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, 1999
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIESEXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _______________ TO _________________
COMMISSION FILE NUMBER: 1-13447
ANNALY MORTGAGE MANAGEMENT, INC.
(Exact name of Registrant as specified in its Charter)
MARYLAND 22-3479661
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
12 EAST 41ST STREET, SUITE 700
NEW YORK, NEW YORK
(Address of principal executive offices)
10017
(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 |_|
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes
of stock, as of the last practicable date:
Class Outstanding May 13, 1999
Common Stock, $.01 par value 12,697,298
ANNALY MORTGAGE MANAGEMENT, INC.
FORM 10-Q
INDEX
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Balance Sheets - March 31, 1999 (Unaudited) and December 31, 1998 1
Statements of Operations (Unaudited) for the quarters ended
March 31, 1999 and 1998 2
Statement of Stockholders' Equity (Unaudited) for the quarter
ended March 31, 1999 3
Statements of Cash Flows (Unaudited) for the quarters ended
quarters ended March 31, 1999 and 1998 4
Notes to Financial Statements (Unaudited) 5-10
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 11-24
Item 3. Quantitative and Qualitative Disclosure About Market Risks 25-26
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 27
Item 2. Changes in Securities and Use of Proceeds 27
Item 3. Defaults Upon Senior Securities 27
Item 4. Submission of Matters to a Vote of Security Holders 27
Item 5. Other Information 27
Item 6. Exhibits and Reports on Form 8-K 27
SIGNATURES 28
ANNALY MORTGAGE MANAGEMENT, INC.
BALANCE SHEETS
- --------------------------------------------------------------------------------
March 31,
1999 December 31,
(unaudited) 1998
----------------------------------
ASSETS
CASH AND CASH EQUIVALENTS $ 329,334 $ 69,020
MORTGAGE-BACKED SECURITIES - At fair value 1,547,618,299 1,520,288,762
ACCRUED INTEREST RECEIVABLE 7,419,163 6,782,043
OTHER ASSETS 231,631 212,214
--------------- ---------------
TOTAL ASSETS $ 1,555,598,427 $ 1,527,352,039
=============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Repurchase agreements $ 1,371,856,000 $ 1,280,510,000
Payable for Mortgage-Backed Securities purchased 43,023,234 111,921,205
Accrued interest payable 9,582,673 5,052,626
Dividends payable 4,190,108 3,857,663
Accounts payable 329,904 139,236
--------------- ---------------
Total liabilities 1,428,981,919 1,401,480,730
--------------- ---------------
STOCKHOLDERS' EQUITY:
Common stock: par value $.01 per share;
100,000,000 authorized, 12,806,898 and 12,758,024
shares issued and outstanding, respectively 128,069 127,580
Additional paid-in capital 132,965,182 132,770,175
Accumulated other comprehensive income (loss) (5,982,920) (6,404,275)
Treasury stock at cost (109,600 shares) (903,163) (903,163)
Retained earnings 409,340 280,992
--------------- ---------------
Total stockholders' equity 126,616,508 125,871,309
--------------- ---------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 1,555,598,427 $ 1,527,352,039
=============== ===============
See notes to financial statements.
1
ANNALY MORTGAGE MANAGEMENT, INC.
STATEMENTS OF OPERATIONS
(UNAUDITED)
- --------------------------------------------------------------------------------
For the For the
Quarter Ended Quarter Ended
March 31, 1999 March 31, 1998
----------------------------
INTEREST INCOME:
Mortgage-Backed Securities $ 22,014,921 $ 20,078,691
Money market account 20 30
------------ ------------
Total interest income 22,014,941 20,078,721
INTEREST EXPENSE:
Repurchase agreements 17,151,041 16,313,474
------------ ------------
NET INTEREST INCOME 4,863,900 3,765,247
GAIN ON SALE OF MORTGAGE-BACKED SECURITIES 64,560 1,427,084
GENERAL AND ADMINISTRATIVE EXPENSES 610,004 484,181
------------ ------------
NET INCOME 4,318,456 4,708,150
------------ ------------
OTHER COMPREHENSIVE INCOME (LOSS):
Urealized gain (loss) on available-for-sale securities 485,915 (2,685,224)
Less: reclassification adjustment for gains included in net
income (64,560) (1,427,084)
------------ ------------
Other comprehensive gain (loss) 421,355 (4,112,308)
------------ ------------
COMPREHENSIVE INCOME $ 4,739,811 $ 595,842
============ ============
NET INCOME PER SHARE:
Basic $ 0.34 $ 0.37
============ ============
Diluted $ 0.33 $ 0.36
============ ============
AVERAGE NUMBER OF SHARES OUTSTANDING:
Basic 12,657,884 12,727,405
============ ============
Diluted 12,952,822 12,923,195
============ ============
See notes to financial statements.
2
ANNALY MORTGAGE MANAGEMENT, INC.
STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE QUARTER ENDED MARCH 31, 1999
(UNAUDITED)
- --------------------------------------------------------------------------------
Common Additional Other
Stock Paid-in Treasury Comprehensive Retained Comprehensive
Par Value Capital Stock Income Earnings Income
-----------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1998 $ 127,580 $132,770,175 $ (903,163) $ 280,992 $(6,404,275)
Net income -- -- $4,318,456 4,318,456 --
Other comprehensive income:
Unrealized net losses on securities,
net of reclassification adjustment -- -- 421,355 -- 421,355
----------
Comprehensive income $4,739,811
==========
Exercise of stock options 489 195,007 -- --
Dividends declared for the quarter ended
March 31, 1999, $0.33 per average share (4,190,108) --
--------------------------------------- ---------------------------
BALANCE, MARCH 31,1999 $ 128,069 $132,965,182 $ (903,163) $ 409,340 $(5,982,920)
======================================= ===========================
Disclosure of reclassification amounts:
Unrealized holding gains arising during period $ 485,915
Less reclassification adjustment of gains
included in net income (64,560)
----------
Net unrealized gains on securities $ 421,355
==========
Total
-------------
BALANCE, DECEMBER 31, 1998 $ 125,871,309
Net income
Other comprehensive income:
Unrealized net losses on securities,
net of reclassification adjustment
Comprehensive income 4,739,811
Exercise of stock options 195,496
Dividends declared for the quarter ended
March 31, 1999, $0.33 per average share (4,190,108)
-------------
BALANCE, MARCH 31,1999 $ 126,616,508
=============
Disclosure of reclassification amounts:
Unrealized holding gains arising during period
Less reclassification adjustment of gains
included in net income
Net unrealized gains on securities
See notes to financial statements.
3
ANNALY MORTGAGE MANAGEMENT, INC.
STATEMENTS OF CASH FLOWS
(UNAUDITED)
- --------------------------------------------------------------------------------
For the For the
Quarter Ended Quarter Ended
March 31, 1999 March 31, 1998
----------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 4,318,456 $ 4,708,150
Adjustments to reconcile net income to
net cash provided by operating activities:
Amortization of mortgage premiums and discounts, net 2,164,643 1,622,343
Gain on sale of Mortgage-Backed Securities (64,560) (1,427,084)
Increase in accrued interest receivable (637,120) (2,178,585)
Increase in other assets (19,417) (62,147)
Increase in accrued interest payable 4,530,047 5,065,225
Increase (decrease) in accounts payable 190,667 (56,565)
--------------- ---------------
Net cash provided by operating activities 10,482,716 7,671,337
--------------- ---------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of Mortgage-Backed Securities (255,168,532) (685,643,269)
Proceeds from sale of Mortgage-Backed Securities 31,769,366 143,782,573
Principal payments on Mortgage-Backed Securities 125,492,931 94,221,118
--------------- ---------------
Net cash used in investing activities (97,906,235) (447,639,578)
--------------- ---------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from repurchase agreements 2,652,589,000 2,632,120,000
Principal payments on repurchase agreements (2,561,243,000) (2,189,919,000)
Proceeds from exercise of stock options 195,496 193,700
Additional cost of initial public offering -- (130,248)
Dividends paid (3,857,663) (2,797,058)
--------------- ---------------
Net cash provided by financing activities 87,683,833 439,467,394
--------------- ---------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 260,314 (500,847)
CASH AND CASH EQUIVALENTS, BEGINNING OF
PERIOD 69,020 511,172
=============== ===============
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 329,334 $ 10,325
=============== ===============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Interest paid $ 12,620,994 $ 11,248,249
=============== ===============
NONCASH FINANCING ACTIVITIES:
Net unrealized gain (loss) on available-for-sale securities $ 421,355 $ (4,112,308)
=============== ===============
Dividends declared, not yet paid $ 4,190,108 $ 4,082,456
=============== ===============
See notes to financial statements.
4
Annaly Mortgage Management, Inc.
NOTES TO FINANCIAL STATEMENTS
(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. On July 31, 1997, the Company received additional proceeds from a
direct offering to officers and directors. An initial public offering was
completed on October 14, 1997. A summary of the Company's significant accounting
policies follows:
Basis of Presentation - The accompanying unaudited financial statements have
been prepared in conformity with the instructions to Form 10-Q and Article 10,
Rule 10-01 of Regulation S-X for interim financial statements. The interim
financial statements for the three month period are unaudited; however, in the
opinion of the Company's management, all adjustments, consisting only of normal
recurring accruals, necessary for a fair statement of the results of operations
have been included. These unaudited financials 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, 1998. The nature of
the Company's business is such that the results of any interim period are not
necessarily indicative of results for a full year.
Cash and Cash Equivalents - Cash and cash equivalents includes cash on hand and
money market funds. The carrying amounts of cash equivalents approximates their
value.
Mortgage-Backed Securities - 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").
Statement of Financial Accounting Standards No. 115, Accounting for Certain
Investments in Debt and Equity Securities ("SFAS 115"), requires the Company to
classify its investments as either trading investments, available-for-sale
investments or held-to-maturity investments. Although the Company generally
intends to hold most of its Mortgage-Backed Securities until maturity, it may,
from time to time, sell any of its Mortgage-Backed Securities as part of its
overall management of its balance sheet. Accordingly, this flexibility requires
the Company to classify all of its Mortgage-Backed Securities as
available-for-sale. All assets classified as available-for-sale are reported at
fair value, with unrealized gains and losses excluded from earnings and reported
as a separate component of stockholders' equity.
Unrealized losses on Mortgage-Backed Securities that are considered other than
temporary, as measured by the amount of decline in fair value attributable to
factors other than temporary, are recognized in income and the cost basis of the
Mortgage-Backed Securities is adjusted. There were no such adjustments for the
quarter ended March 31, 1999 and the year ended December 31, 1998.
Interest income is accrued based on the outstanding principal amount of the
Mortgage-Backed Securities and their contractual terms. Premiums and discounts
associated with the purchase of the Mortgage-Backed Securities are amortized
into interest income over the lives of the securities using the effective yield
method.
Mortgage-Backed Securities transactions are recorded on the date the securities
are purchased or sold. Purchases of newly issued securities are recorded when
all significant uncertainties regarding the characteristics of the securities
are removed, generally shortly before settlement date. Realized gains and losses
on Mortgage-Backed Securities transactions are determined on the specific
identification basis.
5
Credit Risk - At March 31, 1999 and December 31, 1998, the Company has limited
its exposure to credit losses on its portfolio of Mortgage-Backed Securities by
only purchasing securities from Federal Home Loan Mortgage Corporation
("FHLMC"), Federal National Mortgage Association ("FNMA"), or Government
National Mortgage Association ("GNMA"). The payment of principal and interest on
the FHLMC and FNMA Mortgage-Backed Securities are guaranteed by those respective
agencies and the payment of principal and interest on the GNMA Mortgage-Backed
Securities are backed by the full-faith-and-credit of the U.S. government. At
March 31, 1999 and December 31, 1998, all of the Company's Mortgage-Backed
Securities have an implied "AAA" rating.
Income Taxes - The Company has elected to be taxed as a Real Estate Investment
Trust ("REIT") and intends to comply with the provisions of the Internal Revenue
Code of 1986, as amended (the "Code") with respect thereto. Accordingly, the
Company will not be subjected to Federal income tax to the extent of its
distributions to shareholders and as long as certain asset, income and stock
ownership tests are met.
Use of Estimates - The preparation of financial statements in conformity with
generally accepted accounting principles 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.
2. MORTGAGE-BACKED SECURITIES
The following table pertains to the Company's Mortgage-Backed Securities
classified as available-for-sale as of March 31, 1999, which are carried at
their fair value:
Federal Federal Government
Home Loan National National Total
Mortgage Mortgage Mortgage Mortgage
Corporation Association Association Assets
-------------------------------------------------------------------
Mortgage-Backed
Securities, gross $ 428,448,475 $ 1,010,981,635 $ 88,100,157 $ 1,527,530,267
Unamortized discount (171,760) (914,424) -- (1,086,184)
Unamortized premium 8,458,171 17,072,877 1,626,088 27,157,136
------------- --------------- ------------ ---------------
Amortized cost 436,734,886 1,027,140,088 89,726,245 1,553,601,219
Gross unrealized gains 490,807 1,983,325 326,711 2,800,843
Gross unrealized losses (2,976,884) (5,492,002) (314,877) (8,783,763)
------------- --------------- ------------ ---------------
Estimated fair value $ 434,248,809 $ 1,023,631,411 $ 89,738,079 $ 1,547,618,299
============= =============== ============ ===============
6
The following table pertains to the Company's Mortgage-Backed Securities
classified as available-for-sale as of December 31, 1998, which are carried at
their fair value:
Federal Federal Government
Home Loan National National Total
Mortgage Mortgage Mortgage Mortgage
Corporation Association Association Assets
-------------------------------------------------------------------
Mortgage-Backed
Securities, gross $ 449,433,408 $ 955,650,670 $ 97,330,495 $ 1,502,414,573
Unamortized discount (184,996) (423,583) -- (608,579)
Unamortized premium 8,852,370 14,264,277 1,770,397 24,887,044
------------- --------------- ------------ ---------------
Amortized cost 458,100,782 969,491,364 99,100,892 1,526,693,038
Gross unrealized gains 659,557 2,092,119 549,900 3,301,576
Gross unrealized losses (3,487,784) (5,692,759) (525,309) (9,705,852)
------------- --------------- ------------ ---------------
Estimated fair value $ 455,272,555 $ 965,890,724 $ 99,125,483 $ 1,520,288,762
============= =============== ============ ===============
The adjustable rate Mortgage-Backed Securities are limited by periodic caps
(generally interest rate adjustments are limited to no more than 1% every six
months) and lifetime caps. At March 31, 1999, the weighted average lifetime cap
was 11.01%. At December 31, 1998, the weighted average lifetime cap was 10.6%.
During the quarter ended March 31, 1999, the Company realized $64,560 in gains
from the sales of Mortgage-Backed Securities. During the year ended December 31,
1998, the Company realized $3,344,070 in gains from sales of Mortgage-Backed
Securities. There were no losses on sales of Mortgage-Backed Securities for the
quarter ended March 31, 1999. Losses totaled $9,964 for the year ended December
31, 1998.
3. REPURCHASE AGREEMENTS
As of March 31, 1999, the Company had outstanding $1,371,856,000 of repurchase
agreements with a weighted average borrowing rate of 4.85% and a weighted
average remaining maturity of 13 days. At March 31, 1999, Mortgage-Backed
Securities actually pledged had an estimated fair value of $1,410,144,079. As of
December 31, 1998, the Company had outstanding $1,280,510,000 of repurchase
agreements with a weighted average borrowing rate of 5.21% and a weighted
average remaining maturity of 29 days. At December 31, 1998, Mortgage-Backed
Securities actually pledged had an estimated fair value of $1,458,669,078.
7
At March 31, 1999 and December 31, 1998, the repurchase agreements had the
following remaining maturities:
March 31 December 31,
1999 1998
-------------------------------------
Within 30 days $1,347,590,000 $1,222,542,000
30 to 59 days 24,266,000 31,346,000
60 to 89 days 26,622,000
-------------------------------------
$1,371,856,000 $1,280,510,000
=====================================
4. COMMON STOCK
Options were exercised during the quarter ended March 31, 1999 increasing the
total number of shares outstanding to 12,697,298. The number of stock options
exercised was 48,874, with an aggregate purchase price of $195,496. During the
year ended December 31, 1998, 44,124 options were exercised at an aggregate
purchase price of $195,100. Stock buybacks during the year ended December 31,
1998 totaled 109,600 shares at a cost of $903,163.
During the Company's quarter ending March 31, 1999, the Company declared
dividends to shareholders totaling $4,190,108, or $0.33 per weighted average
share which was paid on April 29, 1999. During the Company's year ending
December 31, 1998, the Company declared dividends to shareholders totaling
$15,437,554, or $1.22 per weighted average share, of which $11,579,891 was paid
during the period and $3,857,663 was paid on January 25, 1999. For Federal
income tax purposes dividends paid for the year ended December 31, 1998 are
ordinary income to the Company stockholders.
5. EARNINGS PER SHARE (EPS)
In February 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting No. 128, Earnings Per Share (SFAS No. 128),
which requires dual presentation of Basic EPS and Diluted EPS on the face of the
income statement for all entities with complex capital structures. SFAS No. 128
also requires a reconciliation of the numerator and denominator of Basic EPS and
Diluted EPS computation. For the quarter ended March 31, 1999 the reconciliation
is as follows:
For the Quarter Ended
March 31, 1999
------------------------------------
Income Shares Per-Share
(Numerator) (Denominator) Amount
------------------------------------
Net income $4,318,456
----------
Basic EPS 4,318,456 12,657,884 $0.34
=====
Effect of dilutive securities:
Dilutive stock options 294,938
---------- ----------
Diluted EPS $4,318,456 12,952,822 $0.33
========== ========== =====
8
Options to purchase 408,152 shares were outstanding during the quarter and were
dilutive as the exercise price (between $4.00 and $8.94) was less than the
average stock price for the quarter for the Company of $9.31. Options to
purchase 140,176 shares of stock were outstanding and not considered dilutive.
The exercise price (between $10.00 and $11.28) was greater than the average
stock price for the quarter of $9.31. At March 31, 1999, 83,870 options were
vested and not exercised.
For the year quarter ended March 31, 1998, the reconciliation is as follows:
For the Quarter Ended
March 31, 1999
------------------------------------
Income Shares Per-Share
(Numerator) (Denominator) Amount
------------------------------------
Net income $4,708,150
----------
Basic EPS 4,708,150 12,727,405 $0.37
=====
Effect of dilutive securities:
Dilutive stock options 195,790
---------- ----------
Diluted EPS $4,708,150 12,923,195 $0.36
========== ========== =====
Options to purchase 312,226 shares were outstanding during the quarter and were
dilutive as the exercise price (between $4.00 and $10.00) was less than the
average stock price for the quarter for the Company of $10.83. Options to
purchase 2,426 shares of stock were outstanding and not considered dilutive. The
exercise price of $11.25 was greater than the average stock price for the
quarter of $10.83.
7. COMPREHENSIVE INCOME
The Company adopted FASB Statement No. 130, Reporting Comprehensive Income.
Statement No. 130 requires the reporting of comprehensive income in addition to
net income from operations. Comprehensive income is a more inclusive financial
reporting methodology that includes disclosure of certain financial information
that historically has not been recognized in the calculation of net income. The
Company at March 31, 1999 and December 31, 1998 held securities classified as
available-for-sale. At March 31, 1999 and December 31, 1998, the net unrealized
losses totaled $5,982,920 and $6,404,275, respectively.
8. LEASE COMMITMENTS
The Corporation has a non-cancelable lease for office space, which commenced in
April 1998 and expires in December 2007.
The Corporation's aggregate future minimum lease payments are as follows:
1999 $ 92,804
2000 95,299
2001 97,868
2002 100,515
2003 through 2007 582,406
---------
Total lease commitments $ 968,892
=========
9
9. RELATED PARTY TRANSACTION
Included in "Other Assets" on the Balance sheet is an investment in Annaly
International Money Management, Inc. On June 24, 1998, the Company
acquired 99,960 nonvoting shares, at a cost of $49,980. The officers and
directors of Annaly International Money Management Inc. are also officers
and directors of the Company.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Overview
The Company is a real estate investment trust ("REIT") which acquires and
manages Mortgage-Backed Securities which can be readily financed. The Company
commenced operations on February 18, 1997 upon the closing of the Private
Placement, which resulted in proceeds to the Company of $33 million. The Company
received additional proceeds of $878,000 upon the closing of the Direct Offering
on July 31, 1997. The Company's initial public offering was completed on October
14, 1997 raising net proceeds of $98.8 million. During the year ended December
31, 1998, 109,600 shares were repurchased at a cost of $903,163. Stock options
exercised during the year ended December 31, 1998 totaled 44,124 shares for a
aggregate exercise price of $195,100. During the quarter ended March 31, 1999,
48,874 options were exercised for an aggregate price of $195,496.
The Company's principal business objective is to generate net income for
distribution to stockholders from the spread between the interest income on its
Mortgage-Backed Securities and the costs of borrowing to finance its acquisition
of Mortgage-Backed Securities. The Company will seek to generate growth in
earnings and dividends per share in a variety of ways, including through (i)
issuing new Common Stock and increasing the size of the balance sheet when
opportunities in the market for Mortgage-Backed Securities are likely to allow
growth in earnings per share, (ii) continually reviewing the mix of
Mortgage-Backed Security types on the balance sheet in an effort to improve
risk-adjusted returns, and (iii) attempting to improve the efficiency of the
Company's balance sheet structure through the issuance of uncollateralized
subordinated debt, preferred stock and other forms of capital, to the extent
management deems such issuances appropriate.
Results of Operations: For the Quarter Ended March 31, 1999 and 1998
Net Income Summary
For the quarter ended March 31, 1999, net income, as calculated according
to Generally Accepted Accounting Principles ("GAAP"), was $4,318,456, or $0.34
basic earnings per share, as compared to the quarter ended March 31, 1998 of
$4,708,150 or $0.37 basic earnings per share. Net income for the quarter ended
March 31, 1999 declined by $389,694 from the quarter ended March 31, 1998.
Income for the first quarter of 1999 reflects a greater emphasis on net interest
income and less dependence on gains on the disposition of assets, when compared
to the first quarter of 1998. Taxable earnings for the quarter ended March 31,
1999 was approximately $4,415,809 or $0.35 basic per average share. Taxable
income for the quarter ended March 31, 1998 was $4,260,000 or $0.36 basic per
average share. Net income per share is computed by dividing net income by the
weighted average number of shares of outstanding Common Stock during the period,
which was 12,657,884 and 12,727,405 for the quarter ended March 31, 1999 and
1998, respectively. Dividends per weighted average number of shares outstanding
for the quarter ended March 31, 1999 was $0.33 per share, $4,190,108 in total.
Dividends per weighted average number of shares outstanding for the quarter
ended March 31, 1998 was $0.32 per share, $4,082,456 in total. Return on average
equity was 13.70% and 13.97% on an annualized basis for the quarter ended March
31, 1999 and 1998, respectively.
11
Net Income Summary
(dollars in thousands, except per share amounts)
Quarter Ended Quarter Ended
March 31, 1999 March 31, 1998
-------------------------------
Interest Income $ 22,015 $ 20,079
Interest Expense 17,151 16,313
-------------------------------
Net Interest Income 4,864 3,765
Gain on Sale of Mortgage-Backed Securities 65 1,427
General and Administrative Expenses 610 484
-------------------------------
Net Income $ 4,318 $ 4,708
===============================
Average Number of Outstanding Shares - Basic 12,657,884 12,727,405
Average Number of Outstanding Shares - Diluted 12,952,822 12,923,195
Basic Net Income Per Share $ 0.34 $ 0.37
Diluted Net Income Per Share $ 0.33 $ 0.36
Average Total Assets $ 1,520,582 $ 1,316,110
Average Equity $ 126,120 $ 134,827
Return on Average Assets 1.13% 1.43%
Return on Average Equity 13.70% 13.97%
Taxable Income and GAAP Income
For the quarter ended March 31, 1999 and 1998 , income as calculated for
tax purposes (taxable income) differed from income as calculated according to
generally accepted accounting principles (GAAP income). The differences were in
the calculations of premium and discount amortization, gains on sale of
Mortgage-Backed Securities, and general and administrative expenses.
The distinction between taxable income and GAAP income is important to the
Company's stockholders because dividends are declared on the basis of taxable
income. While the Company does not pay taxes so long as it satisfies the
requirements for exemption from taxation pursuant to the REIT Provisions of the
Code, each year the Company completes a corporate tax form wherein taxable
income is calculated as if the Company were to be taxed. This taxable income
level determines the amount of dividends the Company can pay out over time. The
table below presents the major differences between GAAP and taxable income for
the Company for the quarter ended March 31, 1999, the year ended December 31,
1998, and the four quarters in 1998.
12
Taxable Income
Taxable General & Taxable Mortgage Taxable Gain on Sale
GAAP Net Administrative Amortization of Securities Taxable Net
Income Differences Differences Differences Income
-----------------------------------------------------------------------------------------
(dollars in thousands)
For the Quarter Ended $ 4,318 - $ 98 -- $ 4,416
March 31, 1999
- ---------------------------------------------------------------------------------------------------------------------------
For the Year Ended $15,489 $6 $ 969 ($331) $16,133
December 31, 1998
For the Quarter Ended $ 3,685 $3 $ 439 ($ 20) $ 4,107
December 31, 1998
For the Quarter Ended $ 3,709 $ 228 $ 83 $ 4,020
September 30, 1998
For the Quarter Ended $ 3,387 $2 $ 376 ($ 19) $ 3,746
June 30, 1998
For the Quarter Ended $ 4,708 $1 ($ 74) ($375) $ 4,260
March 31, 1998
Interest Income and Average Earning Asset Yield
The Company had average earning assets of $1.5 billion and $1.3 billion
for the quarter ended March 31, 1999 and 1998, respectively. The Company's
primary source of income for the quarters ended March 31, 1999 and 1998 was
interest income. A portion of income was generated by gains on sales of
Mortgage-Backed Securities. Interest income was $22.0 million and $20.1 million
for the quarters ended March 31, 1999 and 1998, respectively. The yield on
average earning assets was 5.87% and 6.15% for the same respective periods.
Yields on interest earning assets decreased to 5.87% for the quarter ended March
31, 1999 from 6.15% for the quarter ended March 31, 1998. The average asset
balance increased by $2 million for the quarter ended March 31, 1999 as compared
to the quarter ended March 31, 1998 which resulted in an increase in interest
income, even though the yield decreased. The table below shows the Company's
average balance of cash equivalents and Mortgage-Backed Securities, the yields
earned on each type of earning assets, the yield on average earning assets and
interest income for the quarter ended March 31, 1999, the year ended December
31, 1998, and the four quarters in 1998.
Average Earning Asset Yield
Yield on
Average Average
Amortized Amortized
Cost of Yield on Cost of Yield on
Average Mortgage- Average Average Mortgage- Average
Cash Backed Earning Cash Backed Earning Interest
Equivalents Securities Assets Equivalents Securities Assets Income
----------------------------------------------------------------------------------------
(dollars in thousands)
For the Quarter Ended March 31, 1999 $2 $1,502,627 $1,502,629 4.01% 5.87% 5.87% $22,015
- -----------------------------------------------------------------------------------------------------------------------------------
For the Year Ended December 31, 1998 $2 $1,461,789 $1,461,791 4.32% 6.16% 6.16% $89,985
For the Quarter Ended December 31, 1998 $2 $1,446,094 $1,446,096 4.28% 6.12% 6.12% $22,136
For the Quarter Ended September 30, 1998 $2 $1,543,010 $1,543,012 4.20% 6.22% 6.22% $24,009
For the Quarter Ended June 30, 1998 $2 $1,550,968 $1,568,024 4.35% 6.13% 6.13% $23,762
For the Quarter Ended March 31, 1998 $2 $1.307.088 $1,307,090 4.45% 6.15% 6.15% $20,079
The Constant Prepayment Rate (or "CPR") on the Company's portfolio of
Mortgage-Backed Securities for the quarter ended March 31, 1999 increased to 23%
from 21% in quarter ended March 31, 1998. "CPR" means an assumed rate
13
of prepayment for the Company's Mortgage-Backed Securities, expressed as an
annual rate of prepayment relative to the outstanding principal balance of the
Company's Mortgage-Backed Securities. This CPR does not purport to be either a
historical description of the prepayment experience of the Company's
Mortgage-Backed Securities or a prediction of the anticipated rate of prepayment
of the Company's Mortgage-Backed Securities. Since a large portion of the
Company's assets was purchased at a premium to par value and only a small
portion of the Company's assets was purchased at a discount to par value, the
premium balance in the Company's portfolio is substantially higher than the
discount balance.
Principal prepayments had a negative effect on the Company's earning asset yield
for the quarters ended March 31, 1999 and 1998 because the Company adjusts its
rates of premium amortization and discount accretion monthly based upon the
effective yield method, which takes into consideration changes in prepayment
speeds.
Interest Expense and the Cost of Funds
The Company anticipates that its largest expense will usually be the cost
of borrowed funds. The Company had average borrowed funds of $1.4 billion and
total interest expense of $17.1 million for the quarter ended March 31, 1999.
The Company had average borrowed funds of $1.2 billion and total interest
expense of $16.3 million for the quarter ended March 31, 1998. The average cost
of funds was 4.97% and 5.59% for the quarter ended March 31, 1999 and March 31,
1998, respectively. Interest expense is calculated in the same manner for GAAP
and tax purposes. Even though the cost of funds rate declined substantially for
the three month period ending March 31, 1999 when compared to the three month
period ended March 31, 1998, interest expense increased because of the increase
in the average repurchase balance by $2 million.
With the Company's current asset/liability management strategy, changes in
the Company's cost of funds are expected to be closely correlated with changes
in short-term LIBOR, although the Company may choose to extend the maturity of
its liabilities at any time. The Company's average cost of funds was 0.01%
greater than the average one-month LIBOR for the quarter ended March 31, 1999
and 0.09% less than the average one-month LIBOR for the quarter ended March 31,
1998. The Company generally has structured its borrowings to adjust with
one-month LIBOR. During the quarter ended March 31, 1999, average one-month
LIBOR, which was 4.96%, was 0.09% less than average six-month LIBOR, which was
5.05%. During the quarter ended March 31, 1998, average one-month LIBOR, which
was 5.64%, was 0.04% less than average six-month LIBOR, which was 5.68%
The table below shows the Company's average borrowed funds and average
cost of funds as compared to average one- and six-month LIBOR for the quarter
ended March 31, 1999, the year ended December 31, 1998, and the four quarters in
1998.
Average Cost of Funds
Average One- Average Cost
Average Average Month LIBOR of Funds Average Cost of
Average Average One- Six- Relative to Relative to Funds Relative
Borrowed Interest Cost of Month Month Average Six- Average One- to Average Six-
Funds Expense Funds LIBOR LIBOR Month LIBOR Month LIBOR Month LIBOR
----------------------------------------------------------------------------------------------------
(dollars in thousands)
For the Quarter Ended
March 31, 1999 $1,381,663 $17,151 4.97% 4.96% 5.05% (0.09%) 0.01% (0.08%)
- ------------------------------------------------------------------------------------------------------------------------------------
For the Year Ended
December 31, 1998 $1,360,040 $75,735 5.57% 5.57% 5.54% 0.03% - 0.03%
For the Quarter Ended
December 31, 1998 $1,371,240 $18,479 5.39% 5.36% 5.10% 0.26% 0.03% 0.29%
For the Quarter Ended
September 30, 1998 $1,460,612 $20,765 5.68% 5.62% 5.63% (0.01%) 0.06% 0.05%
For the Quarter Ended
June 30, 1998 $1,440,822 $20,178 5.60% 5.66% 5.75% (0.09%) (0.06%) (0.15%)
For the Quarter Ended
March 31, 1998 $1,167,483 $16,313 5.59% 5.64% 5.68% (0.04%) (0.05%) (0.09%)
14
Net Interest Rate Agreement Expense
The Company has not entered into any interest rate agreements to date. As
part of its asset/liability management process, the Company may enter into
interest rate agreements such as interest rate caps, floors and swaps. These
agreements would be entered into to reduce interest rate or prepayment risk and
would be designed to provide income and capital appreciation to the Company in
the event of certain changes in interest rates. However, even after entering
into such agreements, the Company would still be exposed to interest rate and
prepayment risks. The Company reviews the need for interest rate agreements on a
regular basis consistent with its Capital Investment Policy.
Net Interest Income
Net interest income, which equals interest income less interest expense,
totaled $4.9 million for the quarter ended March 31, 1999 and $3.8 million for
quarter ended March 31, 1998. Net interest spread, which equals the yield on the
Company's average assets for the period less the average cost of funds for the
period, was 0.90% for the quarter ended March 31, 1999 compared to 0.56% for the
quarter ended March 31, 1998. Net interest margin, which equals net interest
income divided by average total assets, was 1.27% and 1.14% on an annualized
basis for the quarter ended March 31, 1999 and 1998, respectively. Income for
the first quarter of 1999 reflects a greater emphasis on net interest income and
less dependence on gains on disposition of assets, when compared to the first
quarter of 1998. Net interest income increased because of lower funding cost for
the period. This increase was partially offset by lower yields on assets.
Taxable net interest income was approximately $97,353 greater than GAAP net
interest income because of differing premium and discount amortization, for the
quarter ended March 31, 1999. Taxable net interest income was $74,132 less than
GAAP net interest income because of differing premium and discount amortization,
for the quarter ended March 31, 1998. The principal reason that annualized net
interest margin exceeded net interest spread is that average assets exceeded
average liabilities. A portion of the Company's assets is funded with equity
rather than borrowings. The Company did not have any interest rate agreement
expense for the quarter ended March 31, 1999 and 1998.
The table below shows interest income by earning asset type, average
earning assets by type, total interest income, yield on average interest earning
assets, average repurchase agreements, interest expense, average cost of funds,
and net interest income for the quarter ended March 31, 1999, the year ended
December 31, 1998, and the four quarters in 1998.
GAAP Net Interest Income
(dollars in thousands)
Average
Amortized
Cost of Interest Interest
Mortgage-Backe Income on Income on Total
Securities Mortgage-Backe Average Cash Cash Interest
Held Securities Equivalents Equivalents Income
-----------------------------------------------------------------------
For the Quarter Ended March
31, 1999 $1,502,629 $22,015 $2 -- $22,015
- -------------------------------------------------------------------------------------------------------
For the Year Ended
December 31, 1998 $1,461,790 $89,986 $2 -- $89,986
For the Quarter Ended
December 31, 1998 $1,446,094 $22,136 $2 -- $22,136
Yield on
Average Average
Interest Balance of Average Net
Earning Repurchase Interest Cost of Interest
Assets Agreements Expense Funds Income
-----------------------------------------------------
For the Quarter Ended March
31, 1999 5.87% $1,381,663 $17,151 4.97% $4,864
- -------------------------------------------------------------------------------------
For the Year Ended
December 31, 1998 6.16% $1,360,040 $75,735 5.57% $14,250
For the Quarter Ended
December 31, 1998 6.12% $1,371,240 $18,479 5.39% $3,657
15
For the Quarter Ended
September 30, 1998 $1,543,010 $24,009 $2 -- $24,009
For the Quarter Ended
June 30, 1998 $1,550,968 $23,762 $2 -- $23,762
For the Quarter Ended
March 31, 1998 $1,307,088 $20,079 $2 -- $20,079
For the Quarter Ended
September 30, 1998 6.22% $1,460,612 $20,765 5.68% $3,244
For the Quarter Ended
June 30, 1998 6.13% $1,440,822 $20,178 5.60% $3,584
For the Quarter Ended
March 31, 1998 6.15% $1,167,483 $16,313 5.59% $3,765
Gains and Losses on Sales of Mortgage-Backed Securities
For the quarter ended March 31, 1999, the Company sold Mortgage-Backed
Securities with an aggregate historical amortized cost of $31.7 million for an
aggregate gain of $64,560. During the quarter ended March 31, 1998, the Company
sold Mortgage-Backed Securities with a historical amortized cost of $142.4
million for an aggregate gain of $1.4 million. As stated above, the gain on sale
of assets declined substantially. For the quarter ended March 31, 1999, there
was a greater emphasis on spread income and not gains. Taxable net gains were
approximately the same as GAAP gains (losses) on sale of securities for the
quarter ended March 31, 1999 and $375,163 less for the quarter ended March 31,
1998. The difference between the sale price and the historical amortized cost of
the Mortgage-Backed Securities is a realized gain and increased income
accordingly. The Company does not expect to sell assets on a frequent basis, but
may from time to time sell existing assets to move into new assets which
management believes might have higher risk-adjusted returns or to manage its
balance sheet as part of management's asset/liability management strategy.
Credit Expenses
The Company has not experienced credit losses on its portfolio of
Mortgage-Backed Securities to date, but losses may be experienced in the future.
To date, the Company had limited its exposure to credit losses on its portfolio
of Mortgage-Backed Securities by purchasing only securities, issued or
guaranteed by FNMA, FHLMC or GNMA ("Agency certificates"), which, although not
rated, carry an implied "AAA" rating.
General and Administrative Expenses
General and administrative expenses ("operating expense" or "G&A expense")
were $610,004 for the quarter ended March 31, 1999 and $484,181 for the quarter
ended March 31, 1998. Taxable G&A expenses were approximately $137 and $1,427
less than for GAAP purposes for the quarters ended March 31, 1999 and 1998,
respectively. G&A expense increased as a percentage of assets to 0.16% for the
three month period ended March 31, 1999 compared to 0.15% for the same three
month period in the previous year. The Company experienced economies of scale
with the increasing asset base and because it is internally managed. Also, it
intends to continue to be a low cost provider.
GAAP G&A Expense and Operating Expense Ratios
Total G&A Total G&A
Cash Comp and Expense/Average Expense/Average
Benefits Other G&A Total G&A Assets Equity
Expense Expense Expense (annualized) (annualized)
-------------------------------------------------------------------------
(dollars in thousands)
For the Quarter Ended
March 31, 1999 $333 $277 $610 0.16% 1.93%
- ----------------------------------------------------------------------------------------------------
For the Year Ended
December 31, 1998 $1,210 $896 $2,106 0.14% 1.60%
For the Quarter Ended
December 31, 1998 $380 $219 $599 0.15% 1.90%
For the Quarter Ended
September 30, 1998 $318 $210 $528 0.13% 1.61%
16
For the Quarter Ended
June 30, 1998 $252 $242 $494 0.13% 1.50%
For the Quarter Ended
March 31, 1998 $259 $225 $484 0.15% 1.44%
Net Income and Return on Average Equity
Net income was $4.3 million in the quarter ended March 31, 1999 and $4.7
million for the quarter ended March 31, 1998. Return on average equity was
13.70% on an annualized basis for the quarter ended March 31, 1999 and 13.97% on
an annualized basis for the quarter ended March 31, 1998. The table below shows
the Company's net interest income, gain on sale of Mortgage-Backed Securities
and G&A expense each as a percentage of average equity, and the return on
average equity for the quarter ended March 31, 1999, the year ended December 31,
1998 and the four quarters in 1998.
Components of Return on Average Equity
Gain on Sale of
Mortgage-Backed
Net Interest Securities/
Income/Average Average G&A Expense/Average Return on Average
Equity Equity Equity Equity
--------------------------------------------------------------------------
For the Quarter Ended March 31, 1999
(on an annualized basis) 15.43% 0.20% 1.93% 13.70%
- -----------------------------------------------------------------------------------------------------------------------
For the Year ended December 31, 1998 10.85% 2.55% 1.60% 11.80%
For the Quarter Ended December 31, 1998
(on an annualized basis) 11.45% 1.97% 1.90% 11.71%
For the Quarter Ended September 30, 1998
(on an annualized basis) 9.89% 3.03% 1.61% 11.31%
For the Quarter Ended June 30, 1998
(on an annualized basis) 10.92% 1.90% 1.50% 10.32%
For the Quarter March 31, 1998
(on an annualized basis) 11.18% 4.23% 1.44% 13.97%
Dividends and Taxable Income
The Company has elected to be taxed as a REIT under the Code. Accordingly,
the Company intends to distribute substantially all of its taxable income for
each year to stockholders, including income resulting from gains on sales of
Mortgage-Backed Securities. Through March 31, 1999, earned taxable income
exceeded dividend declarations by approximately $1.1 million or $0.09 per share,
based on the number of shares of Common Stock outstanding at period end.
17
Dividend Summary
Cumulative
Weighted Average Taxable Net Dividends Dividend Undistributed
Taxable Net Common Shares Income Declared Total Pay-out Taxable
Income Outstanding Per Share Per Share Dividends Ratio Income
---------------------------------------------------------------------------------------------
(dollars in thousands, except per share data)
For the Quarter Ended
March 31, 1999 $4,416 12,657,884 $0.35 $0.33 $4,190 94.9% $1,115
- ------------------------------------------------------------------------------------------------------------------------
For the Year Ended
December 31, 1998 $16,133 12,709,116 $1.27 $1.215 $15,437 95.7% $889
For the Quarter Ended
December 31, 1998 $4,107 12,648,116 $0.32 $0.315 $3,859 93.96% $889
For the Quarter Ended
September 30, 1998 $4,020 12,704,194 $0.32 $0.27 $3,415 83.74% $641
For the Quarter Ended
June 30, 1998 $3,746 12,757,674 $0.29 $0.32 $4,082 108.39% $36
For the Quarter Ended
March 31, 1998 $4,260 12,727,405 $0.33 $0.32 $4,082 88.07% $372
Financial Condition
Mortgage-Backed Securities
All of the Company's Mortgage-Backed Securities at March 31, 1999,
December 31, 1998, and March 31, 1998 were Mortgage-Backed Securities backed by
Single-Family Mortgage Loans. All of the mortgage assets underlying such
Mortgage-Backed Securities were secured with a first lien position with respect
to the underlying single-family properties. At March 31, 1999, December 31,
1998, and March 31, 1998, all the Company's Mortgage-Backed Securities were
Agency Certificates, which, although not rated, carry an implied "AAA" rating.
All of the Company's earning assets are marked-to-market at liquidation value.
Discount balances are accreted as an increase in interest income over the
life of discount Mortgage-Backed Securities and premium balances are amortized
as a decrease in interest income over the life of premium Mortgage-Backed
Securities. At March 31, 1999 and 1998, the Company had on its balance sheet a
total of $1.1 million and $608,579, respectively, of unamortized discount (which
is the difference between the remaining principal value and current historical
amortized cost of Mortgage-Backed Securities acquired at a price below principal
value) and a total of $27.2 million and $24.9 million, respectively, of
unamortized premium (which is the difference between the remaining principal
value and the current historical amortized cost of Mortgage-Backed Securities
acquired at a price above principal value).
Mortgage principal repayments received were $125.5 million and $94.2
million for the quarter ended March 31, 1999 and 1998, respectively. Given the
Company's current portfolio composition, if mortgage principal prepayment rates
increase over the life of the Mortgage-Backed Securities comprising the current
portfolio, all other factors being equal, the Company's net interest income
should decrease during the life of such Mortgage-Backed Securities as the
Company will be required to amortize its net premium balance into income over a
shorter time period. Similarly, if mortgage principal prepayment rates decrease
over the life of such Mortgage-Backed Securities, all other factors being equal,
the Company's net interest income should increase during the life of such
Mortgage-Backed Securities as the Company will amortize its net premium balance
over a longer time period.
18
The table below summarizes the Company's Mortgage-Backed Securities, at
the dates indicated.
Mortgage-Backed Securities
Estimated Fair
Amortized Estimated Value/ Weighted
Net Amortized Cost/Principal Fair Principal Average
Principal Value Premium Cost Value Value Value Yield
------------------------------------------------------------------------------------------------
(dollars in thousands)
At March 31, 1999 $1,527,530 $26,071 $1,553,601 101.71% $1,547,618 101.32% 5.94%
- ---------------------------------------------------------------------------------------------------------------------------
At December 31, 1998 $1,502,414 $24,278 $1,526,692 101.62% $1,520,289 101.19% 6.43%
At September 30, 1998 $1,461,056 $24,244 $1,485,300 101.66% $1,483,195 101.52% 6.49%
At June 30, 1998 $1,541,520 $26,532 $1,568,052 101.72% $1,566,188 101.60% 6.50%
At March 31, 1998 $1,495,670 $25,265 $1,520,935 101.70% $1,518,847 101.55% 6.51%
The tables below set forth certain characteristics of the Company's
Mortgage-Backed Securities. The index level for adjustable-rate Mortgage-Backed
Securities is the weighted average rate of the various short-term interest rate
indices which determine the coupon rate.
Adjustable-Rate Mortgage-Backed Security Characteristics
Weighted Weighted Weighted Weighted Weighted Principal Value at
Average Average Average Average Term Weighted Average Period End as % of
Principal Coupon Index Net to Next Average Asset Mortgage-
Value Rate Level Margin Adjustment Lifetime Cap Yield Backed Securities
---------------------------------------------------------------------------------------------------------
(dollars in thousands)
At March 31, 1999 $1,036,947 6.63% 4.97% 1.66% 11 months 11.01% 5.64% 67.88%
- -----------------------------------------------------------------------------------------------------------------------------------
At December 31, 1998 $1,030,654 6.84% 5.18% 1.66% 12 months 10.63% 6.42% 68.60%
At September 30, 1998 $1,050,177 6.78% 5.20% 1.68% 13 months 10.42% 6.51% 71.88%
At June 30, 1998 $1,140,518 6.86% 5.20% 1.66% 15 months 10.42% 6.46% 73.98%
At March 31, 1998 $1,176,716 6.89% 5.45% 1.61% 12 months 10.00% 6.46% 78.68%
Fixed-Rate Mortgage-Backed Security Characteristics
Principal Value as % of
Weighted Average Weighted Average Mortgage-Backed
Principal Value Coupon Rate Asset Yield Securities
-------------------------------------------------------------------------------
(dollars in thousands)
At March 31, 1999 $490,583 6.54% 6.37% 32.12%
- ---------------------------------------------------------------------------------------------------------
At December 31, 1998 $471,760 6.55% 6.47% 31.40%
At September 30, 1998 $410,879 6.69% 6.47% 28.12%
At June 30, 1998 $401,002 6.82% 6.65% 26.02%
At March 31, 1998 $318,954 6.85% 6.70% 21.32%
At March 31, 1999, the Company held Mortgage-Backed Securities with
coupons linked to the one-year, three-year, and five-year Treasury Indices,
one-month LIBOR and the six-month CD rate. The table below segments the
Company's
19
adjustable-rate Mortgage-Backed Securities by type of adjustment index, coupon
adjustment frequency and annual and lifetime cap adjustment.
Adjustable-Rate Mortgage-Backed Securities by Index
March 31, 1999
1-Year 3-Year 5-Year
One-Month Six-Month Treasury Treasury Treasury
LIBOR CD Rate Index Index Index
----------------------------------------------------------
Weighted Average Adjustment Frequency 1 mo. 6 mo. 32 mo. 36 mo. 60 mo.
Weighted Average Term to Next Adjustment 1 mo. 3 mo. 19 mo. 16 mo. 0 mo.
Weighted Average Annual Period Cap None 1.00% 1.71% 1.79% 2.00%
Weighted Average Lifetime Cap at
March 31, 1999 9.13% 11.06% 12.01% 13.13% 11.51%
Mortgage Principal Value as Percentage of
Mortgage-Backed Securities at
March 31, 1999 25.07% 3.34% 32.56% 6.62% 0.29%
At December 31, 1998, the Company held Mortgage-Backed Securities with
coupons linked to the one-year and three-year Treasury indices, one-month LIBOR,
and the six-month CD rate. The table below segments the Company's
adjustable-rate Mortgage Backed Securities by type of adjustment index, coupon
adjustment frequency, and annual and lifetime cap adjustment.
Adjustable-Rate Mortgage-Backed Securities by Index
December 31, 1998
1-Year 3-Year 5-Year
One-Month Six-Month Treasury Treasury Treasury
LIBOR CD Rate Index Index Index
------------------------------------------------------
Weighted Average Adjustment Frequency 1 mo. 6 mo. 32 mo. 36 mo. 60 mo.
Weighted Average Term to Next Adjustment 1 mo. 3 mo. 23 mo. 9 mo. 2 mo.
Weighted Average Annual Period Cap None 1.00% 1.83% 2.00% 2.00%
Weighted Average Lifetime Cap at
December 31, 1998 9.16% 11.04% 11.76% 13.07% 11.57%
Mortgage Principal Value as Percentage of
Mortgage-Backed Securities at
December 31, 1998 29.60% 3.73% 33.33% 1.62% 0.32%
20
The table below shows unrealized gains and losses on the Mortgage-Backed
Securities in the Company's portfolio at the dates indicated.
Unrealized Gains and Losses
(dollars in the thousands)
At March 31, At December 31, At September 30, At June 30, At March 31,
1999 1998 1998 1998 1998
-------------------------------------------------------------------------------
Unrealized Gain $ 2,801 $ 3,302 $ 7,060 $ 2,826 $ 2,622
Unrealized Loss (8,784) (9,706) (9,164) (4,736) (4,710)
-----------------------------------------------------------------------------
Net Unrealized Loss (5,983) (6,404) (2,104) (1,910) (2,088)
=============================================================================
Net Unrealized Loss as % of
Mortgage-Backed Securities
Principal Value (0.39%) (0.43%) 0.18% (0.12%) (0.14%)
Net Unrealized Loss as % of
Mortgage-Backed Securities
Amortized Cost (0.39%) (0.42%) 0.17% (0.12%) (0.14%)
Interest Rate Agreements
Interest rate agreements are assets that are carried on a balance sheet at
estimated liquidation value. At March 31, 1999 and December 31, 1998, there were
no interest rate agreements on the Company's balance sheet. No interest rate
agreements have been entered into since inception of the Company.
Borrowings
To date, the Company's debt has consisted entirely of borrowings
collateralized by a pledge of the Company's Mortgage-Backed Securities. These
borrowings appear on the balance sheet as repurchase agreements. At March 31,
1999, the Company had established uncommitted borrowing facilities in this
market with twenty-three lenders in amounts, which the Company believes, are in
excess of its needs. All of the Company's Mortgage-Backed Securities are
currently accepted as collateral for such borrowings. The Company, however,
limits its borrowings, and thus its potential asset growth, in order to maintain
unused borrowing capacity while increasing the liquidity and strength of its
balance sheet.
For the quarter ended March 31, 1999 and 1998, the term to maturity of the
Company's borrowings has ranged from one day to one year, with a weighted
average original term to maturity of 63 days and 66 days, respectively. The
weighted average remaining maturity was 13 days and 20 days at March 31, 1999
and 1998, respectively. Many of the Company's borrowings have a cost of funds
which adjust monthly based on a fixed spread over or under one-month LIBOR or
based on the daily Fed Funds rate. As a result, the average term to the next
rate adjustment for the Company's borrowings is typically shorter than the term
to maturity for the Company's Mortgage-Backed Securities. At March 31, 1999, the
weighted average cost of funds for all of the Company's borrowings was 4.85% and
the weighted average term to next rate adjustment was 13 days. At March 31,
1998, the weighted average cost of funds for all the Company's borrowings was
5.58% and the weighted average term to next rate adjustment was 20 days.
Liquidity
Liquidity, which is the Company's ability to turn non-cash assets into
cash, allows the Company to purchase additional Mortgage-Backed Securities and
to pledge additional assets to secure existing borrowings should the value of
pledged assets decline. Potential immediate sources of liquidity for the Company
include cash balances and unused borrowing capacity. Unused borrowing capacity
will vary over time as the market value of the Company's Mortgage-Backed
Securities varies. The Company's balance sheet also generates liquidity on an
on-going basis through mortgage principal
21
repayments and net earnings held prior to payment as dividends. Should the
Company's needs ever exceed these on-going sources of liquidity, plus the
immediate sources of liquidity discussed above, management believes that the
Company's Mortgage-Backed Securities could in most circumstances be sold to
raise cash. The maintenance of liquidity is one of the goals of the Company's
Capital Investment Policy. Under this policy, asset growth is limited in order
to preserve unused borrowing capacity for liquidity management purposes.
Stockholders' Equity
The Company uses "available-for-sale" treatment for its Mortgage-Backed
Securities; these assets are carried on the balance sheet at estimated market
value rather than historical amortized cost. Based upon such
"available-for-sale" treatment, the Company's equity base at March 31, 1999 was
$126.7 million, or $9.97 per share. If the Company had used historical amortized
cost accounting, the Company's equity base at March 31, 1999 would have been
$132.6 million, or $10.44 per share. The Company's equity base at March 31, 1998
was $131.7 million, or $10.32 per share. If the Company had used historical
amortized cost accounting, the Company's equity base at March 31, 1998 would
have been $133.8 million, or $10.48 per share.
With the Company's "available-for-sale" accounting treatment, unrealized
fluctuations in market values of assets do not impact GAAP or taxable income but
rather are reflected on the balance sheet by changing the carrying value of the
asset and reflecting the change in stockholders' equity under "Accumulated Other
Comprehensive Income." By accounting for its assets in this manner, the Company
hopes to provide useful information to stockholders and creditors and to
preserve flexibility to sell assets in the future without having to change
accounting methods.
As a result of this mark-to-market accounting treatment, the book value
and book value per share of the Company are likely to fluctuate far more than if
the Company 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 be misleading.
Unrealized changes in the estimated net market value of Mortgage-Backed
Securities have one direct effect on the Company's potential earnings and
dividends: positive market-to-market changes will increase the Company's equity
base and allow the Company to increase its borrowing capacity while negative
changes will tend to limit borrowing capacity under the Company's Capital
Investment Policy. A very large negative change in the net market value of the
Company's Mortgage-Backed Securities might impair the Company's liquidity
position, requiring the Company to sell assets with the likely result of
realized losses upon sale. "Net Unrealized Losses on Assets Available for Sale"
was $6.0 million, or 0.39% of the amortized cost of Mortgage-Backed Securities,
at March 31, 1999. "Net Unrealized Gain on Assets Available for Sale" was $2.1
million, or 0.14% of the amortized cost of Mortgage-Backed Securities, at March
31, 1998.
The table below shows the Company's equity capital base as reported and on
a historical amortized cost basis at March 31, 1999, December 31, 1998,
September 30, 1998, June 30, 1998, and March 31, 1998. Issuances of Common
Stock, the level of GAAP earnings as compared to dividends declared, and other
factors influence the historical cost equity capital base. The GAAP reported
equity capital base is influenced by these factors plus changes in the "Net
Unrealized Losses on Assets Available for Sale" account.
22
Stockholders' Equity
GAAP
Historical Net Unrealized Reported Historical GAAP Reported
Amortized Cost Gains on Assets Equity Base Amortized Cost Equity (Book
Equity Base Available for Sale (Book Value) Equity Per Share Value) Per Share
--------------------------------------------------------------------------------------------
(dollars in thousands, except per share data)
At March 31, 1999 $132,599 ($5,983) $126,617 $10.44 $9.97
- -----------------------------------------------------------------------------------------------------------------------------
At December 31, 1998 $132,275 ($6,404) $125,871 $10.46 $9.95
At September 30, 1998 $132,446 ($2,105) $130,342 $10.47 $10.30
At June 30, 1998 $133,055 ($1,910) $131,145 $10.43 $10.28
At March 31, 1998 $133,751 ($2,088) $131,663 $10.48 $10.32
Leverage
The Company's debt-to-GAAP reported equity ratio at March 31, 1999 and
March 31, 1998 was 10.0:1 and 10:1, respectively. The Company generally expects
to maintain a ratio of debt-to-equity of between 8:1 and 12:1, although the
ratio may vary from time to time based upon various factors, including
management's opinion of the level of risk of its assets and liabilities, the
Company's liquidity position, the level of unused borrowing capacity and
over-collateralization levels required by lenders when the Company pledges
assets to secure borrowings.
The target debt-to-GAAP reported equity ratio is determined under the
Company's Capital Investment Policy. Should the actual debt-to-equity ratio of
the Company increase above the target level due to asset acquisition and/or
market value fluctuations in assets, management will cease to acquire new
assets. Management will, at such time, present a plan to its Board of Directors
to bring the Company back to its target debt-to-equity ratio; in many
circumstances, this would be accomplished in time by the monthly reduction of
the balance of Mortgage-Backed Securities through principal repayments.
Asset/Liability Management and Effect of Changes in Interest Rates
Management continually reviews the Company's asset/liability management
strategy with respect to interest rate risk, mortgage prepayment risk, credit
risk and the related issues of capital adequacy and liquidity. The Company seeks
attractive risk-adjusted stockholder returns while maintaining a strong balance
sheet.
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 it 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 its portfolio of Mortgage-Backed
Securities by entering into interest rate agreements such as interest rate caps
and interest rate swaps.
Changes in interest rates may also have an effect on the rate of mortgage
principal prepayments and, as a result, prepayments on Mortgage-Backed
Securities. The Company seeks to mitigate the effect of changes in the mortgage
principal repayment rate from an economic point of view by balancing assets
purchased at a premium with assets purchased at a discount. To date, the
aggregate premium exceeds the aggregate discount on Mortgage-Backed Securities
in the Company's portfolio. As a result, prepayments, which result in the
expensing of unamortized premium, will reduce the Company's net income compared
to what net income would be absent such prepayments.
23
Status of Year 2000 Compliance
The company has made an ongoing effort to stay abreast of the year 2000
compliance issue. Hardware and software was checked for compliance and necessary
upgrades were completed. In consideration of the Year 2000 issues, the Company
has reviewed the ability of its own computers and computer programs to properly
recognize and handle dates in the Year 2000. Through the normal upgrading of
computer equipment, the Company has already replaced all computers that were not
Year 2000 compliant. The Company has also reviewed all the date fields embedded
in its internally developed spreadsheets, databases and other programs and has
determined that all such programs are using four-digit years in references to
dates. Therefore, the Company believes that all of its equipment and internal
systems are ready for the Year 2000. To date, the Company has incurred minimal
costs in order to be Year 2000 compliant.
The Company believes that most of its exposure to Year 2000 issues
involves the readiness of third parties. Each third party is subject to the Year
2000 issue. The Company is in the process of surveying pertinent third parties
for their compliance. As a result of communications with such third parties, the
Company believes that they are spending the appropriate and necessary resources
to try to identify Year 2000 issues and to resolve them or to mitigate the
impact of them to the best of their ability as they are identified.
Inflation
Virtually all of the Company's assets and liabilities are financial in
nature. As a result, interest rates and other factors drive the Company's
performance far more than does inflation. Changes in interest rates do not
necessarily correlate with inflation rates or changes in inflation rates. The
Company's financial statements are prepared in accordance with GAAP and the
Company's dividends are determined by the Company's net income as calculated for
tax purposes; in each case, the Company's activities and balance sheet are
measured with reference to historical cost or fair market value without
considering inflation.
Other Matters
The Company calculated its qualified REIT Assets, as defined in the
Internal Revenue Code of 1986, as amended (the "Code"), to be 99.5% of its total
assets at March 31, 1999 and 1998, as compared to the Code requirement that at
least 75% of its total assets must be qualified REIT Assets. The Company also
calculates that 99.7% and 93.4% of its revenue qualifies for the 75% source of
income test and 100% of its revenue qualifies for the 95% source of income test
under the REIT rules for the quarter ended March 31, 1999 and 1998,
respectively. The Company also met all REIT requirements regarding the ownership
of its Common Stock and the distributions of its net income. Therefore, as of
March 31, 1999 and 1998, the Company believes that it qualified as a REIT under
the provisions of the Code.
The Company at all times intends to conduct its business so as not to
become regulated as an investment company under the Investment Company Act of
1940. If the Company were to become regulated as an investment company, then the
Company's 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 Commission, in order to qualify for this exemption, the Company must
maintain at least 55% of its assets directly in Qualifying Interests. In
addition, unless certain mortgage securitites represent all the certificates
issued with respect to an underlying pool of mortgages, such mortgage 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. As of March 31, 1999 and 1998, the Company calculates that it is in
compliance with this requirement.
24
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 the Company is 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 the control of the Company. Changes in the general level of
interest rates can affect the Company's net interest income, which is the
difference between the interest income earned on interest-earning assets and the
interest expense incurred in connection with its interest-bearing liabilities,
by affecting the spread between the Company's interest-earning assets and
interest-bearing liabilities. Changes in the level of interest rates also can
affect the value of the Company's Mortgage-Backed Securities and its ability to
realize gains from the sale of such assets. The Company 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 its operations. The use of these types of derivatives to hedge
interest-earning assets and/or interest-bearing liabilities carries certain
risks, including the risk that losses on a hedge position will reduce the funds
available for payments to holders of securities and, indeed, that such losses
may exceed the amount invested in such instruments. Currently, the Company has
not purchased hedging instruments. The profitability of the Company 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 net
portfolio value should interest rates go up or down 400 basis points, assuming
the yield curves of the rate shocks will be parallel to each other and the
current yield curve. Net portfolio value is defined as interest-earning assets
net of interest-bearing liabilities. All changes in income and value are
measured as percentage changes from the projected net interest income and net
portfolio value at the base interest rate scenario. The base interest rate
scenario assumes interest rates at March 31, 1999 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 Net Portfolio Value
- ------------------------------------------------------------------------------------------
- -400 Basis Points 174% 4%
- -300 Basis Points 160% 3%
- -200 Basis Points 50% 2%
- -100 Basis Points 18% 2%
Base Interest Rate
+100 Basis Points (51%) (2%)
+200 Basis Points (78%) (4%)
+300 Basis Points (157%) (7%)
+400 Basis Points (160%) (11%)
ASSET AND LIABILITY MANAGEMENT
Asset and liability management is concerned with the timing and magnitude
of the repricing of assets and liabilities. It is the objective of the Company
to attempt to control risks associated with interest rate movements. Methods for
evaluating interest rate risk include an analysis of the Company's interest rate
sensitivity "gap", which is defined as 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
25
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.
The following table sets forth the estimated maturity or repricing of the
Company's interest-earning assets and interest-bearing liabilities at March
31,1999. 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 (i) 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, (ii) fixed-rate mortgage-related securities
reflect estimated prepayments, which were estimated based on analyses of broker
estimates, the results of a prepayment model utilized by the Company and
empirical data, (iii) non-performing discount loans reflect the estimated timing
of resolutions which result in repayment to the Company and (iv) fixed-rate
loans reflect scheduled contractual amortization, with no estimated prepayment.
Management believes that these assumptions approximate actual experience and
considers them reasonable; however, the interest rate sensitivity of the
Company's assets and liabilities in the table could vary substantially if
different assumptions were used or actual experience differs from the historical
experience on which the assumptions are based.
More than 1
Within 4-12 Year to 3 3 Years
3 Months Months Years and Over Total
-------------------------------------------------------------
Rate Sensitive Assets:
Mortgage-Backed Securities 449,315 324,146 194,074 586,066 1,553,601
Rate Sensitive Liabilities:
Repurchase Agreements 1,371,856 1,371,856
-------------------------------------------------------------
Interest rate sensitivity gap (922,541) 324,146 194,074 586,066
Cumulative rate sensitivity gap (922,541) (598,395) (404,321) 181,745
Cumulative interest rate
sensitivity gap as a percentage
of total rate-sensitive assets (59%) (39%) (26%) 12%
26
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 1 - Financial Data Schedule
(b) Reports
None
27
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ANNALY MORTGAGE MANAGEMENT, INC.
Dated: May 13, 1999 By: /s/ Michael A.J. Farrell
-------------------------------------------------
Michael A.J. Farrell
Chairman of the Board and Chief Executive Officer
(authorized officer of registrant)
Dated: May 13, 1999 By: /s/ Kathryn F. Fagan
-------------------------------------------------
Kathryn F. Fagan
Chief Financial Officer and Treasurer
(principal accounting officer)
28