================================================================================
U. S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
______________________
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1998
[_] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _______________ TO
______________
Commission File No. 001-13709
______________________
ANWORTH MORTGAGE ASSET CORPORATION
(Exact name of Registrant as specified in its charter)
MARYLAND 52-2059785
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1299 Ocean Avenue, #200
Santa Monica, CA 90401
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (310) 394-0115
______________________
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 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
--- ---
As of June 30, 1998, 2,328,000 shares of Common Stock, $0.01 par value per share
were issued and outstanding.
______________________
================================================================================
INDEX
-----
Part I. Financial Information Page
- ------- --------------------- ----
Item 1. Financial Statements
Balance sheet............................................................................3
Statement of Operations (unaudited) for the three months
ended June 30, 1998.....................................................................4
Statement of Cash Flows (unaudited) for the three months
ended June 30, 1998.....................................................................5
Statement of Stockholders' Equity (unaudited) for the three months
ended June 30, 1998.....................................................................6
Notes to Financial Statements............................................................7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Part II. Other Information
- -------- -----------------
Item 1. Legal Proceedings ......................................................................25
Item 2. Changes in Securities...................................................................25
Item 3. Defaults upon Senior Securities.........................................................25
Item 4. Submission of Matters to a Vote of Security Holders.....................................25
Item 5. Other Information.......................................................................25
Item 6. Exhibits and Reports on Form 8-K........................................................25
Signatures............................................................................................26
- ----------
2
ANWORTH MORTGAGE ASSET CORPORATION
Balance Sheet
June 30, 1998
Assets
Adjustable rate mortgage backed securities $ 198,776,000
Cash and cash equivalents 9,537,000
Accrued interest receivable 1,489,000
Prepaid expenses and other 64,000
---------------------
$ 209,866,000
=====================
Liabilities and Stockholders Equity
Liabilities
Reverse repurchase agreements $ 185,226,000
Payable for purchase of ARM securities 4,128,000
Accrued interest payable 1,786,000
Dividends payable 349,000
Accrued expenses and other 124,000
---------------------
191,613,000
---------------------
STOCKHOLDERS' EQUITY
Preferred stock, par value $.01 per share;
authorized 20,000,000 shares;
no shares issued and outstanding -
Common stock; par value $.01 per share; 23,000
authorized 100,000,000 shares; 2,328,000
shares issued and outstanding
Additional paid in capital 18,962,000
Other comprehensive income, unrealized
gain (loss) on available for sale securities (757,000)
Retained earnings 25,000
---------------------
18,253,000
---------------------
$ 209,866,000
=====================
See notes to financial statements.
3
ANWORTH MORTGAGE ASSET CORPORATION
Statement of Operations
Three Months Ended June 30, 1998
Interest income net of
amortization of premium $ 2,799,000
Interest expense 2,318,000
-----------------
Net interest income $ 481,000
Expenses:
Management fee 46,000
Incentive fee 2,000
Other expense 76,000
-----------------
Net Income $ 357,000
=================
Basic and diluted earnings per share $ 0.15
=================
Dividends declared per share $ 0.15
=================
Average number of shares outstanding 2,309,729
=================
See notes to financial statements.
4
ANWORTH MORTGAGE ASSET CORPORATION
Statement of Cash Flows
Three Months Ended June 30, 1998
Operating Activities:
Net income $ 357,000
Adjustments to reconcile net income to
net cash provided by operating activities:
Amortization 337,000
Net realized (gain) loss from securities called -
Decrease (increase) in accrued interest receivable (794,000)
Decrease (increase) in deferred organization expense (52,000)
Increase (decrease) in accrued interest payable 1,746,000
Increase (decrease) in accrued expenses and other 81,000
----------------------
Net cash provided by operating activities 1,675,000
Investing Activities:
Available-for-sale securities:
Purchases (128,135,000)
Principal payments 18,847,000
----------------------
Net cash (used in) investing activities (109,288,000)
Financing Activities:
Net borrowings from reverse repurchase agreements 103,936,000
Proceeds from common stock issued, net 622,000
----------------------
Net cash provided by financing activities 104,558,000
----------------------
Net increase (decrease) in cash and cash equivalents (3,055,000)
Cash and cash equivalents at beginning of period 12,592,000
----------------------
Cash and cash equivalents at end of period $ 9,537,000
======================
See notes to financial statements.
5
ANWORTH MORTGAGE ASSET CORPORATION
Statement of Stockholders' Equity
Three Months Ended June 30, 1998
Common Additional Net
Stock Paid-in Unrealized Retained
Par Value Capital Gain(Loss) Earnings Total
----------------------------------------------------------------
Balance, March 31, 1998 $22,001 $17,892,999 $ 16,482 $17,931,482
Issuance of common stock 1,279 1,069,244 1,070,523
Available-for-sale securities,
Fair value adjustment (756,827) (756,827)
Net income 357,372 357,372
Dividends declared-
$0.15 per share (349,200) (349,200)
----------------------------------------------------------------
Balance, June 30, 1998 $23,280 $18,962,243 $(756,827) $ 24,654 $18,253,350
6
ANWORTH MORTGAGE ASSET CORPORATION
NOTES TO FINANCIAL STATEMENTS
June 30, 1998
NOTE 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Anworth Mortgage Asset Corporation (the "Company") was incorporated in Maryland
on October 20, 1997. The Company commenced its operations of purchasing and
managing an investment portfolio of primarily adjustable-rate mortgage-backed
securities on March 17, 1998, upon completion of its initial public offering of
the Company's common stock.
A summary of the company's significant accounting policies follows:
BASIS OF PRESENTATION
The accompanying unaudited condensed financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Rule 10-01 of Regulation
S-X. Therefore, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements.
In the opinion of management, all material adjustments, consisting of normal
recurring adjustments, considered necessary for a fair presentation have been
included. The condensed Balance Sheet as of June 30, 1998 and the condensed
Statements of Operations and Cash Flows for the period ended June 30, 1998 and
related notes are unaudited. As such, the operating results for the quarter
ended June 30, 1998 are not necessarily indicative of the results that may be
expected for the calendar year ending December 31, 1998.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash on hand and highly liquid investments
with original maturities of twelve months or less.
7
The carrying amount of cash equivalents approximates their fair value.
MORTGAGE BACKED SECURITIES
The Company invests primarily in adjustable-rate mortgage pass-through
certificates and hybrid adjustable-rate mortgage-backed securities ("ARM"
securities). Hybrid ARM securities have an initial interest rate that is fixed
for a certain period, usually three to five years, and then adjusts annually for
the remainder of the term of the loan.
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. It is the Company's policy to
classify each of its ARM securities as available-for-sale and then to monitor
the security's performance over time before making a final determination as to
the permanent classification. At this time all of the Company's ARM securities
are classified as available-for-sale. All assets that are classified as
available-for-sale are carried at fair market value.
Interest income is accrued based on the outstanding principal amount of the ARM
securities and their contractual terms. Premiums associated with the purchase
of ARM securities are amortized into interest income over the estimated lives of
the asset using the effective yield method.
ARM securities are recorded on the date the securities are purchased or sold.
CREDIT RISK
At June 30, 1998 the company has limited its exposure to credit losses on its
portfolio of ARM securities by purchasing primarily securities from Federal Home
Loan Mortgage Corporation ("FHLMC") and Federal National Mortgage Association
("FNMA"). The payment of principal and interest on the FHLMC and FNMA ARM
securities are guaranteed by those respective agencies. At June 30, 1998, all
of the Company's ARM securities have an implied "AAA" rating.
8
DEFERRED ORGANIZATION EXPENSES
With the completion of the initial public offering of its common stock, the
Company became liable for estimated organization expenses in the amount of
$11,889, which will be charged against current income during fiscal 1998.
INCOME TAXES
The Company intends to elect to be taxed as a Real Estate Investment Trust and
to comply with the provisions of the Internal Revenue Code with respect thereto.
Accordingly, the Company will not be subject to Federal income tax to the extent
that its distributions to stockholders satisfy the REIT requirements.
EARNINGS PER SHARE
Earnings per share is computed by dividing net income by the weighted average
number of common shares and common share equivalents (e.g., stock options), if
dilutive, outstanding during the period.
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.
NOTE 2. ADJUSTABLE-RATE MORTGAGE BACKED SECURITIES
The following table pertains to the Company's ARM securities classified as
available-for-sale as of June 30, 1998, which are carried at their fair value:
Federal Federal
Home Loan National Other Total
Mortgage Mortgage Mortgage Mortgage
Corporation Association Assets Assets
- -------------------------------------------------------------------------------------------
Amortized cost ($000's) $45,104 $154,427 $0 $199,533
Unrealized gains (losses) (359) (398) 0 (757)
------------------------------------------------------------
Fair value $44,746 $154,030 $0 $198,776
------------------------------------------------------------
9
NOTE 3. REVERSE REPURCHASE AGREEMENTS
The Company has entered into reverse repurchase agreements to finance most of
its ARM securities. The reverse repurchase agreements are short-term borrowings
that are secured by the market value of the Company's ARM securities and bear
interest rates that have historically moved in close relationship to LIBOR.
At June 30, 1998, the repurchase agreements had the following remaining
maturities (dollars in thousands):
- ----------------------------------------------------------------------
Within 59 days $ 54,924
60 to 89 days 54,883
90 to 119 days 57,057
Over 120 days 18,363
---------------
$185,227
---------------
NOTE 4. INITIAL PUBLIC OFFERING
On March 12, 1998 the Company completed its initial public offering of common
stock, $0.01 par value. The Company issued 2,200,000 shares of common stock at
a price of $9 per share and received net proceeds of $18,414,000, net of
underwriting discount of $0.63 per share. Offering costs in connection with the
public offering, including the underwriting discount and other expenses, which
are estimated to be $500,000, with $490,000 paid through July 1998, have been
charged against the proceeds of the offering. Prior to March 17, 1998, the
Company had no operations other than activities relating to its organization,
registration under the Securities Act of 1933 and the issuance of 100 shares of
its common stock to its initial stockholder.
The company granted the underwriters of the initial public offering of the
Company's common stock a 30-day option to purchase additional shares of common
stock solely to cover over-allotments, if any, at the public offering price of
$9 per share. On April 14, 1998, the underwriters purchased an additional
10
127,900 shares under the terms of this option. As a result, the Company
received additional net proceeds of $1,070,523, net of the underwriting discount
of $0.63 per share, on April 14, 1998, which is reflected in the accompanying
financial statements.
NOTE 5. TRANSACTIONS WITH AFFILIATES
The Company entered into a Management Agreement (the "Agreement") with Anworth
Mortgage Advisory Corporation (the "Manager"), effective March 12, 1998. Under
the terms of the Agreement, the Manager, subject to the supervision of the
Company's Board of Directors, is responsible for the management of the day-to-
day operations of the Company and provides all personnel and office space.
The Company pays the Manager an annual base management fee equal to 1% of the
first $300 million of Average Net Invested Assets (as defined in the Agreement),
plus 0.8% of the portion above $300 million (the "Base Management
Compensation").
In addition to the Base Management Compensation, the Manager shall receive as
incentive compensation for each fiscal quarter an amount equal to 20% of the Net
Income of the Company, before incentive compensation, for such fiscal quarter in
excess of the amount that would produce an annualized Return on Equity
(calculated by multiplying the Return on Equity for such fiscal quarter by four)
equal to the Ten-Year U.S. Treasury Rate for such fiscal quarter plus 1% (the
"Incentive Management Compensation").
For the quarter ended June 30, 1998, the Company paid the Manager $46,000 in
base management fee and $2,000 in incentive management fee in accordance with
the agreement.
The Company has adopted the Anworth Mortgage Asset Corporation 1997 Stock
Option and Awards Plan (the "Stock Option Plan") which authorizes the grant of
options to purchase an aggregate of up to 300,000 of the outstanding shares of
the company's Common Stock. The plan authorizes the Board of Directors, or a
committee of the Board of Directors, to grant incentive stock options ("ISOs")
as defined under section 422 of the Internal Revenue Code of 1986, as amended,
options not so qualified ("NQSOs"), dividend
11
equivalent rights ("DERs") and stock appreciation rights ("SARs"). The exercise
price for any option granted under the Stock Option Plan may not be less than
100% of the fair market value of the shares of Common Stock at the time the
option is granted. As of June 30, 1998, the Company had granted 148,000 options
at an exercise price of $9 per share and 136,000 DERs. Options granted to
officers become exercisable at a rate of 33.3% each year following their date of
grant. Options granted to directors become exercisable six months after their
date of grant. These options will expire on March 11, 2008.
For the quarter ended June 30, 1998, the Company recorded $20,400 in operating
expense associated with this plan.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Certain information contained in this Quarterly Report on Form 10-Q constitutes
"Forward-Looking Statements" within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Exchange Act, which can be
identified by the use of forward-looking terminology such as "may," "will,"
"expect," "anticipate," "estimate," or "continue" or the negatives thereof or
other variations thereon or comparable terminology. Investors are cautioned that
all forward-looking statements involve risks and uncertainties including, but
not limited to, risks related to the future level and relationship of various
interest rates, prepayment rates and the timing of new programs. The statements
in the "Risk Factors" of the Company's Prospectus dated March 12, 1998
constitute cautionary statements identifying important factors, including
certain risks and uncertainties, with respect to such forward-looking statements
that could cause the actual results, performance or achievements of the Company
to differ materially from those reflected in such forward-looking statements.
GENERAL
Anworth Mortgage Asset Corporation (the "Company") was formed in October 1997 to
invest in mortgage assets, including mortgage pass-through certificates,
collateralized mortgage obligations, mortgage loans and other securities
representing interests in, or obligations backed or supported by, pools of
mortgage loans which can be readily financed and short-term investments
(collectively, Mortgage-Backed Securities).
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 commenced operations on March 17,
1998 upon the closing of its initial public offering. Since that date the
Company has been in the process of deploying its capital and building its
balance sheet through the acquisition of mortgage assets and the financing of
those assets in the credit markets. The Company seeks to generate income
through its use of leverage
13
and active management of the asset/liability yield spread. The financial
statements included in this quarterly report on Form 10-Q should be interpreted
in light of this growth process and are not necessarily representative of what
they may be in the future.
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) seeking
to improve productivity by increasing the size of the balance sheet at a rate
faster than the rate of increase in operating expenses, (iii) continually
reviewing the mix of Mortgage-Backed Security types on the balance sheet in an
effort to improve risk-adjusted returns, and (iv) 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.
The Company is organized for tax purposes as a real estate investment trust
("REIT") and therefore generally passes through substantially all of its
earnings to stockholders without paying federal or state income tax at the
corporate level.
The Company's mortgage-backed securities portfolio currently consists of
adjustable-rate agency mortgage pass-through securities. The Company's
investment policy is to invest at least 70% of total assets in "Primary"
adjustable-rate Mortgage Securities and Short-Term Investments (investments with
an average life of one year or less). "Primary" as used herein means either (i)
securities that are rated within one of the two highest rating categories by at
least one of either Standard & Poor's or Moody's, or (ii) securities that are
unrated but are either obligations of the United States or obligations
guaranteed by the United States government or an agency or instrumentality of
the United States government.
The remainder of the Company's investment portfolio, comprising not more than
30% of its total assets, may consist of mortgage assets which are unrated, or,
if rated, are less than Primary, including (i) mortgage loans secured by first
liens on single-
14
family (one-to-four units) residential properties, (ii) mortgage securities
backed by loans on single-family, multi-family, commercial or other real estate-
related properties which are rated at least Investment Grade (rated at least
"BBB" or "Baa" by Standard & Poor's or Moody's, respectively) or (as to single-
family and multi-family Mortgage Securities) the equivalent, if not rated, (iii)
fixed-rate mortgage assets, including the acquisition of such assets for the
purpose of being combined with hedging instruments to obtain investment
characteristics similar to adjustable-rate mortgage assets, and (iv) other
mortgage securities representing interests in, or secured by mortgages on, real
property. The Company may also generate qualified REIT income through investment
in securities of other REITs.
The Company will generally not acquire inverse floaters, Remic residuals or
first loss subordinated bonds. The Company may acquire mortgage derivative
securities, including, but not limited to, interest only, principal only or
other mortgage securities that receive a disproportionate share of interest
income or principal, either as an independent stand-alone investment opportunity
or to assist in the management of prepayment and other risks, but only on a
limited basis due to the greater risk of loss associated with mortgage
derivative securities.
FINANCIAL CONDITION
At June 30, 1998, the Company held total assets of $210 million, $199 million of
which consisted of ARM securities. Since commencing operations, the Company has
purchased either ARM securities (backed by agencies of the U.S. government) or
privately-issued, generally publicly registered, mortgage assets, most of which
are rated AA or higher by at least one of the Rating Agencies. At June 30,
1998, 100% of the mortgage assets held by the Company were Primary assets. Of
the ARM securities owned by the Company, 85% were adjustable-rate pass-through
certificates which reset at least once a year. The remaining 15% were new
origination 3/1 and 5/1 hybrid ARMS. Hybrid ARM securities have an initial
interest rate that is fixed for a certain period, usually three to five years,
and then adjusts annually for the remainder of the term of the loans.
15
The following table presents a schedule of ARM securities owned at June 30, 1998
classified by type of issuer.
ARM SECURITIES BY ISSUER
(Dollar amounts in thousands)
Agency Carrying Portfolio
Value Percentage
- --------------------------------------------------------------------------
FNMA $154,030 77
- --------------------------------------------------------------------------
FHLMC 44,746 23
- --------------------------------------------------------------------------
Total Portfolio $198,776 100
==========================================================================
The following table classifies the Company's portfolio of ARM securities by type
of interest rate index.
ARM ASSETS BY INDEX
(Dollar amounts in thousands)
Index Carrying Portfolio
Value Percentage
- ------------------------------------------------------------------------------
Six-month LIBOR $14,989 7.5%
- ------------------------------------------------------------------------------
Six-month Certificate of
Deposit 11,195 5.6%
- ------------------------------------------------------------------------------
One-year Constant
Maturity Treasury 165,245 83.1%
- ------------------------------------------------------------------------------
Cost of Funds Index 7,346 3.7%
- ------------------------------------------------------------------------------
$198,776 100.0%
==============================================================================
The portfolio had a current weighted average coupon of 7.36% at June 30, 1998
and the current yield of the ARM securities portfolio was 6.25%. The current
yield includes the impact of the amortization of applicable premiums and
discounts. The constant prepayment rate ("CPR") of the Company's ARM portfolio
was 33% during the second quarter of 1998.
The Company analyzes its mortgage-backed securities and the extent to which
prepayments impact the yield of the securities. When historical prepayment
experience exceeds expectations, the Company amortizes the premiums paid on
mortgage assets over a shorter time period, resulting in a reduced yield to
maturity on
16
these mortgage assets. Conversely, if actual prepayments are less than the
assumed constant prepayment rate, the premium would be amortized over a longer
time period, resulting in a higher yield to maturity. The Company monitors its
yield expectations versus its prepayment experience on a monthly basis in order
to adjust the amortization of the net premium as and when appropriate.
The fair value of the Company's portfolio of ARM securities classified as
available-for-sale declined by $757,000 for a negative adjustment of .38% of the
amortized cost of the portfolio as of June 30, 1998. This price decline reflects
the possibility of increased future prepayments which would have the effect of
shortening the average life of the Company's ARM securities and decreasing their
yield and value.
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 1998
For the quarter ended June 30, 1998, the Company's net income was $357,000, or
$0.15 per share (basic and diluted EPS), based on an average of 2,309,729 shares
outstanding. Net interest income for the quarter totaled $481,000. Net interest
income is comprised of the interest income earned on mortgage investments less
interest expense from borrowings. During the second quarter of 1998, the Company
incurred operating expenses of $124,000, consisting of a base management fee of
$46,000, a performance-based fee of $2,000 and other operating expenses of
$76,000.
The Company's return on average equity was 1.87% for the quarter ended June 30,
1998. The table below shows the components of return on average equity.
COMPONENTS OF RETURN ON AVERAGE EQUITY (1)
- -------------------------------------------------------------------------------------------
For the Quarter Net Interest Income/ G&A Expense(2)/ Net Income/
Ended Equity Equity Equity
- -------------------------------------------------------------------------------------------
June 30, 1998 2.52% 0.65% 1.87%
- -------------------------------------------------------------------------------------------
17
(1) Average equity excludes unrealized gain (loss) on available-for-sale ARM
securities.
(2) Excludes performance fees.
The Company is in the early stages of operations, having begun operations on
March 17, 1998. During the second quarter of 1998 the Company was engaged in
the process of deploying capital and investing the cash raised in its initial
public offering. The Company has been adding mortgage assets to the portfolio
through the period and has used reverse repurchase agreements as its primary
source of capital beyond the proceeds of the initial public offering.
The following table shows the Company's average balances of cash equivalents and
mortgage assets, the yields earned on each type of earning assets, the yield on
average earning assets and interest income.
- -----------------------------------------------------------------------------------------------------------------------------------
Yield on
Average Average
Amortized Yield on Amortized Yield on
Average Cost of Average Cost of Average
Cash Mortgage Average Cash Mortgage Earning Interest
in thousands Equivalents Assets Earning Assets Equivalents Assets Assets Income
- -----------------------------------------------------------------------------------------------------------------------------------
For the quarter ended
June 30, 1998 $7,956 $197,302 $205,258 5.32% 6.34% 6.30% $2,799
- -----------------------------------------------------------------------------------------------------------------------------------
The table below shows the Company's average borrowed funds and average cost of
funds as compared to average one- and average three-month LIBOR.
- -----------------------------------------------------------------------------------------------------------------------
Average Average Average
One-month Cost of Cost of
LIBOR Funds Funds
Average Average Relative Relative Relative
Average Average One- Three- to Average to Average to Average
Borrowed Interest Cost of Month Month Three-month One-month Three-month
in thousands Funds Expense Funds LIBOR LIBOR LIBOR LIBOR LIBOR
- -----------------------------------------------------------------------------------------------------------------------
For the quarter
ended
June 30, 1998 $186,365 $2,318 5.61% 5.66% 5.69% (0.03%) (0.05%) (0.08%)
- -----------------------------------------------------------------------------------------------------------------------
The Company did not enter 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 risk and would be designed to
18
provide income and capital appreciation to the Company in the event of certain
changes in interest rates. The Company reviews the need for interest rate
agreements on a regular basis consistent with its Capital Investment Policy.
The Company has not experienced credit losses on its portfolio of ARM securities
to date, but losses may be experienced in the future. At June 30, 1998, the
Company had limited its exposure to credit losses on its portfolio of ARM
securities by purchasing only Agency Certificates, which, although not rated,
carry an implied "AAA" rating.
As a REIT, the Company is required to declare dividends amounting to 85% of each
year's taxable income by the end of each calendar year and to have declared
dividends amounting to 95% of its taxable income for each year by the time it
files its applicable tax return and, therefore, generally passes through
substantially all of its earnings to stockholders without paying federal income
tax at the corporate level. Since the Company, as a REIT, pays its dividends
based on taxable earnings, the dividends may at times be more or less than
reported earnings.
COMMON DIVIDEND
On June 19, 1998 the Company declared a dividend of $0.15 per share payable on
July 10, 1998 to holders of record as of July 1, 1998.
As of June 30, 1998, the Company's yield on its ARM assets portfolio, including
the impact of the amortization of premiums and discounts, was 6.25%. The
Company's cost of funds as of June 30, 1998, was 5.62%.
The Company pays the Manager an annual base management fee, generally based on
average net invested assets, as defined in the Management Agreement, payable
monthly in arrears as follows: 1.0% of the first $300 million of Average Net
Invested Assets, plus 0.8% of the portion above $300 million. During the second
quarter of 1998, the Manager earned a base management fee of $46,000.
In order for the Manager to earn a performance fee, the rate of return on the
stockholders' investment, as defined in the Management Agreement, must exceed
the average ten-year U.S. Treasury rate during the quarter plus 1%. During the
second
19
quarter of 1998, the Manager earned a performance fee of $2,000. During the
second quarter of 1998, after paying this performance fee, the Company's return
on common equity was 1.87% or, on an unannualized basis, 7.69%.
The following table shows operating expenses as a percent of total assets:
ANNUALIZED OPERATING EXPENSE RATIOS
- ------------------------------------------------------------------------------
Management Fee & Total G&A
For The Other Expenses/ Performance Fee/ Expenses/
Quarter Ended Total Assets Total Assets Total Assets
- ------------------------------------------------------------------------------
Jun 30, 1998 0.23% 0.00% 0.23%
- ------------------------------------------------------------------------------
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary source of funds for the quarter ended June 30, 1998
consisted of reverse repurchase agreements, which totaled $185 million at June
30, 1998. The Company's other significant source of funds for the quarter ended
June 30, 1998 consisted of payments of principal and interest from its ARM
securities portfolio in the amount of $16.4 million. Finally, the issuance of
127,900 shares of common stock under the terms of the underwriter's
overallotment option provided net funds to the Company, after underwriting
commissions, of $1.1 million. In the future, the Company expects its primary
sources of funds will consist of borrowed funds under reverse repurchase
agreement transactions with one- to twelve-month maturities and of monthly
payments of principal and interest on its ARM securities portfolio. The
Company's liquid assets generally consist of unpledged ARM assets, cash and cash
equivalents.
The borrowings incurred at June 30, 1998 had a weighted average interest cost of
5.62%. As of June 30, 1998, all of the Company's reverse repurchase agreements
were fixed-rate term reverse repurchase agreements with original maturities that
range from three months to one year. The Company has borrowing arrangements
with ten different financial institutions and on June 30, 1998, had borrowed
funds under reverse repurchase
20
agreements with six of these firms. Because the Company borrows money based on
the fair value of its ARM securities and because increases in short-term
interest rates can negatively impact the valuation of ARM securities, the
Company's borrowing ability could be limited and lenders may initiate margin
calls in the event short-term interest rates increase or the value of the
Company's ARM securities declines for other reasons. For the quarter ended June
30, 1998, the Company had adequate cash flow, liquid assets and unpledged
collateral with which to meet its margin requirements during the period.
Further, the Company believes it will continue to have sufficient liquidity to
meet its future cash requirements from its primary sources of funds for the
foreseeable future without needing to sell assets.
STOCKHOLDERS' EQUITY
The Company uses "available-for-sale" treatment for its Mortgage-Backed
Securities; these assets are carried on the balance sheet at fair value rather
than historical amortized cost. Based upon such fair value accounting treatment,
the Company's equity base at June 30, 1998 was $18.2 million, or $7.84 per
share. If the Company had used historical amortized cost accounting, the
Company's equity base at June 30, 1998 would have been $19.0 million, or $8.17
per share.
With the Company's "available-for-sale" accounting treatment, unrealized
fluctuations in fair 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 "Other
comprehensive income, unrealized gain (loss) on available for sale securities."
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 fair value 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.
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Unrealized changes in the fair value of Mortgage-Backed Securities have one
direct effect on the Company's potential earnings and dividends: positive fair
value 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 fair 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. "Other comprehensive
income, unrealized gain (loss) on available for sale securities" was $757
thousand, or 0.38% of the amortized cost of mortgage backed securities at June
30, 1998.
EFFECTS OF INTEREST RATE CHANGES
The Company has invested in adjustable-rate mortgage securities. Adjustable-
rate mortgage assets are typically subject to periodic and lifetime interest
rate caps that limit the amount an adjustable-rate mortgage securities' interest
rate can change during any given period. Adjustable-rate mortgage securities are
also typically subject to a minimum interest rate payable. The Company
borrowings will not be subject to similar restrictions. Hence, in a period of
increasing interest rates, interest rates on its borrowings could increase
without limitation by caps, while the interest rates on its mortgage assets
could be so limited. This problem would be magnified to the extent the Company
acquires mortgage assets that are not fully indexed. 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 less cash income on its
adjustable-rate mortgage assets than is required to pay interest on the related
borrowings. These factors could lower the Company's net interest income or cause
a net loss during periods of rising interest rates, which would negatively
impact the Company's liquidity and its ability to make distributions to
stockholders.
The Company intends to fund the purchase of a substantial portion of its
adjustable-rate mortgage securities with borrowings that may have interest rates
based on indices and repricing terms similar to, but of somewhat shorter
maturities than, the interest
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rate indices and repricing terms of the mortgage assets. Thus, the Company
anticipates that in most cases the interest rate indices and repricing terms of
its mortgage assets and its funding sources will not be identical, thereby
creating an interest rate mismatch between assets and liabilities. During
periods of changing interest rates, such interest rate mismatches could
negatively impact the Company's net income, dividend yield and the market price
of the Common Stock.
Prepayments are the full or partial repayment of principal prior to the original
term to maturity of a mortgage loan and typically occur due to refinancing of
mortgage loans. Prepayment rates on mortgage securities vary from time to time
and may cause changes in the amount of the Company's net interest income.
Prepayments of adjustable-rate mortgage loans usually can be expected to
increase when mortgage interest rates fall below the then-current interest rates
on such loans and decrease when mortgage interest rates exceed the then-current
interest rate on such loans, although such effects are not predictable.
Prepayment experience also may be affected by the conditions in the housing and
financial markets, general economic conditions and the relative interest rates
on fixed-rate and adjustable-rate mortgage loans underlying mortgage securities.
The purchase prices of mortgage securities are generally based upon assumptions
regarding the expected amounts and rates of prepayments. Where slow prepayment
assumptions are made, the Company may pay a premium for mortgage securities. To
the extent such assumptions materially and adversely differ from the actual
amounts of prepayments, the Company would experience losses. The total
prepayment of any mortgage asset that had been purchased at a premium by the
Company would result in the immediate write-off of any remaining capitalized
premium amount and 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, its financial condition,
cash flows and results of operations could be materially adversely affected.
OTHER MATTERS
As of June 30, 1998, the Company calculates its Qualified REIT Assets, as
defined in the Internal Revenue Code of 1986, as amended (the "Code"), to be
99.9% of its total assets, as
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compared to the Code requirement that at least 75% of its total assets must be
Qualified REIT Assets. The Company also calculates that 99.9% of its 1998
revenue for the quarter ended June 30, 1998 qualifies for both the 75% source of
income test and the 95% source of income test under the REIT rules. The Company
also met all REIT requirements regarding the ownership of its common stock and
the distributions of its net income. Therefore, as of June 30, 1998, the Company
believes that it will continue to qualify 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, as
amended (the "Investment Company Act). 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 SEC, 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
securities represent all of 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. The Company
calculates that it is in compliance with this requirement.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
At June 30, 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
Not applicable
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
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,
ANWORTH MORTGAGE ASSET CORPORATION
Dated: August 13, 1998
By: Lloyd McAdams
/s/ Lloyd McAdams
_________________________
Lloyd McAdams
President
(authorized officer of registrant)
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Dated: August 13, 1998
By: Pamela J. Watson
/s/ Pamela J. Watson
_________________________
Pamela J. Watson,
Chief Financial Officer and Treasurer
(principal accounting officer)
FINANCIAL DATA SCHEDULE
This schedule contains summary financial information extracted from the June 30,
1998 Form 10-Q and is qualified in its entirety by reference to such
financial statements.
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