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: JUNE 30, 2005
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 (IRS Employer Identification No.)
of incorporation or organization)
1211 AVENUE OF THE AMERICAS, SUITE 2902
NEW YORK, NEW YORK
(Address of principal executive offices)
10036
(Zip Code)
(212) 696-0100
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all documents and
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days:
Yes X No___
---
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2) of the Exchange Act:
Yes X No___
---
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the last practicable date:
Class Outstanding at August 3, 2005
Common Stock, $.01 par value 122,554,831
ANNALY MORTGAGE MANAGEMENT, INC.
FORM 10-Q
TABLE OF CONTENTS
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Statements of Financial Condition- June 30, 2005 (Unaudited) and December 31, 2004 1
Consolidated Statements of Operations and Comprehensive Income (Loss) (Unaudited) for the quarters
and six months ended June 30, 2005 and June 30, 2004 2
Consolidated Statements of Stockholders' Equity (Unaudited) for the six months ended June 30, 2005 3
Consolidated Statement of Cash Flows (Unaudited) for the quarters and six months ended June 30, 4
2005 and June 30, 2004
Notes to Consolidated Financial Statements (Unaudited) 5-15
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 15-30
Item 3. Quantitative and Qualitative Disclosures about Market Risk 31-32
Item 4. Controls and Procedures 32
Part II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders 33
Item 6. Exhibits and Reports on Form 8-K 33
SIGNATURES 34
CERTIFICATIONS 35-38
PART I.
ITEM 1. FINANCIAL STATEMENTS
ANNALY MORTGAGE MANAGEMENT, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(DOLLARS IN THOUSANDS, EXCEPT FOR SHARE DATA)
JUNE 30, 2005 DECEMBER 31,
(UNAUDITED) 2004
--------------------- ----------------------
ASSETS
Cash and cash equivalents $ 3,669 $ 5,853
Mortgage-Backed Securities, at fair value 19,165,744 19,038,386
Agency debentures, at fair value 391,092 390,509
Receivable for Mortgage-Backed Securities sold - 1,025
Accrued interest receivable 87,960 81,557
Receivable for advisory and service fees 4,334 2,359
Intangible for customer relationships 15,552 15,613
Goodwill 23,122 23,122
Other assets 1,472 1,875
--------------------- ----------------------
Total assets $19,692,945 $19,560,299
===================== ======================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Repurchase agreements $17,251,594 $16,707,879
Payable for Mortgage-Backed Securities purchased 659,325 1,044,683
Accrued interest payable 29,654 35,721
Dividends payable 44,120 60,632
Other liabilities 1,241 2,819
Accounts payable 6,523 8,095
--------------------- ----------------------
Total liabilities 17,992,457 17,859,829
--------------------- ----------------------
Stockholders' Equity:
7.875% Series A Cumulative Redeemable Preferred Stock: 8,000,000
authorized, 7,412,500 shares issued and outstanding 177,088 177,077
Common stock: par value $.01 per share; 500,000,000 authorized,
122,554,831 and 121,263,000 shares issued and outstanding,
respectively 1,226 1,213
Additional paid-in capital 1,662,347 1,638,635
Accumulated other comprehensive loss (144,853) (120,800)
Retained earnings 4,680 4,345
--------------------- ----------------------
Total stockholders' equity 1,700,488 1,700,470
--------------------- ----------------------
Total liabilities and stockholders' equity $19,692,945 $19,560,299
===================== ======================
See notes to financial statements.
1
PART I.
ITEM 1. FINANCIAL STATEMENTS
ANNALY MORTGAGE MANAGEMENT, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
FOR THE FOR THE FOR THE SIX FOR THE SIX
QUARTER ENDED QUARTER ENDED MONTHS ENDED MONTHS ENDED
JUNE 30, 2005 JUNE 30, 2004 JUNE 30, 2005 JUNE 30, 2004
----------------- --------------- ---------------- --------------
INTEREST INCOME $171,595 $122,234 $347,884 $236,575
INTEREST EXPENSE 133,758 55,648 247,751 105,951
----------------- --------------- ---------------- --------------
NET INTEREST INCOME 37,837 66,586 100,133 130,624
----------------- --------------- ---------------- --------------
OTHER INCOME:
Investment advisory and service fees 9,669 1,558 15,978 1,558
Gain on sale of Mortgage-Backed Securities 11,435 2,126 12,016 2,721
----------------- --------------- ---------------- --------------
TOTAL OTHER INCOME 21,104 3,684 27,994 4,279
----------------- --------------- ---------------- --------------
EXPENSES:
Distribution fees 2,126 298 3,737 298
General and administrative expenses 6,800 5,643 13,464 11,008
----------------- --------------- ---------------- --------------
TOTAL EXPENSES 8,926 5,941 17,201 11,306
----------------- --------------- ---------------- --------------
INCOME BEFORE INCOME TAXES 50,015 64,329 110,926 123,597
INCOME TAXES 3,022 494 4,600 919
----------------- --------------- ---------------- --------------
NET INCOME 46,993 63,835 106,326 122,678
DIVIDENDS ON PREFERRED STOCK 3,648 1,998 7,297 1,998
----------------- --------------- ---------------- --------------
NET INCOME AVAILABLE TO COMMON SHAREHOLDERS $43,345 $61,837 $99,029 $120,680
================= =============== ================ ==============
NET INCOME PER COMMON SHARE
Basic $0.36 $0.52 $0.82 $1.05
================= =============== ================ ==============
Diluted $0.36 $0.52 $0.81 $1.04
================= =============== ================ ==============
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING
Basic 121,740,256 118,276,509 121,506,858 115,391,357
================= =============== ================ ==============
Diluted 122,013,050 118,469,756 121,785,918 115,659,173
================= =============== ================ ==============
NET INCOME $46,993 $63,835 $106,326 $122,678
----------------- --------------- ---------------- --------------
COMPREHENSIVE INCOME (LOSS)
Unrealized gain (loss) on available-for sale securities 79,862 (179,863) (12,037) (127,507)
Less: reclassification adjustment for net gains
included in net income (11,435) (2,126) (12,016) (2,721)
----------------- --------------- ---------------- --------------
Other comprehensive income (loss) 68,427 (181,989) (24,053) (130,228)
----------------- --------------- ---------------- --------------
COMPREHENSIVE INCOME (LOSS) $115,420 ($118,154) $82,273 ($7,550)
================= =============== ================ ==============
See notes to financial statements.
2
PART I
ITEM 1. FINANCIAL STATEMENTS
ANNALY MORTGAGE MANAGEMENT, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE SIX MONTHS ENDED JUNE 30, 2005
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
ACCUMULATED
COMMON ADDITIONAL OTHER
PREFERRED STOCK PAID-IN COMPREHENSIVE COMPREHENSIVE RETAINED
STOCK PAR VALUE CAPITAL INCOME (LOSS) INCOME (LOSS) EARNINGS TOTAL
------------ ------------- ----------- ----------- ------------- ---------- ---------
BALANCE, JANUARY 1, 2005 $177,077 $1,213 $1,638,635 ($120,800) $4,345 $1,700,470
Net income $59,333 59,333
Other comprehensive income (loss)
Unrealized net loss on securities,
net of reclassification adjustment (92,480) (92,480)
-----------
Comprehensive loss ($33,147) (33,147)
===========
Exercise of stock options 99 99
Proceeds from direct purchase and
dividend reinvestment 177 177
Preferred dividend declared for the
quarter ended March 31, 2005, $0.492188
per share (3,648) (3,648)
Common dividend declared for the quarter
ended March 31, 2005, $0.45 per share (54,575) (54,575)
------------ ------------- ----------- ------------- --------- -----------
BALANCE, MARCH 31, 2005 $177,077 $1,213 $1,638,911 ($213,280) $5,455 $1,609,376
Net income $46,993 46,993
Other comprehensive income (loss)
Unrealized net gain on securities,
net of reclassification adjustment 68,427 68,427
-----------
Comprehensive income $115,420 115,420
===========
Reduction in estimated legal cost of
preferred offering 11 11
Exercise of stock options 154 154
Proceeds from direct purchase and
dividend reinvestment 149 149
Proceeds from equity shelf offering 13 23,133 23,146
Preferred dividend declared for the
quarter ended June 30, 2005, $0.492188
per share (3,648) (3,648)
Common dividend declared for the quarter
ended June 30, 2005, $0.36 per share (44,120) (44,120)
------------ ------------- ----------- ----------- ----------- -----------
BALANCE, JUNE 30, 2005 $177,088 $1,226 $1,662,347 ($144,853) $4,680 $1,700,488
============ ============= =========== =========== =========== ===========
See notes to financial statements.
3
PART I
ITEM 1. FINANCIAL STATEMENTS
ANNALY MORTGAGE MANAGEMENT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
FOR THE FOR THE FOR THE SIX FOR THE SIX
QUARTER ENDED QUARTER ENDED MONTHS ENDED MONTHS ENDED
JUNE 30, 2005 JUNE 30, 2004 JUNE 30, 2005 JUNE 30, 2004
----------------- --------------- ---------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $46,993 $63,835 $106,326 $122,678
Adjustments to reconcile net income to net cash
provided by operating activities:
Amortization of Mortgage- Backed Securities
premiums and discounts, net 42,662 56,141 78,729 97,642
Amortization of intangibles 117 18 173 18
Gain on sale of Mortgage-Backed Securities (11,435) (2,126) (12,016) (2,721)
Stock option expense 56 90 56 307
Market value adjustment on long-term repurchase
agreement (328) (1,270) (1,578) (523)
Decrease in accrued interest receivable, net of
purchased interest (7,411) (5,124) (6,956) (21,046)
Decrease (increase) in other assets 445 3 391 (1,188)
Increase in advisory and service fees receivable (1,451) (81) (1,974) (81)
(Decrease) increase in accrued interest payable (4,116) (1,340) (6,067) 4,970
Increase (decrease) in accounts payable 2,454 1,186 (1,562) 353
----------------- ----------------- ----------------- ------------------
Net cash provided by operating activities 67,986 111,332 155,522 200,409
----------------- ----------------- ----------------- ------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of Mortgage-Backed Securities (2,460,318) (3,249,700) (4,822,190) (8,532,426)
Purchase of agency debentures - (100,000) - (250,000)
Proceeds from sale of Mortgage-Backed Securities 870,767 259,938 956,714 284,097
Proceeds from called agency debentures - 150,000 - 250,000
Principal payments on Mortgage-Backed Securities 1,744,661 2,133,853 3,262,889 3,338,072
Cash from FIDAC transaction 2,526 2,526
----------------- ----------------- ----------------- ------------------
Net cash provided by (used in) investing
activities 155,110 (803,383) (602,587) (4,907,731)
----------------- ----------------- ----------------- ------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from repurchase agreements 62,857,935 36,583,949 120,117,481 66,778,141
Principal payments on repurchase agreements (63,044,950) (35,931,226) (119,573,766) (62,449,121)
Proceeds from exercise of stock options 98 112 196 355
Proceeds from direct purchase and dividend
reinvestment 149 1,209 327 1,943
Net proceeds from common stock follow-on offerings - - - 363,592
Net proceeds from preferred offering - 102,708 - 102,708
Net proceeds from equity shelf program 23,146 - 23,146 20,051
Dividends paid (58,223) (60,940) (122,503) (106,095)
----------------- ----------------- ----------------- ------------------
Net cash (used in) provided by financing
activities (221,845) 695,812 444,881 4,711,574
Net increase (decrease) in cash and cash equivalents 1,251 3,761 (2,184) 4,252
Cash and cash equivalents, beginning of period 2,418 738 5,853 247
----------------- ----------------- ----------------- ------------------
Cash and cash equivalents, end of period $3,669 $4,499 $3,669 $4,499
================= ================= ================= ==================
Supplemental disclosure of cash flow information:
Interest paid ($137,874) ($56,989) ($253,818) ($100,982)
================= ================= ================= ==================
Noncash financing activities:
Net change in unrealized loss on
available-for-sale, securities net
of reclassification adjustment $68,427 ($181,989) $24,053 ($130,228)
================= ================= ================= ==================
Dividends declared, not yet paid $44,120 $57,674 $44,120 $57,674
================= ================= ================= ==================
See notes to financial statements.
4
ANNALY MORTGAGE MANAGEMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE QUARTERS AND SIX MONTHS ENDED JUNE 30, 2005 AND 2004
(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.
The Company acquired Fixed Income Discount Advisory Company ("FIDAC") on June 4,
2004 (See Note 2). FIDAC is a registered investment advisor and is a taxable
REIT subsidiary of the Company.
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 financial positions, results of
operations and cash flows 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, 2004. 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.
The consolidated financial statements subsequent to June 4, 2004
include the accounts of the Company and FIDAC. All material intercompany
balances have been eliminated. Certain reclassifications have been made to prior
year financial statements, where appropriate, to conform to the current year
presentation.
CASH AND CASH EQUIVALENTS - Cash and cash equivalents include cash on
hand and money market funds.
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 agency debentures issued by Federal
Home Loan Bank ("FHLB"), Federal Home Loan Mortgage Corporation ("FHLMC"), and
Federal National Mortgage Association ("FNMA"). The Mortgage-Backed Securities
and agency debentures are collectively referred to herein as "Investment
Securities."
Statement of Financial Accounting Standards ("SFAS") 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, SFAS No. 115
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.
Management evaluates securities for other-than-temporary impairment at
least on a quarterly basis, and more frequently when economic or market concerns
warrant such evaluation. Consideration is given to (1) the length of time and
the extent to which the fair value has been less than cost, (2) the financial
condition and near-term prospects of the issuer, and (3) the intent and ability
of the Company to retain its investment in the issuer for a period of time
sufficient to allow for any anticipated recovery in fair value. 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 periods ended
June 30, 2005 or 2004.
5
SFAS No. 107, DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS,
requires disclosure of the fair value of financial instruments for which it is
practicable to estimate that value. The fair value of mortgage-backed securities
and agency debentures available-for-sale and futures contracts is equal to their
carrying value presented in the balance sheet. The fair value of cash and cash
equivalents, accrued interest receivable, receivable for Mortgage-Backed
Securities sold, receivable for advisory fees, repurchase agreements, and
payable for mortgage-backed securities purchased, dividends payable, accounts
payable, and accrued interest payable, generally approximates cost as of June
30, 2005 and December 31, 2004, due to the short term nature of these financial
instruments.
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 projected 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.
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 sale of
Investment Securities are determined on the specific identification basis.
CREDIT RISK - The Company has limited its exposure to credit losses on
its portfolio of Investment Securities by only purchasing securities issued by
FHLMC, FNMA, Government National Mortgage Association ("GNMA"), or 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. 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.
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. The Company and FIDAC have made a joint
election to treat FIDAC as a taxable REIT subsidiary. As such, FIDAC is taxable
as a domestic C Corporation and subject to federal and state and local income
taxes based upon its taxable income.
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.
INTANGIBLE ASSETS - The Company's acquisition of FIDAC was accounted
for using the purchase method. Under the purchase method, net assets and results
of operations of acquired companies are included in the consolidated financial
statements from the date of acquisition. In addition, the cost of FIDAC was
allocated to the assets acquired, including identifiable intangible assets, and
the liabilities assumed based on their estimated fair values at the date of
acquisition. The excess of cost over the fair value of the net assets acquired
was recognized as goodwill.
RECENT ACCOUNTING PRONOUNCEMENTS - In March 2004, the Emerging Issues
Task Force, or "EITF", reached a consensus on Issue No. 03-1, The Meaning of
Other-Than-Temporary Impairment and its Application to Certain Investments. This
Issue provides clarification with respect to the meaning of other-than-temporary
impairment and its application to investments classified as either
available-for-sale or held-to-maturity under SFAS No. 115, and investments
accounted for under the cost method or the equity method. Certain provisions of
this Issue have been
6
deferred to a later date. This Issue is not expected to have a significant
impact on the Company's financial statements when adopted.
On December 16, 2004, the Financial Accounting Standards Board (FASB)
issued SFAS No. 123 (Revised 2004) - Share-Based Payment ("SFAS No. 123R"). SFAS
123R, which replaces SFAS No. 123, requires the Company to measure and recognize
in the financial statements the compensation cost relating to share-based
payment transactions. The compensation cost should be reassured based on the
fair value of the equity instruments issued. SFAS No. 123R is effective for the
Company on January 1, 2006. The adoption of SFAS No. 123R is not expected to
have a significant impact on the Company's financial statements.
2. FIXED INCOME DISCOUNT ADVISORY COMPANY
On December 31, 2003, the Company entered into a merger agreement with
FIDAC. At the annual meeting of the Company's shareholders held on May 27, 2004,
shareholders voted to approve the merger. The merger closed before the opening
of business on June 4, 2004. The merger was accounted for using the purchase
method of accounting in accordance with SFAS No. 141. Accordingly, the
consolidated balance sheets as of June 30, 2005 and December 31, 2004 include
the effects of the merger and the Company's application of the purchase method
of accounting. Additionally, the consolidated statements of operations and of
cash flows for the quarter ended June 30, 2004 include the results of the
Company and FIDAC for the period from June 4, 2004 to June 30, 2004. The
consolidated statements of operation and of cash flows for the quarter ended
June 30, 2005 include a full quarter of results of the Company and FIDAC.
Upon completion of the merger and pursuant to the merger agreement, FDC
Merger Sub ("Merger Sub"), the Company's wholly-owned subsidiary created solely
for the purpose of effectuating the merger, merged with and into FIDAC. As a
result of the merger, Merger Sub ceased to exist, and FIDAC is the surviving
corporation and operates as the Company's wholly-owned taxable REIT subsidiary.
At the time of the merger, each FIDAC shareholder received approximately 2,935
shares of the Company's common stock for each share of FIDAC stock the
shareholder owned and has the right to receive additional shares of the
Company's common stock in the future, based on FIDAC achieving specific
performance goals. FIDAC's shareholders may also receive additional shares of
our common stock as an earn-out in 2005 and 2006 worth up to $49,500,000 if
FIDAC meets specific performance goals under the merger agreement. We cannot
calculate how many shares we will issue under the earn-out provisions since that
will vary depending upon whether and the extent to which FIDAC achieves specific
performance goals. Even if FIDAC achieves specific performance goals for a
fiscal year, the number of additional shares to be issued to the FIDAC
shareholders will vary depending on our average share price for the first 20
trading days of the following fiscal year.
The value of the shares of the Company's common stock issued to the
FIDAC shareholders immediately upon the consummation of the acquisition was
fixed at $40,500,000 based upon the closing price of the Company's common stock
on December 31, 2003, and was paid on June 4, 2004 by delivering 2,201,080
shares of the Company's common stock.
The total amount of goodwill represents the purchase price in excess of
the fair value of the net assets acquired. Under SFAS No. 142, "Goodwill and
Other Intangible Assets," goodwill is not amortized, but tested at least
annually for impairment. Certain customer relationships are deemed by the
Company to have an indefinite life based on a lack of attrition history and
management's expectation of continued service to FIDAC clients and, accordingly,
are not being amortized. Instead, they are required to be tested at least
annually for impairment. FIDAC trademark and non-compete agreements are
considered intangible assets subject to amortization over their estimated life
of three years and one year, respectively. For the quarter ended June 30, 2005,
amortization expense related to these intangibles was $117,000. A deferred tax
liability of $59,000 arising from the temporary difference between the book and
tax basis relating to these amortizable intangible is included in "Other
liabilities" in the Statements of Financial Condition as of June 30, 2005 and
December 31, 2004, respectively.
7
A summary of the fair values of the net assets acquired is as follows:
(DOLLARS IN THOUSANDS)
Cash and cash equivalents $2,526
Receivable for advisory fees and services 1,564
Other assets 591
Customer relationships 15,613
FIDAC trademark 250
Non-compete agreements 140
Goodwill 22,905
Accounts payable (748)
----------
Total fair value of net assets, including acquisition cost $42,841
==========
8
3. MORTGAGE-BACKED SECURITIES
The following table pertains to the Company's Mortgage-Backed
Securities classified as available-for-sale as of June 30, 2005 and December 31,
2004, which are carried at their fair value:
GOVERNMENT TOTAL
FEDERAL HOME FEDERAL NATIONAL NATIONAL MORTGAGE-
LOAN MORTGAGE MORTGAGE MORTGAGE BACKED
JUNE 30, 2005 CORPORATION ASSOCIATION ASSOCIATION SECURITIES
------------------- --------------------- -------------------- ------------------
(dollars in thousands)
Mortgage-Backed Securities, gross $6,521,302 $11,978,713 $405,318 $18,905,333
Unamortized discount (1,008) (777) (78) (1,863)
Unamortized premium 130,936 266,098 6,186 403,220
------------------- --------------------- -------------------- ------------------
Amortized cost 6,651,230 12,244,034 411,426 19,306,690
Gross unrealized gains 4,517 3,133 305 7,955
Gross unrealized losses (45,485) (102,070) (1,346) (148,901)
------------------- --------------------- -------------------- ------------------
Estimated fair value $6,610,262 $12,145,097 $410,385 $19,165,744
=================== ===================== ==================== ==================
GROSS UNREALIZED GROSS UNREALIZED ESTIMATED FAIR
AMORTIZED COST GAIN LOSS VALUE
------------------- --------------------- -------------------- ------------------
(dollars in thousands)
Adjustable rate $12,969,830 $5,421 ($88,229) $12,887,022
Fixed rate 6,336,860 2,534 (60,672) 6,278,722
------------------- --------------------- -------------------- ------------------
Total $19,306,690 $7,955 ($148,901) $19,165,744
=================== ===================== ==================== ==================
GOVERNMENT TOTAL
FEDERAL HOME FEDERAL NATIONAL NATIONAL MORTGAGE-
LOAN MORTGAGE MORTGAGE MORTGAGE BACKED
DECEMBER 31, 2004 CORPORATION ASSOCIATION ASSOCIATION SECURITIES
------------------- --------------------- --------------------- -----------------
(dollars in thousands)
Mortgage-Backed Securities, gross $6,063,131 $12,061,462 $604,310 $18,728,903
Unamortized discount (171) (843) (109) (1,123)
Unamortized premium 130,211 288,217 8,528 426,956
------------------- --------------------- --------------------- -----------------
Amortized cost 6,193,171 12,348,836 612,729 19,154,736
Gross unrealized gains 11,534 9,905 1,582 23,021
Gross unrealized losses (39,429) (97,890) (2,052) (139,371)
------------------- --------------------- --------------------- -----------------
Estimated fair value $6,165,276 $12,260,851 $612,259 $19,038,386
=================== ===================== ===================== =================
GROSS UNREALIZED GROSS UNREALIZED ESTIMATED FAIR
AMORTIZED COST GAIN LOSS VALUE
------------------- --------------------- --------------------- -----------------
(dollars in thousands)
Adjustable rate $13,833,122 $20,713 ($93,796) $13,760,039
Fixed rate 5,321,614 2,308 (45,575) 5,278,347
------------------- --------------------- --------------------- -----------------
Total $19,154,736 $23,021 ($139,371) $19,038,386
=================== ===================== ===================== =================
9
Actual maturities of mortgage-backed securities are generally shorter
than stated contractual maturities. Actual maturities of the Company's
mortgage-backed securities are affected by the contractual lives of the
underlying mortgages, periodic payments of principal, and prepayments of
principal. The following table summarizes the Company's mortgage-backed
securities on June 30, 2005 and December 31, 2004 according to their estimated
weighted-average life classifications:
JUNE 30, 2005 DECEMBER 31, 2004
---------------------------------- ----------------------------------
FAIR VALUE AMORTIZED COST FAIR VALUE AMORTIZED COST
WEIGHTED-AVERAGE LIFE (DOLLARS IN THOUSANDS)
- ------------------------------------------------ ---------------------------------------------------------------------
Less than one year $ 294,873 $ 297,228 $ 357,135 $ 359,433
Greater than one year and less than five years 16,154,951 16,281,126 14,623,143 14,705,212
Greater than or equal to five years 2,715,920 2,728,335 4,058,108 4,090,091
----------------- ---------------- ---------------- -----------------
Total $19,165,744 $19,306,689 $19,038,386 $19,154,736
================= ================ ================ =================
The weighted-average lives of the mortgage-backed securities June 30,
2005 and December 31, 2004 in the table above are based upon data provided
through subscription-based financial information services, assuming constant
principal prepayment rates to the reset date of each security. The prepayment
model considers current yield, forward yield, steepness of the yield curve,
current mortgage rates, mortgage rates of the outstanding loans, loan age,
margin and volatility.
Mortgage-Backed Securities with a carrying value of $6.7 billion were in
a continuous unrealized loss position over 12 months at June 30, 2005 in the
amount of $87.3 million. Mortgage-Backed Securities with a carrying value of
$10.0 billion were in a continuous unrealized loss position for less than 12
months at June 30, 2005 in the amount of $61.6 million. Mortgage-Backed
Securities with a carrying value of $2.2 billion were in a continuous unrealized
loss position over 12 months at December 31, 2004 in the amount of $34.1
million. Mortgage-Backed Securities with a carrying value of $13.1 billion were
in a continuous unrealized loss position for less than 12 months at December 31,
2004 in the amount of $105.3 million. The decline in value of these securities
is solely due to increases 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, to maturity if
necessary, 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
nine months) and lifetime caps. The weighted average lifetime cap was 10.2% at
June 30, 2005 and 10.1% December 31, 2004.
During the quarter ended June 30, 2005, the Company realized $11.4
million in net gains from sales of Mortgage-Backed Securities. During the
quarter ended June 30, 2004, the Company realized $2.1 million in net gains from
sales of Mortgage-Backed Securities.
10
4. AGENCY DEBENTURES
The Company owns callable agency debentures totaling $395.0 million par
value, which were issued by FHLMC, FNMA, and FHLB. All of the Company's agency
debentures are classified as available-for-sale. The agency debentures had
carrying values of $391.1 million and $390.5 million at June 30, 2005 and
December 31, 2004, respectively. The agency debentures with a carrying value of
$391.1 million have been in a continuous unrealized loss position over 12 months
at June 30, 2005 in the amount of $3.9 million. The debentures with a carrying
value of $390.5 million were in a continuous unrealized loss position for less
than 12 months at December 31, 2004 in the amount of $4.5 million. The Company's
agency debentures are adjustable rate and fixed rate with a weighted average
lifetime cap of 5.1% at June 30, 2005 and 3.7% at December 31, 2004. 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 to maturity if necessary,
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
agency debentures.
5. REPURCHASE AGREEMENTS
The Company had outstanding $17.3 billion and $16.7 billion of
repurchase agreements with weighted average borrowing rates of 3.20% and 2.46%,
and weighted average remaining maturities of 81 days and 111 days as of June 30,
2005 and December 31, 2004, respectively. Investment securities pledged as
collateral under these repurchase agreements had an estimated fair value of
$18.6 billion and $17.4 billion at June 30, 2005 and December 31, 2005,
respectively.
At June 30, 2005 and December 31, 2004, the repurchase agreements had
the following remaining maturities:
JUNE 30, 2005 DECEMBER 31, 2004
(DOLLARS IN THOUSANDS)
-------------------------------------------------------------
Within 30 days $15,161,211 $13,059,810
30 to 59 days 240,383 1,598,069
60 to 89 days 100,000 -
90 to 119 days - -
Over 120 days 1,750,000 2,050,000
------------------------------- -----------------------------
Total $17,251,594 $16,707,879
=============================== =============================
6. OTHER LIABILITIES
In 2001, the Company entered into a repurchase agreement maturing in
July 2004. This repurchase agreement provided the buyer the right to extend its
maturity date, in whole or in part, in three-month increments up to July 2006.
The buyer has continuously exercised its right to extend the maturity date, and
the agreement is currently set to mature in July 2006. The repurchase agreement
has a principal amount of $100,000,000, and is included in repurchase agreements
contained in the statements of financial condition. 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 three years using the effective yield
method. At June 30, 2005 and December 31, 2004, the fair value of this interest
rate floor was $1.1 million and $2.7 million, respectively, and is included in
other liabilities in the Statements of Financial Condition.
7. PREFERRED STOCK AND COMMON STOCK
During the quarter ended June 30, 2005, the Company declared dividends to
common shareholders totaling $44.1 million or $0.36 per share, which were paid
on July 28, 2005. During the quarter ended June 30, 2005, the Company declared
dividends to preferred shareholders totaling $3.6 million or $0.492188 per
share, which were paid on June 30, 2005. During the quarter ended June 30, 2005,
10,628 options were exercised under the long-term compensation plan for an
aggregate exercise price of $154,000. In addition, the Company sold 7,902 common
shares through the dividend reinvestment and direct purchase program for
$149,000 during the quarter ended June
11
30, 2005. During the quarter ended June 30, 2005, the Company raised $23.1
million in the Equity Shelf Program by issuing 1,258,603 common shares. During
the quarter ending June 30, 2004, the Company declared dividends to shareholders
totaling $57.7 million or $0.48 per share, which was paid on July 28, 2004.
During the quarter ended June 30, 2004, the Company declared dividends to
preferred shareholders totaling $2.0 million or $0.47 per share, which were paid
on June 30, 2004. During the quarter ended June 30, 2004, no shares were issued
through the Equity Shelf Program. During the quarter ended June 30, 2004, 11,750
options were exercised under the long-term compensation plan for an aggregate
exercise price of $203,000. In addition, the Company sold 69,006 common shares
through the dividend reinvestment and direct purchase program for $1.2 million
during the quarter ended June 30, 2004. During the quarter ended June 30, 2004,
2,201,080 common shares were issued under the terms of the FIDAC merger
agreement.
During the six months ended June 30, 2005, 1,258,603 common shares of
the Company's common stock were issued through the Equity Shelf Program for net
proceeds of $23.1 million. During the six months ended June 30, 2005, 16,128
options were exercised under the long-term compensation plan for an aggregate
exercise price of $253,000. Also, 17,100 common shares were sold through the
dividend reinvestment and direct purchase program for $326,000. 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
raised 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 six months ended June 30, 2004, 1,027,400
shares of the Company's common stock were issued through the Equity Shelf
Program for net proceeds of $20.1 million. During the six months ended June 30,
2004, 40,250 options were exercised under the long-term compensation plan for an
aggregate exercise price of $662,000. In addition, the Company sold 105,942
common shares through the dividend reinvestment and direct purchase program for
$1.9 million for the six months ended June 30, 2004.
8. NET INCOME PER COMMON SHARE
The following table presents a reconciliation of the earnings and
shares used in calculating basic and diluted EPS for the quarters ended June 30,
2005 and 2004.
FOR THE QUARTERS ENDED FOR THE SIX MONTHS ENDED
JUNE 30, 2005 JUNE 30, 2004 JUNE 30, 2005 JUNE 30, 2004
(DOLLARS AND SHARES IN THOUSANDS)
----------------- ----------------- ------------------ ------------------
Net income $46,993 $63,835 $106,326 $122,678
Less: Preferred stock dividend 3,648 1,998 7,297 1,998
----------------- ----------------- ------------------ ------------------
Net income available to common
shareholders $43,345 $61,837 $99,029 $120,680
----------------- ----------------- ------------------ ------------------
Weighted average shares of common
stock outstanding-basic 121,740 118,277 121,507 115,391
Add: Effect of dilutive stock options 273 193 279 268
----------------- ----------------- ------------------ ------------------
Weighted average shares of common
stock outstanding-diluted 122,013 118,470 121,786 115,659
================= ================= ================== ==================
Options to purchase 10,000 shares and 12,500 of common stock were
outstanding and considered anti-dilutive as their exercise price exceeded the
average stock price for each of the quarters and six months ended June 30, 2005
and 2004 respectively.
9. LONG-TERM STOCK INCENTIVE PLAN
The Company has adopted a long term stock incentive plan for executive
officers, key employees and non-employee directors (the "Incentive Plan"). The
Incentive Plan authorizes the Compensation Committee of the board of directors
to grant awards, including non-qualified options as well as incentive stock
options as defined under
12
Section 422 of the Code. 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
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 SIX MONTHS ENDED
2005 2004
------------------------------ ----------------------------------
WEIGHTED WEIGHTED
NUMBER OF AVERAGE NUMBER OF AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE
- ---------------------------------------- ------------ ----------------- --------------- ------------------
Options outstanding at the beginning
of period 1,645,721 $15.66 1,063,259 $14.28
Granted 6,250 18.26 639,750 17.39
Exercised (16,128) 12.21 (40,200) 8.82
Expired (33,750) 17.87 - -
------------ ----------------- --------------- ------------------
Options outstanding at the end of
period. 1,602,093 $15.66 1,662,809 $15.61
============ ================= =============== ==================
The following table summarizes information about stock options outstanding at
June 30, 2005:
WEIGHTED AVERAGE
WEIGHTED AVERAGE REMAINING CONTRACTUAL
RANGE OF EXERCISE PRICES OPTIONS OUTSTANDING EXERCISE PRICE LIFE (YEARS)
- ------------------------------- ----------------------- ------------------------ ---------------------------
$7.94-$19.99 1,592,093 $15.63 7.5
$20.00-$29.99 10,000 20.53 2.5
----------------------- ------------------------ ---------------------------
1,602,093 $15.66 7.4
======================= ======================== ===========================
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:
For the quarters ended For the six months ended
(dollars in thousands)
---------------------------------------------------------------------------
June 30, 2005 June 30, 2004 June 30, 2005 June 30, 2004
---------------- ------------------ ------------------ --------------------
Net income available to common
shareholders, as reported $43,345 $61,837 $99,029 $120,680
Deduct: Total stock-based employee
compensation expense determined
under fair value based method (36) (37) (71) (75)
---------------- ------------------ ------------------ --------------------
Pro-forma net income available to
common shareholers $43,309 $61,800 $98,958 $120,605
================ ================== ================== ====================
Net income per share available to
common shareholders, as reported:
Basic $0.36 $0.52 $0.82 $1.05
================ ================== ================== ====================
Diluted $0.36 $0.52 $0.81 $1.04
================ ================== ================== ====================
Pro-forma net income per share
available to common shareholders:
Basic $0.36 $0.52 $0.81 $1.05
================ ================== ================== ====================
Diluted $0.35 $0.52 $0.81 $1.04
================ ================== ================== ====================
13
10. INCOME TAXES
The Company has elected to be taxed as a REIT under the Code. In
connection with the Company's merger with FIDAC effective June 4, 2004, the
Company and FIDAC made a joint election to treat FIDAC as a taxable REIT
subsidiary under the Code. As a REIT, the Company is not subject to Federal
income tax on earnings distributed to its shareholders. Most states recognize
REIT status as well. The Company has decided to distribute the majority of its
income and retain a portion of the permanent difference between book and taxable
income arising from Section 162(m) of the Code pertaining to employee
remuneration.
During the quarter ended June 30, 2005, the Company recorded $2.4
million of income tax expense for income attributable to FIDAC, its taxable REIT
subsidiary, and the portion of earnings retained based on Code Section 162(m)
limitations. During the quarter ended June 30, 2004, the Company recorded
$658,000 of income tax expense for a portion of earnings retained based on
Section 162(m) limitations.
11. LEASE COMMITMENTS
The Company has a noncancelable lease for office space, which commenced
in May 2002 and expires in December 2009.
The Company's aggregate future minimum lease payments are as follows:
TOTAL PER YEAR
(DOLLARS IN THOUSANDS)
-------------------------
2005 $ 270
2006 530
2007 532
2008 532
2009 532
-------------------------
Total remaining lease payments $2,396
=========================
12. INTEREST RATE RISK
The primary market risk to the Company is interest rate risk. Interest
rates are highly sensitive to many factors, including governmental monetary and
tax policies, domestic and international economic and political considerations
and other factors beyond the Company's control. Changes in the general level of
interest rates can affect net interest income, which is the difference between
the interest income earned on interest-earning assets and the interest expense
incurred in connection with the interest-bearing liabilities, by affecting the
spread between the interest-earning assets and interest-bearing liabilities.
Changes in the level of interest rates also can affect the value of the
Investment Securities and the Company's ability to realize gains from the sale
of these assets. A decline in the value of the Investment 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
Investment Securities by entering into interest rate agreements such as interest
rate caps and interest rate swaps.
14
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.
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 and
risks associated with the investment advisory business of FIDAC, including the
removal by FIDAC's clients of assets FIDAC manages, FIDAC's regulatory
requirements, and competition in the investment advisory business. 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 2004 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 and from
dividends we receive from FIDAC, which earns investment advisory fee income.
FIDAC is our wholly-owned subsidiary, and is a registered investment advisor
that generates advisory and service fee income.
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
15
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.
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 our 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 includes 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. 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 :
QUARTER ENDED CPR
- ------------- ---
June 30, 2005 27%
March 31, 2005 25%
December 31, 2004 27%
September 30, 2004 25%
June 30, 2004 33%
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 reduced contractual maturities on borrowings, such that our
weighted average contractual maturity on our repurchase agreements was 152 days
at June 30, 2005, as compared to 211 days at December 31, 2004.
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.
16
YIELD ON
AVERAGE AVERAGE AVERAGE
INVESTMENT TOTAL INTEREST BALANCE OF TOTAL AVERAGE NET
SECURITIES INTEREST EARNING REPURCHASE INTEREST COST OF INTEREST
HELD (1) INCOME ASSETS AGREEMENTS EXPENSE FUNDS INCOME
------------ -------- --------- ---------- --------- ------- -----------
(RATIOS FOR THE QUARTERS HAVE BEEN ANNUALIZED, DOLLARS IN THOUSANDS)
Quarter Ended June 30, 2005 $18,918,577 $171,595 3.63% $17,658,408 $133,758 3.03% $37,837
Quarter Ended March 31, 2005 $18,798,200 $176,289 3.75% $17,756,241 $113,993 2.57% $62,296
- ---------------------------------------------------------------------------------------------------------------------
Quarter Ended December 31, 2004 $17,932,449 $156,783 3.50% $16,896,216 $93,992 2.23% $62,791
Quarter Ended September 30, 2004 $16,562,971 $138,970 3.36% $15,568,691 $70,173 1.80% $68,797
Quarter Ended June 30, 2004 $16,649,072 $122,234 2.94% $15,880,353 $55,648 1.40% $66,586
Quarter Ended March 31, 2004 $14,452,245 $114,341 3.16% $13,587,211 $50,303 1.48% $64,038
(1) Does not reflect unrealized gains/(losses).
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 in 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. These policies have not changed during 2005.
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, we are required to classify
all of our Investment Securities as available-for-sale. Our policy is to obtain
market values from at least three independent sources and record the market
value of the securities based on the average of the three. Management evaluates
securities for other-than-temporary impairment at least on a quarterly basis,
and more frequently when economic or market concerns warrant such evaluation.
Consideration is given to (1) the length of time and the extent to which the
fair value has been less than cost, (2) the financial condition and near-term
prospects of the issuer, and (3) the intent and ability of the Company to retain
its investment in the issuer for a period of time sufficient to allow for any
anticipated recovery in fair value. The investments with unrealized losses are
not considered other-than-temporarily impaired since the Company has the ability
and intent to hold the investments for a period of time, to maturity if
necessary, sufficient for a forecasted market price recovery up to or beyond the
cost of the investments. 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 June 30, 2005 and 2004. If in the future
management determines an impairment to be other-than-temporary, we may need to
realize a loss that would have an impact on future income.
INTEREST INCOME: 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 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. If our estimate of
prepayments is incorrect, we may be required to make an adjustment to the
amortization or accretion of premiums and discounts that would have an impact on
future income.
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.
17
INCOME TAXES: We have elected to be taxed as a Real Estate Investment
Trust ("REIT") and intend 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. The Company and FIDAC have made a joint election to
treat FIDAC as a taxable REIT subsidiary. As such, FIDAC is taxable as a
domestic C corporation and subject to federal and state and local income taxes
based upon its taxable income.
RESULTS OF OPERATIONS: FOR THE QUARTERS AND SIX MONTHS ENDED JUNE 30, 2005 AND
2004
NET INCOME SUMMARY
For the quarter ended June 30, 2005, our net income was $47.0 million,
or $0.36 basic earnings per share available for common shareholders, as compared
to $63.8 million, or $0.52 basic earnings per average share, for the quarter
ended June 30, 2004. We attribute the decrease in total net income for the
quarter ended June 30, 2005, from the quarter ended June 30, 2004 to the decline
in net interest income. Even with the increased asset base from June 30, 2004 to
June 30, 2005, the decrease in total net income share was primarily due to the
decline in the interest rate spread from 1.54% to 0.60%. For the quarter ended
June 30, 2005, gain on sale of Mortgage-Backed Securities was $11.4 million as
compared to $2.1 million for the quarter ended June 30, 2004. For the quarter
ended June 30, 2005, net investment advisory and service fees totaled $7.5
million, as compared to $1.3 million for the quarter ended June 30, 2004. The
gains on sale of Mortgage-Backed Securities and the net investment advisory and
service fees increased substantially, but did not offset the effect of the
decline in the interest rate spread. Dividends for the quarter ended June 30,
2005, were $0.36 per share of common stock, or $44.1 million in total, and
0.492188 per share of preferred stock, or $3.7 million in total. Dividends per
share for the quarter ended June 30, 2004 were $0.48 per share of common stock,
or $57.7 million in total. Our return on average equity was 11.36% for the
quarter ended June 30, 2005 and 15.76% for the quarter ended June 30, 2004. The
decrease in return on average equity resulted primarily from the decrease in net
interest spread primarily from the increase in the weighted average cost of
funds rate from 1.40% for the quarter ended June 30, 2004 to 3.03% for the
quarter ended June, 30, 2005, which was only partially offset by the increase in
yield from 2.94% to 3.63%.
For the six months ended June 30, 2005, our net income was $106.3
million, or $0.82 basic earnings per share, as compared to $122.7 million, or
$1.05 basic earnings per average share available to common shareholders, for the
six months ended June 30, 2004. We attribute the decrease in net income for the
six months ended June 30, 2005, from the six months ended June 30, 2004 to the
decrease in net interest income. Even with the substantial increase in gain on
sale of mortgage-backed securities and net investment advisory and service fees,
the decline in interest rate spread of 71 basis points resulted in the decline
of net income for the six months ended June 30, 2005. For the six months ended
June 30, 2005, gain on sale of Mortgage-Backed Securities was $12.0 million, as
compared to $2.7 million. For the six months ended June 30, 2005, net investment
advisory and service fees totaled $12.2 million, as compared to $1.3 million for
the six months ended June 30, 2004. Dividends per share for the six months ended
June 30, 2005, were $0.81 per share of common stock, or $98.7 million in total
and $0.984376 per share of preferred stock or $7.3 million in total. Dividends
per share for the six months ended June 30, 2004 were $0.98 per share, or $116.6
million in total and $0.47 per share of preferred stock or $2.0 million in
total. Our return on average equity was 12.73% for the six months ended June 30,
2005 and 16.77% for the six months ended June 30, 2004. The decline in the
return on average equity resulted from the decline in net interest income that
was only partial offset by an increase in net advisory fee income and gains on
the sale of Mortgage-Backed Securities.
18
NET INCOME SUMMARY
(RATIOS FOR THE QUARTER HAVE BEEN ANNUALIZED, DOLLARS IN THE THOUSANDS, EXCEPT
FOR PER SHARE DATA)
QUARTER QUARTER SIX MONTHS
ENDED ENDED ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
2005 2004 2005 2004
---------------- --------------- ---------------- -----------------
Interest income $171,595 $122,234 $347,884 $236,575
Interest expense 133,758 55,648 247,751 105,951
---------------- --------------- ---------------- -----------------
Net interest income 37,837 66,586 100,133 130,624
Investment advisory and service fees 9,669 1,558 15,978 1,558
Gain on sale of Mortgage-Backed
Securities 11,435 2,126 12,016 2,721
Distribution fees 2,126 298 3,737 298
General and administrative expenses 6,800 5,643 13,464 11,008
---------------- --------------- ---------------- -----------------
Income before income taxes 50,015 $64,329 110,926 123,597
Income taxes 3,022 494 4,600 919
---------------- --------------- ---------------- -----------------
Net income 46,993 $63,835 $106,326 $122,678
Dividends on preferred stock 3,648 1,998 7,297 1,998
---------------- --------------- ---------------- -----------------
Net income available to common
shareholders $43,345 $61,837 $99,029 $120,680
================ =============== ================ =================
Weighted average number of basic common
shares outstanding 121,740,256 118,276,509 121,506,858 115,391,357
Weighted average number of diluted
common shares outstanding 122,013,050 118,469,756 121,785,918 115,659,173
Basic net income per common share $0.36 $0.52 $0.82 $1.05
Diluted net income per common share $0.36 $0.52 $0.81 $1.04
Average total assets $19,455,044 $17,790,725 $19,490,129 $16,190,579
Average total equity $1,654,932 $1,620,550 $1,700,488 $1,463,440
Annualized return on average assets 0.97% 1.44% 1.09% 1.52%
Annualized return on average equity 11.36% 15.76% 12.73% 16.77%
INTEREST INCOME AND AVERAGE EARNING ASSET YIELD
We had average earning assets of $18.9 billion and $16.6 billion for
the quarters ended June 30, 2005 and 2004, respectively. Our primary source of
income for the quarters ended June 30, 2005 and 2004 was interest income. A
portion of our income was generated by gains on the sales of our Mortgage-Backed
Securities and net income from FIDAC. Our interest income was $171.6 million for
the quarter ended June 30, 2005 and $122.2 million for the quarter ended June
30, 2004. The yield on average investment securities increased from 2.94% for
the quarter ended June 30, 2004 to 3.63% for the quarter ended June 30, 2005.
Our average earning asset balance increased by $2.3 billion and interest income
increased by $49.4 million for the quarter ended June 30, 2005 as compared to
the quarter ended June 30, 2004. The increase was the direct result of the
increased asset base and increase in weighted average yield. The average coupon
rate at June 30, 2005 was 4.69%, as compared to 4.31% at June 30, 2004. The
prepayment speeds decreased to 27% CPR for the quarter ended June 30, 2005 from
33% CPR for the quarter ended June 30, 2004. The increase in coupon rates, in
conjunction with lower prepayment speeds, resulted in an increase in yield of 69
basis points.
We had average earning assets of $18.9 billion and $15.6 billion for
the six months ended June 30, 2005 and 2004, respectively. Our interest income
was $347.9 million for the six months ended June 30, 2005 and $236.6 million for
the six months ended June 30, 2004. The yield on average investment securities
increased from 3.04% for the six months ended June 30, 2004, to 3.69% for the
six months ended June 30, 2005. Our average earning asset balance increased by
$3.3 billion and interest income increased by $111.3 million for the six months
ended June 30, 2005 as compared to the six months ended June 30, 2004. The
increase in interest income for the six months ended June 30, 2005, when
compared to the six months ended June 30, 2004, resulted from the increased
asset base and the increase in weighted average yield.
The table below shows our average balance of interest earning assets,
our yield on average earning assets and our interest income for the quarters
ended June 30, 2005, March 31, 2005, the year ended December 31, 2004, and the
four quarters in 2004.
19
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
Quarter Ended June 30, 2005 $18,918,577 3.63% 27% $171,595
Quarter Ended March 31, 2005 $18,798,200 3.75% 25% $176,289
- -----------------------------------------------------------------------------------------------------
Year Ended December 31, 2004 $16,399,184 3.25% 29% $532,328
Quarter Ended December 31, 2004 $17,932,449 3.50% 27% $156,783
Quarter Ended September 30, 2004 $16,562,971 3.36% 25% $138,970
Quarter Ended June 30, 2004 $16,649,072 2.94% 33% $122,234
Quarter Ended March 31, 2004 $14,452,245 3.16% 31% $114,341
- -----------------------------------------------------------------------------------------------------
The CPR decreased to 27% for the quarter ended June 30, 2005, as
compared to 33% for the quarter ended June 30, 2004. The total amortization of
premium and discount on Investment Securities for the quarters ended June 30,
2005 and 2004 was $42.7 million and $56.1 million, respectively.
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 $17.7 billion and total interest expense
of $133.8 million for the quarter ended June 30, 2005. We had average borrowed
funds of $15.9 billion and total interest expense of $55.6 million for the
quarter ended June 30, 2004. Our average cost of funds was 3.03% for the quarter
ended June 30, 2005 and 1.40% for the quarter ended June 30, 2004. The cost of
funds rate increased by 163 basis points and the average borrowed funds
increased by $1.8 billion for the quarter ended June 30, 2005 when compared to
the quarter ended June 30, 2004. Interest expense for the quarter increased by
$78.2 million due to the substantial increase in the average repurchase balance
and weighted average cost of funds rate. Our average cost of funds was 0.02%
below average one-month LIBOR and 0.40% below average six-month LIBOR for the
quarter ended June 30, 2005. Our average cost of funds was 0.25% above average
one-month LIBOR and 0.14% below average six-month LIBOR for the quarter ended
June 30, 2004.
We had average borrowed funds of $17.7 billion and total interest
expense of $247.8 million for the six months ended June 30, 2005. We had average
borrowed funds of $14.7 billion and total interest expense of $106.0 million for
the six months ended June 30, 2004. Our average cost of funds was 2.8% for the
six months ended June 30, 2005 and 1.44% for the six months ended June 30, 2004.
The cost of funds rate increased 1.36% and the average borrowed funds increased
by $3.0 billion for the six months ended June 30, 2005 when compared to the six
months ended June 30, 2004. Interest expense for the six months increased by
$141.8 million, due to the substantial increase in the average repurchase
balance and a 136 basis point increase in the average funding rate.
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
quarters ended June 30, 2005, March 31, 2005, the year ended December 31, 2004
and the four quarters in 2004.
20
AVERAGE COST OF FUNDS
(RATIOS FOR THE QUARTERS HAVE BEEN ANNUALIZED, DOLLARS IN THOUSANDS)
AVERAGE
AVERAGE AVERAGE COST OF
ONE-MONTH COST OF FUNDS
LIBOR FUNDS RELATIVE
RELATIVE RELATIVE TO
AVERAGE AVERAGE AVERAGE AVERAGE TO AVERAGE TO AVERAGE AVERAGE
BORROWED INTEREST COST OF ONE-MONTH SIX-MONTH SIX-MONTH ONE-MONTH SIX-MONTH
FUNDS EXPENSE FUNDS LIBOR LIBOR LIBOR LIBOR LIBOR
----------- -------- ------- --------- --------- ---------- ---------- ---------
Quarter Ended June 30, 2005 $17,658,408 $133,758 3.03% 3.05% 3.43% (0.38%) (0.02%) (0.40%)
Quarter Ended March 31, 2005 $17,756,241 $113,993 2.57% 2.58% 3.02% (0.44%) (0.01%) (0.45%)
- ----------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 2004 $15,483,118 $270,116 1.74% 1.50% 1.80% (0.30%) 0.24% (0.06%)
Quarter Ended December 31, 2004 $16,896,216 $93,992 2.23% 2.14% 2.48% (0.34%) 0.09% (0.25%)
Quarter Ended September 30, 2004 $15,568,691 $70,173 1.80% 1.59% 1.97% (0.38%) 0.21% (0.17%)
Quarter Ended June 30, 2004 $15,880,353 $55,648 1.40% 1.15% 1.54% (0.39%) 0.25% (0.14%)
Quarter Ended March 31, 2004 $13,587,211 $50,303 1.48% 1.10% 1.18% (0.08%) 0.38% 0.30%
NET INTEREST INCOME
Our net interest income, which equals interest income less interest
expense, totaled $37.8 million for the quarter ended June 30, 2005 and $66.6
million for the quarter ended June 30, 2004. Our net interest income decreased
because the interest rate spread decreased, even though our asset base
increased. Our net interest spread, which equals the yield on our average assets
for the period less the average cost of funds for the period, was 0.60% for the
quarter ended June 30, 2005 as compared to 1.54 % for the quarter ended June 30,
2004. This 94 basis point decrease was a result of the increase in the cost of
funding for the quarter ended June 30, 2005 to 3.03% from 1.40% for the quarter
ended June 30, 2004. The increase in cost of funds was only partially offset by
the increase in yield on assets, which increased to 3.63% for the quarter ended
June 30, 2005, as compared to 2.94% for the quarter ended June 30, 2004.
Our net interest income totaled $100.1 million for the six months ended
June 30, 2005 and $130.6 million for the six months ended June 30, 2004. Our net
interest income decreased because of the decline in interest rate spread. Our
net interest spread, which equals the yield on our average assets for the period
less the average cost of funds for the period, was 0.89% for the six months
ended June 30, 2005 as compared to 1.60% for the quarter ended June 30, 2004.
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
quarters ended June 30, 2005, March 31, 2005 the year ended December 31, 2004,
and the four quarters in 2004.
NET INTEREST INCOME
(RATIOS FOR THE QUARTERS HAVE BEEN ANNUALIZED, DOLLARS IN THOUSANDS)
YIELD ON
AVERAGE AVERAGE AVERAGE NET
INVESTMENT TOTAL INTEREST BALANCE OF AVERAGE NET INTEREST
SECURITIES INTEREST EARNING REPURCHASE INTEREST COST OF INTEREST RATE
HELD INCOME ASSETS AGREEMENTS EXPENSE FUNDS INCOME SPREAD
---------- -------- --------- ---------- -------- ------- -------- --------
Quarter Ended June 30, 2005 $18,918,577 $171,595 3.63% $17,658,408 $133,758 3.03% $37,837 0.60%
Quarter Ended March 31, 2005 $18,798,200 $176,289 3.75% $17,756,241 $113,993 2.57% $62,296 1.18%
- --------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 2004 $16,399,184 $532,328 3.25% $15,483,118 $270,116 1.74% $262,212 1.51%
Quarter Ended December 31, 1.27%
2004 $17,932,449 $156,783 3.50% $16,896,216 $93,992 2.23% $62,791
Quarter Ended September 30,
2004 $16,562,971 $138,970 3.36% $15,568,691 $70,173 1.80% $68,797 1.56%
Quarter Ended June 30, 2004 $16,649,072 $122,234 2.94% $15,880,353 $55,648 1.40% $66,586 1.54%
Quarter Ended March 31, 2004 $14,452,245 $114,341 3.16% $13,587,211 $50,303 1.48% $64,038 1.68%
21
INVESTMENT ADVISORY AND SERVICE FEES
FIDAC is a registered investment advisor which generally receives
annual net investment advisory fees of approximately 10 to 20 basis points of
the gross assets it manages, assists in managing or supervises. At June 30,
2005, FIDAC had under management approximately $3.1 billion in net assets and
$27.8 billion in gross assets, compared to $1.7 billion in net assets and $12.8
billion in gross assets at June 30, 2004. Investment advisory and service fees
for the quarter ended June 30, 2005 and June 30, 2004 totaled $7.6 and $1.3
million respectively, net of fees paid to third parties pursuant to distribution
service agreements for facilitating and promoting distribution of shares of
FIDAC's clients. At June 30, 2005, net assets under management increased by $1.8
billon and gross assets under management increased by $15.0 billion, when
compared to June 30, 2004. Investment advisory and service fees for the quarter
ended June 30, 2005 are for the entire quarter; whereas for the quarter ended
June 30, 2004, investment advisory and service fees are for the period from June
4, 2004 through June 30, 2004.
GAINS AND LOSSES ON SALES OF MORTGAGE-BACKED SECURITIES
For the quarter ended June 30, 2005, we sold Mortgage-Backed Securities
with an aggregate historical amortized cost of $859.3 million for an aggregate
gain of $11.4 million. For the quarter ended June 30, 2004 we sold
Mortgage-Backed Securities with an aggregate historical amortized cost of $182.8
million for an aggregate gain of $2.1 million. For the six months ended June 30,
2005, we sold Mortgage-Backed Securities with an aggregate historical amortized
cost of $944.7 million for an aggregate gain of $12.0 million. For the six
months ended June 30, 2004, we sold Mortgage-Backed Securities with an aggregate
historical amortized cost of $256.4 million for an aggregate gain of $2.7
million. The difference between the sale price and the historical amortized cost
of our Mortgage-Backed Securities is a realized gain and increases income
accordingly. We do not expect to sell assets on a frequent basis, but may from
time to time sell existing assets to acquire 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 $6.8 million for the
quarter ended June 30, 2005 and $5.6 million for the quarter ended June 30,
2004. G&A expenses as a percentage of average assets were 0.14% and 0.13% for
the quarters ended June 30, 2005 and June 30, 2004 respectively. G&A expenses as
a percentage of average equity were 1.64% and 1.39% on an annualized basis for
the quarters ended June 30, 2005 and June 30, 2004, respectively. The increase
in G&A expenses of $1.2 million for the quarter ended June 30, 2005, was
primarily the result of increased salaries, directors and officers' insurance
and additional costs related to FIDAC business. G&A expense has increased
proportionately with our increased capital base and the growth in staff.
G&A expenses were $13.5 million for the six months ended June 30, 2005
and $11.0 million for the six months ended June 30, 2004. G&A expenses as a
percentage of average assets was 0.14% and 0.14% on an annualized basis for the
six months ended June 30, 2005 and 2004, respectively. G&A expenses as a
percentage of average equity was 1.61% and 1.50% on an annualized basis for the
six months ended June 30, 2005 and 2004, respectively.
The table below shows our total G&A expenses as compared to average
total assets and average equity for the quarter ended June 30, 2005, March 31,
2005, the year ended December 31, 2004, and the four quarters in 2004.
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)
--------- ------------------- -------------------
Quarter Ended June 30, 2005 $6,800 0.14% 1.64%
Quarter Ended March 31, 2005 $6,664 0.14% 1.61%
----------------------------------------- ------------------ ----------------------- ---------------------
Year Ended December 31, 2004 $24,029 0.14% 1.55%
Quarter Ended December 31, 2004 $6,862 0.14% 1.63%
Quarter Ended September 30, 2004 $6,159 0.14% 1.53%
Quarter Ended June 30, 2004 $5,643 0.13% 1.39%
Quarter Ended March 31, 2004 $5,365 0.15% 1.63%
22
NET INCOME AND RETURN ON AVERAGE EQUITY
Our net income was $47.0 million for the quarter ended June 30, 2005
and $63.8 million for the quarter ended June 30, 2004. Our annualized return on
average equity was 11.36% for the quarter ended June 30, 2005 and 15.76% for the
quarter ended June 30, 2004. Our net income was $106.3 million for the six
months ended June 30, 2005 and $122.7 million for the six months ended June 30,
2004. Our return on average equity was 12.73% for the six months ended June 30,
2005 and 16.77% for the six months ended June 30, 2004. We attribute the
decrease in net income and return on average equity to the interest rate spread
compression for the quarter and six months. The decline in spread income was
only partially offset by the increase in gains on sales of Mortgage-Backed
Securities and increase in net advisory and service fees. The table below shows
our net interest income, investment advisory and service fees, gain on sale of
Mortgage-Backed Securities, G&A expenses, and income taxes each as a percentage
of average equity, and the return on average equity for the quarter ended June
30, 2005, March 31, 2005, the year ended December 31, 2004, and the four
quarters in 2004.
COMPONENTS OF RETURN ON AVERAGE EQUITY
(RATIOS FOR ALL QUARTERS ARE ANNUALIZED)
NET
INVESTMENT
ADVISORY AND GAIN ON SALE
SERVICE OF INCOME
NET INTEREST FEES/ MORTGAGE-BACKED G&A EXPENSES/ TAXES/ RETURN ON
INCOME/AVERAGE AVERAGE SECURITIES/ AVERAGE AVERAGE AVERAGE
EQUITY EQUITY AVERAGE EQUITY EQUITY EQUITY EQUITY
-------------- ------------ ---------------- ------------- --------- -----------
Quarter Ended June 30, 2005 9.15% 1.82% 2.76% 1.64% 0.73% 11.36%
Quarter Ended March 31, 2005 15.06% 1.13% 0.14% 1.61% 0.38% 14.34%
- -------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 2004 16.92% 0.62% 0.34% 1.55% 0.29% 16.04%
Quarter Ended December 31, 2004 14.95% 1.10% 0.27% 1.63% 0.57% 14.12%
Quarter Ended September 30, 2004 17.13% 0.94% 0.34% 1.53% 0.29% 16.59%
Quarter Ended June 30, 2004 16.44% 0.31% 0.52% 1.39% 0.12% 15.76%
Quarter Ended March 31, 2004 18.05% - 0.17% 1.63% - 16.59%
FINANCIAL CONDITION
INVESTMENT SECURITIES
All of our Mortgage-Backed Securities at June 30, 2005 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,
which carry an actual or implied "AAA" rating. We mark-to-market all of our
Mortgage Backed Securities to fair value.
All of our agency debentures are callable and carry an implied "AAA"
rating. We mark-to-market all of our agency debentures to fair value.
We accrete discount balances as an increase in interest income over the
life of Investment Securities purchased at a discount and we amortize premium
balances as a decrease in interest income over the life of the Investment
Securities purchased at a premium. At June 30, 2005 and December 31, 2004, we
had in our statement of financial condition a total of $1.9 million and $1.1
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
$403.2 million and $427.0 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).
23
We received mortgage principal repayments of $1.7 billion for the
quarter ended June 30, 2005 and $2.1 billion for the quarter ended June 30,
2004. The overall prepayment speed for the year quarter June 30, 2005 declined
to 27%, as compared to 33% for the quarter ended June 30, 2004, due to a decline
in refinancing activity. 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 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 June 30, 2005,
March 31, 2005, December 31, 2004, September 30, 2004, June 30, 2004, and March
31, 2004.
INVESTMENT SECURITIES
(DOLLARS IN THOUSANDS)
AMORTIZED FAIR WEIGHTED
PRINCIPAL AMORTIZED COST/PRINCIPAL VALUE/PRINCIPAL AVERAGE
AMOUNT NET PREMIUM COST AMOUNT FAIR VALUE AMOUNT YIELD
---------- ----------- ----------- ------------- ----------- --------------- ----------
At June 30, 2005 $19,300,333 $401,356 $19,701,690 102.08% $19,556,836 101.33% 3.78%
At March 31, 2005 $18,887,801 $416,542 $19,304,343 102.21% $19,091,063 101.08% 3.61%
- --------------------------------------------------------------------------------------------------------------------
At December 31, 2004 $19,123,902 $425,792 $19,549,694 102.23% $19,428,895 101.59% 3.43%
At September 30, 2004 $17,893,902 $409,115 $18,303,017 102.29% $18,211,030 101.77% 3.36%
At June 30, 2004 $16,914,635 $384,648 $17,299,283 102.27% $17,121,795 101.22% 3.04%
At March 31, 2004 $17,662,596 $412,563 $18,075,159 102.34% $18,079,598 102.36% 2.72%
The tables below set forth certain characteristics of our Investment
Securities. The index level for adjustable-rate Investment Securities is the
weighted average rate of the various short-term interest rate indices, which
determine the coupon rate.
ADJUSTABLE-RATE INVESTMENT SECURITIES CHARACTERISTICS
(DOLLARS IN THOUSANDS)
WEIGHTED WEIGHTED PRINCIPAL AMOUNT
WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AT PERIOD END AS
AVERAGE AVERAGE AVERAGE TERM TO WEIGHTED ASSET % OF TOTAL
PRINCIPAL COUPON INDEX NET NEXT AVERAGE YIELD INVESTMENT
AMOUNT RATE LEVEL MARGIN ADJUSTMENT LIFETIME CAP (ANNUALIZED) SECURITIES
----------- --------- --------- ---------- ------------ ------------- ------------- -----------------
At June 30, 2005 $12,934,382 4.43% 2.61% 1.82% 24 months 10.30% 3.69% 67.02%
At March 31, 2005 $13,464,087 4.29% 2.50% 1.79% 22 months 10.06% 3.46% 71.28%
- ----------------------------------------------------------------------------------------------------------------------
At December 31, 2004 $13,544,872 4.23% 2.45% 1.78% 24 months 10.12% 3.24% 70.83%
At September 30, 2004 $12,645,118 4.12% 2.34% 1.78% 25 months 10.12% 3.06% 70.67%
At June 30, 2004 $11,806,171 3.95% 2.19% 1.76% 29 months 10.07% 2.73% 69.80%
At March 31, 2004 $13,059,967 3.90% 2.20% 1.70% 30 months 9.77% 2.91% 73.94%
FIXED-RATE INVESTMENT SECURITIES CHARACTERISTICS
(DOLLARS IN THOUSANDS)
PRINCIPAL
AMOUNT AT
WEIGHTED WEIGHTED PERIOD END AS %
AVERAGE COUPON AVERAGE OF TOTAL
PRINCIPAL RATE ASSET YIELD INVESTMENT
AMOUNT (ANNUALIZED) (ANNUALIZED) SECURITIES
---------- -------------- ------------ ---------------
At June 30, 2005 $6,365,952 5.22% 3.96% 32.98%
At March 31, 2005 $5,423,714 5.31% 3.99% 28.72%
- ------------------------- ---------------- ---------------- -------------- ------------------
At December 31, 2004 $5,579,030 5.24% 3.89% 29.17%
At September 30, 2004 $5,248,784 5.19% 4.08% 29.33%
At June 30, 2004 $5,108,464 5.15% 3.77% 30.20%
At March 31, 2004 $4,602,629 5.53% 3.41% 26.06%
24
The following tables provide information on adjustable-rate investment
securities by index at June 30, 2005 and December 31, 2004.
ADJUSTABLE-RATE INVESTMENT SECURITIES BY INDEX
JUNE 30, 2005
National Monthly
Six- 12- 11th Financial Six- Federal
One- Six- Twelve Month Month District Average Month 1-Year 2-Year 3-Year 5-Year Cost
Month Month Month Auction Moving Cost of Mortgage CD Treasury Treasury Treasury Treasury of
Libor Libor Libor Average Average Funds Rate Rate Index Index Index Index Funds
----- ----- ----- ------- ------- ------- -------- ----- -------- -------- -------- ------- ------
Weighted Average Term to
Next Adjustment 1mo. 37 mo. 32 mo. 2 mo. 1 mo. 1 mo. 20 mo. 3 mo. 21 mo. 5 mo. 19 mo. 34 mo. 1 mo.
Weighted Average Annual
Period Cap 7.95% 1.41% 2.37% 1.00% 0.17% 0.26% 2.00% 1.00% 2.02% 2.00% 2.00% 2.00% 2.00%
Weighted Average
Lifetime Cap at
June 30, 2005 8.81% 10.42% 10.16% 13.03% 10.64% 12.59% 10.58% 11.76% 10.18% 11.92% 12.96% 12.58% 13.38%
Investment Principal
Amount as Percentage of
Investment Securities at
June 30, 2005 3.60% 3.55% 24.78% 0.01% 0.19% 0.44% 0.01% 0.04% 33.46% 0.01% 0.22% 0.06% 0.66%
ADJUSTABLE-RATE INVESTMENT SECURITIES BY INDEX
DECEMBER 31, 2004
National Monthly
Six- 12- 11th Financial Six- Federal
One- Six- Twelve Month Month District Average Month 1-Year 2-Year 3-Year 5-Year Cost
Month Month Month Auction Moving Cost of Mortgage CD Treasury Treasury Treasury Treasury of
Libor Libor Libor Average Average Funds Rate Rate Index Index Index Index Funds
----- ----- ----- ------- ------- ------- -------- ----- -------- -------- -------- ------- ------
Weighted Average Term to
Next Adjustment 1mo. 27 mo. 34 mo. 2 mo. 1 mo. 0 mo. 5 mo. 3 mo. 25 mo. 10 mo. 17 mo. 31 mo. 0 mo.
Weighted Average Annual
Period Cap 8.01% 1.07% 2.18% 1.00% 0.17% 0.82% 2.00% 1.00% 1.86% 2.00% 2.00% 2.00% 2.00%
Weighted Average
Lifetime Cap at
December 31, 2004 8.88% 9.86% 10.08% 13.03% 10.65% 12.13% 10.58% 11.66% 10.31% 11.92% 12.96% 12.59% 13.39%
Investment Principal
Value as Percentage of
Investment Securities at
December 31, 2004 8.67% 2.50% 22.96% 0.01% 0.22% 0.98% 0.01% 0.05% 34.31% 0.01% 0.25% 0.07% 0.79%
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 June 30, 2005, we had established uncommitted
borrowing facilities in this market with 32 lenders in amounts, which we believe
are in excess of our needs. All of our Investment Securities are currently
accepted as collateral for these borrowings. However, we limit our borrowings,
and thus our potential asset growth, in order to maintain unused borrowing
capacity and thus increase the liquidity and strength of our statement of
financial condition.
For the quarter ended June 30, 2005, the term to maturity of our
borrowings ranged from one day to three years, with a weighted average original
term to maturity of 152 days. For the quarter ended June 30, 2004, the term to
maturity of our borrowings ranged from one day to three years, with a weighted
average original term to maturity of 198 days. At June 30, 2005, the weighted
average cost of funds for all of our borrowings was 3.20% and the weighted
average term to next rate adjustment was 81 days. At June 30, 2004, the weighted
average cost of funds for all of our borrowings was 1.51% and the weighted
average term to next rate adjustment was 101 days.
25
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. Our potential immediate sources of liquidity include cash balances and
unused borrowing capacity. Unused borrowing capacity will vary over time as the
market value of our investment securities varies. Liquidity is also generated 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.
Borrowings under our repurchase agreements increased by $2.0 million to
$17.3 billion at June 30, 2005, from $15.3 billion at June 30, 2004. 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
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 agreement 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 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 June 30,
2005, 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.
The following table summarizes the effect on our liquidity and cash
flows from contractual obligations at June 30, 2005.
(DOLLARS IN THOUSANDS)
--------------------------
WITHIN ONE ONE TO THREE TO MORE THAN
YEAR THREE YEARS FIVE YEARS FIVE YEARS TOTAL
--------------- ------------ ------------- ------------- --------------
Repurchase agreements $15,501,594 $1,750,000 - - $17,251,594
Long-term operating lease
obligations 535 1,063 798 - 2,396
Employment contracts 11,619 - - - 11,619
--------------- ------------ ------------- ------------- --------------
Total $15,513,718 $1,751,063 $798 - $17,265,609
=============== ============ ============= ============= ==============
STOCKHOLDERS' EQUITY
During the quarter ended June 30, 2005, the Company declared dividends
to common shareholders totaling $44.1 million or $0.36 per share, which were
paid on July 28, 2005. During the quarter ended June 30, 2005, the Company
declared dividends to preferred shareholders totaling $3.6 million or $0.492188
per share, which were paid on June 30, 2005. During the quarter ended June 30,
2005, 10,628 options were exercised under the long-term compensation plan for an
aggregate exercise price of $154,000. In addition, the Company sold 7,902 common
26
shares through the dividend reinvestment and direct purchase program for
$149,000 during the quarter ended June 30, 2005. During the quarter ended June
30, 2005, the Company raised $23.1 million in the Equity Shelf Program by
issuing 1,258,603 common shares. During the quarter ending June 30, 2004, the
Company declared dividends to shareholders totaling $57.7 million or $0.48 per
share, which was paid on July 28, 2004. During the quarter ended June 30, 2004,
the Company declared dividends to preferred shareholders totaling $2.0 million
or $0.47 per share, which were paid on June 30, 2004. During the quarter ended
June 30, 2004, no shares were issued through the Equity Shelf Program. During
the quarter ended June 30, 2004, 11,750 options were exercised under the
long-term compensation plan for an aggregate exercise price of $203,000. In
addition, the Company sold 69,006 common shares through the dividend
reinvestment and direct purchase program for $1.2 million during the quarter
ended June 30, 2004. During the quarter ended June 30, 2004, 2,201,080 common
shares were issued under the terms of the FIDAC merger agreement.
During the six months ended June 30, 2005, 1,258,603 shares of the
Company's common stock were issued through the Equity Shelf Program for net
proceeds of $23.1 million. During the six months ended June 30, 2005, 16,128
options were exercised under the long-term compensation plan for an aggregate
exercise price of $253,000. Also, 17,100 common shares were sold through the
dividend reinvestment and direct purchase program for $327,000. 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
raised 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 six months ended June 30, 2004, 1,027,400
shares of the Company's common stock were issued through the Equity Shelf
Program for net proceeds of $20.1 million. During the six months ended June 30,
2004, 40,250 options were exercised under the long-term compensation plan for an
aggregate exercise price of $662,000. In addition, the Company sold 105,942
common shares through the dividend reinvestment and direct purchase program for
$1.9 million for the six months ended June 30, 2004.
The FIDAC acquisition was completed on June 4, 2004. We issued
2,201,080 common shares to the shareholders of FIDAC, based on the December 31,
2003 closing price of $18.40. We continue to operate as a self-managed and
self-advised real estate investment trust, with FIDAC operating as our
wholly-owned taxable REIT subsidiary, FIDAC's shareholders may also receive
additional shares of our common stock as an earn-out in 2005and 2006 worth up to
$49,500,000 if FIDAC meets specific performance goals under the merger
agreement. We cannot calculate how many shares we will issue under the earn-out
provisions since that will vary depending upon whether and the extent to which
FIDAC achieves specific performance goals. Even if FIDAC achieves specific
performance goals for a fiscal year, the number of additional shares to be
issued to the FIDAC shareholders will vary depending on our average share price
for the first 20 trading days of the following fiscal year.
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)."
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 AT
JUNE 30, MARCH 31, DECEMBER 31, SEPTEMBER 30 JUNE 30 MARCH 31,
2005 2005 2004 2004 2004 2004
-------------- -------------- --------------- -------------- ----------- ------------
Unrealized Gain $ 7,956 $23,683 $23,021 $24,788 $ 27,603 $53,912
Unrealized Loss (152,809) (236,963) (143,821) (116,775) (205,092) (49,412)
-------------- -------------- --------------- -------------- ----------- ------------
Net Unrealized Gain (Loss) ($144,853) ($213,280) ($120,800) (91,987) ($177,489) $4,500
============== ============== =============== ============== =========== ============
Net Unrealized Gain (Loss)
as % of Investment
Securities' Principal (0.75%) (1.13%) (0.63%) (0.51%) (1.05%) 0.03%
Amount
Net Unrealized Gain (Loss)
as % of Investment
Securities' Amortized
Cost (0.74%) (1.11%) (0.62%) (0.50%) (1.03%) 0.03%
27
Mortgage-Backed Securities with a carrying value of $6.7 billion were in
a continuous unrealized loss position over 12 months at June 30, 2005 in the
amount of $87.3 million. Mortgage-Backed Securities with a carrying value of
$10.0 billion were in a continuous unrealized loss position for less than 12
months at June 30, 2005 in the amount of $61.6 million. Mortgage-Backed
Securities with a carrying value of $2.2 billion were in a continuous unrealized
loss position over 12 months at December 31, 2004 in the amount of $34.1
million. Mortgage-Backed Securities with a carrying value of $13.1 billion were
in a continuous unrealized loss position for less than 12 months at December 31,
2004 in the amount of $105.3 million. The decline in value of these securities
is solely due to increases 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, to maturity, if
necessary, 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.
Agency debentures with a carrying value of $391.1 million have been in a
continuous unrealized loss position over 12 months at June 30, 2005 in the
amount of $3.9 million. Agency debentures with a carrying value of $390.5
million were in a continuous unrealized loss position for less than 12 months at
December 31, 2004 in the amount of $4.5 million.
As discussed above, because 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 June 30, 2005 was $1.7
billion, or a book value of $12.43 per common share. If we had used historical
amortized cost accounting, our common equity base at June 30, 2005 would have
been $1.7 billion, or $13.61 per common share. Our equity base at December 31,
2004 was $1.7 billion, or $12.56 per share. If we had used historical amortized
cost accounting, our equity base at December 31, 2004 would have been $1.8
billion, or $13.56 per share.
The table below shows our equity capital base as reported and on a
historical amortized cost basis at June 30, 2005, March 31, 2005, December 31,
2004, September 30, 2004, June 30, 2004 and March 31,2004. 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
NET UNREALIZED
7.875% SERIES GAINS (LOSSES) REPORTED REPORTED COMMON
A CUMULATIVE HISTORICAL ON ASSETS COMMON STOCK HISTORICAL STOCK EQUITY
REDEEMABLE COMMON STOCK AVAILABLE FOR EQUITY BASE COMMON STOCK (BOOK VALUE) PER
PREFERRED STOCK EQUITY BASE SALE (BOOK VALUE) EQUITY PER SHARE SHARE
--------------- ------------ --------------- ------------- ----------------- ----------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
At June 30, 2005 $177,088 $1,668,253 (144,853) $1,523,400 $13.61 $12.43
At March 31, 2005 $177,077 $1,645,579 ($213,280) $1,432,299 $13.57 $11.81
- ------------------------------------------------------------------------------------------------------------------------------
At December 31, 2004 $177,077 $1,821,270 ($120,800) $1,700,470 $13.56 $12.56
At September 30, 2004 $102,708 $1,648,869 ($91,987) $1,556,882 $13.60 $12.84
At June 30, 2004 $102,708 $1,627,292 ($177,489) $1,449,803 $13.54 $12.07
At March 31, 2004 $102,870 $1,581,218 $4,500 $1,585,718 $13.42 $13.45
28
LEVERAGE
Our debt-to-reported equity ratio at June 30, 2005 and June 30, 2004
was 10.1.1 and 9.9:1 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-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 over 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 result, prepayments on Mortgage-Backed
Securities. We will seek to mitigate the effect of changes in the mortgage
principal repayment rate by balancing assets we purchase at a premium with
assets we purchase at a discount. To date, the aggregate premium exceeds the
aggregate discount on our Mortgage-Backed Securities. As a result, prepayments,
which result in the expensing of unamortized premium, will reduce our net income
compared to what net income would be absent such prepayments.
INFLATION
Virtually all of our assets and liabilities are financial in nature. As
a result, interest rates and other factors drive our performance far more than
does inflation. Changes in interest rates do not necessarily correlate with
inflation rates or changes in inflation rates. Our financial statements are
prepared in accordance with GAAP and our dividends based upon our net income as
calculated for tax purposes; in each case, our activities and balance sheet are
measured with reference to historical cost or fair market value without
considering inflation.
CAPITAL RESOURCES
At June 30, 2005, we had no material commitments for capital
expenditures.
OTHER MATTERS
We calculate that our qualified REIT assets, as defined in the Code,
were 100% of our total assets at June 30, 2005 and June 30, 2004, as compared to
the Code requirement that at least 75% of our total assets be qualified REIT
assets. We also calculate that 98% and 94% 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 June 30, 2005 and June
30, 2004 respectively. We also met all REIT requirements regarding the ownership
of our common stock and the distribution of our net income. Therefore, as of
June 30, 2005 and June 30, 2004, we believe that we qualified as a REIT under
the Code.
29
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 June 30,
2005 and December 31, 2004 we were in compliance with this requirement.
30
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 June 30, 2005 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 (12.90%) 0.95%
- -75 Basis Points (9.27%) 0.73%
- -50 Basis Points (5.80%) 0.50%
- -25 Basis Points (2.68%) 0.25%
Base Interest Rate - -
+25 Basis Points 2.31% (0.27%)
+50 Basis Points 4.29% (0.54%)
+75 Basis Points 5.99% (0.83%)
+100 Basis Points 7.46% (1.13%)
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.
31
The following table sets forth the estimated maturity or repricing of
our interest-earning assets and interest-bearing liabilities at June 30, 2005.
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.
Within 3 Months More than 1 3 Years and
Within 3 Months 4-12 Months Year to 3 Years Over Total
---------------- ----------------- ---------------- ---------------- --------------
(dollars in thousands)
Rate Sensitive Assets:
Investment Securities $ 1,486,256 $2,254,130 $6,136,249 $9,423,698 $19,300,333
Rate Sensitive Liabilities:
Repurchase Agreements 15,501,594 - 1,750,000 - 17,251,594
---------------- ----------------- ---------------- ---------------- --------------
Interest rate sensitivity gap ($14,015,338) $2,254,130 $4,386,249 $9,423,698 $2,048,739
================ ================= ================ ================ ==============
Cumulative rate sensitivity gap ($14,015,338) ($11,761,208) ($7,374,959) $2,048,739
Cumulative interest rate
sensitivity gap as a percentage of
total rate-sensitive assets (73%) (61%) (38%) 11%
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
Our management, including our Chief Executive Officer (the "CEO") and
Chief Financial Officer (the "CFO"), reviewed and evaluated the effectiveness of
the design and operation of our disclosure controls and procedures (as defined
in Rule 13a-15(e) of the Securities Exchange Act) as of the end of the period
covered by this quarterly report. Based on that review and evaluation, the CEO
and CFO have concluded that our current disclosure controls and procedures, as
designed and implemented, (1) were structured to ensure that material
information regarding Annaly and its sole subsidiary is made known to our
management, including our CEO and CFO, by our employees and (2) were effective
in providing reasonable assurance that information the Company must disclose in
its periodic reports under the Securities Exchange Act is recorded, processed,
summarized and reported within the time periods prescribed by the SEC's rules
and forms. There have been no significant changes in our internal controls or in
other factors that could significantly affect our internal controls subsequent
to the date of their evaluation. There were no significant material weaknesses
identified in the course of such review and evaluation and, therefore, we have
taken no corrective measures.
During the six months ended June 30, 2005, no change occurred in our
internal control over financial reporting that materially effected, or is likely
to materially effect, our internal control over financial reporting.
32
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The annual meeting of stockholders of Annaly Mortgage Management, Inc.
was held on May 26, 2005.
(b) All Class III director nominees were elected.
Director Votes Received Votes Withheld
- ----------------------- ------------------------ ------------------------
Michael A.J. Farrell 111,791,450 1,566,812
Jonathan D. Green 111,985,680 1,372,582
John A. Lambiase 111,894,841 1,463,421
The continuing directors of the Company are Kevin P. Brady, Donnell A.
Segalas, E. Wayne Nordberg and Wellington Denahan-Norris.
(c) In addition to the election of the Class III directors, the appointment
of Deloitte & Touche LLP as our independent registered public
accounting firm for 2005 was approved and the Company's Executive
Performance Plan was approved.
(d) The Company's Executive Performance Plan was approved.
Proposals and Vote Tabulations
Votes Cast
-----------------------------------
For Against Abstain
---------------- ------------------ -------------------
Approval of appointment of independent
registered public accounting firm for 2005 111,894,786 978,229 485,247
Approval of Executive Performance Plan 102,926,042 8,949,294 1,482,926
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibits
The exhibits required by this item are set forth on the Exhibit Index attached
hereto.
Exhibit Number Exhibit Description
31.1 Certification of Chief Executive Officer, pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer, pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer, 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.
33
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: August 5, 2005 By:/s/ MICHAEL A.J. FARRELL
-------------------------
Michael A.J. Farrell
(Chairman of the Board, Chief
Executive Officer, President and
authorized officer of registrant)
Dated: August 5, 2005 By:/s/ KATHRYN F. FAGAN
-------------------------
Kathryn F. Fagan
(Chief Financial Officer and
Treasurer and principal
financial and chief accounting
officer)
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