Issue No. 03-6, Participating Securities and the Two-Class Method under FASB Statement No. 128, Earnings Per Share, which requires companies with complex capital structures, common stock equivalents or two (or more) classes of securities that participate in the declared dividends to present both basic and diluted earnings per share (“EPS”) on the face of the consolidated statement of operations. Basic EPS is calculated as income available to common stockholders divided by the weighted average number of common shares outstanding during the period. Diluted EPS is calculated using the “if converted” method for common stock equivalents. However, the common stock equivalents are not included in computing diluted EPS if the result is anti-dilutive.
Outstanding shares of Class B Common Stock, participating and convertible into Class A Common Stock, are entitled to receive dividends in an amount equal to the dividends declared on each share of Class A Common Stock if, as and when authorized and declared by the Board of Directors. Following the provisions of EITF 03-6, shares of the Class B Common Stock are included in the computation of basic EPS using the two-class method and, consequently, are presented separately from Class A Common Stock.
The shares of Class C Common Stock are not included in the basic EPS computation as these shares do not have participation rights. The outstanding shares of Class C Common Stock, totaling 319,388 shares, are not included in the computation of diluted EPS for the Class A Common Stock as the conditions for conversion into shares of Class A Common Stock were not met.
Income Taxes
Opteum has elected to be taxed as a REIT under the Code. As further described below, Opteum's TRS, OFS, is a taxpaying entity for income tax purposes and is taxed separately from Opteum. Opteum will generally not be subject to federal income tax on its REIT taxable income to the extent that Opteum distributes its REIT taxable income to its stockholders and satisfies the ongoing REIT requirements, including meeting certain asset, income and stock ownership tests. A REIT must generally distribute at least 90% of its REIT taxable income to its stockholders, of which 85% generally must be distributed within the taxable year, in order to avoid the imposition of an excise tax. The remaining balance may be distributed up to the end of the following taxable year, provided the REIT elects to treat such amount as a prior year distribution and meets certain other requirements.
OFS and its activities are subject to corporate income taxes and the applicable provisions of SFAS No. 109, Accounting for Income Taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. To the extent management believes deferred tax assets will not be fully realized in future periods, a provision will be recorded so as to reflect the net portion, if any, if the deferred tax asset management expects to realize in the consolidated balance sheet of the Company.
Recent Accounting Pronouncements
In September 2006, Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements, (“SAB 108”) was issued. SAB 108 addresses quantifying the financial statement effects of misstatements, specifically, how the effects of prior year uncorrected errors must be considered in quantifying misstatements in the current year financial statements. SAB 108 is effective for fiscal years ending after November 15, 2006, and does not change the SEC staff's previous positions in SAB 99 regarding qualitative considerations in assessing the materiality of misstatements. SAB 108 is not expected to have any material impact on the Company.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, to eliminate the diversity in practice that exists due to the different definitions of fair value that are dispersed among the many accounting pronouncements that require fair value measurements, and the limited guidance for applying those definitions. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company is currently evaluating the impact, if any, of adopting SFAS 157 on the financial statements.
In June 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109 (“FIN 48”), which clarifies the accounting for uncertainty in tax positions. This Interpretation requires that the Company recognize in its financial statements, the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. The provisions of FIN 48 are effective as of the beginning of the 2007 fiscal year, with the cumulative effect, if any, of the change in accounting principle recorded as an adjustment to opening retained earnings. Accordingly, the Company will adopt FIN 48 on January 1, 2007. While the Company is still finalizing its assessment of the impact that FIN 48 will have, it is presently believed that the adoption of FIN 48 will not have a significant impact on its consolidated financial statements.
In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Assets. SFAS 156 amends SFAS 140 with respect to the accounting for separately-recognized servicing assets and liabilities. SFAS 156 requires all separately-recognized servicing assets and liabilities to be initially measured at fair value, and permits companies to elect, on a class-by-class basis, to account for servicing assets and liabilities on either a lower of cost or market value basis or a fair value measurement basis. See “Mortgage Servicing Rights” above for a description of the adoption of SFAS 156.
In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments — an amendment of FASB Statements No. 133 and 140. SFAS 155 (i) permits an entity to measure at fair value any financial instrument that contains an embedded derivative that otherwise would require bifurcation; (ii) establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation; and (iii) contains other provisions that are not germane to the Company. SFAS 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year beginning after September 15, 2006. In late September 2006, the FASB proposed a scope exception under SFAS 155 for securitized interests that only contain an embedded derivative that is tied to the prepayment risk of the underlying prepayable financial asset, and for which the investor does not control the right to accelerate the settlement. The FASB opted to hold the proposed guidance open for a comment period and to re-deliberate the issue upon the expiration of the comment period. The FASB should issue their final guidance in early 2007. The MBS securities owned in the REIT portfolio currently would fall under this scope exception. However, in the future, the Company may own securities that may not fall under the exception or the FASB may repeal the exception, in which case the Company would be subject to the provisions of SFAS 155. Should securities owned by the Company fall under the provisions of SFAS 155 in the future, the Company’s results of operations may exhibit volatility as certain of its future investments may be marked to market through the income statement. Currently, changes in the value of the Company’s MBS securities are recognized through other comprehensive income (loss), a component of stockholders equity.
In January 2006, the Company adopted SFAS No. 123(R), Share-Based Payment, and this adoption did not have an impact on the Company, as the Company had previously accounted for stock-based compensation using the fair value based method prescribed by SFAS 123, Accounting for Stock-Based Compensation. See “Stock-Based Compensation” above for a complete description of the Company’s accounting policy after the adoption of SFAS 123(R).
In November 2005, FASB issued FSP FAS 115-1 and FAS 124-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments (“FSP 115-1 and 124-1”), which clarifies when an investment is considered impaired, whether the impairment is other-than-temporary, and the measurement of an impairment loss. It also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. FSP 115-1 and 124-1 are effective for all reporting periods beginning after December 15, 2005. Implementation of these statements in 2006 did not have a significant impact on the Company’s consolidated financial position or results of operations.
In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections (“SFAS No. 154”), which replaces APB Opinion No. 20, Accounting Changes, and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements-An Amendment of APB Opinion No. 28. SFAS No. 154 provides guidance on the accounting for and reporting of accounting changes and error corrections, and it establishes retrospective application as the required method for reporting a change in accounting principle and the reporting of a correction of an error. SFAS No. 154 was adopted by the Company at the beginning of fiscal 2006.
NOTE 2. OPTEUM FINANCIAL SERVICES, LLC
On November 3, 2005, Opteum acquired 100% of the equity interests of OFS through a merger with a wholly-owned subsidiary of Opteum. OFS is a mortgage lender that originates loans nationwide. The results of operations of OFS have been included in the Company's consolidated financial statements since November 3, 2005.
The Company has increased the aggregate purchase price by $0.8 for additional legal and accounting fees incurred directly related to the merger and it has made insignificant modifications to the allocation of the purchase price to the net assets acquired, based on final valuations and completion of analysis.
At the date of the merger, the Company recorded intangible assets with finite lives in the amount of $2.1 million for proprietary software and $0.6 million for an unlocked loans pipeline. The software intangible has a 36 month life without any significant residual value, and the unlocked loans intangible was reduced as the applicable loans were closed. At December 31, 2005, the accumulated amortization on these intangibles was $0.1 million for each. During 2006, the unlocked loans pipeline was reduced to zero. At December 31, 2006, the software intangible has a remaining unamortized value of $1.3 million, with $0.7 million of amortization being expensed in 2006. Also at the date of the merger, the Company recorded $1.4 million for an intangible related to the Opteum trade name, and $2.1 million of goodwill; these assets are not subject to amortization and through December 31, 2006, no impairment has been recorded.
On December 21, 2006, Opteum sold to Citigroup Global Markets Realty Corp. (“Citigroup Realty”) a Class B non-voting limited liability company membership interest in OFS, representing 7.5% of all of OFS’s outstanding limited liability company membership interests. Immediately following the transaction, Opteum held Class A voting limited liability company membership interests in OFS representing 92.5% of all of OFS’s outstanding limited liability company membership interests. In connection with the transaction, Opteum also granted Citigroup Realty the option, exercisable on or before December 20, 2007, to acquire additional Class B non-voting limited liability company membership interests in OFS representing 7.49% of all of OFS’s outstanding limited liability company membership interests.
NOTE 3. MORTGAGE LOANS HELD FOR SALE, NET
Upon the closing of a residential mortgage loan or shortly thereafter, OFS will sell or securitize the majority of its mortgage loan originations. OFS also sells mortgage loans insured or guaranteed by various government-sponsored entities and private insurance agencies. The insurance or guaranty is provided primarily on a nonrecourse basis to OFS, except where limited by the Federal Housing Administration and Veterans Administration and their respective loan programs. At December 31, 2006, OFS serviced approximately $9.4 billion of mortgage loans sold into the secondary market. All of OFS’s loans held for sale are pledged as collateral under the various financing arrangements described in Note 8. Mortgage loans held for sale consist of the following as of December 31, 2006 and 2005:
(in thousands)
| | December 31, 2006 | | December 31, 2005 |
Mortgage loans held for sale, and other, net | $ | 741,545 | $ | 884,751 |
Deferred loan origination costs and other-net | | 9,188 | | 9,604 |
Valuation allowance | | (899) | | (118) |
| | | | |
| $ | 749,834 | $ | 894,237 |
Included in mortgage loans held for sale above are IRLCs arising from OFS’s economic hedging activities of IRLCs and mortgage loans held for sale. Such assets or liabilities are reported net in the accompanying consolidated financial statements. Fluctuations in the fair market value of IRLCs and other derivatives employed are reflected in the consolidated statement of operations under the caption “Gains on mortgage banking activities.”
NOTE 4. RETAINED INTEREST, TRADING
Retained interest, trading is the subordinated interests retained by OFS resulting from securitizations and includes the over-collateralization and residual net interest spread remaining after payments to the Public Certificates and NIM Notes. Retained interest, trading represents the present value of estimated cash flows to be received from these subordinated interests in the future. The subordinated interests retained are classified as “trading securities” and are reported at fair value with unrealized gains or losses reported in earnings.
All of OFS’s securitizations were structured and are accounted for as sales in accordance with SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. Generally, to meet the sale treatment requirements of SFAS No. 140, the REMIC trust is structured as a “qualifying special purpose entity” or QSPE, which specifically limits the REMIC trust's activities, and OFS surrenders control over the mortgage loans upon their transfer to the REMIC trust.
Valuation of Investments. OFS classifies its retained interests as trading securities and therefore records these securities at their estimated fair value. In order to value the unrated, unquoted, investments, OFS will record these assets at their estimated fair value utilizing pricing information available directly from dealers and the present value calculated by projecting the future cash flows of an investment on a publicly available analytical system. When a publicly available analytical system is utilized, OFS will input the following variable factors which will have an impact on determining the market value:
Interest Rate Forecast. The forward London Interbank Offered Rate (“LIBOR”) interest rate curve.
Discount Rate. The present value of all future cash flows utilizing a discount rate assumption established at the discretion of OFS to represent market conditions and value of similar instruments with similar risks. Discount rates used will vary over time. Management observes discount rates used for assets with similar risk profiles. In selecting which assets to monitor for variations in discount rates, management seeks to identify assets that share most, if not all of the risk attributes of the Company’s retained interests, trading. Such assets are typically traded between market participants whereby the discount rate is the primary variable.
Prepayment Forecast. The prepayment forecast may be expressed by OFS in accordance with one of the following standard market conventions: 1) Constant Prepayment Rate (CPR) or 2) Percentage of a Prepayment Vector (PPV). Prepayment forecasts may be changed as OFS observes trends in the underlying collateral as delineated in the Statement to Certificate Holders generated by the REMIC trust’s Trustee for each underlying security. Prepayment forecast will also vary over time as the level of interest rates change, the difference between rates available to borrowers on adjustable rate versus fixed rate mortgages change and non-interest rate related variables fluctuate such as home price appreciation, among others.
Credit Performance Forecast. A forecast of future credit performance of the underlying collateral pool will include an assumption of default frequency, loss severity, and a recovery lag. In general, OFS will utilize the combination of default frequency and loss severity in conjunction with a collateral prepayment assumption to arrive at a target cumulative loss to the collateral pool over the life of the pool based on historical performance of similar collateral by the originator. The target cumulative loss forecast will be developed and noted at the pricing date of the individual security but may be updated by OFS consistent with observations of the actual collateral pool performance. The Company utilizes a third party source to forecast credit performance.
Default Frequency may be expressed by OFS in accordance with any of three standard market conventions: 1) Constant Default Rate (CDR) 2) Percentage of a Standard Default Assumption (SDA) curve, or 3) a vector or curve established to meet forecasted performance for specific collateral pools.
Loss Severity will be expressed by OFS in accordance with historical performance of similar collateral and the standard market conventions of a percentage of the unpaid principal balance of the forecasted defaults lost during the foreclosure and liquidation process.
During the first year of a new issue OFS may balance positive or adverse effects of the prepayment forecast and the credit performance forecast allowing for deviation between actual and forecasted performance of the collateral pool. After the first year OFS will generally adjust the Prepayment and Credit Performance Forecasts to replicate actual performance trends without balancing adverse and positive effects.
The following table summarizes OFS’s residual interests in securitizations as of December 31, 2006 and December 31, 2005:
(in thousands)
Series | | Issue Date | | December 31, 2006 | | December 31, 2005 |
| | | | | | |
HMAC 2004-1 | | March 4, 2004 | $ | 2,948 | $ | 5,096 |
HMAC 2004-2 | | May 10, 2004 | | 1,939 | | 3,240 |
HMAC 2004-3 | | June 30, 2004 | | 362 | | 1,056 |
HMAC 2004-4 | | August 16, 2004 | | 1,544 | | 3,749 |
HMAC 2004-5 | | September 28, 2004 | | 4,545 | | 6,178 |
HMAC 2004-6 | | November 17, 2004 | | 9,723 | | 14,321 |
OMAC 2005-1 | | January 31, 2005 | | 13,331 | | 14,721 |
OMAC 2005-2 | | April 5, 2005 | | 14,259 | | 11,302 |
OMAC 2005-3 | | June 17, 2005 | | 16,091 | | 14,656 |
OMAC 2005-4 | | August 25, 2005 | | 12,491 | | 12,552 |
OMAC 2005-5 | | November 23, 2005 | | 8,916 | | 11,140 |
OMAC 2006-1 | | March 23, 2006 | | 13,219 | | - |
OMAC 2006-2 | | June 26, 2006 | | 4,831 | | - |
| | | | | | |
Total | | | $ | 104,199 | $ | 98,011 |
Key economic assumptions used in measuring the fair value of retained interests at the date of securitization resulting from securitizations completed during 2006 and 2005 were as follows:
| 2006 | 2005 |
Prepayment speeds (CPR) | 36.25% | 28.65% |
Weighted-average-life | 4.18 | 2.83 |
Expected credit losses | 0.74% | 1.07% |
Discount rates | 16.81% | 14.90% |
Interest rates | Forward LIBOR Yield curve | Forward LIBOR Yield curve |
At December 31, 2006 and December 31, 2005, key economic assumptions and the sensitivity of the current fair value of residual cash flows to the immediate 10% and 20% adverse change in those assumptions are as follows:
(in thousands)
| December 31, |
| | 2006 | | 2005 |
Balance sheet carrying value of retained interests - fair value | $ | 104,199 | $ | 98,011 |
Weighted average life (in years) | | 4.26 | | 2.62 |
Prepayment assumption (annual rate) | | 37.88% | | 32.53% |
Impact on fair value of 10% adverse change | $ | (8,235) | $ | (7,817) |
Impact on fair value of 20% adverse change | $ | (14,939) | $ | (16,089) |
Expected Credit losses (annual rate) | | 0.56% | | 0.61% |
Impact on fair value of 10% adverse change | $ | (3,052) | $ | (3,247) |
Impact on fair value of 20% adverse change | $ | (6,098) | $ | (6,419) |
Residual Cash-Flow discount rate | | 16.03% | | 13.96% |
Impact on fair value of 10% adverse change | $ | (4,575) | $ | (3,804) |
Impact on fair value of 20% adverse change | $ | (8,771) | $ | (7,392) |
Interest rates on variable and adjustable loans and bonds | | Forward LIBOR Yield Curve | | Forward LIBOR Yield Curve |
Impact on fair value of 10% adverse change | $ | (18,554) | $ | (21,265) |
Impact on fair value of 20% adverse change | $ | (39,292) | $ | (34,365) |
These sensitivities are hypothetical and should be used with caution. As the figures indicate, changes in fair value based upon a 10% variation in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, in this table, the effect of the variation in a particular assumption on the fair value of the retained interest is calculated without changing any other assumption, in reality, changes in one factor may result in changes in another which may magnify or counteract the sensitivities. To estimate the impact of a 10% and 20% adverse change of the Forward LIBOR curve, a parallel shift in the forward LIBOR curve was assumed based on the Forward LIBOR curve at December 31, 2006 and December 31, 2005.
Static pool loss percentages are calculated by dividing projected future credit losses (at the time of securitization) and actual losses incurred as of the date indicated by the original balance of each pool of assets. The following static pool loss percentages are calculated based upon all OFS securitizations that have been completed to date:
(in thousands)
Series | Issue Date | Original Unpaid Principal Balance | Projected Aggregate Static Pool Loss Percentage | Static Pool Loss Percentage Through December 31, 2006 | Static Pool Loss Percentage Through December 31, 2005 |
HMAC 2004-1 | March 4, 2004 | $ 309,710 | 0.14% | 0.14% | 0.01% |
HMAC 2004-2 | May 10, 2004 | 388,737 | 0.15 | 0.33 | 0.12 |
HMAC 2004-3 | June 30, 2004 | 417,055 | 0.17 | 0.20 | 0.06 |
HMAC 2004-4 | August 16, 2004 | 410,123 | 0.23 | 0.08 | 0.01 |
HMAC 2004-5 | September 28, 2004 | 413,875 | 0.34 | 0.03 | 0.00 |
HMAC 2004-6 | November 17, 2004 | 761,027 | 0.44 | 0.15 | 0.01 |
OMAC 2005-1 | January 31, 2005 | 802,625 | 0.43 | 0.07 | 0.01 |
OMAC 2005-2 | April 5, 2005 | 883,987 | 0.47 | 0.04 | 0.00 |
OMAC 2005-3 | June 17, 2005 | 937,117 | 0.39 | 0.01 | 0.00 |
OMAC 2005-4 | August 25, 2005 | 1,321,739 | 0.64 | 0.00 | 0.00 |
OMAC 2005-5 | November 23, 2005 | 986,277 | 0.72 | 0.01 | 0.00 |
OMAC 2006-1 | March 23, 2006 | 934,441 | 0.71 | 0.00 | - |
OMAC 2006-2 | June 26, 2006 | 491,572 | 0.90 | 0.00 | - |
| | | | | |
Total | | $ 9,058,285 | | | |
The table below summarizes certain cash flows received from and paid to securitization trusts:
(in thousands)
| | December 31, 2006 | | For the Period November 3, 2005 (date of merger) through December 31, 2005 |
Proceeds from securitizations | $ | 1,436,838 | $ | 989,843 |
Servicing fees received | | 17,878 | | 2,838 |
Servicing advances | | 662 | | 291 |
Cash flows received on retained interests | | 4,356 | | 261 |
The following information presents quantitative information about delinquencies and credit losses on securitized financial assets as of December 31, 2006 and 2005:
(in thousands)
As of Date | | Total Principal Amount of Loans | | Principal Amount of Loans 60 Days or more | | Net Credit Losses |
December 31, 2006 | $ | 5,849,013 | $ | 138,205 | $ | 5,210 |
December 31, 2005 | $ | 6,363,279 | $ | 57,871 | $ | 913 |
NOTE 5.MORTGAGE SERVICING RIGHTS, NET
As permitted by the effective date provisions of SFAS No. 156, the Company has early adopted SFAS No. 156 as of
January 1, 2006 with respect to the valuation of its MSRs. (See Note 1 - Mortgage Servicing Rights.) Activities for MSRs
are summarized as follows for the year ended December 31, 2006 and for the period November 3, 2005 (date of merger) through December 31, 2005:
(in thousands)
| | For the year ended December 31, 2006 | | For the Period November 3, 2005 (date of merger) through December 31, 2005 |
Balance at beginning of period (at cost) | $ | 86,082 | $ | 87,080 |
Adjustment to fair value upon adoption of SFAS 156 at January 1, 2006 | | 4,298 | | - |
Additions | | 43,175 | | - |
Changes in fair value: | | | | |
Changes in fair value | | (33,551) | | 1,432 |
Changes in fair value due to change in valuation assumptions | $ | (1,145) | $ | (2,430) |
| | | | |
Balance at end of period | $ | 98,859 | $ | 86,082 |
The Company elected to account for all originated MSRs as one class and, therefore, all MSRs are carried at fair value. As a result of the early adoption of SFAS 156, the carrying value of the MSRs has been increased by approximately $4.3 million (pre-tax) as of January 1, 2006. As required by the provisions of SFAS 156, the net of tax effect was recorded as a cumulative effect adjustment to retained earnings of OFS as of January 1, 2006. In addition, changes in value due to run-offs of the portfolio are recorded as valuation adjustments instead of amortization.
The fair value of MSRs is determined using discounted cash flow techniques. During 2006, OFS increased the MSR value on a net basis by $12.8 million primarily as a result of additions to the servicing portfolio and changes in market conditions. Estimates of fair value involve several assumptions, including the key valuation assumptions about market expectations of future prepayment rates, interest rates and discount rates. Prepayment rates are projected using a prepayment model. The model considers key factors, such as refinance incentive, housing turnover, seasonality and aging of the pool of loans. Prepayment speeds incorporate expectations of future rates implied by the forward LIBOR/swap curve, as well as collateral specific information
At December 31, 2006 and 2005, key economic assumptions and the sensitivity of the current fair value of MSR rights cash flows to the immediate 10 percent and 20 percent adverse change in those assumptions are as follows: (Note - base case prepayment and discount rate assumptions are a weighted average of the values applied to the various mortgage loans).
(in thousands)
| | December 31, 2006 | | December 31, 2005 |
Prepayment assumption (annual rate) (PSA) | | 424.6 | | 254.0 |
Impact on fair value of 10% adverse change | $ | (3,923) | $ | (3,615) |
Impact on fair value of 20% adverse change | $ | (7,557) | $ | (6,936) |
MSR Cash-Flow Discount Rate | | 14.50% | | 10.74% |
Impact on fair value of 10% adverse change | $ | (3,505) | $ | (4,856) |
Impact on fair value of 20% adverse change | $ | (6,727) | $ | (9,280) |
These sensitivities are entirely hypothetical and should be used with caution. As the figures indicate, changes in fair value based upon 10% and 20% variations in assumptions generally cannot be extrapolated to greater or lesser percentage variation because the relationship of the change in assumption to the change in fair value may not be linear. Also, in this table, the effect of the variation in a particular assumption on the fair value of the MSR is calculated without changing any other assumption. In reality, changes in one factor may result in changes in another which may magnify or counteract the sensitivities.
NOTE 6.MORTGAGE-BACKED SECURITIES
At December 31, 2006 and 2005, all of Opteum's MBS were classified as available-for-sale and, as such, are reported at their estimated fair value. Estimated fair value was determined based on the average of third-party broker quotes received and/or independent pricing sources when available.
The following are the carrying values of Opteum's MBS portfolio at December 31, 2006 and 2005:
(in thousands)
| | December 31, 2006 | | December 31, 2005 |
Hybrid Arms and Balloons | $ | 76,488 | $ | 753,896 |
Adjustable Rate Mortgages | | 2,105,818 | | 2,006,767 |
Fixed Rate Mortgages | | 626,428 | | 733,366 |
| | | | |
Totals | $ | 2,808,734 | $ | 3,494,029 |
The following table presents the components of the carrying value of Opteum's MBS portfolio at December 31, 2006 and 2005:
(in thousands)
| | December 31, 2006 | | December 31, 2005 |
| | | | |
Principal balance | $ | 2,779,867 | $ | 3,457,887 |
Unamortized premium | | 116,114 | | 115,133 |
Unaccreted discount | | (502) | | (2,497) |
Gross unrealized gains | | 422 | | 266 |
Other-than-temporary losses | | (9,971) | | - |
Gross unrealized losses | | (77,196) | | (76,760) |
| | | | |
Carrying value/estimated fair value | $ | 2,808,734 | $ | 3,494,029 |
The following table presents for Opteum's MBS investments with gross unrealized losses, the estimated fair value and gross unrealized losses aggregated by investment category, at December 31, 2006:
(in thousands)
| | Loss Position More than 12 Months | | Loss Position Less than 12 Months | | Total |
| | Estimated Fair Value | | Unrealized Losses | | Estimated Fair Value | | Unrealized Losses | | Estimated Fair Value | | Unrealized Losses |
Hybrid Arms and Balloons | $ | 67,437 | $ | (1,858) | $ | - | $ | - | $ | 67,437 | $ | (1,858) |
Adjustable Rate Mortgages | | 1,232,644 | | (46,715) | | 348,901 | | (2,591) | | 1,581,545 | | (49,306) |
Fixed Rate Mortgages | | 515,067 | | (25,662) | | 48,604 | | (370) | | 563,671 | | (26,032) |
| | | | | | | | | | | | |
| $ | 1,815,148 | $ | (74,235) | $ | 397,505 | $ | (2,961) | $ | 2,212,653 | $ | (77,196) |
The following table presents for Opteum's MBS investments with gross unrealized losses, the estimated fair value and gross unrealized losses aggregated by investment category, at December 31, 2005:
(in thousands)
| | Loss Position Less than 12 Months | | Loss Position More than 12 Months | | Total |
| | Estimated Fair Value | | Unrealized Losses | | Estimated Fair Value | | Unrealized Losses | | Estimated Fair Value | | Unrealized Losses |
Hybrid Arms and Balloons | $ | 563,661 | $ | (8,409) | $ | $141,676 | $ | (4,511) | $ | 705,337 | $ | (12,920) |
Adjustable Rate Mortgages | | 1,648,085 | | (27,918) | | 270,945 | | (8,945) | | 1,919,031 | | (36,862) |
Fixed Rate Mortgages | | 425,261 | | (10,762) | | 346,435 | | (16,215) | | 771,696 | | (26,977) |
| | | | | | | | | | | | |
| $ | 2,637,007 | $ | (47,089) | $ | 759,056 | $ | (29,671) | $ | 3,396,063 | $ | (76,760) |
At December 31, 2006, all of Opteum's MBS investments have contractual maturities greater than 24 months. Actual maturities of MBS investments are generally shorter than stated contractual maturities. Actual maturities of Opteum's MBS investments are affected by the contractual lives of the underlying mortgages, periodic payments of principal, and prepayments of principal.
Approximately $0.3 million of the $10.3 million decline in fair value of MBS investments is not considered to be other-than-temporary. Accordingly, the approximately $10.0 million of other-than-temporary loss is recorded as a charge to earnings on the consolidated statement of operations for the year ended December 31, 2006. Generally, the factors considered in making this determination include: the expected cash flow from the MBS investment, the general quality of the MBS owned, any credit protection available, current market conditions, and the magnitude and duration of the historical decline in market prices as well as Opteum's ability and intention to hold the MBS owned. The approximately $10.0 million of other-than-temporary loss for the period ended December 31, 2006 was based on management’s decision to sell certain MBS securities in the first quarter of 2007 and therefore not hold such securities until their decline in fair market value could be recovered. The aggregate fair market value as of December 31, 2006, of the MBS securities expected to be sold in the first quarter of 2007 was approximately $446 million. The Company has the present intent and ability to hold the remaining available for sale assets until their decline in fair market value could be recovered.
NOTE 7.EARNINGS PER SHARE
The Company follows the provisions of SFAS No. 128, Earnings per Share, and the guidance provided in the FASB's Emerging Issues Task Force (“EITF”) Issue No. 03-6,Participating Securities and the two-class method under FASB Statement No. 128, Earnings Per Share, which requires companies with complex capital structures, common stock equivalents, or two classes of participating securities to present both basic and diluted earnings per share (“EPS”) on the face of the statement of income.operations. Basic EPS is calculated as income available to common stockholders divided by the weighted average number of common shares outstanding during the period. Diluted EPS is calculated using the “if converted” method for common stock equivalents.
As further described in Note 12, effectiveEffective July 9, 2004, the shares of Class B Common Stock, participating and convertible into Class A Common Stock, became entitled to receive dividends in an amount equal to the dividends declared on each share of Class A Common Stock if, as and when authorized and declared by the Board of Directors. Following the provisions of EITF 03-6, the Class B Common Stock, beginning in the three-month period ended September 30, 2004, is included in the computation of basic EPS using the two-class method, and consequently is presented separately from Class A Common Stock. Prior to July 9, 2004, the Class B shares of common stock are not included in the basic EPS computation as the conditions to participate in earnings were not met, and they were not included in the computation of diluted Class A EPS as the conditions for conversion to Class A shares were not met.
The Class C common shares are not included in the basic EPS computation as these shares do not have participation rights. The Class C common shares totaling 319,388 are not included in the computation of diluted Class A EPS as the conditions for conversion to Class A shares were not met (see Note 12).met.
As further discussed in Note 2, effectiveEffective November 3, 2005, the Company issued 1,223,208 shares of Class A Redeemable Preferred Stock, pursuant to the acquisition of OFS. Holders of shares of the preferred stock cannotcould not receive or accrue dividend payments prior to January 1, 2006; therefore, these preferred shares arewere not included in the basic EPS computation for the year ended December 31, 2005 as these shares dodid not have participation rights during the period from their issuance through December 31, 2005 (see Note 12).2005. The shares of the Class A Redeemable Preferred Stock willwere only be eligible to convert into shares of our Class A Common Stock at such time as such conversion iswas approved by a majority number of stockholders; therefore, since this conversion iswas not yet approved prior to December 31, 2005 the shares arewere not included in the computation of diluted Class A Common Stock EPS.EPS as of December 31, 2005.
After January 1, 2006, and prior to March 31, 2006, holders of Class A Redeemable Preferred Stock were entitled to receive dividends according to the formula described in the Company's amended Articles of Incorporation. For the Company's first quarter 2006 dividend declared on March 10, 2006, the shares of Class A Redeemable Preferred Stock, although considered to be participating securities, did not receive a dividend pursuant to the formula. Following the provisions of EITF 03-6, the Class A Redeemable Preferred Stock, a participating security prior to conversion on April 28, 2006, was excluded in the computation of basic EPS using the two-class method.
The conversion of the Class A Redeemable Preferred Stock into shares of Class A Common Stock was approved by the stockholders at the Company's 2006 Annual Meeting of Shareholders on April 28, 2006, and the shares of Class A Redeemable Preferred Stock were converted into shares of Class A Common Stock on that date. For purposes of the EPS computation, the conversion of the shares of Class A Redeemable Preferred Stock into shares of Class A Common Stock has been accounted for as of April 28, 2006, and is included in the computation of basic EPS for the Class A Common Stock as of that date.
As a result of the conversion of the Class A Redeemable Preferred Stock into Class A Common Stock, the EPS presentation for these securities is no longer presented.
The Company has dividend eligible stock incentive plan shares that were outstanding during the year ended December 31, 2006. These stock incentive plan shares have dividend participation rights, but no contractual obligation to share in losses. Since there is no such obligation, these incentive plan shares are not included, pursuant to EITF 03-6, in the twelve months ended December 31, 2006, basic EPS computation for the Class A Common Stock, even though they are participating securities. For the computation of diluted EPS for the Class A Common Stock for the period ended December 31, 2006, 503,644 phantom shares are excluded as their inclusion would be anti-dilutive.
The table below reconciles the numerators and denominators of the basic and diluted EPS.
| | | | | | From September 24, 2003 |
| | Year Ended December 31, | | (inception) through |
| | 2005 | | 2004 | | December 31, 2003 |
Basic and diluted EPS per Class A common share: | | | | | | |
Numerator: net income allocated to the Class A common shares | $ | 23,910,709 | $ | 22,529,855 | $ | (267,167) |
Denominator: basic and diluted: | | | | | | |
Class A common shares outstanding at the balance sheet date | | 23,567,242 | | 20,368,915 | | 4,012,102 |
Dividend eligible equity plan shares issued as of the balance sheet date | | 499,786 | | 313,600 | | - |
Effect of weighting | | (2,645,527) | | (9,230,257) | | (3,514,243) |
Weighted average shares-basic and diluted | | 21,421,501 | | 11,452,258 | | 497,859 |
Basic and diluted EPS per Class A common share | $ | 1.12 | $ | 1.97 | $ | (0.54) |
| | | | | | |
Basic and diluted EPS per Class B common share: | | | | | | |
Numerator: net income allocated to Class B common shares | $ | 371,962 | $ | 327,055 | $ | - |
Denominator: basic and diluted: | | | | | | |
Class B common shares outstanding at the balance sheet date | | 319,388 | | 319,388 | | 319,388 |
Effect of weighting (based on date Class B shares participate in dividends) | | - | | (159,694) | | (319,388) |
Weighted average shares-basic and diluted | | 319,388 | | 159,694 | | - |
Basic and diluted EPS per Class B common share | $ | 1.16 | $ | 2.05 | $ | - |
(in thousands)
Income Taxes
Opteum has elected to be taxed as a REIT under the Code. As further described below, the Company’s TRS is a taxpaying entity for income tax purposes, and is taxed separately from Opteum. Opteum will generally not be subject to federal income tax on its taxable net income to the extent that Opteum distributes its taxable net income to its stockholders and satisfies the ongoing REIT requirements including meeting certain asset, income and stock ownership tests. Under the net income requirements, a REIT must generally distribute at least 90% of its taxable income to its stockholders of which 85% must be distributed within the taxable year in order to avoid the imposition of an excise tax. The remaining balance may be distributed up to the timely filing date of our REIT tax return in the subsequent taxable year.
OFS is the Company’s TRS, and its activities are subject to corporate income taxes, and the applicable provisions of SFAS No. 109, Accounting for Income Taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax base. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
Recent Accounting Pronouncements
In December 2004, the FASB issued SFAS No. 123(R), Share-Based Payment, a revision of SFAS No. 123, which addresses the accounting for share-based payment transactions. SFAS No. 123(R) eliminates the ability to account for employee share-based compensation transactions using APB Opinion No. 25, "Accounting for Stock Issued to Employees," and generally requires instead that such transactions be accounted and recognized in the statement of operations based on their fair value. The adoption of SFAS No. 123(R) on January 1, 2006, will not have an impact on Opteum, as Opteum already uses the fair value method of accounting for all of its share-based payments.
On August 11, 2005, the FASB issued an Exposure draft to amend FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, to (i) specify the conditions under which a qualifying special-purpose entity (SPE) is required to achieve sale accounting, (ii) eliminate inconsistent application of the principles upon which Statement 140 is based, and (iii) address other issues related to transfers of financial assets that arose during redeliberations on the amendment of Statement 140 in order to improve the comparability of financial statements. The Company has not yet evaluated the impact, if any, that application of these new principles will have.
NOTE 2.ACQUISITION OF OPTEUM FINANCIAL SERVICES, LLC
On November 3, 2005, Opteum acquired 100% of the equity interests of Opteum Financial Services, LLC and its subsidiaries (“OFS”) through a newly formed wholly-owned subsidiary of Opteum. OFS is a mortgage lender that originates loans nationwide. Opteum acquired OFS to diversify its revenue stream while remaining in Opteum’s area of expertise. For OFS, the acquisition provides increased access to capital to fund growth. The results of operations of OFS have been included in the accompanying consolidated financial statements for the period from November 3, 2005 through December 31, 2005.
Opteum initially issued 3,717,242 shares of Class A Common Stock and 1,800,000 shares of Class A Redeemable Preferred Stock to the owners of OFS. A portion of the Class A Redeemable Preferred Stock was to be returned to Opteum if OFS did not have a book value of $60.0 million at the date of closing. On February 10, 2006, the owners of OFS and Opteum agreed that 576,792 shares of the Class A Redeemable Preferred Stock would be returned as the OFS book value at closing was less than $60.0 million.
As described in Note 12, the Class A Redeemable Preferred Stock will be convertible into shares of Class A Common Stock if the Company’s stockholders approve the conversion at a future stockholders’ meeting. After accounting for the returned Class A Redeemable Preferred Stock, the final aggregate purchase price amounted to $56,501,440. This consists of: 3,717,242 shares of Class A Common Stock valued at $11.46 per share; 1,223,208 shares of Class A Redeemable Preferred Stock valued at $9.91 per share; and $1,779,846 of transaction costs. The values of the shares issued were based on the average market price of Opteum’s Class A Common Stock over the five day period surrounding September 29, 2005, the date the acquisition agreement was signed and publicly announced.
The owner’s of OFS will be eligible to receive up to $17.5 million in cash (or preferred shares in certain circumstances) over the next five years, depending on the cash flows of certain residual interests in securitizations which were on OFS's balance sheet at the closing.
The following presents the allocation of the purchase price to the fair values of the assets acquired and the liabilities assumed as of November 3, 2005:
Cash and cash equivalents | $ | 3,431,736 |
Loans held for sale | | 1,186,599,447 |
Retained interests, trading | | 94,611,222 |
Mortgage servicing rights, net | | 87,079,777 |
Fixed assets | | 9,919,100 |
Goodwill | | 2,107,130 |
Identified intangibles | | 4,042,617 |
All other assets | | 46,203,917 |
Deferred income tax liability | | (22,580,679) |
All other liabilities | | (1,354,912,827) |
| | |
Net assets acquired | $ | 56,501,440 |
OFS is still in the process of obtaining final valuations and completing its analysis of certain of the intangible assets; accordingly, allocation of the purchase price is subject to potential modification. If changes to the purchase price occur during the twelve month period following the acquisition, the appropriate adjustments will be allocated to the fair values of the assets acquired and liabilities assumed. However, any modification is not expected to be significant. The identified intangibles will be amortized over a weighted average amortization period of approximately three years, and they are not expected to have any significant residual value. The Company recorded intangible assets in the amount of $2,688,370 for proprietary software, unlocked loans and related items at the time of the acquisition. At December 31, 2005, the accumulated amortization on these intangibles was $115,375. The Company recorded $1,354,247 for an intangible related to the Opteum trade name, and $2,107,130 of goodwill; these assets will not be subject to amortization.
The following pro-forma information is based on the assumption that the acquisition of OFS took place as of January 1, 2004. The impact of the application by the Company of SFAS No. 141 to the books and records of OFS upon consummation of the merger have been adjusted such that the impact is reflected in 2004 versus 2005. Accordingly, the figures below will not be consistent with figures presented in the amended Form 8-K filed by the Company on January 20, 2006.
| | 2005 | | 2004 |
Total Net Revenue | $ | 157,198,288 | $ | 110,823,422 |
Income from Operations | | 36,511,991 | | 39,493,512 |
Net Income | | 32,467,979 | | 32,027,655 |
Class A Common stock - basic and diluted | | 1.24 | | 1.97 |
Class B Common stock - basic and diluted | | 1.24 | | 1.97 |
| | | | | | |
| Year Ended December 31, |
| | 2006 | | 2005 | | 2004 |
Basic and diluted EPS per Class A common share: | | | | | | |
Numerator: net (loss) income allocated to the Class A common shares | $ | (48,909) | $ | 23,911 | $ | 22,530 |
Denominator: basic and diluted: | | | | | | |
Class A common shares outstanding at the balance sheet date | | 24,516 | | 23,567 | | 20,369 |
Dividend eligible equity plan shares issued as of the balance sheet date | | - | | 500 | | 314 |
Effect of weighting | | (450) | | (2,646) | | (9,230) |
Weighted average shares-basic and diluted | | 24,066 | | 21,421 | | 11,453 |
Basic and diluted EPS per Class A common share | $ | (2.03) | $ | 1.12 | $ | 1.97 |
| | | | | | |
Basic and diluted EPS per Class B common share: | | | | | | |
Numerator: net (loss) income allocated to Class B common shares | $ | (637) | $ | 372 | $ | 327 |
Denominator: basic and diluted: | | | | | | |
Class B common shares outstanding at the balance sheet date | | 319 | | 319 | | 319 |
Effect of weighting (based on date Class B shares participate in dividends) | | - | | - | | (160) |
Weighted average shares-basic and diluted | | 319 | | 319 | | 159 |
Basic and diluted EPS per Class B common share | $ | (1.99) | $ | 1.16 | $ | 2.05 |
NOTE 3.MORTGAGE LOANS HELD FOR SALE, NET
Upon the closing of a residential mortgage loan or shortly thereafter, OFS will securitize the majority of its mortgage loan originations. OFS also sells mortgage loans insured or guaranteed by various government-sponsored entities and private insurance agencies. The insurance or guaranty is provided primarily on a nonrecourse basis to OFS, except where limited by the Federal Housing Administration and Veterans Administration and their respective loan programs. At December 31, 2005, OFS serviced approximately $7.7 billion of mortgage loans sold into the secondary market. All of OFS’s loans held for sale are pledged as collateral under the various financing arrangements described in Note 8. Mortgage loans held for sale consist of the following as of December 31, 2005:
Mortgage loans held for sale | $ | 884,751,317 |
Deferred loan origination costs—net | | 9,604,290 |
Valuation allowance | | (117,977) |
| | |
| $ | 894,237,630 |
NOTE 4.RETAINED INTEREST, TRADING
Subordinated interests retained represent the over-collateralization and net interest spread, which represents the estimated cash-flows to be received from the trust in the future from mortgage loan securitizations structured as sales in accordance with SFAS No. 140. Generally, to meet the sale treatment requirements of SFAS No. 140, the REMIC Trust is structured as a “qualifying special purpose entity” or QSPE, which specifically limits the trust’s activities, and OFS surrenders control over the mortgage loans upon their transfer to the REMIC Trust. All of OFS’s securitization issues were accounted for as a sale under SFAS No. 140. The subordinated interests retained are classified as “trading securities” and are reported at fair value with unrealized gains or losses reported in earnings.
Valuation of Investments. OFS classifies its retained interests as trading securities and therefore records these securities at their estimated fair value. In order to value the unrated, unquoted, investments, OFS will record these assets at their estimated fair value utilizing either pricing available directly from dealers or the present value calculated by projecting the future cash flows of an investment on a publicly available analytical system. When a publicly available analytical system is utilized, OFS will input the following variable factors which will have an impact on determining the market value:
Interest Rate Forecast. The forward LIBOR interest rate curve.
Discount Rate. The present value of all future cash flows utilizing a discount rate assumption established at the discretion of OFS to represent market conditions and value.
Prepayment Forecast. The prepayment forecast may be expressed by OFS in accordance with one of the following standard market conventions: 1) Constant Prepayment Rate (CPR) or 2) Percentage of a Prepayment Vector (PPV). Prepayment forecasts may be changed as OFS observes trends in the underlying collateral as delineated in the Statement to Certificate Holders generated by the REMIC trust’s Trustee for each underlying security.
Credit Performance Forecast. A forecast of future credit performance of the underlying collateral pool will include an assumption of default frequency, loss severity, and a recovery lag. In general, OFS will utilize the combination of default frequency and loss severity in conjunction with a collateral prepayment assumption to arrive at a target cumulative loss to the collateral pool over the life of the pool based on historical performance of similar collateral by the originator. The target cumulative loss forecast will be developed and noted at the pricing date of the individual security but may be updated by OFS consistent with observations of the actual collateral pool performance.
Default Frequency may be expressed by OFS in accordance with any of three standard market conventions: 1) Constant Default Rate (CDR) 2) Percentage of a Standard Default Assumption (SDA) curve, or 3) a vector or curve established to meet forecasted performance for specific collateral pools.
Loss Severity will be expressed by OFS in accordance with historical performance of similar collateral and the standard market conventions of a percentage of the unpaid principal balance of the forecasted defaults lost during the foreclosure and liquidation process.
During the first year of a new issue OFS may balance positive or adverse effects of the prepayment forecast and the credit performance forecast allowing for deviation between actual and forecasted performance of the collateral pool. After the first year OFS will generally adjust the Prepayment and Credit Performance Forecasts to replicate actual performance trends without balancing adverse and positive effects.
The following table summarizes OFS’s residual interests in securitizations as of December 31, 2005:
Series | | Issue Date | | December 31, 2005 |
| | | | |
HMAC 2004-1 | | March 4, 2004 | $ | 5,096,056 |
HMAC 2004-2 | | May 10, 2004 | | 3,240,431 |
HMAC 2004-3 | | June 30, 2004 | | 1,055,651 |
HMAC 2004-4 | | August 16, 2004 | | 3,749,261 |
HMAC 2004-5 | | September 28, 2004 | | 6,177,669 |
HMAC 2004-6 | | November 17, 2004 | | 14,321,046 |
OpteMac 2005-1 | | January 31, 2005 | | 14,720,910 |
OpteMac 2005-2 | | April 5, 2005 | | 11,301,619 |
OpteMac 2005-3 | | June 17, 2005 | | 14,656,477 |
OpteMac 2005-4 | | August 25, 2005 | | 2,551,775 |
OpteMac 2005-5 | | November 23, 2005 | | 11,139,697 |
| | | | |
Total | | | $ | 98,010,592 |
Key economic assumptions used in measuring the fair value of retained interests at the date of securitization resulting from securitizations completed during 2005 were as follows:
| 2005
|
Prepayment speeds (CPR) | 28.65% |
Weighted-average-life | 2.830 |
Expected credit losses | 1.069% |
Discount rates | 14.896% |
Interest rates | Forward LIBOR Yield curve |
At December 31, 2005 key economic assumptions and the sensitivity of the current fair value of residual cash flows to the immediate 10% and 20% adverse change in those assumptions are as follows:
Balance Sheet Carrying value of retained interests - fair value | $ | 98,010,592 |
Weighted average life (in years) | | 2.62 |
Prepayment assumption (annual rate) | | 32.53% |
Impact on fair value of 10% adverse change | $ | (7,817,000) |
Impact on fair value of 20% adverse change | $ | (16,089,000) |
Expected Credit losses (annual rate) | | 0.607% |
Impact on fair value of 10% adverse change | $ | (3,247,000) |
Impact on fair value of 20% adverse change | $ | (6,419,000) |
Residual Cash-Flow Discount Rate | | 13.96% |
Impact on fair value of 10% adverse change | $ | (3,804,000) |
Impact on fair value of 20% adverse change | $ | (7,392,000) |
Interest rates on variable and adjustable loans and bonds | | Forward LIBOR Yield Curve |
Impact on fair value of 10% adverse change | $ | (21,265,000) |
Impact on fair value of 20% adverse change | $ | (34,365,000) |
These sensitivities are hypothetical and should be used with caution. As the figures indicate, changes in fair value based upon a 10% variation in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, in this table, the effect of the variation in a particular assumption on the fair value of the retained interest is calculated without changing any other assumption, in reality, changes in one factor may result in changes in another which may magnify or counteract the sensitivities. To estimate the impact of a 10% and 20% adverse change of the Forward LIBOR curve, a parallel shift in the forward LIBOR curve was assumed based on the Forward LIBOR curve at December 31, 2005.
Static pool losses are calculated by summing the actual and projected future credit losses and dividing them by the original balance of each pool of assets. The amount shown here is calculated based upon all securitizations occurring in that year.
| Residential Mortgage
Loans Securitized In:
|
Actual and Projected
Credit Losses (%) as of :
| 2005
|
December 31, 2005 | 0.712% |
The table below summarizes certain cash flows received from and paid to securitization trusts:
| | For the Period November 3, 2005 (date of merger) through December 31, 2005 |
Proceeds from securitizations | $ | 989,843,000 |
Servicing fees received | | 2,837,500 |
Servicing advances | | 290,952 |
Repayments of servicing advances | | 0 |
The following information presents quantitative information about delinquencies and credit losses on securitized financial assets as of December 31, 2005:
Type of loan: | | Total Principal Amount of Loans | | Principal Amount of Loans Greater than 60 Days Past Due | | Net Credit Losses |
Mortgage Loans | $ | 6,363,279,281 | $ | 57,871,123 | $ | 912,990 |
NOTE 5.MORTGAGE SERVICING RIGHTS, NET
Activities for mortgage servicing rights are summarized as follows at December 31, 2005:
Balance on acquisition date: | $ | 87,079,777 |
Additions | | 1,431,576 |
Amortization | | (2,429,759) |
| | |
Balance at December 31, 2005: | $ | 86,081,594 |
Estimated amortization expense for the five years ended December 31 and thereafter:
2006 | $ | 14,872,566 |
2007 | | 13,450,007 |
2008 | | 12,027,449 |
2009 | | 10,604,890 |
2010 | | 9,182,331 |
Thereafter | | 25,944,351 |
| $ | 86,081,594 |
At December 31, 2005, key economic assumptions and the sensitivity of the current fair value of mortgage servicing rights cash flows to the immediate 10 percent and 20 percent adverse change in those assumptions are as follows:
Prepayment assumption (annual rate) (PSA) | | 253.72 |
Impact on fair value of 10% adverse change | $ | (3,615,000) |
Impact on fair value of 20% adverse change | $ | (6,936,000) |
MSR Cash-Flow Discount Rate | | 10.74% |
Impact on fair value of 10% adverse change | $ | (4,856,000) |
Impact on fair value of 20% adverse change | $ | (9,280,000) |
These sensitivities are hypothetical and should be used with caution. As the figures indicate, changes in fair value based upon a 10% and 20% variations in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, in this table, the effect of the variation in a particular assumption on the fair value of the mortgage servicing right is calculated without changing any other assumption. In reality, changes in one factor may result in changes in another which may magnify or counteract the sensitivities.
NOTE 6.MORTGAGE-BACKED SECURITIES
At December 31, 2005 and 2004, all of Opteum's mortgage-backed securities (“MBS”) were classified as available-for-sale and, as such, are reported at their estimated fair value. Estimated fair value was determined based on the average of third-party broker quotes received and/or independent pricing sources when available.
At December 31, 2005, Opteum had financed MBS with a historical amortized cost of $99.3 million with the party it acquired the MBS. Such securities are included in MBS at a fair value of $98.0 million and a corresponding repurchase agreement of $94.9 million at December 31, 2005.
The following are the carrying values of Opteum's MBS portfolio at December 31, 2005 and 2004:
| | December 31, 2005 | | December 31, 2004 |
Floating Rate CMO's | $ | - | $ | 250,438,730 |
Hybrid Arms and Balloons | | 753,895,705 | | 569,623,089 |
Adjustable Rate Mortgages | | 2,006,767,437 | | 1,403,381,666 |
Fixed Rate Mortgages | | 733,366,217 | | 749,789,412 |
| | | | |
Totals | $ | 3,494,029,359 | $ | 2,973,232,897 |
The following table presents the components of the carrying value of Opteum's MBS portfolio at December 31, 2005 and 2004:
| | December 31, 2005 | | December 31, 2004 |
| | | | |
Principal balance | $ | 3,457,887,912 | $ | 2,876,568,150 |
Unamortized premium | | 115,133,248 | | 98,202,287 |
Unaccreted discount | | (2,497,423) | | (381,769) |
Gross unrealized gains | | 265,615 | | 7,824,313 |
Gross unrealized losses | | (76,759,993) | | (8,980,084) |
| | | | |
Carrying value/estimated fair value | $ | 3,494,029,359 | $ | 2,973,232,897 |
The following table presents for Opteum's MBS investments with gross unrealized losses, the estimated fair value and gross unrealized losses aggregated by investment category, at December 31, 2005:
| Loss Position Less than 12 Months | Loss Position More than 12 Months | Total |
| | Estimated Fair Value | | Unrealized Losses | | Estimated Fair Value | | Unrealized Losses | | Estimated Fair Value | | Unrealized Losses |
Hybrid Arms and Balloons | $ | 563,661,156 | $ | (8,409,428) | $ | $141,675,752 | $ | (4,510,901) | $ | 705,336,908 | $ | (12,920,329) |
Adjustable Rate Mortgages | | 1,648,085,054 | | (27,917,630) | | 270,945,493 | | (8,944,837) | | 1,919,030,547 | | (36,862,467) |
Fixed Rate Mortgages | | 425,260,838 | | (10,762,306) | | 346,435,009 | | (16,214,890) | | 771,695,847 | | (26,977,197) |
| | | | | | | | | | | | |
| $ | 2,637,007,048 | $ | (47,089,364) | $ | 759,056,254 | $ | (29,670,628) | $ | 3,396,063,302 | $ | (76,759,993) |
The following table presents for Opteum's MBS investments with gross unrealized losses, the estimated fair value and gross unrealized losses aggregated by investment category, at December 31, 2004:
| Loss Position Less than 12 Months | Loss Position More than 12 Months | Total |
| | Estimated Fair Value | | Unrealized Losses | | Estimated Fair Value | | Unrealized Losses | | Estimated Fair Value | | Unrealized Losses |
Hybrid Arms and Balloons | $ | 334,918,233 | $ | (1,974,605) | $ | 31,954,324 | $ | (75,968) | $ | 366,872,557 | $ | (2,050,573) |
Adjustable Rate Mortgages | | 479,284,021 | | (2,930,772) | | 9,374,573 | | (21,845) | | 488,658,594 | | (2,952,617) |
Fixed Rate Mortgages | | 519,546,019 | | (3,950,372) | | 11,260,668 | | (26,522) | | 530,806,687 | | (3,976,894) |
| | | | | | | | | | | | |
| $ | 1,333,748,273 | $ | (8,855,749) | $ | 52,589,565 | $ | (124,335) | $ | 1,386,337,838 | $ | (8,980,084) |
At December 31, 2005, all of Opteum's MBS investments have contractual maturities greater than twenty-three months. Actual maturities of MBS investments are generally shorter than stated contractual maturities. Actual maturities of Opteum's MBS investments are affected by the contractual lives of the underlying mortgages, periodic payments of principal, and prepayments of principal.
The decline in fair value MBS of investments is not considered to be other than temporary. Accordingly, the write down to fair value is recorded in other comprehensive loss as an unrealized loss. The factors considered in making this determination include: the expected cash flow from the MBS investment, the general quality of the MBS owned, any credit protection available, current market conditions, and the magnitude and duration of the historical decline in market prices as well as Opteum's ability and intention to hold the MBS owned.
NOTE 7.FAIR VALUE OF FINANCIAL INSTRUMENTS
The valuation of Opteum’s investments in mortgage backed securities is governed by SFAS No. 107. SFAS No. 107, Disclosures about Fair Value of Financial Instruments, defines the fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties. All REIT securities are reflected in the financial statements at their estimated fair value as of December 31, 2005 and 2004. Estimated fair values for MBS are based on the average of third-party broker quotes received and/or independent pricing sources when available. However, the fair values reported reflect estimates and may not necessarily be indicative of the amounts Opteum could realize in a current market exchange. Cash and cash equivalents, accrued interest receivable, repurchase agreements and accrued interest payable are reflected in the financial statements at their costs, which approximates their fair value because of the short-term nature of these instruments.
Fair value of mortgage loans held for sale, mortgage servicing rights, interest rate lock commitments and commitments to deliver mortgages are based on estimates. Fair value estimates are made as of a specific point in time based on estimates using present value or other valuation techniques. These techniques involve uncertainties and are significantly affected by the assumptions used and the judgments made regarding risk characteristics of various financial instruments, discount rates, estimates of future cash flows, future expected loss experience, and other factors.
Changes in assumptions could significantly affect these estimates and the resulting fair values. Derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in an immediate sale of the instrument. Also, because of differences in methodologies and assumptions used to estimate fair values, the Company’s fair values should not be compared to those of other companies. All forward delivery commitments and option contracts to buy securities are to be contractually settled within six months of the balance sheet date.
Fair value estimates are based on existing financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.
The fair value of certain OFS assets and liabilities either equal or approximate carrying value due to their short-term nature, terms of repayment, floating interest rate associated with the asset or liability or accounting principles applied. Such assets or liabilities include cash, receivables, retained interests, other trading securities, accounts payable and other liabilities, warehouse lines of credit and drafts payable.
The following describes the methods and assumptions used by OFS in estimating fair values of other financial instruments:
§ | Mortgage Loans Held for Sale— Mortgage loans held for sale represent mortgage loans originated and held pending sale to investors. The mortgages are carried at the lower of cost or market as determined by outstanding commitments from investors or current investor yield requirements calculated on the aggregate loan basis. Deferred net fees or costs are not amortized during the period the loans are held for sale, but are recognized when the loan is sold. |
§ | Mortgage Servicing Rights— the estimated fair value of MSRs is determined by obtaining a market valuation from a specialist who brokers MSRs. To determine the market valuation, the third party uses a valuation model which incorporates assumptions relating to the estimate of the cost of servicing per loan, a discount rate, a float value, an inflation rate, ancillary income per loan, prepayment speeds, and default rates that market participants use for acquiring similar servicing rights. |
§ | Interest Rate Lock Commitments—The fair value of interest rate lock commitments is estimated using the fees and rates currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counter-parties. For fixed rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. |
§ | Commitments to Deliver Mortgages—The fair value of these instruments is estimated using current market prices for dealer or investor commitments relative to the Company’s existing positions. These instruments contain an element of risk in the event that the counter-parties may be unable to meet the terms of such agreements. In the event a counterparty to a delivery commitment was unable to fulfill its obligation, the Company would not incur any material loss by replacing the position at market rates in effect at December 31, 2005. The Company minimizes its risk exposure by limiting the counter-parties to those major banks, investment bankers, and private investors who meet established credit and capital guidelines. Management does not expect any counterparty to default on its obligations and, therefore, does not expect to incur any loss due to counterparty default. |
The following tables set forth information about financial instruments and other selected assets, except for those noted above for which the carrying value approximates fair value.
NOTE 8.WAREHOUSE LINES OF CREDIT AND DRAFTS PAYABLE
OFS issues drafts or wires at loan settlement in order to facilitate the closing of mortgage loans held for sale. Drafts payable represent mortgage loans on which a closing has occurred prior to year end but the related drafts have not cleared the respective bank. Upon clearing the bank, the drafts are funded by the appropriate warehouse line of credit. Warehouse and aggregate lines of credit and loans sale agreements accounted for as financing consisted of the following at December 31, 2005:2006:
Warehouse and aggregate lines of credit: | | 2005 |
| | |
A committed warehouse line of credit for $100 million between OFS and Residential Funding Corporation ("RFC"). The agreement expires on March 31, 2006. The agreement provides for interest rates based upon 1 month LIBOR plus a margin between 1.25% and 1.50% depending on the product that was originated or acquired. | $ | 9,246,486 |
| | |
A committed warehouse line of credit for $284.5 million between OFS and Colonial Bank. The agreement expires on May 30, 2006. The agreement provides for interest rates, based upon 1 month LIBOR, plus a margin of 1.25% to 2.00% depending on the product that was originated or acquired. | | 246,706,788 |
| | |
A committed warehouse line of credit for $150 million between OFS and JP Morgan Chase. The agreement expires on May 30, 2006 and is expected to be renewed prior to its expiration. The agreement provides for interest rates based upon 1 month LIBOR plus a margin of 1.25% to 2.00% depending on the product originated or acquired. | | 67,969,568 |
| | |
An Aggregation facility for $1.0 billion between OFS and Citigroup Global Markets Realty Inc. to aggregate loans pending securitization. The agreement expires on February 28, 2007. The agreement provides for interest rates based upon 1 month LIBOR plus a margin of .75%. | | 70,269,031 |
| | |
An Aggregation facility for $500 million between OFS and Bear Stearns to aggregate loans pending securitization. The agreement expires on March 11, 2006 and it is expected to be renewed prior to its expiration. The agreement provides for interest rates based upon 1 month LIBOR plus a margin of 0.75%. | | - |
| | |
A $750 million purchase and security agreement between OFS and UBS Warburg Real Estate Securities, Inc. (“UBS Warburg”) The facility is due upon demand and can be cancelled by either party upon notification to the counterparty. OFS incurs a charge for the facility based on 1 month LIBOR plus 1% to 1.35% depending on the product originated. The facility is secured by loans held for sale and cash generated from sales to investors. | | 469,811,083 |
| | |
| | 864,002,956 |
| | |
Drafts Payable | | 9,738,473 |
| | |
Total Warehouse lines and drafts payable | $ | 873,741,429 |
(in thousands)Warehouse and aggregation lines of credit: | | 2006 |
| | |
A committed warehouse line of credit for $100 million between OFS and Residential Funding Corporation ("RFC"). The agreement expired on February 28, 2007 and was not renewed. RFC is now a party to the JPM syndicated facility below. The agreement provides for interest rates based upon one month LIBOR plus a margin between 1.00% and 2.50% depending on the product that was originated or acquired. | $ | 6,172 |
| | |
A syndicated committed warehouse line of credit for $850 million between OFS and JP Morgan Chase (“JPM”). The agreement expires on May 30, 2007 and is expected to be renewed prior to its expiration. The agreement provides for interest rates based upon one month LIBOR plus a margin of 0.60% to 1.50% depending on the product originated or acquired. | | 409,609 |
| | |
An aggregation facility for $1.5 billion for the whole loan and servicing rights facility, collectively, (of which no more than $100 million may be allocated to the servicing rights facility) between HS Special Purpose, LLC, a wholly-owned subsidiary of OFS, and Citigroup Global Markets Realty Corp. (“Citigroup”) to aggregate loans pending securitization. The agreement expires on December 20, 2007. The agreement provides for interest rates based upon one month LIBOR plus a margin of 0.30%. | | 5,358 |
| | |
A $750 million purchase and security agreement between OFS and UBS Warburg Real Estate Securities, Inc. (“UBS Warburg”) | | 3,283 |
| | |
Drafts payable | | 6,542 |
| | |
Loans sales agreements accounted for as financings: | | |
An uncommitted $700 million purchase agreement between OFS and Colonial Bank. The facility is due upon demand and can be cancelled by either party upon notification to the counterparty. OFS incurs a charge for the facility based on one month LIBOR plus 0.50% for the first $300.0 million purchased and one month LIBOR plus 0.75% for the amount used above and beyond $300.0 million. The facility is secured by loans held for sale and cash generated from sales to investors | | 303,915 |
| | |
| | |
Total Warehouse lines and drafts payable | $ | 734,879 |
In addition to the RFC, Colonial Bank,JPM, Citigroup, UBS Warburg, and CitigroupColonial Bank facilities, OFS has purchase and sale agreements with Greenwich Capital and Fannie Mae. TheThese additional agreements allow for OFS to accelerate the sale of its mortgage loan inventory, resulting in a more effective use of its warehouse facilities. OFS has a combined capacity of $300$100 million under these purchase and sale agreements. There were no amounts sold and being held under these agreements at December 31, 2005.2006. The agreements are not committed facilities and may be terminated at the discretion of either party.
The facilities are secured by mortgage loans and other assets of OFS. The facilities generally contain various covenants pertaining to tangible net worth, net income, available cash and liquidity, leverage ratio, current ratio and servicing delinquency. AtAs of December 31, 2005,2006, OFS was not in compliance with respect to four covenants pertaining to net income and tangible net worth with two covenantslenders. OFS has obtained waivers for the covenant violations. At January 31, 2007, OFS was not in compliance with one lender. The two covenants pertainedcovenant with one lender pertaining to tangible net worth and net income at December 31, 2005. The violations were attributable to the loss reportedworth. OFS has obtained a waiver for the period November 3, 2005, (date of merger) through December 31, 2005, resulting from the required purchase accounting adjustments to the carrying value of certain assets of OFS. On February 28, 2006, these violations were waived by the lender.covenant violation.
NOTE 9.OTHER SECURED BORROWINGS
Other secured borrowings consisted of the following at December 31:
(in thousands)
| | 2005 |
A committed working capital line of credit for $82.5 million between OFS and Colonial Bank. The agreement expires on May 30, 2006. The agreement provides for an interest rate, based on1 month LIBOR plus a margin of up to 2.6% and is secured by the servicing rights for FNMA, FHLMC and REMIC securitizations. | $ | 73,204,674 |
| | |
A committed warehouse line of credit for $150.0 million between OFS and JP Morgan Chase, that allows for a sublimit for mortgage servicing rights. The agreement expires May 30, 2006 and is expected to be renewed prior to its expiration. The agreement provides for interest rate based on LIBOR plus 2.0% | | 7,410,000 |
| | |
Citigroup Global Realty Inc., working capital line of credit secured by the Retained interests in securitizations through OPMAC 2005-4. The facility expires on October 31, 2006. The agreement provides for interest rate based on LIBOR plus 3.00% | | 24,271,665 |
| $ | 104,886,339 |
| | 2006 |
A committed warehouse line of credit for $150.0 million between OFS and JP Morgan Chase, that allows for a sublimit for originated Mortgage Servicing Rights. The agreement expires May 30, 2007 and is expected to be renewed prior to its expiration. The agreement provides for interest rate based on LIBOR plus 1.50% to 1.85% depending on collateral type. | $ | 71,657 |
| | |
Citigroup Global Realty Inc., working capital line of credit for $80.0 million secured by the retained interests in securitizations through OMAC 2006-2. The facility expires on December 20, 2007. The agreement provides for interest rate based on LIBOR plus 1.00% | | 50,320 |
| $ | 121,977 |
NOTE 10. Repurchase AgreementsREPURCHASE AGREEMENTS
Opteum has entered into repurchase agreements to finance most of its MBS security purchases. The repurchase agreements are short-term borrowings that bear interest at rates that have historically moved in close relationship to LIBOR. At December 31, 2006, Opteum had an outstanding amount of $2.7 billion with a net weighted average borrowing rate of 5.31% and these agreements were collateralized by MBS with a fair value of $2.8 billion. At December 31, 2005, Opteum had an outstanding amount of $3.3 billion with a net weighted average borrowing rate of 4.15%, and these agreements were collateralized by MBS with a fair value of $3.5 billion and restricted cash of $2.3 million.
At December 31, 2004, Opteum2006, Opteum's repurchase agreements had an outstanding amount of $2.8 billion with a net weighted average borrowing rate of 2.28%, and these agreements were collateralized by MBS with a fair value of $2.9 billion and restricted cash of $8.7 million.remaining maturities as summarized below:
(in thousands)
| | OVERNIGHT (1 DAY OR LESS) | | BETWEEN 2 AND 30 DAYS | | BETWEEN 31 AND 90 DAYS | | GREATER THAN 90 DAYS | | TOTAL |
Agency-Backed Mortgage-Backed Securities: | | | | | | | | | | |
Amortized cost of securities sold, including accrued interest receivable | $ | - | $ | 859,344 | $ | 807,488 | $ | 1,149,309 | $ | 2,816,141 |
Fair market value of securities sold, including accrued interest receivable | $ | - | $ | 833,436 | $ | 793,702 | $ | 1,106,228 | $ | 2,733,366 |
Repurchase agreement liabilities associated with these securities | $ | - | $ | 842,094 | $ | 805,595 | $ | 1,093,991 | $ | 2,741,680 |
Net weighted average borrowing rate | | - | | 5.31% | | 5.33% | | 5.29% | | 5.31% |
At December 31, 2005, Opteum's repurchase agreements had remaining maturities as summarized below:
| | OVERNIGHT (1 DAY OR LESS) | | BETWEEN 2 AND 30 DAYS | | BETWEEN 31 AND 90 DAYS | | GREATER THAN 90 DAYS | | TOTAL |
Agency-Backed Mortgage-Backed Securities: | | | | | | | | | | |
Amortized cost of securities sold, including accrued interest receivable | $ | — | $ | 906,106,459 | $ | 813,436,832 | $ | 1,533,016,956 | $ | 3,252,560,247 |
Fair market value of securities sold, including accrued interest receivable | $ | — | $ | 893,159,892 | $ | 791,259,152 | $ | 1,498,980,224 | $ | 3,183,399,268 |
Repurchase agreement liabilities associated with these securities | $ | — | $ | 914,262,355 | $ | 857,995,007 | $ | 1,565,341,000 | $ | 3,337,598,362 |
Net weighted average borrowing rate | | — | | 4.22% | | 4.01% | | 4.19% | | 4.15% |
(in thousands)
| | OVERNIGHT (1 DAY OR LESS) | | BETWEEN 2 AND 30 DAYS | | BETWEEN 31 AND 90 DAYS | | GREATER THAN 90 DAYS | | TOTAL |
Agency-Backed Mortgage-Backed Securities: | | | | | | | | | | |
Amortized cost of securities sold, including accrued interest receivable | $ | — | $ | 906,106 | $ | 813,437 | $ | 1,533,017 | $ | 3,252,560 |
Fair market value of securities sold, including accrued interest receivable | $ | — | $ | 893,160 | $ | 791,259 | $ | 1,498,980 | $ | 3,183,399 |
Repurchase agreement liabilities associated with these securities | $ | — | $ | 914,262 | $ | 857,995 | $ | 1,565,341 | $ | 3,337,598 |
Net weighted average borrowing rate | | — | | 4.22% | | 4.01% | | 4.19% | | 4.15% |
At December 31, 2006, Opteum's repurchase agreements had the following counterparties, amounts at risk and weighted average remaining maturities:
(in thousands)
Repurchase Agreement Counterparties | | Amount Outstanding | | Amount at Risk(1) | Weighted Average Maturity of Repurchase Agreements in Days | Percent of Total Amount Outstanding | |
Deutsche Bank Securities, Inc. | $ | 834,940 | $ | 10,189 | 28 | 30.45 | % |
JP Morgan Securities | | 652,936 | | 13,195 | 98 | 23.82 | |
Nomura Securities International, Inc. | | 463,410 | | 13,405 | 94 | 16.90 | |
Washington Mutual | | 333,587 | | 12,476 | 24 | 12.17 | |
Countrywide Securities Corp | | 206,220 | | 4,401 | 79 | 7.52 | |
BNP Paribas | | 92,155 | | 2,666 | 18 | 3.36 | |
Goldman Sachs | | 70,068 | | 1,278 | 122 | 2.56 | |
Bank of America Securities, LLC | | 54,120 | | 1,742 | 136 | 1.97 | |
UBS Investment Bank, LLC | | 21,515 | | 231 | 17 | 0.78 | |
RBS Greenwich Capital | | 12,729 | | 44 | 7 | 0.47 | |
Total | $ | 2,741,680 | $ | 59,627 | | 100.00 | % |
(1)Equal to the fair value of securities sold, plus accrued interest income, minus the sum of repurchase agreement liabilities, plus accrued interest expense.
At December 31, 2004,2005, Opteum's repurchase agreements had the following counterparties, amounts at risk and weighted average remaining maturities as summarized below:maturities:
| | OVERNIGHT (1 DAY OR LESS) | | BETWEEN 2 AND 30 DAYS | | BETWEEN 31 AND 90 DAYS | | GREATER THAN 90 DAYS | | TOTAL |
Agency-Backed Mortgage-Backed Securities: | | | | | | | | | | |
Amortized cost of securities sold, including accrued interest receivable | $ | — | $ | 821,387,879 | $ | 975,251,727 | $ | 1,028,522,165 | $ | 2,825,161,771 |
Fair market value of securities sold, including accrued interest receivable | $ | — | $ | 823,087,580 | $ | 975,020,524 | $ | 1,025,389,631 | $ | 2,823,497,735 |
Repurchase agreement liabilities associated with these securities | $ | — | $ | 797,655,321 | $ | 968,417,528 | $ | 1,005,090,108 | $ | 2,771,162,957 |
Net weighted average borrowing rate | | — | | 2.28% | | 2.11% | | 2.45% | | 2.28% |
(in thousands)
Repurchase Agreement Counterparties | | Amount Outstanding | | Amount at Risk(1) | Weighted Average Maturity of Repurchase Agreements in Days | Percent of Total Amount Outstanding | |
Deutsche Bank Securities, Inc. | $ | 894,748 | $ | 12,018 | 135 | 26.81 | % |
Nomura Securities International, Inc. | | 623,631 | | 27,010 | 122 | 18.69 | |
Cantor Fitzgerald | | 467,638 | | 15,958 | 70 | 14.01 | |
Washington Mutual | | 375,345 | | 11,630 | 7 | 11.25 | |
Goldman Sachs | | 207,525 | | 7,438 | 44 | 6.22 | |
Bear Stearns & Co. Inc. | | 167,610 | | 6,096 | 157 | 5.02 | |
UBS Investment Bank, LLC | | 158,781 | | 5,059 | 93 | 4.76 | |
Merrill Lynch | | 128,119 | | (7,949) | 96 | 3.84 | |
JP Morgan Securities | | 115,807 | | 1,652 | 151 | 3.47 | |
Morgan Stanley | | 73,505 | | 1,767 | 26 | 2.20 | |
Lehman Brothers | | 62,643 | | 2,399 | 87 | 1.88 | |
Countrywide Securities Corp | | 22,930 | | 1,238 | 86 | 0.69 | |
Daiwa Securities America Inc. | | 19,732 | | 39 | 188 | 0.58 | |
Bank of America Securities, LLC | | 19,584 | | 815 | 27 | 0.58 | |
Total | $ | 3,337,598 | $ | 85,170 | | 100.00 | % |
(1)Equal to the fair value of securities sold, plus accrued interest income, minus the sum of repurchase agreement liabilities, plus accrued interest expense.
NOTE 11. TRUST PREFERRED SECURITIES
On May 17, 2005, Opteum completed a private offering of $50.0 million of trust preferred securities of Bimini Capital Trust I (“BCTI”), a Delaware statutory business trust sponsored by Opteum.
Bimini Capital Trust I (“BCTI” or the “trust”) BCTI used the proceeds of the private offering, together with Opteum’sOpteum's investment of $1.6 million in the BCTI common equity securities, to purchase $51.6 million aggregate principal amount of Opteum’sOpteum's BCTI Junior Subordinated Notes with terms that parallel the terms of the BCTI trust preferred securities.
The BCTI trust preferred securities and Opteum's BCTI Junior Subordinated Notes have a fixed rate of interest until March 30, 2010, atof 7.61% and thereafter, through maturity in 2035, the rate will float at a spread of 3.30% over the prevailing three-month LIBOR rate. The BCTI trust preferred securities and Opteum's BCTI Junior Subordinated Notes require quarterly interest distributions and are redeemable at Opteum’sOpteum's option, in whole or in part and without penalty, beginning March 30, 2010 and at any date thereafter. The notesOpteum's BCTI Junior Subordinated Notes are subordinate and junior in right of payment of all present and future senior indebtedness. The proceeds from the private offering net of costs were approximately $48.5 million.
On October 5, 2005, Opteum completed a private offering of $50.0 million of trust preferred securities of Bimini Capital Trust II (“BCTII”), a Delaware statutory business trust sponsored by Opteum.
Bimini Capital Trust II (“BCTII”) BCTII used the proceeds of the private offering, together with Opteum’sOpteum's investment of $1.5 million in the BCTII common equity securities, to purchase $51.5 million aggregate principal amount of Opteum’sOpteum's BCTII Junior Subordinated Notes with terms that parallel the terms of the BCTII trust preferred securities.
The BCTII trust preferred securities and Opteum's BCTII Junior Subordinated Notes have a fixed rate of interest until December 15, 2010, atof 7.8575% and thereafter, through maturity in 2035, the rate will float at a spread of 3.50% over the prevailing three-month LIBOR rate. The BCTII trust preferred securities and Opteum's BCTII Junior Subordinated Notes require quarterly interest distributions and are redeemable at Opteum’sOpteum's option, in whole or in part and without penalty, beginning December 15, 2010, and at any date thereafter. The notesOpteum's BCTII Junior Subordinated Notes are subordinate and junior in right of payment of all present and future senior indebtedness. The proceeds from the private offering net of costs were approximately $48.5 million.
TheEach trust is a variable interest entity pursuant to FIN No. 46 because the holders of the equity investment at risk do not have adequate decision making ability over the trust’strust's activities. Because Opteum’sSince Opteum's investment in the trust’seach trust's common sharesequity securities was financed directly by the applicable trust as a result of its loan of the proceeds to Opteum, that investment is not considered to be an equity investment at risk pursuant to FIN No. 46. Since Opteum’sOpteum's common shares investmentshare investments in BCTI isand BCTII are not a variable interest, Opteum is not the primary beneficiary of the trust.trusts. Therefore, Opteum has not consolidated the financial statements of BCTI and BCTII into its financial statements. Based on the aforementioned accounting guidance, the accompanying consolidated financial statements present the notesOpteum's BCTI and BCTII Junior Subordinated Notes issued to the trusttrusts as a liabilityliabilities and the investmentOpteum's investments in the common equity securities of BCTI and BCTII as an asset.assets. For financial statement purposes, Opteum records payments of interest expense on the corresponding notesJunior Subordinated Notes issued to the BCTI on its statements of income.and BCTII as interest expense.
NOTE 12.CAPITAL STOCK
Authorized Shares
The total number of shares of capital stock which the Company has the authority to issue is 110,000,000 shares, consisting of 100,000,000 shares of common stock having a par value of $0.001 per share and 10,000,000 shares of preferred stock having a par value of $0.001 per share. The Board of Directors has the authority to classify any unissued shares by setting or changing in any one or more respects the preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends, qualifications or terms or conditions of redemption of such shares.
Common Stock
Of the 100,000,000 authorized shares of common stock, 98,000,000 shares were designated as Class A Common Stock, 1,000,000 shares were designated as Class B Common Stock and 1,000,000 shares were designated as Class C Common Stock. Holders of shares of common stock have no sinking fund or redemption rights and have no preemptive rights to subscribe for any of ourthe Company’s securities.
Class A Common Stock
Each outstanding share of Class A Common Stock entitles the holder to one vote on all matters submitted to a vote of stockholders, including the election of directors. Holders of shares of Class A Common Stock are not entitled to cumulate their votes in the election of directors.
Subject to the preferential rights of any other class or series of stock and to the provisions of the Company's charter, , as amended, regarding the restrictions on transfer of stock, holders of shares of Class A Common Stock are entitled to receive dividends on such stock if, as and when authorized and declared by the Board of Directors.
Class B Common Stock
Each outstanding share of Class B Common Stock entitles the holder to one vote on all matters submitted to a vote of common stockholders, including the election of directors. Holders of shares of Class B Common Stock are not entitled to cumulate their votes in the election of directors. Holders of shares of Class A Common Stock and Class B Common Stock shall vote together as one class in all matters except that any matters which would adversely affect the rights and preferences of Class B Common Stock as a separate class shall require a separate approval by holders of a majority of the outstanding shares of our Class B Common Stock.
Holders of shares of Class B Common Stock are entitled to receive dividends on each share of Class B Common Stock in an amount equal to the dividends declared on each share of Class A Common Stock if, as and when authorized and declared by the Board of Directors. Prior to July 9, 2004, no dividends were declared on the shares of Class B Common Stock due to a provision which required that cumulative dividends paid on each share of Class A Common Stock be equal to or greater than the difference between the book value per share of Class A Common Stock at the time of issuance of such shares of Class A Common Stock and $15.00 per share, before dividends could be paid on the Class B Common Stock. As of July 9, 2004, the cumulative dividends paid on each share of Class A Common Stock met this requirement; therefore, as of July 9, 2004, the shares of Class B Common Stock became entitled to receive dividends in an amount equal to the dividends declared on each share of Class A Common Stock if, as and when authorized and declared by the Board of Directors.
Each share of Class B Common Stock shall automatically be converted into one share of Class A Common Stock on the first day of the fiscal quarter following the fiscal quarter during which the Company's Board of Directors were notified that, as of the end of such fiscal quarter, the stockholders' equity attributable to the Class A Common Stock, calculated on a pro forma basis as if conversion of the Class B Common Stock (or portion thereof to be converted) had occurred, and otherwise determined in accordance with GAAP, equals no less than $15.00 per share (adjusted equitably for any stock splits, stock combinations, stock dividends or the like); provided, that the number of shares of Class B Common Stock to be converted into Class A Common Stock in any quarter shall not exceed an amount that will cause the stockholders' equity attributable to the Class A Common Stock calculated as set forth above to be less than $15.00 per share; provided further, that such conversions shall continue to occur until all shares of Class B Common Stock have been converted into shares of Class A Common Stock; and provided further, that the total number of shares of Class A Common Stock issuable upon conversion of the Class B Common Stock shall not exceed 3% of the total shares of common stock outstanding prior to completion of an initial public offering of Opteum's Class A Common Stock. Opteum's Class A Common Stock has a book value per share of $10.33 at December 31, 2005.
Class C Common Stock
No dividends will be paid on the Class C Common Stock. Holders of shares of Class C Common Stock are not entitled to vote on any matter submitted to a vote of stockholders, including the election of directors, except that any matters that would adversely affect the rights and privileges of the Class C Common Stock as a separate class shall require the approval of a majority of the Class C Common Stock.
Each share of Class C Common Stock shall automatically be converted into one share of Class A Common Stock on the first day of the fiscal quarter following the fiscal quarter during which the Company's Board of Directors were notified that, as of the end of such fiscal quarter, the stockholders' equity attributable to the Class A Common Stock, calculated on a pro forma basis as if conversion of the Class C Common Stock had occurred and giving effect to the conversion of all of the shares of Class B Common Stock as of such date, and otherwise determined in accordance with GAAP, equals no less than $15.0015.00 per share (adjusted equitably for any stock splits, stock combinations, stock dividends or the like); provided, that the number of shares of Class C Common Stock to be converted into Class A Common Stock shall not exceed an amount that will cause the stockholders' equity attributable to the Class A Common Stock calculated as set forth above to be less than $15.0015.00 per share; and provided further, that such conversions shall continue to occur until all shares of Class C Common Stock have been converted into shares of Class A Common Stock and provided further, that the total number of shares of Class A Common Stock issuable upon conversion of the Class C Common Stock shall not exceed 3% of the total shares of common stock outstanding prior to completion of an initial public offering of Opteum's Class A Common Stock. Opteum's Class A Common Stock has a book value per share of $10.33 at December 31, 2005.
Initial Capitalization
The three initial independent directors of the Company's Board of Directors subscribed for a total of 7,500 shares of Class A Common Stock in October 2003 at par value, or a price of $0.001 per share. Compensation totaling $28 was recorded as a result of this issuance. See below for a description of additional Class A Common Stock issuances.
Of the 1,000,000 shares of Class B Common Stock authorized for issuance, 319,388 shares were issued to Opteum's initial officers, Jeffrey J. Zimmer and Robert E. Cauley, in October 2003 for a total price of $1,500. Of the 1,000,000 shares of Class C Common Stock authorized for issuance, 319,388 shares were subscribed to by Flagstone Securities, LLC in October 2003 at par value, or a price of $0.001 per share. Compensation totaling $1,181 was recorded as a result of this issuance.
Issuances of Common Stock
On December 11, 2003, Opteum began a private placement offering (the "Offering") of up to 10,000,000 shares of Class A Common Stock at a price to the investors of $15.00 per share. On December 19, 2003, Opteum completed a first closing, in which Opteum issued 4,004,602 shares and received proceeds of $56,598,732, which is net of placement agency fees and expenses totaling $3,350,297. On January 30, 2004, the Offering was closed, and Opteum issued an additional 5,837,055 shares and received proceeds of $82,864,346, which is net of placement agency fees and expenses totaling $4,691,479.
On February 17, 2004, Opteum issued a total of 158,343 shares of Class A Common Stock in a private offering and received proceeds of $2,248,471, which is net of placement agency fees and expenses totaling $126,674.
On September 21, 2004, Opteum issued a total of 5,000,000 shares of Class A Common Stock in an initial public offering and, on September 24, 2004 issued 750,000 shares of Class A Common Stock pursuant to the exercise of an over allotment option by the underwriters. Proceeds of $75,881,557, which is net of underwriter fees and expenses totaling $7,481,136 were received by Opteum.
On December 16, 2004, Opteum issued a total of 4,000,000 shares of Class A Common Stock in a secondary public offering and, on December 17, 2004 issued 600,000 shares of Class A Common Stock pursuant to the exercise of an over allotment option by the underwriters. Proceeds of $66,679,375, which is net of underwriter fees and expenses totaling $4,620,625 were received by Opteum.
During 2004, Opteum issued a total of 11,415 shares of Class A Common Stock to its directors for the payment of director fees. The compensation charges for these issuances were recorded at the respective fair-values at the date of each issuance in accordance with SFAS No. 123. Total compensation charges related to these issuances was $174,386 for the year ended December 31, 2004.
During 2005, Opteum issued a total of 27,800 shares of Class A Common Stock to its directors for the payment of director fees. The compensation charges for these issuances were recorded at the respective fair-values at the date of each issuance in accordance with SFAS No. 123. Total compensation charges related to these issuances was $357,843 for the year ended December 31, 2005.
During 2005, Opteum issued 3,717,242 shares of its Class A Common Stock in connection with an acquisition (see Note 2). Also, a total of 14,667 shares of Class A Common Stock were issued in connection with Opteum’s stock-based compensation plans.
During 2006, Opteum issued for payment of Director fees a total of 37,001 shares of Class A Common Stock, and Opteum also paid $204,979 of cash compensation.
During 2006, Opteum issued 140,490 shares of its Class A Common Stock to Opteum employees pursuant to the terms of the stock incentive plan phantom share grants (see Note 14).
On April 28, 2006, Opteum issued a total of 1,223,208 shares of Class A Common Stock in conjunction with the conversion of the Class A Redeemable Preferred Stock (see Note 7).
On July 17, 2006, Opteum granted 79,725 restricted shares of its Class A Common Stock to certain key employees of the Company's subsidiary pursuant to the terms of the Opteum Inc. 2003 Long Term Incentive Compensation Plan. The shares were subject to forfeiture prior to the November 3, 2006, vesting date. On the vesting date 4,650 total shares were forfeited and 75,075 total shares were issued.
During 2006, Opteum retired 1,089,100 shares of Class A Common Stock.
Dividends
On March 9, 2007, the Company's Board of Directors declared a $0.05 per share cash dividend to the holders of its dividend eligible securities on the record date of March 26, 2007. These dividends are payable on April 13, 2007.
On December 20, 2006, the Company's Board of Directors declared a $0.05 per share cash dividend to the holders of its dividend eligible securities on the record date of January 3, 2007. Dividends were payable on 24,515,717 shares of Class A Common Stock, 503,644 phantom shares granted under the Company's stock incentive plan (see Note 14) and 319,388 shares of Class B Common Stock. The distribution totaling $1,266,937 was paid on January 19, 2007.
On September 7, 2006, the Company's Board of Directors declared a $0.05 per share cash dividend to the holders of its dividend eligible securities on the record date of September 22, 2006. Dividends were payable on 24,396,940 shares of Class A Common Stock, 562,018 phantom shares and 76,375 restricted shares granted under the Company's stock incentive plan (see Note 14) and 319,388 shares of Class B Common Stock. The distribution totaling $1,267,736 was paid on October 13, 2006.
On May 31, 2006, the Company's Board of Directors declared a $0.25 per share cash dividend to the holders of its dividend eligible securities on the record date of June 21, 2006. Dividends were payable on 24,354,114 shares of Class A Common Stock, 612,268 phantom shares granted under the Company's stock incentive plan (see Note 14) and 319,388 shares of Class B Common Stock. The shares of Class A Common Stock include the shares of Class A Redeemable Preferred Stock that were converted on April 28, 2006. The distribution totaling $6,321,444 was paid on July 7, 2006.
On March 10, 2006, the Company's Board of Directors declared a $0.11 per share cash dividend to the holders of its dividend eligible securities. Dividends were payable on 23,083,498 shares of Class A Common Stock, 650,320 phantom shares granted under the Company's stock incentive plan (see Note 14) and 319,388 shares of Class B Common Stock. No dividends were paid on the Class A Redeemable Preferred Stock as the provisions of a formula in the Company's amended Articles of Incorporation were not met. The distribution totaling $2,645,853 was paid on April 7, 2006.
On March 9, 2005, the Company's Board of Directors declared a $0.53 per share cash distribution to holders of its Class A Common Stock. Dividends were payable on 20,374,883 shares of Class A Common Stock, 516,961 phantom shares granted under the Company's stock incentive plan (see Note 14) and 319,388 shares of Class B Common Stock. The distribution totaling $11,241,953 was paid on April 8, 2005.
On May 31, 2005, the Company's Board of Directors declared a $0.40 per share cash distribution to holders of its Class A Common Stock. Dividends were payable on 20,385,936 shares of Class A Common Stock, 512,072 phantom shares granted under the Company's stock incentive plan (see Note 14) and 319,388 shares of Class B Common Stock. The distribution totaling $8,486,958 was paid on July 8, 2005.
On August 24, 2005, the Company's Board of Directors declared a $0.38 per share cash distribution to holders of its Class A Common Stock. Dividends were payable on 20,397,210 shares of Class A Common Stock, 504,675 phantom shares granted under the Company's stock incentive plan (see Note 14) and 319,388 shares of Class B Common Stock. The distribution totaling $8,064,084 was paid on October 7, 2005.
On November 30, 2005, the Company's Board of Directors declared a $0.14 per share cash distribution to holders of its Class A Common Stock. Dividends were payable on 23,819,222 shares of Class A Common Stock, 499,786 phantom shares granted under the Company's stock incentive plan (see Note 14) and 319,388 shares of Class B Common Stock. The distribution totaling $3,449,375 was paid on December 29, 2005.
On March 11, 2004, the Company's Board of Directors declared a $0.39 per share cash distribution to holders of its Class A Common Stock, totaling $3,903,569.Dividends were payable on 10,009,150 shares of Class A Common Stock, Class B Common Stock was not dividend eligible and there were no phantom shares granted under the Company's stock incentive plan. (see Note 14) The distribution totaling $3,903,569 was paid on April 23, 2004.
On June 2, 2004, the Company's Board of Directors declared a $0.52 per share cash distribution to holders of its Class A Common Stock. Dividends were payable on the 10,012,188 shares of Class A common stock outstanding total $5,206,338. Including the dividends paid on theCommon Stock, 313,600 phantom shares granted under the Company's stock incentive plan (see Note 7)Note14), the distribution totaled $5,369,410.Class B Common Stock was not dividend eligible. The distribution totaling $5,369,410, was paid on July 9, 2004.
On August 24, 2004, the Company's Board of Directors declared a $0.52 per share cash distribution to holders of its Class A Common Stock. Dividends were payable on 10,015,656 shares of Class A Common Stock, 313,600 phantom shares granted under the Company's stock incentive plan (see Note 7)14) and 319,388 shares of Class B Common Stock. The distribution totaling $5,537,295 was paid on October 8, 2004.
On November 30, 2004, the Company's Board of Directors declared a $0.54 per share cash distribution to holders of its Class A Common Stock. Dividends were payable on 15,768,915 shares of Class A Common Stock, 313,600 phantom shares granted under the Company's stock incentive plan (see Note 7)14) and 319,388 shares of Class B Common Stock. The distribution totaling $8,857,029$8,857,028 was paid on December 29, 2004.
Preferred Stock
General
The Company's Board of Directors has the authority to classify any unissued shares of preferred stock and to reclassify any previously classified but unissued shares of any series of preferred stock previously authorized by the Board of Directors. Prior to issuance of shares of each class or series of preferred stock, the Board of Directors is required by the Company’s charter to fix the terms, preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications and terms or conditions of redemption for each such class or series.
Classified and Designated Shares
Pursuant to the Company’s supplementary amendment of its charter, effective November 3, 2005, and by resolutions adopted on September 29, 2005, the Company’s Board of Directors classified and designated 1,800,000 shares of the authorized but unissued preferred stock, $0.001 par value, as Class A Redeemable Preferred Stock and 2,000,000 shares of the authorized but unissued preferred stock as Class B Redeemable Preferred Stock.
Class A Redeemable Preferred Stock and Class B Redeemable Preferred Stock
The Class A Redeemable Preferred Stock and Class B Redeemable Preferred Stock rank equal to each other and shall have the same preferences, rights, voting powers, restrictions, limitations as to dividends and other distributions, qualifications and terms; provided, however that the redemption provisions of the Class A Redeemable Preferred Stock and the Class B Redeemable Preferred Stock differ. Each outstanding share of Class A Redeemable Preferred Stock and Class B Redeemable Preferred Stock shall have one-fifth of a vote on all matters submitted to a vote of stockholders (or such lesser fraction of a vote as would be required to comply with the rules and regulations of the NYSE relating to ourthe Company’s right to issue securities without obtaining a stockholder vote). Holders of shares of preferred stock shall vote together with holders of shares of common stock as one class in all matters that would be subject to a vote of stockholders.
If the Class A Redeemable Preferred Stock has not been converted into Class A Common Stock on or before December 31, 2009, then a holder of Class A Redeemable Preferred Stock shall have the right to have his or her shares of Class A Redeemable Preferred stock redeemed in whole or in part at any time and from time to time, at a redemption price per share equal to $24.00 plus all dividends declared and unpaid on such shares to the date of such redemption, subject to certain limitations.
Shares of the Class B Redeemable Preferred Stock are not redeemable prior to the date that is five years from the date of the issuance of such shares (except in connection with a merger transaction, as defined in our amended charter). On or after the date that is five years from the date of issuance, a holder of Class B Redeemable Preferred Stock can redeem his or her shares of Class B Redeemable Preferred Stock in whole or in part at any time and from time to time at a redemption price per share equal to the average daily closing price for the Class A Common Stock on the NYSE for the ten trading day period ending on the trading day immediately preceding the date of issuance of such Class B Redeemable Preferred Stock, plus all dividends declared and unpaid on such Class B Redeemable Preferred Stock from the date of the original issuance of such stock to the date of such redemption.
Holders of shares of Opteum’s preferred stock cannot receive or accrue dividend payments prior to January 1, 2006. After January 1, 2006 and prior to March 31, 2006, holders of the preferred stock are entitled to receive dividends according to the formula describedThere was no change in the Company’s amended charter. On or after March 31, 2006, holdersnumber of issued and outstanding shares of the preferred stock are entitled to receive dividends in the same amount and at the same times as dividends are paid on each share ofCompany's Class AB Common Stock if, as and when authorized and declared by our Board of Directors.
Conversion and Redemption of the Preferred Stock
Pursuant to Opteum’s amended charter, the shares of the Class A Redeemable Preferred Stock and Class B Redeemable Preferred Stock will convert intoC Common Stock. The conversion of the outstanding shares of shares of Class A Common Stock at such time as such conversion is approved by the requisite number of stockholders.
If there is a merger transaction without first converting the Class A Redeemable Preferred Stock into Class A Common Stock in accordance withwas approved by the provisionsCompany's stockholders at the Company's 2006 Annual Meeting of our amended charter,Stockholders on April 28, 2006, and the Class A Redeemable Preferred Stock shall automatically be redeemed by Opteum at a redemption price per share in cash equal to $31.50 plus all declared and unpaid dividends.
Issuances of Class A Redeemable Preferred Stock
On November 3, 2005, pursuant to an acquisition (see Note 2), Opteum issued 1,223,208outstanding shares of Class A Redeemable Preferred Stock (netwere converted into 1,223,208 shares of returned shares). Class A Common Stock on that date
No shares of the Class B Redeemable Preferred Stock have been issued as of December 31, 2005.
Liquidation Rights
As used herein, the term "Class A Redeemable Preferred Stock Per Share Preference Amount" shall mean $24.00, adjusted equitably for any stock splits, stock combinations, stock dividends or the like.
In the event of any involuntary liquidation, dissolution or winding up of the Company, after payment or adequate provision for all known debts and liabilities, and subject to the preferential rights of the holders of any stock senior to Class A Redeemable Preferred Stock, liquidation proceeds shall be allocated to the holders of Class A Redeemable Preferred Stock or to holders of stock on parity with Class A Redeemable Preferred Stock.
Whenever funds are insufficient to pay in full the applicable Class A Redeemable Preferred Stock Per Share Preference Amount, the available funds shall be allocated ratably among the holders of Class A Redeemable Preferred Stock and to holders of stock on parity with such stock.2006.
Ownership Limitations
Opteum’s amended charter, subject to certain exceptions, contains certain restrictions on the number of shares of stock that a person may own. Opteum’s amended charter contains a stock ownership limit that prohibits any person from acquiring or holding, directly or indirectly, applying attribution rules under the Code, shares of stock in excess of 9.8% of the total number or value of the outstanding shares of Opteum’s common stock, whichever is more restrictive, or Opteum’s stock in the aggregate. Opteum’s amended charter further prohibits (i) any person from beneficially or constructively owning shares of Opteum’s stock that would result in Opteum being "closely held" under Section 856(h) of the Code or otherwise cause Opteum to fail to qualify as a REIT, and (ii) any person from transferring shares of Opteum’s stock if such transfer would result in shares of Opteum’s stock being owned by fewer than 100 persons. Opteum’s board of directors, in its sole discretion, may exempt a person from the stock ownership limit. However, Opteum’s board of directors may not grant such an exemption to any person whose ownership, direct or indirect, of an excess of 9.8% of the number or value of the outstanding shares of Opteum’s stock (whichever is more restrictive) would result in Opteum being "closely held" within the meaning of Section 856(h) of the Code or otherwise would result in failing to qualify as a REIT. The person seeking an exemption must represent to the satisfaction of Opteum’s board of directors that it will not violate the aforementioned restriction. The person also must agree that any violation or attempted violation of any of the foregoing restrictions will result in the automatic transfer of the shares of stock causing such violation to the trust (as defined below). Opteum’s board of directors may require a ruling from the IRS or an opinion of counsel, in either case in form and substance satisfactory to Opteum’s board of directors in its sole discretion, to determine or ensure Opteum’s qualification as a REIT.
Any person who acquires or attempts or intends to acquire beneficial or constructive ownership of shares of Opteum’s stock that will or may violate any of the foregoing restrictions on transferability and ownership, or any person who would have owned shares of Opteum’s stock that resulted in a transfer of shares to the trust in the manner described below, will be required to give notice immediately to Opteum and provide Opteum with such other information as Opteum may request in order to determine the effect of such transfer on us.the Company.
If any transfer of shares of Opteum’s stock occurs which, if effective, would result in any person beneficially or constructively owning shares of Opteum’s stock in excess or in violation of the above transfer or ownership limitations, then that number of shares of Opteum’s stock the beneficial or constructive ownership of which otherwise would cause such person to violate such limitations (rounded to the nearest whole share) shall be automatically transferred to a trust for the exclusive benefit of one or more charitable beneficiaries, and the prohibited owner shall not acquire any rights in such shares. Such automatic transfer shall be deemed to be effective as of the close of business on the business day prior to the date of such violative transfer. Shares of stock held in the trust shall be issued and outstanding shares of Opteum’s stock. The prohibited owner shall not benefit economically from ownership of any shares of stock held in the trust, shall have no rights to dividends and shall not possess any rights to vote or other rights attributable to the shares of stock held in the trust. The trustee of the trust shall have all voting rights and rights to dividends or other distributions with respect to shares of stock held in the trust, which rights shall be exercised for the exclusive benefit of the charitable beneficiary. Any dividend or other distribution paid prior to the discovery by Opteum that shares of stock have been transferred to the trustee shall be paid by the recipient of such dividend or distribution to the trustee upon demand, and any dividend or other distribution authorized but unpaid shall be paid when due to the trustee. Any dividend or distribution so paid to the trustee shall be held in trust for the charitable beneficiary. The prohibited owner shall have no voting rights with respect to shares of stock held in the trust and, subject to Maryland law, effective as of the date that such shares of stock have been transferred to the trust, the trustee shall have the authority (at the trustee's sole discretion) (i) to rescind as void any vote cast by a prohibited owner prior to the discovery by Opteum that such shares have been transferred to the trust, and (ii) to recast such vote in accordance with the desires of the trustee acting for the benefit of the charitable beneficiary. However, if Opteum has already taken irreversible corporate action, then the trustee shall not have the authority to rescind and recast such vote.
Within 20 days after receiving notice from Opteum that shares of Opteum’s stock have been transferred to the trust, the trustee shall sell the shares of stock held in the trust to a person, whose ownership of the shares will not violate any of the ownership limitations set forth in Opteum’s amended charter. Upon such sale, the interest of the charitable beneficiary in the shares sold shall terminate and the trustee shall distribute the net proceeds of the sale to the prohibited owner and to the charitable beneficiary as follows. The prohibited owner shall receive the lesser of (i) the price paid by the prohibited owner for the shares or, if the prohibited owner did not give value for the shares in connection with the event causing the shares to be held in the trust (e.g., a gift, devise or other such transaction), the market price, as defined in Opteum’s amended charter, of such shares on the day of the event causing the shares to be held in the trust and (ii) the price per share received by the trustee from the sale or other disposition of the shares held in the trust, in each case reduced by the costs incurred to enforce the ownership limits as to the shares in question. Any net sale proceeds in excess of the amount payable to the prohibited owner shall be paid immediately to the charitable beneficiary. If, prior to the discovery by Opteum that shares of Opteum’s stock have been transferred to the trust, such shares are sold by a prohibited owner, then (i) such shares shall be deemed to have been sold on behalf of the trust and (ii) to the extent that the prohibited owner received an amount for such shares that exceeds the amount that such prohibited owner was entitled to receive pursuant to the aforementioned requirement, such excess shall be paid to the trustee upon demand.
Pursuant to a letter dated November 2, 2006 from the Company to Mr. Norden, the Alyssa Blake Norden Trust of 1993, the Michael Jared Norden Trust of 1993 and the Amy Suzanne Trust of 1993, and based on representations from such persons, the Company increased the ownership limit for the foregoing stockholders to ensure that they would be able to acquire and own the shares of Company Class A Common Stock and Class A Preferred issued to them in connection with the Company's acquisition of OFS. The Company also agreed to monitor its outstanding share ownership, including the extent to which it repurchases its stock, and to use its best efforts to enable the foregoing stockholders to be able to acquire and own any additional Company shares issuable to them in connection with the Company's acquisition of OFS, as well as any Company shares issuable to Mr. Norden pursuant to any present or future employment or other compensation agreement between the Company and Mr. Norden, in each case, with respect to the Company's ownership limits.
In addition, shares of Opteum’s stock held in the trust shall be deemed to have been offered for sale to us,Opteum, or Opteum’s designee, at a price per share equal to the lesser of (i) the price per share in the transaction that resulted in such transfer to the trust (or, in the case of a devise or gift, the market price at the time of such devise or gift) and (ii) the market price on the date Opteum, or Opteum’s designee, accept such offer. Opteum shall have the right to accept such offer until the trustee has sold the shares of stock held in the trust. Upon such a sale to us,Opteum, the interest of the charitable beneficiary in the shares sold shall terminate and the trustee shall distribute the net proceeds of the sale to the prohibited owner.
All certificates representing shares of Opteum’s common stock and preferred stock, if issued, will bear a legend referring to the restrictions described above.
Every record holder of 0.5% or more (or such other percentage as required by the Internal Revenue Code and the related Treasury regulations) of all classes or series of Opteum’s stock, including shares of Opteum’s common stock on any dividend record date during each taxable year, within 30 days after the end of the taxable year, shall be required to give written notice to Opteum stating the name and address of such record holder, the number of shares of each class and series of Opteum’s stock which the record holder beneficially owns and a description of the manner in which such shares are held. Each such record holder shall provide to Opteum such additional information as Opteum may request in order to determine the effect, if any, of such beneficial ownership on Opteum’s qualification as a REIT and to ensure compliance with the stock ownership limits. In addition, each record holder shall upon demand be required to provide to Opteum such information as Opteum may reasonably request in order to determine Opteum’s qualification as a REIT and to comply with the requirements of any taxing authority or governmental authority or to determine such compliance. Opteum may request such information after every sale, disposition or transfer of Opteum’s common stock prior to the date a registration statement for such stock becomes effective.
These ownership limits could delay, defer or prevent a change in control or other transaction of Opteum that might involve a premium price for the Class A Common Stock or otherwise be in the best interest of the stockholders.
NOTE 13. TRANSACTIONS WITH RELATED PARTIES
Transactions with Stockholders
During 2006, OFS received aggregate payments of $1.6 million from Southstar Funding, LLC (“Southstar Funding”) primarily in exchange for the periodperformance of certain interim loan servicing functions. Southstar Funding is fifty percent owned by Southstar Partners, LLC (“Southstar Partners”). Certain officers of OFS, one of whom is also a director of Opteum, own membership interests in Southstar Partners. In addition, an officer of OFS as well as a former director of Opteum serves on the Board of Managers of Southstar Funding. As of December 31, 2006, amounts due from September 24, 2003 (dateSouthstar Funding totaled $0.3 million and no amounts were owed to Southstar Funding. In addition, no amounts were due or owing to Southstar Partners as of inception) through December 19, 2003, Opteum's start-up activities were being fully31, 2006. Amounts paid for interim loan servicing were determined on an arms-length basis and supported by Opteum's President and Chief Executive Officer, Jeffrey J. Zimmer. Mr. Zimmer was also a Class B stockholder during this period of time. On December 19, 2003, at the initial closing of the Offering, Opteum reimbursed the CEO $247,980 for these costs, which were recorded primarily as property and equipment and operating expenses.
The entire issuance of Class C Common Stock was purchased by Flagstone Securities, LLC. Flagstone was the placement agent for Opteum's Class A Common Stock private placement offerings, and pursuantare comparable to the terms of the offerings, received fees for its services. Through December 31, 2003, Flagstone had received $2,943,042 in fees from the Offering, and Flagstone received an additional $4,747,517 from the proceeds of the Offerings that closed in January and February 2004. Flagstone was the lead underwriter for Opteum's Class A Common Stock initial public offering and pursuantamounts charged to the terms of the offering, received fees of $5,836,250 in connection with the sale of Class A Common Stock in the initial public offering, including shares issued in the exercise of the underwriters' over allotment option. Flagstone was also the lead underwriter for Opteum's additional Class A Common Stock public offering and pursuant to the terms of the offering, received fees of $4,278,000 in connection with the sale of Class A Common Stock in the secondary public offering, including shares issued in the exercise of the underwriters' over allotment option. During 2005 Flagstone received fees of $15,000 in connection with the acquisition of OFS.other, non-related parties.
Employment Agreements
Opteum entered into employment agreements with Opteum's initial officers, Jeffrey J. Zimmer and Robert E. Cauley, in 2003. The employment agreements provide for Mr. Zimmer to serve as President and Chief Executive Officer and Mr. Cauley to serve as Chief Investment Officer and Chief Financial Officer. Messrs. Zimmer and Cauley's employment agreements were amended and restated in 2004. The amended and restated agreements extend the term of the agreements to April 2007 and provide that on September 16, 2004, when the registration statement for Opteum's Class A Common Shares became effective that Mr. Zimmer's annual base salary increased to $400,000 and Mr. Cauley's annual base salary increased to $267,500.
Upon the termination of an executive officer's employment either by the Company without "cause" or by the executive officer for "good reason" or by the executive officer for any reason within three months after a "change of control," the executive officer will be entitled to the following severance payments and benefits, subject to his execution and non-revocation of a general release of claims: lump-sum cash payment equal to 300% of the sum of his then-current annual base salary plus average bonus over the prior three years; his prorated annual bonus for the year in which the termination occurs; all stock options held by the executive officer will become fully exercisable and will continue to be exercisable for their full terms and all restricted stock held by such executive officer will become fully vested; health benefits for three years following the executive officer's termination of employment at no cost to the executive officer, subject to reduction to the extent that the executive officer receives comparable benefits from a subsequent employer; and outplacement services at Company expense.
Each of Messrs. Zimmer and Cauley is bound by a non-competition covenant for so long as he is an officer of Opteum and for a one-year period thereafter, unless his employment is terminated by Opteum without "cause" or by him with "good reason" (in each case, as defined in his employment agreement) or by him for any reason after a "change in control" (as defined in his employment agreement) of the Company, in which case his covenant not to compete will lapse on the date of his termination.
OFS has an employment agreement with Peter Norden to serve as Chief Executive Officer and President of OFS and Senior Executive Vice President of Opteum. The employment agreement requires Mr. Norden to devote substantially full-time attention and time to OFS’s and Opteum’s affairs, but also permit him to devote time to his outside business interests. The employment agreement terminates in September 2008; provided, however, that the term shall automatically be extended for one-year periods unless, not later than three months prior to the termination of the existing term, either party provides written notice to the other party of its intent not to further extend the term. The employment agreement provide for an annual base salary of $750,000 and an annual non-discretionary bonus of $750,000 payable in four equal installments.
Upon the termination of Mr. Norden’s employment either by OFS for “cause” or by the executive officer without “good reason” during the term of his employment agreement, Mr. Norden will be entitled to receive his base salary and bonus accrued through the date of termination of his employment.
Upon the termination of an executive officer’s employment either by the OFS without cause or by the executive officer for good reason, Mr. Norden will be entitled under his employment agreement to the following severance payments and benefits, subject to his execution and non-revocation of a general release of claims:
| § | lump-sum cash payment equal to 250% of the sum of his then-current annual base salary plus non-discretionary bonus; |
| § | health benefits for three years following the termination of employment at no cost to the Mr. Norden, subject to reduction to the extent that the Mr. Norden receives comparable benefits from a subsequent employer; and |
| § | outplacement services at the Company’s expense. |
The employment agreement also contain confidentiality provisions that apply indefinitely and non-compete provisions that include covenants not to: (i) conduct, directly or indirectly, any business involving mortgage REITs without the consent of Opteum’s Chief Executive Officer, whether such business is conducted by him individually or as principal, partner, officer, director, consultant, employee, stockholder or manager of any person, partnership, corporation, limited liability company or any other entity; or (ii) own interests in any entity that is competitive, directly or indirectly, with any business carried on by OFS or its successors, subsidiaries and affiliates, with some exceptions.
Mr. Norden is bound by his non-competition covenant for so long as he is an officer of the OFS and for a two-year period thereafter, unless his employment is terminated by OFS without cause or by him with good reason (in each case, as defined in his employment agreement), in which case his covenant not to compete will lapse on the date of his termination.
Other
In January 2005, the four independent directors received a total of 5,968 shares of Class A Common Stock, valued at $92,027, as compensation for their activities as directors. In April 2005, the four independent directors received a total of 6,164 shares of Class A Common Stock, valued at $84,015, as compensation for their activities as directors. In July 2005, the four independent directors received a total of 5,967 shares of Class A Common Stock, valued at $84,015, as compensation for their activities as directors. In October 2005, the four independent directors received a total of 8,481 shares of Class A Common Stock, valued at $85,488, as compensation for their activities as directors. In November 2005, a new independent director was added to the Board of Directors and was issued 1,220 shares of Class A Common Stock, valued at $ 12,298, as compensation for his activities as a director.
One of the Company's directors, Mr. Buford Ortale, was previously a Managing Director in the Investment Banking Group at Avondale Partners, LLC ("Avondale"), one of the placement agents for Opteum's Offering that was completed in January 2004. Mr. Ortale has a continuing affiliation with Avondale pursuant to which he receives compensation from investment banking fees earned by Avondale on transactions referred to Avondale by Mr. Ortale. Mr. Ortale has been paid $360,000 from Avondale for referring Opteum to Avondale.
OFS has a subordinated promissory agreement with Opteum for borrowings in the amount of $65.0 million at December 31, 2005. The note bears an annual interest rate of 11%. This promissory agreement matures on November 1, 2015. Interest accrued at December 31, 2005 was $1,116,575. These amounts are eliminated during the process of preparing consolidated financial statements for the Company. A portion of these loan proceeds were used to repay $18.3 million of debt to the former OFS owners immediately after the closing of the merger transaction.
NOTE 14.STOCK INCENTIVE PLANPLANS
On December 1, 2003, Opteum adopted the 2003 Long Term Incentive Compensation Plan (the “2003 Plan”) to provide Opteum with the flexibility to use stock options and other awards as part of an overall compensation package to provide a means of performance-based compensation to attract and retain qualified personnel. The 2003 Plan was amended and restated in March 2004. Key employees, directors and consultants are eligible to be granted stock options, restricted stock, phantom shares, dividend equivalent rights and other stock-based awards under the 2003 Plan. Subject to adjustment upon certain corporate transactions or events, a maximum of 4,000,000 shares of the Class A Common Stock (but not more than 10% of the Class A Common Stock outstanding on the date of grant) may be subject to stock options, shares of restricted stock, phantom shares and dividend equivalent rights under the 2003 Plan. An initial grant of 313,600 phantom shares was made in June 2004.
During the year ended December 31, 2006, Opteum granted 215,389 phantom shares to employees with an aggregate fair value of $2.0 million. Each phantom share represents a right to receive a share of Opteum's Class A Common Stock. Dividend equivalent rights were also granted on these phantom shares.
During the year ended December 31, 2005, Opteum granted 204,861 phantom shares to employees.employees with an aggregate fair value of $3.1 million. Each phantom share represents a right to receive a share of Opteum’s Class A Common Stock. Dividend equivalent rights were also granted on 203,361 of these phantom shares; the remaining 1,500 phantom shares are not entitled to receive dividend equivalent rights until they vest.
Phantom share awards are valued at the fair value of Opteum’s Class A Common Stock at the date of the grant. The total grant date value of all awards since the inception of the 2003 Plan is $7,822,313 and the grant date value of awards granted in 2005 is $3,118,313.$9.8 million. The phantom share awards do not have an exercise price. The grant date value is being amortized to compensation expense on a straight-line basis over the vesting period of the respective award. The phantom shares vest, based on the employees’ continuing employment, following a schedule as provided in the grant agreements, for periods through November 15, 2008.June 1, 2009.
As of December 31, 2005,2006, a total of 518,461733,850 phantom stock awards have been granted since the inception of the 2003 Plan, however 2,781 and 2,090 shares were forfeited during 2006 and 2005 due to the termination of the grantee’s employment. Of the remaining shares, 172,727389,117 shares have fully vested and 343,644339,862 shares remain unvested. The future compensation charge that was eliminated by the forfeitureforfeitures totaled $31,852.$56,853. No phantom share awards have expired. Of the vested shares, 209,250 and 15,085 were distributedissued to grantees or surrendered to pay income taxes during the yearyears ended December 31, 2006 and 2005. As of December 31, 2005, 501,2862006 504,644 phantom shares were outstanding. Total compensation cost recognized for the year ended December 31, 2006 and 2005 was 2,882,091 and 2004 was $2,130,132 and $745,756 respectively. Dividends paid on phantom shares are charged to retained earnings when declared.
A summary of the status of the Company’s nonvested shares as of December 31, 2006, and changes during the year ended December 31, 2006, is presented below:
| | Shares | | Weighted-Average Grant-Date Fair Value |
Nonvested at January 1, 2006 | | 343,644 | $ | 15.10 |
Granted in 2006 | | 215,389 | | 9.15 |
Vested in 2006 | | (216,390) | | 13.18 |
Forfeited in 2006 | | (2781) | | 8.99 |
Nonvested at December 31, 2006 | | 339,862 | $ | 12.60 |
As of December 31, 2006, there was $4.3 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the 2003 Plan. That cost is expected to be recognized over a weighted-average period of 1.6 years.
On July 17, 2006, the Company granted 79,725 restricted shares of its Class A common Stock to certain key employees of the Company’s subsidiary pursuant to the terms of the 2003 Plan. Such share grants were initially recorded by OFS prior to the merger with the Company. However, these awards were cancelled when the Company and the subject employees agreed to forego the award in contemplation of a new grant under the Company’s 2003 Plan. The restricted shares were valued at the fair value of Opteum’s Class A Common Stock at the date of grant, which totaled $0.7 million for the July 2006 awards, and this amount was amortized to compensation through November 3, 2006, the vesting date of the award, net of any forfeitures. The restricted shares do not have an exercise price. Dividends paid on the restricted shares were charged to retained earnings when declared by the Company’s Board of Directors. The shares were subject to forfeiture, based on continued employment through the vesting date of November 2, 2006. During 2006, 4,650 shares were forfeited.
Opteum also has adopted the 2004 Performance Bonus Plan (the “Performance Bonus Plan”). The Performance Bonus Plan is an annual bonus plan that permits the issuance of the Company’s Class A Common Stock in payment of stock-based awards made under the plan. In 2006, 2005 and 2004 no stock-based awards were made under and no shares of the Company’s stock have been issued under the Performance Bonus Plan.
NOTE 15. SAVINGS INCENTIVE PLAN
Opteum’s employees have the option to participate in the Bimini Mortgage ManagementOpteum Inc., 401K Plan (the “Plan”). Under the terms of the Plan, eligible employees can make tax-deferred 401(k) contributions, and at Opteum’s sole discretion, Opteum can match the employees’ contributions. For the periodyears ended December 31, 2006 and 2005, Opteum made 401(k) matching contributions of $40,547.$63,365 and $40,547, respectively.
OFS’s employees have the option to participate in Thethe Company Savings and Incentive Plan (the “Plan”). Under the terms of the Plan, eligible employees can make tax-deferred 401(k) contributions, and at the OFS’s sole discretion, OFS can match the employees’ contributions as well as make annual profit-sharing contributions to the Plan. For the year ended 2006 and the period November 3, 2005 (date of merger) through December 31, 2005, OFS made 401(k) matching contributions of $40,956.
$241,056 and $40,956, respectively.
NOTE 16. OPERATING LEASES
Certain facilities and equipment are leased under short-term lease agreements expiring at various dates through December 2012.September 2013. All such leases are accounted for as operating leases.
Obligations under non-cancelable operating leases which have an initial term of more than a year are as follows:
2006 | $ | 5,422,465 |
2007 | | 5,020,108 |
2008 | | 3,655,990 |
2009 | | 1,751,847 |
2010 | | 1,046,334 |
Thereafter | | 695,561 |
| | |
| $ | 17,592,305 |
(in thousands)2007 | $ | 5,953 |
2008 | | 5,441 |
2009 | | 3,186 |
2010 | | 1,565 |
2011 | | 1,103 |
Thereafter | | 1,013 |
| | |
| $ | 18,261 |
Rental expense for the year ended December 31, 2006, 2005 and 2004 was $6,325,805, $931,640 and $52,458, for the year ended December 31, 2004 and $12,264 for the period ended December 31, 2003.respectively.
NOTE 17. COMMITMENTS AND CONTINGENCIES
Loans Sold to Investors. Generally, OFS is not exposed to significant credit risk on its loans sold to investors. In the normal course of business, OFS provides certain representations and warranties during the sale of mortgage loans which obligate it to repurchase loans which are subsequently unable to be sold through the normal investor channels. The repurchased loans are secured by the related real estate properties, and can usually be sold directly to other permanent investors. There can be no assurance, however, that OFS will be able to recover the repurchased loan value either through other investor channels or through the assumption of the secured real estate.
OFS recognizes a liability for the estimated fair value of this obligation at the inception of each mortgage loan sale based on the anticipated repurchase levels and historical experience. The liability is recorded as a reduction of the gain on sale of mortgage loans and included as part of other liabilities in the accompanying financial statements.
Changes in the liability during 2006 and for the period November 3, 2005, through December 31, 2005:
Balance—Beginning of year | $ | 2,291,944 |
Provision | | 306,259 |
Charge-Offs | | (560,223) |
| | |
Balance—End of year | $ | 2,037,980 |
(in thousands) | | For the year ended December 31, 2006 | | For the period November 3, 2005, through December 31, 2005 |
Balance—Beginning of period | $ | 2,038 | $ | 2,292 |
Provision | | 8,499 | | 306 |
Charge-Offs | | (3,401) | | (560) |
| | | | |
Balance—End of period | $ | 7,136 | $ | 2,038 |
Loan Funding and Delivery Commitments. At December 31, 2005,2006, OFS has commitments to fund loans approximating$ 368,458,000.476 million. OFS hedges the interest rate risk of such commitments primarily with mandatory delivery commitments. The remaining commitments to fund loans with agreed-upon rates are anticipated to be sold through “best-efforts” and investor programs. OFS does not anticipate any material losses from such sales.
Net Worth Requirements. OFS is required to maintain certain specified levels of minimum net worth to maintain its approved status with Fannie Mae, HUD, and other investors. At December 31, 2006 and 2005, the highest minimum net worth requirement applicable to OFS was approximately $1,740,000.$1.9 million and $1.7 million, respectively. OFS had excess net worth of approximately $2.1 million at December 31, 2006.
Outstanding LitigationLitigation.. OFS The Company is involved in litigationvarious lawsuits and claims, both actual and potential, including some that it has asserted against others, in which monetary and other damages are sought. These lawsuits and claims relate primarily to contractual disputes arising out of the ordinary course of the Company’s business. The outcome of such lawsuits and claims is inherently unpredictable. However, management believes that, in the normal courseaggregate, the outcome of business. Althoughall lawsuits and claims involving the amount of any ultimate liability arising from these matters cannot presently be determined, OFS doesCompany will not anticipate that any such liability will have a material effect on OFS’sthe Company’s consolidated financial position or liquidity; however, any such outcome may be material to the results of operations.operations of any particular period in which costs, if any, are recognized.
As part of the November 3, 2005 merger pursuant to which OFS became a wholly-owned subsidiary of Opteum, the parties to the Agreement and Plan of Merger and Reorganization (the “Merger Agreement”) agreed to special resolution procedures concerning certain litigation matters in which OFS was a party and that was pending at the time of the merger. Certain provisions of the Merger Agreement specified the manner in which four separate litigation matters would be treated for purposes of determining the rights and obligations of the parties to the Merger Agreement. In two of these matters, OFS is the plaintiff and is seeking money damages from third parties. In the other two matters, OFS is a defendant and is defending itself against claims for money damages.
Pursuant to the terms of the Merger Agreement, the former owners of OFS must indemnify the Company for any liabilities arising from the two matters in which OFS is a defendant. In addition, the former owners of OFS are entitled to receive any amounts paid to the Company upon the settlement or final resolution of the two matters in which OFS is the plaintiff.
Guarantees. Opteum has guaranteed the obligations of OFS and OFS’s wholly-owned subsidiary, HS Special Purpose, LLC, under their respective financing facilities with JPMorgan Chase and Citigroup described in Note 8. These guarantees will remain in effect so long as the applicable financing facilities remain in effect. If an Event of Default occurs under these financing facilities that are not cured or waived, Opteum may be required to perform under its guarantees. There is no specific limitation on the maximum potential future payments under these guarantees. However, Opteum’s liability under these guarantees would be reduced in an amount equal to the amount by which the collateral securing such obligations exceeds the amounts outstanding under the applicable facilities.
NOTE 18.SEGMENTS
Opteum follows SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information.” The Company operates in two reportable segments: as a REIT and as an originator of mortgage loans.
Certain of our operations qualify as a REIT, under applicable provisions of the Code. The REIT activities primarily involve Opteum investing in residential mortgage-related securities. As a REIT, these activities are not subject to federal income tax on ourthe net taxable income as long as the earnings from REIT activities are distributed to the stockholders.
On November 3, 2005, Opteum acquired OFS. OFS is a mortgage lender that originates loans. It offers retail and wholesale products including fixed- and adjustable-rate mortgages, 100% financing, interest-only products and home loans for the credit challenged. Opteum has 3433 offices and lending in 4446 states. Goodwill associated with OFS was $2.1 million at December 31, 2005.2006.
The accounting policies of the segments are the same as those described in the summary of significant accounting policies in Note 1. The Company evaluates the performance of its REIT segment and mortgage origination business segment results based on net income. Each of the business segments’ net income or loss includes direct costs incurred at each segment’s operating level, plus a minimal amount of allocated corporate-level expenses.
The following table shows year 2006 summarized financial information concerning the Company’s reportable segments.
(in thousands)
| | REIT | | OFS | | TOTAL(1) |
| | | | | | |
Net interest income | $ | 10,577 | $ | 13,118 | $ | 13,525 |
Other revenues, net | | (7,321) | | 14,792 | | 7,471 |
Inter-segment interest income | | 10,169 | | (10,169) | | - |
Income (loss) before income taxes | | (6,551) | | (70,261) | | (76,812) |
Other interest expense | | - | | (17,756) | | (7,587) |
Depreciation and amortization | | 757 | | 3,627 | | 4,384 |
Income tax expense (benefit) | | - | | (27,218) | | (27,218) |
Total assets | | 3,054,277 | | 1,009,324 | | 3,937,634 |
Capital expenditures | | 757 | | 2,720 | | 3,477 |
(1)Figures reflect the elimination of inter-company transactions between Opteum and OFS
The following table shows year 2005 summarized financial information concerning the Company’s reportable segments.
(Amounts in thousands) | | REIT | | OFS (1) | | TOTAL |
| | | | | | |
Net interest income | $ | 35,885 | $ | 1,097 | $ | 36,982 |
Other revenues, net | | 1,993 | | 2,318 | | 4,311 |
Inter-segment interest income | | - | | - | | - |
Income (loss) before income taxes | | 30,914 | | (10,851) | | 20,063 |
Other interest expense | | - | | 1,093 | | 1,093 |
Depreciation and amortization | | 347 | | 495 | | 842 |
Income tax expense (benefit) | | - | | (4,220) | | (4,220) |
Total assets | | 3,666,257 | | 1,138,844 | | 4,805,101 |
Capital expenditures | | 3,803 | | 869 | | 4,672 |
(in thousands)
| | REIT | | OFS | | TOTAL(1) |
| | | | | | |
Net interest income | $ | 37,061 | $ | 1,038 | $ | 36,982 |
Other revenues, net | | 1,993 | | 2,318 | | 4,311 |
Inter-segment interest income | | 1,117 | | (1,117) | | - |
Income (loss) before income taxes | | 30,914 | | (10,851) | | 20,063 |
Other interest expense | | - | | 2,210 | | 1,093 |
Depreciation and amortization | | 347 | | 495 | | 842 |
Income tax expense (benefit) | | - | | (4,220) | | (4,220) |
Total assets | | 3,782,264 | | 1,144,615 | | 4,805,101 |
Capital expenditures | | 3,803 | | 869 | | 4,672 |
(1) Figures reflect the elimination of inter-company transactions between Opteum and OFS.
The following information is needed to reconcile the segment amounts to the total information, which agrees to the amounts shown in the accompanying consolidated financial statements. During the consolidation process, loans receivable totaling $119.1 million in 2006 and $65.0 million in 2005, and the related interest income and accrued interest, which are recorded on Opteum’s segment financial statements, are eliminated against corresponding liabilities and expenses recorded on OFS’s segment financial statements. The interest income related to these loans is reported above as inter-segment interest income. There were no inter-segment gross revenues during the periodperiods ended December 31, 2006 and November 3, 2005 (date of the merger) through December 31, 2005, except for this interest, and therefore all other revenues were from external sources.
No single customer accounted for more than 10% of revenues at OFS. For the REIT activities, approximately 97.3%93.6% of the interest income was derived from MBS issued by U.S. Government agencies.
For the year ended December 31, 2004, and for the Company’s initial period ended December 31, 2003, the Company’s sole activities were as a REIT. Therefore segment disclosures are the same as reported in the accompanying consolidated financial statements for those periods.
NOTE 19.INCOME TAXES
Year 2004 and 2003
Opteum recorded a deferred tax asset generated by the net operating loss for its initial period of operation from September 24, 2003 (date of inception) to December 31, 2003. This net operating loss was offset by a full valuation allowance, as management believed, pursuant to the REIT qualification of Opteum, that it was not likely that the loss would be utilized in the future to offset taxes payable. There is no tax provision included for the year ended December 31, 2004, as Opteum had satisfied the REIT taxation requirements for the year 2004. The net operating loss carryover from 2003Opteum was fully applied against taxable net income in 2004 and 2005 and is now zero atsolely a non-taxpaying REIT during the year ended December 31, 20052004.
YearYears 2005 and 2006
As more fully described in Note 2, Opteum acquired OFS on November 3, 2005. OFS is a TRS,taxable REIT subsidiary, which is a taxpaying entity for income tax purposes, and is taxed separately from Opteum. At the date of acquisition, OFS recorded net a deferred tax liability of approximately $22.6 million related to the difference in the carrying amount and the tax basis of the originated mortgage servicing rights at the date of the business combination,MSRs, among other items. The tax impacts of OFS are included in the schedules below for its operating activities from November 3, 2005 through December 31, 2005.
Income taxes were as follows2005, and for the year ended December 31, 2005 (amounts in thousands):2006.
The income tax benefit is as follows for the years ended December 31, 2006 and 2005:
Deferred income tax benefit: | | |
Federal | $ | 3,797 |
State | | 423 |
| | |
Total income tax benefit | $ | 4,220 |
(in thousands)
Deferred income tax benefit: | | Year ended December 31, 2006 | | Year ended December 31, 2005 |
Federal | $ | 24,478 | $ | 3,797 |
State | | 2,740 | | 423 |
| | | | |
Total deferred income tax benefit | $ | 27,218 | $ | 4,220 |
The effective income taxes (benefit)tax benefit for the yearyears ended December 31, 2006 and 2005 differ from the amount determined by applying the statutory federal rate of 35% to income (loss) before income tax as follows (amounts in thousands):follows:
(in thousands)
Net income, if taxed at the federal tax rate | $ | 6,994 |
Exclusion of REIT taxable income | | (10,792) |
Permanent tax differences | | 1 |
State tax benefit, net of federal tax effect | | (423) |
| | |
Total income tax benefit | $ | (4,220) |
| | For the year ended December 31, 2006 | | For the period November 3, 2005, through December 31, 2005 |
Balance—Beginning of period | $ | 2,038 | $ | 2,292 |
Provision | | 8,499 | | 306 |
Charge-Offs | | (3,401) | | (560) |
| | | | |
Balance—End of period | $ | 7,136 | $ | 2,038 |
The tax affected cumulative temporary differences that give rise to deferred tax assets and liabilities for the year endedas of December 31, 2006 and 2005, are as follows (amounts in thousands):follows:
Deferred tax assets: | | |
Federal tax loss carryforward | $ | 2,322 |
State tax loss carryforward | | 423 |
Mark-to-market adjustments | | 1,158 |
Total gross deferred tax assets | $ | 3,903 |
| | |
Deferred tax liabilities: | | |
Capitalized cost of mortgage servicing rights | | 18,436 |
Loan origination amounts | | 2,138 |
Intangible assets | | 1,690 |
Total gross deferred tax liabilities | $ | 22,264 |
| | |
Net deferred tax liabilities | $ | 18,361 |
(in thousands)
| | At December 31, 2006 | | At December 31, 2005 |
Deferred tax assets: | | | | |
| $ | 29,684 | $ | 2,322 |
State tax loss carry-forward | | 4,812 | | 423 |
Loan Loss Reserves, Interest and Other | | 5,056 | | 296 |
Mark-to-market adjustments | | 269 | | 1,158 |
Total deferred tax assets | $ | 39,821 | $ | 4,199 |
| | | | |
Deferred tax liabilities: | | | | |
Capitalized cost of mortgage servicing rights | $ | 28,693 | $ | 18,436 |
Loan origination and other amounts | | 2,606 | | 2,138 |
Intangible assets | | 1,341 | | 1,986 |
Total deferred tax liabilities | $ | 32,640 | $ | 22,560 |
| | | | |
Net deferred tax assets (liabilities) | $ | 7,181 | $ | (18,361) |
As described in Note 1, the Company adopted SFAS No. 156 as of January 1, 2006. As a result of this adoption, net deferred tax liabilities were increased by approximately $1.67 million. Management believes that the deferred tax assetassets will more likely than not be realized due to the reversal of the deferred tax liabilityliabilities and expected future taxable income. As of December 31, 2005,2006, the TRS had an estimated federal tax net operating loss carryforward of $7.1about $88 million, which expires beginning in 2025, and is fully available to offset future taxable income.
Tax differences on REIT income
Taxable net income, as generated by Opteum’s qualifying REIT activities, is computed differently from Opteum’s financial statement net income from REIT activities as computed in accordance with generally accepted accounting principles.GAAP. Depending on the number and size of the various items or transactions being accounted for differently, the differences between Opteum’s REIT taxable net income and Opteum’s financial statement net income from REIT activities(loss) can be substantial and each item can affect several years. Since inception through December 31, 2006, Opteum's REIT taxable income is approximately $14.9 million greater than Opteum's financial statement net income as reported in its financial statements.
For the year ended December 31, 2006, Opteum's REIT taxable income was approximately $12.0 million greater than Opteum's financial statement net income from REIT activities. During 2006, Opteum's most significant items and transactions currently being accounted for differently from REIT activities include restrictedinterest on inter-company loans with OFS, other-than-temporary impairment losses on the MBS portfolio, equity plan stock awards, depreciation of property and equipment and the accounting for debt issuance costs. The impairment losses on the MBS portfolio will be recognized for tax purposes in 2007 as the actual sales of the securities are completed. The debt issuance costs are being amortized, and property and equipment are being depreciated, over different useful lives for tax purposes. The future deduction of equity plan stock compensation against REIT taxable income is uncertain both as to the year (as the timing of the tax impact of each restricted stock award is up to each employee who has received a grant) and as to the amount, because the tax impact is measured at the fair value of the shares as of a future date, and this amount may be greater than or less than the financial statement expense already recognized by Opteum.
For the year 2005, Opteum's REIT taxable net income was approximately $2.1 million greater than Opteum's financial statement net income from REIT activities. The most significant portion of this year 2005 amount, $2.0 million, is attributable to the phantomequity plan stock awards, and the future deduction of this amount against taxable net income is uncertain both as to the year (as the timing of the tax impact of each restricted stock award is up to each employee who has received a grant) and as to the amount (the amount of the tax impact is measured at the fair value of the shares as of a future date, and this amount may be greater than or less than the financial statement deduction already taken by Opteum)date).
For the year 2004, Opteum's taxable net income was $0.8 million greater than Opteum's financial statement net income from REIT activities. Of this amount, $0.7 million is attributable to the phantomequity plan stock awards. Since inception through December 31, 2005, Opteum's taxable net income, as reported on its tax returns, is $3.0 million greater than Opteum's financial statement net income from REIT activities as reported in its financial statements.
NOTE 20.SUMMARIZED QUARTERLY RESULTS (UNAUDITED)
The following is a presentation of the quarterly results of operations for the year ended December 31, 2006 (amounts in thousands, except per share data).
| | March 31, 2006 | | June 30, 2006 | | September 30, 2006 | | December 31, 2006 |
Interest income | $ | 60,281 | $ | 75,589 | $ | 68,381 | $ | 50,758 |
Interest expense | | (56,189) | | (60,518) | | (67,102) | | (57,675) |
Net interest income | | 4,092 | | 15,071 | | 1,279 | | (6,917) |
Net gain on sales of mortgage-backed securities | | - | | - | | - | | - |
Direct operating expenses | | 319 | | 227 | | 197 | | 245 |
General and administrative expenses | | 20,106 | | 22,768 | | 25,493 | | 28,455 |
Net (loss) | $ | (7,972) | $ | (8,665) | $ | (6,256) | $ | (33,923) |
Net (loss) per Class A Common Share—Basic and Diluted | $ | (0.34) | $ | (0.06) | $ | (0.25) | $ | (1.37) |
Net (loss) per Class B Common Share—Basic and Diluted | $ | (0.34) | $ | (0.06) | $ | (0.25) | $ | (1.37) |
Weighted average number of Class A common shares outstanding—Basic and Diluted | | 23,437 | | 23,970 | | 24,376 | | 24,466 |
Weighted average number of Class B common shares outstanding—Basic and Diluted | | 319 | | 319 | | 319 | | 319 |
The following is a presentation of the quarterly results of operations for the year ended December 31, 2005 (amounts in thousands, except per share data).
| | March 31, 2005 | | June 30, 2005 | | September 30, 2005 | | December 31, 2005 |
Interest income | $ | 31,070 | $ | 36,749 | $ | 43,574 | $ | 49,248 |
Interest expense | | (19,842) | | (26,453) | | (33,509) | | (43,854) |
Net interest income | | 11,228 | | 10,296 | | 10,065 | | 5,394 |
Net gain on sales of mortgage-backed securities | | 1,982 | | - | | 11 | | - |
Direct operating expenses | | 590 | | 284 | | 299 | | 109 |
General and administrative expenses | | 1,713 | | 1,793 | | 1,902 | | 14,828 |
Net income | $ | 10,907 | $ | $8,219 | $ | 7,875 | $ | (2,718) |
Net income per Class A Common Share—Basic and Diluted | | 0.52 | $ | 0.39 | $ | 0.37 | $ | (0.12) |
Net income per Class B Common Share—Basic and Diluted | $ | 0.51 | $ | 0.39 | $ | 0.37 | $ | (0.11) |
Weighted average number of Class A common shares outstanding—Basic and Diluted | | 20,796 | | 20,897 | | 20,901 | | 23,073 |
Weighted average number of Class B common shares outstanding—Basic and Diluted | | 319 | | 319 | | 319 | | 319 |
The following is a presentation of the quarterly results of operations for the year ended December 31, 2004 (amounts in thousands, except per share data).
| | March 31, 2004 | | June 30, 2004 | | September 30, 2004 | | December 31, 2004 | | March 31, 2004 | | June 30, 2004 | | September 30, 2004 | | December 31, 2004 |
Interest income | $ | 7,194 | $ | 10,959 | $ | 11,017 | $ | 20,463 | $ | 7,194 | $ | 10,959 | $ | 11,017 | $ | 20,463 |
Interest expense | | 2,736 | | 4,344 | | 4,253 | | 10,824 | | (2,736) | | (4,344) | | (4,253) | | (10,824) |
Net interest income | | 4,458 | | 6,615 | | 6,764 | | 9,639 | | 4,458 | | 6,615 | | 6,764 | | 9,639 |
Net gain on sales of mortgage-backed securities | | — | | — | | 122 | | (26) | | — | | — | | 122 | | (26) |
Direct operating expenses | | 226 | | 280 | | 328 | | 374 | | 226 | | 280 | | 328 | | 374 |
General and administrative expenses | | 288 | | 768 | | 812 | | 1,638 | | 288 | | 768 | | 812 | | 1,638 |
Net income | $ | 3,944 | $ | 5,567 | $ | 5,746 | $ | 7,601 | | 3,944 | $ | 5,567 | $ | 5,746 | $ | 7,601 |
Net income per Class A Common Share—Basic and Diluted | $ | 0.49 | $ | 0.56 | $ | 0.51 | $ | 0.44 | $ | 0.49 | $ | 0.56 | $ | 0.51 | $ | 0.44 |
Net income per Class B Common Share—Basic and Diluted | | N/A | | N/A | | 0.53 | | 0.46 | $ | N/A | $ | N/A | $ | 0.53 | $ | 0.46 |
Weighted average number of Class A common shares outstanding—Basic and Diluted | | 8,001 | | 10,012 | | 10,867 | | 16,825 | | 8,001 | | 10,012 | | 10,867 | | 16,825 |
Weighted average number of Class B common shares outstanding—Basic and Diluted | | — | | — | | 319 | | 319 | | — | | — | | 319 | | 319 |
None.
None.