UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: MARCH 31, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _______________ TO _________________
COMMISSION FILE NUMBER: 1-13447
ANNALY MORTGAGE MANAGEMENT, INC.
(Exact name of Registrant as specified in its Charter)
MARYLAND 22-3479661
(State or other jurisdiction of incorporation (IRS Employer
or organization) Identification No.)
1211 AVENUE OF THE AMERAICAS SUITE 2902
NEW YORK, NEW YORK
(Address of principal executive offices)
10036
(Zip Code)
(212) 696-0100
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all documents and
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days:
Yes X No
--- ---
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act):
Yes X No
--- ---
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date:
Class Outstanding at May 7, 2004
Common Stock, $.01 par value 117,894,610
ANNALY MORTGAGE MANAGEMENT, INC.
FORM 10-Q
INDEX
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Statements of Financial Condition- March 31, 2004 (Unaudited) and December 31, 2003 1
Statements of Operations, and Comprehensive Income (Unaudited) for the quarters ended
March 31, 2004 and 2003 2
Statements of Stockholders' Equity (Unaudited) for the quarter ended March 31, 2004 3
Statements of Cash Flows (Unaudited) for the quarters ended March 31, 2004 and 2003 4
Notes to Financial Statements (Unaudited) 5-12
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 13-26
Item 3. Quantitative and Qualitative Disclosure about Market Risk 27-28
Item 4. Controls and Procedures 28
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 29
SIGNATURES 30
PART I.
ITEM 1. FINANCIAL STATEMENTS
ANNALY MORTGAGE MANAGEMENT, INC.
STATEMENTS OF FINANCIAL CONDITION
(DOLLARS IN THOUSANDS)
MARCH 31, 2004 DECEMBER 31,
(UNAUDITED) 2003
--------------------- ----------------------
ASSETS
Cash and cash equivalents $ 738 $ 247
Mortgage-Backed Securities, at fair value 17,046,117 11,956,512
Agency debentures, at fair value 1,033,481 978,167
Receivable for preferred stock proceeds 102,903 -
Receivable for Mortgage-Backed Securities sold 81,200 -
Accrued interest receivable 71,446 53,743
Other assets 2,808 1,617
--------------------- ----------------------
Total assets $18,338,693 $12,990,286
===================== ======================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Repurchase agreements $14,689,300 $11,012,903
Payable for Mortgage-Backed Securities purchased 1,873,813 761,115
Accrued interest payable 21,299 14,989
Dividends payable 58,942 45,155
Other liabilities 4,664 4,017
Accounts payable 2,087 2,887
--------------------- ----------------------
Total liabilities 16,650,105 11,841,066
--------------------- ----------------------
Stockholders' Equity:
7.875% Series A Cumulative Redeemable Preferred Stock: par value $.01 102,870 -
per share; 4,887,500 authorized, 4,250,000 and 0, shares issued and
outstanding, respectively
Common stock: par value $.01 per share; 500,000,000 authorized,
117,866,932, and 96,074,096, shares issued and outstanding, respectively 1,179 961
Additional paid-in capital 1,578,778 1,194,159
Accumulated other comprehensive income (loss) 4,500 (47,261)
Retained earnings 1,261 1,361
--------------------- ----------------------
Total stockholders' equity 1,688,588 1,149,220
--------------------- ----------------------
Total liabilities and stockholders' equity $18,338,693 $12,990,286
===================== ======================
See notes to financial statements.
1
PART I.
ITEM 1. FINANCIAL STATEMENTS
ANNALY MORTGAGE MANAGEMENT, INC
STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
FOR THE QUARTER FOR THE QUARTER ENDED
ENDED MARCH 31, MARCH 31,
2004 2003
------------------------------------------------
INTEREST INCOME $114,341 $87,500
INTEREST EXPENSE 50,303 44,048
--------------------- -----------------------
NET INTEREST INCOME 64,038 43,452
GAIN ON SALE OF MORTGAGE-BACKED SECURITIES 595 11,020
GENERAL AND ADMINISTRATIVE EXPENSES 5,790 3,697
--------------------- -----------------------
NET INCOME 58,843 50,775
--------------------- -----------------------
COMPREHENSIVE INCOME (LOSS):
Unrealized gain on available-for-sale securities 52,356 6,509
Less: reclassification adjustment for net gains
included in net income (595) (11,020)
--------------------- -----------------------
Other comprehensive income (loss) 51,761 (4,511)
--------------------- -----------------------
COMPREHENSIVE INCOME $110,604 $46,264
===================== =======================
NET INCOME PER SHARE:
Basic $0.52 $0.60
===================== =======================
Diluted $0.52 $0.60
===================== =======================
AVERAGE NUMBER OF SHARES OUTSTANDING:
Basic 112,506,206 84,606,786
===================== =======================
Diluted 112,804,001 84,837,390
===================== =======================
See notes to financial statements.
2
PART I.
ITEM 1. FINANCIAL STATEMENTS
ANNALY MORTGAGE MANAGEMENT, INC.
STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE QUARTER ENDED MARCH 31, 2004
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
COMMON ADDITIONAL OTHER
PREFERRED STOCK PAID-IN COMPREHENSIVE COMPREHENSIVE RETAINED
STOCK PAR VALUE CAPITAL INCOME INCOME (LOSS) EARNINGS TOTAL
BALANCE, JANUARY 1, 2004 $961 $1,194,159 ($47,261) $ 1,361 $1,149,220
Net income $58,843 58,843
Other comprehensive income:
Unrealized net gains on
securities, net of
reclassification adjustment 51,761 51,761
-------------
Comprehensive income $110,604 110,604
=============
Proceeds from issuance of 7.875%
Series A
Cumulative redeemable preferred stock $102,870 102,870
Exercise of stock options - 459 459
Proceeds from direct purchase and
dividend reinvestment 1 734 735
Net proceeds from equity shelf program 10 20,041 20,051
Net proceeds from follow-on offering 207 363,385 363,592
Dividend declared for the quarter
ended March 31, 2004,
$0.50 per share (58,943) (58,943)
------------------------------------- ---------------------------------------
BALANCE, MARCH 31, 2004 $102,870 $1,179 $1,578,778 $4,500 $1,261 $1,688,588
===================================== =======================================
See notes to financial statements.
3
PART I.
ITEM 1. FINANCIAL STATEMENTS
ANNALY MORTGAGE MANAGEMENT, INC
STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
FOR THE QUARTER ENDED FOR THE QUARTER ENDED
MARCH 31, MARCH 31,
2004 2003
------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $58,843 $50,775
Adjustments to reconcile net income to net cash
provided by operating activities:
Amortization of Mortgage premiums and discounts, net 41,501 48,519
Gain on sale of Mortgage-Backed Securities (595) (11,020)
Stock option expense 217 2
Market value adjustment on long-term repurchase agreement 747 103
Increase in accrued interest receivable (17,703) (379)
Increase in other assets (1,191) (33)
Increase in accrued interest payable 6,310 980
Decrease in accounts payable (833) (875)
------------------------- -------------------------
Net cash provided by operating activities 87,296 88,072
------------------------- -------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of Mortgage-Backed Securities (5,280,945) (2,297,069)
Purchase of agency debentures (150,000) (171,000)
Proceeds from sale of Mortgage-Backed Securities 24,159 536,246
Proceeds from sale of callable agency debentures 100,000 -
Principal payments of Mortgage-Backed Securities 1,204,219 1,871,524
------------------------- -- -------------------------
Net cash used in investing activities (4,102,567) (60,299)
------------------------- -------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net Proceeds from repurchase agreements 30,194,192 24,295,758
Principal payments on repurchase agreements (26,517,895) (24,266,982)
Proceeds from exercise of stock options 243 215
Proceeds from direct purchase and dividend reinvestment 734 953
Net proceeds from follow-on offerings 363,592 -
Net proceeds from equity shelf program 20,051
Dividends paid (45,155) (57,499)
------------------------- -------------------------
Net cash provided by (used in) financing activities 4,015,762 (27,555)
------------------------- -------------------------
Net increase in cash and cash equivalents 491 219
Cash and cash equivalents, beginning of period 247 726
------------------------- -------------------------
Cash and cash equivalents, end of period $ 738 $ 945
========================= =========================
Supplemental disclosure of cash flow information:
Interest paid $43,993 $43,068
========================= =========================
Noncash financing activities:
Net change in unrealized gain (loss) on available-for-sale
securities net of reclassification adjustment $51,761 ($4,511)
========================= =========================
Dividends declared, not yet paid $58,942 $50,789
========================= =========================
See notes to financial statements.
4
ANNALY MORTGAGE MANAGEMENT, INC.
NOTES TO FINANCIAL STATEMENTS
FOR THE QUARTERS ENDED MARCH 31, 2004 AND 2003
(UNAUDITED)
- --------------------------------------------------------------------------------
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Annaly Mortgage Management, Inc. (the "Company") was incorporated in
Maryland on November 25, 1996. The Company commenced its operations of
purchasing and managing an investment portfolio of Mortgage-Backed Securities on
February 18, 1997, upon receipt of the net proceeds from the private placement
of equity capital. An initial public offering was completed on October 14, 1997.
A SUMMARY OF THE COMPANY'S SIGNIFICANT ACCOUNTING POLICIES FOLLOWS:
BASIS OF PRESENTATION - The accompanying unaudited financial statements
have been prepared in conformity with the instructions to Form 10-Q and Article
10, Rule 10-01 of Regulation S-X for interim financial statements. Accordingly,
they do not include all of the information and footnotes required by accounting
principles generally accepted in the United States of America ("GAAP"). The
interim financial statements are unaudited; however, in the opinion of the
Company's management, all adjustments, consisting only of normal recurring
accruals, necessary for a fair statement of the results of operations have been
included. These unaudited financial statements should be read in conjunction
with the audited financial statements included in the Company's Annual Report on
form 10-K for the year ended December 31, 2003. The nature of the Company's
business is such that the results of any interim period are not necessarily
indicative of results for a full year.
CASH AND CASH EQUIVALENTS - Cash and cash equivalents includes cash on
hand and money market funds. The carrying amounts of cash equivalents
approximate their value.
MORTGAGE-BACKED SECURITIES AND AGENCY DEBENTURES - The Company invests
primarily in mortgage pass-through certificates, collateralized mortgage
obligations and other mortgage-backed securities representing interests in or
obligations backed by pools of mortgage loans (collectively, "Mortgage-Backed
Securities"). The Company also invests in Federal Home Loan Bank ("FHLB"),
Federal Home Loan Mortgage Corporation ("FHLMC"), and Federal National Mortgage
Association ("FNMA") debentures. The Mortgage-Backed Securities and agency
debentures are collectively referred to herein as "Investment Securities."
Statement of Financial Accounting Standards No. 115, Accounting for
Certain Investments in Debt and Equity Securities, requires the Company to
classify its Investment Securities as either trading investments,
available-for-sale investments or held-to-maturity investments. Although the
Company generally intends to hold most of its Investment Securities until
maturity, it may, from time to time, sell any of its Investment Securities as
part of its overall management of its portfolio. Accordingly, this flexibility
requires the Company to classify all of its Investment Securities as
available-for-sale. All assets classified as available-for-sale are reported at
estimated fair value, based on market prices provided by certain dealers who
make markets in these financial instruments, with unrealized gains and losses
excluded from earnings and reported as a separate component of stockholders'
equity.
Unrealized losses on Investment Securities that are considered other
than temporary, as measured by the amount of decline in fair value attributable
to factors other than temporary, are recognized in income and the cost basis of
the Mortgage-Backed Securities is adjusted. There were no such adjustments for
the quarters ended March 31, 2004 or 2003.
Interest income is accrued based on the outstanding principal amount of
the Investment Securities and their contractual terms. Premiums and discounts
associated with the purchase of the Investment Securities are amortized into
interest income over the lives of the securities using the interest method. The
Company's policy for estimating prepayment speeds for calculating the effective
yield is to evaluate historical performance, street consensus prepayment speeds,
and current market conditions.
5
Investment Securities transactions are recorded on the trade date.
Purchases of newly issued securities are recorded when all significant
uncertainties regarding the characteristics of the securities are removed,
generally shortly before settlement date. Realized gain and losses on such
transactions are determined on the specific identification basis.
CREDIT RISK - At March 31, 2004 and December 31, 2003, the Company
has limited its exposure to credit losses on its portfolio of Investment
Securities by only purchasing securities issued by Federal Home Loan Mortgage
Corporation ("FHLMC"), Federal National Mortgage Association ("FNMA"),
Government National Mortgage Association ("GNMA"), or Federal Home Loan Bank
("FHLB"). The payment of principal and interest on the FHLMC and FNMA
Mortgage-Backed Securities are guaranteed by those respective agencies and the
payment of principal and interest on the GNMA Mortgage-Backed Securities are
backed by the full-faith-and-credit of the U.S. government. At March 31, 2004
and December 31, 2003 all of the Company's Investment Securities have an actual
or implied "AAA" rating.
REPURCHASE AGREEMENTS - The Company finances the acquisition of its
Investment Securities through the use of repurchase agreements. Repurchase
agreements are treated as collateralized financing transactions and are carried
at their contractual amounts, including accrued interest, as specified in the
respective agreements. Accrued interest is recorded as a separate line item on
the statement of financial condition.
INCOME TAXES - The Company has elected to be taxed as a Real Estate
Investment Trust ("REIT") and intends to comply with the provisions of the
Internal Revenue Code of 1986, as amended (the "Code"), with respect thereto.
Accordingly, the Company will not be subjected to federal income tax to the
extent of its distributions to shareholders and as long as certain asset, income
and stock ownership tests are met.
USE OF ESTIMATES - The preparation of financial statements in
conformity with GAAP requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
6
2. MORTGAGE-BACKED SECURITIES
The following table pertains to the Company's Mortgage-Backed
Securities classified as available-for-sale as of March 31, 2004 and December
31, 2003, which are carried at their fair value:
GOVERNMENT
FEDERAL HOME LOAN FEDERAL NATIONAL NATIONAL TOTAL
MORTGAGE MORTGAGE MORTGAGE MORTGAGE-BACKED
MARCH 31, 2004 CORPORATION ASSOCIATION ASSOCIATION SECURITIES
--------------------- --------------------- --------------------- ---------------------
(dollars in thousands)
Mortgage-Backed
Securities, gross $5,649,150 $10,580,232 $393,214 $16,622,596
Unamortized discount (247) (761) (179) (1,187)
Unamortized premium 130,039 277,155 6,556 413,750
--------------------- --------------------- --------------------- ---------------------
Amortized cost 5,778,942 10,856,626 399,591 17,035,159
Gross unrealized gains 16,401 36,133 1,378 53,912
Gross unrealized losses (13,538) (27,928) (1,488) (42,954)
--------------------- --------------------- --------------------- ---------------------
Estimated fair value $5,781,805 $10,864,831 $399,481 $17,046,117
===================== ===================== ===================== =====================
GROSS UNREALIZED GROSS UNREALIZED ESTIMATED FAIR
AMORTIZED COST GAIN LOSS VALUE
--------------------- --------------------- --------------------- ---------------------
(dollars in thousands)
Adjustable rate $12,365,716 $39,735 ($23,592) $12,378,859
Fixed rate 4,669,443 14,177 (19,362) 4,664,258
--------------------- --------------------- --------------------- ---------------------
Total $17,035,159 $53,912 ($12,954) $17,046,117
===================== ===================== ===================== =====================
GOVERNMENT
FEDERAL HOME LOAN FEDERAL NATIONAL NATIONAL TOTAL
MORTGAGE MORTGAGE MORTGAGE MORTGAGE-BACKED
MARCH 31, 2004 CORPORATION ASSOCIATION ASSOCIATION SECURITIES
--------------------- --------------------- --------------------- ---------------------
(dollars in thousands)
Mortgage-Backed
Securities, gross $3,763,364 $7,509,544 $419,223 $11,692,130
Unamortized discount (198) (209) (1,441) (1,034)
Unamortized premium 87,726 206,580 7,005 301,311
--------------------- --------------------- --------------------- ---------------------
Amortized cost 3,850,892 7,715,090 426,019 11,992,000
Gross unrealized gains 8,301 16,133 452 24,886
Gross unrealized losses (18,114) (39,984) (2,277) (60,374)
--------------------- --------------------- --------------------- ---------------------
Estimated fair value $3,841,079 $7,691,239 $424,194 $11,956,512
===================== ===================== ===================== =====================
GROSS UNREALIZED GROSS UNREALIZED ESTIMATED FAIR
AMORTIZED COST GAIN LOSS VALUE
---------------------- --------------------- --------------------- --------------------
(dollars in thousands)
Adjustable rate $8,565,873 $13,118 ($35,490) $8,543,501
Fixed rate 3,426,127 11,768 (24,884) 3,413,011
--------------------- --------------------- --------------------- ---------------------
Total $11,992,000 $24,886 ($60,374) $11,956,512
===================== ===================== ===================== =====================
7
The Mortgage-Backed Securities with a carrying value of $718.2 million
have been in a continuous unrealized loss position over 12 months at March 31,
2004 in the amount of $8.4 million. The Mortgage-Backed Securities with a
carrying value of $6.8 billion have been in an unrealized loss position for
less than 12 months at March 31, 2004 in the amount of $34.6 million. The
Mortgage-Backed Securities with a carrying value of $809.0 million have been in
a continuous unrealized loss position over 12 months at December 31, 2003 in the
amount of $8.2 million. The Mortgage-Backed Securities with a carrying value of
$6.7 billion have been in an unrealized loss position for less than 12 months at
December 31, 2003 in the amount of $52.2 million. The reason for the decline in
value of these securities is due to changes in interest rates. All of the
Mortgage-Backed Securities are "AAA" rated or carry an implied "AAA" rating.
These investments are not considered other-than-temporarily impaired since the
Company has the ability and intent to hold the investments for a period of time
sufficient for a forecasted market price recovery up to or beyond the cost of
the investments. Also, the Company is guaranteed payment on the par value of the
securities.
The adjustable rate Mortgage-Backed Securities are limited by periodic
caps (generally interest rate adjustments are limited to no more than 1% every
six months) and lifetime caps. The weighted average lifetime cap was 8.7% at
March 31, 2004 and 9.9% at December 31, 2003.
During the quarter ended March 31, 2004, the Company realized $595,000
in net gains from sales of Mortgage-Backed Securities. During the quarter ended
March 31, 2003, the Company realized $11.0 million in net gains from sales of
Mortgage-Backed Securities.
3. AGENCY DEBENTURES
At March 31, 2004, the Company owned callable agency debentures
totaling $1.0 billion par value and a total discount of $60,000. FHLMC, FNMA,
and FHLB are the issuers of the debentures. All of the Company's agency
debentures are classified as available-for-sale. The agency debentures with a
carrying value of $1.0 billion and $978.2 million at March 31, 2004 and December
31, 2003, respectively. The debentures have been in an unrealized loss position
for less than 12 months at March 31, 2004. The unrealized loss on the Company's
agency debentures at March 31, 2004 and December 31, 2003 was $6.5 million and
$11.8 million, respectively. The Company's agency debentures are adjustable rate
and fixed rate with a weighted average lifetime cap of 5.95% at March 31, 2004
and 5.80% at December 31, 2003. All of the agency debentures carry an implied
"AAA" rating. These investments are not considered other-than-temporarily
impaired since the Company has the ability and intent to hold the investments
for a period of time sufficient for a forecasted market price recovery up to or
beyond the cost of the investments. Also, the Company is guaranteed payment on
the par value of the securities.
4. REPURCHASE AGREEMENTS
The Company had outstanding $14.7 billion and $11.0 billion of
repurchase agreements with a weighted average borrowing rate of 1.44% and 1.51%,
and a weighted average remaining maturity of 103 days and 90 days as of March
31, 2004 and December 31, 2003, respectively. Investment Securities pledged had
an estimated fair value of $15.8 billion at March 31, 2004.
At March 31, 2004 and December 31, 2003, the repurchase agreements had
the following remaining maturities:
MARCH 31, 2004 DECEMBER 31, 2003
----------------------------------------------------------
(dollars in thousands)
Within 30 days $10,646,474 $ 8,589,184
30 to 59 days 1,877,826 709,552
60 to 89 days 125,000 -
90 to 119 days 100,000 -
Over 120 days 1,940,000 1,714,167
---------------------------- -----------------------------
Total $14,689,300 $11,012,903
============================ =============================
8
5. OTHER LIABILITIES
In 2001, the Company entered into a repurchase agreement maturing in
July 2004, at which time, the repurchase agreement gives the buyer the right to
extend, in whole or in part, in three-month increments up to July 2006. The
repurchase agreement has a principal value of $100,000,000. The Company accounts
for the extension option as a separate interest rate floor liability carried at
fair value. The initial fair value of $1.2 million allocated to the extension
option resulted in a similar discount on the repurchase agreement borrowings
that is being amortized over the initial term of 3 years using the effective
yield method. At March 31, 2004 and December 31, 2003, the fair value of this
interest rate floor was a $4.7 million and 4.0 million, respectively, and was
classified as other liabilities.
6. PREFERRED STOCK AND COMMON STOCK
During the quarter ending March 31, 2004, the Company declared dividends to
shareholders totaling $58.9 million or $0.50 per share, which was paid on April
28, 2004. On January 21, 2004, the Company entered into an underwriting
agreement pursuant to which the Company raised net proceeds of approximately
$363.6 million in equity in an offering of 20,700,000 shares of common stock. On
March 31, 2004, the Company entered into an underwriting agreement pursuant to
which the Company raised net proceeds of approximately $102.9 million in net
proceeds through an offering of 4,250,000 shares of 7.875% Series A Cumulative
Redeemable Preferred Stock, which settled on April 5, 2004. During the quarter
ended March 31, 2004, 1,027,400 shares were issued through the Equity Shelf
Program, totaling net proceeds of $20.1 million. During the quarter ended March
31, 2004, 28,500 options were exercised under the long-term compensation plan at
$459,000. Also, 36,936 shares were sold through in the dividend reinvestment
and direct purchase program for $734,000.
7. EARNINGS PER SHARE
For the quarter ended March 31, 2004, the reconciliation is as follows:
FOR THE QUARTER ENDED MARCH 31, 2004
(dollars in thousands, except per share amounts)
Weighted Average
Income Shares Per-Share
(Numerator) (Denominator) Amount
------------------------------------------------------------------------
Net income $58,843
-----------------------
Basic earnings per share $58,843 112,506,206 $0.52
========================
Effect of dilutive securities:
Dilutive stock options 297,795
-----------------------------------------------
Diluted earnings per share $58,843 112,804,001 $0.52
=============================================== ========================
Options to purchase 12,500 shares of stock were outstanding and
considered anti-dilutive as their exercise price exceeded the average stock
price for the quarter.
9
For the quarter ended March 31, 2003, the reconciliation is as follows:
FOR THE QUARTER ENDED MARCH 31, 2003
(dollars in thousands, except per share amounts)
Weighted Average
Income Shares Per-Share
(Numerator) (Denominator) Amount
------------------------------------------------------------------------
Net income $50,775
-----------------------
Basic earnings per share $50,775 84,606,786 $0.60
========================
Effect of dilutive securities:
Dilutive stock options 230,604
-----------------------------------------------
Diluted earnings per share $50,775 84,837,390 $0.60
========================================================================
Options to purchase 6,250 shares of stock were outstanding and
considered anti-dilutive as their exercise price exceeds the average stock price
for the quarter.
8. LONG-TERM STOCK INCENTIVE PLAN
The Company has adopted a long term stock incentive plan for executive
officers, key employees and nonemployee directors (the "Incentive Plan"). The
Incentive Plan authorizes the Compensation Committee of the board of directors
to grant awards, including incentive stock options as defined under Section 422
of the Code ("ISOs") and options not so qualified ("NQSOs"). The Incentive Plan
authorizes the granting of options or other awards for an aggregate of the
greater of 500,000 shares or 9.5% of the fully diluted outstanding shares of the
Company's common stock.
The following table sets forth activity relating to the Company's stock
options awards.
For the Quarter Ended March 31,
-------------------------------------------------------------------
2004 2003
-------------------------------------------------------------------
Weighted Weighted
Number of Average Number of Average
Shares Exercise Price Shares Exercise Price
-------------------------------------------------------------------
Options outstanding at the beginning of
period 1,063,259 $14.28 512,706 $8.59
Granted - - - -
Exercised (28,500) $8.52 (25,373) 8.39
Expired - - - -
---------------- ---------------
Options outstanding at the end of period
1,034,759 $14.44 487,333 $8.71
===================================================================
The following table summarizes information about stock options
outstanding at March 31, 2004:
Weighted Average
Weighted Average Remaining Contractual
Range of Exercise Prices Options Outstanding Exercise Price Life (Years)
- ------------------------------------------------------------------------------------------------------------
$7.94-$19.99 1,022,259 $14.37 7.9
$20.00-$29.99 12,500 20.53 3.7
----------------------------------------------------------------------------
1,034,759 $14.44 7.8
============================================================================
The Company accounts for the incentive plan under the intrinsic value
method in accordance with APB Opinion No. 25, Accounting for Stock Issued to
Employees, and related Interpretations. No stock-based employee compensation
cost is reflected in net income, as all options granted under those plans had an
exercise price equal to the market value of the underlying common stock on the
date of grant. The following table illustrates the effect on net income and
earnings per share if the Company had applied the fair value recognition
provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation,
to stock-based employee compensation:
10
For the Quarter Ended March 31,
(dollars in thousands, except per share data)
2004 2003
------------------------------------------------
Net income, as reported $58,843 $50,775
Deduct: Total stock-based employee compensation expense
determined under fair value based method (28) (7)
------------------------------------------------
Pro-forma net income $58,815 $50,768
================================================
Net income per share, as reported
Basic $0.52 $0.60
Diluted $0.52 $0.60
Pro-forma net income per share
Basic $0.52 $0.60
Diluted $0.52 $0.60
9. LEASE COMMITMENTS
The Company has a noncancelable lease for office space, which commenced
in May 2002 and expires in December 2009.
The Corporation's aggregate future minimum lease payments are as follows:
Total per Year
(dollars in thousands)
2004 375
2005 500
2006 530
2007 532
2008 532
2009 532
------------------------
Total remaining lease payments $3,001
------------------------
10. RELATED PARTY TRANSACTION
Michael A.J. Farrell, the Company's Chairman of the Board, Chief
Executive Officer and President, on behalf of Fixed Income Discount Advisory
Company, ("FIDAC"), approached the Company about the possibility of the Company
acquiring FIDAC. The Company's board of directors formed a special committee of
independent directors to consider this matter and the special committee retained
independent counsel and Lehman Brothers Inc. to act as its financial advisor in
connection with the proposed acquisition. Following negotiations between FIDAC
and the special committee, the special committee determined that the Company
should acquire FIDAC and the Company entered into a Merger Agreement, dated
December 31, 2003, by and among, the Company, FIDAC, FDC Merger Sub, Inc., and
the FIDAC stockholders (the "Merger Agreement").
Pursuant to the Merger Agreement, FIDAC will be merged into a newly
formed wholly-owned subsidiary of the Company. The closing of the merger is
subject to a number of conditions, including the approval of the Company's
stockholders as described below.
Mr. Farrell, Wellington J. Denahan, the Company's Vice Chairman and
Chief Investment Officer, Kathryn F. Fagan, the Company's Chief Financial
Officer and Treasurer, Jennifer S. Karve, the Company's Executive Vice President
and Secretary, and other of the Company's officers and employees are
shareholders of FIDAC. Mr. Farrell, Ms. Denahan and other officers and employees
are actively involved in managing mortgage-backed securities and other fixed
income assets on behalf of FIDAC.
FIDAC is a registered investment advisor which, at December 31, 2003,
managed, assisted in managing or supervised approximately $13.6 billion in gross
assets for a wide array of clients on a discretionary basis. FIDAC is
11
a fee-based asset management business with a global distribution reach. FIDAC
generally receives annual net investment advisory fees of approximately 10 to 15
basis points of the gross assets it manages, assists in managing or supervises.
Under the Merger Agreement with FIDAC, the purchase price will be
payable in shares of the Company's common stock. Upon the consummation of the
merger, the Company will issue shares of its common stock worth $40.5 million,
based upon a valuation of shares of the Company's common stock as of December
31, 2003, to the stockholders of FIDAC. The Merger Agreement includes an
earn-out feature, under which the Company will pay up to an additional $49.5
million, which will be payable in shares of the Company's common stock, to the
stockholders of FIDAC if FIDAC meets certain revenue and pre-tax profit margin
targets over the next three years as described in the Merger Agreement.
The shares issued to the stockholders of FIDAC upon consummation of
the merger will be subject to restrictions on resale for three years after
completion of the merger, subject to certain exceptions. The shares issued to
the stockholders of FIDAC under the earn-out feature will be subject to
restrictions on resale for either two years or one year after the applicable
earn-out period, subject to certain exceptions.
The Merger Agreement is subject to the approval of the Company's
stockholders and several other conditions. A vote on the Merger Agreement will
be held at the next meeting of the Company's stockholders. Approval of the
Merger Agreement will require the affirmative vote of the holders of a majority
of the Company's shares of common stock voting at the stockholder meeting as
long as the total vote cast at the stockholder meeting represents a majority of
the shares entitled to vote at the stockholder meeting. Pursuant to the Merger
Agreement, the FIDAC stockholders have agreed to vote any shares of the
Company's common stock owned of record by them in accordance with, and in the
same proportion as, the votes cast by the Company's stockholders who are not
FIDAC stockholders in connection with the merger. The Company is not certain
that its stockholders will approve the Merger Agreement or that the other
conditions to the merger will be satisfied. If the merger is not completed, the
Company expects to continue to operate under the facilities-sharing arrangement
that it currently has with FIDAC.
11. INTEREST RATE RISK
The primary market risk to the Company is interest rate risk. Interest
rates are highly sensitive to many factors, including governmental monetary and
tax policies, domestic and international economic and political considerations
and other factors beyond the Company's control. Changes in the general level of
interest rates can affect net interest income, which is the difference between
the interest income earned on interest-earning assets and the interest expense
incurred in connection with the interest-bearing liabilities, by affecting the
spread between the interest-earning assets and interest-bearing liabilities.
Changes in the level of interest rates also can affect the value of the
Mortgage-Backed Securities and the Company's ability to realize gains from the
sale of these assets. A decline in the value of the Mortgage-Backed Securities
pledged as collateral for borrowings under repurchase agreements could result in
the counterparties demanding additional collateral pledges or liquidation of
some of the existing collateral to reduce borrowing levels.
The Company seeks to manage the extent to which net income changes as a
function of changes in interest rates by matching adjustable-rate assets with
variable-rate borrowings. In addition, although the Company has not done so to
date, the Company may seek to mitigate the potential impact on net income of
periodic and lifetime coupon adjustment restrictions in the portfolio of
Mortgage-Backed Securities by entering into interest rate agreements such as
interest rate caps and interest rate swaps.
Changes in interest rates may also have an effect on the rate of
mortgage principal prepayments and, as a result, prepayments on Mortgage-Backed
Securities. The Company will seek to mitigate the effect of changes in the
mortgage principal repayment rate by balancing assets purchased at a premium
with assets purchased at a discount. To date, the aggregate premium exceeds the
aggregate discount on the Mortgage-Backed Securities. As a result, prepayments,
which result in the expensing of unamortized premium, will reduce net income
compared to what net income would be absent such prepayments.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain statements contained in this quarterly report, and certain
statements contained in our future filings with the Securities and Exchange
Commission (the "SEC" or the "Commission"), in our press releases or in our
other public or shareholder communications may not be, based on historical facts
and are "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Forward-looking statements which are
based on various assumptions, (some of which are beyond our control) may be
identified by reference to a future period or periods, or by the use of
forward-looking terminology, such as "may," "will," "believe," "expect,"
"anticipate," "continue," or similar terms or variations on those terms, or the
negative of those terms. Actual results could differ materially from those set
forth in forward-looking statements due to a variety of factors, including, but
not limited to, changes in interest rates, changes in yield curve, changes in
prepayment rates, the availability of mortgage backed securities for purchase,
the availability of financing and, if available, the terms of any financing. For
a discussion of the risks and uncertainties which could cause actual results to
differ from those contained in the forward-looking statements, see our 2003 Form
10-K. We do not undertake, and specifically disclaim any obligation, to publicly
release the result of any revisions which may be made to any forward-looking
statements to reflect the occurrence of anticipated or unanticipated events or
circumstances after the date of such statements.
OVERVIEW
We are a real estate investment trust that owns and manages a portfolio
of mortgage-backed securities and agency debentures. Our principal business
objective is to generate net income for distribution to our stockholders from
the spread between the interest income on our investment securities and the
costs of borrowing to finance our acquisition of investment securities.
We are primarily engaged in the business of investing, on a leveraged
basis, in mortgage pass-through certificates, collateralized mortgage
obligations and other mortgage-backed securities representing interests in or
obligations backed by pools of mortgage loans (collectively, "Mortgage-Backed
Securities"). We also invest in Federal Home Loan Bank ("FHLB"), Federal Home
Loan Mortgage Corporation ("FHLMC"), and Federal National Mortgage Association
("FNMA") debentures. The Mortgage-Backed Securities and agency debentures are
collectively referred to herein as "Investment Securities."
Under our capital investment policy, at least 75% of our total assets
must be comprised of high-quality mortgage-backed securities and short-term
investments. High quality securities means securities that (1) are rated within
one of the two highest rating categories by at least one of the nationally
recognized rating agencies, (2) are unrated but are guaranteed by the United
States government or an agency of the United States government, or (3) are
unrated but are determined by us to be of comparable quality to rated
high-quality mortgage-backed securities.
The remainder of our assets, comprising not more than 25% of our total
assets, may consist of other qualified REIT real estate assets which are unrated
or rated less than high quality, but which are at least "investment grade"
(rated "BBB" or better by Standard & Poor's Corporation ("S&P") or the
equivalent by another nationally recognized rating agency) or, if not rated,
determined by us to be of comparable credit quality to an investment which is
rated "BBB" or better.
We may acquire mortgage-backed securities backed by single-family
residential mortgage loans as well as securities backed by loans on
multi-family, commercial or other real estate-related properties. To date, all
of the mortgage-backed securities that we have acquired have been backed by
single-family residential mortgage loans.
13
We have elected to be taxed as a REIT for federal income tax purposes.
Pursuant to the current federal tax regulations, one of the requirements of
maintaining its status as a REIT is that we must distribute at least 90% of our
REIT taxable income (determined without regard to the deduction for dividends
paid and by excluding any net capital gain) to our stockholders, subject to
certain adjustments.
The results of our operations are affected by various factors, many of
which are beyond our control. The results of our operations primarily depend on,
among other things, the amount of our net interest income, the market value of
our assets and the supply of and demand for such assets. Our net interest
income, which reflects the amortization of purchase premiums, varies primarily
as a result of changes in interest rates, borrowing costs and prepayment speeds,
the behavior of which involves various risks and uncertainties. Prepayment
speeds, as reflected by the Constant Prepayment Rate, or CPR, and interest rates
vary according to the type of investment, conditions in financial markets,
competition and other factors, none of which can be predicted with any
certainty. In general, as prepayment speeds on our Mortgage-Backed Securities
portfolio increase, related purchase premium amortization increases, thereby
reducing the net yield on such assets. The CPR on our Investment Securities
portfolio averaged 31% and 41% for the quarters ended March 31, 2004 and 2003,
respectively. Since changes in interest rates may significantly affect our
activities, our operating results depend, in large part, upon our ability to
effectively manage interest rate risks and prepayment risks while maintaining
our status as a REIT.
The following table presents the CPR experienced on our Mortgage-Backed
Securities portfolio, on an annualized basis, for the following quarterly
periods presented.
QUARTER ENDED CPR
- ------------- ---
March 31, 2004 31%
December 31, 2003 37%
September 30, 2003 48%
June 30, 2003 44%
March 31, 2003 41%
We believe that the CPR in future periods will depend, in part, on
changes in and the level of market interest rates across the yield curve, with
higher CPRs expected during periods of declining interest rates and lower CPRs
expected during periods of rising interest rates.
We have extended contractual maturities on borrowings, such that,
our weighted average term to next rate adjustment on our repurchase agreements
was 103 days at March 31, 2004, as compared to 90 days at December 31, 2003.
The table below provides quarterly information regarding our average balances,
interest income, interest expense, yield on assets, cost of funds and net
interest income for the following quarterly periods presented.
Yield on
Average Average Average
Investment Total Interest Balance of Average Net
Securities Interest Earning Repurchase Interest Cost of Interest
Held (1) Income Assets Agreements Expense Funds Income
------------ --------- ---------- ------------ ------------ -------- -----------
(rations for the quarters have been annualized, dollars in thousands)
For the Quarter
Ended March 31, 2004 $14,452,245 $114,341 3.16% $13,587,211 $50,303 1.48% $64,038
For the Quarter Ended
December 31, 2003 $11,799,730 $89,186 3.02% $11,235,908 $42,264 1.50% $46,922
For the Quarter Ended $12,577,165 $66,855 2.13% $12,186,985 $43,922 1.44% $22,933
September 30, 2003
For the Quarter Ended $12,815,290 $93,892 2.93% $12,311,329 $51,770 1.68% $42,122
June 30, 2003
For the Quarter Ended $10,837,147 $87,500 3.23% $10,463,251 $44,048 1.68% $43,452
March 31, 2003
(1) Does not reflect unrealized gains/(losses).
14
We continue to explore alternative business strategies, alternative
investments and other strategic initiatives to complement our core business
strategy of investing, on a leveraged basis, in high quality Investment
Securities. No assurance, however, can be provided that any such strategic
initiative will or will not be implemented in the future.
CRITICAL ACCOUNTING POLICIES
Management's discussion and analysis of financial condition and results
of operations is based on the amounts reported our financial statements. These
financial statements are prepared in conformity with accounting principles
generally accepted in the United States of America. In preparing the financial
statements, management is required to make various judgments, estimates and
assumptions that affect the reported amounts. Changes in these estimates and
assumptions could have a material effect on our financial statements. The
following is a summary of our policies most affected by management's judgments,
estimates and assumptions.
Market valuation of Investment Securities: All assets classified as
available-for-sale are reported at fair value, based on market prices. Although
we generally intend to hold most of our Investment Securities until maturity, we
may, from time to time, sell any of our Investment Securities as part our
overall management of our portfolio. Accordingly, this flexibility requires us
to classify all of our Investment Securities as available-for-sale. Our policy
is to obtain market values from three independent sources and record the market
value of the securities based on the average of the three. Unrealized losses on
Investment Securities that are considered other than temporary, as measured by
the amount of decline in fair value attributable to factors other than
temporary, are recognized in income and the cost basis of the Investment
Securities is adjusted. There were no such adjustments for the quarters ended
March 31, 2004 and 2003.
Investment Securities transactions are recorded on the trade date.
Purchases of newly issued securities are recorded when all significant
uncertainties regarding the characteristics of the securities are removed,
generally shortly before settlement date. Realized gains and losses on such
transactions are determined on the specific identification basis.
Interest income: Interest income is accrued based on the outstanding
principal amount of the outstanding principal amount of the Investment
Securities and their contractual terms. Premiums and discounts associated with
the purchase of the Investment Securities are amortized into interest income
over the projected lives of the securities using the interest method. Our policy
for estimating prepayment speeds for calculating the effective yield is to
evaluate historical performance, street consensus prepayment speeds, and current
market conditions.
Repurchase Agreements: We finance the acquisition of our Investment
Securities through the use of repurchase agreements. Repurchase agreements are
treated as collateralized financing transactions and are carried at their
contractual amounts, including accrued interest, as specified in the respective
agreements. Accrued interest is recorded as a separate line item.
Income Taxes: We have elected to be taxed as a REIT and intend to
comply with the provisions of the Internal Revenue Code of 1986, as amended (the
"Code") with respect thereto. Accordingly, we will not be subjected to federal
income tax to the extent of our distributions to shareholders and as long as
certain asset, income and stock ownership tests are met.
RESULTS OF OPERATIONS: FOR THE QUARTERS ENDED MARCH 31, 2004 AND 2003
NET INCOME SUMMARY
For the quarter ended March 31, 2004, our net income was $58.8 million,
or $0.52 basic earnings per share, as compared to $50.8 million, or $0.60 basic
earnings per average share, for the quarter ended March 31, 2003. We attribute
the increase in total net income for the quarter ended March 31, 2004, over the
quarter ended March 31, 2003 to the increased asset base. The increased asset
base was the result of deploying additional common capital, of approximately,
$574.7 million from March 31, 2003 to March 31, 2004, into our strategy. Even
though total net income increased, net income per share decreased. The decrease
in net income per share was primarily due to the
15
reduction of gains on Mortgage Backed Securities sold. For the quarter ended
March 31, 2004, gain on sale of Mortgage-Backed Securities was $595,000, as
compared to $11.0 million, or $0.13 per share for the quarter ended March 31,
2003. The decline in gain was only partially offset by the increase in the
interest rate spread. The interest rate spread for the quarter ended March 31,
2004 was 1.68%, as compared to 1.55% for the quarter ended March 31, 2003. We
compute our net income per share by dividing net income by the weighted average
number of shares of outstanding common stock during the period, which was
112,506,206 for the quarter ended March 31, 2004 and 84,606,786 for the quarter
ended March 31, 2003. Dividend per share for the quarter ended March 31, 2004,
was $0.50 per share, or $58.9 million in total. Dividend per share for the
quarter ended March 31, 2003 was $0.60 per share, or $50.8 million in total. Our
return on average equity was 16.59% for the quarter ended March 31, 2004 and
18.83% for the quarter ended March 31, 2003. The decline in the return on
average equity resulted from the decline in gains on sale of Mortgage-Backed
Securities.
NET INCOME SUMMARY
(RATIOS FOR THE QUARTER HAVE BEEN ANNUALIZED, DOLLARS IN THE THOUSANDS,
EXCEPT FOR PER SHARE DATA)
-------------------------------------------------------------------------------
QUARTER ENDED QUARTER ENDED
MARCH 31, 2004 MARCH 31, 2003
-------------------- ---------------------
Interest income $114,341 $87,500
Interest expense 50,303 44,048
-------------------- ---------------------
Net interest income 64,038 43,452
Gain on sale of Mortgage Backed Securities 595 11,020
General and administrative expenses 5,790 3,697
-------------------- ---------------------
Net income $58,843 $50,775
==================== =====================
Average number of basic shares outstanding 112,506,206 84,606,786
Average number of diluted shares outstanding 113,259,307 84,837,390
Basic net income per share $0.52 $0.60
Diluted net income per share $0.52 $0.60
Average total assets $15,644,490 $12,169,401
Average total equity $1,418,904 $1,079,113
Annualized return on average assets 1.5% 1.67%
Annualized return on average equity 16.59% 18.83%
INTEREST INCOME AND AVERAGE EARNING ASSET YIELD
We had average earning assets of $14.5 billion and $10.8 billion for
the quarters ended March 31, 2004 and 2003, respectively. Our primary source of
income for the quarters ended March 31, 2004 and 2003 was interest income. A
portion of our income was generated by gains on the sales of our Mortgage-Backed
Securities. The declining yield was the direct result of lower weighted average
coupons on our interest earning assets to 4.33% at March 31, 2004, from 4.85% at
March 31, 2003. Our interest income was $114.3 million for the quarter ended
March 31, 2004 and $87.5 million for the quarter ended March 31, 2003. Our yield
on average earning assets was 3.16% and 3.23% for the same respective periods.
Our average earning asset balance increased by $3.7 billion and interest income
increased by $26.8 million for the quarter ended March 31, 2004 as compared to
the quarter ended March 31, 2003, with the substantial increase in the average
asset base. The increase was the direct result of the increased asset base,
despite the reduction in yield from 3.23% for the quarter ended March 31, 2003
to 3.16% for the quarter ended March 31, 2004. The yield was reduced because the
coupon rate at March 31, 2004 was 4.33%, as compared to 4.85% at March 31, 2003.
So, even though the prepayment speeds decreased to 31% for the quarter ended
March 31, 2004, from 41% for the quarter ended March 31, 2003, the overall yield
declined by 7 basis points. The table below shows our average balance of
interest earning assets, our yield on average earning assets and our interest
income for the quarter ended March 31, 2004, the year ended December 31, 2003
and the four quarters in 2003.
16
AVERAGE EARNING ASSET YIELD
(RATIOS FOR THE QUARTERS HAVE BEEN ANNUALIZED, DOLLARS IN THOUSANDS)
--------------------------------------------------------------------
Average
Average Yield on Constant
Investment Investment Prepayment Interest
Securities Securities Rate Income
---------- ---------- ---- ------
For the Quarter Ended March 31, 2004 $14,452,245 3.16% 31% $114,341
- -----------------------------------------------------------------------------------------
For the Year Ended December 31, 2003 $12,007,333 2.81% 37% $337,433
For the Quarter Ended December 31, 2003 $11,799,730 3.02% 37% $89,186
For the Quarter Ended September 30, 2003 $12,577,165 2.13% 48% $66,855
For the Quarter Ended June 30, 2003 $12,815,290 2.93% 44% $93,892
For the Quarter Ended March 31, 2003 $10,837,147 3.23% 41% $87,500
The constant prepayment rate ("CPR") on our Mortgage-Backed Securities
for the quarters ended March 31, 2004 and 2003 was 31% and 41%, respectively.
CPR is an assumed rate of prepayment for our Mortgage-Backed Securities,
expressed as an annual rate of prepayment relative to the outstanding principal
balance of our Mortgage-Backed Securities. CPR does not purport to be either a
historical description of the prepayment experience of our Mortgage-Backed
Securities or a prediction of the anticipated rate of prepayment of our
Mortgage-Backed Securities. The homeowners' prepayment option makes the average
term yield and performance of a mortgage-backed security uncertain because of
the uncertainty in timing of the return of principal. In general, prepayments
decrease the total yield on a bond purchased at a premium, because over life of
the bond that premium has to be amortized. The faster prepayments, the shorter
the life of the security, which results in the increased amortization. The total
amortization for the quarter ended March 31, 2004 and 2003 was $41.5 million,
$48.5, respectively. The prepayment speeds for March of 2004 were trending
higher than the speeds for January and February 2004. The Company expects this
trend to continue for the second quarter of 2004.
Principal prepayments had a negative effect on our earning asset yield
for the quarters ended March 31, 2004 and 2003 because we adjust our rates of
premium amortization and discount accretion monthly based upon the effective
yield method, which takes into consideration changes in prepayment speeds.
INTEREST EXPENSE AND THE COST OF FUNDS
We anticipate that our largest expense will be the cost of borrowed
funds. We had average borrowed funds of $13.6 billion and total interest expense
of $50.3 million for the quarter ended March 31, 2004. We had average borrowed
funds of $10.5 billion and total interest expense of $44.0 million for the
quarter ended March 31, 2003. Our average cost of funds was 1.48% for the
quarter ended March 31, 2004 and 1.68% for the quarter ended March 31, 2003. The
cost of funds rate decreased 0.20% and the average borrowed funds increased by
$3.1 billion for the quarter ended March 31, 2004 when compared to the quarter
ended March 31, 2003. Interest expense for the quarter increased by $ 6.3
million due to the substantial increase in the average repurchase balance even
though the cost of funds rate decreased. The increase in the average repurchase
balance was the result of the company implementing its leveraged strategy after
the completion of the equity offerings in the second quarter 2003 and the first
quarter 2004, in addition to equity acquired in through the equity shelf
program, the direct purchase and dividend reinvestment plan, and options
exercised.. Since a substantial portion of our repurchase agreements are short
term, market rates are directly reflected in our interest expense. Our average
cost of funds was 0.38% above average one-month LIBOR and 0.30% above average
six-month LIBOR for the quarter ended March 31, 2004. Our average cost of funds
was 0.34% above average one-month LIBOR and 0.35% above average six-month LIBOR
for the quarter ended March 31, 2003.
The table below shows our average borrowed funds and average cost of
funds as compared to average one-month and average six-month LIBOR for the
quarter ended March 31, 2004, the year ended December 31, 2003 and the four
quarters in 2003.
17
AVERAGE COST OF FUNDS
(RATIOS FOR THE QUARTERS HAVE BEEN ANNUALIZED, DOLLARS IN THOUSANDS)
--------------------------------------------------------------------
Average
One-Month Average Cost Average Cost
LIBOR of Funds of Funds
Relative to Relative to Relative to
Average Average Average Average Average Average Average
Borrowed Interest Cost of One-Month Six-Month Six-Month One-Month Six-Month
Funds Expense Funds LIBOR LIBOR LIBOR LIBOR LIBOR
------------- ---------- ----------- ----------- ---------- ------------ ------------- --------------
For the Quarter Ended
March 31, 2004 $13,587,211 $50,303 1.48% 1.10% 1.18% (.08%) 0.38% 0.30%
- ----------------------------------------------------------------------------------------------------------------------------
For the Year Ended
December 31, 2003 $11,549,368 $182,004 1.58% 1.21% 1.23% (0.02%) 0.37% 0.35%
For the Quarter Ended
December 31, 2003 $11,235,908 $42,264 1.50% 1.13% 1.23% (0.10%) 0.37% 0.27%
For the Quarter Ended
September 30, 2003 $12,186,985 $43,922 1.44% 1.11% 1.17% (0.06%) 0.33% 0.27%
For the Quarter Ended
June 30, 2003 $12,311,329 $51,770 1.68% 1.26% 1.20% 0.06% 0.42% 0.48%
For the Quarter Ended
March 31, 2003 $10,463,252 $44,048 1.68% 1.34% 1.33% 0.01% 0.34% 0.35%
NET INTEREST INCOME
Our net interest income, which equals interest income less interest
expense, totaled $64.0 million for the quarter ended March 31, 2004 and $43.5
million for the quarter ended March 31, 2003. Our net interest income increased
because of increase in assets that resulted from the common stock equity
offering in 2003 and during the quarter ended March 31, 2004. Our net interest
spread, which equals the yield on our average assets for the period less the
average cost of funds for the period, was 1.68% for the quarter ended March 31,
2004 as compared to 1.55% for the quarter ended March 31, 2003. Even though the
weighted average coupon at March 31, 2004 of 4.33% declined from 4.85% at March
31, 2003, the improvement in CPR in combination with the reduction in the
funding cost resulted in a 13 basis point increase in the interest rate.
The table below shows our interest income by earning asset type,
average earning assets by type, total interest income, interest expense, average
repurchase agreements, average cost of funds, and net interest income for the
quarter ended March 31, 2004, the year ended December 31, 2003, and the four
quarters in 2003.
NET INTEREST INCOME
(RATIOS FOR THE QUARTERS HAVE BEEN ANNUALIZED, DOLLARS IN THOUSANDS)
--------------------------------------------------------------------
Yield
on Average
Average Average Balance Net
Investment Total Interest of Average Net Interest
Securities Interest Earning Repurchase Interest Cost of Interest Rate
Held Income Assets Agreements Expense Funds Income Spread
----------- --------- -------- ---------- ---------- -------- --------- --------
For the Quarter Ended
March 31, 2004 $14,452,245 $114,341 3.16% $13,587,211 $50,303 1.48% $64,038 1.68%
- ----------------------------------------------------------------------------------------------------------------------
For the Year Ended
December 31, 2003 $12,007,333 $337,433 2.81% $11,549,368 $182,004 1.58% $155,429 1.23%
For the Quarter Ended 1.52%
December 31, 2003 $11,799,730 $89,186 3.02% $11,235,908 $42,264 1.50% $46,922
For the Quarter Ended $12,577,165 $66,855 2.13% $12,186,985 $43,922 1.44% $22,933 0.69%
September 30, 2003
For the Quarter Ended $12,815,290 $93,892 2.93% $12,311,329 $51,770 1.68% $42,122 1.25%
June 30, 2003
For the Quarter Ended $10,837,147 $87,500 3.23% $10,463,252 $44,048 1.68% $43,452 1.55%
March 31, 2003
18
GAINS AND LOSSES ON SALES OF MORTGAGE-BACKED SECURITIES
For the quarter ended March 31, 2004, we sold Mortgage-Backed
Securities with an aggregate historical amortized cost of $73.6 million for an
aggregate gain of $595,000. For the quarter ended March 31, 2003, we sold
Mortgage-Backed Securities with an aggregate historical amortized cost of $744.4
million for an aggregate gain of $11.0 million. The gain on sale of
Mortgage-Backed Securities declined by $10.4 million. The difference between the
sale price and the historical amortized cost of our Mortgage-Backed Securities
is a realized gain and increases income accordingly. We do not expect to sell
assets on a frequent basis, but may from time to time sell existing assets to
move into new assets, which our management believes might have higher
risk-adjusted returns as part of our asset/liability management strategy.
GENERAL AND ADMINISTRATIVE EXPENSE
General and administrative ("G&A") expenses were $5.8 million for the
quarter ended March 31, 2004 and $3.7 for the quarter ended March 31, 2003. G&A
expenses as a percentage of average assets was 0.15% and 0.12% on an annualized
basis for the quarters ended March 31, 2004 and 2003, respectively. G&A expenses
as a percentage of average equity was 1.63% and 1.37% on an annualized basis for
the quarters ended March 31, 2004 and 2003, respectively. The increase of $2.1
million for the quarter ended March 31, 2004,is the result of increased
salaries, D&O insurance, and excise tax estimate.
G&A EXPENSES AND OPERATING EXPENSE RATIOS
(RATIOS FOR THE QUARTERS HAVE BEEN ANNUALIZED, DOLLARS IN THOUSANDS)
--------------------------------------------------------------------
Total G&A Total G&A
Total G&A Expenses/Average Expenses/Average
Expenses Assets (annualized) Equity (annualized)
------------ ---------------------- ---------------------
For the Quarter Ended March 31, 2004 $5,790 0.15% 1.63%
- -----------------------------------------------------------------------------------------------------------
For the Year Ended December 31, 2003 $16,233 0.13% 1.45%
For the Quarter Ended December 31, 2003 $4,225 0.13% 1.47%
For the Quarter Ended September 30, 2003 $4,110 0.12% 1.42%
For the Quarter Ended June 30, 2003 $4,201 0.12% 1.50%
For the Quarter Ended March 31, 2003 $3,697 0.12% 1.37%
NET INCOME AND RETURN ON AVERAGE EQUITY
Our net income was $58.8 million for the quarter ended March 31, 2004
and $50.8 million for the quarter ended March 31, 2003. Our return on average
equity was 16.59% for the quarter ended March 31, 2004 and 18.83% for the
quarter ended March 31, 2003. The table below shows our net interest income,
gain on sale of Mortgage-Backed Securities and G&A expenses each as a percentage
of average equity, and the return on average equity for the quarter ended March
31, 2004, the year ended December 31, 2003, and for the four quarters in 2003.
COMPONENTS OF RETURN ON AVERAGE EQUITY
(RATIOS FOR ALL QUARTERS ARE ANNUALIZED)
----------------------------------------
Gain on Sale of
Net Interest Mortgage-Backed G&A Return on
Income/Average Securities/Average Expenses/Average Average
Equity Equity Equity Equity
For the Quarter Ended March 31, 2004 18.05% 0.17% 1.63% 16.59%
- -------------------------------------------------------------------------------------------------------------------
For the Year Ended December 31, 2003 13.85% 3.64% 1.45% 16.04%
For the Quarter Ended December 31, 2003 16.36% - 1.47% 14.89%
For the Quarter Ended September 30, 2003 7.95% 3.35% 1.42% 9.88%
For the Quarter Ended June 30, 2003 15.06% 7.23% 1.50% 20.79%
For the Quarter Ended March 31, 2003 16.11% 4.09% 1.37% 18.83%
19
FINANCIAL CONDITION
INVESTMENT SECURITIES
All of our Mortgage-Backed Securities at March 31, 2004 were
adjustable-rate or fixed-rate Mortgage-Backed Securities backed by single-family
mortgage loans. All of the mortgage assets underlying these Mortgage-Backed
Securities were secured with a first lien position on the underlying
single-family properties. All our Mortgage-Backed Securities were FHLMC, FNMA or
GNMA mortgage pass-through certificates or collateralized mortgage obligations
("CMOs"), which carry an actual or implied "AAA" rating. We mark-to-market all
of our Mortgage Backed Securities at fair value.
All of our agency debentures are callable and carry an implied "AAA"
rating. We mark-to-market all of our agency debentures at fair value.
We accrete discount balances as an increase in interest income over the
life of discount Investment Securities and we amortize premium balances as a
decrease in interest income over the life of premium Investment Securities. At
March 31, 2004 and December 31, 2003, we had on our statement of financial
condition a total of $1.2 million and $1.5 million respectively, of unamortized
discount (which is the difference between the remaining principal value and
current historical amortized cost of our Investment Securities acquired at a
price below principal value) and a total of $413.8 million and $301.3 million,
respectively, of unamortized premium (which is the difference between the
remaining principal value and the current historical amortized cost of our
Investment Securities acquired at a price above principal value).
We received mortgage principal repayments of $1.2 billion for the
quarter ended March 31, 2004 and $1.9 billion for the quarter ended March 31,
2003. Given our current portfolio composition, if mortgage principal prepayment
rates were to increase over the life of our Mortgage-Backed Securities, all
other factors being equal, our net interest income would decrease during the
life of these Mortgage-Backed Securities as we would be required to amortize our
net premium balance into income over a shorter time period. Similarly, if
mortgage principal prepayment rates were to decrease over the life of our
Mortgage-Backed Securities, all other factors being equal, our net interest
income would increase during the life of these Mortgage-Backed Securities, as we
would amortize our net premium balance over a longer time period.
The table below summarizes our Investment Securities at March 31, 2004,
December 31, 2003, September 30, 2003, June 30, 2003, and March 31, 2003.
INVESTMENT SECURITIES
(DOLLARS IN THOUSANDS)
----------------------
Estimated
Amortized Fair Weighted
Net Amortized Cost/Principal Estimated Value/Principal Average
Principal Value Premium Cost Value Fair Value Value Yield
---------------- -------- ----------- ------------- ------------- --------------- ----------
At March 31, 2004 $17,662,596 $412,563 $18,075,159 102.34% $18,079,598 102.36% 2.72%
- ----------------------------------------------------------------------------------------------------------------------------
At December 31, 2003 $12,682,130 $299,810 $12,981,940 102.36% $12,934,679 101.99% 2.96%
At September 30, 2003 $12,363,260 $293,694 $12,656,954 102.38% $12,605,085 101.96% 2.35%
At June 30, 2003 $13,939,447 $322,838 $14,262,285 102.32% $14,263,475 102.32% 2.87%
At March 31, 2003 $11,957,710 $289,360 $12,247,070 102.42% $12,318,070 103.01% 2.83%
The tables below set forth certain characteristics of our Investment
Securities. The index level for adjustable-rate Investment Securities is the
weighted average rate of the various short-term interest rate indices, which
determine the coupon rate.
20
ADJUSTABLE-RATE INVESTMENT SECURITY CHARACTERISTIC
(DOLLARS IN THOUSANDS)
----------------------
Weighted Principal Value
Weighted Weighted Weighted Average Weighted at Period End as
Average Average Average Term to Weighted Average % of Total
Principal Coupon Index Net Next Average Asset Investment
Value Rate Level Margin Adjustment Lifetime Cap Yield Securities
---------- -------- --------- --------- ---------- ------------ ---------- ----------------
At March 31, 2004 $13,059,967 3.90% 2.20% 1.70% 30 months 9.77% 2.91% 73.94%
- -------------------------------------------------------------------------------------------------------------------------
At December 31, 2003 $9,294,934 3.85% 2.25% 1.60% 23 months 9.86% 2.47% 73.29%
At September 30, 2003 $8,498,116 3.76% 2.17% 1.59% 22 months 9.75% 1.77% 68.74%
At June 30, 2003 $8,889,012 3.69% 2.18% 1.51% 18 months 9.70% 2.47% 63.77%
At March 31, 2003 $7,716,248 3.93% 2.31% 1.62% 13 months 10.04% 2.20% 64.53%
FIXED-RATE INVESTMENT SECURITY CHARACTERISTICS
(DOLLARS IN THOUSANDS)
----------------------
Principal Value
at Period End as
Weighted Weighted % of Total
Average Coupon Average Investment
Principal Value Rate Asset Yield Securities
--------------- -------------- ------------ -----------------
At March 31, 2004 $4,602,629 5.53% 3.41% 26.06%
- --------------------------------------------------------------------------------------------
At December 31, 2003 $3,387,197 5.77% 4.29% 26.71%
At September 30, 2003 $3,865,171 5.86% 3.63% 31.26%
At June 30, 2003 $5,050,434 5.97% 3.58% 36.23%
At March 31, 2003 $4,241,462 6.53% 3.98% 35.47%
The following tables provide information on adjustable-rate investment
securities by index at March 31, 2004 and December 31, 2003.
ADJUSTABLE-RATE INVESTMENT SECURITIES BY INDEX
MARCH 31, 2004
---------------
Six- 12- 11th Interest Six- Monthly
One- Six- Twelve Month Month District Rate Month 1-Year 2-Year 3-Year 5-Year Federal
Month Month Month Auction Moving Cost of Step CD Treasury Treasury Treasury Treasury Cost of
Libor Libor Libor Average Average Funds Up Rate Index Index Index Index Funds
----- ----- ----- ------- ------- --------- ------ ------ -------- -------- ------- ------- ------
Weighted Average Term
to Next Adjustment 1mo. 34 mo. 37 mo. 5 mo. 1 mo. 1 mo. 172 mo. 3 mo. 32 mo. 16 mo. 15 mo. 24 mo. 1 mo.
Weighted Average Annual
Period Cap 7.99% 2.58% 2.05% 1.00% 0.15% None 2.00% 1.00% 1.90% 2.00% 2.00% 2.00% None
Weighted Average
Lifetime
Cap at March 31, 2004 8.87% 9.87% 9.97% 13.02% 10.67% 12.41% 6.76% 11.62% 9.83% 11.92% 12.92% 12.61% 13.40%
Investment Principal
Value as Percentage of
Investment
Securities at
March 31, 2004 12.39% 2.79% 16.90% 0.01% 0.33% 1.45% 1.59% 0.06% 36.90% 0.01% 0.29% 0.11% 1.12%
ADJUSTABLE-RATE INVESTMENT SECURITIES BY INDEX
DECEMBER 31, 2003
-----------------
Six- 12- 11th Interest Six- Monthly
One- Six- Twelve Month Month District Rate Month 1-Year 2-Year 3-Year 5-Year Federal
Month Month Month Auction Moving Cost of Step CD Treasury Treasury Treasury Treasury Cost of
Libor Libor Libor Average Average Funds Up Rate Index Index Index Index Funds
----- ----- ----- ------- ------- --------- ------ ------ -------- -------- ------- ------- ------
Weighted Average Term to
Next Adjustment 1mo. 25 mo. 34 mo. 2 mo. 1 mo. 1 mo. 175 mo. 2 mo. 23 mo. 15 mo. 16 mo. 26 mo. 1 mo.
Weighted Average Annual
Period Cap None 2.14% 2.09% 1.00% 0.14% None 2.00% 1.00% 1.88% 2.00% 2.00% 2.00% None
Weighted Average Lifetime
Cap at December 31, 2003 8.88% 9.88% 10.12% 13.04% 10.70% 12.42% 6.76% 11.62% 10.05% 11.92% 12.89% 12.63% 13.40%
Investment Principal
Value as Percentage of
Investment Securities at
December 31, 2003 17.26% 1.73% 12.00% 0.01% 0.53% 2.13% 2.21% 0.09% 35.10% 0.01% 0.44% 0.17% 1.61%
21
BORROWINGS
To date, our debt has consisted entirely of borrowings collateralized
by a pledge of our Investment Securities. These borrowings appear on our balance
sheet as repurchase agreements. At March 31, 2004, we had established
uncommitted borrowing facilities in this market with twenty-nine lenders in
amounts, which we believe, are in excess of our needs. All of our Investment
Securities are currently accepted as collateral for these borrowings. However,
we limit our borrowings, and thus our potential asset growth, in order to
maintain unused borrowing capacity and thus increase the liquidity and strength
of our balance sheet.
For the quarter ended March 31, 2004, the term to maturity of our
borrowings ranged from one day to three years, with a weighted average original
term to maturity of 211 days. For the quarter ended March 31, 2003, the term to
maturity of our borrowings ranged from one day to three years, with a weighted
average original term to maturity of 197 days. At March 31, 2004, the weighted
average cost of funds for all of our borrowings was 1.44% and the weighted
average term to next rate adjustment was 103 days. At March 31, 2003, the
weighted average cost of funds for all of our borrowings was 1.67% and the
weighted average term to next rate adjustment was 111 days.
LIQUIDITY
Liquidity, which is our ability to turn non-cash assets into cash,
allows us to purchase additional investment securities and to pledge additional
assets to secure existing borrowings should the value of our pledged assets
decline. Potential immediate sources of liquidity for us include cash balances
and unused borrowing capacity. Unused borrowing capacity will vary over time as
the market value of our investment securities varies. Our balance sheet also
generates liquidity on an on-going basis through mortgage principal repayments
and net earnings retained prior to payment as dividends. Should our needs ever
exceed these on-going sources of liquidity plus the immediate sources of
liquidity discussed above, we believe that in most circumstances our investment
securities could be sold to raise cash. The maintenance of liquidity is one of
the goals of our capital investment policy. Under this policy, we limit asset
growth in order to preserve unused borrowing capacity for liquidity management
purposes.
At present, we have entered into uncommitted facilities with 29 lenders
for borrowings in the form of repurchase agreements. Borrowings under our
repurchase agreements increased by $3.7 billion to $14.7 billion at March 31,
2004, from $11.0 billion at December 31, 2003. This increase in leverage was
facilitated by the increase in our equity capital as a result of the issuance of
common stock primarily through public offerings during the second quarter of
2003 and the first quarter of 2004.
We anticipate that, upon repayment of each borrowing under a repurchase
agreement, we will use the collateral immediately for borrowing under a new
repurchase agreement. We have not at the present time entered into any
commitment agreements under which the lender would be required to enter into new
repurchase agreements during a specified period of time, nor do we presently
plan to have liquidity facilities with commercial banks.
Under our repurchase agreements, we may be required to pledge
additional assets to our repurchase agreement counterparties (i.e., lenders) in
the event the estimated fair value of the existing pledged collateral under such
agreements declines and such lenders demand additional collateral (a "margin
call"), which may take the form of additional securities or cash. Specifically,
margin calls result from a decline in the value of the our Mortgage-Backed
Securities securing our repurchase agreements, prepayments on the mortgages
securing such Mortgage-Backed Securities and to changes in the estimated fair
value of such Mortgage-Backed Securities generally due to principal reduction of
such Mortgage-Backed Securities from scheduled amortization and resulting from
changes in market interest rates and other market factors. Through March 31,
2004, we did not have any margin calls on our repurchase agreements that we were
not able to satisfy with either cash or additional pledged collateral. However,
should prepayment speeds on the mortgages underlying our Mortgage-Backed
Securities and/or market interest rates suddenly increase, margin calls on our
repurchase agreements could result, causing an adverse change in our liquidity
position.
22
The following table summarizes the effect on our liquidity and cash
flows from contractual obligations for repurchase agreements and the
non-cancelable office lease at March 31, 2004.
2004 2005 2006 2007 2008 THEREAFTER
---- ---- ---- ---- ---- ----------
(dollars in thousands)
Repurchase Agreements $12,939,300 $950,000 $250,000 550,000 - -
Long-term lease obligations 375 500 530 532 532 532
---------------------------------------------------------------------------------
Total $12,939,675 $950,500 $250,530 $550,532 $532 $532
=================================================================================
STOCKHOLDERS' EQUITY
During the quarter ending March 31, 2004, the Company declared dividends
to shareholders totaling $58.9 million or $0.50 per share, which was paid on
April 28, 2004. On January 21, 2004, the Company entered into an underwriting
agreement pursuant to which the Company raised net proceeds of approximately
$363.6 million in equity in an offering of 20,700,000 shares of common stock. On
March 31, 2004, entered into an underwriting agreement pursuant to which the
Company raised net proceeds of approximately $102.9 million in net proceeds
through an offering of 4,250,000 shares of 7.875% Series A Cumulative Redeemable
Preferred Stock, which settled on April 5, 2004. During the quarter ended March
31, 2004, 1,027,400 shares were issued through the Equity Shelf Program,
totaling net proceeds of $21.1 million. During the quarter ended March 31, 2004,
28,500 options were exercised under the long-term compensation plan at $459,000.
Also, 36,936 shares were purchased in the dividend reinvestment and direct
purchase program at $734,000.
With our "available-for-sale" accounting treatment, unrealized
fluctuations in market values of assets do not impact our GAAP or taxable income
but rather are reflected on our balance sheet by changing the carrying value of
the asset and stockholders' equity under "Accumulated Other Comprehensive Income
(Loss)." By accounting for our assets in this manner, we hope to provide useful
information to stockholders and creditors and to preserve flexibility to sell
assets in the future without having to change accounting methods.
As a result of this mark-to-market accounting treatment, our book value
and book value per share are likely to fluctuate far more than if we used
historical amortized cost accounting. As a result, comparisons with companies
that use historical cost accounting for some or all of their balance sheet may
not be meaningful.
The table below shows unrealized gains and losses on the Investment
Securities in our portfolio.
UNREALIZED GAINS AND LOSSES
---------------------------
(dollars in thousands)
AT AT AT AT AT
MARCH 31, DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31,
2004 2003 2003 2003 2003
-------------------------------------------------------------------------------
Unrealized Gain $53,912 $24,886 $27,439 $51,208 $98,768
Unrealized Loss (49,412) (72,147) (79,309) (50,018) (27,768)
--------------- ---------------- ------------------ ------------- -------------
Net Unrealized Gain (Loss) $4,500 $(47,261) $(51,870) $1,190 $71,000
=============== ================ ================== ============= =============
Net Unrealized Gain (Loss) as % of
Investment Securities' Principal Value 0.03% (0.37%) (0.41%) 0.01% 0.59%
Net Unrealized Gain (Loss) as % of
Investment Securities' Amortized Cost 0.03% (0.37%) (0.41%) 0.01% 0.59%
Unrealized changes in the estimated net market value of Investment
Securities have one direct effect on our potential earnings and dividends:
positive mark-to-market changes increase our equity base and allow us to
increase our borrowing capacity while negative changes decrease our equity base
and tend to limit borrowing capacity under our capital investment policy. A very
large negative change in the net market value of our Investment Securities might
impair our liquidity position, requiring us to sell assets with the likely
result of realized losses upon sale.
23
We use "available-for-sale" treatment for our Investment Securities; we
carry these assets on our balance sheet at estimated market value rather than
historical amortized cost. Based upon this "available-for-sale" treatment, our
common equity base at March 31, 2004 was $1.6 billion, or a book value of $13.45
per share. If we had used historical amortized cost accounting, our equity base
at March 31, 2004 would have been $1.6 billion, or $13.42 per share. Our equity
base at December 31, 2003 was $1.1 billion, or $11.96 per share. If we had used
historical amortized cost accounting, our equity base at December 31, 2003 would
have been $1.2 billion, or $12.45 per share.
The table below shows our equity capital base as reported and on a
historical amortized cost basis at March 31, 2004, December 31, 2003, September
30, 2003, June 30, 2003 and March 31, 2003. Issuances of common stock, the level
of earnings as compared to dividends declared, and other factors influence our
historical cost equity capital base. The reported equity capital base is
influenced by these factors plus changes in the "Unrealized Net Gains (Losses)
on Assets Available for Sale" account.
STOCKHOLDERS' EQUITY
--------------------
7.875% Series
A Cumulative
Redeemable Net Unrealized
Preferred Gains (Losses) Reported Reported Common
Stock: Historical on Assets Common Stock Historical Stock Equity
4,250,000 Common Stock Available for Equity Base Common Stock (Book Value) Per
shares Equity Base Sale (Book Value) Equity Per Share Share
------------- ------------ ---------------- ------------- ---------------- -----------------
(dollars in thousands, except per share data)
At March 31, 2004 $102,870 $1,581,218 $4,500 $1,585,718 $13.42 $13.45
- ------------------------------------------------------------------------------------------------------------------------------
At December 31, 2003 - $1,196,481 $(47,261) $1,149,220 $12.45 $11.96
At September 30, 2003 - $1,197,598 $(51,870) $1,145,728 $12.48 $11.94
At June 30, 2003 - $1,160,248 $1,190 $1,161,438 $12.34 $12.35
At March 31, 2003 - $1,005,712 $ 71,000 $1,076,712 $11.88 $12.72
LEVERAGE
Our debt-to-reported equity ratio at March 31, 2004 and March 31, 2003
was 8.7:1 and 9.5:1, respectively. We generally expect to maintain a ratio of
debt-to-equity of between 8:1 and 12:1, although the ratio may vary from this
range from time to time based upon various factors, including our management's
opinion of the level of risk of our assets and liabilities, our liquidity
position, our level of unused borrowing capacity and over-collateralization
levels required by lenders when we pledge assets to secure borrowings.
Our target debt-to- reported equity ratio is determined under our
capital investment policy. Should our actual debt-to-equity ratio increase above
the target level due to asset acquisition or market value fluctuations in
assets, we will cease to acquire new assets. Our management will, at that time,
present a plan to our Board of Directors to bring us back to our target
debt-to-equity ratio; in many circumstances, this would be accomplished in time
by the monthly reduction of the balance of our Mortgage-Backed Securities
through principal repayments.
ASSET/LIABILITY MANAGEMENT AND EFFECT OF CHANGES IN INTEREST RATES
We continually review our asset/liability management strategy with
respect to interest rate risk, mortgage prepayment risk, credit risk and the
related issues of capital adequacy and liquidity. We seek attractive
risk-adjusted stockholder returns while maintaining a strong balance sheet.
We seek to manage the extent to which our net income changes as a
function of changes in interest rates by matching adjustable-rate assets with
variable-rate borrowings. In addition, although we have not done so to date, we
may seek to mitigate the potential impact on net income of periodic and lifetime
coupon adjustment restrictions in our portfolio of investment securities by
entering into interest rate agreements such as interest rate caps and interest
rate swaps.
Changes in interest rates may also have an effect on the rate of
mortgage principal prepayments and, as a
24
result, prepayments on Mortgage-Backed Securities. We will seek to mitigate the
effect of changes in the mortgage principal repayment rate by balancing assets
we purchase at a premium with assets we purchase at a discount. To date, the
aggregate premium exceeds the aggregate discount on our Mortgage-Backed
Securities. As a result, prepayments, which result in the expensing of
unamortized premium, will reduce our net income compared to what net income
would be absent such prepayments.
OFF-BALANCE SHEET ARRANGEMENTS
We do not have any relationships with unconsolidated entities or
financial partnerships, such as entities often referred to as structured finance
or special purpose entities, which would have been established for the purpose
of facilitating off-balance sheet arrangements or other contractually narrow or
limited purposes. Further, we have not guaranteed any obligations of
unconsolidated entities nor do we have any commitment or intent to provide
additional funding to any such entities. As such, we are not materially exposed
to any market, credit, liquidity or financing risk that could arise if we had
engaged in such relationships.
INFLATION
Virtually all of our assets and liabilities are financial in nature. As a
result, interest rates and other factors drive our performance far more than
does inflation. Changes in interest rates do not necessarily correlate with
inflation rates or changes in inflation rates. Our financial statements are
prepared in accordance with GAAP and our dividends based upon our net income as
calculated for tax purposes; in each case, our activities and balance sheet are
measured with reference to historical cost or fair market value without
considering inflation.
OTHER MATTERS
We calculate that our qualified REIT assets, as defined in the Internal
Revenue Code, are 100% of our total assets at March 31, 2004 and 2003, as
compared to the Internal Revenue Code requirement that at least 75% of our total
assets be qualified REIT assets. We also calculate that 100% of our revenue
qualifies for the 75% source of income test, and 100% of our revenue qualifies
for the 95% source of income test, under the REIT rules for the quarters ended
March 31, 2004 and 2003. We also met all REIT requirements regarding the
ownership of our common stock and the distribution of our net income. Therefore,
as of March 31, 2004 and December 31, 2003, we believe that we qualified as a
REIT under the Internal Revenue Code.
We at all times intend to conduct our business so as not to become
regulated as an investment company under the Investment Company Act. If we were
to become regulated as an investment company, then our use of leverage would be
substantially reduced. The Investment Company Act exempts entities that are
"primarily engaged in the business of purchasing or otherwise acquiring
mortgages and other liens on and interests in real estate" (qualifying
interests). Under current interpretation of the staff of the SEC, in order to
qualify for this exemption, we must maintain at least 55% of our assets directly
in qualifying interests. In addition, unless certain mortgage securitites
represent all the certificates issued with respect to an underlying pool of
mortgages, the Mortgage-Backed Securities may be treated as securities separate
from the underlying mortgage loans and, thus, may not be considered qualifying
interests for purposes of the 55% requirement. We calculate that as of March 31,
2004 and December 31, 2003 we were in compliance with this requirement.
RECENT DEVELOPMENTS
On January 2, 2004, we announced that we had entered into an agreement
to acquire FIDAC. At our annual meeting of stockholders, our stockholders will
vote on whether or not to approve the merger agreement we have entered into in
connection with the acquisition. The acquisition also remains subject to final
confirmation by our Board of Directors that no events have occurred and no
circumstances have arisen that would alter our Board's earlier determination
that such acquisition is in the best interests of us and our stockholders.
Under the merger agreement, our wholly owned Delaware subsidiary, FDC
Merger Sub, Inc., will merge with and into FIDAC, and FIDAC will be the
surviving corporation. The merger agreement provides that FIDAC shareholders
will receive approximately 2,935 shares of our common stock for each share of
FIDAC common stock
25
they own. In addition, FIDAC shareholders have the right to receive additional
shares of our common stock, upon the achievement by FIDAC of specific
performance goals, on or about March 31, 2005, 2006 and 2007, calculated based
on the price of our common stock and the number of FIDAC shares they owned. The
value of the shares of our common stock to be issued to the FIDAC shareholders
immediately upon the consummation of the acquisition was fixed at $40,500,000
based upon the closing price of our shares on December 31, 2003, which is to be
paid by delivering 2,201,080 shares of our common stock. The value of the
additional shares to be paid to FIDAC shareholders has been fixed as up to a
maximum dollar amount of $49,500,000; however, we cannot calculate how many
shares we will issue in the future since that will vary depending on our share
price at the time of each issuance.
26
ITEM. 3 QUANTITATIVE AND QUALITIATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK
Market risk is the exposure to loss resulting from changes in interest
rates, foreign currency exchange rates, commodity prices and equity prices. The
primary market risk to which we are exposed is interest rate risk, which is
highly sensitive to many factors, including governmental monetary and tax
policies, domestic and international economic and political considerations and
other factors beyond our control. Changes in the general level of interest rates
can affect our net interest income, which is the difference between the interest
income earned on interest-earning assets and the interest expense incurred in
connection with our interest-bearing liabilities, by affecting the spread
between our interest-earning assets and interest-bearing liabilities. Changes in
the level of interest rates also can affect the value of our Mortgage-Backed
Securities and our ability to realize gains from the sale of these assets. We
may utilize a variety of financial instruments; including interest rate swaps,
caps, floors and other interest rate exchange contracts, in order to limit the
effects of interest rates on our operations. If we use these types of
derivatives to hedge the risk of interest-earning assets or interest-bearing
liabilities, we may be subject to certain risks, including the risk that losses
on a hedge position will reduce the funds available for payments to holders of
securities and that the losses may exceed the amount we invested in the
instruments. To date, we have not purchased any hedging instruments.
Our profitability and the value of our portfolio may be adversely
affected during any period as a result of changing interest rates. The following
table quantifies the potential changes in net interest income and portfolio
value should interest rates go up or down 25, 50, and 100 basis points, assuming
the yield curves of the rate shocks will be parallel to each other and the
current yield curve. All changes in income and value are measured as percentage
changes from the projected net interest income and portfolio value at the base
interest rate scenario. The base interest rate scenario assumes interest rates
at March 31, 2004 and various estimates regarding prepayment and all activities
are made at each level of rate shock. Actual results could differ significantly
from these estimates.
Projected Percentage Change in Projected Percentage Change in
Change in Interest Rate Net Interest Income Portfolio Value
- ---------------------------------------------------------------------------------------------------------
- -100 Basis Points (7.55%) 0.56%
- -50 Basis Points (5.87%) 0.36%
- -25 Basis Points (2.29%) 0.18%
Base Interest Rate
+25 Basis Points 1.64% (0.17%)
+50 Basis Points 3.90% (0.32%)
+100 Basis Points 4.25% (0.47%)
ASSET AND LIABILITY MANAGEMENT
Asset and liability management is concerned with the timing and
magnitude of the repricing of assets and liabilities. We attempt to control
risks associated with interest rate movements. Methods for evaluating interest
rate risk include an analysis of our interest rate sensitivity "gap", which is
the difference between interest-earning assets and interest-bearing liabilities
maturing or repricing within a given time period. A gap is considered positive
when the amount of interest-rate sensitive assets exceeds the amount of
interest-rate sensitive liabilities. A gap is considered negative when the
amount of interest-rate sensitive liabilities exceeds interest-rate sensitive
assets. During a period of rising interest rates, a negative gap would tend to
adversely affect net interest income, while a positive gap would tend to result
in an increase in net interest income. During a period of falling interest
rates, a negative gap would tend to result in an increase in net interest
income, while a positive gap would tend to affect net interest income adversely.
Because different types of assets and liabilities with the same or similar
maturities may react differently to changes in overall market rates or
conditions, changes in interest rates may affect net interest income positively
or negatively even if an institution were perfectly matched in each maturity
category.
27
The following table sets forth the estimated maturity or repricing of
our interest-earning assets and interest-bearing liabilities at March 31, 2004.
The amounts of assets and liabilities shown within a particular period were
determined in accordance with the contractual terms of the assets and
liabilities, except adjustable-rate loans, and securities are included in the
period in which their interest rates are first scheduled to adjust and not in
the period in which they mature. The interest rate sensitivity of our assets and
liabilities in the table could vary substantially if based on actual prepayment
experience.
More than 1
Within 3 Year to 3 Years and
Months 4-12 Months Years Over Total
-----------------------------------------------------------------------------------
(dollars in thousands)
Rate Sensitive Assets:
Investment Securities $3,153,196 $1,073,705 $5,181,823 $8,253,873 $17,662,597
Rate Sensitive Liabilities:
Repurchase Agreements 12,649,300 940,000 1,100,000 - 14,689,300
-----------------------------------------------------------------------------------
Interest rate sensitivity gap ($9,496,104) $113,705 $4,081,823 $8,253,873 $2,973,297
===================================================================================
Cumulative rate sensitivity gap ($9,496,104) ($9,382,399) ($5,300,576) 2,953,297
===================================================================================
Cumulative interest rate
sensitivity gap as a percentage of (54%) (53%) (30%) 17%
total rate-sensitive assets
Our analysis of risks is based on management's experience, estimates, models and
assumptions. These analyses rely on models which utilize estimates of fair value
and interest rate sensitivity. Actual economic conditions or implementation of
investment decisions by our management may produce results that differ
significantly form the estimates and assumptions used in our models and the
projected results shown in the above tables and in this report. These analyses
contain certain forward-looking statements and are subject to the safe harbor
statement set forth under the heading, "Special Note Regarding Forward-Looking
Statements."
ITEM 4. CONTROLS AND PROCEDURES
As of March 31, 2004, a review and evaluation was performed under the
supervision and with the participation of our management, including our Chairman
of the board of directors, Chief Executive Officer and President and our Chief
Financial Officer and Treasurer, of the effectiveness of the design and
operation of our disclosure controls and procedures. Based on that review and
evaluation, our management, including our Chairman of the board of directors,
Chief Executive Officer and President and our Chief Financial Officer and
Treasurer, concluded that our disclosure controls and procedures were effective
as of March 31, 2004. There have been no significant changes in our internal
controls or in other factors that could significantly affect internal controls
subsequent to March 31, 2004. There were no significant material weaknesses
identified in the course of such review and, therefore, no corrective measures
were taken by us.
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PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit Index
Exhibit Number Exhibit Description
3.1 Form of Articles Supplementary designating the Company's
7.875% Series A Cumulative Redeemable Preferred Stock,
liquidation preference $25.00 per share, par value $0.01
per share (incorporated by reference to Exhibit 3.3 to the
Registrant's Registration Statement on Form 8-A filed with
the Securities and Exchange Commission on April 1, 2004).
4.1 Specimen certificate representing the 7.875% Series A
Cumulative Redeemable Preferred Stock (incorporated by
reference to Exhibit 4.1 to the Registrant's Registration
Statement on Form 8-A filed with the Securities and
Exchange Commission on April 1, 2004).
31.1 Certification of Chief Executive Officer, pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer as adopted
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer, pursuant to 18
U.S.C. 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer, pursuant to 18
U.S.C. 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(b) Reports of Form 8-K
Our Current Report on Form 8-K was filed on January 2, 2004 reporting under item
5 announcing our agreement to acquire Fixed Income Discount Advisory Company;
Our Current Report on Form 8-K was filed on January 16, 2004 reporting under
items 5 and 7 announcing our entering into an underwriting agreement with UBS
Securities LLC and Merrill Lynch, Pierce, Fenner & Smith Incorporated as
representatives of the several underwriters, relating to the sale of 18,000,000
shares of common stock, par value $0.01 per share (the "Common Stock"), and the
granting of an over-allotment option for an additional 2,700,000 shares of
Common Stock to the Underwriters to fulfill over-allotments; and
Our Current Report on Form 8-K was filed on February 6, 2004 reporting under
item 12 announcing our financial results for the fiscal quarter and year ended
December 31, 2003.
We filed the following current reports on Form 8-K subsequent to the first
quarter 2004:
Our Current Report on Form 8-K was filed on April 1, 2004 reporting under items
5 announcing our entering into an underwriting agreement dated March 31, 2004.
We entered into an underwriting agreement with Bear, Stearns & Co. Inc. as
representative of the several underwriters (collectively, the "Underwriters"),
relating to the sale of 4,250,000 shares of 7.875% Series A Cumulative
Redeemable Preferred Stock, par value $0.01 per share (the "Series A Preferred
Stock"), and the granting of an over-allotment option for an additional 637,500
shares of Series A Preferred Stock to the Underwriters solely to fulfill
over-allotments. The offering closed on April 5, 2004; and
Our Current Report on Form 8-K was filed on April 26, 2004 reporting under item
12 announcing our financial results for the fiscal quarter ended March 31, 2004.
29
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ANNALY MORTGAGE MANAGEMENT, INC.
Dated: May 7, 2004 By: /s/ MICHAEL A.J. FARRELL
------------------------
Michael A.J. Farrell
(Chairman of the Board, Chief Executive Officer,
President and authorized officer of registrant)
Dated: May 7, 2004 By: /s/ KATHRYN F. FAGAN
--------------------
Kathryn F. Fagan
(Chief Financial Officer and Treasurer and
principal financial and chief accounting officer)
30