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: SEPTEMBER 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _______________ TO _________________
COMMISSION FILE NUMBER: 1-13447
ANNALY MORTGAGE MANAGEMENT, INC.
(Exact name of Registrant as specified in its Charter)
MARYLAND 22-3479661
(State or other (IRS Employer
jurisdiction of 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 at November 12, 1999
Common Stock, $.01 par value 13,344,408
Annaly Mortgage Management, Inc.
FORM 10-Q
INDEX
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Balance Sheets - September 30, 1999 (Unaudited) and December 31, 1998 1
Statements of Operations (Unaudited) for the quarters ended September 30, 1999 and 1998
and for the nine months ended September 30, 1999 and 1998 2
Statements of Stockholders' Equity (Unaudited) for the quarter ended September 30, 1999 3
Statements of Cash Flows (Unaudited) for the quarters ended September 30, 1999 and 1998
and for the nine months ended September 30, 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 11-23
Item 3. Quantitative and Qualitative Disclosure about Market Risk 24-25
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 26
Item 2. Changes in Securities and Use of Proceeds 26
Item 3. Defaults Upon Senior Securities 26
Item 4. Submission of Matters to a Vote of Security Holders 26
Item 5. Other Information 26
Item 6. Exhibits and Reports on Form 8-K 26
SIGNATURES 27
ANNALY MORTGAGE MANAGEMENT, INC
BALANCE SHEETS
SEPTEMBER 30, 1999
(UNAUDITED) DECEMBER 31,
1998
----------------------- ------------------------
ASSETS
Cash and cash equivalents $ 77,101 $ 69,020
Mortgage-Backed Securities, at fair value 1,401,770,037 1,520,288,762
Accrued interest receivable 6,730,525 6,782,043
Other assets 308,562 212,214
----------------------- ------------------------
Total assets $1,408,886,225 $1,527,352,039
======================= ========================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Repurchase agreements $1,283,762,000 $1,280,510,000
Payable for Mortgage-Backed Securities purchased 111,921,205
Accrued interest payable 6,977,480 5,052,626
Dividends payable 4,587,243 3,857,663
Accounts payable 485,033 139,236
----------------------- ------------------------
Total liabilities 1,295,811,756 1,401,480,730
----------------------- ------------------------
Stockholders' Equity:
Common stock: par value $.01 per share; 100,000,000
Authorized, 13,216,008 and 12,758,024 shares issued
and outstanding, respectively 132,160 127,580
Additional paid-in capital 136,866,156 132,770,175
Accumulated other comprehensive loss (23,775,832) (6,404,275)
Treasury stock at cost (109,600 shares) (903,163) (903,163)
Retained earnings 755,148 280,992
----------------------- ------------------------
Total stockholders' equity 113,074,469 125,871,309
----------------------- ------------------------
Total liabilities and stockholders' equity $1,408,886,225 $1,527,352,039
======================= ========================
See notes to financial statements
1
ANNALY MORTGAGE MANAGEMENT, INC
INCOME STATEMENTS
(UNAUDITED)
For the For the For the Nine For the Nine
Quarter Ended Quarter Ended Months Ended Months Ended
September 30, September 30, September 30, September 30,
1999 1998 1999 1998
---------------- ---------------- ------------------ -----------------
INTEREST INCOME:
Mortgage-Backed Securities $22,152,280 $24,008,528 $66,432,013 $67,849,165
Other interest income 8,992 39 9,130 76
---------------- ---------------- ------------------ -----------------
Total interest income 22,161,272 24,008,567 66,441,143 67,849,241
INTEREST EXPENSE:
Repurchase agreements 17,232,085 20,765,301 51,248,950 57,256,355
---------------- ---------------- ------------------ -----------------
NET INTEREST INCOME 4,929,187 3,243,266 15,192,193 10,592,886
GAIN ON SALE OF MORTGAGE-BACKED SECURITIES
97,656 993,630 188,069 2,716,589
GENERAL AND ADMINISTRATIVE
EXPENSES 513,599 528,240 1,684,613 1,506,139
---------------- ---------------- ------------------ -----------------
NET INCOME 4,513,244 3,708,656 13,695,649 11,803,336
---------------- ---------------- ------------------ -----------------
OTHER COMPREHENSIVE INCOME
Unrealized gain (loss) on available-for-
Sale securities (4,249,848) 799,319 (17,183,488) (1,411,879)
Less: reclassification adjustment for net
gains included in net income (97,656) (993,630) (188,069) (2,716,589)
---------------- ---------------- ------------------ -----------------
Other comprehensive loss (4,347,504) (194,311) (17,371,557) (4,128,468)
---------------- ---------------- ------------------ -----------------
COMPREHENSIVE INCOME (LOSS) $165,740 $3,514,345 ($3,675,908) $7,674,868
================ ================ ================== =================
NET INCOME PER SHARE:
Basic $0.35 $0.29 $1.08 $0.93
================ ================ ================== =================
Diluted $0.35 $0.29 $1.05 $0.91
================ ================ ================== =================
AVERAGE NUMBER OF SHARES OUTSTANDING:
Basic 12,745,416 12,704,194 12,721,670 12,729,673
================ ================ ================== =================
Diluted 13,025,096 12,785,765 13,004,490 13,028,970
================ ================ ================== =================
See notes to financial statements
2
ANNALY MORTGAGE MANAGEMENT, INC
STATEMENT OF STOCKHOLDER'S EQUITY
FOR THE QUARTER ENDED SEPTEMBER 30, 1999
(UNAUDITED)
Common Additional Other
Stock Paid-In Treasury Cgmprehensive Retained Comprehensive
Par Value Capital Stock Income Earnings Income Total
---------------------------------------------------------------------------------------------
BALANCE, JUNE 30, 1999 $128,071 $132,966,180 ($903,163) $829,147 ($19,428,328) $113,591,907
Net Income $4,513,244 4,513,244
Other comprehensive income:
Unrealized net losses on securities,
net of reclassification adjustment (4,347,504) (4,347,504)
------------
Comprehensive income $ 165,740 165,740
============
Proceeds from direct purchase 4,089 3,899,976 3,904,065
Dividends declared for the quarter
ended September 30, 1999,
$0.35 per average share (4,587,243) (4,587,243)
------------------------------------- ------------------------------------------
BALANCE, SEPTEMBER 30, 1999 $132,160 $136,866,156 ($903,163) $755,148 ($23,775,832) $113,074,469
===================================== ==========================================
Disclosure of reclassification amount:
Unrealized holding losses arising
during the period ($4,249,848)
Less: reclassification adjustment
for gains included in net income (97,656)
--------------
Net unrealized losses on securities ($4,347,504)
==============
See notes to financial statements
3
ANNALY MORTGAGE MANAGEMENT, INC
STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the Quarter For the Quarter For the Nine For the Nine
Ended Ended Months Ended Months Ended
September 30, September 30, September 30, September 30,
1999 1999 1999 1998
---------------- ---------------- ---------------- ----------------
Cash flows from operating activities:
Net income $4,513,244 $3,708,656 $13,695,649 $11,803,336
Adjustments to reconcile net income to net cash
Provided by operating activities:
Amortization of mortgage premiums and
discounts, net 1,271,863 2,239,747 5,322,779 6,093,183
Gain on sale of mortgage-backed securities (97,656) (993,630) (188,069) (2,716,589)
Decrease (increase) in accrued interest receivable 671,840 41,076 51,518 (2,199,406)
Decrease (increase) in other assets 94,603 14,394 (96,348) (118,950)
Increase (decrease) in accrued interest payable (1,790,341) 2,537,065 1,924,854 8,444,993
Increase in accounts payable 54,704 117,600 345,796 42,056
---------------- ---------------- ---------------- ----------------
Net cash provided by operating activities 4,718,257 7,664,908 21,056,179 21,348,623
---------------- ---------------- ---------------- ----------------
Cash flows from investing activities:
Purchase of Mortgage-Backed Securities (89,718,550) (241,286,923) (446,469,606) (1,203,070,837)
Proceeds from sale of Mortgage-Backed Securities 65,334,991 83,224,377 113,547,357 308,163,885
Principal payments of Mortgage-Backed Securities 81,208,078 121,339,783 317,013,503 353,474,359
---------------- ---------------- ---------------- ----------------
Net cash provided (used) in investing 56,824,519 (36,722,763) (15,908,745) (541,432,593)
activities
---------------- ---------------- ---------------- ----------------
Cash flows from financing activities:
Proceeds from repurchase agreements 3,183,769,500 2,288,511,000 8,455,952,500 7,530,044,000
Principal payments on repurchase agreements (3,244,747,500) (2,254,398,000) (8,452,700,500) (6,998,532,000)
Proceeds from exercise of stock options 196,496 193,700
Proceeds from direct purchase 3,904,065 3,904,065
Purchase of treasury stock (903,163) (903,163)
Additional cost of initial public offering (130,248)
Dividends paid (4,444,142) (4,082,456) (12,491,913) (10,961,970)
---------------- ---------------- ---------------- ----------------
Net cash provided (used) by financing (61,518,077) 29,127,381 (5,139,352) 519,710,319
activities
---------------- ---------------- ---------------- ----------------
Net increase (decrease) in cash and cash equivalents 24,699 69,526 8,081 (373,651)
Cash and cash equivalents, beginning of period 52,402 10,325 69,020 511,172
---------------- ---------------- ---------------- ----------------
Cash and cash equivalents, end of period $ 77,101 $ 79,851 $ 77,101 $ 137,521
================ ================ ================ ================
Supplemental disclosure of cash flow Information:
Interest paid $19,022,426 $18,318,236 $49,324,096 $48,811,362
================ ================ ================ ================
Noncash financing activities:
Net change in unrealized losses on available-for-sale
securities ($4,347,504) ($194,311) ($17,371,557) ($4,128,468)
================== ================== ================== ================
Dividends declared, not yet paid $4,587,243 $3,414,980 $4,587,243 $3,414,980
================== ================== ================== ================
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 Mortgage-Backed Securities on February 18, 1997, upon
receipt of the net proceeds from the private placement of equity capital. An
initial public offering was completed on October 14, 1997.
A summary of the Company's significant accounting policies follows:
Basis of Presentation - The accompanying unaudited financial statements
have been prepared in conformity with the instructions to Form 10-Q and Article
10, Rule 10-01 of Regulation S-X for interim financial statements. The interim
financial statements for the nine month periods 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 include cash on
hand and money market funds. The carrying amounts of cash equivalents
approximate 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 nine months ended September 30, 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 September 30, 1999 and December 31, 1998, the Company
has limited 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 September 30, 1999 and December 31, 1998, all of the Company's
Mortgage-Backed Securities have a "AAA" rating or an implied a "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.
6
MORTGAGE-BACKED SECURITIES
The following table pertains to the Company's Mortgage-Backed
Securities classified as available-for-sale as of September 30, 1999, which are
carried at their fair value:
Federal Federal Government
Home Loan National National Total
Mortgage Mortgage Mortgage Mortgage-Backed
Corporation Association Association Securities
------------------------------------------------------------------------
Mortgage-Backed
Securities, gross $423,671,222 $878,226,387 $100,667,612 $1,402,565,221
Unamortized discount (153,429) (963,983) (1,117,412)
Unamortized premium 8,414,616 13,839,332 1,844,111 24,098,059
-----------------------------------------------------------------------
Amortized cost 431,932,409 891,101,736 102,511,723 1,425,545,868
Gross unrealized gains 85,395 912,225 997,620
Gross unrealized losses (7,702,536) (14,414,967) (2,655,948) (24,773,451)
-----------------------------------------------------------------------
Estimated fair value $424,315,268 $877,598,994 $99,855,775 $1,401,770,037
=======================================================================
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-Backed
Corporation Association Association Securities
-----------------------------------------------------------------------
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 September 30, 1999, the weighted average
lifetime cap was 10.8%. At December 31, 1998, the weighted average lifetime cap
was 10.6%.
7
During the nine months ended September 30, 1999 and 1998, the Company's
realized $188,069 and $2,716,589 in gains from sales of Mortgage-Backed
Securities, respectively. During the year ended December 31, 1998, the Company
realized $3,344,070 in gains for sales of Mortgage-Backed Securities.
3. REPURCHASE AGREEMENTS
As of September 30, 1999, the Company had outstanding $1,283,762,000 of
repurchase agreements with a weighted average borrowing rate of 5.31%. The
weighted average remaining maturity was 24 days and a weighted average original
term was 63 days. 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%. The weighted average remaining maturity was 29 days and the weighted
average original term was 48 days.
At September 30, 1999 and December 31, 1998, the repurchase agreements
had the following remaining maturities:
September 30, 1999 December 31, 1998
-----------------------------------------
Within 30 days $ 821,311,000 $1,222,542,000
30 to 59 days 420,534,000 31,346,000
60 to 89 days 25,530,000 26,622,000
90 to 119 days 16,387,000
------------------------------------------
$1,283,762,000 $1,280,510,000
==========================================
4. COMMON STOCK
Options were exercised and the direct purchase was implemented during
the nine month period ending September 30, 1999 increasing the total number of
shares outstanding to 13,106,408. The number of stock options exercised was
49,124, with an aggregate purchase price of $196,496. The number of shares
issued in the direct purchase plan was 408,860, with an aggregate purchase price
of $3,904,065. During the year ended December 31, 1998, 44,124 options were
exercised at an aggregate price of $195,100. Stock buybacks during the year
ended December 31, 1999 totaled 109,600 shares at a cost of $903,163.
During the nine months ending September 30, 1999, the Company declared
dividends to shareholders totaling $13,221,493, or $1.03 per weighted average
share, of which $4,587,243 was paid on October 27, 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
8
and Diluted EPS computation. For the nine months ended September 30, 1999 the
reconciliation is as follows:
For the Nine Months Ended
September 30, 1999
-----------------------------------------------------
Income Shares Per-Share
(Numerator) (Denominator) Amount
-----------------------------------------------------
Net income $ 13,695,648
-------------------
Basic EPS 12,721,670 $ 1.08
13,695,648
Effect of dilutive securities:
Dilutive stock options
- 282,820
-----------------------------------------------------
Diluted EPS $ 13,695,648 13,004,490 $ 1.05
=====================================================
Options to purchase 416,460 shares were outstanding during the quarter
and dilutive, as the exercise price (between $4.00 and $8.94) was less than the
average stock price for the nine month period for the Company of $9.86. Options
to purchase 135,676 shares of stock were outstanding during the period and are
not considered dilutive. The exercise price (between $10.00 and $11.25) was
greater than the average stock price for the nine month period of $9.86.
For the nine months ended September 30, 1998, the reconciliation is as
follows:
For the Nine Months Ended
September 30, 1998
-----------------------------------------------------
Income Shares Per-Share
(Numerator) (Denominator) Amount
-----------------------------------------------------
Net income $ 11,803,336
--------------------
Basic EPS 11,803,336 12,729,673 $ 0.93
Effect of dilutive securities:
Dilutive stock options - 299,297
-----------------------------------------------------
Diluted EPS $ 11,803,336 13,028,970 $ 0.91
=====================================================
Options to purchase 312,226 shares were outstanding during the quarter
and dilutive as the exercise price (between $4.00 and $10.00) was less than the
average stock price for the nine month period for the Company of $10.66. 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 of for the
quarter of $10.66.
9
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 September 30, 1999 and December 31, 1998 held securities
classified as available-for-sale. At September 30, 1999 and December 31, 1998,
the net unrealized losses totaled $23,775,832 and $6,404,275, respectively.
7. LEASE COMMITMENTS
The Corporation has non-cancelable lease for office space, which
commenced in April 1998 and expires in December 2007.
The Corporation's aggregate 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 obligation $968,892
========
8. 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
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
We are a real estate investment trust that owns and manages a portfolio
of mortgage-backed securities. Our principal business objective is to generate
net income for distribution to our stockholders from the spread between the
interest income on our mortgage-backed securities and the costs of borrowing to
finance our acquisition of mortgage-backed securities.
We commenced operations on February 18, 1997 upof the consummation of a
private placement. We completed our initial public offering on October 14, 1997.
The 317-day period ended December 31, 1997 was a short operating period
and not a full twelve months. Also, average assets for the period ended December
31, 1997 totaled $476.9 million, whereas average assets for the year ended
December 31, 1998 totaled $1.5 billion. As a result, the comparison of net
income for the period ended February 18, 1997 and the year ended December 31,
1998 may show changes that may not be indicative of future periods.
Results of Operations: For the Quarters Ended September 30, 1999 and 1998
Net Income Summary
For the quarter ended September 30, 1999, our GAAP net income was $4.5
million, or $0.35 basic earnings per average share, as compared to $3.7 million,
or $0.29 basic earnings per average share, for the quarter ended September 30,
1998. We compute our GAAP net income per share by dividing net income by the
weighted average number of shares of outstanding common stock during the period,
which was 12,745,416 for the quarter ended September 30, 1999 and 12,704,194 for
the quarter ended September 30, 1998. Dividends per weighted average number of
shares outstanding for the quarter ended September 30, 1999 was $0.35 per share,
or $4.6 million in total. Dividends per weighted average number of shares
outstanding for the quarters ended September 30, 1998 was $0.27 per share, or
$3.4 million in total. Our return on average equity was 15.93% on an annualized
basis for the quarter ended September 30, 1999 and 11.31% on an annualized basis
for the quarter ended September 30, 1998.
Net Income Summary
Quarter Ended Quarter Ended
September 30, 1999 September 30, 1998
-------------------------- --------------------------
Interest Income $ 22,161 $ 24,008
Interest Expense 17,232 20,765
-------------------------- --------------------------
Net Interest Income 4,929 3,243
Gain on Sale of Mortgage-Backed Securities 98 994
General and Administrative Expenses 513 528
-------------------------- --------------------------
Net Income $ 4,513 $ 3,709
========================== ==========================
Average Number of Shares Outstanding 12,745,416 12,704,194
Basic Net Income Per Share $ 0.35 $ 0.29
Diluted Net Income Per Share $ 0.35 $ 0.29
Average Total Assets $ 1,427,502 $ 1,554,123
Average Equity $ 113,333 $ 131,148
Annualized Return on Average Assets 1.26% 0.95%
Annualized Return on Average Equity 15.93% 11.31%
Taxable Income and GAAP Income
For the quarters ended September 30, 1999 and 1998, our income as
calculated for tax purposes (taxable income) differed from income as calculated
according to GAAP (GAAP income). Our taxable income for the quarter ended
September 30, 1999 was approximately $5.0 million, or $0.39 per share, as
compared to taxable income of $4.0 million, or
11
$0.32 per share, for the quarter ended September 30, 1998. 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
our stockholders because dividends are declared on the basis of taxable income.
While we do not pay taxes so long as we satisfy the requirements for exemption
from taxation pursuant to the REIT provisions of the Internal Revenue Code, each
year we complete a corporate tax form on which taxable income is calculated as
if we were to be taxed. This taxable income level determines the amount of
dividends we can pay out over time. The table below presents the major
differences between our GAAP and taxable income for the quarters ended September
30, 1999 and 1998, June 30, 1999, March 31, 1999, the year ended December 31,
1998, and the period ended December 31, 1997.
Taxable Income
--------------
Taxable General Taxable Taxable Gain
& Mortgage on Sale of
GAAP Net Administrative Amortization Securities Taxable Net
Income Differences Differences Differences Income
------ ----------- ----------- ----------- ------
(dollars in thousands)
For the Quarter Ended
September 30, 1999 $4,513 $5 $744 ($224) $5,038
For the Quarter Ended
September 30, 1998 $3,709 $228 $83 $4,020
For the Quarter Ended
June 30, 1999 $4,864 $2 $230 ($1) $5,095
For the Quarter Ended
March 31, 1999 $4,318 - $98 - $4,416
- -----------------------------------------------------------------------------------------------------------
For the Year Ended
December 31, 1998 $15,489 $6 $959 $23 $16,477
For the Period
Ended
December 31, 1997 $4,919 $3 ($92) $54 $4,884
Interest Income and Average Earning Asset Yield
We had average earning assets of $1.4 billion for the quarter ended
September 30, 1999 and $1.5 billion for the quarter ended September 30, 1998.
Our primary source of income for the quarters ended September 30, 1999 and 1998
was interest income. A portion of our income was generated by gains on the sales
of our mortgage-backed securities. Our interest income was $22.2 million for the
quarter ended September 30, 1999 and $24.0 million for the quarter ended
September 30, 1998. Our yield on average earning assets was 6.26% and 6.22% for
the same respective periods. Our average earning asset balance decreased by
$126.5 million for the quarter ended September 30, 1999 as compared to the
quarter ended September 30, 1998. Interest income decreased for the quarter
ended September 30, 1999 over the same period in 1998, even though the yield
increased by 0.04%. The decline in interest income is due to the significant
decline in average earning assets. The table below shows our average balance of
cash equivalents and mortgage-backed securities, the yields we earned on each
type of earning assets, our yield on average earning assets and our interest
income for the quarters ended September 30, 1999 and 1998, June 30, 1999, March
31, 1999, the year ended December 31, 1998, and the period ended December 31,
1997.
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 September 30, $877 $1,416,525 $1,417,404 4.10% 6.26% 6.25% $22,161
1999
For the Quarter Ended September 30, $2 $1,543,010 $1,543,012 4.20% 6.22% 6.22% $24,008
1998
For the Quarter Ended June 30, 1999 $2 $1,504,669 $1,504,671 4.30% 5.92% 5.92% $22,265
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% $89,986
For the Period Ended December 31, 1997 $30 $448,276 $448,306 4.20% 6.34% 6.34% $24,713
12
The constant prepayment rate (or CPR) on our mortgage-backed securities
for the quarter ended September 30, 1999 was 18% and for the quarter ended
September 30, 1998 was 21%. CPR is an assumed rate of prepayment for our
mortgage-backed securities, expressed as an annual rate of prepayment relative
to the outstanding principal balance of our mortgage-backed securities. CPR does
not purport to be either a historical description of the prepayment experience
of our mortgage-backed securities or a prediction of the anticipated rate of
prepayment of our mortgage-backed securities.
Principal prepayments had a negative effect on our earning asset yield
for the quarters ended September 30, 1999 and 1998 because we adjust our rates
of premium amgrtization and discount accretion monthly based upon the effective
yield method, which takes into consideration changes in prepayment speeds.
Interest Expense and the Cost of Funds
We anticipate that our largest expense will be the cost of borrowed
funds. We had average borrowed funds of $1.3 billion and total interest expense
of $17.2 million for the quarter ended September 30, 1999. We had average
borrowed funds of $1.5 billion and total interest expense of $20.8 million for
the quarter ended September 30, 1998. Our average cost of funds was 5.22% for
the quarter ended September 30, 1999 and 5.68% for the quarter ended September
30, 1998. The cost of funds rate declined 0.46% and the average borrowed funds
declined by $177 million for the quarter ended September 30, 1999 when compared
to the quarter ended September 30, 1998; consequently, interest expense
decreased by 17% for the same time period.
With our current asset/liability management strategy, changes in our
cost of funds are expected to be closely correlated with changes in short-term
LIBOR, although we may choose to extend the maturity of our liabilities at any
time. Our average cost of funds was 0.06% below one-month LIBOR for the quarter
ended September 30, 1999 and 0.06% above one-month LIBOR for the quarter ended
September 30, 1998. We generally have structured our borrowings to adjust with
one-month LIBOR because we believe that one-month LIBOR may continue to be lower
than six-month LIBOR in the present interest rate environment. During the
quarter ended September 30, 1999, average one-month LIBOR, which was 5.28%, was
0.52% lower than average six-month LIBOR, which was 5.80%. During the quarter
ended September 30, 1998, average one-month LIBOR, which was 5.62%, was 0.01%
lower than average six-month LIBOR, which was 5.63%.
The table below shows our average borrowed funds and average cost of
funds as compared to average one-month and average six-month LIBOR for the
quarters ended September 30, 1999 and 1998, June 30, 1999, March 31, 1999, the
year ended December 31, 1998, and period ended December 31, 1997.
13
Average Cost of Funds
Average
One-Month Average Cost Average Cost
LIBOR of Funds of Funds
Average Average Relative to Relative to Relative to
Average Average One- Six- Average Average Average
Borrowed Interest Cost of Month Month Six-Month One-Month Six-Month
Funds Expense Funds LIBOR LIBOR LIBOR LIBOR LIBOR
----- ------- ----- ----- ----- ----- ----- -----
(dollars in thousands)
For the Quarter Ended
September 30, 1999 $1,320,776 $17,232 5.22% 5.28% 5.80% (0.52%) (0.06%) (0.58%)
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, 1999 $1,374,154 $16,865 4.91% 4.96% 5.19% (0.23%) (0.05%) (0.28%)
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 Period Ended
December 31, 1997 $404,140 $19,677 5.61% 5.67% 5.87% (0.20%) (0.06%) (0.26%)
Net Interest Rate Agreement Expense
We have not entered into any interest rate agreements to date. As part
of our asset/liability management process, we may enter into interest rate
agreements such as interest rate caps, floors or swaps. These agreements would
be entered into with the intent to reduce interest rate or prepayment risk and
would be designed to provide us income and capital appreciation in the event of
certain changes in interest rates. However, even after entering into these
agreements, we would still be exposed to interest rate and prepayment risks. We
review the need for interest rate agreements on a regular basis consistent with
our capital investment policy.
Net Interest Income
Our net interest income, which equals interest income less interest
expense, totaled $4.9 million for the quarter ended September 30, 1999 and $3.2
million for the quarter ended September 30, 1998. Our net interest income
increased because of lower funding costs for the period and a higher yield on
average assets. Our net interest spread, which equals the yield on our average
assets for the period less the average cost of funds for the period, was 1.04%
for the quarter ended September 30, 1999 as compared to 0.54% for the quarter
ended September 30, 1998. This 0.50% increase in spread income is reflected in
the $1.7 million increase in net interest income. Net interest margin, which
equals net interest income divided by average interest earning assets, was 1.38%
on an annualized basis for the quarter ended September 30, 1999 and 0.84% on an
annualized basis for the quarter ended September 30, 1998. The principal reason
that annualized net interest margin exceeded net interest spread is that average
interest earning assets exceeded average interest bearing liabilities. A portion
of our assets is funded with equity rather than borrowings. We did not have any
interest rate agreement expenses for the quarters ended September 30, 1999 and
1998.
The table below shows our interest income by earning asset type,
average earning assets by type, total interest income, interest expense, average
repurchase agreements, average cost of funds, and net interest income for the
quarters ended September 30, 1999 and 1998, June 30, 1999, March 31, 1999, the
year ended December 31, 1998, and the period ended December 31, 1997.
14
GAAP Net Interest Income
Average Yield
Amortized on Average
Cost of Interest Average Balance
Mortgage-Backed Income on Average Total Interest of Average Net
Securities Mortgage-Backed Cash Interest Earning Repurchase Interest Cost of Interest
Held Securities Equivalents Income Assets Agreements Expense Funds Income
---- ---------- ----------- ------ ------ ---------- ------- ----- ------
For the Quarter Ended
September 30, 1999 $1,416,525 $22,151 $2 $22,161 6.26% $1,320,776 $17,232 5.22% $4,929
For the Quarter Ended
September 30, 1998 $1,543,010 $24,009 $2 $24,009 6.22% $1,460,612 $20,765 5.68% $3,244
For the Quarter Ended
June 30, 1999 $1,504,669 $22,265 $2 $22,265 5.92% $1,374,154 $16,865 4.91% $5,399
For the Quarter Ended
March 31, 1999 $1,502,629 $22,015 $2 $22,015 5.87% $1,381,663 $17,151 4.97% $4,864
- -------------------------------------------------------------------------------------------------------------------------------
For the Year Ended
December 31, 1998 $1,461,789 $89,986 $2 $89,986 6.16% $1,360,040 $75,735 5.57% $14,251
For the Period Ended
December 31, 1997 $448,276 $24,682 $30 $24,713 6.34% $404,140 $19,677 5.61% $5,036
Gains and Losses on Sales of Mortgage-Backed Securities
For the quarter ended September 30, 1999, we sold mortgage-backed
securities with an aggregate historical amortized cost of $65.2 million for an
aggregate gain of $98,000. For the quarter ended September 30, 1998, we sold
mortgage-backed securities with an aggregate historical amortized cost of $82.2
million for an aggregate gain of $994,000. As stated above, our gain on the sale
of assets declined substantially. For the quarter ended September 30, 1999,
there was a greater emphasis on spread income and not gains. The difference
between the sale price and the historical amortized cost of our mortgage-backed
securities is a realized gain and increases income accordingly. We do not expect
to sell assets on a frequent basis, but may from time to time sell existing
assets to move into new assets, which our management believes might have higher
risk-adjusted returns, or to manage our balance sheet as part of our
asset/liability management strategy.
Credit Losses
We have not experienced credit losses on our mortgage-backed securities
to date. We have limited our exposure to credit losses on our mortgage-backed
securities by purchasing only securities, issued or guaranteed by FNMA, FHLMC or
GNMA, which, although not rated, carry an implied "AAA" rating.
General and Administrative Expenses
G&A expenses were $514,000 for the quarter ended September 30, 1999 and
$528,000 for the quarter ended September 30, 1998. G&A expenses increased as a
percentage of average assets to 0.14% for the quarter ended September 30, 1999
compared to 0.13% for the same period in the previous year. Even though G&A
expenses decreased in total, the decline in average assets was proportionately
larger. So, G&A expenses as a percent of average asset increased by 0.01%.
15
GAAP G&A Expenses and Operating Expense Ratios
Cash
Compensation Total G&A Total G&A
and Expenses/Average Expenses/Average
Benefits Other G&A Total G&A Assets Equity
Expense Expenses Expenses (annualized) (annualized)
------- -------- -------- ------------ ------------
(dollars in thousands)
For the Quarter Ended
September 30, 1999 $337 $177 $514 0.14% 1.81%
For the Quarter Ended
September 30, 1998 $318 $210 $528 0.13% 1.61%
For the Quarter Ended
June 30, 1999 $338 $223 $561 0.15% 1.44%
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 Period Ended
December 31, 1997 $492 $360 $852 0.21% 1.61%
Net Income and Return on Average Equity
Our net income was $4.5 million for the quarter ended September 30,
1999 and $3.7 million for the quarter ended September 30, 1998. Our return on
average equity was 15.93% on an annualized basis for the quarter ended September
30, 1999 and 11.31% on an annualized basis for the quarter ended September 30,
1998. The increase in net income is a direct result of an increase in spread
income. As previously mentioned, the substantial decline in interest expense was
the primary reason that our earnings increased. The table below shows our net
interest income, gain on sale of mortgage-backed securities and G&A expenses
each as a percentage of average equity, and the return on average equity for the
quarters ended September 30, 1999 and 1998, June 30, 1999, March 31, 1999, the
year ended December 31, 1998 and the period ended December 31, 1997.
Components of Return on Average Equity
(Ratios for the Quarters Ended September 30, 1999 and 1998, June 30, 1999, March
31, 1999 and the Period ended December 31, 1997 are annualized)
Gain on Sale of
Net Interest Mortgage-Backed G&A Return on
Income/Average Securities/Average Expenses/Average Average
Equity Equity Equity Equity
-------------- -------------- -------------- --------------
For the Quarter Ended September 30, 1999 17.40% 0.34% 1.81% 15.93%
For the Quarter Ended September 30, 1998 9.89% 3.03% 1.50% 11.31%
For the Quarter Ended June 30, 1999 17.99% 0.08% 1.87% 16.20%
For the Quarter Ended March 31, 1999 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 Period Ended December 31, 1997 9.49% 1.39% 1.61% 9.27%
Dividends and Taxable Income
We have elected to be taxed as a REIT under the Internal Revenue Code.
Accordingly, we have distributed substantially all of our taxable income for
each year since inception to our stockholders, including income resulting from
gains on sales of our mortgage-backed securities. From inception through
September 30, 1999, earned taxable income exceeded dividend declarations by $2.1
million, or $0.16 per share, based on the number of shares of common stock
outstanding at period end.
16
Dividend Summary
----------------
Weighted
Average
Taxable Common Taxable Net Dividends Dividend Cumulative
Net Shares Income Per Declared Total Pay-out Undistributed
Income Outstanding Share Per Share Dividends Ratio Taxable Income
------ ----------- ----- --------- --------- ----- --------------
(dollars in thousands, except per share data)
For the Quarter Ended
September 30, 1999 $5,038 12,745,416 $0.39 $0.35 $4,587 91.1% $2,562
For the Quarter Ended
September 30, 1998 $4,020 12,704,194 $0.32 $0.27 $3,415 85.0% $1,035
For the Quarter Ended
June 30, 1999 $5,095 12,697,338 $0.40 $0.35 $4,444 87.1% $2,111
For the Quarter Ended
March 31, 1999 $4,416 12,657,884 $0.35 $0.33 $4,190 94.9% $1,460
- ----------------------------------------------------------------------------------------------------------------------
For the Year Ended
December 31, 1998 $16,477 12,709,116 $1.30 $1.21 $15,437 93.7% $1,234
For the Period Ended
December 31, 1997 $4,884 5,952,123 $0.82 $0.79 $4,690 96.0% $194
Financial Condition
Mortgage-Backed Securities
All of our mortgage-backed securities at September 30, 1999 were
adjustable-rate or fixed-rate mortgage-backed securities backed by single-family
mortgage loans. All of the mortgage assets underlying these mortgage-backed
securities were secured with a first lien position on the underlying
single-family properties. All our mortgage-backed securities were FHLMC, FNMA or
GNMA mortgage pass-through certificates or CMOs, which carry an implied "AAA"
rating. We mark-to-market all of our earning assets at liquidation value.
We accrete discount balances as an increase in interest income over the
life of discount mortgage-backed securities and we amortize premium balances as
a decrease in interest income over the life of premium mortgage-backed
securities. At September 30, 1999 and 1998, we had on our balance sheet a total
of $1.1 million and $972,000 respectively, of unamortized discount (which is the
difference between the remaining principal value and current historical
amortized cost of our mortgage-backed securities acquired at a price below
principal value) and a total of $24.1 million and $25.2 million, respectively,
of unamortized premium (which is the difference between the remaining principal
value and the current historical amortized cost of our mortgage-backed
securities acquired at a price above principal value).
We received mortgage principal repayments of $81.2 million for the
quarter ended September 30, 1999 and $121.3 million for the quarter ended
September 30, 1998. Given our current portfolio composition, if mortgage
principal prepayment rates were to increase over the life of our mortgage-backed
securities, all other factors being equal, our net interest income would
decrease during the life of these mortgage-backed securities as we would be
required to amortize our net premium balance into income over a shorter time
period. Similarly, if mortgage principal prepayment rates were to decrease over
the life of our mortgage-backed securities, all other factors being equal, our
net interest income would increase during the life of these mortgage-backed
securities as we would amortize our net premium balance over a longer time
period.
17
The table below summarizes our mortgage-backed securities at September
30, 1999 and 1998, June 30, 1999, March 31, 1999 and December 31, 1998, and
December 31, 1997.
Mortgage-Backed Securities
--------------------------
Estimated
Amortized Fair Weighted
Net Amortized Cost/Principal Estimated Value/Principal Average
Principal Value Premium Cost Value Fair Value Value Yield
--------------- ------- ---- ----- ---------- ----- -----
(dollars in thousands)
At September 30, 1999 $1,402,565 $22,981 $1,425,546 101.64% $1,401,770 99.94% 6.41%
At September 30, 1998 $1,461,056 $24,244 $1,485,300 101.66% $1,483,195 101.52% 6.49%
At June 30, 1999 $1,468,547 $24,985 $1,493,532 101.70% $1,474,104 100.38% 6.21%
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 December 31, 1997 $1,138,365 $21,390 $1,159,755 101.88% $1,161,779 102.06% 6.57%
The tables below set forth certain characteristics of our
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 Principal Value
Weighted Average Weighted at Period End
Average Weighted Weighted Term to Weighted Average as % of Total
Principal Coupon Average Average Net Next Average Asset Mortgage-Backed
Value Rate Index Level Margin Adjustment Lifetime Cap Yield Securities
----- ---- ----------- ------ ---------- ------------ ----- ----------
(dollars in thousands)
At September 30, 1999 $889,293 6.76% 5.13% 1.63% 9 months 10.82% 6.14% 63.40%
At September 30, 1998 $1,050,177 6.78% 5.20% 1.68% 13 months 10.42% 6.51% 71.88%
At June 30, 1999 $941,559 6.67% 5.18% 1.71% 11 months 11.00% 5.84% 64.12%
At March 31, 1999 $1,036,947 6.63% 4.97% 1.66% 11 months 11.01% 5364% 67.88%
- --------------------------------------------------------------------------------------------------------------------------
At December 31, 1998 $1,030,654 6.84% 5.18% 1.66% 12 months 10.63% 6.42% 68.60%
At December 31, 1997 $994,653 7.13% 5.52% 1.61% 22 months 10.78% 6.50% 87.38%
Fixed-Rate Mortgage-Backed Security Characteristics
---------------------------------------------------
Principal Value
Weighted Weighted as % of Total
Average Average Mortgage-Backed
Principal Value Coupon Rate Asset Yield Securities
--------------- ----------- ----------- ----------
(dollars in thousands)
At September 30, 1999 $513,272 6.58% 6.91% 36.60%
At September 30, 1998 $410,879 6.69% 6.47% 28.12%
At June 30, 1999 $526,988 6.58% 6.88% 35.88%
At March 31, 1999 $401,002 6.82% 6.65% 26.02%
- --------------------------------------------------------------------------------------------
At December 31, 1998 $471,760 6.55% 6.47% 31.40%
At December 31, 1997 $143,712 7.50% 7.08% 12.62%
18
At September 30, 1999 and December 31, 1998 we 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. At September 30,
1998 we held Mortgage-Backed Securities with coupons linked to one-year and
three-year Treasury Indices, one-month LIBOR and the six-month CD rate.
Adjustable-Rate Mortgage-Backed Securities by Index
September 30, 1999
3-Year
One-Month Six-Month 1-Year Treasury 5-Year
LIBOR CD Rate Treasury Index Index Treasury Index
----- ------- -------------- ----- --------------
Weighted Average Adjustment Frequency 1 mo. 6 mo. 12 mo. 36 mo. 60 mo.
Weighted Average Term to Next Adjustment 1 mo. 3 mo. 17 mo. 16 mo. 12 mo.
Weighted Average Annual Period Cap None 1.00% 1.60% 1.78% 1.34%
Weighted Average Lifetime Cap at
September 30, 1999 9.14% 11.35% 11.71% 13.17% 11.64%
Mortgage Principal Value as Percentage of
Mortgage-Backed Securities at
September 30, 1999 28.94% 2.32% 25.53% 5.85% 0.76%
Adjustable-Rate Mortgage-Backed Securities by Index
December 31, 1998
1-Year 3-Year
One-Month Six-Month Treasury Treasury 5-Year
LIBOR CD Rate Index Index Treasury Index
----- ------- ----- ----- --------------
Weighted Average Adjustment Frequency 1 mo. 6 mo. 12 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%
Adjustable-Rate Mortgage-Backed Securities by Index
September 30, 1998
3-Year
One-Month Six-Month 1-Year Treasury
LIBOR CD Rate Treasury Index Index
----- ------- -------------- -----
Weighted Average Adjustment Frequency 1 mo. 6 mo. 12 mo. 36 mo.
Weighted Average Term to Next Adjustment 1 mo. 3 mo. 14 mo. 9 mo.
Weighted Average Annual Period Cap None 1.00% 2.00% 2.00%
Weighted Average Lifetime Cap at
September 30, 1998 9.14% 10.95% 11.82% 14.16%
Mortgage Principal Value as Percentage of
Mortgage-Backed Securities at
September 30, 1998 36.55% 4.44% 30.88% 0.01%
Interest Rate Agreements
Interest rate agreements are assets that are carried on a balance sheet
at estimated liquidation value. We have not entered into any interest rate
agreements since our inception.
19
Borrowings
To date, our debt has consisted entirely of borrowings collateralized
by a pledge of our mortgage-backed securities. These borrowings appear on our
balance sheet as repurchase agreements. At September 30, 1999, we had
established uncommitted borrowing facilities in this market with twenty-three
lenders in amounts, which we believe, are in excess of our needs. All of our
mortgage-backed securities are currently accepted as collateral for these
borrowings. However, we limit our borrowings, and thus our potential asset
growth, in order to maintain unused borrowing capacity and thus increase the
liquidity and strength of our balance sheet.
For the quarters ended September 30, 1999 and 1998, the term to
maturity of our borrowings ranged from one day to one year, with a weighted
average original term to maturity of 63 days for the quarter ended September 30,
1999 and 87 days for the quarter ended September 30, 1998. At September 30,
1999, the weighted average cost of funds for all of our borrowings was 5.31% and
the weighted average term to next rate adjustment was 24 days. At September 30,
1998, the weighted average cost of funds for all of our borrowings was 5.59% and
the weighted average term to next rate adjustment was 29 days.
Liquidity
Liquidity, which is our ability to turn non-cash assets into cash,
allows us to purchase additional mortgage-backed securities and to pledge
additional assets to secure existing borrowings should the value of our pledged
assets decline. Potential immediate sources of liquidity for us include cash
balances and unused borrowing capacity. Unused borrowing capacity will vary over
time as the market value of our mortgage-backed securities varies. Our balance
sheet also generates liquidity on an on-going basis through mortgage principal
repayments and net earnings held prior to payment as dividends. Should our needs
ever exceed these on-going sources of liquidity plus the immediate sources of
liquidity discussed above, we believe that our mortgage-backed securities could
in most circumstances be sold to raise cash. The maintenance of liquidity is one
of the goals of our capital investment policy. Under this policy, we limit asset
growth in order to preserve unused borrowing capacity for liquidity management
purposes.
Stockholders' Equity
We use "available-for-sale" treatment for our mortgage-backed
securities; we carry these assets on our balance sheet at estimated market value
rather than historical amortized cost. Based upon this "available-for-sale"
treatment, our equity base at September 30, 1999 was $113.0 million, or $8.63
per share. If we had used historical amortized cost accounting, our equity base
at September 30, 1999 would have been $136.9 million, or $10.44 per share. Our
equity base at September 30, 1998 was $131.1 million, or $10.28 per share. If we
had used historical amortized cost accounting, our equity base at September 30,
1998 would have been $131.0 million, or $10.30 per share. During the quarter
ended September 30, 1999, the Company raised additional capital in the amount of
$3.9 million through its direct purchase program.
With our "available-for-sale" accounting treatment, unrealized
fluctuations in market values of assets do not impact our GAAP or taxable income
but rather are reflected on our balance sheet by changing the carrying value of
the asset and stockholders' equity under "Accumulated Other Comprehensive Income
(Loss)." By accounting for our assets in this manner, we hope to provide useful
information to stockholders and creditors and to preserve flexibility to sell
assets in the future without having to change accounting methods.
As a result of this mark-to-market accounting treatment, our book value
and book value per share are likely to fluctuate far more than if we used
historical amortized cost accounting. As a result, comparisons with companies
that use historical cost accounting for some or all of their balance sheet may
not be meaningful.
20
The table below shows unrealized gains and losses on the
mortgage-backed securities in our portfolio.
Unrealized Gains and Losses
---------------------------
(dollars in thousands)
At September 30, At September 30, At June 30, At March 31, At December 31,
1999 1998 1999 1999 1998
---------------------------------------------------------------------------------------
Unrealized Gain $ 998 $7,060 $ 1,744 $2,801 $3,302
Unrealized Loss (24,773) (9,164) (21,172) (8,784) (9,706)
---------------------------------------------------------------------------------------
Net Unrealized Loss ($23,775) ($2,104) ($19,428) ($5,983) ($6,404)
=======================================================================================
Net Unrealized Loss as % of
Mortgage-Backed Securities
Principal Value (1.70%) (0.14%) (1.32%) (0.39%) (0.43%)
Net Unrealized Loss as % of
Mortgage-Backed Securities
Amortized Cost (1.68%) (0.14%) (1.30%) (0.39%) (0.42%)
Unrealized changes in the estimated net market value of mortgage-backed
securities have one direct effect on our potential earnings and dividends:
positive market-to-market changes increase our equity base and allow us to
increase our borrowing capacity while negative changes tend to limit borrowing
capacity under our capital investment policy. A very large negative change in
the net market value of our mortgage-backed securities might impair our
liquidity position, requiring us to sell assets with the likely result of
realized losses upon sale. "Unrealized Losses on Available for Sale Securities"
was $23.8 million, or 1.68% of the amortized cost of our mortgage-backed
securities at September 30, 1999. "Unrealized Losses on Available for Sale
Securities" was $2.1 million or 0.14% of the amortized cost of our
mortgage-backed securities at September 30, 1998.
The table below shows our equity capital base as reported and on a
historical amortized cost basis at September 30, 1999 and 1998, June 30, 1999,
March 31,1999, December 31, 1998 and December 31, 1997. Issuances of common
stock, the level of GAAP earnings as compared to dividends declared, and other
factors influence our 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.
Stockholders' Equity
Historical
Historical Net Unrealized GAAP Reported Amortized Cost GAAP Reported
Amortized Cost Gains on Assets Equity Base Equity Per Equity (Book
Equity Base Available for Sale (Book Value) Share Value) Per Share
----------- ------------------ ------------ ----- ----------------
(dollars in thousands, except per share data)
At September 30, 1999 $136,850 ($23,776) $113,074 $10.44 $8.63
At September 30, 1998 $132,446 ($2,105) $130,342 $10.47 $10.30
At June 30, 1999 $133,020 ($19,428) $113,592 $10.48 $8.95
At March 31, 1999 $133,055 ($1,910) $131,145 $10.43 $10.28
- --------------------------------------------------------------------------------------------------------------
At December 31, 1998 $132,275 ($6,404) $125,871 $10.46 $9.95
At December 31, 1997 $133,062 $2,024 $135,086 $10.47 $10.62
Leverage
Our debt-to-GAAP reported equity ratio at September 30, 1999 and, 1998
was 11.3:1 and 11.1:1, respectively. We generally expect to maintain a ratio of
debt-to-equity of between 8:1 and 12:1, although the ratio may vary from this
range from time to time based upon various factors, including our management's
opinion of the level of risk of our assets and liabilities, our liquidity
position, our level of unused borrowing capacity and over-collateralization
levels required by lenders when we pledge assets to secure borrowings.
Our target debt-to-GAAP reported equity ratio is determined under our
capital investment policy. Should our actual
21
debt-to-equity ratio increase above the target level due to asset
acquisition or market value fluctuations in assets, we will cease to acquire new
assets. Our management will, at that time, present a plan to our Board of
Directors to bring us back to our target debt-to-equity ratio; in many
circumstances, this would be accomplished in time by the monthly reduction of
the balance of our mortgage-backed securities through principal repayments.
Asset/Liability Management and Effect of Changes in Interest Rates
We continually review our asset/liability management strategy with
respect to interest rate risk, mortgage prepayment risk, credit risk and the
related issues of capital adequacy and liquidity. We seek attractive
risk-adjusted stockholder returns while maintaining a strong balance sheet.
We seek to manage the extent to which our net income changes as a
function of changes in interest rates by matching adjustable-rate assets with
variable-rate borrowings. In addition, although we have not done so to date, we
may seek to mitigate the potential impact on net income of periodic and lifetime
coupon adjustment restrictions in our portfolio of 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. We will seek to mitigate the effect of changes in the mortgage
principal repayment rate by balancing assets we purchase at a premium with
assets we purchase at a discount. To date, the aggregate premium exceeds the
aggregate discount on our mortgage-backed securities. As a result, prepayments,
which result in the expensing of unamortized premium, will reduce our net income
compared to what net income would be absent such prepayments.
Status of Year 2000 Compliance
We have made an ongoing effort to protect against the year 2000 risk.
The year 2000 risk arises because certain computer programs have been written
using two digits rather than four to define the applicable years. Consequently,
date-sensitive software may recognize a date using "00" as the year 1900 rather
than the year 2000. This could result in system failures or miscalculations
causing disruptions of operations.
We have engaged a consultant to assist us in protecting against the
year 2000 risk. With the assistance of the consultant, we have reviewed the
ability of our computers and computer programs to recognize properly and handle
dates in the year 2000 and have completed upgrades, as appropriate. In addition,
we have reviewed all the date fields embedded in our internally developed
spreadsheets, databases and other programs and have determined that these
programs are using four-digit years in reference to dates. Therefore, we believe
that all of our equipment and internal systems are year 2000 compliant. To date,
we have incurred minimal costs to become year 2000 compliant.
We believe that most of our exposure to year 2000 issues involves the
readiness of third parties. Each third party is subject to the year 2000 risk.
We have surveyed pertinent third parties for their compliance. As a result of
communications with these third parties, we believe that they are spending the
appropriate and necessary resources to try to identify year 2000 issues and to
resolve them or mitigate their impact 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 September 30, 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 99.6% and 96.2% 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 quarters ended September 30, 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
September 30, 1999 and 1998, the Company believes that it qualified as a REIT
under the provisions of the Code.
22
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 September 30, 1999 and 1998, the Company calculates that it
is in compliance with this requirement.
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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
portfolio value should interest rates go up or down 300 basis points, assuming
the yield curves of the rate shocks will be parallel to each other and the
current yield curve. All changes in income and value are measured as percentage
changes from the projected net interest income and portfolio value at the base
interest rate scenario. The base interest rate scenario assumes interest rates
at September 30, 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 Portfolio Value
- -----------------------------------------------------------------------------------------------------------
- -200 Basis Points 41% 2%
- -100 Basis Points 10% 1%
- -50 Basis Points 3% 0%
Base Interest Rate
+50 Basis Points (23%) (2%)
+100 Basis Points (35%) (3%)
+200 Basis Points (65%) (5%)
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
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 September 30, 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 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.
Mortgage-Backed 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. 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.
24
More than 1
Within Year to 3 3 Years and
3 Months 4-12 Months Years Over Total
-------------------------------------------------------------------------------
Rate Sensitive Assets:
Mortgage-Backed Securities $ 444,467 $ 259,658 $112,536 $585,904 $1,402,565
Rate Sensitive Liabilities:
Repurchase Agreements 1,267,375 16,387 $1,283,762
-------------------------------------------------------------------------------
Interest rate sensitivity gap ($ 22,908) $ 243,271 $112,536 $585,904 $ 118,803
-------------------------------------------------------------------------------
Cumulative rate sensitivity gap ($ 822,908) ($579,637) ($467,101) $118,803
===============================================================================
Cumulative interest rate
sensitivity gap as a percentage of
total rate-sensitive assets (59%) (41%) (33%) 8%
The Company's analysis of risks is based on management's experience, estimates,
models and assumptions. These analysis rely on models which utilize estimates of
fair value and interest rate sensitivity. Actual economic conditions or
implementation of investment decisions by Management may produce results that
differ significantly form the estimates and assumptions used in the company's
models and the projected results shown in the above tables and in this report.
These analysis contain certain "forward-looking statements" and are subject to
the Safe Harbor statement contained in Private Securities Litigation Reform Act
of 1995.
25
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 1 - Financial Data Schedule
(b) Reports
None
26
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: November 12, 1999 By:/s/ Michael A.J. Farrell
-------------------------
Michael A.J. Farrell
Chairman of the Board and Chief Executive Officer
(authorized officer of registrant)
Dated: November 12, 1999 By:/s/ Kathryn F. Fagan
---------------------
Kathryn F. Fagan
Chief Financial Officer and Treasurer
(principal accounting officer)