In order for the Company’s Caps to qualify for hedge accounting, upon entering into the Cap Agreement, the Company must anticipate that the hedge will be highly “effective,” as defined by FAS 133, in limiting the Company’s cost beyond the Cap threshold on its matching (on an aggregate basis) anticipated repurchase agreements during the active period of the Cap. As long as the hedge remains effective, changes in the estimated fair value of the Caps are included in other comprehensive income. Upon commencement of the Cap Agreement active period, the premium paid to enter into the Cap Agreement is amortized and reflected in interest expense. The periodic amortization of the premium expense is based on an estimated allocation of the premium, determined at inception of the hedge, for the monthly components on an estimated fair value basis. Payments received in connection with the Cap Agreement, if any, are reported as a reduction to interest expense. If it is determined that a Cap Agreement is not effective, the premium would be reduced and a corresponding charge made to interest expense, for the ineffective portion of the Cap Agreement. The maximum cost related to the Company’s Caps is limited to the original price paid to enter into the Cap Agreement.
The Company purchases Caps by incurring a one-time fee or premium. Pursuant to the terms of the Caps, the Company will receive cash payments if the interest rate index specified in any such Cap Agreement increases above contractually specified levels. Therefore, such Caps have the effect of capping the interest rate on a portion of the Company’s borrowings above a level specified by the Cap Agreement.
When the Company enters into a Swap, it agrees to pay a fixed rate of interest and to receive a variable interest rate, generally based on the London Interbank Offered Rate (“LIBOR”). The Company’s Swaps are designated as cash flow hedges against the benchmark interest rate risk associated with the Company’s borrowings.
All changes in the unrealized gains/losses on any Swap are recorded in accumulated other comprehensive income/(loss) and are reclassified to earnings as interest expense is recognized on the Company’s hedged borrowings. If it becomes probable that the forecasted transaction, which in this case refers to interest payments to be made under the Company’s short-term borrowing agreements, will not occur by the end of the originally specified time period, as documented at the inception of the hedging relationship, then the related gain or loss in accumulated other comprehensive income/(loss) would be reclassified to income.
Realized gains and losses resulting from the termination of a Swap are initially recorded in accumulated other comprehensive income/(loss) as a separate component of equity. The gain or loss from a terminated Swap remains in accumulated other comprehensive income/(loss) until the forecasted interest payments affect earnings. If it becomes probable that the forecasted interest payments will not occur, then the entire gain or loss would be recognized though earnings.
On January 1, 2003, the Company adopted FASB Statement No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure” (“FAS 148”). FAS 148 amended FAS No. 123 “Accounting for Stock-Based Compensation” (“FAS 123”) and provided alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, FAS 148 amended the disclosure requirements of FAS 123, to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The adoption of FAS 148 did not have a significant impact on Company’s results of operations; however, the future effect of FAS 148 will be based on, among other things, the underlying terms of future grants of stock based compensation. (See Note 14(a).)
In January 2003, the FASB issued FIN 46, which was revised in December 2003. FIN 46 requires consolidation by the primary beneficiary of all variable interest entities (“VIE”). FIN 46 became effective immediately for investments in all VIE acquired after February 1, 2003 and for previously held investments beginning with the first interim period beginning after June 15, 2003. FIN 46 applied to one of the Company’s equity investments in real estate in which it has a majority interest as a limited partner but had not historically consolidated because it did not have effective control under the terms of the respective partnership agreements. The Company determined that this entity was a VIE and the Company was the primary beneficiary. The application of FIN 46 did not have a material impact on the Company’s consolidated financial statements, as its investment as a limited partner in such entity is immaterial. (See Note 7.)
MFA MORTGAGE INVESTMENTS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
In April 2003, the FASB issued FAS No. 149, “Amendments of Statements 133 on Derivative Instruments and Hedging Activities,” (“FAS 149”) which amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under FAS 133. This statement is effective for contracts entered into or modified after June 30, 2003, with certain exceptions, and for hedging relationships designated after June 30, 2003. The adoption of FAS 149 did not have any impact on the Company’s financial statements.
In May 2003, the FASB issued FAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity,” (“FAS 150”) which establishes standards for how an issuer classifies its liabilities. This statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise shall be effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of FAS 150 did not have any impact on the Company’s financial statements.
(l) New Accounting Pronouncements
In December 2004, the FASB revised FAS 123 through the issuance of FAS No. 123 “Share Based Payment”, revised (“FAS 123-R”). FAS 123-R is effective for the Company commencing in the third quarter of 2005. FAS 123-R, among other things, eliminates the alternative to use the intrinsic value method of accounting for stock based compensation and requires entities to recognize the cost of employee services received in exchange for awards of equity instruments based on the grant-date fair value of those awards (with limited exceptions). The fair value based method in FAS 123-R is similar to the fair-value-based method in FAS 123 in most respects, subject to certain key differences. The Company is in the process of evaluating the impact of such key differences between FAS 123 and FAS-123R, but does not currently believe that the adoption of FAS 123-R will have a material impact on the Company, as the Company had applied the fair value method of accounting for stock based compensation on January 1, 2003.
(m) Reclassifications
Certain prior period amounts have been reclassified to conform to the current period presentation.
3. Related Parties
(a) Advisor Fees and Advisor Merger
Prior to January 1, 2002, the Advisor managed the operations and investments, and performed administrative services, for the Company. Prior to the Advisor Merger, the Advisor was owned directly and indirectly by certain of the Company’s directors and executive officers (see discussion below). For the services and functions provided to the Company, the Advisor received a monthly management fee in an amount equal to 1.10% per annum of the first $300 million of Stockholders’ Equity of the Company, plus 0.80% per annum of the portion of Stockholders’ Equity of the Company above $300 million. The Company also paid the Advisor, as incentive compensation for each calendar quarter, an amount equal to 20% of the dollar amount by which the annualized return on equity for such quarter exceeded the amount necessary to provide an annualized return on equity equal to the ten-year U.S. treasury rate plus 1%.
The Company entered into an Agreement and Plan of Merger, dated September 24, 2001 (the “Advisor Merger Agreement”), with the Advisor, America First Companies L.L.C. (“AFC”) and the stockholders of the Advisor. In December 2001, the Company’s stockholders approved the terms of the Advisor Merger Agreement, which provided for the merger of the Advisor into the Company effective 12:01 a.m. on January 1, 2002. Pursuant to the Advisor Merger Agreement, the Company issued 1,287,501 shares of its Common Stock to the stockholders of the Advisor effective January 1, 2002. As a result, the Company became self-advised commencing January 1, 2002 and, since such time, has directly incurred the cost of all overhead necessary for its operation and administration. The market value of the Common Stock issued in the Advisor Merger, valued as of the consummation of the Advisor Merger in excess of the estimated fair value of the net tangible assets acquired, was charged to operating income of the Company for the year ended December 31, 2001.
Certain of the Company’s directors and executive officers who were involved in discussions and negotiations relating to the Advisor Merger had, and continue to have, interests that would be affected by the Advisor Merger. At the time of the Advisor Merger, AFC owned 80% of the outstanding capital stock of the Advisor. At that time, Michael Yanney, the Company’s former Chairman of the Board, who retired from the Board in March 2003, and George H. Krauss, one of the Company’s directors, beneficially owned approximately 57% and 17%, respectively, of AFC. In addition, Stewart Zimmerman, the Company’s President and Chief Executive Officer, and William S. Gorin, the Company’s Executive Vice President and Chief Financial Officer, collectively owned 3% of AFC. At the time of the Advisor Merger, Messrs. Zimmerman, Gorin and Ronald A. Freydberg, the Company’s Executive Vice
51
MFA MORTGAGE INVESTMENTS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
President and Chief Portfolio Officer, also owned, in the aggregate, the remaining 20% of the Advisor. Accordingly, the Advisor Merger resulted in these individuals receiving, in the aggregate, beneficial ownership of an additional 1,287,501 shares of the Common Stock valued at $11.3 million at the time of the Advisor Merger.
Because the Advisor Merger was between affiliated parties and may not be considered to have been negotiated in a completely arm’s-length manner, the Board established a special committee of the Board which consisted of three of the Company’s independent directors who had no personal interest in the Advisor Merger, to direct the negotiations relating to the Advisor Merger on the Company’s behalf and to consider and make recommendations to the Board relating to the Advisor Merger.
(b) Property Management
America First Properties Management Company L.L.C. (the “Property Manager”), a wholly-owned subsidiary of AFC, provides property management services for the multi-family apartment properties in which the Company holds investment interests. Prior to January 1, 2004, the Property Manager received a management fee equal to a stated percentage of the gross revenues generated by these properties, ranging from 3.5% to 4.0% of gross receipts. Commencing January 1, 2004, such fee was reduced to 3.0% and may be increased to 4.0% if a property meets certain performance objectives. The Company paid the Property Manager fees of approximately $127,000, $298,000 and $412,000, respectively, for the years ended December 31, 2004, 2003 and 2002. The Property Manager also provided property management services to certain properties in which the Company previously held investment interests. Michael Yanney, the Company’s former Chairman of the Board, who retired from the Board in March 2003, has been the Chairman of AFC since 1984 and Mr. Yanney and George H. Krauss, one of the Company’s directors, beneficially own equity interests in AFC.
(c) Investment in Retirement Centers Corporation
From 1998 thorough September 30, 2002, the Company held all of the non-voting preferred stock, representing 95% of the ownership and economic interest in RCC. Through September 30, 2002, Mr. Gorin, the Company’s Executive Vice President and Chief Financial Officer, held all of the voting common stock of RCC, representing a 5% economic interest and 100% controlling interest in RCC.
On October 1, 2002, the Company purchased 100% of the voting common stock held by Mr. Gorin for $260,000. The purchase price was based on the estimated value of the underlying properties, as determined by independent appraisers, net of the related mortgage indebtedness. As a result of the purchase of this voting common stock, RCC became a wholly-owned subsidiary of the Company. (See Note 7.)
(d) Investments in Certain Corporate Debt Securities
Prior to the Company liquidating its corporate debt securities portfolio in 2002, the Company held the corporate debt securities of RCN Corporation (“RCN”), which were purchased between February 1999 and August 2000, and Level 3 Corporation (“Level 3”), which were purchased between August 1998 and August 2000. Mr. Yanney, who retired as the Company’s Chairman of the Board in March 2003, was on the board of directors of both RCN and Level 3 at the time these debt securities were purchased and sold. W. David Scott, who retired from the Board in May 2004, is the son of the individual who was the Chairman of both Level 3 and RCN and served as a Director of the Company at the time these securities were purchased and sold.
(e) Advisory Services
During the fourth quarter of 2003, the Company formed and became the sole stockholder of MFA Spartan, Inc., a Delaware corporation (“Spartan Inc.”). Spartan Inc. then formed and, pursuant to an operating agreement dated November 6, 2003, became the sole member of MFA Spartan I, LLC, a Delaware limited liability company (“Spartan LLC”). On November 7, 2003, Spartan LLC entered into a sub-advisory agreement, which was subsequently amended and restated on October 1, 2004, with America First Apartment Advisory Corporation (“AFAAC”), a Maryland corporation and the external advisor of America First Apartment Investors, Inc. (“AFAI”), pursuant to which Spartan LLC agreed, among other things, to provide sub-advisory services to AFAAC with respect to, and to assist AFAAC in connection with, AFAI’s acquisition and disposition of MBS and the maintenance of AFAI’s MBS portfolio. During the years ended 2004 and 2003, the Company earned a fee of $65,000 and $2,000, respectively, relating to the sub-advisory services rendered by Spartan LLC to AFAAC. George H. Krauss, one of the Company’s directors, is a member of the board of directors of AFAI and beneficially owns 17% of AFC, which owns 100% of the voting stock of AFAAC.
52
MFA MORTGAGE INVESTMENTS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
4. Mortgage-Backed Securities
At December 31, 2004 and 2003, all of the Company’s MBS were classified as available-for-sale and, as such, were carried at their estimated fair value, based on prices obtained from a third-party pricing service or, if pricing is not available for an MBS from such pricing service, the average of broker quotes received for such MBS is used to determine the estimated fair value of such MBS. The following table presents the carrying value of the Company’s MBS at December 31, 2004 and 2003.
| | | | | | | | | |
(In Thousands) | | 2004
| | 2003
|
| Agency MBS: | | | | | | | | |
| Fannie Mae Certificates | | $ | 4,067,878 | | | $ | 2,782,066 | |
| Ginnie Mae Certificates | | | 1,454,450 | | | | 344,363 | |
| Freddie Mac Certificates | | | 729,866 | | | | 1,109,941 | |
| Non-Agency MBS: | | | | | | | | |
| AAA rated | | | 519,390 | | | | 136,348 | |
| AA rated | | | 2,315 | | | | - | |
| single A rated | | | 1,619 | | | | - | |
| BBB rated | | | 898 | | | | - | |
| BB and below rated | | | 1,070 | | | | - | |
| Non-rated | | | 88 | | | | - | |
| |
| | |
| |
| | $ | 6,777,574 | | | $ | 4,372,718 | |
| |
| | |
| |
At December 31, 2004 and 2003, the Company’s portfolio of MBS consisted of pools of ARM-MBS with carrying values of approximately $6.770 billion and $4.366 billion, respectively, and fixed-rate MBS with carrying values of approximately $7.2 million and $7.1 million, respectively.
Agency MBS:Although not rated, Agency MBS carry an implied AAA rating. Agency MBS are guaranteed as to principal and/or interest by an agency of the U.S. government, such as Ginnie Mae, or federally chartered corporation, such as Fannie Mae or Freddie Mac. The payment of principal and/or interest on Fannie Mae and Freddie Mac MBS is guaranteed by those respective agencies and the payment of principal and/or interest on Ginnie Mae MBS is backed by the full faith and credit of the U.S. government.
Non-Agency MBS: Non-Agency MBS are certificates that are backed by pools of single-family and multi-family mortgage loans, which are not guaranteed by the U.S. government or any of its agencies or any federally chartered corporation. Non-Agency MBS may be rated from AAA to B by one or more of the Rating Agencies. AAA is the highest bond rating given by Rating Agencies and indicates the relative security of the investment. Certain non-Agency MBS may also be non-rated.
The following table presents the amortized cost, gross unrealized gains, gross unrealized losses and fair value of the Company’s MBS at December 31, 2004 and 2003:
| | | | | | | | | |
(In Thousands) | | 2004
| | 2003
|
| Principal balance | | $ | 6,640,050 | | | $ | 4,245,458 | |
| Principal payment receivable | | | 25,799 | | | | 40,170 | |
| |
| | |
| |
| | | 6,665,849 | | | | 4,285,628 | |
| Unamortized premium | | | 145,483 | | | | 96,162 | |
| Unaccreted discount | | | (322 | ) | | | (299 | ) |
| Discount designated as a credit reserve | | | (325 | ) | | | - | |
| Gross unrealized gains | | | 7,112 | | | | 10,882 | |
| Gross unrealized losses | | | (40,223 | ) | | | (19,655 | ) |
| |
| | |
| |
| Carrying value/estimated fair value | | $ | 6,777,574 | | | $ | 4,372,718 | |
| |
| | |
| |
Historically, the Company’s MBS were either Agency MBS, which have an implied AAA rating, or non-Agency MBS that were rated AAA by one or more of the Rating Agencies; accordingly, no unrealized losses associated with these MBS were considered to be credit related. During the fourth quarter of 2004, the Company purchased $6.4 million of non-Agency MBS rated below AAA. Approximately $1.5 million of these MBS were
53
MFA MORTGAGE INVESTMENTS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
rated BB (below investment grade) and below, of which $234,000 were not rated by a Rating Agency. The MBS rated BB and below, including the non-rated MBS, were purchased at a discount, of which $335,000 was designated as credit protection against future credit losses. In addition, a lesser amount of the discount was identified as a discount related to the yield component and is accreted to interest income under the effective yield method over the life of the securities, as adjusted for prepayments.
The initial credit protection (i.e., discount) may be adjusted over time, based on review of the underlying collateral, economic conditions and other factors. If the performance of these securities is more favorable than initially forecasted, a portion of the amount designated as credit protection may be accreted into interest income over time. Conversely, if in the future the performance of these securities is less favorable than initially forecasted, additional reserves could be warranted, which would be charged to the Company’s earnings. Except for credit related discounts discussed above, the Company did not recognize any asset impairment or credit reserves against any of the Company’s MBS during the years ended December 31, 2004, 2003 and 2002.
At December 31, 2004, the Company had 56 MBS, with an amortized cost of $917.0 million, that had unrealized losses for 12 months or more, all of which were Agency or AAA rated MBS. At December 31, 2004, these MBS had gross unrealized losses of $11.3 million.
The following table presents the gross unrealized losses and estimated fair value of the Company’s MBS on which there were unrealized losses, aggregated by investment category and length of time that such individual securities have been in a continuous unrealized loss position, at December 31, 2004.
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Less than 12 Months
| | 12 Months or more
| | Total
|
(In Thousands)
| | Estimated Fair Value
| | Unrealized losses
| | Estimated Fair Value
| | Unrealized losses
| | Estimated Fair Value
| | Unrealized losses
|
| Agency MBS: | | | | | | | | | | | | | | | | | | | | | | | | |
| Fannie Mae | | $ | 2,840,216 | | | $ | 19,820 | | | $ | 608,659 | | | $ | 7,545 | | | $ | 3,448,875 | | | $ | 27,365 | |
| Ginnie Mae | | | 849,267 | | | | 5,309 | | | | - | | | | - | | | | 849,267 | | | | 5,309 | |
| Freddie Mac | | | 284,429 | | | | 2,352 | | | | 216,951 | | | | 2,836 | | | | 501,380 | | | | 5,188 | |
| Non-Agency AAA rated MBS | | | 288,648 | | | | 1,485 | | | | 80,090 | | | | 876 | | | | 368,738 | | | | 2,361 | |
| | |
| | |
| | |
| | |
| | |
| | |
| |
| Total temporarily impaired securities | | $ | 4,262,560 | | | $ | 28,966 | | | $ | 905,700 | | | $ | 11,257 | | | $ | 5,168,260 | | | $ | 40,223 | |
| | |
| | |
| | |
| | |
| | |
| | |
| |
All of the Company’s MBS that had unrealized losses at December 31, 2004 were either Agency MBS, which have an implied AAA rating or non-agency MBS that were rated AAA, as such none of the unrealized losses are considered to be credit related. In addition, the Company expects to retain such MBS in its portfolio.
The following table presents interest income and premium amortization on the Company’s MBS portfolio for the years ended December 31, 2004, 2003 and 2002.
| | | | | | | | | | | | | |
(In Thousands) | | 2004 | | 2003 | | 2002 |
| |
| |
| |
|
| Coupon interest on MBS | | $ | 222,614 | | | $ | 165,063 | | | $ | 154,329 | |
| Premium amortization | | | (47,683 | ) | | | (45,452 | ) | | | (28,093 | ) |
| Discount accretion | | | 26 | | | | 1 | | | | 2 | |
| |
| | |
| | |
| |
| Interest income on MBS, net | | $ | 174,957 | | | $ | 119,612 | | | $ | 126,238 | |
| |
| | |
| | |
| |
5. Corporate Debt Securities
During 2002, the Company liquidated its remaining portfolio of corporate debt securities, realizing gains of $937,000 and losses of $1,575,000. These securities were comprised of non-investment grade, high yield bonds. The Company had taken an impairment charge of $3,474,000 on certain of its corporate debt securities during 2002. The Company has not had any investments in corporate debt securities subsequent to 2002.
6. Corporate Equity Securities
During 2002, the Company liquidated its remaining portfolio of corporate equity securities, realizing gains of $569,000. The Company has not had any investments in corporate equity securities subsequent to 2002.
54
MFA MORTGAGE INVESTMENTS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
7. Real Estate and Equity Interests in Real Estate
At December 31, 2004, the Company indirectly held investments representing ownership interests in the following properties: (i) a 100% ownership interest in The Greenhouse, a 128-unit multi-family apartment property located in Omaha, Nebraska; (ii) a 99.9% ownership interest in Lealand Place, a 191-unit apartment property located in Lawrenceville, Georgia; and (iii) a 99% limited partner interest in Owings Chase Limited Partnership (“Owings Chase LP”), which owns Cameron, a 201-unit multi-family apartment complex in Charlotte, North Carolina.
Real estate investments, all of which were consolidated with the Company at December 31, 2004, and equity interests in real estate at December 31, 2003 were as follows:
| | | | | | | | | |
| | December 31,
|
| (In Thousands) | | 2004 | | 2003 |
| |
| |
|
| Real Estate: | | | | | | | | |
| Land and buildings | | $ | 30,017 | | | $ | 21,486 | |
| Cash | | | 428 | | | | 283 | |
| Prepaid and other assets | | | 509 | | | | 324 | |
| Mortgages payable | | | (22,686 | ) | (1) | | (16,161 | ) |
| Accrued interest payable | | | (101 | ) | | | (58 | ) |
| Other payables | | | (327 | ) | | | (210 | ) |
| | |
| | |
| |
| Net real estate related assets | | $ | 7,840 | | | $ | 5,664 | |
| | |
| | |
| |
| Equity Interest in Real Estate | | $ | - | | | $ | 2,802 | (2) |
| | |
| | |
| |
(1) Each of the three properties serves as collateral for their respective mortgage. The mortgages collateralized by The Greenhouse and Lealand Place are non-recourse, subject to customary non-recourse exceptions, which generally means that the lender’s final source of prepayment in the event of default is foreclosure of the property securing such loan. The mortgage collateralized by Cameron is, under certain limited circumstances, guaranteed by the Company. At December 31, 2004, these mortgages had fixed interest rates ranging from 6.87% to 8.08% and maturities ranging from February 1, 2010 to February 1, 2011. In December 2000, the Company loaned Greenhouse Holdings, LLC (which owns The Greenhouse) $437,000 to fund building improvements which remained outstanding at December 31, 2004, such loan is eliminated in consolidation.
(2) At December 31, 2003, equity interests in real estate were comprised of the Company’s 99% limited partner interest in Owings Chase LP, which owns Cameron, 201-unit multi-family apartment property, located in Charlotte, North Carolina. Such investment has been consolidated since January 1, 2004, on a prospective basis in accordance with the provisions of FIN 46.
The following table presents the summary results of operations for such real estate investments that were consolidated for the years ended December 31, 2004, 2003 and 2002:
| | | | | | | | | | | | | |
| | December 31,
|
| (In Thousands) | | 2004(1) | | 2003 | | 2002(2) | |
| |
| |
| |
|
| Revenue from operations of real estate | | $ | 4,126 | | | $ | 2,663 | | | $ | 685 | |
| Interest expense for mortgages on real estate | | | (1,698 | ) | | | (1,102 | ) | | | (304 | ) |
| Other real estate operations expense | | | (2,860 | ) | | | (1,767 | ) | | | (185 | ) |
| |
| | |
| | |
| |
| | $ | (432 | ) | | $ | (206 | ) | | $ | 196 | |
| |
| | |
| | |
| |
(1) Owings Chase LP was consolidated with the Company commencing on January 1, 2004; for 2003 and 2002, Owings Chase LP was accounted for under the equity method.
(2) Prior to October 1, 2002, the Company held 100% of the non-voting preferred stock of RCC, which represented a 95% economic interest in RCC, and, as such, the net assets of RCC were included in equity interests in real estate and income recognized under the equity method. On October 1, 2002, the Company purchased the voting common stock of RCC, which represented the remaining outstanding securities of RCC that were not then owned by the Company. Upon acquiring the controlling interest in RCC, the Company changed from the equity method of accounting for this investment to consolidating RCC on a prospective basis.
55
MFA MORTGAGE INVESTMENTS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
For the years ended December 31, 2003 and 2002, the Company reported income from equity interests in real estate included the results of operations for Owings Chase LP and two additional real estate investments, which were sold during 2003. The Company did not report any income from equity interest in real estate for the year ended December 31, 2004, as all real estate investments were consolidated since January 1, 2004 on a prospective basis. The following table presents the Company’s net loss/income from equity interests in real estate for the years ended December 31, 2003 and 2002.
| | | | | | | | | |
| | December 31,
|
| (In Thousands) | | 2003 | | 2002 |
| |
| |
|
| Gains on sale of real estate and equity investments in real estate, net | | $ | 1,697 | | (1) | $ | - | |
| (Loss)/income from equity interests in real estate | | | (421 | ) | | | 80 | (2) |
| |
| | |
| |
| | $ | 1,276 | | | $ | 80 | |
| |
| | |
| |
(1) During 2003, the following real estate related transactions occurred with respect to the Company: (i) Morrowood Associates, Ltd., a limited partnership in which the Company held a 99% limited partner interest, sold its sole investment, Morrowood Townhouses, a 264-unit multi-family apartment property located in Morrow, Georgia; (ii) the Company sold its 50% limited partner interest in Gold Key Venture, a Georgia Limited Partnership, which held Laurel Park, a 387-unit multi-family apartment property located in Riverdale, Georgia; and (iii) Harmony Bay Associates, Ltd, a limited partnership in which the Company held a 99% limited partner interest, sold its sole investment asset, Harmony Bay Apartments, a 300-unit multi-family apartment property located in Roswell, Georgia. As a result of these transactions, the Company realized gains of $621,000 and $1,084,000 and a loss of $4,000, respectively.
(2) Does not include the results for RCC from October 1, 2002 though December 31, 2002.
8. Hedging Instruments/Hedging Activity
In connection with the Company’s interest rate risk management process, the Company periodically hedges a portion of its interest rate risk by entering into derivative financial instrument contracts. To date, such instruments are comprised of Caps and Swaps, which in effect modify the repricing characteristics of the Company’s repurchase agreements and cash flows on such liabilities. The use of Hedging Instruments creates exposure to credit risk relating to potential losses that could be recognized if the counterparties to these instruments fail to perform their obligations under the contracts. To mitigate this exposure, the Company only enters into such transactions with financial institutions whose parent or holding company’s long-term debt rating is single A or better, as determined by one of the Rating Agencies. In the event of a default by the counterparty, the Company would not receive payments provided for under the terms of the Hedging Instrument, could incur a loss for the remaining unamortized premium cost of the Cap and could have difficulty obtaining its assets pledged as collateral for Swaps.
The following table sets forth the impact of the Company’s Hedging Instruments on the Company’s Other Comprehensive Income for the years ended December 31, 2004, 2003 and 2002.
| | | | | | | | | | | | | |
| | | For the Year Ended December 31,
|
| (In Thousands) | | 2004 | | 2003 | | 2002 | |
| |
| |
| |
|
Accumulated Other Comprehensive Loss from Hedging Instruments: | | | | | | | | | | | | |
| Balance at beginning of year | | $ | (3,336 | ) | | $ | (2,936 | ) | | $ | 164 | |
| Unrealized holding gains/(losses) on Hedging Instruments, net | | | 1,347 | | | | (400 | ) | | | (3,100 | ) |
| |
| | |
| | |
| |
| Balance at the end of year | | $ | (1,989 | ) | | $ | (3,336 | ) | | $ | (2,936 | ) |
| |
| | |
| | |
| |
(a) Interest Rate Caps
The Company’s Caps are designated as cash flow hedges against interest rate risk associated with the Company’s existing and forecasted repurchase agreements. At December 31, 2004, the Company had 15 Caps with an aggregate notional amount of $560.0 million purchased to hedge against increases in interest rates on $560.0 million of its current and/or anticipated 30-day term repurchase agreements. The Caps had an amortized cost of approximately $3.5 million and an estimated fair value of $1.2 million at December 31, 2004, resulting in a net unrealized loss of approximately $2.3 million, which is included as a component of accumulated other comprehensive income. The Company incurred premium amortization expense on its Caps, which is recorded as interest expense on the Company’s repurchase agreements that such Caps hedge, of $2.5 million, $432,000 and $3,000 for the years ended December 31, 2004, 2003 and 2002, respectively. If the 30-day LIBOR were to increase
56
MFA MORTGAGE INVESTMENTS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
above the rate specified in the Cap Agreement during the effective term of the Cap, the Company would receive monthly payments from its Cap Agreement counterparty. The Company did not receive any payments from counterparties related to its Caps during the years ended December 31, 2004, 2003 or 2002.
The table below presents information about the Company’s Caps at December 31, 2004:
| | | | | | | | | | | | | | | | | | | | | | | | | |
(Dollars in Thousands) | | Weighted Average Remaining Active Period | | Weighted Average LIBOR Strike Rate(1) | | Notional Amount | | Unamortized Premium | | Estimated Fair Value/Carrying Value | | Gross Unrealized (Loss) |
| |
| |
| |
| |
| |
| |
|
| Months until active: | | | | | | | | | | | | | | | | | | | | | | | | |
| Currently active | | | 7 Months | | | | 4.22 | % | | $ | 310,000 | | | $ | 1,360 | | | $ | 129 | | | $ | (1,231 | ) |
| Within six months | | | 18 Months | | | | 3.75 | | | | 100,000 | | | | 635 | | | | 296 | | | | (339 | ) |
| Six to nine months | | | 18 Months | | | | 3.88 | | | | 100,000 | | | | 960 | | | | 450 | | | | (510 | ) |
| Nine to 12 months | | | 18 Months | | | | 3.75 | | | | 50,000 | | | | 601 | | | | 370 | | | | (231 | ) |
| 12 to 24 months | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | |
| |
| | |
| | |
| | |
| | |
| | |
| |
| Weighted Average/Total | | | 12 Months | | | | 4.03 | % | | $ | 560,000 | | | $ | 3,556 | | | $ | 1,245 | | | $ | (2,311 | ) |
| | | | | |
| | |
| | |
| | |
| |
(1) The 30-day LIBOR strike rate at which payments would become due to the Company under the terms of the Cap Agreement. At December 31, 2004, the 30-day LIBOR was 2.40%.
(b) Interest Rate Swap
The Company’s Swaps are used to lock-in the fixed Swap rate related to a portion of its current and anticipated future 30-day term repurchase agreements.
The table below presents information about the Company’s Swaps at December 31, 2004:
| | | | | | | | | | | | | | | | | | | | | |
(Dollars in Thousands) | | Weighted
Average Active
Period | | Notional
Amount | | Weighted
Average
Swap Rate | | Estimated Fair
Value/Carrying
Value | | Gross
Unrealized
Gain |
| |
| |
| |
| |
| |
|
| Currently Active | | | 20 Months | | | $ | 180,000 | | | | 3.19 | % | | $ | 321 | | | $ | 321 | |
9. Repurchase Agreements
The Company’s repurchase agreements are collateralized by the Company’s MBS and typically bear interest at rates that are LIBOR-based. At December 31, 2004, the Company had outstanding balances of $6.113 billion under 375 repurchase agreements with a weighted average borrowing rate of 2.32% and a weighted average remaining contractual maturity of 7.9 months. At December 31, 2004, all of the Company’s borrowings were fixed-rate term repurchase agreements with original maturities that range from one to 36 months. At December 31, 2003, the Company had outstanding balances of $4.024 billion under 258 repurchase agreements with a weighted average borrowing rate of 1.36%. At December 31, 2004 and 2003, the repurchase agreements had the following remaining contractual maturities:
| | | | | | | | | |
| | | December 31,
|
(In Thousands) | | 2004
| | 2003
|
| Within 30 days | | $ | 996,200 | | | $ | 412,611 | |
| >30 days to 3 months | | | 1,024,859 | | | | 503,044 | |
| >3 months to 6 months | | | 1,376,773 | | | | 1,022,560 | |
| >6 months to 12 months | | | 1,158,300 | | | | 1,613,761 | |
| >12 months to 24 months | | | 1,556,900 | | | | 148,200 | |
| >24 months to 36 months | | | - | | | | 324,200 | |
| |
| | |
| |
| | $ | 6,113,032 | | | $ | 4,024,376 | |
| |
| | |
| |
57
MFA MORTGAGE INVESTMENTS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
10. Commitments and Contingencies
(a) Lease Commitments
The Company has a lease through August 31, 2012 for its corporate headquarters, located at 350 Park Avenue, New York, New York. This lease provides for, among other things, monthly payments based on annual rent of: (i) $338,000 though July 31 2005; (ii) $348,000 from August 1, 2005 through November 30, 2008 and (iii) $357,000 from December 1, 2008 through August 31, 2012. During the fourth quarter of 2004, the Company entered into a lease for an additional space at its corporate headquarters, which will commence in March of 2005 and run through July 31, 2007. This lease provides for, among other things, monthly payments based on annual rent of $152,000. In addition, the Company has a lease through December 2007 for its off-site back-up facilities located in Rockville Centre, New York. This lease provides for, among other things, annual rent of $23,000.
At December 31, 2004, the projected minimum rental payments (exclusive of possible rent escalation charges and normal recurring charges for maintenance, insurance and taxes) were as follows:
| | | | | |
Year Ended December 31,
| | At December 31,
|
| | (In Thousands) |
| 2005 | | $ | 492 | |
| 2006 | | | 522 | |
| 2007 | | | 472 | |
| 2008 | | | 349 | |
| 2009 | | | 357 | |
| Thereafter | | | 954 | |
| |
| |
| | $ | 3,146 | |
| |
| |
11. Stockholders’ Equity
(a) Dividends on Preferred Stock
At December 31, 2004, the Company had issued and outstanding 3.8 million shares of Preferred Stock, with a par value $0.01 per share and a liquidation preference of $25.00 per share. The Preferred Stock, which is redeemable exclusively at the Company’s option commencing on April 27, 2009 (subject to the Company’s right under limited circumstances to redeem the Preferred Stock prior to that date in order to preserve its REIT status), is senior to the Common Stock with respect to dividends and distributions. The Preferred Stock must be paid a dividend at a rate of 8.50% per year of the $25.00 liquidation preference before the Common Stock is entitled to receive any dividends and is senior to the Common Stock with respect to distributions upon liquidation, dissolution or winding up. The Preferred Stock generally does not have any voting rights, subject to an exception in the event Company’s fails to pay dividends on the Preferred Stock for six or more quarterly periods (whether or not consecutive). Under such circumstances, the Preferred Stock will be entitled to vote to elect two additional directors to the Board, until all unpaid dividends have been paid or declared and set apart for payment. In addition, certain material and adverse changes to the terms of the Preferred Stock cannot be made without the affirmative vote of holders of at least 66 2/3% of the outstanding shares of Preferred Stock. Through December 31, 2004, the Company had declared and paid all required quarterly dividends on the Preferred Stock.
The following table presents dividends declared by the Company on its Preferred Stock, since such securities were first issued on April 27, 2004.
| | | | | | | | | |
Declaration Date | | Record Date | | Payment Date | | Dividend
Per share |
| |
| |
| |
|
| May 27, 2004 | | June 4, 2004 | | June 30, 2004 | | $ | 0.37780 | (1) |
| August 24, 2004 | | September 1, 2004 | | September 30, 2004 | | | 0.53125 | |
| November 19, 2004 | | December 1, 2004 | | December 31, 2004 | | | 0.53125 | |
(1) Represents dividend for the period of April 27, 2004 through June 30, 2004.
58
MFA MORTGAGE INVESTMENTS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(b) Dividends on Common Stock
The following table presents dividends declared by the Company on its Common Stock during the years ended December 31, 2004, 2003 and 2002:
| | | | | | | | | |
Declaration Date | | Record Date | | Payment Date | | Dividend Per share |
| |
| |
| |
|
2004 | | | | | | | | |
April 1, 2004 | | April 12, 2004 | | April 30, 2004 | | $ | 0.260 | (1) |
July 1, 2004 | | July 12, 2004 | | July 30, 2004 | | | 0.250 | |
October 4, 2004 | | October 12, 2004 | | October 29, 2004 | | | 0.230 | |
December 16, 2004 | | December 27, 2004 | | January 31, 2005 | | | 0.220 | |
2003 | | | | | | | | |
| March 13, 2003 | | March 28, 2003 | | April 30, 2003 | | $ | 0.280 | |
| May 22, 2003 | | June 30, 2003 | | July 31, 2003 | | | 0.280 | |
| September 10, 2003 | | September 30, 2003 | | October 31, 2003 | | | 0.280 | |
| December 17, 2003 | | December 30, 2003 | | January 30, 2004 | | | 0.250 | |
2002 | | | | | | | | |
| March 12, 2002 | | March 28, 2002 | | April 30, 2002 | | $ | 0.300 | (2) |
| June 12, 2002 | | June 28, 2002 | | July 30, 2002 | | | 0.300 | (2) |
| September 12, 2002 | | September 30, 2002 | | October 30, 2002 | | | 0.320 | (3) |
| December 19, 2002 | | December 30, 2002 | | January 24, 2003 | | | 0.320 | (3) |
| | |
| (1) | Includes a special dividend of $0.01 per share. |
| | |
| (2) | Includes a special dividend of $0.02 per share. |
| | |
| (3) | Includes a special dividend of $0.04 per share. |
For income tax purposes, a portion of each of the dividends declared in December 2004, 2003 and 2002 were treated as a dividend for stockholders in the subsequent year.
In general, the Company’s dividends have been characterized as ordinary income to its stockholders for income tax purposes. However, a portion of the Company’s dividends may, from time to time, be characterized as capital gains or return of capital. For the years ended December 31, 2004 and 2003, a portion of the Company’s dividends were deemed to be capital gains, with the remainder characterized as ordinary income, to stockholders.
(c) Shelf Registration Statements
On September 25, 2001, the Company filed a shelf registration statement on Form S-3 with the Securities Exchange Commission (“SEC”) under the Securities Act of 1933, as amended (the “Act”), with respect to an aggregate of $300.0 million of Common Stock and/or preferred stock that may be sold by the Company from time to time pursuant to Rule 415 of the Act. On October 5, 2001, the Commission declared this shelf registration statement effective. At December 31, 2004, the Company had $8.7 million remaining on this shelf registration statement.
On June 27, 2003, the Company filed a shelf registration statement on Form S-3 with the SEC under the Act with respect to an aggregate of $500.0 million of Common Stock and/or preferred stock that may be sold by the Company from time to time pursuant to Rule 415 of the Act. On July 8, 2003, the SEC declared this registration statement effective. On July 21, 2004, the Company filed a post-effective amendment to this shelf registration statement, which was declared effective by the SEC on August 12, 2004. At December 31, 2004, the Company had $244.0 million available under this shelf registration statement.
On December 17, 2004, the Company filed a shelf registration statement on Form S-3 with the SEC under the Act for the purpose of registering additional Common Stock for sale through the DRSPP. This shelf registration statement was declared effective by the SEC on January 4, 2005 and, when combined with the unused portion of the Company’s previous DRSPP shelf registration statement, registered an aggregate of 10 million shares of Common Stock. At December 31, 2004, 552,891 shares of Common Stock remained available for issuance pursuant to the prior DRSPP shelf registration statement.
On December 17, 2004, the Company filed a registration statement on Form S-8 with the SEC under the Act for the purpose of registering additional Common Stock for issuance in connection with the exercise of awards under the Company’s 2004 Equity Compensation Plan (the “2004 Plan”), which amended and restated the Company’s
59
MFA MORTGAGE INVESTMENTS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Second Amended and Restated 1997 Stock Option Plan (the “1997 Plan”). This registration statement became effective automatically upon filing and, when combined with the previously registered, but unissued, portions of the Company’s prior registration statements on Form S-8 relating to awards under the 1997 Plan, related to an aggregate of 3.3 million shares of Common Stock.
(d) Equity Issued
During the year ended December 31, 2004, the Company issued shares of its Common Stock and Preferred Stock through public offerings. In September 2003, the Company initiated its DRSPP, which is designed to provide existing stockholders and new investors with a convenient and economical way to purchase shares of Common Stock (through the automatic reinvestment of dividends and/or optional monthly cash investments). On August 20, 2004, the Company initiated a controlled equity offering program (the “CEO Program”) through which it may publicly offer and sell, from time to time, shares of Common Stock through Cantor Fitzgerald & Co. (“Cantor”) in privately negotiated and/or at-the-market transactions. During the year ended December 31, 2004, the Company issued shares of its Common and Preferred Stock pursuant to public offerings, the DRSPP and the CEO Program as follows:
| | | | | | | | | |
Sold Pursuant To | | Securities Sold | | Number of Shares Issued |
| |
| |
|
| Public Offerings | | | Common Stock | | | | 8,625,000 | |
| DRSPP | | | Common Stock | | | | 1,833,215 | |
| CEO Program | | | Common Stock | | | | 8,357,302 | |
| Public Offerings | | | Preferred Stock | | | | 3,840,000 | |
12.EPS Calculation
The following table presents a reconciliation of the earnings and shares used in calculating basic and diluted EPS for the years ended December 31, 2004, 2003 and 2002:
| | | | | | | | | | | | | |
| | 2004 | | 2003 | | 2002 |
| |
| |
| |
|
(In Thousands) | | | | | | | | | | | | |
| Net Income | | $ | 78,073 | | | $ | 57,848 | | | $ | 56,094 | |
| Less: Preferred Stock dividends | | | 3,576 | | | | - | | | | - | |
| | |
| | |
| | |
| |
| Net income available to Common Stockholders | | $ | 74,497 | | | $ | 57,848 | | | $ | 56,094 | |
| |
| | |
| | |
| |
| Weighted average shares of Common Stock outstanding – basic | | | 76,168 | | | | 53,999 | | | | 41,432 | |
| Add: Effect of assumed shares issued under treasury stock method for stock options | | | 49 | | | | 62 | | | | 102 | |
| |
| | |
| | |
| |
| Weighted average shares of Common Stock Outstanding – diluted | | | 76,217 | | | | 54,061 | | | | 41,534 | |
| |
| | |
| | |
| |
13. Accumulated Other Comprehensive Loss
Accumulated other comprehensive loss at December 31, 2004 and 2003 was as follows:
| | | | | | | | | |
| | 2004 | | 2003 |
| |
| |
|
(In Thousands) | | | | | | | | |
| Available-for-sale MBS: | | | | | | | | |
| Unrealized gains | | $ | 7,112 | | | $ | 10,882 | |
| Unrealized (losses) | | | (40,223 | ) | | | (19,655 | ) |
| |
| | |
| |
| | | (33,111 | ) | | | (8,773 | ) |
| |
| | |
| |
| Hedging Instruments: | | | | | | | | |
| Unrealized (losses) on Caps | | | (2,310 | ) | | | (3,336 | ) |
| Unrealized gains on Swaps | | | 321 | | | | - | |
| |
| | |
| |
| | | | (1,989 | ) | | | (3,336 | ) |
| |
| | |
| |
| Accumulated other comprehensive (loss) | | $ | (35,100 | ) | | $ | (12,109 | ) |
| |
| | |
| |
60
MFA MORTGAGE INVESTMENTS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
14.2004 Equity Compensation Plan, Employment Agreements and Other Benefit Plans
(a) 2004 Equity Compensation Plan
During the second quarter of 2004, the Company adopted the 2004 Plan, as approved by the Company’s stockholders. The 2004 Plan amended and restated the 1997 Plan.
In accordance with the terms of the 2004 Plan, directors, officers and employees of the Company and any of its subsidiaries and other persons expected to provide significant services (of a type expressly approved by the Compensation Committee of the Board as covered services for these purposes) to the Company and any of its subsidiaries are eligible to be granted stock options (“Options”), restricted stock, phantom shares, dividend equivalent rights (“DERs”) and other stock-based awards under the 2004 Plan.
In general, subject to certain exceptions, stock-based awards relating to a maximum of 3,500,000 shares of Common Stock may be granted under the 2004 Plan; forfeitures and/or awards that expire unexercised do not count towards such limit. Subject to certain exceptions, a participant may not receive stock-based awards relating to greater than 500,000 shares of Common Stock in any one-year and no award may be granted to any person who, assuming exercise of all Options and payment of all awards held by such person, would own or be deemed to own more than 9.8% of the outstanding shares of the Company’s capital stock. At December 31, 2004, an aggregate of 1,087,000 shares were subject to outstanding awards under the 2004 Plan, of which 793,500 were exercisable. Unless previously terminated by the Board, awards may be granted under the 2004 Plan until the tenth anniversary of the date that the Company’s stockholders approved such plan.
A DER is a right to receive, as specified by the Compensation Committee at the time of grant, a distribution equal to the dividend distributions paid on a share of Common Stock. DERs may be granted separately or together with other awards and are paid in cash or other consideration at such times, and in accordance with such rules, as the Compensation Committee shall determine in its discretion.
Pursuant to Section 422(b) of the Code, in order for stock options granted under the 2004 Plan and vesting in any one calendar year to qualify as an incentive stock option (“ISO”) for tax purposes, the market value of the Common Stock, as determined on the date of grant, shall not exceed $100,000 during a calendar year. The exercise price of an ISO may not be lower than 100% (110% in the case of an ISO granted to a 10% stockholder) of the fair market value of the Common Stock on the date of grant. The exercise price for any other type of Option so issued may not be less than the fair market value on the date of grant. Each Option is exercisable after the period or periods specified in the award agreement, which will generally not exceed ten years from the date of grant. Options will be exercisable at such times and subject to such terms as determined by the Compensation Committee.
At December 31, 2004, the Company had 293,500 Options outstanding that were not yet vested. These unvested Options, which are scheduled to vest through February 1, 2007, had a weighted average vesting period of 14 months, and unrecognized corresponding aggregate expense of $872,000 that is expected to be recognized over the actual vesting period, subject to changes in estimated and/or actual forfeitures. Activity in the 2004 Plan is summarized as follows for the years ended December 31, 2004, 2003 and 2002:
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | 2004 | | 2003 | | 2002 |
| |
| |
| |
|
| | Options | | Weighted
Average
Exercise
Price | | Options | | Weighted
Average
Exercise
Price | | Options | | Weighted
Average
Exercise
Price |
| |
| |
| |
| |
| |
| |
|
| Outstanding at beginning of year: | | | 1,012,250 | | | $ | 9.32 | | | | 643,750 | | | $ | 8.09 | | | | 793,750 | | | $ | 6.12 | |
| Granted | | | 80,000 | | | | 9.54 | | | | 452,250 | | | | 10.25 | | | | - | | | | - | |
| Cancelled | | | (5,250 | ) | | | 10.25 | | | | - | | | | - | | | | (60,000 | ) | | | - | |
| Exercised | | | - | | | | - | | | | (83,750 | ) | | | 4.88 | | | | (90,000 | ) | | | 4.88 | |
| |
| | | | | | |
| | | | | | |
| | | | |
| Outstanding at end of year | | | 1,087,000 | | | $ | 9.34 | | | | 1,012,250 | | | $ | 9.32 | | | | 643,750 | | | $ | 8.09 | |
| |
| | | | | | |
| | | | | | |
| | | | |
| Options exercisable at end of year | | | 793,500 | | | $ | 9.07 | | | | 673,063 | | | $ | 8.85 | | | | 643,750 | | | $ | 8.09 | |
All DERs granted prior to October 1, 2003 vested on the same basis as the underlying Options. Dividends are paid on vested DERs only to the extent of ordinary income. DERs are not entitled to distributions representing a return of capital. Dividends paid on a DER granted with respect to an ISO are charged to Stockholders’ Equity when declared and dividends paid on DERs granted with respect to NQSOs are charged to earnings when declared. For the years ended December 31, 2004, 2003 and 2002, the Company recorded charges of $603,000,
61
MFA MORTGAGE INVESTMENTS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
$519,000 and $573,000, respectively, to Stockholders’ Equity (included in dividends paid or accrued) associated with the DERs on ISOs and charges of $1,800, $2,700 and $3,500, respectively, to earnings associated with DERs on NQSOs. At December 31, 2004, the Company had 960,750 DERs outstanding, of which 689,750 were vested.
Effective January 1, 2002, the status of the employees of the Advisor changed such that they became employees of the Company. Accordingly, the unvested Options outstanding at January 1, 2002 were treated as newly granted Options to employees and accounted for under the APB 25, with the difference between the market value of the Common Stock and Option price expensed over the remaining vesting period of approximately seven months. The Company did not incur any expense for Options granted prior to October 1, 2003 during 2003, as all Options had vested during 2002. The Company recorded expenses of $558,000 and $529,000 related to Options and related DERs granted during the years ended December 31, 2004 and 2003.
The Company uses the Black-Scholes valuation model to determine Option expense. The following represents the weighted average assumptions used to value the Options granted during the years ended December 31, 2004 and 2003:
| | | | | | | | | | | | | | | | | | | | | | | | | |
For Year Ended
| | Weighted Average Strike Price
| | Weighted Average Fair Value forOptions Granted
| | Weighted Average DividendYield(1)
| | Weighted AverageVolatility
| | Weighted Average Risk-Free Interest Rate
| | Weighted Average Expected Life in Years
|
2004 | | $ | 9.54 | | | $ | 3.34 | | | | 3.38 | % | | | 34.13 | % | | | 3.90 | % | | | 7 | |
| 2003 | | | 10.25 | | | | 3.75 | | | | - | | | | 35.11 | | | | 3.92 | | | | 6 | |
(1) 57,500 of the 80,000 Options granted in 2004, were granted with DERs attached; all Options granted in 2003 were granted with DERs attached. Options granted with DERs attached are assumed to have a dividend yield of 0%.
(b) Employment Agreements
The Company has an employment agreement with each of its five senior officers, with varying terms that provide for, among other things, base salary, bonuses and change-in-control provisions, subject to certain events.
(c) Deferred Compensation Plans
On December 19, 2002, the Board adopted the MFA Mortgage Investments, Inc. 2003 Non-employee Directors’ Deferred Compensation Plan and the MFA Mortgage Investments, Inc. Senior Officers Deferred Bonus Plan (collectively, the “Deferred Plans”). Pursuant to the Deferred Plans, Directors and senior officers of the Company may elect to defer a certain percentage of their compensation. The Deferred Plans are intended to provide non-employee Directors and senior officers of the Company with an opportunity to defer up to 100% of certain compensation, as defined in the Deferred Plans, while at the same time aligning their interests with the interests of the Company’s stockholders. Amounts deferred are considered to be converted into “stock units” of the Company, which do not represent stock of the Company, but rather the right to receive a cash payment equal to the fair market value of an equivalent number of shares of the Common Stock. Deferred accounts increase or decrease in value as would equivalent shares of the Common Stock and are settled in cash at the termination of the deferral period, based on the value of the stock units at that time. The Deferred Plans are non-qualified plans under the Employee Retirement Income Security Act (“ERISA”) and are not funded. Prior to the time that the deferred accounts are settled, participants are unsecured creditors of the Company.
At the time a participant’s deferral of compensation is made, it is intended that such participant will not recognize income for income tax purposes, nor will the Company receive a deduction until such time that the compensation is actually distributed to the participant. At December 31, 2004 and 2003, the Company had the following liability under the Deferred Plans, which included amounts deferred by participants, as well as the market value adjustments for the equivalent stock units:
| | | | | | | | | |
(In Thousands) | | December 31,2004
| | December 31,2003
|
| Directors’ deferred | | $ | 282 | | | $ | 130 | |
| Officers’ deferred | | | 127 | | | | - | |
| | |
| | |
| |
| | $ | 409 | | | $ | 130 | |
| | |
| | |
| |
(d) Savings Plan
Effective October 1, 2002, the Company adopted a tax-qualified employee savings plan (the “Savings Plan”). Pursuant to Section 401(k) of the Code, eligible employees of the Company are able to make deferral contributions,
62
MFA MORTGAGE INVESTMENTS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
subject to limitations under applicable law. Participant’s accounts are self-directed and the Company bears all costs associated with administering the Savings Plan. The Company matches 100% of the first 3% of eligible compensation deferred by employees and 50% of the next 2%, with a maximum match of $8,000. Substantially all of the Company’s employees are eligible to participate in the Savings Plan. The Company has elected to operate the Savings Plan under applicable safe harbor provisions of the Code, whereby among other things, the Company must make contributions for all eligible employees regardless of whether or not such individuals make deferrals and all matches contributed by the Company immediately vest 100%. For the years ended December 31, 2004 and 2003, the Company recognized expenses for matching contributions of $60,000 and $39,000, respectively.
15. Estimated Fair Value of Financial Instruments
FAS 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. The relevance and reliability of the estimates of fair values presented are limited, given the dynamic nature of market conditions and numerous other factors over time. The following methods and assumptions were used by the Company in arriving at the estimated fair value of its financial instruments:
MBS: Reflects prices obtained from a third party pricing service or, if pricing is not available for an MBS from such pricing service, the average of broker quotes received for such MBS is used to determine the estimated fair value of such MBS.
Cash: Estimated fair value approximates the carrying value of such assets.
Repurchase agreements: Reflects the present value of the contractual cash flow discounted at the LIBOR quoted at the valuation date, for the term closest to the weighted average term to maturity of the aggregate repurchase agreements.
Real Estate Mortgages: Reflects the discounted amout of contractual future cash outflows of the mortgages using the approximate rate of borrowing that the Company would expect to pay, if such obligations, based on the remaining terms, were financed at the valuation date.
Caps: Reflects prices obtained from the counterparties to the Caps, with whom the Company could, at the Company’s option, settle such instruments.
Swaps: Reflects prices obtained from the counterparties to the Swaps, with whom the Company could, at the Company’s option, settle such instruments.
Commitments: Commitments to purchase securities are derived by applying the fees currently charged to enter into similar agreements, taking into account remaining terms of the agreements and the present creditworthiness of the counterparties. The commitments existing at December 31, 2004 and 2003 would have been offered at substantially the same rates and under substantially the same terms that would have existed at December 31, 2004 and 2003, respectively; therefore, the estimated fair value of the commitments was zero at those dates and are not included in the table below.
The following table presents the carrying value and estimated fair value of financial instruments, at December 31, 2004 and 2003:
| | | | | | | | | | | | | | | | | |
| | 2004
| | 2003
|
(In Thousands)
| | Carrying Value
| | Estimated Fair Value
| | Carrying Value
| | Estimated Fair Value
|
Financial Assets: | | | | | | | | | | | | | | | | |
| Cash and cash equivalents | | $ | 68,341 | | | $ | 68,341 | | | $ | 139,707 | | | $ | 139,707 | |
| MBS | | | 6,777,574 | | | | 6,777,574 | | | | 4,372,718 | | | | 4,372,718 | |
| Hedging Instruments | | | 1,566 | | | | 1,566 | | | | 276 | | | | 276 | |
Financial Liabilities: | | | | | | | | | | | | | | | | |
| Repurchase agreements | | | 6,113,032 | | | | 6,089,516 | | | | 4,024,376 | | | | 4,026,457 | |
Real Estate Mortgages(1) | | | 22,686 | | | | 23,397 | | | | 16,161 | (2) | | | 16,873 | |
| Caps | | | 1,245 | | | | 1,245 | | | | 276 | | | | 276 | |
| Swaps | | | 321 | | | | 321 | | | | - | | | | - | |
(1) Mortgage loans contain prepayment penalties, which impacts the fair value of such instruments.
(2) Does not include mortgages of entities that were accounted for under the equity method.
63
MFA MORTGAGE INVESTMENTS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
16. Summary of Quarterly Results of Operations (Unaudited)
| | | | | | | | | | | | | | | | | |
| | | 2004 Quarter Ended
|
(In Thousands, Except per Share Amounts) | | March 31 | | June 30 | | September 30 | | December 31 |
| |
| |
| |
| |
|
| Interest and dividend income | | $ | 40,233 | | | $ | 38,849 | | | $ | 42,415 | | | $ | 54,267 | |
| Interest expense | | | 16,141 | | | | 18,952 | | | | 21,959 | | | | 31,836 | |
| |
| | |
| | |
| | |
| |
| Net interest and dividend income | | | 24,092 | | | | 19,897 | | | | 20,456 | | | | 22,431 | |
| Other income | | | 1,164 | | | | 1,047 | | | | 1,409 | | | | 1,072 | |
| Operating and other expenses | | | 3,351 | | | | 3,244 | | | | 3,217 | | | | 3,683 | |
| |
| | |
| | |
| | |
| |
| Net income | | $ | 21,905 | | | $ | 17,700 | | | $ | 18,648 | | | $ | 19,820 | |
| |
| | |
| | |
| | |
| |
| Less: Preferred Stock Dividends | | | - | | | | 756 | | | | 1,062 | | | | 1,758 | |
| |
| | |
| | |
| | |
| |
| Net Income Available to Common Stockholders | | $ | 21,905 | | | $ | 16,944 | | | $ | 17,586 | | | $ | 18,062 | |
| |
| | |
| | |
| | |
| |
| Earnings per share - basic | | $ | 0.32 | | | $ | 0.22 | | | $ | 0.22 | | | $ | 0.22 | |
| |
| | |
| | |
| | |
| |
| Earnings per share - diluted | | $ | 0.32 | | | $ | 0.22 | | | $ | 0.22 | | | $ | 0.22 | |
| |
| | |
| | |
| | |
| |
| | | | | | | | | | | | | | | | | |
| | | 2003 Quarter Ended
|
(In Thousands, Except per Share Amounts) | | March 31 | | June 30 | | September 30 | | December 31 |
| |
| |
| |
| |
|
| Interest and dividend income | | $ | 32,188 | | | $ | 30,790 | | | $ | 26,482 | | | $ | 30,898 | |
| Interest expense | | | 14,967 | | | | 14,700 | | | | 13,386 | | | | 13,539 | |
| |
| | |
| | |
| | |
| |
| Net interest and dividend income | | | 17,221 | | | | 16,090 | | | | 13,096 | | | | 17,359 | |
| Other (loss)/income | | | 327 | | | | 1,707 | | | | 977 | | | | 665 | |
| Operating and other expenses | | | 2,204 | | | | 2,390 | | | | 2,310 | | | | 2,690 | |
| |
| | |
| | |
| | |
| |
| Net income | | $ | 15,344 | | | $ | 15,407 | | | $ | 11,763 | | | $ | 15,334 | |
| |
| | |
| | |
| | |
| |
| Earnings per share - basic | | $ | 0.33 | | | $ | 0.30 | | | $ | 0.21 | | | $ | 0.25 | |
| |
| | |
| | |
| | |
| |
| Earnings per share - diluted | | $ | 0.33 | | | $ | 0.30 | | | $ | 0.21 | | | $ | 0.25 | |
| |
| | |
| | |
| | |
| |
64
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
As reported in the Company’s current report on Form 8-K, filed on March 19, 2003, reporting under Item 4, the Company changed its independent accountants beginning in 2003. There were no disagreements with either of the Company’s independent accountants on accounting principles or practices, financial statement disclosure or auditing scope or procedure or other required reportable events during the years ended December 31, 2004, 2003 and 2002.
Item 9A. Controls and Procedures
A review and evaluation was performed by the Company’s management, including the Company’s Chief Executive Officer (the “CEO”) and Chief Financial Officer (the “CFO”), of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of the end of the period covered by this annual report on Form 10-K. Based on that review and evaluation, the CEO and CFO have concluded that the Company’s current disclosure controls and procedures, as designed and implemented, were effective. There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect the Company’s internal controls subsequent to the date of their evaluation. There were no significant material weaknesses identified in the course of such review and evaluation and, therefore, the Company took no corrective measures.
Management Report On Internal Control Over Financial Reporting
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rules 13a-15(f) and 15d-15(f) promulgated under the Exchange Act as a process designed by, or under the supervision of, the Company’s principal executive and principal financial officers and effected by the Company’s Board, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP and includes those policies and procedures that:
| | | | |
| | • | | pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; |
| | | | |
| | • | | provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and Directors of the Company; and |
| | | | |
| | • | | 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. Projections of any evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.
The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004. In making this assessment, the Company’s management used criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework.
Based on its assessment, the Company’s management believes that, as of December 31, 2004, the Company’s internal control over financial reporting was effective based on those criteria.
The Company’s independent auditors, Ernst & Young LLP, have issued an audit report on management’s assessment of the Company’s internal control over financial reporting. This report appears on page 39 of this annual report on Form 10-K.
Item 9B. Other Information
None.
65
PART III
Item 10. Directors and Executive Officers of the Registrant.
The information regarding the Company’s directors and certain other matters required by Item 401 of Regulation S-K is incorporated herein by reference to the Company’s proxy statement, relating to its 2005 annual meeting of stockholders to be held on May 13, 2005 (the “Proxy Statement”), to be filed with the SEC within 120 days after December 31, 2004.
The information regarding the Company’s executive officers required by Item 401 of Regulation S-K appears under Item 4A of Part I of this annual report on Form 10-K.
The information regarding compliance with Section 16(a) of the Exchange Act required by Item 405 of Regulation S-K is incorporated herein by reference to the Proxy Statement to be filed with the SEC within 120 days after December 31, 2004.
The information regarding the Company’s Code of Business Conduct and Ethics required by Item 406 of Regulation S-K is incorporated herein by reference to the Proxy Statement to be filed with the SEC within 120 days after December 31, 2004.
Item 11. Executive Compensation.
The information regarding executive compensation required by Item 402 of Regulation S-K is incorporated herein by reference to the Proxy Statement to be filed with the SEC within 120 days after December 31, 2004.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The tables on equity compensation plan information and beneficial ownership of the Company required by Items 201(d) and 403 of Regulation S-K are incorporated herein by reference to the Proxy Statement to be filed with the SEC within 120 days after December 31, 2004.
Item 13. Certain Relationships and Related Transactions.
The information regarding certain relationships and related transactions required by Item 404 of Regulation S-K is incorporated herein by reference to the Proxy Statement to be filed with the SEC within 120 days after December 31, 2004.
Item 14. Principal Accountant Fees and Services.
The information concerning principal accounting fees and services and the audit committee’s preapproval policies and procedures required by Item 14 is incorporated herein by reference to the Proxy Statement to be filed with the SEC within 120 days after December 31, 2004.
66
PART IV
Item 15. Exhibits and Financial Statement Schedules.
(a) The following documents are filed as part of this report:
1. Financial Statements. The consolidated financial statements of the Company, together with the Independent Registered Public Accounting Firms’ Reports thereon, are set forth on pages 38 through 64 of this annual report on Form 10-K and are incorporated herein by reference.
2. Financial Statement Schedules. Financial statement schedules have been omitted because they are not applicable or the required information is presented in the consolidated financial statements and/or in the notes to consolidated financial statements filed in response to Item 8 hereof.
3. Exhibits.
2.1 Agreement and Plan of Merger by and among the Registrant, America First Mortgage Advisory Corporation (“AFMAC”) and the shareholders of AFMAC, dated September 24, 2001 (incorporated herein by reference to Exhibit A of the definitive Proxy Statement, dated November 12, 2001, filed by the Registrant pursuant to the Exchange Act (Commission File No. 1-13991)).
3.1 Amended and Restated Articles of Incorporation of the Registrant (incorporated herein by reference to Form 8-K, dated April 10, 1998, filed by the Registrant pursuant to the Exchange Act (Commission File No. 1-13991)).
3.2 Articles of Amendment to the Amended and Restated Articles of Incorporation of the Registrant, dated August 6, 2002 (incorporated herein by reference to Form 8-K, dated August 13, 2002, filed by the Registrant pursuant to the Exchange Act (Commission File No. 1-13991)).
3.3 Articles of Amendment to the Amended and Restated Articles of Incorporation of the Registrant, dated August 16, 2002 (incorporated herein by reference to Exhibit 3.3 of the Form 10-Q, for the quarter ended September 30, 2002, filed by the Registrant pursuant to the Exchange Act (Commission File No. 1-13991)).
3.4 Articles Supplementary of the Registrant, dated April 22, 2004, designating the Registrant’s 8.50% Series A Cumulative Redeemable Preferred Stock (incorporated herein by reference to Exhibit 3.4 of the Form 8-A, dated April 23, 2004, filed by the Registrant pursuant to the Act (SEC File No. 1-13991)).
3.5 Amended and Restated Bylaws of the Registrant (incorporated herein by reference to the Form 8-K, dated August 13, 2002, filed by the Registrant pursuant to the Exchange Act (Commission File No. 1-13991)).
4.1 Specimen of Common Stock Certificate of the Registrant (incorporated herein by reference to Exhibit 4.1 of the Registration Statement on Form S-4, dated February 12, 1998, filed by the Registrant pursuant to the Securities Act of 1933 (Commission File No. 333-46179)).
4.2 Specimen of Stock Certificate representing the 8.50% Series A Cumulative Redeemable Preferred Stock of the Registrant (incorporated herein by reference to Exhibit 4 of the Form 8-A, dated April 23, 2004, filed by the Registrant pursuant to the Exchange Act (Commission File No. 1-13991)).
10.1 Employment Agreement of Stewart Zimmerman, dated September 25, 2003 (incorporated herein by reference to Exhibit 10.1 of the Form 10-Q, for the quarter ended September 30, 2003, filed by the Registrant pursuant to the Exchange Act (Commission File No. 1-13991)).
10.2 Employment Agreement of William S. Gorin, dated September 25, 2003 (incorporated herein by reference to Exhibit 10.2 of the Form 10-Q, for the quarter ended September 30, 2003, filed by the Registrant pursuant to the Exchange Act (Commission File No. 1-13991)).
10.3 Employment Agreement of Ronald A. Freydberg, dated March 30, 2004 (incorporated herein by reference to Exhibit 10.3 of the Form 10-Q for the quarter ended March 31, 2004, filed by the Registrant pursuant to the Exchange Act (Commission File No. 1-13991)).
67
10.4 Employment Agreement of Teresa D. Covello, dated November 1, 2003 (incorporated herein by reference to Exhibit 10.4 of the Form 10-K for the year-ended December 31 ,2003, filed by the Registrant pursuant to the Exchange Act (Commission File No. 1-13991)).
10.5 Employment Agreement of Timothy W. Korth II, dated August 1, 2003 (incorporated herein by reference to the Form 8-K, dated August 7, 2003, filed by the Registrant pursuant to the Exchange Act (Commission File No. 1-13991)).
10.6 2004 Equity Compensation Plan of the Company (incorporated herein by reference to Exhibit 10.1 of the Post-Effective Amendment No. 1 to the Registration Statement on Form S-3, dated July 21, 2004, filed by the Registrant pursuant to the 33 Act (Commission File No. 333-106606)).
10.7 MFA Mortgage Investments, Inc. Senior Officers Deferred Compensation Plan, adopted December 19, 2002 (incorporated herein by reference to Form 10-K, for the year ended December 31, 2002, filed with the Securities and Exchange Commission pursuant to the Exchange Act (Commission File No. 1-13991)).
10.8 MFA Mortgage Investments, Inc. 2003 Non-Employee Directors Deferred Compensation Plan, adopted December 19, 2002 (incorporated herein by reference to Form 10-K, for the year ended December 31, 2002, filed with the Securities and Exchange Commission pursuant to the Exchange Act (Commission File No. 1-13991)).
10.9 Form of Incentive Stock Option Award Agreement relating to the Registrant’s 2004 Equity Compensation Plan (incorporated herein by reference to Exhibit 10.9 of the Form 10-Q, dated September 30, 2004, filed by the Registrant pursuant to the Exchange Act (Commission File No. 1-13991)).
10.10 Form of Non-Qualified Stock Option Award Agreement relating to the Registrant’s 2004 Equity Compensation Plan (incorporated herein by reference to Exhibit 10.10 of the Form 10-Q, dated September 30, 2004, filed by the Registrant pursuant to the Exchange Act (Commission File No. 1-13991)).
10.11 Form of Restricted Stock Award Agreement relating to the Registrant’s 2004 Equity Compensation Plan (incorporated herein by reference to Exhibit 10.11 of the Form 10-Q, dated September 30, 2004, filed by the Registrant pursuant to the Exchange Act (Commission File No. 1-13991)).
23.1 Consent of Ernst & Young LLP.
23.2 Consent of PricewaterhouseCoopers LLP.
31.1 Certification of the Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of the Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of the Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of the Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
68
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| | | | | |
| | | MFA Mortgage Investments, Inc. |
| | | | | |
| Date: February 9, 2005 | | | By /s/ | Stewart Zimmerman |
| | | | |
|
| | | | | Stewart Zimmerman |
| | | | | Chief Executive Officer and President |
| | | | | |
| Date: February 9, 2005 | | | By /s/ | William S. Gorin |
| | | | |
|
| | | | | William S. Gorin |
| | | | | Executive Vice President and
Chief Financial Officer
(Principal Financial Officer) |
| | | | | |
| Date: February 9, 2005 | | | By /s/ | Teresa D. Covello |
| | | | |
|
| | | | | Teresa D. Covello |
| | | | | Senior Vice President and
Chief Accounting Officer
(Principal Accounting Officer) |
| |
Pursuant to the requirements of the Securities Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
| | | | | |
| |
| | | | | |
| Date: February 9, 2005 | | | By /s/ | Stewart Zimmerman |
| | | | |
|
| | | | | Stewart Zimmerman |
| | | | | Chairman, President and
Chief Executive Officer |
| | | | | |
| | | | | |
| Date: February 9, 2005 | | | By /s/ | Stephen R. Blank |
| | | | |
|
| | | | | Stephen R. Blank |
| | | | | Director |
| | | | | |
| Date: February 9, 2005 | | | By /s/ | James Brodsky |
| | | | |
|
| | | | | James Brodsky |
| | | | | Director |
| | | | | |
| Date: February 9, 2005 | | | By /s/ | Edison C. Buchanan |
| | | | |
|
| | | | | Edison C. Buchanan |
| | | | | Director |
| | | | | |
| Date: February 9, 2005 | | | By /s/ | Michael L. Dahir |
| | | | |
|
| | | | | Michael L. Dahir |
| | | | | Director |
| | | | | |
| | | | | |
| Date: February 9, 2005 | | | By /s/ | Alan Gosule |
| | | | |
|
| | | | | Alan Gosule |
| | | | | Director |
| | | | | |
| Date: February 9, 2005 | | | By /s/ | George Krauss |
| | | | |
|
| | | | | George Krauss |
| | | | | Director |
69
