1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the quarterly period ended: March 31, 1998
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: 1-13485
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.
(Exact name of Registrant as specified in its Charter)
Maryland 430-69111
(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification Number)
445 Marine View Avenue, Suite 230
Del Mar, California 92014
(Address of principal executive offices) Zip Code
Registrant's telephone number, including area code (619) 350-5000
(Former name, former address and former fiscal year, if changed since last
report)
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 files such reports), and (2) has been subject to such
filing requirements for the past 90 days.
X YES _____ NO
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common Stock ($.01 par value) 8,114,000 as of May 1, 1998
2
INDEX
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Balance Sheets at March 31, 1998 and December 31, 1997 1
Statements of Operations for the three months ended March 31, 1998, for the
three months ended December 31, 1997 and for the period from
February 11, 1997 (commencement of operations) through March 31, 1997 2
Statements of Cash Flows for the three months ended March 31, 1998, for the
three months ended December 31, 1997 and for the period from
February 11, 1997 (commencement of operations) through March 31, 1997 3
Notes to Financial Statements 4
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 9
Item 3. Quantitative and Qualitative Disclosures about Market Risk 16
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 16
Item 2. Changes in Securities and Use of Proceeds 16
Item 3. Defaults Upon Senior Securities 16
Item 4. Submission of Matters to a Vote of Security Holders 16
Item 5. Other Information 16
Item 6. Exhibits and Reports on Form 8-K 16
3
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.
BALANCE SHEETS
(dollars in thousands, except share data)
March 31, 1998 December 31 1997
-------------- ----------------
ASSETS
Cash and cash equivalents $ 1,061 $ 5,893
Mortgage securities available-for-sale 350,760 387,099
Mortgage loans held-for-investment 536,457 162,762
Interest rate cap agreements 365 411
Accrued interest receivable 8,557 5,169
Due from affiliate 636 269
Other assets 358 231
--------- ---------
$ 898,194 $ 561,834
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Reverse repurchase agreements $ 785,936 $ 451,288
Accrued interest payable 3,006 1,839
Accrued expenses and other liabilities 660 632
Management fees payable 469 208
Accrued dividends -- 1,298
--------- ---------
Total liabilities 790,071 455,265
--------- ---------
Stockholders' Equity:
Preferred stock, par value $.01 per share; 1,000,000 shares
authorized; no shares issued and outstanding -- --
Common stock, par value $.01 per share; 25,000,000 shares
authorized; 8,114,000 shares issued and outstanding 81 81
Additional paid-in capital 109,763 109,786
Accumulated other comprehensive loss (4,000) (3,300)
Cumulative dividends declared (2,401) (2,401)
Retained earnings 4,680 2,403
--------- ---------
Total stockholders' equity 108,123 106,569
--------- ---------
$ 898,194 $ 561,834
========= =========
See accompanying notes to financial statements
1
4
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.
STATEMENTS OF OPERATIONS
(dollars in thousands, except share data)
For the period from
For the For the February 11, 1997
Three Months Three Months (commencement of
Ended Ended operations) through
March 31, 1998 December 31, 1997 March 31, 1997
-------------- ----------------- ------------------
Interest income:
Mortgage assets $14,381 $ 5,767 $ 217
Cash and investments 72 91 109
------- ------- -------
Total interest income 14,453 5,858 326
Interest expense 11,049 4,357 170
------- ------- -------
Net interest income 3,404 1,501 156
Provision for loan losses 136 -- --
------- ------- -------
Net interest income after provision for loan losses 3,268 1,501 156
Other operating income:
Prepayment penalty 22 -- --
Other expenses:
Management fee 469 109 3
General and administrative expenses 544 92 7
------- ------- -------
Total other expenses 1,013 201 10
------- ------- -------
Net income $ 2,277 $ 1,300 $ 146
======= ======= =======
Net income per share of Common Stock -- Basic $ 0.28 $ 0.22 $ 0.09
Net income per share of Common Stock -- Diluted $ 0.28 $ 0.21 $ 0.09
Dividends per share of Common Stock for related period $ 0.28 $ 0.16 $ 0.09
See accompanying notes to financial statements.
2
5
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.
STATEMENTS OF CASH FLOWS
(dollars in thousands, except share data)
For the period from
For the For the February 11, 1997
Three Months Three Months (commencement of
Ended Ended operations) through
March 31, 1998 December 31, 1998 March 31, 1997
------------- ------------- -------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 2,277 $ 1,300 $ 146
Adjustments to reconcile net income to net cash provided
by operating activities:
Amortization of premium on mortgage assets 1,915 797 20
Amortization of interest rate cap agreements 46 46 --
Provision for loan loss 136 -- --
Increase in accrued interest receivable (3,388) (2,937) (999)
Increase in other assets (127) (80) (4)
Increase in due from affiliate (367) (269) --
Increase in accrued interest payable 1,167 233 155
Increase in accrued expenses, other liabilities & management fees 289 450 169
------------- ------------- -------------
Net cash provided by (used in) operating activities 1,948 (460) (553)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of mortgage securities available-for-sale -- (183,933) (153,120)
Purchases of mortgage loans held for investment (378,341) (162,762 --
Principal payments on mortgage securities available-for-sale 34,106 20,534 --
Principal payments on mortgage loans held for investment 4,128 --
------------- ------------- -------------
Net cash used in investing activities (340,106) (326,161) (153,120)
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in net borrowings from reverse repurchase agreements 334,648 241,582 141,068
Increase/(decrease) in net proceeds from stock issuances -- 89,702 20,165
Dividends paid (1,298) (519) (145)
Other (23) -- --
------------- ------------- -------------
Net cash provided by financing activities 333,328 330,765 161,088
Net increase/(decrease) in cash and cash equivalents (4,832) 4,144 7,415
Cash and cash equivalents at beginning of period 5,893 1,749 --
------------- ------------- -------------
Cash and cash equivalents at end of period $ 1,061 $ 5,893 $ 7,415
============= ============= =============
Supplemental information - interest paid $ 7,968 $ 3,837 $ 34
============= ============= =============
Non-cash transactions:
Increase in accumulated other comprehensive loss $ (700) $ (4,104) $ (217)
============= ============= =============
See accompanying notes to financial statements.
3
6
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 1. BASIS OF FINANCIAL PRESENTATION AND ORGANIZATION
Basis of Financial Statement Presentation
The accompanying financial statements have been prepared in accordance with
Generally Accepted Accounting Principles ("GAAP") and with the instructions to
Form 10-Q promulgated under the Securities and Exchange Act of 1934.
Accordingly, they do not include all of the information and footnotes required
by GAAP for complete financial statements. In the opinion of the management, all
adjustments (consisting of normal recurring adjustments) considered necessary
for a fair presentation of American Residential Investment Trust, Inc. (the
"Company") and its financial condition and results of operations have been
included. Operating results for the quarter ended March 31, 1998 are not
necessarily indicative of the results that may be expected for the year ended
December 31, 1998.
Organization
American Residential Investment Trust, Inc., a Maryland corporation, commenced
operations on February 11, 1997. The Company was financed through a private
equity funding from its manager, Home Asset Management Corporation (the
"Manager"). The Company operates as a mortgage real estate investment trust
which has elected to be taxed as a real estate investment trust ("REIT") for
Federal income tax purposes, which generally will allow the Company to pass
through its income to its stockholders without payment of corporate level
Federal income tax. The Company was formed for the purpose of investing in
residential adjustable-rate mortgage-backed securities and mortgage loans
(collectively, "Mortgage Assets"). The Company finances its acquisitions of
Mortgage Assets with equity and short-term secured borrowings.
Income Per Share
Effective December 31, 1997, the Company adopted Statement of Financial
Accounting Standards No. 128, "Earnings per Share" (SFAS No. 128"). This
statement replaces the previously reported primary and fully diluted income per
share with basic and diluted income per share. Unlike primary income per share,
basic income per share excludes any dilutive effect of options. Diluted income
per share is very similar to the previously reported fully diluted income per
share. All income per share amounts have been restated to conform to the SFAS
No. 128 requirements.
4
7
The following table illustrates the computation of basic and diluted earnings
per share:
For the period from
For the For the February 11, 1997
Three Months Three Months (commencement of
Ended Ended operations) through
March 31, 1998 December 31, 1997 March 31, 1997
-------------- ----------------- --------------
(dollars in thousands, except per share data)
Numerator:
Net income $ 2,277 $ 1,300 $ 146
Denominator:
Denominator for basic earnings per share - weighted average
number of common shares outstanding during the period 8,114,000 6,082,750 1,600,000
Incremental common shares attributable to dilutive
outstanding options 7,700 41,399 --
---------- ---------- ----------
Denominator for diluted earnings per share 8,121,700 6,124,149 1,600,000
Basic earnings per share $ 0.28 $ 0.21 $ 0.09
Diluted earnings per share $ 0.28 $ 0.21 $ 0.09
Comprehensive Income
In June 1997, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards No. 130, Reporting Comprehensive Income
(Statement 130). Statement 130 establishes standards for reporting and display
of comprehensive income and its components in the financial statements.
The FASB defines comprehensive income as "the change in equity of a business
enterprise during a period from transactions and other events and circumstances
from non-owner sources. It includes all changes in equity during a period except
those resulting from investments by owners and distributions to owners."
The following table illustrates comprehensive income:
For the period from
For the For the February 11, 1997
Three Months Three Months (commencement of
Ended Ended operations) through
March 31, 1998 December 31, 1997 March 31, 1997
-------------- ----------------- --------------
(dollars in thousands)
Net income $ 2,277 $ 1,300 $ 146
Other comprehensive loss (700) (4,100) (217)
------- ------- -------
Comprehensive income (loss) $ 1,577 $(2,800) $ (71)
======= ======= =======
5
8
NOTE 2. MORTGAGE SECURITIES AVAILABLE FOR SALE
At March 31, 1998, the Company's Mortgage Securities consisted of the following
mortgage participation certificates issued or guaranteed by Federal government
sponsored agencies:
Federal Home Federal National
Loan Mortgage Mortgage
Corporation Association Total
------------ ---------------- -------------
(dollars in thousands)
Mortgage Securities available-for-sale,
principal $ 230,316 $ 111,034 $ 341,350
Unamortized premium 8,746 4,664 13,410
--------- --------- ---------
Amortized cost 239,062 115,698 354,760
Unrealized loss (2,603) (1,397) (4,000)
--------- --------- ---------
Fair value $ 236,459 $ 114,301 $ 350,760
========= ========= =========
At March 31, 1998 all investments in Mortgage Securities consisted of interests
in adjustable rate mortgage loans on residential properties. The securitized
interest in pools of adjustable rate mortgages from the Federal Home Loan
Mortgage Corporation and the Federal National Mortgage Association are
guaranteed as to principal and interest. The original maturity is subject to
change based on the prepayments of the underlying mortgage loans.
At March 31, 1998, the weighted average interest rate on the Mortgage Securities
was 7.87% per annum based on the amortized cost of the Mortgage Securities. All
Mortgage Securities have a repricing frequency of one year or less.
NOTE 3. MORTGAGE LOANS HELD FOR INVESTMENT
The Company purchases certain non-conforming Mortgage Loans to be held as
long-term investments. At March 31, 1998, Mortgage Loans held for investment
consists of the following (dollars in thousands):
Mortgage Loans held for investment, principal $ 499,113
Unamortized premium 39,997
Allowance for loan losses (2,653)
---------
$ 536,457
=========
6
9
At March 31, 1998, the weighted average interest rate on the Mortgage Loans was
9.18% per annum. All Mortgage Loans have a repricing frequency of two years or
less. At March 31, 1998, 33.90% of the collateral was located in California with
no other state representing more than 7.67%.
NOTE 4. REVERSE REPURCHASE AGREEMENTS
The Company has entered into uncommitted reverse repurchase agreements, which
may be withdrawn at any time, to finance the acquisition of its Mortgage Assets.
The maximum aggregate amount available under the uncommitted reverse repurchase
agreements at March 31, 1998 is over $2.5 billion. These reverse repurchase
agreements are collateralized by a portion of the Company's Mortgage Assets.
Mortgage Securities
The maximum outstanding reverse repurchase agreements with any one lender during
the quarter was 31.02%. At March 31, 1998, Mortgage Securities pledged had an
estimated fair value of approximately $288.7 million.
At March 31, 1998, the Company had approximately $282.7 million of Mortgage
Securities reverse repurchase agreements outstanding with a weighted average
borrowing rate of 5.49% per annum and a weighted average remaining maturity of
40 days. The maximum month end balance and the average balance outstanding for
the quarter ended March 31, 1998 were $282.7 million and $293.1 million,
respectively. At March 31, 1998, the Mortgage Securities reverse repurchase
agreements were comprised of the following:
Repurchase Underlying Interest Rate Weighted Average
Mortgage Securities Liability Collateral (per annum) Maturity Date
- ---------------------------------------- ------------- -------------- ----------------- ----------------
(dollars in thousands)
--------------------------------------------------------------------
ABN-AMRO $ 40,036 $ 40,648 5.55% May 2, 1998
Prudential 87,698 88,655 5.54 April 29, 1998
Federal Home Loan Mortgage Corporation 9,318 9,332 5.50 April 1, 1998
Morgan Stanley 22,900 23,400 5.58 May 26, 1998
First Boston 76,029 79,676 5.34 June 7, 1998
First Union 46,714 46,947 5.55 April 24, 1998
--------- --------- ---- --------------
$ 282,695 $ 288,658 5.49% May 10, 1998
========= ========= ==== ==============
Mortgage Loans
Reverse repurchase agreements for Mortgage Loans are currently placed with one
investment banking firm. At March 31, 1998, Mortgage Loans pledged had an
estimated fair value of approximately $539.5 million.
7
10
At March 31, 1998, the Company had approximately $503.2 million of Mortgage
Loans reverse repurchase agreements outstanding with a weighted average
borrowing rate of 6.11% per annum and a weighted average remaining maturity of
one day. The maximum month end balance and the average balance outstanding for
the quarter ended March 31, 1998 were $503.2 million and $393.1 million,
respectively. At March 31, 1998, the Mortgage Loans reverse repurchase
agreements were comprised of the following:
Repurchase Underlying Interest Rate Weighted Average
Mortgage Loans Liability Collateral (per annum) Maturity Date
- ---------------------- --------------- --------------- ------------------ ----------------
(dollars in thousands)
---------------------------------------------------------------------------
Lehman Brothers $ 503,241 $ 539,110 6.11% April 1, 1998
============== ============== ============ ==============
NOTE 5. STOCKHOLDERS' EQUITY
On April 14, 1998, the Company declared a dividend of $2.3 million or $0.28 per
share. This dividend was paid on April 30, 1998 to holders of record of Common
Stock as of April 24, 1998. On December 19, 1997, the Company declared a
dividend of $1.3 million or $0.16 per share. The dividend was paid on January
21, 1998 to holders of record of Common Stock as of December 31, 1997.
8
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The statements contained in this Report that are not purely historical are
forward looking statements, including statements regarding the Company's
expectations, hopes, beliefs, intentions or strategies regarding the future.
Statements which use the words "expects", "will", "may", "anticipates" and
"seeks" are forward looking statements. These forward looking statements,
including statements regarding changes in the Company's future income, are based
on information available to the Company on the date hereof, and the Company
assumes no obligation to update any such forward looking statement. It is
important to note that the Company's actual results could differ materially from
those in such forward looking statements. Among the factors that could cause
actual results to differ materially are the factors set forth below under the
heading "Business Risks". In particular, the Company's future income could be
affected by changes in interest rates, changes in levels of prepayments, lack of
available Mortgage Assets which meet the Company's acquisition criteria, the
type of Mortgage Assets acquired by the Company and the credit characteristics
of the borrowers under Mortgage Loans acquired by the Company.
OVERVIEW
The Company's income to date consists primarily of interest income generated
from its Mortgage Assets and its cash balances (collectively, "earning assets").
The Company funds its acquisitions of earning assets with both its equity
capital and with borrowings. For that portion of the Company's earning assets
funded with equity capital ("equity-funded lending"), net interest income is
derived from the average yield on earning assets. Due to the adjustable-rate
nature of its earning assets, the Company expects that income from this source
will tend to increase and decrease as interest rates rise and fall,
respectively.
For that portion of the Company's earning assets funded with borrowings ("spread
lending"), the resulting net interest income is a function of the volume of
spread lending and the difference between the Company's average yield on earning
assets and the cost of borrowed funds and interest rate hedging agreements.
Income from spread lending may initially decrease following an increase in
interest rates and then, after a lag period, be restored to its former level as
earning assets yields adjust to market conditions. Income from spread lending
may likewise increase following a fall in interest rates, but then decrease as
earning assets yields adjust to the new market conditions after a lag period.
The Company may seek to generate growth in net income in a variety of ways,
including methods such as (i) issuing new Common Stock and increasing the
balance/amount of the earning assets when opportunities in the mortgage market
are likely to allow growth in net income per share of Common Stock, (ii)
improving productivity by increasing the size of the earning assets at a rate
faster than operating expenses increase, (iii) changing the mix of Mortgage
Asset types among the earning assets in an effort to improve returns,
9
12
and (iv) increasing the efficiency with which the Company uses its equity
capital over time by increasing the Company's use of debt when prudent and by
issuing subordinated debt, preferred stock or other forms of debt and equity.
There can be no assurance, however, that the Company's efforts will be
successful or that the Company will increase or maintain its income level.
RESULTS OF OPERATIONS
The Company does not believe that a comparison of the quarters ended March 31,
1997 and March 31, 1998 is meaningful because of the Company's significantly
greater level of operations in 1998.
For the quarter ended March 31, 1998, the Company generated net income of
approximately $2.3 million and diluted net income per share of Common Stock of
$0.28. At March 31, 1998 the Company held Mortgage Securities that had a
carrying value of approximately $350.8 million, including a $4.0 million net
unrealized loss, and Mortgage Loans with a carrying value of approximately
$536.5 million.
Net income for the Company increased 75.15% from approximately $1.3 million for
the quarter ended December 31, 1997, to approximately $2.3 million for the
quarter ended March 31, 1998. The growth in net income was directly attributable
to an increase in net interest income. Net interest income grew 126.78% between
the quarter ended December 31, 1997 and the quarter ended March 31, 1998, from
approximately $1.5 million to approximately $3.4 million respectively. This
increase in net interest income was partially offset by an increase in general
and administrative expenses. From the quarter ended December 31, 1997 to the
quarter ended March 31, 1998, general and administrative expenses increased from
approximately $201,000 to approximately $1.0 million.
The growth in net interest income between the quarters ended December 31, 1997
and March 31, 1998 was due to an increase in the Company's Mortgage Loans
held-for-investment during the first quarter of 1998. Similarly, the increase in
general and administrative expenses between the quarters ended December 31, 1997
and March 31, 1998 is primarily the result of the Company's increased management
fees which resulted from the increase in the Company's Mortgage Loans and the
increased professional fees and printing and reproduction expenses related to
the Form 10-K and annual report.
The Company experienced high levels of prepayments in the Mortgage Securities
portfolio during the quarter ended March 31, 1998. The annualized Mortgage
Securities principal prepayment rate for the Company was approximately 37.39% in
the quarter ending March 31, 1998 compared to the annualized Mortgage Securities
principal prepayment rate of approximately 31.43% for the quarter ended December
31, 1997. The Company anticipates that prepayment rates in the Mortgage
Securities portfolio will continue at high levels for an indefinite period and
may increase above current levels. As such, the Company has also increased the
amortization of the premiums on these Mortgage Securities.
10
13
Liquidity and Capital Resources
During the quarter ended March 31, 1998, net cash provided by operating
activities was $1.9 million. Net cash provided by operating activities was
negatively impacted by an increase in accrued interest receivable. Mortgage
Loans at December 31, 1997 were approximately $162.8 million compared to $536.5
million at March 31, 1998 and, therefore, accrued interest receivable at March
31, 1998 has increased proportionally to loans, thereby negatively affecting
cash. Net cash for the period was positively affected by an increase in accrued
interest payable.
Net cash used in investing activities for the quarter ended March 31, 1998 was
approximately $340.0 million. Net cash used for the period was negatively
affected by the purchase of Mortgage Loans in the amount of approximately $378.3
million and positively affected by principal prepayments of approximately $38.2
million.
For the quarter ended March 31, 1998, net cash provided by financing activities
was approximately $333.3 million. Net cash provided was primarily affected by
borrowings under reverse repurchase agreements.
At March 31, 1998 the Company had uncommitted reverse repurchase agreement
facilities, which may be withdrawn at any time, in place to provide over $2.5
billion to finance investments in Mortgage Assets. In addition, the Company has
a line of credit with one counter party to a reverse repurchase agreement.
Pursuant to the line of credit, the Company may borrow the lesser of $25 million
and the outstanding principal and interest receivable balance with the counter
party, for a period of up to 36 days at an interest rate equal to LIBOR plus
0.6%. The line of credit has no set expiration date.
If the Company's cash resources are insufficient to satisfy the Company's
liquidity requirements, the Company may be required to sell additional equity or
debt securities. There is no assurance that such financing will be available to
the Company on favorable terms, or at all.
BUSINESS RISKS
High Levels of Mortgage Loan Prepayments May Reduce Operating Income
Prepayments of Mortgage Assets adversely affect the Company's results of
operations in several ways. A portion of the adjustable-rate Mortgage Assets
acquired by the Company bear initial "teaser" interest rates which are lower
than their "fully-indexed" rates (the applicable index plus a margin). In the
event that such an adjustable-rate Mortgage Asset is prepaid prior to or soon
after the time of adjustment to a fully-indexed rate, the Company will have held
the Mortgage Asset during its least profitable period and lost the opportunity
to receive interest at the fully-indexed rate over the expected life of the
adjustable-rate Mortgage Asset. In addition, the prepayment of any Mortgage
Asset that had been purchased with a premium by the Company would result in the
immediate
11
14
write-off of any remaining capitalized premium amount and the consequent
reduction of the Company's net interest income by such amount. Finally, in the
event that the Company is unable to acquire new Mortgage Assets to replace the
prepaid Mortgage Assets, the Company's financial condition and results of
operations could be materially adversely affected.
Mortgage Asset prepayment rates generally increase when new Mortgage Loan
interest rates fall below the interest rates on the adjustable-rate Mortgage
Assets. Prepayment experience also may be affected by the geographic location of
the property securing the adjustable-rate Mortgage Loans, the assumability of an
adjustable-rate Mortgage Loan, the ability of the borrower to obtain or convert
to a fixed-rate Mortgage Loan, conditions in the housing and financial markets
and general economic conditions. The level of prepayments is also subject to the
same seasonal influences as the residential real estate industry with prepayment
rates generally being highest in the summer months and lowest in the winter
months. The Company experienced high levels of prepayments during the three
months ended March 31, 1998 and the Company anticipates that prepayment rates
will continue at high levels for an indefinite period and may increase above
current levels.
Certain Mortgage Loans acquired by the Company may contain provisions
restricting prepayments of such Mortgage Loans and require a charge in
connection with the prepayment thereof. Such prepayment restrictions can, but do
not necessarily, provide a deterrent to prepayments. Prepayment charges may be
in an amount which is less than the figure which would fully compensate the
Company for a lower yield upon reinvestment of the prepayment proceeds.
Borrower Credit May Decrease Value of Mortgage Loans
A substantial portion of the Company's Mortgage Assets consist of Mortgage
Loans. Accordingly, during the time it holds Mortgage Loans, the Company is
subject to increased credit risks, including risks of borrower defaults and
bankruptcies and special hazard losses that are not covered by standard hazard
insurance (such as those occurring from earthquakes or floods). In the event of
a default on any Mortgage Loan held by the Company, the Company will bear the
risk of loss of principal to the extent of any deficiency between the value of
the secured property, and the amount owing on the Mortgage Loan, less any
payments from an insurer or guarantor. Defaulted Mortgage Loans will also cease
to be eligible collateral for borrowings, and will have to be financed by the
Company out of other funds until ultimately liquidated. Although the Company
established an allowance for Mortgage Loan losses in amounts adequate to cover
these risks, in view of its limited operating history and lack of experience
with the Company's current Mortgage Loans and Mortgage Loans that may be
acquired pursuant to the Freedom Program, there can be no assurance that any
allowance for Mortgage Loan losses which are established will be sufficient to
offset losses on Mortgage Loans in the future.
12
15
The Company's loans remain relatively young from a delinquency perspective, and
there has not yet been any losses incurred on these loans. Because of the age of
the Company's loans, current delinquency and loss information is not yet
expected to be representative of future delinquencies and losses. At March 31,
1998, there were approximately 1.25% of Mortgage Loans that were greater than 60
days delinquent. In addition, at March 31, 1998, there were no Mortgage Loans in
bankruptcy.
Credit risks associated with non-conforming Mortgage Loans, especially sub-prime
Mortgage Loans, may be greater than those associated with Mortgage Loans that
conform to FNMA and FHLMC guidelines. The principal difference between
non-conforming sub-prime Mortgage Loans and conforming Mortgage Loans include
the applicable loan-to-value ratios, the credit and income histories of the
mortgagors, the documentation required for approval of the mortgagors, the types
of properties securing the Mortgage Loans, loan sizes and the mortgagors'
occupancy status with respect to the mortgaged property. As a result of these
and other factors, the interest rates charged on non-conforming Mortgage Loans
are often higher than those charged for conforming Mortgage Loans. The
combination of different underwriting criteria and higher rates of interest may
lead to higher delinquency rates and/or credit losses for non-conforming as
compared to conforming Mortgage Loans and could have an adverse effect on the
Company to the extent that the Company invests in such Mortgage Loans or
securities secured by such Mortgage Loans.
Even assuming that properties secured by the Mortgage Loans held by the Company
provide adequate security for such Mortgage Loans, substantial delays could be
encountered in connection with the foreclosure of defaulted Mortgage Loans, with
corresponding delays in the receipt of related proceeds by the Company. State
and local statutes and rules may delay or prevent the Company's foreclosure on
or sale of the mortgaged property and may prevent the Company from receiving net
proceeds sufficient to repay all amounts due on the related Mortgage Loan. In
addition, the Company's servicing agent may be entitled to receive all expenses
reasonably incurred in attempting to recover amounts due and not yet repaid on
liquidated Mortgage Loans, thereby reducing amounts available to the Company.
Some properties which will collateralize the Company's Mortgage Loans may have
unique characteristics or may be subject to seasonal factors which could
materially prolong the time period required to resell such properties
Sudden Interest Rate Fluctuations May Reduce Income From Operations
Substantially all of the Company's Mortgage Assets have a repricing frequency of
two years or less, and substantially all of the Company's borrowings have
maturities of six months or less. The interest rates on the Company's borrowings
may be based on interest rate indices which are different from, and adjust more
rapidly than, the interest rate indices of its related Mortgage Assets.
Consequently, changes in interest rates may significantly influence the
Company's net interest income. While increases in interest rates will generally
increase the yields on the Company's adjustable-rate Mortgage Assets, rising
rates will also increase the cost of borrowings by the Company. To the
13
16
extent such costs rise more rapidly than the yields on such Mortgage Assets, the
Company's net interest income will be reduced or a net interest loss may result.
Adjustable-rate Mortgage Assets are typically subject to periodic and lifetime
interest rate caps which limit the amount an adjustable-rate Mortgage Asset
interest rate can change during any given period. The Company's borrowings will
not be subject to similar restrictions. Hence, in a period of increasing
interest rates, the cost of the Company's borrowings could increase without
limitation by caps while the yields on the Company's Mortgage Assets could be
limited. Further, some adjustable-rate Mortgage Assets may be subject to
periodic payment caps that result in some portion of the interest being deferred
and added to the principal outstanding. This could result in receipt by the
Company of a lesser amount of cash income on its adjustable-rate Mortgage Assets
than is required to pay interest on the related borrowings, which will not have
such payment caps. These factors could lower the Company's net interest income
or cause a net interest loss during periods of rising interest rates, which
would negatively impact the Company's financial condition and results of
operations.
Failure To Successfully Manage Interest Rate Risks May Adversely Affect Results
of Operations
The Company will follow a program intended to protect against interest rate
changes. However, developing an effective interest rate risk management strategy
is complex and no management strategy can completely insulate the Company from
risks associated with interest rate changes. In addition, hedging involves
transaction costs. In the event the Company hedges against interest rate risks,
the Company may substantially reduce its net income. Further, the Federal tax
laws applicable to REITs may limit the Company's ability to fully hedge its
interest rate risks. Such Federal tax laws may prevent the Company from
effectively implementing hedging strategies that, absent such restrictions,
would best insulate the Company from the risks associated with changing interest
rates.
In the event that the Company purchases interest rate caps or other interest
rate derivatives to hedge against lifetime, periodic rate or payment caps, and
the provider of such caps on interest rate derivatives becomes financially
unsound or insolvent, the Company may be forced to unwind such caps on its
interest rate derivatives with such provider and may take a loss thereon.
Further, the Company could suffer the adverse consequences that the hedging
transaction was intended to protect against. Although the Company intends to
purchase interest rate caps and derivatives only from financially sound
institutions and to monitor the financial strength of such institutions on a
periodic basis, no assurance can be given that the Company can avoid such third
party risks.
Currently, the Company has entered into hedging transactions which seek to
protect only against the Mortgage Securities lifetime rate caps and not against
periodic rate caps or unexpected payments. In addition, the Company's lifetime
cap hedges are for a two year period which does not begin until the second
quarter of 1998. Accordingly, the Company may not be adequately protected
against risks associated with interest rate changes and
14
17
such changes could adversely affect the Company's financial condition and
results of operations.
The Company Has Significant Conflicts with, and Is Dependent on, an Affiliate of
the Executive Officers of the Company
The Company is subject to conflicts of interest with the Manager and its
executive officers. The executive officers of the Company generally will also be
executive officers, employees and stockholders of the Manager, and will
therefore be affiliated with the Manager. The Manager will manage the day-to-day
operations of the Company. Accordingly, the Company's success will depend in
significant part on the Manager. Under the Management Agreement, the Manager
will receive an annual base management fee payable monthly in arrears and the
Manager will have the opportunity to earn incentive compensation under the
Management Agreement based on the Company's annualized net income. The ability
of the Company to achieve the performance level required for the Manager to earn
the incentive compensation is dependent upon the level and volatility of
interest rates, the Company's ability to react to changes in interest rates and
to implement the operating strategies described herein, and other factors, many
of which are not within the Company's control. In evaluating Mortgage Assets for
investment and other strategies, an undue emphasis on maximizing income at the
expense of other criteria, such as preservation of capital, in order to achieve
higher incentive compensation for the Manager, could result in increased risk to
the value of the Company's Mortgage Asset portfolio.
The Management Agreement does not limit or restrict the right of the Manager or
any of its officers, directors, employees or affiliates to engage in any
business or to render services of any kind to any other person, including
purchasing, or rendering advice to others purchasing, Mortgage Assets which meet
the Company's policies and criteria, except that the Manager and its officers,
directors, or employees will not be permitted to provide any such services to
any REIT which invests primarily in residential Mortgage Assets, other than the
Company.
Future Offerings of Securities May Affect Market Price of Common Stock
The Company may in the future increase its capital resources by making
additional offerings of equity and debt securities, including classes of
preferred stock, Common Stock, commercial paper, medium-term notes, CMOs and
senior or subordinated notes. All debt securities and classes of preferred stock
will be senior to the Common Stock in a liquidation of the Company. The effect
of additional equity offerings may be the dilution of the equity of stockholders
of the Company or the reduction of the price of the Company's Common Stock, or
both. The Company is unable to estimate the amount, timing or nature of
additional offerings as they will depend upon market conditions and other
factors. There can be no assurance that the Company will be able to raise the
capital it will require through such offerings on favorable terms or at all. The
inability of the Company to obtain needed sources of capital on favorable terms
could have a material adverse affect on the Company
15
18
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Not required
PART II. OTHER INFORMATION
Item. 1. Legal Proceedings
At March 31, 1998, there were no pending legal proceedings to which
the Company was a party or of which any of its property was subject.
Item 2. Changes in Securities and Use of Proceeds
None
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K:
(a) Exhibits
None
(b) Reports on Form 8-K
None
16
19
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
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.
Dated: May 11, 1998 By: /s/ MARK A. CONGER
----------------------------------------
Mark A. Conger,
Executive Vice President
Chief Financial Officer
(authorized signatory and
principal financial officer)
17